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can see, two of the three classes of resources (organizational and human) are directly
tied to the human resource management function. As Chapter 1 pointed out, the role of
human resource management is to ensure that a company’s human resources provide a
competitive advantage. Chapter 1 also pointed out some of the major competitive
challenges that companies face today. These challenges require companies to take a
proactive, strategic approach in the marketplace.

To be maximally effective, the HRM function must be integrally involved in the
company’s strategic management process.2 This means that human resource managers
should (1) have input into the strategic plan, both in terms of people-related issues and in
terms of the ability of the human resource pool to implement particular strategic
alternatives; (2) have specific knowledge of the organization’s strategic goals; (3) know
what types of employee skills, behaviors, and attitudes are needed to support the strategic
plan; and (4) develop programs to ensure that employees have those skills, behaviors, and
attitudes.

We begin this chapter by discussing the concepts of business models and strategy
and by depicting the strategic management process. Then, we discuss the levels of
integration between the HRM function and the strategic management process in strategy
formulation. Next, we explore the role of culture and talent as critical levers in the strategy
implementation process. Then we review some of the more common strategic models
and, within the context of these models, discuss the various types of employee skills,
behaviors, and attitudes, and the ways HRM practices aid in implementing the strategic
plan. Finally, we discuss the role of HR in creating competitive advantage.

What Is a Business Model?
A business model is a story of how the firm will create value for customers and, more
important, how it will do so profitably. We often hear or read of companies that have
“transformed their business model” in one way or another, but what that means is not
always clear. To understand this, we need to grasp a few basic accounting concepts.

First, fixed costs are generally considered the costs that are incurred regardless of the
number of units produced. For instance, if you are producing widgets in a factory, you
have the rent you pay for the factory, depreciation of the machines, the utilities, the
property taxes, and so on. In addition, you generally have a set number of employees who
work a set number of hours with a specified level of benefits, and although you might be
able to vary these over time, on a regular basis you pay the same total labor costs whether
your factory runs at 70% capacity or 95% capacity.

Second, you have a number of variable costs, which are those costs that vary directly
with the units produced. For instance, all of the materials that go into the widget might
cost a total of $10, which means that you have to charge at least $10 per widget, or you
cannot even cover the variable costs of production.

Third is the concept of “contribution margins,” or margins. Margins are the difference
between what you charge for your product and the variable costs of that product. They are

Source: Video produced for the Center for Executive Succession in the Darla Moore School of Business
at the University of South Carolina by Coal Powered Filmworks

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called contribution margins because they are what contributes to your ability to cover your
fixed costs. So, for instance, if you charged $15 for each widget, your contribution margin
would be $5 ($15 price – $10 variable cost).

Fourth, the gross margin is the total amount of margin you made and is calculated as
the number of units sold times the contribution margin. If you sold 1,000,000 units, your
gross margin would then be $5,000,000. Did you make a profit? That depends. Profit refers
to what is left after you have paid your variable costs and your fixed costs. If your gross
margin was $5,000,000, and your fixed costs were $6,000,000, then you lost $1,000,000.

GM’S ATTEMPT TO SURVIVE
Let’s look at how a business model plays out with the recent challenges faced by General
Motors (GM). Critics of GM talk about the fact that GM has higher labor costs than its
foreign competitors. This is true, but misleading. GM’s average hourly wage for its existing
workforce is reasonably competitive. However, the two aspects that make GM
uncompetitive are its benefit costs (in particular, health care) and, most important, the cost
of its legacy workforce.

A legacy workforce describes the former workers (i.e., those no longer working for the
company) to whom the firm still owes financial obligations. GM and the United
Automobile Workers (UAW) union have negotiated contracts over the years that provide
substantial retirement benefits for former GM workers. In particular, retired GM workers
have defined benefit plans that guarantee a certain percentage of their final (preretirement)
salary as a pension payment as long as they live; in addition, the company pays for their
health insurance. The contract specifies that workers are entitled to retire at full pension
after 30 years of service.

This might have seemed sustainable when the projections were that GM would
continue growing its sales and margins. However, since the 1970s, foreign competitors
have been eating away at GM’s market share to the extent that GM’s former 50% of the
market has shrunk to closer to 20%. Since the 2008 economic crisis, the market itself has
been shrinking, leaving GM with a decreasing percentage of a decreasing market. For
instance, in December of 2005, GM sold 26% of the cars in the global market, but by 2015
that market share had shrunk to 11.2%.3 Thus, in addition to the legacy workforce, GM had
a significant number of plants with thousands of employees that were completely
unnecessary, given the volume of cars GM can produce and sell.4

If you look at Figure 2.1, you’ll see that the solid lines represent the old GM business
model, which was based on projections that GM would be able to sell 4 million units at a
reasonably high margin, and thus completely cover its fixed costs to make a strong profit.
However, the reality was that its products didn’t sell at the higher prices, so to try to sell 4
million vehicles, GM offered discounts, which cut into its margins. When GM ended up
selling only 3.5 million vehicles, and those were sold at a lower margin, the company could
not cover its fixed costs, resulting in a $9 billion loss in 2008 (this is illustrated by the
dotted blue line in the figure). So, when GM refers to the “redesigned business model,”
what it is referring to is a significant reduction in fixed costs (through closing plants and
cutting workers) to get the fixed-cost base low enough (the dotted brown line) to remain
profitable while selling fewer cars at lower margins (again, the dotted blue line).

Figure 2.1
An Illustration of a Business Model for GM

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One can easily see how, given the large component that labor costs are to most
companies, reference to business models almost inevitably leads to discussions of labor
costs. These can be the high cost associated with current unionized employees in
developed countries within North America or Europe or, in some cases, the high costs
associated with a legacy workforce. For instance, the Big Three automakers have huge
numbers of retired or laid-off workers for whom they still have the liability of paying
pensions and health care benefits. This is a significant component of their fixed-cost base,
which makes it difficult for them to compete with other automakers that either have fewer
retirees to cover or have no comparable costs because their home governments provide
pensions and health care. In fact, this changing business model at GM has driven it to
locate more manufacturing outside of the United States.

What Is Strategic Management?
LO 2-1
Describe the differences between strategy formulation and
strategy implementation.

Many authors have noted that in today’s competitive market, organizations must engage
in strategic planning to survive and prosper. Strategy comes from the Greek word
strategos, which has its roots in military language. It refers to a general’s grand design
behind a war or battle. In fact, Webster’s New American Dictionary defines strategy as the
“skillful employment and coordination of tactics” and as “artful planning and
management.”

Strategic management is a process, an approach to addressing the competitive
challenges an organization faces. It can be thought of as managing the “pattern or plan
that integrates an organization’s major goals, policies, and action sequences into a
cohesive whole.”5 These strategies can be either the generic approach to competing or the
specific adjustments and actions taken to deal with a particular situation.

First, business organizations engage in generic strategies that often fit into some
strategic type. One example is “cost, differentiation, or focus.”6 Another is “defender,
analyzer, prospector, or reactor.”7 Different organizations within the same industry often
have different generic strategies. These generic strategy types describe the consistent way
the company attempts to position itself relative to competitors.

However, a generic strategy is only a small part of strategic management.
The second aspect of strategic management is the process of developing strategies for
achieving the company’s goals in light of its current environment. Thus, business
organizations engage in generic strategies, but they also make choices about such things
as how to scare off competitors, how to keep competitors weaker, how to react to and
influence pending legislation, how to deal with various stakeholders and special interest
groups, how to lower production costs, how to raise revenues, what technology to
implement, and how many and what types of people to employ. Each of these decisions
may present competitive challenges that have to be considered.

Strategic management is more than a collection of strategic types. It is a process for
analyzing a company’s competitive situation, developing the company’s strategic goals,
and devising a plan of action and allocation of resources (human, organizational, and
physical) that will increase the likelihood of achieving those goals. This kind of strategic
approach should be emphasized in human resource management. HR managers should
be trained to identify the competitive issues the company faces with regard to human
resources and think strategically about how to respond.

Strategic human resource management (SHRM) can be thought of as “the pattern of
planned human resource deployments and activities intended to enable an organization to
achieve its goals.”8 For example, many firms have developed integrated manufacturing
systems such as advanced manufacturing technology, just-in-time inventory control, and
total quality management in an effort to increase their competitive position. However,
these systems must be run by people. SHRM in these cases entails assessing the
employee skills required to run these systems and engaging in HRM practices, such as
selection and training, that develop these skills in employees.9 To take a strategic
approach to HRM, we must first understand the role of HRM in the strategic management
process.

Strategic human resource management (SHRM)
A pattern of planned human resource deployments and activities intended to enable an
organization to achieve its goals.

COMPONENTS OF THE STRATEGIC MANAGEMENT PROCESS

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LO 2-2
List the components of the strategic management process.

The strategic management process has two distinct yet interdependent phases: strategy
formulation and strategy implementation. During strategy formulation, the strategic
planning groups decide on a strategic direction by defining the company’s mission and
goals, its external opportunities and threats, and its internal strengths and weaknesses.
They then generate various strategic alternatives and compare those alternatives’ ability to
achieve the company’s mission and goals. During strategy implementation, the
organization follows through on the chosen strategy. This consists of structuring the
organization, allocating resources, ensuring that the firm has skilled employees in place,
and developing reward systems that align employee behavior with the organization’s
strategic goals. Both of these strategic management phases must be performed
effectively. This process does not happen sequentially. As we will discuss later with regard
to emergent strategies, this process entails a constant cycling of information and decision
making. Figure 2.2 presents the strategic management process.

Strategy formulation
The process of deciding on a strategic direction by defining a company’s mission and
goals, its external opportunities and threats, and its internal strengths and weaknesses.

Strategy implementation
The process of devising structures and allocating resources to enact the strategy a
company has chosen.

In recent years organizations have recognized that the success of the strategic
management process depends largely on the extent to which the HRM function is
involved.10

LINKAGE BETWEEN HRM AND THE STRATEGIC MANAGEMENT
PROCESS
The strategic choice really consists of answering questions about competition—that is,
how the firm will compete to achieve its mission and goals. These decisions consist of
addressing the issues of where to compete, how to compete, and with what to
compete, which are described in Figure 2.3.

Figure 2.2
A Model of the Strategic Management Process

Figure 2.3
Strategy—Decisions about Competition

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Although these decisions are all important, strategic decision makers often pay less
attention to the “with what will we compete” issue, resulting in poor strategic decisions.
For example, PepsiCo in the 1980s acquired the fast-food chains of Kentucky Fried
Chicken, Taco Bell, and Pizza Hut (“where to compete” decisions) in an effort to increase
its customer base. However, it failed to adequately recognize the differences between its
existing workforce (mostly professionals) and that of the fast-food industry (lower-skilled
people and high schoolers) as well as its ability to manage such a workforce. This was
one reason that PepsiCo, in 1998, spun off the fast-food chains. In essence, it had made a
decision about where to compete without fully understanding what resources would be
needed to compete in that market.

Boeing illustrates how failing to address the “with what” issue resulted in problems in
its “how to compete” decisions. When the aerospace firm’s consumer products division
entered into a price war with Airbus Industrie, it was forced to move away from its
traditional customer service strategy toward emphasizing cost reduction.11 The strategy
was a success on the sales end as Boeing received large numbers of s for aircraft
from firms such as Delta, Continental, Southwest, and Singapore Airlines. However, it had
recently gone through a large workforce reduction (thus, it didn’t have enough people to fill
the s) and did not have the production technology to enable the necessary increase in
productivity. The result of this failure to address “with what will we compete” in making a
decision about how to compete resulted in the firm’s inability to meet delivery deadlines
and the ensuing penalties it had to pay to its customers. The end result is that after all the
travails, for the first time in the history of the industry, Airbus sold more planes than
Boeing in 2003. Luckily, Boeing was able to overcome this stumble, in large part because
of a number of stumbles on the part of its chief rival, Airbus. However, Boeing has faced
difficulties as its new Dreamliner was grounded because of fires starting in the wiring.

ROLE OF HRM IN STRATEGY FORMULATION
LO 2-3
Discuss the role of the HRM function in strategy formulation.

As the preceding examples illustrate, often the “with what will we compete” question
presents ideal avenues for HRM to influence the strategic management process. This
might be through either limiting strategic options or forcing thoughtfulness among the
executive team regarding how and at what cost the firm might gain or develop the human
resources (people) necessary for such a strategy to be successful. For example, HRM
executives at PepsiCo could have noted that the firm had no expertise in managing the
workforce of fast-food restaurants. The limiting role would have been for these
executives to argue against the acquisition because of this lack of resources.
Alternatively, they might have influenced the decision by educating top executives as to
the costs (of hiring, training, and so on) associated with gaining people who had the right
skills to manage such a workforce.

A firm’s strategic management decision-making process usually takes place at its top
levels, with a strategic planning group consisting of the chief executive officer, the chief
financial officer, the president, and various vice presidents. However, each component of
the process involves people-related business issues. Therefore, the HRM function needs to
be involved in each of those components. One recent study of 115 strategic business units
within Fortune 500 corporations found that 49 to 69% of the companies had some link
between HRM and the strategic planning process.12 However, the level of linkage varied,
and it is important to understand these different levels.

Four levels of integration seem to exist between the HRM function and the strategic
management function: administrative linkage, one-way linkage, two-way linkage, and
integrative linkage.13 These levels of linkage will be discussed in relation to the different
components of strategic management. The linkages are illustrated in Figure 2.4.

Figure 2.4
Linkages of Strategic Planning and HRM

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Administrative Linkage
LO 2-4
Describe the linkages between HRM and strategy formulation.

In administrative linkage (the lowest level of integration), the HRM function’s attention is
focused on day-to-day activities. The HRM executive has no time or opportunity to take a
strategic outlook toward HRM issues. The company’s strategic business planning function
exists without any input from the HRM department. Thus, in this level of integration, the
HRM department is completely divorced from any component of the strategic
management process in both strategy formulation and strategy implementation. The
department simply engages in administrative work unrelated to the company’s core
business needs.

One-Way Linkage
In one-way linkage, the firm’s strategic business planning function develops the strategic
plan and then informs the HRM function of the plan. Early in the history of SHRM, people
believed this level of integration constituted strategic HRM—that is, the role of the
HRM function is to design systems and/or programs that implement the
strategic plan. Although one-way linkage does recognize the importance of human
resources in implementing the strategic plan, it precludes the company from considering
human resource issues while formulating the strategic plan. This level of integration often
leads to strategic plans that the company cannot successfully implement.

Two-Way Linkage
Two-way linkage allows for consideration of human resource issues during the strategy
formulation process. This integration occurs in three sequential steps. First, the strategic
planning team informs the HRM function of the various strategies the company is
considering. Then HRM executives analyze the human resource implications of the
various strategies, presenting the results of this analysis to the strategic planning team.
Finally, after the strategic decision has been made, the strategic plan is passed on to the
HRM executive, who develops programs to implement it. The strategic planning function
and the HRM function are interdependent in two-way linkage.

Integrative Linkage
Integrative linkage is dynamic and multifaceted, based on continuing rather than
sequential interaction. In most cases the HRM executive is an integral member of the
senior management team. Rather than using an iterative process of information exchange,
companies with integrative linkage have their HRM functions built in to the strategy
formulation and implementation processes. It is this role that we will discuss throughout
the rest of this chapter.

Thus, in strategic HRM, the HRM function is involved in both strategy formulation and
strategy implementation. The HRM executive gives strategic planners information about
the company’s human resource capabilities, and these capabilities are usually a direct
function of the HRM practices.14 This information about human resource capabilities
helps top managers choose the best strategy because they can consider how well each
strategic alternative would be implemented. Once the strategic choice has been
determined, the role of HRM changes to the development and alignment of HRM practices
that will give the company employees having the necessary skills to implement the
strategy.15 In addition, HRM practices must be designed to elicit actions from employees
in the company.16 One recent study found that strategic HR functions were positively

SOURCE: Adapted from K. Golden and V. Ramanujam, “Between a Dream and a Nightmare: On the
Integration of the Human Resource Function and the Strategic Business Planning Process,” Human
Resource Management 24 (1985), pp. 429–51.

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related to firm performance, but only when those firms had structures and systems in
place to leverage the input of their employees.17 In the next two sections of this chapter,
we show how HRM can provide a competitive advantage in the strategic management
process.

Strategy Formulation
Five major components of the strategic management process are relevant to strategy
formulation.18 These components are depicted in Figure 2.5. The first component is the
organization’s mission. The mission is a statement of the organization’s reason for being;
it usually specifies the customers served, the needs satisfied and/or the values received by
the customers, and the technology used. The mission statement is often accompanied by
a statement of a company’s vision and/or values. For example, Table 2.1 illustrates the
mission and values of Merck & Co., Inc.

Figure 2.5
Strategy Formulation

SOURCE: Adapted from K. Golden and V. Ramanujam, “Between a Dream and a Nightmare,” Human
Resource Management 24