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Competitive Strategy Chapter 8

Industry Evolution

Industry structures change, often in fundamental ways. This Industry evolution takes on critical importance for the formulation of strategy. It can increase or decrease the attractiveness of an industry as an investment. Understanding this process and being able to predict change is important because the cost of reacting strategically usually increases as the need for change becomes more obvious.

Basic Concepts in Industry Evolution – Industry changes will carry strategic significance if they promise to affect the underlying sources of the five competitive forces. The following needs to be asked: Are there any changes occurring in the industry that will affect each element of structure? If this question is asked in a disciplined way for each competitive force and the economic causes underlying it, a profile of the significant issues in the evolution of an industry will result.

Product Life Cycle – This is the grandfather of concepts for predicting the probable course of the industry’s evolution. The hypothesis is that an industry passes through a number of phases or stages: Introduction, growth, maturity, and decline which are defined by inflection points in the rate of growth of industry sales. As the industry goes through its life cycle, the nature of competition will shift. Some criticisms are:

• Duration of the stages varies widely

• Industry growth does not always go through the S pattern

• Companies can affect the shape of the growth curve

• The nature of competition associated with each stage of the life cycle is different for different industries.

A framework for forecasting evolution

Every industry begins with an initial structure – the entry barriers, buyer, and supplier power, and so on which exist when the industry comes into existence. The evolutionary process works to push the industry towards its potential structure. Important in this process are the investment decisions made by both the existing firms and the new entrants. The luck, skills, resources, and orientation of firms in the industry can shape the evolutionary path the industry will actually take.

Evolutionary Process

1. Long run changes in growth – this is a key variable in determining the intensity of rivalry. There are many reasons why long run growth changes:

a. Demographics

b. Trends in needs

c. Change in relative position of substitutes

d. Change in the position of complementary products

e. Penetration of the customer group

f. Products offered by the industry

2. Changes in buyer segments served – additional segmentation of existing buyer segments can take place by creating different products. The requirements for serving these new buyers can have a fundamental impact on industry structure.

3. Buyer’s learning – products have a tendency to become more like commodities over time as customers become more sophisticated and purchasing tends to be based on better information. There is a natural force reducing differentiation.

4. Reduction of Uncertainty – Most new industries are initially characterized by a high level of uncertainty. This often leads firms to a high degree of experimentation. Over time however, there is a continual process by which uncertainty is resolved. This reduction in uncertainty also attracts new entrants.

5. Diffusion of proprietary knowledge – Over time, a technology becomes more established and knowledge about it becomes more widespread. In the absence of patent protection, proprietary advantage will tend to erode. This rate of diffusion depends on the industry

6. Accumulation of experience – The significance of the learning curve depends upon whether firms can establish significant and sustainable leads.

7. Expansion or contraction in scale – Has a number of implications. First, it tends to widen the set of available strategies. It also allows vertical integration to become more feasible. Finally, there may be a tendancy for large industry scale to attract new entrants.

8. Changes in input and currency costs – the important classes of input costs subject to change are:

a. Wage rates

b. Material costs

c. Cost of capital

d. Communication costs

e. Transportation costs

f. Exchange rate fluctuations

9. Product innovation – this can widen the market and promote industry growth and it can enhance product differentiation

10. Marketing innovation – can influence industry structure directly through increasing demand.

11. Process innovation – Innovations can make the process more or less capital intensive, increase or decrease economies of scale, change the proportion of fixed costs, increase or decrease vertical integration, and affect the process of accumulating experience.

12. Structural change in adjacent industries – Since the structure of suppliers’ and customers’ industries affects their bargaining power with an industry, changes in their structure have potentially important consequences for industry evolution.

13. Government policy change – The most direct through full blown regulation of such key variables as entry into the industry, competitive practices, or profitability.

14. Entries and exits – The entry or exit by an established firm often leads to a structural change in the industry.

Key Relationships in Industry Evolution –How do industries change? They do not change in a piecemeal fashion, because an industry is an interrelated system where one change sets of a chain reaction.

The industry will consolidate? – often accepted as fact, but not true! Key factors:

• If mobility barriers are high or if they increase, concentration will almost always increase.

• No concentration takes place if mobility barriers are low or falling.

• Exit barriers deter consolidation.

• Long run profit potential depends on future structure.

Changes in industry boundaries – structural change is often accompanied by changes in industry boundaries.

Firms can influence Industry Structure

Competitive Strategy – Chapter 6 – Strategy towards Buyers and Suppliers

Buyer Selection – the bargaining power of buyers is one of the key competitive forces determining the potential profitability on an industry. It is rare that a buyer group is homogeneous from a structural standpoint. Buyers of consumer goods often vary a great deal, and differ in their purchasing needs. Because of this buyers have different structural buying power, growth potential, and the cost in serving them. As a result, buyer selection, the choice of targeting buyers, becomes an important strategic variable

Four broad criteria that determine the quality of buyers

1. Purchasing needs versus company capabilities – such a match will allow the firm to achieve the highest level of product differentiation vis-à-vis its buyers vs competitors.

2. Growth potential – determined by three conditions in industrial business

• Industry growth rate

• Primary market growth rate

• Change in the market share in the industry

Growth potential of a household buyer is determined by –

• Demographics

• Quality of purchases

3. Structural position

• Intrinsic buying power – the leverage buyers can potentially exert over sellers.

i. Buyers without much intrinsic bargaining power are those that purchase small quantities relative to sales, lack qualified alternative sources, face high costs, and lack ability to backward integrate.

ii. Buyers not sensitive to price are those who find the product is a small part of the product cost, the penalty for product failure is high, effectiveness of the product can yield major improvement, the buyer competes with a high quality strategy to which the purchased product contributes, the buyer seeks a custom design, the buyer is very profitable, the buyer is poorly informed, and the motivation of the decision maker is not narrowly defined.

• The propensity to exercise this bargaining power

4. Cost of Servicing – varies for one of the following reasons

• Order size

• Selling direct vs. distributors

• Required lead times

• Steadiness of order flow for purposes of planning

• Shipping cost

• Selling cost

• Need for customization or modification

The basic strategic principle in buyer selection is to seek out and attempt to sell to the most favorable buyers available. The most favorable buyers though, will in part depend on the position of the individual firm. The firm with a low cost position can sell to powerful, price sensitive buyers and still be successful. The firm without a cost advantage or differentiation must be selective about its buyers if it desires an above average return.

Good buyers can be created through strategy. Characteristics that make buyers favorable can be influenced by the firm, such as building switching costs and shifting the decision maker.

The basis of buyer’s choice can be broadened. Ideally, the basis can be shifted away from purchase price and in directions where the firm has some distinctive abilities or where switching costs can be created. Two ways to broaden buyer’s choice are:

1. Increase the value added

• Providing responsive customer service

• Providing engineering assistance

• Providing credit or rapid delivery

• Creating new features of the product

2. Redefine the way the buyer thinks about the project

• Resale value

• Maintenance cost / downtime

• Fuel cost

• Revenue generation

• Cost of installation

High cost buyers can be eliminated, the quality of buyers changes over time, and switching costs should be considered in making strategic moves.

Purchasing strategy – key issues are

• Stability and competitiveness of the supplier pool

• Optimal degree of vertical integration

• Allocation of purchases among qualified buyers

• Creation of maximum leverage with chosen suppliers

In purchasing, the goal is to find mechanisms to offset or surmount the sources of supplier’s power. Do this by:

• Spreading purchases

• Avoiding switching costs

• Help qualify Alternate sources

• Promote standardization

• Create a threat of backward integration

• Use a tapered integration

Chapter 5 – Competitive Moves

A central characteristic of competition is that firms are inter-dependent. The outcome of a move by one firm depends to some extent on the reactions of its rivals. Bad or irrational moves can often make good strategic moves unsuccessful.

Firms face a dilemma – Pursue the interest of the industry as a whole or behave in its narrow self interests and risk touching of retaliation.

Industry Instability – the first question a firm has to ask when considering an offensive or defensive move is how stable is the industry. Each industry is unique in how careful you must be.

• If rivalry is high, then generally moves are very risky.

• A history of competing or continuity of interaction promotes stability.

• Multiple bargaining areas, more than one competitive arena, promote stability.

Structure sets the basic parameters within which competitive moves are made. It influences the position of the competitors, the pressures on them, and the degree to which their interests are likely to conflict.

Competitive Moves

The goal of the firm is to avoid destabilizing and costly warfare while still outperforming other firms.

One approach is to use superior resources to force an outcome. Often called the brute force approach, it involves overcoming and outlasting retaliation.

Cooperative or non-threatening moves – can be made based off of an analysis of the competitors goals and assumptions and does not threaten or reduce the performance of the competitor. Three categories of moves –

1. Improve both the firm’s and competitor’s positions even if the competitor does not match. Involves the least risk.

2. Improves both the firm’s and the competitor’s position only if a certain number match them. More common, has two steps.

• Assessing the impact of the move on all competitors

• Assessing the pressures on all to forgo the benefits by breaking rank

3. Improves the firm’s position because competitors will not match them. This is because either competitors do not notice the moves, will not be concerned because of self-perceptions or assumptions, or their performance is impaired little if at all.

Executing moves so as to improve everyone’s performance requires that competitors understand that the move is not threatening. Active market signaling through announcements, public commentary is one way to indicate benign intentions.

Threatening Moves – key to success is predicting and influencing retaliation

Key questions are:

• How likely is retaliation?

• How soon will they retaliate?

• How effective will their retaliation be?

• How tough will retaliation be?

• How can retaliation be influenced?

Lags in retaliation – Other things being equal, the firm will want to make the move that gives it the most time before its competitors can effectively retaliate. Stem from four sources:

1. perceptual lags (the move was kept secret or low profile)

2. lags in mounting a retaliatory strategy (years to match product)

3. inability to pinpoint retaliation, raises short-run costs

4. lags caused by conflicting goals or mixed motives

Defensive Moves – the most effective defensive move is to prevent the battle altogether.

• Discipline as a form of defense – competitor’s moves are swiftly retaliated against

• Denying a base – no place for the competitor to meet its goals. Worth paying a substantial short-run price if market share is threatened.

Commitment – the most important concept in planning and executing defensive/offensive competitive moves. It can guarantee the likelihood, speed, and vigor of retaliation to offensive moves. Communicating commitment reduces uncertainty. Three types:

1. a firm is unequivocally sticking with a move

2. a firm will retaliate if a competitor makes a certain move

3. a firm will take no action or forgo action

Communicating commitment – the building blocks are:

• Assets, resources, and other mechanisms to carry out the commitment quickly

• A clear intention to carry out the commitment

• Inability to back down or perceived resolve not to back down

• Ability to detect compliance to the terms referred to (smell cheating).

Trust as a commitment

Focal Points – a resting place on which the competitive process can converge its expectations. The power of focal points resides in the need and desire of competitors to mutually achieve some stable outcome to avoid difficult and unsettling moves. Three implications:

1. Firms should seek to identify a desirable focal point as early as possible

2. industry prices or other decision variable may be simplified so that a focal point can be identified

3. it is in the firms best interest to set up the game to make the focal point that is best for it to seem to emerge.

Information should be selectively disclosed

Chapter 4 – Market Signals

Any action that provides a direct or indirect indication of a competitors intentions, motives, goals, or internal situation. Some signals are bluffs, some are warnings, and some are earnest commitments to action.

Types of Market Signals

1. Prior Announcements

A formal communication that a competitor will or will not do something. This can be an attempt to stake out a commitment (get buyers ready, dissuade others from adding capacity), can be a threat of action, test of competitor sentiment, communicates pleasure or displeasure, conciliatory step to minimize provocation, avoid costly simultaneous moves (prevent overcapacity), and communication with the financial community. Announcements can be Bluffs! Although often carried in the media, press releases, or speeches, they do not have to be carried out.

2. Announcement of Results or actions after the fact

3. Public Discussions of the Industry by competitors

4. Competitor discussions and explanations of their own moves

5. Competitors’ tactics relative to what they could have done

6. Manner in which Strategic changes are initially implemented

7. Divergence from past goals

8. Divergence from Industry Precedent

9. The Cross-Parry – one firm initiates a move in one area while the competitor responds in a different area

10. The fighting Brand – a brand introduced to have the effect of punishing or threatening to punish (Mr Pib example)

11. Private Anti Trust suits

Use History to Identify Signals!

Chapter 3: A Framework for Competitor Analysis

Competitive analysis involves positioning a business to maximize the value of the capabilities that distinguish it from it’s competitors.

The four diagnostic components of competitor analysis – understanding these will allow an informed prediction of our competitor’s response.

1. Future Goals (less attention paid to 1 & 2, they are harder to observe)

2. Assumptions

3. Current Strategy

4. Capabilities

Can be used for self analysis and to see what the competition concludes about you. Also should be used on potential competitors (Firms not in the industry but who could be, firms who would have synergy in the industry, would be an extension of corporate strategy, customers or supplier who might integrate backward/forward)

1. Future Goals

Will allow predictions about whether or not each competitor is satisfied with their present position and financial results; from this we determine how likely they are to change strategy and with how much vigor. It will also aid in predicting their reaction to strategic change, the seriousness of their intentions, and whether the corporate parent will support. Goals can be financial, market leadership, technological, social performance.

Business Unit Goals – Financial goals, attitude to risk, values or beliefs, organizational structure, control and incentive systems, accounting system, kinds of managers, unanimity about decisions, composition of the board, contractual commitments, regulatory/anti-trust/government and social constraints.

Corporate Parent Goals – Results of the parent company, overall goals, strategic importance, why are they in the business, economic relationship, values or beliefs, generic strategy, performance and needs of other units, diversification plans, organizational structure, how is divisional management controlled and compensated, anti-trust or social sensitivities, emotional attachment

Portfolio Analysis – How is each business classified, which business is classified as a cash cow, candidates for harvest/diversement, which b is stability, which business is a defensive move, in a promising area, high leverage

Finding a happy place – One approach is formulation strategy where a firm can meet its objectives without threatening its competitor. Want to avoid bitter price wars. Don’t mess with growing/baby/emotionally attached to businesses.

2. Assumptions

2 major categories – assumptions about itself and the industry/the companies within it.

Every firm operates on a set of assumptions about itself. These assumptions may or may not be accurate. Examining these assumptions can reveal blind spots (rooting out these blind spots will help the firm identify moves with a lower probability of immediate retaliation and identify moves where retaliation is not effective.

Identify assumptions:

• What do they believe about their relative position in (cost/quality/tech)? What does it see as its strengths/weaknesses? Accurate?

• Do they have strong historical or emotional identification with a product

• Are there cultural, regional, or national differences?

• Is there organizational dogma that affects views?

• What do they see as the future demand/industry trends?

• What do the think about their competitors?

• Do they believe the conventional wisdom?

• Assumptions may be reflected by current strategy

History as an indicator of goals and assumptions

• What is the current financial position compared to the past?

• What has been the history in the marketplace (has it been beaten, failed)?

• In what area has it starred or succeeded in?

• How has it reacted to strategic moves? Rationally? Emotionally?

Managerial Background

• Functional background of top management

• Type of strategies that have personally worked or not worked in the past

• Other businesses they have worked in

• Major events they have lived through

• From their writings and speaking

• What particular advisers are used by the competitor

3. Current Strategy –

May be Explicit or Implicit, but is most useful when thought of as the key operating policies in each functional area of the business and how it seeks to interrelate theses.

4. Capabilities

A company’s strengths and weaknesses determine its ability to initiate or react to strategic moves and to deal with the environmental or industry events that occur.

Areas of Strength and Weakness

• Core Capabilities

• Ability to grow

• Quick response capability

• Ability to Adapt (fixed vs. variable costs, ability to change in a functional area, response to exogenous events, exit barriers, does it share manufacturing facilities/sales force

• Staying Power

Putting the four together – The Competitor Response Profile

Offensive Moves – predict the strategic changes the competitor might initiate

• Satisfaction with current position

• Probable moves

• Strength and seriousness of moves – important to asses what the competitor may gain from the move

Defensive Capability

• Vulnerability of competitor

• Provocation – which moves would cause them to retaliate

• Effectiveness of Retaliation – what move are they impeded from reacting to quickly

Picking the battleground – choose a battleground in which you component is ill prepared, least enthusiastic, or most uncomfortable in competing. Also you want to create a feeling of mixed motives or conflicting goals for your competitor.

Need for a competitor intelligence system – organized mechanism to ensure efficiency

1. Collect Field Data – Collect Published Data

2. Compile this Data

3. Catalog it

4. Digest

5. Communicate it to Strategists

6. Come up with Competitor Analysis

Chapter 2 – Generic Competitive Strategies

Three Generic Strategies

1. Overall Cost Leadership – seeks to achieve overall cost leadership in an industry through a set of functional policies aimed at this objective. Requires aggressive construction of efficient-scale facilities, vigorous pursuit of cost reductions from experience, tight cost and overhead control, avoidance of marginal customer accounts, and cost minimization in areas like R&D, sales, advertising and so on. The low cost position protects the firm from all five forces because bargaining can only continue to erode profits until those of the next most efficient competitor are eliminated. Achieving an overall low cost position often requires a high market share or other advantages, such as favorable access to raw materials.

2. Differentiation – Differentiating the product or service offering of the firm, creating something that is perceived industrywide as being unique. This can take many forms: design or brand image, technology, features, customer service, dealer network. Ideally, a firm differentiates itself along multiple dimensions. Differentiation, if achieved, is a viable strategy for earning above average returns in an industry because it creates a defensible position for coping with the five forces.

3. Focus – focusing on a particular buyer group, segment of the product line, or geographic market. This strategy is built around serving a particular target very well. It rests on the premise that the firm is thus able to serve its narrow strategic target more effectively or efficiently than competitors who are competing more broadly. Focus necessarily involves a tradeoff between profitability and sales volume.

Successfully implementing these three strategies requires different resources and skills. They also imply different organizational arrangements, control procedures, and incentive systems.

Stuck in the Middle – a firm failing to develop its strategy in one of the three directions

Risks of the generic Strategies

1. Failing to attain the strategy

2. The value of the strategic advantage to erode with industry evolution

Risks of Overall Cost Leadership – imposes severe burdens on the firm to keep up its position, which means reinvesting in modern equipment, ruthlessly scrapping obsolete assets, avoiding product line proliferation and being alert for technological improvements

Risks of Differentiation – Cost differential becomes too great for differentiation to hold brand loyalty, buyers need for the differentiation falls, and imitation narrows perceived differentiation.

Risks of Focus – The cost differential widens to eliminate the cost advantages, the differences in desired products narrow, and competitors find submarkets within the strategic target and out focus the focuser.