Course Project

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Course Project
Week 8
Guidelines and Grading Rubric (200 points)
 
Use your Course Project organization selected during Week 2 for this assignment.
 
COMPANY NAME, WEBSITE, and INDUSTRY
State the company name, website address, and industry.
 
BACKGROUND and HISTORY
Briefly describe the company in the case analysis. What is their primary business, who were the officers or key players described in the case study? If the case study company is currently in business, list the company’s current CEO, total sales, and profit or loss for the last year where data is available. Identify key events or phases in the company’s history. Describe the performance of this company in the industry. Visit the company’s website and use http://finance.yahoo.com and/or some other financial search engine to find this data. (15 points)
 
NOTE: Make sure to use APA citations throughout the paper. The textbook should be cited if it is the source of information. If you are not familiar with APA citation, check out the tutorial APA Guidelines for Citing Sources at the end of the course Syllabus. There are videos to help you with the APA format and business research in the Week 1 Llecture.
 
ANALYSIS VIA PORTER’S FIVE FORCES MODEL
Analyze the competitive environment by listing the threat of new entrants, the bargaining power of buyers, the bargaining power of suppliers, the threat of substitute products and services, and the intensity of rivalry among competitors in the industry (Chapter 2). Summarize your key points in a figure. (25 points)
 
STRATEGY USED
How does this company create and sustain a competitive advantage? What strategy from the readings was undertaken by this company? Were they successful? Can all companies use this strategy? How is the strategy affected by the life cycle in the industry? Remember to reference Porter’s generic strategies identified in Chapter 5 of the textbook, THIS IS CRITICAL. (40 points)
 
Specific STRATEGY(S)
Choose six specific strategies from this list.
Ensuring Coherence in Strategic Direction (pages 26–32)
Value Chain Analysis (pages 81–93)
Resource View of Firm (pages 93–104)
Industry Life Cycle Strategies (pages 187–195)
Turnaround Strategies (pages 193–195)
Vertical Integration (pages 210–214)
Portfolio Management and the BCG Matrix (pages 216–226)
Strategic Alliances and Joint Ventures (pages 226–228)
Achieving Competitive Advantage (pages 256–267)
Entry Model (pages 267–272)
Entrepreneurial Strategy (pages 292–311)
External Governance Control (pages 340–347)
Linking Strategic Rewards (pages 366–372)
Creating Ambidextrous Organization Designs (pages 383–387)
Leadership (pages 392–416)
 
Apply them in detail to the organization. Be sure to think strategically and show the results clearly. Use the strategy as a sub-header for each section so it is clear what is being applied. (90 points)
 
COURSE OF ACTION RECOMMENDED
If you were in a position to advise this company, what strategy would you recommend to sustain competitive advantage and achieve future growth? Be specific and list the steps the company should take for successful implementation of your course of action. (15 points)
 
OPINION
What do you think of this case study? Describe what you believe are the lessons learned from this case. (10 points)
 
REFERENCES
When you have completed the paper using the above sections, insert a page break and have a separate reference page. The references should be listed in accordance with the APA guidelines as shown in the tutorial. (5 points)
 
FORMAT

  • Use a title page.

 

  • Font: Use Times New Roman, 12 point.

 

  • Place your name in the upper left hand corner of the page.

 

  • Each section of your paper should be headed by the bolded, capitalized item described above.

 

  • Indent paragraphs.

 

  • Insert page numbers bottom right.

 

  • Paper length should be six to eight double-spaced pages not including title page, references, or illustrations and tables.

 

  • Use APA citations throughout the paper. If you are not familiar with APA citation, refer to tutorial, which is contained in the last section of our course Syllabus.

 

  • Include a separate Reference page at the end of the paper.

 

  • Please prepare reference page as follows.

 
References
 
Dess, G., Lumpkin, G., & Eisner, A. (2012). Strategic Management (6e). Boston: McGraw-Hill Irwin.
 
Side Notes

  • Save your paper in the following format: Your last name, initials of your first and middle name, and the company discussed in the case study.

EXAMPLE: If your name is Edward R Jones and you are writing a case study on Google, then the file name for your paper would be jonesergoogle.doc
 

  • Place the paper in the Dropbox designated by the weekly assignment.

 
Note that the report is worth 200 points and points are allocated for each section as noted in the outline.
This project is intended to provide current material for class discussion and review. This material must relate to your Course Project subject. To receive full credit for this requirement, submit the In the News during Week 2. The project may draw on items from the online environment—newspapers, magazines, and websites—to provide current (i.e., within the last year) examples of course-related topics (i.e., Business Strategy from this week’s reading assignment). Relevance and probable interest to the class are especially welcome. These items should be accompanied by a one- to two-page report (using bullet points). Be sure to use specific course concepts from this week’s readings in Chapters 2, 3, and 4. Examples are: Competitive Intelligence (pg. 42-44), Demographics (pg. 47–50), Porter’s 5 Forces (pg. 55–68), Value Chain Analysis (pg. 81–93), Resource Based View (pg. 93–102), Balanced Scorecard (pg. 107–110), Human Capital (pg. 127–136), and Social Capital (pg. 137–144).
Be sure you include the news article or a summary, as well as the 1- to 2-page report using bullet points that fully addresses the following points in this order.

  • The organization you have chosen for your Course Project by name,
  • why and how the news material is important and relevant to the course content using specific course concepts from this week’s assigned reading by citing the name of the concept and the page it is located on in the textbook, and
  • what practical managerial implications the material has.

 
 
 

  1. Examples are: Competitive Intelligence (pg. 42-44), Demographics (pg. 47–50), Porter’s 5 Forces (pg. 55–68), Value Chain Analysis (pg. 81–93), Resource Based View (pg. 93–102), Balanced Scorecard (pg. 107–110), Human Capital (pg. 127–136), and Social Capital (pg. 137–144)

One of the authors of this text has conducted on-site interviews with executives from several industries to identify indicators that firms monitor as inputs to their strategy process. Examples of such indicators included:
Page 42-44
 

  • A Motel 6 executive.The number of rooms in the budget segment of the industry in the United States and the difference between the average daily room rate and the consumer price index (CPI).
  • A Pier 1 Imports executive.Net disposable income (NDI), consumer confidence index, and housing starts.
  • A Johnson & Johnson medical products executive.Percentage of gross domestic product (GDP) spent on health care, number of active hospital beds, and the size and power of purchasing agents (indicates the concentration of buyers).

 
Such indices are critical for managers in determining a firm’s strategic direction and resource allocation.
Competitive Intelligence
 
Competitive intelligence (CI) helps firms define and understand their industry and identify rivals’ strengths and weaknesses. 13 This includes the intelligence gathering associated with collecting data on competitors and interpreting such data. Done properly, competitive intelligence helps a company avoid surprises by anticipating competitors’ moves and decreasing response time. 14
(printed 2/26/01); and www.yahoo.com.
ompetitive intelligence
 
a firm’s activities of collecting and interpreting data on competitors, defining and understanding the industry, and identifying competitors’ strengths and weaknesses.
 
Examples of competitive analysis are evident in daily newspapers and periodicals such as The Wall Street Journal, BusinessWeek, and Fortune. For example, banks continually track home loan, auto loan, and certificate of deposit (CD) interest rates charged by rivals. Major airlines change hundreds of fares daily in response to competitors’ tactics. Car manufacturers are keenly aware of announced cuts or increases in rivals’ production volume, sales, and sales incentives (e.g., rebates and low interest rates on financing). This information is used in their marketing, pricing, and production strategies.
strategy spotlight 2.1: How Zara, a Spanish Retailer, Spots Opportunities
 
After massive investments in sophisticated IT systems, many companies continue to miss market shifts that their rivals exploit. With IT investments, however, it’s not how much you spend but how you spend it. To continually identify gaps in the market, firms need real-time data and the ability to share it widely throughout the organization. Those hard data must be supplemented with direct observations from the field.
 
Consider Spanish retailer, Zara, whose success is often attributed to its flexible supply chain. Equally impressive is Zara’s ability to spot changing preferences among its fickle customers—despite spending only one-quarter of the industry average on IT. Zara’s designers, marketing managers, and buyers work side by side in the company’s sprawling headquarters. The open office plan fosters frequent discussions and promotes the sharing of real-time data as well as field observations and anecdotes. By co-locating employees from different functions, Zara allows them to break out of their silos and develop a holistic feel for the market, see how their work fits, and sense new opportunities as they arise.
 
For instance, in the summer of 2007, Zara launched a line of slim-fit clothes, including pencil skirts and tapered jeans, in response to catwalk trends and what celebrities were wearing. Marketing executives projected that the new items would fly off the racks, but the daily statistics revealed that the items were not selling. So Zara marketing managers immediately went into the field to see firsthand what was happening. They talked to managers, employees, and customers and quickly realized that women loved how the clothes looked but struggled to squeeze into their usual size in the dressing room. Zara responded by recalling the items and relabeling them one size smaller. The company then watched sales boom as customers happily fit into their usual size. The shared, real-time data supplemented with firsthand observation helped employees respond quickly and tip the balance from failure to success.
Zara has experienced tremendous growth and increasing market power. By 2007, it was the biggest fashion company in Europe, outpacing H&M as queen of cheap chic. It is committed to international expansion. In 2008, Korea, Ukraine, Montenegro, Egypt, and Honduras were conquered, and, in 2009, Zara announced a joint venture with India’s Tata Group to open stores in India.
 
Finally, in September 2010, Zara launched its first online retail stores in France, Spain, Italy, Portugal, and the United Kingdom. Since Zara is “liked” by more than 4.5 million people who have signed up as fans on Facebook, the key to its success will now be to convert those fans to customers.
 
Source: Sull, D. 2010. Are You Ready to Rebound? Harvard Business Review. 88(3): 72; D’Aveni, R. A. 2010. Beating the Commodity Trap. Boston: Harvard Business Press; and, Caesar, J. 2010. Zara Launches Online Retail Store. www.bbc.co.uk. September 2: np.
 
The Internet has dramatically accelerated the speed at which firms can find competitive intelligence. Leonard Fuld, founder of the Cambridge, Massachusetts, training and consulting firm Fuld & Co., specializes in competitive intelligence. 15 His firm often profiles top company and business group managers and considers these issues: What is their background? What is their style? Are they marketers? Are they cost cutters? Fuld has found that the more articles he collects and the more biographies he downloads, the better he can develop profiles.
 
One of Fuld & Co.’s clients asked it to determine the size, strength, and technical capabilities of a privately-held company. Initially, it was difficult to get detailed information. Then one analyst used Deja News (www.dejanews.com), now part of Google, to tap into some online discussion groups. The analyst’s research determined that the company had posted 14 job openings on one Usenet group. That posting was a road map to the competitor’s development strategy.
 
At times, a firm’s aggressive efforts to gather competitive intelligence may lead to unethical or illegal behaviors. 16 Strategy Spotlight 2.2 provides an example of a company, United technological accomplishments. UT built the first working helicopter, developed the first commercially available hydrogen cells, and designed complete life support systems for space shuttles. UT believes strongly in a robust code of ethics. In the last decade, they have clearly articulated their principles governing business conduct. These include an antitrust guide, an ethics guide when contracting with the U.S. government and foreign governments, a policy on accepting gifts from suppliers, and guidelines for proper usage of e-mail. One such document is the Code of Ethics Guide on Competitive Intelligence. This encourages managers and workers to ask themselves these five questions whenever they have ethical concerns.
 

  1. Have I done anything that coerced somebody to share this information? Have I, for example, threatened a supplier by indicating that future business opportunities will be influenced by the receipt of information with respect to a competitor?
  2. Am I in a place where I should not be? If, for example, I am a field representative with privileges to move around in a customer’s facility, have I gone outside the areas permitted? Have I misled anybody in order to gain access?
  3. Is the contemplated technique for gathering information evasive, such as sifting through trash or setting up an electronic “snooping” device directed at a competitor’s facility from across the street?
  4. Have I misled somebody in a way that the person believed sharing information with me was required or would be protected by a confidentiality agreement? Have I, for example, called and misrepresented myself as a government official who was seeking some information for some official purpose?
  5. Have I done something to evade or circumvent a system intended to secure or protect information?

Sources: Nelson, B. 2003. The thinker. Forbes, March 3: 62–64; and The Fuld war room—Survival kit 010. Code of ethics (printed 2/26/01); and www.yahoo.com.
 
A word of caution: Executives must be careful to avoid spending so much time and effort tracking the actions of traditional competitors that they ignore new competitors. Further, broad environmental changes and events may have a dramatic impact on a firm’s viability. Peter Drucker, considered the father of modern management, wrote:
 
Increasingly, a winning strategy will require information about events and conditions outside the institution: noncustomers, technologies other than those currently used by the company and its present competitors, markets not currently served, and so on. 17
 
Consider the fall of the once-mighty Encyclopaedia Britannica.18 Its demise was not caused by a traditional competitor in the encyclopedia industry. It was caused by new technology. CD-ROMs came out of nowhere and devastated the printed encyclopedia industry. Why? A full set of the Encyclopaedia Britannica sells for about $2,000, but an encyclopedia on CD-ROM, such as Microsoft Encarta, sells for about $50. To make matters worse, many people receive Encarta free with their personal computers.
Environmental Forecasting
 
Environmental scanning, monitoring, and competitive intelligence are important inputs for analyzing the external environment. Environmental forecasting involves the development of plausible projections about the direction, scope, speed, and intensity of environmental change. 19 Its purpose is to predict change. 20 It asks: How long will it take a new technology to reach the marketplace? Will the present social con
Page 47-50
One of the most basic techniques for analyzing firm and industry conditions is SWOT analysis. SWOT stands for strengths, weaknesses, opportunities, and threats. It provides “raw material”—a basic listing of conditions both inside and surrounding your company.
 
SWOT analysis
 
a framework for analyzing a company’s internal and external environment and that stands for strengths, weaknesses, opportunities, and threats.
 
The Strengths and Weaknesses refer to the internal conditions of the firm—where your firm excels (strengths) and where it may be lacking relative to competitors (weaknesses). Opportunities and Threats are environmental conditions external to the firm. These could be factors either in the general or competitive environment. In the general environment, one might experience developments that are beneficial for most companies such as improving economic conditions, that lower borrowing costs or trends that benefit some companies and harm others. An example is the heightened concern with fitness, which is a threat to some companies (e.g., tobacco) and an opportunity to others (e.g., health clubs). Opportunities and threats are also present in the competitive environment among firms competing for the same customers.
 
The general idea of SWOT analysis is that a firm’s strategy must:
 

  • build on its strengths,
  • remedy the weaknesses or work around them,
  • take advantage of the opportunities presented by the environment, and,
  • protect the firm from the threats.

Despite its apparent simplicity, the SWOT approach has been very popular. First, it forces managers to consider both internal and external factors simultaneously. Second, its emphasis on identifying opportunities and threats makes firms act proactively rather than reactively. Third, it raises awareness about the role of strategy in creating a match between the environmental conditions and the firm’s internal strengths and weaknesses. Finally, its conceptual simplicity is achieved without sacrificing analytical rigor. (We will also address some of the limitations of SWOT analysis in Chapter 3.)
The General Environment
LO2.4
 
The impact of the general environment on a firm’s strategies and performance.
 
The general environment is composed of factors that can have dramatic effects on firm strategy.25 Typically, a firm has little ability to predict trends and events in the general environment and even less ability to control them. When listening to CNBC, for example, you can hear many experts espouse different perspectives on what action the Federal Reserve Board may take on short-term interest rates—an action that can have huge effects on the valuation of entire economic sectors. Also, it’s difficult to predict future political events such as the ongoing Middle East peace negotiations and tensions on the Korean peninsula. Dramatic innovations in information technology (e.g., the Internet) have helped keep inflation in check by lowering the cost of doing business in the United States at the beginning of the 21st century. 26
general environment
 
factors external to an industry, and usually beyond a firm’s control, that affect a firm’s strategy.
 
We divide the general environment into six segments: demographic, sociocultural, political/legal, technological, economic, and global. Exhibit 2.3 provides examples of key trends and events in each of the six segments of the general environment.
Exhibit 2.3: General Environment: Key Trends and Events
 
Demographic
 

  • Aging population
  • Rising affluence
  • Changes in ethnic composition
  • Geographic distribution of population
  • Greater disparities in income levels

 
Sociocultural
 

  • More women in the workforce
  • Increase in temporary workers
  • Greater concern for fitness
  • Greater concern for environment
  • Postponement of family formation

Political/Legal
 

  • Tort reform
  • Americans with Disabilities Act (ADA) of 1990
  • Repeal of Glass-Steagall Act in 1999 (banks may now offer brokerage services)
  • Deregulation of utility and other industries
  • Increases in federally mandated minimum wages
  • Taxation at local, state, federal levels
  • Legislation on corporate governance reforms in bookkeeping, stock options, etc. (Sarbanes-Oxley Act of 2002)

 
Technological
 

  • Genetic engineering
  • Emergence of Internet technology
  • Computer-aided design/computer-aided manufacturing systems (CAD/CAM)
  • Research in synthetic and exotic materials
  • Pollution/global warming
  • Miniaturization of computing technologies
  • Wireless communications
  • Nanotechnology

Economic
 

  • Interest rates
  • Unemployment rates
  • Consumer Price Index
  • Trends in GDP
  • Changes in stock market valuations

 
Global
 

  • Increasing global trade
  • Currency exchange rates
  • Emergence of the Indian and Chinese economies
  • Trade agreements among regional blocs (e.g., NAFTA, EU, ASEAN)
  • Creation of WTO (leading to decreasing tariffs/free trade in services)
  • Increased risks associated with terrorism

 
The Demographic Segment
 
Demographics are the most easily understood and quantifiable elements of the general environment. They are at the root of many changes in society. Demographics include elements such as the aging population, 27 rising or declining affluence, changes in ethnic composition, geographic distribution of the population, and disparities in income level. 28
demographic segment of the general environment
 
genetic and observable characteristics of a population, including the levels and growth of age, density, sex, race, ethnicity, education, geographic region, and income.
 
The impact of a demographic trend, like all segments of the general environment, varies across industries. Rising levels of affluence in many developed countries bode well for brokerage services as well as for upscale pets and supplies. However, this trend may adversely affect fast-food restaurants because people can afford to dine at higher-priced restaurants. Fast-food restaurants depend on minimum-wage employees to operate efficiently, but the competition for labor intensifies as more attractive employment opportunities become prevalent, thus threatening the employment base for restaurants. Let’s look at the details of one of these trends.
strategy spotlight 2.4: China’s Growing Middle Class Helps Cargo Carriers Rebound from the Recession
 
Increasingly, wealthy Chinese consumers eat more imported fresh fish, lobster, and cheese and wear imported fashions. One implication: They are helping global air cargo revenue rebound from the decline in 2009, the worst year in five decades.
strategy spotlight 2.4: China’s Growing Middle Class Helps Cargo Carriers Rebound from the Recession
 
Increasingly, wealthy Chinese consumers eat more imported fresh fish, lobster, and cheese and wear imported fashions. One implication: They are helping global air cargo revenue rebound from the decline in 2009, the worst year in five decades.
 
China, with its soaring demand for luxury goods and perishable foods from overseas will lead an 18.5 percent recovery in air shipments in 2010, according to the International Air Transport Association. “China has attracted more investment and luxury brands, as purchasing power has gotten much stronger,” said Kelvin Lau, an equity analyst at Daiwa Institute of Research in Hong Kong. For example, Cathay Pacific, the biggest carrier in Hong Kong, is flying 100 tons of lobster and 150 tons of grouper to China and Hong Kong every month from Australia and Indonesia. It also increased shipments of sashimi-grade fish to the country from Tokyo by 60 percent in the first four months of 2010.
 
The size of China’s middle class could rise to 46 percent of all households by 2020, from 32 percent in 2010, claims the research firm Euromonitor International. The firm defines middle-class households as those with annual disposable incomes equivalent to $5,000 to $15,000.
 
United Parcel Service, the world’s largest package-delivery firm, has added two cargo planes in Hong Kong and one in Shanghai in 2010. FedEx, the world’s largest air cargo carrier, is planning to buy more air freighters for its longest routes to Asia.
 
Shanghai International Port, China’s largest port group, had a throughput of 428 million tons in 2010—up from 365 tons the previous year. And Global Logistic Properties Ltd., a logistics company whose customers include Walmart China and FedEx, expects cargo demand through the Beijing airport to increase by 15 percent a year from 2010 to 2015.
 
Source: Leung, W. & Ling, C. S. 2010. Chinese Consumers’ Appetites Fatten Air Shippers. International Herald Tribune. July 30: 15; Wong, F. & Lian, R. 2011. Shanghai International Port Posts 44 Percent Jump in 2010 Net. www.reuters.com. January 11: np; and, Park, K. 2011. Global Logistic to Expand in Smaller China Cities to Tap on Rental Growth.
www.bloomberg.com. January 4: np.
 
The aging population in the United States and other developed countries has important implications. The U.S. Bureau of Statistics states that only 18 percent of American workers were 55 and older in 2008. 29 However, by 2012 that figure will increase to 24 percent, or about one in four, of all U.S. workers. At the same time, the United States is expected to experience a significant drop in younger workers aged 25 to 44 from 68 percent to 64 percent by 2018, making it increasingly important for employers to recruit and retain older workers.
 
Strategy Spotlight 2.4 discusses how the increasing appetite for high-end consumer goods by China’s growing middle class has boosted the revenues for air cargo carriers. This comes at a time when many western economies are still reeling from a recession.
The Sociocultural Segment
 
sociocultural segment of the general environment
 
the values, beliefs, and lifestyles of a society.
 
Sociocultural forces influence the values, beliefs, and lifestyles of a society. Examples include a higher percentage of women in the workforce, dual-income families, increases in the number of temporary workers, greater concern for healthy diets and physical fitness, greater interest in the environment, and postponement of having children. Such forces enhance sales of products and services in many industries but depress sales in others. The increased number of women in the workforce has increased the need for business clothing merchandise but decreased the demand for baking product staples (since people would have less time to cook from scratch). This health and fitness trend has helped industries that manufacture exercise equipment and healthful foods but harmed industries that produce unhealthful foods.
 
Increased educational attainment by women in the workplace has led to more women in upper management positions. 30 Given such educational attainment, it is hardly surprising that companies owned by women have been one of the driving forces of the U.S. economy; these companies (now more than 9 million in number) account for 40 percent of all U.S. businesses and have generated more than $3.6 trillion in annual revenue. In addition, women have a tremendous impact on consumer spending decisions. Not surprisingly, many companies have focused their advertising and promotion efforts on female consumers. Consider, for example, Lowe’s efforts to attract female shoppers:
Lowe’s has found that women prefer to do larger home-improvement projects with a man—be it a boyfriend, husband, or neighbor. As a result, in addition to its “recipe card classes” (that explain various projects that take only one weekend), Lowe’s offers co-ed store clinics for projects like sink installation. “Women like to feel they’re given the same attention as a male customer,” states Lowe’s spokesperson Julie Valeant-Yenichek, who points out that most seminar attendees, whether male or female, are inexperienced. 31
 
Home Depot recently spent millions of dollars to add softer lighting and brighter signs in 300 stores. Why? It is an effort to match rival Lowe’s appeal to women.
The Political/Legal Segment
 
political/legal segment of the general environment
 
how a society creates and exercises power, including rules, laws, and taxation policies.
 
Political processes and legislation influence environmental regulations with which industries must comply.32,33 Some important elements of the political/legal arena include tort reform, the Americans with Disabilities Act (ADA) of 1990, the repeal of the Glass-Steagall Act in 1999 (banks may now offer brokerage services), deregulation of utilities and other industries, and increases in the federally mandated minimum wage. 34
Government legislation can also have a significant impact on the governance of corporations. The U.S. Congress passed the Sarbanes-Oxley Act in 2002, which greatly increases the accountability of auditors, executives, and corporate lawyers. This act responded to the widespread perception that existing governance mechanisms failed to protect the interests of shareholders, employees, and creditors. Clearly, Sarbanes-Oxley has also created a tremendous demand for professional accounting services.
 
Legislation can also affect firms in the high-tech sector of the economy by expanding the number of temporary visas available for highly skilled foreign professionals. 35 For example, a bill passed by the U.S. Congress in October 2000 allowed 195,000 H-1B visas for each of the following three years—up from a cap of 115,000. However, beginning in 2006 and continuing through 2010, the annual cap on H-1B visas has shrunk to only 65,000—with an additional 20,000 visas available for foreigners with a Master’s or higher degree from a U.S. institution. Many of the visas are for professionals from India with computer and software expertise. As one would expect, this is a political “hot potato” for industry executives as well as U.S. labor and workers’ right groups. The key arguments against increases in H-1B visas are that H-1B workers drive down wages and take jobs from Americans.
 
Strategy Spotlight 2.5 discusses one of the proactive steps that Microsoft has taken to address this issue.
 
 
 
The Technological Segment
 
technological segment of the general environment
 
innovation and state of knowledge in industrial arts, engineering, applied sciences, and pure science; and their interaction with society.
 
Developments in technology lead to new products and services and improve how they are produced and delivered to the end user. 36 Innovations can create entirely new industries and alter the boundaries of existing industries. 37 Technological developments and trends include genetic engineering, Internet technology, computer-aided design/computer-aided manufacturing (CAD/CAM), research in artificial and exotic materials, and, on the downside, pollution and global warming. 38 Petroleum and primary metals industries spend significantly to reduce their pollution. Engineering and consulting firms that work with polluting industries derive financial benefits from solving such problems.
Page 55-68
The Competitive Environment
LO2.5
 
How forces in the competitive environment can affect profitability, and how a firm can improve its competitive position by increasing its power vis-à-vis these forces.
 
Managers must consider the competitive environment (also sometimes referred to as the task or industry environment). The nature of competition in an industry, as well as the profitability of a firm, is often more directly influenced by developments in the competitive environment.
 
The competitive environment consists of many factors that are particularly relevant to a firm’s strategy. These include competitors (existing or potential), customers, and suppliers. Potential competitors may include a supplier considering forward integration, such as an automobile manufacturer acquiring a rental car company, or a firm in an entirely new industry introducing a similar product that uses a more efficient technology.
 
industry
 
a group of firms that produce similar goods or services.
 
competitive environment
 
factors that pertain to an industry and affect a firm’s strategies.
Next, we will discuss key concepts and analytical techniques that managers should use to assess their competitive environments. First, we examine Michael Porter’s five-forces model that illustrates how these forces can be used to explain an industry’s profitability. 48 Second, we discuss how the five forces are being affected by the capabilities provided by Internet technologies. Third, we address some of the limitations, or “caveats,” that managers should be familiar with when conducting industry analysis. Finally, we address the concept of strategic groups, because even within an industry it is often useful to group firms on the basis of similarities of their strategies. As we will see, competition tends to be more intense among firms within a strategic group than between strategic groups.
Porter’s Five-Forces Model of Industry Competition
 
The “five-forces” model developed by Michael E. Porter has been the most commonly used analytical tool for examining the competitive environment. It describes the competitive environment in terms of five basic competitive forces. 49
 

  1. The threat of new entrants.
  2. The bargaining power of buyers.
  3. The bargaining power of suppliers.
  4. The threat of substitute products and services.
  5. The intensity of rivalry among competitors in an industry.

 
Porter’s five-forces model of industry competition
 
a tool for examining the industry-level competitive environment, especially the ability of firms in that industry to set prices and minimize costs.
Each of these forces affects a firm’s ability to compete in a given market. Together, they determine the profit potential for a particular industry. The model is shown in Exhibit 2.7. A manager should be familiar with the five-forces model for several reasons. It helps you decide whether your firm should remain in or exit an industry. It provides the rationale for increasing or decreasing resource commitments. The model helps you assess how to improve your firm’s competitive position with regard to each of the five forces. 50 For example, you can use insights provided by the five-forces model to create higher entry barriers that discourage new rivals from competing with you. 51 Or you may develop strong relationships with your distribution channels. You may decide to find suppliers who satisfy the price/performance criteria needed to make your product or service a top performer.
 
 
Source: Adapted and reprinted with permission of The Free Press, a division of Simon & Schuster Adult Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.
The Threat of New Entrants
 
threat of new entrants
 
the possibility that the profits of established firms in the industry may be eroded by new competitors.
 
The threat of new entrants refers to the possibility that the profits of established firms in the industry may be eroded by new competitors. 52 The extent of the threat depends on existing barriers to entry and the combined reactions from existing competitors. 53 If entry barriers are high and/or the newcomer can anticipate a sharp retaliation from established competitors, the threat of entry is low. These circumstances discourage new competitors. There are six major sources of entry barriers.
Economies of Scale
 
economies of scale
 
decreases in cost per unit as absolute output per period increases.
 
Economies of scale refers to spreading the costs of production over the number of units produced. The cost of a product per unit declines as the absolute volume per period increases. This deters entry by forcing the entrant to come in at a large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disadvantage. Both are undesirable options.
Product Differentiation
 
product differentiation
 
the degree that a product has strong brand loyalty or customer loyalty.
 
When existing competitors have strong brand identification and customer loyalty, differentiation creates a barrier to entry by forcing entrants to spend heavily to overcome existing customer loyalties.
Capital Requirements
 
The need to invest large financial resources to compete creates a barrier to entry, especially if the capital is required for risky or unrecoverable up-front advertising or research and development (R&D).
Switching Costs
 
switching cost
 
one-time costs that a buyer/supplier faces when switching from one supplier/buyer to another.
 
A barrier to entry is created by the existence of one-time costs that the buyer faces when switching from one supplier’s product or service to another.
Access to Distribution Channels
 
The new entrant’s need to secure distribution for its product can create a barrier to entry.
Cost Disadvantages Independent of Scale
 
Some existing competitors may have advantages that are independent of size or economies of scale. These derive from:

  • Proprietary products
  • Favorable access to raw materials
  • Government subsidies
  • Favorable government policies

 
In an environment where few, if any, of these entry barriers are present, the threat of new entry is high. For example, if a new firm can launch its business with a low capital investment and operate efficiently despite its small scale of operation, it is likely to be a threat. One company that failed because of low entry barriers in an industry is ProCD. 54 You probably never heard of this company. It didn’t last very long. ProCD provides an example of a firm that failed because it entered an industry with very low entry barriers.
 
The story begins in 1986 when Nynex (a former Baby Bell company) issued the first electronic phone book, a compact disk containing all listings for the New York City area. It charged $10,000 per copy and sold the CDs to the FBI, IRS, and other large commercial and government organizations. James Bryant, the Nynex executive in charge of the project, smelled a fantastic business opportunity. He quit Nynex and set up his own firm, ProCD, with the ambitious goal of producing an electronic directory covering the entire United States.
The telephone companies, fearing an attack on their highly profitable Yellow Pages business, refused to license digital copies of their listings. Bryant was not deterred. He hired Chinese workers at $3.50 a day to type every listing from every U.S. telephone book into a database. The result contained more than 70 million phone numbers and was used to create a master disk that enabled ProCD to make hundreds of thousands of copies. Each CD sold for hundreds of dollars and cost less than a dollar each to produce.
 
It was a profitable business indeed! However, success was fleeting. Competitors such as Digital Directory Assistance and American Business Information quickly launched competing products with the same information. Since customers couldn’t tell one product from the next, the players were forced to compete on price alone. Prices for the CD soon plummeted to a few dollars each. A high-priced, high-margin product just months earlier, the CD phone book became little more than a cheap commodity.
The Bargaining Power of Buyers
 
bargaining power of buyers
 
the threat that buyers may force down prices, bargain for higher quality or more services, and play competitors against each other.
Buyers threaten an industry by forcing down prices, bargaining for higher quality or more services, and playing competitors against each other. These actions erode industry profitability. 55 The power of each large buyer group depends on attributes of the market situation and the importance of purchases from that group compared with the industry’s overall business. A buyer group is powerful when:
 

  • It is concentrated or purchases large volumes relative to seller sales. If a large percentage of a supplier’s sales are purchased by a single buyer, the importance of the buyer’s business to the supplier increases. Large-volume buyers also are powerful in industries with high fixed costs (e.g., steel manufacturing).
  • The products it purchases from the industry are standard or undifferentiated. Confident they can always find alternative suppliers, buyers play one company against the other, as in commodity grain products.
  • The buyer faces few switching costs. Switching costs lock the buyer to particular sellers. Conversely, the buyer’s power is enhanced if the seller faces high switching costs.
  • It earns low profits. Low profits create incentives to lower purchasing costs. On the other hand, highly profitable buyers are generally less price sensitive.
  • The buyers pose a credible threat of backward integration. If buyers are either partially integrated or pose a credible threat of backward integration, they are typically able to secure bargaining concessions.
  • The industry’s product is unimportant to the quality of the buyer’s products or services. When the quality of the buyer’s products is not affected by the industry’s product, the buyer is more price sensitive.

At times, a firm or set of firms in an industry may increase its buyer power by using the services of a third party. FreeMarkets Online is one such third party. 56 Pittsburgh-based FreeMarkets has developed software enabling large industrial buyers to organize online auctions for qualified suppliers of semistandard parts such as fabricated components, packaging materials, metal stampings, and services. By aggregating buyers, FreeMarkets increases the buyers’ bargaining power. The results are impressive. In its first 48 auctions, most participating companies saved over 15 percent; some saved as much as 50 percent.
strategy spotlight 2.7: Tuition Increases: Sometimes Students Have Low Bargaining Power
 
Students at the University of California at Berkeley got hit with a 32 percent tuition fee increase in 2010. They protested by taking over a classroom building. As noted by Forbes writer Asher Hawkins: “It was a futile effort. Students who are already embarked on a four-year program are something of a captive audience, and California’s state coffers are empty.”
 
After the increase, the tuition and fees for in-state undergraduate students will come to about $10,000 for the academic year. (This represents a compound annual increase of nearly 10 percent over the past decade.) Although this may still seem like a reasonable price for a high-quality education, there could be more price increases ahead.
At some state schools, the risk of sharp tuition increases is quite high. Forbes conducted a study that analyzed university financial data, state budgets, and tuition levels to come up with a “danger list.” These are state schools that are most likely to raise tuition or cut the quality of the educational experience over the next four-year period. It should be something for students to consider when deciding where to go for undergraduate school.
 
Five of the 10 schools on the high-risk short list were part of the University of California system. A big contributing factor is the state’s enormous budget deficit. And since Berkeley and UCLA have 10 to 12 applicants for every available spot, they are easy targets for legislators looking for ways to balance the budget. A spokesman for the UC system, Peter King, agrees: “The factors employed by Forbes to generate this ranking list capture well the perfect storm that has enveloped the University of California system.”
 
On January 8, 2011, California Governor Jerry Brown proposed cutting a combined $1 billion from the University of California and California State systems, which had a combined $5.6 billion general fund budget in 2010. Mark Yudof, president of the UC system stated, “The collective tuition payments made by UC students for the first time in history would exceed what the state contributes to the system’s general fund.”
 
Sources: Staley, O. 2011. California universities feel the squeeze. Bloomberg Businessweek. January 24–January 30: 29–30; Hawkins, A. 2010. Tuition risk. Forbes. May 10: 36; and, Woo, S. 2011. California governor unveils spending plan. www.wsj.com. January 11: np.
Although a firm may be tempted to take advantage of its suppliers because of high buyer power, it must be aware of the potential long-term backlash from such actions. A recent example (Strategy Spotlight 2.7) is the growing resentment that students have toward state universities in California because of steep increases in tuition. Unfortunately, students are essentially a captive market and have relatively little bargaining power.
The Bargaining Power of Suppliers
 
bargaining power of suppliers
 
the threat that suppliers may raise prices or reduce the quality of purchased goods and services.
 
Suppliers can exert bargaining power by threatening to raise prices or reduce the quality of purchased goods and services. Powerful suppliers can squeeze the profitability of firms so far that they can’t recover the costs of raw material inputs. 57 The factors that make suppliers powerful tend to mirror those that make buyers powerful. A supplier group will be powerful when:

  • The supplier group is dominated by a few companies and is more concentrated (few firms dominate the industry) than the industry it sells to. Suppliers selling to fragmented industries influence prices, quality, and terms.
  • The supplier group is not obliged to contend with substitute products for sale to the industry. The power of even large, powerful suppliers can be checked if they compete with substitutes.
  • The industry is not an important customer of the supplier group. When suppliers sell to several industries and a particular industry does not represent a significant fraction of its sales, suppliers are more prone to exert power.
  • The supplier’s product is an important input to the buyer’s business. When such inputs are important to the success of the buyer’s manufacturing process or product quality, the bargaining power of suppliers is high.
  • The supplier group’s products are differentiated or it has built up switching costs for the buyer. Differentiation or switching costs facing the buyers cut off their options to play one supplier against another.
  • The supplier group poses a credible threat of forward integration. This provides a check against the industry’s ability to improve the terms by which it purchases.

 
The Threat of Substitute Products and Services
 
threat of substitute products and services
 
the threat of limiting the potential returns of an industry by placing a ceiling on the prices that firms in that industry can profitably charge without losing too many customers to substitute products.
All firms within an industry compete with industries producing substitute products and services. 58 Substitutes limit the potential returns of an industry by placing a ceiling on the prices that firms in that industry can profitably charge. The more attractive the price/performance ratio of substitute products, the tighter the lid on an industry’s profits.
 
Identifying substitute products involves searching for other products or services that can perform the same function as the industry’s offerings. This may lead a manager into businesses seemingly far removed from the industry. For example, the airline industry might not consider video cameras much of a threat. But as digital technology has improved and wireless and other forms of telecommunication have become more efficient, teleconferencing has become a viable substitute for business travel. That is, the rate of improvement in the price–performance relationship of the substitute product (or service) is high.
 
Teleconferencing can save both time and money, as IBM found out with its “Manager Jam” idea. 59 With 319,000 employees scattered around six continents, it is one of the world’s largest businesses (including 32,000 managers) and can be a pretty confusing place. The shift to an increasingly mobile workplace means many managers supervise employees they rarely see face-to-face. To enhance coordination, Samuel Palmisano, IBM’s new CEO, launched one of his first big initiatives: a two-year program exploring the role of the manager in the 21st century. “Manager Jam,” as the project was nicknamed, was a 48-hour real-time Web event in which managers from 50 different countries swapped ideas and strategies for dealing with problems shared by all of them, regardless of geography. Some 8,100 managers logged on to the company’s intranet to participate in the discussion forums.
substitute products and services
 
products and services outside the industry that serve the same customer needs as the industry’s products and services.
 
Renewable energy resources are also a promising substitute product and are rapidly becoming more economically competitive with fossil fuels. Strategy Spotlight 2.8 addresses this critical issue.
The Intensity of Rivalry among Competitors in an Industry
 
intensity of rivalry among competitors in an industry
 
the threat that customers will switch their business to competitors within the industry.
 
Firms use tactics like price competition, advertising battles, product introductions, and increased customer service or warranties. Rivalry occurs when competitors sense the pressure or act on an opportunity to improve their position. 60
 
Some forms of competition, such as price competition, are typically highly destabilizing and are likely to erode the average level of profitability in an industry. 61 Rivals easily match price cuts, an action that lowers profits for all firms. On the other hand, advertising battles expand overall demand or enhance the level of product differentiation for the benefit of all firms in the industry. Rivalry, of course, differs across industries. In some instances it is characterized as warlike, bitter, or cutthroat, whereas in other industries it is referred to as polite and gentlemanly. Intense rivalry is the result of several interacting factors, including the following:

  • Numerous or equally balanced competitors. When there are many firms in an industry, the likelihood of mavericks is great. Some firms believe they can make moves without being noticed. Even when there are relatively few firms, and they are nearly equal in size and resources, instability results from fighting among companies having the resources for sustained and vigorous retaliation.
  • Slow industry growth. Slow industry growth turns competition into a fight for market share, since firms seek to expand their sales.
  • High fixed or storage costs. High fixed costs create strong pressures for all firms to increase capacity. Excess capacity often leads to escalating price cutting.
  • Lack of differentiation or switching costs. Where the product or service is perceived as a commodity or near commodity, the buyer’s choice is typically based on price and service, resulting in pressures for intense price and service competition. Lack of switching costs, described earlier, has the same effect.
  • Capacity augmented in large increments. Where economies of scale require that capacity must be added in large increments, capacity additions can be very disruptive to the industry supply/demand balance.
  • High exit barriers. Exit barriers are economic, strategic, and emotional factors that keep firms competing even though they may be earning low or negative returns on their investments. Some exit barriers are specialized assets, fixed costs of exit, strategic interrelationships (e.g., relationships between the business units and others within a company in terms of image, marketing, shared facilities, and so on), emotional barriers, and government and social pressures (e.g., governmental discouragement of exit out of concern for job loss).

strategy spotlight 2.8: The Growing Viability of Renewable Resources as Substitutes for Fossil Fuels
 
Renewable resources currently provide just over 6 percent of total U.S. energy. However, that figure could increase rapidly in the years ahead, according to a joint report issued in September 2006 by the Worldwatch Institute and the Center for Progress, entitled “American Energy: The Renewable Path to Energy Security.”
 
The report indicates that many of the new technologies that harness renewables are, or soon will be, economically competitive with fossil fuels. Dynamic growth rates are driving down costs and spurring rapid advances in technologies. And, since 2000, global wind energy generation has more than tripled, solar cell production has risen six-fold, production of fuel ethanol from crops has more than doubled, and biodiesel production has expanded nearly four-fold. Annual global investment in “new” renewable energy has risen almost six-fold since 1995, with cumulative investment over the period nearly $180 billion.
 
A November 2006 study by the RAND Corporation is consistent with the aforementioned report. It asserts that the economy of the United States would likely benefit, rather than be slowed, if the nation attained the goal of supplying 25 percent of its energy needs from renewable sources by 2025. Such developments would also reduce U.S. dependence on oil, which would mean a substantial start on capping greenhouse gas emissions, which most scientists link to global warming.
 
Deep Patel, founder of Los Angeles–based online clean-energy technologies retailer GoGreenSolar.com, provides some practical insights:

  • Clean energy is regional: Think solar in sunny climates like California, geothermal in Nevada, and wind in blustery states such as Oklahoma.
  • Big corporations tend to hire established, renewable energy companies. “But no one’s paying as much attention to smaller businesses and homeowners that want to go solar. For entrepreneurs, that represents the biggest untapped market.”
  • Consumers need help “taking a staged approach to going solar.” At GoGreenSolar, a “Plug N Play Solar Power Kit” starts consumers off with two solar panels that they can add to later. Patel’s prediction: more such modular solutions will become available.

 
Sources: Anonymous. 2008. Clean Energy. Entrepreneur, December: 59; Clayton, M. 2006. Greener, cleaner … and competitive. www.csmonitor.com. December 4; and, Anonymous. 2006. Renewables becoming cost-competitive with fossil fuels in the U.S. www.worldwatch.org. September 18.
 
Rivalry between firms is often based solely on price, but it can involve other factors. Take Pfizer’s market position in the impotence treatment market. Pfizer was the first pharmaceutical firm to develop Viagra, a highly successful drug that treats impotence.
 
In several countries, the United Kingdom among them, Pfizer faced a lawsuit by Eli Lilly & Co. and Icos Corp. challenging its patent protection. These two pharmaceutical firms recently entered into a joint venture to market Cialis, a drug to compete with Viagra. The U.K. courts agreed and lifted the patent.
This opened the door for Eli Lilly and Icos to proceed with challenging Pfizer’s market position. Because Cialis has fewer side effects than Viagra, the drug has the potential to rapidly decrease Pfizer’s market share in the United Kingdom if physicians switch prescriptions from Viagra to Cialis. If future patent challenges are successful, Pfizer may see its sales of Viagra erode rapidly. 62 But Pfizer is hardly standing still. It recently doubled its advertising expenditures on Viagra.
 
Exhibit 2.8 summarizes our discussion of industry five-forces analysis. It points out how various factors such as economies of scale and capital requirements affect each “force.”
Exhibit 2.8: Competitive Analysis Checklist
Economies of scale are X Product differentiation is X Capital requirements are X Switching costs are X Incumbent’s control of X distribution channels is Incumbent’s proprietary knowledge is X Incumbent’s access to raw materials is X Incumbent’s access to government subsidies is X
Concentration of buyers relative to suppliers is X Switching costs are X Product differentiation of suppliers is X Threat of backward integration by buyers is X Extent of buyer’s profits is X Importance of the supplier’s input to quality of buyer’s final product is X
The differentiation of the substitute product is X Rate of improvement in price–performance relationship of substitute product is X
Number of competitors is Industry growth rate is X X Fixed costs are X Storage costs are X Product differentiation is X Switching costs are X Exit barriers are X Strategic stakes are X
How the Internet and Digital Technologies Are Affecting the Five Competitive Forces
LO2.6
 
How the Internet and digitally based capabilities are affecting the five competitive forces and industry profitability.
 
The Internet and other digital technologies are having a significant impact on nearly every industry. These technologies have fundamentally changed the ways businesses interact with each other and with consumers. In most cases, these changes have affected industry forces in ways that have created many new strategic challenges. In this section, we will evaluate Michael Porter’s five-forces model in terms of the actual use of the Internet and the new technological capabilities that it makes possible.
 
Internet
 
a global network of linked computers that use a common transmission format, exchange information and store data.
The Threat of New Entrants
 
In most industries, the threat of new entrants has increased because digital and Internet-based technologies lower barriers to entry. For example, businesses that reach customers primarily through the Internet may enjoy savings on other traditional expenses such as office rent, sales-force salaries, printing, and postage. This may encourage more entrants who, because of the lower start-up expenses, see an opportunity to capture market share by offering a product or performing a service more efficiently than existing competitors. Thus, a new cyber entrant can use the savings provided by the Internet to charge lower prices and compete on price despite the incumbent’s scale advantages.
 
Alternatively, because digital technologies often make it possible for young firms to provide services that are equivalent or superior to an incumbent, a new entrant may be able to serve a market more effectively, with more personalized services and greater attention to product details. A new firm may be able to build a reputation in its niche and charge premium prices. By so doing, it can capture part of an incumbent’s business and erode profitability. Consider Voice Over Internet Protocol (VOIP), a fast growing alternative to traditional phone service, which is expected to reach 25 million U.S. households by 2012. 63 Savings of 20 to 30 percent are common for VOIP consumers. This is driving prices down and lowering telecom industry profits. More importantly it threatens the value of the phone line infrastructure that the major carriers have invested in so heavily.
 
Another potential benefit of Web-based business is access to distribution channels. Manufacturers or distributors that can reach potential outlets for their products more efficiently by means of the Internet may enter markets that were previously closed to them. Access is not guaranteed, however, because strong barriers to entry exist in certain industries. 64
The Bargaining Power of Buyers
 
The Internet and wireless technologies may increase buyer power by providing consumers with more information to make buying decisions and by lowering switching costs. But these technologies may also suppress the power of traditional buyer channels that have concentrated buying power in the hands of a few, giving buyers new ways to access sellers. To sort out these differences, let’s first distinguish between two types of buyers: end users and buyer channel intermediaries.
 
End users are the final customers in a distribution channel. Internet sales activity that is labeled “B2C”—that is, business-to-consumer—is concerned with end users. The Internet is likely to increase the power of these buyers for several reasons. First, the Internet provides large amounts of consumer information. This gives end users the information they need to shop for quality merchandise and bargain for price concessions. The automobile industry provides an excellent example. For a small fee, agencies such as Consumers Union (publishers of Consumer Reports) will provide customers with detailed information about actual automobile manufacturer costs. 65 This information, available online, can be used to bid down dealers’ profits. Second, an end user’s switching costs are also potentially much lower because of the Internet. Switching may involve only a few clicks of the mouse to find and view a competing product or service online.
 
In contrast, the bargaining power of distribution channel buyers may decrease because of the Internet. Buyer channel intermediaries are the wholesalers, distributors, and retailers who serve as intermediaries between manufacturers and end users. In some industries, they are dominated by powerful players that control who gains access to the latest goods or the best merchandise. The Internet and wireless communications, however, make it much easier and less expensive for businesses to reach customers directly. Thus, the Internet may increase the power of incumbent firms relative to that of traditional buyer channels. Strategy Spotlight 2.9 illustrates some of the changes brought on by the Internet that have affected the industry’s two types of buyers.
The Bargaining Power of Suppliers
 
Use of the Internet and digital technologies to speed up and streamline the process of acquiring supplies is already benefiting many sectors of the economy. But the net effect of the Internet on supplier power will depend on the nature of competition in a given industry. As with buyer power, the extent to which the Internet is a benefit or a detriment also hinges on the supplier’s position along the supply chain.
 
The role of suppliers involves providing products or services to other businesses. The term “B2B”—that is, business-to-business—often refers to businesses that supply or sell to other businesses. The effect of the Internet on the bargaining power of suppliers is a double-edged sword. On the one hand, suppliers may find it difficult to hold onto customers because buyers can do comparative shopping and price negotiations so much faster on the Internet. This is especially damaging to supply-chain intermediaries, such as product distributors, who cannot stop suppliers from directly accessing other potential business customers. In addition, the Internet inhibits the ability of suppliers to offer highly differentiated products or unique services. Most procurement technologies can be imitated by competing suppliers, and the technologies that make it possible to design and customize new products rapidly are being used by all competitors.
 
On the other hand, several factors may also contribute to stronger supplier power. First, the growth of new Web-based business may create more downstream outlets for suppliers to sell to. Second, suppliers may be able to create Web-based purchasing arrangements that make purchasing easier and discourage their customers from switching. Online procurement systems directly link suppliers and customers, reducing transaction costs and paperwork.66 Third, the use of proprietary software that links buyers to a supplier’s website may create a rapid, low-cost ordering capability that discourages the buyer from seeking other sources of supply. Amazon.com, for example, created and patented One-Click purchasing technology that speeds up the ordering process for customers who enroll in the service. 67
Finally, suppliers will have greater power to the extent that they can reach end users directly without intermediaries. Previously, suppliers often had to work through intermediaries who brought their products or services to market for a fee. But a process known as disintermediation is removing the organizations or business process layers responsible for intermediary steps in the value chain of many industries. 68 Just as the Internet is eliminating some business functions, it is creating an opening for new functions. These new activities are entering the value chain by a process known as reintermediation—the introduction of new types of intermediaries. Many of these new functions are affecting traditional supply chains. For example, delivery services are enjoying a boom because of the Internet. Many more consumers are choosing to have products delivered to their door rather than going out to pick them up.
strategy spotlight 2.9: Buyer Power in the Book Industry: The Role of the Internet
 
The $25 billion book publishing industry illustrates some of the changes brought on by the Internet that have affected buying power among two types of buyers—end users and buyer channel intermediaries. Prior to the Internet, book publishers worked primarily through large distributors. These intermediaries such as Tennessee-based Ingram, one of the largest and most powerful distributors, exercised strong control over the movement of books from publishers to bookstores. This power was especially strong relative to small, independent publishers who often found it difficult to get their books into bookstores and in front of potential customers.
 
The Internet has significantly changed these relationships. Publishers can now negotiate distribution agreements directly with online retailers such as Amazon and Books-A-Million. Such online bookstores now account for about $4 billion in annual sales. And small publishers can use the Internet to sell directly to end users and publicize new titles, without depending on buyer channel intermediaries to handle their books. By using the Internet to appeal to niche markets, 63,000 small publishers with revenues of less than $50 million each generated $14.2 billion in sales in 2005—over half of the industry’s total sales.
 
Future trends for the industry do not look favorable. The Book Industry Study Group (BISG) released figures in May 2009 which estimated that publishers’ revenues in 2008 reached $40.3 billion, up 1 percent from 2007’s total. BISG expects revenues to increase to $43.5 billion by the end of 2012. There is also good news for online book sellers: According to results from a 2010 worldwide survey by Nielsen Online, 44 percent of users had bought books online—up from 34 percent just three years earlier.
Sources: Healy, M. 2009. Book Industry Trends 2009 shows publishers’ net revenues rose 1.0 percent in 2007 to reach $40.3 billion. www.bisg.org. May 29: np; Books “most popular online buy.” 2008. newsvote.bbc.co.uk. January 29: np. Hoynes, M. 2002. Is it the same for book sales? BookWeb.org, www.bookweb.org, March 20; www.parapublishing.com; Teague, D. 2005. U.S. book production reaches new high of 195,000 titles in 2004; Fiction soars.Bowker.com, www.bowker.com, May 24; and Teicher, C. M. 2007. March of the small presses. Publishers Weekly, www.publishersweekly.com, March 26; and The Nielsen Company, 2010. Global trends in online: A Nielsen global consumer report.
The Threat of Substitutes
 
Along with traditional marketplaces, the Internet has created a new marketplace and a new channel. In general, therefore, the threat of substitutes is heightened because the Internet introduces new ways to accomplish the same tasks.
 
Consumers will generally choose to use a product or service until a substitute that meets the same need becomes available at a lower cost. The economies created by Internet technologies have led to the development of numerous substitutes for traditional ways of doing business. For example, a company called Conferenza is offering an alternative way to participate in conferences for people who don’t want to spend the time and money to attend. Conferenza’s website provides summaries of many conference events, quality ratings using an “event intelligence” score, and schedules of upcoming events. 69
 
 
Another example of substitution is in the realm of electronic storage. With expanded desktop computing, the need to store information electronically has increased dramatically. Until recently, the trend has been to create increasingly larger desktop storage capabilities and techniques for compressing information that create storage efficiencies. But a viable substitute has recently emerged: storing information digitally on the Internet. Companies such as My Docs Online Inc. are providing Web-based storage that firms can access simply by leasing space online. Since these storage places are virtual, they can be accessed anywhere the Web can be accessed. Travelers can access important documents and files without transporting them physically from place to place. Cyberstorage is not free, but it is cheaper and more convenient than purchasing and carrying disk storage. 70
The Intensity of Competitive Rivalry
 
Because the Internet creates more tools and means for competing, rivalry among competitors is likely to be more intense. Only those competitors that can use digital technologies and the Web to give themselves a distinct image, create unique product offerings, or provide “faster, smarter, cheaper” services are likely to capture greater profitability with the new technology. Such gains are hard to sustain, however, because in most cases the new technology can be imitated quickly. Thus, the Internet tends to increase rivalry by making it difficult for firms to differentiate themselves and by shifting customer attention to issues of price.
 
Rivalry is more intense when switching costs are low and product or service differentiation is minimized. Because the Internet makes it possible to shop around, it has “commoditized” products that might previously have been regarded as rare or unique. Since the Internet reduces the importance of location, products that previously had to be sought out in geographically distant outlets are now readily available online. This makes competitors in cyberspace seem more equally balanced, thus intensifying rivalry.
 
The problem is made worse for marketers by the presence of shopping robots (“bots”) and infomediaries that search the Web for the best possible prices. Consumer websites like mySimon and PriceSCAN seek out all the Web locations that sell similar products and provide price comparisons. 71 Obviously, this focuses the consumer exclusively on price. Some shopping infomediaries, such as BizRate and CNET, not only search for the lowest prices on many different products but also rank the customer service quality of different sites that sell similarly priced items. 72 Such infomediary services are good for consumers because they give them the chance to compare services as well as price. For businesses, however, they increase rivalry by consolidating the marketing message that consumers use to make a purchase decision into a few key pieces of information over which the selling company has little control.
Exhibit 2.9 summarizes many of the ways the Internet is affecting industry structure. These influences will also change how companies develop and deploy strategies to generate above-average profits and sustainable competitive advantage.
Exhibit 2.9: How the Internet and Digital Technologies Influence Industry
+ – Threat of New Entrants • Lower barriers to entry increase number of new entrants. • Many Internet-based capabilities can be easily imitated. Bargaining Power of Buyers Reduces the power of buyer intermediaries in many distribution channels. • Switching costs decrease. • Information availability online empowers end users. Bargaining Power of Suppliers •Online procurement methods can increase bargaining power over suppliers. • The Internet gives suppliers access to more customers and makes it easier to reach end users. • Online procurement practices deter competition and reduce differentiating features. Threat of Substitutes •Internet-based increases in overall efficiency can expand industry sales. • Internet-based capabilities create more opportunities for substitution. Intensity of Rivalry • Since location is less important, the number of competitors increases. • Differences among competitors are harder to perceive online. • Rivalry tends to focus on price and differentiating features are minimized.
Sources: Bodily, S. & Venkataraman, S. 2004. Not walls, windows: Capturing value in the digital age. Journal of Business Strategy, 25(3): 15–25; Lumpkin, G. T., Droege, S. B., & Dess, G. G. 2002. E-commerce strategies: Achieving sustainable competitive advantage and avoiding pitfalls. Organizational Dynamics, 30 (Spring): 1–17.
Using Industry Analysis: A Few Caveats
 
For industry analysis to be valuable, a company must collect and evaluate a wide variety of information. As the trend toward globalization accelerates, information on foreign markets as well as on a wider variety of competitors, suppliers, customers, substitutes, and potential new entrants becomes more critical. Industry analysis helps a firm not only to evaluate the profit potential of an industry but also consider various ways to strengthen its position vis-à-vis the five forces. However, we’d like to address a few caveats.
 
First, managers must not always avoid low profit industries (or low profit segments in profitable industries).73 Such industries can still yield high returns for some players who pursue sound strategies. As examples, consider Paychex, a payroll-processing company, and WellPoint Health Network, a huge health care insurer: 74
 
Paychex, with $2 billion in revenues, became successful by serving small businesses. Existing firms had ignored them because they assumed that such businesses could not afford the service. When Paychex’s founder, Tom Golisano, failed to convince his bosses at Electronic Accounting Systems that they were missing a great opportunity, he launched the firm. It now serves nearly 600,000 clients in the United States and Germany. Paychex’s after-tax-return on sales is a stunning 24 percent.
In 1986, WellPoint Health Network (when it was known as Blue Cross of California) suffered a loss of $160 million. That year, Leonard Schaeffer became CEO and challenged the conventional wisdom that individuals and small firms were money losers. (This was certainly “heresy” at the time—the firm was losing $5 million a year insuring 65,000 individuals!) However, by the early 1990s, the health insurer was leading the industry in profitability. The firm has continued to grow and outperform its rivals even during economic downturns. By 2010, its revenues and profits were $65 billion and $4.8 billion, respectively—each figure representing an annual increase of over 18 percent for the most recent four-year period.
 
zero-sum game
 
a situation in which multiple players interact, and winners win only by taking from other players.
 
Second, five-forces analysis implicitly assumes a zero-sum game, determining how a firm can enhance its position relative to the forces. Yet such an approach can often be short-sighted; that is, it can overlook the many potential benefits of developing constructive win–win relationships with suppliers and customers. Establishing long-term mutually beneficial relationships with suppliers improves a firm’s ability to implement just-in-time (JIT) inventory systems, which let it manage inventories better and respond quickly to market demands. A recent study found that if a company exploits its powerful position against a supplier, that action may come back to haunt the company. 75 Consider, for example, General Motors’ heavy-handed dealings with its suppliers: 76
GM has a reputation for particularly aggressive tactics. Although it is striving to crack down on the most egregious of these, it continues to rank dead last in the annual supplier satisfaction survey. “It’s a brutal process,” says David E. Cole, who is head of the Center for Automotive Research in Ann Arbor. “There are bodies lying by the side of the road.”
 
Suppliers point to one particularly nasty tactic: shopping their technology out the back door to see if rivals can make it cheaper. In one case, a GM purchasing manager showed a supplier’s new brake design to Delphi Corporation. He was fired. However, in a recent survey, parts executives said they tend to bring hot new technology to other carmakers first. This is yet another reason GM finds it hard to compete in an intensely competitive industry.
 
Third, the five-forces analysis also has been criticized for being essentially a static analysis. External forces as well as strategies of individual firms are continually changing the structure of all industries. The search for a dynamic theory of strategy has led to greater use of game theory in industrial organization economics research and strategy research.
 
 
Based on game-theoretic considerations, Brandenburger and Nalebuff recently introduced the concept of the value net, 77 which in many ways is an extension of the five-forces analysis. It is illustrated in Exhibit 2.10. The value net represents all the players in the game and analyzes how their interactions affect a firm’s ability to generate and appropriate value. The vertical dimension of the net includes suppliers and customers. The firm has direct transactions with them. On the horizontal dimension are substitutes and complements, players with whom a firm interacts but may not necessarily transact. The concept of complementors is perhaps the single most important contribution of value net analysis and is explained in more detail below.
Exhibit 2.10: The Value Net
 
Source: Reprinted by permission of Harvard Business Review. Exhibit from “The Right Game: Use Game Theory to Shape Strategy,” by A. Brandenburger and B. J. Nalebuff, July–August 1995. Copyright © 1995 by the Harvard Business School Publishing Corporation. All rights reserved.
Source: Reprinted by permission of Harvard Business Review. Exhibit from “The Right Game: Use Game Theory to Shape Strategy,” by A. Brandenburger and B. J. Nalebuff, July–August 1995. Copyright © 1995 by the Harvard Business School Publishing Corporation. All rights reserved.
 
Complements typically are products or services that have a potential impact on the value of a firm’s own products or services. Those who produce complements are usually referred to as complementors.78 Powerful hardware is of no value to a user unless there is software that runs on it. Similarly, new and better software is possible only if the hardware on which it can be run is available. This is equally true in the video game industry, where the sales of game consoles and video games complement each other. Nintendo’s success in the early 1990s was a result of their ability to manage their relationship with their complementors. They built a security chip into the hardware and then licensed the right to develop games to outside firms. These firms paid a royalty to Nintendo for each copy of the game sold. The royalty revenue enabled Nintendo to sell game consoles at close to their cost, thereby increasing their market share, which, in turn, caused more games to be sold and more royalties to be generated. 79
 
complements
 
products or services that have an impact on the value of a firm’s products or services.
 
Despite efforts to create win–win scenarios, conflict among complementors is inevitable.80 After all, it is naive to expect that even the closest of partners will do you the favor of abandoning their own interests. And even the most successful partnerships are seldom trouble free. Power is a factor that comes into play as we see in Strategy Spotlight 2.10 with the example of Apple’s iPod—an enormously successful product.
 
We would like to close this section with some recent insights from Michael Porter, the originator of the five-forces analysis. 81 He addresses two critical issues in conducting a good industry analysis, which will yield an improved understanding of the root causes of profitability: (1) choosing the appropriate time frame and (2) a rigorous quantification of the five force

  • Good industry analysis looks rigorously at the structural underpinnings of profitability. A first step is to understand the time horizon. One of the essential tasks in industry analysis is to distinguish short-term fluctuations from structural changes. A good guideline for the appropriate time horizon is the full business cycle for the particular industry. For most industries, a three- to five-year horizon is appropriate. However, for some industries with long lead times, such as mining, the appropriate horizon may be a decade or more. It is average profitability over this period, not profitability in any particular year, which should be the focus of analysis.
  • The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability. As much as possible, analysts should look at industry structure quantitatively, rather than be satisfied with lists of qualitative factors. Many elements of five forces can be quantified: the percentage of the buyer’s total cost accounted for by the industry’s product (to understand buyer price sensitivity); the percentage of industry sales required to fill a plant or operate a logistical network to efficient scale (to help assess barriers to entry); and the buyer’s switching cost (determining the inducement an entrant or rival must offer customers).

Strategic Groups within Industries
 
In an industry analysis, two assumptions are unassailable: (1) No two firms are totally different, and (2) no two firms are exactly the same. The issue becomes one of identifying groups of firms that are more similar to each other than firms that are not, otherwise known as strategic groups.82 This is important because rivalry tends to be greater among firms that are alike. Strategic groups are clusters of firms that share similar strategies. After all, is Kmart more concerned about Nordstrom or Walmart? Is Mercedes more concerned about Hyundai or BMW? The answers are straightforward. 83
 
strategic groups
 
clusters of firms that share similar strategies.
 
These examples are not meant to trivialize the strategic groups concept.84 Classifying an industry into strategic groups involves judgment. If it is useful as an analytical tool, we must exercise caution in deciding what dimensions to use to map these firms. Dimensions include breadth of product and geographic scope, price/quality, degree of vertical integration, type of distribution (e.g., dealers, mass merchandisers, private label), and so on. Dimensions should also be selected to reflect the variety of strategic combinations in an industry. For example, if all firms in an industry have roughly the same level of product differentiation (or R&D intensity), this would not be a good dimension to select.
LO2.7
 
The concept of strategic groups and their strategy and performance implications.
 
What value is the strategic groups concept as an analytical tool? First, strategic groupings help a firm identify barriers to mobility that protect a group from attacks by other groups.85 Mobility barriers are factors that deter the movement of firms from one strategic position to another. For example, in the chainsaw industry, the major barriers protecting the high-quality/dealer-oriented group are technology, brand image, and an established network of servicing dealers.

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