Strategy Summary PDF

1. Introduction to Strategy Strategy is about answering: 1. Where to compete? Determining industries or markets. 2. How to compete? Deciding the firm's position and activities. The purpose of strategy is to create competitive advantage that generates superior and sustainable financial returns. There are 2 requirements to do so successfully: understanding the business landscape and the choice of a position within this landscape. Effective strategy aligns activities and ensures consistency, achieving superior, sustainable financial returns. A successful strategy integrates external landscape analysis with internal activity coherence. Poor strategies result from misalignment or failure to adapt to challenges. 2. Misconceptions About Strategy Many confuse strategy with tools like marketing, innovation, or cost-cutting. True strategy is about competitive positioning in a challenging environment. Operational effectiveness (e.g., cutting costs) is necessary but not sufficient. 3. Evolution of Competitive Strategy Military roots: Strategy focused on overarching goals, beyond tactics. 19th-century business: new reasons to aplly strategy to business o second industrial revolution o better access to market capitalàlarge scale investment became possible and profitable o economies of scale and scope Academic foundations of business strategy developed in parallel to changes in this industrial economy: SWOT Analysis (1960s): underlying premise=overarching plan for marshaling an organization to succeed in an uncertain environments Porter’s Five Forces (1979): Shifted focus to industry structures affecting profitability. 4. Michael Porter’s Five Forces Framework Developed in 1979, it is still one of the most used tools in industry analysis. Classical economics had posited supply and demand curves in which many suppliers sold undifferentiated products to many buyers, thus achieving an equilibrium of price and quantity for the marketàno single firm had any influence over pricing. The trouble with this model was its limited application to industries in which participants could influence price. For example, some industries with few suppliers or buyers changing the balance of power. 1950s studies suggested some structural factors helped explain why one industry was more or less profitable than another. Porter’s framework systematically evaluates those factors, focusing on how they influence industry profitability. Its power lies in its incorporation of the real-world, commonsense variables, or forces, that can make a particular industry an easy or difficult environment. Porter identified five forces determining industry attractiveness: 1. Threat of New Entrants: o New players who can quickly erode profitability by increasing competition Easier for them to make inroads when the incumber players do not benefit from economies of scale, strong brand identity, or proprietary knowledge (barriers) o Barriers (e.g., capital, brand loyalty) protect incumbents. 2. Bargaining Power of Suppliers: o Unique, concentrated suppliers can raise costs, reducing firm margins (e.g., Coca-Cola syrup bottlers). 3. Bargaining Power of Buyers: o Consolidated buyers, or buyers who are free to direct their purchases elsewhere, force price reductions (e.g., US retail industry àWalmart, Amazon, Target have a lot of power as business buyers because they’re the main actors and have the potential to switch vendors). 4. Threat of Substitutes: o Alternatives (e.g., streaming over cable TV) cap profitability. 5. Intensity of Rivalry: o Competition manifesting itself in aggressive actions: competitors of similar size and sell undifferentiated products, or industry growth is slow Resulting in price wars o High fixed costs and slow growth increase price wars, especially in industries like airlines. o Car industry 6. Complementary Forces o Added later by Adam Brandenburger and Barry Nalebuff: Complements: Goods/services that enhance another product's value (e.g., apps on applestore boosting Apple’s ecosystem). It’s important how easily buyers and the complements themselves can switch to alternative (in the apple- app developers relationship, apple has the upper hand because of its market share and reach) Examples: Consider how structural forces are manifested in two very different industries such as airlines and pharmaceuticals. Following US deregulation in the airline industry in 1978, many new entrants emerged to compete on the most profitableroutes.13 This eventually led to overcapacity, saddling airlines with high fixed costs and underutilized assets on many routes. àThis resulted in margining sufferings because of price wars Relatively low barriers to entry, the availability of substitutes (travelers have other options, such as car, train, bus, or even private and chartered jets), and especially intense competition has made airlines among the least profitable industries. Pharmaceutical companies, in contrast, have enjoyed rather favorable structural forces. Industry revenues have grown as new disease areas have presented themselves, giving firms a “growing pie” for which to compete. Drug development takes years and may cost hundreds of millions of dollars, dissuading potential entrants. In the United States in particular, buyers have traditionally held little leverage because patients are generally unwilling to gamble with their health, and decision power is diffused; doctors are happy to prescribe, and insured patients pay only a fraction of the drug cost. It is not hard to see why the industry has generated such attractive returns Over the years, with empiric evidence, threat of new entrants and intensity of rivrly have proven to be the most influential forces. 2 the integrated set o choices: achieving internal The firm decides how to compete with its business model: the underlying logic of the firm, how it operates, and how it creates and captures value. 2.1 Business models Companies within the same industry can adopt different business models by targeting distinct markets and offering unique value propositions: Luxury vs. Mass Market: BMW focuses on luxury vehicles, targeting high-income consumers, emphasizing premium engineering and design. Ford caters to the mass market, offering a wide range of vehicles to meet diverse needs. Cost Leadership vs. Premium Service: Walmart competes with everyday low prices, relying on cost efficiency and economies of scale. Harrods, DKM, and Nordstrom serve premium segments, offering high-end brands, personalized service, and an upscale shopping experience. Reinvented Experiences: Cirque du Soleil redefined the circus, targeting adults with a blend of music, dance, and acrobatics in partnership with upscale hotels, abandoning traditional elements like animal acts. Components of Business models Business models are structured around two fundamental considerations: 1. Value Proposition: o Differentiation: Increases customer willingness to pay through superior quality, innovation, or branding (e.g., BMW, Cirque du Soleil). o Low Cost: Attracts price-sensitive customers by minimizing costs while maintaining acceptable quality (e.g., Walmart, Aldi). 2. Target Market: o Broad Scope: Aiming for the mass market with products and pricing that appeal to a wide audience (e.g., Ford, Walmart). o Narrow Focus: Serving niche markets with specialized offerings (e.g., Cirque du Soleil, Williams-Sonoma). The core goal is to maximize the gap between the customer’s willingness to pay (WTP) and the firm’s costs: Differentiated Firms: Increase WTP significantly while controlling cost increases, justifying premium pricing. Low-Cost Firms: Reduce prices below competitors by driving down costs, targeting high-volume customers. Some firms have it both: driving down costs and increasing willingness to pay, securing clients some way, while benefitting from economies of scale An underlying economic logic must tie together the chosen activities, ensuring that the right customer value is delivered at the right cost. For example, by driving costs out of every area of their businesses, retailers such as Walmart, Aldi, and Lidl can consistently offer lower prices to their customers across product categories. This in turn attracts the volume of purchases required to operate at the low gross margins that come with discount pricing. 2.2 FIT A coherent set of activities is essential for achieving competitive advantage: 1. Consistency: Activities must align with the value proposition and target market. o BMW ensures high-quality engineering and design to justify premium pricing. o Walmart focuses on sourcing low-cost products and minimizing operating expenses. 2. Mutual Reinforcement: o Cirque du Soleil’s choices (adult-focused shows, upscale partnerships) complement each other, enhancing its differentiated model. 3. Optimization of Effort: enabling cost efficiencies among the activities, eace decision must make to others easier to execute o IKEA’s decisions streamline operations, such as efficient inventory management and customer self-service, placing the stores out of urban centers. 2.3 Trade-offs Activities that fit together imply the converse is true: other activities would not fit. Trade-offs are necessary for focus and clarity: Nordstrom trades higher sales volumes for premium pricing and service quality, avoiding discount retailing to maintain its brand image. BMW cannot easily shift to economy cars due to its focus on luxury design, engineering, and marketing. Limits on coordination and control within the organization require tradeoffs. Front-line staff members, for example perform better when they are equipped with a clear mandate. Firms that refuse trade-offs risk sending mixed signals, confusing customers and employees. In other words, the business model determines the tactics available to the organization as well as those that are not. 3. Importance of Positioning Definition: Firms aim to widen the gap between their customers’ willingness to pay (WTP) and their costs, creating a sustainable competitive advantage. The business landscape metaphor identifies profitable areas (market segments) where firms can maximize this wedge. Successful strategic positioning requires internal and external consistency. Challenges: Identifying the right position on the landscape and building a supporting business model are difficult. Many firms fail by adopting “me too” strategies, which lead to undifferentiated competition, low profitability, and mediocre performance. How to avoid this fate? Firms must offer something unique and valuable to customers, complementors, or suppliers. 3.1 Strategic Options for the Business Landscape The business landscape provides multiple pathways for firms to reposition or redesign their business models to increase profitability. 1. Different Target Market (Point B): o Firms can shift to a less competitive or more fragmented segment with better alignment between offerings and customer needs. o Example: A mousetrap company targets institutional clients (e.g., hotels, offices) instead of households. 2. Different Business Model (Point C): o The firm retains its market but modifies its business model, potentially rebranding or adding premium features to justify higher pricing. 3. Different Positioning and New Target Market (Point D): o A dramatic shift involves entering a new segment with new positioning. o Example: A mousetrap firm repurposes its design for small-pet protection, creating a niche market with high WTP and low competition. 4. Different Business Landscape:changing the topography o External factors, such as alliances or complementary products, can reshape the competitive landscape and open new opportunities for value creation and capture. o Example: Collaborating with a pest control company or developing complementary products like cheese-related traps. Case Studies of Successful Positioning 1. Enterprise Rent-A-Car: differentiated itself by targeting local renters (repair or replacement vehicles) instead of competing in crowded airport markets. 2. Nucor: used mini-mill technology to disrupt traditional steel manufacturing, creating a more flexible, cost-efficient, and profitable model. 3. FedEx: created a new segment with overnight parcel delivery, leveraging sophisticated logistics to dominate this space. 4. Hilti: transitioned from manufacturing tools to managing tool fleets for construction firms, offloading operational burdens and creating unique value. 3.2 Southwest Airlines: Strategic Positioning in Action Challenge: The airline industry faces intense competition, high fixed costs, and low profitability. Solution: o Positioned as a low-cost carrier, targeting price-sensitive customers willing to forgo full-service amenities. o Differentiated with no frills, a point-to-point route system, and exclusive reliance on a single aircraft type (Boeing 737), optimizing efficiency. Key Strategic Choices: o Avoided highly competitive routes, reducing rivalry. o Focused on smaller, secondary airports to mitigate customer bargaining power. o Created operational efficiencies: § Ground crews operated like pit crews, minimizing turnaround times. § No meals or assigned seating reduced costs and sped up operations. o Developed a strong culture of motivated employees, ensuring productivity and alignment. Results: Despite industry challenges, Southwest has remained profitable for decades, with a business model that aligns all activities and demonstrates strong internal and external consistency. 4 Performance Over the Long Run For firms with a competitive advantage, maintaining long-term success involves addressing various threats. Value creation and capture through positioning and business models are not permanent; over time, internal and external forces can disrupt them. 4.1 Recognizing External Threats 1. Imitation: success attracts competitors who replicate profitable strategies. o Historical examples (e.g., Chrysler’s minivan, Apple’s operating system) show that innovation advantages, even when patented, are often short-lived. o Firms can counter imitation through economies of scale, relationships, network effects, and credible retaliation strategies. 2. Substitution: when customer needs or technology shift. o Examples include digital photography displacing film and videoconferencing reducing business travel. o Firms can respond by differentiating their offerings or incorporate the benefits that are shifting demand. If the shift is unavoidable, encouraging substitution on their terms by using an established brand and superior cost position 3. Holdup o Occurs when suppliers, buyers, or complementors gain bargaining power, capturing more value. o Growing dependence on, or interdependence among these parties can lead to greater overlap and conflict in claiming value o Mitigation strategies include diversification of suppliers, contracts, or vertical integration. Internal Barriers to Response Often, firms are so vulnerable to external threats because of their prior succsess: organizations attempt to fit their response within their existing strategy and fail to recognize that a change in opportunity may require a new strategy. Common barriers include: Perception: Failing to recognize the threat. Motivation: Recognizing but avoiding action. Inspiration: Willingness to act without clear strategies. Coordination: Knowing how to act but failing to execute. Examples: Blockbuster: Slow response to Netflix due to fears of cannibalizing in-store revenue (perception). When they finally responded the public had become too accustomed to Netflix’s model. Incremental tweaks left few good options (inspiration) and the existing model was too intertwined with the high fixed costs of the retail (coordination) 4.2 Maintaining Success Over Time If a firm has created competitive advantage, then it has figured out a profitable way to thrive in its position on the business landscape. However, threats to sustainability exist because the structural forces (Porter) are not static. Imitation and Substitution= new entrants and rivalry. Holdup= sifts of power towards supplier, buyers or complementors. Case Study: Microsoft and Intel: Collaborated successfullyà complementarity. But faced imitation threats. Intel mitigated risks by launching branding campaigns, diversifying offerings (launching its own computer to avoid Hold up by buyers), and maintaining control over critical components. 10. Alternative Perspectives Not based on Porter’s model 1. Blue Ocean Strategy: focus on the strategic move o Red oceans: overcrowded by competitors àgrowth and profitability are constrained and eventually eroded by competitors o Blue oceans: unmet demand can be found Creating new demand with a value proposition that no other company has yet delivered Can emerge from unattractive core businesses once the boundaries of existing industries are shifted o Examples: Cirque du Soleil, Ford’s Model T, and Dell’s build-to-order PCs. 2. Resource-Based View (RBV): focus on resources and capabilities o Resources= what company has Capabilities= what is does with them o The inward approach of the Porter’s model had led some to over emphasize choosing the right industry Proponents of RBV sought to bridge the outward and inward approaches Ownership of valuable resources is the source of a company’s advantage but the value of these resources can be determined only by external forces 1. Market demand 2. Scarcity 3. Appropriability o Sustainable advantage comes from unique, valuable, inimitable resources (e.g., Google’s algorithm, Apple’s ecosystem). 3. Emergent Strategy: focus on adaptability experimentation, and learning over rigid, centralized planning. o Unlike deliberate strategies, it develops through iterative processes, where real-time market feedback and operational experiences guide adjustments. o formalized strategies often fail due to unforeseen external events. o Netflix exemplifies this approach, pivoting from DVD rentals to streaming after testing and learning from its initial missteps. 11. Key Takeaways Strategy integrates internal activities with external realities. Competitive advantage depends on fit, trade-offs, and adaptability. Sustaining advantage requires vigilance against external and internal threats. Industry analysis Introduction An industry is defined as a group of firms offering products or services perceived by customers as meeting the same needs. Firms operate in an industry environment consisting of suppliers, customers, and potential entrants, which shape profitability. Collectively, we refer to the firms in the industry and in the industry environment as market participants. Industry analysis reveals how profits are distributed among these participants and helps firms respond to negative developments or seize opportunities. It is based on a fundamental principle of economics: people respond to incentivesàif there are profits to be made, market participants will try to appropriate them. It identifies threats, opportunities, and strategic actions, aiding firms in increasing profits, assessing competition, and shaping the industry environment. Steps for Industry Analysis: 1. Define the industry. 2. Identify key players (market participants). 3. Analyze their influence on profitability. 4. Test and refine the analysis. 5. Develop strategies to navigate the environment. 6. Predict and respond to changes influencing profitability. 1 The Five Forces Framework Developed in 1979, the Five Forces framework analyzes the competitive forces shaping industry profitability: 1. Threat of New Entrants: Barriers to entry like capital requirements and brand loyalty protect incumbents. 2. Bargaining Power of Suppliers: Powerful suppliers can raise costs, squeezing profits. 3. Bargaining Power of Buyers: Buyers can demand lower prices or higher quality. 4. Threat of Substitutes: Alternatives to a product cap profitability. 5. Rivalry Among Competitors: Intense rivalry reduces margins. Later, complements (products enhancing others' value) were added as a force influencing industry dynamics. Economic Foundations Rooted in industrial organization economics and game theory, the framework simplifies complex economic modeling to assess factors like price elasticity and fixed costs. It helps managers determine profitability drivers such as willingness to pay (WTP), costs, and pricing power. Microeconomics foundations: Influence of substitutes on price elasticity of demand Rivalry among existing competitors is likely to be grater when fixed costs are high and marginal costs are low Game theory: retaliating against new market entrants by lowering price can help deter market entry Industry Profitability Variations The framework explains profitability discrepancies across industries. For example: High-profit industries (e.g., soft drinks, security brokers) face muted competitive forces. Low-profit industries (e.g., airlines, hotels) are impacted by intense competition and high supplier/buyer power. Case Study: Ofo Ofo, a dockless bike-sharing startup, initially thrived with rapid expansion but failed due to intense competition, low barriers to entry, and substitutes. Its inability to withstand these forces, like price competition and switching costs, led to its collapse by 2019. 2 Methodology of Five Forces Analysis Five Forces Analysis Methodology When applying Porter’s model it is important to focus on the economic factors influencing the forces, including potential changes over time. Complements are also integrated into the framework for a holistic view. 1. Threat of New Entrants When profits in an industry are high, new competitors are incentivized to enter, increasing competition and lowering profitability. The ease of entry depends on barriers to entry whose size depends on: Supply-Side Economies of Scale: they give high volume incumbents a cost advantage over entrants because they force a potential entrants to enter at scale or to accept a cost disadvantage (DHL vs UPS and FedEx in the US) o Economies of experience and of scope can also create barriers to enter (It consulting) Demand-Side Benefits of Scaleànetwork effects: make larger platforms (e.g., eBay, Facebook) more valuable for users, deterring new entrants, because the value buyers get increases as more people buy it Customer Switching Costs: high switching costs discourage customers from changing suppliers (e.g., Microsoft Windows users). Capital Requirements: industries requiring significant upfront investments (e.g., semiconductors) are harder to enter. Incumbency Advantages: first movers benefit from resources, branding, or expertise unavailable to newcomers. Distribution Channel Access: limited capacity or established relationships favor incumbents (e.g., movie distribution channels). Restrictive Government Policy: governments can restrict or prohibit new entrants. Licensing, patents, and regulations act as barriers. High Barriers to Exit: costly exits, long term contracts, (e.g., pension liabilities) deter new entries by reducing industry flexibility. These barriers are exogenous to the industry, other can be endogenous, i.e. created by industry participants to deter entrants (game theory aspect of market entry): Incumbent Retaliation: aggressive responses from incumbents discourage entry: o Price cuts o Advertising Incumbents have substaintial resources 2. Bargaining Power of Suppliers Suppliers influence profitability by raising prices or reducing the quality of goods provided to firms. Bargaining power influences price, while price sensitivity influences quantity (crude oil and soccer players). Key factors that enhance supplier power include: Supplier Concentration: when supplier are more concentrated than the industry they sell to, they have more market power. (e.g., Microsoft and Intel in PC manufacturing). Switching Costs: high costs deter buyers from switching suppliers (e.g., Adobe Photoshop users with extensive document libraries). Differentiated Products: unique products increase supplier power (e.g., branded footwear for specific markets). Few or No Substitutes: suppliers of patent-protected drugs have significant bargaining power. Threat of Forward Integration: suppliers creating competing products (e.g., soda manufacturers bottling their own drinks). Low Dependence on Industry: suppliers with diverse customer bases are less reliant on any single industry. 3. Bargaining Power of Buyers Buyers' power is the mirror image of suppliers’ power. Key factors influencing buyer power include: Customer Concentration (Monopsony Power): when customer are more concentrated than the industry from which they are buying, or they are buying in volumes that are large compared to the size of a vendor. (Costco exert significant leverage over suppliers). Low Switching Costs: commoditized industries (e.g., airlines) face high buyer power due to easy supplier switching. Undifferentiated Products: lack of perceived differences (e.g., fresh produce) strengthens buyer power. Threat of Backward Integration: buyers producing their own goods (e.g., supermarket chains creating store-brand products). Price Sensitivity Drivers: Concentration of Purchases: customers are price-sensitive when purchases form a large part of their expenses (e.g., steel manufacturers buying raw materials). Financial Pressure: customers earning low profits demand lower prices. Impact on Product Quality: buyers scrutinize the cost of components directly affecting product quality. Strategist also need to consider the power distributor have over consumers. 4. the threats of substitutes Substitutes compete for industry profits by offering alternatives outside the industry. One product is a substitute for another if a price increase in one increases sales in the other. The threat increases when substitutes offer similar benefits at lower costs or better performance-to-price ratios. Factors Affecting the Threat: Closeness: the closer the substitute, the higher the risk of substitution. Performance/Price Ratio: substitutes that provide slightly lower performance at much lower prices pose a greater threat. 5. Rivalry among existing competitors Rivalry among competitors reduces profits. Price-based competition is especially harmful, but firms may also compete on dimensions like product features, delivery time, or service quality. Factors contributing to price based competition: Lack of Differentiation and low switching costs High Fixed Costs and low marginal costs: encourage firms to lower prices to cover costs Need for capacity to expand in large increments: large changes in industry supply create price volatility Perishability: products with a short shelf life force price cuts close to expiration. Factors contributing to intense industry competition: Many competitors of roughly the same size: when there are few large competitorsàoligopolist pricing. When one is significantly bigger than the othersàthey act as a price leader. When everyone is the same sizeàhigher competition Slow industry growth: pie is too small High exit barriers Diversity of rivals’ approaches: the lack of common approach to producing profit reduces the chance of tacit collusion 6. extending the analysis to cooperation and complements The Five Forces framework traditionally emphasizes competition, but, sometimes, a business will cooperate with customers or another business in order to grow a marketàmake the pie bigger Complements: product typically consumed together, provide an incentive to cooperate. These complements, such as apps for smartphones or software for PCs, enhance product value and customer loyalty. For instance, Apple’s ecosystem of apps boosts its device value, while Google Chrome complements its online services, lowering entry barriers for rivals like Microsoft and Netscape in the browser industry. This cooperation is termed “co-opetition,” where businesses collaborate to grow the overall market while competing for profits. Complements as the Sixth Force Complements can act as a "sixth force" in Porter’s framework, influencing demand and creating competitive dynamics (Netscape vs. Microsoft). While it’s useful to think of complements as a sixth force, strategists must also assess how complements affect the five forces, such as lowering entry barriers or reshaping supplier dynamics. Factors Influencing Complements The power of complements depends on several factors: Complement concentration: dominant complements exert significant influence, like Google launching Chrome. Relative switching costs: ff switching between competitors is easier than switching complements, complements gain more power. Influence on demand: complements like the Premier League boost demand for cable and streaming services. Asymmetric threats: some core markets can enter complement markets but not vice versa (e.g., automakers leveraging battery technology). Rate of profit growth: a fast-growing profit opportunity is likely to decrease the influence of complements on the industry. 2 Applying Industry Analysis Industry analysis helps firms identify ways to profit within their environment by either finding or creating attractive conditions or developing a competitive advantage despite challenging conditions. These approaches are not mutually exclusive. 1. Positioning and Creating Attractive Environments Positioning= establishing a unique position in a market segment relative to competing firms. It involves establishing a unique market segment to fend off competitive threats and exploit opportunities. Firms can also reshape industry structures by leveraging changes over time. Differentiating the product and developing a powerful brand mitigate rivalry from competitors, and A cohesive owners community creates switching costs for those considering alternatives. 2. Key Considerations in Applying Industry Analysis 1. Profitability in Tough Industries: companies like The Economist Group and Southwest Airlines show it is possible to profit even in highly competitive environments by effectively addressing the Five Forces. 2. Identifying New Positions: strategists can react to competitive forces by occupying untapped niches. 3. Spotting and Exploiting Change: recognizing shifts in industry structure, before others, can reveal new opportunities. 4. Shaping Industry Structure: firms can proactively influence industry structure 5. Leveraging Technology: innovators can use technological understanding to defend profits against imitators. 6. Expanding into New Markets: analysis is especially critical for geographic or product-line expansion. 3. Turning Threats into Opportunities Strategists can convert challenges into opportunities Example: The Wine Industry Neither the budget nor the premium segment appears highly attractive. Budget segment: Powerful costumers Large entry barriers Intense rivalry Threat of substitutes Premium segment: Powerful distributors and retailer, customers aren’t price sensitive but they like to switch Easy to enter Limited price competition, fragmented market However, boutique winemakers have succeeded by targeting niche customer bases and developing direct-to-consumer business models. Yellow Tail found success by simplifying wine choices, targeting consumers of substitute products, and creating a sense of fun. However, barriers to imitation are necessary for sustaining profitability, as imitators quickly eroded Yellow Tail’s competitive edge. 4. An example of performing and applying industry analysis The strategic process involves identifying issues, forming hypotheses, and testing them to direct specific actions. For Walmart, two strategic questions are posed: identifying profit opportunities and assessing threats to profitability. Hypotheses include profit potential in expanding stores and services and the threat of rising labor costs. 4.1 Define the Industry Defining the industry is a crucial step that considers customers’ perspectives. Walmart competes in the "lower price but less convenient" than supermarket industry, facing direct competition not from local supermarkets but from other discount retailers. Local supermarkets are substitutes for Walmart, for consumers who calue convenience over pricing, the supermarket is an attractive option. The US Department of Commerce categorizes Walmart under "general merchandise retailers," but a detailed industry definition includes analyzing customer groups, needs, and technologies. Industry definition should be unambiguous and useful in addressing the issue at handàspecific enough to direct action. It should allowWalmart to explore precise profit opportunities, such as geographic locations and possible new store formats. One approach would be to define Walmart’s industry as the superstore industry in the United States; in this case, competitors in 2003 were Target and Kmart. Warehouse clubs would be substitutes, so is Amazon and local supermarkets. The dimensions along which we define the industry give us insights into positioning. One dimension of positioning is physical location, other are product range pricing and technology. Walmart superstore, Costco warehouse clubs, local supermarkets, and Amazon occupy different positions and would require different analysis. Performing and applying industry analysis requires research: 4.2 identify the players To evaluate Walmart’s profitability, it is crucial to identify the "players" in the industry based on Porter’s framework, dividing them into categories like potential entrants, suppliers, customers, substitutes, and industry competitors. For Walmart in 2003, the key players included: Industry Rivals: Walmart, Kmart, Target. Suppliers: various manufacturers of consumer goods (e.g., P&G, Unilever), Walmart’s private-label suppliers, landowners for store locations, IT and logistics. Customers: primarily individual or family consumers. Substitutes: supermarkets, online food delivery, specialty markets. Potential Entrants: domestic and foreign supermarket chains. Complements: transportation and financial services. Nonmarket Actors: labor unions, government agencies. 4.3 Analyze the Players' Influence on Profitability Threat of New Entrants: Barriers to entry include economies of scale in purchasing, distribution, and store operations, though switching costs and capital costs are low. Incumbent advantages include relationships with zoning authorities and control over large retail spaces. Exit barriers are not high. Bargaining Power of Suppliers: Branded product suppliers like P&G have significant power due to innovation and marketing investments. Labor suppliers, particularly in regions with unions, can affect Walmart’s profitability. Property suppliers hold power in competitive urban markets. Bargaining Power of Buyers: Customers are price-sensitive, and superstore purchases represent a substantial share of household expenses. Threat of Substitutes: High due to numerous options like supermarkets, online retailers, and specialty stores, though substitutes often trade off higher prices for convenience. Rivalry Among Existing Firms: High rivalry driven by price competition among firms selling undifferentiated products. Large-scale competitors like Target differentiate by focusing on higher-end products. Complements: Driving and payment services complement Walmart’s superstores, presenting opportunities in related sectors like auto services and banking. Profitability in the superstore industry is low due to high, price based rivalry, customer bargaining power, and threats from substitutes 4.4 Test the analysis The best way to test and industry analysis is to compare its predictions with observed levels of profitability. If an industry has generally low profitability, then the analysis should have identified at least one powerful force that shrinks the profit pie. In the US superstore industry, Kmart’s losses and its subsequent bankruptcy and reorganization suggest that this is indeed a tough industry. From our analysis, we would expect that some combination of hard-bargaining suppliers, price-sensitive customers, a potent threat of substitutes, and intense industry rivalry caused the company’s demise. However he financial performance of Walmart and Target suggests that it is possible to mitigate the threat of the competitive forces in this industry. Now we need to pivot from analyzing the industry and its environment to understanding how to succeed in that environment. 2.5 Develop a way to deal with the industry environment Instead of merely labeling an industry as attractive or unattractive, the goal of industry analysis is to uncover profit opportunities, develop strategies to exploit them, and identify threats to profitability with counter-strategies. We started with two strategi questions about Walmart, to answer these, it's necessary to understand Walmart's source of profitsàcompetitive advantages, which include: Lower SG&A Costs: Walmart's superstore sales costs in 2003 were 18% of sales, compared to 21% for Kmart and 26% for Target Scaleàadvantage in sourcing goods Efficient Supply Chain: Walmart achieved superior inventory turnover compared to its competitors 2.5.1 Analyze Positioning for Profitability Positioning for the Threat of New Entrants The superstore industry leverages economies of scale and scope. A viable position involves: Local Markets: superstores need a potential customer base of 76,000–150,000 to remain viable. Distribution Centers: these centers require proximity to multiple stores within a 150-mile radius for efficiency. Even at this stage, the analysis is pointing to a positioning that looks like Walmart’s: large scale stores with a wide range of products saturating regions with numerous small towns Positioning to Counter the Bargaining Power of Suppliers Walmart counters supplier power by: Being a large purchaser, thus commanding better terms. Increasing product substitution through private-label brands (20% of sales in 2003). Leveraging alternative sourcing and competition to limit supplier control. o Positioning itself in state with weaker unions and lower minimum wages Positioning to Counter the Bargaining Power of Buyers Early market entry allows Walmart to establish dominance. Buyers face switching costs tied to geographic convenience, although these are mitigated by substitutes. Positioning to Counter the Threat of Substitutes By focusing on small-town locations, Walmart has a local monopoly, diminishing competition from substitutes like local supermarkets and specialty retailers. Walmart also competes with substitutes directly through platforms like Walmart.com. Positioning to Counter Industry Rivalry Walmart's competitive advantage and willingness to compete on price have muted industry rivalry. Low-cost structure and efficiency mitigate industry rivalry, especially after competitors like Kmart faced bankruptcy. Other rivals, such as Target, pursue different market segments, focusing on upscale products. Walmart’s Integrated Set of Positioning Choices Walmart's strategy in the superstore industry can be summarized: large-scale stores, large product range, rural and small-town locations, regional cost in the industry. This is an integrated set of choices because the decisions are mutually reinforcing. Identifying New Profit Opportunities Returning to earlier hypotheses: 1. Walmart could expand into untapped rural and small-town markets. 2. Introducing new services (e.g., banking) in existing stores could exploit local market dominance. Testing these hypotheses would involve analyzing infrastructure and consumer behavior in targeted regions. 2.5.2 Exploit Industry Change The last step is to look at change in the industry and its environment. Companies can exploit change and even act to shape the industry and its environment in their favor. Changes could be market-driven or external, such as regulatory developments or new technologies. Industry analysis helps companies predict the impacts of these changes and adapt accordingly. Analyze Profitability Over Time Changes like technological advancements or regulations can dramatically alter an industry's profitability. For example, the Internet revolutionized the newspaper industry, causing a shift in the value captured by traditional print media. The emergence of alternative platforms reduced barriers to entry, diminished advertiser dependency, and redefined the competitive landscape. Of course, strategist cannot anticipate every conceivable technology development. But they can use the five forces framework to explore how changes in various factors can affect the five forces, thus influencing industry profitability. Impact on Walmart Changes in the Threat of New Entrants Walmart’s strategy of entering local markets at the minimum efficient scale makes it hard for rivals to displace them. Maintaining cost leadership helps the company deter competitors in smaller markets. Changes in the Bargaining Power of Suppliers As Walmart grows and increases private labels, product supplier power decreases. However, as it moves towards urban areas, the company faces rising labor costs in urban areas due to unionization, higher wages, and regulatory pressures. Moreover, as it seeks to expand beyond its traditional market of rural areas, il will face more competition for suitable locations (neighborhoods, labor unions). Strategies to avoid this would include experimenting with models requiring less workers and targeting regions with less stringent labor laws. From a non-market perspective, lobbying and developing community relationships, are likely to be increasingly important. Changes in the Bargaining Power of Buyers Walmart faces price-sensitive customers, especially in rural markets, but as it expands into affluent areas, customers gain more alternatives. Walmart can address this by increasing switching costs, such as proximity to substitutes. Changes in the Threat of Substitutes Substitutes for Walmart are increasing, especially with urbanization and online competitors. Traffic congestion makes closer substitutes more attractive. Walmart could counter this by exploring innovative delivery models for densely populated areas. Changes in Industry Rivalry Expansion into new geographic markets may intensify rivalry. Competition might shift towards localized dominance rather than head- to-head competition between neighboring superstores. Changes in the Influence of Complements As urban population density grows, Walmart could form partnerships with parking facilities, leveraging complements to enhance customer convenience. Threats to Walmart’s Profitability Labor costs are an ongoing concern, but increasing rivalry, increasing costs and distribution inefficiencies in urban markets pose significant threats. Walmart may explore smaller store formats or focus on premium offerings like Sam’s Club to compete in affluent urban markets. 2.5.3 Leverage Industry Analysis to Compete over Time Industry analysis is a snapshot in time, but businesses compete through time. Developing a strategy for competitive positioning is critical, particularly for innovators. Amazon, for example, adopted a strategy termed "Get Big Fast!" that focused on building barriers to entry through economies of scale, brand positioning, and strategic pricing. Walmart similarly leveraged economies of scale by expanding its reach into rural markets, creating a significant regional presence that established barriers to entry for competitors. Timing as a Factor in Market Entry: early market entry at scale, as Walmart demonstrated by entering rural markets before competitors, creates significant barriers. Timing and commitment, such as building distribution centers and promptly following up with store openings, deter competitors. Walmart’s ability to signal commitment in this way has allowed it to maintain its competitive edge. 2.5.4 Explore Opportunities to Shape Industry Structure Shaping the Industry Advantage Companies can actively influence and shape their industry's structure. For example, Boeing once held a dominant position in the very large commercial transport (VLCT) segment, extracting significant profits from airlines. However, a combination of factors—including state support for competitors—shifted the industry's dynamics, resulting in greater competition. Examples of Shaping Industry Structure Fragmented Industries: Consolidation trends, such as Qualcomm’s acquisition of smaller firms in the semiconductor industry, help shape the competitive landscape. Emerging Markets: Emerging industries can be influenced by securing valuable assets or creating customer switching costs. Complementors' Role: Google mitigated the threat of mobile platforms dominating search advertising by developing the Android operating system, ensuring no platform gained too much power. Walmart's Approach As a market leader, Walmart has shaped the U.S. retail environment through expansion and operational efficiencies. However, substitutes and customer bargaining power remain significant forces. Walmart's strategy focuses on expanding into substitute industries and leveraging scale to maintain competitiveness. 2.6 Criticism and Limitations 2.6.1 Does the Five Forces Framework Analyze the Business Environment Adequately? Critics argue the framework excludes important players such as governments, trade unions, and complements. Additionally, it is static and cannot account for evolving industry structures or strategic interactions like collusion. Yes, it needs to be augmented with complements, but non-market actors can be represented with their influence on the five forces The framework is useful for developing strategies over time. When treated as a snapshot, it helps strategists analyze current forces and plan for desired future changes. Yes, it doesn’t predict specific competitor responses, in some cases it is helpful to supplement it with game theory 2.6.2 Does Industry Analysis Explain Competitive Advantage? The framework focuses on industry economics but doesn’t address why specific firms outperform others. To understand competitive advantage, strategists consider decisions around activities, resources, and capabilities, as explained by resource-based theories. Competitive advantage complements, rather than competes with, the Five Forces framework. 2.6.3 Does Industry Analysis Help Companies Identify New Opportunities and Anticipate Change? The framework is criticized for focusing on existing competition rather than creating new ways of competing, a concept central to approaches like Blue Ocean Strategy. While valid, the the Five Forces is a tool for understanding competitive dynamics, not necessarily for innovation, so it has a different approach that the Blue Ocean Strategy. Scenarios and dynamic strategies can supplement it to anticipate future changes. 2.7 Conclusion: The Business World Changes, but Industries Remain Management trends may shift, but fundamental economic principles endure. Industry analysis allows organizations to understand and adapt to competitive forces. As technology and environments evolve, firms must integrate economic principles into strategies for survival and success. 3.How Much Does Industry Matter? This section examines the significance of industry context for a firm's success. It explores the "firm versus industry" debate, questioning whether individual firm characteristics or the broader industry environment play a more significant role in determining profitability. Key Arguments: 1. Importance of Both Firm and Industry: Michael Porter asserts that strategy must align both the firm and the industry environment. A firm cannot succeed without dealing effectively with competitive forces, regardless of its internal characteristics. 2. Research on Industry Effects: o Richard Schmalensee (1985) found that industry effects (differences between industries) explained up to 75% of the variance in profitability, suggesting the critical role of industry characteristics. o Richard Rumelt (1991) countered this by finding that firm-specific effects explained 46% of profitability variance, while industry effects accounted for only 8%. This highlighted significant differences among firms within the same industry. o McGahan and Porter (1997) found both firm-specific and industry effects to be important, with firm effects accounting for 32% and industry effects for 36% of profitability variance. They noted considerable variation across industries. 3. General Conclusions: o Empirical studies reveal that industry effects explain 5-15% of profitability variance, while firm effects account for 30-45%. o Competitive forces within industries affect all firms, but firms can respond differently through branding, strategies, and differentiation. Takeaway: While industries matter, firms' strategic choices and unique characteristics often have a larger impact on profitability. The Five Forces framework helps identify competitive pressures and opportunities, emphasizing that firm-specific responses can lead to success within the same competitive environment. Competitive advantage 1 The Logic of Value Creation and Distribution Competitive advantage arises when a firm creates added value, which is the difference between the willingness to pay (WTP) of customers and the supplier opportunity costs (SOC). The case of Harnischfeger Industries’ portal cranes illustrates the concepts of value creation and distribution. Harnischfeger Industries Case: Harnischfeger, based in Milwaukee, produced material-handling equipment, including portal cranes, which were introduced in the late 1970s as a more efficient alternative to forklift fleets. The portal cranes offered significant customer benefits. Despite this value gap, Harnischfeger struggled to profit, raising questions about value capture. 1.1 Willingness to Pay and Supplier Opportunity Cost Willingness to Pay (WTP): The maximum amount a customer is willing to pay for a product or service. Supplier Opportunity Cost (SOC): The minimum amount a supplier will accept for their resources based on alternative uses (I’m assuming it is the same as WTS?). The value created by a transaction is given by the difference In the Harnischfeger case, the WTP for a portal crane was $7.5 million, while SOC was estimated at $2.0 million. The transaction value is the difference between these figures. 1.2 Added Value Definition: added value measures a firm’s unique contribution to a transaction, the total value created by all participants in a transaction minus the maxima value that could be created without the firm. Without added value, a firm cannot capture profits. Unrestricted bargaining: the amount of value a firm can claim cannot exceed its added value. Competition and Added Value: The entry of competitors, such as Kranco, reduced Harnischfeger’s added value to zero, as Kranco offered similar products at similar costs. To regain value, Harnischfeger needed to differentiate its offering, such as adding services that raised WTP without significantly increasing costsàwidening the gap between WTP and SOC 1.3 Added Value and Competitive Advantage Competitive advantage emerges from creating a wider gap between WTP and SOC than competitors. A firm establishes added value by making sure that it is unique in some valuable wayàcompetitive advantage comes from scarcity This often involves either: 1. Increasing WTP without raising costs proportionally. 2. Reducing SOC without lowering WTP. 1.4 Supplier Opportunity Costs Versus Actual Costs Theoretical Framework: SOC represents the least suppliers will accept, while actual costs reflect concrete financial expenditures. The relationship between the two is key to understanding and reducing supplier costs strategically. Practical Application: Managers often focus on reducing actual costs while ensuring that SOC does not escalate. Efforts like streamlining supply chains and improving supplier relationships can drive competitive advantageàthis is why we talk about Willingness to Pay 2. The Tension Between Costs and Willingness to Pay Widening the wedge between cost and willingness to pay is difficult because a firm must often incur higher costs in order to deliver a product or service for which customers are willing to pay more Example: Whole Foods maintained high margins through premium pricing for organic foods and superior customer service. However, competitors eroded this advantage by offering similar products at lower costs. Strategies for Competitive Advantage: Differentiation Strategy: focuses on increasing WTP with minimal cost increase. o Example: Hilti specializes in power tools for commercial clients, incorporating R&D and high-quality services to command high prices. o Important to note that differentiated does not mean merely different, we mean that the company had boosted WTP Low-Cost Strategy: focuses on minimizing costs with a slight reduction in WTP. o Example: Ryanair reduces amenities to achieve very low costs, dirving costs per passenfer to very low levels. This created lower WTP in its customer, but for its target, price-sensitive travelers, costs savings are grater. Dual Competitive Advantage: combining differentiation and cost efficiency. Scholars have two hypothesis: o Dual advantage is rare and typically based on operational practices across firms that are easily copied o Breaking the trade-offs between cost and WTP is a fundamental way to transform competitions in an industries o Examples: § Apple: Boosts WTP through innovation and complementary products like the App Store, which adds utility and convenience. § Barry-Wehmiller: Differentiates itself with a "human leadership" approach, increasing customer satisfaction and employee-driven cost savings. § Trader Joe’s: Uses a mix of high-quality products and unique customer experiences to maintain high customer loyalty and justify premium prices. 3. Activity Analysis To analyze competitive advantage, strategists separate a firm into its discrete activities or processes and then examine how each contributes to the firm’s relative cost position or willingness to pay. Differences among firms in those activities dictate competitive advantage. A four-step process is recommended: 1. Catalog Activities (Value Chain Analysis): Identify all primary (e.g., production, logistics) and support (e.g., HR, technology) activities. 2. Analyze Costs: Assess cost drivers, including economies of scale, product mix, and logistics. 3. Analyze WTP: Determine how activities influence customer perception and WTP. 4. Predict Changes: Anticipate shifts in activities or external factors impacting competitive positioning. 3.1 Value Chain Analysis The value chain is an activity template that illustrates the sequence of activities or discrete economic functions a company performs. The template divides activity into two classes primary activities that directly generate a good or service, and support activities that make the primary activities possible. Primary activities are furtherly broken down into inbound logistics, operations, outbound logistics, marketing and sales, and post sales service. Support activities include procurement of inputs, development of technology and human resources, and general firm infrastructure. Note: the value chain should not represent everything the firm does. It is intended to highlight the activities that the firm does differently from competitors, including what it does not do that is competitors might. Example: Hurtigruten (cruise operator) uses low-cost ships, with more beds, and avoids luxury amenities, differentiating itself from rivals. What they do similar to competitors (like maintenance) is not included in their value chain analysis. 3.2 Cost Analysis Once activities have been cataloged, they must be analyzed in terms of their impact on cost and willingness to pay relative to the competition. Competitive cost analysis is the usual starting point for the strategic analysis of competitive advantage. Collins Kitchen analyzed its cost structure and found inefficiencies compared to Betsy Baking, which used scale economies and simpler operations for a cost advantage: Collins cataloged the major elements of their value chain and calculated costs associated with each class of activities For each activity, the managers then determine cost drivers, factors that increase or decrease the cost of an activity o They are critical because they allow managers to estimate competitors’ cost positions. Using their own company’s costs and the numerical relationships to cost drivers, managers can estimate a competitor’s cost position. Points about relative cost analysis: When reviewing a relative cost analysis, it is important to focus on differences in individual activities, not just differences in total costs good cost analysis typically focuses on a subset of a firm's activities o they usually break out in greatest detail cost categories that: § pick up on significant differences across competitors or strategic options § correspond to technically separable activities § are large enough to influence the overall cost position significantly for activities that account for thicker lives of costs. It's important to look closely at cost drivers: o the analysis of any cost category should focus on the drivers that have the biggest impact on it a particular cost driver should be included only if it is likely to vary across the competitors under consideration because the analysis of relative costs inevitably involves many assumptions, sensitivity analysis is crucial. 3.3 WTP analysis Indicates that differences in willingness to pay account for more variation in profitability among competitors than disparities in cost levels. Activities like product design and manufacturing often influence product characteristics (e.g., quality, durability, aesthetics) and customers’ willingness to pay. Additionally, post-sale activities, complementary goods, branding, and advertising are subtle but significant contributors to willingness to pay. Although a perfect formula for calculating willingness to pay would be ideal, such a tool is typically infeasible. Willingness to pay depends on intangible factors, customer perceptions, and the nonlinear effects of firm activities. It also varies when firms sell through intermediaries rather than directly to end-users, adding further complexity. Without precise tools, firms simplify the process by focusing on four questions: 1. Who is the buyer? Identifying the actual decision-maker in the purchase process (e.g., parents buying snacks for children). 2. What does the buyer want? Understanding customer preferences, desires, and trade-offs (e.g., price, freshness, or brand recognition). 3. How well are the buyer’s needs being met? Evaluating how effectively a firm and its competitors satisfy customer needs. 4. How do differences in meeting buyer needs link to activities? Connecting success in meeting customer needs to specific firm activities. Guidelines for Willingness-to-Pay Analysis The process should refine activities to focus on needs that influence customer choice. For example: Needs satisfied equally well by competitors can be ignored. Needs with a small impact on decision-making relative to other products can also be excluded. Customers differ in preferences: Horizontal differentiation involves customers ranking product differently based on subjective factors (e.g., brand preference) vertical differentiation arises when customers agree on quality but differ in how much they will pay for better versions (e.g., hardcover vs. paperback books). Customer segmentation is the usual response to horizontal differences in preferences. Firms identify clusters of customers with similar desires and tailor their offerings accordingly. The more diverse customer needs are, and the cheaper it is to customize the firm’s product, the more segments a firm typically considers. Challenges in Analyzing Willingness to Pay While it is possible to quantify willingness to pay precisely in some settings (e.g., Harnischfeger’s cost-saving crane example), most cases involve intangible factors that complicate calculations. Subjective perceptions, evolving preferences, and unclear customer benefits make willingness-to-pay analysis challenging. Market research tools like surveys or conjoint analysis help estimate willingness to pay, but they are not perfect. For new or innovative products, traditional methods may fail to capture true willingness to pay, requiring creative insights or real-world experiments (e.g., testing customer response to different price points). In settings with evolving customer preferences, experimentation is crucial. Online platforms, for instance, can use pricing experiments to gauge willingness to pay.. 3.4 Explore Options and Make Choices This step focuses on generating options to widen the gap between costs and willingness to pay (WTP). The process is creative, and identifying effective changes in activities can create a competitive advantage. Key points include: 1. Identify Competitor's Essential Drivers: o Example: Betsy Baking reduced delivery costs using preservatives, lowering WTP slightly but saving significantly on costs. o Savory Pastries prioritized freshness, but Collins managers noted that an even fresher product could command a premium. 2. When considering changes in activities, anticipate competitors’ reactions: 3. In crafting alternatives focus on buyer benefits over physical attributes: o Managers often overly focus on product features instead of value creation for buyers. o Example: Some apparel firms use efficient packaging and shipping methods to reduce labor at department stores, creating benefits beyond the product. 4. In rapidly changing markets, target “Bleeding Edge” customers: o Early adopters often predict broader market trends. o Tesla initially targeted car enthusiasts to refine its product before launching at scale. 5. Underserved or Customer Segments often point the way to creative alternatives: o Underserved segments often indicate creative opportunities, e.g., Tinder for casual relationships or IKEA for budget-conscious consumers avoiding premium services. 6. One of the most potent ways a firm can widen the gap is to adjust the scope of its operations: o targeting specific segments, helps firms achieve economies of scale or explore untapped markets. o Broader is not always better, there may be diseconomies of scope and attempts to serve heterogeneous customers may introduce compromises into the value chain 7. Options-First Approach: o Firms can start with options (e.g., reducing delivery costs or adding features) and assess their effects on cost/WTP gaps. This strategy simplifies decision-making and ensures a focus on impactful options. Finally, managers should seek to eliminate wasteful activities that incur costs without generating WTP and find cost-effective ways to boost WTP. 3.5 The Whole Versus the Parts So far, our analysis has focused on decomposing the firs into parts. In the final step we must work to build a version of the whole. After all competitive advantage stems from an integrated set of choices, a fragmented approach to activities leads to inconsistency and failure. Landscape metaphor: Managers operate within a "landscape" of possible configurations of activities. Each decision impacts others (e.g., production affects marketing). Successful firms align these decisions to reach "peaks" of value. Graphically the interactions make the landscape rugged, this ruggedness has implications 1. Incremental changes rarely result in major improvements. To scale a new peak of competitive advantage, firms must make comprehensive adjustments across activities. o To improve long term prospects, a firm may have to step down and tread through a valley 2. Firms within the same industry can succeed using very different strategies. o Example: Merrill Lynch and Edward Jones represent two extremes of retail brokerage strategies. Merrill serves large cities with full services, while Edward Jones operates small offices targeting rural areas. 3. Internal Consistency: o Firms must ensure their strategies and activities reinforce each other. For example, Tesla aligns its production, marketing, and customer focus to consistently target environmentally conscious drivers. 4 concluding thoughts 1. A successful firm strives to generate greater profits than the typical firm in its industry 2. Competitive advantage comes from added value o A firm has added value when the network of customers, suppliers, and complements is better off with it than without is o A firm cannot claim any value unless it adds some 3. To have added value a firm must drive a wedge between customers’ WTP and supplier costs 4. A firm can use its analysis of activities to generate admasses option for creating competitive advantage. In doing soàboth deconstruct and craft an integrated vision 5. analyzing value propositions Attributes and Customer Choices: attributes like pricing, variety of goods, freshness, ease of parking, and checkout speed influence customer decisions. Grocery industry exemplifies how withing the same industry many strategies can arise: Walmart and Aldi focus on low-cost models. Whole Foods emphasizes fresh, organic produce and excellent service. Trader Joe's offers novel, easy-to-prepare items at bargain prices. Value Proposition Decisions: leaders must determine their mix of desired customer attributes, what mix will the company offer?. These choices impact operational activities, costs, and overall WTP. A value proposition diagram is a visual tool that helps executives evaluate company performance in these areas. Case Study – Airlines: Southwest Airlines used a value proposition focused on low prices, frequent flights, and friendly service. In comparison: Traditional airlines prioritized amenities and extensive networks. Bus services offered lower prices but fewer attractive attributes. Link Between Value Proposition and Competitive Advantage Understanding Relationships: The placement of a company in value proposition diagrams doesn't always align with competitive advantage. Companies superior across all attributes may still lack an advantage if their cost position is poor. In practice, however, almost all companies with competitive advantage are superior on Segmenting Attributes: Attributes in diagrams can be ordered by company strengths or customer importance, highlighting key areas where competitors thrive (e.g., Betsy Baking's success in low prices). Market Segmentation: Different customer segments (e.g., leisure vs. business travelers) value distinct attributes, necessitating tailored value propositions. Uses of Value Proposition Diagrams 1. Taking Stock of current value proposition: companies evaluate if they excel in any key attributes relative to competitors. A lack of distinction signals trouble, so does excelling in every aspect, while excelling in certain attributes reveals conscious strategic choices. 2. Adjusting Attribute Mix: firms refine their offerings based on insights. For example, airlines like Southwest removed less- valued amenities (e.g., free meals) and enhanced core aspects like low fares and punctuality. 3. Exploring New Attribute Combinations: using tools like the Blue Ocean Strategy, firms identify innovative mixes of attributes that redefine markets. Examples include apps offering private, on-demand flights that introduce unprecedented flexibility to air travel. Creating new market space The Challenge of Competition Competition in saturated or slow-growth markets often leads to stagnation as companies converge on similar strategies, this creates a competitive convergence solely on the basis of incremental improvements in cost or quality. Based on research, the authors identify six basic approaches to creating new market space. To create new market space, companies must reimagine the boundaries of competition, moving beyond traditional industry conventions. This involves systematically exploring across: 1. Substitute industries, 2. Strategic groups within industries, 3. Buyer groups, 4. Complementary product and service offerings, 5. Functional and emotional orientations, and 6. Time (emerging trends). Looking Across Substitute Industries Companies often unconsciously compete with substitute industries when buyers make decisions between alternatives. For instance, Home Depot revolutionized the home improvement market by empowering "do-it-yourselfers" instead of relying on professional contractors. By eliminating unnecessary costs, such as city locations and premium service, and emphasizing warehouse formats, Home Depot turned latent demand into actual sales. They offer the expertise of professional home contractors at markedly lower prices than hardware stores. Similarly, Intuit’s Quicken disrupted personal finance management by simplifying software to resemble a physical checkbook. Instead of competing with high-cost professional accounting services or complicated software, Quicken addressed the pencil as the key competitor. Looking Across Strategic Groups Strategic groups within an industry consist of companies positioned similarly in terms of price and performance, pursuing a similar strategy. Most companies focus on improving their competitive position within a strategic group. Instead, companies can create new market space by targeting overlooked needs. To innovate and create new market spaces, businesses should examine why customers choose to move between strategic groups. This involves identifying the factors that lead customers to trade up for better performance or down for lower costs. Case Study - Polo Ralph Lauren: Polo Ralph Lauren successfully created a new market by combining elements of two distinct strategic groups in the fashion industry: high-end designer haute couture and classical clothing lines. The brand retained key advantages of both—elegance and exclusivity from haute couture, and practicality and affordability from classical lines. This strategy attracted both existing and new customers. By understanding why customers trade across groups, businesses can redefine the competitive landscape, combining elements from multiple groups to form innovative offerings. Looking across the chain of buyers Industries traditionally define their target customers based on conventional wisdom. However, within any market, there are multiple players in the "buyer chain," including purchasers, users, and influencers. They may differ and each have distinct definitions of value. Individual companies in an industry often target different customer segments, but an industry typically converges on a single buyer group. Challenging an industry’s conventional wisdom about which group to target can lead to the discovery of new market space. Bloomberg Example: Bloomberg transformed the financial-information industry by shifting its focus from IT managers (purchasers) to traders and analysts (users). Bloomberg's innovative terminals offered real-time analytics and enhanced usability, enabling traders to make quicker, better-informed decisions. This shift created significant market growth and a value curve that was different from anything else in the industry. Philips Lighting Example: Philips focused on influencers like CFOs and PR professionals to drive sales of its environmentally friendly Alto fluorescent lamps. By addressing environmental disposal costs, Philips not only captured market share but also created a new category with superior margins. Looking across complementary product and service offerings Most products and services are used alongside complementary ones. These complements affect the perceived value of the main product, even though they lie outside the primary industry’s bounds. Companies can explore the entire buyer journey, including what happens before, during, and after a product is used, to uncover untapped value. Companies can create new market space by zeroing in on the complements that detract from the value of their own product or service. Borders and Barnes & Noble (B&N): By redefining the retail bookstore experience, these companies created a new market. Their book superstores emphasized the joy of lifelong learning, with knowledgeable staff, ample book selection, and inviting spaces like cafes and reading areas. This approach transformed bookstores from purely retail spaces into centers for discovery and intellectual engagement, increasing book consumption by over 50%. They transformed the product from the book itself to the pleasure of reading. Looking Across Functional or Emotional Appeal to Buyers Industries often focus on either functional (utility-driven) or emotional (feeling-driven) appeals. Historically, industries have trained customers to expect one type of appeal, but disrupting this norm can create new markets. Companies find new market spaces when they are willing to challenge the functional-emotional orientation of their industry. On one side, emotionally oriented businesses offer many extras that add price without enhancing functionalityàstripping those extras may create a fundamentally simple, lower-priced business model that customers would welcome. On the other, functionally oriented industries can infuse commodity products with new life by adding a dose of emotion. Starbucks: Transformed coffee from a functional product into an emotional experience by positioning its cafes as “caffeine-induced oases,” thus commanding premium prices and redefining coffee consumption. Swatch: Transitioned budget watches from purely functional items to fashion statements, combining affordability with emotional appeal. The Body Shop: Moved in the opposite direction by reducing costs associated with emotional branding (like glamour) and emphasizing functional benefits such as natural ingredients and environmental responsibility, challenging the norms of the cosmetics industry. Looking across time All industries are subject to external trends that affect their business over time, looking at these trends with the right perspective can unlock innovation that creates new market space. Most companies tend to adapt incrementally to unfolding events, focusing on projecting the direction of emerging technologies or regulatory changes. This reactive approach often limits the ability to capitalize on transformative trends. Instead, the key to innovation lies in understanding how these trends alter customer value and leveraging these insights to actively shape the future. It is not about predicting the future, but finding insights in trends that are observable today. Principles for Trend Analysis: 1. Decisiveness: the trend must be crucial for the business. 2. Irreversibility: The trend should signify a lasting shift, not a temporary phenomenon. 3. Clarity of Trajectory: The trend must have a clear direction that can be reasonably anticipated. Having identified a trend of this nature, managers can then look across time and ask themselves what the market would look like if the trend were taken to its logical conclusion. Cisco Systems: Cisco capitalized on the increasing demand for fast data exchange in the 1990s. Identifying the irreversible shift toward higher data rates, Cisco innovated to solve the challenge of incompatible networks, creating routers and switches that revolutionized networking. This strategic insight positioned Cisco to dominate a market where over 80% of internet traffic flows through its products today. Enron: In the 1980s, Enron foresaw the impact of gas industry deregulation. By acquiring regional pipeline companies and creating a national network, Enron unlocked substantial value, enabling cost reductions and reliable delivery across the United States. Strategic Relevance Large corporations also harness these principles to regenerate themselves. Companies like Toyota, through its Lexus brand, or Sony, with the Walkman, have demonstrated how understanding and acting on key trends can yield substantial market transformation. This systematic approach to leveraging trends not only benefits startups but also helps large organizations reimagine their value propositions. By aligning their strategies with decisive, irreversible, and clear trends, companies can secure long-term growth and redefine their market positioning. Competing on resources Strategic Evolution and the Challenge of Change: Traditional strategy tools like portfolio planning, the experience curve, and Porter’s Five Forces were once seen as definitive in shaping corporate strategy. By the 1980s and 1990s, these approaches faced challenges as global competition and technological advancements transformed business landscapes. Large corporations, such as IBM and General Motors, struggled to justify their multi-divisional models, with many undergoing transformations or experiencing setbacks. Introduction to the Resource-Based View (RBV): The RBV combines an internal focus on a company’s unique resources with external competitive dynamics, offering a more holistic approach to strategy. It explains in clear managerial terms: Why some competitors are more profitable that others How to put the idea of core competence into practice How to develop diversification strategies that make sense It emphasizes how firms’ internal resources, such as physical assets, intangible capabilities, and organizational culture, drive performance in competitive environments. A company will be positioned to succeed if it has the best and most appropriate stock of resources for its business and strategy. Valuable resources can be physical (e.g., infrastructure), intangible (e.g., brand reputation), or organizational capabilities embedded in routines. Competitive advantage, whatever its source, ultimately can be attributed to the ownership of a valuable resource that enables the company to perform activities better or more cheaply than competitors. Superior performance will therefore be based on developing a competitively distinct set of resources and developing them in a well- conceived strategy. Competitively valuable resources Resources cannot be evaluated in isolation, because their value is determined in the interplay with market forces. For resources to sustain competitive advantage, they must pass specific tests: Inimitability: is the resource hard to copy? If yes, it limits competition and any profit it generates is more likely to be sustainable. Factors like physical uniqueness, path dependency (unique history of accumulation) causal ambiguity economic deterrence (large capital investments) Durability: how quickly does the resource depreciate? Resources must retain value over time. Appropriability: who captures the value that the resource generates? The firm must retain the profits from resource use. Substitutability: can a unique resource be trumped by a different resource? The absence of easy alternatives adds value to the resource. Competitive superiority: whose resource is really better? Core competence has too often become a “feel good” exercise that no one really fails. It should not be an internal assessment of which activity the company performs best. It should be an external assessment of what is does better than competitors. The way to avoid the vacuousness of generic statements of core competence is to disaggregate the corporation’s resources. Conclusions about critical resources should be based on objective data from the market. Strategic implications Managers should build their strategies on resources that meet the five tests outlined above; these test capture how market forces determine the value of resources. They force managers to look outwards and inward at the same time. Investing in Resources: resources degrade over time, necessitating continual reinvestment. For example: Disney revived its animation capabilities under CEO Michael Eisner, leading to successes like The Lion King. Marks & Spencer invested in retail innovations to remain competitive. The mandate to reinvest in strategic resources my seem obvious. The great contribution of the core competence notion is its recognition that, in corporations with a traditional divisional structure, investment in the corporation resources often takes a backseat to optimizing current divisional profitability. Core competence, therefore, identifies the critical role that the corporate office has to play as the guardian of what are, in essence, the crown jewels of the corporation. Avoiding Pitfalls: even valuable resources can fail to deliver returns if they are applied in structurally unattractive industries. Missteps, such as diversification into unrelated areas without leveraging existing capabilities, often lead to failure. Managers must balance resource-based strategies with a sharp eye on industry dynamics and competitive positioning. Upgrading Resources: What if a company has no valuable resources? Or its resources are valuable only in industries that are unattractive? In these cases, companies must continually upgrade the number and quality of their resources and associated competitive positions in order to hold off the almost inevitable decay in their value. Companies like Sharp demonstrate how sequential upgrading of technology and competencies (e.g., from calculators to LCDs) can build durable competitive advantage. Leveraging Resources: Corporate strategies should maximize the utility of resources across various markets, enabling competitive advantages and entrance into new markets. However, success requires aligning resources with corporate needs and market dynamics. For instance, Disney’s strategic expansion into multiple industries helped combat undervaluation caused by underutilized resources. Challenges in Leveraging Resources: 1. Overestimation of Resource Transferability: Companies often misjudge the ability to apply resources in new contexts. Marks & Spencer, despite its dominance in the UK, struggled in the North American market due to contextual differences in competitive advantages like supply chain efficiency. 2. Misjudgment of Industry Entry Barriers: Managers may misunderstand the requirements for success in high-profitability industries. The difficulty of amassing necessary resources often impedes success, as seen in Philip Morris’s failed foray into the soft drink market. 3. Generalization of Competitive Resources: Companies sometimes assume a resource’s effectiveness in one market guarantees its success in another. Chrysler’s failed aerospace venture illustrates the pitfalls of this assumption. Newell’s Success Newell stands out by effectively utilizing and expanding its resources: The company specialized in producing high-volume household goods, later diversifying through acquisitions. Each acquisition complemented Newell’s core strengths, including cost-control systems and streamlined inventory processes. Today, Newell holds strong positions in multiple markets, benefiting from 15% annual earnings growth. Strategic Insights: 1. Leveraging resources effectively demands an understanding of industry-specific dynamics and rigorous application of market tests. 2. Strategies should combine resource assessment with competitive evaluation, transcending management trends to ensure lasting success. Corporate strategy 1. Introduction Corporate strategy is essential for firms operating multiple business units in different industries, focusing on: Deciding the scope of businesses to operate in. Structuring relationships between these businesses. A corporate strategy is successful when it enables a firm to improve competitiveness of its individual business units, creating value that exceeds the sum of its parts. It does so by, facilitating linkages and leveraging shared assets (both tangible and intangible) and considering these decisions collectively, not in isolation. 2.1 Corporate Strategy and Value Creation The relationship between corporate strategy and value creation revolves around: 1. Synergy: the additional value created by combining assets or resources. 2. Ownership: whether owning assets maximizes the value of synergies. 3. Organization: how resources are structured to realize synergies. 2.1.1 The Better-Off Test: Are There Synergies? Is it better off if the firm organizes the transaction differently, or if it does not engage in it at all? Firms must justify ownership or long term contracts based on creating synergies (value greater than alternatives like spot market transactions). Spot market transactions involve independent firms trading without long-term commitments. Value is created if the combination of willingness to pay (WTP) minus supplier opportunity costs (SOC) exceeds alternatives. Positive synergies occur when: WTP increases (e.g., improved quality or features). SOC decreases (e.g., economies of scale or cost reductions). Firms must avoid dual competitive disadvantages where WTP decreases and SOC increases. 2.1.2 The Potential for Negative Synergies in Long-Term Relationships Two firms deciding whether to be in an exclusive relationship need to recognise that it is much easier to realise negative synergies than it is to create positive ones. Parties that interested in seeing a transaction go forward may conjure up synergies that are very likely to be realised. This was the case with 1. AOL-Time Warner (2000): o Expected synergies included combining Time Warner’s media and broadband assets with AOL’s Internet expertise. o Result: The merger led to massive shareholder value destruction, as the expected synergies failed to materialize. 2. AT&T-DirectTV: o Anticipated synergies: Reduced content costs, increased subscribers, and bundling efficiencies. o Result: AT&T spun off DirectTV after it failed to deliver on these promises, leading to subscription and revenue losses. In evaluating the potential for positive synergies in a long term relationship, a firm must examine the specific details of each proposed synergy, how it is supposed to be realised, and whether there are less expensive ways to create it. With AOL-Time Warner, for example, There was no obvious reason why a merger was necessary to realise any potential synergies between them, a licencing agreement would have been a less expensive and less risky way to test whether such synergies actually existed. Types of Negative Synergies Organizational Culture: culture is very hard to change, as member of an organization usually cannot articulate their assumptions. Cultural clashes can emerge when firms have different competitive assumptions or operational styles. In exclusive exchanges, cultural differences are magnified, increasing governance and sustainability costs. Example: Firms with rigid hierarchies struggle to adapt to agile partners, leading to inefficiencies. Industry Expectations and Competitive Pressures: Disparities in industry dynamics (e.g., mature vs. evolving markets) create friction. For instance, a supplier in a mature market may struggle to meet the rapid demands of a buyer in an evolving industry, leading to delays and frustration. Anchored to its own frame of reference, each side may resist taking steps-or not even know how to do so- that would smooth its interaction with the other, thus increasing the cost of their relationship. Innovation and Expansion Constraints: Exclusive contracts may limit innovation. Suppliers tied to a single firm (e.g., Mazda in the automobile industry) lose opportunities to work with others who may value their technology more. Conversely, another supplier might develop innovations better suited for Mazda, creating misaligned incentives. Incentives and Competition: Long-term agreements reduce exposure to market forces, which can demotivate firms to innovate or cut costs. For example, Mazda's suppliers might become complacent with a secure contract, leading to lower-quality outputs or slower responses to market demands. 2.1.3 Conditions for Positive Synergies in a Long-Term Exchange Criteria for Positive Synergies For long-term exchanges to be successful, firms must carefully assess whether the benefits outweigh potential negative synergies. For positive synergies to exist in a long-term exchange, this exchange must create value that cannot be sustained through spot market transactions. The new mode of exchange must enable the two firms to develop a product that costs less than competing product and/or increases WTP by being sufficiently differentiated from these products without commensurately increasing SOC. Limitations of Spot Markets Positive synergies emerge when the relationship addresses inefficiencies of spot markets: 1. Short-term Perspectives: spot markets may encourage actions to meet quarterly goals, compromising quality or integrity. 2. Lack of Standardization: a business incurs costs in searching for, negotiating with, and monitoring an exchange partner that meets its needs. 3. Switching Costs: Once a firm finds a reliable partner, returning to the spot market is costly. Three conditions favor long-term arrangements over spot markets: asset specificity, frequency, and uncertainty. 1. Asset Specificity Involves the extent to which the assets involved to produce the goods or services in question can be easily redeployed for some other purpose. The higher the asset specificity, the more valuable a long-term arrangement becomes, as it mitigates the risk of underutilization. Example: Milk Co. must choose between producing ice cream and cheese, each requiring unique investments. The WTP for cheese is higher but less consistent across buyers in the spot market. Ice cream, with a broader appeal, becomes the better option unless a long-term contract resolves these inefficiencies. Firms with highly specific assets are more likely to seek long-term agreements to ensure profitability and justify their investment. 2. Frequency When transactions are frequent, the cumulative costs of spot market exchanges (negotiations, monitoring, etc.) justify a long-term contract. Such contracts reduce repeated transaction costs and facilitate investments in process improvements. Example: Toyota’s frequent interactions with its suppliers enable collaborative improvements in automobile quality. The relationship reduces SOC and incre

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