Managing Industry Competition PDF

CHAPTER 2 Managing Industry Competition...

CHAPTER 2 Managing Industry Competition iStock.com/golero KNOWLEDGE OBJECTIVES After studying this chapter, you should be able to 1. Define industry competition 2. Analyze an industry using the five forces framework 3. Articulate the three generic strategies 4. Understand the six leading debates concerning the industry-based view 5. Draw strategic implications for action 32 Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.  OPENING CASE Emerging Markets Global Competition in the Cruise Industry The cruise industry is the second life of the ocean aircraft carrier. The new ones keep getting bigger. liner industry. Eclipsed by jets, the last ocean liners The world’s largest are Royal Caribbean’s Oasis of the stopped service in the 1980s. The modern cruise Seas and Allure of the Seas, each at 225,000 tons with industry began in the 1960s when the Big Three— 2,700 cabins and room for 5,400 passengers. Megaships Norwegian, Carnival, and Royal Caribbean cruise are more profitable because they enable cruise lines to lines, all headquartered in Miami—were launched spread fixed costs across more customers. and dedicated to vacation cruises, not transporta- The glamor of the industry has attracted many en- tion. In 1977, ABC started its weekly Love Boat tele- trants. Yet entry barriers are high, and successes rare. vision series, which became a decade-long unpaid Between 1966 and 2008, 88 firms entered the US commercial for the fledgling industry. Portrayed as market, but 77 either dropped out or dropped dead. a blend of fun and romance, the cruise industry gra­ A new entrant since 1989, Switzerland-based MSC dually gained popularity beginning in the 1980s. Cruises took ten years to establish itself, ultimately Geographically, competition is literally global. The becoming the world’s fourth-largest cruise operator. key markets are the Caribbean, Alaska, Mexico, and MSC Cruises was able to do this only because its Europe. The hottest new market is Asia, primarily parent company, Mediterranean Shipping Company China, which may become the second-largest mar- (MSC), was willing to subsidize such money-losing in- ket for cruise passengers behind the United States dulgences in the beginning. when you read the case. A vast majority of cruises Suppliers to the cruise industry are shipbuilders are international, stopping at ports in multiple coun- and their suppliers. Although China, South Korea, and tries. Only a few cruises, such as those around the Japan—in this order—are the world’s top three ship- Hawaiian islands, are domestic. A large, modern building nations (of all kinds of ships), European ship- cruise ship is essentially a hotel, multiple restaurants builders have maintained their excellence in construct- and bars, swimming pools, a shopping center, a ca- ing and servicing the floating vacationlands. Of the sino, a theater, a sports center, an art gallery, a kids 32 cruise ships on order, 30 are being built in center, and a travel agency all combined into one. Europe—specifically, Finland, France, Germany, and The complexities of the operations—dealing with Italy. Shipbuilders are eager to bid for cruise ship port authorities, tour operators, and employees contracts, because of the reduced demand for other from around the world (typically dozens of national- oceangoing cargo ships, first thanks to the Global ities are employed)—are mind-boggling. The three Financial Crisis of 2008–2009 and more recently to earliest entrants are the Big Three incumbents—led the trade wars of 2018–2019. by Carnival—that still dominate the competition, Buyers of cruises number approximately 22 million attracting 80% of the passengers. Nicknamed “Car- every year, led by 12 million from America and six nivore,” Carnival has acquired many smaller lines million from Europe. The typical passengers—in the such as Costa, Cunard, Holland America, P&O, and colorful language of the Economist magazine—are Princess, which have been called brands. Combined, “newly-weds, nearly-deads, and over-feds.” Cruise Carnival’s brands have 47% of the passenger market lines attract them not only with world-class destina- share. Royal Caribbean is the second largest cruise tions, food choices, and family friendliness, but also operator (23%), followed by Norwegian (10%). with a variety of on-board activities such as entertain- Initially, the industry was serviced by redundant ment, gambling, shopping, and sports. Every year, ocean liners. By the 1990s, purpose-built megaships in- approximately 3.5% of the US and Australian popu- creasingly entered service. Every year since 2001, nine lations take cruises. While only 1/60th of the Chinese or more new cruise ships hit the waves. Costing more population cruise (fewer than one million every year), than $1 billion each, most of these megaships were the number of cruises from Chinese ports has been 100,000 tons or greater—larger than the Nimitz-class growing by double digits recently. 33 Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 34 PART 1 FOUNDATIONS OF GLOBAL STRATEGY OPENING CASE (Continued) As vacation service providers, cruise ships compete with passengers may be scarred away by the ordeal of the a variety of transportation substitutes such as jets, trains, passengers on Diamond Princess and Grand Princess and motor coaches (buses), as well as establishment substi- during the 2020 coronavirus outbreak. Thanks to their tutes such as hotels, restaurants, and tourist attractions. Yet, proximity on a ship, a single case of coronavirus ended cruise ships offer an impossible-to-imitate advantage: The up spreading to hundreds of passengers, forcing the au- hotel (the ship) conveniently goes with the passengers, who thorities to quarantine all passengers inside their cabin are delivered to the next city while sleeping at night. Cer- rooms on board the ship for two weeks. As a result, many tain coastal areas of the world are most ideal for such sea- cruise lines had to suspend their cruises in 2020. Second, borne tourism. For example, consider a week-long cruise the Big Three essentially offer English language-based throughout the Baltic Sea (stopping in Copenhagen, Rostock cruises throughout the world, with some local adapta- [Germany], Tallinn, St. Petersburg, Helsinki, and Stockholm) tion (for example, with more Chinese-speaking staff or the Strait of Malacca (stopping in Singapore, Penang, for cruises in the Asia Pacific). Such a lack of differentia- Langkawi, and Phuket). Imagine the hassle of flying or taking tion is making room for Hapag-Lloyd’s single-language train rides to that many locations, finding local transportation, (German) ships to gain market share in Germany. checking into multiple hotels (with all that packing and un- Single-language ships in Chinese and Japanese are also packing!), and then at the end of touring one city struggling in emerging in Asia, aiming to eat Big Three’s lunch. While the middle of local traffic to get to the airport or train station the industry is indeed global, each cruise, by definition, several hours before departure time. In comparison, cruise is local. How the Big Three and other aspiring cruise passengers, after a good night’s sleep while sailing, arrive at lines can effectively “think global” and “act local” at the each location bright and early, leisurely stroll off the ship, en- same time is likely to be a key determinant on who will joy the sites stress-free, and come back to the ship before rule the waves in the future. dinner, which is usually served while the ship commences its run to the next port. It is not surprising that more vacationers are attracted by this mode. Despite the glamour, captains of this industry know Sources: (1) The author’s interviews on board Carnival, Nor- that they need steel stomachs to navigate the waters in- wegian, Princess, and Royal Caribbean ships, 2008–2019; fested by love boats—indeed, too many of them. Two is- (2) Bloomberg Businessweek, 2014, Asia is getting its own love boats, June 2: 20–21; (3) Bloomberg Businessweek, 2015, The sues loom large on the horizon. First, competition among People’s Republic of Cruiseland, April 27: 50–57; (4) J. Daniels, the survivors now focuses on who can fill an armada of L. Radebaugh, & J. Sullivan, 2013, International Business, bigger, fancier vessels. However, mass tourism has its lim- 14th ed., Upper Saddle River, NJ: Prentice Hall; (5) Economist, its. Given the crowding in hunting for a table at cafeteria 2014, Sailing into headwinds, January 11: 56–57; (6) Princess or fighting for a “beach chair” near the on-board swim- Cruise Lines, 2020, Updates on Diamond Princess, www. ming pool, Royal Caribbean is actually “Commoners’ princess.com; (7) Wall Street Journal, 2019, Making 180,000 Caribbean,” according to one passenger. Many would-be tons feel cozy at sea, December 19: A11. H ow can the cruise industry grow out of the ocean liner industry, which has now disappeared? How do cruise lines in this industry compete? Why are new entrants interested in joining the waves? How do cruise lines deal with suppliers and cus- tomers? Finally, are there any substitutes for cruising? This chapter addresses these and other strategic questions. We accomplish this by introducing the industry-based view, which is one of the three leading perspectives on strategy. (The other two, resource-based and institution-based views, will be covered in Chapters 3 and 4, respectively.) As noted in Chapter 1, a basic strategy tool is SWOT analysis, which deals with internal strengths (S) and weaknesses (W) as well as environmental opportunities (O) and threats (T). The focus of this chapter is O and T from the industry environment, S and W will be discussed in Chapter 3. We start by defining industry competition. Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.  Chapter 2 Managing Industry Competition 35 Then the five forces framework will be introduced, followed by a discussion of three generic strategies. Finally, we outline six leading debates. Defining Industry Competition An industry is a group of firms producing products (goods and/or services) that are similar to industry each other. The traditional understanding is based on a 1776 book published by Adam Smith, A group of firms producing the founding father of the economics discipline, The Wealth of Nations. The book portrayed products (goods and/or a model of perfect competition, in which price is set by the invisible hand known as the services) that are similar to “market,” where all firms are small price takers, no firm is large enough to dictate pricing, each other. and market entry is relatively easy. However, such perfect competition is rarely observed in perfect competition the real world. In the real world, some firms can be large, and some even dominant. They A competitive situation in have the ability to throw their weight around, making new entry difficult. Consequently, which price is set by the since the 1930s, a more realistic branch of economics, called industrial organization (IO) “market,” all firms are price economics (or industrial economics), has emerged to focus on larger firms. Its primary takers, and entries and exits contribution is a structure-conduct-performance (SCP) model. Structure refers to the are relatively easy. structural attributes of an industry (such as the cost of entry). Conduct is firm actions (such industrial organization as product differentiation). Performance is the result of firm conduct in response to industry (IO) economics (industrial structure, which can be classified as (1) average (normal), (2) below-average, and (3) above- economics) average. The model suggests that industry structure determines firm conduct (or strategy), A branch of economics that which, in turn, determines firm performance.1 seeks to better understand However, the goal of IO economics is not to help firms compete. Instead, as a branch how firms in an industry of economics, it is to help policy makers better understand how firms compete so policy compete and then how to makers can properly regulate them. In terms of the number of firms in one industry, there is regulate them. a continuum ranging from thousands of small firms in perfect competition to only one firm structure-conduct- in a monopoly. In between, there may be an oligopoly with only a few players or a duopoly performance (SCP) model with two competitors. Small firms can only hope to earn average returns at best, whereas An industrial organization monopolists, oligopolists, and duopolists may earn above-average returns. Economists and economics model that sug- policy makers are usually alarmed by above-average returns, which they label excess profits. gests that industry structure Monopoly is usually outlawed and oligopoly scrutinized. determines firm conduct An intense focus on above-average firm performance is shared by IO economics and (strategy), which in turn de- strategy. However, IO economists and policy makers are concerned with the minimization termines firm performance. rather than the maximization of above-average profits. The name of the game, from the perspective of strategists in charge of profit-maximizing firms, is exactly the opposite—to structure try to earn above-average returns (of course, within legal and ethical boundaries). Therefore, Structural attributes of an strategists have turned the SCP model upside down by drawing on its insights to help firms industry such as the cost of entry. perform better.2 This transformation comprises the heart of this chapter. conduct The Five Forces Framework Firm actions such as prod- uct differentiation. The industry-based view of strategy is underpinned by the five forces framework, which was performance first advocated by Michael Porter (a Harvard strategy professor who is an IO economist by training) and later extended and strengthened by numerous others. This section introduces The result of firm conduct. this framework. monopoly A situation whereby only one From Economics to Strategy firm provides the goods and/ Leveraging decades of IO economics research, Porter in a 1980 book, Competitive Strategy, or services for an industry. “translated” and extended the SCP model for strategy audiences.3 The five forces framework oligopoly from this book forms the backbone of the industry-based view. Shown in Figure 2.1, these five A situation whereby a few forces are (1) the intensity of rivalry among competitors, (2) the threat of entrants, (3) the bar- firms control an industry. gaining power of suppliers, (4) the bargaining power of buyers, and (5) the threat of substitutes. A key insight is that firm performance critically depends on the degree of competitiveness of duopoly these five forces within an industry. The stronger and more competitive these forces are, the A special case of oligopoly less likely the focal firm will be able to earn above-average returns, and vice versa (Table 2.1). that has only two players. Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 36 PART 1 FOUNDATIONS OF GLOBAL STRATEGY five forces framework FIGURE 2.1 The Five Forces Framework A framework governing the competitiveness of Rivalry among an industry proposed by competitors Michael Porter. The five forces are (1) the intensity of rivalry among competitors, (2) the threat of entrants, (3) the bargaining power of suppliers, (4) the bargaining power of buyers, and (5) the Threat of Threat of threat of substitutes. substitutes entrants Industry competitiveness Bargaining Bargaining power of buyers power of suppliers TABLE 2.1 Threats of the Five Forces Threats Indicative of Strong Competitive Forces that Can Five Forces Depress Industry Profitability Rivalry among A large number of competing firms competitors Rivals are similar in size, influence, and product offerings High-price, low-frequency, “big ticket” purchases Capacity is added in large increments Industry slow growth or decline High exit costs Threat of entrants Little scale-based advantages (economies of scale) Little non-scale-based advantages Inadequate product proliferation Insufficient product differentiation Little fear of retaliation because of focal firm’s lack of excess capacity No government policy banning or discouraging entry Bargaining power of A small number of suppliers suppliers Suppliers provide unique, differentiated products Suppliers are willing and able to vertically integrate forward Bargaining power of A small number of buyers buyers Buyers purchase standard, undifferentiated products from focal firm Buyers are willing and able to vertically integrate backward Threat of substitutes Substitutes are superior to existing products in quality and function Switching costs to use substitutes are low Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.  Chapter 2 Managing Industry Competition 37 Rivalry among Competitors Actions indicative of a high degree of rivalry include (1) frequent price wars, (2) proliferation of new products, (3) intense advertising campaigns, and (4) high-cost competitive actions and reactions (such as honoring all competitors’ coupons). Such intense rivalry reduces profits.4 The key question is: What conditions lead to intense rivalry? At least six sets of conditions emerge (Table 2.1). First, the number of competitors is cru- cial. The more concentrated an industry is, the fewer competitors there will be, and the more likely those competitors will recognize their mutual interdependence and, thus, restrain their rivalry. In the automobile industry, the few ultraluxury automakers such as Ferrari, Lamborghini, and Rolls-Royce do not engage in intense competitive actions (such as deep discounts) typically found among mass-market competitors. Second, rivals of similar size, market influence, and product offerings often vigorously compete with each other. This is especially true for firms unable to differentiate their pro­ ducts, such as airlines. In contrast, the presence of a dominant player lessens rivalry because it can set industry-wide prices and discipline behaviors deviating too much from the price norm. De Beers in the diamond industry is one such example. Third, in industries whose products are “big tickets” and purchased infrequently (such as cars, mattresses, and motorcycles), it may be difficult to establish dominance (the market dominance leader has a very large market share). Without a dominant market leader, the upshot is more A situation whereby the intense rivalry. In contrast, it may be relatively easier for leading firms to dominate in staple market leader has a very goods industries with lower-priced, more frequently purchased products (such as beers and large market share. tissues).5 This is because consumers for staple goods do not spend much time doing research on their purchase decisions and find it convenient to stick with well-known brands. On the other hand, consumers for big ticket items are more interested in searching for a good deal every time they buy. How often do you buy a car? Chances are that the next time you buy a car, you will do some research again. Therefore, the producer that sold you a car several years ago runs the risk of losing you as a customer. Fourth, in some industries, new capacity must be added in large increments, thus fueling intense rivalry. If the route between two seaports is currently served by two cruise lines (each with one ship of equal size), any existing company’s new addition of merely one equivalent ship will increase the capacity by 50%. Thus, the two existing cruise lines are often compelled to cut prices (see the Opening Case). Industries such as hotels, petrochemicals, semicon- ductors, and steel often periodically experience overcapacity, leading to price-cutting as a primary coping mechanism.6 Fifth, slow industry growth or decline makes rivals more desperate, often unleashing actions not used previously. In the life-and-death fight to remain viable after the 2008 economic crisis and the 2020 COVID pandemic, many luxury goods makers had to resort to discounting, a practice they typically avoided before (see Strategy in Action 2.1). Finally, industries experiencing high exit costs are likely to see firms continue to operate at a loss.7 Specialized equipment that is of little alternative use or cannot be sold off poses as an exit barrier. In addition, emotional, personal, and career costs, especially on the part of executives admitting failure, may be high. In Japan and Germany, managers may be legally prosecuted if their firms file for bankruptcy.8 Thus, it is not surprising that these managers will try everything before taking their firms out of an industry. Overall, if there are only a small number of rivals led by a few dominant firms, new ca- pacity is added incrementally, industry growth is strong, and exit costs are reasonable, then the degree of rivalry is likely to be moderate and industry profits more stable. Conditions opposite to those may unleash intense rivalry. Threat of Entrants In addition to keeping an eye on existing rivals, established firms in an industry— incumbent incumbents—also have a vested interest in keeping potential new entrants out.9 New en- A current member of an trants are motivated to enter an industry because of the lucrative above-average returns some industry that competes incumbents earn.10 For example, Amazon has entered numerous industries, such as artificial against other members. Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 38 PART 1 FOUNDATIONS OF GLOBAL STRATEGY STRATEGY IN ACTION 2.1 Emerging Markets High Fashion Fights Recession Pumping out fancy clothing, handbags, jewelry, perfumes, and the best. Shoppers go for fewer, more classic items such as one watches, the high end of the fashion industry—otherwise known Burberry raincoat (as opposed to two designer dresses) and one as the luxury goods industry—had a challenging time in the Great Birkin bag by Hermès (rather than three bags by less-prestigious Recession of 2008–2009. In 2009, total luxury goods industry sales brands). For this reason, LVMH, according to its proud president, fell by 20%. How did the industry cope? “always gains market share in crises.” Its sales grew from $24 Of the five forces, the threat of substitutes was relatively insig- billion in 2008 to $29 billion in 2011 to $36 billion in 2013, with nificant. Potential new entrants were not dying to enter when in- profit margins at a healthy 40% or so—twice as high as some of its cumbents were struggling. Devastated by order cancellations from weaker rivals. automakers and shoemakers, suppliers such as leather tanneries In addition to managing interfirm rivalry, how to manage were eager to work with any order that luxury goods firms could fickle customers was tricky. Although the seriously rich were not lavish on them. Managing industry competition, thus, boiled affected by the Great Recession, their number remained small. Most down to how to manage rivalry and manage customers. firms had been relying on the “aspirational” customers to fund their The high fashion world was dominated by the Big Three: LVMH growth. As the recession became worse, many middle-class custom- ($36 billion sales in 2013, with more than 50 brands such as Louis ers in economically depressed, developed economies began to hunt Vuitton handbags, Moët Hennessy liquor, Christian Dior fashion, for value instead of triviality and showing off. Japan had been the TAG Heuer watches, and Bulgari jewelry), Richemont ($13 billion, number one market for luxury goods for years, and most Japanese with Cartier jewelry and Piaget watches), and Kering ($12 billion, with women reportedly owned at least one LVMH product. But sales Gucci handbags, Yves Saint Laurent clothing, and Sergio Rossi shoes). were falling after 2005 and dropped sharply after 2008. Young Japa­ Next were several smaller players such as Burberry, Hermès, Prada, nese women seemed more individualistic than their mothers and and Swatch. Virtually all firms pursue a differentiation strategy and often hauled home lesser-known (and cheaper) brands. a smaller number of them engage in a focus strategy. By definition, Emerging markets, especially China, offered luxury goods high fashion means high prices. An informal code of conduct (or firms the best hope. Since 2008, while global sales declined, norm) permeates the industry: no discount, no coupons, no price Chinese consumption (both at home and traveling) had been wars please—in theory at least. Discounting, so frequently used in the growing between 20% and 30%. In 2011, China rocketed ahead of low-end fashion industry, is viewed as dangerous and poisonous, not Japan for the first time as the world’s champion consumer of luxury only to the occasional firm that unleashes it, but also to the image and goods—splashing $13 billion to command a 28% global market margin of the whole world of high fashion. share. In 2013, the luxury market in China shot up to $19 billion. In desperation, many firms cut prices—but quietly. At Tiffany Everybody that was somebody in high fashion had been elbow- jewelry stores, salespeople advised customers about diamond ring ing its way into China. However, a hallmark of emerging markets price reductions, but otherwise there was no publicity. Richemont and is unpredictability. Since President Xi Jinping came to power in Gucci offloaded their excess inventory to discount websites. Coach 2012, his anticorruption campaign curtailed the growth of con- launched a lower-priced line branded Poppy as a fighter brand with- spicuous consumption in China, forcing firms to look elsewhere. out cheapening the image of the Coach brand. During the month be- In 2020, the luxury goods industry was hit by a more devastating fore Christmas in 2008, American department stores such as Macy’s recession caused by COVID-19. How would it cope this time? and Saks Fifth Avenue offered some savage price slashing of up to 80% of some luxury goods. The only firm that stood rock solid was LVMH, which claimed that it never puts its products on sale at a discount. Sources: (1) Bloomberg Businessweek, 2018, The Arnaults try to refash- When the going gets tough, it destroys stock instead. In contrast to ion LVMH for millennials, July 16: 14–15; (2) BusinessWeek, 2009, many luxury goods firms that rely on department stores, LVMH owns Coach’s new bag, June 29: 41–43; (3) BusinessWeek, 2009, When dis- its retail shops, thus having complete control over pricing. counting can be dangerous, August 3: 49; (4) Economist, 2009, LVMH The bloodbath in the Great Recession forced weaker players in the recession, September 19: 79–81; (5) Economist, 2010, Fashion- such as Christian Lacroix and Escada to file for bankruptcy. But ably alive, November 13: 76; (6) Economist, 2011, The glossy posse, it made stronger players such as LVMH even more formidable. October 1: 67; (7) Economist, 2014, China: Beyond bling, December 13: LVMH benefited from an established pattern in high fashion: the 8; (8) Economist, 2014, Exclusively for everybody, December 13: special flight to quality. When people have less money, they spend it on report; (9) Economist, 2020, Fashion victims, June 20: 52–53. intelligence, cloud computing, consumer electronics, digital streaming, physical retail, and publishing. For incumbents such as Walgreens in the drugstore industry, they are learning a entry barrier new, terrifying phrase: being “Amazoned.”11 Industry structures that Incumbents’ primary weapons are entry barriers, which are industry structures that in- increase the costs of entry. crease the costs of entry. For instance, Airbus’s A380 burned $12 billion and Boeing’s 787 Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.  Chapter 2 Managing Industry Competition 39 consumed $10 billion before their maiden flights—literally sky-high barriers for all potential entrants. The key question is: What conditions have created such high entry barriers? As shown in Table 2.1, at least six structural attributes are associated with high entry barriers. The first is whether incumbents enjoy scale-based advantages. The key concept scale-based advantage is economies of scale, which refer to reductions in per unit costs by increasing the scale of Advantage derived from production and distribution. For example, Walmart thrives on using its enormous economies economies of scale (the of scale in distribution to spread logistics and overhead cost over a large number of stores, more a firm produces some which results in lower prices. products, the lower the unit Another set of advantages that incumbents may enjoy is independent of scale: non- costs become). scale-based advantages.12 Proprietary technology (such as patents) is one example. Entrants economies of scale have to “invent around,” the outcome of which is costly and uncertain. Entrants can also Reduction in per unit costs directly copy proprietary technology, which may trigger lawsuits by incumbents for patent by increasing the scale of violations. Another source of such advantages is knowhow, the intricate knowledge of how to production. make products and serve customers that takes years, sometimes decades, to accumulate. New entrants often have trouble mastering such knowhow. non-scale-based In addition to scale-based and non-scale-based low-cost advantages, another entry barrier advantage is product proliferation, which refers to efforts to fill product space in a manner that leaves Low-cost advantage that is little “unmet demand” for potential entrants.13 In the textbook publishing industry, Cengage not derived from the econo- mies of scale. Learning, our multibillion dollar multinational publisher, has teamed with your author (whose nickname is “Mr. Global”) to not only publish this market-leading text, Global Strategy, but product proliferation also Global Business and GLOBAL around the world. European students can enjoy a European Efforts to fill product space adaptation (coauthored with Klaus Meyer). Indian students can study an Indian adaptation in a manner that leaves (coauthored with Deepak Srivastava). For non-English readers, there are Quanqiu Qiye Zhan- little “unmet demand” for lue (Chinese), Estrategia Global (Spanish), and Estratégia Global (Portuguese). potential entrants. Also important is product differentiation—the uniqueness of incumbents’ products that product differentiation customers value. Its two underlying sources are (1) brand identification and (2) customer loyalty. Incumbents, often through intense advertising, would like customers to identify their The uniqueness of products that customers value. brands with some unique attributes. BMW brags about its cars being the “ultimate driving machines.” Champagne makers in the French region of Champagne argue that competing network externality products made elsewhere are not really worthy of the name champagne. The value a user derives A second source of product differentiation is customer loyalty, especially when switch- from a product increases ing costs for new products are substantial. Many high-tech industries are characterized by with the number (or the network externalities, whereby the value a user derives from a product or service increases network) of other users of with the number (or the network) of other users of the same product.14 Such a product or the same product. service can be called a platform, which is defined as an intermediary that connects two or platform more distinct groups of users and enables their direct interaction.15 Think of Airbnb, Ali- An intermediary that con- baba, Amazon, Apple, Craigslist, eBay, Facebook, Rakuten, Uber, and WeChat. Platforms nects two or more distinct have a winner-take-all property, whereby winners (incumbents) whose technology standard groups of users and enables is embraced by the market (such as Microsoft Word and Excel) lock out potential entrants. In their direct interaction. other words, these industries have an interesting, increasing returns characteristic as opposed to diminishing returns taught in basic economics.16 excess capacity Another entry barrier is possible retaliation by incumbents. Incumbents often maintain Additional production some excess capacity that is designed to punish new entrants. To think slightly outside the capacity currently underuti- box, perhaps the best example is the armed forces. They cost taxpayers huge sums of money lized or not utilized. and clearly represent excess capacity in peace time. But they exist for one reason: to deter foreign invasion (or punish new entrants). No country has ever unilaterally disbanded its armed forces, and the worst punishment for defeated countries (such as Germany and Japan in 1945 and Iraq in 2003) is to have their military dismantled. In general, the more credible and predictable the retaliation, the more likely new entrants may be deterred. Coca-Cola has been known to retaliate by slashing prices if any competitor (other than Pepsi) crosses the threshold of 10% share in any local market. As a result, potential entrants often think twice before proceeding. Finally, government policy banning or discouraging entries can serve as another entry barrier. For example, drug patents are government-imposed entry barriers. Their expiration often unleashes new entrants marketing generic drugs. In the airline industry, the US and Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 40 PART 1 FOUNDATIONS OF GLOBAL STRATEGY Indian governments only allow foreign entrants, respectively, a maximum of 25% and 49% of equity in their countries’ airlines. In the Canadian wireless telephone service industry, the lowering of government-imposed entry barriers leads to a proliferation of new entrants, threatening the profit margins of incumbents.17 Overall, if incumbents can leverage scale-based or non-scale-based advantages (or both), offer numerous products, provide significant differentiation, maintain a credible threat of re- taliation, or enjoy regulatory protection, the threat of potential entry becomes weak. Thus, in- cumbents can enjoy higher profits.18 Otherwise, incumbents may be under siege. Incumbents may be especially vulnerable when entrants bring in fundamentally new technologies and business models to disrupt an existing industry (see the Closing Case). For example, Airbnb entered Texas in 2008. By the mid-2010s, it had grabbed 10% revenue from incumbent hotels, especially those hotels at the lower end that do not cater to business travelers. Further, Airbnb has severely curtailed hotels’ ability to increase prices during the peak season.19 Bargaining Power of Suppliers Suppliers are organizations that provide inputs such as materials, services, and manpower to bargaining power of firms in the focal industry. The bargaining power of suppliers refers to their ability to raise supplier prices or reduce the quality of goods and services. Three conditions may lead to suppliers’ The ability of suppliers strong bargaining power (see Table 2.1). First, if the supplier industry is dominated by a few to raise prices or reduce firms, then they may gain an upper hand. Hundreds of airlines around the world have to rely the quality of goods and on only two suppliers: Boeing and Airbus. It is not surprising that Boeing and Airbus enjoy services. a great deal of bargaining power. Second, the bargaining power of suppliers can become substantial if they provide unique, differentiated products with few or no substitutes. For instance, as a supplier of mission-critical software for most personal computers (PCs), Microsoft is able to extract significant price hikes from PC makers such as Dell, HP, and Lenovo whenever its Windows unleashes a new version. Likewise, law firms can charge high fees from clients by providing highly specialized legal services. Finally, suppliers may enhance their bargaining power if they are willing and able to enter forward integration the focal industry by forward integration. In other words, suppliers may threaten to be- Acquiring and owning come both suppliers and rivals. For example, in addition to supplying phones and computers downstream assets. to traditional telecom and electronics retail stores, Apple has established many Apple Stores in major cities. In luxury goods, Prada used to supply 50% of its output to distribution chan- nels such as department stores and jewelry shops. Now it only supplies 20% of its products to outside distribution channels and prefers to sell 80% of its products in Prada-owned stores and online channels (see Strategy in Action 2.1).20 In other words, via forward integration, Apple and Prada are both suppliers to and rivals for their distribution channel partners. In summary, powerful suppliers can squeeze profitability out of firms in the focal industry. Thus, firms in the focal industry have an incentive to strengthen their own bargaining power by reducing their dependence on certain suppliers.21 For example, Walmart has implemented a policy of not having any supplier account for more than 3% of its purchases. Dealing with powerful suppliers, focal firms can bring new value to suppliers (such as increasing contract duration), nurture new suppliers, or play hardball (such as canceling orders and suspending future business—or at least threatening to do so).22 Bargaining Power of Buyers From the perspective of buyers, whether individual or corporate, firms in the focal indus- try are essentially suppliers. Therefore, our previous discussion on suppliers is relevant bargaining power of buyer here (Table 2.1). Three conditions lead to the strong bargaining power of buyers. First, The ability of buyers to a small number of buyers leads to strong bargaining power. For example, hundreds of reduce prices or demand automobile-component suppliers try to sell to a small number of automakers such as BMW, quality improvement of Ford, and Honda. These buyers frequently extract price concessions and quality improve- goods and services. ments by playing off suppliers against each other. When these automakers invest abroad, they often encourage or coerce suppliers to invest with them and demand that supplier factories Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.  Chapter 2 Managing Industry Competition 41 be sited next to the assembly plants—at the suppliers’ own expenses. It is no surprise that many suppliers comply.23 This is how Toyota cloned Toyota City in Guangzhou, China. Its main Toyota-owned factory is surrounded by 30 supplier factories. Second, buyers may have strong bargaining power if they purchase standard, undifferen- tiated commodity products from suppliers. Although automobile components suppliers as a group possess less bargaining power relative to automakers, suppliers are not equally power- less. There are usually several tiers. Top-tier suppliers are the most crucial, often supplying nonstandard, differentiated key components such as electric systems, steering wheels, and car seats. Bottom-tier suppliers make standard, undifferentiated commodity products such as seat-belt buckles, cup holders, or simple nuts and bolts. Obviously, automakers possess more bargaining power when dealing with bottom-tier suppliers. Finally, like suppliers, buyers may enhance their bargaining power by entering the focal industry through backward integration. Buyers such as Costco, Marks & Spencer, and backward integration Tesco now directly compete with their own suppliers such as Procter & Gamble (P&G) Acquiring and owning and Johnson & Johnson, by procuring store brand (also known as private label) products.24 upstream assets. Store brand products, such as Kirkland (for Costco), Kroger, and Safeway brands, compete side by side with national brands on the store shelf. Store brand products command ap- proximately 40% of grocery sales in Spain, 30% in Britain, and 20% in the United States.25 Only leading brand producers such as Frito-Lay (potato chips) can resist the demand made by the powerful stores to make private label goods for the stores. Many mediocre brand producers, when facing the choice of producing private label goods for the stores or being kicked out of shelf space (because their products are replaceable), surrender to the strong bargaining power of stores. Overall, buyers can capture value by enhancing bargaining power. Buyers’ bargaining pow- er may be minimized if focal firms sell to numerous buyers, provide differentiated products, and enhance entry barriers. Threat of Substitutes Substitutes are products and services of different industries that satisfy customer needs cur- substitute rently met by the focal industry. For instance, plant-based “meat-like” products are substi- Product and service of a dif- tuting some real meat-based products.26 Two areas of substitutes are particularly threatening ferent industry that satisfies (Table 2.1). First, if substitutes are superior to existing products in quality and function, then customer needs currently they may rapidly emerge to attract a large number of customers. Online media has pushed met by the focal industry. many print-based newspapers and magazines to the brink of extinction. Smartphones are now substituting some PCs, cameras, maps, and print books. Second, substitutes may pose significant threats if switching costs are low. For example, consumers incur virtually no costs when switching from cow milk to soy milk. Both are readily available on supermarket shelves. However, no substitutes exist for large passenger jets, especially for transoceanic transportation. The only other way to go to Hawaii or New Zealand seems to be swimming (!). Overall, the threat of substitutes requires firms to vigilantly scan the larger environment rather than the narrowly defined focal industry. They need to pay attention to developments in seemingly unrelated industries. Enhancing customer value of existing products (such as more competitive pricing, higher quality, better utility, and more convenient locations) may reduce the attractiveness of substitutes. Lessons from the Five Forces Framework Taken together, the five forces framework offers three significant lessons (Table 2.2): The framework reinforces the important point that not all industries are equal in terms of potential profitability. When firms have the luxury to choose (such as diversified companies contemplating entry to new industries or entrepreneurial start- ups scanning new opportunities), they will be better off if they choose an industry whose five forces are weak. Michael Dell confessed that he probably would have avoided the PC industry had he known how competitive the industry would become. Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 42 PART 1 FOUNDATIONS OF GLOBAL STRATEGY industry positioning TABLE 2.2 Lessons from the Five Forces Framework. Ways to position a firm Not all industries are equal in terms of potential profitability. within an industry in order The task for strategists is to assess the opportunities (O) and threats (T) underlying each to minimize the threats pre- of the five competitive forces affecting an industry. sented by the five forces. The challenge is to stake out a position that is strong and defensible relative to the artificial intelligence five forces. (AI) Simulation of human intel- The task is to assess the opportunities (O) and threats (T) underlying each ligence processes by ma- chines, especially computer competitive force affecting an industry and then to estimate the likely profit systems. potential of the industry.27 The challenge, according to Porter, is “to stake out a position that is less vulnerable to Big Data (data analytics) attack from head-to-head opponents, whether established or new, and less vulnerable Analyzing extremely large to erosion from the direction of buyers, suppliers, and substitutes.”28 In other words, data sets that may reveal the key is to position your firm well within an industry and defend its position. previously unknown pat- Consequently, the five forces framework also becomes known as the industry terns, trends, and associa- positioning school. tions. Although the thrust of this framework was put forward more than 40 years ago, it has con- Internet of things (IoT) tinued to assert strong influence on practice and research today. While it has been debated A system of interconnect- and modified (introduced later), its core features remain remarkably insightful—even during ed devices and machines the digital age (see Strategy in Action 2.2). linked by the Internet. STRATEGY IN ACTION 2.2 Digital Strategy and Five Forces “What is your digital strategy?” This is a question recently raised their used books to potential customers on the focal by many gurus, consultants, and board directors as if it were a campus. brand new strategy. Digital strategy encompasses a bewildering Threat of potential entry is also heightened because digital array of new jargons and technologies such as artificial intel- technologies lower entry barriers. Numerous online ligence (AI), Big Data (data analytics), cloud computing, shopping websites can directly reach customers, severely cybersecurity, Industry 4.0, Internet of things (IoT), online handicapping brick-and-mortar stores and malls that interface design, robotics, and social media. In truth, a digital have to shoulder rents, sales forces, and inventories. In the strategy—sometimes called a digital business model—is re- travel industry, TripAdvisor has significantly disrupted ally the application of digital technologies to existing business ac- the livelihood of travel agents, guidebook publishers, and tivities or to develop new ways of competition. As a result, the five travel reviewers. forces framework continues to be insightful. Unfortunately, from a Bargaining power of suppliers is often enhanced. Because SWOT standpoint, instead of presenting great opportunities (O), suppliers are able to reach more buyers (including many digital technologies unleash tremendous threats (T). overseas), the focal firms’ “special relationship” with suppliers becomes less valuable.  ivalry among competitors is likely to be more intense. R Bargaining power of buyers is often enhanced too. Digital Digital technologies tend to reduce differentiation among technologies provide buyers with more information and competitors and drive the basis of competition to price. facilitate more comparison shopping. Focal firms’ room The Internet enables more competitors from distant for profits can be squeezed. locations to join the competition, thus intensifying Threat of substitutes has also become more acute. Digital rivalry. For example, a college student selling her used technologies have lower switching costs for many end textbooks used to compete only with fellow students from users to adopt new products and services. For example, her campus, who a generation ago would post a limited Wikipedia and numerous other online knowledge sources number of hard-copy advertisements on the wall of the substitute the need to purchase encyclopedias and student union building. Today, she has to compete against dictionaries. They forced the Encyclopedia Britannica (in students from around the country (maybe around the print since 1768) to go completely online after 2010. world), who can use Amazon’s digital platform to ship Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.  Chapter 2 Managing Industry Competition 43 Three Generic Strategies digital strategy (digital business model) Having identified the five forces underlying industry competition, the next challenge is how An application of digital to make strategic choices. In a 1985 book, Competitive Advantage, Porter suggested three technologies to existing generic strategies: (1) cost leadership, (2) differentiation, and (3) focus. All three generic business activities and/ strategies are intended to strengthen the focal firm’s position relative to the five competitive or to develop new ways of forces (see Table 2.3).29 competition. Cost Leadership generic strategy Strategy intended to Recall that our definition of strategy is a firm’s theory about how to compete successfully (see strengthen the focal firm’s Chapter 1). A cost leadership strategy suggests that a firm’s theory about how to compete position relative to the five successfully centers on low costs and prices. Offering the same value of a product at a competitive forces, which lower price—in other words, better value—tends to attract many customers. A cost leader can be (1) cost leadership, often positions its products to target “average” customers for the mass market with little (2) differentiation, and differentiation. The key functional areas center on efficiency in manufacturing, services, and (3) focus. logistics. The hallmark of this strategy is a high-volume, low-margin approach. cost leadership A cost leader such as Walmart can minimize the threats from the five forces.30 First, it is A competitive strategy that able to charge lower prices and make better profits compared with higher-cost rivals. Second, centers on competing on its low-cost advantage is a significant entry barrier. Third, the cost leader typically buys a large low costs and prices. volume from suppliers, which reduces their bargaining power. Even Walmart’s largest supplier, P&G, is afraid of Walmart’s size. Fourth, the cost leader would be less negatively affected if strong suppliers increase prices or powerful buyers force prices down. Finally, the cost leader For most incumbents, a digital strategy is defensive in nature. In position themselves at the center of such a vast IoT network. A the conservative luxury goods industry (see Strategy in Action 2.1), five forces analysis in the future will help us understand why their brands such as Prada that are late to the digital game are falling be- digital strategy—or someone else’s, such as Amazon Alexa’s or hind. The future of Chanel and Céline, which still shun e-commerce AT&T’s—succeeds or fails. altogether, can be questionable. Well thought out and executed, a digital strategy can also become an offensive strategy. Burberry has led the luxury goods industry in being the first to livestream its dis- Sources: (1) E. Banalieva & C. Dhanaraj, 2019, Internalization the- plays and being the first to use Twitter’s “buy” function. Most fun- ory for the digital economy, Journal of International Business Stud- damentally, a digital strategy can be conceptualized along two di- ies 50: 1372–1387; (2) Bloomberg Businessweek, 2018, AI painted mensions: (1) from value chains to digital ecosystems and (2) from a this, May 21: The sooner than you think issue; (3) Economist, 2015, fuzzy understanding of the needs of end costumers to a sharper one. Strutting their stuff, February 14: 58; (4) Economist, 2018, GrAIt Key to a successful ecosystem driver is to become the first choice expectations, March 31: special report; (5) Economist, 2019, The destination for a specific domain, such as Amazon for books, Cruise. digital assembly line, September 7: 57–58; (6) A. Hagiu & E. Alt- com for cruises, and Wikipedia for basic research. man, 2017, Finding the platform in your product, Harvard Busi- Big Data analytics can enable firms—both incumbents and ness Review July: 95–100; (7) M. Jacobides, 2019, In the ecosystem new entrants—to gain a superior understanding of the needs of economy, what’s your strategy? Harvard Business Review Septem- end customers. A hot recent topic is IoT, which is a system of inter- ber: 129–137; (8) L. Moeller, N. Hodson, & M. Sangin, 2018, The connected devices and machines. To compete for a share in your coming wave of digital disruption, PwC Strategy + Business Spring: (future) smart home, Sony and Vizio are duking it out in IoT tele- 41–47; (9) M. Porter, 2001, Strategy and the Internet, Harvard vision, Honeywell and Nest are fighting to install IoT-connected Business Review March: 63–78; (10) P. Weill & S. Woerner, 2018, environmental-management systems, Motorola and Belkin are What’s Your Digital Business Model? Boston: Harvard Business elbowing each other to provide security cameras, and Philips and School Press; (11) The World in 2018, 2018, Luxury’s triumph of Flux are eager to provide IoT-enabled light bulbs. Note that in experience over hope, London: Economist; (12) M. Van Alstyne, each of these examples, an incumbent and a new entrant are vying G. Parker, & S. Choudary, 2016, Pipelines, platforms, and the for dominance. Which firm will you trust to coordinate all these new rules of strategy, Harvard Business Review April: 54–62; (13) IoT assets and access all relevant data? Technology giants, such F. Zhu & N. Furr, 2016, Products to platforms, Harvard Business as Apple, Google, Huawei, Intel, and Samsung, are determined to Review April: 73–78. Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 44 PART 1 FOUNDATIONS OF GLOBAL STRATEGY TABLE 2.3 Three Generic Competitive Strategies. Product Market Key Functional Differentiation Segmentation Areas Cost leadership Low (mainly by Low (mass market) Manufacturing, services, price) and logistics Differentiation High (mainly by High (many market Research and develop- uniqueness) segments) ment (R&D), marketing, and sales Focus Extremely high Low (one or a few R&D, marketing, and sales segments) challenges substitutes to outcompete not only the utility of its products, but also its prices—a very difficult proposition. Thus, a true cost leader is relatively safe from these threats. However, a cost leadership strategy has at least two drawbacks. First, there is always the dan- ger of being outcompeted on costs. This forces the leader to continuously search for lower costs. Otherwise, it may no longer be a cost leader. A case in point is Southwest Airlines, the legendary, Dallas-based discount carrier that has been the role model for numerous budget airlines around the world, such as AirAsia in Malaysia, IndiGo in India, and Ryanair in Ireland. While Southwest has become the fourth-largest airline in the United States, it is no longer the cost leader.31 At 8.25 cents, Southwest’s per-mile cost to fly one passenger (technically known as available seat mile) is still below that of its three larger rivals (Delta: 8.98 cents, United: 8.81, and American: 8.55). But the true cost leaders are now the ultrabudget Spirit Airlines (5.95) and Allegiant Travel (5.66), which pack more seats onto planes by not allowing seats to recline.