Industry and Competitive Analysis Analysis is the critical starting point of strategic thinking. Kenichi Ohmae Awareness of the environment is not a special project to be undertaken only when warning of change becomes deafening … Kenneth R. Andrews Crafting strategy is an analysis-driven exercise, not an activity where managers can succeed by sheer effort and creativity. Judgments about what strategy to pursue should ideally be grounded in a probing assessment of a company’s external environment and internal situation.
Unless a company’s strategy is well-matched to the full range of external and internal situational considerations, its suitability is suspect. THE ROLE OF SITUATION ANALYSIS IN STRATEGY-MAKING While the phrase situation analysis tends to conjure up images of collecting reams of data and developing all sorts of facts and figures, such impressions don’t apply here. From a strategy-making standpoint, the purpose of situation analysis is to determine the features in a company’s internal/external environment that will most directly affect its strategic options and opportunities.
The effort concentrates on generating solid answers to a well-defined set of strategic questions, then using these answers first to form an understandable picture of the company’s strategic situation and second to identify what its realistic strategic options are. In studying the methods of strategic situation analysis, it is customary to begin with single-business companies instead of diversified enterprises. This is because strategic analysis of diversified companies draws on many of the 3 I Industry and Competitive Analysis 57
concepts and techniques used in evaluating the strategic situations of singlebusiness companies. In single-business strategic analysis, the two biggest situational considerations are (1) industry and competitive conditions (the heart of a single-business company’s “external environment”) and (2) the company’s own internal situation and competitive position. This chapter examines the techniques of industry and competitive analysis, the terms used to refer to external situation analysis of a single-business company. Chapter 4 covers the tools of company situation analysis.
Industry and competitive analysis looks broadly at a company’s macroenvironment; company situation analysis examines the narrower field of its microenvironment. Figure 3-1 presents the external-internal framework of strategic situation analysis for a single-business company. It indicates both the analytical steps involved and the connection to developing business strategy. Note the logical flow from analysis of the company’s external and internal situation to evaluation of alternatives to choice of strategy. Also note that situation analysis is the starting point in the process.
Indeed, as we shall see in the rest of this chapter ·and in Chapter 4, managers must understand a company’s macro- and microenvironments to do agood job of establishing a mission, setting objectives, and crafting business strategy. The three criteria for deciding whether a strategy is “good” are whether it fits the situation, whether it helps build competitive advantage, and whether it is likely to boost company performance. Analysis of industry and competitive conditions is the starting point in evaluating a company’s strategic situation and market position.
THE METHODS OF INDUSTRY AND COMPETITIVE ANALYSIS Industries differ widely in their economic characteristics, competitive situations, and future outlooks. The pace of technological change can range from fast to slow. Capital requirements can be big or small. The market can be worldwide or local. Sellers’ products can be standardized or highly differentiated. Competitive forces can be strong or weak and can center on price, quality, service, or other variables. Buyer demand can be rising briskly or declining.
Industry conditions differ so much that leading companies in unattractive industries can find it hard to earn respectable profits, while even weak companies in attractive industries can turn in good performances. Industry and competitive analysis utilizes a toolkit of concepts and techniques to get a clear fix on changing industry conditions and on the nature and strength of competitive forces. It is a way of thinking strategically about an industry’s overall situation and drawing conclusions about whether the industry is an attractive investment for company funds.
The framework for industry and competitive analysis hangs on developing probing answers to seven questions: 1. What are the chief economic characteristics of the industry? 2. What factors are driving change in the industry, and what impact will they have? 3. What competitive forces are at work in the industry, and how strong are they? 4. Which companies are in the strongest/weakest competitive positions? 5. Who will likely make what competitive moves next? There are seven questions to ask in thinking strategically about market conditions in a given industry.
– 58 F I G U R E 3-1 I I The Concepts and Techniques of Strategic Management From Situation Analysis toStr • • • • ·High barriers protect positions and profits of existing firms; lowbilrriers make existing firms vulnerable to entry. • ·• • [1ore buyers will shopforlowestprice .. . . . . .·. < B~yers havemore power beciJUSe itis easier to switch from seller ~o seller.. · ·· ~bise~. risk factor;. investments in technologyfa~ilities/eqlilpmentrnay · beconne obsolete before they )Near ouf . Raises capital requirements; .
often creiltes cpnnpetitiye differences iJnd cost •differences among MY versu. s partiiliiY versus:nonint. egratepfirms: · · · · ,;,,; : · • >Bigrequirements mak~ investment decisions critical; ·tirhing becomes •. •• . •. · • important;creates a barrier to entry and exit. . . . . . ·. . . . ·. . > · • · •·•·· ···’.. t Sh()rten~ prq(Juqtlife cycle; in~re? ses risk peqaus[; qf opportunities fqr . ·. · ·. ·deapf(o:Qging. · · .. .;’ ,, __ ,;’; ____ _ inC:tease>jolume-~od rn. ark~t share needeqto•• beC:C? s{cofr1p~titil~ i . •_·)’ · · · · · · ·
While it is important to judge what growth stage an industry is in, there’s more analytical value in identifying the specific factors causing industry change. Industry conditions change because forces are in motion that create incentives or pressures for change 2 The most dominant forces are called driving forces because they have the biggest influences on what kinds of changes will take place in the industry’s structure and environment. Driving forces analysis has two steps: (1) identifying what the driving forces are and (2) assessing the impact they will have on the industry.
The Most Common Driving Forces Many events affect an industry powerfully enough to qualify as driving forces. Some are one-of- a-kind, but most fall into one of several basic categories. The most common driving forces are shownhere 3 • Changes in the Long-Term Industry Growth Rate. Shifts in industry growth up or down are a force for industry change because they affect the balance between industry supply and buyer demand, entry and exit, and how hard it will be for a firm to capture additional sales.
A strong upsurge in long-term demand frequently attracts new firms and encourages 2lbid. , Several different factors can affect an industry powerfully enough to act as driving forces. 3What p. 162. follows draws on the discussion in Porter, Competitive Stj·al’egy, pp. 164-83. 3 I ·Industry and Competitive Analysis 63 • • • • • • established ones to invest in additional capacity. In a shrinking market, some firms will exit the industry; and the remaining ones may postpone further capacity investments. Changes in Who Buys the Product and How They Use It.
Shifts in buyer demographics and the emergences of new ways to use the product can force adjustments in customer service offerings (credit, technical assistance, maintenance and repair), open the way to market the industry’s product through a different mix of dealers and retail outlets, prompt producers to broaden/narrow their product lines, increase/ decrease capital requirements, and change sales and promotion approaches. The computer industry has been transformed by the surge of interest in personal and mid-size computers.
Consumer interest in cordless telephones and mobile telephones has opened a major new buyer segment for telephone equipment manufacturers. Product Innovation. Product innovation can broaden an industry’s customer base, rejuvenate industry growth, and widen the degree of product differentiation among rival sellers. Successful new product introductions strengthen a company’s position, usually at the expense of companies who stick with their old products or are slow to follow with their own versions of the new product.
Industries where product innovation has been a key driving force include copying equipment, cameras and photographic equipment, computers, electronic video games, toys, prescription drugs, frozen foods, and personal computer software. Technological Change. Advances in technology can dramatically alter an industry’s landscape, making it possible to produce new and/or better products at a lower cost and opening up whole new industry frontiers. Technological change can also change in capital requirements, minimum efficient plant sizes, and desirability of vertical integration, and learning or experience curve effects.
Marketing Innovation. When firms are successful in introducing new ways to market their products, they can spark a burst of buyer interest, widen industry demand, increase product differentiation, and/or lower unit costs-any or all of which can alter the competitive positions of rival firms and force strategy revisions. Entry or Exit of Major Firms. The entry of one or more foreign companies into a market once dominated by domestic firms nearly always produces a big shakeup in industry conditions.
Likewise, when an established domestic firm in another industry attempts entry either by acquisition or by launching its own startup venture, it usually intends to apply its skills and resources in some innovative fashion. Entry by a major firm often produces a “new ballgame” not only with new key players but also with new rules for competing. Similarly; exit of a major firm changes industry structure by reducing the number of market leaders (perhaps increasing the dominance of the leaders who remain) and causing a rush to capture the exiting firm’s customers.
Diffusion of Technical Know-How. As knowledge about how to perform a particular activity or to execute a particular manufacturing technology spreads, any technically-based competitive advantage held by firms possessing this know-how erodes. Diffusion of technical I I The Concepts and Techniques of Strategic Management 64 e e know-how occurs through scientific journals, trade publications, on-site plant tours, word-of-mouth among suppliers and customers, and the hiring away of knowledgeable employees.
It can also occur when the possessors of technological know-how license others to use it for a fee or team up with a company interested in turning the technology into a new business venture. Often companies acquire technical know-how by buying a company with the desired skills, patents, or manufacturing capabilities. In recent years technology transfer across national boundaries has emerged as one of the most important driving forces in globalizing markets and competition.
As companies in more countries gain access to technical know-how, they upgrade their manufacturing capabilities to compete with established companies. Technology transfer has turned many domestic industries into global ones (e. g. , automobiles, tires, consumer electronics, telecommunications, and computers). Increasing Globalization of the Industry. Global competition usually changes patterns of competitive advantage among key players. Industries move toward globalization for several reasons.
Certain firms may launch aggressive long-term strategies to win a globally dominant market position. Demand for the industry’s product may emerge in more countries. Trade barriers may drop. Technology-transfer may open the door for more companies in more countries to enter the industry on a major scale. Significant labor cost differences among countries may create a strong reason to locate plants for labor-intensive products in low-wage countries (wages in South Korea, Taiwan, and Singapore, for example, are about one-fourth those in the United States).
Significant cost economies may accrue to firms with world-scale volumes as opposed to national-scale volumes. The growing ability of multinational companies to transfer their production, marketing, and management know-how from country to country at significantly lower cost than companies with a one-country production base may give multinational competitors a significant competitive advantage over domestic-only competitors.
Globalization is most likely to be a driving force in industries (a) based on natural resources (supplies of crude oil, copper, and cotton, for example, are geographically scattered all over the globe), (b) where low-cost production is a critical consideration (making it imperative to locate plant facilities in countries where the lowest costs can be achieved), and (c) where one or more growthoriented, market-seeking companies are pushing hard to gain a significant competitive position in as many attractive country markets as they can. Changes in Cost and Efficiency.
In industries where significant economies of scale are emerging or strong learning curve effects are allowing firms with the most production experience to undercut rivals’ prices, large market share becomes such a distinct advantage that all firms are pressured to adopt volume-building strategies-a “race for growth” dominates the industry. Likewise, sharply rising costs for a key input (either raw materials or labor) can cause a scramble to either (a) line up reliable supplies at affordable prices or (b) search out lower-cost substitutes.
Any time important changes in cost or efficiency take place, firms’ positions can change radically concerning who has how big a cost advantage. 3 I Industry and Competitive Analysis 65 • Emerging Buyer Preferences for a Differentiated Instead of a Commodity Product (or for a more standardized product instead of strongly differentiated products). Sometimes growing numbers of buyers decide that a standard product at a bargain price meets their needs as effectively as premium priced brands offering more features and options.
These swings in buyer demand can drive industry change by shifting patronage to sellers of cheaper commodity products and creating a price-competitive market environment. Such a development may so dominate the market that industry producers can’t do much more than compete hard on price. On the other hand, a shift away from standardized products occurs when sellers are able to win a bigger and more loyal buyer following by introducing new features, making style changes, offering options and accessories, and creating image differences via advertising and packaging.
Then the driver of change is the struggle among rivals to out-differentiate one another. Industries evolve differently depending on whether the forces in motion are acting to increase or decrease the emphasis on product differentiation. • Regulatory Influences and Government Policy Changes. Regulatory and governmental actions can often force significant changes in industry practices and strategic approaches. Deregulation has been a major driving force in the airline, banking, natural gas, and telecommunications industries.
Drunk driving laws and drinking age legislation recently . became driving forces in the alcoholic beverage industry. In international markets, newly-enacted regulations of host governments to open up their domestic markets to foreign participation or to close off foreign participation to protect domestic companies are a major factor in shaping whether the competitive struggle between foreign and domestic companies occurs on a level playing field or whether it is one-sided (owing to government favoritism).
e Changing Societal Concerns, Attitudes, and Lifestyles. Emerging social issues and changing attitudes and lifestyles can be powerful instigators of industry change. Consumer concerns about salt, sugar, chemical additives, cholesterol, and nutrition are forcing the food industry to reexamine food processing techniques, redirect R&D efforts, and introduce healthier products. Safety concerns are driving change in the automobile, toy, and outdoor power equipment industries.
Increased interest in physical fitness is producing whole new industries to supply exercise equipment, jogging clothes and shoes, and medically supervised diet programs. Social concerns about air and water pollution are affecting industries that discharge waste products. Growing antismoking sentiment is posing a major long-term threat to the cigarette industry. • Reductions in Uncertainty and Business Risk. A young, emerging industry is typically characterized by an unproven cost structure and much uncertainty over potential market size, R&D costs, and distribution channels.
Emerging industries tend to attract only the most entrepreneurial companies. Over time, however, if pioneering firms succeed and uncertainty about the industry’s viability fades, more conservative firms are usually enticed to enter the industry. Often, the entrants are larger, financially-strong firms hunting for attractive growth industries. In international markets, conservatism is prevalent in the early stages of globalization. Firms tend to minimize their risk by relying initially 66 I I The Concepts and Techniques of Strategic Management
on exporting, licensing, and joint ventures. Then, as their experience accumulates and as perceived risk levels decline, companies move more quickly and aggressively to form wholly owned subsidiaries and to pursue full-scale, multicountry competitive strategies. The foregoing list of potential driving forces in an industry indicates why it is too simplistic to view industry change only in terms of moving from one growth stage to another and why it is essential to probe for the causes underlying the emergence of new industry conditions.
However, while many forces of change may be at work in an industry, no more than three or four are likely to be driving forces in the sense that they act as the major determinants of how the industry evolves and operates. Strategic analysts must resist the temptation to label everything they see changing as driving forces; the analytical task is to evaluate the forces of industry change carefully enough to separate major factors from minor ones. Analyzing driving forces has practical strategy-making value.
First, the driving forces in an industry indicate to managers what external factors will have the greatest effect on the company’s business over the next one to three years. Second, to position the company to deal with these forces, managers must assess the implications and consequences of each driving force-that is, they must project what impact the driving forces will have on the industry. Third, strategy-makers need to craft a strategy that is responsive to the driving forces and their effects on the industry.
One way to predict future driving forces is to utilize environmental scanning techniques. Environmental scanning involves studying and interpreting social, political, economic, ecological, and technological events in an effort to spot budding trends and conditions that could eventually affect the industry. It attempts to look broadly at “first of its kind” happenings, what kinds of new ideas and approaches are catching on, and extrapolate their possible implications 5 to 20 years into the future.
For example, environmental scanning could involve judgments about the demand for energy in the year 2000, uses for computers 20 years from now, or the condition of forests in the 21st century given the growing demand for paper. Environmental scanning raises managers’ awareness of potential developments that could have an important impact on industry conditions and pose new opportunities and threats. Environmental scanning can be accomplished by systematically monitoring and studying current events, constructing scenarios, and employing the Delphi method (a technique for finding consensus among a group of “knowledgeable experts”).
Although highly qualitative and subjective, environmental scanning helps managers lengthen their planning horizon, translate vague inklings into clearer strategic issues (for which they can begin to develop a strategic answer), and think strategically about future developments in the surrounding environment 4 Companies that undertake formal environmental Ernvimnmental Scannirng Techniques 4For The task of driving forces analysis is to separate the major causes of changing industry conditions from minor ones; usually no more than three or four factors qualify as driving forces. Basic Concept –
Strategists use environmental scanning to spot budding trends and developments that could emerge as new driving forces. further discussion of the nature and use of environmental scanning, see Roy Amara and Andrew J. Lipinski, Business Planning for an Uncertain Future: Scenarios and Strategies (New York Pergamon Press, 1983); Harold E. Klein and Robert U. Linneman, “Environmental Assessment: An International Study of Corporate Practice,” journal of Business Strategy 5, no. 1 (Summer 1984), pp. 55-75; and Arnoldo C. Hax and Nicolas S. Majluf, The Strategy Concept and Process (Englewood Cliffs, N.
j. : Prentice Hall, 1991), chaps. 5 and 8. 3 I Industry and Competitive Analysis 67 scanning include General Electric, AT&T, Coca-Cola, Ford, General Motors, Du Pont, and Shell Oil. Analyzing the Strength of Competitive forces One of the big cornerstones of industry and competitive analysis involves carefully studying the industry’s competitive process to discover the main sources of competitive pressure and how strong they are. This analytical step is essential because managers cannot devise a successful strategy without understanding the industry’s special competitive character.
Even though competitive pressures differ in different industries, competition itself works similarly enough to use a common framework in gauging its nature and intensity. As a rule, competition in an industry is a composite of five competitive forces: 1. The rivalry among competing sellers in the industry. 2. The market attempts of companies in other industries to win customers to their own substitute products. 3. The potential entry of new competitors. 4. The bargaining power and leverage exercisable by suppliers of key raw materials and components.
5. The bargaining power and leverage exercisable by buyers of the product. The fivecforces model, as diagrammed in Figure 3-3, is extremely helpful in systematically diagnosing the principal competitive pressures in a market and assessing how strong and important each one is. 5 Not only is it the most widely used technique of competition analysis, but it is also straightforward to use. The Rivalry among Competing Sellers The rnost powerful of the five competitive forces is usually the competitive battle among rival firms.
6 How vigorously sellers use the competitive weapons at their disposal to jockey for a stronger market position and win a competitive edge over rivals shows the strength of this competitive force. Competitive strategy is the narrower portion of business Basic Concept Competitive strategy is the part of business strategy that deals with management’s plan for competing successfullyhow to build sustainable competitive advantage, how to outmaneuver rivals, how to defend against competitive pressures, and how to strengthen the firm’s market position.
strategy dealing with a company’s competitive approaches for achieving market success, its offensive moves to secure a competitive edge over rival firms, and its defensive moves to protect its competitive position? The challenge in crafting a winning competitive strategy, of course, is how to gain an edge over rivals. The big complication is that the success of any one firm’s strategy hinges on what strategies its rivals employ and the resources rivals 5For 6 a thorough treatment of the five-forces model by its originator, see Porter, Competitive Strategy, chap. 1.
Parts of this section are based on the discussion in Arthur A. Thompson, “Competition as a Strategic Process,” Antitrust Bulletin 25, no. 4 (Winter 1980), pp. 777-1303. 7 The distinction between competitive strategy and business strategy is useful here. As we defined it in Chapter 2, business strategy not only addresses the issue of how to compete, it also embraces all of the functional area support strategies, how management plans to respOnd to changing industry conditions of all kinds (not just those that are competition-related), and how management intends to address the full range of strategic issues.
Competitive strategy, however, is narrower in scope. It focuses on the firm’s competitive approach, the competitive edge strived for, and specific moves to outmaneuver rival companies. 68 I I The Concepts and Techniques of Strategic Management F I G U . R E 3-3 The ”Five-Forces”. Model of Competitiol1: AKeyAnalytical Tool Competitive forces coming from the market attempts of outsiders to win buyers over to their products Competitive forces arising from suppliers’ exercise of bargaining power and leverage
Competitive forces arising from buyers’ – · ex. To overcome the switching cost barrier, new entrants may have to offer buyers a bigger price cut or extra quality or service. All this can Principle of Competitive Markets The competitive threat that outsiders will enter a market is stronger when entry barriers are low, when incumbents are not inclined to fight vigorously to prevent a newcomer from gaining a market foothold, and when a newcomer can expect to earn attractive profits.
E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (March-April 1979), p. 138. 10 Porter, Competitive Strategy, pp. 7-17. 9Michael 72 I I The Concepts and Techniques of Strategic Management • • • • • mean lower profit margins for new entrants-something that increases the risk to startup companies dependent on sizable, early profits to support their new investment. Capital requirements.
The larger the total dollar investment needed to enter the market successfully; the more limited the pool of potential entrants. The most obvious capital requirements are associated with manufacturing plant and equipment, working capital to finance inventories and customer credit, introductory advertising and sales promotion to establish a clientele, and covering startup losses. Cost disadvantages independent of size. Existing firms may have cost advantages not available to potential entrants regardless of the entrant’s size.
These advantages can include access to the best and cheapest raw materials, possession of patents and proprietary technological knowhow, the benefits of learning and experience curve effects, having built and equipped plants years earlier at lower costs, favorable locations, and lower borrowing costs. Access to distribution channels. In the case of consumer goods, a potential entrant may face the barrier of gaining adequate access to distribution channels. Wholesale distributors may be reluctant to take on a product that lacks buyer recognition. A network of retail dealers may have to be set up from scratch.
Retailers may have to be convinced to give a new brand ample display space and an adequate trial period. The more existing producers have tied up present distribution channels, the tougher entry will be. To overcome this barrier, entrants may have to ‘buy” distribution access by offering better margins to dealers and distributors or by giving advertising allowances and other promotional incentives. As a consequence, a potential entrant’s profits may be squeezed until its product gains such acceptance that distributors and retailers want to carry it.
Regulatory policies. Government agencies can limit or even bar entry by requiring licenses and permits. Regulated industries like banking, insurance, radio and television stations, liquor retailing, and railroads feature government-controlled entry. In international markets, host governments commonly limit foreign entry and must approve all foreign investment applications. Stringent government-mandated safety regulations and environmental pollution standards are entry barriers because they raise entry costs.
Tariffs and international trade restrictions. National governments commonly use tariffs and trade restrictions (antidumping rules, local content requirements, and quotas) to raise entry barriers for foreign firms. In 1988, due to tariffs imposed by the South Korean government, a Ford Taurus cost South Korean car buyers over $40,000. European governments require that certain Asian products, from electronic typewriters to copying machines, contain European-made parts and labor equal to 40 percent of the selling price.
And to protect European chipmakers from low-cost Asian competition, European governments instituted a rigid formula to calculate floor prices for computer memory chips. 3 I Industry and Competitive Analysis 73 Even if a potential entrant is willing to tackle the problems of entry barriers, it still faces the issue of how existing firms will reactY Will incumbent firms react passively; or will they aggressively defend their market positions with price cuts, increased advertising, product improvements, and whatever else will give a new entrant (as well as other rivals) a hard time?
A potential entrant often has second thoughts when incumbents send strong signals that they will stoutly defend their market positions against entry and when they have the financial resources to do so. A potential entrant may also turn away when incumbent firms can use leverage with distributors and customers to keep their business. The best test of whether potential entry is a strong or weak competitive force is to ask if the industry’s growth and profit prospects are attractive enough to induce additional entry.
When the answer is no, potential entry is not a source of competitive pressure. When the answer is yes (as in industries where lower-cost foreign competitors are seeking new markets), then potential entry is a strong force. The stronger the threat of entry, the greater the motivation of incumbent firms to fortify their positions against newcomers to make entry more costly or difficult. One additional point: the threat of entry changes as industry prospects grow brighter or dimmer and as entry barriers rise or fall.
For example, the expiration of a key patent can greatly increase the threat of entry. A technological discovery can create an economy of scale and advantage where none existed before. New actions by incumbent firms to increase advertising, strengthen distributor-dealer relations, step up R&D, or improve product quality can erect higher roadblocks to entry. In international markets, entry barriers for foreign-based firms ease when tariffs are lowered; domestic wholesalers and dealers seek out lower-cost foreign-made goods, and domestic buyers become more willing to purchase foreign brands.
The Competitive force of Substitute Products Firms in one industry are, quite often, in close competition with firms in another industry because their respective products are good substitutes. The producers of eyeglasses compete with the makers of contact lenses. The sugar industry competes with companies that produce artificial sweeteners. The producers of plastic containers confront strong competition from makers of glass bottles and jars, paperboard cartons, and tin and aluminum cans. The competitive force of substitute products comes into play in several ways.
First, the presence of readily available and competitively priced substitutes places a ceiling on the prices companies in an industry can afford to charge without giving customers an incentive to switch to substitutes and thus eroding their own market position. 12 This price ceiling, at the same time, puts a lid on the profits that industry members can earn unless they find ways to cut costs. When substitutes are cheaper than an industry’s product, industry members come under heavy competitive pressure to reduce prices and find ways to absorb the price cuts with cost reductions.
Second, the availability of substitutes invites customers to compare quality and performance as well as 11 Porter, “How Competitive Forces Shape Strategy,” p. 140; and Porter, Competitive Strategy, pp. 14–15. 12 Principle of Competitive Markets The competitive threat posed by substitute products is strong when prices of substitutes are · attractive, buyers’ switching costs are low, and buyers believe substitutes have equal or better features. Ibid. , p. 142; and pp. 23-24. 74 I I The Concepts and Techniques of Strategic Management price.
For example, firms that buy glass bottles and jars from glassware manufacturers monitor whether they can just as effectively package their products in plastic containers, paper cartons, or tin cans. Because of competitive pressure from substitute products, industry rivals have to convince customers their product is more advantageous than substitutes. Usually this requires devising a competitive strategy to differentiate the industry’s product from substitute products via some combination of lower cost, better quality, better service, and more desirable performance features.
· Another determinant of whether substitutes are a strong or weak competitive force is whether it is difficult or costly for customers to switch to substitutes13 Typical switching costs include employee retraining costs, the costs of purchasing additional equipment, costs for technical help needed to make the changeover, the time and cost to test the quality and reliability of the substitute, and the psychic costs of severing old supplier relationships and establishing new ones. If switching costs are high, sellers of substitutes must offer a major cost or performance benefit to steal the industry’s customers.
When switching costs are low, it’s much easier for the sellers of substitutes to convince buyers to change over to their product. As a rule, then, the lower the price of substitutes, the higher their quality and performance, and the lower the user’s switching costs, the more intense are the competitive pressures posed by substitute products. The best indicators of the competitive strength of substitute products are the rate at which their sales are growing, the market inroads they are making, the plans the sellers of substitutes have for expanding production capacity, and the size of their profits.
The Power of Supp~iers Whether the suppliers to an industry are a weak or strong competitive force depends on market conditions in the supplier industry and the significance of the item they supply. l 4 The competitive force of suppliers is greatly diminished whenever the item they provide is a standard commodity available on the open market from a large number of suppliers with ample ability to fill orders. Then it is relatively simple to multiple-source whatever is needed, choosing to buy from whichever suppliers offer the best deal.
In such cases, suppliers can win concessions only when supplies-become tight and users are so anxious to secure what they need that they agree to terms more favorable to suppliers. Suppliers are also in a weak bargaining position whenever there are good substitute inputs and switching is neither costly nor difficult. For example, soft drink bottlers check the power of aluminum can suppliers by using plastic containers and glass bottles. Suppliers also have less leverage when the industry they are supplying is a major customer.
In this case, the well-being of suppliers becomes closely tied to the well-being of their major customers. Suppliers then have a big incentive to protect the customer industry via reasonable prices, improved quality, and new products and services that might enhance their customers’ positions, sales, and profits. When industry members form a close working relationship with major suppliers, they may gain substantial benefit in the form of better-quality components, just-in-time deliveries, and reduced inventory costs.
13Porter, Competitive Strategy, p. 10. 14 Ibid. , pp. 27-28. Principle of Competitive Markets The suppliers to an industry are a strong competitive force whenever they have sufficient bargaining power to command a price premium for their materials or components and whenever they can affect the competitive wellbeing of industry rivals by the reliability of their deliveries or by the quality and performance of the items they supply. 3 I Industry and Competitive Analysis 75
On the other hand, powerful suppliers can put an industry in a profit squeeze with price increases that can’t be fully passed on to the industry’s own customers. Suppliers become a strong competitive force when their product makes up a sizable fraction of the costs of an industry’s product, is crucial to the industry’s production process, and/ or significantly affects the quality of the industry’s product. Likewise, a supplier (or group of suppliers) gains bargaining leverage the more difficult or costly it is for users to switch suppliers.
Big suppliers with good reputations and growing demand for their output are harder to wring concessions from than struggling suppliers striving to broaden their customer base. Suppliers are also more powerful when they can supply a component cheaper than industry members can make it themselves. For instance, the producers of outdoor power equipment (lawnmowers, rotary tillers, snowblowers, and so on) find it cheaper to buy small engines from outside manufacturers rather than make their own because the quantity they need is too small to justify the investment and master the process.
Small-engine manufacturers, by supplying many kinds of engines to the whole power equipment industry; sell enough to capture scale economies, become proficient in the manufacturing techniques, and keep costs well below what power equipment firms would incur on their own. Small engine suppliers can price the item below what it would cost the user to self-manufacture but far enough above their own costs to generate an attractive profit margin. In such situations, suppliers’ bargaining position is strong until a customer needs enough parts to justify backward integration.
Then the balance of power shifts away from the supplier. The more credible the threat of backward integration, the more leverage companies have in negotiating favorable terms with suppliers. A final instance in which an industry’s suppliers play an important competitive role is when suppliers, for one reason or another, do not have the manufacturing capability or a strong enough incentive to provide items of adequate quality. Suppliers who lack the ability or incentive to provide quality parts can seriously damage their customers’ business.
For example, if auto parts suppliers provide lower-quality components to U. S. automobile manufacturers, they can so increase the warranty and defective goods costs that they seriously impair U. S. auto firms’ profits, reputation, and competitive position in world markets. The Power of Buyers Just as with suppliers, the competitive strength of buyers can range from strong to weak. Buyers have substantial bargaining leverage in a number of situations. l 5 The most obvious is when buyers are large and purchase a sizable percentage of the industry’s output.
The bigger buyers are and the larger the quantities they purchase, the more clout they have in negotiating with sellers. Often, large buyers successfully leverage their size and volume purchases to obtain price concessions and other favorable terms. Buyers also gain power when the cost of switching to competing brands or substitutes is relatively low. Any time buyers can meet their needs by sourcing from several sellers, they have added room to negotiate. When sellers’ products are virtually identical, buyers can switch with little or no cost.
However, if sellers’ Principle of Competitive Markets – Buyers become a stronger competitive force the more they are able to exercise bargaining leverage over price, quality, service, or other terms of conditions oj:9ale. 15Ibid. , pp. 24-27. 76 I I The Concepts and Techniques of Strategic Management products are strongly differentiated, buyers are less able to switch without incurring sizable switching costs. One last point: all buyers don’t have equal bargaining power with sellers; some may be less sensitive than others to price, quality, or service.
For example, in the apparel industry, major manufacturers confront significant customer power when they sell to retail chains like Sears or Kmart. But they can get much better prices selling to small owner-managed boutiques. Competitive Strategy Principle A company ‘s competitive strategy is increasingly effective the more it provides good defenses against the five competitive forces, influences the industry’s competitive rules in the company’s favor, and helps create sustainable competitive advantage.
Strategic ~mplkations of the five Competitive forces The contribution of Figure 3-3 is the assist it provides in exposing the makeup of competitive forces. To analyze the competitive environment, the strength of each one of the five competitive forces must be assessed. The collective impact of these forces determines what competition is like in a given market. As a rule, the stronger competitive forces are, the lower the collective profitability of participating firms. The most brutally competitive situation occurs when the five forces are tough enough to cause prolonged subpar profitability or even losses for most or all firms.
The competitive structure of an industry is clearly “unattractive” from a profit-making standpoint if rivalry among sellers is very strong, entry barriers are low, competition from substitutes is strong, and both suppliers and customers have considerable bargaining leverage. On the other hand, when an industry offers superior long-term profit prospects, competitive forces are not unduly strong and the competitive structure of the industry is “favorable” and “attractive.
” The “ideal” competitive environment from a profit-making perspective is one in which both suppliers and customers are in a weak bargaining position, there are no good substitutes, entry barriers are relatively high, and rivalry among present sellers is only moderate. However, even where some of the five competitive forces are strong, an industry can be competitively attractive to those firms whose market position and strategy provide a good enough defense against competitive pressures to preserve their competitive advantage and retain an ability to earn above-average profits.
In coping with competitive forces, successful strategists craft competitive approaches that will (1) insulate the firm as much as possible from the five competitive forces, (2) influence the industry’s competitive rules in the company’s favor, and (3) provide a strong, secure position of advantage from which to “play the game” of competition as it unfolds in the industry. Strategists cannot do this task well without first perceptively analyzing the whole competitive picture of the industry via the five forces model. Assessing the Competitive Positions of Rival Companies
Strategic group mapping is a technique for displaying the different competitive positions that rival firms occupy in an industry. The next step in examining the industry’s competitive structure is studying the market positions of rival companies. One technique for comparing the competitive positions of industry participants is strategic group mapping16 This analytical tool bridges the gap between looking at the industry as a whole and considering the standing of each firm separately. It is most useful when an industry has too many competitors to examine each one in depth.
16Jbid. , chap. 7. 3 I Industry and Competitive Analysis 77 A strategic group consists of those rival firms with similar competitive approaches and positions in the marketP Companies in the same strategic group can resemble one another in several ways: they may have comparable product lines, be vertically integrated to the same degree, offer buyers similar services and technical assistance, appeal to similar types of buyers with the same product attributes, emphasize the same distribution channels, depend on identical technology, and/or sell in the same price/ quality range.
An industry has only one strategic group if aUsellers use essentially identical strategies. At the other extreme, there are as many strategic groups as there are competitors if each one pursues a distinctively different competitive approach and occupies a substantially different position in the marketplace. To construct a strategic group map, analysts need to: 1. Identify the competitive characteristics that differentiate
firms in the industry-typical variables are price/quality range (high, medium, low), geographic coverage (local, regional, national, global), degree of vertical integration (none, partial, full), product-line breadth (wide, narrow), use of distribution channels (one, some, all), and degree of service offered (no frills, limited, full service). 2. Plot the firms on a two-variable map using pairs of these differentiating characteristics. 3. Assign firms that fall in about the same strategy space to the same strategic group. 4.
Draw circles around each strategic group, making the circles proportional to the size of the group’s respective share of total industry sales revenues. This produces a two-dimensional strategic group map such as the one for the beer industry shown in Illustration Capsule 10. To map the positions of strategic groups accurately in the industry’s overall “strategy space,” several guidelines must be observed. 18 First, the two variables selected as axes for the map should not be highly correlated; if they are, the circles on the map will fall along a diagonal and analysts will learn nothing more than they would by considering only one variable.
For instance, if companieswith broad product lines use multiple distribution channels while companies with narrow lines use a single distribution channel, one of the variables is redundant. Second, the variables chosen as axes for the map should expose big differences in how rivals have positioned themselves to compete in the marketplace. This means that analysts must identify the characteristics that differentiate rival firms and use these differences as variables for the axes and as the basis for deciding which firm belongs in which group.
Third, the variables used for the axes don’t have to be either quantitative or continuous; they can be discrete variables or defined in terms of distinct classes and combinations. Fourth, the circles on the map should be drawn proportional to the combined sales of the firms in each group so that the map will reflect the relative size of each strategic group. Fifth, if more than two good competitive variables can be used for axes, several maps can be drawn to give different exposures to 17 Ibid. , pp. 129-30. 18Ibid. , pp. 152-54. 78
I I The Concepts and Techniques of Strategic Management STRATEGIC GROUP MAP OIF THIE U. S. IBRIEWiNG INDUSTRY High Low Principle of Competitive Markets Some strategic groups are usually more favorably positioned than others because driving forces and competitive pressures do not affect each group evenly and profit prospects vary among groups based on the relative attractiveness of their market positions. the competitive relationships. Because there is not necessarily one best map, it is advisable to experiment with different pairs of competitive variables.
Strate. JSic group analysis helps deepen understanding of competitive rivalry. 1 To begin with, driving forces and competitive pressures often favor some strategic groups and hurt others. Firms in adversely affected strategic groups may try to shift to a more favorably situated group; how hard such a move proves to be depends on whether the entry barriers in the target group are high or low. Attempts by rival firms to enter a new strategic group nearly always increase competitive pressures. If certain firms are known to be changing their
19Ibid. , pp. 130, 132-38, and 154-55. 3 I Industry and Competitive Analysis 79 competitive positions, arrows can be added to the map to show the targeted direction and help clarify the picture of competitive jockeying among rivals. Second, the profit potential of different strategic groups may vary due to the strengths and weaknesses in each group’s market position. Differences in profitability can occur because of different bargaining leverage with suppliers or customers and different exposure to competition from substitute products.
Generally speaking, the closer strategic groups are on the map, the stronger competitive rivalry among member firms tends to be. Although firms in the same strategic group are the closest rivals, the next closest rivals are in the immediately adjacent groups. Often, firms in strategic groups that are far apart on the map hardly compete at all. For instance, Heineken Brewing Co. in Amsterdam and Dixie Brewing Co. in New Orleans both sell beer, but the prices and perceived qualities of their products are much too different to generate any real competition between them.
For the same reason, Timex is not a meaningful competitor of Rolex, and Subaru is not a close competitor of Lincoln or Mercedes-Benz. Competitor Analysis: Predicting What Moves Whkh Rivals Are Uke! y to Make Next Studying the actions and behavior of close competitors is essential. Unless a company pays attention to what competitors are doing, it ends up “flying blind” into battle. A firm can’t outmaneuver its rivals without monitoring their actions and anticipating what moves they are likely to make next.
The strategies rivals are using and the actions they are likely to take next have direct bearing on what a company’s own best strategic moves are-whether it will need to defend against rivals’ actions or whether rivals’ moves provide an opening for a new offensive thrust. Competitive Strategy Principle Successful strategists take great pains in scouting competitors-understanding their strategies, watching their actions, sizing up their strengths and weaknesses, and trying to anticipate what moves they will make next.
Competitors’ Strategies Strategists can get a quick profile of key competitors by studying where they are in the industry; their strategic objectives (as revealed by their recent actions), and their basic competitive approaches. Table 3-3 provides an easy-to-use scheme for categorizing rivals’ objectives and strategies. Such a summary, along with a strategic group map, usually suffices to diagnose the competitive intent of rivals. !Evaluating Who the industry’s Major Players Are Going to Be It’s usually obvious who the current major contenders are, but these same firms are not necessarily positioned strongly for the future.
Some may be losing ground or be ill-equipped to compete on the industry’s future battleground. Smaller companies may be poised for an offensive against larger but vulnerable rivals. In fast-moving, high-technology industries and in globally competitive industries, companies can and do fall from leadership; others end up being acquired. Today’s industry leaders don’t automatically become tomorrow’s. In deciding whether a competitor is favorably positioned to gain market ground, attention needs to center on why there is potential for it to do better or worse than other rivals.
Usually; how securely a company holds its present market share is a function of its vulnerability to driving forces and competitive pressures, whether it has a competitive advantage or disadvantage, and whether it is the likely target of offensive attacks from other industry ~dentifying T A B L E 3-3 Categorizing the Objectives and Strategies of Competitors Strategic Intent Be the dominant leader • Overtake the opresent industry leader • Be among the industry leaders (top 0 Competitive Scope Local • Regional o National • Multicountry • Global o Market Share Objective • Aggressive expansion via both acquisition and internal growth • Expansion
via internal growth (boost market share at the expense af rival firms) 0 0 Competitive Position/Situation • Strategic Posture • Mostly offensive • Mostly defensive • A combination of offense and defense o Aggressive risk- taker • Conservative follower o Competitive Strategy Striving fur tow cost leadership • Mostly focusing on a market niche -High end -Low end -Geographic -Buyers with special needs ~Other • • • • 0 • • Getting stronger; on the move • Well-entrenched; able to maintain its present position • Stuck in the middle of the 5) pack ‘ —-‘ –Move intothetopjO · • Expansion via.
Going after a. different market P? sition(trying to Move up a notch or > acquisition : move ‘frorn a weaker two in the industrY> • • • Hold onto presentshare · •. toa. stiongerposition) rankings (bygrovvirigatarate Overtake a particular • ·o·O equal to theo industry • ··~ Strbggling; losing ground rival (notnece~sarity. ·. average) ( • ··R. etrenchirtg. to a position the leader) . o Give up share if that can be defended Maintbinp(jstttOn necesspry to profitability,. t16t ovillume) •. : 0 0 0 • 0 0 •• 0 0. 0 00 0 • 0 •• • •• •• •• 000 000 00 • 0 0 • • 0 0 0 00 ° 0 ••
Pursuing differentiation based on -Quality -Service -Technological superiority -Breadth of product line -Image and reputation -Other attributes Note: Since a focus strategy can be aimed at any of several market niches and a differentiation strategy can be keyed to any of several attributes, it is best to be explicit about what kind of focus strategy or differentiation strategy a given firm is pursuing. AU focusers do not pursue the same market niche, and a!! differentiators do not pursue the same differentiating attributes. 3 I Industry and Competitive Analysis 81 participants.
Trying to identify which rivals are poised to gain or lose market position helps a strategist figure out what kinds of moves key rivals are likely to make next. Predicting Competitors’ Next Moves Predicting rivals’ moves is the hardest yet most useful part of competitor analysis. Good clues about what moves a specific competitor may make next come from finding out how much pressure the rival is under to improve its financial performance. Aggressive rivals usually undertake some type of new strategic initiative. Content rivals are likely to continue their present strategy with only minor fine-tuning.
Ailing rivals can be performing so poorly that fresh strategic moves, either offensive or defensive, are virtually certain. Since managers generally operate from assumptions about the industry’s future and beliefs about their own firm’s situation, strategists can gain insights into the strategic thinking of rival managers by examining their public pronouncements about where the industry is headed and what it will take to be successful, listening to what they are saying about their firm’s situation, gathering information about what they are doing, and studying their past actions and leadership styles.
Strategists also need to consider whether a rival is flexible enough to make major strategic changes. To predict a competitor’s next moves, an analyst must get a good “feel” for the rival’s situation, how its managers think, and what its options are. The detective work can be tedious and time-consuming since the information comes in bits and pieces from many sources.
But it is a task worth doing well because the information gives managers more time to prepare countermoves and a chance to beat rivals to the punch by moving first. Pinpointing the ~. etitibH fr0 ril5ubsitutes (a strong,·. moderate •. . .: -:·,-_: . -. – ·- . >—– · · < -. _ – – “- – 7.. INDUSTR~PROSPECTS ~~o bvERP. Ll ATTRACTIGENEss • Fa2tors’rnaking the industry attractive • . •. ·• ·Factor~· makrng. the:rnduslry. unattra,tiVe···· -_·:’. ___:_·_:-,-··– _”_,- _. _-‘ ;··. ;:;_·
