Competitive Strategy, by Michael Porter

Competitive Strategy

Michael Porter (born in 1947) is an American academic known for his theories on competitive strategy for firms and nations (see Michael Porter Wikipedia profile). He is a professor at Harvard Business School and was one of the founders of the consulting firm the Monitor Group (now part of Deloitte). He is credited for creating the well known Five forces and Value chain frameworks, which are taught in business schools and applied by practitioners worldwide.

I first came across his works in strategy textbooks while at business school in the early 2000s, but only read the original books a few years ago, and re-read them again in full for the purposes of this blog. While his style can be dry at times, his books contain many illuminating insights, whose knowledge can probably avoid costly mistakes.

Below are the key lessons from Competitive Strategy:

Introduction

1. Every firm competing in an industry has a competitive strategy, whether explicit or implicit.
2. There are significant benefits to gain through an explicit process of formulating strategy, to insure that at least the policies (if not the actions) of functional departments are coordinated and directed at some common set of goals.
3. Competitive strategy is a broad formula for how a business is going to compete, what its goals should be, and what policies will be needed to carry out those goals. Competitive strategy is a combination of the ends (goals) for which the firm is striving and the means (policies) by which it is seeking to get there. The wheel of competitive strategy articulates these key aspects.
4. Competitive strategy involves the consideration of internal and external limits: strengths and weaknesses (profile of assets and skills relative to competitors), personal values (motivations and needs of key executives and personnel who must implement the chosen strategy), industry opportunities and threats (competitive environment) and societal expectations (government policy, social concerns, mores).
5. The appropriateness of a competitive strategy can be determined by testing the proposed goals and policies for consistency.
   1. Internal consistency: Are the goals mutually achievable? Do the key operating policies address the goals? Do the key operating policies reinforce each other?
   2. Environmental fit: Do the goals and policies exploit industry opportunities? Do the goals and policies deal with industry threats (including the risk of competitive response) to the degree possible with available resources? Does the timing of the goals and policies reflect the ability of the environment to absorb the actions? Are the goals and policies responsive to broader societal concerns?
   3. Resource fit: Do the goals and policies match the resources available to the company relative to competitors? Does the timing of the goals and policies reflect the organization’s ability to change?
   4. Communication and implementation: Are the goals well understood by the key implementers? Is there enough congruence between the goals and policies and the values of the key implementers to insure commitment? Is there sufficient managerial capability to allow for effective implementation?
6. Process to formulate a competitive strategy:
   • A- What is the business doing now?
     1. Identification: What is the implicit or explicit current strategy?
     2. Implied assumptions: What assumptions about the company’s relative position, strengths and weaknesses, competitors, and industry trends must be made for the current strategy to make sense?
   • B- What is happening in the environment?
     1. Industry analysis: What are the key factors for competitive success and the important industry opportunities and threats?
     2. Competitor analysis: What are the capabilities and limitations of existing and potential competitors, and their probable future moves?
     3. Societal analysis: What important governmental, social, and political factors will present opportunities or threats?
     4. Strengths and weaknesses: Given an analysis of industry and competitors, what are the company’s strengths and weaknesses relative to present and future competitors?
   • C- What should the business be doing?
     1. Tests of assumptions and strategy: How do the assumptions embodied in the current strategy compare with the analysis in B above? How does the strategy meet the consistency tests described above?
     2. Strategic alternatives: What are the feasible strategic alternatives given the analysis above? (Is the current strategy one of these?)
     3. Strategic choice: Which alternative best relates the company’s situation to external opportunities and threats?

General analytical techniques

The structural analysis of industries

1. The essence of formulating competitive strategy is relating a company to its environment.
2. The state of competition in an industry depends on five basic competitive forces: threat of entry, intensity of rivalry among existing competitors, pressure from substitute products, bargaining power of buyers, bargaining power of suppliers.
3. The collective strength of these forces determines the ultimate profit potential in the industry, where profit potential is measured in terms of long run return on invested capital (“ROIC”). Not all industries have the same potential. They differ fundamentally in their ultimate profit potential as the collective strength of the forces differs.
4. The goal of competitive strategy for a business unit in an industry is to find a position in the industry where the company can best defend itself against these competitive forces or can influence them in its favor.
5. An industry is a group of firms producing products that are close substitutes for each other.
6. Competition in an industry continually works to drive down ROIC toward the competitive floor rate of return (yield on long-term government securities + risk of capital loss). Firms habitually earning lower returns will eventually go out of business (investors will not tolerate returns below this in the long run) while higher returns stimulate the inflow of capital into an industry (new entry or additional investment by existing competitors). The strength of the competitive forces determines the degree to which this inflow of investment occurs and drives the return to the free market level, and thus the ability of firms to sustain above-average returns.
7. Competition in an industry goes well beyond the established players: customers, suppliers, substitutes, and potential entrants are all “competitors” to firms in the industry.
8. The extreme case of competitive intensity is the economist’s perfectly competitive industry, where entry is free, existing firms have no bargaining power against suppliers and customers, and rivalry is unbridled because the numerous firms and products are all alike.
9. Different forces take on prominence in shaping competition in each industry. In the ocean-going tanker industry the key force is probably the buyers (the major oil companies), whereas in tires it is powerful original equipment (OEM) buyers coupled with tough competitors. In the steel industry the key forces are foreign competitors and substitute materials.
10. The underlying structure of an industry should be distinguished from short-run factors that can affect competition and profitability in a transient way.

Threat of entry

1. New entrants to an industry bring new capacity, the desire to gain market share, and often substantial resources. Prices can be bid down or incumbents’ costs inflated as a result, reducing profitability.
2. Acquisition into an industry with intent to build market position should be viewed as entry even though no entirely new entity is created.
3. The threat of entry into an industry depends on the barriers to entry that are present, coupled with the reaction from existing competitors that the entrant can expect. If barriers are high and/or the newcomer can expect sharp retaliation from entrenched competitors, the threat of entry is low.
4. Major sources of barriers to entry:
   1. Economies of scale. Economies of scale refer to declines in unit costs of a product (or operation or function that goes into producing a product) as the absolute volume per period increases. They deter entry by forcing the entrant to come in at large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disadvantage. They can be present in nearly every function of a business, and may relate to an entire functional area, or stem from particular operations or activities. Units of multi-business firms may be able to reap similar economies if they share operations or functions with other businesses in the company. The benefits of sharing are particularly potent if there are joint costs. Joint costs occur when a firm producing product A or an operation or function that is part of producing A must inherently have the capacity to produce product B. The firm that competes in both passenger and freight may have a substantial advantage over the firm competing in only one market. The same occurs in businesses that involve manufacturing processes with by-products. The entrant who cannot capture the highest available incremental revenue from the by-products can face a disadvantage if incumbent firms do. A common situation of joint costs occurs when business units can share intangible assets such as brand names and know-how. A type of economies of scale entry barrier occurs when there are economies to vertical integration, that is, operating in successive stages of production or distribution. Here the entrant must enter integrated or face a cost disadvantage, as well as possible foreclosure of inputs or markets for its product if most established competitors are integrated.
   1. Product differentiation. Product differentiation means that established firms have brand identification and customer loyalties, which stem from past advertising, customer service, product differences, or simply being first into the industry. Differentiation creates a barrier to entry by forcing entrants to spend heavily to overcome existing customer loyalties. This effort usually involves start-up losses and often takes an extended period of time. Such investments in building a brand name are particularly risky since they have no salvage value if entry fails. Product differentiation is perhaps the most important entry barrier in baby care products, OTC drugs, cosmetics, investment banking, and public accounting.
   2. Capital requirements. The need to invest large financial resources in order to compete creates a barrier to entry, particularly if the capital is required for risky or unrecoverable up-front advertising or R&D. Capital may be necessary not only for production facilities but also for things like customer credit, inventories, or covering start-up losses. Xerox created a major capital barrier to entry in copiers when it chose to rent copiers rather than sell them outright, which greatly increased the need for working capital.
   3. Switching costs. A barrier to entry is created by the presence of switching costs, that is, one-time costs facing the buyer of switching from one supplier’s product to another’s. Switching costs may include employee retraining costs, cost of new ancillary equipment, cost and time in testing or qualifying a new source, need for technical help as a result of reliance on seller engineering aid, product redesign, or even psychic costs of severing a relationship. If switching costs are high, then new entrants must offer a major improvement in cost or performance in order for the buyer to switch from an incumbent. In IV solutions and kits for use in hospitals, procedures for attaching solutions to patients differ among competitive products and the hardware for hanging the IV bottles are not compatible. Switching encounters great resistance from nurses responsible for administering the treatment and requires new investments in hardware.
   4. Access to distribution channels. A barrier to entry can be created by the new entrant’s need to secure distribution for its product. To the extent that distribution channels for the product have already been served by established firms, the new firm must persuade the channels to accept its product through price breaks, cooperative advertising allowances, and the like, which reduce profits. The manufacturer of a new food product, for example, must persuade the retailer to give it space on the fiercely competitive supermarket shelf via promises of promotions, intense selling efforts to the retailer, or some other means. The more limited the wholesale or retail channels for a product are and the more existing competitors have these tied up, the tougher entry into the industry will be. Existing competitors may have ties with channels based on long relationships, high-quality service, or even exclusive relationships in which the channel is solely identified with a particular manufacturer. Sometimes this barrier to entry is so high that to surmount it a new firm must create an entirely new distribution channel, as Timex did in the watch industry.
   5. Cost advantages independent of scale. Established firms may have cost advantages not replicable by potential entrants no matter what their size and attained economies of scale.
      1. Proprietary product technology: product know-how or design characteristics that are kept proprietary through patents or secrecy.
      2. Favorable access to raw materials: established firms may have locked up the most favorable sources and/or tied up foreseeable needs early at prices reflecting a lower demand for them than currently exists.
      3. Favorable locations: established firms may have cornered favorable locations before market forces bid up prices to capture their full value.
      4. Government subsidies: preferential government subsidies may give established firms lasting advantages in some businesses.
      5. Learning or experience curve: in some businesses, there is an observed tendency for unit costs to decline as the firm gains more cumulative experience in producing a product. Costs decline because workers improve their methods and become more efficient (the classic learning curve), layout improves, specialized equipment and processes are developed, better performance is coaxed from equipment, product design changes make manufacturing easier, techniques for measurement and control of operations improve, and so on. Experience is just a name for certain kinds of technological change and may apply not only to production but also to distribution, logistics, and other functions. Cost declines with experience seem to be the most significant in businesses involving a high labor content performing intricate tasks and/or complex assembly operations (aircraft manufacture, shipbuilding). Economies of scale are dependent on volume per period, and not on cumulative volume, and are very different analytically from experience. If costs decline with experience in an industry, and if the experience can be kept proprietary by established firms, then this effect leads to an entry barrier. Newly started firms, with no experience, will have inherently higher costs than established firms and must bear heavy start-up losses from below- or near-cost pricing in order to gain the experience to achieve cost parity with established firms (if they ever can). The decline in cost from experience can be augmented if there are diversified firms in the industry who share operations or functions subject to such a decline with other units in the company, or where there are related activities in the company from which incomplete though useful experience can be obtained.
   6. Government policy: Government can limit or even foreclose entry into industries with such controls as licensing requirements and limits on access to raw materials (like mountains on which to build ski areas).
5. Conditions that signal the strong likelihood of retaliation to entry and hence deter it:
   1. A history of vigorous retaliation to entrants.
   2. Established firms with substantial resources to fight back, including excess cash and unused borrowing capacity, adequate excess productive capacity to meet all likely future needs, or great leverage with distribution channels or customers.
   3. Established firms with great commitment to the industry and highly illiquid assets employed in it.
   4. Slow industry growth, which limits the ability of the industry to absorb a new firm without depressing the sales and financial performance of established firms.
6. The condition of entry in an industry can be summarized in an important hypothetical concept called the entry deterring price: the prevailing structure of prices (and related terms such as product quality and service) which just balances the potential rewards from entry (forecast by the potential entrant) with the expected costs of overcoming structural entry barriers and risking retaliation. If the current price level is higher than the entry deterring price, entrants will forecast above-average profits from entry, and entry will occur. The threat of entry into an industry can be eliminated if incumbent firms choose or are forced by competition to price below this hypothetical entry deterring price.
7. Entry barriers can and do change as the conditions previously described change. Although entry barriers sometimes change for reasons largely outside the firm’s control, the firm’s strategic decisions also can have a major impact.
8. Some firms may possess resources or skills which allow them to overcome entry barrier into an industry more cheaply than most other firms.
9. There are limits to economies of scale as an entry barrier. Large-scale and hence lower costs may involve trade-offs with other potentially valuable barriers to entry such as product differentiation (scale may work against product image or responsive service, for example) or the ability to develop proprietary technology rapidly. Technological change may penalize the large-scale firm if facilities designed to reap scale economies are also more specialized and less flexible in adapting to new technologies. Commitment to achieving scale economies by using existing technology may cloud the perception of new technological possibilities or of other new ways of competing that are less dependent on scale.
10. Experience is a more ethereal entry barrier than scale. Frequently, experience cannot be kept proprietary, due to copying, hiring of competitors’ employees, purchasing of the latest machinery from equipment suppliers or purchasing of know-how from consultants or other firms. Experience may accumulate more rapidly for the second and third firms in the market than it did for the pioneer. The barrier can be nullified by product or process innovations leading to a substantially new technology and thereby creating an entirely new experience curve. Pursuit of low cost through experience may involve trade-offs with other valuable barriers, such as product differentiation through image or technological progressiveness. Aggressive pursuit of cost declines through experience may draw attention away from market developments in other areas or may cloud perception of new technologies that nullify past experience.

Intensity of rivalry among existing competitors

1. Rivalry among existing competitors takes the familiar form of jockeying for position—using tactics like price competition, advertising battles, product introductions, and increased customer service or warranties.
2. Rivalry occurs because one or more competitors either feels the pressure or sees the opportunity to improve position.
3. In most industries, competitive moves by one firm have noticeable effects on its competitors and thus may incite retaliation or efforts to counter the move; that is, firms are mutually dependent.
4. Some forms of competition, notably price competition, are highly unstable and quite likely to leave the entire industry worse off from the standpoint of profitability. Price cuts are quickly and easily matched by rivals, and once matched they lower revenues for all firms unless industry price elasticity of demand is high enough. Advertising battles, on the other hand, may well expand demand or enhance the level of product differentiation in the industry for the benefit of all firms.
5. Intense rivalry is the result of a number of interacting structural factors:
   1. Numerous or equally balanced competitors.
   2. Slow industry growth. Slow industry growth turns competition into a market share game for firms seeking expansion.
   3. High fixed or storage costs. High fixed costs create strong pressures for all firms to fill capacity which often lead to rapidly escalating price cutting when excess capacity is present. The significant characteristic of costs is fixed costs relative to value added, and not fixed costs as a proportion of total costs. A situation related to high fixed costs is one in which the product, once produced, is very difficult or costly to store. Here firms will also be vulnerable to temptations to shade prices in order to insure sales.
   4. Lack of differentiation or switching costs. Where the product or service is perceived as a commodity or near commodity, choice by the buyer is largely based on price and service, and pressures for intense price and service competition result.
   5. Capacity augmented in large increments. Where economies of scale dictate that capacity must be added in large increments, capacity additions can be chronically disruptive to the industry supply/demand balance, particularly where there is a risk of bunching capacity additions.
   6. Diverse competitors. Competitors diverse in strategies, origins, personalities, and relationships to their parent companies have differing goals and differing strategies for how to compete and may continually run head on into each other in the process. Foreign competitors. Owner-operators of small manufacturing or service firms which may be satisfied with a subnormal rate of return on their invested capital to maintain the independence of self-ownership. Firms viewing a market as an outlet for excess capacity. A BU that is part of a vertical chain of businesses. A BU that is being developed for long-run growth.
   7. High strategic stakes. Rivalry in an industry becomes even more volatile if a number of firms have high stakes in achieving success there.
   8. High exit barriers. Exit barriers are economic, strategic, and emotional factors that keep companies competing in businesses even though they may be earning low or even negative returns on investment. When exit barriers are high, excess capacity does not leave the industry, and companies that lose the competitive battle do not give up. Rather, they grimly hang on and, because of their weakness, have to resort to extreme tactics. The profitability of the entire industry can be persistently low as a result.
      1. Specialized assets: assets highly specialized to the particular business or location have low liquidation values or high costs of transfer or conversion.
      2. Fixed costs of exit: these include labor agreements, resettlement costs, maintaining capabilities for spare parts, and so on.
      3. Strategic interrelationships: interrelationships between the BU and others in the company in terms of image, marketing ability, access to financial markets, shared facilities, and so on. They cause the firm to attach high strategic importance to being in the business.
      4. Emotional barriers: management’s unwillingness to make economically justified exit decisions is caused by identification with the particular business, loyalty to employees, fear for one’s own career, pride, etc.
      5. Government and social restrictions: these involve government denial or discouragement of exit out of concern for job loss and regional economic effects.
6. The factors that determine the intensity of competitive rivalry can and do change.
   1. Industry maturity: as an industry matures its growth rate declines, resulting in intensified rivalry, declining profits, and (often) a shake-out.
   2. M&A: when an acquisition introduces a very different personality to an industry.
   3. Technological innovation: can boost the level of fixed costs in the production process and raise the volatility of rivalry.
   4. Strategic shifts: a firm may try to (a) raise buyers’ switching costs by providing engineering assistance to customers to design its product into their operations or to make them dependent for technical advice, (b) raise product differentiation through new kinds of services, marketing innovations, or product changes, (c) focus selling efforts on the fastest growing segments of the industry or on market areas with the lowest fixed costs can reduce the impact of industry rivalry, or (d) avoid confronting competitors with high exit barriers and thus sidestep involvement in bitter price cutting, or lower its own exit barriers.
7. Often exit and entry barriers are related. The best case from the viewpoint of industry profits is one in which entry barriers are high but exit barriers are low. Here entry will be deterred, and unsuccessful competitors will leave the industry. The case of low entry and exit barriers is merely unexciting, but the worst case is one in which entry barriers are low and exit barriers are high. Here entry is easy and will be attracted by upturns in economic conditions or other temporary windfalls. However, capacity will not leave the industry when results deteriorate. As a result capacity stacks up in the industry and profitability is usually chronically poor.

Pressure from substitute products

1. All firms in an industry are competing, in a broad sense, with industries producing substitute products. Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge. The more attractive the price-performance alternative offered by substitutes, the firmer the lid on industry profits.
2. Identifying substitute products is a matter of searching for other products that can perform the same function as the product of the industry. Sometimes doing so can be a subtle task, and one which leads the analyst into businesses seemingly far removed from the industry.
3. Substitute products that deserve the most attention are those that (1) are subject to trends improving their price-performance tradeoff with the industry’s product, or (2) are produced by industries earning high profits. In the security guard industry, for example, electronic alarm systems represent a potent substitute. Moreover, they can only become more important since labor-intensive guard services face inevitable cost escalation, whereas electronic systems are highly likely to improve in performance and decline in costs. The appropriate response of security guard firms is probably to offer packages of guards and electronic systems, based on a redefinition of the security guard as a skilled operator, rather than to try to outcompete electronic systems across the board.

Bargaining power of buyers

1. Buyers compete with the industry by forcing down prices, bargaining for higher quality or more services, and playing competitors against each other—all at the expense of industry profitability.
2. A buyer group is powerful if:
   1. The products it purchases from the industry are standard or undifferentiated. Buyers, sure that they can always find alternative suppliers, may play one company against another.
   2. It faces few switching costs. Switching costs lock the buyer to particular sellers.
   3. It earns low profits. Low profits create great incentives to lower purchasing costs. Highly profitable buyers, however, are generally less price sensitive (if the item does not represent a large fraction of their costs) and may take a longer run view toward preserving the health of their suppliers.
   4. Buyers pose a credible threat of backward integration. The major automobile producers produce some of their needs for a given component in-house and purchase the rest from outside suppliers. Their threat of further integration is therefore credible, and partial manufacturing in-house gives them a detailed knowledge of costs which is a great aid in negotiation. Buyer power can be partially neutralized when firms in the industry offer a threat of forward integration into the buyers’ industry.
   5. The industry’s product is unimportant to the quality of the buyers’ products or services. When the quality of the buyers’ products is very much affected by the industry’s product, buyers are generally less price sensitive.
   6. The buyer has full information. Where the buyer has full information about demand, actual market prices, and even supplier costs, this usually yields the buyer greater bargaining leverage than when information is poor. The buyer is in a greater position to insure that it receives the most favorable prices offered to others and can counter suppliers’ claims that their viability is threatened.
3. Most of these sources of buyer power can be attributed to consumers as well as to industrial and commercial buyers. Consumers also tend to be more price sensitive if they are purchasing products that are undifferentiated, expensive relative to their incomes, or where quality is not particularly important.
4. The buyer power of wholesalers and retailers is determined by the same rules, with one important addition. Retailers can gain significant bargaining power over manufacturers when they can influence consumers’ purchasing decisions. Wholesalers can gain bargaining power, similarly, if they can influence the purchase decisions of the retailers or other firms to which they sell.
5. The power of buyers rises or falls as the factors described above change with time or as a result of a company’s strategic decisions. In the ready-to-wear clothing industry, for example, as the buyers (department stores and clothing stores) have become more concentrated and control has passed to large chains, the industry has come under increasing pressure and has suffered falling margins. The industry has been unable to differentiate its product or engender switching costs that lock in its buyers enough to neutralize these trends, and the influx of imports has not helped.
6. A company’s choice of buyer groups to sell to should be viewed as a crucial strategic decision. A company can improve its strategic posture by finding buyers who possess the least power to influence it adversely. For example, the replacement market for most products is less price sensitive than the OEM market.

Bargaining power of suppliers

1. Suppliers can exert bargaining power over participants in an industry by threatening to raise prices or reduce the quality of purchased goods and services. Powerful suppliers can thereby squeeze profitability out of an industry unable to recover cost increases in its own prices.
2. A supplier group is powerful if the following apply:
   1. It is dominated by a few companies and is more concentrated than the industry it sells to. Suppliers selling to more fragmented buyers will usually be able to exert considerable influence in prices, quality, and terms.
   2. It is not obliged to contend with other substitute products for sale to the industry. The power of even large, powerful suppliers can be checked if they compete with substitutes.
   3. The industry is not an important customer of the supplier group. When suppliers sell to a number of industries and a particular industry does not represent a significant fraction of sales, suppliers are much more prone to exert power. If the industry is an important customer, suppliers’ fortunes will be closely tied to the industry and they will want to protect it through reasonable pricing and assistance in R&D and lobbying.
   4. The suppliers’ product is an important input to the buyer’s business. Such an input is important to the success of the buyer’s manufacturing process or product quality. This is particularly true where the input is not storable.
   5. The supplier group’s products are differentiated or it has built up switching costs. Differentiation or switching costs facing the buyers cut off their options to play one supplier against another. If the supplier faces switching costs the effect is the reverse.
   6. The supplier group poses a credible threat of forward integration. This provides a check against the industry’s ability to improve the terms on which it purchases.
3. Labor must be recognized as a supplier as well, and one that exerts great power in many industries. The key additions in assessing the power of labor are its degree of organization, and whether the supply of scarce varieties of labor can expand.

Government as a force in industry competition

1. Government is often a buyer or supplier and can influence industry competition by the policies it adopts.
2. Government can also affect the position of substitutes through regulations, subsidies, or other means.
3. Government can also affect rivalry among competitors by influencing industry growth, the cost structure through regulations, and so on.

Structural analysis and competitive strategy

1. Once the forces and their underlying causes have been diagnosed, the firm is in a position to identify its strengths and weaknesses relative to the industry.
2. An effective competitive strategy takes offensive or defensive action in order to create a defendable position against the five competitive forces, through (a) positioning, (b) influencing the balance of forces or (c) anticipating shifts and exploiting change.
   1. Positioning. This approach consists of building defenses against the competitive forces or finding positions where the forces are weakest. It takes the structure of the industry as given and matches the company’s strengths and weaknesses to it. If the company is a low-cost producer, it may choose to sell to powerful buyers while it takes care to sell them only products not vulnerable to competition from substitutes.
   2. Influencing the balance. This posture is designed to do more than merely cope with the forces themselves; it is meant to take the offensive and alter their causes. Innovations in marketing can raise brand identification or otherwise differentiate the product. Capital investments in large-scale facilities or vertical integration affect entry barriers.
   3. Exploiting change.
3. The framework for analyzing industry competition can be used in setting diversification strategy. It provides a guide for answering the extremely difficult question inherent in diversification decisions: “What is the potential of this business?” The framework may allow a company to spot an industry with a good future before this good future is reflected in the prices of acquisition candidates.

Structural analysis and industry definition

1. Any definition of an industry is essentially a choice of where to draw the line between established competitors and substitute products, between existing firms and potential entrants, and between existing firms and suppliers and buyers. If these broad sources of competition are recognized, however, and their relative impact assessed, then where the lines are actually drawn becomes more or less irrelevant to strategy formulation. Latent sources of competition will not be overlooked, nor will key dimensions of competition.
2. Definition of an industry is not the same as definition of where the firm wants to compete (defining its business), however. Just because the industry is defined broadly, for example, does not mean that the firm can or should compete broadly; and there may be strong benefits to competing in a group of related industries,

Generic competitive strengths

1. Competitive strategy is taking offensive or defensive actions to create a defendable position in an industry, to cope successfully with the five forces and thereby yield a superior return on investment.
2. There are three internally consistent generic strategies, which can be used singly or in combination, for creating such a defendable position in the long run and outperform competitors.

Three generic strategies

1. Overall cost leadership. This strategy is to achieve overall cost leadership in an industry through a set of functional policies aimed at this objective. A low-cost position yields above-average returns despite the presence of strong competitive forces, defending the firm against rivals (it can still earn returns after competitors have competed their profits away), powerful buyers (prices can only be driven down to the level of the next most efficient competitor), powerful suppliers (more flexibility to cope with input cost increases), and substitutes. Common requirements include:
   • Efficient-scale facilities.
   • Vigorous pursuit of cost reduction from experience.
   • Tight cost and overhead control.
   • Products designed for ease of manufacture.
   • Avoidance of marginal customer accounts.
   • Cost minimization in R&D, service, sales force, advertising.
   • Investment (upfront, pricing, startup losses) to build a high relative market share.
   • Favorable access to raw materials.
   • Wide line of related products to spread costs.
   • Access to capital.
   • Process engineering skills.
   • Intense supervision of labor.
   • Low-cost distribution system.
   • Frequent, detailed control reports.
   • Structured organization and responsibilities.
   • Incentives based on meeting strict quantitative targets.
2. Differentiation. This strategy is one of differentiating the product or service offering of the firm, creating something perceived industry-wide as being unique, along one or ideally several dimensions such as design or brand image, technology, features, customer service, or dealer network. Differentiation provides insulation against competitive rivalry (brand loyalty by customers and resulting lower sensitivity to price), supplier power (higher margins), buyer power (lack of comparable alternatives), substitutes (customer loyalty). It may sometimes preclude a high market share, as it requires a notion of exclusivity. Common requirement include:
   • Strong marketing abilities.
   • Product engineering.
   • Creative flair.
   • Strong capability in basic research.
   • Corporate reputation for quality or technological leadership.
   • Long tradition in the industry or unique combination of skills drawn from other businesses.
   • Strong cooperation from channels.
   • Strong coordination among functions (R&D, product development, marketing).
   • Subjective measurement and incentives.
   • Amenities to attract highly skilled labor, scientists, or creative people.
3. Focus. This strategy is focusing on a particular buyer group, segment of the product line, or geographical market, and achieving either differentiation (better meeting their needs), lower costs, or both. It rests on the premise that the firm will be able to serve its narrow strategic market more effectively or efficiently than firms competing more broadly. It implies some limitations on the overall market share.
   • Combination of the above policies directed at the particular strategic target.

Stuck in the middle

1. A firm failing to develop its strategy in at least one of the three strategic directions is “stuck in the middle”.
   1. Almost guaranteed low profitability: loses high volume / low price customers or bids away its profits to get their business, loses high margin business to focused or differentiated firms.
   2. Blurred corporate culture and conflicting set of organizational arrangements and motivation system.
2. The firm stuck in the middle must pick a generic strategy (the one best suited to its strengths and least replicable by competitors): achieve cost leadership, focus on a particular target or achieve some uniqueness.
3. It takes time and effort for a firm stuck in the middle to extricate itself from this position. Some firms have a tendency to flip back and forth between the three generic strategies.
4. In some industries, smaller (focused or differentiated) firms and larger (cost leadership) firms are the most profitable, and medium-sized firms are the least profitable, leading to a U-shaped relationship between market share and profitability.
5. This U-shaped relationship does not hold in every industry: in some, it’s solely a cost game (bulk commodities), in others, cost is not important (inverse relationship between market share and profitability).
6. Low cost may not be incompatible with differentiation or focus, and may be achievable without high share.

Risks of the generic strategies

1. Risks in pursuing the generic strategies are two: (a) failing to attain or sustain the strategy, (b) for the value of the strategic advantage to erode with industry evolution.
2. The three strategies erect different kinds of defenses against competitive forces, and involve differing types of risks.
3. Risks of overall cost leadership:
   1. Technological change that nullifies past investments or learning.
   2. Low-cost learning by newcomers or followers.
   3. Inability to see required product or marketing change.
   4. Inflation in costs narrowing the price differential with differentiated firms.
4. Risks of differentiation:
   1. The cost differential becomes too great with low-cost competitors to hold brand loyalty.
   2. Buyers’ need for the differentiating factor falls (e.g. as buyers become more sophisticated).
   3. Imitation narrows perceived differentiation.
5. Risks of focus:
   1. The cost differential widens with broad-range competitors, eliminating the cost advantages or offsetting the differentiation achieved by focus.
   2. The differences in desired products or services narrow between the strategic target and the market as a whole.
   3. Competitors find submarkets within the strategic target and outfocus the focuser.

A framework for competitor analysis

1. Competitive strategy involves positioning a business to maximize the value of the capabilities that distinguish it from its competitors.
2. Competitor analysis is therefore a central aspect of strategy formulation, though it is often not done explicitly or comprehensively.
3. There are four diagnostic components:
   1. Future goals: what drives the competitor.
   2. Current strategy: how the business is currently competing.
   3. Assumptions: held about itself and the industry.
   4. Capabilities: strengths and weaknesses.
4. They lead to the competitor’s response profile:
   1. Is the competitor satisfied with its current position?
   2. What likely moves will the competitor make?
   3. Where is the competitor vulnerable?
   4. What will provoke the greatest retaliation?
5. All significant existing competitors must be analyzed.
6. It may be important to analyze potential competitors:
   1. Firms which could overcome entry barriers cheaply.
   2. Firms with obvious synergies.
   3. Firms for whom competition is an obvious extension of the corporate strategy.
   4. Customers or suppliers who may integrate vertically.
7. It may also be valuable to predict probable mergers among established competitors or involving outsiders:
   1. Acquiring firms: potential entrants (see above).
   2. Acquisition targets: ownership, ability to cope with future developments, attractiveness as a base of operations.

The components of competitor analysis

Future goals

A knowledge of goals (financial, market leadership, technological position, social performance) will allow predictions about (a) whether a competitor is satisfied with its position and results, (b) how likely it is to change or react, and (c) how serious its initiatives are.

1. Business unit goals
   1. Financial goals. What are the stated and unstated financial goals of the competitor? How does it make trade-offs between long-run and short-run performance, between growth and profits, between growth and dividends?
   2. Attitude toward risk.
   3. Values and beliefs. Does the competitor have widely shared economic or noneconomic values or beliefs which affects its goals? Does it want to be the market leader, industry statesman, maverick, technological leader? Does it have a history of following a particular strategy or policy institutionalized into a goal? Strongly held views about product design or quality? Location preferences?
   4. Organizational structure. What clues does the structure provide about the relative status of each functional area and the coordination that is deemed important? How does the firm allocate responsibilities and power for key decisions (resource allocation, pricing, product changes)? Where do functional leaders stand in the organizational chart?
   5. Control and compensation. How are executives and salespeople compensated? What measures of performance are tracked regularly? This yields clues about what the firm deems important and how managers will respond to events.
   6. Accounting. How does the firm value inventory, allocate costs, account for inflation? This can influence the firm’s perception of its performance, costs, way it sets prices.
   7. Executives. What kinds of managers lead the firm? What are their backgrounds and experience? What kinds of younger managers are getting rewarded? Where is the firm hiring outsiders?
   8. Unanimity. How much unanimity is there among management about future direction? Are management factions favoring different goals?
   9. Board. What are the backgrounds, management styles and affiliations of outsiders? It can provide clues about the company’s orientation, posture toward risk, preferred strategic approaches.
   10. Contractual limits. What contractual commitments may limit alternatives, e.g. debt covenants, licensing or JV agreements?
   11. Constraints. Are there constraints on the behavior of the firm (regulatory, antitrust, social) that will affect its reaction to competitor moves or its willingness to gain market share?
2. Corporate goals. The corporate parent is likely to impose constraints or requirements on the business unit that will be crucial to predicting its behavior:
   1. Results. What are the current results (growth, rate of return, etc.) of the parent company? This gives an indication of the likely targets for the business unit.
   2. Goals. What are the goals of the parent and thus the probable needs from its business unit?
   3. Strategic importance. What strategic importance does the parent attach to the business unit? Does it view it as core or on the periphery? Is it seen as a growth area and key to the future or as mature and stable and a source of cash?
   4. Rationale. Why did the parent get into this business: excess capacity, need for vertical integration, to exploit distribution channels, for marketing strength?
   5. Relationship. What is the economic relationship between the business and the rest of the portfolio: vertical integration, complementary to other businesses, shared R&D? What special requirements does this place on the business unit relative to the way it would behave as a free-standing company?
   6. Values and beliefs. What are the corporate-wide values and beliefs of top management? Do they seek technological leadership, avoidance of layoffs to fight against unions?
   7. Generic strategy. Is there a generic strategy that the parent has applied elsewhere and may attempt in this business?
   8. Performance and needs of other units. Given the performance and needs of other units, what sales targets, hurdles for ROI and constraints on capital might be placed on the business? Will the unit command support or will it be assigned a low priority in terms of attention and resources? What funds will be left for the unit?
   9. Diversification plans. Is the parent planning to diversify into other areas that will consume capital? Will there be synergies with the unit?
   10. Organizational structure. What clues does the structure provide about the relative status, position and goals of the unit? Does it report directly to the CEO or an influential group VP, or to a manager on his way out? Is it grouped with other units, thus making a coordinated strategy more likely?
   11. Control and compensation. How is divisional management controlled and compensated? What is the frequency of reveiws? What is the size and basis of bonuses?
   12. Executives. What kind of executives are rewarded by the parent? How rapidly do managers move in and out to other units? This may provide clues about their time horizons and attitude toward balancing risky strategies versus safer ones.
   13. Recruitment. Where does the parent recruit from? has management been promoted from within (meaning past strategy is likely to continue) or from outside? What functional areas did the current general manager come from (which may indicate the emphasis top management will want to bring to bear)?
   14. Constraints. Does the corporation have antitrust, regulatory or social sensitivities which may affect the unit?
   15. Emotional attachment. Does the parent or some of its top managers have an emtional attachment to the unit? Is it one of the early businesses? Are past executives of the unit in top corporate jobs? Did current top management make the decision to acquire or develop the unit? Were any programs of the unit begun under the leadership of a top manager? These relationships may signal a disproportionate attention and support, and indicate exit barriers.
3. Portfolio analysis. Analysis of the parent company’s collection of businesses can provide clues to what the objectives of the unit will be, how hard it will fight to maintain its position and performance, and how likely it is to attempt to change its strategic position.
   1. Classification. What criteria are used to classify businesses? How is each business classified?
   2. Cash cows. Which businesses are counted on to be cash cows?
   3. Harvest or divestment. Which businesses are candidates for harvest or divestment?
   4. Stability. Which businesses are sources of stability to offset fluctuations in the rest of the portfolio?
   5. Defensive moves. Which businesses represent defensive moves to protect other major businesses?
   6. Promising areas. Which businesses are the most promising areas in which to invest resources and build market position?
   7. Leverage. Which businesses have a lot of leverage in the portfolio, i.e. where performance changes will have significant impact on the overall performance? These will be protected vigorously.
4. Competitors’ goals and strategic positioning. One approach in formulating strategy is to look for positions in the market where a firm can meet its objectives without threatening its competitors. Analyzing competitors’ goals helps the firm avoid strategic moves that will trigger bitter warfare.

Assumptions

The second crucial component in competitor analysis is to identify each competitor’s assumptions about itself and about the industry and the other companies in it. Where a competitor’s assumptions about itself are inaccurate, this provides a strategic lever: e.g. a competitor mistakenly believing it has a strong customer loyalty may refuse to react to a provocative price cut and end up losing significant market position. Rooting out blind spots will help the firm identify moves with a lower probability of immediate retaliation or moves with ineffective retaliation.

1. Relative position. Based on public statements, claims of management and sales force, and other indications, what does the competitor appear to believe about its relative position in cost, product quality, technological sophistication and other aspects? What does it see as its strengths and weaknesses? Are these accurate?
2. Identification. Does the competitor have strong historical or emotional identification with particular products or functional policies which will be strongly held to, e.g. product design, desire for quality, manufacturing location, selling approach, distribution arrangements?
3. Differences. Are there cultural, regional or national differences that will affect the way competitors perceive and assign significance to events?
4. Values or canons. Are there organizational values or canons that have been strongly institutionalized and will affect the way events are viewed? Are there policies the founder believed in strongly that may still linger?
5. Future demand and trends. What does the competitor believe in terms of future demand for the product and about the significance of industry trends? Will it hesitate to add capacity because of uncertainties or overbuild for the opposite reason? Des it believe the industry is concentrating when it may not be?
6. Competitors. What does the competitor believe about the goals and capabilities of its competitors? Will it overestimate or underestimate any of them?
7. Wisdom. Does the competitor seem to believe in industry conventional wisdom, rules of thumb and common approaches that do not reflect new market conditions?
8. Strategy. A competitor’s assumptions may be influenced by its current strategy, which may not lead to objectivity.

History as an indicator of goals and assumptions. One of the often powerful indicators of a competitor’s goals and assumptions is its history in the business.

1. Past performance. What is the competitor’s current financial performance and market share, compared to that of the recent past? The competitor will almost always be striving to regain the performance of the recent past.
2. Failures. Where has the firm failed or been beaten, and thus not likely to trad again?
3. Successes. In what areas has the firm starred or succeeded: new product introductions, innovative marketing techniques, others? It may feel confident to initiate a move in such areas.
4. Reaction. How has the firm reacted to particular strategic moves or industry events: rationally or emotionally, slowly or quickly?

Managerial backgrounds as an indicator of goals and assumptions. Another key indicator is where the leadership has come from and what the manager’s track records and personal successes and failures have been.

1. Functional backgrounds. Leaders with financial backgrounds can emphasize different strategic directions than leaders with marketing or production backgrounds.
2. Types of strategies. A second clue is the types of strategies that have or have not worked for them in the past. If cutting costs was a successful remedy, it may be adopted the next time.
3. Other businesses. The other businesses they have worked in, and the corresponding rules of the game and strategic approaches, can be important.
4. Major events. Top managers can be greatly influenced by major events they have lived through, such as a sharp recession, energy shortage, major currency fluctuations.
5. Other sources. Writings, speeches, technical background, board of directors, outside activities can also provide clues.
6. Advisors. Consulting firms, advertising agencies, investment banks and other advisors used can be important clues. What other companies use these advisors and what have they done? What conceptual approaches and techniques are the advisors known for?

Current strategy

A competitor’s strategy is most usefully thought of as its key operating policies in each functional area of the business and how it seeks to interrelate the functions.

Capabilities

Goals, assumptions, and current strategy will influence the likelihood, timing, nature and intensity of a competitor’s reaction. Its strengths and weaknesses will determine its ability to initiate or react to strategic moves and to deal with environmental or industry events.

1. Position with respect to the five competitive forces.
2. Strengths and weaknesses in key areas of the business.
   1. Products. Standing of products in each market segment, from the user’s point of view. Breadth and depth of the product line.
   2. Dealer / Distribution. Channel coverage and quality. Strength of channel relationships. Ability to service the channels.
   3. Marketing and selling. Skills in each aspect of the marketing mix. Skills in market research and new product development. Training and skills of the work force.
   4. Operations. Manufacturing cost position (economies of scale, learning curve,, newness of equipment). Technological sophistication and flexibility of facilities and equipment. Proprietary know-how and unique patent or cost advantages. Skills in capacity addition, quality control, tooling. Location, including labor and transportation cost. Labor force climate, unionization situation. Access to and cost of raw materials. Degree of vertical integration.
   5. Research and engineering. Patents and copyrights. In-house capability in the R&D process (production research, process research, basic research, development, imitation). R&D staff skills in terms of creativity, simplicity, quality, reliability. Access to outside sources of research and engineering (suppliers, customers, contractors).
   6. Overall costs. Overall relative costs. Shared costs or activities with other business units. Where the firm is generating the scale or other factors that are key to its cost position.
   7. Financial strength. Cash flow. Short and long-term borrowing capacity (debt/equity ratio). New equity capacity over the foreseeable future. Financial management ability, including negotiation, raising capital, credit, inventories, and accounts receivable.
   8. Organization. Unity of values and clarity of purpose in the organization. Organizational fatigue based on recent requirements placed on it. Consistency of organizational arrangements with strategy.
   9. General managerial ability. Leadership qualities of CEO, ability of CEO to motivate. Ability to coordinate particular functions or groups of functions (e.g. manufacturing with research). Age, training, and functional orientations of management. Depth of management. Flexibility and adaptability of management.
   10. Corporate portfolio. Ability of corporation to support planned changes in all business units in terms of financial and other resources. Ability of corporation to supplement or reinforce business unit strengths.
   11. Other. Special treatment by or access to government bodies. Personnel turnover.
3. Core capabilities.
   1. Functional. What are the firm’s capabilities in each of the functional areas? What is it best at? Worst at?
   2. Consistency. How does the firm measure up to the tests of consistency of is strategy?
   3. Changes. Are there any probable changes in those capabilities as the firm matures? Will they increase or diminish over time?
4. Ability to grow.
   1. Capabilities. Will the firm’s capabilities increase or diminish if it grows? In which areas?
   2. Capacity. What is the firm’s capacity for growth in terms of people, skills and plant capacity?
   3. Sustainable growth. Sustainable growth = ROE x RR = (asset turnover) x (after-tax return on sales) x (assets/equity) x (fraction of earnings retained). What is the firm’s sustainable growth in financial terms? Given a Du Pont analysis, can it grow with the industry? Can it increase market share? How sensitive is sustainable growth to raising outside capital? To achieving good short-term financial results?
5. Quick response capability. What is the firm’s capacity to respond quickly to moves by others, or to mount an immediate offensive?
   1. Uncommitted cash reserves.
   2. Reserve borrowing power.
   3. Excess plant capacity.
   4. Unintroduced but on-the-shelf new products.
6. Ability to adapt to change.
   1. Costs. What are the firm’s fixed versus variable costs? Its cost of unused capacity?
   2. Functional areas. What is the firm’s ability to adapt and respond to changed conditions in each functional area. Can it adapt to competing on cost? managing more complex product lines? adding new products? competing on service? escalation in marketing activity?
   3. Exogenous events. Can it respond to exogenous events such as a sustained rate of inflation? technological changes which make obsolete existing plants? a recession? increases in wage rates? government regulation that will affect the business?
   4. Exit barriers. Does the firm have exit barriers which will keep it from scaling down or divesting its operations in the business?
   5. Shared costs. Does the firm share manufacturing facilities, a sales force, or other facilities or personnel with other units of its corporate parent? These may provide constraints to adaptation or may impede cost control.
7. Staying power. What is the ability of the firm to sustain a protracted battle, which may put pressure on earnings or cash flow?
   1. Cash reserves.
   2. Unanimity among management.
   3. Long time horizon in its financial goals.
   4. Lack of stock market pressure.

Putting the four components together: the competitor response profile

1. Offensive moves. The first step is to predict the strategic changes the firm may initiate.
   1. Satisfaction with the current position. Comparing the firm’s goals with its position, is the firm likely to initiate change?
   2. Probable moves. Based on its goals, assumptions and capabilities, what are the most probable strategic changes the firm will make?
   3. Strength and seriousness of moves. What is the expected strength of these probable moves, and what may the firm gain from them?
2. Defensive capabilities. The next step is to construct a list of possible moves and possible industry and environmental changes.
   1. Vulnerability. To what moves and events would the firm be most vulnerable: asymmetrical profit consequences vs initiating firm, too much capital needed to retaliate?
   2. Provocation. What moves or events threaten the firm so much that it will be forced to retaliate? Hot buttons, reflecting strongly held goals or emotional commitments, will lead to a disproportionate response, and are to be avoided where possible.
   3. Effectiveness of retaliation. To what moves or events is the firm impeded from reacting to quickly or effectively?
3. Picking the battleground. Assuming competitors will retaliate, the firm’s strategic agenda is selecting the best battleground, ideally a strategy competitors are frozen from reacting to or that creates conflicting goals.

Competitor analysis and industry forecasting

1. What are the implications of the interaction of competitors’ probable moves?
2. Are firms’ strategies converging and likely to clash?
3. Do firms have sustainable growth rates in line with the industry’s forecasted growth rate? Or will a gap invite entry?
4. Will probable moves impact industry structure?

The need for a competitor intelligence system

1. Answering these questions about competitors creates enormous needs for data.
2. Creative ways must be devised to collect field and published data, and put it in concise and usable form
3. Gathering data is a waste of time unless they are used in formulating strategy.

Market signals

1. A market signal is any action by a competitor that provides an indication of its intentions, motives, goals, or internal situation.
2. Some signals are bluffs (designed to mislead), some are warnings, some are earnest commitments to a course of action.
3. The medium chosen for the announcement is one clue to its underlying motive.

Types of market signals

1. Prior announcements of moves
   1. Preempting. If a firm announces a new major capacity addition sufficient to meet all expected industry demand, it may be trying to dissuade others from adding capacity. Or if it announces a new product well before it is ready, it may be enticing buyers to wait for the release instead of buying competing products in the interim.
   2. Threats. If a firm learns that a competitor intends to lower prices, it may announce its intention to lower its prices even below, to deter the competitor from going through.
   3. Tests of competitor sentiments. A firm may announce a new warranty program to see how others will react, go through if the reactions are mild, or withdraw/amend if competitors show displeasure or announce different programs.
   4. Communicating pleasure or displeasure. Announcing a move in line with a competitor might indicate pleasure, while announcing a punishing or substantially different move can indicate displeasure.
   5. Minimizing provocation. If a firm believes price levels should be adjusted downward in the industry, it may announce the move well ahead of time and justify it in terms of specific changes in costs, so competitors do not read is as a bid for market share. But such announcements can also be used to lull competitors into a false sense of security.
   6. Avoid costly simultaneous moves. Firms may announce expansion plans well in advance, to facilitate the scheduling of capacity additions by competitors so as to minimize overcapacity.
   7. Financial communication. Firms often have a PR motive in presenting their situation in the best possible light. This can cause trouble by sending inappropriate signals to competitors.
   8. Internal support. Committing the firm to do something publicly can be a way of cutting off internal debate.
2. Announcements of results or actions after the fact. Ex-post announcements insure that other firms know and take note of the data disclosed.
3. Public discussions of the industry by competitors. These can be an attempt to get other firms to operate under the same assumptions (pleas for discipline on price, capacity additions, advertising competition) with an implicit promis to cooperate if others act properly).
4. Discussions of their own moves. This can serve three purposes: (a) get others to see the logic of the move so they can follow it or not take it as a provocation, (b) deter others from trying by telling how costly and difficult the move was, (c) communicate commitment to convince competitors that the firm is there to stay.
5. Tactics relative to what they could have done. If it could have hurt competitors more, this may signal conciliation.
6. Manner in which strategic changes are implemented. The manner in which a strategic change is implemented can help differentiate between a desire to inflict penalty (aggressively sell a new product to the key customers of its rivals, cut prices first on products at the heart of a competitor’s product line, make a move at an unusual time of the year) and a desire to make a move in the best interests d the industry as a whole (introduce a new product in a peripheral market, cut prices first in segments where the competitor does not have a great interest, make a move at a normal time of the year).
7. Divergence from past goals. This may indicate a major realignment in goals or assumptions.
8. Divergence from industry precedent. This is usually an aggressive signal.
9. Cross-parry. This is when a firm initiates a move in one area, and a competitor responds in another area to signal displeasure and avoid triggering a set of destructive moves. This can be an effective way to discipline a competitor if there is a divergence of market share (the cost of meeting a price cut is a lot greater for a form with a large market share).
10. Fighting brand. A firm threatened by another can introduce a brand to punish or threaten to punish the source of the threat.
11. Private antitrust suits. This can be taken as a sign of displeasure (you have pushed too far and better back off), as a way to neutralize the power of a big firm, or as a way to penalize smaller firms (high legal costs, attention diverted).

The use of history in identifying signals

• Studying the relationship between a firm’s announcements or signals and its moves or outcomes can greatly improve one’s ability to read signals accurately.
  • Product change preceded by certain sales force activities.
  • Product introductions after a sales meeting or a rice change in the existing line
  • Announcement of capacity additions when capacity utilization reaches a certain level.

Can attention to market signals be a distraction?

Competitive moves

Industry instability: the likelihood of competitive warfare

1. The first question for the firm considering offensive or defensive moves is the degree of instability in the industry.
2. The greater the number of competitors, the more equal their relative power, the more standardized their products, the higher their fixed costs, and the slower the industry growth, the greater the likelihood that there will be repeated efforts by firms to pursue their own self-interest.
3. The more diverse or asymmetrical their goals and perspectives, the greater their stakes in the business, and the less segmented the market, the harder to properly interpret each others’ moves and sustain a cooperative outcome.
4. A history of interaction among the parties (which facilitates the building of trust), multiple bargaining areas (which provide ways to reward or discipline a competitor), and interconnections through JVs (which foster cooperation) promotes stability.

Competitive moves

1. In an oligopoly, the goal of the firm is to avoid destabilizing and costly warfare, but yet still outperform other firms. Making competitive moves is best thought of as brute force (using superior resources andsignifi capabilities to force an outcome skewed toward the interests of the firm) applied with finesse (structuring the game to maximize the outcome).
2. Cooperative or nonthreatening moves. These are a place to begin to improve position.
   1. Moves that improve the firm’s and competitors’ position even if they do not match them. Thus case involves the least risk and reflects weak past strategy (inappropriate advertising campaign, pricing structure out of line).
   2. Moves that improve the firm’s and competitors’ position only if a significant number match them. This case is the most common (reduction of warranty from 2 years to 1 year, change in costs calling for change in price). The key steps are (a) assessing the impact of the move on each competitor and (b) assessing the benefits of breaking ranks vs. cooperating. Executing such moves requires that competitors understand that the move is not threatening, which can be done through active signaling (e.g. discussion of cost increases), reliance on a traditional industry leader (wait for it to move first), link to a readily visible index.
   3. Moves that improve the firm’s position because competitors will not follow. This involves moves competitors will not respond to because they do not perceive a need to do so: (a) they do not notice, (b) they are not concerned because of their self-perception or assumptions about the industry and how to compete, (c) it does not impair their performance per their own criteria. Timex entered the watch industry with a low-price watch sold through drugstores. It was so different from the high-quality high-priced Swiss watch sold through jewelry stores that the Swiss did not perceive it as competition at all.
3. Threatening moves. The essence of oligopoly is that many moves that would significantly improve a firm’s position threaten competitors.
   1. A key to the success of such moves is predicting and influencing retaliation.
      1. How likely is retaliation?
      2. How soon will retaliation come?
      3. How effective will retaliation be?
      4. How tough will retaliation be?
      5. Can retaliation be influenced?
   2. Lags in retaliation. The firm will want to make moves that gives it more time before competitors can effectively retaliate.
      1. Perceptual lags. The move was kept secret or introduced quietly away from competitors’ center of attention. The more efficient the competitor monitoring system, the shorter the lag.
      2. Lags in mounting a retaliatory strategy. Retaliation to a price cut can be immediate, but it can take years for a defensive research effort to match a product change or for modern capacity to be put on stream.
      3. Inability to pinpoint retaliation. Particularly for larger firms, retaliatory moves may have to be generalized to all customers rather than restricted to the contested customers or segments. To match a price cut by a small competitor, a larger firm may have to give a price discount to all its customers.
      4. Lags caused by conflicting goals or mixed motives. Finding such a situation is at the heart of many success stories (Timex, VW, Bic razors).
4. Defensive moves.
   1. Good defense is creating a situation in which competitors conclude that the move is unwise.
   2. Discipline as a form of defense. Such discipline is likely to be more effective if it is made immediately and surely after a move (so the aggressor will expect it each time) and focused on the initiator (e.g. fighting brand which is a copy).
   3. Denying a base. The denial of an adequate base for the competitor to meet its goals (growth, market share, ROI) can cause it to withdraw. Tactics include (a) strong price competition, (b) heavy research expenditures, (c) special deals to load customers up with inventory.

Commitment

1. Commitment is the single most important concept in planning and executing offensive or defensive moves.
2. Establishing commitment is a form of communicating the firm’s resources and intentions unequivocally.
3. There are three major types of commitment:
   1. Commitment that the firm is sticking with a move it is making. This can deter retaliation.
   2. Commitment that the firm will retaliate. This can deter threatening moves.
   3. Commitment that the firm will take no action or forgo an action. This can create trust and deescalate battles. A persuasive way is for the firm to demonstrably reduce its performance (eg yield market share in cyclical downturns) to the benefit of competitors.
4. A commitment will be persuasive if it appears binding and irreversible.
5. The firm that can commit itself first may skew the outcome in its favor.
6. The building blocks of credible commitment are the following:
   1. Visible assets, resources and other discipline mechanisms to carry out the commitment quickly: excess cash reserves, excess production capacity, a large corps of salespersons, extensive research facilities, small positions in a competitor’s other business, fighting brands, on-the-shelf unintroduced new products.
   2. A clear intention to carry out the commitment.
   3. A history of adherence to past commitments.
   4. Inability to back down. Long-term contracts, agreements to meet price curs, guarantees of equivalent quality, public statements.
   5. Perceived moral resolve not to back down.
   6. Ability to detect compliance to the terms, so competitors will not be tempted to cheat. Known systems of monitoring sales, talking to customers, interviewing distributors.

Focal points

1. Diverging expectations in an oligopoly lead to instability.
2. Game theory suggests discovering a focal point on which expectations can converge: logical price point, percentage markup pricing rules, divisions of market share, informal sharing of the market on some geographic or customer basis.
3. A desirable focal point should be set as early as possible.
4. Industry prices or terminology may be simplified so that a focal point can be identified: e.g. price per sqm rather than absolute prices.
5. The firm should try to set up the game to make the best focal point for it emerge.

A note on information and secrecy

1. Companies are disclosing more and more about themselves.
2. Selective release of information can sometimes serve useful purposes, but often information about plans or intentions can make it a great deal easier for competitors to formulate strategy.

Strategy toward buyers and suppliers

Buyer selection

1. The buyer group facing an industry is rarely homogeneous. They can differ in their volume of purchase, the importance of the product as an input to their production process, income, education, purchasing needs (customer service, product quality or reliability, information in sales presentations), growth potential, costs of servicing.
2. As a result, buyer selection is an important strategic variable.
3. The firm should sell to the most favorable buyers possible, to the extent it has any choice.
4. There are four criteria that determine the quality of buyers from a strategic standpoint:
   1. Purchasing needs versus company capabilities. The firm will increase its competitive advantage if it targets its efforts toward buyers whose particular needs it is in the best relative position to serve. Such a match will allow the firm to achieve the highest level of product differentiation and to minimize the cost of serving these buyers relative to its competitors. Diagnosing the purchasing needs of particular buyers is a matter of identifying all the factors that enter into each buyers purchasing decision and the factors involved in executing the purchase transaction (shipping, delivery, order processing). These can then be ranked.
   2. Growth potential. The higher the growth potential of a buyer, the more probably its demand for the firm’s product will increase over time. The growth potential of an industrial buyer is determined by (a) the growth rate of its industry, (b) the growth rate of its primary market segments, (c) its change in market share. The growth potential of a household buyer is determined by (a) demographics (future size of a particular segment) and (b) quantity of purchase (substitutes, social trends).
   3. Structural position. Buyers without much intrinsic bargaining power will be good buyers: (a) purchase small quantities relative to the size of sellers, (b) lack qualified alternative sources, (c) face high shopping, transaction or negotiation costs, (d) lack a credible threat of backward integration, (e) face high fixed costs of switching suppliers (modifying products, testing or certifying, retraining employees, ancillary equipment, new logistical arrangements, severing a relationship). Their propensity to use this leverage to force down a seller’s margins may differ as they may be more or less price sensitive (though this can change as the industry matures or substitutes begin to put pressure on their own margins) or willing to trade price against other attributes.
   4. Cost of servicing. If these costs are high, otherwise good buyers may lose their attraction. These costs can vary greatly, based on (a) order size, (b) selling direct versus through distributors, (c) required lead time, (d) steadiness of order flow, (d) shipping cost, (e) selling cost, (f) need for customization.
5. These criteria do not necessarily move in the same direction, so the ultimate choice is often a weighing and balancing process.

Purchasing strategy

1. Key issues in purchasing strategy are as follows:
   1. Stability and competitiveness of the supplier pool. It is desirable to purchase from suppliers who will maintain or improve their competitive position in terms of their products or services (adequate or superior quality/cost to insure the firm’s own competitiveness) and will continue to meet the firm needs (minimize the cost of changing suppliers).
   2. Optimal degree of vertical integration.
   3. Allocation of purchases among qualified suppliers. The goal is to find mechanisms to offset or surmount sources of supplier power.
      1. Spread purchases. The business given to each supplier must be large enough to cause the supplier concern over losing it. Volume discounts should be negotiated.
      2. Avoid switching costs. Resist the temptation to become too dependent for engineering assistance, insure employees are not coopted, require that an alternate supplier is used, disapprove investments in ancillary equipment tied to particular supplier, resist products involving specialized training.
      3. Help qualify alternate sources.
      4. Promote standardization of specs to reduce differentiation .
      5. Create a threat of backward integration through statements, leaked word of internal studies, contingency plans with consultants.
      6. Use tapered integration, i.e., partial integration into an item while buying some outside.
   4. Creation of maximal leverage with chosen suppliers.
2. The objective is to lower the total long-run costs of purchasing.
   1. Maintaining alternative sources of supply or avoiding switching costs can involve short-run expenses.
   2. The firm should purchase from low-cost suppliers unless there are offsetting benefits in terms of long-run bargaining power.

Structural analysis within industries

1. The five broad competitive forces provide a context in which all firms in an industry compete.
2. But some firms are persistently more profitable than others.

Dimensions of competitive strategy

1. Companies’ strategies for competing in an industry differ in a wide variety of ways, along the following strategic dimensions:
   1. Specialization. Degree to which it focuses its efforts in terms of product line width, target customer segments, geographic markets served.
   2. Brand identification. Degree to which it seeks brand identification versus competition based on price or other variables. Brand identification can be achieved via advertising, sales force or other means.
   3. Push versus pull. Degree to which it seeks brand identification directly with ultimate consumers versus support of distribution channels.
   4. Channel selection. Choice of distribution channels (company. owned, specialty, broad-line).
   5. Product quality. Level of product quality in terms of raw materials, specifications, adherence to tolerances, features.
   6. Technological leadership. Degree to which it seeks to be a technological leader versus following or imitation.
   7. Vertical integration. Extent of value added, including captive distribution, exclusive or own outlets, in house service network.
   8. Cost position. Extent to which it seeks the low-cost position.
   9. Service. Degree to which it provides ancillary services.
   10. Price policy. Relative price position in the market.
   11. Leverage. Amount of financial and operating leverage.
   12. Relationship with parent company. Requirements by the parent, objectives, resources, shared operations or functions.
   13. Relationship to home and host government.
2. The scope for strategic differences along a particular dimension depends on the industry. In a commodity business, no firm has much brand identification and product quality is uniform, yet firms vary in backward integration, service, forward integration into dealerships, relative cost positions, relationship to their parents.

Strategic groups

1. The first step in structural analysis within industries is to characterize the strategies of all significant competitors along these dimensions. This allows for the mapping of the industry into strategic groups.
   1. A strategic group is the group of firms in an industry following the same or a similar strategy along the strategic dimensions.
   2. Once groups have formed, the firms in the same strategic group generally resemble one another closely, tend to have similar market shares and to be affected by and respond similarly to external events or competitive moves.
   3. The profit potential of firms in different strategic groups is often different, because the five broad competitive forces will not have equal impact.
   4. Within a strategic group, the profitability of particular firms should differ in the long run based on their ability to implement the common strategy.
2. The second step is to assess the height and composition of the mobility barriers.
   1. Entry barriers depend on the particular strategic group that the entrant seeks to join. Market shares can be very stable in some strategic groups, yet there can be rapid entry and exit in others.
   2. Mobility barriers also deter the movement of firms from one strategic group to another.
   3. Firms have different skills, resources, goals and risk postures, and thus select different strategies.
   4. In some industries, early entrants have access to strategies more costly to later entrants. Later entrants may tend to be firms with increased financial resources, while those with few resources may be compelled to enter early when capital costs of entry are low.
   5. As an industry increases in size, vertical integration, captive distribution and in-house servicing may become more feasible. Conversely, maturity may lessen buyers’ desire for service or for a full product line, and thus reduce mobility barriers.
3. The third step is to assess the relative bargaining power of each strategic group with its suppliers and buyers.
   1. Different strategic groups have different degrees of bargaining power with suppliers or customers.
   2. Their strategies may yield different vulnerability to common suppliers or buyers, or involve different suppliers or buyers.
4. The fourth step is to assess the relative position of each strategic group vis-à-vis substitute products.
   • Strategic groups may face differing levels of exposure to competition from substitutes if they focus on different parts of the product line, serve different customers, operate at different levels of quality, have different cost positions.
5. The fifth step is to assess the extent to which customers overlap among strategic groups and their vulnerability to warfare initiated by other groups.
   1. Extent to which customer targets overlap (“market interdependence”). This is the most important influence on rivalry among groups.
   2. Product differentiation. If products are seen as interchangeable, rivalry will tend to be greater than if divergent strategies lead to distinct and differing brand preferences.
   3. Number of groups and their relative size. An industry with a complicated map of strategic groups of equal size will tend to be more competitive than one with few groups of unequal size.
   4. Extent to which strategies diverge (“strategic distance”). Firms pursuing widely different strategic approaches tend to have different ideas about how to compete and a difficult time understanding each other and avoiding mistaken reactions.
   5. The most volatile situation is the one in which several equally balanced strategic groups, following markedly different strategies, are competing for the same basic customer. Conversely, a situation in which there are only a few large groups that compete for distinct customer segments with strategies that do not differ except along a few dimensions is likely to be more stable.
   6. A particular strategic group will be most exposed to rivalry from other strategic groups if they compete for the same market segments, with products perceived as similar, are relatively equal in size, and follow quite different strategic approaches for getting the product to market. Conversely, a strategic group that has a large share, targets itself to distinct segments not served by others and achieves high product differentiation is likely to be more insulated from intergroup rivalry.

Strategic groups and a firm’s profitability

1. The underlying determinants of a firm’s profitability are as follows:
   1. Common industry characteristics.
   2. Characteristics of strategic group.
      1. Height of mobility barriers.
      2. Bargaining power with customers and suppliers.
      3. Vulnerability to substitute products.
      4. Exposure to rivalry from other groups. If their target markets overlap, rivalry within a group will spill over to less protected groups through lower prices or higher costs.
      5. Degree of competition within the group. Firms may compete away potential profits among themselves, notably if there are many firms.
   3. Firm’s position within its strategic group.
      1. Firm’s scale relative to others in the group. If there are economies of scale, firms with a larger share will have a higher profit potential.
      2. Firm’s costs of entry into the group. Its skills or resources, notably based on its position in other industries or other strategic groups, may give it an advantage versus others.
      3. Firm’s ability to execute in an operational sense. Some firms are superior in their ability to organize and manage operations, develop creative advertising and make technological breakthroughs with similar budgets.
2. There are many kinds of potentially profitable strategies. Low-cost position overall is not necessarily the only way to compete, however firms must be constantly aware of their cost differential with low-cost groups,
3. The relationship between profitability and market share depends on the industry. Leaders’ returns are higher in industries with heavy advertising or R&D outlays (soap, perfume, soft drinks, cereals, drugs) and/or production economies of scale (radio, TV), while followers’ returns are higher in industries with absent or low economies of scale (clothing, footwear, meat products) and/or high segmentation (medical goods, liquor, sporting goods).

Implications for formulation of strategy

1. Formulating competitive strategy in an industry can be viewed as the choice of which strategic group to compete in. This choice may involve selecting the group with the best trade-off between profit potential and the firm’s costs of entering it, or creating an entirely new strategic group.
2. The broadest guidance for the formulation of strategy is stated in terms of matching a firm’s strengths and weaknesses, particularly its distinctive competence, to the opportunities and risk in its environment.
3. Strengths and weaknesses can be:
   1. Structural: factors that improve or lower mobility barriers, bargaining power vis-à-vis buyers and suppliers, insulation from rivalry, scale, costs of entry.
   2. Implementational: based on people and managerial skills.
4. Strategic opportunities include:
   1. Creating a new group. This is the opportunity with the highest payoff.
   2. Shifting to a better group.
   3. Strengthening the position of the group or the firm.
5. Risks include:
   1. Risks of inaction. Other firms entering the group, adverse evolution of structural factors.
   2. Risks of pursuing opportunities. Investments to improve the firm’s position, attempt to shift groups or create a new group.

The strategic group map as an analytical tool

1. The strategic group map is a useful way to display competition in an industry and to see how industry changes or how trends might affect it.
2. The analyst must select the few strategic variables used as axes:
   1. The best variables are those that determine the key mobility barriers.
   2. The variables should not move together.
   3. The axes need not be continuous or monotonic variables.
   4. An industry can be mapped several times, using various combinations of strategic dimensions.
3. The following analytical steps can then be illuminating:
   1. Identifying mobility barriers that protect each group from attacks from other groups. In the US chainsaw industry, key barriers protecting the high quality dealer-oriented group are technology, brand image, and an established network of servicing dealers, while key barriers protecting the private label group are economies of scale, experience, and relationships with customers.
   2. Identifying marginal groups, whose position is tenuous. These are candidates for exit or for attempts at moving into another group.
   3. Charting directions of strategic movement, drawing arrows
   4. Analyzing trends and their implications for the strategic group. Is the trend closing off the viability of some groups, and if so, where will they shift? Is it elevating the barriers held by some groups? Will it reduce the ability of groups to separate themselves along some dimension?
   5. Predicting reactions. Firms in a group tend to react symmetrically to disturbances or trends.

Industry evolution

1. Industries’ structures change, often in fundamental ways, thus increasing or decreasing the basic attractiveness of an industry as an investment opportunity., and requiring firms to make strategic adjustments.

Basic concepts in industry evolution

1. The simplest approach is to ask in a disciplined way, for each competitive force and underlying economic cause, if there are changes occurring in the industry that will affect it.
2. It is not always clear, hence the interest of analytical techniques that will aid in anticipating the pattern of industry changes.
3. Product life cycle.
   1. Introduction: flat phase reflects the difficulty of overcoming buyer inertia and stimulating trials.
      1. Buyers: high income purchaser, inertia, buyer must be convinced to try the product.
      2. Products: poor quality, basic design undergoing frequent changes, no standards, product design and development key.
      3. Marketing: high marketing costs, creaming price strategy.
      4. Manufacturing and distribution: overcapacity, short runs, high costs, skilled labor, specialized channels.
      5. R&D: changing production techniques.
      6. Foreign trade: some exports.
      7. Overall strategy: best period to increase market share.
      8. Competition: few companies.
      9. Risk: high risk.
      10. Profits: high prices, high margins, low profits.
   1. Growth: rapid growth as many buyers rush into the market once the product has proven itself useful.
      1. Buyers: widening buyers, uneven quality accepted.
      2. Products: technical and performance differentiation, improvements in quality, reliability key for complex products.
      3. Marketing: high advertising (but lower %), advertising and distribution key for nontechnical products.
      4. Manufacturing and distribution: undercapacity, shift toward mass production, scramble for distribution, mass channels.
      5. R&D: –
      6. Foreign trade: significant exports, few imports.
      7. Overall strategy: practical to change price or quality image, marketing the key function.
      8. Competition: entry, many competitors, lots of mergers and casualties.
      9. Risk: risks can be taken because growth covers them up.
      10. Profits: highest profits, fairly high prices, recession resistant, high P/Es, good acquisition climate.
   1. Maturity: penetration of potential buyers is reached, causing growth to level off to the underlying rate of growth of the buyer group.
      1. Buyers: mass market, saturation, repeat buying, choosing among brands.
      2. Products: superior quality, less differentiation, standardization, less rapid changes, trade-ins.
      3. Marketing: market segmentation, efforts to extend life cycle, broaden line, service and deals more prevalent, packaging important, advertising competition.
      4. Manufacturing and distribution: some overcapacity, long runs, stable processes, lower labor skills, distribution channels pare down their lines to improve margins.
      5. R&D: –
      6. Foreign trade: failing exports, significant imports.
      7. Overall strategy: bad time to increase market share, to change price or quality image, having competitive costs and marketing effectiveness becomes key,
      8. Competition; price competition, shakeout, increase in private brands.
      9. Risk: cyclically sets in.
      10. Profits: falling prices, lower margins and profits, lower dealer margins, stable market shares and price structures, tough to sell companies.
   1. Decline: growth tapers off as new substitute products appear.
      1. Buyers: sophisticated buyers.
      2. Products: little product differentiation, spotty quality.
      3. Marketing; low advertising to sales.
      4. Manufacturing and distribution: substantial overcapacity, mass production, specialty channels.
      5. R&D: –
      6. Foreign trade: no exports, significant imports.
      7. Overall strategy: cost control key.
      8. Competition: exits, fewer competitors.
      9. Risk: –
      10. Profits: low prices and margins, prices fall hut might rise in late decline.
   2. The concept has attracted legitimate criticism:
      1. The duration of the stages varies widely and it is often not clear what stage an industry is in.
      2. Industry growth does not always go through an S-shaped pattern.
      3. Companies can affect the shape of the curve through innovation and repositioning.
      4. The nature of competition in each stage is different for different industries.
4. Evolutionary processes. Industries evolve because some forces are in motion that create incentives or pressures for change. The firm must ask itself what influence each of them will have on the structure of the industry and on its position, and how it can prepare to deal with it effectively now.
   1. Long-run change in growth. It is a key variable in determining the intensity of rivalry, and sets the pace of expansion required to maintain share, thereby influencing the supply demand balance and inducing new entrants.
      1. Demographics. In consumer goods, demographic changes determine the size of the buyer pool and thus growth in demand. Part of the effect is caused by income elasticity. For industrial products, demographics affect demand for end products, which filters back to affect the industries supplying inputs. Firms can cope with adverse demographics by widening the buyer group through product or marketing innovation, or additional service offering.
      2. Trends in needs. Demand is affected by changes in the lifestyle, tastes, philosophies, and social conditions of the buyer population, and by changes in government regulation. Increase in property theft has increased demand for security guards, locks, safes, and alarm systems. Legislation legalizing gambling has increased demand for slot machines.
      3. Change in the relative position of substitutes. Industry growth will be adversely affected if the relative cost of a substitute falls or if its ability to satisfy buyers’ needs improves. To predict long-run change in growth, the firm must identify all the substitute products.
      4. Changes in the position of complementary products. It is similarly important to identify complements comprehensively and in a broad sense, and chart trends in their cost, quality and availability. Credit is a complementary product to purchases of durable goods, specialized personnel is a complementary product to technical goods.
      5. Penetration of the customer group. Most very high growth rates are the result of increasing penetration, or sales to new customers rather than to repeat customers. Once penetration is reached the industry is selling primarily to repeat buyers, the key to achieving growth then being to stimulate rapid replacement (physical, technological, or design obsolescence) or increasing per capita consumption. For durable goods, achieving penetration can lead to an abrupt drop in demand, overcapacity in manufacturing and distribution, a decline in profit margins, and a more apparent sensitivity to the business cycle.
      6. Product change. Product innovation can improve an industry’s circumstances, and increase the industry’s growth rate.
   2. Changes in buyer segments served. Calculators were initially sold to scientists and engineers, later to students and bill payers, light aircraft to the military and later to private and commercial users. Additional segmentation of existing buyer segments can also take place by creating different products and marketing techniques. The requirements for serving these new buyers (eg credit, in-house servicing) may create economies of scale and raise capital requirements, thus raising entry barriers.
   3. Buyers’ learning. Through repeat purchasing, buyers accumulate knowledge about a product, its use, and the characteristics of competing brands. Products become more like commodities, leading to squeezed margins. Learning may also lead to increased demand for warranty protection, service, improved performance. Offsetting buyer’s experience are changes in the product or in the way it is sold or used, or expanding the customer base to inexperienced buyers.
   4. Reduction of uncertainty. Technologies are proven or disproven, buyers are identified, potential market size is assessed, successful strategies are imitated and poor ones abandoned. This may attract larger, established firms. The firm must prepare to defend its position against imitators and entrants, or adjust its approach if its early bets prove wrong.
   5. Diffusion of proprietary knowledge. Product and process technologies become less proprietary (physical inspection of products, diffusion by suppliers, capital goods manufacturers, distributors, customers, former employees, consulting firms and other experts). This makes it easier for new competitors to spring up, but also for customers and suppliers to vertically integrate. Offsetting forces include (i) protection of know-how and specialized personnel, (ii) continual innovation to maintain the lead, and (iii) shoring up of strategic position in other areas.
   6. Accumulation of experience. In some industries, unit costs decline with experience in manufacturing, distributing, and marketing the product. The learning curve will be significant if followers are unable to catch up. If the firm is not gaining experience the fastest, it must prepare to practice rapid imitation or build advantages elsewhere (differentiation, focus).
   7. Expansion (or contraction) in scale. Increasing market size may allow larger firms to substitute capital for labor, adopt production methods with economies of scale, establish captive distribution or service organizations, use national advertising. Strategies of vertical integration become more feasible, and new entrants may be attracted.
   8. Changes in input costs (wage rates, material costs, cost of capital, communication and transportation) and FX rates. These may impact demand, shift geographic boundaries, alter competitiveness.
   9. Product innovation. They can come from inside or outside the industry, and can widen the market, enhance differentiation, and nullify buyer experience. The process of rapid product introduction can also create mobility barriers (marketing, distribution, manufacturing).
   10. Marketing and distribution innovation. This can allow reaching new customers, reduce price sensitivity, lower costs, shift power relative to buyers, change economies of scale, and affect the balance of fixed versus variable costs and hence the volatility of rivalry.
   11. Process innovation. They can come from inside or outside the industry, change capital intensity, economies of scale, the proportion of fixed costs, vertical integration, or lead to globalization.
   12. Structural change in adjacent industries. Concentration of retailers squeezed profits of apparel makers. Record retailers stopped allowing consumers to play records in the store, so radio stations became critical to record sales, causing only the leading songs to be played and the recording industry to purchase advertising time.
   13. Government policy change. Requirements for licensing restrict entry, pricing regulation can cause exits, quality and environmental regulation worsen the position of smaller firms.
   14. Entries and exits. Firms enter an industry because they perceive opportunities for growth and profits that exceed the costs of surmounting mobility barriers. Industry growth, particularly through visible forms such as regulatory changes or product innovations, is an important signal. Firms exit because they no longer perceive the possibility of earning returns that exceed their cost of capital.

Key relationships in industry evolution

1. Consolidation
   1. If mobility barriers are high or increase, concentration almost always increases.
   2. No concentration takes place if mobility barriers are low or failing. Where barriers are low, unsuccessful firms that exit will be replaced by new firms. If a wave of exits occurs because of a downturn, there may be a temporary increase in concentration, but at the first signs that profits and sales pick up, new entrants will appear.
   3. Exit barriers deter consolidation. Exit barriers keep companies operating even though they are earning subnormal returns on investment.
   4. Long-run profit potential depends on future structure. Profit levels are usually high in the early period of rapid growth. When growth levels off, there is usually a period of turmoil. If mobility barriers are high or have increased as the industry matures, the remaining firms may enjoy healthy financial results in the new era of slower growth..
2. Changes in industry boundaries. Innovations in the industry or in substitutes may enlarge the industry by placing more firms into direct competition.
3. Firms can influence industry structure. Industry evolution should not be greeted as a fait accompli to be reacted to, but as an opportunity. The firm can influence regulatory changes, diffusion of innovation through licensing, development of complementary products industry (provide assistance, help forming trade associations or stating their case to the government).

Generic industry environments

Competitive strategy in fragmented industries

1. There is no single precise quantitative definition of a fragmented industry. The essential notion that makes these industries a unique environment in which to compete is the absence of market leaders with the power to shape industry events.
2. Fragmented industries are common in services, retailing, distribution, wood and metal fabrication, agricultural products, and “creative” businesses.

What makes an industry fragmented?

1. Some industries are fragmented for historical reasons—because of the resources or abilities of the firms historically in them—and there is no fundamental economic basis for fragmentation.
2. However, in many industries there are underlying economic causes:
   1. Low overall entry barriers. Nearly all fragmented industries have low overall entry barriers. Otherwise they could not be populated by so many small firms.
   2. Absence of economies of scale or experience curve. Most fragmented industries are characterized by the absence of significant scale economies or learning curves in any major aspect of the business, whether it be manufacturing (simple fabrication, assembly or warehousing operation, high labor content, high personal service content, hard to mechanize or routinize) marketing, distribution, or research. In an industry like lobster fishing, having multiple boats does little to lower fishing costs because all boats are essentially fishing in the same waters with the same chance of a good catch, thus there are many small operators with roughly equal costs.
   3. High transportation costs. High transportation costs limit the size of an efficient plant or production location despite the presence of economies of scale. Transportation costs balanced against economies of scale determine the radius a plant can economically service. Transportation costs are high in such industries as cement, fluid milk, highly caustic chemicals and many service industries (because the service is “produced” at the customer’s premises or the customer must come to where the service is produced).
   4. High inventory costs or erratic sales fluctuations. Although there may be intrinsic economies of scale in production, they may not be reaped if inventory carrying costs are high and sales fluctuate. Small-scale, less specialized facilities or distribution systems are usually more flexible in absorbing output shifts than large, more specialized ones, even though they may have higher operating costs at a steady operating rate.
   5. No advantages of size in dealing with buyers or suppliers. The structure of the buyer groups and supplier industries is such that a firm gains no significant bargaining power in dealing with these adjacent businesses from being large. Buyers might be so large that even a large firm in the industry would only be marginally better off in bargaining with them than a smaller firm. Buyers or suppliers might be powerful enough to keep companies in the industry small, through intentionally spreading their business or encouraging entry.
   6. Diseconomies of scale in some important aspect. Diseconomies of scale can stem from a variety of factors.
      1. Rapid product changes or style changes demand quick response and intense coordination among functions. Where frequent new product introductions and style changes are essential to competition, allowing only short lead times, a large firm may be less efficient than a smaller one.
      2. If maintaining a low overhead is crucial to success, this can favor the small firm under the iron hand of an owner-manager, unencumbered by pension plans and other corporate trappings and less subject to scrutiny by government regulators than the larger firm.
      3. A highly diverse product line requiring customization to individual users requires a great deal of user-manufacturer interface on small volumes of product and can favor the small firm over the larger one. There are no dominant firms in advertising or interior design.
      4. If heavy creative content is required, it is often difficult to maintain the productivity of creative personnel in a very large company.
      5. If close local control and supervision of operations is essential to success, the small firm may have an edge. Absentee management works less effectively than an owner-manager who maintains close control over a relatively small operation. In nightclubs and eating places, an intense amount of close, personal supervision seems to be required.
      6. Where personal service is the key to the business, smaller firms are often more efficient. The quality of personal service and the customer’s perception that individualized, responsive service is being provided often seem to decline with the size of the firm once a threshold is reached. This leads to fragmentation in industries as beauty care and consulting.
      7. Where a local image and local contacts are key (with intense business development, contact building, and sales effort on a local level necessary to compete), a local or regional firm can often outperform a larger firm provided it faces no significant cost disadvantages. In industries like aluminum fabricating, building supply, and distribution, a local presence is essential to success.
   7. Diverse market needs. In some industries buyers’ tastes are fragmented, with different buyers each desiring special varieties of a product and willing (and able) to pay a premium for it rather than accept a more standardized version. Thus the demand for any particular product variety is small, and adequate volume is not present to support production, distribution, or marketing strategies that would yield advantages to the large firm. Sometimes fragmented buyers’ tastes stem from regional or local differences in market needs. In the fire engine industry, every local fire department wants its own customized fire engine with many expensive bells, whistles, and other options. Production is job shop and almost purely assembly, and there are literally dozens of fire engine manufacturers, none of whom has a major market share.
   8. High product differentiation, particularly if based on image. If product differentiation is very high and based on image, it can place limits on a firm’s size and provide an umbrella that allows inefficient firms to survive. Large size may be inconsistent with an image of exclusivity or with the buyer’s desire to have a brand all his or her own. Closely related to this situation is one in which key suppliers to the industry value exclusivity or a particular image in the channel for their products or services. Performing artists may prefer dealing with a small booking agency or record label that carries the image they desire to cultivate.
   9. Exit barriers. If there are exit barriers, marginal firms will tend to stay in the industry and thereby hold back consolidation. Aside from economic exit barriers, managerial exit barriers appear to be common in fragmented industries (goals that are not necessarily profit-oriented, romantic appeal or excitement despite low profitability). This is common in fishing and talent agencies.
   10. Local regulation. Local regulation, by forcing the firm to comply with standards that may be particularistic, or to be attuned to a local political scene, can be a major source of fragmentation, even where the other conditions do not hold. Local regulation has been a contributing factor to fragmentation in liquor retailing, dry cleaning and fitting eyeglasses.
   11. Government prohibition of concentration. Legal restrictions prohibit consolidation in industries such as electric power, television and radio stations, electronic funds transfer systems.
   12. Newness. An industry can be fragmented because it is new and no firms have yet developed the skills and resources to command a significant market share. Solar heating and fiber optics may well have been in this state in 1979.

Overcoming fragmentation

1. Overcoming fragmentation can be a very significant strategic opportunity. The payoff to consolidating a fragmented industry can be high because the costs of entry into it are by definition low, and there tend to be small and relatively weak competitors who offer little threat of retaliation.
2. Common approaches to overcoming fragmentation are as follows:
   1. Create economies of scale or experience curve. As in the beef cattle industry, if technological change leads to economies of scale or a significant experience curve, then consolidation can occur.
   2. Standardize diverse market needs. Product or marketing innovations can standardize heretofore diverse market needs. The creation of a new product might coalesce buyers’ tastes; a design change might dramatically lower the cost of a standardized variety (leading buyers to judge the standardized product a better value than the expensive, custom variety); modularizing a product might allow components to be produced in large volumes and thereby reap economies of scale or experience cost declines while maintaining the heterogeneity of final products.
   3. Neutralize or split off aspects most responsible for fragmentation. This approach recognizes that the root cause of the fragmentation cannot be altered; rather, the strategy is to neutralize the parts of the business subject to fragmentation to allow advantages of share in other aspects to come into play. In fast-food, fragmentation was overcome by franchising the individual locations to owner-managers, who operate under the mantle of a national organization which markets the brand name and provides central purchasing and other services: close control and maintenance of service are insured, as well as the benefits of economies of scale. In the record industry, the desire of artists to deal with small, personalized organizations has been dealt with by the use of multiple in-house labels: each label is set up independently and strives to create the personal touch for its artists, but all use the same record pressing, marketing, promotion, and distribution organization.
   4. Make acquisitions for a critical mass. In some industries there may be some advantages to holding a significant share, but it is extremely difficult to build share incrementally. In such cases, acquiring local companies can be successful, provided the acquisitions can be integrated and managed.
   5. Recognize industry trends early. Sometimes industries consolidate naturally as they mature (particularly if the primary source of fragmentation was the newness of the industry) or due to exogenous industry trends (government or regulatory changes). Recognizing these trends and positioning the company to take advantage of them can be an important way of overcoming fragmentation.
3. Many industries are fragmented, not for fundamental economic reasons, but because they are “stuck” in a fragmented state.
   1. Existing firms lack resources or skills. Sometimes the steps required to overcome fragmentation are evident, but existing firms lack the resources to make the necessary strategic investments. Firms may lack (a) the capital or expertise to construct large-scale facilities or to make required investments in vertical integration, (b) the resources or skills to develop in-house distribution channels, in-house service organizations, specialized logistical facilities, or consumer brand franchises that would promote industry consolidation.
   2. Existing firms are myopic or complacent. Firms may be emotionally tied to traditional industry practices that support the fragmented structure or otherwise unable to perceive opportunities for change. This may explain the fragmentation of the U.S. wine industry: producers had long been production-oriented and had made little effort to develop national distribution or consumer brand recognition.
   3. Lack of attention by outside firms. Some industries remain fragmented because of lack of attention by outside firms. Industries that escape attention (and offer ripe prospects for entry) tend to be those off the beaten track (manufacture of labels, mushroom farming) or those lacking glamour or any apparent excitement (manufacture of air filters and grease filters). They may also be too new or too small to be of interest to major established firms.
4. If a firm can spot an industry in which the fragmented structure does not reflect the underlying economics of competition, this can provide a most significant strategic opportunity. A company can enter such an industry cheaply because of its initial structure. Since there are no underlying economic causes of fragmentation, none of the investment costs or risks of innovations to change underlying economic structure need be borne.

Coping with fragmentation

1. Fragmented industries are characterized not only by many competitors but also by a generally weak bargaining position with suppliers and buyers. Marginal profitability can be the result.
2. In such an environment, strategic positioning is of particularly crucial significance. The strategic challenge is to cope with fragmentation by becoming one of the most successful firms, although able to garner only a modest market share.
3. There are a number of possible strategic alternatives for coping with a fragmented structure:
   1. Tightly managed decentralization. Since fragmented industries often are characterized by the need for intense coordination, local management orientation, high personal service, and close control, an important alternative for competition is tightly managed decentralization. This strategy involves deliberately keeping individual operations small and as autonomous as possible, supported by tight central control and performance-oriented compensation for local managers. The essential notion is to recognize and cater to the causes of fragmentation but to add a degree of professionalism to the manner in which local managers operate. In the food retailing industry, Dillon has a strategy of acquiring small, regional grocery chains and keeping them autonomous, each with its own name, buying group, and so on. This system is reinforced with central control and a strong promotion-from-within policy. The strategy has avoided the homogenizing of individual units and resulting insensitivity to local conditions that plague some food chains, and as a by-product, has kept unionization low.
   2. “Formula” facilities. Another alternative is to view the key strategic variable in the business as the building of efficient, low-cost facilities at multiple locations. This involves designing a standard facility, and polishing to a science the process of constructing and putting the facility into operation at minimum cost. The firm thereby lowers its investment relative to competitors and/or provides a more attractive or efficient location from which to do business. Successful mobile home producers such as Fleetwood have followed this strategy.
   3. Increased value added. Many fragmented industries produce products or services that are commodities or otherwise difficult to differentiate. In such cases, an effective strategy may be to increase the value added of the business by providing more service with sale, by engaging in some final fabrication of the product (like cutting to size or punching holes), or by doing subassembly or assembly of components before they are sold to the customer. Enhanced product differentiation, and thereby higher margins, that cannot be achieved on the basic product or service may be achievable through such activities. This concept has been successfully implemented by a number of metal distributors who have positioned themselves as “metal service centers” engaging in simple fabrication operations and providing a great deal of advice to the customer in what had historically been a purely pass-through business. Some electronic component distributors have similarly been successful in subassembly of connectors from individual components or assembling kits. Value added can also sometimes be enhanced by forward integration from manufacturing into distribution or retailing. This step may neutralize buyers’ power or allow greater product differentiation by better controlling the conditions of sale.
   4. Specialization by product type or product segment. When industry fragmentation results from or is accompanied by the presence of numerous items in the product line, an effective strategy for achieving above-average results can be to specialize on a tightly constrained group of products. It can allow the firm to achieve some bargaining power with suppliers by developing a significant volume of their products. It may also allow the enhancement of product differentiation with the customer as a result of the specialist’s perceived expertise and image in the particular product area. The focused strategy allows the firm to be better informed about the product area and potentially to invest in its ability to educate customers and to provide services relating to the particular area. The cost of such a strategy of specialization may be some limitation in the growth prospects for the firm.
   5. Specialization by customer type. If competition is intense because of a fragmented structure, a firm can potentially benefit by specialization on a particular category of customer in the industry, perhaps the customers (a) with the least bargaining leverage because they purchase small annual volumes or because they are small in absolute size, (b) who are the least price sensitive or (c) who most need the value added the firm can provide.
   6. Specialization by type of order. The firm can specialize in a particular type of order to cope with intense competitive pressure in a fragmented industry. One approach is to service only small orders for which the customer wants immediate delivery and is less price sensitive. Or the firm can service only custom orders to take advantage of less price sensitivity or to build switching costs.
   7. A focused geographic area. Even if a significant industry-wide share is out of reach or there are no national economies of scale, there may be substantial economies in blanketing a given geographic area by concentrating facilities, marketing attention, and sales activity. This can economize on the use of the sales force, allow more efficient advertising, allow a single distribution center. Having bits and pieces of business in a number of areas, on the other hand, accentuates the problems of competing in a fragmented industry. The blanketing strategy has been quite effective for food stores, which remain a fragmented industry despite the presence of some large national chains.
   8. Bare bones/no frills. Given the intensity of competition and low margins in many fragmented industries, a simple but powerful strategic alternative can be intense attention to maintaining a bare bones/no frills competitive posture—that is, low overhead, low-skilled employees, tight cost control, and attention to detail. This places the firm in the best position to compete on price and still make an above-average return.
   9. Backward integration. Although the causes of fragmentation can preclude a large share of the market, selective backward integration may lower costs and put pressure on competitors who cannot afford such integration.

Potential strategic traps

1. The unique structural environment of the fragmented industry offers a number of characteristic strategic traps. Some common traps are as follows:
   1. Seeking dominance. The underlying structure of a fragmented industry makes seeking dominance futile unless that structure can be fundamentally changed. Barring this, a company trying to gain a dominant share of a fragmented industry is usually doomed to failure. The firm exposes itself to inefficiencies, loss of product differentiation, and whims of suppliers and customers as it increases its share. Prelude Corporation, which stated goal of being the “General Motors of the lobster industry”, built a large fleet of expensive, high-technology lobster boats; established in-house maintenance and docking facilities; and vertically integrated into trucking and restaurants. The economics were such that its vessels had no significant advantage in catching lobsters over other fishermen, and its high overhead structure and heavy fixed costs maximized its vulnerability to the fluctuations of the catch. The high fixed costs also led to undercutting on price by small fishermen who did not measure their businesses against corporate ROI targets but seemed satisfied with a much lower return. The result was a financial crisis and eventual cessation of operations. It did not address the causes of fragmentation, and hence its strategy of dominance was futile.
   2. Lack of strategic discipline. Extreme strategic discipline (focus, specialization) is nearly always required for effective competition in fragmented industries. Implementing this may require the courage to turn away some business, and to go against the conventional wisdom of how things are done in the business generally. An undisciplined or opportunistic strategy may work in the short run, but usually maximizes exposure to intense competitive in the longer run.
   3. Overcentralization. The essence of competition in many fragmented industries is personal service, local contacts, close control of operations, ability to react to fluctuations or style changes. Whereas centralized control is often useful and even essential in managing a multiunit enterprise in a fragmented industry, centralized structure can be a disaster, because it slows response time, lowers the incentives of those at the local level, and can drive away skilled individuals necessary to perform many personal services. Similarly, centralized production or marketing is subject to no economies of scale, or even diseconomies, and thus weaken the firm.
   4. Assumption that competitors have the same overhead and objectives. The peculiar nature of fragmented industries often means that there are many small, privately held firms. Also, owner-managers may have noneconomic reasons for being in the business. The assumption that these competitors will have an overhead structure or objectives of a corporation is a serious error. They often work out of homes, use family labor, and avoid regulatory costs and the need to offer employee benefits. Even though they may be “inefficient,” it does not mean that their costs are high relative to those of a corporation. Similarly, they may be satisfied with much different (and lower) levels of profitability than a corporation, and they may be much more interested in keeping up volume and providing work for their employees than profitability per se. Thus their reactions to price changes and to other industry events may be a lot different than the “normal” company.
   5. Overreactions to new products. In a fragmented industry the large number of competitors almost always insures that the buyer will exercise a great deal of power and be able to play one competitor against the other. In such a setting, products early in their life can often appear as salvations to an otherwise intense competitive situation. With rapidly growing demand and buyers unfamiliar with the new product, price competition may be modest and buyers may be clamoring for education and service from the firm. This is such a welcomed relief that firms make major investments in gearing up to respond. At the first signs of maturity, however, the fragmented structure catches up with demand and the margins disappear. Thus there is a risk of overreacting to new products in ways that will raise costs and overhead and put the firm at a competitive disadvantage in price competition.

Formulating strategy

1. Step one: what is the structure and the position of competitors? Conduct a full industry and competitor analysis to identify the sources of the competitive forces in the industry, the structure within the industry, and the positions of the significant competitors.
2. Step two: why is the industry fragmented? Identify the causes of fragmentation in the industry. It is essential that the list of causes be complete and that their relationship to the economics of the industry be established. If there is no underlying economic basis for the fragmentation, this is an important conclusion.
3. Step three: can fragmentation be overcome? How? Examine the causes of industry fragmentation one by one. Can any of these sources of fragmentation be overcome through innovation or strategic change? Is the infusion of resources or a fresh perspective all that is necessary? Will any of the sources of fragmentation be altered directly or indirectly by industry trends?
4. Step four: is overcoming fragmentation profitable? Where should the firm be positioned to do so? If fragmentation can be overcome, the firm must assess whether or not the implied future structure of the industry will yield attractive returns. To answer this question the firm must predict the new structural equilibrium in the industry once consolidation occurs and must then reapply structural analysis. If the consolidated industry does promise attractive returns, the final question is, What is the best, defendable position for the firm to adopt to take advantage of industry consolidation?
5. Step five: if fragmentation is inevitable, what is the best alternative for coping with it? If the chances of overcoming fragmentation analyzed in step three are unfavorable, select the best alternative for coping with the fragmented structure.

Competitive strategy in emerging industries

1. Emerging industries are newly formed or reformed industries created by technological innovations, shifts in relative costs, emergence of new customer needs or other economic or sociological changes.
2. The essential characteristic from the viewpoint of formulating strategy is that there are no rules of the game, which is both a source of risk and opportunity.

Common structural characteristics

1. Technological uncertainty: there usually a great deal of uncertainty about the technology in an emerging industry. What product configuration will prove to be the best? What production technology will prove to be the most efficient?
2. Strategic uncertainty: a wide variety of strategic approaches are being tried by industry participants, with no “right” strategy clearly identified, and different approaches to product/market positioning, marketing, servicing, etc. Firms often have poor information about competitors (market share) characteristics of customers and industry conditions (industry sales).
3. High initial costs but steep cost reduction: small production volume and newness usually combine to produce high costs. Ideas come rapidly in terms of improved procedures, plant layout, and employees achieve major productivity gains as job familiarity increases. As a result, costs decline at a very high proportional rate.
4. Embryonic companies and spin-offs. Without established rules of the game or scale economies as deterrents, newly formed companies are in a position to get into emerging industries. Many spin-off firms are also created, due to the rewards of equity participation or unwillingness of existing firms to try out new ideas.
5. First-time buyers. Buyers of emerging industry products are inherently first-time buyers. The marketing task is thus one of inducing substitution. The buyer must be informed about the basic nature and functions of the new product or service, be convinced it can perform these functions and that the risk of purchasing it are rational given the potential benefits.
6. Short time horizon. The pressure to develop customers or produce products to meet demand is so great that problems are dealt with expeditiously. Industry conventions are often born out of pure chance (e.g. a marketing manager adopts a two-tiered price used in his previous firm and competitors imitate it).
7. Subsidy. In many emerging industries, especially those with radical new technology or that address societal concerns, early entrants may be subsidized, by government or non government sources, via grants, tax incentives, subsidies to buyers, etc. These subsidies a a mixed blessing, as they add instability and government involvement.

Early mobility barriers

1. Early barriers stem less from the need to command massive resources than from the ability to bear risk, be creative technologically, and make forward-looking decisions to garner input supplies and distribution channels.
2. Common early barriers are the following:
   • Proprietary technology.
   • Access to distribution channels.
   • Access to raw materials and other inputs (skilled labor) of appropriate cost and quality.
   • Cost advantages due to experience.
   • Risk, which raises the opportunity cost of capital.
3. They usually are not:
   • Brand identification: it is just being created.
   • Economies of scale: the industry is too small.
   • Capital: large firms can find substantial capital for a low-risk investment.

Problems constraining industry development

1. Inability to obtain raw materials and components. The development of emerging industries requires that new suppliers be established or existing suppliers expand output and/or modify raw materials and components. In the process, severe shortages are common.
2. Period of rapid escalation of raw material prices. Confronted with burgeoning demand and inadequate supply, prices for key raw materials often skyrocket. As suppliers expand or industry participants integrate vertically, prices can fall off just as sharply.
3. Absence of infrastructure. Emerging industries often face lack of infrastructure: distribution channels, service facilities, trained mechanics, complementary products.
4. Absence of product or technological standardization. Inability to agree on standards, due to high product and technological uncertainty, accentuates problems in the supply of raw materials and complements, and can impede cost improvements.
5. Perceived likelihood of obsolescence. Growth will be impeded if buyers perceive that second or third generation products will significantly make obsolete existing products.
6. Customers’ confusion. Confusion, result from the presence of multiple product approaches, technological variations, and conflicting claims and counterclaims by competitors, can limit industry sales by raising the perceived risk of purchase.
7. Erratic product quality. Erratic quality, due to many newly established firms, lack of standards and technological uncertainty, can affect the image and credibility of the entire industry.
8. Image and credibility with the financial community. The image of the industry with the financial community may be poor, due to newness, uncertainty, customer confusion and erratic quality, which can affect the ability of firms to secure low-cost financing but also the ability of buyers to obtain credit.
9. Regulatory approval. Emerging industries often face delays and red tape in gaining recognition and approval by regulatory agencies if they offer new approaches to needs within regulated spheres. If it is outside a regulated sphere, regulators take notice once a growth boom increases the size of the industry, with regulation coming abruptly and slowing progress. On the other hand, government policy can put an industry on the map overnight, e.g. by mandating smoke alarms.
10. High costs. Because unit costs are high initially, firms may be required to price below cost. The problem is starting the cost-volume cycle.
11. Response of threatened entities. Threatened entities (substitute producers, labor unions, distribution channels wit ties to the old product, etc.) can fight the emerging industry (a) in the regulatory or political arena, (b) at the collective bargaining table or (c) for substitutes, by lowering prices or increasing investments to become more competitive.

Early and late markets

1. One of the crucial questions in an emerging industry is the assessment of which markets will open up early and which will come later. This helps focus product development and marketing efforts and forecast structural evolution. Markets, segments and particular buyers may have greatly different receptivity to a new product.
2. Nature of the benefit: the earliest markets are usually those in which the advantage is one of performance, cost advantages often being viewed with suspicion in light of newness, uncertainty, and erratic performance.
   1. Performance advantage
      1. How large is the performance advantage for buyers?
      2. How obvious is it?
      3. How pressing is the need for the buyer to improve along the dimension offered by the new product?
      4. Does the advantage improve the buyer’s competitive position?
      5. How strong is competitive pressure to compel changeover? Defensive advantages usually stimulate adoption before offensive advantages.
      6. How price and/or cost sensitive is the buyer, if the added performance entails higher cost?
   2. Cost advantage
      1. How large is the cost advantage for buyers?
      2. How obvious is it?
      3. Can a lasting competitive advantage be gained from lowering costs?
      4. How strong is competitive pressure to compel changeover?
      5. How cost-oriented is the buyer’s business strategy?
3. State of the art required to yield significant benefits. Some buyers may achieve high benefits even with rudimentary versions, prompting early adoption, while others will require more sophisticated versions.
4. Cost of product failure. Buyers facing a high cost of product failure (need to plug the product into an integrated system, penalties for interrupted service, limited financial resources) will usually be slower in adopting a new product.
5. Introduction of switching costs. The costs of introducing a new product or substituting an old one will differ for different buyers:
   1. Costs of retraining employees.
   2. Costs of acquiring new ancillary equipment.
   3. Write-offs in old technology investment.
   4. Capital requirements for changeover.
   5. Engineering or R&D costs of changeover.
   6. Costs in modifying stages of production.
6. Support services. If the new product requires skilled operators or service technicians, it is likely to be adopted first by buyers who have such resources or have experience in dealing with them.
7. Cost of obsolescence. Some buyers will be forced to acquire successive generations of the new product to remain competitive. Depending on the changeover costs, they may be more or less willing to buy early.
8. Asymmetric government, regulatory or labor barriers. The degree of regulatory barriers to adopting the new product may differ for various buyers (e.g. food and pharma are closely monitored on changes in their manufacturing process).
9. Resources to change. Buyers will differ with respect to the resources they have available for changeover to the new product (capital, engineering, R&D personnel).
10. Perception of technological change. Buyers may differ in their comfort with and experience in technological change. Businesses in rapidly changing or high-tech industries are more likely to be early buyers than firms in very stable, low-tech industries.
11. Personal risk to the decision maker. Buyers will be slowest to adopt when the decision maker faces the greatest perceived risk if the decision proves incorrect.

Strategic choices

1. Formulation of strategy must cope with uncertainty and risk (undefined rules, unsettled and changing structure, hard to diagnose competitors) yet the emerging phase is the period with the greatest degrees of freedom and leverage from good strategic choices.
2. Shaping industry structure. The firm should try to define the rules of the game (product policy, marketing approach, pricing strategy) in a way that will yield it the strongest position in the long run.
3. Externalities in industry development. The overriding problem for the industry is inducing substitution and attracting first-time buyers. It is usually in the firm’ interest during this phase to help promote standardization, police substandard quality and fly-by-night producers, and present a consistent front to suppliers, customers, government and the financial community. Industry conferences and associations can be a useful device, as can the avoidance of strategies that degrade competitors. The balance between industry outlook and firm outlook must shift in the direction of the firm as the industry begins to achieve significant penetration.
4. Changing role of suppliers and channels. As the industry grows in size and proves itself, early exploitation of a shift in orientation of suppliers (respond to special needs in terms of varieties, service and delivery) and distribution channels (invest in facilities and advertising) can give the firm strategic leverage.
5. Shifting mobility barriers. Early mobility barriers may erode quickly, often to be replaced by very different ones as the industry grows in size and as the technology matures. This implies that (a) the firm must find new ways to defend its position, (b) the nature of entrants may shift to more established firms often competing on the basis of new mobility barriers like scale and marketing clout, and (c) customers or suppliers may integrate into the industry.

Timing entry

1. A crucial strategic choice is the appropriate timing of entry.
2. Early entry is appropriate when:
   1. Image and reputation of the firm are important to the buyer, and the firm can develop an enhanced reputation by being a pioneer.
   2. Early entry can initiate the learning process in a business in which the learning curve is important, experience is difficult to imitate, and will not be nullified by successive technological generations.
   3. Customer loyalty will be great, so that benefits will accrue to the firm that sells to the customer first.
   4. Absolute cost advantages can be gained by early commitment to suppliers of raw materials, distribution channels, etc.
3. Early entry is risky when:
   1. Competition and segmentation will be made on a different basis later, and the firm therefore builds the wrong skills and may face high costs of changeover.
   2. Costs of opening up the market (customer education, regulatory approvals, technological pioneering) are great but the benefits cannot be made proprietary.
   3. Early competition with small upstarts is costly and will be replaced by more formidable competition later.
   4. Technological change will make early investments obsolete and confer an advantage to later entrants.

Tactical moves

1. Early commitments to suppliers of raw materials will yield favorable priorities in times of shortages.
2. Financing can be timed to take advantage of a Wall Street love affair with the industry, even if it is ahead of actual needs.

Coping with competitors

1. Coping with competitors may be difficult, especially for firms that have been pioneers and enjoyed high market shares.
2. Pioneers often expand excessive resources responding to competitors who may have little chance of becoming market forces in the long run, instead of building their own strengths and developing the industry.
3. It may even be appropriate to encourage the entry of certain competitors.

Techniques for forecasting

1. The overriding aspect of emerging industries is great uncertainty, coupled with the certainty that change will occur.
2. The device of scenarios is particularly useful.
   1. The starting point is to estimate the future evolution of product and technology in terms of cost, product variety, and performance.
   2. The next step is to develop the implications for competition for each scenario and the probable success of competitors.
   3. The firm can then assess which scenario it will bet on or how it will behave if each scenario actually occurs..

Which emerging industries to enter

1. An emerging industry is attractive if its ultimate structure is consistent with above-average returns and the firm can create a defendable position in the long run.
2. Too often firms enter emerging industries because they are growing rapidly, incumbents are currently very profitable, or future industry size promises to be large.

The transition to industry maturity

1. Many industries pass from periods of rapid growth to more modest industry maturity growth.
2. Maturity can be delayed by innovations or other events, and industries may regain their rapid growth in response to strategic breakthroughs.
3. When the transition to maturity occurs, firms may have difficulties perceiving environmental changes clearly, and when they are perceived, responding to them (which requires strategic changes).

Industry changes during transition

1. Slowing growth means more competition for market share. Competitors are likely to turn their attention inward toward attacking the shares of others and thus be more aggressive. The likelihood of misperceptions and irrational retaliation is also great. As a result, outbreaks of price, service, and promotional warfare are common.
2. Firms in the industry are increasingly selling to experienced repeat buyers. The product is no longer new, but an established, legitimate item. Buyers are increasingly knowledgeable and experienced, and shift their focus from deciding whether to purchase the product at all to making choices among brands.
3. Competition often shifts towards greater emphasis on cost and service. This shifts the requirements for success, and may increase capital needs to acquire modern facilities and equipment.
4. There is a topping-out problem in adding industry capacity and personnel. Firms need to monitor competitors’ capacity additions closely and time their own capacity additions with precision, otherwise overcapacity will occur. Overshooting of capacity is common, especially when the size of effective increments is high.
5. Manufacturing, marketing, distributing, selling and research methods are often undergoing change. The firm may need to reorient its functional policies, which usually requires capital resources and mew skills.
6. New products and applications are harder to come by. This requires a change in attitude toward research and new product development.
7. International competition increases. Due to increased standardization and emphasis on costs, transition is often marked by the emergence of significant international competitors, which often have different cost structures and goals.
8. Industry profits often fall, sometimes temporarily and sometimes permanently. Falling profits reduce cash flows, send the prices of listed stocks tumbling and make debt financing more difficult.
9. Dealers’ margins fall, but their power increases. Many dealers drop out of the business as a result of depressed margins, which tightens competition among industry participants for dealers, who are less easy to find and hold.

Some strategic implications of transition

1. Strategic sloppiness is generally exposed by maturity. Rapid growth tends to mask strategic errors. Maturity may force companies to confront the need to choose among the three generic strategies.
2. Cost analysis becomes increasingly important to rationalize the product mix and price correctly.
   1. Broad product lines and frequent introductions may no longer be viable, cost competition and fights for market share being too demanding. Sophistication in product costing is thus necessary to allow pruning of unprofitable items and focus on items with some distinctive advantage or whose buyers are “good” buyers.
   2. Similarly, implicit subsidization through average-cost pricing invites price cutting or new product introductions by competitors against the items priced artificially high. As a result, maturity requires capability to measure costs on individual items and to price accordingly.
   3. Other aspects of pricing strategy may need to be changed, e.g. escalator clauses for inflation.
3. The importance of process innovation usually increases, as does the payoff for designing the product and its delivery system to facilitate lower-cost manufacturing and control, e.g. common dish formulation in foodservice (improves consistency of meals, allows easier shifting of cooks, easier control of operations, and other cost savings).
4. Increasing purchases of existing customers may be more desirable than seeking new customers. This strategy of more $ per customer (supplying peripheral equipment and service, upgrading and widening the product line) is often less costly than finding new customers.
5. Assets can be acquired cheaply as a result of distress. A strategy of acquiring distressed companies or used equipment can improve margins and create a low-cost position if the rate of technological change is not too high.
6. Buyer selection can be key to continued profitability. As buyers become more knowledgeable and exercise more pressure, identifying good buyers and locking them in becomes crucial.
7. Firms can become lower-cost producers for certain types of buyers, product varieties, or order sizes. Firms explicitly designing their manufacturing process for flexibility, rapid setups and short lots may well enjoy cost advantages for servicing custom orders or small lots over high-volume producers. Finding new cost curves is key to implementing the generic strategy of focus.
8. Firms may escape maturity by competing internationally. Obsolete equipment in the home market can sometimes be used in international markers, lowering the cost of entry. Industry structure may be more favorable, with less sophisticated and powerful buyers and fewer competitors.
9. Strategic shifts required to compete should not necessarily be attempted. For some companies, a disinvestment may be better than reinvesting with an uncertain payout. Due to inertia at larger firms, smaller and more flexible firms or new entrants with no ties to the past may be able to segment the market easier or build a strong position.

Strategic pitfalls in transition

1. A company’s self-perception and its perception of the industry. Firms’ perceptions about themselves (“we are the quality leader”), the industry, competitors, buyers or suppliers may become inaccurate as transition proceeds, priorities adjust and competitors respond.
2. Caught in the middle. Transition often squeezes out the slack that has made the “caught in the middle” strategy viable in the past.
3. The cash trap – investments to build share in a mature market. In a mature industry, the odds are against recouping investments to build market share. A related pitfall is placing attention on revenues instead of profitability.
4. Giving up market share too easily in favor of short-run profits. Some firms try to maintain past profitability at the expense of current or future market share, which can be shortsighted if economies of scale become significant in the mature industry.
5. Resentment and irrational reaction to price competition (“we will not compete on price”). This can lead competitors willing to price aggressively to take share that will be crucial in establishing a low-cost position.
6. Resentment and irrational reaction to changes in industry practices (“they are hurting the industry”). Resistance to changes in industry practices (marketing techniques, production methods, nature of distributor contracts) can put a firm seriously behind in adapting to the new competitive environment.
7. Overemphasis on creative new products rather than improving and aggressively selling existing ones. As maturity sets in, it is usually appropriate to shift the focus of innovation on standardization rather than newness.
8. Clinging to higher quality as an excuse for not meeting aggressive pricing and marketing moves of competitors. Quality differentials have a tendency to erode with maturity, and knowledgeable buyers may be willing to trade quality for lower prices. Many firms find it difficult to accept that they do not have the highest quality product or that their quality is unnecessarily high.
9. Overhanging excess capacity. Excess capacity creates pressure to utilize it, in ways that may undermine the firm’s strategy, e.g. pushing a firm in the middle rather than maintaining a focused strategy. It is often desirable to sell off excess capacity (to other industries) or to scrap it.

Organizational implications of maturity

1. Scaled down expectations for financial performance. The standards for acceptable growth and profits must often be reduced. If managers try to meet the old standards, they may take actions that are dysfunctional for the long-run health of the company.
2. More discipline for the organization. Environmental changes allow less slack and require greater discipline in execution.
3. Scaled down expectations for advancement. Past rates of personal advancement are unlikely to be possible, leading many managers to leave. The challenge for general management is to find new ways to motivate and reward personnel.
4. More attention on the human dimension. External stimuli of the past need to be replaced by internal support and encouragement, mechanisms to build company identification and loyalty.
5. Recentralization. The pressure on cost control may require the shift to a more functional organization which increases central control, eliminates overhead and enhances coordination among units.

Industry transition and the general manager

1. Transition to maturity signals a new way of life in a firm. The excitement of rapid growth and pioneering are replaced by the need to control costs, compete on price, market aggressively. The atmosphere may change in ways the general manager may find undesirable. The skills required of the general manager shift.
2. Some unfortunate outcomes are as follows:
   1. Denies transition. The general manager fails to recognize the and accept the changes required or lacks the required skills.
   1. Leaves active management. The general manager relinquishes control, recognizing the new way of life is not satisfactory or his managerial skills are inadequate.

Competitive strategy in declining industries

1. Declining industries are those that have experienced an absolute decline in unit sales over a sustained period.
2. The decline phase of a business is characterized in the life-cycle model as one of shrinking margins, pruning product lines, falling R&D and advertising, and a dwindling number of competitors. The accepted strategic prescription for decline is a “harvest” strategy, that is, eliminating investment and generating maximum cash flow from the business, followed by eventual divestment.
3. But the nature of competition during decline as well as the strategic alternatives available to firms for coping with decline are a great deal more complex. Some industries age gracefully, whereas others are characterized by bitter warfare, prolonged excess capacity, and heavy operating losses. Successful strategies vary just as widely. Some firms have reaped high returns from strategies actually involving heavy reinvestment in a declining industry that make their businesses better cash cows later. Others have avoided losses subsequently borne by their competitors by exiting before the decline was generally recognized, and not harvesting at all.

Structural determinants of competition in decline

1. The extent to which the incipient competitive pressure erodes profitability depends on some key conditions, which influence how easily capacity will leave the industry and how bitterly the remaining firms will try to stem the tide of their own shrinking sales.
2. Conditions of demand: the process by which demand declines and the characteristics of the market segments that remain have a major influence on competition in the decline phase.
   1. Uncertainty. If all firms believe that demand might revitalize or level off, they will probably try to hold onto their positions and remain in the industry, leading to bitter warfare. If all firms are certain that industry demand will continue to decline, it will facilitate the process of withdrawing capacity from the market in an orderly fashion. Firms may well differ in their perceptions of future demand; some firms may foresee a higher probability of revitalization, and these firms will be prone to hang on. A firm’s perception of the likelihood of future decline is influenced by its position and its exit barriers: the stronger its position or the higher the exit barriers it faces in leaving, the more optimism seems to exist in its projections of the future.
   2. Rate and pattern of decline. If the decline is proceeding slowly or if the industry’s sales are inherently erratic, it may be difficult to separate the downward trend in sales from the confusion caused by period-to-period fluctuations If demand is declining precipitously, on the other hand, firms have a hard time in justifying optimistic future projections, which makes abandonments of whole plants or divestiture of whole divisions more likely, adjusting industry capacity downward. In industrial businesses whose product is an important input to customers, demand can decline precipitously if one or two major producers decide to withdraw: customers fear for the continued availability of a key input, and they are prone to shift to a substitute more quickly than otherwise.
   3. Structure of remaining demand pockets. As demand declines, the nature of the pockets of demand that remain plays a major role in determining the profitability of the remaining competitors. In general, an end game can be profitable for the survivors if the remaining pockets of demand (a) involve buyers who are price-insensitive or have little bargaining power (premium cigars, replacement demand when demand from OEMs has disappeared), (b) are immune to substitutes, (c) do not depend on powerful suppliers and (d) are protected by mobility barriers.
   4. Causes of decline. Industry demand declines for a number of different reasons:
      1. Technological substitution. One source of decline is substitute products created through technological innovation (electronic calculators for sliderules) or made prominent by shifts in relative costs and quality (synthetics for leather).
      2. Demographics. Another source of decline is shrinkage in the size of the customer group that purchases the product.
      3. Shifts in needs. Demand can fall because of sociological or other reasons which change buyers’ needs or tastes. Cigar consumption has plummeted because of cigars’ plummeting social acceptability.
3. Exit barriers: crucial to competition in declining industries is the manner in which capacity leaves the market. Exit barriers stem from a number of fundamental sources:
   1. Durable and specialized assets. If the assets of a business, either fixed or working capital, are highly specialized to the particular business, company, or location in which they are being used, this creates exit barriers by diminishing the liquidation value of the firm’s investment in the business. They must be sold to someone who intends to use them in the same business (and if they are specialized enough, in the same location), and the number of buyers is usually few, or their value is greatly diminished and they must often be scrapped. Sometimes assets can be sold to overseas markets at a different stage of economic development, even though they have little value in the home country. The value of specialized assets will usually diminish as it becomes increasingly clear that the industry is declining.
   2. Fixed costs of exit. Often substantial fixed costs of exiting elevate exit barriers by reducing the effective liquidation value of a business: costs of labor settlements, full-time efforts of skilled managers, attorneys, and accountants, maintaining availability of spare parts to past customers after exit, resettlement and/or retraining of management or employees, cancellation penalties on (or outsourcing of) long-term contracts to purchase inputs or sell products, hidden costs of exit (once the decision to divest becomes known, employee productivity may be prone to sag and financial results to deteriorate, customers pull out their business, and suppliers lose interest in meeting promises). On the other hand, sometimes exit can allow the firm to avoid fixed investments it would otherwise have had to make.
   3. Strategic exit barriers. A diversified firm may face barriers because the business is important to the company from an overall strategic point of view:
      1. Interrelatedness: The business may be part of a total strategy involving a group of businesses, and leaving it would diminish the impact of the strategy. The business may be central to the corporation’s identity or image. Exiting may hurt the company’s relationships with key distribution channels or may lower overall clout in purchasing. Exit may idle shared facilities or other assets.
      2. Access to financial markets: Exiting may reduce the confidence of the capital markets in the firm or worsen the firm’s ability to attract acquisition candidates (or buyers). If the divested business is large relative to the total, its divestment may strongly reduce the financial credibility of the firm. A write-off may negatively affect earnings or raise the cost of capital.
      3. Vertical integration. If the business is vertically related to another in the company, the effect on barriers to exit depends on whether the cause of decline affects the entire vertical chain or just one link.
   4. Information barriers. The more related a business is to others in the company, particularly in terms of sharing assets or having a buyer-seller relationship, the more difficult it can be to develop clear information about the true performance of the business.
   5. Managerial or emotional barriers. Divestments are probably the most unpalatable decision managements have to make. In a single business company, exit costs managers their jobs, and may (a) cause a blow to pride, and the stigma of “giving up”, (b) sever an identification with the business that may be longstanding, or (c) be a sign of failure which reduces job mobility. The longer the history and tradition of the firm and the lower the likely mobility of senior management, the more these considerations are likely to deter exit. Identification, pride and concern for external image can also extend to top management of the diversified firm, especially if they played some personal role in the business. Diversified companies may also have the luxury of funding poor performers with profitable businesses, and avoiding disclosure of poor results in a sick division. Managerial exit barriers can be so strong that in a many cases, divestments do not occur until a change in top management. Managerial barriers can be reduced by experience with exit, e.g. in industries where technological failure and product substitution are common, where product lives are short, or in high-technology fields, where possibilities for new businesses are more likely to be perceived.
   6. Government and social barriers. In some situations, closing down a business is next to impossible because of government concern, community pressure, informal political pressure, or social concern that managements feel for their employees and local communities. Capacity does not leave the industry as it shrinks, and competitors grimly battle it out to survive.
   7. Mechanism for asset disposition. The manner in which the assets of firms are disposed of can strongly influence the potential profitability of a declining industry. In the Canadian dissolving pulp industry, for example, a major plant was not retired but sold to a group of entrepreneurs at a significant discount to book value. With a lower investment base, managers of the new entity could make decisions on pricing and other aspects of strategy that were rational for them but which severely crippled the remaining firms. Selling the assets to the employees at a discount can have the same effect. Thus if assets in a declining industry are disposed of within the industry and not then retired, it is even worse for subsequent competition than if the original owners of the firms stayed in business. The situation in which government subsidies keep ailing firms alive in declining industries is nearly as bad. Not only does capacity not leave the market, but also the subsidized firm can depress profit potential even further because it is basing its decisions on different economics.
4. Volatility of rivalry: because of falling sales, the decline phase of an industry will be particularly susceptible to fierce price warfare among competitors, especially in the following situations:
   • The product is perceived as a commodity.
   • Fixed costs are high.
   • Many firms are locked by exit barriers into the industry.
   • A number of firms perceive a high strategic importance in maintaining their position in the industry.
   • The relative strengths of remaining firms are relatively balanced so that one or a few firms cannot easily win the competitive battle.
   • Firms are uncertain about their relative competitive strengths and many attempt ill-fated efforts at changing position.

Strategic alternatives in decline

1. Discussions of strategy during decline usually revolve around disinvestment or harvest, but there is a range of strategic alternatives. In the harvest and divest strategies, the business is managed to produce disinvestment. In leadership or niche strategies, however, the firm may actually want to strengthen its position in the declining industry.
2. Leadership: seek a leadership position in terms of market share. This strategy is directed at taking advantage of a declining industry whose structure is such that the remaining firm has the potential to reap above-average profitability and leadership is feasible. Once this position is attained the firm switches to a holding position or controlled harvest strategy. The premise is that by achieving leadership the firm is in a superior position to hold position or harvest. Tactical steps that can contribute to executing the leadership strategy are the following:
   • Aggressive pricing, marketing or other actions to build market share and insure rapid retirement of capacity from the industry by other firms.
   • Purchasing market share by acquiring competitors.
   • Purchasing and retiring competitors’ capacity.
   • Reducing competitors’ exit barriers by manufacturing spare parts for their products, taking over long-term contracts, or producing private label goods for them.
   • Demonstrating a strong commitment to staying in the industry through public statements and behavior.
   • Demonstrating superior strengths to dispel competitors’ thoughts of attempting to battle it out.
   • Developing and disclosing credible information about future industry decline.
   • Raising the stakes for competitors to stay by precipitating the need for investment in new products or process improvements.
3. Niche: create or defend a strong position in a particular segment. The objective is to identify a segment (or demand pocket) that will not only maintain stable demand or decay slowly but also has structural characteristics allowing high returns, and invest in building its position in this segment, using some of the tactics above.
4. Harvest: manage a controlled disinvestment, taking advantage of strengths. This strategy presupposes some genuine past strengths on which the firm can live, as well as an industry environment that does not degenerate into bitter warfare. A basic distinction is between actions that are visible to the customer (price increase, lower advertising) and those that are not (deferred maintenance, dropping marginal accounts). The firm seeks to optimize cash flow, by:
   1. Eliminating or curtailing new investment.
   2. Cutting maintenance of the facilities.
   3. Raising prices.
   4. Reaping benefits of past goodwill in continued sales, even though advertising and research have been curtailed.
   5. Reducing the number of models.
   6. Shrinking the number of channels employed.
   7. Eliminating small customers.
   8. Eroding service in terms of delivery time, speed of repair or sales assistance.
5. Divest quickly: liquidate the investment as early in the decline phase as possible. This strategy rests on the premise that the firm can maximize its net investment recovery by selling the business early in decline, rather than by harvesting and selling it later or by building a leadership or niche position.

Choosing a strategy for decline

1. Determine the position of the firm in a declining industry:
   1. Is the structure of the industry conducive to a hospitable decline phase?
   2. What are the exit barriers facing each competitor? Who will exit quickly and who will remain?
   3. Of the firms that stay, what are their relative strengths for competing in the pockets of demand that will remain? How seriously must their position be eroded before exit is likely, given their exit barriers?
   4. What are the exit barriers facing the firm?
   5. What are the firm’s relative strengths vis a vis the pockets of demand that remain?
2. Selecting a strategy for decline is matching the desirability of remaining in the industry with the firm’s strengths relative to competitors in the remaining pockets:
   1. Favorable industry structure (low uncertainty, low exit barriers)
      1. Strengths: leadership or niche (depending on the desirability of competing in most segments vs selecting one or two).
      2. Lacks strengths: harvest or divest quickly (depending on the feasibility of harvest and the opportunities for sale).
   2. Unfavorable industry structure (high uncertainty, high exit barriers):
      1. Strengths: niche or harvest.
      2. Lacks strengths: divest quickly.
3. There is a third dimension: the firm’s strategic needs to remain in the business. Strategic needs for cash flow may skew the decision toward harvest or early sale even though the other factors point to leadership.
4. There may be advantages to an early commitment to leadership or sale.
5. A key part of strategy is encouraging particular competitors out of the industry.

Pitfalls in decline

1. Failure to recognize decline. Some firms fail to look objectively at the prospects of decline, because of long identification with the industry or overly narrow perception of substitutes. The most objective firms are those that also participate in the substitute industry.
2. A war of attrition. Warfare with competitors having high exit barriers usually leads to disaster.
3. Harvesting without clear strengths. Unless industry structure is very favorable for the decline phase, harvesting strategies by firms without clear strengths usually collapse, as customers take their business elsewhere once marketing or service deteriorates or prices are raised;

Preparing for decline

• If the firm can forecast industry conditions in the decline phase, it may be able to improve its positions during the maturity phase that improve its position for decline:
  1. Minimize investments or other actions that raise exit barriers.
  2. Place strategic emphasis on market segments that will be favorable under decline conditions.
  3. Create switching costs.

Competition in global industries

1. A global industry is one in which the strategic positions of competitors in major geographic or national markets are fundamentally affected by their overall global positions.
2. Global industries require a firm to compete in a worldwide, coordinated basis or face strategic disadvantages.
3. Some industries populated by multinational companies do not have the essential characteristics of a global industry.
4. There are many differences competing internationally versus nationally: different factor costs, market circumstances, roles of foreign governments, goals, resources, and ability to monitor competitors.
5. Structural factors in market forces operating in global industries are the same as those in domestic industries. Structural analysis must however encompass foreign competitors, a wider pool of potential entrants and substitutes, and increased possibilities that firms’ goals, personalities, and priorities will differ.
6. The central issue can be framed in two ways: (1) Does the firm gain strategic advantage from competing on a global basis? (2) How threatened will the firm be by international competition?

Sources and impediments to global competition

1. Firms can participate in international activities through three basic mechanisms: licensing, export, and foreign direct investment. Usually, the first foray overseas involves exports or licensing, and only after it has gained some international experience will it consider foreign direct investment.
2. An industry becomes global because there are economic or other advantages to a firm competing in a coordinated way in many national markets.
3. Even in industries that are generally global, there may be aspects of localness that remain due to these impediments and the national firm may be preeminent over global competitors.
4. Sources of global competitive advantage
   1. Comparative advantage. When countries have significant advantages in factor cost or factor quality in producing a product, they will become the main site of production and exports will flow to other parts of the world. In such industries, the strategic position of the global firm in the countries possessing a comparative advantage is crucial to its world position.
   2. Production economies of scale. If there are economies of scale extending beyond the size of national markets, the firm can potentially achieve a cost advantage through centralized production and global competition.
   3. Global experience. In technologies where proprietary experience yields significant cost declines, the ability to sell similar product varieties in many national markets can bring benefits.
   4. Logistical economies of scale. If an international logistic system involves fixed costs that can be spread, the global competitor has a potential cost advantage.
   5. Marketing economies of scale. Although many aspects of marketing must be carried out in each national market, there may be potential economies of scale that exceed the size of national markets, e.g. brand names with international recognition, proprietary marketing techniques, worldwide salesforce in industries where sales are complex, infrequent, and to few buyers.
   6. Purchasing economies of scale. When there are opportunities to achieve economies of scale in purchasing as a result of bargaining power or long production runs, the global firm may have a potential cost advantage.
   7. Product differentiation. In some businesses, e.g. technologically progressive or fashion related, global competition can give the firm an edge in reputation and credibility.
   8. Proprietary product technology. When economies of scale in research are high, the application of proprietary technology in several markets can yield global economies.
   9. Mobility of production. Where the production of a product or service is mobile, the fixed costs can be spread over many national markets, and the firm can invest in skilled people or mobile equipment which could not be justified by a single national market.
5. Economic impediments to global competition. These raise the direct cost of competing globally.
   1. Transportation and storage costs. Transport or storage costs offset economies of centralized production, as well as the efficiency of production.
   1. Differing product needs. Global competition is impeded when national markets demand different product varieties.
   2. Established distribution channels. The need to gain access to distribution channels in each national market can impede global competition.
   3. Local repair. The need to offer local manufacturers’ repair can impede the international competitor.
   4. Sales force. If the product requires a local direct sales force, the international competitor confronts potential scale economy barriers, most severe if national competitors’ salesforces sell a wide line of products.
   5. Sensitivity to lead times. Because of short fashion cycles, rapidly moving technology, sensitivity to the times dense to work against global competition. A related issue is the time required to physically transport goods globally.
   6. Complex segmentation within geographic markets. Complex segmentation increases the need for product lines with many varieties or customize features.
   1. Lack of world demand. Global competition cannot occur if demand does not exist in a significant number of major countries. The situation can arise because the industry is new or because the product or service only fits the needs of an unusual customer group.
6. Managerial impediments to global competition. These do not necessarily affect cost directly but raise the complexity of the managerial task.
   1. Differing marketing tasks. Even with similar products, the marketing task can vary geographically: the nature of distribution channels, marketing media, and cost effective means of reaching the buyer can differ a lot from country to country. There may also be a customer bias toward dealing with local firms.
   1. Intensive local services. Where intensive localized marketing, service, or other customer interaction is required to compete in the industry, the firm can find it tough to operate on a global basis against local rivals.
   2. Rapidly changing technology. Global firms may have difficulties operating where rapidly changing technology requires frequent product and process redesign attuned to the local markets.
7. Government impediments. There are a wide variety of government impediments to global competition, most under the guise of protecting local firms or local employment: (1) tariffs and duties, (2) quotas, (3) preferential procurement from local firms by government entities, (4) governmental insistence on local R&D or requiring locally produced components, (5) preferential tax treatment, labor policies, or other rules and regulations benefiting local firms, (6) bribery laws, tax laws, or other policies by home governments that are detrimental in international operations. Such impediments are more likely to occur in industries that are salient, or that affect important objectives such as employment, regional development, indigenous sources of strategic raw materials, defense, and cultural significance.
8. Perceptual or resource impediments. Incumbent firms may also face perception or resource limitations. They may lack the necessary vision, managerial and technical skills, or resources to build world-scale facilities or to penetrate new national markets.

Evolution to global industries

Few industries begin as global, but they tend to evolve into them overtime, due to external triggers and strategic innovations by firms.

1. Environmental triggers to globalization.
   1. Increased scale economies. Technological advances that increase scale economies provide a trigger for global competition.
   1. Decreased transportation or storage costs. Falling transport or storage costs are a clear stimulus.
   2. Rationalized or changed distribution channels. If distribution channels are being changed or rationalized, the burden of foreign firms gaining access to them may be eased.
   3. Changed factor costs. Increases in the cost of labor, energy, and raw materials can shift the optimum production or distribution configuration in ways that make global competition more beneficial.
   4. Narrowed national economic and social circumstances. As geographic markets become more similar in their economic and cultural circumstances, the potential for world competition increases.
   5. Reduced government constraints. Government policy changes that remove quotas, reduce tariffs, or promote international corporation on technical standards, increase the possibilities for global competition.
2. Strategic innovations stimulating globalization.
   1. Product redefinition. If required product differences among countries lessen – as the industry matures, firms redesign products to make them acceptable in many markets, or redefine the image or concept of the product through marketing innovation – global competition may yield advantages.
   1. Identification of market segments. There maybe segments of the markets that are common to many countries and that are being poorly served in many of them.
   2. Reduced costs of adaptations. Lower costs of altering basic products to meet local needs (e.g. modularization, technology changes) will ease impediments.
   3. Design changes. Design changes leading to more standardized components that are subject to global purchasing economies can trigger shifts toward global competition.
   4. De-integration of production. In some industries, government constraints can be circumvented by assembling locally while producing some or all components centrally.
   5. Elimination of constraints from resources or perception. New entrants may have the resources, the ability to start fresh or, in the case of foreign firms, experience with possible product redefinitions.

Competition in global industries

1. Industrial policy and competitive behavior. In global industries, competitors operate from different home bases. Their relationship with their home countries must be thoroughly examined. In some industries, the political relations between the home country and the buying country may matter as much as the relative merits of one’s firms product against another’s.
2. Relationship with host governments. Host governments may block global competition or create different strategic groups: (1) firms competing globally on a coordinated basis, (2) multinational companies that follow a strategy of local responsiveness and may receive local government support, (3) local firms.
3. Systemic competition. It may be necessary for firms to make defensive investments in particular markets to prevent competitors from reaping advantages that can benefit their global posture.
4. Difficulty in competitor analysis. The analysis of global industries can be difficult because of the presence of foreign firms, the need to analyze their relationship with their host governments, and differences in labor practices and managerial structures.

Strategic alternatives in global industries

1. The fundamental choice is whether the firm must compete globally or whether it can find niches in one or a few national markets.
2. The alternatives are the following:
   1. Broad line global competition. This strategy is directed at competing worldwide in the full product line of the industry, taking advantage of the sources of competitive advantage to achieve differentiation or an overall low cost position. This requires substantial resources and a long time horizon.
   1. Global focus. This strategy targets a particular segment of the industry in which the firm competes on a worldwide basis. It yields either low cost or differentiation in this segment.
   2. National focus. This strategy takes advantage of national market differences to create a focused approach to a particular national market, that allows the firm to outcompete global firms. The aim is either differentiation or low cost in serving the particular needs of a national market, or some segments thereof.
   3. Protected niche. This strategy seeks out countries with governmental restraints such as a high proportion of local content in the product, high tariffs, and so on. The firm places extreme attention on the host government to insure that protection remains in force.
3. An alternative is transnational coalitions, or cooperative agreements between firms in different home countries.

Trends affecting global competition

1. Reduction in differences among countries. Economic differences among developed and newly developed countries may be narrowing, which works toward reducing impediments to world competition.
2. More aggressive industrial policy. Industrial policies of many countries are changing. Many are taking aggressive postures to stimulate selected sectors.
3. National recognition and protection of distinctive assets. Governments are increasingly aware of their distinctive resources, and increasingly prone to capture the economic benefits of these assets. Examples include natural resources, or the presence of abundant low-waged labor.
4. Freer flow of technology. A free or flow of technology gives a wide variety of firms the ability to invest in modern, world-scale facilities.
5. Global emergence of new large-scale markets. Countries such as China, Russia, and India may emerge as huge markets in the future.
6. NDC competition. Newly developed countries, which traditionally competed on the basis of cheap labor or natural resources, have made inroads in other industries. The most vulnerable industries are those who lack the following entry barriers: (1) rapidly changing technology that can be kept proprietary, (2) highly skilled labor, (3) sensitivity to lead times, (4) complex distribution or service, and (5) complex, technical selling task.

Strategic decisions

The strategic analysis of vertical integration

1. Vertical integration is the combination of technologically distinct production, distribution, selling, and/or other economic processes within the confines of the firm.
2. It represents a decision by the firm to use internal transactions rather than market transactions to accomplish its economic purposes.
3. The vertical integration decision is not the “make or buy“ financial formula, which consists of balancing the cost savings of integration with the investment required, but rather the numbers that serve for the calculation.
4. The decision must also consider the broader strategic issues and administrative problems that can affect the success of the firm.
5. The balance will differ depending on (1) the industry and strategic situation of the firm, and (2) whether the firm adopts a policy of tapered integration, full integration or quasi-integration.

Strategic benefits of vertical integration

1. Economies of integration
   1. Economies of combined operations. Combining distinct operations can sometimes yield efficiencies, e.g. reduce the number of steps in the production process, reduce handling and transportation costs, and use slack capacity.
   1. Economies of internal control and coordination.
   2. Economies of information. Integrated operations may reduce the cost of gaining information, or reduce the need to collect some types of information about the market. E.g. an integrated food processor can use sales projections for the final product for all segments of the vertical chain.
   3. Economies of avoiding the market. An integrated firm can potentially save on some of the selling, price, shopping, negotiating, and transaction costs of market transactions. No salesforce and no marketing or purchasing departments are needed, and advertising is unnecessary.
   4. Economies of stable relationships. Knowing that the purchasing and selling relationship is stable, units may be able to develop more efficient procedures for dealing with each other, or tune their product to the exact requirements of the adjacent unit.
   5. Characteristics of vertical integration economies. A firm with a strategy of low-cost production may place a great value on achieving economies of all types. One with weakness in marketing may save by avoiding market transactions.
2. Tap into technology. In some circumstances, vertical integration can provide familiarity with technology in upstream or downstream businesses that is crucial to the success of the base business.
3. Assure supply and/or demand. Vertical integration assures the firm that it will receive available supplies in tight markets or that it will have an outlet for its products and periods of low overall demand. Products should pass from unit to unit at transfer prices reflecting market prices, to ensure that each unit will manage its business properly. Assurance of supply and demand should not be viewed as complete protection from ups and downs in the market, but rather as reducing uncertainty about their effects on the firm.
4. Offset bargaining power and input cost distortions. If a firm is dealing with suppliers or buyers with significant bargaining power, it pays for the firm to integrate even if there are no other savings from integration.
5. Enhanced ability to differentiate. Vertical integration can improve the ability of the firm to differentiate by offering a wider slice of value added under the control of management.
6. Elevate entry and mobility barriers. If vertical integration achieves benefits, it can give the firm some competitive advantage in the form of higher prices, lower costs, or lower risk.
7. Enter a higher-return business. If the contemplated return on investment is greater than the opportunity cost of capital for the firm, then it may be profitable to integrate even if there are no economies.
8. Defend against foreclosure. It may be necessary to defend against foreclosure access to suppliers are buyers its competitors are integrated.

Strategic costs of integration

The strategic cost of vertical integration involve entry cost, flexibility, balance, ability to manage the integrated firm, and the use of internal organizational incentives versus market incentives.

1. Cost of overcoming mobility barriers. Vertical integration requires the firm to overcome the mobility barriers to compete in the adjacent business.
2. Increased operating leverage. Vertical integration increases the proportion of costs that are fixed.
3. Reduced flexibility to change partners. Vertical integration implies that the fortunes of a business unit or partly tied to the ability of its in-house supplier or customer to compete successfully. Technological changes or management issues can create a situation in which (1) the in-house supplier is providing a high cost, inferior quality, or inappropriate product or service or (2) the in-house customer is losing market share.
4. Higher overall exit barriers. Vertical integration that increases the specialization of assets, strategic into relationships, or emotional ties to a business may raise overall exit barriers.
5. Capital investment requirements. Vertical integration consumes capital, which has an opportunity cost, whereas dealing with an independent entity uses investment capital of others. It can also drain capital needed elsewhere in the company.
6. Foreclosure of access to supplier or consumer research and/or know-how. By integrating, the firm may cut itself off from the flow of technology of its suppliers or customers. This can be a significant risk when suppliers or customers have large-scale research efforts or difficult to replicate know-how.
7. Maintaining balance. The stage of the vertical chain with excess capacity (or excess demand) must sell some of its output (or purchase some of its inputs) on the open market or sacrifice market position, which may be difficult as it would compel the firm to sell or buy from its competitors. Productive capacities the upstream and downstream units must therefore held in balance.
8. Dulled incentives. The incentives for the upstream business to perform may be dulled because it sells in-house instead of competing for the business. Conversely, the business buying internally may not bargain as hard as it would with outside vendors. The use of an outside instead of an inside source often places the burden of proof on the unit manager and requires an explanation to top management. Also, there may be a sense of comradeship that can make arms-length agreements difficult, especially one unit is in trouble or earning very low returns. This leads to the “bad apple” problem: when the adjacent unit is sick, its problems may spill over to the healthy unit.
9. Differing managerial requirements. There is a subtle tendency to view integrated businesses as similar from a managerial point of view because they transact with each other. But they can be fundamentally different, and thus require a different organization, different controls, incentives, capital budgeting guidelines, management techniques, and judgments (e.g. manufacturing and retailing, or metal production and metal fabrication).

Strategic issues in forward integration

1. Improved ability to differentiate the product. Forward integration can allow the firm to differentiate more successfully because it can control more elements of the production process or the way the product is sold.
2. Access to distribution channels. Forward integration solves problems of access to distribution channels and removes any bargaining power the channels have.
3. Better access to market information. Forward integration toward the demand leading stage (where key market decisions are made) can provide the firm with critical market information that allows the entire vertical chain to function more effectively: quantity of demand, optimal product mix, trends in buyer tastes, competitive developments that will ultimately affect its product. Cyclical, erratic, and changing demand increase the benefits of timely market information. If final demand is highly stable, market information gained from customers alone may be more than sufficient. Likewise, if there are many small customers, informal sampling probably gives an accurate indication of the situation in forward markets. The presence of a few large and powerful customers, on the other hand, means that accurate for information may be hard to obtain.
4. Higher price realization. In some cases, forward integration can allow the firm to realize higher prices by making it possible to set different prices for different customers.

Strategic issues in backward integration

1. Proprietary knowledge. By producing its needs internally, the firm can avoid sharing proprietary data with a suppliers, I needed to manufacture component parts or raw materials.
2. Differentiation. Backward integration can allow the firm to enhance differentiation, by gaining control over the production of key inputs.

Long-term contracts and economies of integration

1. Some economies of integration could be gained by the right type of long-term or even short term contract between independent firms.
2. The firm should always consider the option of contracting with an independent entity to achieve the same benefits as integration, especially when the risks and costs of integration are great.
3. Tapered integration is partial integration backward or forward, the firm purchasing the rest of us needs on the open market. It can yield many of the benefits of integration while reducing some of the costs.
   1. Tapered integration results in less elevation of fixed costs than full integration.
   2. Independent suppliers can be used to bear the risk of fluctuations, while in-house suppliers maintain steady production rates.
   1. Tapered integration allows the firm to prove that a threat of full integration is credible, which provides a strong discipline on suppliers or buyers.
   2. It also gives the firm a detailed knowledge of the cost of operating in the adjacent industry and a source of emergency supply.
   3. By necessity, it requires the firm to buy or sell to competitors. If this is a serious risk, tapered integration is unwise.
4. Quasi-integration is the establishment of a relationship between vertically related businesses that is somewhere in between long-term contracts and full ownership. Common forms include minority equity investment, loans or loan guarantees, pre-purchase credits, exclusive dealing agreements, specialized logistical facilities, and cooperative R&D. The ensuing community of interest can lower costs, while eliminating the necessity to commit to the full supply and demand, to make the full capital investment, and to manage the adjacent business.

Illusions in vertical integration decisions

1. A strong market position in one stage can automatically be extended to the other. Rather than distributing all of its products through a captive retail unit, a strong manufacturer might well be better served if many retailers are competing actively to sell its products.
2. It is always cheaper to do things internally. There are many hidden costs and risks in vertical integration that may be avoided by dealing with outside firms.
3. It often makes sense to integrate into a competitive business. The deck is stacked against integration into a highly competitive industry, where firms earn low returns and compete vigorously, and where buyers have many suppliers to choose from.
4. Vertical integration can save a strategically sick business. Each stage of a vertical chain must be strategically sound to ensure the health of the enterprise as a whole. If one link is sick, the sickness is more likely to spread to the other healthy units.
5. Experience in one part automatically qualifies management to direct upstream or downstream units. The managerial characteristics of vertically related businesses are often extremely different.

Capacity expansion

1. Capacity expansion is one of the most significance strategic decisions because of (1) the amount of capital involved and (2) the complexity of the decision-making problem, which requires expectations about future demand and expectations about competitors’ behavior.
2. It is a central aspect of strategy in commodity-type businesses.
3. The strategic issue is (1) how to add capacity to improve the competitive position of the firm, while (2) avoiding industry overcapacity, which may persist for long periods of time.

Elements of the capacity expansion decision

1. The essence of the capacity decision is not the discounted cash flow calculations found in finance textbooks, but the numbers that go into it, including assessments about future demand, technology trends, capacity additions of competitors, supply/demand balance and resulting industry prices and costs.
2. Where there is great uncertainty about future demand, any differences in risk or version and financial capabilities usually leads to an orderly expansion process: risk-taking firms, those loaded with cash or with high strategic steaks in the industry will jump in, while others will wait and see what the future actually brings.
3. Where future demand is perceived to be fairly certain, the capacity expansion process becomes a game of preemption, coupled with heavy market signaling to deter other firms from investing. The problem occurs when too many firms try to preempt, and capacity is overbuilt.

Causes of overbuilding capacity

1. There seems to be a strong tendency toward overbuilding of capacity.
2. The risk is most severe in commodity businesses for two reasons: (1) demand is generally cyclical, which leads to excessively optimistic expectations in upturns, and (2) products are not differentiated, meaning sales are tied to the amount of capacity and cost competitiveness.
3. Technological reasons for overbuilding:
   1. Adding capacity in large lumps. The necessity to add capacity in large lumps increases the risk that bunching of capacity decisions will lead to serious overcapacity.
   2. Economies of scale or significant learning curve. This makes attempts at preemptive behavior more likely.
   3. Long lead times in adding capacity. This increases the penalty to firms left behind without capacity.
   4. Increased minimum efficient scale. Where new larger plants or significantly more efficient and less demand is growing rapidly the number of plants miss drink or they will be over capacity. Unless every firm can consolidate their several points some will have to reduce market share which they may load to do. More likely every firm will build the larger gnu facilities, creating overcapacity.
   1. Changes in production technology. New technology attracts investments, wild plants using the old technology are left operating.
4. Structural reasons for overbuilding:
   1. Significant exit barriers. Where exit barriers are significant, inefficient excess capacity does not leave the market smoothly.
   2. Forcing by suppliers. Equipment suppliers can increase overbuilding of capacity through subsidies, easy financing, price cuts, etc.
   3. Building credibility. When firms are trying to sell new products to large buyers, the time it takes for them to build credibility leads to significant overcapacity. A related case is when buyers encourage firms to invest in capacity with implied promises of future business. Pressure of buyers is strongest with the industry faces close substitutes. Here, lack of capacity can help substitutes penetrate the industry, and firms will seek to prevent that.
   4. Integrated competitors. If competitors are also integrated downstream, each firm will want to protect its ability to supply its downstream operations, and thus insure they have enough capacity. The same holds its competitors are integrated upstream.
   5. Capacity share affects demand. In some industries, the firm with the greatest capacity will be approached by buyers first and make it a disproportionate share of demand.
   6. Age and type of capacity affects demand. In some industries, such as in service businesses, capacity is marketed directly to buyers: having the most modern, well decorated outlets, may yield competitive benefits.
5. Competitive reasons for overbuilding:
   1. Large number of firms. The tendency toward overbuilding is most severe when many firms have the resources to add capacity to the market.
   1. Lack of credible market leaders. If many firms are vying for market leadership, and none has the credibility to enforce an orderly expansion process, the instability will be increased.
   2. New entry. New entrants often create or aggravate the problem of overbuilding. Businesses with easy entry will see new entrants rush in during periods of favorable conditions.
   3. First mover advantages. Building capacity early offers advantages, such as short lead times in ordering equipment, lower equipment costs, and the opportunity to take advantage of supply/demand imbalances first.
6. Information flow reasons for overbuilding:
   1. Inflation of future expectations. Expectations about future demand can become overinflated as competitors listen to each other’s public statements.
   1. Divergent assumptions or perceptions. If firms have differing perceptions of each other, they may either overbuild, or be left behind and seek to catch up.
   2. Breakdown of market signaling. When firms no longer trust market signals, the instability of the capacity expansion process increases.
   3. Structural change. Structural change can often promote overbuilding, because it refers firms to invest in new types of equipment or because the turmoil will make them misestimate their relative strengths.
   4. Financial community pressure. Security analysts, by questioning managements who have not invested while their competitors have, may accentuate pressures to overbuilt. Also, the need to make positive statements to boost stock prices may be interpreted by competitors as aggressive, prompting a retaliation.
7. Managerial reasons for overbuilding:
   1. Production orientation. When production has been the main concern of management, pride in having the shiniest new plants and fear of being left behind are high.
   1. Asymmetric aversion to risk. Managers have more to lose by being left behind and losing market share than by building too much capacity along with everyone else.
8. Governmental reasons for overbuilding:
   1. Perverse tax incentives. Tax incentives can sometimes encourage over investment, notably in shipping.
   1. Desire for indigenous industry. Industries subject to a nationalistic fervor are prone to overcapacity.
   1. Pressures to increase or maintain employment. Governments sometimes exert pressure on firms to invest to increase or maintain employment.

Limits to capacity expansion

1. Financing constraints.
2. Company diversification.
3. Top management with a finance background.
4. Pollution control costs.
5. Uncertainty about the future.
6. Severe problems because of previous periods if overcapacity.
7. Announcements by competitors: capacity additions, discouraging message about future demand or obsolescence of current capacity.

Preemptive strategies

1. One approach to capacity expansion in a growing market is the preemptive strategy, in which the firm seeks to lock up a major portion of the market to discourage its competitors from expanding and to deter entry.
2. It is an inherently risky strategy because (1) it involves the early commitment of major resources (investments in facilities but also in withstanding poor short term results) before the outcome is known and (2) if unsuccessful in deterring competition, it can lead to disastrous warfare.
3. The following conditions must be satisfied:
   1. Large capacity expansion relative to expected market size.
   2. Large economies of scale relative to total market demand, or significant experience curve.
   3. Credibility of the preempting firm.
   4. Ability to signal preemptive motive before competitors act.
   5. Willingness of competitors to back down.
4. Preemption will be risky against the following types of competitors:
   1. Competitors with goals other than purely economic.
   2. Competitors for whom this business is a major strategic thrust or is related to others in their portfolio.
   3. Competitors who have equal or better staying power, a longer time horizon, or a greater willingness to trade profits for market position.

Entry into new businesses

1. Some economic principles are essential to the success or failure of entry, though they are quite often lost in the concern for other factors.
2. If market forces work perfectly, no entry decision can yield an above-average ROI.
3. The key is to find industry situations in which market forces are not working perfectly.

Entry through internal development

1. Entry through internal development involves the creation of a new business entity, thus requiring the firm to confront (a) entry barriers and (b) retaliation from incumbent firms.
2. Analyzing the decision to enter requires balancing:
   1. Expected cash-flows from being in the industry (assuming stable prices and costs).
   2. Investment costs to be in the business (manufacturing facilities, inventory, sales force).
   3. Additional investments to overcome other entry barriers (brand identification, proprietary technology, distribution channels, access to raw materials).
   4. Expected cost from retaliation (lower prices, escalation in marketing activities, promotions, warranties, credit and quality improvements).
   5. Expected cost from capacity addition (excess capacity and lower prices).
3. Industry is most likely to be disruptive and provoke retaliation in the following industries:
   1. Slow growth. In a slow-growing market, market share gains by a new entrant may involve an unwelcome drop in incumbents’ absolute sales, prompting vigorous retaliation.
   2. Commodity-like products. In such businesses there are no brand loyalties or segmented markets to insulate incumbents and vice versa. Price cutting is especially likely to occur.
   3. High fixed costs. When fixed costs are high, the addition of capacity by a new entrant is prone to trigger retaliation if incumbents’ capacity utilization falls significantly.
   4. High industry concentration. In such industries, an entrant is particularly noticeable and make a dent in incumbents’ market position.
   5. Incumbents who attach high importance to their position. When incumbents place a high strategic or emotional premium on maintaining their market share, retaliation can be bitter.
4. Prime targets for internal entry fall into one of the following categories:
   1. The industry is in disequilibrium, e.g. due to (a) new industries (no firm has locked up supplies of raw materials, created significant brand identification, or has much proclivity to retaliate), (b) rising entry barriers, (c) poor information (backwater industries which do not come to the attention of established firms). The market may be sending the same signals to others, so the firm should have a clear notion of why it and not others will reap the benefits of disequilibrium.
   2. Slow or ineffectual expected retaliation from incumbents, e.g. because (a) the incumbents costs of retaliation may harm their existing business (responding to an entrant may alienate existing distributors’ loyalties, cut into sales of its bread and butter products, help legitimize the entrant’s strategy or is inconsistent with the incumbent’s strategy) or outweigh the benefits, (b) there is a paternal dominant firm that sees itself as the spokesperson for the industry and behave in ways that are best for the industry (hold up prices, preserve product quality, maintain high levels of customer service) but not necessarily best for it, (c) the entrant can exploit conventional wisdom.
   3. The firm has lower entry costs than other firms, because it possesses assets or skills enabling it to overcome entry barriers (proprietary technology, established distribution channels, a recognized and transferable brand name) or because of lower expected retaliation (respect as a competitor due to its size, resources or reputation, nonthreatening because of a history of confining to niches, not cutting prices, etc.).
   4. The firm has distinctive ability to influence the industry structure.
   5. There will be positive effects on a firm’s existing businesses, e.g. through improvement of distributor relations, company image, defense against threats.

Generic concepts for entry

1. Reduce product costs. Find a way to produce at a lower cost than incumbents, e.g. (a) new product technology, (b) larger or more modern facilities, (c) shared activities yielding a cost advantage.
2. Buy in with low price. Sacrifice returns in the short run to force competitors to yield share.
3. Offer a superior product, broadly defined.
4. Discover a new niche. Find an unrecognized market segment or niche with requirements the firm can cater to.
5. Introduce a marketing innovation. Find a new way to market the product which overcomes product differentiation barriers or circumvents distributors’ power.
6. Use piggybacked distribution. Build an entry strategy based on established distribution relationships drawn from other businesses.

Entry through acquisition

1. Contrary to entry through internal development, acquisition does not add a new firm to the industry.
2. The price of an acquisition is set in the market for companies, which has become organized with (a) finders, brokers, investment bankers working actively to generate multiple bidders and (b) many press articles and statistics.
3. Contributing to market efficiency is the fact that the seller has the option to keep running the business, which puts a floor under the price for the business.
4. An efficient market for companies works to eliminate above-average profits from making an acquisition. It is therefore difficult to win at the acquisition game.
5. Acquisitions will most likely be profitable if:
   1. The floor price created by the seller’s alternative of keeping the business is low, e.g. because the seller (a) has estate problems, (b) needs capital quickly, (c) has lost key management or sees no successors for existing management, (d) perceives capital constraints to growth or (e) recognizes its managerial weakness.
   2. The market for companies is imperfect and does not eliminate above-average returns through the bidding process, e.g. because (a) the buyer has superior information (knowledge of industry & trends, insights), (b) the number of bidders is low (unusual or large business, buyer states it will not participate in a bidding war), (c) the condition of the economy is bad, (d) the target company is sick, or (e) the seller has objectives besides maximizing price (name and reputation of buyer, treatment of employees, interference in the business).
   3. The buyer has a unique ability to operate the acquired business, e.g. because (a) the buyer has a distinctive ability to improve the operations of the target, (b) the buyer uses the acquisition as a base to change industry structure or take advantage of slow incumbents, or (c) the acquisition will uniquely help the buyer’s position in s existing business.
   4. There are no “irrational” or synergetic bidders, e.g. competitors who (a) see a unique way to improve the target, (b) will reap benefits in their existing business or (c) have goals other than the maximization of profit.

Sequenced entry

• A firm can enter into a strategic group and subsequently move to another ultimate target group, thus lowering the risk of entry. E.g. P&G acquired Charmin, which had a high-quality toilet tissue and production facilities, but no brand identification and only regional distribution. It invested substantial resources creating brand identification, building national distribution, and improving the product and facilities.

Portfolio techniques in competitor analysis

• Techniques for portfolio analysis have their greatest applicability and developing strategy of the corporate level rather than developing competitive strategy in individual industries.

The growth share matrix

• The BCG growth/share matrix is based on the use of relative market shares and industry growth as proxies for (1) the competitive position of a firm’s business unit in its industry and (2) cashflow required to operate the business unit. The underlying assumption is that the experience curve is operating and that the firm with the largest relative share will thereby be the lowest cost producer.
• The key idea is that business units located in each of the four quadrants will be in fundamentally different cashflow positions and should be managed differently.
• Cash cows: businesses with a high relative share in low growth markets will produce healthy cash flow, which can be used to fund other developing businesses. Ideally, cash cows are used to make question marks into stars.
• Dogs: businesses with low relative share in low-growth markets will often be modest cash users. They will be cash traps because of their weak competitive position. They should either be harvested or divested from the portfolio.
• Stars: businesses with high relative share in high-growth markets usually require large amounts of cash to sustain growth but have a strong market position that will yield high reported profits. They may be nearly in cash balance. They eventually become cash cows as their market growth slows.
• Question marks (or wildcats): businesses with low relative share in rapidly growing markets require large cash inflows to finance growth and are weak cash generators because of their poor competitive position. Those that are not chosen for investment should be harvested (managed to generate cash) until they become dogs.
• Limitations. The applicability of the portfolio model depends on a number of conditions, which do not always hold: (1) the market has been defined properly, (2) relative market share is a good proxy for competitive position and relative costs, (3) market growth is a good proxy for required cash investment.
• Use in competitor analysis. The growth/share matrix by itself is not very useful in determining strategy for a particular business. However, the firm can plot the corporate portfolio for each of its significant competitors, ideally at several points in time. This will give some indication about the goals the competitor’s parent may be expecting it to meet.

The company position/industry attractiveness screen

• The two axes in this 3×3 matrix, variously attributed to GE, McKinsey, and Shell, are (1) the strength, or competitive position, of the business unit (high, medium, low) on the vertical axis, and (2) the attractiveness of the industry (high, medium, low) on the horizontal axis.
• Depending on where a unit falls on the matrix, its broad strategic mandate is either (1) to build position by investing capital (HH, HM, MH), (2) to hold by using cash selectively (HL, MM, LH), or (3) to harvest or divest (ML,LM, LL).
• The criteria for industry attractiveness include: market size, market growth, competitive structure, industry profitability, environmental, social, and legal context, etc.
• The criteria for the business unit position include: size, growth, market share, profitability, technological position, strengths and weaknesses, image, and people.
• The real issues involve deciding where to plot the business on the grid, deciding if position on the grid implies the indicated strategy, and working out the detailed strategic concept for building, holding, or harvesting.
• The screen can be used to gain insight into what strategic mandate a competitors business unit may be receiving from its parent.

Appendix B- How to conduct an industry analysis

• There are two types of data: published data and field data.
• A full-blown industry analysis is a massive task that can consume months if one is starting from scratch.

Industry analysis strategy

• The first step is to determine just what it is one is looking for: “anything about the industry” is much too broad to serve as an effective guide for research. Researchers may find it useful to have a framework for systematically collecting raw data.
• With a framework for assembling data, the second major strategy question is how sequentially to develop data in each area. There are important benefits in getting a general overview of the industry first, and only then focusing on the specifics.
• Who is in the industry. It is wise to develop a rough list of industry participants right away, especially the leading firms. An entering wedge for many of the sources is the industry’s SIC code.
• Industry studies. If one is lucky, there may be a relatively comprehensive industry study available or a number of broadly-based articles.
• Annual reports. If there are any publicly held firm in the industry, annual reports should be consulted early.
• Get into the field early. Researchers tend to spend too much time looking for publish sources and using the library before they begin to tap field sources. Although it is important to gain some basic understanding of the industry to maximize the value of field interviews, the researcher should not exhaust all publish sources before getting into the field. Field sources tend to be more efficient because they get to the issues, without the wasted time of reading useless documents. Interviews also sometimes help the researcher identify the issues.
• Get over the hump. Experience shows that the morale of researchers in an industry study often goes through a U-shaped cycle as the study proceeds. Euphoria gives way to confusion, but sometime later it all begins to come together.

Published sources

• Every published source should be combed tenaciously for references to other sources, both other publish sources and sources for field interviews. Often articles will cite individuals who tend to be well informed or particularly vocal industry observers.
• Keep a thorough bibliography of everything that is uncovered.
• Industry studies. The first category are book-length studies of the industry, often written by economists. The second category is the typically shorter, more focused studies conducted by securities or consulting firms.
• Trade associations. Many industries have trade associations, which serve as clearing houses for industry data and sometimes publish detailed industry statistics. Usually, an introduction from a member of the association is helpful in gaining the cooperation of staff in sending data.
• Trade magazines. Most industries have one or more trade magazines which cover industry events on a regular basis. Reading through them over a long period of time is an extremely useful way to understand the competitive dynamics and important changes in an industry, as well as to diagnose its norms and attitudes.
• Business press. A wide variety of business publications cover companies and industries on an intermittent basis.
• Company directories and statistical data. There are a variety of directories of both public and private firms. Many list firms by SAC code, and thus provide a way to build a complete list of industry participants.
• Company documents. Most companies publish a variety of documents about themselves, particularly if they are publicly traded. In addition to annual reports, 10-K’s, proxy statements, prospectuses, and other government filings can be useful. Also useful are speeches or testimony by firm executives, press releases, product literature, manuals, published company histories, transcripts of annual meetings, want ads, patents, and even advertising.
• Major government sources. The IRS provides extensive annual financial information on industries based on corporate tax returns. Another source of government statistics is the Bureau of the Census. One feature that can be particularly useful is the special report Concentration ratios in manufacturing industry. Another useful government source for price level changes in industries is the Bureau of Labor Statistics, Wholesale price index.
• Other sources. Antitrust records, local newspapers in which competitors facilities or headquarters are located, local tax records.

Field data

• In gathering field data it is important to have a framework for (1) identifying possible sources, (2) determining whether attitude toward cooperation with the research is likely to be, and (3) developing an approach to them.
• Sources of field data include:
  • Industry participants: current or former employees.
  • Adjacent industries: suppliers, distributors, customers.
  • Service organizations: trade associations, banks, consultants, auditors, advertising agencies.
  • Industry observers: standard setting organizations, unions, trade and local press, chambers of commerce, government, international organizations, watch dog groups, financial community (securities analysts), agencies involved in regulation, industry promotion, financing, etc.
• Industry competitors will perhaps be the most uncertain about cooperating with researchers. The next most sensitive sources are service organizations, such as consultants, auditors, bankers, and trade association personnel. Most of the other sources are not threatened directly by industry research.
• The most perceptive outside observers of the industry are often suppliers’ or customers’ executives who have taken an active interest in industry participants over a long period of time. Retailers and wholesalers are often excellent sources as well.
• The researcher should attempt to speak with individuals in all of the major groups since each of them can supply important data and provide useful cross-checks.
• One of the arts of interviewing is cross-checking and verifying data from different sources.
• Initially, to gather background, it is best to make contact with someone who is knowledgeable about the industry but who does not have a competitive or direct economic stake in it. When the researcher is in a position to ask more perceptive and discriminating questions, direct industry participants can be tackled.
• To maximize the chances of success in any interview, it is important to have a personal introduction, no matter how indirect.
• Particularly receptive subjects for field interviews are often individuals who have been quoted in articles.
• Another good method is to attend industry conventions to meet people informally and generate contacts.
• Contacts. It is generally most productive to make contact with potential sources by phone. People are apt to put a letter aside, while a telephone call forces the issue.
• Lead time. Researchers should begin to arrange interviews as early as possible, since lead times may be long
• Quid pro quo. When arranging an interview. One should have something to offer the interviewee in return for his or her time.
• Affiliation. An interviewer must be prepared to give his or her affiliation and make some statement about the identity or the nature of his or her client.
• Perseverance. No matter how skillful the interviewer, scheduling interviews is invariably a frustrating process. This should not deter the interviewer.
• Credibility. Interviewers greatly build credibility in arranging interviews and conducting them by having some knowledge of the business.
• Teamwork. Interviewing is a tiring job and should ideally be done in teams of two if resources permit. While one member asks a question, the other can be taking notes and thinking up the next round of questions. It also allows one interviewer to maintain eye contact while the other takes notes. Teamwork also allows for a debriefing session immediately after the interview or at the end of the day, which is extremely useful in reviewing and clarifying notes, checking for consistent impressions, analyzing the interview, and synthesizing findings.
• Questions. Gathering accurate data depends on asking unbiased questions, which do not pre-judge or limit the answer nor expose the interviewer’s own leanings. Be careful not to signal what the desired answer is. Most people like to be cooperative and agreeable, and search signaling may bias the answer.
• Notes. In addition to taking notes, the researcher can benefit from writing down observations about the interview itself.
• Relationships. A good interviewer is usually adept at quickly building a relationship with the subject. Making an effort to adapt to the style of the interviewee, and to make the interaction personal will pay off in the quality inn candor of the information received.
• Informal. Much interesting information often comes after the formal interview is over. This can be done by meeting on neutral ground, getting a tour, having lunch, or discussing topics of common interest.
• Sensitive data. It will generally be most productive to start an interview with non-threatening general questions rather than asking for specific numbers or other potentially sensitive data. It is best state explicitly at the beginning of an interview that the researcher is not asking for proprietary data but rather impressions about the industry.
• Pursuing leads. Researcher should always devote some time to ask the following questions: whom else should we speak to? What publications should be familiar with? Are there any conventions did may be useful to attend? Are there any books that might be enlightening? The way to maximize the use of interviews is to gain for the leads from each one. If an interviewee is willing to provide a personal reference to another individual, the offer should always be taken.
• Phone interviews. These can be quite productive relatively late and study when questions can be highly focused. They work best with suppliers, customers, distributors, and other third-party sources.

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Competitive Strategy