Strategic Management Concepts and Cases [2nd Edition, 2 ed.] 9781119411697

Table of contents :
Cover
Title Page
Copyright
About the Authors
Preface
Acknowledgements
Contents
In Praise of Strategic Management
1 What Is Business Strategy?
What Is Business Strategy?
Competitive Advantage
The Strategic Management Process
What Information and Analysis Guides Strategy Formulation?
Mission
External Analysis
Internal Analysis
How are Strategies Formulated?
Strategy Vehicles for Achieving Strategic Objectives
Strategy Implementation
Who is Responsible for Business Strategy?
Who Benefits from a Good Business Strategy?
Summary
Key Terms
Review Questions
Application Exercises
References
2 Analysis of the External Environment: Opportunities and Threats
Determining the Right Landscape: Defining a Firm’s Industry
Five Forces that Shape Average Profitability Within Industries
Rivalry: Competition among Established Companies
Buyer Power: Bargaining Power and Price Sensitivity
Supplier Bargaining Power
Threat of New Entrants
Threat of Substitute Products
Overall Industry Attractiveness
Where Should We Compete? New Thinking about the Five Forces and Industry Attractiveness
How the General Environment Shapes Firm and Industry Profitability
Complementary Products or Services
Technological Change
General Economic Conditions
Demographic Forces
Ecological/Natural Environment
Global Forces
Political, Legal, and Regulatory Forces
Social/Cultural Forces
Summary
Key Terms
Review Questions
Application Exercises
Strategy Tool
References
3 Internal Analysis: Strengths, Weaknesses, and Competitive Advantage
The Value Chain
The Resource-Based View
Resources
Capabilities
Priorities
Creating a Sustainable Competitive Advantage: The VRIO Model of Sustainability
Value
Rarity
Inimitability
Organized to Exploit
Assessing Competitive Advantage with VRIO
The Company Diamond: A Tool for Assessing Competitive Advantage
Gathering Data for Company Diamond Analysis
Using the Company Diamond
Summary
Key Terms
Review Questions
Application Exercises
References
4 Cost Advantage
Economies of Scale and Scope
Ability to Spread Fixed Costs of Production
Ability to Spread Nonproduction Costs
Specialization of Machines and Equipment
Specialization of Tasks and People
Evaluating Economies of Scale: The Scale Curve
Economies of Scope
Learning and Experience
The Learning Curve
The Experience Curve
Experience Curves and Market Share
How Strategists Use the Scale and Experience Curves to Make Decisions
Proprietary Knowledge
Lower Input Costs
Bargaining Power over Suppliers
Cooperation with Suppliers
Location Advantages
Preferred Access to Inputs
Different Business Model or Value Chain
Eliminating Steps in the Value Chain
Performing Completely New Activities
Revisiting Tata
Summary
Key Terms
Review Questions
Application Exercises
Strategy Tool
References
5 Differentiation Advantage
What is Product Differentiation?
Sources of Product Differentiation
Different Product/Service Features
Quality or Reliability
Convenience
Brand Image
How to Find Sources of Product Differentiation
Customer Segmentation
Mapping the Consumption Chain
Building the Resources and Capabilities to Differentiate
New Thinking: Achieving Low Cost and Differentiation
Assessing Differentiation Performance
Strategy in Your Career: What is Your Unique Value?
Summary
Key Terms
Review Questions
Application Exercises
Strategy Tool
References
6 Corporate Strategy
Corporate Versus Business Unit Strategy
Creating Value Through Diversification
Levels of Diversification
Value Creation: Exploit and Expand Resources and Capabilities
The Eight Ss
Destroying Value Through Diversification
Methods of Diversification
The Acquisition and Integration Process
Making the Acquisition
Integrating the Target
Summary
Key Terms
Review Questions
Application Exercises
References
7 Vertical Integration and Outsourcing
What is Vertical Integration?
The Value Chain
Forward Integration and Backward Integration
Three Key Reasons to Vertically Integrate
Capabilities
Coordination
Control
Dangers of Vertical Integration
Loss of Flexibility
Loss of Focus
Advantages of Outsourcing
Dangers of Outsourcing
Summary
Key Terms
Review Questions
Application Exercises
Strategy Tool
References
8 Strategic Alliances
What Is a Strategic Alliance?
Choosing an Alliance
Types of Alliances
Nonequity or Contractual Alliance
Equity Alliance
Joint Venture
Vertical and Horizontal Alliances
Ways to Create Value in Alliances
Combine Unique Resources
Pool Similar Resources
Create New, Alliance-Specific Resources
Lower Transaction Costs
The Risks of Alliances
Hold-Up
Misrepresentation
Building Trust to Lower the Risks of Alliances
Building an Alliance Management Capability
Improves Knowledge Management
Increases External Visibility
Provides Internal Coordination
Facilitates Intervention and Accountability
Summary
Key Terms
Review Questions
Application Exercises
Strategy Tool
References
9 International Strategy
The Globalization of Business
Why Firms Expand Internationally
Growth
Efficiency
Managing Risk
Knowledge
Responding to Customers or Competitors
Where Firms Should Expand
Cultural Distance
Administrative Distance
Geographic Distance
Economic Distance
How Firms Compete Internationally
Multidomestic Strategy—Adapt to Fit the Local Market
Global Strategy—Aggregate and Standardize to Gain Economies of Scale
Arbitrage Strategy
Combining International Strategies
How a Firm Gets into a Country: Modes of Entry
Exporting
Licensing and Franchising
Alliances and Joint Ventures
Wholly Owned Subsidiaries
Choosing a Mode of Entry
Summary
Key Terms
Review Questions
Application Exercises
Strategy Tool
References
10 Innovative Strategies That Change the Nature of Competition
What Is an Innovative Strategy?
Incremental Versus Radical Innovation
Categories of Innovative Strategies
Reconfiguring the Value Chain to Eliminate Activities (Disintermediation)
Low-End Disruptive Innovations
High-End/Top-Down Disruptive Innovations
Reconfiguring the Value Chain to Allow for Mass Customization
Blue Ocean Strategy—Creating New Markets by Targeting Nonconsumers
Create a Platform to Coordinate and Share Private Assets
Free Business/Revenue Models
Hypercompetition: The Accelerating Pace of Innovation
Innovation and the Product/Business/Industry Life Cycle (S-Curve)
Introduction Stage
Growth Stage
Maturity Stage
Decline Stage
Summary
Key Terms
Review Questions
Application Exercises
References
11 Competitive Strategy
Understanding the Competitive Landscape
Strategic Groups and Mobility Barriers
Strategy Canvas
Evaluating the Competition
What Drives the Competitor?
What Is the Competitor Doing or Capable of Doing?
How Will a Competitor Respond to Specific Moves?
Using Game Theory to Evaluate Specific Moves
Principles of Competitive Strategy
Know Your Strengths and Weaknesses
Bring Strength against Weakness
Protect and Neutralize Vulnerabilities
Develop Strategies That Cannot Be Easily Copied
Competitive Actions for Different Market Environments
Competition under Monopoly
Competition under Oligopoly
“Perfect” Competition
Dynamic Environments
Summary
Key Terms
Review Questions
Application Exercises
Strategy Tool
References
12 Implementing Strategy
Alignment: The 7 S Model
Strategy
Structure
Systems
Staffing
Skills
Style
Shared Values
Strategic Change
The Three Phases of Change
The Eight Steps to Successful Change
Measurement
Line of Sight
Summary
Key Terms
Review Questions
Application Exercises
References
13 Corporate Governance and Ethics
The Purposes of the Corporation
The Shareholder Primacy Model
The Stakeholder Model
Governance: Boards and Incentives
The Board of Directors
Compensation and Incentives
Corporate Ethics
Corporate Culture and Ethics
Creating an Ethical Climate
Summary
Key Terms
Review Questions
Application Exercises
References
14 Strategy and Society
Strategy and Social-Value Organizations
The Tools of Strategy and the Creation of Social Value
External Analysis and the Value Net
Internal Analysis: Resources and Capabilities
Cost Leadership, Differentiation, and Innovative Strategies
Corporate Strategy and Alliances
Implementation and Governance
Strategy and Social Change
Corporate Social Responsibility (CSR)
CSR and Firm Performance
Social Entrepreneurship
Types of Social Entrepreneurship
Skills of Social Entrepreneurs
Challenges in Social Entrepreneurship
Summary
Key Terms
Review Questions
Application Exercises
References
Glossary
Company Index
Author Index
Subject Index
CASE 01 Walmart Stores: Gaining and Sustaining a Competitive Advantage
CASE 02 Coca-Cola and Pepsi The Shifting Landscape of the Carbonated Soft Drink Industry
CASE 03 ESPN in 2015 Continued Dominance in Sports Television?
CASE 04 Southwest Airlines Flying High with Low Costs
CASE 05 Harley-Davidson Growth Challenges Ahead
CASE 06 CVS in 2015 From Neighborhood Pharmacy Provider to Health Care Company
CASE 07 Nike Sourcing and Strategy in Athletic Footwear
CASE 08 AT&T and Apple A Strategic Alliance
CASE 09 Samsung Overtaking Philips, Panasonic, and Sony as the Leader in the Consumer Electronics Industry
CASE 10 Tesla Motors Disrupting the Auto Industry?
CASE 11 Smartphone Wars
CASE 12 Lincoln Electric Aligning for Global Growth
CASE 13 ICARUS Revisited The Rise and Fall of Valeant Pharmaceuticals
CASE 14 Tabitha’s Way Local Food Pantry Entrepreneurship in Feeding the Hungry
CASE 15 Corporate Governance and Ethics A Series of Decisions
CASE 16 Netflix, Redbox and Hulu Offering New Business Models in Home Video Entertainment
CASE 17 Uber Technologies Inc.
CASE 18 Safe Water Network Mastering the Model at Dzemeni
EULA

Citation preview

Strategic Management Second Edition

Strategic Management Concepts and Cases

Second Edition

JEFF DYER

ROBERT JENSEN

Brigham Young University, Marriott School

Brigham Young University, Marriott School

PAUL GODFREY

DAVID BRYCE

Brigham Young University, Marriott School

Brigham Young University, Marriott School

VICE PRESIDENT & DIRECTOR EDITORIAL DIRECTOR EXECUTIVE EDITOR PROJECT MANAGER PRODUCT DESIGNER SENIOR DEVELOPMENT EDITOR EDITORIAL ASSISTANT MARKET DEVELOPMENT MANAGER SENIOR CONTENT MANAGER SENIOR PRODUCTION EDITORS SENIOR DESIGNER SENIOR PHOTO EDITOR COVER CREDIT

George Hoffman Veronica Visentin Lisé Johnson Jennifer Manias Rebecca Costantini Wendy Ashenberg Ethan Lipson Christopher DeJohn Dorothy Sinclair Suzie Pfister and Valerie Vargas Thomas Nery Billy Ray

© hxdbzxy

This book was set in 9.5/12.5 Source Sans Pro by SPi Global and printed and bound by LSC-Kendallville. The cover was printed by LSC-Kendallville. This book is printed on acid free paper. Founded in 1807, John Wiley & Sons, Inc. has been a valued source of knowledge and understanding for more than 200 years, helping people around the world meet their needs and fulfill their aspirations. Our company is built on a foundation of principles that include responsibility to the communities we serve and where we live and work. In 2008, we launched a Corporate Citizenship Initiative, a global effort to address the environmental, social, economic, and ethical challenges we face in our business. Among the issues we are addressing are carbon impact, paper specifications and procurement, ethical conduct within our business and among our vendors, and community and charitable support. For more information, please visit our website: www.wiley.com/go/citizenship. Copyright © 2018, 2016 John Wiley & Sons, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc. 222 Rosewood Drive, Danvers, MA 01923, website www .copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, (201)748-6011, fax (201)748-6008, website http://www.wiley.com/go/permissions. Evaluation copies are provided to qualified academics and professionals for review purposes only, for use in their courses during the next academic year. These copies are licensed and may not be sold or transferred to a third party. Upon completion of the review period, please return the evaluation copy to Wiley. Return instructions and a free of charge return shipping label are available at www.wiley .com/go/returnlabel. If you have chosen to adopt this textbook for use in your course, please accept this book as your complimentary desk copy. Outside of the United States, please contact your local representative. ISBN: 9781119411697 The inside back cover will contain printing identification and country of origin if omitted from this page. In addition, if the ISBN on the back cover differs from the ISBN on this page, the one on the back cover is correct. Printed in the United States of America 10 9 8 7 6 5 4 3 2 1

About the Authors JEFF DYER (Ph.D., UCLA, 1993) is the Horace Beesley Professor of Strategy at the Marriott School, BYU where he serves as Chair of the Department of Organizational Leadership and Strategy. Before joining BYU, Dr. Dyer was a professor at the University of Pennsylvania’s Wharton School where he maintains an adjunct professor position and continues to teach Executive MBAs. Dr. Dyer has considerable consulting experience, having spent 5 years working as a strategy ­consultant and manager at Bain & Company, where he consulted with such clients as Baxter International, Kraft, ­Maryland National Bank, and First National Stores. Since then he has been a consultant, speaker, or trainer for a variety of companies, including Adobe, AT&T, Cisco, General Electric, General Mills, Gilead Sciences, Harley-Davidson, Hewlett Packard, Intel, Johnson & Johnson, and Sony. Dyer is the only strategy scholar in the world to have published at least six times in the Harvard Business Review and six times in Strategic Management Journal, the top academic journal in the strategy field. In 2012, he was ranked the world’s #1 “most influential” management scholar among scholars who completed their Ph.D.s after 1990. This ranking, published in Academy of Management Perspectives, was based upon an equal weighting of academic citations (academic influence) and non-“.edu” Google searches (business influence). His book, The Innovator’s DNA, is a business best seller and has been published in 13 languages, and his new book, The Innovator’s Method, has already hit top 10 business bestseller lists. PAUL C. GODFREY (Ph.D., Washington, 1994) currently serves as the William and Roceil Low Professor of Business Strategy in the Marriott School of Management at Brigham Young University. Paul teaches classes to BYU undergraduates, as well as MBA and Executive MBA students. He was honored in 2013 with the Marriott School’s Teaching Award, and in 2017 with the school’s research award. His research has appeared in the Academy of Management Review, the Strategic Management Journal, the Journal of Business Ethics, and the Journal of Management Inquiry. He has recently published a book on eliminating poverty with Stanford University Press. He has also co-edited two other books and served as a special issue editor for two academic journals. He currently serves as Associate Academic Director of the Economic Self-Reliance Center at the Marriott School. He currently consults with a

variety of for-profit and not-for-profit organizations. Paul received his MBA and PhD degrees from the University of Washington and a Bachelor of Science degree in Political Science from the University of Utah. ROBERT J. JENSEN (Ph.D., Wharton, 2006) is an associate professor of Strategy and International Business and is a Whitman Faculty and Peery Research Fellow at the Marriott School of Management, Brigham Young University. He received his Ph.D. from the Wharton School, ­University of Pennsylvania. He has published in many of the top management journals including Strategic Management Journal, Organization Science, Management Science, and the Journal of International Business Studies. His professional awards include the ­McKinsey & Company/SMS Best Conference Paper prize, honorable m ­ ention, a finalist for the Blackwell Best Dissertation Prize from the Academy of Management, as well as the William H. ­Newman Best P ­ aper from a Dissertation award, and runner up for the Booz Allen Hamilton/SMS Ph.D. fellowship. His work was honored as the best paper published in Competitiveness Review in 2009 and his papers have been selected seven times for the best paper proceedings of the Academy of Management. His research interests include leveraging knowledge assets through transfer and replication including the problems of overcoming the stickiness, or difficulty, of such transfers. He also researches the boundaries of the firm in extreme locations such as the ­Bottom of the Pyramid including the rise of hybrid organizations in such locations. He is also currently working on a study of the factors, both student, faculty, and course content factors, that impact student success in management classes, particularly in online settings, and which professor characteristics and routines can best be replicated in that medium. DAVID J. BRYCE (Ph.D., Wharton, 2003) is Associate Professor of Organizational Leadership and Strategy at the Marriott School of Management and has been an adjunct Associate Professor of Management at the Wharton School where he has taught strategy in the MBA program for executives. David earned a Ph.D. in strategy and applied economics from the Wharton School and is author on a number of thought-leading articles for senior executives, including articles in the Harvard Business Review. He conducts research in the area of corporate strategy and has published in top academic journals such as v

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Management Science and Organization ­Science. For more than 20 years, he has served as consultant on ­important strategic challenges to executives of start-ups, mid-market companies, and major corporations, including Eli Lilly, Prudential, Procter & Gamble, Microsoft, Johnson & Johnson, and the LG Group. He has worked with clients on enterprise strategy,

new ­market entry, ­branding, pricing, positioning, and growth. He has also ­conducted many strategy-oriented leadership training ­sessions over the past 10 years within the Fortune 50, ­including extensively at Microsoft. Prior to his academic ­career, he held partner, vice president, and other senior positions at several global management consulting firms.

Preface Why does the world need another strategy textbook? The answer is that we simply have not been able to find a textbook that we felt fully met the needs of our students. What are those needs? First, we wanted to write a textbook that would engage students’ interest using numerous practical examples and tools that would help them actually DO analysis to answer key strategic questions. For example, leading firms and strategy consulting firms have tools to teach strategists how to actually conduct a “5 Forces” analysis, calculate a scale or experience curve, or conduct a net promoter score analysis. We wanted to provide those tools. We also wanted to create interactive learning tools that would connect with a new generation of learners. This meant we needed to provide interactive digital learning experiences such as the “white board” animated videos that we have created to support our textbook. When students are more engaged, they learn more—and they enjoy it more! Not surprisingly, this increases student satisfaction with the course and the professor. As we looked at how we could create an enjoyable and engaging strategy course learning experience, we realized as an author group that we were somewhat uniquely qualified to create that type of experience. Why? Because we collectively have over 13 years of full-time management consulting experience at top consulting firms. Why does this matter? Because we have practical experience applying strategy concepts and tools to real companies—practical experience that we have embedded in this textbook. Perhaps just as important, we know how to write to a management audience, having published three books targeting a practitioner audience, seven articles in Harvard Business Review, and another four articles in Sloan Management Review. Perhaps most important is the fact that we’ve tested the text, cases, video animations, and strategy tools with large groups of business students at BYU and Wharton over the past 10 years—with remarkable results. Average student satisfaction ratings have been 6.6/7.0 across multiple instructors for strategy courses using our materials. The bottom line is that we see better student satisfaction and higher teaching ratings because of using this material. In just the past year, we have class tested Strategic Management at over 40 institutions with over 900 students. In exit surveys, 76% of students rated the experience as positive or very positive. A few of their quotes are in the margin below.

Key Book Differentiators Because this is a strategy book, we should tell you that our strategy in writing this book is to offer unique value. The key differentiators of this book can be summarized with the acronym TACT—Text, Animated Executive Summary Videos, Cases, and Tools. Text. Each of our chapters is written in an accessible Harvard Business Review style with lots of practical examples, and each chapter is roughly 20 percent shorter than the chapters of the average strategy textbook. You can assign the whole chapter (not just a few pages) and feel confident that your students will not perceive it as a waste of time. This is not to say that we haven’t included core strategy concepts, frameworks, and theories. They are all there. Animated Executive Summary Videos. Each chapter is accompanied by at least one 8–10 minute animated video that brings the content to life. Today’s students love to learn through interactive technology, and student response to our animated videos has been positively off-the-charts. Research shows that student recall increases by more than 15 percent when material is presented with a white board animation versus a typical talking head lecture.1 These animated videos allow you to flip the classroom. 1 Study by Richard Wiseman. Available at http://www.sparkol.com/blog/how-scribe-videos-increase-your-studentslearning-by-15/

MY FAVORITE ASPECT WAS THE EXAMPLES USED TO EXPLAIN THE CONCEPTS. IT REALLY HELPED ME UNDERSTAND THE MATERIAL. –BILL BOCHICCHIO, STUDENT, VILLANOVA UNIVERSITY THE WHITEBOARD ANIMATIONS WERE VERY ENTERTAINING AND HELPED EXPLAIN SOME OF THE CONCEPTS IN REAL LIFE SITUATIONS. –CAMERON LANDRY, STUDENT, MCNEESE STATE UNIVERSITY

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When students view the videos before class, they get the core concepts in a memorable way. Then you have more time to discuss questions and help them deeply understand and synthesize the concepts and tools. THE CASES WERE MY FAVORITE PART—UNDERSTANDING REAL WORLD EXAMPLES HELPED PUT THINGS INTO PROPER PERSPECTIVE. – PHILIP SIEKMANN, STUDENT, PENNSYLVANIA COLLEGE OF TECHNOLOGY

I LIKED THE EXAMPLES AND THEIR OVERALL RELEVANCE. I ALSO LIKED THE STRATEGIC TOOLS AND THE EXPLANATIONS. –DAVID GRANTHAM, STUDENT, KENNESAW STATE UNIVERSITY

I FOUND IT TO BE A VERY EASY READ. IT WAS ONE OF THE FEW BUSINESS TEXTBOOKS THAT I ENJOYED READING WHICH MADE LEARNING EASIER AND MORE FUN. –TAYLOR LEE, STUDENT, SAN JOSE STATE UNIVERSITY

Cases. We will admit that differentiating cases isn’t easy, but we think we’ve done a few things to make using our cases easier. Our cases offer new, shortened, and updated “classic” cases on familiar companies (e.g., Walmart, Coke and Pepsi, Intel, Southwest, Nike, etc.). If you build your course around these cases, you’ll experience very low switching costs moving to our book. We’ve also written cases on companies and topics that millennials gravitate to such as Tesla, Uber, ESPN, Amazon, skype, ­Netflix/Redbox/Hulu, Samsung, and the AT&T-Apple alliance. We also provide brief Case Notes and PowerPoint presentations to summarize key ­take-aways for each case. Tools. Almost every chapter will offer a “Strategy Tool” to teach students how to apply a theory, framework, or concept. Students will feel like they have learned how to DO something—actually conduct analysis that will help with strategic decisions. Some of these tools are used in Fortune 500 companies and in strategy consulting firms such as Bain, BCG, and McKinsey when they do strategy analysis for clients. For example, the book shows the student how to assess the attractiveness of an industry, how to calculate and use scale or experience curve, how to create a net promoter score to assess whether a differentiation strategy is working, and how to decide whether to “make” versus “buy.” Many of the end-of-chapter cases integrate the strategy tool into the case so you can easily have students apply the tool as they analyze the case. Our students tell us that these tools help them feel that they are acquiring useful ­analytical skills to help them in making strategic decisions. We think the combination of well-conceived and executed Text, Animated Executive Summary Videos, Cases, and Tools can dramatically improve student satisfaction with your strategy course. Indeed, a random sample of strategy professors who reviewed our text book preferred it over their current textbooks by almost 4:1. That’s a pretty powerful endorsement. So, does the world need another strategy text? We answer “yes,” and we offer one that provides students with a well-designed, engaging, and learning-rich combination of TACT: Text, Animated Executive Summary Videos, Cases, and Tools. We’ve also found that, when our students enjoy their courses, we enjoy teaching much more.

What’s New in Edition 2? When you open the book, you’ll see much that’s new, from new color schemes to layouts. There’s more that’s new, however, than just cosmetics; we’ve taken time to respond to feedback from users of the first edition, sharpened our ties to the overarching framework of our book, and provided new updates and cases. Let’s look at each of these in turn: User Feedback. While we got rave reviews for the first edition, we also received some very insightful critique. One new thing we’ve added is a feature in most chapters called, Strategy and Your Career. These sidebars will help students see a stronger link between what they study in the classroom and the things they care about most: landing great jobs and leading fulfilling lives. We also are upgrading the quality of the Teaching Notes and PowerPoint Presentations that you can use to teach concepts in the classroom. Sharper Focus. We approach strategy—the search for competitive advantage—as the answer to four critical questions: Where should we compete? Why do we win with customers? How do we deliver unique value to win with customers? How will we win over time, or sustain our competitive advantage? Several chapters now include a specific section that details new thinking about the answers to these four questions. For example, we explore the idea that “where you compete” is less at the industry level and more at the “job-to-be-done” level. We also discuss new thinking that

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suggests unique value is less about cost versus differentiation and more about cost and differentiation—meaning that companies are increasingly offering differentiated products at a lower price. New Content and Cases. We’ve updated a number of chapter-opening vignettes. Chapter 12, for example, featured the demise of Enron, which occurred when today’s college seniors were preschoolers; this edition now uses the failures of Wells Fargo in 2016 to highlight the role of corporate governance. For Chapter  6, on corporate strategy, we’ve added new content: two more S’s to the ways firms can add value through diversification. Finally, the Second Edition has new cases on ESPN, CVS Pharmacy, Tesla, Uber, Columbia Helicopters, and Valient Pharmaceuticals, among others. Our case library continues to grow as we add new cases each year to keep strategy teaching fresh and current. We also continue to create additional strategy animations to further teach your students how to use the strategy tools found in the text. For example, how to calculate a scale or experience curve, or how to calculate a net promoter score. Similar to our case library, our animation library will continue to grow. You’ll soon see new “tool” animations on how to analyze a case and how to create a strategy canvas. Practical Application Guide. This brief manual, authored by Sheri B. Schulte, University of Akron, provides an introduction to a “flipped classroom” approach of teaching Strategic Management. It contains practical ­exercises linking to key topics throughout the text. Each exercise is accompanied by ­facilitator’s instructions, questions for classroom discussion and follow up, and suggested answers. If you are a current user of our book, let us say “Thank You!” for your support and your wonderful feedback. If you are thinking about adopting our text, we’d encourage you to give our total offering (text, animations, cases, PowerPoints, tools) a very serious look. This edition keeps all that was great about the first edition—an approachable text that helps students understand and use real-world strategy tools to supplement strategy models—and builds on those strengths to offer a text that better meets your needs, emphasizes a simple framework to help students see an overarching vision of strategy, and content that builds on the latest and greatest strategic moves by companies.

Student and Instructor Resources Companion Website. The Strategic Management Website at http://www.wiley.com/ college/dyer contains myriad tools and links to aid both teaching and learning, including resources listed here. Teaching Notes. The Teaching Notes offer helpful teaching ideas. They offer chapterby-chapter text highlights, learning objectives, chapter outlines, and answers to endof-chapter material. Case Notes. Written for each case presented with Strategic Management, each Case Note includes a brief case summary, learning objectives for the instructor, learning outcomes for the students, and a brief teaching plan with questions and answers. In addition, we’ve provided a matrix showing alternative teaching approaches for each case. Test Bank. This comprehensive Test Bank contains over 100 questions per chapter. The multiple-choice, fill-in, and short-essay questions vary in degree of difficulty. All questions are tagged with learning objectives, Bloom’s Taxonomy categories, and AACSB Standards. The Computerized Test Bank allows instructors to modify and add questions to the master bank and to customize their exams. In addition, a Respondus Test Bank is available for use with learning management systems. PowerPoint Presentation Slides. This robust set of slides for chapters and cases can be accessed on the instructor companion site. Lecture notes accompany most slides. A set of slides without lecture notes is available on the student companion site.

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WileyPLUS WileyPLUS is a research-based online environment for effective teaching and learning. WileyPLUS builds students’ confidence because it takes the guess-work out of studying by providing students with a clear roadmap: what to do, how to do it, if they did it right. Students will take more initiative so you’ll have greater impact on their achievement in the classroom and beyond.

WileyPLUS for Instructors  WileyPLUS enables you to: •  Assign automatically graded homework, practice, and quizzes from the chapters, cases, animations, and test bank. •  Track your students’ progress in an instructor’s grade book. •  Access all teaching and learning resources, including an online version of the text, and student and instructor supplements, in one easy-to-use website. These include animated executive summary videos, additional cases, teaching notes, and full color PowerPoint slides. •  Create class presentations using Wiley-provided resources, with the ability to customize and add your own materials.

WileyPLUS for Students  In WileyPLUS, students will find various helpful tools, such as an ebook, animations, videos, additional c­ ases, a virtual Career Center, and flashcards.

Acknowledgements Writing a book is a daunting task, and we’ve had much help in this process. We thank our colleagues in the Academy for years of interactions too numerous to mention, but each of which enlarged our view and clarified our understanding of how to teach strategy most effectively. Thanks to our colleagues and our students at BYU and the Wharton School for their excellent feedback on drafts of our book. Their insightful comments on the text, animations, cases, and tools brought gaps and holes to light that we would have missed. Thank you to James Aida, Preston Alder, David Benson, Jared Brand, Tyler Cornaby, Caleb Flint, Mark Hansen, ­Michael Hendron, Bryson Hilton, Chad Howland, Benjamin King, David Kryscynski, Jake Lundin, Christian Mealey, Matthew Moen, Kyle Nelson, Lee Perry, Erin Pew, Zachary Sumner, David Thornblad, Joseph Woodbury, and Bryant Woolsey for their research and assistance writing the cases. And, thank you to Sheri Schulte for contributing the Practical Application Guide. We gratefully acknowledge the advice, cooperation, wisdom, and work of the team at John Wiley who shepherded this book from its inception to its publication. Executive Editor Lisé Johnson, Project Manager Jennifer Manias, Development Editor Wendy Ashenberg, Product Designer Rebecca Costantini, and Market Development Manager Christopher DeJohn have all taught us about the process of bringing such a massive undertaking to fruition. Their professionalism has enriched the content of the book and our own lives, and their patience with us as we moved through the process has been inspiring. In addition, we’d like to thank the remainder of the team at Wiley: Thomas Nery, Suzie Chapman, Valerie Vargas, Billy Ray, Alden Farrar, and Ethan Lipson. Finally, we’d like to thank the numerous reviewers who have contributed valuable time and incredible feedback: Reviewers for the Second Edition Mitchell Adrian, McNeese State University David Boss, Ohio University Jamie Collins, Sam Houston State University Dean Frost, Bemidji State University Kimberly Goudy, Central Ohio Technical College Timothy Gubler, University of California, Riverside Uma Gupta, Buffalo State, The State University of New York Jeff Gutenberg, Geneseo, The State University of New York Amad Hassan, Morehead State University Carla Jones, Sam Houston State University John Keifer, Ohio University George Puia, Saginaw Valley State University Ram Subramanian, Stetson University Barry VanderKelen, California Polytechnic State University, San Luis Obispo Melissa Waite, Brockport, The State University of New York John Walker, Iowa State University Yanli Zhang, Montclair State University Reviewers for the First Edition Joshua Aaron, East Carolina University Mitchell Adrian, McNeese State University

A D Amar, Seton Hall University Kristin Backhaus, SUNY New Paltz Chip Baumgardner, Penn College Brian Boyd, Arizona State University Luke Cashen, Nicholls State University Kalyan Chakravarty, California State University, Northridge Brian Connelly, Auburn University Kristal Davison, University of Mississippi Meredith Downes, Illinois State University Linda Edelman, Bentley University James Fiet, University of Louisville Quentin Fleming, University of South Carolina William Forster, Lehigh University Donna Galla, American Military University Joseph Goldman, University of Minnesota John Guarino, Averett University William Hayden, SUNY Buffalo Michael Hennelly, West Point Tim Holcomb, Florida State University Lucas Hopkins, Middle Georgia State University David Hover, San Jose State University M. Nesij Huvaj, University of Connecticut Joy Karriker, East Carolina University xi

xii  ack nowledgem en ts

Richard Kernochan, California State University, Northridge Konghee Kim, St. Cloud State University John Lipinski, Middle Tennessee State University Al Lovvorn, The Citadel Dali Ma, Drexel University Tatiana Manilova, Bentley University Ismatilla Mardanov, Southeast Missouri State University Daniel Marrone, Farmingdale State College Michael McDermott, Northern Kentucky University Ghoreishi Minoo, Millersville University Mike Montalbano, Bentley University John Morris, Oregon State University Patricia Norman, Baylor University William Norton, Georgia Southern University Roman Nowacki, Northern Illinois University Don Okhomina, Fayetteville State University Hugh O’Neill, University of North Carolina Christopher Penney, Mississippi State University Peter Pinto, Bowling Green University Herve Queneau, Brooklyn College Amit Shah, Frostburg State University James Spina, University of Maryland Don Stull, Texas Tech University Ram Subramanian, Montclair State University Charles Wainwright, Belmont University Jorge Walter, Portland State University Edward Ward, St. Cloud State University Paula Weber, St. Cloud State University Yanli Zhang, Montclair State University Focus Group Participants Mitchell Adrian, McNeese State University Frances Amatucci, Slippery Rock University of Pennsylvania Elsa Anaya, Palo Alto Community College Bindu Arya, University of Missouri, St Louis Koren Borges, University of North Florida Kalyan Chakravarty, California State University, Northridge Larry Chasteen, University of Texas, Dallas William Forster, Lehigh University Dean Frost, Bemidji State University Anne Fuller, California State University, Sacramento Donna Galla, American Military University Lucas Hopkins, Middle Georgia State University Dawn Keig, Brenau University Vance Lewis, University of Texas, Dallas Sali Li, University of South Carolina John Lipinski, Middle Tennessee State University Cindy Liu, Cal State Polytechnic University Daniel Marrone, Farmingdale State College Don Okhomina, Fayetteville State University Michael Provitera, Barry University Herve Queneau, Brooklyn College Timothy Rogers, Ozarks Tech Community College Veronica Rosas-Tatum, Palo Alto Community College Mark Ryan, Hawkeye Community College Stephen Takach, University of Texas, San Antonio

Beverly Tyler, North Carolina State University Edward Ward, St. Cloud State University James Weber, St. Cloud State University Carol Young, Metropolitan State University Wiley Technology Summit Participants Lakami Baker, Auburn University Brent Beal, University of Texas, Tyler Larry Chasteen, University of Texas, Dallas Dean Frost, Bemidji State University Stephen Hallam, University of Akron David King, Iowa State University Donald Kopka, Towson University Marie Milena Loubeau, Miami Dade College Don Okhomina, Fayetteville State University Thomas Shirley, San Jose State University Thomas Swartwood, Drake University Class Testers Mitchell Adrian, McNeese State University Rajshree Agarwal, University of Maryland, College Park Francis Amatucci, Slippery Rock University Jeff Bailey, University of Idaho Lakami Baker, Auburn University Chip Baumgardner, Penn College Brent Beal, University of Texas, Tyler Gregory Blundell, Kent State University, Kent John Buttermore, Slippery Rock University McKay Christensen, Brigham Young University Daniel Connors, Providence College Dean Frost, Bemidji State University James Glasglow, Villanova University David Gras, Texas Christian University John Guarino, Averett University Uma Gupta, Buffalo State University Stephen Hallam, University of Akron John Hopkins, Clemson University Paul Hudec, Wisconsin School of Engineering David King, Iowa State University Donald Kopka, Towson State University David Kryscynski, Brigham Young University Martin Lewison, Farmingdale State College George Mason, Providence College Stuart Napshin, Kennesaw State University Scott Newbert, Villanova University Roman Nowacki, Northern Illinois University Don Okhomina, Fayetteville State University Paulo Prochno, University of Maryland, College Park Rhonda Rhodes, Cal Poly Pomona William Ritchie, James Madison University Douglas Sanford, Towson University Ben Shaffer, University of Wisconsin, Milwaukee Lois Shelton, California State University, Northridge Thomas Shirley, San Jose State University Richard Smith, Iowa State University Roger Strickland, Santa Fe College

  ac k n owl e d gements   xiii

Thomas Swartwood, Drake University Ram Subramanian, Montclair State University Xiwei Yi, University of Houston, Downtown Yuping Zeng, Southern Illinois University, Edwardsville Student Focus Group Participants Rachel Abel, Auburn University William Annan, Villanova University Andrea Arbon, Brigham Young University Vincent Arrington, McNeese State University Brian Basili, Villanova University Kelly Becker, Clemson University Cody Brackett, Iowa State University Doreen Compher, The University of Akron Lincoln Eppard, Iowa State University Laura Eppley, Kent State University Hannah Gay, University Wisconsin, Milwaukee Yuliya Gitman, Drake University Laura Jones, University of Texas at Tyler

Daniel Larsen, Iowa State University Tyler Look, Auburn University Miranda Matuke, Bemidji State University Michael Minocchi, Kent State University Monica Ghadiyaram, Virginia Tech Moriah Mitsuda, Brigham Young University Ashley Mueller, University Wisconsin, Milwaukee Rebeka Perkins, Santa Fe College Zaineb Sehgal, University of Texas at Tyler Bryttan Thompson, Iowa State University Mythy Tran, Santa Fe College Taylor VanDevender, McNeese State University Corrie VanDyke, Clemson University Kelsey Vetter, Iowa State University Christopher Wahl, Drake University Courtney Weiner, Towson University Stew Williamson, Brigham Young University Sarah Wright, The University of Akron Lynn Wu, Virginia Tech

Brief Contents ABOUT THE AUTHORS   v

CA S E 04 Southwest Airlines: Flying High with

Low Costs  C-37

PREFACE   vii ACKNOWLEDGEMENTS   xi

1 What Is Business Strategy?  1 2 Analysis of the External Environment: Opportunities and Threats  17

CA S E 05 Harley-Davidson: Growth Challenges

Ahead  C-52 CA S E 06 CVS in 2015: From Neighborhood

Pharmacy Provider to Health Care Company  C-64

3 Internal Analysis: Strengths, Weaknesses, and Competitive Advantage  44

CA S E 07 Nike: Sourcing and Strategy in Athletic

4 Cost Advantage  61

CA S E 08 AT&T and Apple: A Strategic

Footwear  C-74 Alliance  C-83

5 Differentiation Advantage  79 6 Corporate Strategy  98

CA S E 09 Samsung: Overtaking Philips, Panasonic,

and Sony as the Leader in the Consumer Electronics Industry  C-96

7 Vertical Integration and Outsourcing  117 8 Strategic Alliances  133

CA S E 10 Tesla Motors: Disrupting the Auto

Industry?  C-110

9 International Strategy  152 10 Innovative Strategies That Change the Nature of Competition  177

CA S E 11 

Smartphone Wars  C-120

CA S E 12 Lincoln Electric: Aligning for Global

Growth  C-134

11 Competitive Strategy  194 12 Implementing Strategy  213

CA S E 13 

13 Corporate Governance and Ethics  231

CA S E 14 Tabitha’s Way Local Food Pantry:

Entrepreneurship in Feeding the Hungry  C-153

14 Strategy and Society  247 GLOSSARY  262

CA S E 15 Corporate Governance and Ethics:

A Series of Decisions  C-163

INDEX  267 C ASE 01 Walmart Stores: Gaining and Sustaining

CA S E 16 Netflix, Redbox and Hulu: Offering

New Business Models in Home Video Entertainment  C-166

a Competitive Advantage  C-1 C ASE 02 Coca-Cola and Pepsi: The Shifting

Landscape of the Carbonated Soft Drink Industry  C-12 C ASE 03 ESPN in 2015: Continued Dominance in

Sports Television?  C-25

ICARUS Revisited: The Rise and Fall of Valeant Pharmaceuticals  C-142

CA S E 17 

Uber Technologies Inc.  C-178

CA S E 18 Safe Water Network: Mastering the

Model at Dzemeni  C-189 ADDITIONAL CASES CAN BE FOUND IN WILEYPLUS

Contents ABOUT THE AUTHORS   v PREFACE   vii ACKNOWLEDGEMENTS   xi

1 What Is Business Strategy? 

1

What Is Business Strategy?  2 Competitive Advantage  3 The Strategic Management Process  4 What Information and Analysis Guides Strategy Formulation?  7 Mission  8 External Analysis  8 Internal Analysis  9 How are Strategies Formulated?  10 Strategy Vehicles for Achieving Strategic Objectives  10 Strategy Implementation  11 Who is Responsible for Business Strategy?  12 Who Benefits from a Good Business Strategy?  13 Summary  14 Key Terms  14 Review Questions  15 Application Exercises  15 References  15

2 Analysis of the External

Environment: Opportunities and Threats  17

Determining the Right Landscape: Defining a Firm’s Industry  19 Five Forces that Shape Average Profitability Within Industries  21 Rivalry: Competition among Established Companies  22 Buyer Power: Bargaining Power and Price Sensitivity  24 Supplier Bargaining Power  25 Threat of New Entrants  26 Threat of Substitute Products  28 Overall Industry Attractiveness  29 Where Should We Compete? New Thinking about the Five Forces and Industry Attractiveness  30 How the General Environment Shapes Firm and Industry Profitability  31

Complementary Products or Services  33 Technological Change  33 General Economic Conditions  34 Demographic Forces  35 Ecological/Natural Environment  35 Global Forces  36 Political, Legal, and Regulatory Forces  36 Social/Cultural Forces  36 Summary  37 Key Terms  37 Review Questions  37 Application Exercises  38 Strategy Tool  38 References  42

3 Internal Analysis: Strengths,

Weaknesses, and Competitive Advantage  44

The Value Chain  46 The Resource-Based View  47 Resources  47 Capabilities  47 Priorities  49 Creating a Sustainable Competitive Advantage: The VRIO Model of Sustainability  49 Value  50 Rarity  50 Inimitability  50 Organized to Exploit  53 Assessing Competitive Advantage with VRIO  53 The Company Diamond: A Tool for Assessing Competitive Advantage  54 Gathering Data for Company Diamond Analysis  55 Using the Company Diamond  56 Summary  58 Key Terms  58 Review Questions  59 Application Exercises  59 References  59

4 Cost Advantage 

61

Economies of Scale and Scope  63 Ability to Spread Fixed Costs of Production  63 Ability to Spread Nonproduction Costs  63

xvi  contents

Specialization of Machines and Equipment  64 Specialization of Tasks and People  64 Evaluating Economies of Scale: The Scale Curve  65 Economies of Scope  66 Learning and Experience  67 The Learning Curve  67 The Experience Curve  67 Experience Curves and Market Share  69 How Strategists Use the Scale and Experience Curves to Make Decisions  70 Proprietary Knowledge  72 Lower Input Costs  72 Bargaining Power over Suppliers  72 Cooperation with Suppliers  73 Location Advantages  73 Preferred Access to Inputs  74 Different Business Model or Value Chain  74 Eliminating Steps in the Value Chain  74 Performing Completely New Activities  74 Revisiting Tata  75 Summary  75 Key Terms  76 Review Questions  76 Application Exercises  76 Strategy Tool  76 References  77

5 Differentiation Advantage  What is Product Differentiation?  80 Sources of Product Differentiation  81 Different Product/Service Features  81 Quality or Reliability  83 Convenience  83 Brand Image  85 How to Find Sources of Product Differentiation  85 Customer Segmentation  85 Mapping the Consumption Chain  88 Building the Resources and Capabilities to Differentiate  91 New Thinking: Achieving Low Cost and Differentiation  92 Assessing Differentiation Performance  93 Strategy in Your Career: What is Your Unique Value?  94 Summary  94 Key Terms  95 Review Questions  95 Application Exercises  95 Strategy Tool  95 References  96

79

6 Corporate Strategy 

98

Corporate Versus Business Unit Strategy  99 Creating Value Through Diversification  100 Levels of Diversification  100 Value Creation: Exploit and Expand Resources and Capabilities  101 The Eight Ss  102 Destroying Value Through Diversification  106 Methods of Diversification  108 The Acquisition and Integration Process  109 Making the Acquisition  109 Integrating the Target  109 Summary  113 Key Terms  114 Review Questions  114 Application Exercises  114 References  115

7 Vertical Integration and Outsourcing 

117

What is Vertical Integration?  118 The Value Chain  119 Forward Integration and Backward Integration  119 Three Key Reasons to Vertically Integrate  120 Capabilities  120 Coordination  121 Control  123 Dangers of Vertical Integration  124 Loss of Flexibility  124 Loss of Focus  125 Advantages of Outsourcing  126 Dangers of Outsourcing  128 Summary  129 Key Terms  129 Review Questions  129 Application Exercises  130 Strategy Tool  130 References  131

8 Strategic Alliances 

133

What Is a Strategic Alliance?  134 Choosing an Alliance  135 Types of Alliances  137 Nonequity or Contractual Alliance  137 Equity Alliance  138 Joint Venture  138 Vertical and Horizontal Alliances  138 Ways to Create Value in Alliances  140

  contents  xvii

Combine Unique Resources  140 Pool Similar Resources  141 Create New, Alliance-Specific Resources  142 Lower Transaction Costs  142 The Risks of Alliances  143 Hold-Up  143 Misrepresentation  143 Building Trust to Lower the Risks of Alliances  143 Building an Alliance Management Capability  146 Improves Knowledge Management  146 Increases External Visibility  146 Provides Internal Coordination  147 Facilitates Intervention and Accountability  147 Summary  148 Key Terms  148 Review Questions  148 Application Exercises  149 Strategy Tool  149 References  150

9 International Strategy 

152

The Globalization of Business  153 Why Firms Expand Internationally  155 Growth  155 Efficiency  155 Managing Risk  157 Knowledge  157 Responding to Customers or Competitors  158 Where Firms Should Expand  158 Cultural Distance  159 Administrative Distance  160 Geographic Distance  161 Economic Distance  161 How Firms Compete Internationally  162 Multidomestic Strategy—Adapt to Fit the Local Market  163 Global Strategy—Aggregate and Standardize to Gain Economies of Scale  165 Arbitrage Strategy  166 Combining International Strategies  167 How a Firm Gets into a Country: Modes of Entry  168 Exporting  168 Licensing and Franchising  168 Alliances and Joint Ventures  169 Wholly Owned Subsidiaries  170 Choosing a Mode of Entry  171 Summary  171 Key Terms  172 Review Questions  172 Application Exercises  172 Strategy Tool  173 References  174

10 Innovative Strategies

That Change the Nature of Competition  177

What Is an Innovative Strategy?  178 Incremental Versus Radical Innovation  179 Categories of Innovative Strategies  181 Reconfiguring the Value Chain to Eliminate Activities (Disintermediation)  181 Low-End Disruptive Innovations  182 High-End/Top-Down Disruptive Innovations  184 Reconfiguring the Value Chain to Allow for Mass Customization  185 Blue Ocean Strategy—Creating New Markets by Targeting Nonconsumers  185 Create a Platform to Coordinate and Share Private Assets  186 Free Business/Revenue Models  187 Hypercompetition: The Accelerating Pace of Innovation  189 Innovation and the Product/Business/Industry Life Cycle (S-Curve)  190 Introduction Stage  190 Growth Stage  190 Maturity Stage  191 Decline Stage  191 Summary  192 Key Terms  192 Review Questions  192 Application Exercises  192 References  193

11 Competitive Strategy 

194

Understanding the Competitive Landscape  195 Strategic Groups and Mobility Barriers  195 Strategy Canvas  197 Evaluating the Competition  199 What Drives the Competitor?  199 What Is the Competitor Doing or Capable of Doing?  200 How Will a Competitor Respond to Specific Moves?  200 Using Game Theory to Evaluate Specific Moves  200 Principles of Competitive Strategy  204 Know Your Strengths and Weaknesses  204 Bring Strength against Weakness  205 Protect and Neutralize Vulnerabilities  205 Develop Strategies That Cannot Be Easily Copied  205 Competitive Actions for Different Market Environments  206 Competition under Monopoly  206 Competition under Oligopoly  207

xviii  contents

“Perfect” Competition  208 Dynamic Environments  210 Summary  210 Key Terms  210 Review Questions  210 Application Exercises  211 References  211

12 Implementing Strategy 

213

Alignment: The 7 S Model  215 Strategy  215 Structure  215 Systems  217 Staffing  217 Skills  217 Style  218 Shared Values  218 Strategic Change  220 The Three Phases of Change  221 The Eight Steps to Successful Change  222 Measurement  225 Line of Sight  225 Summary  228 Key Terms  228 Review Questions  228 Application Exercises  229 References  229

GLOSSARY  262 INDEX  267 CA S E 01  Walmart Stores: Gaining and

Sustaining a Competitive Advantage  C-1 CA S E 02  Coca-Cola and Pepsi: The Shifting

13 Corporate Governance and Ethics 

External Analysis and the Value Net  249 Internal Analysis: Resources and Capabilities  251 Cost Leadership, Differentiation, and Innovative Strategies  251 Corporate Strategy and Alliances  252 Implementation and Governance  252 Strategy and Social Change  253 Corporate Social Responsibility (CSR)  253 CSR and Firm Performance  254 Social Entrepreneurship  254 Types of Social Entrepreneurship  255 Skills of Social Entrepreneurs  256 Challenges in Social Entrepreneurship  257 Summary  259 Key Terms   259 Review Questions  259 Application Exercises  259 References  260

Landscape of the Carbonated Soft Drink Industry  C-12

231

The Purposes of the Corporation  232 The Shareholder Primacy Model  233 The Stakeholder Model  234 Governance: Boards and Incentives  236 The Board of Directors  237 Compensation and Incentives  238 Corporate Ethics  239 Corporate Culture and Ethics  241 Creating an Ethical Climate  242 Summary  244 Key Terms  244 Review Questions  244 Application Exercises  244 References  245

CA S E 03  ESPN in 2015: Continued Dominance

CA S E 06 

 VS in 2015: From Neighborhood C Pharmacy Provider to Health Care Company  C-64

14 Strategy and Society 

CA S E 07 

 ike: Sourcing and Strategy in Athletic N Footwear  C-74

247

Strategy and Social-Value Organizations  248 The Tools of Strategy and the Creation of Social Value  249

in Sports Television?  C-25 CA S E 04  Southwest Airlines: Flying High with

Low Costs  C-37 CA S E 05  Harley-Davidson: Growth Challenges

Ahead  C-52

CA S E 08  AT&T and Apple: A Strategic

Alliance  C-83

  contents  xix C AS E 09  Samsung: Overtaking Philips,

Panasonic, and Sony as the Leader in the Consumer Electronics Industry  C-96

CA S E 15  Corporate Governance and Ethics:

A Series of Decisions  C-163 CA S E 16  Netflix, Redbox and Hulu: Offering

New Business Models in Home Video Entertainment  C-166

C AS E 10  Tesla Motors: Disrupting the Auto

Industry?  C-110 C AS E 11 

Smartphone Wars  C-120

C AS E 12  Lincoln Electric: Aligning for Global

Growth  C-134 C AS E 13 ICARUS Revisited: The Rise and Fall of

Valeant Pharmaceuticals  C-142 C AS E 14  Tabitha’s Way Local Food Pantry:

Entrepreneurship in Feeding the Hungry  C-153

CA S E 17 

Uber Technologies Inc.  C-178

CA S E 18  Safe Water Network: Mastering the

Model at Dzemeni  C-189 ADDITIONAL CASES CAN BE FOUND IN WILEYPLUS

In Praise of Strategic Management “Exciting, challenging, and well constructed” KALYAN CHAKRAVARTY, CALIFORNIA STATE UNIVERSITY, NORTHRIDGE

“[The cases] are wide-reaching in terms of topics covered and can easily be used to illustrate a variety of theoretic concepts from strategy. I think they are all well-written and well-informed.” MEREDITH DOWNES, ILLINOIS STATE UNIVERSITY

“Timely strategic issues; I can easily link the cases to the concepts.” KONGHEE KIM, ST. CLOUD STATE UNIVERSITY

“It is a challenge to engage and show the application of strategy concepts to undergraduate students. This text. . .is an effective resource for meeting this challenge. They combine professional and succinct introductory videos with integrated chapter and case content to relate information in a way that is accessible to students.” DAVID KING, IOWA STATE UNIVERSITY

“The authors have found a way to present the strategy concepts in a concise manner that is easy for modern day students to understand and relate.” LAKAMI BAKER, AUBURN UNIVERSITY

“Quite an offering of ideas and insights that we want our students to dig in and reflect upon.” JOSEPH GOLDMAN, UNIVERSITY OF MINNESOTA

“I appreciate the author’s ability to accurately describe the concepts while not losing the target audience in the process.” LUCAS HOPKINS, MIDDLE GEORGIA STATE COLLEGE

“The book, overall, and individual chapters are exactly what I was looking for myself. It is a fresh breath with contemporary examples and a youthful tone.” M. NESIJ HUVAJ, SUFFOLK UNIVERSITY

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“The greatest strength is the combination of academic rigor and practical, consultinglike approach to strategic management.” HERVE QUENEAU, BROOKLYN COLLEGE

“This project brings a refreshingly practical perspective to strategy, while not sacrificing rigor.” RAM SUBRAMANIAN, MONTCLAIR STATE UNIVERSITY

“It’s engaging for the students, has hands on strategy tools, and [is] loaded with examples.” EDWARD WARD, SAINT CLOUD STATE UNIVERSITY

“Practical, applicable, rich with current examples. Well written and more professional than many.” KRISTIN BACKHAUS, SUNY NEW PALTZ

“Clearly, the greatest strength is the uniqueness of the information as compared to other strategy texts.” BRIAN CONNELLY, AUBURN UNIVERSITY

“A text on strategy written so that students can grasp the concepts better than most texts I have seen or used.” DON STULL, TEXAS TECH UNIVERSITY

“My students embraced the contemporary examples utilized in the text, which help to explain concepts, the interesting and focused approach of the timely cases and the animated videos, which help explain the concepts. The text, the cases, and the accompanying animated videos provide effective approaches to support the different learning styles of the students.” JAMES GLASGOW, VILLANOVA UNIVERSITY

“Excellent text. A great combination of conceptual material and business practices on Strategic Management for students in today’s global economy.” PETER PINTO, BOWLING GREEN STATE UNIVERSITY

“The Dyer book is one of the best written I’ve seen, accessible to students and having great explanations. It also has cool animations.” JIM WEBER, ST. CLOUD STATE UNIVERSITY

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“Perhaps the top benefits. . .are the innovative support materials. For example, the animated videos are a great way to wrap-up each lecture.” DAVID GRAS, TEXAS CHRISTIAN UNIVERSITY

“This text provides excellent in-class exercises that provide hands on demonstration of strategic management concepts.” GEORGE MASON, PROVIDENCE COLLEGE

CHAPTER 1 What Is Business Strategy? LEARNING OBJECTIVES Studying this chapter should provide you with the knowledge to: 1. Define business strategy, including the importance of competitive advantage, the four choices that are critical to strategy formulation, and the strategic management process.

3. Discuss how strategies are formulated and implemented in order to achieve objectives. 4. Explain who is responsible for, and who benefits from, good business strategy.

2. Summarize the information that the company’s mission and thorough external and internal analysis provide to guide strategy.

STANCA SANDA/Alamy Stock Photo

Strategy at Apple

In 2000, Apple computer held a loyal customer base but was limping along as a relatively minor player in the personal computer market. Launched by Steve Jobs and Steve Wozniak, Apple was one of the pioneers in the industry. Unlike other PC makers that relied on Microsoft’s operating system and application software, Apple wrote its own operating system software and much of its application software, which was known as being easy to use. In fact, Apple was the first to introduce software on a low cost personal computer with drop-down menus and a graphical user ­interface that allowed customers to easily complete a task, such

as drag a file to the trash to delete it. However, Apple’s investment in unique software led to high-priced computers and created files that were originally incompatible with those of Microsoft’s Windows operating system and Office software suite. As a result, Apple rarely achieved more than about a 5 percent share of the computer market.1 That all changed in 2001, however, when Apple entered an ­entirely new market with the launch of an MP3 portable music player called the iPod. Apple’s MP3 player was not the first on the market. A company called Rio had offered an MP3 player for a couple of years before iPod’s entry into the market. But iPod quickly took market share from the Rio, for three primary reasons: 1. iPod had a mini hard drive that allowed it to hold 500 songs, as opposed to the roughly 15 songs the Rio could hold using flash memory. 2. iPod was the first to introduce a “fly wheel” navigation button—the round button that was easy to use and allowed users to quickly scroll through menus and songs. 3. iPod was backed with Apple’s name and an innovative design.2 These advantages helped iPod quickly move to industry leadership, despite the fact that an iPod cost 15 to 25 percent more than a Rio.3 At the time the iPod was launched, it was difficult for most consumers to access digital downloads of songs legally. Initially, the iPod was snapped up only by a relatively small group of users, mostly

1

2  CHA PT E R 1   What Is Business Strategy? t­eenagers and college students, who were illegally downloading songs through Napster and other free downloading sites. Apple recognized that to grow the market for iPods, it needed to help consumers legally access songs to play on their ­iPods. As a result, Apple developed software called iTunes, allowing customers to legally download songs. One main reason iTunes was able to provide legal downloads before its competitors was because Steve Jobs, as CEO of both Apple and Pixar (the animation movie production company), understood that music companies, like movie companies, were concerned about people pirating their products. So Apple worked with the music companies to sell songs that had been digitized using software that prevented customers from copying the songs to more than a few computers. iTunes was designed to be easy to use with the iPod. Customers now could easily and legally access songs simply by connecting their iPods to their computers and letting the software do to the rest. Even a technologychallenged grandparent could do it.4 But Apple wasn’t done with its music player strategy. Apple’s experience in the computer business was that other companies could make similar products, often at lower prices. Indeed, while Apple and IBM were the pioneers of the personal computer industry and dominated it during the early years, lower-priced competitors such as Dell, Hewlett-Packard, Lenovo, and ASUS, eventually came to dominate the market. Apple realized it needed to prevent easy imitation of its

business strategy  A plan to achieve competitive advantage that involves making four inter-related strategic choices: (1) markets to compete in; (2) unique value the firm will offer in those markets; (3) the resources and capabilities required to offer that unique value better than competitors; and (4) ways to sustain the advantage by preventing imitation. competitive advantage  When a firm generates higher profits compared to its competitors. market  The industry, customer segment, or geographic area that a company competes in. unique value  The reason a firm wins with customers or the value proposition it offers to customers, such as a low cost advantage or differentiation advantage or both.

music offering. So it created proprietary software called Fairplay that restricted the use of music downloaded from iTunes to iPods only. That meant consumers couldn’t buy a lower-priced MP3 player and use it with iTunes because it was incompatible. If they wanted to use a different MP3 player, they would have to download and pay for ­music a second time.5 Now Apple has bundled an MP3 player into the ­iPhone, which makes it move convenient for customers because they don’t have to carry two devices. To top it off, Apple did something that no other maker of computers, music players, or any other electronic device company had done. It opened its own stores to sell Apple products. This required that Apple learn how to operate retail stores. The Apple Stores helped Apple create a direct link to its customers, making it easier for consumers to learn about and try out Apple products—and get their products serviced. As a result of Apple’s strategic initiatives, it has built a very ­secure market position in music players, currently holding over 70  percent of that market.6 But the battle isn’t over. Amazon has entered the industry, offering music buyers unrestricted use of its songs. Moreover, competitors e-Music, Pandora.com and Spotify are offering music via subscription. Users can listen to any song they want for a monthly subscription fee. The $17 billion music industry is so large that it will continue to attract new competitors who want to dethrone Apple.

How did Apple enter the music industry and within 10 years become the dominant seller of both songs and music players? How did Pandora, a start-up, succeed in the music industry while former giant Sony (maker of the Walkman and Discman) struggled? For that matter, why is any company successful? Understanding the series of actions taken by Apple to achieve a dominant position in the online music business will go a long way toward understanding business strategy—a company’s dynamic plan to gain, and sustain, competitive advantage in its markets. In this chapter, we’ll help you get started by answering some basic questions. We begin with the most obvious: “What is a business strategy?”

What Is Business Strategy? The word strategy comes from the Greek word strategos, meaning, “the art of the general.” In other words, the origin of strategy comes from the art of war, and, specifically, the role of a general in a war. In fact, there is a famous treatise titled The Art of War that is said to have been authored by Sun Tzu, a legendary Chinese general. In the art of war, the goal is to win—but that is not the strategy. Can you imagine the great general Hannibal saying something like, “Our strategy is to beat Rome!” No, Hannibal’s goal was to defeat Rome. His strategy was to bring hidden strengths against the weaknesses of his enemy at the point of attack—which he did when he crossed the Alps to attack in a way that his enemies did not believe he could. He achieved an advantage through his strategy. In similar fashion, a company’s business strategy is defined as a company’s dynamic plan to gain, and sustain competitive advantage in the marketplace. This plan is based on the theory its leaders have about how to succeed in a particular market. This theory involves predictions about which markets are attractive and how a company can offer unique value to customers in those markets in a way that won’t be easily imitated by competitors. This theory then gets translated into a plan to gain competitive advantage. This plan must be dynamic to

   What Is Business Strategy?  3

respond to new information that comes as customers, competitor, and technologies change. Apple’s theory of how to gain a competitive advantage in music download business was to create cool and easy-to-use MP3 players that could easily—and legally—download digital songs from a computer through the iTunes store. Apple sought to sustain its advantage by making it impossible for competitor MP3 players to download songs from the iTunes store. The Apple Stores contributed to Apple’s advantage by providing a direct physical link to customers that competitors couldn’t match. In this particular instance, Apple’s plan to gain, and sustain, competitive advantage worked. But there have been other times, such as with the Apple Newton Message Pad (the first handheld computer that Apple sold as a personal digital assistant) that Apple’s theory about how to gain and sustain competitive advantage did not work. Sometimes strategies are successful and sometimes they are not. Strategies are more likely to be successful when the plan explicitly takes into account four factors: 1. Where to compete, or the attractiveness of a market or customer segment in the targeted markets 2. How to offer unique value relative to the competition in the targeted markets 3. What resources or capabilities are necessary to deliver that unique value 4. How to sustain a competitive advantage once it has been achieved The goal of the strategic plan is to create competitive advantage. First, let’s examine the goal.

Competitive Advantage What exactly do we mean when we use the term competitive advantage?7 In the sports world, it is usually obvious when a team has a competitive advantage over another team: The better team wins the game by having a higher score. The ability to consistently win is based on attracting and developing better players and coaches, and by employing strategies to exploit the weaknesses of opponents. In the business world, the scoring is measured by looking at the profits (as a percentage of invested capital) generated by each firm. We describe the most common ways of measuring profits in Strategy in Practice: Measuring American Home Products’ Competitive Advantage. Just as in sports, where an inferior team may outscore a superior team on a given day, it may be possible for an inferior company to outscore a superior company in a particular quarter, or perhaps even a year. Competitive advantage requires that a firm consistently outperform its rivals in generating above-average profits. A firm has a competitive advantage when it can consistently generate above-average profits through a strategy that competitors are unable to imitate or find too costly to imitate. Above-average profits are profit returns in excess of what an investor expects from other investments with a similar amount of risk. Risk is an investor’s uncertainty about the profits or losses that will result from a particular investment. For example, investors suffer a lot of uncertainty (and, hence, risk) when they put their money into a start-up company that is trying to launch products based on a new technology, such as a solar power company. There is much less risk in investing in a stable firm with a long history of profitability, such as a utility company that supplies power to customers who have few, if any, alternative sources of power.9 Many organizations work to achieve objectives other than profit. For example, universities, many hospitals, government agencies, not-for-profit organizations, and social entrepreneurs play important roles in making our economy work and our society a better place to live. These organizations do not measure their success in terms of profit rates, but they still use many of the tools of strategic management to help them succeed (see Chapter 14). For these organizations, success might be measured using tangible outcomes such as the number of degrees granted, patient health and satisfaction measures, people served, or some other measure of an improved society. The primary source of a company’s competitive advantage can come from several areas of its operations. For example, the diamond company De Beers has an advantage that comes from paying lower costs for its diamonds than other companies do, because De Beers owns its own

above-average profits  Returns in excess of what an investor expects from other investments with a similar amount of risk.

4  CHA PT E R 1   What Is Business Strategy?

Strategy in Practice Measuring American Home Products’ Competitive Advantage To see which firms in an industry are most successful, we typically compare their return on assets (ROA), a calculation of operating profits divided by total assets, or their return on equity (ROE), which is operating profits divided by total stockholders’ equity. The company that consistently generates the highest returns for its investors, in terms of ROA or ROE, wins the game. For example, from 1971 to 2000, the pharmaceutical company American

Home Products averaged 19 percent ROA, compared to competitor ­American Cyanamid’s 7 percent. American Home Products’ ROA was higher than American Cyanamid’s every year for 30 years. This is evidence that during this time period, American Home Products had a competitive advantage over American Cyanamid.8 American Home Products’ advantage over American Cyanamid has frequently been attributed to its ability to develop more blockbuster drugs (through more effective research and development) and to quickly get those drugs to market through a larger and more effective sales force.

20 18

Operating Profit (ROA %)

16 14 12 10 8 6 4 2

American Cyanamid

Pfizer

Upjohn

Schering Plough

Eli Lilly

Bristol Myers Squibb

Merck

American Home Products

0

Profitability of Different Firms in the Pharmaceutical Industry Source: Annual reports; 1973–1992

strategic management process  The process by which organizations formulate a plan and allocate resources to achieve competitive advantage that involves making four strategic choices: (1) markets to compete in; (2) unique value the firm will offer in those markets; (3) the resources and capabilities required to offer that unique value better than competitors; and (4) ways to sustain the advantage by preventing imitation.

diamond mines. Competitive advantage can also come from different functional areas within the company. Biotechnology pioneer Genentech’s advantage comes primarily from research and development that has produced several blockbuster drugs; Toyota’s advantage in automobiles comes primarily from its operations (known as the Toyota Production System); Procter & Gamble’s advantage in household products comes largely from its sales and marketing, and Nordstrom’s advantage as a retailer comes largely from its merchandising and service.

The Strategic Management Process The processes that firms use to develop a strategy can differ dramatically across firms. In some cases, executives do not spend significant time on strategy formulation, and strategies are ­often based only on recent experience and limited information. However, we propose that a better approach to the formulation of strategy is the strategic management process outlined in Figure 1.1. The strategic management process for formulating and implementing strategy involves thorough external analysis and internal analysis. Only after conducting an analysis of the company’s external environment and its internal resources and capabilities are a firm’s

   What Is Business Strategy?  5

Mission

External Analysis

Internal Analysis

• Industry structure • Opportunities/threats [Chapter 2]

• Resources and capabilities • Strengths/weaknesses [Chapter 3]

Strategy Formulation Cost Advantage [Chapter 4]

Differentiation Advantage [Chapter 5]

Corporate Strategy [Chapter 6]

Vertical Integration [Chapter 7]

Strategic Alliances [Chapter 8]

Dynamic Strategic Actions

Disruptive Business Models [Chapter 10]

Competitor Interaction/ Game Theory [Chapter 11]

Business Level Strategies

Strategy Vehicles

International Strategy [Chapter 9]

Strategy Implementation Strategy Implementation [Chapter 12]

Governance and Ethics [Chapter 13]

Social Value Organizations [Chapter 14]

FIGURE 1.1    The Strategic Management Process

executives and managers able to identify the most attractive business opportunities and ­formulate a strategy for achieving competitive advantage. The central task of the strategy formulation process is specifying the high-level plan and set of actions the company will take in its quest to achieve competitive advantage. After the plan for creating competitive advantage is created, the final step is to develop a detailed plan to effectively implement, or put into action, the firm’s strategy through specific activities. The focus of the strategic management process should be to make four key strategic choices, as shown in Figure 1.2 1. Which markets will the company pursue? A company’s markets include the high-level industry and specific customer segments in which it competes and its geographic markets. 2. What unique value does the company offer customer in those markets? This is the firm’s value proposition, the reason the company wins with a set of customers.10 3. What resources and capabilities are required? What does the company need to have and know how to do so that it can deliver its unique value better than competitors, and exactly how will the company deliver its unique value through an implementation plan?11 4. How the company will capture value and sustain a competitive advantage over time? Firms need to create barriers to imitation to keep other companies from delivering the same value.

external analysis  Examining the forces that influence industry attractiveness, including opportunities and threats that exist in the environment. internal analysis  The analysis of a firm’s resources and capabilities (its strength and weaknesses) to assess how effectively the firm is able to deliver the unique value (value proposition) that it hopes to provide to customers.

6  CHA PT E R 1   What Is Business Strategy?

Markets to Pursue

• What industry, customer segment, and geographic markets are most attractive as business arenas?

Unique Value to Offer

• What value proposition will offer unique value relative to competitors in the areas of cost or differentiation or both?

Resources and Capabilities to Develop

• What resources and capabilities are required in order to deliver that unique value better than competitors?

Sustaining Advantage

• How to create barriers to imitation to prevent other companies from offering that same value?

FIGURE 1.2    Four Key Strategic Choices in Strategic Management

Markets  One of the first decisions a company must make is where to compete or which markets it will serve. Leaders must choose the industries a company competes in and the specific customer segments or needs it will address (the focus of chapter 2) within those industries. For example, before iPod, Apple competed only in the computer industry. Its product markets included desktop and laptop computers. Launching iPod and iTunes took Apple into the music industry. Later, when Apple launched the iPhone, it entered the cell phone business. Apple targets the high-end customer segments within its industries. Its customers want the latest in technology, see themselves as innovators, appreciate design and elegance, and are not price sensitive. It is also important to select geographic markets to serve. Apple competes on a worldwide basis, which allows it to spread heavy research and development costs across its many geographic markets. By contrast, Walmart started by focusing on rural markets, which allowed it to offer lower prices than the “mom and pop” retail stores in small towns.12 Unique Value  cost advantage  An advantage that a firm has over its competitors in the activities associated with producing a product or service, thereby allowing it to produce the same product at lower cost.

differentiation strategy  An advantage a firm has over its competitors by making a product more attractive by offering unique qualities in the form of features, reliability, and convenience that distinguishes it from competing products.

After a company chooses the markets in which to compete, it then attempts to offer unique value in those markets. This is often referred to as a company’s value proposition, or the value that it proposes to offer to customers. Companies typically try to achieve a competitive advantage by choosing between one of two generic strategies for offering unique value: low cost or differentiation. Companies such as Walmart, Ryanair, Taco Bell, and Kia attract customers by being cost leaders, offering products or services that are priced lower than competitor offerings. A firm that chooses a low-cost strategy (the focus of Chapter 4) focuses on reducing its costs below those of its competitors. Key sources of cost advantage include economies of scale, lower-cost inputs, or proprietary production know-how. A firm that chooses a differentiation strategy (the focus of Chapter 5) focuses on offering features, quality, convenience, or image that customers cannot get from competitors. Apple’s unique value is offering iPods (music players), iPhones (smart phones), and iPads (tablets) that are well designed, innovative, easy to use, and have features that competing products don’t have (“there’s an App for that”). In similar fashion, Starbucks wins through differentiation by offering multiple blends of high-quality coffee in convenient locations. The traditional answer to offering unique value is to be either a low-cost (low-price) provider or a differentiator. In fact, strategy professor Michael Porter, whose five forces analysis will be introduced later in this chapter, has cautioned that trying to do both simultaneously

   What Information and Analysis Guides Strategy Formulation?  7

can result in being “stuck in the middle”—meaning that by trying to do both, companies don’t effectively do the job of either low price, or differentiation. Increasingly, however, companies are finding ways to deliver on both low cost and differentiation.13 Does Amazon beat brick-and-mortar stores because of price or differentiation (e.g., convenience)? Does Uber beat taxis because of price or differentiation (e.g., convenience)? The answer, of course, is  both. Some companies have discovered ways to offer both low price and a differentiated product—which turns out to be a powerful source of competitive advantage (See “New Thinking: Achieving both Cost and Differentiation Advantages” at the end of Chapter 5).

Resources and Capabilities  Delivering unique value requires developing resources and capabilities (the focus of Chapter 3) that will allow the company to perform activities better than competitors. Indeed, perhaps the most critical role of the strategist is to figure out how to build or acquire the resources and capabilities necessary to deliver unique value. Resources refer to assets that the firm accumulates over time, such as plants, equipment, land, brands, patents, cash, and people. Elon Musk is a key resource for Tesla because his reputation as an innovator allows him to raise the large sums of money Tesla needs for product development at a low price. Capabilities refer to processes (or recipes) the firm develops to coordinate human activity to achieve specific goals. To illustrate, Starbucks has key resources that allow it to succeed through differentiation, including its Starbucks brand, its retail store locations, its recipes to produce different coffee blends, and even some patents to protect those recipes. Its capabilities include its processes to roast coffee beans for the best flavor, create new coffee blends, design stores with great atmosphere, and find optimal store locations. These resources and capabilities have allowed Starbucks to deliver unique value to customers, thereby helping the company outperform other coffee shops within the coffee retailing industry. The development of key resources and capabilities needed to deliver unique value should be part of the company’s strategy implementation plan. The strategy implementation plan involves the company developing a set of processes (capabilities) within each function (e.g., R&D, operations, sales, service, HR, etc.) that align with the unique value the company hopes to offer. For example, because Walmart’s unique value is “low prices,” every function of the company is focused on how it can perform its activities at the lowest possible cost. Strategists also have learned that it is helpful to align the firm’s structure (organization design), staffing (people), skills (capabilities/processes), systems (e.g., information and reward systems), and shared values and style (its culture) with its strategy for offering unique value (implementation is discussed in detail in Chapter 12). Sustaining Advantage 

By being the first to offer music downloads through its easyto-use iTunes software, Apple encouraged its customers to store their entire music libraries on iTunes. Designing iTunes so that it wouldn’t download songs to other music players helped Apple to prevent competing MP3 players from taking market share from iPod. Of course, Apple’s brand image and its Apple Stores also prevent competitors from easily imitating its products and services. These actions helped Apple capture and sustain the value it created.

What Information and Analysis Guides Strategy Formulation? As Figure 1.1 shows, the earliest steps in the strategic management process involve analyses and choices that later result in the formulation and implementation of a company’s strategy. These choices are made within the context of the company’s mission and only after an analysis of the external environment and internal organization.

8  CHA PT E R 1   What Is Business Strategy?

Mission mission  A company’s primary purpose that often specifies the business or businesses in which the firm intends to compete—or the customers it intends to serve.

A company’s mission outlines the company’s primary purpose and often specifies the business or businesses in which the firm intends to compete—or the customers it intends to serve. People in business often use the terms mission, vision, or purpose somewhat interchangeably. For our purposes in this book, we will use the term mission to refer to the primary purpose of the organization. Most business firms start with a mission, even if it isn’t formally stated. For example, Starbucks founder Howard Schultz got the idea to introduce coffee bars to America when he visited Italy and experienced the great coffee and convenience of Italian espresso bars. His external analysis of the coffee shop industry in the United States led him to believe that there was an opportunity to bring an exceptional coffee experience to America. Schultz once said American coffee was so bad it tasted like “swill.” He discovered café latte when visiting an espresso bar in Verona, Italy, and thought, “I have to take this to America.”14 So he launched Starbucks, a company that offered higher-quality coffee than traditional coffee shops, and included many varieties at a premium price. In essence, Starbucks started with a mission to bring high-quality coffee to the masses in the United States. As companies grow and develop formal mission statements, these statements often define the core values that a firm espouses, and are often written to inspire employees to behave in particular ways. Starbucks formalized its mission as follows: Our mission: to nurture and inspire the human spirit—one person, one cup, and one neighborhood at a time.15 It then proceeds with the statement: Here are the principles of how we live that every day— which is followed by a set of principles or values designed to guide employee behaviors. Even after it has been formalized, however, a company’s mission is still open to interpretation, as Strategy in Practice: Apple’s Evolving Mission shows.

External Analysis

SWOT analysis  Strategic planning method used to evaluate the strengths, weaknesses, opportunities, and threats involved in a business.

External analysis is critical for addressing the first strategic choice: Where should we compete? External analysis involves: (1) an examination of the competition and the forces that shape ­industry competition and profitability; and (2) customer analysis to understand what customers really want. The combined results of external analysis with internal analysis of the firm are often summarized as a SWOT analysis. SWOT is an acronym for Strengths, Weaknesses, ­Opportunities, and Threats.16 External analysis is particularly useful for shedding light on the latter two: opportunities and threats.

Industry Analysis  One of the central questions for the strategist is to determine which markets or industries to compete in. The fact of the matter is, all industries are not created equal. To illustrate, between 1992 and 2006, the average return on invested capital in US industries ranged from as low as zero to more than 50 percent.17 The most profitable industries include prepackaged software, soft drinks, and pharmaceuticals. These industries are more than five times as profitable as the least profitable industries, which include airlines, hotels, and steel. This does not mean that a steel or airline company cannot be successful or profitable (Southwest Airlines has been quite profitable18), but it does mean that the average profitability of all firms in these industries is low compared to other industries. This makes the challenge of making money in these low-profit industries even greater. Why are some industries more profitable than others? Strategy professor Michael Porter developed a model for conducting industry analysis called the Five Forces that Shape Industry Competition.19 Understanding the five forces that shape industry competition is one of the starting points for developing strategy, and will be discussed in detail in Chapter 2. This framework helps managers think about what the company can do to increase its power over suppliers and buyers, create barriers to other firms looking to enter the market, reduce the threat of substitute products or services, and reduce rivalry with competitors.

   What Information and Analysis Guides Strategy Formulation?  9

Strategy in Practice Apple’s Evolving Mission When Steve Jobs and Steve Wozniak launched Apple in 1976, their primary purpose was to make great computers that people loved to use. Twenty-four years later, Apple was still essentially a computer company when it launched the iPod, a device that took the company into the music industry. But did you know that Apple was not the first computer company to make a small, handheld MP3 player with a mini-hard drive that could store your entire music library? That honor goes to Compaq (later acquired by HP). Compaq developed an MP3 player before Apple, but the company decided this was not an industry and product market that it wanted to enter. Compaq decided not to pursue the MP3 business because it saw its mission as being a computer maker, and music players fell outside of that mission. Instead of refining the design and launching its MP3 player on the market, Compaq sold the technology to a Korean company. In contrast, Apple decided that this product market was not outside its mission. Apple’s decision was influenced by its external analysis. Apple looked at the multibillion-dollar music business and ­

quickly realized that no company was offering legal digital downloads—so the market was wide open because of the challenges of protecting the files from easily being copied. Apple’s leaders also considered its internal capabilities. Unlike Compaq— which only made computer hardware but not software—Apple had vast experience at writing software for Apple computers. It also had far greater design expertise than Compaq. In fact, the company had long been hailed for the cutting-edge designs of the iMac and some of its other computers. Apple decided to channel its internal capabilities at writing software to navigate an MP3 player. Apple’s software engineers came up with the innovative “flywheel” design for navigating the iPod. Likewise, it channeled its design capabilities toward designing a product that was elegant and small enough to fit in your pocket. As a result of formulating a strategy to enter the MP3 player ­market—and subsequently the iPhone and iPad markets—­Apple’s mission has broadened. The company no longer focuses on just being a computer maker. In fact, in 2007 it changed its name from Apple Computer Inc. to Apple Inc. to reflect this change in its mission.

Customer Analysis 

External analysis also involves an analysis of customers or potential customers, notably an analysis of their needs and price sensitivity. In particular, the strategist can make better decisions about how to offer unique value by considering groups of customers who all have similar needs. This is called customer segmentation analysis.20 For example, in the automobile industry, some customers want cars that are very stylish, powerful, luxurious, and packed with technology and gadgets. These customers are the focus of companies such as Porsche, Mercedes-Benz, BMW, and Lexus. Others want trucks with the capacity to haul heavy items and move easily over rough terrain. These customers are the focus of the truck divisions of Chevy and Ford. Still others want economy cars for basic transportation—the focus of ­Hyundai and Kia. External analysis should enlighten managers about the competitive forces that influence the profitability of particular markets and industries, as well as opportunities and threats. In addition, it should shed light on what customers want and what they are willing to pay to have their needs met.

price sensitivity  The degree to which the price of a product or service affects consumers’ willingness to purchase the product or service. segmentation analysis  Dividing up customers into groups or segments based on similar needs or wants.

Internal Analysis Whereas external analysis focuses on a company’s industry, customers, and competitors, ­internal analysis focuses on the company itself. Internal analysis completes the SWOT by focusing on strengths and weaknesses. More formally, internal analysis involves an analysis of the company’s set of resources and capabilities that can be deployed—or should be developed—to deliver unique value to customers. We discuss internal analysis in greater detail in Chapter 3. In the 1980s, the resource-based view of the firm, also known as the resource-based model, was developed to explain why some firms outperform other firms within the same industry.21 Why does Nucor make money in the steel business when most of its US competitors do not? Why does Southwest fly high in the air travel business while most of its competitors are (financially) grounded? The resource-based model assumes that each company is a collection of resources and capabilities (also referred to as competencies) that are deployed to deliver unique value.22 Firms that don’t have the resources and capabilities that are necessary to implement the strategies they are contemplating may need to improve, change, or possibly create them in order to offer unique value to their customers. This is where resource allocation becomes an

resource-based review of firm  Determining the strategic resources available to a company.

10  CHA PT E R 1   What Is Business Strategy?

important dimension of strategy. After a company decides how it hopes to offer unique value, it must allocate the resources necessary to build those resources or capabilities. For example, after Target realized that it could not compete directly on prices with Walmart, it allocated additional resources to move “upmarket.” This involved investing heavily in a trends department, a new mix of higher-quality products, relationships with designers, more expensive suburban retail locations, and significant TV advertising to get the message out to customers.

How are Strategies Formulated? Formulating a strategy involves selecting which actions the company will take to gain and sustain competitive advantage. Remember, competitive advantage requires that the company do all of the following: •  Provide unique value to a set of customers in the appropriate markets. •  Develop a set of resources and capabilities that allow the company to deliver that unique value to customers better than competitors. •  Sustain the competitive advantage by figuring out how to prevent imitation of the chosen strategy.

corporate strategy  Decisions about what markets to compete in, made by executives at the corporate level of an organization. business unit strategy  Decisions about how to gain and sustain advantage, made at the manager level for each standalone business unit within a company. functional strategy  Decisions about how to effectively implement the business unit strategy within functional areas like finance, product development, operations, information technology, sales and marketing, and customer service.

strategy vehicles  Activities and strategic choices—such as make versus buy, acquisitions, and strategic alliances—that influence a firm’s ability to enter particular markets, deliver unique value to customers, or create barriers to imitating its product.

A company will also need to formulate, and then implement, strategy at three different levels of the organization: corporate, business unit (product), and functional. Corporate strategy refers to decisions that are made by senior corporate executives about where to compete in terms of industries and markets. For example, Amazon’s corporate executives made the decision to use its Kindle to enter the electronic reader/tablet business where it would face new competitors such as Apple. Similarly, Amazon’s launch of Amazon Web ­Services—a business that provides web hosting, cloud storage, and marketplace software—was made at corporate headquarters by the corporate management team. Business unit strategy is made at the level of the strategic business unit—standalone business units in a company that typically have their own profit and loss responsibility. Amazon’s online discount business would be considered one business unit, whereas Kindle and Amazon Web Services would be different business units. The general manager of each business unit addresses the questions we’ve identified regarding how to gain and sustain advantage in that particular market. Finally, within each business unit are different functions such as product development, operations, information technology, sales and marketing, and customer service. A functional strategy should align with the overall business unit strategies to effectively implement the business unit strategy (see Figure 1.3).

Strategy Vehicles for Achieving Strategic Objectives In many instances, firms rely on a few key strategy vehicles to help them enter attractive markets and build the resources and capabilities necessary to deliver unique value. These strategy vehicles include such things as diversification, acquisitions, alliances, vertical integration, and international expansion. In some cases, a firm may choose to grow by diversifying, adding to its products or opening a new line of business. Acquisition is a strategy vehicle used for growth and diversification or to acquire key resources. For example, when Apple acquired NeXT Computing, the late Steve Jobs’s start-up, Apple acquired the operating system that became OSX—and the acquisition brought Steve Jobs back to Apple.23 More recently, Apple acquired SIRI, a company that made voice recognition and search software that was the technology behind SIRI (pronounced sir’-ee), Apple’s personal assistant on the iPhone. Sometimes companies decide to access new resources and capabilities through a strategic alliance—an exclusive relationship with another firm—rather than through acquisition. For example, Apple teamed up with AT&T in an alliance to launch the iPhone in the United

   How are Strategies Formulated?  11

Corporate Strategy (Where to compete)

Business Unit 1 Strategy (How to compete)

R&D Strategy (How to implement)

Business Unit 2 Strategy (How to compete)

Operations Strategy (How to implement)

Marketing Strategy (How to implement)

Identifies where to compete in terms of industries and markets.

Identifies what unique value to offer (cost or differentiation) and how to deliver it

Provides guidance for managing and allocating resources to distinct business units

Provides a plan to achieve competitive advantage

H.R. Strategy (How to implement)

Strategies and tactics of the functional areas should align with and implement the overall business unit strategy. FIGURE 1.3    Multiple Levels of Strategic Analysis

States. AT&T put huge promotional dollars behind the iPhone—and paid Apple 10 percent of its ­revenues from each iPhone subscriber—in order to be the exclusive distributor of iPhones for the first five years. Vertical integration, or the make-buy decision, is also a vehicle for achieving objectives.24 For example, when Apple decided to move into retailing by establishing Apple Stores, the company made a decision to “make” stores that sold their own products, rather than simply “buy” the retailing services of stores run by other companies, such as Best Buy or Walmart. Finally, companies may use international expansion as a vehicle to achieve economies of scale, access key resources, or learn new skills. Indeed, some companies use international expansion as a primary source of competitive advantage. These strategy vehicles—discussed in detail in Chapters 6 to 9—are important tools that strategists use to achieve key strategic objectives.

Strategy Implementation The final step in the strategic management process is to implement the strategy that was chosen during the strategy formulation phase. Strategy implementation occurs when a company adopts a set of organizational processes that enable it to effectively carry out its strategy. Effective implementation typically requires the following: 1. The functional strategies within the company—research and development, operations, sales and marketing, human resource management—are well aligned with delivering the unique value identified in the overall strategy. Implementation is generally more successful when a company can measure how effectively functional activities are being performed to support the overall strategy. 2. The organization’s structure, systems, staff (people), skills (processor capabilities, style, and shared values (culture) are designed to facilitate the execution of the strategy. This is the McKinsey 7 S framework, which is useful for creating the alignment necessary to ensure effective implementation. We discuss how companies can effectively create alignment with their strategy—or change the organization to align with a new strategy—in Chapter 12. The Strategy in Practice: Walmart Functional Strategies Implement the Overall Strategy feature describes some of the actions that Walmart has taken to ensure that its functional activities align with and implement the overall business unit strategy.

strategy implementation  The translation of a chosen strategy into organizational action so as to effectively implement the activities required to achieve strategic goals and objectives.

12  CHA PT E R 1   What Is Business Strategy?

Strategy in Practice Walmart Functional Strategies Implement the Overall “Low Cost” Strategy When a company has a clear strategy regarding how it plans to offer unique value, or “win” with customers, this helps guide the implementation of the overall strategy within each of the different business functions. As we’ve discussed, Walmart’s strategy is to win by being a cost leader in its markets. Walmart’s functional areas support that strategy in a number of ways:25 •  Walmart’s human resource management strategy focuses on keeping labor costs as low as possible.  Walmart pays relatively low wages and has few layers of management, which minimizes labor costs. Walmart also has a nonunion stance and once even closed a store in Canada when the workers tried to unionize.26 Managers have small offices with inexpensive furniture, and

when they travel, they stay at inexpensive hotels and frequently share a room. •  Walmart’s information technology and operations areas also focus attention on cost reduction.  Walmart has invested in information technology to lower the costs of communicating with thousands of suppliers and to provide suppliers with real-time data on what products are selling, at what price, in what store. •  Walmart purchasing department negotiates aggressively with suppliers. Walmart uses its tremendous buying power to get the lowest prices on products from its suppliers. It also offers a product mix that appeals to price-sensitive customers. •  Marketing does price checks at competitors.  The goal of the marketing staff is to ensure that Walmart’s prices are always as low, if not lower, than competitors.

To ensure successful implementation, the organization should have clear metrics, or ways to measure whether or not the plan is being implemented. In Chapter 12, we provide a strategy tool, our version of the balanced scorecard, which suggests some useful metrics that functional area leaders, and the CEO and top management team, can use to determine how effectively strategies are being implemented.27

Who is Responsible for Business Strategy? strategic leaders  Organizational leaders charged with formulating and implementing a strategy with the objective of ensuring the survival and success of an organization. deliberate strategy  A plan or pattern of action that is formulated through a deliberate planning process that is then carried out to achieve the mission or goals of an organization.

emergent strategy  A plan or pattern of action that develops and emerges over time in an organization despite a mission or goals.

Strategic leaders are typically the leaders of an organization who develop strategy through the strategic management process. These leaders are responsible for not only formulating strategy, but also for explaining the strategy in a way that employees will understand—and in a way that will motivate employees to execute it. Chapter 13 explains the role the board of directors and the top management team play in formulating and implementing strategy. Theorist Henry Mintzberg refers to strategies that are developed by management, using the strategic management process shown in Figure 1.1, as “intended” or “deliberate” strategies.28 Deliberate ­strategies are implemented as a result of careful analysis of markets, customers, competitors, and a firm’s resources and capabilities. Target’s move to upscale discount retailing came after it concluded that it could not compete with Walmart on costs and prices. So it created a trends department, created partnerships with high-end fashion designers (e.g., Oscar de la Renta) and stores (Neiman Marcus), offered a higher-end mix of products, and built stores in more affluent suburban areas as opposed to rural towns. Target’s strategy to become Tar-zhay was the result of a deliberate strategic plan. Emergent strategy is a strategy that was not expressly intended in the original planning of strategy. Strategies that emerge when leaders recognize and act on unexpected opportunities that occur through serendipity, such as ideas from people within the organization, are called emergent strategies.29 Apple’s transformation from a computer company to a company known mostly for its music players and cell phones was the result of a strategy that emerged after the introduction of the iPod. The iPod opened up opportunities—such as the iPhone and iPad— that the company’s senior executives did not necessarily foresee. Successful companies typically have strategies that are partly deliberate, due to effective strategic planning processes, and partly emergent, due to a willingness to respond to changes in the external environment and to ideas that come from within the organization. That is why a strategy needs to be a plan to gain and sustain advantage. In a successful company, everyone in the organization has some responsibility for understanding the company’s strategy and for offering ideas to improve the company’s strategic position.

   Who is Responsible for Business Strategy?  13

Ethics and Strategy The Price Companies Pay to Stay Competitive One of the central ethical challenges facing the strategist is making decisions designed to deliver unique value to customers. A decision could, for example, focus on low cost and how it might result in reduced value for specific stakeholder groups. Over the past few years, an increasing number of US companies have shut down US facilities and fired American workers as they have shifted their activities overseas to save money. For example, IBM laid off more than 1,200 employees in New York and Vermont because their jobs could be done more cost effectively in “Brazil, India, and now China.”32 In similar fashion, HP announced layoffs of 500 customer service workers in Arkansas due to global restructuring, the term often used to describe a company’s plan to fire workers and move activities from one location to another.33 And Eaton, a 101-year-old Cleveland-based manufacturer of electronic components, moved its corporate address to Ireland, where the top corporate tax rate is 12.5 percent versus 35 percent in the United States. These are only a few

of the many examples of organizations making difficult decisions in order to stay competitive. But at what price? In each of these instances, the company’s leaders are responding to customer demands (lower prices) and shareholder demands (higher profit returns). But in doing so, they are neglecting employee demands (job retention) and community demands (taxes provide community benefits). Some may question whether it is ethical to fire employees and avoid US taxes in order to better meet the desires of customers and shareholders. Others will argue that if the company does not keep its customers and shareholders happy, employees will eventually lose their jobs anyway because the company will not be cost competitive, and companies that go bankrupt cannot pay taxes. The challenge of meeting the sometimes-competing needs of various stakeholder groups is one that is constantly faced by a company’s leaders. A typical response is to prioritize stakeholders’ needs—with customers and shareholders needs coming first—and take strategic actions that best meet their needs. But actions that take unduly from employees and communities to compensate ­customers and shareholders are viewed by many as unethical.

Who Benefits from a Good Business Strategy? Every organization has a set of stakeholders to whom it is accountable—and who therefore can influence business strategy. Organizations have four primary stakeholder groups: 1. Capital market stakeholders (shareholders, banks, etc.)

stakeholders  Those who have a share or an interest in the activities and performance of an organization.

2. Product market stakeholders (customers, suppliers) 3. Organizational stakeholders (employees) 4. Community stakeholders (communities, government bodies, community activists)30 There is a lively debate that will be discussed in Chapter  13 about which of these four stakeholder groups is the most important and should be the primary beneficiaries of successful business strategies. Some people believe that shareholders (owners of the company) are the most important. Others make the case that customers, employees, governments, or communities should be the primary beneficiaries of business activity. In the United States, shareholders typically receive highest priority, but each stakeholder group can influence the strategic decisions that are made by a company. Sometimes, different stakeholder groups have conflicting views as to the appropriateness of different strategic decisions. Imagine that your company can lower its product costs by closing down your plants in the United States and moving production to China, where labor is cheaper. This will require firing many of your US employees. Both the employee stakeholder group and community stakeholder groups in the cities where your plants are located will perceive this move as negative, and they will try to stop the company from making this decision. However, shareholders and customer stakeholder groups may applaud this decision. It could increase profits for shareholders and lower prices for customers, or both. Because of conflicts like this, companies need to make sure their strategic actions follow accepted ethical standards for business activity. In the ideal situation, a firm has such an effective business strategy that it generates above-average profit returns. Above-average returns allow companies to not only meet the expectations of shareholders, but also satisfy the expectations of other suppliers of capital, product-market, organizational, and community stakeholders. Since stakeholders influence, and are influenced by, strategic decisions made by a company’s management team, it is important to understand and consider the needs of different stakeholder groups when making strategic decisions.31

shareholders  Owners of a company.

14  CHA PT E R 1   What Is Business Strategy?

Strategy in Your Career Understanding business strategy and the strategic management process is important for at least two reasons: 1. When you start your own company or are the president or general manager of a department or division within a company, your primary job will be to formulate and implement an effective business strategy. Even as a junior person in your company, by understanding basic strategy principles you will be more effective at developing and implementing ideas that are consistent with, and support, your business unit’s overall strategy. Being able to understand and contribute to your firm’s strategy may lead to earlier promotions as you stand out from your peers.

2. Understanding strategy will help you evaluate the strategy of companies you choose to work for. Effective strategy can give a company competitive advantage over its rivals. Companies with competitive advantage typically provide superior advancement opportunities, higher pay, and greater job security than companies without any competitive advantage. In summary, understanding the strategic management ­ rocess—as well as the concepts that are fundamental to the forp mulation, and implementation, of strategy—will likely be very helpful as you pursue a successful career in business.

Summary •  A company’s business strategy is defined as a plan to achieve competitive advantage. Formulating a strategy involves making four key choices: (1) what markets or industries the company will pursue; (2) what unique value to offer the customer in those markets; (3) what resources and capabilities will allow the firm to deliver that unique value better than competitors; and (4) how the company will sustain its advantage and prevent imitation of its strategy by competitors. •  The strategic management process involves the selection of a company mission as well as external and internal analyses that contribute to the formulation of a company’s strategy. A company’s mission outlines the company’s primary purpose and scope of activity. External analysis involves an analysis of the company’s current (or potential) markets or industries to understand the environmental factors that influence a firm’s profitability. Internal analysis involves an analysis of the company’s set of resources and capabilities (or new ones that need to be developed) that can be deployed to create competitive advantages. •  These analyses contribute to the formulation of a company’s strategy. After the plan for creating competitive advantage is created,

the final step is to develop a plan to effectively implement the firm’s strategy. •  Every organization has a set of stakeholders to whom it is ­accountable—and who therefore can influence business strategy. The four primary stakeholder groups are capital market stakeholders (shareholders, other suppliers of capital like banks), product market stakeholders (customers, suppliers), organizational stakeholders (employees), and community stakeholders (communities, government bodies). •  The chief executive officer and vice presidents of the different business functions are ultimately responsible for a company’s strategy. They are often assisted by a VP of strategic planning (chief strategy officer), who may lead a planning staff, or in some cases by a management-consulting firm. Good strategic leaders, however, will seek information and ideas from anyone in the company. •  You need to understand business strategy because: (1) it will give you the tools to more effectively evaluate, and contribute, to the strategy of the company that employs you; and (2) it will give you the knowledge you need to evaluate the strategy of organizations you may want to join.

Key Terms above-average profits  3 business strategy  2 business unit strategy  10 competitive advantage  2 corporate strategy  10 cost advantage  6 deliberate strategy  12 differentiation strategy  6 emergent strategy  12

external analysis  5 functional strategy  10 internal analysis  5 market 2 mission 8 price sensitivity  9 resource-based review of firm  9 segmentation analysis  9 shareholders 13

stakeholders 13 strategic leaders  12 strategic management process  4 strategy implementation  11 strategy vehicles  10 SWOT analysis  8 unique value  2

  References 15

Review Questions 1. Why is it important for you to understand business strategy? 2. How would you describe/define strategy? 3. What are the four choices that are part of strategy formulation? 4. What are the two generic strategies, or primary ways, in which companies attempt to offer unique value relative to competitors? 5. Who is ultimately responsible for a company’s strategy? Who does this individual (or individuals) call on for help in formulating strategy for the firm?

6. According to Michael Porter’s “five forces” model, why do some firms earn higher profits than other firms? 7. What are resources and capabilities, what is the difference between them, and why do firms need to assess them? 8. What are three keys to the successful implementation of a company strategy? 9. Who are the four primary stakeholder groups that influence strategic decisions in a company?

Application Exercises Exercise 1: Examine the Business Strategy of a Company 1. Identify a company you would like to learn more about that seems to have a competitive advantage (earns above-average profit returns). 2. Gather data about the strategy of that company, using public ­sources such as the company website or its annual reports, public ­articles, and your own experience.

­ ssignment, because companies often try to hide their sources of coma petitive advantage. Exercise 2: Amazon is an online discount retailer that has successfully entered other businesses, such as electronic devices with the Kindle, Kindle Fire, and Echo as well Amazon Web Services. Read what you can about Amazon’s entry into these new businesses, and try to explain:

3. Identify the mission statement of the company, if it has one. How does this mission statement guide the behavior and actions of people in the company?

1. why you think they chose to compete in those markets,

4. What markets or industries does the company focus on? Does this differ from competitors in any particular way?

3. what resources and capabilities did they possess that they were able to utilize to succeed in the new markets; and what new capabilities did they need to develop; and

5. What unique value does it try to offer to customers? Why do most of its customers pick its products over those of competitors? 6. Try to identify any resources or capabilities this company has that help it offer unique value. This is the most difficult step in the

2. their unique value is in those markets—why do they win with customers;

4. what makes it hard for competitors to imitate their offerings.

References S. Levy, Insanely Great: The Life and Times of Macintosh, the Computer that Changed Everything (New York: Penguin Books, 1994). 1

S. Levy, The Perfect Thing: How the iPod Shuffles Commerce, Culture, and Coolness. (New York: Simon and Schuster, 2006). 2

D. Yoffie, Apple Computer 2005 (Cambridge, MA: Harvard Business School Press, 2005). 3

E. Smith, “Can Anybody Catch iTunes?” The Wall Street Journal (Nov. 27, 2006), pp. 41 +. 4

5 P. Kafka, “How Are Those DRM-free MP3s Selling?” Silicon Alley Insider (2008), www.alleyinsider.com/2008/3.

http://www.afterdawn.com/news/article.cfm/2009/09/09/ipod_ market_share_at_738_percent_225_million_ipods_sold_more_ games_for_touch_than_psp_nds_apple. 6

For more discussion about competitive advantage see: J. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17(1) (1991): 99–120; R. Reed, “Causal Ambiguity, 7

Barriers to Imitation, and Sustained Competitive Advantage,” Academy of Management Review, 15 (1) (1990): 88–102. M. E. Porter, Competitive Advantage, 2nd ed. (New York: The Free Press, 1998). 8 T. C. Powell, N. Rahman, and W. H. Starbuck, “European and American Origins of Competitive Advantage,” Advances in Strategic Management, 27 (2010): 313–351.

For a discussion of risk versus uncertainty see F. Knight, F. Risk, Uncertainty, and Profit (Chicago: Houghton Mifflin Co., 1921). According to Knight, though the distribution of outcomes may be very wide, risk is possible to measure, whereas uncertainty is immeasurable; even the possible distribution of outcomes is unknown. 9

See M. Porter, “What Is Strategy,” Harvard Business Review (Nov.– Dec.1996): 61–78.

10

See B. Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal 5(2) (1984): 171–180. Also see Barney, 99–120.

11

See: http://www.dailymail.co.uk/news/article-1394087/Is-end-MomPop-stores-Mini-Wal-Mart-express-stores-coming- town-near-you.html. 12

16  CHA PT E R 1   What Is Business Strategy? Hill, Charles L. (1988). “Differentiation or low cost or differentiation and low cost: A contingency framework.” Academy of Management Review, Vol. 13, Issue 3, pp. 401–412. Dyer, Jeff, David Bryce, and Paul Godfrey (2017). “Strategy 2.0: New Answers to Strategy’s Big Questions.” Brigham Young University Working Paper.

13

H. Shultz, Pour Your Heart Into It: How Starbucks Built a Company One Cup at a Time (New York: Hyperion, 1997).

14

See: http://www.starbucks.com/about-us/company-information/ mission-statement.

21 This is often called the resource-based view of the firm within the field of strategic management. See Wernerfelt, 171–180, and Barney, 99–120.

See G. Hamel and C. K. Prahalad, “The Core Competence of the Corporation,” Harvard Business Review (May–June, 1990). 22

23 See: D. E. Dilger, “Apple’s 15 Years of NeXT,” Apple Insider (Dec. 21, 2011), http://appleinsider.com/articles/11/12/21/apples_15_years_of_ next

15

24

The technique of SWOT analysis is credited to Albert Humphrey. For more information see T. Hill & R. Westbrook, “SWOT Analysis: It’s Time for a Product Recall,” Long Range Planning 30 (1) (1997): 46–52. doi:10.1016/S0024-6301(96)00095-7. J. Scott Armstrong, “The Value of Formal Planning for Strategic Decisions,” Strategic Management Journal 3 (3) (1982): 197–211.

25

16

Harvard Business Review, HBR’s 10 Must-Reads on Strategy (2011), http://books.google.com/books?id=aI-UUMi7jpsC&pg=PA48&lpg=P A48&dq=1992+to+2006+average+return+on+invested+capital&sour ce=bl&ots=Od-2BgCcJe&sig=c9BVKyhhl8tvBJDGPwOwb-K9IAM&hl= en&sa=X&ei=B5SeUYGFOaPiiAL5h4HQDw&ved=0CDEQ6AEwAQ#v= onepage&q=1992%20to%202006%20average%20return%20on%20 invested%20capital&f=false

17

18 J. Mouawad, “Pushing 40, Southwest Is Still Playing the Rebel,” New York Times (Nov. 20, 2010),” http://www.nytimes.com/2010/11/21/ business/21south.html?pagewanted=all&_r=0

M. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review (Jan. 2008): 79–93. 19

For an overview of customer segmentation see D. Goldstein, “What Is Customer Segmentation?” Mind of Marketing (May 2007), http://www .mindofmarketing.net/2007/05/customer-segmentation-why-exactlydoes.html. Also, see C. Christensen and M. Raynor, The Innovator’s Dilemma, Chapter 3 for a discussion of segmenting customers based on product attributes, demographics, or “job-to-be-done.” Also see: C. Christensen 2010. Integrating around the job to be done.” Harvard Business School Press, Module note. N9-611-004.

20

See: http://www.businessdictionary.com/definition/make-or-buydecision.html. P. Ghemewat, S. Bradley, K. Mark, “Wal-Mart Stores in 2003,” Harvard Business Review (Sep. 2003). S. Berfield, “Walmart vs. Union-Backed OUR Walmart,” BloombergBusinessweek (December 13, 2012). http://www.businessweek.com/ articles/2012-12-13/walmart-vs-dot-union-backed-our-walmart.

26

27 R. S. Kaplan and David P. Norton, “The Balanced Scorecard—­Measures that Drive Performance,” Harvard Business Review (Feb. 1992).

H. Mintzberg, The Rise and Fall of Strategic Planning (New York: The Free Press, 1994).

28

K. Moore, “Porter or Mintzberg: Whose View of Strategy Is the Most Relevant Today?” Forbes (March 28, 2011), http://www.forbes.com/ sites/karlmoore/2011/03/28/porter-or-mintzberg-whose-view-ofstrategy-is-the-most-relevant-today/

29

R. E. Freeman, Strategic Management: A Stakeholder Approach (Boston: Pitman, 1984).

30

J. Harrison and R. E. Freeman, “Stakeholders, Social Responsibility, and Performance: Empirical Evidence and Theoretical Perspectives,” Academy of Management Journal 42 (5) (1999): 479–485.

31

A. Kelly. “IBM layoffs: Computer Company Cuts Thousands of Jobs as Part of Restructuring Plan.” International Business Times (June 12, 2013), http://www.ibtimes.com/ibm-layoffs-computer-company-cutsthousands-jobs-worldwide-part-restructuring-plan-1304949

32

L. Jones and L. Turner. “Update: HP to Lay Off 500 in Conway,” Arkansas Business (July 8, 2013), http://www.arkansasbusiness.com/article/93433/ reports-hewlett-packard-to-lay-off-500-in-conway?page=all 33

CHAPTER 2 Analysis of the External Environment: Opportunities and Threats LEARNING OBJECTIVES Studying this chapter should provide you with the knowledge to: 1. Explain the importance of correctly identifying and choosing a firm’s industries and markets. 2. Identify and measure the five major forces that shape average firm profitability within industries to evaluate the overall attractiveness of an industry.

4. Discuss situations in which entry into both attractive and unattractive industries follows “new thinking” rather than conventional wisdom. 5. Identify the factors in the general environment that affect firm and industry profitability.

3. Discuss how understanding the five forces that shape industry competition is useful as a starting point for developing strategy.

Joan Cros Garcia - Corbis/Getty Images

Nokia and the Smartphone Industry Nokia, a long-time leader in the telecommunications equipment and mobile phone ­industry, got its start in that industry in 1981 when it acquired a 51 percent stake in a Finnish telecommunication firm. Since that time, Nokia has sold more mobile phones than any other company. The firm has been the world leader in market share since the mid-1980s. By 2008, Nokia’s worldwide market share had reached 40 percent, more than double the approximately 18 ­percent market share of Samsung, its nearest rival. The Nokia brand was a top seller everywhere, including the United States, China, Latin America, and Africa. Not only was Nokia the leader in handset manufacturing, offering value to its customers by manufacturing a full line of phones from the lowest end of the price range to the most expensive, the company also manufactured some of its own cell phone components, such as cameras and accessories. In addition, Nokia designed and manufactured network infrastructure equipment, launched a gaming device (N-Gage) that tapped into the entertainment and media markets, and owned Symbian, the leading operating system for the new generation of multifunctional 3G phones. In all, Nokia had 9 divisions producing products for a variety of industries, each with separate profit

17

18  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats and loss accountability.1 As late as 2003, Nokia appeared to have a c­ ompetitive advantage in cell phones in the same way that ­Microsoft had an advantage in PC operating system software and Intel in microprocessors. By 2010, however, Nokia had taken a nose dive. Although it still held a reasonable 32 percent of the worldwide market share of cell phones, the company commanded only 2 percent of the emerging smartphone market in North America. Nokia’s profits had plunged 68 percent, from nearly €8 million in 2007 to only €3.3 million in 2009. Moreover, the firm’s stock also tumbled, falling 86 percent from a high of $39.57 a share in October 2007 to $7.15 a share in April 2014. What happened? To a large extent, Nokia was caught off guard by fundamental changes in the mobile phone industry from 2003 to the present. Before the introduction of 3G (third generation) smartphones, the cell phone manufacturing industry had power over its suppliers, the makers of chips, and other parts for cell phones. Software wasn’t a big part of the picture and most handset makers programmed their own software. The firm that could make the most attractive phone with the best hardware features at the lowest cost outperformed others in the industry. For years, Nokia had offered unique value to its customers by having the latest and best hardware. With the advent of 3G smartphones, however, software became the central differentiator. Today, most people buy a phone based on its operating system and the applications the operating system can run. Nokia did see the change coming and poured Research and Development (R&D) dollars into its own Symbian operating system, focusing on building the resources and capabilities necessary to compete in software. In 2003, 80 percent of all 3G phones—the first ones able to surf the ­Internet—were sold by companies that had licensed Nokia’s Symbian operating system. In contrast, Microsoft, Nokia’s major ­competitor at the time, had great difficulty with the early launch of Windows Mobile operating system for 3G smartphones. ­Several of Microsoft’s partners abandoned Windows Mobile for Nokia’s Symbian system.2 Nokia failed, however, to look more broadly at what the cell phone market was becoming and who might become its new competitors in that emerging market. It wasn’t prepared to compete with them and couldn’t sustain its competitive advantage. With the introduction of Apple’s iPhone and Google’s Android operating system, Nokia’s share of operating systems plummeted so far that the company eventually teamed up with its old rival, Microsoft, to

offer Windows Mobile 7 on Nokia phones.3 But this did little to stop the onslaught from Apple and Samsung, who sold phones using ­Google’s Android system. In the first quarter of 2011, Nokia sold 108.5 million handsets for a total of $9.4 billion. Apple, in contrast, sold only 18.6 million iPhones but made $11.9 billion.4 Nokia had clearly lost the market for high-end phones to Apple and other phones running the Android operating system. In addition, Nokia’s low-end handsets were under pressure from new Asian manufacturers. Indeed, thousands of new low-cost Shanzhai manufacturers, small Chinese firms focused on creating knockoff products, now make phones with names such as “Nckia.” The Shanzhai manufacturers flooded the markets in China, India, the Middle East, and Africa, threatening to erode Nokia’s market share in the remaining markets where Nokia was still dominant.5 Indeed, Nokia’s position in cell phones became so stark that in 2013 it sold its entire cell phone business, the cornerstone of its previous success, to Microsoft. Not only did Nokia have to sell, but it did so at a shockingly low price of only €5.5 billion, off from the highest market capitalization of €110 billion during its glory days.6 Microsoft bought the rights to nearly all of Nokia except for the Nokia brand and its famous ringtone, leaving a hollowed-out Nokia without most of its critical resources and a two-year ban on selling any Nokia-branded phones. Microsoft merged Nokia’s business into its Microsoft Mobile subsidiary, shut down production of all Nokia phones that didn’t run the Windows Mobile operating system7 and laid off 12,500 former Nokia workers.8 After the two-year ban was up, in 2015, Nokia attempted a comeback. It merged with the French telecommunications company Alcatel-Lucent in an all-stock trade that made Nokia the majority shareholder. This gave Nokia some future potentially strategic resources such as undersea cable capable of running 5G, a potential future revolution in telecommunications.9 The much smaller and poorer Nokia, however, was still intent on competing in the smartphone industry. On January 8, 2017, Nokia released its first smartphone since its collapse in 2010, the Nokia 6. The phone ran the Android operating system and might provide just the boost Nokia needs. It was initially sold only in China, but in spite of a price of $245 USD, it sold out its entire initial stock of 100,000 units in just 60 seconds with more than 1 million pre-orders within days of its opening!10 In mid-February, 2017 Nokia’s stock price was at $5 USD, down from its high of $58 in 2000 but up from its near-death low of $1.71 in July, 2012.11

As described in Chapter 1, strategy involves crafting a plan to create competitive ­advantage— and superior profitability—in particular markets. This plan, however, is shaped by the landscape in which the firm competes. A firm’s external environment provides both opportunities—ways of taking advantage of conditions in the environment to become more profitable—and threats— conditions in the competitive environment that endanger the profitability of the firm.12 Successful firms have a deep understanding of their environment and constantly scan the horizon to see opportunities and threats as they emerge.13 One of the key threats a strategist must understand and cope with is competition. Often, however, managers define competition too narrowly, as if it occurred only among today’s direct

   Determining the Right Landscape: Defining a Firm’s Industry  19

competitors. Nokia was so focused on Microsoft as its key competitor in the 3G operating system industry, and Motorola and Ericsson as its cell phone competitors, that it failed to effectively prepare for Apple’s entry into the industry. Competition for profits goes beyond established industry competitors to include four other forces that shape industry attractiveness and profitability: customers, suppliers, potential entrants, and substitute products. Together, all five forces define an industry’s structure and shape the competitive interactions—and profitability—of companies within that industry. Even though industries might appear to differ significantly, the principles that determine the underlying drivers of profitability are often the same. The global cell phone industry, for instance, appears to have nothing in common with the highly-profitable soft drink industry or the low-cost airline industry (i.e., Southwest and JetBlue). But to understand industry competition and profitability in these and other industries we must analyze the same five forces. This chapter will help you to recognize the major threats and opportunities that make up the competitive landscape, both the industry forces and general macroeconomic forces that drive industry attractiveness—and profitability.

Determining the Right Landscape: Defining a Firm’s Industry The first strategic decision that most firms must make is to select the industry, and markets, in which it will compete. The Strategy in Practice feature discusses the U.S. government’s classification of industries. A firm’s industry also determines which customers and which competitors will be part of the firm’s landscape. The landscape is typically defined by: (1) the industry (or industries) in which a firm competes, and (2) the product and geographic markets within that industry that the firm targets. For example, Nokia competes primarily in the cellular telephone m ­ anufacturing and operating system industries. Within the cellular telephone manufacturing industry, Nokia targets multiple product markets by selling a range of handsets, from high-end smartphones to inexpensive basic phones. The company also targets multiple geographic markets, focusing mainly on Europe and developing economies in the Middle East and Africa. Be careful about assuming that it is obvious which industry a company competes in. For example, it seems obvious that Barnes & Noble competes in the book retailing industry and Microsoft competes in the computer software industry. However, it may be less obvious that those aren’t their only industries. In addition to operating systems, Microsoft also makes the X-Box gaming system, so it competes in the gaming console industry as well as the PC operating system industry. Barnes & Noble sells an e-reader, the Nook that combines electronic books with computer hardware. Amazon.com, Barnes & Nobles’ main book retailing competitor, not only sells books and the Kindle e-Reader, but also sells web services competing with Microsoft and a wide range of products online as a discount retailer competing with Walmart. Firms must choose which markets to compete in, with many large firms choosing to compete in several at the same time. If managers do not properly define and understand their industry, they may be vulnerable to unseen competitors. For example, Nokia defined itself primarily as a mobile handset manufacturer. As a result, managers failed to see computer hardware companies like Apple and web search companies like Google becoming potential competitors—or potential partners. (Nokia now uses Google’s Android operating system on its smartphones.) Their focus on preventing Microsoft from creating a dominant position in the mobile operating system industry caused them to overlook Apple, a company that has consistently been the leader in innovative,

20  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

Strategy In Practice How the U.S. Government Defines Industries

NAICS codes can be useful not just for helping to define an industry but also for determining who the primary competitors are, although in fast-changing industries, the NAICS can sometimes lag behind changing technologies or changing customer demands. As we’ve seen, Nokia failed to seriously update the definition of its industry to include all the companies competing under its new classification code. The choice of industries is important because not all industries are created equal. The profits of an average firm in some industries are substantially higher than profits of an average firm in other industries. Figure 2.1 shows the return on equity for a variety of industries over a ten-year period. As you can see, the industry in which a firm competes has a direct bearing on the profits earned by that firm.

One tool that helps to define industries is the NAICS (North American Industry Classification System), a series of codes generated by the US government.14 These codes (formerly referred to as SIC codes, for Standard Industrial Classification) vary from 2 to 7 digits, becoming more narrow with increasing numbers of digits. Table 2.1 provides the NAICS codes for the cell phone handset manufacturing and mobile operating system industries. In Nokia’s early years, it competed primarily in category 334220, cell phones. As cell phones became more sophisticated, Nokia also began to compete in category 511210, operating systems.

TA B LE 2 .1     NAICS Codes for Nokia

Handset Hardware Business

Handset Software Business

Code

Classification

Code

Classification

33

Manufacturing

51

Information

334

Computer and Electronic Product Manufacturing

511

Publishing Industries

3342

Communication Equipment Manufacturers

5112

Software Publishers

33422

Wireless Communication Equipment Manufacturers

51121

Software Publishers

334220

Cellular Telephone Manufacturers

511210

Operating Systems Software Publishers

20% 10%

Renewable Energy

Real Estate, general

Advertising

Steel

Insurance (composite)

Investment Brokers

Industry Average ROE

Healthcare (Composite)

Education

Pharmaceuticals

Oil & Gas

Soft Drinks

–10%

0%

Return on Equity

30%

Varying Profitability of US Industries, 2006–2016.

FIGURE 2.1    Varying Attractiveness of US Industries 4th Q 2006 – 4th Q 2016 Source: Bloomberg, Morningstar, Compustat, Capital IQ – compiled by Prof. of Finance Aswan Damadoran of the Stern School of Business, NYU

   Five Forces that Shape Average Profitability Within Industries  21

user-friendly operating systems for a variety of platforms.15 At the time Apple didn’t make phones, while Microsoft had announced plans to start making them. Because of how Nokia defined their industry, it was easy for them to overlook Apple, a non-phone manufacturer. Truly understanding an industry often begins by taking a customer-oriented view. Rather than identifying the industry based on the product or service they produce (such as cell phone handsets), firms should think carefully about the job that products do for customers. What need does a product fill? Understanding customer needs can be very helpful in defining the boundaries of an industry. If two firms have products that do the same job for customers— that meet similar customer needs—then those two firms can be considered part of the same industry. For instance, companies that meet the need for communication by manufacturing mobile handsets, as opposed to mobile ham radios (long-range walkie talkies), compete in the same industry.16 In the case of cell phones, changing customer needs broadened the boundaries of the industry, from primarily hardware manufacturing to include mobile operating systems and applications that allowed phones to do far more jobs for customers than just place a phone call. This led to new competitors for Nokia, including Apple and Google.

Five Forces that Shape Average Profitability Within Industries Michael Porter, a well-known strategy professor at Harvard, identified five forces that shape the profit-making potential of the average firm in an industry. As shown in Figure 2.2, those five forces are: (1) rivalry, (2) buyer power, (3) supplier power, (4) threat of new entrants, and (5) threat of substitute products. The strength of each of these five forces (known as Porter’s Five Forces17) varies widely from industry to industry. For instance, in the semiconductor industry, the threat of substitutes is almost nonexistent, while in the carbonated soft drink industry it is a significant threat. A careful analysis of the five forces is a powerful way for firms to discover the threats and opportunities in their environments. We provide a tool at the end of this chapter to help you conduct a careful analysis of an industry’s five forces.

NEW ENTRANTS

BUYER POWER

COMPETITOR RIVALRY

rivalry  Competition among firms within an industry. Typically this involves firms putting pressure on each other and limiting each other’s profit potential by attempting to gain profits and/or market share. substitute  A product that is fundamentally different yet serves the same function or purpose as another product. threats  Conditions in the competitive environment that endanger the profitability of a firm.

SUPPLIER POWER

SUBSTITUTES

FIGURE 2.2    Analyzing Major Threats and Opportunities: The Five Forces Industry Analysis Tool Source: Adapted from Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 86, 1 (January 2008), pp. 80–86.

opportunities  Ways of taking advantage of conditions in the environment to become more profitable.

22  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

There are three basic steps involved in using the five forces analysis tool: •  Step 1: Identify the specific factors relevant to each of the five major forces. We describe the factors that contribute to each of the five forces in the next five sections of this chapter. •  Step 2: Analyze the strength of each force. To what extent is it shaping the industry’s attractiveness? The appendix at the end of the book lists several sources where you might find the data you need to analyze each of the five forces. attractiveness of an industry  The degree to which an average firm in the industry can earn good profits.

•  Step 3: Estimate the overall strength of the combined five forces to determine the general attractiveness of the industry, the profit potential for an average firm in the industry. Instructions for steps 2 and 3 are at the end of the chapter. Step 1, the factors relevant to each of the five forces, is discussed next.

Rivalry: Competition among Established Companies Competition in an industry is sometimes referred to as war, with each company deploying as many weapons in its arsenal as possible to gain greater profits. Because there are typically a limited number of buyers, each firm’s profits often come at the expense of other firms in the industry. Each move by a firm provokes countermoves among competitors, resulting in a constantly shifting competitive landscape populated by winners and losers. (Chapter 11 explores how successful firms manage that shifting landscape by planning for the countermoves of their rivals.) Firms’ moves and countermoves can take many forms, including sales and promotions, better quality or service, a wider variety of products, or lower prices. Not surprisingly, these types of moves increase rivalry—the intensity with which companies compete with each other for customers—which tends to squeeze the profit margins of most firms in an industry. Rivalry among firms in an industry—for either rational or irrational reasons—is such an important determinant of profitability that it is shown at the center of Figure 2.2. The following 7 factors are critical to understanding the intensity of rivalry in an industry: 1. The number and size of competitors 2. Standardization of products 3. Costs to buyers of switching to another product 4. Growth in demand for products 5. Levels of unused production capacity 6. High fixed costs and highly perishable products 7. The difficulty for firms of leaving the industry

The Number and Relative Size of Competitors  The more competitors there are in an industry, the more likely that one or more of them will take action to gain profits at the expense of others. Economists call an industry with a lot of competitors a fragmented industry. In a fragmented industry, it is difficult to keep track of the pricing and competitive moves of multiple players. The large number of firms responding to one another tend to create intense rivalry. The same is true of the relative sizes of competitors. If firms are approximately the same size, they tend to be able to respond, or retaliate, strongly to moves by rival firms. Industries that are concentrated, as opposed to fragmented, have far fewer competitors and tend to be dominated by a few large firms. In these industries, rivalry is typically much less intense. Smaller competitors do not have the capability to respond to actions taken by large firms, and the few large competitors are more aware of each other and less likely to risk actions that may result in price wars. Relatively Standardized Products 

Differentiated products, ones that boast different features or better quality, tend to engender loyalty in customers because they meet

   Five Forces that Shape Average Profitability Within Industries  23

customer needs in unique ways. When products are standardized, or commodity-like, buyers are less loyal to a particular brand and it is easier to convince them to switch brands. A rider may be fiercely loyal to his or her Harley-Davidson motorcycle, for example, but willing to buy several different brands of gas for the Harley. Firms that sell standardized products—­ manufactured products or materials that are interchangeable regardless of who makes them like bolts and nuts, rubber, plastics, or commodities such as coal, crude oil, salt, or sugar—often have to compete by offering sales, rebates, or lowering prices. Price wars increase rivalry and decrease profits.

Low Switching Costs for Buyers  Switching costs include any cost to the customer for changing brands. Switching costs for buyers are related to the degree of product standardization. For a computer user, changing operating system or word processing software would entail considerable switching costs because the user would need to: (1) convert files to the new software, and (2) learn how to use the new software. Switching from an iPod to another MP3 player might require music lovers to move all of their music files from iTunes to a different music software. In contrast, most of us can change our brand of gum or candy bar without any switching costs. The lower the switching costs, the easier it is for competitors to poach customers, thereby increasing industry rivalry. Switching costs are a fundamental part of not just rivalry but also the other four forces: 1. Buyer power: If customers, or buyers, can easily switch firms, then buyers have increased power. 2. Supplier power: If firms can’t switch suppliers easily, then suppliers have increased power. 3. New entrants: If buyers can easily switch to new companies attempting to enter the industry, there is a greater threat of new entrants. 4. Substitutes: If buyers can switch to substitute products without much difficulty, firms face an increased threat from those substitutes.

Slow Growth in Demand for Products or Services 

When demand is increasing rapidly, most firms can grow without taking existing customers from competitors. When growth slows, however, firms can become desperate. They may try to increase their sales volume by attracting customers from their competitors through sales promotions, price discounts, or other tactics.18 Of course, competitors then respond with their own sales promotions and price cuts, thereby increasing industry rivalry. Consider the flat-screen television industry. When large, flat-panel displays were first introduced, prices were high. They remained that way for years while industry growth exploded. As flat-panel manufacturers anticipated slower growth, from 18 percent in 2010 to 4 percent in the first half of 2011, they dropped prices by more than 25 percent in the last quarter of 2010 in a bid to gain what market share they could from their competitors.19

High Levels of Unused Production Capacity 

Unused production capacity is expensive. Firms typically try to produce at or near their full production capacity so that they can spread the fixed cost of factories, machinery, and other means of production across more units. In fact, they may try to produce more product than the market demands, in order to use their capacity completely. However, when more is produced than is demanded in the market, firms often have to drop their price or risk having unsold product. This has frequently been the case in the automobile industry. During an economic downturn, automakers offer price cuts, rebates, and special sales incentives to buyers so that they don’t have significant unused production capacity or lots of older-model cars left to sell when new ones are produced.

High Fixed Costs, Highly Perishable Products, High Storage Costs Indus-

tries that produce or serve products in these three categories sometimes find themselves with a supply of products that they have to sell quickly or take large losses on. For example, airlines operate with high fixed costs. Most of the cost of a flight is in the airplane, the fuel, and the pilot and flight attendants. It is not in the cost of serving an additional passenger. The marginal

switching costs  Barriers that help keep buyers using the same supplier by imposing extra costs for switching suppliers.

24  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

cost of adding an additional passenger is truly only peanuts (and a drink). If it appears that a ­scheduled flight is going to have few passengers, an airline may be tempted to discount steeply in order to fill as many seats as possible. The variable cost of an additional passenger is very little, so selling a seat for less would not cost the airline money, but leaving it empty would mean the airline has fewer passengers over whom to spread its fixed costs. Firms that sell highly perishable products, such as fruits or vegetables, face similar problems. As food nears the date when produce will spoil, grocery chains often steeply discount it rather than lose the sale completely. Products with high storage costs exhibit the same characteristics. If firms have an oversupply and are forced to store the product, they may discount the price to avoid storage costs. In all three cases, steep discounting leads to increased rivalry as competitors are forced to respond with discounts of their own, or be left with losses while others recoup their production costs.

High Exit Barriers  In some industries, companies don’t exit even when they aren’t making a lot of money. Most often, they stay because they have made investments in specialized equipment that can’t be used in any other industry. For example, steel blast furnaces are very expensive and cannot be used in any industry other than steelmaking. If the firm exits the steel industry, its blast furnaces lose most of their value. Another barrier to exit is labor or government agreements that make it difficult to close a plant. Emotional ties to employees or a business can also lead to less than rational decisions by top management to stay in business.

Buyer Power: Bargaining Power and Price Sensitivity supplier  A firm that provides products that are inputs to another firm’s production process.

When buyers have sufficient power, they can demand either lower prices or better products from their suppliers, thereby hurting average profitability of firms in the supplier industry. The two primary situations in which buyers have high power are when buyers hold a stronger bargaining position than sellers and when buyers are price-sensitive. The strength of a buyer’s bargaining power or price sensitivity can be affected by a number of factors. When firms understand what causes buyers to have power over their industry, they have a better chance of countering that power.

Buyer Bargaining Power  Four key factors influence the degree to which buyers have bargaining power over their suppliers. We already discussed two of these factors—buyers’ switching costs and demand—because they are also factors in rivalry among firms. The two remaining factors are the concentration and size of buyers and the threat that buyers can backward integrate: •  Number, or concentration, and size of buyers: Buyer concentration reflects the law of supply and demand. If there are few buyers but many sellers, then the sellers must compete more strongly for buyer business. Sellers in this situation are likely to give concessions to make the sale. Likewise, the larger the number of buyers, compared to sellers, the more likely sellers are to increase the level of competition in order to gain buyers’ business. For example, farmers, as suppliers to the frozen-food industry, are not very concentrated. The three largest farmers account for only about 1 percent of all food produced and sold. Frozen food makers, however, are concentrated. The top four (Nestlé, Schwan, ConAgra, and H.J. Heinz) accounted for nearly half (48.6 percent) of total market share in their industry in 2010.20 This means that frozen-food manufacturers, as buyers, have a great deal of power over farmers. A farmer who needs the business of the big four frozen-food makers in order to sell this year’s crop may be willing to accept a lower price in order to secure their business. backward integration  A firm purchases one or more of its suppliers in order to make a product itself rather than buying it from another firm.

•  Credible threat of backward integration: In some cases, a buyer can exert pressure over suppliers by threatening them with backward integration, meaning they will make the product themselves. For example, one way Walmart keeps prices low for consumers is by threatening to expand its Sam’s Choice store brand products into additional categories if manufacturers of other branded products don’t meet Walmart’s pricing demands.

   Five Forces that Shape Average Profitability Within Industries  25

Buyer Price Sensitivity  In general, when buyers are more price-sensitive, they are more likely to exert pressure on suppliers to keep prices low. Buyers exert pressure not just through price negotiation but also through more comparison-shopping and a greater willingness to switch suppliers. Buyer price sensitivity tends to increase in the following situations: •  Buyers are struggling financially: When companies, or consumers, are struggling financially, they are more likely to be price-conscious and to look for less expensive sources of supply. If many of an industry’s buyers are in the same situation, there is a cap on what suppliers can charge. •  Product is significant proportion of buyer’s costs: Buyers tend to care more about getting a good price when the product they are buying creates a large part of the costs of their own production (or their budget, if the buyers are the end consumers). If the product is only a small part of their cost structure, buyers are less likely to bother negotiating or c­omparison-shopping. For instance, end consumers are less likely to do extensive ­comparison-shopping for a gallon of milk than they are for a home or car. Likewise, auto manufacturers are less likely to pressure suppliers of electrical wiring for price cuts than suppliers of steel or engine components. •  Buyers purchase in large volumes: When buyers purchase in large volumes, they typically expect to get breaks in price. In essence, the buyer is taking a risk by being willing to buy large amounts at once rather than smaller amounts over time. •  Product doesn’t affect buyers’ performance very much: If a product is very important to the quality of the buyers’ end product, then buyers tend not to be very price conscious. For instance, when Nokia had the most innovative handsets on the market, many cellular phone carriers, like Verizon and T-Mobile, were willing to pay whatever Nokia charged in order to be able offer Nokia phones to their customers. However, if suppliers’ products don’t affect buyers’ quality or performance very much, then buyers are much more likely to be price conscious. For instance, the plastic casing on tablet or laptop computers doesn’t enhance the performance of the computers very much; it doesn’t drive sales to the end consumer. As a consequence, PC manufacturers are likely to shop around for price discounts on plastic casings in ways that they might not for the microprocessors that run the computers. •  Product doesn’t save buyers money: If a product saves buyers money, they tend not to be very price-conscious when purchasing it. These types of products can be anything from machinery in manufacturing industries that replaces highly skilled, costly labor to ­inexpensive, overseas labor that replaces more expensive labor or machinery in countries such as the United States. If a product does not save buyers money, however, buyers are as likely to be price conscious as they are with other types of products they buy.

Supplier Bargaining Power The factors that increase the bargaining power of suppliers are very similar to those that increase the bargaining power of buyers. In this case, however, the firms are not customers, but suppliers, those from whom your industry purchases inputs. When supplier industries have strong bargaining power, they can charge higher prices, which tends to decrease average profitability in a buyer’s industry. As firms understand the factors that give suppliers power, they may be able to make decisions that decrease that power.

Number, or Concentration, and Size of Suppliers  As with buyer concentration, supplier concentration also follows the law of supply and demand. If there are few sellers, but lots of buyers in an industry, then the buyers have to compete to get the products that they want, often paying higher prices to get sufficient supply. Likewise, the larger the number of sellers compared to the buyers, the less likely buyers are to pay the price that sellers are demanding.

26  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

For instance, ARM, a designer of semiconductor chips for smartphones, has, for years, controlled upwards of 95 percent of the market for its product,21 resulting in a highly concentrated supplier industry dominated by one large firm. As a consequence, Nokia, or any other smart phone handset manufacturer that wants a sufficient supply of chips, and wants the high-­ quality chips that won ARM its market share in the first place, has to buy from chip manufacturers who license from ARM. ARM has sufficient power that it can, to a large degree, set the price for its product. Suppliers who charge more often squeeze the profits of buyers, who may not be able to pass additional costs through to their customers. In fact, ARM’s rise to power in the mobile semiconductor chip industry is a major contributor to Nokia’s current difficulties. Nokia cannot charge enough for its low-cost handsets to make a good profit after paying for expensive ARM chips.

forward integration  A firm goes into the business of its former buyers, rather than continuing to sell to them.

Credible Threat of Forward Integration 

In some cases, a supplier can exert pressure over its buyers by threatening them with forward integration, doing what its buyers do, if the buyers don’t offer price concessions. A good example of this is Google and its decision to forward integrate into the smart phone handset industry by manufacturing its own phones.22 Google also licenses its Android operating system to other handset makers, such as HTC and Samsung. Google’s ability to forward integrate, even if they don’t sell many phones, gives Google power over those handset makers. When there is a credible threat of forward integration, buyers are often willing to take a cut in profit by paying higher prices, rather than risk losing the supply altogether and creating a new rival (if the supplier hasn’t already forward integrated).

Threat of New Entrants

barriers to entry  The way organizations make it more difficult for potential entrants to get a foothold in the industry.

As previously shown in Figure 2.1, not all industries are created equal. Industries in which the average firm is making good profits can often be targets, enticing firms from outside those industries to enter. Likewise, quickly growing industries are often attractive, which increases the incentive for outside firms to enter those industries. One of the important tasks for strategists is to identify firms that might enter their industries. New entrants pose a double hazard. First, they typically are anxious to gain market share.23 Unless the industry is growing quickly, that market share must come at the expense of existing firms. Second, new entrants bring new production capacity, which tends to drive prices down unless demand is growing faster than the increase in supply. New entrants mean greater rivalry, so existing firms often try to discourage new entrants by building barriers to entry. The higher the barriers to entry, the more difficult it is for potential entrants to get a foothold in the industry, and the more likely that they are to quit or choose to not enter in the first place. Likewise, incumbent firms, those already in the industry, often signal new entrants that they are likely to retaliate by slashing prices, increasing advertising, or other competitive moves that help the established firms hold on to their market share. If the threats of retaliation are perceived as credible, potential entrants might decide to stay away. It is essential for firms to understand the barriers to entry that already exist in their industry and to consider ways of increasing them. Existing firms may also want to build new barriers. Firms that are considering going into an industry can use an analysis of the barriers to entry in the target industry to help them determine how likely they are to succeed if they attempt to enter.

Economies of Scale, Experience, or Learning 

These types of economies occur when the cost per unit of production (the cost for producing each individual product or service) decreases as a firm produces more. Typically, these economies come from mass manufacturing methods, discounts through purchasing in high volumes, employees becoming quicker and better at production, and being able to spread the fixed costs of production machinery, R&D, advertising, and marketing across more units.24 Chapter 4 will explore these three types of cost advantages in greater detail. In essence, lower costs allow the firm either to lower its price, perhaps in retaliation for a new firm entering the market, or to maintain its price while earning more profits than competitors.

   Five Forces that Shape Average Profitability Within Industries  27

When economies of scale, experience, or learning exist in an industry, new firms will be at a cost disadvantage. New firms are not likely to have as much market share as existing firms, so they will not produce as much and can’t achieve the same economies as existing firms. Some firms may not be able to lower their prices sufficiently to match incumbent firms’ prices. Other new entrants may match incumbent prices, but earn smaller profit margins than the incumbents. The higher the economies of scale, the greater the barrier to entry and the easier it is for the larger incumbent to pose a credible threat of retaliation. If conditions change so that cost savings from these economies become smaller, the barrier diminishes. For example, from the late 1980s until the early 2000s, the cell phone handset manufacturing industry possessed high economies of scale. Nokia produced millions of handsets per year during this time and had the lowest costs of its competitors. Consequently, the number of firms in the industry was relatively stable during this period. However, the invention of flexible manufacturing processes, coupled with the rise of low-cost, highlyskilled labor in China in the mid-2000s, lowered the cost savings that could be achieved from high levels of production and allowed thousands of new Shanzhai manufacturers to successfully enter the industry.

Other Cost Advantages Not Related to Scale 

Incumbent firms might have cost advantages relative to new entrants for a variety of reasons besides economies of scale. These include the following: 1. Patents or proprietary technology, such as those that exist in the pharmaceutical industry 2. Better locations, a deterrent to firms wishing to enter markets where Starbucks is dominant, for example 3. Economies of scope, less expensive costs per unit created by bundling different types of products. For example, Procter & Gamble has low-cost marketing and distribution costs, compared to firms that manufacture only one type of product, because P&G ships dozens of different types of products to the same retailers. (See Chapter  4 for a more detailed explanation of economies of scope.) 4. Preferential access to critical resources, such as raw materials or access to distribution networks. For example, Chinese makers of lithium ion batteries have government-protected access to sources of rare earth elements, raw materials that are necessary for battery production. In many industries, new entrants face high barriers in the cost of building a dealer network or recruiting retailers to sell their products. With a limited number of potential dealers and retailers, new entrants often find themselves having to cut prices, and profit margins as well, to secure access to distribution. As with economies of scale, it is important for firms to track whether barriers are rising or falling. An expiring patent or the advent of an innovative distribution channel, such as the Internet, has the potential to radically change the strength of barriers related to cost advantages.

Capital Requirements 

It costs money to enter a new industry. Not only do potential entrants often need capital to build a factory or store, but they may also have to invest in R&D to generate viable products, build inventory, undertake sufficient advertising and marketing to take market share from incumbent firms, and have sufficient cash on hand to cover customer credit. Anything that increases the start-up costs will reduce the pool of possible entrants. For instance, the computer semiconductor chip industry, dominated by Intel, makes a very complex product. New entrants would need to spend years of R&D before they had a viable product and could make their first sale. The high capital requirements needed for long periods of R&D limit the number of entrants to those with enough financial or other resources to enter. However, firms that already have made R&D investments in similar products, such as semiconductor chips for mobile phones, could lower the capital costs associated with entering the computer semiconductor industry. It is likely no coincidence that ARM, the maker of mobile semiconductor chips, is one of only a few successful entrants into Intel’s industry in the last 30 or more years.

28  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

Network Effects  network effects  Growth in demand for a firm’s product that results from a growth in the number of existing customers.

In some industries, network effects increase the switching costs for customers, making it more difficult for new entrants to take business from incumbent firms. When network effects are in operation, the greater the number of people using products from a given firm, the greater the demand grows for that firm’s product. For example, the more people who use a particular social networking site, the more customers want to continue to use the site, and the more new customers are likely to try it. A new entrant wanting to compete with Facebook is at a distinct disadvantage, because most of their potential customers’ “friends” are likely to be on Facebook, making it less likely that they will be willing to switch to a new social media site. For new entrants to compete with a firm like Facebook they have to be innovative enough to attract large numbers of users quickly, creating their own network effect.

Government Policy Restrictions 

Finally, government policies may make it more difficult to enter a market or even restrict a market completely to new entrants. For instance, governments often raise the costs of entry by requiring bonding, licenses, insurance, or environmental studies before a firm can enter an industry. New entrants will have to use capital that might have been used for R&D, production, or advertising to meet those requirements. When competing across international borders, additional regulations, such as trade restrictions and local content requirements, may be applied to try to limit foreign competition. In some industries, such as hairstyling, the requirements might be fairly minimal, but in others, such as oil refining, they can become so onerous that most new firms cannot overcome the barrier.

Threat of Substitute Products A substitute is a product that is fundamentally different yet serves the same basic function or purpose as another product. One of the primary problems for the strategist in assessing substitutes is determining what is a substitute and what isn’t. It involves determining the boundaries of an industry, as we addressed earlier in the chapter, and then scanning other industries to find products that might serve the same basic functions. For instance, e-mail is a substitute for telephone messages, faxed documents, or documents delivered via the post office. All four are ways of delivering messages. Similarly, fruit juice is a substitute for any number of other drink products, including coffee, wine, and soda. Generally, something can be considered a substitute if it serves the same function, such as quenching thirst, but does so with a different set of characteristics. If the product has the same basic characteristics and is made using the same general set of inputs, it would be considered part of rivalry, rather than a substitute. For instance, competitor brands serving the same basic need, such as Apples iPhone and Samsung smartphones running Google’s Android operating system, are rivals, not substitutes. In general, substitutes put downward pressure on the price that firms in an industry can charge. For instance, streaming video across the Internet is a substitute for watching movies in the theater. Even if you had the only movie theater in an area, you could not charge whatever price you wanted to. As your price rose, more customers would switch to streaming video. If the price difference is enough, customers will stream even though the quality is lower and they have to wait weeks or months before the movie leaves the theater and is available online. For some industries, such as newspapers, the low price of the substitute—in this case, free news on the Internet—can be disastrous, creating such a low cap on the prices they can charge that many firms go out of business. The factors that determine the intensity of a threat of substitutes include the awareness and availability of substitutes and their price and performance compared to an industry’s products.

Awareness and Availability  Sometimes customers aren’t readily aware that substitutes exist. The threat increases when substitute products are well known. This is particularly true if there are strong brands among the substitute products. Likewise, if the substitute product is just as easy for customers to obtain as the industry’s products are, it is more of a threat. If the substitute is difficult to find or acquire, the threat is diminished.

   Overall Industry Attractiveness  29

Price and Performance 

A significant part of the customer decision to switch to substitutes will concern the price and performance trade-offs. As we discussed earlier in the chapter, customers are more likely to switch to a substitute if the costs of switching are low. The price of the substitute, itself, also factors into customers’ decisions. If substitutes are cheaper than products from another industry, the threat is higher. Likewise, if the performance of substitutes is similar or better, the threat is higher. The closer the substitute is in performance, the less flexible a seller can be with price. For instance, many newspapers have seen steep declines in circulation as Internet news has gained in quality. The Wall Street Journal, however, has not declined in circulation over the same time period because online substitutes for serious business news have not increased in quality nearly as fast as for other types of news.

Overall Industry Attractiveness Understanding the five forces that shape industry competition is useful as a starting point for developing strategy. Indeed, managers often define competition too narrowly, as if it occurred only among direct competitors. Yet competition for profits goes beyond direct rivals to include buyers, suppliers, potential entrants, and substitute products. The extended rivalry that results from all five forces defines an industry’s structure and shapes the nature of competitive interaction within an industry. Every company should know what the average profitability of its industry is and how that has been changing over time. The five forces help explain why industry profitability is what it is—and why it might be changing. Attractive (profitable) industries are those where firms have created power over buyers and suppliers, created barriers to entry to reduce the threat of new entrants, and minimized the threat of substitutes while keeping rivalry to a minimum. Even inefficient, relatively poorly run companies can earn superior profits under such conditions. At the other extreme are unattractive industries. Firms in these industries are consistently pressured by buyers and suppliers alike. They face high rivalry, easy entrance for new competitors, and many well-positioned substitute products. Under these conditions, only the most efficient, well-run companies are able to turn a profit. Each of the five forces can be analyzed to determine how, and the degree to which, it contributes to industry attractiveness. We provide a strategy tool at the end of this chapter for analyzing each force. After doing an analysis of each force, these can be combined to develop a detailed picture of what is driving the overall profitability—the attractiveness—of the industry. Few industries will rate high (attractive) or low (unattractive) on all forces. A significant threat from just one or two of the five forces is often sufficient to destroy the attractiveness of an industry. For example, many firms in the auto industry have struggled to be profitable over the last decade. This industry, however, has relatively low buyer and supplier power, no real threat of substitutes, and a moderate threat of new entrants. Rivalry, however, has been fierce, with constant excess production capacity and price discounting. Sometimes, it only takes one of the five forces to be unattractive to make an industry struggle. When many of the five forces are unattractive, firms face great challenges maintaining profitability. However, understanding each force and how it is influencing profitability helps managers know where to focus in dealing with those challenges. Moreover, a company strategist who understands that competition extends well beyond existing rivals will perceive wider competitive threats and be better prepared to address them. At the same time, thinking comprehensively about an industry’s structure can uncover opportunities to improve performance on each of the five forces, thereby becoming the basis for distinct strategies that yield superior performance. One thing to keep in mind is that the five forces are subject to change. Each of the five forces can be altered by actions taken by firms inside or outside the industry. For instance, Google built the Android operating system, even though it gives it away for free, to increase the number of suppliers for its search engine, thus decreasing the supplier power that Apple might have earned had it been able to dominate the smartphone industry. A good strategist always has her eye on actions and trends that might change any of the five forces in her industry. Not all of those trends come from actions taken by firms close to the industry. Some come from the general environment. These are discussed in the next section.

30  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

Where Should We Compete? New Thinking about the Five Forces and Industry Attractiveness Strategists have long argued that where you compete is the starting point for strategic analysis. The traditional answer to this question has been to use the Five Forces model we just studied to compete in attractive (i.e. profitable) industries or markets characterized by high bargaining power over suppliers and buyers, low threats of substitutes or new entry, and low rivalry. This traditional argument is reflected in the recent best seller “Playing to Win,” by prominent strategists A.G. Lafley and Roger Martin, who argue, “Porter’s five forces help define the fundamental attractiveness of an industry and its individual segments.”25 We agree that the Five Forces model describes the kind of industry or market you’d like to create or compete in, and it remains an excellent model that firms all over the world use to keep tabs on the industry and markets they compete in and to get guidance about what tactical moves they can make to increase profitability in their industry. Executives, however, have to choose markets to compete in before they enter. This is where new thinking turns the Five Forces a bit upside down. Traditionally, you would give executives the advice to enter industries or markets that are rated “attractive” by the Five Forces. But, the success of their choice to enter is determined almost completely by the unique value the firm hopes to offer and the resources and capabilities (these concepts will be covered extensively in Chapter 3) it has to deliver that unique value. Thus, whether a market is attractive may depend more on what the entrant can offer to that market rather than the structural characteristics of the market. To use a popular idiom: “Beauty is in the eye of the beholder.” Or, in other words, unattractive markets according to traditional industry analysis may be quite attractive to the right kind of entrant. By almost any measure of attractiveness, the automobile industry is not an attractive industry to enter. Entry barriers are enormous, bargaining power over customers is minimal, rivalry is high, and average profitability is quite low. No wonder there hasn’t been a successful US-based company entrant since Chrysler in 1925. Yet in 2008, during the Great Recession while the US government was bailing out GM and Chrysler to the tune of $80 billion26 Tesla, a California-based firm, entered anyway. They entered an unattractive industry at the depths of its unattractiveness—typically, a foolhardy strategic decision. Tesla entered the automobile market with the Roadster, a pricy, beautifully designed, battery electric (BEV) sports car. They followed with the Model S and Model X—both targeted at wealthy individuals with a penchant for fast cars and a desire to reduce carbon emissions and US dependence on foreign oil.27 Within nine years of entry, by February 2017, Tesla had generated a market value of more than $44.6 billion—double that of Chrysler and closing in on the 114-year-old Ford28—all in an “unattractive” industry. Where successful companies choose to compete doesn’t depend so much on the historical profitability or structural attractiveness of the market. Rather, it is fundamentally tied to what unique value they can offer, what capabilities they have, and whether they can prevent imitation (all concepts covered more fully in Chapter 3). For industries that are not attractive from a Five Forces perspective, successful entry requires offering a unique value proposition with unique resources and capabilities. If you use an approach that mimics what incumbents are doing, your profits will be poor—just like incumbents. Nucor entered the unattractive steel industry, but did so in a radically different way. It used Mini-Mill technology and sourced scrap steel, rather than the traditional enormous steel production plants using iron and coke as their raw materials. Nucor was, and is still, able to produce steel at a much lower cost and to be highly profitable at a time when many US steel manufacturers have gone out of business.29 Markets that are unattractive from a Five Forces perspective can still be attractive to new entrants—but only when they offer unique value.

   How the General Environment Shapes Firm and Industry Profitability  31

On the flip side, it is also important to understand that attractive markets from a Five Forces perspective are typically unattractive for new entrants. In an article for Harvard Business Review (see “Strategies to Crack Well Guarded Markets”), we reported that, on average, new entrants into highly profitable (attractive) markets were 30 % less profitable than new entrants into ­unattractive markets (i.e., in general, it is easier for new entrants to make money in u ­ nattractive industries than attractive ones).30 The reason? Barriers to entry made it difficult for the new entrant to establish itself. So, on average, an attractive market (from a Five Forces ­perspective) is actually the least attractive market for a new entrant. But wait. We also found that when new entrants did achieve profitability in the most attractive markets, they were four times as ­profitable as the average profitable entrant elsewhere. For example, the beverage industry has historically been a high-profit industry (indeed one of the most profitable)—but one with high barriers to entry. So according to the logic we’ve been discussing, it should be an u ­ nattractive market for new entrants. Walmart, however, decided to enter anyway—offering consistently low prices with its Sam’s Choice brand. We won’t spell out exactly how Walmart did it because those barriers to entry are part of the Coca-Cola and Pepsi case that is a companion to this chapter. Suffice it to say that Walmart was able to overcome each element of the b ­ arriers to entry that Coca-Cola and Pepsi had painstakingly erected over decades. By figuring out how to circumvent the entry barriers, Walmart was able to grab almost 5 percent share in an attractive market, indeed in one of the most attractive markets from a Five Forces ­perspective. The point is that if firms figure out how to circumvent the barriers to entry into an attractive market, it can be profitable even if they aren’t able to enter with a particularly unique value ­proposition (Sam’s Choice Cola isn’t all that unique). Finally, we’ve learned that industries as we’ve historically defined them (e.g., automobiles, medical equipment, computers, cell phones, etc.—think about the NAICS codes we covered at the beginning of this chapter) are becoming somewhat irrelevant as it relates to finding attractive markets to compete in (it is not irrelevant to studying the dynamics of an industry you are already in). In deciding where to compete (i.e., which markets to enter), it is helpful to be as specific as possible rather than using broad generalities such as industries as they have historically been defined. In fact, as Harvard Business Professor Clayton Christensen has suggested, you compete at the “job to be done” level (if you truly understand the functional, emotional, and social needs of your customer segment the task of offering unique value becomes much easier).31 Tesla started in the automobile industry by targeting wealthy individuals who loved fast cars but also had a desire to be green. Customers purchased a Tesla not just because it solved a functional need (transportation, rapid acceleration/speed) but also an emotional need (“I want a green world”) and a social need (“I want to be part of the Tesla community and want others to know about my social consciousness”). Now Telsa has added in-home battery charging stations and roof-mounted solar panels for homes. So from a historical perspective, Tesla is now in the roofing segment of the home construction industry as well as being in the automobile industry. One could say that Tesla is in the energy industry at a very high level—which is true. But it has expanded into roof tiles and battery-charging stations to do a particular job for a very specific segment of customers: provide a convenient one-stop shop for clean energy at home and on the road for individuals who want a green world.32 When the industry is defined at the “job to be done” level, it then makes it easier to identify what other companies are also trying to do at that specific job (competitors) and what substitutes exist for that job.

How the General Environment Shapes Firm and Industry Profitability To determine the landscape that a firm competes in, it isn’t enough to only understand the five forces that directly affect an industry. The general environment also needs to be understood, as it can affect firms in a variety of ways,33 including affecting the shape of each of the five

32  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

industry forces. A simple way to think about the general environment is to break it down into eight ­categories. Strategic managers in the best companies are focused on each of these categories, looking for trends that might lead to new opportunities or threats. This is illustrated in Figure 2.3: •  Complementary products or services •  Technological change •  General economic conditions •  Population demographics •  Ecological/natural environment •  Global competitive forces •  Political, legal, and regulatory forces •  Social/cultural forces Developments in each of the eight categories shown in the outer ring have the potential to shape and change the general landscape for any specific industry. Each category can affect an industry’s dynamics, which are shown by the area within the center circle, altering any or all of the five forces. You should always keep in mind that an industry’s five forces are not static. The five forces are subject to change and may change, even radically, if elements of the general environment change. When you are examining the general environment, it is important, then, to not just get a picture of what things look like today but to analyze trends and the direction each category is headed toward tomorrow. Remember, as well, that this analysis is industry specific. You want to know how each of the eight categories is going to affect the industry you are studying, rather than how it might affect a single firm. Both levels of analysis can be useful. But at this stage you want to know how the general environment might affect the five forces, potentially giving you advanced notice of what is going to change in your industry and a chance to plan accordingly. THE GENERAL ENVIRONMENT Complimentary Products/Services

NEW ENTRANTS

Social/Cultural Forces

Political/ Legal/ Regulatory Forces

Global Forces

BUYER POWER

COMPETITOR RIVALRY

Technology Change

SUPPLIER POWER

SUBSTITUTES

Ecological/Natural Environment FIGURE 2.3    Trends in Opportunities and Threats in the General Environment

General Economic Conditions

Demographics

   How the General Environment Shapes Firm and Industry Profitability  33

The relative importance of each of the general environmental factors differs from industry to industry. In the fast-food industry, social forces, such as a shift toward healthier eating, are likely to significantly alter the threat of substitutes, but technological change doesn’t play as a large a role. In the motorcycle manufacturing industry, demographics play a key role, as many industrialized nations experience an upward trend in the average age of the population, but changes in societal perceptions of motorcycles don’t appear to be shifting quickly, resulting in fewer people riding because of their age rather than a societal shift in the perception of motorcycles. Managers need to develop a deep sense of which environmental factors are strategically relevant to their own industries.34 Managers need to understand not only which factors have the largest impact on their industry right now, but also which factors are likely to change in the future, so that they can adapt their firms’ strategies to changing conditions.

Complementary Products or Services Complementary products or services are those that can be used in tandem with those in another industry. For example, video gaming hardware and software, or smartphone operating systems and apps, are complementary sets of products. When two complements are used together, they are worth more than when they are used apart. Complementary pairs or groups (also called ecosystems) of products can be found in many places, not just in the technology sector.35 Gas stations and roads are complements to automobiles, and piping is a complementary product to natural gas. Trends in complementary industries have the potential to radically alter—for better or worse—the landscape in which firms compete. Take the rise of application software (apps), for instance. In the 1990s, Microsoft created tools for software designers. By doing so, Microsoft lowered the barriers to entry in the application software industry, a complementary industry to operating systems. Apple made it even easier to enter the app industry by releasing segments of its operating system code, creating even more new entrants and sparking the rise of single-purpose, inexpensive apps for mobile computing devices. Now, customers at Apple’s app store can choose from hundreds of thousands of apps for their iPhones. The number of new entrants in the app industry is actually increasing the barriers to entry in the smartphone operating system industry. It would be difficult for a new mobile operating system to come on the scene and compete with Apple or Android. Even powerful Microsoft has experienced challenges entering the mobile operating system business even though it had a head start over Apple and Google.36 For many industries, changes in complementary products are one of the most important trends to keep an eye on. Some consider them significant enough that they even refer to them as a sixth force among the five industry forces.37

Technological Change Technological change within an industry has the potential to radically reshape a firm’s landscape, and sometimes society with it. Technological changes can include new products, such as smartphones; new processes, such as hydraulic fracturing (fracking), which has dramatically increased the output of the natural gas industry; or new materials, such as lithium batteries, which make electric automobiles possible. In many industries, the pace of technological change has accelerated over the last couple of decades.38 Managers find it increasingly important to consistently scan the environment to locate potential new technologies that might affect their industries.39 Early adopters are often able to gain greater market share and earn higher profit margins than those who are late to adopt, suggesting the importance of incorporating new technologies early. Not only can technology change the nature of rivalry in an industry by giving some firms an upper hand in gaining market share, but it can sometimes lower barriers to entry. For instance, flexible manufacturing processes have allowed Shanzhai handset makers to nearly match Nokia’s cost of manufacturing cell phones. Even in low-technology industries such as steel, new technology can sometimes pave the way for new entrants. In the 1970s, a new technology for smelting steel called the electric arc oven allowed new firms, such as Nucor, to enter

complementary products or services  Products or services that can be used in tandem with those from another industry.

34  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

the industry with only one-tenth the capital investment that would have been needed to start a traditional steel firm. Perhaps the technological change that has affected the threat of new entrants in the greatest number of industries in the last 20 years is the Internet. Some have suggested that the next giant wave of technology change, one we are in the middle of experiencing is wireless communication, like smartphones, which allow individuals to connect to and from anywhere and anyone at any time; and the coming 5G wireless revolution, which promises to allow those connections to occur at speeds that truly allow connection to and from anything and anyone, at anytime, and from anywhere no matter how much data is being transmitted.40

General Economic Conditions Changing macroeconomic forces can also have a large impact on industries. The state of an economy can affect a region or nation and, subsequently, the ability of the average firm in an industry to be profitable. Analyzing the economic environment typically involves measuring the economic growth rate, interest rates, currency exchange rates, and the rate of inflation or deflation. The appendix provides a list of sources where you can find information on these economic indicators.

Economic Growth 

How quickly, or slowly, an economy is growing has a direct impact on most firms’ bottom line. Economic expansion tends to improve customer balance sheets, lower price sensitivity, and increase the growth rate in an industry, as customers purchase more, easing rivalry. For example, a number of African nations, such as Nigeria and Kenya, have experienced solid levels of economic growth in the last few years.41 As a consequence, a growing percentage of the population has sufficient disposable income to afford products like automobiles and cell phones. Companies providing products like these in Africa have experienced a boom in customer demand.42 The reverse is also true. When an economy slows down, industry growth rates slow, customers are more price sensitive, and suppliers are also likely to be struggling and pursuing ways of increasing profits—at the expense of firms in your industry, if they have the power to do so.

Interest Rates 

Interest rates particularly affect rivalry by increasing or decreasing the demand for an industry’s products. This is particularly true for expensive items like housing, cars, and even education, which often require customers to take out loans to purchase. For example, the housing boom experienced in the United States and Europe in the early 2000s was fueled by low-interest-rate loans, sometimes below 4 percent, when the average mortgage interest rate in the previous decade had been above 6 percent. When interest rates are low, industry growth rates increase and rivalry decreases. When interest rates are high, the opposite can occur. In addition, interest rates affect the cost of capital. When interest rates are low, many firms can afford to invest in new assets. As interest rates increase, new investments become more difficult. As a result, firms sometimes engage in price wars as a strategy for gaining market share when rates are high, rather than investing in R&D and new product development.

Currency Exchange Rates  Currency exchange rates reflect the value of one country’s currency in relation to the currency from another country. Exchange rates can have a large impact on the prices that customers pay for products from firms in other countries, directly affecting profitability for those firms. For instance, from mid-2010 to mid-2011, the Swiss franc appreciated 65 percent against the U.S. dollar, making Swiss products 65 percent more costly in the United States, even though the cost of production hadn’t changed at all. Nestlé, a Swiss firm, was particularly hard hit. It either had to decrease its profit margin to cover the extra cost or increase its prices substantially, risking fewer customers buying its products. Inflation 

A significant, consistent rise in prices, known as inflation, can create many problems for firms. Inflation, or the opposite, deflation, means that the value of the dollar doesn’t stay constant. Today, a product may cost $1. If inflation is at 2 percent a year (low

   How the General Environment Shapes Firm and Industry Profitability  35

inflation), then next year that product will cost $1.02. If it is higher, though, say 30 percent, which is not unheard of around the world, the product would cost $1.30 next year and $1.63 the year after that, doubling the cost in three years. Inflation or deflation, if they are high enough, can make it hard for firms to plan investments. Inflation tends to decrease overall economic growth, increasing rivalry and possibly buyer and supplier power and the threat of substitutes. When firms can’t predict what price they will be able to get for a particular product, investments in new product development become riskier. When inflation is high, many industries experience increases in price competition, rather than development, as a means of gaining market share.

Demographic Forces Demographic forces involve changes in the basic characteristics of a population, including changes in the overall number of people, the average age, the number of each gender or ethnicity, or the income distribution of the population.43 Because demographic changes involve basic shifts in the product and geographic markets that firms target, demographic changes are always accompanied by opportunities and threats. Even though demographics often change slowly, they fundamentally reshape the landscape, so good strategic managers have a firm understanding of demographic trends. The appendix contains a list of readily available sources for demographic information. Some sources, such as the World Bank, contain hundreds of different demographic indicators. Over the last 50 years, the size the world’s population has more than doubled, from around 3 billion to more than 7 billion people. Projections suggest that the Earth’s population could reach 9 billion by 2040.44 Each new individual is a potential new consumer, suggesting that growth rates of many industries will increase over time. However, increases in consumption resulting from population growth also mean that supplies of raw materials (such as the rare-earth metals terbium and europium currently used in flat-panel displays45) are likely to decrease. Furthermore, the world population isn’t spread evenly over all nations. The enormous populations of China and India account, to a large degree, for the number of firms that have set up operations in those countries. The average age of the population within a nation can also have a tremendous effect on some industries. In Japan, for instance, more than 20 percent of the population is over age 65. In the United States, this won’t occur until around 2040.46 The robotics industry has already felt this shift. Japanese companies like Honda have invested tens of millions of dollars in robots for home use, including walk-assist robots that help seniors with weakened muscles remain ambulatory when they would otherwise need to use a wheelchair.47

Ecological/Natural Environment The natural environment can also be a source of change for many industries. In some cases, this involves changes to the physical environment such as increasing shortages of key inputs like rare earth metals or fluctuations in the amount and cost of energy (i.e., oil and gas). More often, though, current trends in the natural environment involve changes in the public’s perception of how business affects the environment. From global warming to clean air and water, the public in many countries—including developing economies like China—are demanding that firms be more proactive in protecting the environment. Many firms have responded by implementing green initiatives. Although some of these may be for public relations purposes only many firms have established serious goals. For instance, Procter & ­Gamble has goals to use 30 percent renewable energy to power its plants by 2020. By 2014, 7.5 percent of its energy needs were already met by renewable energy. They have also ­promised to reduce their energy consumption, water usage, greenhouse gas emissions, and waste by 20 percent by 2020. They have already reduced them by 8 percent by 2014.48 If consumers truly care about the environment, then actions like these increase rivalry as competitors are forced to respond in kind.

36  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

Global Forces Global forces also play a large role in shaping many industries. Over the last 50 years, as communications and transportation technologies have undergone a revolution, trade barriers among nations have fallen dramatically. Many countries, from South Korea and Taiwan, to China and India, to Brazil and South Africa, have enjoyed remarkable economic growth and a rising standard of living. These changes have caused firms from many countries to expand operations and begin producing and selling across national borders. We will examine global forces and strategies for capitalizing on them in greater detail in Chapter 9.

Political, Legal, and Regulatory Forces Political, legal, and regulatory forces are those that arise from the use of government. When new laws are passed, they may alter the shape of an industry and influence the strategic actions that firms might take.49 For example, the federal Affordable Health Care Act, enacted in 2009, m ­ andated that health insurance companies insure everyone, including those with preexisting conditions. This changed the cost structure of the insurance and healthcare industries, ­resulting in c­ onsolidation and less rivalry, as inefficient firms either went out of business or were acquired by more viable firms. In the United States, following the Great Recession of 2008–2009, the Federal Reserve required banks to keep larger amounts of cash on hand to cover potential mortgage-related losses. One consequence of this regulation was less lending to small b ­ usinesses, erecting entry barriers in many industries and changing the nature of rivalry in industries with many small firms. Because political processes, laws, and regulations have the potential to shape and constrain industries, managers should analyze and understand the impact of new laws and regulations and decide how to respond. The Affordable Health Care Act, for example, required firms with over 50 employees to provide health insurance for their workers, or face fines. Because the law also provided for health insurance exchanges through which uninsured people could buy their own insurance, some firms dropped employee health insurance as a benefit. Their managers have determined that the fines their companies face would be cheaper than the current premiums for health insurance. Of course, laws can provide opportunities as well as threats. For instance, laws in many countries and states in the United States that require electricity providers to obtain a percentage of their electricity from renewable sources have resulted in a boom in demand for wind turbines and solar panels. Because of the potentially far-ranging effect of laws and regulations, many firms and industries strategically lobby government in an attempt to influence the lawmakers to enact legislation favorable to their industries.

Social/Cultural Forces Social forces refer to society’s cultural values and norms, or attitudes. Values and attitudes are so fundamental that they often affect the other six general environmental forces, shaping the overall landscape in which firms compete. For instance, changing cultural norms about health have resulted in laws against sodas being sold in schools and lawsuits against fast-food retailers such as McDonald’s for marketing “unhealthy” food to children. Like the other environmental forces, however, social forces can create opportunities if a firm happens to be among the first to act on changes in values and attitudes. For instance, Facebook helped to change social norms about connecting to friends and family. It reaped enormous profits for being among the first to capitalize on the change in social networking. Social forces are different, sometimes radically so, in different countries. Firms that compete in a global industry must understand differences among consumers in each country they serve. For example, the collectivist orientation of many people in China results in a general belief that the well-being of the group is more important than that of the individual and a related norm of open information sharing.50 This open-sharing norm allows a greater acceptance of product knockoffs and software pirating than many people are comfortable with in countries that tend to have individualist orientations, such as the United States.

  Review Questions 37

Summary •  One of the primary decisions that firms need to make is which industry, or environment, they are going to compete in. Defining a firm’s industry correctly is important because it helps managers to identify their competition. One tool for helping to define an industry is the NAICS codes produced by the U.S. government. •  Not all industries are equally attractive. Five major forces determine the attractiveness of an industry, defined as the profitability of the average firm in the industry. These forces are: rivalry, buyer power, supplier power, threat of new entrants, and threat of substitute products. •  Good managers develop a deep understanding of the effect of each of the five forces on industry attractiveness. Such an understanding allows them to take strategic action to influence the five forces in a positive way for their firm and industry. Misunderstanding the nature of the five forces can lead to decisions that destroy industry profitability.

•  New thinking suggests that for potential entrants the conventional wisdom needs to be re-examined. Rather than suggesting that new entrants should always look for industries that are attractive, for new entrants who possess unique value, entering an unattractive industry can be much more profitable than entering an attractive industry. But if you don’t possess that unique value you can still enter attractive industries if you completely understand the barriers to entry and can overcome each one. •  Eight general environmental factors can affect the profit potential of a firm: complementary products or services; technological change; general economic conditions; demographic forces; the ecological/ natural environment; global forces; political, legal, and regulatory forces; and social/cultural forces. Changes in any of these eight factors can create additional opportunities and threats and often shape the five industry-specific forces.

Key Terms attractiveness of an industry  22 backward integration  24 barriers to entry  26 complementary products or services  33

forward integration  26 network effects  28 opportunities 21 rivalry 21

substitute 21 supplier 24 switching costs  23 threats 21

Review Questions 1. Why is it important for a firm to accurately determine what indus­ try it is in?

not hold? Besides the examples used in the book, can you think of any other examples?

2. How should a firm decide what industry it is in?

11. Can you identify some of the eight general environmental factors that might be important for the personal care industries that Procter & Gamble participate in, such as shampoo, dish and laundry detergents, toothpaste, and cough medicine, to name a few. Please feel free to use the Internet to get more information about Procter & Gamble. The appendix also has a guide about how to gather information about the eight general environmental trends. If your professor assigns this question as part of a larger project, you may find the appendix to be very useful as a starting point.

3. What are the five major industry forces? How do they shape average profitability in an industry? 4. What factors determine the intensity of rivalry? 5. Which type of industry has more rivalry, fragmented or concentrated, and why? 6. Explain what happens to buyer power when buyers have increased price sensitivity. 7. Explain what it means for suppliers to have a credible threat of forward integration. 8. What factors determine the intensity of the threat of new entrants? 9. What are substitutes? Can you name any substitutes for the laptop most of your classmates are using? What about substitutes for watching your University play football on Saturdays? 10. Under what conditions does the traditional advice concerning entering attractive markets and staying away from unattractive ones

12. How does each of the eight general environmental factors influ­ ence industry profitability? Take your time in answering this one and examine how at least one general environmental factors affects each of the Five Forces (you can use a different environmental factor for each of the Five Forces). 13. What are the elements of a complete external analysis?

38  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats

Application Exercises Exercise 1: Practice evaluating the industry five forces using the strategy tools presented in this chapter using the cola industry case included in your textbook. Read the case, Coca-Cola, Pepsi, and the Shifting Landscape of the ­Carbonated Soft Drink Industry. 1. Use the strategy tool presented in this chapter, along with data from the case, to evaluate: a. The intensity of rivalry within the cola manufacturing industry (where Coca-Cola and Pepsi are prominent firms). Is rivalry high, medium or low? b. The intensity of supplier power within the cola bottling industry (where Coca-Cola and Pepsi are prominent suppliers). Is supplier power high, medium, or low? 2. Where sufficient data aren’t available, use qualitative evidence to evaluate the strength of a particular factor. Whether there is sufficient data or not, fill in the explanation/data line of each strategy tool where the data can be found and/or a summary of your logic. 3. Which industry is likely to be more attractive: cola manufacturing or bottling? Why? Use your analysis to back up your claim.

Exercise 2: Practice Evaluating the Five Forces, using the strategy tools presented in this chapter. 1. Use either an industry that your professor assigns to you or pick an industry of your choice. 2. Use a Five Forces tool that your professor assigns to you (or one of your choice) to evaluate that force within the industry you are

analyzing. Be prepared to either hand in your completed analysis, using the tools from Figures 2.3–2.9, or show and explain it in class.

Exercise 3: Analyze the effects of the general environment on an industry of your choice. 1. Identify an industry you would like to learn more about. Ideally, you should be able to gather sufficient information on this industry to thoroughly analyze the impact of the general environment on industry profitability. Although information is available for a wide variety of industries, this exercise will be easier if you choose an industry that has been written about consistently in the business press. In order to manage the volume of data required for a thorough analysis, your instructor might want you to focus solely on the home country of the largest firms in the industry (unless most firms earn a majority of their profits from abroad). 2. Use data from a variety of sources, including those listed in the appendix, in your analysis. 3. Try to identify the major effects of each of the eight factors (complementary products; technological change; general economic conditions; demographic forces; ecological/natural environment forces; global forces; political, legal, and regulatory forces; and social/cultural forces) on industry profitability. 4. Identify and predict any short-term to medium-term changes in any of the eight factors that might alter average profitability in the industry. Address how those changes will affect industry profitability in the future. 5. As part of the analysis, consider how the general environmental factors may affect each of the five industry forces (rivalry, buyer power, supplier power, threat of new entrants, and threat of substitutes).

Strategy Tool Evaluating Industry Attractiveness Using Porter’s Five Forces Model Understanding the five forces and their effect on the landscape that a firm competes in is a cornerstone of successful strategic analysis. Figures 2.4 through 2.9 are general analytical tools used by a number of Fortune 500 firms to evaluate the intensity of the five forces in an industry, either their own or one they are thinking about entering.50 These tools essentially help to quantify the ideas that we have already discussed in this chapter. In practice, top management often implicitly understands the dynamics of the five forces and might not personally use the tools presented here to map out the strength of each force and its overall effect on industry profitability. However, a number of Fortune 500 firms use these tools in their strategic planning departments to provide rigor to the strategic analyses and recommendations they present to top management. Although the tools might appear complicated, they distill the concepts from this chapter, allowing a relatively simple, yet comprehensive and detailed analysis of the five forces. You can look for the data to complete these analysis tools in the sources listed in the appendix at the end of the book. Many of the

indicators in these analysis tools are objective numbers that you can obtain from various data sources. Others are more subjective; they require a logical argument for the level—low, medium, or high—that you choose. Even for more subjective indicators, however, data from various sources, for instance, articles in the business press, can take the guesswork out of doing a five-forces analysis. To use the tools, for each separate item, put an X in the box that most accurately reflects the data you have gathered on your industry. For some boxes this is a range of data, for instance, 60 to 70 percent combined market share in the rivalry tool. If the correct number is anywhere within the range, put an X in the appropriate box. Cite your data source and/or explain the logic of your placement underneath each item. Your answer for some rows of boxes will be an average of more than one item. For instance, in the rivalry tool, the degree of industry standardization is the average of the four items below it. After filling out each item, you will use the columns. Each column is assigned a number, 1 through 5. The columns will help you to find the correct answer for elements that have subsets to them. For instance, in the rivalry worksheet, you need to determine whether the degree of industry product standardization is low, medium, or high. The low,

  Application Exercises 39 FIGURE 2.4    StrategyTool - Evaluating the Intensity of Rivalry (mark an × in the appropriate box for each factor)

1. Number and Relative Size of Competitors • Top 4 competitors’ combined industry market share

1

2

3

4

5

70%

Explanation/Source of Data:

High

2. Degree of Industry Product Standardization

Med.

Low

(take the average of the bullet points below)

• Difference between competitors in price of similar products

15%

100%

75%

50%

25%

0%

Explanation/Source of Data:

• What % of industry’s products are sold at discount? Explanation/Source of Data:

• Customers’ ability to recognize brands from industry

Low

Med.

High

Low

Med.

High

Explanation/Source of Data:

• Degree of switching costs Explanation/Source of Data:

3. Industry Growth Rate Explanation/Source of Data:

5%

100%

4. Unused Industry Production Capacity • % of Industry wide production capacity currently in use Explanation/Source of Data:

5. Degree to which firms have high fixed costs or products have high storage costs or are perishable

High

Med.

Low

High

Med.

Low

Explanation/Source of Data:

6. Extent of Exit Barriers Explanation/Source of Data:

Overall Intensity of Rivalry (take the average of the major factors, items numbered 1 through 6)

medium, and high are encased in boxes, letting you know that this is a major concept, while the rows that are not in boxes will help determine the answer to the major concept. You also should notice that each row of boxes lines up with a number to the left. Each number is a major concept that you will use to determine the overall level of whichever force you are measuring, in this case, rivalry. So, to determine the degree of standardization, you will use data and/or logic to put an X on the right answer (according to your data) for each of the four rows underneath Product Standardization. Now the columns come into play. Notice that each X that you placed falls under one of the columns. Each column has a number 1 through 5. Add up the placement of your Xs and then divide by the number of rows you were using (in this case there were four) to determine whether Product Standardization is high, medium, or low. For example, if the answer, according to your data and/or logic, for the four rows under Product Standardization was 1) 5%–10%, 2) 50%, 3) Med, and 4) Med (each of these four items was in column 3), you would add these together (3+3+3+3), getting the number 12. You would then divide by the number of rows you were using (4) and end up with the number 3. That tells you to put an X in the row of boxes for Product Standardization that is in column 3, which would be medium. If the sum for the four rows doesn’t divide evenly by 4, round the decimal to the nearest whole number to see which column your X should go in. So, if instead of 12 our total was 15, we still would divide

Fiercely Competitive

Neutral

Mildly Competitive

by 4 rows, returning the number 3.75. This means we would put our X under column 4, meaning that Product Standardization is between medium and low. To get the value for the overall intensity of each force, you will first add the values from the boxes with Xs in them (the major concepts, i.e., that have a row of boxes and a number next to them on the left side of the worksheet). The values come from the columns. So you would look down each column and see if a box has an X in it. If all the boxes are in Column 1, we would get a 6 for the rivalry worksheet because there are six major concepts. If all of the boxes were in column 5, we would get a 30 (6 x 5 = 30). After you have a total from adding the numbers of each box, which you obtained from the column it is in, you divide that number into the number of major concepts (6 for rivalry) times the number of columns (5). For the rivalry worksheet, the total number possible is 30. Suppose the sum of all of the major concepts (found in the boxes, each one under a numbered column) for your analysis is 15. Using those two numbers, you have 30 divided by 15 = 2. You would then place your answer for the Overall Intensity of Rivalry (the row at the very bottom) under column 2, resulting in Rivalry that is relatively competitive (halfway between fiercely competitive and neutral). As with the subconcepts, always round your answer to the nearest whole number. If you got a 1.6 or a 2.4, you still would put your final X under column 2. And now that you know how to use the worksheets, go and do great work!

40  CHA PT E R 2   Analysis of the External Environment: Opportunities and Threats FIGURE 2.5    StrategyTool - Evaluating the Intensity of Buyer Power (mark an × in the appropriate box for each factor)

1. Buyer Industry Bargaining Power (take the average of the bullet points below)

• Buyer concentration (top 4 buyers as a % of total industry volume sold to buyers)

1

2

High >70%

3

4

Med. 60-70%

50-60%

5 Low

40-50%

50%

30-50%

20-30%

5-20%

50%

30-50%

15-30%

5-15%

70%

60-70%

50-60%

40-50%

30%

20-30%

10-20%

5-10%

>5%

5%

Explanation/Source of Data:

• Difference between suppliers in price of similar products Explanation/Source of Data:

• Importance of suppliers’ brands to the end consumer

High

Med.

Low

High

Med.

Low

High Power

Neutral

Low Power

Explanation/Source of Data:

3. Possibility of Supplier Forward Integration Explanation/Source of Data:

Overall Intensity of Supplier Power (take the average of the major factors, items 1 through 3, above)

  Application Exercises 41 FIGURE 2.7    Strategy Tool - Evaluating the Intensity Threat of New Entrants (mark an × in the appropriate box for each factor)

1. Incumbent Firms’ Cost Advantages (take the average of the bullet points below)

• Size of scales economies: measured as the slope of the scale curve (see Chapter 4 for how to calculate this)

1

2

Low >95%

3

4

Med. 85-95%

80-85%

5 High

70-80%

>70%

Explanation/Source of Data:

• Size of investment in plant and machinery required to enter industry

Small

Med.

Large

Small

Med.

Large

Low

Med.

High

Explanation/Source of Data:

• Size of investment in marketing needed to match incumbent brand awareness Explanation/Source of Data:

• Degree to which incumbents employ property rights, like patents, to protect their market share Explanation/Source of Data:

• Market share required to break even

40%

Explanation/Source of Data:

Low

Med.

High

Weak

Neutral

Strong

Low

Med.

High

• Degree to which network effects affect buying decision Explanation/Source of Data:

Low

Med.

High

• Cost for entrants to comply with government regulations

Low

Med.

High

Low

Med.

High

2. Other Incumbent Firm Advantages (take the average of the bullet points below)

• Strength of incumbents’ brands (how influential in customer purchase decision?) Explanation/Source of Data:

• Size of switching cost for incumbents’ customers Explanation/Source of Data:

Explanation/Source of Data:

3. Additional Considerations (take the average of the bullet points below)

• Profitability of average incumbent

>15%

10-15%

5-10%

0-5%

5%

3-5%

1-3%

0-1%