Strategic Management

Need of Strategic Management:1. Due to change 2. To provide guide lines 3. Research and development 4. Probability for business performance 5. ystemi!ed decision

". #mproves $ommunication %. &llocation of resource '. #mproves $oordination (. )elps the managers to have holistic approach

Importance of Strategic Management:-

1. To the shape the *uture of business 2. +ffective strategic idea 3. ,angers and employer are innovative and creative 4. #ts decentrali!ed the ,anagement 5. #ts helps to increase the productivity ". To ,a-es discipline %. To ,a-e control

'. To ma-es for.ard s thin-ing

The Strategic Planning Process:

#n today/s highly competitive business environment0 budget1oriented planning or forecast1based planning methods are insufficient for a large corporation to survive and prosper. The firm must engage in strategic planning that clearly defines ob2ectives and assesses both the internal and e3ternal situation to formulate strategy0 implement the strategy0 evaluate the progress0 and ma-e ad2ustments as necessary to stay on trac-. & simplified vie. of the strategic planning process is sho.n by the follo.ing diagram4 The Strategic Planning Process

The Strategic Planning Process Mission & Objectives

Environmental Scanning

Strateg !orm"lation

Strateg Implementation

Eval"ation & #ontrol

Mission and Objectives The mission statement describes the company/s business vision0 including the unchanging values and purpose of the firm and for.ard1loo-ing visionary goals that guide the pursuit of future opportunities. 5uided by the business vision0 the firm/s leaders can define measurable financial and strategic ob2ectives. *inancial ob2ectives involve measures such as sales targets and earnings gro.th. trategic ob2ectives are related to the firm/s business position0 and may include measures such as mar-et share and reputation. Environmental Scan The environmental scan includes the follo.ing components4

#nternal analysis of the firm &nalysis of the firm/s industry 6tas- environment7 +3ternal microenvironment 6P+ T analysis7

The internal analysis can identify the firm/s strengths and .ea-nesses and the e3ternal analysis reveals opportunities and threats. & profile of the strengths0 .ea-nesses0 opportunities0 and threats is generated by means of a 89T analysis &n industry analysis can be performed using a frame.or- developed by ,ichael Porter -no.n as Porter/s five forces. This frame.or- evaluates entry barriers0 suppliers0 customers0 substitute products0 and industry rivalry. Strateg !orm"lation 5iven the information from the environmental scan0 the firm should match its strengths to the opportunities that it has identified0 .hile addressing its .ea-nesses and e3ternal threats. To attain superior profitability0 the firm see-s to develop a competitive advantage over its rivals. & competitive advantage can be based on cost or differentiation. ,ichael Porter identified three industry1independent generic strategies from .hich the firm can choose. Strateg Implementation The selected strategy is implemented by means of programs0 budgets0 and procedures. #mplementation involves organi!ation of the firm/s resources and motivation of the staff to achieve ob2ectives. The .ay in .hich the strategy is implemented can have a significant impact on .hether it .ill be successful. #n a large company0 those .ho implement the strategy li-ely .ill be different people from those .ho formulated it. *or this reason0 care must be ta-en to communicate the strategy and the reasoning behind it. 9ther.ise0 the implementation might not succeed if the strategy is misunderstood or if lo.er1 level managers resist its implementation because they do not understand .hy the particular strategy .as selected. Eval"ation & #ontrol The implementation of the strategy must be monitored and ad2ustments made as needed. +valuation and control consists of the follo.ing steps4 1. Define parameters to be measured

2. Define target values for those parameters 3. Perform measurements 4. $ompare measured results to the pre1defined standard 5. ,a-e necessary changes

$#% %ro&th-Share Matri'

$ompanies that are large enough to be organi!ed into strategic business units face the challenge of allocating resources among those units. #n the early 1(%:/s the ;oston $onsulting 5roup developed a model for managing a portfolio of different business units 6or ma2or product lines7. The ;$5 gro&th-share matri' displays the various business units on a graph of the mar-et gro.th rate vs. mar-et share relative to competitors4
$#% %ro&th-Share Matri'

Resources are allocated to business units according to .here they are situated on the grid as follo.s4

#ash #o& 1 a business unit that has a large mar-et share in a mature0 slo. gro.ing industry. $ash co.s re<uire little investment and generate cash that can be used to invest in other business units. Star 1 a business unit that has a large mar-et share in a fast gro.ing industry. tars may generate cash0 but because the mar-et is gro.ing rapidly they re<uire investment to maintain their lead. #f successful0 a star .ill become a cash co. .hen its industry matures. ("estion Mar) *or Problem #hild+ 1 a business unit that has a small mar-et share in a high gro.th mar-et. These business units re<uire resources to gro. mar-et share0 but .hether they .ill succeed and become stars is un-no.n.

,og 1 a business unit that has a small mar-et share in a mature industry. & dog may not re<uire substantial cash0 but it ties up capital that could better be deployed else.here. =nless a dog has some other strategic purpose0 it should be li<uidated if there is little prospect for it to gain mar-et share.

The ;$5 matri3 provides a frame.or- for allocating resources among different business units and allo.s one to compare many business units at a glance. )o.ever0 the approach has received some negative criticism for the follo.ing reasons4

The lin- bet.een mar-et share and profitability is <uestionable since increasing mar-et share can be very e3pensive. The approach may overemphasi!e high gro.th0 since it ignores the potential of declining mar-ets. The model considers mar-et gro.th rate to be a given. #n practice the firm may be able to gro. the mar-et.

These issues are addressed by the 5+ > ,c?insey ,atri30 .hich considers mar-et gro.th rate to be only one of many factors that ma-e an industry attractive0 and .hich considers relative mar-et share to be only one of many factors describing the competitive strength of the business unit.

The $"siness -ision and #ompan Mission Statement

8hile a business must continually adapt to its competitive environment0 there are certain core ideals that remain relatively steady and provide guidance in the process of strategic decision1ma-ing. These unchanging ideals form the b"siness vision and are e3pressed in the company mission statement. #n their 1((" article entitled Building Your Company's Vision0 @ames $ollins and @erry Porras provided a frame.or- for understanding business vision and articulating it in a mission statement. The mission statement communicates the firm/s core ideology and visionary goals0 generally consisting of the follo.ing three components4 1. #ore val"es to .hich the firm is committed 2. #ore p"rpose of the firm 3. -isionar goals the firm .ill pursue to fulfill its mission The firm/s core values and purpose constitute its core ideology and remain relatively constant. They are independent of industry structure and the product life cycle. The core ideology is not created in a mission statementA rather0 the mission statement is simply an e3pression of .hat already e3ists. The specific phrasing of the ideology may change .ith the times0 but the underlying ideology remains constant.

The three components of the business vision can be portrayed as follo.s4

#ore -al"es

#ore P"rpose

$"siness -i sio n

-isionar %oals

#ore -al"es The core values are a fe. values 6no more than five or so7 that are central to the firm. $ore values reflect the deeply held values of the organi!ation and are independent of the current industry environment and management fads.

9ne .ay to determine .hether a value is a core value to as- .hether it .ould continue to be supported if circumstances changed and caused it to be seen as a liability. #f the ans.er is that it .ould be -ept0 then it is core value. &nother .ay to determine .hich values are core is to imagine the firm moving into a totally different industry. The values that .ould be carried .ith it into the ne. industry are the core values of the firm. $ore values .ill not change even if the industry in .hich the company operates changes. #f the industry changes such that the core values are not appreciated0 then the firm should see- ne. mar-ets .here its core values are vie.ed as an asset. *or e3ample0 if innovation is a core value but then 1: years do.n the road innovation is no longer valued by the current customers0 rather than change its values the firm should see- ne. mar-ets .here innovation is advantageous. The follo.ing are a fe. e3amples of values that some firms has chosen to be in their core4

e3cellent customer service pioneering technology creativity integrity social responsibility

#ore P"rpose The core purpose is the reason that the firm e3ists. This core purpose is e3pressed in a carefully formulated mission statement. Bi-e the core values0 the core purpose is relatively unchanging and for many firms endures for decades or even centuries. This purpose sets the firm apart from other firms in its industry and sets the direction in .hich the firm .ill proceed. The core purpose is an idealistic reason for being. 8hile firms e3ist to earn a profit0 the profit motive should not be highlighted in the mission statement since it provides little direction to the firm/s employees. 8hat is more important is how the firm .ill earn its profit since the Cho.C is .hat defines the firm. #nitial attempts at stating a core purpose often result in too specific of a statement that focuses on a product or service. To isolate the core purpose0 it is useful to as-

C.hyC in response to first1pass0 product1oriented mission statements. *or e3ample0 if a mar-et research firm initially states that its purpose is to provide mar-et research data to its customers0 as-ing C.hyC leads to the fact that the data is to help customers better understand their mar-ets. $ontinuing to as- C.hyC may lead to the revelation that the firm/s core purpose is to assist its clients in reaching their ob2ectives by helping them to better understand their mar-ets. The core purpose and values of the firm are not selected 1 they are discovered. The stated ideology should not be a goal or aspiration but rather0 it should portray the firm as it really is. &ny attempt to state a value that is not already held by the firm/s employees is li-ely to not be ta-en seriously.

-isionar %oals The visionary goals are the lofty ob2ectives that the firm/s management decides to pursue. This vision describes some milestone that the firm .ill reach in the future and may re<uire a decade or more to achieve. #n contrast to the core ideology that the firm discovers0 visionary goals are selected. These visionary goals are longer term and more challenging than strategic or tactical goals. There may be only a 5:D chance of reali!ing the vision0 but the firm must believe that it can do so. $ollins and Porras describe these lofty ob2ectives as C;ig0 )airy0 &udacious 5oals.C These goals should be challenging enough so that people nearly gasp .hen they learn of them and reali!e the effort that .ill be re<uired to reach them. ,ost visionary goals fall into one of the follo.ing categories4

Target 1 <uantitative or <ualitative goals such as a sales target or *ord/s goal to Cdemocrati!e the automobile.C #ommon enem 1 centered on overta-ing a specific firm such as the 1(5:/s goal of Philip1,orris to displace R@R. .ole model 1 to become li-e another firm in a different industry or mar-et. *or e3ample0 a cycling accessories firm might strive to become Cthe Ei-e of the cycling industry.C

Internal transformation 1 especially appropriate for very large corporations. *or e3ample0 5+ set the goal of becoming number one or number t.o in every mar-et it serves.

8hile visionary goals may re<uire significant stretching to achieve0 many visionary companies have succeeded in reaching them. 9nce such a goal is reached0 it needs to be replacedA other.ise0 it is unli-ely that the organi!ation .ill continue to be successful. *or e3ample0 *ord succeeded in placing the automobile .ithin the reach of everyday people0 but did not replace this goal .ith a better one and 5eneral ,otors overtoo- *ord in the 1(3:/s.

#ompetitive /dvantage
8hen a firm sustains profits that e3ceed the average for its industry0 the firm is said to possess a competitive advantage over its rivals. The goal of much of business strategy is to achieve a sustainable competitive advantage. ,ichael Porter identified t.o basic types of competitive advantage4

#ost advantage ,ifferentiation advantage

& competitive advantage e3ists .hen the firm is able to deliver the same benefits as competitors but at a lo.er cost 6cost advantage70 or deliver benefits that e3ceed those of competing products 6differentiation advantage7. Thus0 a competitive advantage enables the firm to create superior value for its customers and superior profits for itself. $ost and differentiation advantages are -no.n as positional advantages since they describe the firm/s position in the industry as a leader in either cost or differentiation. & resource-based view emphasi!es that a firm utili!es its resources and capabilities to create a competitive advantage that ultimately results in superior value creation.

The follo.ing diagram combines the resource1based and positioning vie.s to illustrate the concept of competitive advantage4

/ Model of #ompetitive /dvantage

Resources

Distinctive $ompetencies

$ost &dvantage or Differentiation &dvantage

Falue $reation

$apabilities

.eso"rces and #apabilities &ccording to the resource1based vie.0 in order to develop a competitive advantage the firm must have resources and capabilities that are superior to those of its competitors. 8ithout this superiority0 the competitors simply could replicate .hat the firm .as doing and any advantage <uic-ly .ould disappear. .eso"rces are the firm1specific assets useful for creating a cost or differentiation advantage and that fe. competitors can ac<uire easily. The follo.ing are some e3amples of such resources4

Patents and trademar-s Proprietary -no.1ho. #nstalled customer base Reputation of the firm ;rand e<uity

#apabilities refer to the firm/s ability to utili!e its resources effectively. &n e3ample of a capability is the ability to bring a product to mar-et faster than competitors. uch capabilities are embedded in the routines of the organi!ation and are not easily documented as procedures and thus are difficult for competitors to replicate. The firm/s resources and capabilities together form its distinctive competencies. These competencies enable innovation0 efficiency0 <uality0 and customer responsiveness0 all of .hich can be leveraged to create a cost advantage or a differentiation advantage. #ost /dvantage and ,ifferentiation /dvantage $ompetitive advantage is created by using resources and capabilities to achieve either a lo.er cost structure or a differentiated product. & firm positions itself in its industry through its choice of lo. cost or differentiation. This decision is a central component of the firm/s competitive strategy. &nother important decision is ho. broad or narro. a mar-et segment to target. Porter formed a matri3 using cost advantage0 differentiation advantage0 and a broad or narro. focus to identify a set of generic strategies that the firm can pursue to create and sustain a competitive advantage.

-al"e #reation The firm creates value by performing a series of activities that Porter identified as the value chain. #n addition to the firm/s o.n value1creating activities0 the firm operates in a value system of vertical activities including those of upstream suppliers and do.nstream channel members. To achieve a competitive advantage0 the firm must perform one or more value creating activities in a .ay that creates more overall value than do competitors. uperior value is created through lo.er costs or superior benefits to the consumer 6differentiation7.

#ore #ompetencies

#n their 1((: article entitled0 The Core Competence of the Corporation 0 $.?. Prahalad and 5ary )amel coined the term core competencies0 or the collective learning and coordination s-ills behind the firm/s product lines. They made the case that core competencies are the source of competitive advantage and enable the firm to introduce an array of ne. products and services. &ccording to Prahalad and )amel0 core competencies lead to the development of core products. $ore products are not directly sold to end usersA rather0 they are used to build a larger number of end1user products. *or e3ample0 motors are a core product that can be used in .ide array of end products. The business units of the corporation each tap into the relatively fe. core products to develop a larger number of end user products based on the core product technology. This flo. from core competencies to end products is sho.n in the follo.ing diagram4

#ore #ompetencies to End Prod"cts

End Products 1 2 3 4 5 " % ' ( 1: 11 12

$"siness 0

$"siness 1

$"siness 2

$"siness 3

#ore Prod"ct 0

#ore Prod"ct 1

#ompetence 0

#ompetence 1

#ompetence 2

#ompetence 3

The intersection of mar-et opportunities .ith core competencies forms the basis for launching ne. businesses. ;y combining a set of core competencies in different .ays and matching them to mar-et opportunities0 a corporation can launch a vast array of businesses. 8ithout core competencies0 a large corporation is 2ust a collection of discrete businesses. $ore competencies serve as the glue that bonds the business units together into a coherent portfolio.

,eveloping #ore #ompetencies &ccording to Prahalad and )amel0 core competencies arise from the integration of multiple technologies and the coordination of diverse production s-ills. ome e3amples include Philip/s e3pertise in optical media and ony/s ability to miniaturi!e electronics. There are three tests useful for identifying a core competence. & core competence should4 1. provide access to a .ide variety of mar-ets0 and 2. contribute significantly to the end1product benefits0 and 3. be difficult for competitors to imitate. $ore competencies tend to be rooted in the ability to integrate and coordinate various groups in the organi!ation. 8hile a company may be able to hire a team of brilliant scientists in a particular technology0 in doing so it does not automatically gain a core competence in that technology. #t is the effective coordination among all the groups involved in bringing a product to mar-et that results in a core competence. #t is not necessarily an e3pensive underta-ing to develop core competencies. The missing pieces of a core competency often can be ac<uired at a lo. cost through alliances and licensing agreements. #n many cases an organi!ational design that facilitates sharing of competencies can result in much more effective utili!ation of those competencies for little or no additional cost.

To better understand ho. to develop core competencies0 it is .orth.hile to understand .hat they do not entail. &ccording to Prahalad and )amel0 core competencies are not necessarily about4

outspending rivals on RGD sharing costs among business units integrating vertically

8hile the building of core competencies may be facilitated by some of these actions0 by themselves they are insufficient.

The 4oss of #ore #ompetencies $ost1cutting moves sometimes destroy the ability to build core competencies. *or e3ample0 decentrali!ation ma-es it more difficult to build core competencies because autonomous groups rely on outsourcing of critical tas-s0 and this outsourcing prevents the firm from developing core competencies in those tas-s since it no longer consolidates the -no.1ho. that is spread throughout the company. *ailure to recogni!e core competencies may lead to decisions that result in their loss. *or e3ample0 in the 1(%:/s many =. . manufacturers divested themselves of their television manufacturing businesses0 reasoning that the industry .as mature and that high <uality0 lo. cost models .ere available from *ar +ast manufacturers. #n the process0 they lost their core competence in video0 and this loss resulted in a handicap in the ne.er digital television industry. imilarly0 ,otorola divested itself of its semiconductor DR&, business at 25"?b level0 and then .as unable to enter the 1,b mar-et on its o.n. ;y recogni!ing its core competencies and understanding the time re<uired to build them or regain them0 a company can ma-e better divestment decisions. #ore Prod"cts $ore competencies manifest themselves in core products that serve as a lin- bet.een the competencies and end products. $ore products enable value creation in the end products. +3amples of firms and some of their core products include4

3, 1 substrates0 coatings0 and adhesives

;lac- G Dec-er 1 small electric motors $anon 1 laser printer subsystems ,atsushita 1 F$R subsystems0 compressors E+$ 1 semiconductors )onda 1 gasoline po.ered engines

The core products are used to launch a variety of end products. *or e3ample0 )onda uses its engines in automobiles0 motorcycles0 la.n mo.ers0 and portable generators. ;ecause firms may sell their core products to other firms that use them as the basis for end user products0 traditional measures of brand mar-et share are insufficient for evaluating the success of core competencies. Prahalad and )amel suggest that core product share is the appropriate metric. 8hile a company may have a lo. brand share0 it may have high core product share and it is this share that is important from a core competency standpoint. 9nce a firm has successful core products0 it can e3pand the number of uses in order to gain a cost advantage via economies of scale and economies of scope.

Implications for #orporate Management Prahalad and )amel suggest that a corporation should be organi!ed into a portfolio of core competencies rather than a portfolio of independent business units. ;usiness unit managers tend to focus on getting immediate end1products to mar-et rapidly and usually do not feel responsible for developing company1.ide core competencies. $onse<uently0 .ithout the incentive and direction from corporate management to do other.ise0 strategic business units are inclined to underinvest in the building of core competencies. #f a business unit does manage to develop its o.n core competencies over time0 due to its autonomy it may not share them .ith other business units. &s a solution to this problem0 Prahalad and )amel suggest that corporate managers should have the ability to allocate not only cash but also core competencies among business units. ;usiness units that lose -ey employees for the sa-e of a corporate core competency should be recogni!ed for their contribution.

#orporate Strateg :

T pes of #orporate Strateg :

Strategic Management Concepts

&lthough the term Hstrategic managementI is bantered around a lot in the businesses .orld0 it is not understood very .ell by most people. +ssentially strategic management ans.ers the <uestions of H.here do you .ant your business to goI 6goals70 Hho. is your business going to get thereI 6strategy7 and Hho. .ill you -no. .hen you get thereI 6evaluation7. & strategic management analogy is ta-ing a trip during your vacation. *irst you decide .here you .ant to go J the natural beauty of Kello.stone or the bright lights of Bas Fegas. Then you develop a strategy of ho. to get there J ta-e an airplane 6.hich flights70 drive your car 6.hich high.ays70 etc. This .ill be influenced by the amount of money0 time and 9ther resources you have available. Then you monitor your trip to see if your strategy ta-es you to your destination and ho. your strategy .or-ed 6missed *lights0 poor road conditions0 etc.7. ;elo. are concepts to help e3pand your understand of strategic management for a business. These .ill help sharpen your focus for using trategic ,anagement for a Falue1added *arm ;usiness. 17 27 trategic management involves deciding .hat is important for the long1range success of your business and focusing on it. trategic management as-s0 H)o. should # position my business to meet management and business goalsLI

37 & business strategy is a series of business decisions that lead to achieving a business goal. 47 trategic management involves the Hbig pictureI of your business. 57 trategic management involves planning0 analy!ing and implementing a business strategy. "7 trategic management is most effective if you can step bac- far enough and say Hall things are possible.I %7 The essence of strategic management is matching business resources to mar-et opportunities. '7 trategic management involves see-ing and identifying opportunities and threats in the mar-et and industry and the outside .orld in general. (7 trategic management is based on the premise that Hall businesses are not the same.I 1:7 trategic management involves assessing the strengths and .ea-nesses of your business. 117 8hen assessing strengths and .ea-nesses0 personal s-ills and abilities are li-ely to be more important than business assets. 127 trategic management involves loo-ing into the future rather than d.elling on the past. 137 trategic management is proactive rather than reactive. 147 trategic management involves anticipating change and ta-ing advantage of it. 157 trategic thin-ing involves assessing ho. decisions made today .ill affect my business in the future. 1"7 trategic management is more of a state1of mind than a rigid process. 1%7 & military connotation of strategic management is Hit hasnMt .on every .ar0 but it has avoided a lot of ambushes.I

1'7 trategic management is most useful for businesses .ith uni<ue or differentiated products for niche0 specialty or differentiated product ,ar-ets. 1(7 trategic planning comes before business planning. trategic planning is used to identify and assess alternative business strategies. ;usiness planning is used to implement a business strategy. 2:7 trategic planning is more .ords and less numbers than business planning. 217 & strategic plan is a HlivingI document that changes as your goals and resources evolve.

Strategic management

%lobal Strategic Management

During the last half of the t.entieth century0 many barriers to international trade fell and a .ave of firms began pursuing global strategies to gain a competitive advantage. )o.ever0 some industries benefit more from globali!ation than do others0 and some nations have a comparative advantage over other nations in certain industries. To create a successful global strategy0 managers first must understand the nature of global industries and the dynamics of global competition. So"rces of #ompetitive /dvantage from a %lobal Strateg & .ell1designed global strategy can help a firm to gain a competitive advantage. This advantage can arise from the follo.ing sources4

Efficienc

o o o

+conomies of scale from access to more customers and mar-ets +3ploit another country/s resources 1 labor0 ra. materials +3tend the product life cycle 1 older products can be sold in lesser developed countries 9perational fle3ibility 1 shift production as costs0 e3change rates0 etc. change over time

Strategic
o o o

*irst mover advantage and only provider of a product to a mar-et $ross subsidi!ation bet.een countries Transfer price

.is)
o

Diversify macroeconomic ris-s 6business cycles not perfectly correlated among countries7 Diversify operational ris-s 6labor problems0 earth<ua-es0 .ars7

4earning
o

;roaden learning opportunities due to diversity of operating environments

.ep"tation
o

$rossover customers bet.een mar-ets 1 reputation and brand identification

umantra 5hoshal of #E +&D proposed a frame.or- comprising three categories of strategic ob2ectives and three sources of advantage that can be used to achieve them. &ssembling these into a matri3 results in the follo.ing frame.or-4

Strategic Objectives

Sources of Competitive Advantage National ,ifferences Scale Economies Scope Economies

Efficienc in Operations !le'ibilit

+3ploit factor cost differences ,ar-et or policy1induced changes

cale in each activity

haring investments and costs

;alancing scale .ith Portfolio strategic G operational ris-s diversification

Innovation and ocietal differences in +3perience 1 cost reduction hared learning across 4earning management and organi!ation and innovation activities

The Nat"re of #ompetitive /dvantage in %lobal Ind"stries & global industry can be defined as4

&n industry in .hich firms must compete in all .orld mar-ets of that product in order to survive. &n industry in .hich a firm/s competitive advantage depends on economies of scale and economies of scope gained across mar-ets.

ome industries are more suited for globali!ation than are others. The follo.ing drivers determine an industry/s globali!ation potential. 05 #ost ,rivers o Bocation of strategic resources
o o

Differences in country costs Potential for economies of scale 6production0 RGD0 etc.7 *lat e3perience curves in an industry inhibits globali!ation. 9ne reason that the facsimile industry had more global potential than the furniture industry is that for fa3 machines0 the production costs drop 3:D14:D .ith each doubling of volumeA the curve is much flatter for the furniture industry and many service industries. #ndustries for .hich the larger e3penses are in RGD0 such as the aircraft industry0 e3hibit more economies of scale than those industries for .hich the larger e3penses are rent and labor0 such as the dry cleaning industry. #ndustries in .hich costs drop by at least 2:D for each doubling of volume tend to be good candidates for globali!ation.

Transportation costs 6value>bul- or value>.eight ratio7 NO Diamonds and semiconductors are more global than ice.

15 #"stomer ,rivers o $ommon customer needs favor globali!ation. *or e3ample0 the facsimile industry/s customers have more homogeneous needs than those of the furniture industry0 .hose needs are defined by local tastes0 culture0 etc.
o

5lobal customers4 if a firm/s customers are other global businesses0 globali!ation may be re<uired to reach these customers in all their mar-ets. *urthermore0 global customers often re<uire globally standardi!ed products. 5lobal channels re<uire a globally coordinated mar-eting program. trong established local distribution channels inhibits globali!ation. Transferable mar-eting4 .hether mar-eting elements such as brand names and advertising re<uire little local adaptation. 8orld brands .ith non1dictionary names may be developed in order to benefit from a single global advertising campaign.

25 #ompetitive ,rivers o 5lobal competitors4 The e3istence of many global competitors indicates that an industry is ripe for globali!ation. 5lobal competitors .ill have a cost advantage over local competitors.
o

8hen competitors begin leveraging their global positions through cross1subsidi!ation0 an industry is ripe for globali!ation.

35 %overnment ,rivers o Trade policies

o

Technical standards

Regulations

The furniture industry is an e3ample of an industry that did not lend itself to globali!ation before the 1(":/s. ;ecause furniture has a high bul- compared to its value0 and because furniture is easily damaged in shipping0 transport costs traditionally .ere high. 5overnment trade barriers also .ere unfavorable. The .edish furniture company #?+& pioneered a move to.ards globali!ation in the furniture industry. #?+&/s furniture .as unassembled and therefore could be shipped more economically. #?+& also lo.ered costs by involving the customer in the value chainA the customer carried the furniture home and assembled it himself. #?+& also had a frugal culture that gave it cost advantages. #?+& successfully e3panded in +urope since customers in different countries .ere .illing to purchase similar designs. )o.ever0 after successfully e3panding to several countries0 #?+& ran into difficulties in the =. . mar-et for several reasons4

Different tastes in furniture and a re<uirement for more customi!ed furniture. Difficult to transfer #?+&/s frugal culture to the =. . The .edish ?rona increased in value0 increasing the cost of furniture made in .eden and sold in the =. . toc-1outs due to the one to t.o month shipping time from +urope ,ore competition in the =. . than in +urope

#o"ntr #omparative /dvantages #ompetitive advantage is a firm/s ability to transform inputs into goods and services at a ma3imum profit on a sustained basis0 better than competitors. #omparative advantage resides in the factor endo.ments and created endo.ments of particular regions. *actor endo.ments include land0 natural resources0 labor0 and the si!e of the local population. #n the 1(2:/s0 .edish economists +li )ec-sher and ;ertil 9hlin developed the factor1proportions theory0 according to .hich a country en2oys a comparative advantage in those goods that ma-e intensive use of factors that the country has in relative abundance.

,ichael +. Porter argued that a nation can create its o.n endo.ments to gain a comparative advantage. $reated endo.ments include s-illed labor0 the technology and -no.ledge base0 government support0 and culture. Porter/s Diamond of Eational &dvantage is a frame.or- that illustrates the determinants of national advantage. This diamond represents the national playing field that countries establish for their industries. T pes of International Strateg : M"lti-domestic vs5 %lobal ulti-domestic !trategy

Product customi!ed for each mar-et Decentrali!ed control 1 local decision ma-ing +ffective .hen large differences e3ist bet.een countries &dvantages4 product differentiation0 local responsiveness0 minimi!ed political ris-0 minimi!ed e3change rate ris-

"lobal !trategy

Product is the same in all countries. $entrali!ed control 1 little decision1ma-ing authority on the local level +ffective .hen differences bet.een countries are small &dvantages4 cost0 coordinated activities0 faster product development

& fully multi1local value chain .ill have every function from RGD to distribution and service performed entirely at the local level in each country. &t the other e3treme0 a fully global value chain .ill source each activity in a different country. Philips is a good e3ample of a company that follo.ed a multidomestic strategy. This strategy resulted in4

#nnovation from local RGD +ntrepreneurial spirit Products tailored to individual countries )igh <uality due to bac-.ard integration

The multi1domestic strategy also presented Philips .ith many challenges4

)igh costs due to tailored products and duplication across countries The innovation from the local RGD groups resulted in products that .ere RGD driven instead of mar-et driven. Decentrali!ed control meant that national buy1in .as re<uired before introducing a product 1 time to mar-et .as slo..

,atsushita is a good e3ample of a company that follo.ed a global strategy. This strategy resulted in4

trong global distribution net.or$ompany1.ide mission statement that .as follo.ed closely *inancial control ,ore applied RGD &bility to get to mar-et <uic-ly and force standards since individual country buy1in .as not necessary.

The global strategy presented ,atsushita .ith the follo.ing challenges4

Problem of strong yen Too much dependency on one product 1 the F$R Boss of non1&sian employees because of glass ceilings

& third strategy0 .hich .as appropriate to 8hirlpool is one of mass customi!ation0 discussed belo..

%lobal #ost Str"ct"re /nal sis #n 1('"0 8hirlpool $orporation .as considering e3panding into +urope by ac<uiring Philips/ ,a2or Domestic &ppliance Division. *rom the frame.or- of customers0 costs0 competitors0 and government0 there .ere several pros and cons to this proposed strategy.

Pros

#nternal components of the appliances could be the same0 offering economies of scale. The cost to customi!e the outer structure of the appliances .as relatively lo.. The appliance industry .as mature .ith lo. gro.th. The ac<uisition .ould offer an avenue to continue gro.ing.

Cons

*ragmented distribution net.or- in +urope. Different consumer needs and preferences. *or e3ample0 in +urope refrigerators tend to be smaller than in the =. .0 have only one outside door0 and have standard si!es so they can be built into the -itchen cabinet. #n @apan0 refrigerators tend to have several doors in order to -eep different compartments at different temperatures and to isolate odors. &lso0 because houses are smaller in @apan0 consumers desire <uieter appliances. 8hirlpool already .as the dominant player in a fragmented industry.

ince Philip/s had a relatively small mar-et share in the +uropean appliance mar-et0 one must analy!e the cost structure to determine if the ac<uisition .ould offer 8hirlpool a competitive advantage. 8ith the ac<uisition0 8hirlpool .ould be able to cut costs on ra. materials0 depreciation and maintenance0 RGD0 and general and administrative costs. These costs represented 53D of 8hirlpool/s cost structure. $ompared to most other industries0 this percentage of costs that could benefit from economies of scale is <uite large. #t .ould be reasonable to e3pect a 1:D reduction in these costs0 an amount that .ould decrease overall cost by 5.3D0 doubling profits. uch potential 2ustifies the ris- of increasing the comple3ity of the organi!ation. ;ecause of the different preferences of consumers in different mar-ets0 a purely global strategy .ith standard products .as not appropriate. 8hirlpool .ould have to adapt its products to local mar-ets0 but maintain some global integration in order to reali!e cost benefits. This strategy is -no.n as Cmass customi!ation.C 8hirlpool ac<uired Philips/ ,a2or Domestic &ppliance Division0 4%D in 1('( and the remainder in 1((1. #nitially0 margins doubled as predicted. )o.ever0 local competitors responded by better tailoring their products and cutting costsA

8hirlpool/s profits then began to decline. 8hirlpool applied the same strategy to &sia0 but 5+ .as outperforming 8hirlpool there by tailoring its products as part of its multi1domestic strategy.

%lobali6ing Service $"sinesses ervice industries tend to have a flat e3perience curve and lo.er economies of scale. )o.ever0 some economy of scale may be gained through -no.ledge sharing0 .hich enables the cost of developing the -no.ledge over a larger base. &lso0 in some industries such as professional services0 capacity utili!ation can better be managed as the scope of operations increases. 9n the customer side0 because a service firm/s customers may themselves be operating internationally0 global e3pansion may be a necessity. ?no.ledge gained in foreign mar-ets can used to better service customers. *inally0 being global also enhances a firm/s reputation0 .hich is critical in service businesses. )igh <uality service products often depend on the service firm/s culture0 and maintaining a consistent culture .hen e3panding globally is a challenge. & good e3ample of a service firm that e3perienced global e3pansion challenges is the management consulting firm ;ain G $ompany0 #nc. #n consulting0 a firm/s most important strategic asset is its reputation0 so a consistent firm culture is very important. ;ain faced the follo.ing challenges0 .hich depend on the firm/s strategy and .hich affect the ability to maintain a consistent culture4

$oordinating across offices and sharing -no.ledge 8hether to hire locals or international staff )o. to compensate

Modes of !oreign Mar)et Entr &n important part of a global strategy is the method that the firm .ill use to enter the foreign mar-et. There are four possible modes of foreign mar-et entry4

+3porting Bicensing 6includes franchising7

@oint Fenture *oreign Direct #nvestment

These options vary in their degree of speed0 control0 and ris-0 as .ell as the re<uired level of investment and mar-et -no.ledge. The entry mode selection can have a significant impact on the firm/s foreign mar-et success.

Iss"es in Emerging Economies #n emerging economies0 capital mar-ets are relatively inefficient. There is a lac- of information0 the cost of capital is high0 and venture capital is virtually none3istent. ;ecause of the scarcity of high1<uality educational institutions0 the labor mar-ets lac- .ell trained people and companies often must fill the void. ;ecause of lac-ing communications infrastructure0 building a brand name is difficult but good brands are highly valued because of lo.er product <uality of the alternatives. Relationships .ith government officials often are necessary to succeed0 and contracts may not be .ell enforced by the legal system. 8hen a large government monopoly 6e.g. a state1o.ned oil company7 is privati!ed0 there often is political pressure in the country against allo.ing the firm to be ac<uired by a foreign entity. 8hereas a very large =. . oil company may prefer ac<uisitions0 because of the anti1foreign sentiment 2oint ventures often are more appropriate for outside companies interested in ne.ly privati!ed emerging economy firms.

7no&ledge Management in %lobal !irms There is much value in transferring -no.ledge and best practices bet.een parts of a global firm. )o.ever0 many barriers prevent -no.ledge from being transferred4

;arriers attributable to the -no.ledge source o lac- of motivation

o

lac- of credibility

;arriers attributable to the -no.ledge itself 1 ambiguity and comple3ity

;arriers attributable to the -no.ledge recipient

o o

lac- of motivation 6not invented here syndrome7 lac- of absorptive capacity 1 need prere<uisite -no.ledge to advance to ne3t level

;arriers attributable to the recipient/s e3isting process 1 process rigidity ;arriers attributable to the recipient/s e3ternal environment and constraints

*urthermore0 even .hen the transfer is successful0 there often is a temporary drop in performance before the improvements are seen. During this period0 there is danger of losing faith in the ne. .ay of doing things. To facilitate -no.ledge transfer a firm can4

#mplement processes to systematically identify valuable -no.ledge and best practices. $reate incentives to motivate both the -no.ledge source and recipient. Develop absorptive capacity in the recipient 1 cumulative -no.ledge Develop strong technical and social net.or-s bet.een parts of the firm that can share -no.ledge.

#o"ntr Management $ountry managers must have the follo.ing -no.ledge4

?no.ledge of strategic management *irm1specific -no.ledge $ountry1specific -no.ledge ?no.ledge of the global environment

$ountry organi!ations can assume the role of implementor0 contributor0 strategic leader0 or blac- hole0 depending on the combination of importance of the local mar-et and local resources.

Strategic Importance of Local Market 4o& 8igh

Level of Local Resources & Capabilities 4o& #mplementor ;lac- )ole 8igh $ontributor trategic Beader

The least favorable of these roles is the blac- hole0 .hich is a subsidiary in a strategically important mar-et that has fe. capabilities. & firm can find itself in this situation because of company traditions0 ignorance of local conditions0 unfavorable entry conditions0 misreading the mar-et0 e3cessive reliance on e3patriates0 and poor e3ternal relations. To get out of a blac- hole a firm can form alliances0 focus its investments0 implement a local RGD organi!ation0 or .hen all else fails0 e3it the country. $ountry managers assume different roles 6The #ew Country anagers0 @ohn &. Puelch0 Professor of ;usiness &dministration0 )arvard ;usiness chool7.

#nternational tructure4 $ountry manager is a trader .ho implements policy. ,ultinational tructure4 $ountry manager plays the role of a functional manager .ith profit and loss responsibilities. Transnational tructure4 $ountry manager acts as a cabinet member 6team player7 since management control systems are standardi!ed and decision1 ma-ing po.er is shifted to the region manager. The country manager develops the lead mar-et in his country and transfers the -no.ledge gained to other similar mar-ets. 5lobal tructure4 $ountry manager acts as an ambassador and administrator. #n a global firm there usually are business directors .ho oversee mar-eting and sales. The role of the country manager becomes one of a statesman. This person usually is a local .ith good government contacts.

Hierarchical Levels of Strategy

trategy can be formulated on three different levels4

corporate level business unit level functional or departmental level.

8hile strategy may be about competing and surviving as a firm0 one can argue that products0 not corporations compete0 and products are developed by business units. The role of the corporation then is to manage its business units and products so that each is competitive and so that each contributes to corporate purposes. $onsider Te3tron0 #nc.0 a successful conglomerate corporation that pursues profits through a range of businesses in unrelated industries. Te3tron has four core business segments4

&ircraft 1 32D of revenues &utomotive 1 25D of revenues #ndustrial 1 3(D of revenues *inance 1 4D of revenues.

8hile the corporation must manage its portfolio of businesses to gro. and survive0 the success of a diversified firm depends upon its ability to manage each of its product lines. 8hile there is no single competitor to Te3tron0 .e can tal- about the competitors and strategy of each of its business units. #n the finance business segment0 for e3ample0 the chief rivals are ma2or ban-s providing commercial financing. ,any managers consider the business level to be the proper focus for strategic planning.

#orporate 4evel Strateg $orporate level strategy fundamentally is concerned .ith the selection of businesses in .hich the company should compete and .ith the development and coordination of that portfolio of businesses. $orporate level strategy is concerned .ith4

Reach 1 defining the issues that are corporate responsibilitiesA these might include identifying the overall goals of the corporation0 the types of businesses in .hich the corporation should be involved0 and the .ay in .hich businesses .ill be integrated and managed. $ompetitive $ontact 1 defining .here in the corporation competition is to be locali!ed. Ta-e the case of insurance4 #n the mid11((:/s0 &etna as a corporation .as clearly identified .ith its commercial and property casualty insurance products. The conglomerate Te3tron .as not. *or Te3tron0 competition in the insurance mar-ets too- place specifically at the business unit level0 through its subsidiary0 Paul Revere. 6Te3tron divested itself of The Paul Revere $orporation in 1((%.7 ,anaging &ctivities and ;usiness #nterrelationships 1 $orporate strategy see-s to develop synergies by sharing and coordinating staff and other resources across business units0 investing financial resources across business units0 and using business units to complement other corporate business activities. #gor &nsoff introduced the concept of synergy to corporate strategy. ,anagement Practices 1 $orporations decide ho. business units are to be governed4 through direct corporate intervention 6centrali!ation7 or through more or less autonomous government 6decentrali!ation7 that relies on persuasion and re.ards.

$orporations are responsible for creating value through their businesses. They do so by managing their portfolio of businesses0 ensuring that the businesses are successful over the long1term0 developing business units0 and sometimes ensuring that each business is compatible .ith others in the portfolio.

$"siness 9nit 4evel Strateg & strategic business unit may be a division0 product line0 or other profit center that can be planned independently from the other business units of the firm. &t the business unit level0 the strategic issues are less about the coordination of operating units and more about developing and sustaining a competitive advantage for the goods and services that are produced. &t the business level0 the strategy formulation phase deals .ith4

positioning the business against rivals

anticipating changes in demand and technologies and ad2usting the strategy to accommodate them influencing the nature of competition through strategic actions such as vertical integration and through political actions such as lobbying.

,ichael Porter identified three generic strategies 6cost leadership0 differentiation0 and focus7 that can be implemented at the business unit level to create a competitive advantage and defend against the adverse effects of the five forces.

!"nctional 4evel Strateg The functional level of the organi!ation is the level of the operating divisions and departments. The strategic issues at the functional level are related to business processes and the value chain. *unctional level strategies in mar-eting0 finance0 operations0 human resources0 and RGD involve the development and coordination of resources through .hich business unit level strategies can be e3ecuted efficiently and effectively. *unctional units of an organi!ation are involved in higher level strategies by providing input into the business unit level and corporate level strategy0 such as providing information on resources and capabilities on .hich the higher level strategies can be based. 9nce the higher1level strategy is developed0 the functional units translate it into discrete action1plans that each department or division must accomplish for the strategy to succeed.

8ori6ontal Integration

The ac<uisition of additional business activities at the same level of the value chain is referred to as hori6ontal integration. This form of e3pansion contrasts .ith vertical integration by .hich the firm e3pands into upstream or do.nstream activities. )ori!ontal gro.th can be achieved by internal e3pansion or by e3ternal

e3pansion through mergers and ac<uisitions of firms offering similar products and services. & firm may diversify by gro.ing hori!ontally into unrelated businesses. ome e3amples of hori!ontal integration include4

The tandard 9il $ompany/s ac<uisition of 4: refineries. &n automobile manufacturer/s ac<uisition of a sport utility vehicle manufacturer. & media company/s o.nership of radio0 television0 ne.spapers0 boo-s0 and maga!ines.

/dvantages of 8ori6ontal Integration The follo.ing are some benefits sought by firms that hori!ontally integrate4

+conomies of scale 1 acheived by selling more of the same product0 for e3ample0 by geographic e3pansion. +conomies of scope 1 achieved by sharing resources common to different products. $ommonly referred to as Csynergies.C #ncreased mar-et po.er 6over suppliers and do.nstream channel members7 Reduction in the cost of international trade by operating factories in foreign mar-ets.

ometimes benefits can be gained through customer perceptions of lin-ages bet.een products. *or e3ample0 in some cases synergy can be achieved by using the same brand name to promote multiple products. )o.ever0 such e3tensions can have dra.bac-s0 as pointed out by &l Ries and @ac- Trout in their mar-eting classic0 Positioning.

Pitfalls of 8ori6ontal Integration )ori!ontal integration by ac<uisition of a competitor .ill increase a firm/s mar-et share. )o.ever0 if the industry concentration increases significantly then anti1trust issues may arise.

&side from legal issues0 another concern is .hether the anticipated economic gains .ill materiali!e. ;efore e3panding the scope of the firm through hori!ontal integration0 management should be sure that the imagined benefits are real. ,any blunders have been made by firms that broadened their hori!ontal scope to achieve synergies that did not e3ist0 for e3ample0 computer hard.are manufacturers .ho entered the soft.are business on the premise that there .ere synergies bet.een hard.are and soft.are. )o.ever0 a connection bet.een t.o products does not necessarily imply reali!able economies of scope. *inally0 even .hen the potential benefits of hori!ontal integration e3ist0 they do not materiali!e spontaneously. There must be an e3plicit hori!ontal strategy in place. uch strategies generally do not arise from the bottom1up0 but rather0 must be formulated by corporate management.

PEST /nal sis

& scan of the e3ternal macro1environment in .hich the firm operates can be e3pressed in terms of the follo.ing factors4

Political Economic Social Technological

The acronym PEST 6or sometimes rearranged as C T+PC7 is used to describe a frame.or- for the analysis of these macro environmental factors. & P+ T analysis fits into an overall environmental scan as sho.n in the follo.ing diagram4

Environmental Scan : E'ternal /nal sis : Macro environment < P5E5S5T5 ; Microenvironment ; Internal /nal sis

Political !actors Political factors include government regulations and legal issues and define both formal and informal rules under .hich the firm must operate. ome e3amples include4

ta3 policy employment la.s environmental regulations trade restrictions and tariffs political stability

Economic !actors +conomic factors affect the purchasing po.er of potential customers and the firm/s cost of capital. The follo.ing are e3amples of factors in the macroeconomy4

economic gro.th interest rates e3change rates

inflation rate

Social !actors ocial factors include the demographic and cultural aspects of the e3ternal macro environment. These factors affect customer needs and the si!e of potential mar-ets. ome social factors include4

health consciousness population gro.th rate age distribution career attitudes emphasis on safety

Technological !actors Technological factors can lo.er barriers to entry0 reduce minimum efficient production levels0 and influence outsourcing decisions. ome technological factors include4

RGD activity automation technology incentives rate of technological change

Porter=s !ive !orces / MO,E4 !O. IN,9ST.> /N/4>SIS

The model of pure competition implies that ris-1ad2usted rates of return should be constant across firms and industries. )o.ever0 numerous economic studies have affirmed that different industries can sustain different levels of profitabilityA part of this difference is e3plained by industry structure. ,ichael Porter provided a frame.or- that models an industry as being influenced by five forces. The strategic business manager see-ing to develop an edge over rival firms can use this model to better understand the industry conte3t in .hich the firm operates.

,iagram of Porter=s ? !orces

S9PP4IE. PO@E.
upplier concentration #mportance of volume to supplier Differentiation of inputs #mpact of inputs on cost or differentiation .itching costs of firms in the industry Presence of substitute inputs Threat of for.ard integration $ost relative to total purchases in industry

$/..IE.S TO ENT.>
&bsolute cost advantages Proprietary learning curve &ccess to inputs 5overnment policy +conomies of scale $apital re<uirements ;rand identity .itching costs &ccess to distribution +3pected retaliation Proprietary products

T8.E/T O! S9$STIT9TES
1 .itching costs 1;uyer inclination to substitute 1Price1performance trade1off of substitutes

$9>E. PO@E.
;argaining leverage ;uyer volume ;uyer information ;rand identity Price sensitivity Threat of bac-.ard integration Product differentiation ;uyer concentration vs. industry ubstitutes available ;uyers/ incentives

,E%.EE O! .I-/4.> 1+3it barriers 1#ndustry concentration 1*i3ed costs>Falue added 1#ndustry gro.th 1#ntermittent overcapacity 1Product differences 1 .itching costs 1;rand identity 1Diversity of rivals 1$orporate sta-es

I5 .ivalr #n the traditional economic model0 competition among rival firms drives profits to !ero. ;ut competition is not perfect and firms are not unsophisticated passive price ta-ers. Rather0 firms strive for a competitive advantage over their rivals. The intensity of rivalry among firms varies across industries0 and strategic analysts are interested in these differences. +conomists measure rivalry by indicators of industry concentration. The $oncentration Ratio 6$R7 is one such measure. The ;ureau of $ensus periodically reports the $R for ma2or tandard #ndustrial $lassifications 6 #$/s7. The $R indicates the percent of mar-et share held by the four largest firms 6$R/s for the largest '0 250 and 5: firms in an industry also are available7. & high concentration ratio indicates that a high concentration of mar-et share is held by the largest firms 1 the industry is concentrated. 8ith only a fe. firms holding a large mar-et share0 the competitive landscape is less competitive 6closer to a monopoly7. & lo.

concentration ratio indicates that the industry is characteri!ed by many rivals0 none of .hich has a significant mar-et share. These fragmented mar-ets are said to be competitive. The concentration ratio is not the only available measureA the trend is to define industries in terms that convey more information than distribution of mar-et share. #f rivalry among firms in an industry is lo.0 the industry is considered to be disciplined. This discipline may result from the industry/s history of competition0 the role of a leading firm0 or informal compliance .ith a generally understood code of conduct. +3plicit collusion generally is illegal and not an optionA in lo.1rivalry industries competitive moves must be constrained informally. )o.ever0 a mavericfirm see-ing a competitive advantage can displace the other.ise disciplined mar-et. 8hen a rival acts in a .ay that elicits a counter1response by other firms0 rivalry intensifies. The intensity of rivalry commonly is referred to as being cutthroat0 intense0 moderate0 or .ea-0 based on the firms/ aggressiveness in attempting to gain an advantage. #n pursuing an advantage over its rivals0 a firm can choose from several competitive moves4

$hanging prices 1 raising or lo.ering prices to gain a temporary advantage. #mproving product differentiation 1 improving features0 implementing innovations in the manufacturing process and in the product itself. $reatively using channels of distribution 1 using vertical integration or using a distribution channel that is novel to the industry. *or e3ample0 .ith high1end 2e.elry stores reluctant to carry its .atches0 Time3 moved into drugstores and other non1traditional outlets and cornered the lo. to mid1price .atch mar-et. +3ploiting relationships .ith suppliers 1 for e3ample0 from the 1(5:/s to the 1(%:/s ears0 Roebuc- and $o. dominated the retail household appliance mar-et. ears set high <uality standards and re<uired suppliers to meet its demands for product specifications and price.

The intensity of rivalry is influenced by the follo.ing industry characteristics4 1. / larger n"mber of firms increases rivalry because more firms must compete for the same customers and resources. The rivalry intensifies if the firms have similar mar-et share0 leading to a struggle for mar-et leadership.

2. Slo& mar)et gro&th causes firms to fight for mar-et share. #n a gro.ing mar-et0 firms are able to improve revenues simply because of the e3panding mar-et. 3. 8igh fi'ed costs result in an economy of scale effect that increases rivalry. 8hen total costs are mostly fi3ed costs0 the firm must produce near capacity to attain the lo.est unit costs. ince the firm must sell this large <uantity of product0 high levels of production lead to a fight for mar-et share and results in increased rivalry. 4. 8igh storage costs or highl perishable prod"cts cause a producer to sell goods as soon as possible. #f other producers are attempting to unload at the same time0 competition for customers intensifies. 5. 4o& s&itching costs increases rivalry. 8hen a customer can freely s.itch from one product to another there is a greater struggle to capture customers. ". 4o& levels of prod"ct differentiation is associated .ith higher levels of rivalry. ;rand identification0 on the other hand0 tends to constrain rivalry. %. Strategic sta)es are high .hen a firm is losing mar-et position or has potential for great gains. This intensifies rivalry. '. 8igh e'it barriers place a high cost on abandoning the product. The firm must compete. )igh e3it barriers cause a firm to remain in an industry0 even .hen the venture is not profitable. & common e3it barrier is asset specificity. 8hen the plant and e<uipment re<uired for manufacturing a product is highly speciali!ed0 these assets cannot easily be sold to other buyers in another industry. Bitton #ndustries/ ac<uisition of #ngalls hipbuilding facilities illustrates this concept. Bitton .as successful in the 1(":/s .ith its contracts to build Eavy ships. ;ut .hen the Fietnam .ar ended0 defense spending declined and Bitton sa. a sudden decline in its earnings. &s the firm restructured0 divesting from the shipbuilding plant .as not feasible since such a large and highly speciali!ed investment could not be sold easily0 and Bitton .as forced to stay in a declining shipbuilding mar-et. (. / diversit of rivals .ith different cultures0 histories0 and philosophies ma-e an industry unstable. There is greater possibility for maveric-s and for mis2udging rival/s moves. Rivalry is volatile and can be intense. The hospital industry0 for e3ample0 is populated by hospitals that historically are community or charitable institutions0 by hospitals that are associated .ith

religious organi!ations or universities0 and by hospitals that are for1profit enterprises. This mi3 of philosophies about mission has lead occasionally to fierce local struggles by hospitals over .ho .ill get e3pensive diagnostic and therapeutic services. &t other times0 local hospitals are highly cooperative .ith one another on issues such as community disaster planning.

1:. Ind"str Sha)eo"t5 & gro.ing mar-et and the potential for high profits induces ne. firms to enter a mar-et and incumbent firms to increase production. & point is reached .here the industry becomes cro.ded .ith competitors0 and demand cannot support the ne. entrants and the resulting increased supply. The industry may become cro.ded if its gro.th rate slo.s and the mar-et becomes saturated0 creating a situation of e3cess capacity .ith too many goods chasing too fe. buyers. & sha-eout ensues0 .ith intense competition0 price .ars0 and company failures. ;$5 founder ;ruce )enderson generali!ed this observation as the Rule of Three and *our4 a stable mar-et .ill not have more than three significant competitors0 and the largest competitor .ill have no more than four times the mar-et share of the smallest. #f this rule is true0 it implies that4
o o o o o

#f there is a larger number of competitors0 a sha-eout is inevitable urviving rivals .ill have to gro. faster than the mar-et +ventual losers .ill have a negative cash flo. if they attempt to gro. &ll e3cept the t.o largest rivals .ill be losers The definition of .hat constitutes the Cmar-etC is strategically important.

8hatever the merits of this rule for stable mar-ets0 it is clear that mar-et stability and changes in supply and demand affect rivalry. $yclical demand tends to create cutthroat competition. This is true in the disposable diaper industry in .hich demand fluctuates .ith birth rates0 and in the greeting card industry in .hich there are more predictable business cycles. II5 Threat of S"bstit"tes

#n Porter/s model0 substitute products refer to products in other industries. To the economist0 a threat of substitutes e3ists .hen a product/s demand is affected by the price change of a substitute product. & product/s price elasticity is affected by substitute products 1 as more substitutes become available0 the demand becomes more elastic since customers have more alternatives. & close substitute product constrains the ability of firms in an industry to raise prices. The competition engendered by a Threat of ubstitute comes from products outside the industry. The price of aluminum beverage cans is constrained by the price of glass bottles0 steel cans0 and plastic containers. These containers are substitutes0 yet they are not rivals in the aluminum can industry. To the manufacturer of automobile tires0 tire retreads are a substitute. Today0 ne. tires are not so e3pensive that car o.ners give much consideration to retreading old tires. ;ut in the truc-ing industry ne. tires are e3pensive and tires must be replaced often. #n the truc- tire mar-et0 retreading remains a viable substitute industry. #n the disposable diaper industry0 cloth diapers are a substitute and their prices constrain the price of disposables. 8hile the treat of substitutes typically impacts an industry through price competition0 there can be other concerns in assessing the threat of substitutes. $onsider the substitutability of different types of TF transmission4 local station transmission to home TF antennas via the air.ays versus transmission via cable0 satellite0 and telephone lines. The ne. technologies available and the changing structure of the entertainment media are contributing to competition among these substitute means of connecting the home to entertainment. +3cept in remote areas it is unli-ely that cable TF could compete .ith free TF from an aerial .ithout the greater diversity of entertainment that it affords the customer. III5 $" er Po&er The po.er of buyers is the impact that customers have on a producing industry. #n general0 .hen buyer po.er is strong0 the relationship to the producing industry is near to .hat an economist terms a monopson 1 a mar-et in .hich there are many suppliers and one buyer. =nder such mar-et conditions0 the buyer sets the price. #n reality fe. pure monopsonies e3ist0 but fre<uently there is some asymmetry bet.een a producing industry and buyers. The follo.ing tables outline some factors that determine buyer po.er.
I-5

S"pplier Po&er

& producing industry re<uires ra. materials 1 labor0 components0 and other supplies. This re<uirement leads to buyer1supplier relationships bet.een the industry and the firms that provide it the ra. materials used to create products. uppliers0 if po.erful0 can e3ert an influence on the producing industry0 such as selling ra. materials at a high price to capture some of the industry/s profits. The follo.ing tables outline some factors that determine supplier po.er. -5 $arriers to Entr : Threat of Entr #t is not only incumbent rivals that pose a threat to firms in an industryA the possibility that ne. firms may enter the industry also affects competition. #n theory0 any firm should be able to enter and e3it a mar-et0 and if free entry and e3it e3ists0 then profits al.ays should be nominal. #n reality0 ho.ever0 industries possess characteristics that protect the high profit levels of firms in the mar-et and inhibit additional rivals from entering the mar-et. These are barriers to entry. ;arriers to entry are more than the normal e<uilibrium ad2ustments that mar-ets typically ma-e. *or e3ample0 .hen industry profits increase0 .e .ould e3pect additional firms to enter the mar-et to ta-e advantage of the high profit levels0 over time driving do.n profits for all firms in the industry. 8hen profits decrease0 .e .ould e3pect some firms to e3it the mar-et thus restoring a mar-et e<uilibrium. *alling prices0 or the e3pectation that future prices .ill fall0 deters rivals from entering a mar-et. *irms also may be reluctant to enter mar-ets that are e3tremely uncertain0 especially if entering involves e3pensive start1up costs. These are normal accommodations to mar-et conditions. ;ut if firms individually 6collective action .ould be illegal collusion7 -eep prices artificially lo. as a strategy to prevent potential entrants from entering the mar-et0 such entr -deterring pricing establishes a barrier. ;arriers to entry are uni<ue industry characteristics that define the industry. ;arriers reduce the rate of entry of ne. firms0 thus maintaining a level of profits for those already in the industry. *rom a strategic perspective0 barriers can be created or e3ploited to enhance a firm/s competitive advantage. ;arriers to entry arise from several sources4 1. %overnment creates barriers5 &lthough the principal role of the government in a mar-et is to preserve competition through anti1trust actions0 government also restricts competition through the granting of monopolies and through regulation. #ndustries such as utilities are considered natural monopolies because it has been more efficient to have one electric company provide

po.er to a locality than to permit many electric companies to compete in a local mar-et. To restrain utilities from e3ploiting this advantage0 government permits a monopoly0 but regulates the industry. #llustrative of this -ind of barrier to entry is the local cable company. The franchise to a cable provider may be granted by competitive bidding0 but once the franchise is a.arded by a community a monopoly is created. Bocal governments .ere not effective in monitoring price gouging by cable operators0 so the federal government has enacted legislation to revie. and restrict prices. The regulatory authority of the government in restricting competition is historically evident in the ban-ing industry. =ntil the 1(%:/s0 the mar-ets that ban-s could enter .ere limited by state governments. &s a result0 most ban-s .ere local commercial and retail ban-ing facilities. ;an-s competed through strategies that emphasi!ed simple mar-eting devices such as a.arding toasters to ne. customers for opening a chec-ing account. 8hen ban-s .ere deregulated0 ban-s .ere permitted to cross state boundaries and e3pand their mar-ets. Deregulation of ban-s intensified rivalry and created uncertainty for ban-s as they attempted to maintain mar-et share. #n the late 1(%:/s0 the strategy of ban-s shifted from simple mar-eting tactics to mergers and geographic e3pansion as rivals attempted to e3pand mar-ets. 2. Patents and proprietar )no&ledge serve to restrict entr into an ind"str 5 #deas and -no.ledge that provide competitive advantages are treated as private property .hen patented0 preventing others from using the -no.ledge and thus creating a barrier to entry. +d.in Band introduced the Polaroid camera in 1(4% and held a monopoly in the instant photography industry. #n 1(%50 ?oda- attempted to enter the instant camera mar-et and sold a comparable camera. Polaroid sued for patent infringement and .on0 -eeping ?oda- out of the instant camera industry. 3. /sset specificit inhibits entr into an ind"str 5 &sset specificity is the e3tent to .hich the firm/s assets can be utili!ed to produce a different product. 8hen an industry re<uires highly speciali!ed technology or plants and e<uipment0 potential entrants are reluctant to commit to ac<uiring speciali!ed assets that cannot be sold or converted into other uses if the venture fails. &sset specificity provides a barrier to entry for t.o reasons4 *irst0 .hen firms already hold speciali!ed assets they fiercely resist efforts by others from ta-ing their mar-et share. Ee. entrants can anticipate aggressive rivalry. *or e3ample0 ?oda- had much capital invested in its photographic e<uipment business and aggressively resisted efforts by *u2i to intrude in its mar-et. These assets are both large and industry specific. The second reason is that

potential entrants are reluctant to ma-e investments in highly speciali!ed assets. 4. Organi6ational *Internal+ Economies of Scale5 The most cost efficient level of production is termed Minim"m Efficient Scale 6,+ 7. This is the point at .hich unit costs for production are at minimum 1 i.e.0 the most cost efficient level of production. #f ,+ for firms in an industry is -no.n0 then .e can determine the amount of mar-et share necessary for lo. cost entry or cost parity .ith rivals. *or e3ample0 in long distance communications roughly 1:D of the mar-et is necessary for ,+ . #f sales for a long distance operator fail to reach 1:D of the mar-et0 the firm is not competitive. The e3istence of such an economy of scale creates a barrier to entry. The greater the difference bet.een industry ,+ and entry unit costs0 the greater the barrier to entry. o industries .ith high ,+ deter entry of small0 start1up businesses. To operate at less than ,+ there must be a consideration that permits the firm to sell at a premium price 1 such as product differentiation or local monopoly.

;arriers to e3it .or- similarly to barriers to entry. +3it barriers limit the ability of a firm to leave the mar-et and can e3acerbate rivalry 1 unable to leave the industry0 a firm must compete. ome of an industry/s entry and e3it barriers can be summari!ed as follo.s4

Eas to Enter if there is:

,iffic"lt to Enter if there is:

$ommon technology Bittle brand franchise &ccess to distribution channels Bo. scale threshold

Patented or proprietary -no.1ho. Difficulty in brand s.itching Restricted distribution channels )igh scale threshold

Eas to E'it if there are:

,iffic"lt to E'it if there are:

alable assets

peciali!ed assets

Bo. e3it costs #ndependent businesses

)igh e3it costs #nterrelated businesses

,>N/MI# N/T9.E O! IN,9ST.> .I-/4.> 9ur descriptive and analytic models of industry tend to e3amine the industry at a given state. The nature and fascination of business is that it is not static. 8hile .e are prone to generali!e0 for e3ample0 list 5,0 *ord0 and $hrysler as the C;ig 3C and assume their dominance0 .e also have seen the automobile industry change. $urrently0 the entertainment and communications industries are in flu3. Phone companies0 computer firms0 and entertainment are merging and forming strategic alliances that re1map the information terrain. chumpeter and0 more recently0 Porter have attempted to move the understanding of industry competition from a static economic or industry organi!ation model to an emphasis on the interdependence of forces as dynamic0 or punctuated e$uilibrium0 as Porter terms it. #n chumpeter/s and Porter/s vie. the dynamism of mar-ets is driven by innovation. 8e can envision these forces at .or- as .e e3amine the follo.ing changes4