MMVA ZG512 Manufacturing

Strategy
Rajiv Gupta
BITS Pilani
Session 3
 Session 3
• Module 1
– Recap of Session 2
• Module 2
– Porter’s 5 Forces of Competition (contd.)
• Threat of Substitute Products
• Module 3
– Porter’s 5 Forces of Competition (contd.)
• Bargaining Power of Buyers
• Bargaining Power of Suppliers
• Module 4
– Structural Analysis and Competitive Strategy
• Module 5
– Summary and Wrap-up

2
 Session 3
• Begin Module 1
– Recap of Session 2

3
 Recap of Session 2
• In Session 2, we discussed the role that
manufacturing plays in the formulation of
business strategy
• We discussed how, in several companies,
manufacturing plays a reactive rather than a
proactive role
• Manufacturing represents the largest investment
among all functional areas and it is important
that we give importance to the function during
strategy development
4
 Recap of Session 2
• We began the discussion on Michael
Porter’s 5 Forces that determine the
competitive structure of an industry
• The first two of these forces, i.e., The
Barriers to Entry and the Rivalry among
Existing Competitors were discussed.

5
 Session 3
• End of module 1

6
 Session 3
• Begin Module 2
– Porter’s 5 Forces of Competition (contd.)
• Threat of Substitute Products

7
 The Porter Framework
Industry Profitability is Determined by

Threat of
New Entrants

Bargaining Power Rivalry Among Bargaining Power

of Suppliers Existing Competitors of Buyers

Threat of Substitute
Products or Services
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 Threat of Substitute Products
Substitutes limit potential returns through
pricing
• Functionally equivalent products
• Threat from products with trends improving
price performance tradeoff versus the
industry’s product
• Threat from products produced by industries
earning high profits.
• Collective industry response may improve
position

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 Threat of Substitute Products
• Functionally equivalent products
– Certain products may be considered different, but
could perform a similar function, e.g., sugar vs. high
fructose corn syrup, fiberglass vs styrofoam for
insulation
– With functionally equivalent products, people are
concerned about the cost vs. difference in
performance
– Similar examples exist in services, e.g., rail vs. road
vs. air transport

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 Threat of Substitute Products
• Products with trends improving price
performance tradeoffs
– Electronics industry has a long term trend toward
improving price performance ratios
– Replacement of tapes with CDs, with DVDs with
memory sticks

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 Threat of Substitute Products
• Products produced by industries earning high
profits
– Substitutes come into play when some technical
development leads to price reduction or performance
improvement
– Companies can analyze such trends to see whether
they can take actions to ward off the threat or use it
as part of their own strategy
– Example can be the use of electronic surveillance
systems replacing security guards. Companies can
opt to offer packages combining the two with the
security guards assuming a more skilled role
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 Threat of Substitute Products
• Collective industry response may improve
position
– When an industry is faced with a threat of a substitute
product, advertising is sometimes used to point out
the strength of existing products or weaknesses of the
substitutes
– If the industry takes a collective step in advertising, it
has a bigger impact as opposed to the efforts of a
single company

13
 Session 3
• End of module 2

14
 Session 3
• Begin Module 3
– Porter’s 5 Competive Forces
• Bargaining Power of Buyers
• Bargaining Power of Suppliers

15
 The Porter Framework
Industry Profitability is Determined by

Threat of
New Entrants

Bargaining Power Rivalry Among Bargaining Power

of Suppliers Existing Competitors of Buyers

Threat of Substitute
Products or Services
16
 Bargaining Power of Buyers
Buyers are powerful from the following factors
• Few customers
• Purchases represent a significant amount of
buyer’s costs
• Purchases are undifferentiated or standard
• Low switching costs
• Low profitability
• Threat of backward integration
• Industry’s product is unimportant to the quality of
the buyer’s products or services
• Full information about markets, prices and costs
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 Bargaining Power of Buyers
• Few customers
– When few, large customers exist, they can exert
significant pressure for more favorable terms
– If the buyer represents a large fraction of the sales,
losing the customer can be a large loss
• Purchases represent a significant amount of
buyer’s costs
– If the purchase represents a large amount of the
buyer’s costs, he will attempt to shop for a favorable
price as the reduction will have a significant impact on
his total cost, i.e., he is more price sensitive

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 Bargaining Power of Buyers
• Purchases are undifferentiated or standard
– With fewer differences among competing products,
the buyer has more options and is less inclined to pay
a higher price
• Low switching costs
– High switching costs tie a buyer to a particular seller.
Conversely, low switching costs free up the buyer to
look at alternatives

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 Bargaining Power of Buyers
• Low profitability
– When the buyer’s company is not very profitable, there is
greater pressure to reduce costs of purchased parts.
Hence more intense bargaining/negotiations.
– A more profitable company tends to be less price sensitive
• Threat of backward integration
– When the buyer’s company can integrate backward, it is a
threat to loss of business and can force a company to
negotiate
– Some companies decide to make some of the parts in-
house to keep the threat of backward integration credible

20
 Bargaining Power of Buyers
• Industry’s product is unimportant to the quality of
the buyer’s products or services
– When the quality of the buyer’s product is affected by
the product, the buyer will be less price sensitive
– This happens when the part is a critical part, e.g., oil-
field equipment or medical equipment
• Full information about markets, prices and costs
– When the buyer has information about demand,
market prices, and the supplier costs, he is in a better
position to negotiate

21
 Bargaining Power of Suppliers
Suppliers are powerful from the following
factors
• Few suppliers
• Little threat from substitutes
• Industry is not an important customer of the
supplier
• Supplier’s product is an important input to
buyer’s business
• High product differentiation or switching costs
• Threat of forward integration
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 Bargaining Power of Suppliers
• Few suppliers
– When there are few, powerful suppliers, they
exert a great influence on prices and purchase
terms
– Also when the buyers are fragmented and small
• Little threat from substitutes
– Even large suppliers have to be careful if there
are substitute products in the market
– However, if the threat of substitutes is low, the
supplier can exert more pricing power

23
 Bargaining Power of Suppliers
• Industry is not an important customer of the
supplier
– If a particular industry/company does not represent a
large percentage of the sales of a company, the seller
is not too concerned about the loss of business
– However, if the buyer is an important buyer, the seller
will be more flexible in negotiation
• Supplier’s product is an important input to buyer’s
business
– If the supplier’s product is critical to the buyer’s
business this raises the bargaining power of the seller
– This also happens when the product is not easily
stored
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 Bargaining Power of Suppliers
• High product differentiation or switching
costs
– High differentiation or switching costs work in
favor of the seller.
– Low differentiation or switching costs work in
favor of the buyer
• Threat of forward integration
– When the supplier shows a credible threat of
forward integration, it can give him greater
bargaining power
25
 Session 3
• End of module 3

26
 Session 3
• Begin Module 4
– Structural Analysis and Competitive Strategy

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 Structural Analysis
• Once a company understands the forces that
affect their competitive position, it can identify
its strengths and weaknesses vis a vis the
market and the competition
• The company is in a position to evaluate
whether there is a credible threat of substitute
products, whether they have a significant
barrier to entry by a new competitor, what is
their position vis a vis existing competitors,
etc.
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 Possible Approaches
• As a result of assessing the current competitive
threats, a company can decide to either take an
offensive or a defensive approach relative to its
own position
• Specific actions can include
– Positioning the firm to provide the best defense
against existing competitive forces
– Influencing the balance of forces through strategic
moves
– Anticipating shifts in factors and responding to them

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 Possible Approaches
• Positioning the firm
– The company takes the structure of the competition
and matches its own strengths and weaknesses to it.
– The company tries to build defense in their weak
areas and tries to exploit the points of weakness in
the competition
– There could be certain area where the company
should confront the competition, and where they
should avoid confrontation
– Example could be a low cost producer selling to
buyers that are not subject to competition from
substitutes 30
 Possible Approaches
• Influencing the balance
– This is a more aggressive approach
– Here the company does not merely try to take into
account the current competitive scenario, but also
tries to change it to its own advantage
– Examples could be aggressive marketing to create
differentiation for the product or service or large
capital investments to create barriers to entry for
newcomers

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 Possible Approaches
• Anticipating shifts
– Industry tends to evolve. Some patterns of evolution
are predictable, e.g., as an industry grows mature, the
growth rates slow down, and advertising declines
– Companies need to evaluate whether these trends
affect the structure of competition. For example in
mature industries, differentiation is reduced. This
increases the power of buyers and lowers barriers to
entry. So competition would increase.

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 Strategy Framework
• Where are we now? Where are we taking
the business?
• How are we going to position our business?
• How are we going to get there?
• What are our options? What are our
competitors’ options?
• What are the five or six most critical
assumptions?

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 Strategy Framework
• What acquisition candidates will be
tracked and or acquired to implement the
strategy? What joint ventures or major
licensing arrangements will be pursued?
• What internal actions are needed to
support Strategy?

34
 Session 3
• End of module 4

35
 Session 3
• Begin Module 5
– Summary and wrap up

36
 Summary
• In this class we completed the discussion on
Porter’s Structure of 5 Competitive Forces
• Specifically we discussed the Threat of
Substitute Products, The Bargaining Power of
Buyers and the Bargaining Power of Suppliers
• The Threat of Substitute Products can put
pressure on a company to be more flexible in
negotiations. The threat is greater or less
depending on different structural elements

37
 Summary
• The Bargaining Power of powerful Buyers tends
to bring down the prices of products when the
seller has less clout in the market
• The Bargaining Power of Sellers tends to drive
up prices of purchased parts and raw materials
when the sellers have a strong presence
• Companies need to determine what is the best
way in which they ought to address the threats
from all 5 force after careful evaluation of their
situation
38
 Session 3
• End Module 5
– Summary and wrap up

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