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Business Strategy

External Environment

Prof. Dr. Bernd Venohr Berlin, April 2007

2007 Prof. Dr. Bernd Venohr

Agenda
Introduction to Strategy
1 2 3 4 5 6 7 8 9 Course Overview and Strategy Concept Economics of Strategy Shareholder Value External Environment Internal Environment Competitive Positioning Diversification Mergers & Acquisitions Global Strategy

Business Strategy

Corporate Strategy

Strategy Process
10 Organizational Structure and Control 11 Strategic Leadership
2007 Prof. Dr. Bernd Venohr

Agenda
Introduction to Strategy 4 External Environment

- General environment analysis - Industry analysis - Summary and Outlook next Session

2007 Prof. Dr. Bernd Venohr

Where are we today?


Introduction to Strategy 1
Course Overview Strategy Concept

Economics of Strategy

3 Business Strategy 4
External Environment

Shareholder Value

Corporate Strategy 7 8
Diversification Global Strategy

Internal Environment

Competitive Positioning

Mergers & Acquisitions

Strategy Process 10
Organizational Structure and Control

11 Leadership
2007 Prof. Dr. Bernd Venohr

Strategic

General purpose of external analysis


Identify
Opportunities: conditions that may help firm achieve strategic competitiveness Threats: hinders or constrains firms pursuit of strategic competitiveness

Two types of environment


Macro environment Micro environment (industry)
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

General environment (macro environment)


Demographic Population size, age structure, geographic mix, ethnicity, income distribution Socio cultural Social attitudes, cultural values Political / legal Arena of competition for attention and resources from govt. Law and regulations guiding competition
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

Technological Institutions and activities that effect knowledge creation Translation of new knowledge into new products and processes Economic Nature and direction of macro economy

PEST is an acronym for Political, Economic, Social and Technological factors


political
Ecological / environm ental issues current legislation hom e m arket future legislation European / international legislation regulatory bodies and processes governm ent policies governm ent term and change trading policies funding, grants and initiatives hom e m arket lobbying / pressure groups international pressure groups lifestyle trends dem ographics consum er attitudes and opinions m edia view s law changes affecting social factors brand, com pany, technology im age consum er buying patterns fashion and role m odels m ajor events and influences buying access and trends Ethnic / religious factors advertising and publicity

economic
hom e econom y situation hom e econom y trends overseas econom ies and trends general taxation issues taxation specific to product/services Seasonality / w eather issues m arket and trade cycles specific industry factors m arket routes and distribution trends Custom er / end-user drivers interest and exchange rates com peting technology developm ent research funding Associated / dependent technologies replacem ent technology / solutions m aturity of technology m anufacturing m aturity and capacity inform ation and com m unications consum er buying m echanism s / technology technology legislation innovation potential technology access, licencing, patents intellectual property issues

social

technological

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

Agenda
Introduction to Strategy 4 External Environment

- General environment analysis - Industry analysis - Summary and Outlook next Session

2007 Prof. Dr. Bernd Venohr

Objectives of industry analysis Explain and predict the average long-term profitability of the companies in a particular industry: empirical results show substantial and sustained differences in profitability among industries Gain understanding of profit differences among competitors in the same industry (= relative performance): empirical results show that they are very often large and longlived. Industry attributes shape such within-industry differences and enable companies to pursue strategies
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004) Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy
2007 Prof. Dr. Bernd Venohr

Process of industry analysis (microenvironment)

Define industry boundaries Identify the participants Highlight the drivers of long term industry profitability (= five forces) Identify the factors that drive each force Assess the strength of each force Conclusion: Assess industry profitability potential
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

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Michael Porter Background


Michael E. Porter is the Bishop William Laurence University Professor at the Harvard Business School. He has written eighteen books and countless articles. His main book Competitive Strategy (1980), Techniques for Analyzing Industries and Competitors, is now in its 63rd imprint and has been translated into 17 languages. His second major strategy book, Competitive Advantage, is in its 34th printing. Porter subsequently moved from competition between firms to competition between nations. In The Competitive Advantage of Nations (1990) he examined how some states were wealthy and why others were not. Porter als has been very active in consulting with major corporations worldwide and advises governments on economic strategies
Source: Wikepedia
2007 Prof. Dr. Bernd Venohr

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The art of strategy: to find an advantaged competitive position in an attractive industry

Advantage

Competitive position

In

a re c

sin

u et r

ns r

Disadvantage Lo Industry attractiveness Hi

2007 Prof. Dr. Bernd Venohr

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Porter Framework: Five Forces determine industry attractiveness


In any competitive industry there are five basic forces at work that determine long-term industry profitability.*The collective strength of these five forces determines the potential for firms in the industry to earn returns on investment in excess of opportunity cost of capital (= industry attractiveness) Underlying each of the five forces are a number of economic and technical determinants of its strengths in a particular industry: e.g. the threat of entry is a function of 7 types of structural entry barriers and the expected retaliation of encumbents, itself a function of some predictable industry characteristics
*The structure of the industry should be considered separately from short term fluctuations in the industry for example, variations in demand or cyclical economic conditions Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
2007 Prof. Dr. Bernd Venohr

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Porter Framework: Competitive Position determines profits differences vis-a-vis direct competitors (= relative performance versus competitors)
Holding industry constant, some firms do better because of their relative competitive position, or competitive advantage, within the industry Basic economics of strategy: a company cannot earn superior returns unless it achieves either lower average costs or higher average prices than its competitors. The gap between a firms profitability and industry average profitability can be composed in cost and price components

Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
2007 Prof. Dr. Bernd Venohr

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Porter Framework: There are two basic types of competitive advantage = price - cost to increase , a firm must either : Decrease cost below its competitors Cost leadership Increase price above its competitors Differentiation

Generic Strategies (Porter)


Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
2007 Prof. Dr. Bernd Venohr

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Porters five forces framework brings three new aspects to economic analysis
Relax assumption of both large numbers of competitors / buyers and homogeneity (oligopolistic rivalry instead of perfectly competitive market in which behavior of market participants will be immaterial to one another, need for strategy) Along vertical dimension shift from two-stage vertical chains consisting of a supplier and a buyer to three-stage chains made up of suppliers, rivals, buyers Create new horizontal dimension: account for potential entrants and substitutes

Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
2007 Prof. Dr. Bernd Venohr

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Porters Five Forces of Competition Framework: the collective strength of the five forces determines an industrys long-term profitability and potential for value creation
SUPPLIERS
Bargaining power of suppliers INDUSTRY COMPETITORS POTENTIAL ENTRANTS Threat of new entrants Rivalry among existing firms Threat of SUBSTITUTES substitutes

Bargaining power of buyers

BUYERS
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Industry Boundaries: Before one can analyze an industry one must define it
Key challenge: standard statistical definitions only partly relevant official statistical definitions (SIC codes; NACE codes) are mostly based on technical input considerations (=e.g. metal manufacturer) that rarely correspond to competitively relevant industry conditions (=e.g. car components manufacturer) it is rare that a company is in direct competition with every company statistically defined as being in its industry; on the other hand it is likely that the firm competes with many companies outside the industry Company perspective important: who are my competitors? substitution on demand side: competitors that offer products or services that are close substitutes substitution on supply side/ technological substitutability: can know how and production equipment be cross-utilized between two product lines?
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004) Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy
2007 Prof. Dr. Bernd Venohr

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Three Scope issues in defining an industry


Horizontal: across product markets (narrow or broad definitions of substitutes)

Vertical: along value chain (how many vertically linked stages?)

Geographic: across local / regional / national boundaries (are physically separate markets treated as being served by the same industry or different industries?)

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004) Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy
2007 Prof. Dr. Bernd Venohr

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The concept of value proposition helps to define the horizontal scope (=substitution products from the customer perspective)
What Customers? Which Needs?

What end
users?

What
channels?

What Relative Price?

Which products? Which features? Which services?

Entrepreneurial/creative process: A new value proposition can create a new industry


Source: Michael M. Porter; What is strategy? World Business Forum, June 6, 2006
2007 Prof. Dr. Bernd Venohr

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The concept of value chain helps to define the vertical scope of an industry
Separate value chains One Integrated value chain

Ability to Leverage Key Activities Across Businesses


Firm Infrastructure (e.g. Financing, Planning, Inv estor Relations) Support Activ ities Human Resource Management (e.g. Recruiting, Training, Compensation System) Technology Dev elopment (e.g. Product Design, Testing, Process Design, Material Research, Market Research) Procurement (e.g. Components, Machinery, Adv ertising, Serv ices) Inbound Logistics (e.g. Incoming Material Storage, Data Collection, Serv ice, Customer Access) Operations (e.g. Assembly, Component Fabrication, Branch Operations) Outbound Logistics (e.g. Order Processing, Warehousing, Report Preparation) Marketing & Sales (e.g. Sales Force, Promotion, Adv ertising, Proposal Writing, Web site) After-Sales Serv ice (e.g. Installation, Customer Support, Complaint Resolution, Repair)

M a r g i n

Value: What buyers are willing to pay

Primary Activ ities

Source: Michael M. Porter; What is strategy? World Business Forum, June 6, 2006
2007 Prof. Dr. Bernd Venohr

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The degree of integration of value chains across boarders helps to define the geographic scope of an industry
Local Separate local value chains Regional National CrossNational Global Integrated global value chain

Ability to Leverage Key Activities Across Geography


Firm Infrastructure
(e.g. Financing, Planning, Investor Relations)

Support Activities

Human Resource Management


(e.g. Recruiting, Training, Compensation System)

Technology Development
(e.g. Product Design, Testing, Process Design, Material Research, Market Research)

M a r g

Procurement
(e.g. Components, Machinery, Advertising, Services)

Value What buyers are willing to pay

Inbound Logistics
(e.g. Incoming Material Storage, Data Collection, Service, Customer Access)

Operations
(e.g. Assembly, Component Fabrication, Branch Operations)

Outbound Logistics
(e.g. Order Processing, Warehousing, Report Preparation)

Marketing & Sales


(e.g. Sales Force, Promotion, Advertising, Proposal Writing, Web site)

After-Sales Service
(e.g. Installation, Customer Support, Complaint Resolution, Repair)

i n

Primary Activities

A distinct strategy is needed for each relevant geographic market


Source: Michael M. Porter; What is strategy? World Business Forum, June 6, 2006
2007 Prof. Dr. Bernd Venohr

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Industry definition: Example car industry


What industry is BMW in?: World Auto industry European Auto industry World luxury car industry? Key criterion: SUBSTITUTABILITY On the demand side: Are buyers willing to substitute between types of cars and across countries (=similar value proposition)? On the supply side: Are manufacturers able to switch production between types of cars and across countries based on an integrated global value chain? May need to analyze industry at different levels for different types of decision
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

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Segmenting the world automobile market


REGION
US&Canada W.Europe Luxury Cars Full-size sedans Mid-size sedans Small sedans Station wagons Passenger minivans Sports cars Sport-utility Pick-up trucks E.Europe Asia Lat.America Australia Africa

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

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A strategic group is a group of firms in an industry following the same or similar strategy

Identifying strategic groups: Identify principal strategic variables which distinguish firms Position each firm in relation to these variables Identify clusters
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

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Strategic Group Mapping: Firms in same strategic group have two or more competitive characteristics in common

Sell in same price/quality range Cover same geographic areas Be vertically integrated to same degree Have comparable product line breadth Emphasize same types of distribution channels Offer buyers similar services Use identical technological approaches
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2007 Prof. Dr. Bernd Venohr

Strategic groups in the world automobile industry


Broad
REGIONALLY-FOCUSED BROAD-LINE PRODUCERS e.g. Fiat, PSA, Renault, Kia, NATIONALLY FOCUSED, INTERMEDIATE LINE PRODUCERS e.g. Tofas, Proton, Maruti First Auto Works (China) GLOBAL, BROAD-LINE PRODUCERS e.g., GM, Ford, Toyota, Nissan, Honda, VW, DaimlerChrysler GLOBAL SUPPLIERS OF NARROW MODEL RANGE e.g., Subaru, Isuzu, Suzuki, Saab, Hyundai, Daihatsu LUXURY CAR MANUFACTURERS e.g., Aston Martin, BMW, Rolls Royce (ow ned by VW)

PRODUCT RANGE

NATIONALLY- FOCUSED, SMALL, SPECIALIST PRODUCERS e.g., Bristol (U.K.), Classic Roadsters (U.S.), Morgan (U.K.)

Narrow National
2007 Prof. Dr. Bernd Venohr

PERFORMANCE CAR PRODUCERS e.g., Porsche, Ferrari (ow ned by Fiat) Maserati, Lotus

GEOGRAPHICAL SCOPE

Global
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Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)

Porters Five Forces of Competition Framework: the collective strength of the five forces determines the average profitability of an industry
SUPPLIERS
Bargaining power of suppliers INDUSTRY COMPETITORS POTENTIAL ENTRANTS Threat of new entrants Rivalry among existing firms Threat of SUBSTITUTES substitutes

Bargaining power of buyers

BUYERS
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Porters guiding question: what happens to the potential profit or value created by a product or service?
Is it bargained away by the suppliers? Or by customers? Is it dissipated in rivalry? Is it appropriated by new entrants? Is it limited by the existence of substitutes?
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Force 1: Rivalry among existing competitors usually the most powerful of the five forces
Strategic rivalry, not perfect competition in perfect competition behavior of market participants would be immaterial to one another rivalry: the purposeful behavior of one firm in a market is substantially affected by the purposeful behavior of another firm in the same or a related market Strategic rivalry creates several issues for managers: who are the my rivals? how will they be affected by my actions? how will they react to my actions? how will I react to their reaction? Main objective is not to engage in rivalry but to develop mechanism that allow firm(s) to avoid rivalry and its profit destroying effects Three main groups of structural determinants number and relative size of competitors industry-basic conditions behavioral determinants
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Force 1: Degree of rivalry is high


Competitors are numerous or are roughly equal in size and power Industry growth is slow There is low product differentiation (products are commodities) There are low switching costs There are high fixed or storage costs High fixed costs: pressure to fill capacity, probability of price cutting High storage costs: cut prices to get rid of product Capacity can only be added in large chunks (more disruptive than anything) There are high exit barriers: specialized assets, fixed costs to exit, emotional barriers, government restrictions Strategic confusion: Firms have diverse strategies, corporate priorities, resources, and countries of origin
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Force 2: Threat of new entrants: New firms want piece of profits


New entrants bring new capacity, desire for market share and new resources. Threat of new entry (potential competition) constrains price and service levels competitors can offer The strength of this threat depends primarily on barriers to entry reaction from existing competitors Entry barriers: whenever it is difficult or uneconomic for an outsider to replicate the position the incumbents reduce threat of entry whenever profits, adjusted for cost of capital, rise above zero protect incumbents from competition
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Force 2: Threat of new entrants - typical entry barriers


Barriers to entry can take many forms: Economies of scale: declines in costs of production as absolute volume per period increases Product differentiation: established firms have brand identification and customer loyalty Capital requirements: for facilities, inventories, start up losses Other cost disadvantages: proprietary technology, favorable access to raw materials, favorable locations, government subsidies, learning curve Distribution channels: established channels already carry existing firms products

Government policy : limits access to raw materials, licenses


Are established firms expected to respond forcefully? Is there a history of such retaliation? Do established firms have substantial resources to retaliate (cash, capacity)? Is there currently slow industry growth?

2007 Prof. Dr. Bernd Venohr

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Force 2: Threat of new entrants Minimum Efficient Scale as entry barrier


Minimum Efficient Scale (MES) is the smallest volume (market share) for which the unit costs reach a minimum; required to enter an industry as efficient competitor MES determines what market share a potential entrant must gain to be able to produce efficiently; it also sizes an entrantss upfront capital commitment Example: MES is the following industries is: Cigarettes 20.0% Tires 30%

Unit Costs

Entry Point
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

MES

Volume

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Force 2: Threat of new entrants brand images as entry barrier

Source: Michael Porter, Competitive Strategy


2007 Prof. Dr. Bernd Venohr

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Force 3: Threat of substitute products or services


Every product and service has some substitute: at one level all products are substitutes since they compete for the buyers budget; e.g. Plastic vs. Glass vs. Metal Newspapers vs. TV vs. Internet Eyeglasses vs. Contact Lens vs. Laser Surgery A substitute can perform the same function (=fulfill the same needs) as the product of the industry in question customer function performed, not just physically similar products/services examples: e-mail/fax/overnight mail The closeness and availability of substitutes set limits to the actions of every competitor in an industry: the more substitutes and the greater the ease of switching between them the less the latitude available to the competitors and the more intense their rivalry Represents an implicit ceiling on prices that existing firms can charge
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Force 4: Bargaining power of buyers


Buyer power : vertical forces that influence who appropriates the value created by an industry Allows customers to squeeze industry margins pressing competitors to reduce prices increase level of service offered without recompense Most important determinant: size and concentration of customers A group of buyers is powerful, if: It purchases large volumes relative to seller sales The products it purchases are undifferentiated The product the group purchases is a significant fraction of the buyers costs (Cost of purchases as % of buyers total costs) It earns low profits The industrys product is unimportant to the quality of the buyers products It faces few switching costs Buyers pose a credible threat of backward integration
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Force 5: Bargaining power of suppliers


Mirror image of buyer power: who appropriates the value created by an industry Key determinants: relative size and concentration of suppliers relative to industry participants degree of differentiation in inputs supplied A supplier group is powerful, if: It is dominated by a few firms and is more concentrated than the industry it sells to The supplier groups products are differentiated or it has built up switching costs There are few substitutes for the suppliers products The supplier poses a credible threat of forward integration The industry is not an important customer of the supplier group Acid test: can supplier set prices that reflect the value of their inputs to the industry and not just their own production cost?
Source: Michael Porter, Competitive Strategy
2007 Prof. Dr. Bernd Venohr

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Summary: The structural determinants of competition


Bargaining power of suppliers
Buyers price sensitivity Relative bargaining power

Threat of new entrants


Capital requirements Economies of scale Absolute cost advantage Product differentiation Access to distribution channels Legal / regulatory barriers Retaliation

Rivalry among existing competitors


Concentration Diversity of competitors Product differentiation Excess capacity & exit barriers Cost structure

Threat of substitute products / services


Buyers propensity to substitute Relative prices & performance of substitutes

Bargaining power of buyers


Buyers price sensitivity Relative bargaining power

Source: Michael Porter, Competitive Strategy


2007 Prof. Dr. Bernd Venohr

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Example US drug industry (Long-term ROIC = 22%)


SUPPLIER POWER LOW THREAT OF ENTRY LOW
economies of scale and high capital requirements for R&D , clinical trials and sales force product differentiation control of distribution channels patent protection

INDUSTRY COMPETITIVENESS LOW


high concentration product differentiation patent protection steady demand growth no cyclical fluctuations of demand

THREAT OF SUBSTITUTES
LOW no substitutes (Changing as managed care encourages generics)

BUYER POWER LOW


Physician as buyer: Not price sensitive No bargaining power (Changing with managed care)
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Source: Han, Strategic Management,CalState


2007 Prof. Dr. Bernd Venohr

Example US Airline Industry (Long-term ROIC = 5%)


SUPPLIER POWER HIGH strong labor unions concentrated aircraft makers

THREAT OF ENTRY HIGH


entrants have cost advantages low capital requirements little product differentiation deregulation of governmental barriers

INDUSTRY COMPETITIVENESS HIGH


many companies little product differentiation excess capacity high fixed/variable costs cyclical fluctuations of demand

THREAT OF SUBSTITUTES MEDIUM


autos for short distance travel

BUYER POWER MEDIUM/HIGH


Buyers extremely price sensitive Good access to information Low switching costs
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Source: Han, Strategic Management,CalState


2007 Prof. Dr. Bernd Venohr

Strategic Implications of the Five Competitive Forces

Competitive environment is unattractive when:


Rivalry is strong Entry barriers are low Competition from substitutes is strong Suppliers and customers have considerable bargaining power

Competitive environment is ideal when:


Rivalry is moderate Entry barriers are high Good substitutes do not exist Suppliers and customers are in a weak bargaining position
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2007 Prof. Dr. Bernd Venohr

Implications of five forces framework for strategy: Coping With the Five Competitive Forces
In a world of no competitive advantage, a firm is stuck in the pricedriven world of pure economic competition, selling commodity - like goods in direct competition with many similar firms The best industry a company can be in is one in which its position is so unique that it has virtually no competition near monopoly category of one

Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Startegy and the business landscape
2007 Prof. Dr. Bernd Venohr

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Implications of five forces framework for strategy: key task of strategy is to create a competitive advantage
Competitive strategy is about taking action to create a defendable position against the 5 forces Position the firm so its capabilities provide the best defense against the existing competitive forces Influence the balance of forces Anticipate shifts in key factors underlying the forces and respond so as to exploit the changes The strongest force or forces become crucial for strategy formulation

Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Startegy and the business landscape
2007 Prof. Dr. Bernd Venohr

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Limitations of Five Forces Analysis


Static snapshot of industry attractiveness Individual firm actions that change industry structure are not considered Example: role of innovation de-emphasized 5 Forces are more or less mutually exclusive, but may not be exhaustive e.g. role of related and supporting industries :Assumes buyers, suppliers, competitors and substitute providers interact at arms length and ignores role of cooperation and complementors (e.g. horizontal alliances; complementary component providers) impact of all macroeconomic forces understood only through their impact on five forces Framework, not formal model many variables, tries to capture complexity of actual competition identify the relevant variables and the questions that the user must answer in order to develop conclusions tailored to a particular industry and company limited empirical support
Source: Pnkaj Ghemawat, Strategy and the business landscape
2007 Prof. Dr. Bernd Venohr

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What is more important: industry (picking the right horseor company (the skill of the jockey) ?

When an industry with a reputation for difficult economics meets a manager with a reputation for excellence, it is usually the industry that keeps its reputation intact.

Warren Buffet

2007 Prof. Dr. Bernd Venohr

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For most businesses, competitive position has a far greater impact on profitability than industry attractiveness: Industry effects explain only about 10 20% of the variation of a firms economic profitability
Percentage of variance in firms return on assets explained by: Industry effects 19.6% 4.0% 18.7% 8.1% Firm-specific effects 0.6% 44.2% 31.7% 35.8% Unexplained variance 80.4% 44.8% 48.4% 52.0%

Schmalensee (1985) Rumelt (1991) McGahan & Porter (1997) Hawawini et al (2003)

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

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Agenda
Introduction to Strategy 4 External Environment

- General environment analysis - Industry analysis - Summary and Outlook next Session

2007 Prof. Dr. Bernd Venohr

48

New Assignment and Outlook next Session


Read slides on session 4 downloaded from ILIAS Visit company web pages and prepare as team a brief description using Porters 5 Forces framework What industry (industries) your company is in ? Build a Porters five forces model for your companies main industry : Which forces are the strongest/weakest ? Assess the attractiveness of your companies main industry: Is this a good industry to be in? Use financial results (Return on sales/ROS) or, if available, Return on Capital Employed/ROIC) for your company and 2 competitors to prove your assertion. Topics of next session Brief 3 page presentation on each company (attractiveness of industry); bring presentation on usb stick Lecture: Internal environment
2007 Prof. Dr. Bernd Venohr

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Appendix

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The starting point: The Industrial Organization Model of superior returns


Why are some firms more successful than others?
Profits = f (industry structure) Characteristics of external environment largely determine appropriate firm strategies and performance Industry in which company operates has strong influence on its economic performance

Choose attractive industries Largely focuses on industry structure or attractiveness rather than internal firm characteristics
Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy
2007 Prof. Dr. Bernd Venohr

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Structure-conduct-performance trilogy: Industry structure constrains options and drives performance


Key thesis: industry structure determined conduct / behavior of firms, whose joint conduct the determined the collective performance of the firms in the industry Performance defined broadly: Profitability technical efficiency (cost minimisation) innovativeness Firm conduct (strategy): firms choice of key decision variables like Price Advertising Capacity Product quality Industry structure: relatively stable economic and technical dimensions of an industry in which competition occurred barries to entry number and size of distribution of firms (conecentration ratio) product differentiation and overall elasticity of demand Key assumption: since structure determined firms conduct, which jointly determined performance, one could ignore conduct and look directly at industry structure to explain performance Numerous empirical studies explored the relationship between structural variables and performance focussing on a limited number of structural variables
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Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy
2007 Prof. Dr. Bernd Venohr

Structure-conduct-performance

Industry Structure Number of buyers and sellers Degree of product differentiation Barriers to entry Cost structures Vertical integration Alliances

Firm Conduct Pricing Advertising R&D Investment in plant and equipment

Performance Economic profits Accounting profits (ratios) NPV/DCF MVA/EVA Tobins Q

Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy
2007 Prof. Dr. Bernd Venohr

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Limitations of IO framework for strategy


Framed in public policy terms: objective minimizing excess profits. Profits reflect some problem in industry structure, that can/should be fixed by government regulation Mainly concernd with industries; firms assumed identical (firms in industry are strategically similar) Analysis of competitors missing Static perspective Highlighting few key elements Assume away conduct as relevant to performance: industry structure = firm performance
Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the Business Landscape
2007 Prof. Dr. Bernd Venohr

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Uses of industry analysis for strategy

Business level: Develop strategies to outperform industry averages; better understanding of intra-industry profit differences to develop better matches between internal resources and industry environment Corporate level: Decisions to enter/exit particular industries; allocation of resources and evaluation of performance across portfolio of businesses

2007 Prof. Dr. Bernd Venohr

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In addition, Porter stresses the management perspective in analysing industries


Strategy and not public policy objective strategy: maximizing economic profits and creating near-monopoly positions rather than public policy: minimizing excess profits and controlling monopolies Industry structure partly exogenous and endogenous exogenous economic and technical factors are outside the control of a company endogenous factors are subject to influence by firm actions through strategy (change rules of competition in an industry / shape industry structure to attain advantaged position) Industry structure is tied to company economics: structure manifests itself in revenue, costs investment and on the collective balance sheets and income statements of industry
2007 Prof. Dr. Bernd Venohr

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Porter Framework: There are two basic types of competitive advantage


Competitive advantage depends on driving a wider wedge between Price (buyers willingness to pay) and Costs than competitors There are logically only two basic types of competitive advantage: lower cost: by designing, producing and marketing a comparable product or service more efficiently than competitors a firm can gain higher profitability at comparable or lower prices differentiation: providing unique and superior non-price value to customers through product or service performance, special features, after sales support etc. and commanding premium prices that exceed the extra costs of differentiation
Source: Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning; Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
2007 Prof. Dr. Bernd Venohr

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Vertical segmentation & industry profit pools the US auto industry


25%

20

Operating margin

15

Leasing

Service & repair Warranty Aftermarket parts Auto rental

10

Auto manufacturing New car dealers

Auto loans Used car dealers

Auto insurance

Gasoline Share of industry revenue

100%

Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
2007 Prof. Dr. Bernd Venohr

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Guidelines: Strategic Groups


Constructing a Strategic Group Map STEP 1: Identify competitive characteristics that differentiate firms in an industry from one another STEP 2: Plot firms on a two-variable map using pairs of these differentiating characteristics STEP 3: STEP 4:

Assign firms that fall in about the same strategy space to same strategic group

Draw circles around each group, making circles proportional to size of groups respective share of total industry sales Variables chosen as axes should expose big differences in how rivals compete Variables do not have to be either quantitative or continuous Drawing sizes of circles proportional to combined sales of firms in each strategic group allows map to reflect relative sizes of each strategic group If more than two good competitive variables can be used, several maps can be drawn
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2007 Prof. Dr. Bernd Venohr

3 C-Framework for business definition


Cost: defensible cost barriers that result in large relative cost position differences degree of cost sharing similarity of value adding steps degree of experience transfer possible Customers: intrinisically different customer needs leading to different price points and defensible differentiation degree of substitution degree of customer sharing/customer synergies Competitor overlap as acid test
Source: Bain
2007 Prof. Dr. Bernd Venohr

Define the boundaries where competitive advantage can be established and sustained (business battlefield)

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Demand and/or value chain differences lead to cost barriers and/or customer value barriers which create a separate business arena
Low Separate Business

Cost barriers

High

One Business

High Customer value barriers


Source: Bain & Company, Business Definition; Richard Koch, The Financial Times Guide to Strategy 2007 Prof. Dr. Bernd Venohr

Low

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