Where Firms Should Expand: The CAGE Model

The smaller the distance the better

Where should firms expand?
• Cultural Distances
• Refers to differences in language and culture. These may include
differences in:
• Religion
• Ethnicity
• Trust for outsiders
• How genders are expected to behave
• The degree to which the culture is focused on individuality or collective action
• How people accept ambiguity or follow rules and laws
• The degree to which people allow abused of political or market power.
• All these differences affect how people should interact and how
business should be conducted.
Where should firms expand (Cont’d)?
• Administrative Distance
• Refers to differences in the legal, political, and regulatory
institutions between countries.
• Administrative distance caused some challenges for U.S. firms in
industrialized nations like France, which has a different legal system
from the U.S. and U.K.
• Regulations can be applied capriciously in emerging and third-world
markets.
• Industries most affected: those employing large number of
employees, those serving the government directly, those extracting
natural resources, and those producing staple goods (e.g. corn in
Mexico).
• A firm tends to face increased administrative distance when it
competes with a local champion, a local firm that the government
sees important for the future.
Where should firms expand (Cont’d)?
• Geographic Distance
• Refers to how many miles separate two countries.
• Companies are more likely to succeed in nearby countries. That’s
why most U.S. companies expand first to Canada and Mexico.
• Companies are also more likely to enter countries with good
transportation infrastructure.
• Geographic distance increases the cost of managing daily operations
and coordinating activities.
Where should firms expand (Cont’d)?
• Economic Distance
• Refers to differences in the average income of customers in two
countries, usually measured as per capita GDP (Gross Domestic
Product).
• Firms from wealthy nations tend to expand to other wealthy nations
because the customers there earn enough income to buy similar
products.
• The industries that are most affected by economic distance are
those for which the demand for products is very elastic.
 Summary
• The value chain can be used to answer the important question:
– What is a firm good at?
• However, it can't be used to answer the critical question:
– What is the firm better at than relevant competitors?
• To answer the second question:
– First, we'll define a set of concepts-resources, capabilities, and
priorities-to help in understanding the sources of a firm's strengths.
– Second, we will introduce the VRIO model, which measures the
magnitude and durability of a firm's strengths versus competitive
rivals.

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 Creating Sustainable Competitive Advantage :
The VRIO Model
• Competitive advantages arise when resources or capabilities
possess two attributes:
– Value
– Rarity
• Two other principles determine the durability, or sustainability, of
competitive advantage:
– Inimitability– the characteristics that make a resource or capability difficult to
imitate.
– Organization's ability to exploit profit returns generated by its unique and
valuable resources.

• Together, these four characteristics-value, rarity, inimitability, and

organization to exploit profits-are often abbreviated as VRIO.

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Value
• Value denotes worth for customers
• A resource creates value if its contributions allow a
company to produce a product or service that is of
worth to end users
– Products or services have value when they create direct
pleasure, satisfaction, or happiness for the end user.

– Or, when they create indirect opportunities that for users to

experience produce pleasure and satisfaction.

Are there companies that do not create value?

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Rarity
• To be rare is to be uncommon, or not available to other competitors.

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Inimitability
• Inimitability is the extent to which competitors cannot easily reproduce a product by
employing equal, or equivalent, sources of value in their own products and services.

• Several factors drive inimitability, thereby acting as barriers to imitation.

– Path Dependence. Path dependence means that the process through which
a resource or capability came into being may make it difficult for competitors to
imitate (e.g. the learning curve to build large commercial aircraft).
– Tacit Knowledge. For many processes, such as cooking French fries at
McDonald's, the actions needed to imitate the sequence can be codified, or
written down, and easily learned by others. Such easy-to-codify-and-learn
knowledge is referred to as explicit knowledge. Tacit knowledge is just the
opposite. Many valuable skills and processes can't be learned easily, if they can
be learned at all (Steve Jobs’ ability to spot great design in product).
– Causal Ambiguity. Causality refers to the notion that one thing causes
another: A leads to B. Sometimes, however, the causal relationship is unclear or
ambiguous, and the relationship between variable A and outcome B is difficult to
disentangle (e.g. GM’s inability to learn Toyota’s production system).
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Inimitability (Cont’d)
• Several factors drive inimitability, thereby acting as barriers to
imitation. We'll describe each one below.
– Complexity. Resources, capabilities, and priorities become difficult for
competitors to imitate when they span the organization or contain many
interrelated elements and exhibit substantial complexity (e.g. GM’s inability to
learn Toyota’s production system).
– Time Compression Diseconomies. Diseconomies happen when an
action increases, rather than decreases, cost and inefficiency. Timing is crucial
in the development or deployment of many resources, capabilities, or priorities
and can become a diseconomy in many cases (e.g. processes cannot be
rushed/learning curve)
– Network Effects and First-Mover Advantages. Recall from Chapter
2 that much of the reason eBay is so successful has to do with network effects,
which economists call positive network externalities.

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Organized to Exploit
• A firm may employ valuable, rare, and difficult-to-imitate
resources and yet still lack a sustainable competitive
advantage because the firm may not be organized to exploit
or have the contracts and systems in place to capture the
profits that resources create.

• Organized to exploit: The degree to which the legal,

administrative, and operating structure of the firm allows it to
capture the rents generated by resources.

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 Resources and Competitive Advantage
Is the resource Is the resource Is the resource Is the company
Valuable? Rare? Inimitable? Organized to
exploit?

No No No No Competitive Failure

Yes No No No Competitive Parity

Yes Yes No No Competitive

Advantage
Yes Yes Yes No Durable Competitive
Advantage

Yes Yes Yes Yes Sustained

Competitive
Advantage

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Five Forces that Shape Average Profitability Within Industries
• Michael Porter, a well-known Harvard strategy professor, identified five
forces that shape the profit-making potential of the average firm in an
industry (known as Porter's Five Forces).

• These Five Forces are:

– Rivalry
– Buyer Power
– Supplier Power
– New Entrants
– Substitutes

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© Hongwei Xu
Porter’s Five Forces Model
of Industry Competition

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Rivalry: Competition among Established Companies
in an Industry: fundamental question: how intense is competition in the
industry?

1. The number and size of competitors

2. Standardization of products (differentiation)
3. Costs to buyers of switching to another product
(switching cost)
4. Growth in demand for products
5. Levels of unused production capacity
6. High fixed costs (e.g. airlines) and highly perishable products
7. The difficulty for firms of leaving the industry (exit
barriers)
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Factors Leading to Highly Competitive Rivalry

1. Numerous or equally balanced competitors

2. Lack of differentiation
3. Low switch cost for customers
4. Slow industry growth
5. High levels of unused production capacity (High strategic
stakes)
6. High fixed costs and highly perishable products
7. High exit barriers

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Buyer Power: Bargaining Power and Price Sensitivity
• Buyer Bargaining Power. Four key factors influencing buyers’ bargaining
power over their suppliers:
– Buyers‘ switching costs
– Demand
– Number, or concentration, and size of buyers
– Credible threat of backward integration (Walmart can expand its Sam’s Choice store
brands)

• Buyer Price Sensitivity. In general, when buyers are more price-sensitive, they
are more likely to exert pressure on suppliers to keep prices low. Buyer tend to be
more price-sensitive when:
– Buyers are struggling financially
– Product is significant proportion of buyer's costs
– Buyers purchase in large volumes
– Product doesn't affect buyers' performance very much (Nokia’s handsets to carriers).
– Product doesn't save buyers money
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The Bargaining Power of Buyers
• A buyer group is powerful when
– It is concentrated or purchases large volumes relative to seller
sales (Walmart)
– The products it purchases from the industry are standard or
undifferentiated
– The buyer faces few switching costs
– It earns low profits
– The buyers pose a credible threat of backward integration
– The industry’s product is unimportant to the quality of the buyer’s
products or services

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In Other Words:
• Fundamental Question: How badly does a buyer need your
products or services?
• Factors contributing to high buyer power:
– Few buyers compared to the number of sellers
– Buyers purchases high volume relative to seller’s sales
– Products are undifferentiated
– Buyer has low switching costs
– Buyer has low profits
– Buyer can “integrate backward” and supply the product to itself

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Supplier Power
• When supplier industries have strong bargaining power, they
can charge higher prices, which tend to decrease average
profitability in an industry.
• As firms understand the factors that give suppliers power,
they can make decisions to decrease that power.
– Number, or Concentration, and Size of Suppliers.
– Credible Threat of Forward Integration (e.g. a manufacturer performs its own
distribution process).

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The Bargaining Power of Suppliers :
• A supplier group will be powerful when:
– The supplier group is dominated by a few companies, and is more
concentrated than the industry it sells to
– The supplier group is not obliged to contend with substitute
products for sale to the industry
– The industry is not an important customer of the supplier group
– The supplier’s product is an important input to the buyer’s business
– The supplier group’s products are differentiated or it has built up
switching costs for the buyer
– The supplier group poses a credible threat of forward integration

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In Other Words:
• Fundamental Question: how badly does a supplier need your
business?
• Factors contributing to high supplier power:
– Supplier industry dominated by few firms
– Buyer is not important to customer
– Supplier’s product is important input to buyer’s product
– Supplier’s products have high switching costs
– Supplier can “integrate forward” and become competitor of buyer

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Threats of New Entrants

• Economies of Scale, Experience, or Learning

• Other Cost Advantages Not Related to Scale
• Capital Requirements (e.g. Intel)
• Network Effects (e.g. Ebay)
• Government Policy Restrictions

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In Other Words:
• Fundamental Question: how easy is it for another
company to enter the industry?
• Factors making easy entry to industry
– Low economies of scale
– Low product differentiation
– Low capital requirements
– No switching costs for buyer
– Easy access to distribution channels
– Little government regulation

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Threats of Substitutes
• Substitute Products: products from another industry that serve a similar
need/function
• A substitute is a product that is fundamentally different yet serves the
same basic function or purpose as another product
• One of the primary problems for the strategist in assessing substitutes
is determining what is a substitute and what isn't.
• Two factors determine the intensity of substitute threat:
– Awareness and Availability
– Price and Performance
• Close substitutes constrain the ability of firms in an industry to raise
prices.
– Laser Teeth Whitening vs Home Teeth Whitening

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In Other Words:
• Fundamental Question: What other products or services from
other industries could perform the same function as your
products or services?

• Factors indicating high threat of substitutes:

– Few switching costs for buyer
– Price of substitute lower or quality higher than for your products
– Firms offering substitutes have high profitability

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 Overall Industry Attractiveness
• Understanding the five forces that shape industry competition is useful as
a starting point for developing strategy (Managers often define competition too
narrowly—Dangerous!)

• The five forces help explain why industry profitability is what it is-and
why it might be changing.

• Few industries will rate high (attractive) or low (unattractive) on all forces.
A significant threat from just one or two of the five forces is often
sufficient to destroy the attractiveness of an industry (e.g. rivalry in the
Auto industry).

• One thing to keep in mind is that the five forces are subject to change.
Each of the five forces can be altered by actions taken by firms within or
outside the industry.
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Strategic Implications of the Five Competitive
Forces
• An industry is ideal (attractive or (profitable) from a profit-
making standpoint when:
– Rivalry is moderate
– Entry barriers are high and no firm is likely to enter
– Good substitutes do not exist
– Suppliers and customers are in a weak bargaining position

© Hongwei Xu