Chapter Two:

Strategy Analysis

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 Strategic choice depends on:
• A. Industry choice: The choice of industry or a set of
industries in which the firm operates.
• B. Competitive positioning: The manner in which the firm
intends to compete with other firms in its chosen industry
or industries.
• C. Corporate strategy: The way in which the firm expects
to create and exploit synergies across the range of
businesses in which it operates.

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 A. Industry Analysis
• Average profit of the market varies considerably based
on different industries. The differences imply the
associated risk factor as well. The risk and return
preference of each firm is best demonstrated by the
choice of its industry. Profit of each industry depends on
Porter’s “five forces”.
1. Rivalry among existing firms
2. Threat of new entrants.
3. Threat of substitute products
4. Bargaining power of buyers
5. Bargaining power of suppliers

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 A. Industry Structure and Profitability
DEGREE OF ACTUAL AND POTENTIAL COMPETITION
1. Rivalry Among 2. Threat of New 3. Threat of
Existing Firms Entrants Substitute Products
Industry growth Scale economies Relative price and
performance
Concentration First mover advantage
Buyers willingness to
Differentiation Distribution access
switch
Switching costs Relationships
Scale/learning economies Legal barriers
Fixed variable costs
Excess capacity
Industry
Exit barriers
Profitability
BARGAINING POWER OF INPUT AND OUTPUT MARKETS
4. Bargaining Power of Buyers 5. Bargaining Power of Suppliers
Switching costs Switching costs
Differentiation Differentiation
Importance of product for cost and Importance of product for cost and
quality quality
Number of buyers Number of suppliers
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Volume per buyers Volume of suppliers
 1. Rivalry among existing firms
depends on:
• i. Industry Growth rate: The competitive behavior of a firm with high growth
industry and stagnant industry is different.
• ii. Concentration and balance of competitors: Concentration of the number
of firms in the industry shapes the competitive behavior of the firm.
(Example: IBM in mainframe computer formulates the rules of industry,
Coke-Pepsi restrict price cut)
• iii. Degree of Differentiation and switching costs: If the products are very
similar the switching cost of customers is low and price competition is
common. If the products are differentiated switching cost is high and rivalry
is less acute.
• iv. Scale or Learning Economies and Ratio of Fixed Cost to Variable Cost:
For steep learning curve and large economies of scale there are incentives
for aggressive competition. Similarly, for high fixed cost to variable cost ratio
there is incentive to reduce price to utilize the installed capacity. (example:
airline industry)
• v. Excess Capacity and exit barriers: If capacity in an industry is lager than
customer demand, there is a strong incentive for firms to cut prices to fill
capacity. Exit becomes then difficult.

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 2. Threat of New Entrants
depends on:
• i. Economies of Scale: Large scale economies is a constraint for new entrants.
The existing firm is motivated to handle this risk by a large investment in
research and development (pharmaceutical or jet engines), in brand
advertising (soft-drink), or in physical plant and equipment (telecommunication)
• ii. First Mover Advantage: The first mover might be able to set industry
standard, to enter into exclusive arrangements with suppliers of cheap raw
materials, or to acquire scarce government licenses. He may capitalize
learning economies or significant switching costs. This makes new entrance
difficult. (example: switching cost of Microsoft’s DOS operating system is quite
high)
• iii. Access to channels of Distribution and Relationship: Limited capacity of
distribution channels and high costs of developing new channels can act as
powerful barriers to new entry. Existing relationship between firms and
customers in an industry also make it difficult for new firms to enter an industry.
• iv. Legal Barriers: Patents, copyrights limit new entries. Similarly, licensing
regulations limit entry into taxi services, medical services, broadcasting,
telecommunications industries, etc.

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 3. Threat of substitute products

• Substitute products are not necessarily similar products

rather the products that perform the same function. For
example, car rental and air lines may be substitutes, Jute
and synthetics are substitutes. Technological innovation
may introduce substitute like computer for type writers. It
depends on:
• i. Relative price and performance
• Ii. Customers’ willingness to switch

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 Relative Bargaining Power in Input and
Output Markets
• While degree on competition in an industry determines
whether or not there is potential to earn abnormal profits,
the actual profits are influenced by the industry's
bargaining power with its suppliers and customers. On
the input side there is labor, raw materials and
components, and finances. On the output side firm may
either sell directly to the final customers, or enter into
contract with intermediaries in the distribution chain.
There is a competition among all these factors called
relative bargaining

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 4. Bargaining Power of buyers
Depends on:
• 1. Price sensitivity: Buyers are more price sensitive when
the products are undifferentiated and switching cost is
low.
• 2. Relative bargaining power: In a monopoly market
there is low bargaining power of the buyers and in a
perfect market there is high bargaining power of the
buyers. This in turn, depends on number of buyers
relative to number of sellers, as well as the volume per
buyer.

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 5. Bargaining Power of Suppliers

• Suppliers’ bargaining power is the opposite to the

bargaining power of the buyers. In a monopolistic and
oligopolistic market the supplier or suppliers have strong
bargaining power. (Example: Power of Coke-Pepsi on
bottlers) On the other hand, in a perfect market they do
not have a bargaining power as they have to accept the
market price. (Example: can producers lack power).
Market of intermediate goods also determines the
bargaining power when they are the exclusive suppliers
for the next sequence of producers. (IBM’s unique
position as mainframe suppliers dominates computer
leasing business)

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 Industry Analysis: Case Study
Personal Computer Industry
• Introduction: Computer industry introduced in 1981 when IBM announced its
PC with Intel’s microprocessor and Microsoft’s DOS operating system. With
tremendous growth, in 1997 there was 100 million PC installed capacity, 30
million PC overseas sales with 21% annual growth rate. Since then the
profitability went down. Despite the spectacular growth in 1998 the industry
experienced low profitability. Why?
• Concentrated market: Top 5 firms were dominants in total sales that there
was acute competition among them and so price cut was very common.
• Undifferentiated products: Most firms producing identical products and acute
competition experienced price cut. .
• Low switching cost as different brands use same Intel microprocessor and
Microsoft Windows operating system
• Easy entry due to easy availability of spare parts. (Michael Dell started Dell
computers with mare assembling at his dormitory room)
• Power of suppliers and buyers: Intel (microprocessor) and Microsoft (DOS)
hold strong bargaining power as suppliers. From 1983 to 1993 corporate
buyers became price sensitive as computer procurement cost was very
significant for successes, and once being aware of the technology brand
names mattered little to them.
• Tremendous pressure on firms to unnecessarily spend large sums of money
for R&D to introduce new products rapidly, maintain high quality, and
provide excellent customer support that contributed to low profits.
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 B. Competitive Strategy Analysis
• This is the strategy of positioning a firm in the industry. It
refers to the strategy of the competitive advantage of the
firm over other firms of the same industry. Commonly it is
either (i) Cost Leadership or (ii) Product Differentiation.
• (i) Cost Leadership refers to the firm’s advantage in the
cost of production. This depends on the production
system.
• (ii) Product Differentiation refers to the advantage of the
firm regarding the specification of the product. This
depends on the acceptability of customers on the
marketing point.

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 Strategies
for Creating
Competitive
Advantage

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 Competitive Strategy 1:Cost Leadership

• Cost Leadership means to create sustainable cost advantage

over rivals with regard to same product or service. It arises
from:
– Economies of scale: To explore the optimum scale
– Economies of learning: Complication of technology of production.
Both short run and long run
– Efficient production: constrained optimization
– Simpler product design: Alter value chain to bypass cost-
producing activities like CPM-PERT.
– Lower input cost: procure or produce?
– Low cost distribution: owning or hiring?
– Little research and development or brand advertisement. Industry
standard? Cost-benefit of low R&D?
– Tight Cost Control system: To ascertain the cost centre,
standardize costs and identify the agent responsible for variation

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 Competitive Strategy 2:
Product Differentiation
• Product differentiation strategy seeks to be unique
in industry along some lines highly valued by
customers. It implies to identify such attributes, and
meet that in a unique and cost-efficient way. It
involves:
– Superior product quality
– Superior product variety
– Superior customer service
– More flexible delivery
– Investment in brand image
– Investment in R&D, engineering skills and marketing
capabilities
– More focus on creativity and innovation.

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 Case Analysis: Personal Computer Industry (Contd.)
Success of Dell Computers

• Despite the constraints of industry analysis Dell was quite successful.

Why?
1. Direct selling (through internet web site). Utility of retailer went down as
computer became standardized on the Windows-Intel platform. Dell was
pioneer in direct selling. It saves the markup of retailers.
2. Made-to-order manufacturing. This allowed to concentrate more on quick
assembling and shipping. It saved the cost of inventory pileup, working
capital and obsolete inventories.
3. Expertise third party after sale services & very effective telephone based
servicing.
4. Lowest accounts receivable days of the industry by encouraging the
customers to pay on credit card.
5. Dynamic R&D investment: Dell recognized that Intel and Microsoft are
key suppliers and they invested huge amounts in developing new
generation processors and software. So Dell R&D concentrated in the
organizational aspect that respond quickly to these changes.

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 C. Corporate Strategy Analysis
• This refers to the corporate decision whether to
concentrate on single line of business or to diversify
the business among different lines. The portfolio
theory says that diversification is more economic on
the part of the investors rather than the firm.
Conflicting views have been observed. Example:
General Electric is successful in creating significant
values by managing highly diversified business
ranging from aircraft engines to light bulb. Sears has
not been successful in retailing together with
financial services.

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 Corporate Strategy Analysis (Contd.)
Merits of diversification
Advantage of value creation at corporate level (diversification of products within the
organization is better than introducing a new business)
1. Significant information gap between buyers and producers. Besides, due to poor
legal infrastructure buyers may not enforce warranties
2. Significant information gap between investors and entrepreneurs. (lemon’s problem)
3. Unavailability of quality people. When employer fails to assess the quality of
applicant for new position, he would like to stick to the old people and give them
promotion.
Merits of Concentration
Disadvantages of value creation at corporate level: (introducing a new business is better
than diversification of products within the organization)
1. Individual units can exploit large scale economy. Top management of a diversified
business may lack information, skills and expertise related to different businesses.
2. Diversified business is motivated more by higher investment rather than higher profit.
Some of the units of diversifies business may not be profitable.
4. Creates agency problem like share price of Boeing went down in USA when it started
rubber production in Malaysia,

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 Applying corporate strategy analysis
Amazon.com
• Amazon.com, a pioneer in electronic commerce sector, started
operation as online bookseller in 1995 and went public 1997.
Successes led an increase in share price. Market capitalization was
$36 billion in 1999. Expansion strategy included acquisition of other
online businesses, and selling online CD, videos, gift, pharmaceutical
drugs, pet supplies, and groceries.
• Advantages:
1. Valuable brand name of Amazan.com in online businesses could be
utilized in other businesses as well. Since electronic commerce is a
new phenomena, customers valued it quite high.
2. Amazon acquired critical expertise in flawless execution of electronic
retailing that can be exploited in many areas.
3. Amazon has been able to create a tremendous amount of loyalty
among its customers through superior marketing and execution.
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 Applying corporate strategy analysis
Amazon.com (Contd.)
• Constraints:
• Amazon was expanding too rapidly. Expansion beyond
book retailing may fail fail.
• Competitors like Wal-Mart, Barnes & Noble are also
having valuable brand names execution capabilities, and
customer loyalty. Which must offer formidable competition
in retail business.
• Expanding rapidly in so many areas may confuse
customers, dilute Amazon’s brand value, and increase
chance of poor execution.

• Effect:
• Sales increases but profitability goes down and more
importantly share price goes down from $221 in April
1999 to $118 in May 1999.

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