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2
Managing Industry
hapter
c chapter

Competition

Part I: Foundations of Global Strategy

Global Strategy
Mike W. Peng
 Outline
• Defining industry competition
• The five forces framework
• Three generic strategies
• Debates and extensions
• The savvy strategist

2–2
 Defining Industry Competition
• Industry:
 A group of firms producing products (goods
and/or services) that are similar to each other
• Theories of industry competition
 Perfect competition (rarely observed)
 Industrial organization (IO) economics model
 Industry structure determines strategy and
firm performance (SCP model)
 Original goal-help regulators minimize
firm’s excess profits
 Strategists use the IO model to try to earn
excess profits

2–3
 Five Forces Framework
• The Five Forces Framework
 “Translated” and extended from the SCP model in
1980 by Michael Porter
 A key proposition:
 The focal firm’s performance critically depends on
the degree of competitiveness of the five forces
within an industry
 The stronger and more competitive these forces
are, the less likely the focal firm is able to earn
above-average return, and vice versa

2–4
The Five Forces
Framework

Figure 2.1
2–5
 Threats of the Five Forces
Threats indicative of strong competitive forces that can
Five forces depress industry profitability

Rivalry among  A large number of competing firms

competitors  Rivals are similar in size, influence, and product offerings
 High-price, low-frequency purchases
 Capacity is added in large increments
 Industry slow growth or decline
 High exit costs

Threat of  Little scale-based low-cost advantages

potential entry (economies of scale)
 Little non-scale-based low-cost advantages
 Insufficient product differentiation
 Little fear of retaliation
 No government policy banning or discouraging entry
Table 2.1
2–6
 Threats of the Five Forces (cont’d)
Threats indicative of strong competitive forces that can
Five forces depress industry profitability

Bargaining power • A small number of suppliers

of suppliers • Suppliers provide unique, differentiated products
• Focal firm is not an important customer of suppliers
• Suppliers are willing and able to vertically integrate forward

Bargaining power • A small number of buyers

of buyers• Products provide little cost savings or quality of life
enhancement
• Buyers purchase standard, undifferentiated products
from focal firm
• Buyers are having economic difficulties
• Buyers are willing and able to vertically integrate backward

Table 2.1 cont’d

2–7
 Threats of the Five Forces (cont’d)
Threats indicative of strong competitive forces that can
Five forces depress industry profitability

Threat of • Substitutes superior to existing products in quality and

of substitutes quality and function
• Switching costs to use substitutes are low

Table 2.1 cont’d

2–8
2–9
 Five Forces Framework:
Lessons from the Five Forces Framework
• Not all industries are equal in terms of their potential
profitability
• The task for strategists is to assess the opportunities (O)
and threats (T) underlying each competitive force
affecting an industry, and then estimate the likely profit
potential of the industry
• Use the five forces model as an industry positioning tool
• Core features of the five forces model remain remarkably
insightful when analyzing new phenomena, such as
e-commerce

2–10
 The basis of the generic strategies
• Porter argues that a firm’s strengths ultimate fall
into one of two headings: cost advantage and
differentiation
• By applying these strengths in a broad or a
narrow focus, three generic strategies result:
cost leadership, differentiation and focus
• They are called generic strategies because they
are not specific to a firm or an industry
 Porter’s Generic strategies
• Porter identified the four strategies to achieve a
competitive advantage
• Cost leadership: superior profits through lower
costs
• Differentiation: higher profits by adding value to
the product areas which are of real significance
for customers who in turn are willing to pay
premium prices
• Focus strategy: concentrating on a limited part
of the market Focus strategy is then subdivided
into focus cost leadership and focus
differentiation
 Porter’s generic strategies

Advantage Advantage
Target scope Low cost Product uniqueness

Broad Cost leadership Differentiation strategy

(industry wide) strategy

Narrow Focus strategy Focus strategy

(market wide) (low cost) (differentiation)
 Generic strategies at a glance

Low cost Differentiation Focus

Low cost culture Adding value Niche markets
Economies of scale through Targeting
Eliminate -product features Limited territory
unnecessary costs -product quality Focus on a specific
Enjoy high profits -distinctive offering group of customers
through cost Offer something Either cost leader
advantage new or different or differentiation
High costs but with in the segment
charge premium
price
 Cost leadership
• This strategy concentrates on aiming to become
the lowest cost producer in the industry
through economies of scale
• In this way the firm can compete on price with
every other producers in the industry and earn
higher unit profits
• Cost reduction provides the focus of the
organisation’s strategy
• Competitive advantage is achieved by driving
down costs
 Cost leadership
• Cost leadership is based on
 Efficiency to drive down costs
 Effectiveness- knowing what is and what is not
important to customers and saving on the latter
• But there is room for only one cost leader
• A successful cost leadership strategy requires
that the firm is the cost leader and is
unchallenged in this position
• Cost leadership is especially beneficial in
markets where customers are price sensitive
 Sources of cost leadership
• Size - economies of scale
• Greater labour efficiency and effectiveness
• Control of overheads
• Superior management
• Greater operating efficiency and effectiveness
• Low cost production
• Low cost labour
• Design for low cost production
• Use the latest technology to reduce costs and or
enhance productivity
• Relocation to low cost site
• Favourable access to low cost sources of supply
• Reduction in waste
 Firms that succeed in cost leadership
• Firms that succeed in cost leadership have the
following strengths:
 Access to the capital required to make significant
investment in fixed assets
 Design skills for efficient manufacture
 A high level of expertise in manufacturing process
engineering
 Efficient distribution channels
• Examples of cost leadership : Ryanair, Toyota,
Wal-Mart (parent company of Asda), Tesco
2–26
 Ryanair History
1985: The 2004: Most Popular Online Booking
Beginning
•25 Employees •Most Popular online, 2003
•15 Seat Aircraft •98% online booking
•5’2” Standard

First “Fare 1997: We go

War” Public
1986:
1995: Low Fares Win!
First Fiscal Year
1987: First •Overtakes Aer Lingus, British Airways
Jet •Largest Irish airline, Dublin
•3 BAC 1-11 Aircrafts •10th Birthday
•Opened New Destinations
1990: Rapid Growth And The Upset
•Accumulates £20M Losses
•20m invested
•Copying the Southwest Model
•Michael O’ Leary, Restructured
April 2013, Thomas Elias, Alison Tardie, Brandon Plourde, Loren
Plourde, UMFK
 Existing Strategy, Vision, and
Mission
Strategy: Cost Leadership;
Low Cost
Vision Mission
Firmly Establish itself as Europe’s Ryanair seeks to offer low fares
leading scheduled passenger that generate increased
airline through continued passenger traffic while
improvements and expanded maintaining a continues focus on
offerings of its low-fares service. cost-containment and operating
efficiencies.
Cost Comparison
 A misconception
• Cost leadership is often seen as a strategy that
aims to attract customers with low prices that
are made possible by low costs
• But cost leadership does not necessarily mean
selling at the lowest price
• It might mean selling at the industry average
price but enjoying above average profits through
low cost production
• The low costs result in high profit margins
 Benefits of cost leadership
• Enjoy higher than average profits
• Engage in price war
• Eliminate rivals
• Defend market share
• Increase market share
• Build barriers to the entry of newcomers to the
market
• Weaken the threat of substitutes
• Enter new markets
 Five forces analysis
• Porter developed the five forces model as a framework
for the analysis of profitability of the industry
• The five forces are:
 Suppliers power: powerful suppliers can push up the cost of
inputs
 Buyers’ power: powerful buyers can negotiate low prices
 The threat of substitutes: where there is a strong threat firms
need to remain very competitive
 The ease or otherwise of entry to the market: low barriers raise
the prospect new firms pushing down prices
 The intensity of rivalry in the market: intense competition forces
firms to keep prices down
• The five forces model can be used to analyse each of
the generic strategies
 Five forces and cost leadership

The five forces The cost leader is

Entry barriers Able to cut prices to discourage potential

entrants to the market
Buyer power Able to offer a competitive price to buyers
with power
Supplier power Protected from a powerful buyer by low
costs
Threat of Able to make use of low price as defence
substitution against substitutes
Rivalry Is better able to compete on price
 Risks of cost leadership
• Vulnerability to even lower cost operators
• As technology improves, a competitor may be
able to leapfrog the production capabilities, thus
eliminating the competitive advantage
• It could lead to a damaging price wars
• There might by difficulty in sustaining cost
leadership in the long run
• A firm following a focus strategy might be able to
achieve even lower cost within their segment
 Differentiation
• A differentiation strategy calls for the
development of a product or service that offers
attributes that are both unique and are valued by
customers
• Customers perceive the product to be different
and better than that of rivals
• As a result the value added by the uniqueness
of the product may allow the firm to charge a
premium price for it
 Differentiation
• Success in a differentiation strategy means
 Gaining a competitive advantage by making their
product different from competitors
 Competing on the basis of value added to customers
 Persuading customers that the firm’s product is
superior to that offered by rivals
 Customers being willing to pay a premium price to
cover higher costs
• Differentiation can be based on product image
or durability,after-sales,quality,additional
features,after sales
• And it requires talent, research capability and
strong marketing
 Extra costs and premium prices
• Differentiation adds costs in order to add value
• The extra costs can only be recouped if the
market is willing to pay a premium price
• Problems occur if the extra costs incurred
outweigh the additional revenue generated by
higher prices
• For a successful differentiation strategy it is
insufficient merely to add value - customers
must recognise and appreciate the difference
• Extra costs should be added only in areas that
customers perceive to be important
 Sources of differentiation
• Creation of strong brand
• Superior performance
• High quality
• Additional features offered
• Innovation in packaging
• Speed of distribution
• Higher service levels
• Greater flexibility
• Delivery
• Quality of the materials
 Firms that succeed in a differentiation
strategy
• Firms that succeed in a differentiation strategy
have:
 Have access to leading scientific research
 A strong creative product development team
 Strong sales team with the ability to successfully
communicate the strengths of the product
 Reputation for quality and innovation
• Examples:
 BMW
 Miele - high quality domestic appliances
 James Purdey – rifles
 Bang and Olufsen- high quality hi-fi
 Mercedes
 LEGO – the main problems

• Non competitive products

• Non differentiated products

• Technological gap – technological driven toy

increased
LEGO – The main strategy changes (1/5)

• Product differentiation: no more the colored

bricks, but…
LEGO – The main strategy changes (2/5)

• Product differentiation: no more the colored

bricks for guys, but…
LEGO – The main strategy changes (3/5)

• Product differentiation: not only stories,

but..
LEGO – The main strategy changes (4/5)

• Reducing the technological gap and the

relation with clients
LEGO – The main strategy changes (5/5)
• Different channels (from “just imagine” to
“play on”)
 Differentiation: benefits
• Differentiation offers the prospect of charging a
premium price
• Demand for a differentiated product will be less
elastic than that for competitors products
• Differentiation can result in above average
profits
• Differentiation can create additional barriers to
entry to the market for newcomers
 The five forces and differentiation

Five forces A firm pursuing a differentiation strategy…

Entry barriers Benefits from customer loyalty which discourages
potential entrants

Buyer power Enjoys some protection since large buyers have

less power to negotiate because of the absence of
close alternatives
Supplier power Is better able to pass on supplier price increases
to customers

Threat of Is protected from the threat of substitutes by

substitution customer loyalty

Rivalry Benefits from brand loyalty to keep customers

from rivals
 Risks of differentiation strategy
• There are difficulties of sustaining differentiation
• Differentiation involves higher costs
• There is a risk of creating differences that customers do
not value
• Customers might become price sensitive and choose on
price rather than uniqueness
• It might involve differentiation on dimensions that
become less important to customers over time
• Customers may no longer need the differentiation factor
• Imitators may narrow the differentiation
• Rivals pursuing a focus strategy may be able to achieve
even greater differentiation in their market segments
 Focus strategy
• In a focus strategy the firm concentrates on one (or at
most a limited number of) segments of the market
• The premise behind this strategy is that the needs of the
group can be bettered served by focussing entirely on it
• The firm might feel more secure in the niche with greater
insulation from competition
• A focus strategy means that the firm’s efforts are not
spread too thinly
• Focus strategies are
 Cost focus: cost leader in a particular segment
 Focus differentiation: differentiation in the chosen segment
 Requirements of a focus strategy
• A focus strategy requires…
• The identification of a suitable target customer
group
• Identification of the specific needs of that group
• Confirmation that the market is sufficiently large
to sustain the business
• Estimation of the extent of competition within the
segment
• Production of products to meet the specific
needs of that group
• A decision on whether to opt for cost leadership
or differentiation within the segment
 Benefits of a focus strategy
• It involves lower investment in resources
• The firm benefits from specialisation
• It provides scope for greater knowledge of a
segment of the market
• It makes entry to new markets easier and less
costly
• Firms using a focus strategy often enjoy a high
degree of customer loyalty
 Focussed cost leadership
• A strategy that aims…
• To attract one type of customer with a low cost
product
• To be the lowest cost operator in one particular
niche segment of the market
• Example :Hyundai
 Focussed differentiation
• A strategy that aims to attract one type of
customer with a differentiated product
• It involves distinctiveness in one segment
• Aims to exploit unique position in a niche
segment of the market
• Not the cheapest but the best or most distinctive
in that segment
• Example: BMW, Mercedes
2–54
 The five forces and a focus strategy

The five forces A firm pursuing a focus strategy…

Entry barriers Develops core competencies that can act as an entry
barrier

Buyer power Enjoys some insulation since large buyers have less
power to negotiate because few alternatives are
available

Supplier power Is better able to pass on supplier price rises thereby

reducing the impact of supplier power

Threat of substitution Enjoys some protection against substitutes by

specialised products and core competencies

Rivalry Enjoys some protection because rivals cannot meet

differentiation focused customer needs
 Problems associated with focus strategy
• Limited opportunities for growth
• Sacrifice of economies of scale that would be
available from a larger market
• The firm could outgrow the market
• Danger of decline in the chose segment or niche
• A reputation for specialisation inhibits move into
new sectors
• Risk of imitation
• Risk of changes in the target segment
 Stuck in the middle
• Porter argued that a firm must make a conscious
choice about the competitive advantage it seeks
to develop
• If it fails to choose one of these strategies,it
risks being “stuck in the middle”,trying to be all
things to all people,and ends up with no
competitive strategy at all
• Being stuck in the middle leads to low
profitability
• Competitors with a clear strategy outperform
those whose strategy is unclear or attempt a
combination of strategies
 What is wrong with being “stuck in the
middle”?
• It is difficult to simultaneously become
differentiated and low cost
• The firm loses out to others able to undercut it
and to those able to offer a superior product
• If a firm differentiates itself by supplying very
high quality products it risks undermining that
quality if it seeks to be come a cost leader
• Such a firm also suffers from a blurred corporate
culture and the projection of a confusing image
 Multiple strategies
• Firms that are able to succeed at multiple
strategies create separate business units for
each strategy
• By separating the strategies into
 Different units
 Each with its own culture
 Each with its own brands
 Generic strategies: summary
• Cost leadership
 Being the lowest cost producer in the industry as a
whole
• Differentiation
 The exploitation of a product or service which is
believed to be unique
• Focus
 Restricting activities to only part of the market
through:
 Providing goods or services at lower cost to that
segment (cost focus)
 Providing a differentiated product or service to that
segment (differentiation focus)
 The Savvy Strategist
• For strategic practice, the industry-based view
provides:
 A systematic foundation for industry analysis and
competitor analysis, to which a more detailed
examination, introduced in later chapters, can be
added
 A set of answers to the four fundamental questions in
strategy discussed in Chapter 1
 Evidence that industry-specific conditions play an
important role in determining firm performance

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