1. Review: Classes 1 - 3 Objective of Business. Intro. Prisoners’ Dilemma (Game Theory intro) What is Strategy? IBP: Cost strategy, KSF changed, Constraints on options. Resources & Capabilities. Starbucks: Customer Buying? Value Chain - internal view, Growth Perils. A-B: Power of consistent, unique strategy; power of leader; potential environmental change? Tonight: External view

2. THE INDUSTRY ENVIRONMENT Company TJB Suppliers X TJB Competitors Customers Social structure The national/ international economy Technology Government & Politics The natural environment Demographic structure Social structure From Environmental Analysis to Industry Analysis The Industry Environment lies at the core of the Macro Environment. The Macro Environment impacts the firm through its effect on the Industry Environment. Context: PEST

3. The Spectrum of Industry Structures Concentration Entry and Exit Barriers Product Differentiation Information Perfect Competition OligopolyDuopolyMonopoly Many firms A few firmsTwo firmsOne firm No barriersSignificant barriersHigh barriers Homogeneous Product Potential for product differentiation Perfect Information flow Imperfect availability of information

4. Porter’s Five Forces of Competition ** Framework SUPPLIERS POTENTIAL ENTRANTS SUBSTITUTES BUYERS INDUSTRY COMPETITORS Rivalry among existing firms Bargaining power of suppliers Bargaining power of buyers Threat of new entrants Threat of substitutes Book

5. Threat of Substitutes Extent of competitive pressure from producers of substitutes depends upon: Buyers’ propensity to substitute The price-performance characteristics of substitutes. My worksheet

6. The Threat of Entry Entrants’ threat to industry profitability depends upon the height of barriers to entry. The principal sources of barriers to entry are: Capital requirements Economies of scale Absolute cost advantage Product differentiation Access to channels of distribution Legal and regulatory barriers Retaliation

7. Bargaining Power of Buyers Buyer’s price sensitivityRelative bargaining power Cost of purchases as % of buyer’s total costs. How differentiated is the purchased item? How intense is competition between buyers? How important is the item to quality of the buyers’ own output? S ize and concentration of buyers relative to sellers. Buyer’s information. Ability to backward integrate. Note: analysis of supplier power is symmetric

8. Rivalry Between Established Competitors The extent to which industry profitability is depressed by aggressive price competition depends upon: Concentration (number and size distribution of firms) Diversity of competitors (differences in goals, cost structure, etc.) Product differentiation Excess capacity and exit barriers Cost conditions –Extent of scale economies –Ratio of fixed to variable costs

9. Market Growth Less than -5% -5% to 0 0 to 5% 5% to 10% Over 10% Figure 3.5. The Impact of Growth on Profitability Surprised?

10. Applying Five - Forces Analysis Forecasting Industry Profitability Past profitability a poor indicator of future profitability. TJB - ?? PharmDrugs v Steel, Airlines If we can forecast changes in industry structure we can predict likely impact on competition and profitability. Strategies to Improve Industry Profitability What structural variables are depressing profitability Which can be changed by individual or collective strategies?POA

11. Profitability of US Industries, 1985-97

12. Industry EVA/CEMV/CEROA Tobacco0.09363.231414.3979 Computer Software & Services0.05904.033110.3530 Entertainment0.04422.82408.4403 Personal Care 0.02812.87008.005 Medical Products0.02763.09879.5384 Food Processing0.02511.70908.5306 IT Consulting Services0.02062.71366.5260 Drugs & Research0.00653.38077.6439 Chemicals0.00291.81957.9589 Beverages0.00182.16885.5960 Eating Places0.00142.32466.8867 Textiles-0.00121.93927.4093 Building Materials-0.00561.55215.6250 Metals-0.01011.7447- Telephone Companies-0.01241.36804.6181 Semiconductors & Components-0.01262.05605.9906 Aluminium-0.01281.4844- Paper & Products-0.01491.29025.2342 Broadcasting & Publishing-0.01491.80426.0059 Cars & Trucks-0.01500.94732.1660 Computers & Peripherals-0.03061.73323.1143 Electrical Products-0.03271.30564.6276 Aerospace & Defence-0.03311.39824.8390 Railroads-0.03401.02573.7780 Airlines-0.04161.16760.9866 Construction & Engineering-0.04581.6749- Steel-0.06471.29672.2646 Mean (all industries)-0.01101.89305.5989 US Industrial Profitability, 1986-97: EVA, Market Value Added, and ROA

13. High Med. Low StrongAverage Weak Market Attractiveness How much Profit is there to be made? Competitive Strength: What % of profit can WE make? X Plant is first entry into the Y Industry Market Attractiveness & Competitive Strength for various ZZZ markets Sector Industry 1Industry 2Industry 4Industry 3Industry 5

14. Drawing Industry Boundaries : Identifying the Relevant Market 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 –On the supply side : are manufacturers able to switch production between types of cars and across countries May need to analyze industry at different levels for different types of decision

15. The Value Net COMPANY CUSTOMERS SUPPLIERS COMPLEMENTORS COMPETITORS Book. Complexity & Tools

16. SUPPLIERS POTENTIAL ENTRANTS SUBSTITUTES BUYERS INDUSTRY COMPETITORS Rivalry among existing firms Bargaining power of suppliers Bargaining power of buyers Threat of new entrants Threat of substitutes COMPLEMENTS The suppliers of complements create value for the industry and can exercise bargaining power Five Forces or Six? Introducing Complements

17. Dynamic Competition Porter framework assumes (a)industry structure drives competitive behavior (b)Industry structure is stable. But---competition also changes industry structure Schumpeterian Competition: A“perennial gale of creative destruction” where innovation overthrows established market leaders Hypercompetition: “intense and rapid competitive moves….creating disequilibrium through continuously creating new competitive advantages and destroying, obsoleting or neutralizing opponents’ competitive advantages

18. Applying Five Forces to Emerging E-commerce Markets Applying Five Forces to Emerging E-commerce Markets The more unstable is industry structure—the less helpful is analysis based upon industry structure. Taking account of time—willingness to endure losses today in order to reap profit tomorrow General structural features of digital, networked industries: Low entry barriers + Extreme scale economies + Network externalities = Winner-take-all markets = Intense competition

19. Pre-requisites for success What drives competition? What are the main dimensions of competition? How intense is competition? How can we obtain a superior competitive position? Analysis of demand Who are our customers? What do they want? KEY SUCCESS FACTORS Analysis of competition What drives competition? What drives competition? What are the main dimensions of competition? What are the main dimensions of competition? How intense is competition?How intense is competition? How can we obtain a superior competitive position?How can we obtain a superior competitive position? What do customers want? How does the firm survive competition Pre-requisites for success Identifying Key Success Factors

20. Identifying Key Success Factors Through Modeling Profitability: The Airline Industry Profitability = Yield x Load factor - Unit Cost Income Revenue RPMs Expenses ASMs RPMs ASMs ASMs = x - Price competitiveness. Efficiency of route planning. Flexibility and responsiveness. Customer loyalty. Meeting customer requirements. Wage rates. Fuel efficiency of planes. Employee productivity. Load factors. Administrative overhead. Strength of competition on routes. Responsiveness to cha- anging market conditions % business travelers. Achieving differentia- tion advantage ASM = Available Seat MilesRPM = Revenue Passenger Miles

21. ROCE Return on Sales Sales/Capital Employed Sales mix of products Avoiding markdowns through tight inventory control Max. buying power to minimize cost of goods purchased Max. sales/sq. foot through: * location *product mix *customer service*quality control Max. inventory turnover through electronic data interchange, close vendor relationships, fast delivery Minimize capital deployment through outsourcing & leasing Identifying Key Success Factors by Analyzing Profit Drivers: Retailing Identifying Key Success Factors by Analyzing Profit Drivers: Retailing

22. SUMMARY: What Have We Learned? Forecasting Industry Profitability Past profitability a poor indicator of future profitability. If we can forecast changes in industry structure we can predict likely impact on competition and profitability. Strategies to Improve Industry Profitability What structural variables are depressing profitability? Which can be changed by individual or collective strategies? Defining Industry Boundaries Key criterion: substitution Working at different levels of aggregation

23. SUMMARY (continued) Key Success Factors Starting point for the analysis of competitive advantage Game Theory Valuable in analyzing competitive rivalry between small number of players Analysis of cooperation & competition Offers insights into the structure of the game; competitive interaction; use of specific strategic plays. Industry Analysis & The New Economy Porter 5 forces analysis less useful when industry structure unstable Key to understanding digital, networked markets is to understand their underlying structure (esp. scale economies and network externalities)

24. Industry Evolution The industry life cycle Industry structure, competition, and success factors over the life cycle. Anticipating and shaping the future. OUTLIN E

25. The Industry Life Cycle Drivers of industry evolution : demand growth creation and diffusion of knowledge Introduction Growth Maturity Decline Industry Sales Time

26. Product and Process Innovation Over Time Time Rate of innovation Product Innovation Process Innovation

27. Standardization of Product Features in Autos FEATURE INTRODUCTIONGENERAL ADOPTION Speedometer 1901 by OldsmobileCirca 1915 Automatic transmission 1st installed 1904Introduced by Packard as an option, 1938. Standard on Cadillacs early 1950s Electric headlamps GM introduces, 1908Standard equipment by 1916 All-steel body GM adoptes 1912Standard by early 1920s All-steel enclosed body Dodge, 1923Becomes standard late 1920s Radio Optional extra 1923Standard equipment, 1946 Four-wheel drive Appeared 1924Only limited availability by 1994 Hydraulic brakes Introduced 1924 Became standard 1939 Shatterproof glass 1st used 1927Standard features in Fords 1938 Power steering Introduced 1952Standard equipment by1969 Antilock brakes Introduced 1972Standard on GM cars in 1991 Air bags GM introduces, 1974By 1994 most new cars equipped with air bags

28. How Typical is the Life Cycle Pattern? Technology-intensive industries (e.g. pharmaceuticals, semiconductors, computers) may retain features of emerging industries. Individual products do not. Other industries (especially those providing basic necessities, e.g. food processing, construction, apparel) reach maturity, but not decline. Industries may experience life cycle regeneration. Sales Sales 1900 ‘50 ‘60 ‘90 1930 50 60 90 MOTORCYCLES TV’s Life cycle model can help us to anticipate industry evolution—but dangerous to assume any common, pre- determined pattern of industy development. Tools, Complexity Color B&W Portable HDTV ?

29. Evolution of Industry Structure over the Life Cycle INTRODUCTION GROWTH MATURITY DECLINE DEMANDAffluent buyersIncreasingMass market Knowledgeable, penetrationreplacement customers, resi- demand dual segments TECHNOLOGYRapid productProduct and Incremental Well-diffused innovation process innovation innovation technology PRODUCTS Wide variety, Standardization Commoditiz- Continued rapid design changeation commoditization MANUFACT-Short-runs, skill Capacity shortage, Deskilling Overcapacity URING intensive mass-production TRADE -----Production shifts from advanced to developing countries----- COMPETITION Technology-Entry & exit Shakeout & Price wars, consolidation exit (p. 315) KSFs Product innovation Process techno- Cost efficiency Overhead red- logy. Design for uction, ration- alization, low cost sourcing

30. The Driving Forces of Industry Evolution Customers become more knowledgeable & experienced Diffusion of technology Demand growth slows as market saturation approaches Customers become more price conscious Products become more standardized Distribution channels consolidate Production shifts to low-wage countries Price competition intensifies Bargaining power of distributors increases BASIC CONDITIONS INDUSTRY STRUCTURE COMPETITION Excess capacity increases Production becomes less R&D & skill-intensive Quest for new sources of differentiation

31. Preparing for the Future : The Role of Scenario Analysis in Adapting to Industry Change Stages in undertaking multiple Scenario Analysis: Identify major forces driving industry change Predict possible impacts of each force on the industry environment Identify interactions between different external forces Among range of outcomes, identify 2-4 most likely/ most interesting scenarios: configurations of changeforces and outcomes Consider implications of each scenario for the company Identify key signposts pointing toward the emergence of each scenario Prepare contingency plan Tool, POA, Option Value

32. 1880s 1920s 1960s 2000 Mail order, catalogue retailing e.g. Sears Roebuck Chain Stores e.g. A&P Discount Stores e.g. K-Mart Wal-Mart “Category Killers” e.g. Toys-R-Us, Home Depot Internet Retailers e.g. Amazon; Webvan Warehouse Clubs e.g. Price Club Sam’s Club Innovation & Renewal over the Industry Life Cycle: Retailing Innovation & Renewal over the Industry Life Cycle: Retailing

33. Review: New tools. Use Insights from to develop POA 4 C’s, PEST 5 Forces => Market Attractiveness, can combine w/ Competitive Strength => Corporate Strategy Key Success Factors Life Cycle Scenarios, option value Value Equivalence Line - next Strategic Groups & competing w/in and between, p. 127 - 129

34. BCG’s Strategic Environments Matrix Small Big SIZE OF ADVANTAGE Many Few SOURCES OF ADVANTAGE FRAGMENTEDSPECIALIZATION apparel, housebuildingpharmaceuticals, luxury cars jewelry retailing, sawmillschocolate confectionery STALEMATEVOLUME basic chemicals, volumejet engines, food supermarkets grade paper, ship owningmotorcycles, standard (VLCCs), wholesale bankingmicroprocessors

35. BCG’s Analysis of the Strategic Characteristics of Specialization Businesses high low ENVIRONMENTAL VARIABILITY ABILITY TO SYSTEMATIZE low high CREATIVE EXPERIMENTAL fashion, toiletries, magazines general publishing food products PERCEPTIVE ANALYTICAL high tech luxury cars, confectionery paper towels