Classic Approaches to Strategy by yurtgc548


									Foundations of Competitive

   Industry Analysis
  Strategy Flowchart

                                     Where do
                 Where are           we want to   Mission,
Industry &       we now?                          Vision, &
Organizational                                    Target
Analysis                                          Setting

                         How do we
                         get there?
                        Competitive &
Where are we now?
       Organizational   Environmental/Industry
          Analysis             Analysis

          Strengths        Opportunities

        Weaknesses            Threats

           VRIO             Porter Forces
Industry Analysis
   As the Cramer case showed, it is critical to
    understand your industry.
   Cronin had the wrong model of what his
    industry was about.
   Industry analysis is about:
       Where are we now?
       What are our opportunities?
       What are our threats?
       Who is in position to capture the value that we

   The value of (surplus from) an activity is the
    difference between its benefit and its cost.
   Cost recall is defined in terms of economic
       economic cost ignores sunk expenditures (i.e.,
        expenses that cannot be affected by decisions
        over the relevant decision-making horizon)
       economic cost pays attention to imputed costs
        (e.g., an opportunity to utilize a resource in a
        different way).
The Value of Trade

   When a good or service is traded, the value
    or surplus from that transaction is the
    difference between the buyer’s benefit and
    the seller’s cost.
   Two issues:
       Efficiency: a transaction should take place if and
        only if the buyer’s benefit is not less than the
        seller’s cost.
       Capture of surplus: how is the surplus (value
        created) divided between buyer and seller?
An Experiment

   Six people will write their value of a candy bar
    on a 3x5 card (and their names).
   Three pairs will be formed at random.
   One player in each pair will be assigned to be
    the buyer and one the seller.
   Trade will take place under rules to be
    defined; however, the rules will prevent you
    from making or refusing a trade inconsistent
    with your stated value for the candy bar.
Notes on Experiment
Division of Surplus
            Buyer’s power increasing

       b                  b             b
        c                  c            c

            Seller’s power increasing

   Profits are revenue minus costs (economic
    costs, of course).
   Profits go up when revenue goes up or costs
    go down or both.
   Hence, profits a function of
       Total surplus
       Power of firm to capture surplus
           More power as seller (revenues go up)
           More power as an input buyer (costs go down)
Traditional Industry Taxonomies
    Monopoly is when there is only one
    Oligopoly is when there are only a few
     producers, each of whom can be expected
     to react to the actions of the others.
    A competitive market is one in which
     there are many producers, none of whom
     can be expected to react to the actions of
     the others.
Porter Forces Model
   ENTRANTS                                                  GOVERNMENT

   Threat of new
              entrants                                            Government regulation,
                                                        antitrust, and trade policies

   SUPPLIERS                                                             BUYERS
                 Bargaining power                      power of buyers
                 of suppliers         Rivalry among
                                      existing firms
    Threat of substitute goods                              Coordination and
           and services                                          standardization

   SUBSTITUTES                                                 & NETWORK

    Industry competitors: The impact that the
     rivalry among existing firms has on a firm's
     competitive strategy.
    Potential entrants: The impact that
     potential entry by new firms has on a firm's
    Substitutes: The impact that substitute
     products have on a firm's competitive

      Complements & networks: For some
       products, complements or network
       externalities (or both) have important
       effects on what its producer can do.
      Suppliers: The behavior of suppliers has
       an impact on strategy.
      Customers: The behavior of customers
       can have an impact on strategy.

   Government: All firms operate in an
    environment affected by the laws, rules, and
    practices of government.
Issues with Suppliers
   What is the bargaining power of suppliers?
       The more bargaining power they have, the more surplus
        they capture.
       The suppliers’ bargaining power is a function of their
        market structure.
   The potential for vertical integration and being
    locked out.
       Vertical integration can be way to protect yourself against
        changes in supplier structure
       Vertical integration can sometimes increase the pie.
The Issue with Customers
   Customers’ bargaining power, which is a
    function of
       their costs of switching to competitors or
        substitute products
       the size of a single customer as a proportion of all
        your customers.
       market structure of customers (if you sell an
        intermediate good or service).
            Generally, like a competitive market downstream: a
             competitive market maximizes value and multitude of
             competitors shifts market power to you.
The Main Issues with Competitors

   Loosely, more competitors mean customers have
    more choice; more choice means you have less
    market power; hence:
        competition   sellers’ share of surplus 
   But also fierceness and discipline among
    competitors affects whether industry retains market
    power or it shifts to customers.
       “air service” experiment
       Electronic components
           Distributors don’t
           Active component sellers do
       Coke & Pepsi
Issues with Competitors
   Intensity of competition
       the more intense the competition, the lower
        profits will be.
   The number of competitors
       the more competitors there are, the lower profits
        will be if only because pie divided among more.
   Relative size of competitors
       large, dominant firm can often impose discipline
       similarly sized firms usually compete more
Rivalry among existing firms

   The dimensions along which firms compete
    and the fierceness of that competition.
   Firms compete on many dimensions.
   The most important of which is price.
       Why? Because its the dimension firms most want
        to avoid competing on.
       Going head-to-head on price is bad news for
        firms! – Recall the Bertrand Trap!
The Fundamental Rule of Competitive

Competitive strategy is like
 driving, not football: Head-on
 collisions are to be avoided.
Key issue: Fierceness of price
   Homogeneity of             Firm production
    product. More               capacities. More
    homogenous, fiercer         capacity, fiercer
    price comp.                Number of firms. More,
   Customers’ knowledge
                               Frequency of interaction &
    of prices. More know,       non-myopic play
    fiercer.                   Variability in demand.
   Customers’ switching        More variable, fiercer
    costs. Lower costs,        “Barriers” to exit. More
    fiercer.                    barriers, fiercer
The Issues with Potential Entrants
   If potential entrants enter, they are new
   Deterring potential entrants from entering is a
    strategic issue that affects your competitive
Threat of Entry

      An entrant is a potential competitor
      Entry is bad because
          can result in more intense price pressure
           (lower margins)
          can result in smaller mkt. share even if prices
           not much affected
          or both!
      Principal issue: Is entry deterred? Can it
       be deterred?
Inherent Barriers to Entry
    Protections on intellectual property
    Legal or regulatory restrictions
    High consumer switching costs
    High supplier switching costs
    Recouping industry-specific initial investments
    Text in red can also be strategic barriers to
     entry—a topic for later. Can sometimes leverage
     non-red items strategically to deter entry (also a
     topic for later).
The Issue with Substitutes and
     Pricing and availability of substitutes and
      complements affects demand for your
         Availability of complements affects
          competition among rivals (e.g., lack of
          software for OS/2 vs. abundance of software
          for Windows).
         As you saw in MBA 201A, demand for your
          product shifts with the prices of complements
          & substitutes.
Substitute goods & services

 Recall what substitute
goods are.                                  D(psub = high)
       example: air vs. rail               D(psub = low)
   Issues w/ substitutes
       how close substitutes are
       level of price competition in
        substitute mkt.
Complements & Networks

   Recall complementary
    goods (e.g., cars & gasoline)
                                    P   D(pcomp = low)
   Strategic success can               D(pcomp = high)
    depend on what happens in
    complementary market
       prices                               Q
       standards
   Network externalities
Network Externalities

   An externality, recall, is an effect that one entity’s
    action has on another that the first entity does not
    consider in deciding what action to take.
       Air pollution 
       Painting your house 
       Getting a telephone 
       Getting a credit card 
       Using a Linux-based computer 
       Buying a DVD player 
   The ones in red are network externalities. The last
    two (with 2 thumbs) exhibit positive & negative
    network externalities.
Consequences of Network Externalities

   … on pricing
       Need to establish an installed base can require low
        introductory pricing
       Issues in how price to different parts of market for incentive
           Who should pay for a phone call?
           How should fees be set for credit cards?
   … work directly with complements providers
       Encourage development
       Deal with ancillary concerns (e.g., IP)
   … effect on market structure
       Natural monopoly generation
   An issue in many network industries is standards
   Proprietary standards affect market power
       Can create monopoly
       But can hinder growth, particularly if there’s a standards
   Common standards generally …
       … good for software producers
       … good for consumers (except for market power concerns)
       … mixed for hardware producers
           negative if fosters competition
           positive if foster software production
           positive if increase network size
A “Seventh Force”
   The government
       antitrust law and its enforcement
       regulation
       infrastructure (complement)
       intellectual property law
       differences in these factors across governmental
       trade policy
       lobbying competition

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