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					 ADM 5261 Strategy Formulation
  Session 2: The Environment

                       MBA Program
                   Faculty of Administration
                     University of Ottawa
                    September 12th, 2001

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                   The Environment

• Early strategy research
• Porter’s 5 forces of competition
• Today’s environment
     – Arthur and increasing returns
     – Financial markets
• Assignment #2


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             Early Strategy Research

• Grew out of economics
• Considered the impact of the
  environment on the choices available to
  firms
• Concluded that to be successful, firms
  must fit their strategies and their
  structures to their environments

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                   Environment -> Firm
     Structure-Conduct- Market structure   ->   Firm conduct and
     Performance                                hence firm
     Bain/Mason (1960’s)                        performance
     Chandler (1960’s)   Changes in        ->   Changes in firm
                         technology and         strategy and
                         market                 hence
                         organization           organizational
                                                structure
     Contingency theory   Environment      ->   Organizational
     (1960’s)                                   design

     Rumelt (1970’s)      Industry         ->   Diversification
                                                strategies and
                                                organizational
                                                structure
     Porter (1985)        Industry         ->   Five forces of
                          organization          competition
                                                affecting the firm

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       Structure-Conduct-Performance
• Industry structure
   –   barriers to entry
   –   the number and size distribution of firms
   –   product differentiation
   –   overall elasticity of demand
• Conduct
   –   price
   –   advertising
   –   capacity
   –   quality
• Performance
   – profitability
   – cost minimization
   – innovativeness
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                     Chandler
• Strategy and Structure (1962)
  – Sears, Standard Oil, GM, Dupont
  – Increased scope: product line and geographic
  – Increased need for communication,
    coordination, and information consolidation
  – The rise of the multidivisional structure
• The Visible Hand (1977)
  – Changes in transportation and communication
    increased the role of strategic choice

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                     Contingency Theory
• Burns and Stalker (1961)
  – compared mechanistic and organic modes of
    organizing
• Woodward (1965)
  – best performing firms match organizational
    structures to their tasks
• Lawrence and Lorsch (1967)
  – better performing firms match organizational
    structure (differentiation and integration) to
    degree of environmental uncertainty
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              Diversification Strategies
• Compared strategy and the adoption of the
  multidivisional structure
• Strategic classifications: single, dominant,
  related, unrelated
• Adoption of MD structure depends on:
  – strategic classification (more diversified more
    likely to adopt)
  – year (increases from 1950 to 1970)
  – home country (US, UK more likely to adopt)
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      Porter’s Five Forces Model of Competition

                     Threat of
                      Threat of
                       New
                    New Entrants
                     Entrants



Bargaining          Rivalry Among        Bargaining
 Power of          Competing Firms        Power of
 Suppliers           in Industry           Buyers



                      Threat of
                      Substitute
                      Products
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                       Bargaining Power of Buyers
Buyer groups are likely to be powerful if:
* Buyers are concentrated or purchases
  are large relative to seller’s sales
                                                  Buyers compete
* Purchase accounts for a significant           with the supplying
  fraction of supplier’s sales                        industry by:
* Products are undifferentiated
                                             * Bargaining down prices
* Buyers face few switching costs             * Forcing higher quality
* Buyers’ industry earns low profits             * Playing firms off of
                                                            each other
* Buyer presents a credible threat of
  backward integration
* Product unimportant to quality
* Buyer has full information
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                         Bargaining Power of Suppliers
                                 Suppliers are likely to be powerful if:
                                 * Supplier industry is dominated by
Suppliers exert power              a few firms
in the industry by:
                                 * Suppliers’ products have few
* Threatening to raise
                                   substitutes
  prices or to reduce quality    * Buyer is not an important customer
                                   to supplier
Powerful suppliers
can squeeze industry             * Suppliers’ product is an important
profitability if firms             input to buyers’ product
are unable to recover            * Suppliers’ products are differentiated
cost increases
                                 * Suppliers’ products have high
                                   switching costs
                                 * Supplier poses credible threat of
                                   forward integration
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                    Threat of Substitute Products


                            Keys to evaluate substitute products:

 Products                     * Products with improving
 with similar                   price/performance tradeoffs
 function limit                 relative to present industry
 the prices                     products
 firms can
 charge                          For Example:
                                 Electronic security systems in place
                                 of security guards
                                 Fax machines in place of overnight
                                 mail delivery
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                    Threat of New Entrants

                           * Economies of Scale

    Barriers to            * Product Differentiation
      Entry
                           * Capital Requirements

                           * Switching Costs
                           * Access to Distribution Channels

                           * Cost Disadvantages Independent
                             of Scale

                           * Government Policy


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      Today’s Environment:
Brian Arthur & Increasing Returns
Old Economy             New Economy
• Resource-based        • Knowledge-based
• Diminishing returns   • Increasing returns
• Firms strive to       • Firms strive to adapt
  optimize




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                     Increasing Returns
• Why do they exist?
  – Up-front costs
  – Network effects
  – Customer groove-in
• How should a firm respond?
  – Be an early mover
  – Build partnerships
  – Invest for market share
  – Manage commitment/adaptability requirement
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        Today’s Environment:
Financial Markets: NASDAQ COMPX




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         COMPX vs.
Networking Equipment Suppliers




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    COMPX, NT vs. Internet Icons




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                    So What?

• Is this aspect of the environment
  important to your business?
• If so, how will it affect your business?
• Will strategy researchers consider this
  Internet bubble to have been important?
• If so, what will they have to say about
  it?

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Assignment #2: The Environment

• Analyze your firm’s environment
      – Porter’s 5 force’s model
• Be sure to consider
      – Current and *future* forces
      – Effect of increasing returns as appropriate
• Use real data
      – Start with bookmarks on course website


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                    Criteria for Evaluation

• Quality of data sources and data
      – Pertinent
      – Diverse
• Quality of analysis
      – Identification of key forces and their
        expected evolution



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