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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
• 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
     Contingency theory   Environment      ->   Organizational
     (1960’s)                                   design

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

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• 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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• 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
• 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 Entrants

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

                      Threat of
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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
  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
                           * 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

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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

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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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