Foundations of Competitive Strategy

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Foundations of Competitive Strategy

• Industry Analysis

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Strategy Flowchart

Where do we want to be?
Where are we now?
Mission, Vision, Target Setting
Industry Organizational Analysis
How do we get there?
Competitive Organizational Actions
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Where are we now?
Organizational Analysis
Environmental/Industry Analysis
Strengths
Opportunities
Weaknesses
Threats
VRIO
Porter Forces Model
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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
  create?

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Value

• The value of (surplus from) an activity is the
  difference between its benefit and its cost.
• Cost recall is defined in terms of economic cost.
• 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).

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The Value of Trade

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

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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.

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Notes on Experiment
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Division of Surplus
Buyers power increasing
p
p
p
Sellers power increasing
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Profits

• 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)

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Traditional Industry Taxonomies

• Monopoly is when there is only one producer.
• 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.

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Porter Forces Model
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Porter

• 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 strategy.
• Substitutes The impact that substitute products
  have on a firm's competitive strategy.

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Porter

• 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.

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Porter

• Government All firms operate in an environment
  affected by the laws, rules, and practices of
  government.

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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.

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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.

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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 dont
• Active component sellers do
• Coke Pepsi

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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
  fiercely.

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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!

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The Fundamental Rule of Competitive Strategy

• Competitive strategy is like driving, not
  football Head-on collisions are to be avoided.

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Key issue Fierceness of price competition

• Homogeneity of product. More homogenous, fiercer
  price comp.
• Customers knowledge of prices. More know,
  fiercer.
• Customers switching costs. Lower costs, fiercer.

• Firm production capacities. More capacity,
  fiercer
• Number of firms. More, fiercer
• Frequency of interaction non-myopic play
• Variability in demand. More variable, fiercer
• Barriers to exit. More barriers, fiercer

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The Issues with Potential Entrants

• If potential entrants enter, they are new
  competitors.
• Deterring potential entrants from entering is a
  strategic issue that affects your competitive
  strategy.

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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?

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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
  entrya topic for later. Can sometimes leverage
  non-red items strategically to deter entry (also
  a topic for later).

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The Issue with Substitutes and Complements

• Pricing and availability of substitutes and
  complements affects demand for your product.
• 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.

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Substitute goods services

• Recall what substitute
• goods are.
• example air vs. rail
• Issues w/ substitutes
• how close substitutes are
• level of price competition in substitute mkt.

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Complements Networks

• Recall complementary goods (e.g., cars
  gasoline)
• Strategic success can depend on what happens in
  complementary market
• prices
• standards
• Network externalities

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Network Externalities

• An externality, recall, is an effect that one
  entitys 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.

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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 reasons
• 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

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Standards

• An issue in many network industries is standards
  setting
• Proprietary standards affect market power
• Can create monopoly
• But can hinder growth, particularly if theres a
  standards war
• 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

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A Seventh Force

• The government
• antitrust law and its enforcement
• regulation
• infrastructure (complement)
• intellectual property law
• differences in these factors across governmental
  jurisdictions.
• trade policy
• lobbying competition