Competitive Advantage in Mature Industries

Competitive Advantage in Mature Industries

• Key success factors in mature industries• Strategic Implementation: Structure, Systems,

Style

• Strategies for declining industries

OUTLINE

Competitive Advantage in Retailing: Retailers with the Highest and Lowest Valuation Ratios

Competitive Advantage in Retailing: Retailers with the Highest and Lowest Valuation Ratios

TOP 15 Valuation Sales Ratio ($,bil.)

Amazon.com (US) n.a. 3.9Caremark Rx (US) 18.0 6.8Expedia 16.6 0.6Autozone (US) 13.1 5.3Hennes & Mauritz (Swe.) 10.5 5.9Next (UK) 10.1 3.6Bed, Bath & Beyond (US) 8.5 3.7Woolworth (Australia) 8.0 16.0Gap (US) 4.1 14.5TJX (US) 6.9 12.0Inditex (Spain) 6.8 4.7Wal-Mart (US) 5.7 244.5 Radio Shack 5.6 4.6Family Dollar Stores 5.1 4.2Best Buy (US) 5.0 20.9

Toys-R-Us 0.6 11.3J.C. Penny (US) 0.7 32.3Federated Dept. Stores (US) 1.1 15.4J. Sainsbury (UK) 1.1 29.8 Ito-Yokado (Japan) 1.1 28.0Ahold 1.2 78.3Safeway plc (UK) 1.3 29.8Pinault-Printemps-Redoute (France) 1.4 32.2Sears Roebuck (US) 1.4 41.4Dixons Group (UK) 1.4 8.0Albertson’s (US) 1.5 35.6May Department Stores (US) 1.7 11.9Office Depot (US) 1.7 11.4CVS 1.9 24.2Kingfisher (UK) 2.0 17.6

BOTTOM 15 Valuation Sales Ratio ($, bil.)

Key Success Factors in Mature IndustriesKey Success Factors in Mature Industries

• Opportunities for sustainable -- limited potential for differentiationcompetitive advantage are -- technology stable and well diffusedlimited -- ease of entry due to well developed

industry infrastructure and powerful distributors -- international competition : domestic

cost advantage vulnerable

• Sources of -- Economies of scalecost advantage -- Low-cost inputs

-- Low overheads

• Segment and customer -- As general industry environment selection deteriorates, important to locate

attractive segments and woo good customers.

• Sources of differentiation -- Emphasis on image differentiation and advantage differentiation through complementary

services.

• Sources of innovation -- Limited opportunity for product and process innovation but considerable

opportunity for strategic innovation

Sources of Strategic Innovation in Mature IndustriesSources of Strategic Innovation in Mature Industries

• Reconfiguring the value chain: - Benetton and Zara in clothing - Southwest & Ryanair in airlines

- Dell in PCs

• Redefining markets and products - Swatch in watches - Starbucks in coffee shops - Barnes & Noble in book retailing

• Innovative approaches to - Virgin Atlantic in air travel

differentiation - Sephora in cosmetics retailing

Who are the strategic innovators?• New entrants - CNN in news broadcasting

- Nucor in the U.S. steel industry• Existing firms on the periphery -Sun Records in rock ‘n roll music • Firms from adjacent industries - Apple in consumer electronics

Why not leading incumbents?• They are constrained by “industry recipes,” relationships with existing customers, investments in resources & capabilities linked to past strategies.

TIME

RA

TE

OF

INN

OV

AT

ION

Processinnovation

Strategicinnovation

Productinnovation

Product, Process, and Strategic Innovation over the Life Cycle

Product, Process, and Strategic Innovation over the Life Cycle

Strategy Implementation in Mature Industries:The Traditional Model

Strategy Implementation in Mature Industries:The Traditional Model

STRATEGY - Pursuit of cost efficiency through mass production

STRUCTURE - Functional departments

- Line and staff distinction

- Job specialization

CONTROLS - Quantitative, short-term performance targets

- Hierarchical monitoring and control

- Standard, formalized operating procedures, reporting, and management by exception.

INCENTIVES - Emphasis on financial incentives linked to individual performance

TOP - Primary functions are control and MANAGEMENT strategic decision making

- Two main styles: politician and autocrat

The Competitive Environment of Declining Industries

The Competitive Environment of Declining Industries

Features - Excess capacity

of declining - Lack of technological change

industries - Consolidation (but some new entry as old firms exit)

- Old machines and employees

Smooth adjustment - Predictability of declineof capacity Durable assetsdepends upon Costs of closure

- Barriers to exit Managementcommitment

- Strategies of surviving firms

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Strategy Options in Declining Industries

Strategy Options in Declining Industries

LEADERSHIP Establish dominant market position-encourage exit of rivals

-buy market share through acquisition

-acquire capacity

-demonstrate commitment

-dispel optimism about the industry’s future

-raise the stakes

NICHE Identify an attractive segment and dominate it.

HARVEST Maximize cash flow from existing sources

DIVEST Get out while there is still a market for industry assets

Strategy Alternatives for a Declining IndustryStrategy Alternatives for a Declining Industry

LEADERSHIP

or

NICHE

HARVEST

or

DIVEST

NICHE

or

HARVEST

DIVEST QUICKLY

COMPANY’S COMPETITIVE POSITION

Strengths in remaining demand

pockets

Lacks strength inremaining demand

pockets

INDUSTRY STRUCTURE

Favorableto decline

Unfavorableto decline

Vertical Integration and The Scope of the Firm

Vertical Integration and The Scope of the Firm

• Transactions Costs and the Scope of the Firm--Why does the firm exist?--The evolution of firms and markets

• The Costs and Benefits of Vertical Integration• Designing Vertical Relationships• Recent Trends

OUTLINE

From Business Strategy to Corporate Strategy: The Scope of the Firm

From Business Strategy to Corporate Strategy: The Scope of the Firm

• Business Strategy is concerned with how a firm computes within a particular market

• Corporate Strategy is concerned with where a firm competes, i.e. the scope of its activities

• The dimensions of scope are– geographical scope– vertical scope– product scope

P1 P2 P3 C1 C2 C3

Vertical Product GeographicalScope Scope Scope

V1

V2

V3

P3P2P1 C3C2C1

V1

V2

V3

[A] Single Integrated Firm

[B] SeveralSpecialized Firms linkedby Markets

In situation [A] the business units are integrated within a single firm.In situation [B] the business units are independent firms linked by markets.Are the administrative costs of the integrated firm less than the transactioncosts of markets?

Transactions Costs and the Scope of the Firm

Transactions Costs and the Scope of the Firm

Transactions Costs and The Existence of the Firm

Transactions Costs and The Existence of the Firm

• Transaction cost theory explains not just the boundaries of firms, also the existence of firms.• In 18th century English woollen industry, no firms – independent spinners and weavers linked by merchants.• Residential remodeling industry -- mainly independent self- employed builders, plumbers, electricians, painters.• Key issue -- transaction costs of the market vs.

administrative costs of firms.• Where transaction costs high—firm is more efficient means of organization

Note: transaction costs comprise costs of search and contract negotiation and enforcement

Aggregate Concentration in US Manufacturing, 1947-97

0

5

10

15

20

25

30

35

40

45

1947 1954 1962 1970 1978 1987 1997

Top-200 cos. share of value added in US manufacturing

Determinants of Changes in Corporate ScopeDeterminants of Changes in Corporate Scope

1800 – 1980 Expanding scale and scope of industrial corporations due todeclining administrative costs of firms:• Advances in transportation, information and communication technologies• Advances in management—accounting systems, decision sciences, financial techniques, organizational innovations, scientific management

1980 – 1995 Shrinking size and scope of biggest industrial corporations.

Increasingly Increased no. of managerial Admin. costs ofturbulent decisions. Need for fast firms rise relative external responses to external to transaction environment change costs of markets

1995 – 2007 Rapid increase in global concentration (steel, aluminium, oil, beer, banking, cement).

Key drivers: quest for market power and scale economies.

Also, large corporations better at reconciling size with agility

The Costs and Benefits of Vertical Integration: BENEFITS

The Costs and Benefits of Vertical Integration: BENEFITS

• Technical economies from integrating processes e.g. iron and steel production

—but doesn’t necessarily require common ownership

• Superior coordination • Avoids transactions costs of market contracts in situations

where there are:-- small numbers of firms-- transaction-specific investments-- opportunism and strategic

misrepresentation-- taxes and regulations on market

transactions

Williamson (1975)• Complete vs incomplete contracts

– Bounded rationality– Measurement problems– Information asymmetry

Ensure all contracts are incomplete• Asset specificity creates quasi-rents

– the difference in value of an asset in its best and next best use (fundamental transformation to small N bargaining or bilateral monopoly)

• Site specificity – assets located side by side to save costs • Physical asset specificity – customized to a particular transaction• Human asset specificity – workers have specialized skills

Holdup

• The existence of quasi-rents creates the incentive for opportunism in the form of hold-up– E.g. If I make you the exclusive supplier of a critical part then I

expose myself to your demands• Firms integrate to avoid the threat of hold-up or the costs

of avoiding it (e.g. litigation, distrust)• Integration is efficient if the transaction costs of hold-up

exceed governance costs• In theory, hold-up should be very rare because potential

victims will integrate before being held up.

The Costs and Benefits of Vertical Integration: COSTS

The Costs and Benefits of Vertical Integration: COSTS

• Differences in optimal scale of operation between different stages prevents balanced VI

• Strategic differences between different vertical stages creates management difficulties (dominant logic)

• Inhibits development of and exploitation of core competencies

• Limits flexibility -- in responding to demand cycles -- in responding to changes in

technology, customer preferences, etc.

(But, VI may be conducive to system-wide flexibility)

• Compounding of risk• Also lack of market prices increases inefficiency (may result

in tapered integration –part internal, part market)

When is Vertical Integration More Attractive than Outsourcing?

When is Vertical Integration More Attractive than Outsourcing?

How many firms are available The fewer the companies to undertake the activities? the more attractive is VI

Is transaction-specific investment If yes, VI more attractiveneeded?

Does limited information permit VI can limit opportunism cheating?

Are taxes or regulation imposed VI can avoid themon transactions?

Do the different stages have similar Greater the similarity, the optimal scales of operation? more attractive is VI

Are the two stages strategically Greater the strategicsimilar? similarity ---the more

attractive is VI

How great the need for entrepreneurship Greater the need, the greater& continual upgrading of capabilities the disadvantages of VI

How uncertain is market demand? Greater the unpredictability ----the more costly is VI

Are risks compounded by VI increases risk.linkages between vertical stages

Iron oremining

Steelproduction

Steel stripproduction

Canmaking

The value chain for steel cans

MARKETCONTRACTS

VERTICAL INTEGRATION

MARKETCONTRACTS

Canning of food, drink,

oil, etc.

VERTICAL INTEGRATION,AND MARKETCONTRACTS

What factors explain why some stages are vertically integrated,while others are linked by market transactions?

More brainteasers

• Why do car manufacturers not own dealerships anymore?

• Why don’t Hollywood studios produce or exhibit films anymore? Why were they completely integrated before WWII?

Designing Vertical Relationships: Long-Term Contracts and Quasi-Vertical Integration

Designing Vertical Relationships: Long-Term Contracts and Quasi-Vertical Integration

• Intermediate between spot transactions and vertical integration are several types of vertical relationships

---such relationships may combine benefits of both market transactions and internalization

• Key issues in designing vertical relationships

-- How is risk allocated between the parties?

-- Are the incentives appropriate?

Recent Trends in Vertical RelationshipsRecent Trends in Vertical Relationships

• From competitive contracting to supplier partnerships, e.g. in autos

• From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services).

• Diffusion of franchising• Technology partnerships (e.g. IBM- Apple; Canon- HP)• Inter-firm networks

General conclusion:- boundaries between firms and markets becoming increasingly blurred.

Different Types of Vertical RelationshipDifferent Types of Vertical Relationship

Spot sales/ purchases

Long-term contracts

Agency agreements

Franchises

Vertical integration

Joint ventures

Informal supplier/ customer

relationships

Supplier/ customer

partnerships

Low Degree of Commitment High

Low

Lo

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orm

aliz

atio

n H

igh

Birdseye Case

• Why did Birds Eye develop as a vertically integrated producer the way it did?

• Did a vertically integrated producer have a competitive advantage over more vertically specialized suppliers of frozen foods during the early 1980s?

• What should Birds Eye have done in 1979?