Strategic Management 1e - Gies College of Businessbusiness.illinois.edu/josephm/BADM544_S… · PPT...

Part 1 Strategy Analysis

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LO 3-1 Apply the PESTEL model to organize and assess the impact of external forces on the firm.

LO 3-2 Apply the structure-conduct-performance (SCP) model to explain the effect of industry structure on firm profitability.

LO 3-3Apply the five forces model to understand the profit potential of the firms industry.

LO 3-4Describe the strategic role of complements in creating positive-sum co-opetition.

LO 3-5Understand the role of industry dynamics and industry convergence in shaping the firms external environment.

LO 3-6Apply the strategic group model to reveal performance differences between clusters of firms in the same industry.

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Chapter Case 3

Build Your Dreams (BYD) to Sidestep Entry Barriers

Changing U.S. car market

More competition from outside the U.S.

However, NO new entry firms in the last 2 decades

High barriers to entry

BYD led by founder, Wang Chuanfu in China is entering the car market

Batteries to carsbypassing many hurdles

Electric cars have fewer parts

BYD has the battery technology

Selling in China, Africa, & South America

Hybrid Car Video

3*

INSTRUCTOR: The embedded video (click on Hybrid Car Video while in slideshow mode) is 3 minutes on some thoughts on the future of cars in the U.S. URL link is below also.

http://bigthink.com/felixkramer#!video_idea_id=18790

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BYD Electric Vehicles

What are their chances of success?Warren Buffet invested for 10% equity.

-- Sticker price half that of a Chevy Volt.

-- Many obstacles are ahead

Which PESTEL factors will be most important for electric vehicles in the 21st century?BYD was Chinas fastest-growing carmaker

Sold more than 500,000 cars in 2010

Shanghai government subsidy for EVs

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PESTEL Framework

Political

Government pressures

Subsidies and incentives

Differences in countries, states, and regions

Economic

Growth rates

Interest rates

Employment levels

Currency exchange

Sociocultural

Norms, culture, values

Demographics

Lifestyle changes

Technological

Innovation

Diffusion

Research & development

Environmental

Global warming

Sustainability

Pollution

Legal

Court system

Legislation

Hiring laws

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EXHIBIT 3.1

The Firm Embedded in Its External Environment

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INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text.

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STRATEGY HIGHLIGHT 3.1

UBS Relents to Pressure

by U.S. Government

Large Swiss bank in troubleU.S. government accused UBS of aiding in tax evasionBillions of dollars moved offshoreNames of 52,000 U.S. citizens soughtEventually over 4,450 names were releasedImperils Swiss Bank secrecyHistorically, a competitive advantage

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3*

EXHIBIT 3.2

Industry Structures along the Continuum

Bank Oligopolies Video

INSTRUCTOR: A 3-minute embedded video from CNBC is found at the bottom of this slide (click on Bank Oligoplolies Video while in slideshow mode). It discusses banking in Australia as an oligopolistic industry.

http://www.cnbc.com/id/15840232?play=1&video=1614100860

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Efficient Markets

The efficient market hypothesis, in financial markets, is one in which prices reflect information instantaneously and one in which extra-ordinary profit opportunities are thus rapidly dissipated by the action of profit-seeking individuals in the market.

How well does the efficient market hypothesis for capital markets apply to product markets?

If the efficient market hypothesis applied fully to product markets then we should see over time equalization in risk-adjusted rates of return across industries.

What do the data support?

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Average Return on Equity in US Industries, 1982-1993

Number

of

Industries

First Quartile

Average

22.2%

Fourth Quartile

Average

9.3%

Note:Return on Equity = Net Income / Year End Shareholders Equity; Analysis based on sample of 593 industries

Source:Silverman 2000

Average = 14.7%

Median = 13.8%

11.7%

13.8%

16.5%

Return on Equity (Percent)

Differences in Profitability Across Industries

7

Industries differ in how much profit they typically provide. In this chart, we take each industry in the U.S. over a long period of time and for each, calculate ROE. Then plot a histogram. A big range. Top quartile roughly 2.5x as profitable as bottom quartile

Possible (but possibly dangerous) discussion: So what?

If youre trying to maximize shareholder returns, doesnt it just matter whether you can surprise the capital markets? Investment analysts know what industry youre in, so can industry membership possibly be the source of any pleasant surprise?

7

Industries differ in how much profit they typically provide. In this chart, we take each industry in the U.S. over a long period of time and for each, calculate ROE. Then plot a histogram. A big range. Top quartile roughly 2.5x as profitable as bottom quartile

Possible (but possibly dangerous) discussion: So what?

If youre trying to maximize shareholder returns, doesnt it just matter whether you can surprise the capital markets? Investment analysts know what industry youre in, so can industry membership possibly be the source of any pleasant surprise?

0

10

20

30

40

50

60

70

80

90

100

2%4%6%8%10%12%14%16%18%20%22%24%26%28%30%32%

79.bin

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Some Industries Are More Profitable Than Others

ROE & ROA - Selected Industries, 1989

0%

5%

10%

15%

20%

25%

30%

Pharmaceuticals

Tires / Rubber

Home Appliances

ROE

ROA

80.bin

Differences in Profitability Across Selected Industries

Source: Pankaj Ghemawat and Jan W. Rivkin, Creating Competitive Advantage

Chart3

1.345

4.273

5.21

6.711

7.996

8.56

9.825

11.294

11.429

13.591

14.934

16.085

16.882

22.365

24.955

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Operating income / assets, 1988-95 (%)

Sheet1

PRIM_SICNTEMPROA

484114.0005.210Cable television serviceScheduled air transport1.345

737336.5006.711Computer integrated system designMotor vehicles4.273

1311169.25011.294Crude petroleum and natural gasCable television service5.210

38436.00014.934Dental equipment and suppliesComputer system design6.711

59129.75011.429Drug storesEngineering services7.996

581257.25013.591Eating placesTrucking except local8.560

871117.6257.996Engineering servicesRace track operations9.825

371112.6254.273Motor vehicles and car bodiesPetroleum / natural gas11.294

283456.62524.955PharmaceuticalsDrug stores11.429

737247.62522.365Prepackaged softwareEating places13.591

79487.0009.825Race track operationsDental equipment14.934

451214.0001.345Scheduled air transportWomen's clothing stores16.085

367444.75016.882SemiconductorsSemiconductors16.882

421324.0008.560Trucking except localPrepackaged software22.365

562110.00016.085Women's clothing storesPharmaceuticals24.955

679215.12555.162

679415.62528.271

24517.12524.788

50137.00023.929

36516.00022.504

28518.00020.994

384544.25018.906

357618.37517.851

34437.25016.951

36787.25016.847

271120.00016.329

384125.25016.311

27619.00015.967

73717.75015.913

366330.75015.908

628214.87515.723National Semiconductor5.59116053.800

384224.25015.322Analog Devices10.0954864.184

284418.50015.006AMD11.62112243.504

27218.75014.999Motorola14.02936173.000

87326.00014.996Texas Instruments18.14438065.000

283613.50014.943Intel24.49557050.466

679511.62514.744

242112.75014.184Harris3.9174836.200

37216.00013.990Micron Technology28.7137421.496

282112.50013.973LSI Logic8.4325784.874

362112.00013.855

28916.12513.849

20136.00013.794

27317.87513.646TWA-4.08230599.112

73639.75013.626Continental-2.73449884.766

56518.00013.614USAir-0.43453272.364

737413.75013.385Delta0.97980143.990

37248.87513.117United2.29297768.984

382324.25013.007American3.037103487.510

35646.62512.986Southwest8.50413822.385

356110.25012.655

358513.12512.441

78127.50012.208

371436.12511.942

807110.00011.768

357121.75011.724

39447.00011.421

531121.00011.274

367211.12511.167

52118.00011.159

382615.62511.071

533114.25010.912

541130.00010.873

263115.12510.828

20158.00010.760

641122.37510.569

35557.00010.461

381219.50010.418

22536.00010.407

57318.37510.194

596110.0009.714

701119.2509.678

32418.0009.630

481363.5009.598

481211.5009.479

30816.2509.420

353112.0009.402

34336.0009.039

873410.8758.938

25116.0008.894

50519.5008.789

35377.0008.777

491193.0008.749

20867.0008.724

35729.6258.707

492313.8758.668

386110.1258.660

262122.3758.634

291130.7508.588

382523.0008.572

37318.0008.568

492465.7508.443

35638.0008.429

382712.6258.283

57127.0008.229

35787.0008.205

366137.2507.909

483324.0007.895

32736.0007.659

679857.0007.587

63246.2507.491

51227.6257.278

494121.0007.222

492216.6256.913

401114.0006.785

45226.0006.642

34527.5006.611

495516.3756.098

504512.0006.031

35237.6255.907

48326.0005.523

49917.7505.486

331227.2505.361

44128.0005.341

615317.7505.210

50846.3754.705

104119.3754.519

49618.0004.445

635112.3754.370

655221.5004.274

61628.8753.873

153125.2503.724

617213.7503.609

651229.2503.533

621133.0002.911

633145.5002.635

631129.7502.016

614118.6251.977

138113.7500.873

873116.625-5.299

283534.750-10.162

INTEL CORP24.49557050.466

TEXAS INSTRUMENTS INC18.14438065.000

MOTOROLA INC14.02936173.000

NATIONAL SEMICONDUCTOR CORP5.59116053.800

ADVANCED MICRO DEVICES11.62112243.504

MICRON TECHNOLOGY INC28.7137421.496

LSI LOGIC CORP8.4325784.874

ANALOG DEVICES10.0954864.184

HARRIS CORP3.9174836.200

VLSI TECHNOLOGY INC5.5453499.298

INTEGRATED DEVICE TECH INC12.7442459.910

CYPRESS SEMICONDUCTOR CORP13.8912429.972

INTL RECTIFIER CORP5.7422161.622

EG&G INC17.1221993.196

BURR-BROWN CORP9.9881496.662

SILICONIX INC3.7061295.666

CHIPS & TECHNOLOGIES INC2.7461294.723

ALTERA CORP20.4091124.034

DALLAS SEMICONDUCTOR CORP16.9141035.814

LINEAR TECHNOLOGY CORP25.7621021.687

EXAR CORP12.2191008.277

UNITRODE CORP6.599924.573

MICROSEMI CORP8.020824.497

MAXIM INTEGRATED PRODUCTS22.912801.991

XICOR INC-5.673779.672

LATTICE SEMICONDUCTOR CORP17.469767.794

ALPHA INDS1.982582.386

IMP INC0.148459.621

OPTEK TECHNOLOGY INC7.907424.122

SEEQ TECHNOLOGY INC-5.054323.993

SYMMETRICOM INC2.657270.369

ZITEL CORP3.146244.149

SUPERTEX INC13.607218.215

SEMTECH CORP13.512215.619

DIODES INC12.162196.097

JETRONIC INDUSTRIES INC23.035161.234

SOLITRON DEVICES INC-3.303158.097

LOGIC DEVICES INC9.819111.388

MICROPAC INDUSTRIES INC9.93584.170

DENSE-PAC MICROSYSTEMS INC4.40274.626

SEMICON INC-0.14272.685

HYTEK MICROSYSTEMS INC-20.70559.036

DIONICS INC-25.69513.021

MSI ELECTRONICS INC-70.5468.712

AMR CORP-DEL3.037103487.510

UAL CORP2.29297768.984

UNITED AIR LINES INC2.31997275.831

DELTA AIR LINES INC0.97980143.990

USAIR GROUP-0.43453272.364

CONTINENTAL AIRLS INC -CL A-2.73449884.766

U S AIR INC-2.11645694.939

KLM ROYAL DUTCH AIR -NY REG2.47334773.300

TRANS WORLD AIRLINES-4.08230599.112

SOUTHWEST AIRLINES8.50413822.385

COMAIR HOLDINGS INC15.7402064.029

SKYWEST INC9.1921234.397

CCAIR INC-3.375459.400

BIG SKY TRANSPORTATION-2.84355.679

COMCAST CORP -CL A SPL7.4856489.350

CABLEVISION SYSTEMS -CL A3.0435203.926

STORER COMMUNICATIONS INC2.4323880.368

VIACOM INC -CL A8.6043016.680

ADELPHIA COMMUN -CL A5.8362328.797

CENTURY COMMUN -CL A5.9412264.412

WASHINGTON POST -CL B9.1111285.606

TCA CABLE TV INC12.2751031.454

JONES INTERCABLE INC -CL A2.445981.637

C TEC CORP0.050598.971

JONES INTERCABLE -LP-CL A-2.541255.352

WINNEBAGO INDUSTRIES-33.58291.643

NTN CANADA INC1.84916.740

SHENANDOAH TELECOMMUN CO3.4235.195

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Profitability Differences Across Selected Industries

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Profitability Differences Within the Semiconductor Industry

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Profitability Differences Within the Airline Industry

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Looking within that distribution, a few selected industries. Pharmaceuticals far more profitable than scheduled air transport

What patterns do you see?

Goal of next module is to allow you to see the patterns across a much broader set of industries well

Looking within that distribution, a few selected industries. Pharmaceuticals far more profitable than scheduled air transport

What patterns do you see?

Goal of next module is to allow you to see the patterns across a much broader set of industries well

-50510152025

Scheduled air transport

Cable television service

Engineering services

Race track operations

Drug stores

Dental equipment

Semiconductors

Pharmaceuticals


82.bin

83.bin

*

Within Industries, Some Competitors Perform Better than Others.

ROE - Pharmaceutical Industry 1989

0%

10%

20%

30%

40%

50%

60%

Amgen

AMP

Eli Lilly

Merck

Mylan

Pfizer

Differences in Profitability Within Selected Industries

Source: Pankaj Ghemawat and Jan W. Rivkin, Creating Competitive Advantage

Chart2

5.591

10.095

11.621

14.029

18.144

24.495

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Semiconductor Industry

Sheet1

PRIM_SICNTEMPROA

484114.0005.210Cable television serviceScheduled air transport1.345

737336.5006.711Computer integrated system designMotor vehicles4.273

1311169.25011.294Crude petroleum and natural gasCable television service5.210

38436.00014.934Dental equipment and suppliesComputer system design6.711

59129.75011.429Drug storesEngineering services7.996

581257.25013.591Eating placesTrucking except local8.560

871117.6257.996Engineering servicesRace track operations9.825

371112.6254.273Motor vehicles and car bodiesPetroleum / natural gas11.294

283456.62524.955PharmaceuticalsDrug stores11.429

737247.62522.365Prepackaged softwareEating places13.591

79487.0009.825Race track operationsDental equipment14.934

451214.0001.345Scheduled air transportWomen's clothing stores16.085

367444.75016.882SemiconductorsSemiconductors16.882

421324.0008.560Trucking except localPrepackaged software22.365

562110.00016.085Women's clothing storesPharmaceuticals24.955

679215.12555.162

679415.62528.271

24517.12524.788

50137.00023.929

36516.00022.504

28518.00020.994

384544.25018.906

357618.37517.851

34437.25016.951

36787.25016.847

271120.00016.329

384125.25016.311

27619.00015.967

73717.75015.913

366330.75015.908

628214.87515.723National Semiconductor5.59116053.800

384224.25015.322Analog Devices10.0954864.184

284418.50015.006AMD11.62112243.504

27218.75014.999Motorola14.02936173.000

87326.00014.996Texas Instruments18.14438065.000

283613.50014.943Intel24.49557050.466

679511.62514.744

242112.75014.184Harris3.9174836.200

37216.00013.990Micron Technology28.7137421.496

282112.50013.973LSI Logic8.4325784.874

362112.00013.855

28916.12513.849

20136.00013.794

27317.87513.646TWA-4.08230599.112

73639.75013.626Continental-2.73449884.766

56518.00013.614USAir-0.43453272.364

737413.75013.385Delta0.97980143.990

37248.87513.117United2.29297768.984

382324.25013.007American3.037103487.510

35646.62512.986Southwest8.50413822.385

356110.25012.655

358513.12512.441

78127.50012.208

371436.12511.942

807110.00011.768

357121.75011.724

39447.00011.421

531121.00011.274

367211.12511.167

52118.00011.159

382615.62511.071

533114.25010.912

541130.00010.873

263115.12510.828

20158.00010.760

641122.37510.569

35557.00010.461

381219.50010.418

22536.00010.407

57318.37510.194

596110.0009.714

701119.2509.678

32418.0009.630

481363.5009.598

481211.5009.479

30816.2509.420

353112.0009.402

34336.0009.039

873410.8758.938

25116.0008.894

50519.5008.789

35377.0008.777

491193.0008.749

20867.0008.724

35729.6258.707

492313.8758.668

386110.1258.660

262122.3758.634

291130.7508.588

382523.0008.572

37318.0008.568

492465.7508.443

35638.0008.429

382712.6258.283

57127.0008.229

35787.0008.205

366137.2507.909

483324.0007.895

32736.0007.659

679857.0007.587

63246.2507.491

51227.6257.278

494121.0007.222

492216.6256.913

401114.0006.785

45226.0006.642

34527.5006.611

495516.3756.098

504512.0006.031

35237.6255.907

48326.0005.523

49917.7505.486

331227.2505.361

44128.0005.341

615317.7505.210

50846.3754.705

104119.3754.519

49618.0004.445

635112.3754.370

655221.5004.274

61628.8753.873

153125.2503.724

617213.7503.609

651229.2503.533

621133.0002.911

633145.5002.635

631129.7502.016

614118.6251.977

138113.7500.873

873116.625-5.299

283534.750-10.162

INTEL CORP24.49557050.466

TEXAS INSTRUMENTS INC18.14438065.000

MOTOROLA INC14.02936173.000

NATIONAL SEMICONDUCTOR CORP5.59116053.800

ADVANCED MICRO DEVICES11.62112243.504

MICRON TECHNOLOGY INC28.7137421.496

LSI LOGIC CORP8.4325784.874

ANALOG DEVICES10.0954864.184

HARRIS CORP3.9174836.200

VLSI TECHNOLOGY INC5.5453499.298

INTEGRATED DEVICE TECH INC12.7442459.910

CYPRESS SEMICONDUCTOR CORP13.8912429.972

INTL RECTIFIER CORP5.7422161.622

EG&G INC17.1221993.196

BURR-BROWN CORP9.9881496.662

SILICONIX INC3.7061295.666

CHIPS & TECHNOLOGIES INC2.7461294.723

ALTERA CORP20.4091124.034

DALLAS SEMICONDUCTOR CORP16.9141035.814

LINEAR TECHNOLOGY CORP25.7621021.687

EXAR CORP12.2191008.277

UNITRODE CORP6.599924.573

MICROSEMI CORP8.020824.497

MAXIM INTEGRATED PRODUCTS22.912801.991

XICOR INC-5.673779.672

LATTICE SEMICONDUCTOR CORP17.469767.794

ALPHA INDS1.982582.386

IMP INC0.148459.621

OPTEK TECHNOLOGY INC7.907424.122

SEEQ TECHNOLOGY INC-5.054323.993

SYMMETRICOM INC2.657270.369

ZITEL CORP3.146244.149

SUPERTEX INC13.607218.215

SEMTECH CORP13.512215.619

DIODES INC12.162196.097

JETRONIC INDUSTRIES INC23.035161.234

SOLITRON DEVICES INC-3.303158.097

LOGIC DEVICES INC9.819111.388

MICROPAC INDUSTRIES INC9.93584.170

DENSE-PAC MICROSYSTEMS INC4.40274.626

SEMICON INC-0.14272.685

HYTEK MICROSYSTEMS INC-20.70559.036

DIONICS INC-25.69513.021

MSI ELECTRONICS INC-70.5468.712

AMR CORP-DEL3.037103487.510

UAL CORP2.29297768.984

UNITED AIR LINES INC2.31997275.831

DELTA AIR LINES INC0.97980143.990

USAIR GROUP-0.43453272.364

CONTINENTAL AIRLS INC -CL A-2.73449884.766

U S AIR INC-2.11645694.939

KLM ROYAL DUTCH AIR -NY REG2.47334773.300

TRANS WORLD AIRLINES-4.08230599.112

SOUTHWEST AIRLINES8.50413822.385

COMAIR HOLDINGS INC15.7402064.029

SKYWEST INC9.1921234.397

CCAIR INC-3.375459.400

BIG SKY TRANSPORTATION-2.84355.679

COMCAST CORP -CL A SPL7.4856489.350

CABLEVISION SYSTEMS -CL A3.0435203.926

STORER COMMUNICATIONS INC2.4323880.368

VIACOM INC -CL A8.6043016.680

ADELPHIA COMMUN -CL A5.8362328.797

CENTURY COMMUN -CL A5.9412264.412

WASHINGTON POST -CL B9.1111285.606

TCA CABLE TV INC12.2751031.454

JONES INTERCABLE INC -CL A2.445981.637

C TEC CORP0.050598.971

JONES INTERCABLE -LP-CL A-2.541255.352

WINNEBAGO INDUSTRIES-33.58291.643

NTN CANADA INC1.84916.740

SHENANDOAH TELECOMMUN CO3.4235.195

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Those industry averages mask a lot of variation. Lets take semiconductors and airlines from the top and bottom respectively

Point out Intel

Understanding difference between Intel and TWA requires understanding both the industry and intra-industry differences

Companies make decent money even in poor industries. Companies do poorly even in attractive businesses. So we need to understand intra-industry competitive advantage

Would you rather be at a disadvantage in a good industry or at an advantage in a poor one?

Those industry averages mask a lot of variation. Lets take semiconductors and airlines from the top and bottom respectively

Point out Intel

Understanding difference between Intel and TWA requires understanding both the industry and intra-industry differences

Companies make decent money even in poor industries. Companies do poorly even in attractive businesses. So we need to understand intra-industry competitive advantage

Would you rather be at a disadvantage in a good industry or at an advantage in a poor one?


-50510152025

National Semiconductor

Analog Devices

AMD

Motorola

Texas Instruments

Intel


85.bin

*

5-*

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The U.S. Auto Industrys Profit Pool

Exhibit 5.7 The U.S. Auto Industrys Profit Pool

Source: Adapted by permission of Harvard Business Review. Exhibit from A Fresh Look at Strategy by O. Gadiesh and J. L. Gilbert, Harvard Business Review 76, no. 3 (1998), pp. 139-48. Copyright 1998 by the Harvard Business School Publishing Corporation, all rights reserved.

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Decomposition of Variance in Profitability

Source: Anita M. McGahan and Michael E. Porter, How Much Does Industry Matter Really? Strategic Management Journal, 1997

Tendency to ask, which matters more. Lots of conventional wisdom and research on this

Warren Buffets line on this: When an industry with a reputation for tough economics meets a manger with a reputation for excellent performance, its usually the industry that keeps its reputation intact

Research in this line: takes the full distribution of returns across not just firms, but across business segments within firms. So Disney split into film & TV, theme parks, consumer products. By regression techniques, tease out how much of the variation is due to differences across industry vs. differences in the advantage enjoyed by a segment within its industry. Other effects also considered: corporate parent, year, transient effects

Research indicates that, despite a fair amount of year-to-year noise, business segment effects are very large and industry effects are also large. [Industry effects perhaps overstated]

Large business segment effects => need some systematic way to think through differences in success within industries. Start doing that in the competitive positioning module

Tendency to ask, which matters more. Lots of conventional wisdom and research on this

Warren Buffets line on this: When an industry with a reputation for tough economics meets a manger with a reputation for excellent performance, its usually the industry that keeps its reputation intact

Research in this line: takes the full distribution of returns across not just firms, but across business segments within firms. So Disney split into film & TV, theme parks, consumer products. By regression techniques, tease out how much of the variation is due to differences across industry vs. differences in the advantage enjoyed by a segment within its industry. Other effects also considered: corporate parent, year, transient effects

Research indicates that, despite a fair amount of year-to-year noise, business segment effects are very large and industry effects are also large. [Industry effects perhaps overstated]

Large business segment effects => need some systematic way to think through differences in success within industries. Start doing that in the competitive positioning module

Year

2%

Industry

18%

Corporate

parent

4%

Business

segment

30%

Transient

46%

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*

Three Factors Determining Company Performance

Industry Context

e.g., during the last two decades, companies in the airlines industry have been persistently less profitable than those in the pharmaceutical industry

National Context

e.g., worlds most successful consumer electronics firms are in Japan

Company Capabilities and Strategies

e.g., Wal-mart and Southwest Airlines

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Structure-Conduct-Performance

Industry Structure

Number of buyers

and sellers

Degree of product

differentiation

Barriers to entry

Cost structures

Vertical integration

Alliances

Firm Conduct

Pricing

Advertising

R&D

Investment in

plant and

equipment

Performance

Econ profits

Accounting

profits (ratios)

NPV/DCF

MVA/EVA

Tobins Q

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The Structure-Conduct-Performance Paradigm

The Feedback Critique

No one-way causal link.

Conduct can affect market structure.

Market performance can affect conduct as well as market structure.

The Causal View

Market Structure

Conduct

Performance

Clarke Modifications of Baye Chapter 7

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3*

Competitive Forces and Firm Strategy

The Five Forces Model

The classic industry analysis model

Threat of Entry/Barriers to Entry

Note: High barriers to entry means threat of entry is low

Power of SuppliersPower of BuyersThreat of SubstitutesRivalry Among Existing Competitors

3*


*

EXHIBIT 3.3

Porters Five Forces Model

Source: Porter, M. E. (2008), The five competitive forces that shape strategy, Harvard Business Review

5 forces video- M. Porter

3*

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INSTRUCTOR: The embedded video at the bottom of this slide is a 13-minute-long interview with Michael Porter. He uses the airline vs. soft drinks industries as examples of applying the five forces model. The URL is also posted below. It was taped in summer 2008 and is referenced in the text (endnote 37).

THIS LINK IS REPEATED IN SLIDE 27 IF YOU PREFER TO WAIT TO USE IT UNTIL THE APPLICATION OF THE 5 FORCES TOOL THERE.

http://www.youtube.com/watch?v=mYF2_FBCvXw

*

Barriers To Entry

The free entry and free exit assumption that works reasonably well for describing financial markets seems to be a premise that strays so far from our world of experience that the assumption impedes our understanding of real-world product competition. Thus, empirical evidence suggests that (risk-adjusted) ROE does NOT equalize in the long run.

3*

A Taxonomy of Barriers to Entry

(1) Economies of Scale

Product-specific economies of scale

Lower setup costs as a percentage of total costs

More specialized machinery and tooling (e.g., Honda)

Plant-specific economies of scale

Engineers 2/3 rule: Since the area of a sphere or cylinder varies as two-thirds power of volume, the cost of constructing process industry plants can be expected to rise as two thirds power of their output capacity. (This rule applies to petroleum refining, cement making, iron ore reduction and steel conversion).

Also economies of massed reserves

3*

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Economies of Scale

Multi-product economies of scale (economies of scope)

Example: Cost (Iron, Steel) < Cost (Iron) + Cost (Steel)

Key idea: Shareable input (In this case, thermal economies in the production of iron and steel)

Modern examples: Aircraft, Automobiles, Consumer electronics, Household Appliances; Personal Computers, Software, Power Tools

Multi-plant economies of scale

Economies of multi-plant production, investment, and physical distribution.

3*

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*

Examples of Economies of Scope

Aircraft: Common wing, nose, and tail components allow several models to be leveraged using different numbers of fuselage modules to create aircraft of different lengths and passenger capacities by Boeing and Airbus Industries.

Automobiles: The Taurus platform was leveraged to provide the basis for Taurus sedans and minivans.

Consumer Electronics: Over 160 variations of the Sony Walkman were leveraged by mixing and matching modular components in a few basic system designs. (Legos)

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(2) Experience Curve Advantages

Marvin Lieberman, a management professor at UCLA, found that in the chemical industry, on average, each doubling of plant scale over time was accomplished by an 11% reduction in unit costs. Thus, there is an 89% learning curve.

(Note: The mere presence of an experience curve does not insure an entry barrier. Another critical prerequisite is that the experience be kept proprietary, and not be made available to competitors and potential entrants.)

3*

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(3) Intended Excess Capacity

Building extra capacity for the intended purpose of deterring entrants from entering the industry. (Note: potential free-rider problems)

Excess capacity deters entry by increasing the credibility of price cutting as an entry response by incumbents (ex: Dupont in the production of Titanium Dioxide for paint)

Innocent excess capacity: Demand is cyclical; Demand falls short of expectations; Demand is expected to grow.

3*

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(4) Reputation

A history of incumbent firms reacting aggressively to entrants may play a role in current market interactions.

(5) Product Differentiation

Brand identification and customer loyalty to incumbent products may be a barrier to potential entrants (e.g., Coca-Cola). Product differentiation appears to be an important entry barrier in the market for over-the counter drugs and in the brewing industry.

3*

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(6) Capital Requirements

(7) High Switching Costs of Buyers

E.g., changing may require employee retraining (e.g., IV solutions, and computer software).

3*

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A Taxonomy of Barriers To Entry

(8) Access to Distribution Channels

The manufacturer of a new food product, for example, must persuade the retailer to give it space on the fiercely competitive supermarket shelf via promises of promotion, and intense selling efforts to retailers.

(9) Favorable Access to Raw Materials

and to Markets

Alcoa --> bauxite

Exclusive dealing arrangements

Favorable geographic locations

3*

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(10) Proprietary Technology

Product know how

Low cost product design

Patents (and other government restrictions)

(11) Exit barriers (of incumbents) can be entry barriers (to potential entrants)

3*

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High exit costs:

High exogenous and endogenous sunk costs (not just high fixed costs!)

High asset specificity

Highly illiquid assets

Low salvage value if exit occurs

High switching costs

Low mobility of assets

Credible commitments

Irreversible investment

e.g., Alaskan pipeline built in 1977 at a cost of $10 billion

3*

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Power of Suppliers HIGH IF:

Dominated by a few companies

No substitutes for supplier products

Suppliers products are differentiated

Incumbents face high switching costs

Product is important input to buyer

Forward Integration is a credible threat

3*

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Power of Buyers HIGH IF:

A few large buyers (potential collusion)

Large buyers relative to a seller (e.g., HMO power buying pharmaceuticals)

Products are standardized and undifferentiated

Buyers face few switching costs

High switching costs for sellers

Backward Integration is credible (buyer has full information)

3*

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Threat of Substitutes HIGH IF:

Substitute is good price-performance trade-off

Buyers switching costs to substitute is low

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Incumbent Rivalry HIGH IF:

Many competitors in the industry (industry concentration is low)

Firms are of equal size

Industry growth is slow or shrinking

(over-capacity is high)

Exit barriers are high

Contractual obligations

Geographic or historical attachments

Products and services are direct substitutes (product differentiation is low)

3*

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Degree of Rivalry

Advertising battles, on the other hand, may well expand or enhance the level of product differentiation in the industry for the benefit of all firms.

In other words, advertising is not necessarily a zero-sum game.

3*

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The Uses of Industry Analysis

Static Analysis -

How do we explain current rivalry and profitability?

Dynamic Analysis -

Where is the industry Headed In likely to be in the future?

3*

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Industries Evolve over Time as the Relationships Between the Five Forces Change

Dynamic 5-Forces Analysis

3*

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3*

SUPPLIERS

POTENTIAL

ENTRANTS

SUBSTITUTES

BUYERS

INDUSTRY

COMPETITORS

Rivalry among

existing firms

Bargaining power of suppliers

Bargaining power of buyers

Threat of

new entrants

Threat of

substitutes

COMPLEMENTS

The suppliers of

complements create

value for the industry

and can exercise

bargaining power

Five Forces or Six? Introducing Complements

7

7

Substitutes and Complements

Substitute: An alternative from outside the given industry for its product or service. When its performance increases or its price falls, industry demand decreases.

Plastic vs. aluminium containers

Video conference vs. business travel

Complement: A product or service or competency that adds value to original product. When its performance increases or its price falls, industry demand increases.

Paper for Xerox copiers

iTunes for iPod music players

Complementor: If customers value your product more when combined with another firms product or service.

Michelin tires for Ford & GM

3*

*

A Sixth Force -- Complementors

The biggest benefit of considering complementors is that they add a cooperative dimension to Porters (1980) competitive forces model.

Thinking [about] complements is a different way of thinking about business. Its about finding ways to make the pie bigger rather than fighting with competitors over a fixed pie. To benefit from this insight, think about how to expand the pie by developing new complements or making existing complements more affordable.

Brandenburger & Nalebuff

3*

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EXHIBIT 3.5

Determining Industry Attractiveness

3*


*







3*

Strategic Groups

Mobility Barrier Dimensions To Consider:

Specialization

Width of product line

Target customer segments

Geographic markets served

Brand Identification

Advertising

Sales Force

Technological Leadership

First Mover vs. Imitation Strategy

3*


*

Strategic Groups

Mobility Barrier Dimensions To Consider:

Product Quality

Raw materials

Specifications

Features

Durability

Cost Position

Economies of scale and scope

Vertical Integration

Backward and/or forward

Exclusive contracts and in-house service networks

3*


*

Strategic Groups

Mapping Groups

Auto industry example

GM, Ford, Toyota gas

BYD, Tesla electric

ID best dimensions

Choose two for map

Locate firms on map

Bubble size = market share

Rivalry is strongest in the same group

Some groups are more profitable than others

Mobility Barriers

Firms would try to move to the profit spots BUT

Specific factors that separate groups

Airlines

International routes

Regulations: airport slots

3*


*

EXHIBIT 3.7

Strategic Groups and Mobility Barrier U.S. Airlines

3*


*

Empirical Testing of Structure-Conduct (Strategy)- Performance

ROE(j) = 14.7 + .050 CR4(j) + .119 [CAP/S](j) +

(2.08) (1.98)

1.30 [A/S](j) +1.40 [R&D/S](j) +0.26 [GROW](j)

(7.20) (2.95) (2.90)

t-statistics in parenthesesR-squared = .43

CR4 = 4-firm concentrationROE = return on equity

R&D/S = R&D/SalesA/S = advertising/sales

CAP/S = capital expenditures/SalesGROW = demand growth

3*

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Model Specification

In practice, researchers estimate a statistical model of the following form where data are aggregated to the industry level:

Industry Profit Rates = f (Concentration, Barriers to Entry, Demand )

3*

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Model Specification

Multiple regression analysis seeks to evaluate the degrees to which deviations of the dependent variable (and in this course our focus has been on profit rates as the dependent variable) from its mean are explained by or associated with variations in each of a set of independent or explanatory variables (e.g., concentration, barriers to entry, demand, etc.)

3*

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Model Specification

The nature of this association is captured by regression coefficients relating the profit rates in the industry of each independent variable, allowing us to determine the effect, for example, of a 10% increase in seller concentration on profit rates, holding all other explanatory variables constant (i.e., ceteris paribus)

3*

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Model Specification

Variable Predicted Sign Reason

CR4+Higher concentration enables higher prices

CAP/S+Capital-cost barrier to entry

A/S+Advertising intensity as a product differentiation barrier to entry

R&D/S+Technological know-how

GROW+Demand growth leads toless likely price wars

3*

Structure-Conduct-Performance

Industry Structure

Number of buyers

and sellers

Degree of product

differentiation

Barriers to entry

Cost structures


Alliances

Firm Conduct

Pricing

Advertising

R&D

Investment in

plant and

equipment

Performance

Econ profits

Accounting

profits (ratios)

NPV/DCF

MVA/EVA

Tobins Q


Model Specification

Note that the multiple regression results are consistent with (but do not prove!) the structure-conduct-performance model.

As you probably are aware from your statistics classes, there are many potential problems that can interfere with the reliable estimation of regression models, leading to incorrect inference about the statistical significance and economic importance of explanatory variables.

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Three Potential Problems:

(1)Mis-specification problems;

(2)Measurement problems; and

(3)Identification problems

3*

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(1) Mis-specification Problems:

Important Variables Omitted. In our regression, the impact of substitute products, and the power of buyers and suppliers have not been included in the model specification.

Irrelevant Variables Included. If you believe in perfect capital markets then you may question the idea of capital cost entry barriers and therefore you would question the inclusion of the independent variable [CAP/S] in the model.

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(1) Mis-specification Problems:

Model assumes a linear relationship. Since the regression assumes a linear relationship, this may turn out to be a poor approximation if some of the explanatory variables (e.g., ADV/S) influence the dependent variable (i.e., ROE) in a non-linear way.

Independent variable may not be truly independent. For example, not only can increased concentration affect profit rates but profit rates may affect industry concentration.

Multicollinearity. If independent variables such as (ADV/S) and {R&D/S) are highly correlated, then the validity of the t-statistics come into question.

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(2) Measurement Problems:

For example, CR4 may not be the best measure of industry concentration, where the HHI is a better measure. Perhaps some performance measure other than ROE would also be better for testing the theory.

Note: If the evidence is not consistent with the theory it is not necessarily the case that we abandon the theory. One of the many possibilities is that we do not have good measures of the theoretical concepts.

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Identification Problems:

- These problems are related to the idea that correlation does not imply causality.

For example, you might maintain that high advertising/sales is a barrier to entry (product differentiation) strategy that causes high profit rates. The regression is consistent with Porters (1980) theory.

3-*

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(3) Identification Problems

However, you might argue instead that high profit rates allow more discretionary spending in marketing and thus, high profit rates cause high advertising/sales. The empirical evidence is also consistent with this theory. Thus, we have an identification problem. The data are consistent with multiple theories and we must find more refined tests and better econometric methods in order to advance our scientific knowledge in strategic management.

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*

*

INSTRUCTOR: The embedded video (click on Hybrid Car Video while in slideshow mode) is 3 minutes on some thoughts on the future of cars in the U.S. URL link is below also.

http://bigthink.com/felixkramer#!video_idea_id=18790

*


*

*

INSTRUCTOR: A 3-minute embedded video from CNBC is found at the bottom of this slide (click on Bank Oligoplolies Video while in slideshow mode). It discusses banking in Australia as an oligopolistic industry.

http://www.cnbc.com/id/15840232?play=1&video=1614100860

*


*

INSTRUCTOR: The embedded video at the bottom of this slide is a 13-minute-long interview with Michael Porter. He uses the airline vs. soft drinks industries as examples of applying the five forces model. The URL is also posted below. It was taped in summer 2008 and is referenced in the text (endnote 37).

THIS LINK IS REPEATED IN SLIDE 27 IF YOU PREFER TO WAIT TO USE IT UNTIL THE APPLICATION OF THE 5 FORCES TOOL THERE.

http://www.youtube.com/watch?v=mYF2_FBCvXw

*

*


*


*


*


*


*

2005 Mara Lederman, Rotman School of Management

0

10

20

30

40

50

60

70

80

90

100

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

30%

32%

Average Return on Equity in US Industries, 1982

-

1993

Number

of

Industries

First Quartile

Average

22.2%

Fourth Quartile

Average

9.3%

Note:

Return on Equity = Net Income / Year End Shareholders Equity; A

nalysis based on sample of 593 industries

Source:

Silverman 2000

Average = 14.7%

Median = 13.8%

11.7%

13.8%

16.5%

Return on Equity (Percent)

Differences in Profitability Across Industries


Differences in Profitability Across Selected Industries

-5

0

5

10

15

20

25

Scheduled air transport

Cable television service

Engineering services

Race track operations

Drug stores

Dental equipment

Semiconductors

Pharmaceuticals


Source:

Pankaj

Ghemawat

and Jan W.

Rivkin

, Creating Competitive Advantage


Differences in Profitability Within Selected Industries


-5

0

5

10

15

20

25

National Semiconductor

Analog Devices

AMD

Motorola

Texas Instruments

Intel


Source:

Pankaj

Ghemawat

and Jan W.

Rivkin

, Creating Competitive Advantage

5

-

22

Copyright 2005 by The McGraw

-

Hill Companies, Inc. All rights reserved.

The U.S. Auto Industrys Profit Pool

Exhibit 5.7 The U.S. Auto Industrys Profit Pool

Source: Adapted by permission of Harvard Business Review. Exhibi

t from A Fresh Look at Strategy by O. Gadiesh

and J. L. Gilbert,

Harvard Business Review

76, no. 3 (1998), pp. 139

-

48. Copyright

1998 by the Harvard Business

School Publishing Corporation, all rights reserved.


Decomposition of Variance in Profitability

Year

2%

Industry

18%

Corporate

parent

4%

Business

segment

30%

Transient

46%

Source: Anita M. McGahan and Michael E. Porter, How Much Does

Industry Matter

Really?

Strategic Management Journal,

1997

Structure

-

Conduct

-

Performance

Structure

-

Conduct

-

Performance

Industry Structure

Number of buyers

and sellers

Degree of product

differentiation

Barriers to entry

Cost structures


Alliances

Industry Structure

Number of buyers

and sellers

Degree of product

differentiation

Barriers to entry

Cost structures


Alliances

Firm Conduct

Pricing

Advertising

R&D

Investment in

plant and

equipment

Firm Conduct

Pricing

Advertising

R&D

Investment in

plant and

equipment

Performance

Econ profits

Accounting

profits (ratios)

NPV/DCF

MVA/EVA

Tobins Q

Performance

Econ profits

Accounting

profits (ratios)

NPV/DCF

MVA/EVA

Tobins Q

Clarke Modifications of Baye Chapter 7

4

The Structure

-

Conduct

-

Performance Paradigm

The Causal View

Market

Structure

Conduct

Performance

The Feedback Critique

n

No one

-

way causal link.

n

Conduct can affect market structure.

n

Market performance can affect

conduct as well as market structure.

SUPPLIERS

POTENTIAL

ENTRANTS

SUBSTITUTES

BUYERS

INDUSTRY

COMPETITORS

Rivalry among

existing firms

Bargaining power of suppliers

Bargaining power of buyers

Threat of

new entrants

Threat of

substitutes

COMPLEMENTS

The suppliers of

complements create

value for the industry

and can exercise

bargaining power

Five Forces or Six?

Introducing Complements

Five Forces or Six?

Introducing Complements

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