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2007 Prof. Dr. Bernd Venohr
Business Strategy
External Environment
Prof. Dr. Bernd Venohr
Berlin, April 2007
4
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Agenda
Introduction to StrategyCourse Overview and Strategy Concept
Economics of Strategy
Shareholder Value
Business Strategy
External EnvironmentInternal Environment
Competitive Positioning
Corporate StrategyDiversification
Mergers & Acquisitions
Global Strategy
Strategy ProcessOrganizational Structure and Control
Strategic Leadership
1
2
3
45
6
7
8
9
10
11
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Agenda
4
Introduction to Strategy
External Environment
- General environment analysis
- Industry analysis
- Summary and Outlook next Session
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Where are we today?
Introduction to Strategy
Business Strategy Corporate StrategyExternalEnvironment
InternalEnvironment
CompetitivePositioning
Diversification
Mergers &Acquisitions
GlobalStrategy
Course OverviewStrategy Concept
Economics ofStrategy
Shareholder Value
Strategy Process
1 2
OrganizationalStructure andControl
StrategicLeadership
10
11
4 5
6
7
8 9
3
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General purpose of external analysis
Identify
Opportunities: conditions that may help firm achieve strategic competitiveness
Threats: hinders or constrains firms pursuit of strategic competitiveness
Two types of environment
Macro environment
Micro environment (industry)
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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General environment (macro environment)
Demographic
Population size, age structure,
geographic mix, ethnicity, income
distribution
Socio cultural
Social attitudes, cultural values
Political / legal
Arena of competition for attention andresources from govt.
Law and regulations guiding
competition
Technological
Institutions and activities that effect
knowledge creation
Translation of new knowledge into
new products and processes
Economic
Nature and direction of macro
economy
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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PEST is an acronym for Political, Economic, Social andTechnological factors
technological competing technology developme nt
res earch funding
Associated / dependent technologies
replacement technology / solutions
maturity of technology
manufacturing m aturity and capacity
information and communications
consumer buying me chanisms / technology
technology legislation
innovation potential
technology access, licencing, patents
intellectual property issues
social lifestyle tre nds
demographics
consumer attitudes and opinions
media views
law changes affecting social factors
brand, company, technology image
consumer buying patterns
fashion and role m odels
major events and influences
buying access and trends
Ethnic / re ligious factors
advertising and publicity
economic home economy situation
home economy trends
overseas economies and trends
general taxation issues
taxation specific to product/services
Seasonality / weather issues
marke t and trade cycles
specific industry factors
marke t routes and distribution trends
Customer / end-user drivers
interest and exchange rates
political Ecological / environmental issues
current legislation home m arket
future legislation
European / international legislation
regulatory bodies and processes
governme nt policies
governme nt term and change
trading policies
funding, grants and initiatives
home market lobbying / pressure groups
international pressure groups
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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4
Agenda
Introduction to Strategy
External Environment
- General environment analysis
- Industry analysis
- Summary and Outlook next Session
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Objectives of industry analysis
Explain and predict the average long-term profitability ofthe companies in a particular industry: empirical results showsubstantial and sustained differences in profitability amongindustries
Gain understanding of profit differences among competi-tors in the same industry (= relative performance):empirical results show that they are very often large and long-lived. Industry attributes shape such within-industry differences
and enable companies to pursue strategies
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy
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Process of industry analysis (microenvironment)
Define industry boundaries
Identify the participants
Highlight the drivers of long term industry profitability (= five forces)
Identify the factors that drive each force
Assess the strength of each force
Conclusion: Assess industry profitability potential
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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Michael Porter Background
Michael E. Porter is the Bishop William Laurence UniversityProfessor at the Harvard Business School.
He has written eighteen books and countless articles. Hismain bookCompetitive Strategy(1980), Techniques forAnalyzing Industries and Competitors, is now in its 63rdimprint and has been translated into 17 languages. His
second major strategy book, Competitive Advantage, is inits 34th printing.
Porter subsequently moved from competition between firmsto competition between nations. In The Competitive
Advantage of Nations (1990) he examined how somestates were wealthy and why others were not.
Porter als has been very active in consulting with majorcorporations worldwide and advises governments oneconomic strategies
Source: Wikepedia
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The art of strategy: to find an advantaged competitiveposition in an attractive industry
Lo Hi
Industry attractiveness
Incr
easing
retu
rns
Advantage
Competitive
position
Disadvantage
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Porter Framework:Five Forces determine industry attractiveness
In any competitive industry there are five basic forces at work that
determine long-term industry profitability.*The collective strength of
these five forces determines the potential for firms in the industry to
earn returns on investment in excess of opportunity cost of capital
(= industry attractiveness)
Underlying each of the five forces are a number of economic and
technical determinants of its strengths in a particular industry: e.g. the
threat of entry is a function of 7 types of structural entry barriers and the
expected retaliation of encumbents, itself a function of some predictable
industry characteristics
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
*The structure of the industry should be considered separately from short term fluctuations in the industry -
for example, variations in demand or cyclical economic conditions
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Porter Framework: Competitive Position determinesprofits differences vis-a-vis direct competitors (= relativeperformance versus competitors)
Holding industry constant, some firms do better because of their
relative competitive position, orcompetitiveadvantage, within the
industry
Basic economics of strategy:
a company cannot earn superior returns unless it achieves either
lower average costs or higher average prices than its competitors.
The gap between a firms profitability and industry average
profitability can be composed in cost and price components
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
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Porter Framework: There are two basic types of competitiveadvantage
= price - cost
to increase , a firm must either :
Decrease costbelow its
competitors
Increase priceabove its
competitors
Cost leadership Differentiation
Generic Strategies (Porter)Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
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Porters five forces framework brings three new aspects toeconomic analysis
Relax assumption of both large numbers of competitors / buyers and
homogeneity (oligopolistic rivalry instead of perfectly competitive market in
which behavior of market participants will be immaterial to one another,
need for strategy)
Along vertical dimension shift from two-stage vertical chains
consisting of a supplier and a buyer to three-stage chains made up of
suppliers, rivals, buyers
Create new horizontal dimension: account for potential entrants and
substitutes
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
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17 2007 Prof. Dr. Bernd Venohr
Porters Five Forces of Competition Framework:the collective strength of the five forces determinesan industrys long-term profitability and potentialfor value creation
SUPPLIERS
POTENTIAL
ENTRANTSSUBSTITUTES
BUYERS
INDUSTRY
COMPETITORS
Rivalry among
existing firms
Bargaining power of suppliers
Bargaining power of buyers
Threat of
new entrants
Threat of
substitutes
Source: Michael Porter, Competitive Strategy
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18 2007 Prof. Dr. Bernd Venohr
Industry Boundaries: Before one can analyze an industryone must define it
Key challenge: standard statistical definitions only partly relevant
official statistical definitions (SIC codes; NACE codes) are mostly basedon technical input considerations (=e.g. metal manufacturer) that rarelycorrespond to competitively relevant industry conditions (=e.g. carcomponents manufacturer)
it is rare that a company is in direct competition with every companystatistically defined as being in its industry; on the other hand it is likelythat the firm competes with many companies outside the industry
Company perspective important: who are my competitors?
substitution on demand side: competitors that offer products or services
that are close substitutes substitution on supply side/ technological substitutability: can know how
and production equipment be cross-utilized between two product lines?
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy
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19 2007 Prof. Dr. Bernd Venohr
Three Scope issues in defining an industry
Horizontal: across product markets (narrow or broad definitions ofsubstitutes)
Vertical: along value chain (how many vertically linked stages?)
Geographic: across local / regional / national boundaries (are physicallyseparate markets treated as being served by the same industry or different
industries?)
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
Michael Porter, Industrial Organizaition and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy
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20 2007 Prof. Dr. Bernd Venohr
The concept of value proposition helps to define thehorizontal scope (=substitution products from thecustomer perspective)
What
Relative
Price?
What
Customers?
Which
Needs?
What end
users?
What
channels?
Which products?
Which features?
Which services?
Entrepreneurial/creative process:
A new value proposition can create a new industry
Source: Michael M. Porter; What is s trategy? World Business Forum, June 6, 2006
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The concept of value chain helps to define the verticalscope of an industry
Separate value chains One Integrated value chain
Ability to Leverage Key Activities Across Businesses
Source: Michael M. Porter; What is s trategy? World Business Forum, June 6, 2006
Marketing& Sales
(e.g. SalesForce,
Promotion,Advertising,
ProposalWriting, Website)
InboundLogistics
(e.g.IncomingMaterialStorage,
DataCollection,Service,CustomerAccess)
Operations
(e.g.Assembly,ComponentFabrication,
BranchOperations)
OutboundLogistics
(e.g. OrderProcessing,
Warehousing,Report
Preparation)
After-SalesService
(e.g.Installation,CustomerSupport,
ComplaintResolution,Repair)
Marg
in
Primary Activities
Firm Infrastructure(e.g. Financing, Planning, Investor Relations)
Procurement(e.g. Components, Machinery, Advertising, Serv ices)
Technology Dev elopment(e.g. Product Design, Testing, Process Design, Material Research, Market Research)
Human Resource Management(e.g. Recruiting, Training, Compensation System)
Value:
What
buyers are
willing to
pay
Support
Activities
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The degree of integration of value chains across boardershelps to define the geographic scope of an industry
GlobalNationalLocal Regional
SupportActivities
Marketing
& Sales
(e.g. Sales
Force,Promotion,
Advertising,Proposal
Writing, Web
site)
Inbound
Logistics
(e.g. Incoming
MaterialStorage, Data
Collection,Service,
Customer
Access)
Operations
(e.g. Assembly,
Component
Fabrication,
Branch
Operations)
Outbound
Logistics
(e.g. Order
Processing,Warehousing,
ReportPreparation)
After-Sales
Service
(e.g. Installation,
CustomerSupport,
ComplaintResolution,
Repair)
M
a
r
g
i
n
Primary Activities
Firm Infrastructure(e.g. Financing, Planning, Investor Relations)
Procurement(e.g. Components, Machinery, Advertising, Services)
Technology Development(e.g. Product Design, Testing, Process Design, Material Research, Market Research)
Human Resource Management
(e.g. Recruiting, Training, Compensation System)
Value
What buyersare willing to
pay
Separate local value
chains
Integrated global
value chainAbility to Leverage Key Activities Across Geography
Cross-
National
A distinct strategy is needed for each relevant geographic market
Source: Michael M. Porter; What is s trategy? World Business Forum, June 6, 2006
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23 2007 Prof. Dr. Bernd Venohr
Industry definition: Example car industry
What industry is BMW in?:
World Auto industry
European Auto industry
World luxury car industry?
Key criterion: SUBSTITUTABILITY
On the demand side: Are buyers willing to substitute between types of cars
and across countries (=similar value proposition)?
On the supply side: Are manufacturers able to switch production between
types of cars and across countries based on an integrated global value
chain?
May need to analyze industry at different levels for different types of
decision
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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24 2007 Prof. Dr. Bernd Venohr
Segmenting the world automobile market
Luxury Cars
Full-size sedans
Mid-size sedans
Small sedans
Station wagons
Passenger minivans
Sports cars
Sport-utility
Pick-up trucks
US&Canada W.Europe E.Europe Asia Lat.America Australia Africa
REGION
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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A strategic group is a group of firms in anindustry following the same or similar strategy
Identifying strategic groups:
Identify principal strategic variables which
distinguish firms Position each firm in relation to these variables
Identify clusters
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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Strategic Group Mapping: Firms in same strategic grouphave two or more competitive characteristics in common
Sell in same price/quality range
Cover same geographic areas
Be vertically integrated to same degree
Have comparable product line breadth
Emphasize same types of distribution channels
Offer buyers similar services
Use identical technological approaches
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Strategic groups in the world automobile industry
Broad
PRODUCTRANGE
Narrow
National GEOGRAPHICAL SCOPE Global
NATIONALLY- FOCUSED,
SMALL, SPECIALIST
PRODUCERS e.g., Bristol
(U.K.), Classic Roadsters
(U.S.), Morgan (U.K.)
NATIONALLY FOCUSED,
INTERMEDIATE LINE
PRODUCERSe.g. Tofas, Proton, Maruti
First Auto Works (China)
REGIONALLY-FOCUSED
BROAD-LINE PRODUCERS
e.g. Fiat, PSA, Renault,
Kia,
PERFORMANCE CAR
PRODUCERS e.g., Porsche,
Ferrari (owned by Fiat) Maserati,
Lotus
LUXURY CAR
MANUFACTURERS
e.g., Aston Martin, BMW,
Rolls Royce (owned by VW)
GLOBAL SUPPLIERS OF
NARROW MODEL RANGE
e.g., Subaru, Isuzu,
Suzuki, Saab, Hyundai,
Daihatsu
GLOBAL, BROAD-LINE
PRODUCERS
e.g., GM, Ford, Toyota,
Nissan, Honda, VW,
DaimlerChrysler
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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Porters Five Forces of Competition Framework:the collective strength of the five forces determinesthe average profitability of an industry
SUPPLIERS
POTENTIAL
ENTRANTSSUBSTITUTES
BUYERS
INDUSTRY
COMPETITORS
Rivalry among
existing firms
Bargaining power of suppliers
Bargaining power of buyers
Threat of
new entrants
Threat of
substitutes
Source: Michael Porter, Competitive Strategy
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Porters guiding question: what happens to the potentialprofit or value created by a product or service?
Is it bargained away by the suppliers?
Or by customers?
Is it dissipated in rivalry?
Is it appropriated by new entrants?
Is it limited by the existence of substitutes?
Source: Michael Porter, Competitive Strategy
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Force 1: Rivalry among existing competitors usually the most powerful of the five forces
Strategic rivalry, not perfect competition
in perfect competition behavior of market participants would be immaterial to one another
rivalry: the purposeful behavior of one firm in a market is substantially affected by thepurposeful behavior of another firm in the same or a related market
Strategic rivalry creates several issues for managers:
who are the my rivals?
how will they be affected by my actions?
how will they react to my actions?
how will I react to their reaction?
Main objective is not to engage in rivalry but to develop mechanism that allow firm(s) toavoid rivalry and its profit destroying effects
Three main groups of structural determinants
number and relative size of competitors
industry-basic conditions
behavioral determinants
Source: Michael Porter, Competitive Strategy
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Force 1: Degree of rivalry is high
Competitors are numerous or are roughly equal in size and power
Industry growth is slow
There is low product differentiation (products are commodities)
There are low switching costs
There are high fixed or storage costs
High fixed costs: pressure to fill capacity, probability of price cutting
High storage costs: cut prices to get rid of product
Capacity can only be added in large chunks (more disruptive than anything)
There are high exit barriers: specialized assets, fixed costs to exit,
emotional barriers, government restrictions Strategic confusion: Firms have diverse strategies, corporate priorities,
resources, and countries of origin
Source: Michael Porter, Competitive Strategy
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Force 2: Threat of new entrants:New firms want piece of profits
New entrants bring new capacity, desire for market share and new
resources. Threat of new entry (potential competition) constrains price
and service levels competitors can offer
The strength of this threat depends primarily on barriers to entry
reaction from existing competitors
Entry barriers: whenever it is difficult or uneconomic for an outsider to
replicate the position the incumbents
reduce threat of entry whenever profits, adjusted for cost of capital, rise
above zero
protect incumbents from competition
Source: Michael Porter, Competitive Strategy
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Force 2: Threat of new entrants - typical entry barriers
Barriers to entry can take many forms:
Economies of scale: declines in costs of production as absolute volume per
period increases
Product differentiation: established firms have brand identification and customer
loyalty
Capital requirements: for facilities, inventories, start up losses
Other cost disadvantages: proprietary technology, favorable access to raw
materials, favorable locations, government subsidies, learning curve
Distribution channels: established channels already carry existing firms products
Government policy : limits access to raw materials, licenses
Are established firms expected to respond forcefully?
Is there a history of such retaliation? Do established firms have substantial resources to retaliate (cash, capacity)?
Is there currently slow industry growth?
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Force 2: Threat of new entrants Minimum Efficient Scale as entry barrier
Volume
Unit
Costs
MESEntry
Point
Minimum Efficient Scale (MES) is the smallest volume
(market share) for which the unit costs reach a
minimum; required to enter an industry as efficient
competitor
MES determines what market share a potential entrant
must gain to be able to produce efficiently; it also sizes
an entrantss upfront capital commitment
Example: MES is the following industries is:
Cigarettes 20.0%
Tires 30%
Source: Michael Porter, Competitive Strategy
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Force 2: Threat of new entrants brand images as entry barrier
Source: Michael Porter, Competitive Strategy
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Force 3: Threat of substitute products or services
Every product and service has some substitute: at one level all products aresubstitutes since they compete for the buyers budget; e.g.
Plastic vs. Glass vs. Metal
Newspapers vs. TV vs. Internet
Eyeglasses vs. Contact Lens vs. Laser Surgery
A substitute can perform the same function (=fulfill the same needs) as theproduct of the industry in question
customer function performed, not just physically similar products/services
examples: e-mail/fax/overnight mail
The closeness and availability of substitutes set limits to the actions of everycompetitor in an industry:
the more substitutes and the greater the ease of switching between them
the less the latitude available to the competitors and the more intense their rivalry
Represents an implicit ceiling on prices that existing firms can charge
Source: Michael Porter, Competitive Strategy
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Force 4: Bargaining power of buyers
Buyer power : vertical forces that influence who appropriates the valuecreated by an industry
Allows customers to squeeze industry margins
pressing competitors to reduce prices
increase level of service offered without recompense
Most important determinant: size and concentration of customers
A group of buyers is powerful, if:
It purchases large volumes relative to seller sales
The products it purchases are undifferentiated
The product the group purchases is a significant fraction of the buyers costs(Cost of purchases as % of buyers total costs)
It earns low profits
The industrys product is unimportant to the quality of the buyers products It faces few switching costs
Buyers pose a credible threat of backward integration
Source: Michael Porter, Competitive Strategy
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Force 5: Bargaining power of suppliers
Mirror image of buyer power: who appropriates the value created by an
industry
Key determinants:
relative size and concentration of suppliers relative to industry participants
degree of differentiation in inputs supplied
A supplier group is powerful, if: It is dominated by a few firms and is more concentrated than the industry it sells to
The supplier groups products are differentiated or it has built up switching costs
There are few substitutes for the suppliers products
The supplier poses a credible threat of forward integration
The industry is not an important customer of the supplier group
Acid test: can supplier set prices that reflect the value of their inputs to the
industry and not just their own production cost?
Source: Michael Porter, Competitive Strategy
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Capital requirements Economies of scale
Absolute cost advantage
Product differentiation
Access to distributionchannels
Legal / regulatorybarriers
Retaliation
Buyers propensity tosubstitute
Relative prices &performance ofsubstitutes
Buyers price sensitivity Relative bargaining
power
Concentration Diversity of competitors
Product differentiation
Excess capacity & exitbarriers
Cost structure
Buyers price sensitivity Relative bargaining
power
Summary: The structural determinants of competition
Threat of new entrantsThreat of substituteproducts / services
Bargaining powerof buyers
Rivalry amongexisting competitors
Bargaining powerof suppliers
Source: Michael Porter, Competitive Strategy
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SUPPLIER POWER
LOW
THREAT OF ENTRY
LOW economies of scale
and high capital
requirements for R&D ,clinical trials and sales
force
product differentiation
control of distribution
channels
patent protection
INDUSTRY
COMPETITIVENESS
LOW
high concentration
product differentiation
patent protection
steady demand growth
no cyclical fluctuations of
demand
THREAT OF
SUBSTITUTESLOW
no substitutes(Changing as managed
care encourages
generics)
BUYER POWERLOW
Physician as buyer:
Not price sensitive
No bargaining power
(Changing with managed care)
Example US drug industry (Long-term ROIC = 22%)
Source: Han, Strategic Management,CalState
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41 2007 Prof. Dr. Bernd Venohr
SUPPLIER POWER
HIGH
strong labor unions
concentrated aircraft makers
THREAT OF ENTRY
HIGH
entrants have costadvantages
low capital requirements
little product differentiation
deregulation of
governmental barriers
INDUSTRY
COMPETITIVENESS
HIGH many companies
little product differentiation
excess capacity
high fixed/variable costs
cyclical fluctuations of
demand
THREAT OF
SUBSTITUTES
MEDIUM
autos for short distance
travel
BUYER POWERMEDIUM/HIGH
Buyers extremely price sensitive
Good access to information
Low switching costs
Example US Airline Industry (Long-term ROIC = 5%)
Source: Han, Strategic Management,CalState
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Strategic Implications of the Five Competitive Forces
Competitive environment is unattractive when:
Rivalry is strong
Entry barriers are low
Competition from substitutes is strong
Suppliers and customers have considerable bargaining power
Competitive environment is idealwhen:
Rivalry is moderate
Entry barriers are high
Good substitutes do not exist
Suppliers and customers are in a weak bargaining position
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Implications of five forces framework for strategy:Coping With the Five Competitive Forces
In a world of no competitive advantage, a firm is stuck in the price-
driven world of pure economic competition, selling commodity - like
goods in direct competition with many similar firms
The best industry a company can be in is one in which its position is
so unique that it has virtually no competition
near monopoly
category of one
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Startegy and the business landscape
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44 2007 Prof. Dr. Bernd Venohr
Implications of five forces framework for strategy:key task of strategy is to create a competitive advantage
Competitive strategy is about taking action to create a defendable
position against the 5 forces
Position the firm so its capabilities provide the best defense against the
existing competitive forces
Influence the balance of forces Anticipate shifts in key factors underlying the forces and respond so as to
exploit the changes
The strongest force or forces become crucial for strategy formulation
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Startegy and the business landscape
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45 2007 Prof. Dr. Bernd Venohr
Limitations of Five Forces Analysis
Static snapshot of industry attractiveness
Individual firm actions that change industry structure are not considered
Example: role of innovation de-emphasized
5 Forces are more or less mutually exclusive, but may not be exhaustive
e.g. role of related and supporting industries :Assumes buyers, suppliers,
competitors and substitute providers interact at arms length and ignores role ofcooperation and complementors (e.g. horizontal alliances; complementarycomponent providers)
impact of all macroeconomic forces understood only through their impact on fiveforces
Framework, not formal model
many variables, tries to capture complexity of actual competition identify the relevant variables and the questions that the user must answer in
order to develop conclusions tailored to a particular industry and company
limited empirical support
Source: Pnkaj Ghemawat, Strategy and the business l andscape
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When an industry with a reputation
for difficult economics meets a
manager with a reputation forexcellence, it is usually the industry
that keeps its reputation intact.
Warren Buffet
What is more important: industry (picking the righthorseor company (the skill of the jockey) ?
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For most businesses, competitive position has afar greater impact on profitability than industryattractiveness: Industry effects explain only about10 20% of the variation of a firms economic profitability
Percentage of variance in firms return on assets explained by:
Source: Robert M. Grant, Contemporary Strategy Analysis:
Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
Firm-specific
effects
Unexplained
variance
0.6% 80.4%
44.2% 44.8%
31.7% 48.4%
35.8% 52.0%
Industry effects
19.6%
4.0%
18.7%
8.1%
Schmalensee (1985)
Rumelt (1991)
McGahan & Porter
(1997)
Hawawini et al (2003)
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4
Agenda
Introduction to Strategy
External Environment
- General environment analysis
- Industry analysis
- Summary and Outlook next Session
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Read slides on session 4 downloaded from ILIAS
Visit company web pages and prepare as team a brief description
using Porters 5 Forces framework
What industry (industries) your company is in ?
Build a Porters five forces model for your companies main industry : Which
forces are the strongest/weakest ? Assess the attractiveness of your companies main industry: Is this a good
industry to be in? Use financial results (Return on sales/ROS) or, if available,
Return on Capital Employed/ROIC) for your company and 2 competitors to prove
your assertion.
Topics of next session
Brief 3 page presentation on each company (attractiveness of industry); bringpresentation on usb stick
Lecture: Internal environment
New Assignment and Outlook next Session
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Appendix
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The starting point: The Industrial Organization Model ofsuperior returns
Why are some firms more successful than others?
Profits = f (industry structure)
Characteristics of external environment largely determine
appropriate firm strategies and performance
Industry in which company operates has strong influence
on its economic performance
Choose attractive industries
Largely focuses on industry structure or attractiveness
rather than internal firm characteristics
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy
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Structure-conduct-performance trilogy: Industry structureconstrains options and drives performance
Key thesis:industry structure determined
conduct / behavior of firms, whose joint
conduct the determined the collective
performance of the firms in the industry
Performance defined broadly:
Profitability
technical efficiency (cost minimisation)
innovativeness
Firm conduct (strategy): firms choice of
key decision variables like
Price
Advertising
Capacity
Product quality
Industry structure: relatively stable
economic and technical dimensions of an
industry in which competition occurred
barries to entry
number and size of distribution of firms
(conecentration ratio)
product differentiation and overall elasticityof demand
Key assumption: since structure determined
firms conduct, which jointly determined
performance, one could ignore conduct and
look directly at industry structure to explain
performance
Numerous empirical studies explored therelationship between structural variables and
performance focussing on a limited number of
structural variables
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy
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Structure-conduct-performance
Number of buyers
and sellers
Degree of productdifferentiation
Barriers to entry
Cost structures
Vertical integration
Alliances
Pricing
Advertising
R&D
Investment in plant
and equipment
Economic profits
Accounting profits
(ratios)
NPV/DCF
MVA/EVA
Tobins Q
Industry Structure Firm Conduct Performance
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy
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Limitations of IO framework for strategy
Framed in public policy terms: objective minimizing excess profits. Profitsreflect some problem in industry structure, that can/should be fixed bygovernment regulation
Mainly concernd with industries; firms assumed identical(firms in industry are strategically similar)
Analysis of competitors missing
Static perspective
Highlighting few key elements
Assume away conduct as relevant to performance:industry structure = firm performance
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the Business Landscape
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Uses of industry analysis for strategy
Business level: Develop strategies to outperform industryaverages; better understanding of intra-industry profitdifferences to develop better matches between internal
resources and industry environment
Corporate level: Decisions to enter/exit particular industries;allocation of resources and evaluation of performance acrossportfolio of businesses
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In addition, Porter stresses the management perspective inanalysing industries
Strategy and not public policy objective
strategy: maximizing economic profits and creating near-monopoly
positions rather than
public policy: minimizing excess profits and controlling monopolies
Industry structure partly exogenous and endogenous exogenous economic and technical factors are outside the control of a
company
endogenous factors are subject to influence by firm actions through
strategy (change rules of competition in an industry / shape industry
structure to attain advantaged position)
Industry structure is tied to company economics: structure manifests
itself in revenue, costs investment and on the collective balance sheets and
income statements of industry
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Porter Framework: There are two basic types of competitiveadvantage
Competitive advantage depends on driving a wider wedge between
Price (buyers willingness to pay) and
Costs than competitors
There are logically only two basic types of competitive advantage: lower cost: by designing, producing and marketing a comparable product
or service more efficiently than competitors a firm can gain higher
profitability at comparable or lower prices
differentiation: providing unique and superior non-price value to
customers through product or service performance, special features, after
sales support etc. and commanding premium prices that exceed the extracosts of differentiation
Source: Michael Porter, Industrial Organizai tion and the evolution of concepts for strategic planning;
Michael Porter, Toward a dynamic theory of strategy; Pankaj Ghemawat, Strategy and the business landscape
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0
5
0
10
15
20
25%
100%
Share of industry revenue
Auto loans
Leasing
Warranty
Gasoline
Auto
insurance
Aftermarket
partsAuto rental
Operatingmargin
Auto
manufacturing
New car
dealersUsed car dealers
Service & repair
Vertical segmentation & industry profit pools the US auto industry
Source: Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
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Guidelines: Strategic Groups
Constructing a Strategic Group Map
STEP 1: Identify competitive characteristics that differentiate firms in an industry
from one another
STEP 2: Plot firms on a two-variable map using pairs of these differentiating
characteristics
STEP 3: Assign firms that fall in about the same strategy space to same strategic
group
STEP 4: Draw circles around each group, making circles proportional to size of
groups respective share of total industry sales
Variables chosen as axes should expose bigdifferences in how rivals compete
Variables do nothave to be either quantitative or continuous
Drawing sizes of circles proportional to combined sales of firms in each strategic
group allows map to reflect relative sizes of each strategic group
If more than two good competitive variables can be used, several maps can be
drawn
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3 C-Framework for business definition
Cost: defensible cost barriers that result in
large relative cost position differences
degree of cost sharing
similarity of value adding steps
degree of experience transfer possible
Customers: intrinisically different customer
needs leading to different price points
and defensible differentiation
degree of substitution
degree of customer sharing/customer
synergies
Competitoroverlap as acid test
Define the boundaries
where competitiveadvantage can be
established and
sustained (business
battlefield)
Source: Bain
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Demand and/or value chain differences lead tocost barriers and/or customer value barriers whichcreate a separate business arena
High Low
Customer value barriers
Low
Cost barriers
High One
Business
Separate
Business
Source: Bain & Company, Business Definition; Richard Koch, The Financial Times Guide to Strategy
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