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Key Relationships in Industry Evolution

Key Relationships in Industry Evolution

In the context of this analysis, how do industries change? They do not change in a piecemeal fashion, because an industry is an interrelated system. Change in one element of an industry’s structure tends to trigger changes in other areas. For example, an innovation in marketing might develop a new buyer segment, but serving this new segment may trigger changes in manufacturing methods, thereby increasing economies of scale. The firms reaping these economies first will also be in a position to start backward integration, which will affect power with suppliers – and so on. One industry change, therefore, often sets off a chain reaction leading to many other changes.

It should be clear from the discussion in this chapter that whereas industry evolution is always occurring in nearly every business and requires a strategic response, there is no one way in which industries evolve. Any single model for evolution such as the product

life cycle should therefore be rejected. However, there are some particularly

important relationships in the evolutionary process.

WILL THE INDUSTRY CONSOLIDATE?

It seems to be an accepted fact that industries tend to consolidate

over time, but as a general statement, it simply is not true. In a

broad sample of 151 4-digit U.S. manufacturing industries in the

1963-1972 time period, for example, 69 increased in 4-firm concentration

more than 2 percentage points, whereas 52 decreased more

than 2 percentage points over the same period. The question of

whether consolidation will occur in an industry exposes perhaps the

most important interrelationship among elements of industry structure – that

involving competitive rivalry, mobility barriers, and exit

barriers.

Industry Concentration and Mobility Barriers Move Together.

If mobility barriers are high or especially if they increase, concentration

almost always increases. For example, concentration has increased

in the U.S. wine industry. In the standard-quality segment of

the market, which represents much of the volume, the strategic

changes described earlier in this chapter have greatly increased barriers

to mobility (high advertising, national distribution, rapid brand

innovation, etc). As a result, the larger firms have gotten further

ahead of smaller ones, and few new firms have entered to challenge

them.

No Concentration Takes Place f Mobility Barriers Are Low or

Falling. Where barriers are low, unsuccessful firms that exit will be

replaced by new firms. If a wave of exit has occurred because of an

economic downturn or some other general adversity, there may be a

temporary increase in industry concentration. But at the first signs

that profits and sales in the industry are picking up, new entrants

will appear. Thus a shake-out when an industry reaches maturity

does not necessarily imply long-run consolidation.

Exit Barriers Deter Consolidation. Exit barriers keep companies operating in an industry even though they are earning subnormal returns on investment. Even in an industry with relatively high mobility barriers, the leading firms cannot count on reaping the benefits of consolidation if high exit barriers hold unsuccessful firms in the market.

Long-run Profit Potential Depends on Future Structure. In the period of very rapid growth early in the life of an industry (especially after initial product acceptance has been achieved), profit levels are usually high. For example, growth in sales of skiing equipment were in excess of 20 percent per year in the late 1960s, and nearly all firms in the industry enjoyed strong financial results. When growth levels off in an industry, however, there is a period of turmoil as intensified rivalry weeds out the weaker firms. All firms in the industry may suffer financially during this adjustment period. Whether or not the remaining firms will enjoy above-average profitability will depend on the level of mobility barriers, as well as the other structural features of the industry. If mobility barriers are high or have increased as the industry has matured, the remaining firms in the industry may enjoy healthy financial results even in the new era of slower growth. If mobility barriers are low, however, slower growth probably means the end of above-average profits for the industry. Thus mature industries may or may not be as profitable as they were in their developmental period.

CHANGES IN INDUSTRY BOUNDARIES

Structural change in an industry is often accompanied by changes in industry boundaries.

Industry evolution has a strong tendency to shift these boundaries. Innovations in the industry or those involving substitutes may effectively enlarge the industry by placing more firms into direct competition. Reduction in transportation cost relative to timber cost, for example, had made timber supply a world market rather than one restricted to continents. Innovations increasing the reliability and lowering the cost of electronic surveillance devices have put them into effective competition with security guard services. Structural changes making it easier for suppliers to integrate forward into the industry may well mean that suppliers effectively become competitors. Or buyers purchasing private label goods in large quantities and dictating product design criteria may become effective competitors in the manufacturing industry (Sears-Roebuck). Part of the analysis of the strategic significance of industry evolution is clearly an analysis of how industry boundaries may be affected.

FIRMS CAN INFLUENCE INDUSTRY STRUCTURE

As described briefly in Chapter 1 and highlighted here, industry structural change can be influenced by firms’ strategic behavior. If it understands the significance of structural change for its position, the firm can seek to influence industry change in ways favorable to it, either through the way it reacts to strategic changes of competitors or in the strategic changes it initiates.

Another way a company can influence structural change is to be very sensitive to external forces that can cause the industry to evolve. With a head start, it is often possible to direct such forces in ways appropriate to the firm’s position. For example, the specific form of regulatory changes can be influenced; the diffusion of innovations coming from outside the industry can be altered by the form that licensing or other agreements with innovating firms take; positive action can be initiated to improve the cost or supply of complementary

products through providing direct assistance and help in forming trade associations or in stating their case to the government; and so on for the other important forces causing structural change. Industry evolution should not be greeted as afraid accompli, to be reacted to, but as an opportunity.

Date Published: Feb 10, 2011 - 6:14 pm

Evolutionary Processes

Evolutionary Processes

Although initial structure, structural potential, and particular firms’ investment decisions will be industry-specific, we can generalize about what are the important evolutionary processes. There are some predictable (and interacting) dynamic processes that occur in every industry in one form or another, though their speed and direction will differ from industry to industry:

• long-run changes in growth;

• changes in buyer segments served;

• buyers’ learning;

reduction of uncertainty;

• diffusion of proprietary knowledge;

• accumulation of experience;

• expansion (or contraction) in scale;

• changes in input and currency costs;

• product innovation;

• marketing innovation;

• process innovation;

• structural change in adjacent industries;

• government policy change;

• entries and exits.

Each evolutionary process will be described, with attention to its determinants, its relationship to other processes, and its strategic implications.

LONG-RUN CHANGES IN GROWTH

Perhaps the most ubiquitous force leading to structural change is a change in the long-run industry growth rate. Industry growth is a key variable in determining the intensity of rivalry in the industry, and it sets the pace of expansion required to maintain share, thereby influencing the supply and demand balance and the inducement the industry offers to new entrants.

There are five important external reasons why long-run industry growth changes:

DEMOGRAPHICS

In consumer goods, demographic changes are one key determinant of the size of the buyer pool for a product and thereby the rate of growth in demand. The potential customer group for a product may be as broad as all households, but it usually consists of buyers characterized by particular age groups, income levels, educational levels, or geographic locations. As the total growth rate of the popup

lotion, its distribution by age group and income level, and demographic factors change, these translate directly into alterations in demand. A particularly vivid current example of this situation is the adverse effect of the reduced U.S. birthrate on demand for baby products of all types, whereas products catering to the 25-to-35-year- old age group are currently enjoying the effects of the post-World War II baby boom. Demographics also represent a potential problem for the recording and candy industries, which have traditionally sold most heavily to the pre-20-year-old age group, which is currently shrinking.

Part of the effect of demographic changes is caused by income elasticity, which refers to the change in a buyer’s demand for a product as his/her income rises. For some products (mink golf club covers), demand tends to rise disproportionately with buyers’ income. For other products, demand rises less than proportionally as incomes rise, or even falls. It is important from a strategic point of view to identify where an industry’s product lies in this spectrum, because it is critical to forecasting long-run growth as general income levels of buyers change both in a firm’s home country and in potential international markets. Sometimes industries can shift their products up or down the scale of income elasticity through product innovation, however, so the effects of income elasticity are not necessarily a foregone conclusion.

For industrial products, the effect of demographic changes on demand is based on the life cycle of customer industries. Demographics affect consumers’ demand for end products, which filters back to affect the industries supplying inputs toward those end products.

Firms can attempt to cope with adverse demographics by widening the buyer group for their product through product innovations, new marketing approaches, additional service offerings, and so on. These approaches can in turn affect industry structure by raising economies of scale, exposing the industry to fundamentally different buyer groups with different bargaining power, and so forth.

TRENDS IN NEEDS

Demand for an industry’s product is affected by changes in the lifestyle, tastes, philosophies, and social conditions of the buyer population which any society tends to experience over time. For example, in the late 1960s and early 1970s there were such shifts in the United States as a return to “nature,” increased leisure time, more casual dress, and nostalgia. These trends boosted demand for backpacks, blue jeans, and other products. The recent “back to basics” movement in education is creating new demand for standardized reading and writing tests, to give another example. There have also been social trends such as an increase in the crime rate, the changing role of women, and increased health consciousness that have increased demand for some products (bicycles, day care) and reduced demand for others.

Trends in needs like these not only directly affect demand but also affect the demand for industrial products indirectly through intervening industries. Trends in needs affect the demand in particular industry segments as well as total industry demand. Needs may be newly created or just made more intense by social trends. For exam- pie, property theft has increased quite dramatically in the last twenty years, greatly increasing the demand for security guards, locks, safes, and alarm systems. The rising expected losses due to theft have justified greater spending to prevent it.

Finally, changes in government regulation can increase or decrease needs for products. For example, demand for pinball and slot machines is growing as a result of impending and already passed legislation that legalizes gambling.4

CHANGE IN THE RELATIVE Position OF SUBSTITUTES

Demand for a product is affected by the cost and quality, broadly defined, of substitute products. If the cost of a substitute falls in relative terms, or if its ability improves to satisfy the buyer’s needs, industry growth will be adversely affected (and vice versa). Examples are the inroads that television and radio have made on the demand for live concerts by symphony orchestras and other perform- ing groups; the growth in demand for magazine advertising space as television advertising rates climb sharply and prime advertising television time becomes increasingly scarce; and the depressing effect of rising prices on the demand of such products as chocolate candy and soft drinks relative to their substitutes.

In predicting long-run change in growth, a firm must identify all the substitute products that can meet the needs its product satisfies. Then technological and other trends that will affect the cost or quality of each of these substitutes should be charted. Comparing these with the analogous trends for the industry will yield predictions

about future industry growth rates and identify critical ways in which substitutes are gaining, thereby providing leads for strategic action.5

CHANGES IN THE Pension OF COMPLEMENTARY PRODUCTS

The effective cost and quality of many products to the buyer depends on the cost, quality, and availability of complementary products, or products used jointly with them. For example, in many areas of the United States mobile homes are primarily sited in mobile home parks. In the last decade there has been a chronic shortage of these parks, which has limited demand for mobile homes. Similarly, demand for stereophonic records was strongly affected by the availability of stereophonic audio equipment, which in turn was affected by the cost and reliability of this equipment.

Just as it is important to identify substitutes for an industry’s product it is important to identify complements comprehensively. Complementary products should be viewed broadly. For example, credit at prevailing interest rates is a complementary product to purchases of durable goods. Specialized personnel are a complementary product to many technically oriented goods (e.g., computer programmers to computers and mining engineers to coal mining). Charting trends in cost, availability, and quality of complementary products will yield predictions about long-run growth for an industry’s product.

PENETRATION OF THE CUSTOMER GROUP

Most very high industry growth rates are the result of increasing penetration, or sales to new customers rather than to repeat customers. Eventually, however, it is a fact of life that an industry must reach essentially complete penetration. Its growth rate is then determined by replacement demand. Renewed periods of adding new customers can sometimes be stimulated by product or marketing changes, which broaden the scope of the customer base or stimulate rapid replacement. However, all very high growth rates eventually come to an end.

Once penetration is reached the industry is selling primarily to repeat buyers. There may well be major differences betweeen selling to repeat and first-time buyers that have important consequences for

industry structure. The key to achieving industry growth when selling to repeat buyers is either stimulating rapid replacement of the product or increasing per capita consumption. Since replacement is determined by physical, technological, or design obsolescence as perceived by the buyer, strategies to maintain growth after penetration will hinge on affecting these factors. For example, replacement demand for clothing is stimulated by annual and even seasonal style changes. And the classic story of General Motors’ ascendency over Ford is an example of how model changes stimulated demand after market saturation for the basic (one color: black) automobile occurred.

Whereas penetration most often means that industry demand will level off, for durable goods, achieving penetration can lead to an abrupt drop in industry demand. After most potential customers have purchased the product, its durability implies that few will buy replacements for a number of years. If industry penetration has been rapid, this situation may translate into several very lean years for industry demand. For example, industry sales of snowmobiles, which underwent very rapid penetration, fell from 425,000 units per year in the peak year (1970-1971. to 125,000 to 200,000 units per year in l976l977.6 Recreational vehicles underwent a similar though not quite so dramatic decline. The relation between the growth rate after penetration and growth before penetration will be a function of how fast penetration has been reached and the average time before replacement, and this figure can be calculated.

The decline in industry sales for durables means that manufacturing and distributing capacity will inherently overshoot demand. As a result, a serious decline in profit margins usually occurs, and some producers may exit. Another characteristic of the demand for durable goods is that growth fueled by penetration can overshadow cyclicality despite the fact that the product is inherently sensitive to the business cycle. An industry approaching penetration will thus have its first deep cycle, exacerbating the problem of overshooting.

PRODUCT CHANGE

The five external causes of industry growth have presupposed no change in the products offered by the industry. Product innovation by the industry, however, can allow it to serve new needs, can improve the industry’s position vies- substitutes, and can eliminate or reduce the necessity of scarce or costly complementary products. Thus product innovation can improve an industry’s circumstances relative to the five external causes of growth, and thereby increase the industry’s growth rate. Product innovations have played a major part in fueling the rapid growth of motorcycles, bicycles, and chain saws, for example.

CHANGES IN BUYER SEGMENTS SERVED

The second important evolutionary process is change in the buyer segments served by the industry. For example, early electronic calculators were sold to scientists and engineers, only later to students and bill payers. Light aircraft were initially sold to the military and later to private and commercial users. Related to this is the possibility that additional segmentation of existing buyer segments can take place by creating different products (broadly defined) and marketing techniques for them. A final possibility is that certain buyer segments are no longer served4

The significance of new buyer segments for industry evolution is that the requirements for serving these new buyers (or eliminating requirements for serving obsolete segments) can have a fundamental impact on industry structure. For example, although early buyers of the product may not have required credit and field servicing, later buyers might. If the provision of credit and in-house service creates potential economies of scale and raises capital requirements, then entry barriers will rise significantly.

A good example is provided by changes occurring in the optical character reader business in the late 1970s. This industry and its leader, Recognition Equipment, have been producing large, expensive optical scanning machines to sort checks, credit cards, and mail. Each machine has been custom-made, requiring special engineering and produced on a job-shop basis. In recent years, however, small wands for use with retail point-of-sale terminals have been developed. In addition to opening up a vast potential market, the wands are amenable to high-volume, standardized manufacturing and will be purchased in large quantities by individual buyers. This development promises to change economies of scale, capital requirements, marketing methods, and many other aspects of industry structure.

Analysis of industry evolution, then, should include an identification of all potential new buyer segments and their characteristics.

LEARNING BY BUYERS

Through repeat purchasing, buyers accumulate knowledge about a product, its use, and the characteristics of competing brands. Products have a tendency to become more like commodities over time as buyers become more sophisticated and purchasing tends to be based on better information. Thus there is a natural force reducing product differentiation over time in an industry. Learning about the product may lead to increasing demands by buyers for warranty protection, service, improved performance characteristics, and so forth.

An example is the aerosol packaging industry. Aerosol packaging first came into use in consumer goods in the 1950s. The package, an extremely important part of marketing many consumer goods, often represents an important cost item to the marketing company. In the early years of aerosol packaging, consumer marketers were unfamiliar with how to design aerosol applications, how aerosol containers were filled, and how best to market aerosol products. A contract aerosol filling industry sprang up to assemble and fill aerosol packages, and this industry also played a major role in assisting consumer marketing companies find new aerosol applications, solve production problems, and so on. Over time, however, consumer marketers learned a great deal about aerosols and began developing their own applications and marketing programs, in some cases actually initiating integration backward. Contract fillers found it increasingly difficult to differentiate their services, and their role became increasingly one of supplying commodity aerosol containers. As a result, contract fillers’ profit margins were severely squeezed, and many left the industry.

A buyer’s learning tends to progress at different rates for different products, depending on how important the purchase is and the buyer’s technical expertise. Smart or interested (because it is an important product) buyers tend to learn faster.

Offsetting buyer’s experience is change in the product or in the way it is sold or used, such as new features, new additives (hexachlorophene), style changes, new advertising appeals, and the like.

This development nullifies some of the buyer’s accumulated know

edge and hence enhances the possibilities for continued product differentiation. Such possibilities are also enhanced by expanding the customer base to new buyers inexperienced with the product, particularly those whose purchasing characteristics tend to make them learn slowly.

REDUCTION OF UNCERTAINTY

Another type of learning that affects industry structure is reduction of uncertainty. Most new industries are initially characterized by a great deal of uncertainty about such things as the potential size of the market, optimal product configuration, nature of potential buyers and how they can best be reached, and whether technological problems can be overcome. This uncertainty often leads firms to a high degree of experimentation, with many different strategies adopted representing different bets about the future. Rapid growth provides slack to allow these differing strategies to coexist for long periods of time.

Over time, however, there is a continual process by which uncertainties are resolved. Technologies are proven or disproven, buyers are identified, and indications are gleaned from the industry’s growth about its potential size. Hand in hand with such reduction of uncertainty is a process of imitation of successful strategies and the abandonment of poor ones.

Reduction of uncertainty may also attract new types of entrants into the industry. Reduced risk may attract larger, established firms with lower-risk profiles than the newly created companies so common in emerging industries. As it becomes clear that an industry’s potential is large and technological hurdles can be overcome, bigger firms may find it worth their while to enter – which has happened in recreational vehicles, video games, solar heating, and many other industries. Of course events can create new uncertainties in an industry, but like buyers’ learning, reduction of uncertainty will be continually operating to resolve existing doubts.

Strategically, reduction of uncertainty and imitation suggest that a firm cannot rely on uncertainty alone to protect it from its rivals or from new entrants very long. Depending on mobility barriers, the imitation of successful strategies can be more or less difficult. To protect its position a firm must strategically prepare either to defend its position against imitators and new entrants or adjust its

DIFFUSION OF PROPRIETARY KNOWLEDGE

Product and process technologies developed by particular firms (or suppliers or other parties) tend to become less proprietary. Over time, a technology becomes more established and knowledge about it more widespread. Diffusion occurs through a variety of mechanisms. First, firms can learn from physical inspection of competitors’ proprietary products and from information gleaned from a variety of sources about the size, location, organization, and other characteristics of competitors’ operations. Suppliers, distributors, and customers are all conduits for such information and often have strong interest in promoting diffusion for their own purposes (e.g., creating another strong supplier). Second, proprietary information is also diffused as it becomes embodied in capital goods produced by outside suppliers. Unless firms in the industry make their own capital goods or protect the information they give to suppliers, the technology may become purchasable by competitors. Third, personnel turnover increases the number of people who have the proprietary information and may provide a direct conduit for the information to other firms. Spin-off firms founded by technical personnel who have left pioneering companies are common, as is the practice of hiring away personnel. Finally, specialized personnel who are expert in the technology invariably become more numerous from sources such as consulting firms, suppliers, customers, response of university technical schools, and so on.

In the absence of patent protection, therefore, proprietary advantages will tend to erode, as hard as it is for some firms to accept this fact. Thus any mobility barriers built on proprietary knowledge or specialized technology tend to erode over time, as do those caused by shortages of qualified, specialized personnel. These changes make it easier not only for new competitors to spring up but also for suppliers or customers to vertically integrate into the industry.

Returning to the previously discussed aerosol example, over time the new aerosol technology became better and better known. Since the production volume needed to achieve efficient scale in aerosol packaging was relatively small, many large consumer marketing companies could support their own captive filling operations.

As knowledge about the technology and specialized personnel became more common, many of these companies vertically integrated into aerosol filling or could threaten to do so. This development left the contract filler in the role of meeting emergency demand and in a

very adverse bargaining situation. The response of many contract fillers was to invest in improving filling technology and to invent new aerosol applications to restore their technological advantage. This strategy proved to be increasingly difficult, and the contract fillers’ position weakened substantially over time.

The rate of diffusion of proprietary technology will depend on the particular industry. The more complex the technology, the more specialized the required technical personnel, the greater the critical mass of research personnel required, or the greater the economies of scale in the research function, the slower proprietary technology will tend to diffuse. When heavy capital requirements and economies of scale in R&D confront imitators, proprietary technology can provide a lasting mobility barrier.

One key offsetting force to diffusion of proprietary technology is patent protection, which legally inhibits diffusion. However, this protection is unreliable in preventing diffusion since patents can be sidestepped by similar inventions. The other offsetting force to diffusion is the continual creation of new proprietary technology through research and development. New knowledge will provide companies with additional periods of proprietary advantages. However, continual innovation may not pay if the diffusion period is short and buyers’ loyalties to pioneering firms are not very strong.

Two of many possible patterns of mobility barriers arising from proprietary technology are illustrated in Figure 8-3. Economies of scale in research were initially low in both industries since the initial, crude, breakthrough innovations that created the product could be made by small groups of research personnel. This situation is relatively common, having occurred in such industries as minicomputers, semiconductors, and others. Proprietary technology provided a modest initial mobility barrier in such an industry, but one that was soon eroded by diffusion. In one industry, the complex technology led to increasing economies of scale in the research function. In the other, there was little opportunity for continued technological innovation and hence little need for further research on a significant scale. In the first industry, then, mobility barriers from proprietary technology quickly rose again to a level higher than the initial one. Eventually they tailed off as opportunities for further innovation

waned and diffusion took over. In the other industry, mobility barriers from proprietary technology quickly sunk to a low level. Thus one industry would probably have a profitable maturity phase, whereas the other would be dependent on other sources of barriers to prevent profit erosion to the competitive level. In the aerosol example, the nature of the technology did not allow the secondary increase in entry barriers.

From a strategic point of view, the diffusion of knowledge about technology means that to maintain position (1. existing know- how and specialized personnel must be protected, which is very difficult to do in practice;7 (2. technological development must occur to maintain the lead; or (3. strategic position must be shored up in other areas. Planning for the defense of strategic position against technological diffusion takes on high priority if a firm’s existing position is heavily dependent on technological barriers.

ACCUMULATION OF EXPERIENCE

In some industries, whose characteristics were identified in Chapter 1, unit costs decline with experience in manufacturing, distributing, and marketing the product. The significance of the learning curve for industry competition is dependent upon whether firms

with more experience can establish significant and sustainable leads over others. For these leads to persist, firms that are behind must be unable to catch up by copying the methods of leaders, buying new and more efficient machinery the leaders may have pioneered, and

so on. If firms that are behind can leapfrog, the leaders may be at a disadvantage from bearing the expense of research, experimentation, and introduction of new methods and equipment in the first place. The tendency for proprietary technology to diffuse works against the learning curve to some extent.

When experience can be kept proprietary, it can be a potent force in industry change. If the firm is not gaining experience the fastest, it must prepare strategically to either practice rapid imitation or build strategic advantages in other areas besides cost. Doing the latter requires the firm to adopt generic strategies of differentiation or focus.

EXPANSION (OR CONTRACTION) IN SCALE

A growing industry is, by definition, increasing its total scale. This growth is usually accompanied by increases in the absolute size of the leading firms in the industry, and firms gaining market share must be increasing in size even more rapidly. Increasing scale in industry and firm has a number of implications for industry structure. First, it tends to widen the set of available strategies in ways that often lead to increased economies of scale and capital requirements in the industry. For example, it may allow larger firms to substitute capital for labor, adopt production methods subject to greater economies of scale, establish captive distribution channels or a captive service organization and utilize national advertising. Increasing scale also can make it feasible for an outsider to enter the industry with substantial competitive advantages by being the first to adopt such changes.

The way in which increasing scale operates on industry structure is illustrated by light aircraft in the 1960s and early 1970s. In this industry, growth allowed Cessna (the industry leader) to shift its production process from job shop to quasi-mass production. This change resulted in a cost advantage for Cessna because it reaped economies of scale in mass production as yet unavailable to its major competitors. If Cessna’s two leading competitors also reach the scale

to begin more capital-intensive mass production, barriers to entry into the industry by outsiders will increase markedly.

Another consequence of industry growth is that strategies of vertical integration tend to become more feasible, and increased vertical integration tends to elevate barriers. Increasing industry scale

also means that suppliers to the industry are selling it larger volumes of goods, and the industry’s customers as a group are purchasing larger quantities. To the extent that individual suppliers or buyers are increasing their sales or purchases as well, there may be temptations for them to begin forward or backward integration into the industry. Whether or not integration actually occurs, the bargaining power of suppliers or buyers will go up.

There may also be a tendency for large industry scale to attract new entrants, who can make it tougher for existing leaders, particularly if the entrants are large, established firms. Many large firms will enter a market only after it has reached a significant absolute size (to justify the fixed costs of entry and make a material contribution to their overall sales), even though they have been probable potential entrants right from the industry’s birth as a result of skills or assets they bring from their existing businesses. For example, in the recreational vehicle industry the initial entrants were new firms started from scratch and relatively small diversifying mobile home producers whose production process was similar to that of making recreational vehicles. As the industry got large enough, big farm equipment and automotive companies began to enter. These firms had ample resources for competing in recreational vehicles drawn from their existing operations, but they left it to the smaller firms to develop the market and prove that a significant market existed before they entered.

CHANGES IN INPUT COSTS AND EXCHANGE RATES

Every industry uses a variety of inputs to its manufacturing, distribution, and marketing process. Changes in the cost or quality of these inputs can affect industry structure. The important classes of input costs subject to change are the following:

• wage rates (encompassing the full costs of labor);

• material costs;

• cost of capital;

• communication costs (including media);

• transportation costs.

The most straightforward effect is in increasing or decreasing the cost (and price) of the product, thereby affecting demand. For example, the cost of producing movies has risen quite markedly in recent years. This rise is squeezing independent producers relative to well-financed movie companies, particularly since movie tax shelters have been circumscribed by 1976 tax legislation. This development has cut a major avenue of financing for independent producers.

Changes in wage rates or capital costs may change the shape of the industry’s cost curve, altering economies of scale or promoting substitution of capital for labor. Escalating labor costs in service calls and deliveries are fundamentally affecting strategy in many industries. Changes in the cost of communication or transportation can promote reorganization of production, which affects entry barriers. Changes in communication costs may lead to use of different cost-effective selling media (and thereby changes in the level of product differentiation), changed distribution arrangements, and so on. In addition, changes in transportation costs can shift geographic market boundaries, which either increases or decreases the effective number of competitors in the industry.

Exchange rate fluctuations can also have a profound effect on industry competition. The devaluation of the dollar against the yen and many European currencies, for example, has triggered significant shifts in position in many industries since 1971.

PRODUCT INNOVATION

A major source of industry structural change is technological innovations of various types and origins. Innovation in product is one important type. Product innovation can widen the market and hence promote industry growth and/or it can enhance product differentiation. Product innovation also can have indirect effects. The process of rapid product introduction, and associated needs for high marketing costs, may itself create mobility barriers. Innovations may require new marketing, distribution, or manufacturing methods that change economies of scale or other mobility barriers. Significant product change can also nullify buyer experience and hence impact purchasing behavior.

Product innovations can come from outside or inside the industry. Color television was pioneered by RCA, a leader in black and white television. However, electronic calculators were introduced by electronics companies and not mechanical calculator or slide rule

producers. Thus forecasting product innovations involves examining possible external sources. Many innovations flow vertically, originated by customers and suppliers, where the industry is an important customer or source of inputs.

An example of the influence of product innovation on structure is the introduction of the digital watch. Economies of scale in producing digital watches are greater than those in producing most conventional watch varieties. Competing in digital watches also requires large capital investments and an entirely new technological base compared to conventional watches. Thus mobility barriers and other aspects of the structure of the watch industry are changing rapidly.

MARKETING INNOVATION

Like innovations in product, those in marketing can influence industry structure directly through increasing demand. Breakthroughs in the use of advertising media, new marketing themes or channels, and so forth can allow reaching new consumers or reducing price sensitivity (raising product differentiation). For example, movie companies have boosted demand by advertising movies on television. The discovery of new channels of distribution can similarly widen demand or raise product differentiation; innovations in marketing that make it more efficient can lower the cost of the product.

Innovations in marketing and distribution also have effects on other elements of industry structure. New forms of marketing can be subject to increased or decreased economies of scale and hence affect mobility barriers. For example, the shift in marketing wine from low-key magazine advertising to network television has raised the mobility barriers in the wine industry. Marketing innovations can also shift power relative to buyers, and affect the balance of fixed and variable costs and hence the volatility of rivalry.

PROCESS INNOVATION

The final class of innovation that can change industry Structure is that in the manufacturing process or methods. Innovations can

make the process more or less capital intensive, increase or decrease

economies of scale, change the proportion of fixed costs, increase or

decrease vertical integration, affect the process of accumulating experience,

and so on – all of which affect industry structure. Innovations

that increase scale economies or extend the experience curve

beyond the size of national markets can lead to industry globalize- -I ion (see Chapter 13..

An example of the way in which interacting evolutionary processes can trigger manufacturing changes is found in changes occurring

in the computer service bureau business in 1977. Computer service

bureaus provide computer power and a library of programs to a

wide variety of users, including those in business, education, and financial

institutions. Traditionally service bureaus have been local or

regional organizations serving primarily smaller businesses with simple

computer packages in areas like accounting and payroll. However,

a substitute product, the minicomputer, has made cheap computer

power easily accessible to even small organizations. As a

result, forces have been set in motion which are promoting the development

of large regional and national service bureaus. First, more

sophisticated programs are being developed to differentiate the service

bureau from the minicomputer, which require substantial investments.

The economies of spreading such investments over a large

number of users are promoting concentration. Second, pressure to

offer computer power at low cost is putting a premium on efficient

use of facilities. This development is adding to the impetus toward

national companies to take advantage of time zone changes to make

use of off-hours capacity. Third, computer technology continues to

increase in complexity, raising technological barriers to establish a

service bureau at least in the short run. So all these forces built up in

the evolutionary process have led to a change in the manufacturing

process of the leading service bureaus.

Manufacturing innovations that change structure can come

from outside the industry as well as from within. Developments in

computerized machine tools and other manufacturing equipment by

equipment suppliers, for example, may lead to increased scale economies

in production in an industry. The 1950s innovations by fiberglass

producers that led to the use of fiberglass in boats greatly reduced

the difficulty of designing and building pleasure boats. This

reduction in entry barriers triggered the entry of a large number of

new companies into the industry with disastrous consequences for

profits, many failing between 1960 and 1962 as the industry under

went a shake-out. In the metal container industry, suppliers of steel expended substantial resources to help defend steel cans against the inroads of the aluminum can through innovations reducing the gauge of steel and techniques for lower-cost can manufacture. All these examples suggest that the firm must broaden its view of technological change beyond industry boundaries.

STRUCTURAL CHANGE IN ADJACENT INDUSTRIES

Since the structure of suppliers’ and customers’ industries affects their bargaining power with an industry, changes in their structure have potentially important consequences for industry evolution. For example, there has been substantial chain-store development in the retailing of clothing and hardware in the 1960s and 1970s. As the structure of retailing has become concentrated, the retailers’ bargaining power with their supplying industries has increased. Apparel makers are getting squeezed by retailers, who are ordering closer and closer to the selling season and demanding other concessions. Manufacturers’ marketing and promotional strategies have had to adjust, and concentration in apparel manufacturing is forecast to increase. The mass merchandising revolution in retailing generally has had similar effects on many other industries (watches, small appliances, toiletries).

Whereas changes in the concentration or vertical integration of adjacent industries attract the most attention, more subtle changes in the methods of competition in the adjacent industries can often be just as important in affecting evolution. For example, in the 1950s and early 1960s record retailers dropped the policy of allowing consumers to play records in the store. The effects of this change in the adjacent recording industry proved to be profound. Since the consumer could no longer sample records in the store, what radio stations played became critical to record sales. However, because advertising rates were becoming increasingly tied to sustained audience size, radio stations were shifting to the “Top 40” format, that is, repeatedly playing only the leading songs. It became extremely difficult to get a new, unproven record aired on the radio. The change in retailing created a powerful new element for the recording industry – radio stations – which changed the strategic requirements for success. It also forced the recording industry to purchase advertising time for new record releases on radio stations, the only sure way to

assure that new recordings were played, and generally increased barriers into the recording industry.

The importance of changes in the structure of adjacent industries points to the need to diagnose and prepare for structural evolution in supplying and buying industries, just as in the industry itself.

GOVERNMENT POLICY CHANGE

Government influences can have a significant and tangible impact on industry structural change, the most direct through full- blown regulation of such key variables as entry into the industry, competitive practices, or profitability. For example, pending national health insurance legislation with cost-plus reimbursement will fundamentally affect profit potential in the proprietary hospital and clinical laboratory industries. Requirements for licensing, an intermediate form of government regulation, tend to restrict entry and thereby provide an entry barrier protecting existing firms. Changes in government pricing regulation also can have a fundamental impact on industry structure. A current example is the profound consequences that have accompanied the shift from legally fixed commissions to negotiated commissions in securities transactions. Fixed commissions created a price umbrella for securities firms and shifted competition from price to service and research. Ending fixed commissions has shifted competition to price and resulted in mass exit from the industry, either through outright failure or mergers. Mobility barriers in the new environment are dramatically increased. Government actions can also dramatically increase or decrease the likelihood of international competition

Less direct forms of government influence on industry structure occur through the regulation of product quality and safety, environmental quality, and tariffs or foreign investments. The effect of many new product quality and environmental regulations, though they surely achieve some desirable social objectives, is to raise capital requirements, elevate economies of scale through the imposition of research and testing requirements, and otherwise worsen the position of smaller firms in an industry and raise barriers facing new firms.

An example of the impact of quality regulation is in the security guard industry. Criticism has mounted over the lack of training that companies give their guards in the use of weapons, arrest techniques,

and so on, and legislation to require mandatory training of a specified duration is on the horizon. Although such a requirement will be easily met by the larger companies, many smaller companies may be severely hurt by the increased overhead and the need to compete for higher skilled employees.

ENTRY AND EXIT

Entry clearly affects industry structure, particularly entry by established firms from other industries. Firms enter an industry because they perceive opportunities for growth and profits that exceed the costs of entry (or of surmounting mobility barriers).9 Based on case studies of many industries, industry growth seems to be the most important signal to outsiders that there are future profits to be made, even though this can often be a poor assumption. Entry also follows particularly visible indications of future growth, such as regulatory changes, product innovations, and so on. For example, the energy crisis and recent proposed legislation to provide federal subsidy have evoked rapid entry into solar heating even though demand for solar heating is still quite low.

The entry into an industry (by either acquisition or internal development) of an established firm is often a major driving force for industry structural change.1 Established firms from other markets generally have skills or resources that can be applied to change competition in the new industry; in fact this often provides a major motivation for their entry decision. Such skills and resources are very often different from those of existing firms, and their application in many cases changes the industry’s structure. Also, firms in other markets may be able to perceive opportunities to change industry structure better than existing firms because they have no ties to historical strategies and may be in a position to be more aware of technological changes occurring outside the industry that can be applied to competing in it.

An example will serve to illustrate. In 1960, the U.S. wine industry was composed primarily of small family firms producing premium wines and selling them in regional markets. There was little advertising or promotion, few firms had national distribution, and the competitive focus of most firms in the industry was clearly on the a production of fine wines.’ Profits in the industry were modest. In the mid-1960s, however, a number of large consumer marketing companies (e.g., Heinlein, United Brands) either entered the industry through internal development or purchased existing wine producers. They began investing heavily in consumer advertising and promotion for both low-cost and premium brands. Since several of these firms had national distribution through liquor stores because they produced other alcoholic beverages, they rapidly expanded distribution for their brands nationally. Frequent introduction of new brand names became the rule in the industry, and many new products were introduced at the low end of the quality spectrum, which old-line companies had generally downplayed while they developed a name for U.S. wines. The profitability of the industry leaders was excellent. Thus the entry of a different type of firm into the U.S. wine industry has caused or at least speeded up a significant structural change in the industry, and one which the early family-controlled participants in the industry had neither the skills, the resources, nor the inclination to cause themselves.

Exit changes industry structure by reducing the number of firms and possibly increasing the dominance of the leading ones. Firms exit because they no longer perceive the possibility of earning returns on their investment that exceed the opportunity cost of capital. The exit process is impeded by exit barriers , which worsen the position of remaining, healthier firms and may lead to price warfare and other competitive outbreaks. Increases in concentration and the ability of an industry’s profitability to climb in response to industry structural shifts also will be impeded by the presence of exit barriers.

The evolutionary processes are a tool for predicting industry changes. Each evolutionary process is the basis of a key strategic question. For example, the potential impact of government regulatory change on an industry’s structure means that a company must ask itself, “Are there any government actions on the horizon that may influence some element of the structure of my industry? If so, what does the change do for my relative strategic position, and how

can I prepare to deal with it effectively now?” A similar question can be formulated for each of the other evolutionary processes discussed above. The set of questions that result should be asked on a repeated basis, perhaps even formally through the strategic planning process

Furthermore, each evolutionary process identifies a number of key strategic signals, or pieces of key strategic information, for which the firm must constantly scan its environment. The entry of an established firm from another industry, a key development affecting a substitute product, and so on should cause a red light to go in the minds of executives charged with maintaining the strategic health of a business. This red light should trigger a chain of analysis to predict the significance of the change for the industry and the appropriate response.

Finally, it is important to note that learning, experience, increasing market size, and several other of the processes discussed above will be operating even if there are no important distinct events to signal this. The implication is that regular attention should be given to structural changes that may be resulting from these hidden processes.

Date Published: Feb 10, 2011 - 6:12 pm

Basic Concepts in Industry Evolution

Basic Concepts in Industry Evolution

The starting point for analyzing industry evolution is the framework of structural analysis in Chapter 1. Industry changes will carry strategic significance if they promise to affect the underlying sources of the five competitive forces; otherwise changes are important only in a tactical sense. The simplest approach to analyzing evolution is to ask the following question: Are there any changes occurring in the industry that will affect each element of structure? For example, do any of the industry trends imply an increase or decrease in mobility barriers? An increase or decrease in the relative power of buyers or suppliers? If this question is asked in a disciplined way for each competitive force and the economic causes underlying it, a profile of the significant issues in the evolution of an industry will result.

Although this industry-specific approach is the place to start, it may not be sufficient, because it is not always clear what industry changes are occurring currently, much less which changes might occur in the future. Given the importance of being able to predict evolution, it is desirable to have some analytical techniques which will aid in anticipating the pattern of industry changes that we might expect to occur.

PRODUCT LIFE CYCLE

The grandfather of concepts for predicting the probable course of industry evolution is the familiar product life cycle. The hypothesis is that an industry’ passes through a number of phases or stages – introduction, growth, maturity, These stages are defined by inflection points in the rate of growth of industry sales. Industry growth follows an S-shaped curve because of the process of innovation and diffusion of a new product. 2 The flat introductory phase of industry growth reflects the difficulty of overcoming buyer inertia and stimulating trials of the new product. Rapid growth occurs as many buyers rush into the market once the product has proven itself successful. Penetration of the product’s potential buyers is eventually reached, causing the rapid growth to stop and to level off to the underlying rate of growth of the relevant buyer group. Finally, growth will eventually taper off as new substitute products appear.

As the industry goes through its life cycle, the nature of competition will shift. The most common predictions about how an industry will change over the life cycle and how this should affect strategy.

The product life cycle has attracted some legitimate criticism:

1. The duration of the stages varies widely from industry to industry, and it is often not clear what stage of the life cycle an industry is in. This problem diminishes the usefulness of the concept as a planning tool.

2. Industry growth does not always go through the S-shaped pattern at all. Sometimes industries skip maturity, passing straight from growth to decline. Sometimes industry growth revitalizes after a period of decline, as has occurred in the motorcycle and bicycle industries and recently in the radio broadcasting industry. Some industries seem to skip the slow takeoff of the introductory phase altogether.

3. Companies can affect the shape of the growth curve through product innovation and repositioning, extending it in a variety of ways.3 If a company takes the life cycle as given, it becomes an undesirable self-fulfilling prophesy.

4. The nature of competition associated with each stage of the life cycle is different for different industries. For example, some industries start out highly concentrated and stay that way. Others, like bank cash dispensers, are concentrated for a significant period and then become less so. Still others begin highly fragmented; of these some consolidate (automobiles) and some do not (electronic component distribution). The same divergent patterns apply to advertising, R&D expenditures, degree of price competition, and most other industry characteristics. Divergent patterns such as these call into serious question the strategic implications ascribed to the life cycle.

The real problem with the product life cycle as a predictor of industry evolution is that it attempts to describe one pattern of evolution that will invariably occur. And except for the industry growth rate, there is little or no underlying rationale for why the competitive

changes associated with the life cycle will happen. Since actual industry evolution takes so many different paths, the life cycle pattern

does not always hold, even if it is a common or even the most common pattern of evolution. Nothing in the concept allows us to predict when it will hold and when it will not.

A FRAMEWORK FOR FORECASTING EVOLUTION

instead of attempting to describe industry evolution, it will prove more fruitful to look underneath the process to see what really drives it. Like any evolution, industries evolve because some forces are in motion that create incentives or pressures for change. These can be called evolutionary processes.

Every industry begins with an initial structure – the entry bar- riers, buyer and supplier power, and so on which exist when the industry comes into existence. This structure is usually (though not always) a far cry from the configuration the industry will take later in its development. The initial structure results from a combination of underlying economic and technical characteristics of the industry, the initial constraints of small industry size, and the skills and resources of the companies that are early entrants. For example, even an industry like automobiles with enormous possibilities for economies of scale started out with labor-intensive, job-shop production operations because of the small volumes of cars produced during the early years.

The evolutionary processes work to push the industry toward its potential structure, which is rarely known completely as an industry evolves. Imbedded in the underlying technology, product characteristics, and nature of present and potential buyers, however, there is a range of structures the industry might possibly achieve, depending on the direction and success of research and development, marketing innovations, and the like.

It is important to realize that instrumental in much industry evolution are the investment decisions by both existing firms in the industry and new entrants. In response to pressures or incentives created by the evolutionary process, firms invest to take advantage of possibilities for new marketing approaches, new manufacturing facilities, and the like, which shift entry barriers, alter relative power against suppliers and buyers, and so on. The luck, skills, resources, and orientation of firms in the industry can shape the evolutionary path the industry will actually take. Despite potential for structural change, an industry may not actually change because no firm happens to discover a feasible new marketing approach; or potential scale economies may go unrealized because no firm possesses the financial resources to construct a fully integrated facility or simply because no firm is inclined to think about costs. Because innovation, technological developments, and the identities (and resources) of the particular firms either in the industry or considering entry into it are so important to evolution, industry evolution will not only be hard to forecast with certainty but also an industry can potentially evolve in a variety of ways at a variety of different speeds, depending on the luck of the draw.

Date Published: Feb 10, 2011 - 6:10 pm

The Strategic Group Map as an Analytical Tool

The Strategic Group Map as an Analytical Tool

We are now in a position to return to a discussion of the strategic group map as an analytical tool. The map is a very useful way to graphically display competition in an industry and to see how industry changes or how trends might affect it. It is a map of “strategy space,” instead of price and volume.

In mapping strategic groups, the few strategic variables used as axes of the map must be selected by the analyst. In doing so, a number of principles will prove useful. First, the best strategic variables to use as axes are those that determine the key mobility barriers in the industry. For example, in soft drinks the key barriers are brand identification and distribution channels, which thus serve as useful axes in a strategic group map. Second, in mapping groups it is important to select as axes variables that do not move together. For example, if all the firms with high product differentiation also have broad product lines, then both these variables should not serve as axes on the map. Rather, variables that reflect the diversity of strata

gig combinations in the industry should be selected. Third, the axes for a map need not be continuous or monotonic variables. For example, the target channels in the chain saw industry are servicing dealers, mass merchandisers, and sellers of private labels. Some firms focus on one of these, whereas some attempt to span the range. Servicing dealers are most distinct from private label in terms of required strategy, and mass merchandisers are somewhere in between. In mapping the industry, it is perhaps most illuminating to array firms as shown in Figure 7-3. Firms are located to reflect their mix of channels. A final principle is that an industry can be mapped several times, using various combinations of strategic dimensions, to help the analyst see the key competitive issues. Mapping is a tool to help diagnose competitive relationships, and there is no necessarily right approach.

Having constructed a strategic group map of an industry, a number of analytical steps can be illuminating:

Identifying Mobility Barriers. The mobility barriers that protect each group from attacks from other groups can be identified. For example, the key barriers protecting the high quality/dealer-oriented group in Figure 7-3 are technology, brand image, and an established network of servicing dealers. The key barriers protecting the private label group, on the other hand, are economies of scale, experience, and to some extent relationships with private label customers. Such an exercise can be very illuminating in predicting threats to the various groups and probable shifts in position among firms.

Identifying Marginal Groups. A structural analysis like that described earlier in this chapter can identify groups whose position is tenuous or marginal. These are candidates for exit or for attempts at moving into another group.

Charting Directions of Strategic Movement. A very important use of the strategic group map is to chart the directions in which firms’ strategies are moving and might shift from an industry-wide point of view. This task is most easily done by drawing arrows emanating from each strategic group that represent the direction in which the group (or a firm in the group) seems to be moving in strategic space, if any. Doing this for all groups might show that firms are moving apart strategically, which can be stabilizing to industry competition, particularly if it involves increasing separation of the target market segments served. Or such an exercise might show that strategic positions are converging, which can be very volatile.

Analyzing Trends. It can be illuminating to think through the implications of each industry trend for the strategic group map. Is the trend closing off the viability of some groups? Where will firms in that group shift? Is the trend elevating the barriers held by some groups? Will the trend reduce the ability of groups to separate them selves along some dimension? All these factors can lead to predictions about industry evolution.

Predicting Reactions. The map can be used to predict reactions of the industry to an event. Firms in a group tend to react symmetrically to disturbances or trends given the similarity of their strategies.

Date Published: Feb 10, 2011 - 6:09 pm

Implications for Formulation of Strategy

Implications for Formulation of Strategy

Formulating competitive strategy in an industry can be viewed as the choice of which strategic group to compete in. This choice may involve selecting the existing group that involves the best tradeoff between profit potential and the firm’s costs of entering it, or it may involve the creation of an entirely new strategic group. Structural analysis within an industry points to the factors that will determine the success of a particular strategic positioning for the firm.

As described in the Introduction, the broadest guidance for the formulation of strategy is stated in terms of matching a firm’s strengths and weaknesses, particularly its distinctive competence, to the opportunities and risk in its environment. The principles of structural analysis within an industry allow us to be much more concrete and specific about just what a firm’s strengths, weaknesses, distinctive competence, and industry opportunities and risks are. A firm’s strengths and weaknesses can be listed as follows:

Strengths

• factors that build the mobility barriers protecting its strategic group;

• factors enhancing the bargaining power of its group vis buyers and suppliers;

• factors insulating its group from rivalry from other firms;

• greater scale relative to its strategic group;

• factors allowing lower costs of entry into its strategic group than others;

• strong implementation abilities vis- its strategy relative to its competitors;

• resources and skills allowing the firm to overcome mobility barriers and move into even more desirable strategic

Weaknesses

• factors that lower the mobility barriers protecting its strategic group;

• factors worsening the bargaining power of its group vis-a-vis buyers and suppliers;

• factors exposing its group to rivalry from other firms;

• smaller scale relative to its strategic group;

• factors causing higher costs of entry into its strategic group than others;

• weaker implementation abilities vis-a-vis its strategy relative to its competitors;

• the lack of resources and skills that would allow the firm to overcome mobility barriers and move into more desirable strategic groups.

If the key mobility barriers into a firm’s strategic group are based, for example, on its broad product line, proprietary technology, or absolute cost advantages due to experience, these sources of mobility barriers define some of the firm’s key strengths. Or if the most desirable strategic group in the firm’s industry is protected by mobility barriers resting on the achievement of economies of scale through a captive distribution and service organization, the lack of such a factor becomes one of the firm’s key weaknesses. Structural analysis gives us a framework for systematically identifying a firm’s key strengths and weaknesses relative to competitors. These strengths and weaknesses are not cast in concrete but can change as industry evolution realigns the relative position of strategic groups or as firms innovate or make investments to change their structural position.

This framework for viewing strengths and weaknesses illuminates two fundamentally different types: structural and implementation. Structural strengths and weaknesses rest on the underlying characteristics of industry structure, such as mobility barriers, determinants of relative bargaining power, and so on. As such they are relatively stable and difficult to overcome. Strengths and weaknesses in implementation, based on differences in a firm’s ability to execute strategies, rest on people and managerial abilities. As such, they may be more ephemeral, though not necessarily. In any case, it is important to make a distinction between the two in analysis of strategy.

The strategic opportunities facing the firm in its industry can also be made more concrete by using these concepts. Opportunities can be divided into a number of categories:

• create a new strategic group;

• shift to a more favorably situated strategic group;

• strengthen the structural position of the existing group or the firm’s position in the group;

• shift to a new group and strengthen that group’s structural position.

Perhaps the class of opportunities with the highest payoff is in creating a new strategic group. Technological changes or evolution in the structure of the industry often open up possibilities for entirely new strategic groups. Even without such stimuli, the visionary firm might be able to perceive a new, favorably situated strategic group not perceived by its competitors. American Motors, for example, identified a uniquely positioned compact car in the mid-1950s, for a time overcoming serious disadvantages vis- the Big Three. Timex created a new conception of a low-price, reliable watch, coupling new manufacturing techniques with a new distribution and marketing approach. More recently, Hanes created an entirely new group in hosiery with its L’eggs strategy. Although vision is a scarce commodity, structural analysis can help direct thinking toward the areas of change that would yield the highest payoff.

Another class of potential strategic opportunity is represented by the more favorably situated strategic groups in the industry that the firm might choose to enter.

A third type of strategic opportunity is the possibility for the firm to make investments or adjustments that improve the structural position of its existing strategic group or its position within the group, for example, increase mobility barriers, improve position vis substitute products, strengthen marketing ability, and so on. It is also possible to view such investments and adjustments as creating a new and better strategic group.

A final type of strategic opportunity is that of entering other strategic groups and increasing their mobility barriers or otherwise improving their position. Structural evolution in an industry is a powerful creator of possibilities to make this change as well as to improve the firm’s position in its existing group.

The risks facing a firm can be identified by using the same basic concepts:

• risks of other firms entering its strategic group;

• risks of factors reducing the mobility barriers of the firm’s strategic group, lowering power with customers or suppliers, worsening position relative to substitute products, or exposing it to greater rivalry;

• risks that accompany investments designed to improve the firm’s position by increasing mobility barriers;

• risks of attempting to overcome mobility barriers into more desirable strategic groups or entirely new groups.

The first two can be viewed as threats to the firm’s existing position, or risks of inaction, whereas the latter are risks of pursuing opportunities.

The firm’s choice of strategies, or which strategic group to compete in, is a process of relating all these factors. Many, if not most, major strategic breakthroughs come about because of changing structure. Structural analysis shows how a firm’s existing strategic position coupled with existing industry structure translates into per- furnace in the marketplace. If industry structure is unchanging, then the cost of overcoming mobility barriers to move to another strategic group already occupied by other firms may well eliminate the benefits. However, if the firm can perceive an entirely new strategic position that is favorable structurally, or if it can change its position at a time when industry evolution lowers the cost of shifting, then a truly significant improvement in performance can result. The framework identified here should illuminate what to look for in such a repositioning.

The three generic strategies identified in Chapter 2 represent three broad and consistent approaches to successful strategic positioning. In the context of this chapter, they are different broad types of strategic groups that can be successful depending on the economics of the particular industry. This chapter has added a lot more flesh and blood to the analysis of the generic strategies. It is clear, based on this chapter, that the generic strategies rest on creating (in different ways) mobility barriers; favorable position with buyers, suppliers, and substitutes; and insulation from rivalry. Our extended concept of structural analysis, then, is a way of making the notion of generic strategies clearer and more operational.

Date Published: Feb 10, 2011 - 6:08 pm

Strategic Groups and a Firm’s Profitability

Strategic Groups and a Firm’s Profitability

We have seen that differing strategic groups can have varying situations with respect to each and every competitive force acting on an industry. We are now in a position to answer the question posed earlier; namely, what factors determine the market power and hence profit potential of individual firms in an industry, and how do these factors relate to their strategic choices?

Building on the concepts already presented, the underlying determinants of a firm’s profitability are as follows:

Coition INDUSTRY CHARACTERISTICS

1. Industry-wide elements of structure that determine the strength of the five competitive forces and that apply equally to all firms; these traits include such factors as the rate of growth of industry demand, overall potential for product differentiation, structure of supplier industries, aspects of technology, and so on, that set the overall context of competition for all firms in the industry.

CHARACTERISTICS OF STRATEGIC GROUP

2. The height of mobility barriers protecting the firm’s strategic group.

3. The bargaining power of the firm’s strategic group with customers and suppliers.

4. The vulnerability of the firm’s strategic group to substitute products.

5. The exposure of the firm’s strategic group to rivalry from other groups.

FiRM’S PosiTioN WITHIN ITS STRATEGIC GROUP

6. The degree of competition within the strategic group.

7. The scale of the firm relative to others in its group.

8. Costsofentryintothegroup.

9. The ability of the firm to execute or implement its chosen strategy in an operational sense.

Industry-wide characteristics of market structure raise or lower profit potential for all firms in the industry, but not all strategies in the industry have equal profit potential. The higher the mobility barriers protecting the strategic group, the stronger the group’s bargaining position with suppliers and customers, the lower the group’s vulnerability to substitute products, and the less exposed the group is to rivalry from other groups, the higher the average profit potential of firms in that group will be. Thus a second critical set of determinants of a firm’s success is the position of its strategic group in the industry, which has been amplified in earlier sections.

The third category of determinants of a firm’s position, which has not been discussed so far, is where the firm stands within its strategic group. A number of factors are crucial to this standing. First, the degree of competition within the group is important because firms in the group may compete away potential profits among themselves. This effect is more likely to occur if there are many firms in the strategic group.

Second, all firms following the same strategy are not necessarily equally positioned from a structural standpoint. Specifically, a firm’s structural position may be affected by its scale relative to others in its strategic group. If there are any economies of scale operating that are large enough so that costs are still declining in the range of market shares held by firms in the group, then the firms that have relatively small shares will have lower profit potential. For example, although Ford and GM have relatively similar strategies and could be classified in the same strategic group, GM’s greater scale allows it to reap some of the economies inherent in the strategy that Ford cannot, such as in research and development and model changeover costs. Firms like Ford have overcome scale-related mobility barriers and gotten into the strategic group, but they still face some cost disadvantages relative to a larger firm in the group.

The firm’s position in its strategic group also depends on its cost of entering the group. The skills and resources available to the firm in entering a group may give it an advantage or disadvantage relative to others in the group. Some of these skills or resources for entry are based on the firm’s position in other industries or its previous success in other strategic groups in the same industry. For example, John Deere could get into almost any strategic group in the construction equipment industry more cheaply than most firms because of its strong position in farm equipment. Or Procter and Gamble’s Char-

mm could enter the national brand toilet tissue group more cheaply because of the combination of Charmin’s past technological accomplishments coupled with Procter and Gamble’s distribution strength.

The costs of entry into a group can be affected by the firm’s timing of entry into it. In some industries it may be more expensive for late entrants into a strategic group to establish their position (e.g., higher cost of establishing an equivalent brand name; higher cost of finding good distribution channels because of foreclosure of channels by other firms). Or the situation may be reversed if newer entrants can purchase the latest equipment or use new technology. Differences in timing of entry may also translate into differences in cumulative experience and hence costs. Thus differences in timing of entry may translate into differences in sustainable profitability among members of the same strategic group.

The final factor entering into the analysis of a firm’s position in its strategic group is its implementation ability. Not all firms pursuing the same strategy (thus in the same strategic group) will necessarily be equally profitable even if the other conditions that have been described are identical. Some firms are superior in their ability to organize and manage operations, develop creative advertising themes with equal budgets, make technological breakthroughs with the same expenditures on R&D, and so on. These sorts of skills are not structural advantages of the sort created by mobility barriers and the other factors discussed above, but they may well be relatively stable advantages. The firms that have superior implementation ability will be more profitable than other firms in the strategic group.

This cascading array of factors jointly determine the profit prospects of the individual firm, and at the same time, its prospects for market share. The firm will be most profitable if it is in a favorable industry, a favorable strategic group within that industry, and has a strong position in its group. New entrants do not eliminate the attractiveness of the industry because of entry barriers; the attractiveness of a strategic group is preserved by mobility barriers. The strength of a firm’s position in its group is the result of its history and the skills and resources available to it.

This analysis makes it clear that there are many different kinds of potentially profitable strategies. Successful strategies can be based on a wide variety of mobility barriers or approaches to dealing with the competitive forces. The three generic strategies described in Chapter 2 represent the broadest difference in approach; many van-

actions of these are possible. Much stress has recently been placed on cost position as the determinant of strategic position. Although cost is one approach to developing barriers, it should be clear that there are many others.

In view of the interacting nature of the considerations determining firm profitability, the profit potential of a firm is strongly affected by the competitive outcome in those strategic groups that are market interdependent and have higher mobility barriers. The strategic groups with higher mobility barriers have greater profit potential than the less protected groups if competition within them is not too great. However, if competition within them is fierce for some reason and their prices and profits are thereby lowered, it can also destroy the profitability of the firms in the interdependent groups less protected by mobility barriers. Lower prices (or higher costs through advertising and other forms of non-price competition) spill over via market interdependence so that less protected groups must respond, driving down their own profits. This is a risk that must be assessed in choosing a strategic group.

A good example of this process is seen in the soft drink industry. If Coke and Pepsi get into a price war or advertising battle, their profits are diminished, but not nearly so much as those of the regional and local brands who inevitably are affected because their producers are competing for the same customers. Competition among Coke, Pepsi, and the other major brands, protected by substantial mobility barriers, lowers the profit umbrella over the regional and local brands. They tend to lose not only profits but relative share.

ARE LARGE FIRMS MORE PROFITABLE THAN

SMALL FIRMS?

There has been much recent discussion about strategy arguing that the firm with the largest market share will be the most profitable. 6 The previous analysis suggests that whether this is true or not depends on the circumstances. If large firms in an industry compete in strategic groups that are more protected by mobility barriers than smaller firms, in stronger positions relative to customers and suppliers, more insulated from rivalry with other groups, and so on, then the large firms will indeed be more profitable than smaller firms. For example, in industries like brewing and the manufacture of toiletries and television sets, where there are substantial economies of scale in manufacturing, distributing, and servicing a full product line as well as economies of scale in national advertising, then the large firms in the industry will probably be more profitable than smaller firms. On the other hand, if economies of scale in production, distribution, or other functions are not too great, smaller firms following specialist strategies may be able to achieve higher product differentiation or greater technological progressiveness or superior service in their particular product niches than larger firms. In such industries, smaller firms may well be more profitable than larger, broader-line firms (as in women’s clothing and carpets).

It is sometimes argued that if firms with small shares are more profitable than those with large shares, it reflects a mistake in industry definition. Proponents of the dominant role of market share argue that we should define the market more narrowly, in which case “small” firms will indeed have a larger share of a specialized segment than does a broad-line firm. But if we use a narrow market definition, we should also define the market narrowly in industries where broad-line firms happen to be the most profitable. In such cases we would often find that large firms did not necessarily have the highest share of every segment but yet reaped advantages of overall scale. Ascribing the higher profits of specialized, small-share firms to specialized market definition begs the question we are seeking to answer; namely, under what industry circumstances can a firm select a specialist strategy (to take just one strategic option) without being vulnerable to economies of scale or product differentiation achieved by broader-line firms? Or under what circumstances is overall share in the industry unimportant? The answer will differ by industry, depending on the array of mobility barriers and the other structural and firm-specific features that I have outlined.

Empirical evidence suggests that the relationship between the profitability of larger share and smaller share depends on the industry. Exhibit 7-1 compares the rate of return on equity of the largest firms accounting for at least 30 percent of industry sales (leaders) to the rate of return on equity of the medium-sized firms in the same industry (followers). In this calculation small firms with assets less than dollarsignr500,000 were excluded. Although some of the industries in the sample are overly broad, it is striking that followers were noticeably.

Date Published: Feb 10, 2011 - 6:08 pm

STRATEGIC GROUPS AND RIVALRY AMONG FIRMS

The presence of more than one strategic group in an industry has implications for industry rivalry, or competition in price, advertising, service, and other variables. Some of the structural features that determine the strength of competitive rivalry (Chapter 1. may apply to all firms in the industry and thus provide the context in which the strategic groups interact. Broadly speaking, however, the existence of multiple strategic groups usually means that the forces of competitive rivalry are not faced equally by all firms in the industry.

The first point to be made is that the presence of several strategic groups will often affect the overall level of rivalry in the industry. Their presence will generally increase rivalry because it implies greater diversity or asymmetry among firms in the industry in the sense defined in Chapter 1. Differences in strategy and external circumstances mean that firms will have differing preferences about risk taking, time horizon, price levels, quality levels, and so on.

These differences will complicate the process of firms understanding each others’ intentions and reacting to them, and will thus increase the likelihood of repeated outbreaks of warfare. The industry with a complicated map of strategic groups will tend to be more competitive as a whole than one with few groups. Recent research has verified this point in a number of contexts.5

Not all differences in strategy are equally significant in affecting industry rivalry, however, and the process of competitive rivalry is not symmetrical. Some firms are more exposed to damaging price cutting and other forms of rivalry from other strategic groups than others. Four factors determine how strongly the strategic groups in

an industry will interact in competing for customers:

• the market interdependence among groups, or the extent to which their customer targets overlap;

• the product differentiation achieved by the groups;

• the number of strategic groups and their relative sizes;

• the strategic distance among groups, or the extent to which strategies diverge.

The most important influence on rivalry among strategic groups is their market interdependence, or the degree to which different strategic groups are competing for the same customers or competing for customers in distinctly different market segments. When strategic groups have high market interdependence, differences in strategy will lead to the most vigorous rivalry, for example, in fertilizer where the customer (the farmer) is the same for all groups. When strategic groups are targeting very different segments, their interest in and effect on each other is much less severe. As the customers they are selling to become more distinguished, the rivalry becomes more (but not the same) as if the groups were in different industries.

The second key factor influencing rivalry is the degree of product differentiation created by the groups’ strategies. If divergent strategies lead to distinct and differing brand preferences by customers, then rivalry among the groups will tend to be much less than if the product offerings are seen as interchangeable.

The more numerous and more equal in size (market share) the strategic groups, the more their strategic asymmetry generally increases competitive rivalry, other things being equal. Numerous groups imply great diversity and a high probability that one group will trigger an outbreak of warfare by attacking the position of other groups through price cutting or other tactics. Conversely, if groups are greatly unequal in size – for example, one strategic group constitutes a small share of an industry and another is a very large share – their strategic differences are likely to have little impact on the way they compete with each other, since the power of the small group to affect the large groups through competitive tactics is probably low.

The final factor, strategic distance, refers to the degree to which strategies in different groups diverge in terms of the key variables, such as brand identification, cost position, and technological leadership, as well as in external circumstances, such as relationships to parents or governments. The more the strategic distance among groups, other things being equal, the more vigorous competitive

skirmishing is likely to be among the firms. Firms pursuing widely different strategic approaches tend to have quite different ideas about how to compete and a difficult time understanding each others’ behavior and avoiding mistaken reactions and outbreaks of warfare. In ammonium fertilizer, as an instance, oil company participants, chemical company participants, cooperatives, and independents all have very different objectives and constraints. For example, tax benefits and unusual motives have led cooperatives to expand even when overall industry conditions were poor. Oil companies did the same thing for different reasons in the 1960s.

All four factors interrelate to determine the pattern of rivalry for customers among strategic groups in an industry. For example, the most volatile situation, likely to be associated with intense competition, is the one in which several equally balanced strategic groups, each following markedly different strategies, are competing for the same basic customer. Conversely, a situation likely to be more stable (and profitable) is one in which there are only a few large strategic groups that each compete for distinct customer segments with strategies that do not differ except along a few dimensions.

A particular strategic group will face rivalry from other groups based on the factors just discussed. It will be most exposed to bouts of rivalry from the other strategic groups that share market interdependence. The volatility of this rivalry will depend on the other conditions identified above. A particular group will be most exposed to rivalry from other strategic groups, for example, if they compete for the same market segments with products perceived as similar, are relatively equal in size, and follow quite different strategic approaches for getting the product to market (have high strategic distance). Achieving stability will be extremely difficult for such a strategic group, and outbreaks of aggressive warfare are likely to insure a very competitive outcome for it. However, a strategic group that has a large collective share and/or targets its efforts to distinct market segments not served by other strategic groups and achieves high product differentiation is likely to be more insulated from intergroup rivalry. The secure strategic groups that are the most insulated from rivalry will only be able to maintain profitability, however, if mobility barriers protect them from shifts in strategic position by other firms.

Thus, strategic groups affect the pattern of rivalry within the industry. This process is illustrated schematically by the strategic group map shown in Figure 7-2, which is similar to Figure 7-1 except that the horizontal axis is the target customer segment of the strategic group in order to measure market interdependence. The vertical axis is another key dimension of strategy in the industry. The lettered symbols are strategic groups, their size proportional to the collective market share of firms in the group. The shape of the groups is used to represent their overall strategic configuration, with differences in shape representing strategic distance. Applying the analysis presented earlier, it is clear that Group D will be much less affected by industry rivalry than Group A. Group A competes with similarly large Groups B and C, who use very different strategies to reach the same basic customer segment. Firms in these three groups are in constant warfare. Group D, on the other hand, competes for a different segment and interacts most strongly in reaching this segment with Groups F and F, who are smaller and follow similar strategies (they could be viewed as “specialist” producers following the “round” strategy or close variants to it).

The fifth step in structural analysis within an industry, then, is to assess the pattern of market interdependence among strategic groups and their vulnerability to warfare initiated by other groups.

Date Published: Feb 10, 2011 - 6:07 pm

STRATEGIC GROUPS AND THE THREAT OF SUBSTITUTES

Strategic groups may also face differing levels of exposure to competition from substitute products if they are focusing on different parts of the product line, serving different customers, operating at different levels of quality or technological sophistication, have different cost positions, and so on. Such differences may make them more or less vulnerable to substitutes even though the strategic groups are all in the same industry.

For example, a minicomputer firm focusing on business customers, selling machines complete with software to perform a wide variety of functions, will be less vulnerable to substitution from microcomputers than a firm primarily selling to industrial buyers for repetitive process-control applications. Or a mining company with a low-cost ore source may be less vulnerable to a substitute material

whose advantage is solely based on price than a mining company with a high-cost ore source that has based its strategy on a high level of customer service.

Therefore, the fourth step in structural analysis within an industry is to assess the relative position of each strategic group substitute products.

Date Published: Feb 10, 2011 - 6:06 pm

STRATEGIC GROUPS AND BARGAINING POWER

STRATEGIC GROUPS AND BARGAINING POWER

Just as different strategic groups are protected by differing mobility barriers, they enjoy differing degrees of bargaining power with suppliers or customers. If we examine the factors leading to the presence or absence of bargaining power discussed in Chapter 1, it is apparent that they relate to some extent to the strategy adopted by the particular firm. For example, concerning bargaining power with buyers, Hewlett-Packard (HP) is in a strategic group in electronic calculators emphasizing high quality and technological leadership and focusing on the sophisticated user. Although such a strategy may limit HP’s potential market share, it does expose it to less price- sensitive and less powerful buyers than the firms competing with essentially standardized products in the mass market, where buyers have little need for sophisticated product features. Relating this example to the terminology of Chapter 1, HP’s products are more differentiated than those of the mass market competitors, its buyers are more quality-oriented, and the cost of the calculator is smaller relative to the buyers’ budgets and to the value of the service they want it to perform. An example where different strategic groups have differing bargaining power with suppliers is the much greater volume of purchases and threat of backward integration that large, broad-line, national department store chains like Sears have as bargaining levers with suppliers relative to local, single-unit department stores.

Strategic groups will have differing amounts of power vis-à-vis suppliers and buyers for two categories of reasons, both illustrated in the examples above: Their strategies may yield them differing degrees of vulnerability to common suppliers or buyers; or their strategies may involve dealing with different suppliers or buyers with correspondingly different levels of bargaining power. The extent to which relative power can vary depends on the industry; in some industries all strategic groups could be in essentially the same position with respect to suppliers and buyers.

The third step in structural analysis within an industry, then, is to assess the relative bargaining power of each strategic group in the industry with its suppliers and buyers.

Date Published: Feb 10, 2011 - 6:05 pm

MOBILITY BARRIERS AND GROUP FORMATION

MOBILITY BARRIERS AND GROUP FORMATION

Strategic groups form and change in an industry for a variety of reasons. First, firms often begin with or later develop differences in skills or resources, and thus select different strategies. The well-situated firms outdistance others in the race toward the strategic groups protected by high mobility barriers as the industry develops. Second, firms differ in their goals or risk posture. Some firms may be more prone to making risky investments in building mobility barriers than others. Business units that differ in their relationship to a parent company (e.g., being vertically related, unrelated, or a free-standing firm) may differ in goals in ways that will lead to differences in strategy, as may international competitors with different situations in their other markets than domestic firms.

The historical development of an industry provides another explanation for why firms differ in their strategies. In some industries, being an early entrant provides access to strategies more costly to later entrants. Mobility barriers from scale economies, product differentiation, and other causes may also change, either as a result of firm’s investments or exogenous causes. Changing mobility barriers mean that early entrants into the industry may pursue very different strategies than later entrants, some of which may not be available to later entrants. The irreversibility of many forms of investment decisions sometimes precludes early entrants from adopting the strategies of the later entrants who have the advantages of hindsight.

A related point is that the process of historical evolution of an industry tends to lead to the self-selection of different types of entrants at different times. For example, later entrants into an industry may tend to be firms with increased financial resources who can afford to wait until some of the uncertainties in the industry are resolved. Firms with few resources, on the other hand, could have been compelled to enter early when capital costs of entry were low.

Changes in the structure of the industry can either facilitate the formation of new strategic groups or work to homogenize groups. For example, as an industry increases in total size, strategies involving vertical integration, captive distribution channels, and in-house servicing may become increasingly feasible for the aggressive firm, promoting the formation of new strategic groups. Similarly, technological changes or changes in buyers’ behavior can shift industry boundaries, bringing entirely new strategic groups into play.4 Conversely, maturity in an industry, which lessens the buyer’s desire for service capability or for the reassurance embodied in the manufacturer having a full product line, can work to reduce the mobility barriers that accrue to some strategic dimensions, leading to a reduction in the number of strategic groups. As a consequence of all these factors, we would expect to see the array of strategic groups and the distribution of profit rates of firms within an industry change over time.

Date Published: Feb 10, 2011 - 6:05 pm

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Summary: Analytical solution : You can find micromeritics analytical services and analytical hierarchy process

Key Relationships in Industry Evolution

Evolutionary Processes

Basic Concepts in Industry Evolution

The Strategic Group Map as an Analytical Tool

Implications for Formulation of Strategy

Strategic Groups and a Firm’s Profitability

STRATEGIC GROUPS AND RIVALRY AMONG FIRMS

STRATEGIC GROUPS AND THE THREAT OF SUBSTITUTES

STRATEGIC GROUPS AND BARGAINING POWER

MOBILITY BARRIERS AND GROUP FORMATION

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