When going international, pressures for local responsiveness imply that it is difficult for a firm to realize the full benefits from economies of scale, learning effects and location economies.
For example, Ford, Honda, Toyota pursue a strategy of establishing top to bottom design and production facilities in Japan, Europe, America.
Also, due to pressures for local responsiveness, it may not be possible to leverage skills and products associated with a firm’s core competencies from one nation to another.
For example, despite being labelled ‘poster child’, Mc Donalds customizes its product offerings to account for national differences in tastes and preferences.
In this case, when firms compete internationally, they can make us of four main strategies.
Global standardization strategy
Firms following this strategy focus on increasing profitability and profit growth by obtaining maximum benefits from the cost reductions that come from economies of scale, learning effects and location economies. In this case, their strategy is a low cost global one.
Firms that follow this strategy try to avoid customize their product offering and marketing strategy, to local conditions because customization involves shorter production runs and duplication of functions.
Firms following this type of strategy prefer to market a standardized product worldwide so that they can benefit the maximum benefits from economies of scale and learning effects.
This strategy is best when there are strong pressures for cost reductions and demands for local responsiveness are minimal. These conditions are there in markets where there are products that serve universal needs.
This strategy focuses on increasing profitability by customizing the firm’s goods or services. This is done in order to ensure that they provide a good match to tastes and preferences and cost pressures are not intense.
By doing this, the firm increases the value of that product in the local market. However, because it involves some duplication of functions and smaller production runs, customization limits the ability of the firm to capture the cost reductions associated with mass producing a standardized product for global consumption.
Researchers, Christopher Bartlett and Sumantra Ghoshal argue that in the present global environment, competitive conditions are very intense to survive.
Accordingly, firms must realize location economies and experience effects, leverage products internationally and transfer core competencies and skills within the company and pay attention to pressures for local responsiveness.
Thereby, a transnational strategy where low costs along with localization is to be adopted. However, adopting this strategy has become a major problem for most of today’s companies.
For example, Caterpillar redesigned its products to use many identical components. Also, they augment the centralized manufacturing of components with assembly plants in major global markets. At these plants, Caterpillar adds local product features.
Caterpillar started to pursue this strategy in the 1980s and it has been very successful.
This strategy is where products first produced in their domestic market are sold internationally with minimal customization. In this case, the firm is selling a product which serves universal needs.
These firms tend to centralize product development functions at home but tend to establish manufacturing and marketing functions in each major country or geographic region in which they do business.
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Those distinctive Santa Claus pot bellies that make guys look a little bit like they’re pregnant, are not caused by beer alone. Scientists from NYU and UC say, it’s a myth, there’s nothing special or magical about beer that causes a special beer gut. Alcohol is alcohol and your body can’t tell the difference whether it’s beer, wine or hard alcohol.
The reason why some beer drinkers get a beer belly comes down to a few other factors. First, the serving size of a beer is 12 to 16 ounces. A glass of wine is 5 to 6 ounces and a shot is only 1 to 2 ounces.
So beer is often consumed in higher quantities than other types of alcohol and so you’re consuming more calories. There are also lifestyle factors at play like poor diet. You often see beer served alongside foods like sausages, hamburgers and pizza. A very poor diet with or without beer can alone cause the pot belly and you’re even more prone if you’re over 35 and or if you’re male.
After 35 years, metabolism slows down. You can’t eat as much as you used to. This sounds terrible and this is why some older folks put on weight. They don’t react to their slower metabolism.
You also don’t really see pop buildings in women and that’s because women tend to store fat in their hips, their thighs and their booties instead of their waist. But, if you’ve ever encountered an authentic belly; so big and round that you can rest a drink on it, you know there’s something a little different going on there.
It’s not squishy or jiggly. It’s kind of hard like you could pop it and you can’t just pinch the fat. There are two reasons for this. If they’re an extreme alcoholic, they could have ascites which is fluid retention usually caused by liver disease.
For most, beer bellies is because of visceral fat. This is a fat that lives not right under the skin like that squishy subcutaneous fat packed deeper in the body around the organs. It feels hard because it pushes against your abdominal muscles.
Visceral fat is higher risk health-wise because it can cause insulin resistance diabetes, high blood pressure, heart disease. Subcutaneous fat is generally less worrisome and everyone needs at least a little to cushion their nerves, blood vessels, your skeleton and to regulate body temperature.
Take sumo wrestlers as an example. These guys look really fat. They eat a ton of food but they’re healthier than others who look just like them. The wrestlers don’t have insulin resistance, heart disease or diabetes and it’s because they have a lot of subcutaneous fat and very little of that beer belly visceral fat.
In 2007, German scientists at the University of Leipzig, successfully isolated three genes that process body fat. When they looked at an individual’s gene expression, they could correctly predict if they would store more visceral fat or subcutaneous fat. This is why someone’s weight is an imperfect measure of their overall health and it’s also why the last beer belly contributor is genetics.
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Firms that are involved in the global competition, typically face two types of competitive pressures. These affect their ability to realize location economies and experience effects, to leverage products and transfer competencies and skills within the enterprise.
Pressures for cost reductions
In order to respond to this type of pressure, a firm should try to lower the costs of value creation.
For example, a manufacturer might produce in large quantities a standardized product at an optimal location in the world. Or, a firm might outsource certain functions to low-cost foreign suppliers in order to reduce costs.
This pressure can be intense in some industries. For example in commodity type products industries, where meaningful differentiation on non-price factors is difficult and price is the main competitive weapon. This is specially the case for products that serve universal needs. Universal needs exist when the tastes and preferences of consumers in different nations are similar.
Competition is also high in industries where major competitors are based in low-cost locations. This is when there is persistent excess capacity and consumers are powerful with low switching costs.
This type of pressure has increased with the liberalization of the world trade and investment environment in recent decades.
Pressures to be locally responsive
Pressures for local responsiveness mainly arise from national differences in consumer tastes and preferences, infrastructure, accepted business practices and distribution channels and host-government demands.
Responding to this type of pressure mainly requires differentiating its products and marketing strategy from one country to another. In this case, businesses have to consider various types of differences.
Differences in consumers tastes and preferences
In this case, a firm’s products and marketing message must be customized to appeal to the tastes and preferences of local customers. This creates pressure to delegate production and marketing responsibilities to overseas subsidiaries.
A good case to understand this is the automobile industry in the 1990s. This industry moved towards the creation of “world cars”. In this what was expected was that global companies such as General Motors, Ford, Toyota will be able to sell the same basic vehicle over the world.
If successful, this strategy would have enabled automobile companies to reap significant gains from global scale economies. However, this strategy ran aground on the hard rocks of consumer reality.
For example, North American consumers show a strong demand for pickup trucks. But, European consumers purchase pickup trucks as utility vehicles and mainly only firms purchase them in Europe. Thereby, the product mix and marketing message needs to be tailored to consider the different nature of demand in North America and Europe.
However, some people argue that standardized consumer products are on the rise citing examples like Subway sandwiches, Mc Donald’s hamburgers, Coca Cola, Gap clothes, Apple iPhones and Micorosft’s Xbox.
Differences in Infrastructure and Traditional Practices
In order to fulfill this need, delegation of manufacturing and production functions to foreign subsidiaries could become necessary.
For example, in North America, consumer electrical systems are based on 110 volts whereas, in some European countries, 240 volt systems are standard. Hence, domestic electric appliances have to be customized for this difference in infrastructure.
Another example is the wireless telecommunications industry. A technical standard known as GSM is common in Europe while CDMA is more common in US and Asia. So, equipment developed for GSM will not work on CDMA network. Therefore, companies such as Nokia, Motorola, Samsung which manufacture wireless handsets and infrastructure such as switches, need to customize their product according to the technical standard prevailing in a given country.
Differences in distribution channels
This may make it necessary to delegate marketing functions to national subsidiaries.
For example, British and Japanese doctors will not accept or respond favorably to a U.S. style high pressure sales force. Therefore, pharmaceutical companies have to adopt different marketing practices in Britain and Japan compared with U.S. That is, soft sell vs hard sell.
Host Government Demands
For example, pharmaceutical companies are subject to local clinical testing, registration procedures and pricing restrictions.
Rise of regionalism
For example, the creation of EU market with a single currency, common business regulations, standard infrastructure results in the reduction of national differences among countries within the EU. Also, North America which includes US, Canada and Mexico.
If products can be standardized within a region, greater economies of scale can be achieved. Therefore, managers must make a judgement call about the appropriate level of aggregation given.
- the product market they are looking at
- nature of national differences and trends for regional convergence
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Firms that operate internationally are able to benefit a lot.Leveraging products and competencies.
Leveraging products and competencies
For example, Procter and Gamble developed most of its best selling products like Pampers, disposable diapers and Ivory soap in the U.S. and then sold them around the world.
Another example is Microsoft which developed its software in the United States, which sells its software in the international market.
The returns from such a strategy are greater in countries where a company enters lack comparable products. For example, Toyota increased their profits by entering the large automobile markets of North America and Europe, offering products that were different from those offered by local rivals (Ford and GM), by their superior quality and reliability.
The success of most of the above businesses are based on their core competencies. These refer to skills within the firm, that competitors cannot easily match or imitate. Such core competencies usually reduce the costs of value creation.
For example, Toyota’s core competence is in the production of cars. Its ability to produce high quality, well designed cars at a lower cost is a benefit.
Since core competencies are the source of a firm’s competitive advantage, the successful global expansion by manufacturing companies like Toyota and P&G was based on leveraging products, selling them internationally and transferring core competencies to foreign markets.
For instance, Starbucks and IKEA were more successful overseas.
Location economies are the economies of scale that arise from performing a value creation activity in the optimal location for that activity. For example, value creation costs can be lowered or its products can be differentiated.
For example, Clear Vision Optical, a manufacturer and distributor of eye wear, now generates annual gross revenues of more than $100 million. Clear Vision is a multinational firm with production facilities on three continents and customers around the world. Initially starting from U.S they shifted to Hong Kong due to low labor costs, skilled workforce and tax breaks given by the Hong Kong government. Then in a few years they moved part of their production to China.
For example, Lenovo Think Pad is designed in the U.S. because Lenovo believes that U.S. is the best location to the basic design work. However, the case, keyboard and hard drive are made in Thailand, the display screen and memory are made in South Korea, built in wireless card in Malaysia and the microprocessor in U.S. Then, these components are shipped to an assembly operation in China, where the product is assembled before being shipped to the U.S for final sale. Also, the marketing and sales strategy for North America is developed by Lenovo personnel in the U.S. This is mainly because managers believe that due to their knowledge of the local market place, U.S. personnel add more value to the product through their marketing efforts than personnel based elsewhere. This concept is termed as creation of a global web.
However, transport costs and trade barriers complicate this picture. Due to favorable factor endowments, New Zealand may have a comparative advantage for automobile assembly operations. But, high transport costs makes it uneconomical to serve global markets.
The experience curve refers to systematic reductions in production costs that have been observed to occur over the life of a product. This can be explained in terms of learning effects and economies of scale.
Learning effects are cost savings that come from learning by doing. Learning effects will be very significant when a technologically complex task is repeated because there is more that can be learned about the task. This is important during the startup period of a new process and they cease after about three years.Any decline in the experience curve after such a point is due to economies of scale.
Economies of scale refer to reductions in unit cost achieve by producing a large volume of a product.
Moving down the experience curve allows a firm to reduce its cost of creating value and increase its profitability. Also, most experience based cost economies are plant based. Therefore, a key to going downwards on the experience curve is to increase the volume produced by single plant as soon as possible.
This is easily achievable because global markets serve a global market from a single location. Therefore, they are likely to build accumulated volume more quickly than a firm that serves only its home market.
Also, to get down the experience curve rapidly, a firm may need to price and market aggressively, so that the demand will expand rapidly. But, once a firm has established a low cost position, it can act as a barrier to new competition.
Leveraging subsidiary skills
Leveraging skills created within subsidiaries and applying them to other operations within the firm’s global network creates value.
For example, Mc Donalds in France has hardwood floors, exposed brick walls and armchairs. The menu also has been upgraded.
So, managers in a multi national entreprise must be able to recognize valuable skills that lead to competencies and establish an incentive system that encourages local employees to acquire new skills. This is risky at times.
To achieve this, the companies must reward people for successes and not sanction them unnecessarily. Also, managers of these companies must identify when valuable new skills have been created in a subsidiary.
Finally, the business has to act ad facilitators helping them to transfer valuable skills within the firm.
Thus, global expansion has several benefits which ultimately lead to better profits.
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According to Hill and Hult (2017), the operations of a firm can be considered as a value chain composed of a series of distinct value creation activities. This includes promotion, marketing and sales, materials management, R&D, human resources, information systems, etc.
These value chain activities can be categorized as primary and supporting activities. Primary activities have to do with the design, creation and delivery of the product. Generally, the primary activities can be divided into four functions; research and development, production, marketing and sales, customer service.
Considering on adding value to the product,
- R&D adds value through superior product design which can increase the functionality of products and production processes
- Production adds value to the product by performing its activities efficiently
- Marketing and sales create value through brand positioning and advertising. They also discover consumer needs and communicate them back to the R&D function of the company.
- For example, Ford produced a high value version of its Ford expedition SUV. Sold ad the Lincoln Navigator and priced around $10 000 higher, the Navigator has the same body, engine, chassis and design as the Expedition. Through high skilled advertising and marketing, with some minor feature changes, Ford has fostered the perception that the Navigator is a luxury SUV. This has enabled Navigator to be of higher price than the Expedition.
- Customer service adds value by providing after sales service and support.
- For example, Caterpillar, the U.S. based manufacturer of heavy earth moving equipment can get spare parts to any point int he world within 24 hours.This minimizes the amount of downtime its customers have to suffer if their Capital equipment malfunctions. This is an extremely valuable capability in an industry where downtime is very expensive. It helps to increase the value that customers associate with Caterpillar products and the price that Caterpillar can charge.
Support activities of the value chain provides inputs that allow the primary activities to occur. In order to obtain competitive advantage, support activities can be as important as primary activities.
For example, Dell has used its information system to attain competitive advantage over rivals. That is, when a customer places an order for a Dell product over the firm’s website, that information is immediately transmitted via the internet to suppliers who then configure their production schedules to produce and ship that product so that it arrives at the right assembly plant at the right time. Thereby, the amount of inventory that Dell holds in its factories has reduced into two days. This is a great cost saving.
Also, Dell’s logistics function goes hand in hand with its information system. That is, Dell’s information systems tells Dell on a real time basis where are the parts, when they will arrive at the assembly plant and how much production should be scheduled.
Thus, considering supporting activities in a value chain,
- Information systems adds value in terms of efficiency and effectiveness with which a firm can manage its other value creation activities.
- Logistics function controls the transmission of physical materials through the value chain, from procurement through production into distribution.
- Human resources function helps create value by ensuring that people are adequately trained, motivated and compensated to perform their value creation tasks.
- Finally, the infrastructure includes the organization structure, control systems and culture of the firm.
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Dogs are very sensitive animals which can easily perceive whether we are happy, sad or even just tired. Fortunately, they are also very loving creatures and their affection and company can come in very handy.
During these times, however often we humans are not as good at reciprocating the sensitivity. As with human beings, canines are susceptible to depression.
They may not be caused by the same issues. But, if we are aware of our dogs eventual behavior, we should be able to easily identify a bite of depression whether short or prolonged. However, if a dog has only recently been adopted into our family, it may be difficult to differentiate between their normal demeanor and depression.
The most recognizable symptoms include a lack of appetite, apathy, inactivity and a lack of affection towards their caregivers. We may also observe hiding, sleep excessively or an unwillingness to engage in play activity.
However, it is essential to point out that some of these signs may be present due to an underlying condition or dizziness. This is why it is so important to take them to a vet to rule out a physical health problem. Causes of depression and dogs are varied. But, they usually appear after a significant change to their routine.
A traumatic experience, hormonal changes or as we have said, disease determining this underlying cause is essential in solving the behavioral problem. The death of a loved one or the introduction of a new family member such as a baby are common causes of depression in dogs.
But, there are many possible issues at play. When depression generates a clinical picture which puts the dog’s health at risk, it will be essential to go to a veterinarian preferably one specialized in ethology. If they also show behavioral changes which involve aggression, going to professional dog trainer or educator will be essential.
The situation can worsen and become dangerous. If your dog is going through an episode of sadness or depression, do not hesitate to follow advice to improve their well-being.
- Offer between three and four quality walks a day where they can smell their environment and interact with other dogs
- Don’t forget the physical exercise and play before going home
- Spending time with your dog doesn’t mean being by their side without doing anything. It requires quality time speaking to them, petting and generally offering a lot of love and affection.
Mental stimulation is as important as physical exercise. So, in your day to day, you shouldn’t neglect basic obedience, training, mental stimulation exercises and intelligence toys.
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Reviewing the basic ideas about strategic positioning, Charles Hill(2017) argues that businesses can compete either on cost leadership or by creating differences between their products and those of their competitors. This argument is based on Porter(2008).
Porter’s other distinction is between competing for a whole market or for a particular market segment. Market segmentation permits companies to divide their potential customers into categories with particular preferences and buying behaviors. These categories include socio-economic, demographic, ethnic, cultural or lifestyle. Porter’s generic strategy ‘focus’ implies that the company pursues certain market segments.
Ikea for explanation
The warehouse type stores of Ikea sell the same broad range of affordable home furnishings, kitchens, accessories and food. IKEA having its roots in Sweden, was founded in 1943 as a mail order company. With 351 stores in 46 countries, IKEA is the largest furniture retailer in the world.
The IKEA stores are often structured as a one way layout where customers are lead counter-clockwise. This is called “the long natural way”. This way is designed to encourage customers to see the store in its entirety.
Also, immediately before checking out, there is an in-store warehouse where customers can pick up the items they purchased. Also, IKEA thinks so much about its customers that the furniture is also packed flat for ease of transportation.
IKEA targets the young, 20 to 30 year old ones, who are upwardly mobile and looking for tasteful but inexpensive disposable furniture of a certain quality standard for the price they are willing to pay.
The products sold in IKEA are manufactured by more than 1050 suppliers based in 53 countries. In this case, IKEA focuses on the design of products and works closely with suppliers, to bring down manufacturing costs. When developing a new product line, IKEA’s designers will develop a prototype design, look at the price that rivals charge for a similar piece, and then work with suppliers to figure out a way to cut prices by 40% without compromising on quality.
IKEA also produces about 10% of its sales, in house. By doing this, it makes use of the knowledge it has gained to help its suppliers improve their productivity. This lowers costs across the entire supply chain. However, there are differences in the products offered by IKEA in different regions of the world.
For example, in North America, sizes are different to reflect American demand for bigger beds. This localization strategy was adapted after a painful experience.
Narrating the painful experience, in the late 1980s, when IKEA first entered US, it thought that consumers would flock to its stores the same way in Western Europe. Then, IKEA realized European style furniture were not big enough. This resulted in the company redesigning its offerings to better match American tastes.
Also, when IKEA entered China in 2000s, it made adaptations to the local market. For example, because many Chinese apartments have balconies, IKEA’s Chinese stores include a balcony section. Also, in China, the IKEA stores are located near public transportation with delivery service provided.
Thereby, as seen from IKEA’s case study, strategy is the action that managers take to attain the goals of the firm. Accordingly, managers can increase the profitability by pursuing strategies that lower costs or add value to the firm’s products. This enables to raise prices.
According to Porter, businesses should decide where they should position themselves with regard to value and cost, in order to attain a good level of profits.
In general, to maximize the profitability of a business, a firm must do three things:
- pick a position on the efficiency frontier that is viable
- configure its internal operations(value creation activities)
- make sure that the firm has the right organization structure in place to execute its strategy
In simple, the strategy, operations and organization of the firm must all be consistent with each other in order to attain a competitive advantage and superior profitability.
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Before developing a strategy, businesses should analyse the industry. Good industry analysis looks at the structural underpinnings of profitability. It will take place in a few steps.
1.Understanding the appropriate time horizon
In this case, the business has to distinguish between temporary or cyclical changes from structural changes. A good guideline in this case is the full business cycle for the particular industry. The focus of the analysis should be average profitability over this period.
2. Understand the underpinnings of competition and the root causes of profitability
Analysts should look at industry structure quantitatively. This is applicable to almost all the forces of Porter’s competitive forces.
3. Understand the relationship between the strength of competitive forces and profit
Industry structure defines the gap between revenue and costs.
4. Look at the industry in systematic terms
Look at the forces that underpin or constrain the profitability. Consider how might shifts in one competitive force trigger reactions in others.
After understanding the forces that shape the industry competition, every company should consider what is the average profitability of its industry and how this has bee changing over time.
Porter’s five forces reveal why industry profitability is what it is. It is then that a company can incorporate industry conditions onto strategy. These forces will reveal the most significant aspects of the competitive environment.
Understanding the industry structure guides managers towards fruitful possibilities for strategic action such as positioning the company to better cope with current competitive forces, anticipating and exploiting shifts in the forces, shaping the balance of forces to create a new industry structure.
The best of such developed strategies will usually exploit the following.
1. Company positioning
Strategy is a way of finding a position in the industry, where the forces are weakest.
Ex: Paccar, a Washington based company with about 20% of the North American heavy truck market focuses only on one group of customers; owner operators. As a part of their strategy, Paccar invested heavily to develop an array of features with owner operators in mind. These included luxurious sleeper cabins, plush leather seats, noise insulated cabins, sleek exterior styling. Customers pay Paccar a 10% premium and its Kenworth and Peterbilt brands are considered status symbols at truck stops. Thus, Paccar illustrates the principles of positioning a company within a given industry structure. That is, the firm has found a portion of its industry where the competitive forces are weaker, where it can avoid buyer power and price based rivalry. With this, Paccar has been profitable for 68 years straight and has earned a long run return on equity above 20%.
The five forces analysis can also be helpful in analyzing entry and exit. Exit is indicated when industry structure is poor or declining and the company has no prospect of a superior positioning.
Strategists can use the framework to spot an industry with a good future before this good future is reflected in the prices of acquisition candidates.
The five forces analysis also reveals industries that are not attractive for the average entrant but which the company can surmount entry barriers at lower cost than most firms.
2. Industry Change
Industry changes bring the opportunity to spot and claim promising new strategic positions. For example, with the advent of the internet and the digital distribution of music, some analysts predicted the birth of many music labels. They predicted that the internet would remove distribution as a barrier to entry, unleashing a flood of new players into the music industry.
The labels tried for several years to develop into digital distribution but major companies hesitated in selling their music through a rival platform. It is into this vacuum that Apple and iTunes music store stepped in. By permitting the creation of a powerful new gatekeeper, the major labels allowed industry structure to shift against them
Thus, structural changes open up new needs and ways to serve existing needs. Smaller competitors in the industry can capitalize on such changes or new entrants can fill in.
3. Shaping industry structure
A firm can lead its industry towards new ways of competing that alter the five forces for the better. In reshaping structure, a company wants its competitors to follow so that the entire industry will be transformed.
An industry’s structure can be reshaped by redividing profitability in favor of incumbents or by expanding the overall profit pool. The first way aims to increase the profit share. The second way aims to increase the overall economic value generated by the industry which can be shared by rivals, buyers and suppliers.
For example, Sysco; one of the largest food distributor in North America recognized that, given its size and national reach, it might change this state of affairs. It led the move to introduce private label distributor brands with specifications tailored to the food service market, moderating supplier power.
Sysco emphasized value added services to buyers like credit, menu planning and inventory management. These moves together with stepped up investments in information technology and regional distribution centers substantially raised the bar for new entrants while making substitute less attractive.
However, there is a darker side to shaping industry structure. Faced with pressures to gain market share, managers may trigger new kinds of competition that no incumbent may win.
For example, IBM tried to make up for its late entry by offering an open architecture that would set industry standards and attract complementary makers of application software and peripherals. It then ceded ownership of the critical components of the PC. Then, it became the temporarily dominant firm in an industry with an unattractive structure.
When overall demand grows, the industry’s quality level rises. Expanding the overall profit pool creates win win opportunities for multiple industry participants.
4. Defining the industry
Drawing industry boundaries correctly, will clarify the causes of profitability and the appropriate unit for setting strategy. Mistakes in industry definition made by competitors present opportunities for staking out superior strategic positions.
However, when conducting the industry analysis, it is necessary to follow the best practices.
- Avoid defining the industry too broadly or too narrowly
- Avoid making lists instead of engaging in analysis
- Avoid paying equal attention to all forces, instead dig deep into the most important ones
- Avoid confusing effect with cause
- Consider industry trends
- Avoid confusing cyclical or transient changes with true structural changes
- Use the framework to guide strategic choices
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The first formative analysis of competitive strategy appeared in the Harvard Business Review, in 1979. This was put forward by Michael Porter. Porter argued that there are 5 forces that shape competitive strategy.
- Rivalry among existing competitors
- Threat of new entrants
- Threat of substitute products or services
- Bargaining power of suppliers
- Bargaining power of customers
If the forces are intense, almost no company earns attractive returns on investment. For example, airlines, textiles, hotels.
Thus, industry structure drives competition and profitability.
Thereby, understanding the competitive forces and their causes, indicates the roots of an industry’s current profitability and provides a framework for future profits too.
Forces that shape competition
The strongest competitive force(s) determine the profitability of an industry. Thereby, they become the most important in strategy formulation. For instance, in the photographic film industry, low returns are the result of Kodak and Fuji, the world’s leading producers of photographic film being superior substitutes. In this case, coping with the substitute becomes the first strategic priority.
The structure of an industry is shaped by
- Threat of entry
- New entrants bring in new capacity and desire to gain market share.
- This puts pressure on prices, costs and the rate of investment necessary to compete.
- When new entrants are diversifying from other markets, they can leverage existing capabilities and cash flows in order to disturb the competition. For instance, Pepsi did this when it entered the bottled water industry, Microsoft did this when it entered the internet browsers industry, Apple did it when it entered the music distribution business.
- Hence, the threat of entry puts a cap into the profit potential of an industry. Thereby, the firms in the industry must hold low prices or increase investments.
For example, Starbucks must invest in modernizing its stores and menus due to low barriers to entry in the coffee industry
- This is why barriers to entry are advantageous to the existing firms in an industry.
- Sources of barriers to entry
- Supply side economies of scale
- This is when firms produce at larger volume and enjoy lower costs per unit. Therefore, this deters entry by forcing the entrant to come into the industry in a large scale.
- Demand side benefits of scale (network effects)
- This is when a buyer’s willingness to pay for a company’s products increase with the number of other buyers who also patronize the company. For example, online auction participants are attracted to Ebay since it offers the most potential trading partners.
- Hence, demand side benefits of scale discourage the entry by limiting the willingness of customers to buy from newcomers.
- Supply side economies of scale
- Sources of barriers to entry
- Customer switching costs
- These are the fixed costs that buyers will face when they change suppliers. For example, ERP software is a product with high switching costs.
- Capital requirements
- This barrier is particularly great if the capital requirement is for unrecoverable and harder to finance expenditures like upfront advertising or R &D.
- Incumbency advantages
- These are the cost or quality advantages for firms irrespective of their size, which is not available to its potential rivals. For example, proprietary technology, preferential access to the best raw material sources, brand identity.
- For example, Target and Walmart have located stores in freestanding sites rather than regional shopping centres.
- Unequal access to distribution channels
- Sometimes, new entrants must bypass distribution channels altogether or create their own.
- Restrictive government policy
- Government directly limits entry into industries such as licensing requirements and restrictions on foreign investment.
- For example, regulated industries are like liquor retailing, taxi services.
- Power of
- Powerful suppliers have the following
- Greater concentration in the industry. For example, Microsoft’s near monopoly in operating systems coupled with the fragmentation of PC assemblers.
- Not being dependent heavily on the industry for revenues.
- Industry participants face switching costs in changing suppliers.
- Differentiated products. For example, pharmaceutical companies that offer patented drugs.
- Absence of substitutes
- Threat of integrating forward into the industry.
- Powerful suppliers have the following characteristics
- Power of
- Powerful buyers will be present in the following
- Existence of few buyers or each buyer purchases in large volumes.
- Standardized products.
- Few switching costs
- Ability to threaten to integrate backward
- On the other hand, buyers can be price sensitive
in the following conditions:
- If the product purchased represents a significant fraction of its procurement budget
- IF they earn low profits or strapped for cash
- Quality of the products is little affected by the industry’s product.
- Powerful buyers will be present in the following cases
- Threat of
- Substitutes limit profit potential
- Threat of substitutes will be high in the
- It offers an attractive price performance trade off to the industry’s product. For example, telephone service providers suffered from the advent of inexpensive internet based phone services such as Vonage and Skype
- The cost of switching to buyers is low
- Rivalry among existing competitors
- This can be in the form of price discounting, new product introductions, advertising campaigns and service improvements.
- The level of rivalry will be high in the following cases:
- Numerous competitors roughly equal in size and power
- Slow industry growth
- High exit barriers
- Rivals are highly committed to the business
- Lack of familiarity of the different firms in the industry
- The strength of the rivalry indicates the intensity and basis of competition.
- Profitability is affected by
- The dimensions on which competition takes place
- Whether rivals converge to compete on the same dimensions
- Sustained price competition trains people to pay less attention to products’ features.
- Price completion will occur in the following instances:
- Identical products
- High fixed costs and low marginal costs
- Capacity must be expanded in large increments to achieve efficiency
- Perishable products
- Competition on dimensions other than price such as product features, support services, delivery time, brand image is less likely to reduce profitability. This is because they improve customer value and therefore, can support higher prices.
In this way, the Porter’s five forces determine the industry’s long run profit potential.
However, other visible attributes of an industry also should be considered.
- Industry growth rate
- Fast growing industries are not always attractive. An expanding industry offers opportunities for all competitors. However, suppliers can become powerful in a fast growing industry.
- Without new entrants, a high industry growth rate does not guarantee profitability if the customers are and substitutes are attractive.
- Technology and innovation
- Advanced technology alone cannot make an industry attractive or not.
- The government policies and their ways of involvement will affect industry in various ways
- Complementary products and services
- Complements affect profitability via their influence of the five forces outlined above. For example, in application software, barriers to entry were lowered when producers of complementary operating system software like Microsoft provided tool sets making it easier to write applications.
The above discussion was based on a constant industry state. But, practically, industries keep on changing.
Shifts in industry structure can emanate from outside of an industry. These can boost industry’s potential profit or reduce it.
Porter’s five competitive forces provide a framework to identify the most important industry developments and for anticipation of their impact on industry attractiveness.
Shifting threat of new entry
Ex: When Merck’s patent for the cholesterol reducer Zocor expired, 3 pharmaceutical makers entered the market for the drug.
Ex: In 1970s, retailers like Walmart, Kmart, Toys R Us began to adopt new procurement, distribution and inventory control technologies with large fixed costs. These investments increased the economies of scale and made it more difficult for small retailers to enter the business.
Changing supplier or buyer power
Ex: In the global appliance industry, competitors including Electrolux, General Electric and Whirlpool have been squeezed by the consolidation of retail channels.
Shifting threat of substitution
Ex: The earliest microwave ovens were large and priced above $2000, making them poor substitutes for conventional ovens. With technological advances, they became serious substitutes.
Ex: Flash computer memory has become a good substitute for low capacity hard drives.
New bases of rivalry
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Most musicians love to use the Taylor Guitar for various reasons. Based on various surveys conducted by state authorities ad research councils, the following have been considered as he top five reasons why Taylor Guitars are still on high demand.
Playability and Quality
Taylor Guitars just play like butter. It’s so smooth that you can work with it without any hassle. You don’t have to fight the guitar and that’s a huge advantage. Even guitar makers claim that.
Taylor’s neck is a bolt-on neck system that has wood shims in between the fretboard extension on the heel, that allows tail if the Taylor factory just set it up exactly the way we want to set up. When it comes across the country, they tune it up together.
When a customer comes to play, it plays great. But, the great thing is over time, if it actually gets high, you can bring it back to any authorized repair center and they can reset the neck for you under Taylor warranty and set up exactly the way you want.
So the playability is a function of all those things coming together.
There is so much innovation in the Taylor factory. Every step done to building guitars were done on purpose. If you look at this guitar today, it does not look like a guitar you used to see it on a wall right first off. It’s not glossy. It’s got these weird edges around and you roll it all the way around.
There’s a lot of different players out there with different playing styles and they’re going to use because those guitars for different reasons. Recording and playing on their couch, playing with their buddies or even playing live.
So, there’s five different body shapes that Taylor offers. From a really small comfortable guitar to a big boomy jumbo guitar which is the grand orchestra and everything in between. Then, you start adding in the different tone woods. There are a lot of different models and options out there that you can get something for everyone.
Thus, Taylor is not only just stepping outside of the standard woods, but in addition to increasing the diversity of tone, that’s being made available through the body shapes, there’s also a sense of sustainable ethics. Taylor wants to ethically source the woods.
Taylor uses sustainable tone woods found in Africa. They’re renewable. They grow within 30 to 40 years because they grow along the tropical zone. So, they grow really fast and they also sound great.
Good customer care
Taylor takes good care of the customers after they bought the guitar. Taylor guitars comes with a lifetime of service and repair. If there’s something that is manufactured wrong with the guitar, and the beauty is a lot of that can be done in the field.
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