Business- Level Strategy and the Industry Environment Chapter Six Business- Level Strategy and the Industry Environment

Copyright © Houghton Mifflin Company. All rights reserved. “All men can see these tactics whereby I conquer but what none can see is the strategy out of which victory evolves.” - Sun Tzu Copyright © Houghton Mifflin Company. All rights reserved. © RoyaltyFree/ David DeLossy/ Getty Images

The Industry Environment There is the need to continually formulate and implement business-level strategies to sustain competitive advantage over time in different industry environments. Different industry environments present different opportunities and threats. A company’s business model and strategies have to change to meet the environment. Companies must face the challenges of developing and maintaining a competitive strategy in: Fragmented Industries • Mature Industries Embryonic Industries • Declining Industries Growth Industries Copyright © Houghton Mifflin Company. All rights reserved.

Fragmented Industries A fragmented industry is one composed of a large number of small and medium-sized companies. Reasons for fragmented industries Low barriers to entry due to lack of economies of scale Low entry barriers permit constant entry by new companies Specialized customer needs require small job lots of products - no room for a mass-production Diseconomies of scale Strategies Chaining – networks of linked outlets to achieve cost leadership Franchising – for rapid growth with proven business concepts, reputation, management skills and economies of scale Horizontal Merger – acquisition to obtain economies and growth IT and Internet – to develop new business models Copyright © Houghton Mifflin Company. All rights reserved.

Embryonic and Growth Industries An embryonic industry is one that is just beginning to develop when technological innovation creates new market or product opportunities. A growth industry is one in which first- time demand is expanding rapidly as many new customers enter the market. Strategy is determined by market demand Innovators and early adopters have different needs from the early and late majority Company must be prepared to cross the chasm between the early adopters and the later majority Companies must understand the factors that affect a market’s growth rate – in order to tailor the business model to the changing industry environment. Copyright © Houghton Mifflin Company. All rights reserved.

Market Characteristics: Embryonic and Growth Industries Reasons for slow growth in market demand Limited performance and poor quality of the first products Customer unfamiliarity with what the new product can do for them Poorly developed distribution channels Lack of complementary products High production costs Mass markets typically start to develop when: Technological progress makes a product easier to use and increases its value to the average customer. Key complementary products are developed that do the same. Companies find ways to reduce production costs allowing them to lower prices. Copyright © Houghton Mifflin Company. All rights reserved.

Market Development and Customer Groups Both innovators and early adopters enter the market while the industry is in its embryonic state. Figure 6.1 Copyright © Houghton Mifflin Company. All rights reserved.

Market Share of Different Customer Segments Most market demand and industry profits arise during the early and late majority customer segments. Figure 6.2 Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Implications: Crossing the Chasm Innovators and Early Adopters are (While the Early Majority are NOT): Technologically sophisticated and tolerant of engineering imperfections Typically reached through specialized distribution channels Relatively few in number and not particularly price-sensitive To cross the chasm between the Early Adopters and the Early Majority Correctly identify the needs of the first wave of early majority users. Alter the business model in response. Alter the value chain and distribution channels to reach the early majority. Design the product to meet the needs of the early majority so that the product can be modified and produced or provided at low cost. Anticipate the moves of competitors. Copyright © Houghton Mifflin Company. All rights reserved.

The Chasm: AOL and Prodigy Figure 6.3 The business model and strategies required to compete in an embryonic market populated by Early Adopters and Innovators are very different than those required to compete in a high-growth mass market populated by the Early Majority. Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Implications of Market Growth Rates Different markets develop at different rates. Growth rate measures the rate at which the industry’s product spreads in the marketplace. Growth rates for new kinds of products seem to have accelerated over time: Use of mass media • Low-cost mass production Factors affecting market growth rates: Relative advantage • Complexity Compatibility • Observability Availability of • Trialability complementary products Business-level strategy is a major determinant of industry profitability. The choice of business model and strategies can accelerate or retard market growth. Copyright © Houghton Mifflin Company. All rights reserved.

Differences in Diffusion Rates Figure 6.4 Different markets develop at different growth rates. Source: Peter Brimelow, “The Silent Boom,” Forbes, July 7, 1997, pp. 170-171. Reprinted by permission of Forbes Magazine © 2002 Forbes, Inc. Copyright © Houghton Mifflin Company. All rights reserved.

Navigating Through the Life Cycle to Maturity The amount and type of resources and capital needed to pursue a company’s business model depends on two crucial factors: Competitive advantage of company’s business model Stage of the industry life cycle Embryonic stages – share building strategies Development of distinctive competencies and competitive advantage. Requires capital to develop R&D and sales/service competencies. Growth stages – maintain relative competitive position Strengthen business model to prepare to survive industry shakeout. Requires investment to keep up with rapid growth of the market. Shakeout stage – increase share during fierce competition Invest in share-increasing strategies at expense of weak competitors. Weak companies should exit the industry during the harvest stage. Maturity stage – hold-and-maintain to defend business model Dominant companies want to reap the reward of prior investments. A company’s investment depends on the level of competition and source of the company’s competitive advantage. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Mature Industries A mature industry is dominated by a small number of large companies whose actions are so highly interdependent that success of one company’s strategy depends on the response of its rivals. Evolution of mature industries Industry becomes consolidated as a result of the fierce competition during the shakeout stage. Business level strategy is based on how established companies collectively try to reduce strength of competition. Interdependent companies try to protect industry profitability. Strategies Deter entry into industry Product proliferation  Maintaining Price cutting excess capacity Manage industry rivalry Price signaling  Capacity control Price leadership  Nonprice competition Copyright © Houghton Mifflin Company. All rights reserved.

Strategies for Deterring Entry of Rivals Figure 6.5 Filling the Niches: making it difficult for new competitors to break into a new industry & establish a beachhead Sending a Signal: to potential new entrants contemplating entry that new entry will be met with price cuts Warning of Retaliation: by increasing output and forcing down prices until market entry would be unprofitable to entrants Copyright © Houghton Mifflin Company. All rights reserved.

Product Proliferation in the Restaurant Industry Figure 6.6 Where the product spaces have been filled, it is difficult for a new company to gain a foothold in the market and differentiate itself. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. “We built our company by focusing upon a pretty simple, but focused premise of Quality, Service, Cleanliness, and Value.” - Ray Kroc, Founder of McDonalds Copyright © Houghton Mifflin Company. All rights reserved. www.mcdonalds.com

Strategies for Managing Industry Rivalry Figure 6.7 Convey intentions (e.g. Tit-for-Tat) regarding pricing to other companies to allow the industry to choose the most favorable pricing options. Intent is to improve industry profitability. Informal pricing when one company takes the responsibility for choosing the most favorable industry pricing option. Formal price setting jointly by companies is illegal. Differentiation by offering products with different features or applying different marketing techniques: Market development Market penetration Product development Product proliferation Market Signaling to secure coordination with rivals as a capacity control strategy and to reduce industry investment risks. Collusion on timing of new investments is illegal. Copyright © Houghton Mifflin Company. All rights reserved.

Four Nonprice Competitive Strategies Figure 6.8 Copyright © Houghton Mifflin Company. All rights reserved.

Toyota’s Product Lineup Figure 6.9 Toyota has used market development to become a broad differentiator and has developed a vehicle for almost every main segment of the car market. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Game Theory Companies in an industry can be viewed as players that are all simultaneously making choices about which business models and strategies to pursue in order to maximize their profitability. Basic principles that underlie game theory: Look Forward and Reason Back – Decision Trees Look forward, think ahead, and anticipate how rivals will respond to whatever strategic moves they make Reason backwards to determine which strategic moves to pursue today based on how rivals will respond to future strategic moves Know Thy Rival – how is the rival likely to act Find the Dominant Strategy – Payoff Matrix One that makes you better off if you play that strategy No matter what strategy your opponent uses Strategy Shapes the Payoff Structure of the Game These basic principles of game theory can be used in determining which business model and strategies to pursue. Copyright © Houghton Mifflin Company. All rights reserved.

A Decision Tree for UPS’s Pricing Strategy Figure 6.10 Copyright © Houghton Mifflin Company. All rights reserved.

A Payoff Matrix for GM and Ford Figure 6.11 Copyright © Houghton Mifflin Company. All rights reserved.

Altered Payoff Matrix for GM and Ford Figure 6.12 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Declining Industries A declining industry is one in which market demand has leveled off or is falling and the size of total market starts to shrink. Competition tends to intensify and industry profits tend to fall. Reasons for and severity of the decline Reasons - technological change, social trends, demographic shifts Intensity of competition is greater when: The decline is rapid versus slow and gradual. The industry has high fixed costs. The exit barriers are high. The product is perceived as a commodity. Not all industry segments typically decline at the same rate Creating pockets of demand Strategies Leadership – seeks to become dominant player in declining industry Niche – focuses on pockets of demand that are declining more slowly Harvest – optimizes cash flow Divestment – sells business to others Copyright © Houghton Mifflin Company. All rights reserved.

Factors for Intensity of Competition in Declining Industries Figure 6.13 Copyright © Houghton Mifflin Company. All rights reserved.

Strategy Selection in a Declining Industry Figure 6.14 Choice of strategy is determined by: Severity of the industry decline Company strength relative to the remaining pockets of demand Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. “Whatever you shoot is dead for a while before it starts to stink. The same goes for strategies.” - Gary Hamel Copyright © Houghton Mifflin Company. All rights reserved. © RoyaltyFree/ Lawrence M. Sawyer/ Getty Images