External & Industry Analysis

External & Industry Analysis
Welcome External & Industry Analysis

Today’s Plan of Action Brief Review Performance Analysis Presentations
Strategic Audit of Ice Fili (External Analysis) What is Internal Analysis [In book and here]? Next Week’s Assignment

Strategic Audit: An Audit of the Strategic Health of a Company
STRATEGIC OPTIONS Strategy Analysis: *At the BU level *At the Corporate Level External/Environmt’l Analysis Internal/Resources Analysis. Performance Analysis Diagnostics Winning Strategy

Strategic Audit: An Audit of the Strategic Health of a Company
Strategic Options for Value Creation and Appropriation Strategy Analysis: What is this firm’s strategy? How effective and sound? Markides Strategy Analysis Inspired Tool at the BU level: What is this company’s Who/What/How? Are these Who/What/How consistent? Are they well communicated and in use? At the Corporate Level: The 4 Poles Analysis External/Environmental Analysis: What does this firm’s external environment looks like? How is it changing? What opportunities or threats is there out there? How can this firm shape its environment and take advantage of it? GDPest Tool: To Examine the General Environment Porter’s Five Forces Analysis: To examine the Competitive Environment Internal/Resources Analysis: What does this firms’ internal environment look like? How is it changing? How can the firm take advantage of it or change it to create and maintain a sustainable competitive advantage? Barney’s VRIO Tool: To examine the firm’s resources and capabilities. Performance Analysis: How is this firm’s performance? How it this company doing? Chacar’s Performance Analysis Tool: -Examine Performance from all angles (Financial, Functional-Mfg, Mktg, Fin., Op., HR…, Cultural..) -Benchmark performance to Past, Goals, ‘Competitors’, ‘Best in Class’, Expectations, Potential.. Diagnostics Winning Strategy

Strategy Analysis: Your First Tool/GSA
Step 1: Description (What is this firm’s Theory on How to Get C.A.) What is A (Who/What/How)? What is B (Who/What/How)? How does the company plan to go from A to B? Step 2: Strategy Analysis Test/Critique Is this a good theory of Competitive Advantage (or of how to create value)? A cool lecture to help you think about this Is the strategy clear to all and well communicated? Are the who what how consistent? Is this a unique value proposition? .. Bad strategy is typically all goals, a laundry list, one that does not understand where the company is. Need to have all A/B component and plan to get there in place in addition to value creation. International Harvester went bankrupt when it had a lofty goal and a plan- but biggest problem was labor and they never addressed that issue – i.e. they did not know what their A is- where they were at the time. Ikea, Enterprise

Performance Analysis: Assess performance from all angles to assess Strategic Health
Go beyond the financials Balanced indicators Linked to profit drivers and financial impact Compare against multiple benchmarks Own past performance Competitors and others (industry definition matters) Run the numbers Quantify the sources of value Use Analysis to identify the best next Steps to make/Consider the potential that might be tapped from New markets or bigger shares of existing ones Recombining and redeploying the firm’s resources

Always need to combine financial skills with Strategic and Operational Flair for success
Data analysis in combination with Strategic Flair and Operational Know-How is used to generate hypotheses You will often need further investigation to determine which hypotheses are true. The ‘fix’ to the problem will depend on which hypotheses are correct.

Strategy is a who/what/how combination (aka resource/market positioning) that creates value.
Strategy is about making choices. Choosing a ‘who, what, how’ is also choosing not to do other things. A sound/consistent value creating combination may not be always so. Good strategists revisit their strategies often. Performance reflects the choices we make and fail to make. There are no right answers, only good questions and sound ways of approaching them.

A Seemingly Great Industry Position is not enough.
The more the profit potential the bigger ‘legs’ potential will have to overcome barriers to entry HIGH BARRIERS TO ENTRY -Reputation (65% of new business through word of mouth) -High capital requirements ($25 million to build a 600 bed club) -Economies of scale + INTENSE COMPETITION -Identified competitors together have 65% as many beds as Club Med in the Caribbean -May not be price-based competition - Perillo tours charges $1,099-1,399 for a week in resort or on cruise ship SUPPLIERS SQUEEZED $22 million from low wages $20 million in tax & interest concessions from host governments $8 million from airline discounts + + LIMITED BUYER POWER -Private individuals purchase -High perceived risk if vacation bad -Buyers cannot backward integrate -Buyers relatively price insensitive - THREAT OF SUBSTITUTES -Alternative leisure options non-inclusive vacations, stay at home vacations

What is External Environment Analysis?

The Environment: General (PEST or GDPest) & Competitive
General Environment The trends in the broader society that influence an industry and the firms in it Types of Trends Demographic Economic Political/legal Sociocultural Technological Global trends Demographic Trends Changes in population size, age structure, geographic distribution, ethnic mix, and income distribution Economic Trends The direction of the economy in which a firm competes or may choose to compete Political/Legal Trends The changes in organizations and interest groups that compete for a voice in developing and overseeing the body of laws and regulations that guide interactions among firms and nations Sociocultural Trends Changes in a society’s attitudes and cultural values Technological Trends Changes in the activities involved with creating new knowledge and translating that knowledge into new products, processes, and materials Global Trends Changes in relevant emerging and developed country global markets, important international political events, and critical changes in cultural and institutional characteristics of global markets. Q Source: Ireland, Hitt & Hoskisson 2006 – Copyright Thompson Business & Professional Publishing

The 5-Forces Framework P, Q SUPPLIERS Bargaining power of suppliers
Threat of new entrants MARKET COMPETITORS POTENTIAL ENTRANTS SUBSTITUTES Rivalry among existing firms Threat of substitute products or services Bargaining power of customers BUYERS P, Q Source: Porter (1980)

Step 1 - What Industry is Ice-Fili in?
Industry Analysis Step 1 - What Industry is Ice-Fili in?

Industry Analysis Step 1 – Define the industry the firm is in Step 2 - Identify the players: Competitors, substitutes, suppliers, buyers, and potential entrants

The 5-Forces Framework SUPPLIERS MARKET COMPETITORS POTENTIAL ENTRANTS
SUBSTITUTES Rivalry among existing firms BUYERS Source: Porter (1980)

Industry Analysis Step 3 - Evaluate the 5-forces: Their intensity, the underlying conditions that drive this intensity, and the implication for the performance of companies in this industry

The 5-Forces Framework SUPPLIERS Bargaining power of suppliers
Threat of new entrants MARKET COMPETITORS POTENTIAL ENTRANTS SUBSTITUTES Rivalry among existing firms Threat of substitute products or services Bargaining power of customers BUYERS Source: Porter (1980)

Industry Analysis Step 4 - What would it take for any company to be successful in this industry; or how can we change the industry forces in our favor; aka industry key success factors

Generic Drivers of Industry Forces
SUPPLIER POWER Factors determining power of suppliers relative to producers same as those determining power of producers relative to buyers--see “Buyer Power” box. Generic Drivers of Industry Forces THREAT OF ENTRY economies of scale absolute cost advantages capital requirements product differentiation access to distribution channels governmental and legal barriers retaliation by established producers INDUSTRY COMPETITIVENESS concentration product differentiation excess capacity ratio of fixed to variable costs demand growth cyclical fluctuations of demand exit barriers THREAT OF SUBSTITUTES buyer propensity to substitute relative price performance of substitutes Forces Siphon II If forces weak > attractive ind. (if already in it. Entrants must pay large $ to get over business) Forces (+resources) define how firm can best compete. Forces change over time. BUYER POWER Price sensitivity cost of purchases profitability of buyers importance of the product to quality of buyers’ product Bargaining power size and concentration of buyers relative to suppliers buyers’ switching costs buyers’ information buyers’ ability to backward integrate

Generic Responses to Industry Forces
SUPPLIER POWER Reduce Suppliers’ Uniqueness Backward Vertical Integration Use Multiple Suppliers Generic Responses to Industry Forces THREAT OF ENTRY Erect barriers to entry by building: economies of scale absolute cost advantages Influence govt. policy requirements . . . Overcome barriers to entry through: product differentiation . . . INDUSTRY COMPETITIVENESS Compete on dimensions besides price Consolidate ownership Build a first-mover advantage . . . THREAT OF SUBSTITUTES Improve product’s attractiveness relative to substitutes: Lower Prices Product differentiation Move into new businesses Forces Siphon II If forces weak > attractive ind. (if already in it. Entrants must pay large $ to get over business) Forces (+resources) define how firm can best compete. Forces change over time. BUYER POWER Reduce Buyers’ Uniqueness Forward Vertical Integration Product Differentiation Target New Market Segments Source: Barney (1997)

External Environment Analysis

The Environment: General (PEST or GDPest) & Competitive
General Environment The trends in the broader society that influence an industry and the firms in it Types of Trends Demographic Economic Political/legal Sociocultural Technological Global trends Demographic Trends Changes in population size, age structure, geographic distribution, ethnic mix, and income distribution Economic Trends The direction of the economy in which a firm competes or may choose to compete Political/Legal Trends The changes in organizations and interest groups that compete for a voice in developing and overseeing the body of laws and regulations that guide interactions among firms and nations Sociocultural Trends Changes in a society’s attitudes and cultural values Technological Trends Changes in the activities involved with creating new knowledge and translating that knowledge into new products, processes, and materials Global Trends Changes in relevant emerging and developed country global markets, important international political events, and critical changes in cultural and institutional characteristics of global markets. Q Source: Ireland, Hitt & Hoskisson 2006 – Copyright Thompson Business & Professional Publishing

The 5-Forces Framework P, Q SUPPLIERS Bargaining power of suppliers
Threat of new entrants MARKET COMPETITORS POTENTIAL ENTRANTS SUBSTITUTES Rivalry among existing firms Threat of substitute products or services Bargaining power of customers BUYERS P, Q Source: Porter (1980)

Where we are today: (The Key Steps in a Strategic Audit)
Understand the company’s goal and strategy Assess the company’s performance Analyze the company’s environment and its industry Evaluate the company’s resources (inc. leaders), capabilities, and renewal and erosion factors Evaluate potential strategies that the company can follow Try and determine the implementation issues Recommend a strategy

Process: Try and support each conclusion with data from the case
What can we say about the ice cream industry’s attractiveness without doing a five forces analysis? Process: Try and support each conclusion with data from the case P

The Russian Ice Cream Industry is Unattractive even if one or several companies are successful
Undifferentiated products with many companies using the same brand names (p.4) Declining demand when other industries are growing: Down 3.5% between ’99 and ’00. (p.2) Increased competition: 87 companies in 1996 vs. 150 in 1998 vs. 300 in 2002 (new entrants from alcohol industry, meat and fish packers, and from abroad) (p.2 and 10) Several foreign companies pulled out of the market inc. Ben & Jerry & Unilever (p.1) Decreased Prices in Real Terms Using the dollar term as an approximation of real terms In 1997 average price is $2.66 per kilo: Revenues of $69.1 Million (Exh. 7a) / Production of 26,000 tonnes (Exh. 9) In 2001 average price is $1.35 per kilo: Revenues of $25.7 Million (Exh. 7a) / Production of 19,000 tonnes (Exh. 9) Decreased Performance: Industry margins 15%-20% in 2000 vs. 30%-40% in 1998 (p. 5) Most competitors are diversifying out of the business …  We generally do not need a full blown industry analysis to determine if an industry is attractive or not

Why is the 5-forces framework one of the most famous strategy tools?
If we generally do not need a full blown industry analysis to determine if an industry is attractive or not:

Why is Porter Framework so Popular?
Great Insight: Anyone who can force you to lower your price or your volumes or can raise your costs is your competitor. These include all those companies . . . Who sell similar products or services (i.e., makers of substitutes) Who could begin selling what you sell (i.e., potential entrants) Whom you purchase from (i.e., your suppliers) Who you sell to (i.e., your buyers) As well as your direct rivals.

Step 1 - What Industry is Ice-Fili in?
Industry Analysis Step 1 - What Industry is Ice-Fili in?

Ice-Fili’s Industry ‘Confectionary industry’; ‘Indulgence industry’
Too broad to be useful ‘Moscow ice cream industry’ Too narrow, misses too many competitors. ‘Russian ice cream industry” Probably best

Defining the Competitors and Industry is Crucial
How you frame the situation Determines what you see, think and hear Determines what you do How you define your business Determines who you “see” as your customers, competitors, and so on Determines what you do (your strategy) Coke Pepsi

By Pullitzer Prize Winning Political Cartoonist David Horsey
“.. no one succeeded in capturing the organizing principle behind the president's consciousness the way Horsey did here. While many critics were busy vilifying Reagan as a reckless cowboy hell-bent upon launching nuclear weapons or ridiculing his growing mental incapacities, Horsey instead chose to contemplate Reagan's interior self. Recreating the world as it might appear to a simple-minded, second-tier actor who had lost his way after the death of the studio system, he depicts a transcontinental high noon taking place over a crude world map. Reagan, in the role of town sheriff, stands tall across the geographical expanse of North America, drawing six-guns from his holster to defend the free world. Staring back at him across Europe and the Atlantic Ocean is Gorbachev — portrayed as a missile-wielding, fur-clad Cossack. He holds sway over the place we knew then as the Soviet Union but referred to here as "Evil Empire." The complete picture of Reagan's world-view is formed by other designated names of new or grossly modified political entities, separated on the map, Saul Steinberg-like, by dotted lines of his own making. In a United States that presages the 'Blue' and 'Red' Americas of the 2000 Presidential election, New York and New England are marked "Democrats and Welfare Bums," the Pacific Northwest as "Ecotopians and Hippies," while the city of San Francisco is indicated with the descriptive term "Homos." The South and Midwest, on the other hand, are labeled "Republicans and other Real Americans" while the rest of the country is simply called "California." Across the pond, Reagan's Europe bears a striking resemblance to today's 'Old' Europe of Donald Rumsfeld, contemptuously dismissed as "Socialists and Pacifist Wimps." The Middle East, of course, is designated "Our Oil." .. What makes The World According to Reagan so powerful is Horsey's ability to capture the essential riddle of Ronald Reagan, presenting us with the man's odd charisma and goofy charm and juxtaposing it with his myopic vision and the potential danger it posed to the human race. “ The Expanding Genius Of David Horsey, by Jim Demetre, Artdish 2003? By Pullitzer Prize Winning Political Cartoonist David Horsey

How we define our industry or business is often the biggest constraining factor to our decision process Apple

What are cows and chicken?

Whom Do You See? Looks like President Clinton and Vice President Gore, right? It's Clinton's face twice, with two different haircuts.

Is the Left Center Circle Bigger?
No, they're both the same size

There’s no one “right way” to define the industry.
Business Definition Merits Dangers Narrow Focuses resources and attention on clear purpose Potential to miss opportunities, threats, emerging competitors Broad Big picture Unclear focus Wasted resources Missed opportunities/threats

Industry Analysis Step 1 – Define the industry the firm is in Step 2 - Identify the players: Competitors, substitutes, suppliers, buyers, and potential entrants

The 5-Forces Framework SUPPLIERS MARKET COMPETITORS POTENTIAL ENTRANTS
SUBSTITUTES Rivalry among existing firms BUYERS Source: Porter (1980)

Industry Analysis Step 3 - Evaluate the 5-forces: Their intensity, the underlying conditions that drive this intensity, and the implication for the performance of companies in this industry

The 5-Forces Framework SUPPLIERS Bargaining power of suppliers
Threat of new entrants MARKET COMPETITORS POTENTIAL ENTRANTS SUBSTITUTES Rivalry among existing firms Threat of substitute products or services Bargaining power of customers BUYERS Source: Porter (1980)

What do we look for to determine whether rivalry is high?

Rivalry is high when: Industry concentration is low
Competitors are very homogeneous Little product differentiation exists Excess capacity and exit barriers are present Scale economies are high and the ratio of fixed to variable costs is high Exit barriers: Specialized assets High fixed costs of exit Strategic interrelationships Emotional barriers Government and social restrictions

Is rivalry high in the Russian Ice Cream industry?

Undifferentiated products and Low concentration and rising capacity leads to high rivalry
- Industry Concentration definitely very low: Largest domestic producer has only 5% market share in 2002 and it has been decreasing (p.10 and Exhibit 1b), second largest’ share less than 4% (p14) Number of companies in the industry is rising from 87 companies in 1996 vs. 150 in 1998 vs. 300 in 2002 (p.2 and 10) -/+ Excluding a couple of companies (Haagen-Daz, Baskin Robins) most companies produce very similar products (p.1) - Products with greatest sales volumes are not differentiated: Brand names have become generic and cannot be protected by trademarks: Lakomka (?30%) and Leningradskoe (p.4) - Overcapacity: Sales at 376 tonnes in 2002 vs. likely capacity greater than 470 tonnes (1991 peak) (Exhibits 1a and 1b) Overcapacity exacerbated as product becomes less seasonal ? High economies of scale in ?purchasing, ?distribution, ?advertising + But no apparent barriers to exit + Some cooperation between Russian producers (Association of Russian Ice Cream Producers) ..

What do we look for to determine how high the threat of substitutability is?

The threat of substitutes is high when:
Buyers have a high propensity to substitute The relative price and performance of substitutes is high

Is the threat of substitutes high in the Russian Ice Cream industry?

Numerous products seem to compete for consumers’ ruble
- Buyers seem to have a high propensity to substitute ‘Nowadays students prefer beer to ice cream’ (p.2) - Substitute products numerous: Beer (Baltica and dozens of other domestic brands) Soft drinks (primarily Coke and Pepsi) Chocolate (Mars, Nestle, and numerous domestic players) Yogurts - Substitutes aggressive advertisers and growing much faster than ice cream (p.2) No information on ‘relative price performance’ of substitute but seems high if consumers are substituting S

What do we look for to determine whether buyers have a high or low power?

When is buyer power high? I
When price sensitivity of focal industry is high: Cost of supplier product relative to total costs of focal industry products high Product differentiation of supplies low Competition between focal industry players is high

When is buyer power high? II
Relative bargaining power of focal firms is high: Size and concentration of focal industry firms relatives to suppliers is high Focal industry firms face little if no switching costs Focal industry firms know and understand well the cost structure of suppliers Focal industry firms can easily integrate backward

Is Buyer power high in the Russian Ice Cream industry?

Distributors run the show and retailers are likely to become more powerful as they grow and strengthen End consumers and distributors are extremely price sensitive: Actual Product costs has a significant impact on distributors’ profits Producers undifferentiated (although some brand differentiation) ? Distribution industry competitive Relative bargaining power of focal firms is very high: The number of distributors seems to be smaller than the number of ice cream producers and they seem to be much larger Distributors have no switching costs Retailers will be more likely to switch as they grow in strength and size Cafes and restaurants can switch customers to other brands (like Coke and Pepsi) so they will be powerful ? Customers have no switching costs Distributors serve the largest channels (kiosks and convenience stores) and shop around to get the products they want Costs seem to be well known since ingredients are very basic and manufacturing processes generic although varying Retailers and Distributors could potentially make or source their own ice cream using well known brand names + Forward vertical integration (into kiosks: e.g. Russkii Holod, and into distribution: franchising name for restaurants and cafes

What do we look for to determine whether suppliers have a high or low power?

When is supplier power low? I
When price sensitivity of focal industry is high: Cost of supplier product relative to total costs of focal industry products high Product differentiation of supplies low Competition between focal industry players is high

When is supplier power low? II
Relative bargaining power of focal firms is high: Size and concentration of focal industry firms relatives to suppliers is high Focal industry firms face little if no switching costs Focal industry firms know and understand well the cost structure of suppliers Focal industry firms can easily integrate backward

Is supplier power high in the Russian Ice Cream industry?

No evidence of supplier power
- Supplies mostly commodities (milk, sugar, packaging, ..) although prices vary seasonally - Many suppliers for most supplies + Limited local supply of high quality butter and specialist equipment

What do we look for to determine how low the threat of entry is?

The threat of entry is low when:
Economies of scale are present Incumbents have an absolute cost advantage High capital is needed to start Existing products are highly differentiated Channels of distribution are preempted or difficult to access Government and legal barriers exist Retaliation by established competitors is likely

Is the threat of entry high in the Russian Ice Cream industry?

No evident barriers to entry
Entry relatively easy as evidenced by the large numbers of new entrants New entrants seem to have lower costs than incumbents rather than the other way around Existing products are not highly differentiated Several channels of distribution are available although distributors are able to exert power No apparent government or legal barriers No apparent retaliation by incumbents to new entrants

Conclusion: The Russian Ice Cream Industry is unattractive
SUPPLIERS Bargaining power of suppliers is Low There are no Barriers to Entry MARKET COMPETITORS POTENTIAL ENTRANTS SUBSTITUTES Rivalry is high Threat of substitute products is high Customers have a High Bargaining Power BUYERS Source: Porter (1980)

Industry Analysis Step 4 - What would it take for any company to be successful in this industry; or how can we change the industry forces in our favor; aka industry key success factors

What can a generic ice cream producer do to change the industry forces in its favor?
Reduce capacity Cut costs Differentiate its products Focus on the new ‘supermarket’ retail channel and home consumption of ice cream Merge with some of the efficient regional producers to form a national company Consolidate the industry Forward vertically integrate into cafes Forward vertically integrate into distribution Forward vertically integrate into kiosks …

Generic Drivers of Industry Forces
SUPPLIER POWER Factors determining power of suppliers relative to producers same as those determining power of producers relative to buyers--see “Buyer Power” box. Generic Drivers of Industry Forces THREAT OF ENTRY economies of scale absolute cost advantages capital requirements product differentiation access to distribution channels governmental and legal barriers retaliation by established producers INDUSTRY COMPETITIVENESS concentration product differentiation excess capacity ratio of fixed to variable costs demand growth cyclical fluctuations of demand exit barriers THREAT OF SUBSTITUTES buyer propensity to substitute relative price performance of substitutes Forces Siphon II If forces weak > attractive ind. (if already in it. Entrants must pay large $ to get over business) Forces (+resources) define how firm can best compete. Forces change over time. BUYER POWER Price sensitivity cost of purchases profitability of buyers importance of the product to quality of buyers’ product Bargaining power size and concentration of buyers relative to suppliers buyers’ switching costs buyers’ information buyers’ ability to backward integrate

Generic Responses to Industry Forces
SUPPLIER POWER Reduce Suppliers’ Uniqueness Backward Vertical Integration Use Multiple Suppliers Generic Responses to Industry Forces THREAT OF ENTRY Erect barriers to entry by building: economies of scale absolute cost advantages Influence govt. policy requirements . . . Overcome barriers to entry through: product differentiation . . . INDUSTRY COMPETITIVENESS Compete on dimensions besides price Consolidate ownership Build a first-mover advantage . . . THREAT OF SUBSTITUTES Improve product’s attractiveness relative to substitutes: Lower Prices Product differentiation Move into new businesses Forces Siphon II If forces weak > attractive ind. (if already in it. Entrants must pay large $ to get over business) Forces (+resources) define how firm can best compete. Forces change over time. BUYER POWER Reduce Buyers’ Uniqueness Forward Vertical Integration Product Differentiation Target New Market Segments Source: Barney (1997)

Build up barriers to entry
Develop preferred/differentiated brands Control distribution/block distribution with a full product line Integrate vertically into distribution, retailing (kiosks) Push for increased regulation to limit entrants

Reduce rivalry Buy up small regional players (as Nestle is doing)
Increase product differentiation which will put pressure on some of the weaker producers who will then likely exit Increase demand for ice cream/per capita consumption which will ease competitive pressures

Reduce buyer power Develop differentiated brands (increase the focus on marketing) Integrate forward into distribution Integrate forward into retailing (kiosks or cafes)

Mitigate threat of substitutes
Make ice cream snacks better value for money: Increase their desirability through differentiation, or Lower prices

So many options! How to chose? Let’s first get to know Ice-Fili

What do we know about Ice-Fili?
Its performance? Its strategy? Its resources and capabilities (its leadership)?

Ice-Fili may have the highest market share but it is definitely losing ground

Ice-Fili’s Strategy/ Aspirations
Beat Nestle Dominate the market

What strategy did/will Nestle pursue?

Try and dominate the market
Produce locally to maintain low costs Develop own distribution system, kiosks, and refrigerated displays Buy up small producers (instant market access and less competition) Deep pockets and expertise

What strategy did Unilever pursue?

Forward vertical integration and differentiation
Purchased 3000 kiosks in Moscow Invested $6.2 Million in advertising to support Algida brand : with sales = 1000 tonnes, the advertising was $0.62 per portion!. Since prices probably were about Nestles (13 roubles=$0.40  advertising to sales ratio = 125%) Deep pockets and expertise and still retreated

Industry is not destiny Strength at home does not translate to strength abroad

What are the different competitor groups/segments within the Russian Ice Cream market?

What Market Positions Do Rivals Occupy?
One technique to reveal different competitive positions of industry rivals is strategic group mapping A strategic group is a cluster of firms in an industry with similar competitive approaches and market positions

What would it take to reach Ice-Fili’s goals: dominate the ice-cream industry and beat Nestle?

Dominating the market requires dominating the impulse segment
Impulse market is the most important segment in the industry: 78% of volume goes through kiosks and convenience stores (Exhibit 8) 17% of volume goes to gastronoms but even these outlets load it into mobile ice cream carts to sell it sound the streets Only 5% is consumed in restaurants (3%) or at home (2%) The non-impulse markets are likely to develop eventually but: Eat at home tubs often have lower margins Café sales also likely to be low margins since switching costs are low on premise and at home consumption are likely to be too small even in the near future Retreating from the impulse segments will make branding even more costly and the likelihood of success lower

What drives the success in the impulse market?

What drives the success in the impulse market
What drives the success in the impulse market? Profit = revenues - costs High sales: Availability Affordability (compared to pocket money) Relative affordability (compares to other snacks) Desirability: quality and brand strength (will lead to a premium price) Variety Weather Per capita consumption Controlled costs  Must haves are preferred products, strong brands, right price points, superior distribution, and lowered delivered cost

Are Russian Consumers ready to pay extra for quality ice-cream?

Are Russian Consumers ready to pay extra for quality ice-cream?
Ice-Fili’s management seems to believe that Russians want only high quality Russian Ice Cream But there is no other data in the case that supports this statement. In fact quite the opposite: Regional producers must be using lesser quality products if they are able to sell it at 3 roubles a portion and making significant inroads Nestle with an inferior ice-cream is catching up to Ice-Fili’s market share although it is selling at a price premium!!

Exercise: What is the Impact of halving the cost of dairy & oils?
Could the company increase the appeal of its products by lowering the quality of its ingredients? Exercise: What is the Impact of halving the cost of dairy & oils?

What is the Ice Cream Cost Structure in Russia?
Ingredients % of Ingredient Costs Condensed Milk Milk Powder Butter Oils Sugar Flavorings Total Ingredients 100%

Ingredients % of Ingredient Costs Condensed Milk 30% Milk Powder 12% Butter 13% Oils % Sugar 12% Flavorings 30% Total Ingredients %

Ingredients % of % of % of % of % of Retail Price Ingredients Mfg Wholesale Retail inc VAT Costs Price Price Price Condensed Milk 30% Milk Powder 12% Butter 13% Oils % Sugar 12% Flavorings 30% Total Ingredients % Packaging Labor Other Expenses Manufacturing Margins Manufacturing Price 100% Distributors Costs Distributors Margins Wholesale Price % Retails Costs Retail Margin Retail net of VAT % VAT Retail price including VAT % Use Exhibit 9

Ingredients % of % of % of % of % of Retail Price Ingredients Mfg Wholesale Retail inc VAT Costs Price Price Price Condensed Milk 30% Milk Powder 12% Butter 13% Oils % Sugar 12% Flavorings 30% Total Ingredients % Packaging Labor Other Expenses Manufacturing Margins Manufacturing Price 100% Distributors Costs Distributors Margins Wholesale Price % Retails Costs Retail Margin Retail net of VAT % 83.3 VAT Retail price including VAT %

What is the Impact of halving the cost of dairy & oils?
Ingredients % of % of % of % of % of Ing. Mfg Whl Retail RP w/ Costs Price Price Price VAT Condensed Milk 30% Milk Powder 12% Butter 13% Oils 3% Subtotal 58.0% Sugar 12% Flavorings 30% Total Ingredients % Impact of halving the costs 29%

How about Costs by Activity?

Costs by Activity? Activity % of Manufacturing Price
Labor and Overhead Labor % Other Expenses 17% Total % Breakdown of Costs by Activity Mfg Labor (90% of total labor) 11.7% SG&A Labor (10% of total) % Manufacturing Overhead (60% of total) 10.2% SG&A overhead (40% of total) % Marketing (1% of sales) % Balance of SG&A Overhead %

Activity % of Manufacturing Price Ingredients % of % of % of % of % of Retail Price Ingredients Mfg Wholesale Retail inc VAT Costs Price Price Price Condensed Milk 30% Milk Powder 12% Butter 13% Oils % Sugar 12% Flavorings 30% Total Ingredients Costs % Packaging Manufacturing Labor Manufacturing Overhead Total Manufacturing Costs SG&ALabor SG&A Overhead Marketing Total Manufacturers cost Manufacturer’s margin Manufacturing Price 100% Distribution Costs Distributors margins Wholesale Price % Retail Costs Retail Margin Retail net of VAT % VAT Retail price including VAT %

% of % of % of % of % of Retail Price Ingredients Mfg Wholesale Retail inc VAT Costs Price Price Price Ingredients Condensed Milk 30% Milk Powder 12% Butter 13% Oils 3% Sugar 12% Flavorings (cocoa, berries, etc.) 30% Total Ingredients Costs % Packaging Manufacturing Labor Manufacturing Overhead Total Manufacturing Costs SG&ALabor SG&A Overhead Marketing Total Manufacturers cost Manufacturer’s margin Manufacturing Price 100% Distribution Costs Distributors margins Wholesale Price % Retail Costs % 24.0 Retail Margin Retail net of VAT % 83.3 VAT Retail price including VAT %

What are the relative economics by Activity?
% of Retail Price Ice-Fili Nestle Regional Producers inc VAT Roubles Roubles Roubles Per portion Per Portin Per Portion Ingredients Condensed Milk Milk Powder Butter Oils Sugar Flavorings (cocoa, berries, etc.) 5.0 Total Ingredients Costs Packaging Manufacturing Labor Manufacturing Overhead Total Manufacturing Costs 30.8 SG&ALabor SG&A Overhead Marketing Total Manufacturers cost 34.0 Manufacturer’s margin Manufacturing Price 40.0 Distribution Costs 12.7 Distributors margins Wholesale Price Retail Costs Retail Margin Retail net of VAT 83.3 VAT Retail price including VAT 100%

What are your assumptions on cost differences?
Item Ice-Fili Nestle Regional Producers Assumptions Fats & Oils High Q Low Q Oil & fats at 50% of price Labor Cost Moscow 50% regional Regional Regional Labor is 50% of Moscow Overhead High Low (50%) Small players have low overhead Packaging Small players use cheap or no packaging Marketing 2% 12 times Ice-Fili Nestle spends $6 million Price per portion 6-8 roubles Derived

What are the relative economics by Activity?
% of Retail Price Ice-Fili Nestle Regional Producers inc VAT Roubles Roubles Roubles Per portion Per Portin Per Portion Ingredients Condensed Milk Milk Powder Butter Oils Sugar Flavorings (cocoa, berries, etc.) Total Ingredients Costs Packaging Manufacturing Labor Manufacturing Overhead Total Manufacturing Costs SG&ALabor SG&A Overhead Marketing Total Manufacturers cost Manufacturer’s margin Manufacturing Price Distribution Costs Distributors margins Wholesale Price Retail Costs Retail Margin Retail net of VAT VAT Retail price including VAT 100%

What are your assumptions on cost differences of Ice-Fili versus regional producers?
Nestle (as a % of wholesale price) Assumption Savings on Dairy Ingredients (Fats & Oils) 50% Lesser quality Savings on Labor Cost All regional 50% less Savings on Manufacturing Overhead Regional costs, smaller Savings on SG&A Overhead Savings on Packaging Little to no packaging Marketing spent compared to Ice-Fili 0% more Almost no marketing Manufacturers margin 10% lower

Nestle vs. Regional Producers
Ice-Fili Ice-Fili Ice-Fili Regional Regional Regional % of % of Roubles % of % of Roubles Ice-Fili Retail Per portion Co. Retail Per Portion Sales Sales Sales Sales Ingredients Dairy/Oils % Sugar % Flavorings (cocoa, berries, etc.) 12.6% Total Ingredients Costs % Packaging % Total Materials Costs 55.0% Manufacturing Labor 11.7% Manufacturing Overhead 10.2% Total Manufactured Cost 76.9% SG&A % Marketing % Total cost % Manufacturer’s margin 15.0% Manufacturing Price 100% Distributors gross Wholesale Price Retail Gross Margin Retail price net of VAT VAT Retail price including VAT 100% %

What are your assumptions on cost differences of Ice-Fili versus Nestle?
Item Nestle (as a % of manufacturing) Assumption Savings on Dairy Ingredients (Fats & Oils) 50% Lesser quality Savings on Labor Cost 25% 50% regional Savings on Manufacturing Overhead 0% Same Savings on SG&A Overhead Savings on Packaging Marketing compared to Ice-Fili 1200% more $6 vs. $500k on the same volume Manufacturers margin 10% lower Price per portion 10.5% lo Nestle 8-13

Nestle vs. Ice-Fili Ice-Fili Ice-Fili Ice-Fili Nestle Nestle Nestle
% of % of Roubles % of % of Roubles Ice-Fili Retail Per portion Co. Retail Per Portion Sales Sales Sales Sales Ingredients Dairy/Oils % Sugar % Flavorings (cocoa, berries, etc.) 12.6% Total Ingredients Costs % Packaging % Total Materials Costs 55.0% Manufacturing Labor 11.7% Manufacturing Overhead 10.2% Total Manufactured Cost 76.9% SG&A % Marketing % Total cost % Manufacturer’s margin 15.0% Manufacturing Price 100% Distributors gross Wholesale Price Retail Gross Margin Retail price net of VAT VAT Retail price including VAT 100% %

Impact of cost changes Halfing the cost of all dairy products (50% of ingredients costs) leads to a decrease in 11.6% in manufacturer’s price.  the consumers may be willing to pay for that extra quality If only the butter costs can be halved (13% of ingredients costs) overall manufacturer’s price decreases only by 2.7% ATTN: Higher quality will not lead to CA, still subject to imitation

Can Ice-Fili differentiate its products?

Evaluating differentiation
Snack category behavior and Nestle’s sales seems to indicate that branding could be effective If Ice-Fili truly has a superior product failing to advertise it is not optimal Comparing to Unilever & Nestle, a minimum level of advertising irrespective of sales seems $6 million a year so spend 10x current budget of $500k?

How much is advertising worth?
Base $Millions Volume Up 25% Price Up 10% Difference Revenues 500 625 687.5 187.5 Variable Costs 333.3 416.7 83.3 Contribution 166.7 208.3 270.8 104.2 A combination of a 10% price increase with a 25% sales increase in ice cream would increase annual contributions by over $100 Million for investment in advertising. Since the beer and soft drink categories are growing at about 25% annually this seems feasible

What should Ice-Fili not do?
Do not buy kiosks – a cash retail busines – if it can be avoided (did not provide Unilever with an advantage) Do not run ice cream parlors –also a retail business- requires huge cash outlays and very different management skills Do not pack meat, vegetables, other frozen foods, or dry ice export: A distraction from the core business. If Ice-Fili focuses it might grow 5-10 times its size in the next 5 years. Do not expand internationally: until it has a significant share of the Russian market

What Happened? The fate of Anatoly Shamanov, the largest shareholder and president of OAO Ice-Fili, the country's oldest ice-cream manufacturer, is similar in many respects to the fate of Anatoly Daursky. In 2001, he successfully fended off an attack by his former partner Viktor Lutovinov, who had bought up 30% of Ice-Fili's shares and tried to gain control over the company. At the end of 2002, Lutovinov sold his shareholdings to Guta, which immediately launched an attack on Ice-Fili. After some resistance, Shamanov had to sell his share block, although the buyer was not Guta but Russian General Bank and NIKoil (now Uralsib). Last year, Guta tried by various means to take control of the ice cream manufacturer, but the new owners fought to the bitter end. At the end of June, the parties signed a memorandum to end the corporate dispute. However, the events at Ice-Fili no longer concerned Shamanov. Company employees confirmed that after selling his shares, the former head of the refrigeration complex showed up at the premises only a few times. (By August 2005 owned 99.45% then sold it to Britain's Fleming Family & Partners investment fund who consolidated it with another company

When assessing the structural attractiveness of and industry . . .
First, define the industry Then map out who the main actors are Direct rivals Potential entrants Sellers of substitute products or services Suppliers Buyers Assess where the power is now / shifting to in future and why Quantify the impact these forces have on the viability of the business model. Finally figure out how to reverse the forces or capitalize on them in your favor

Issues with the 5 Forces Different for different firms
Framework is relatively static.. Moreover it does not take into account structural changes Political Economic Social Technological is forgotten Industry does not predetermine profitability need to also examine the resource base of the firm Ignores complementary products Industry definition is key can completely change the analysis

What about Complementors?

Complements to Competitive Interaction
Complementors The network of companies that sell products or services that are complementary to another firm’s product or service If a complementor’s product or service adds value to the sale of a firm’s product or service, it is likely to also create value for that firm. A firm can increase its chances of achieving value creation by paying attention to customers, suppliers, competitors, and complementors.

Value Creation in an Industry
SOURCE: Adapted from A. Brandenburger & B. Nalebuff, 1996, Co-opetition, New York: Currency Doubleday, 17.

Lesson #1: Defining the industry is half the battle
Many different industry definitions Initial industry definition sets the terms of the discussion for industry analysis. Industry definition may change over time, it is not etched in stone.

Lesson #2: There is no “right” industry definition
“Impulse Indulgence industry” Candy, yogurt, beer, .. are all competitors Few substitutes Too broad to be useful “Moscow ice cream industry” A large segment of the market currently served by Ice-Fili Reflects current strategic positioning Too narrow because misses potential threats and opportunities “Russian Ice-Cream Industry” Fits just right Based on what the company currently produces

Lesson #3: Check lists are written in blood
The five forces framework is a checklist to ensure that you consider all the components of the industry. Check all forces initially to ensure completeness, then hone in on key issues. Examining forces components in a generic fashion allows instantaneous identifications of possible options.

Lesson #4: Industry is not Destiny
You can make money in a lousy industry and lose money in what seems to be a very attractive industry or never manage to enter it

Profitability of US industries, 1985 - 1997

Industry is important, but it’s not everything!
Percentage of total profit variance attributable to: Estimates by McGahan & Porter Estimates by Rumelt Industry effects 19 15 Business unit effects 32 45 Corporate parent effects 4 2 Year effects 2 n/a Not explained by model 43 38 TOTAL 100 100 Source: “How Much Does Industry Matter, Really?,” Anita McGahan and Michael Porter, Strategic Mgmt Jnl, Vol. 18

Lesson #4: Industry is not Destiny
Industries indeed differ You need to figure out how to change the forces in your favor

Lesson #5: We do not have strategic solutions but a Chinese Menu 
There is no one solution to one industry problem but there are sets of potential generic solutions that can be used as a starting point

Forces (+resources) define how firm can best compete.
SUPPLIER POWER Reduce Suppliers’ Uniqueness Backward Vertical Integration Use Multiple Suppliers THREAT OF ENTRY Erect barriers to entry by building: economies of scale absolute cost advantages Influence govt. policy requirements . . . Overcome barriers to entry through: product differentiation . . . INDUSTRY COMPETITIVENESS Compete on dimensions besides price Consolidate ownership Build a first-mover advantage . . . THREAT OF SUBSTITUTES Improve product’s attractiveness relative to substitutes: Lower Prices Product differentiation Move into new businesses Forces Siphon II If forces weak > attractive ind. (if already in it. Entrants must pay large $ to get over business) Forces (+resources) define how firm can best compete. Forces change over time. BUYER POWER Reduce Buyers’ Uniqueness Forward Vertical Integration Product Differentiation Target New Market Segments Source: Barney (1997)

Next Time Case Prep: Use the Generic Case questions and Specific Questions on syllabus and board. Case Prep: Harlequin Individual Presentations of an External Analysis Read Assigned Chapters and if you can play with the quizzes.

External & Industry Analysis

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