CH-1-2 Strategic Management and Strategic Competitiveness – Strategic Management: Concepts and Cases: Competitiveness and Globalization : Chapter Notes

This Document Contains Chapters 1 to 2 Chapter 1 Strategic Management and Strategic Competitiveness LEARNING OBJECTIVES 1. Define strategic competitiveness, strategy, competitive advantage, above-average returns, and the strategic management process. 2. Describe the competitive landscape and explain how globalization and technological changes shape it. 3. Use the industrial organization (I/O) model to explain how firms can earn above-average returns. 4. Use the resource-based model to explain how firms can earn above average-returns. 5. Describe vision and mission and discuss their value. 6. Define stakeholders and describe their ability to influence organizations. 7. Describe the work of strategic leaders. 8. Explain the strategic management process. CHAPTER OUTLINE Opening Case The Global Impact of the Golden Arches THE COMPETITIVE LANDSCAPE The Global Economy Strategic Focus Starbucks is a New Economy Multinational THE I/O MODEL OF ABOVE-AVERAGE RETURNS Strategic Focus The Airlines Industry Exemplifies the I/O Model – Imitation and Poor Performance THE RESOURCE-BASED MODEL OF ABOVE-AVERAGE RETURNS VISION AND MISSION Vision Mission STAKEHOLDERS Classifications of Stakeholders STRATEGIC LEADERS The Work of Effective Strategic Leaders Predicting Outcomes of Strategic Decisions: Profit Pools THE STRATEGIC MANAGEMENT PROCESS SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES VIDEO CASE This Document Contains Chapters 1 to 2 LECTURE NOTES Chapter Introduction: You may want to begin this lecture with a general comment that Chapter 1 provides an overview of the strategic management process. This chapter introduces a number of key terms and models that students will study in more detail in Chapters 2 through 13. Stress the importance of students paying careful attention to the concepts introduced in this chapter so that they are well-grounded in strategic management concepts before proceeding further. OPENING CASE The Global Impact of the Golden Arches McDonald’s is a global company with broad market penetration and an extremely strong brand. It is larger and more successful than its rivals. As the case notes, however, McDonald’s success makes it an easy target. Public reaction to a 2012 ad turned from positive to negative as criticism of its food and link to the obesity problem were spread via social media. The company responded by offering healthy menu options and including nutritional information on its packaging. It also has added Wi-Fi in its stores to attract more customers (especially students). Even though the company is successful it must be constantly aware of changing conditions that might impact its costs, demand, and ability to perform. Teaching Note: To initiate discussion, ask how the case lays the groundwork for the importance of strategy as defined in the chapter—the coordinated set of commitments and actions designed to achieve competitive advantage. Ask students identify other ways that McDonald’s has responded to the many environmental changes that it is experiencing. The case also provides a nice lead-in to discuss global strategy and how companies compete in very different markets. Ask students if they have been to a McDonald’s in another country and, if so, to identify some of the ways the company caters to local conditions. 1 Define strategic competitiveness, strategy, competitive advantage, above-average returns, and the strategic management process. Strategic competitiveness is achieved when a firm successfully formulates and implements a value-creating strategy. By implementing a value-creating strategy that current and potential competitors are not simultaneously implementing and that competitors are unable to duplicate, or find too costly to imitate, a firm achieves a competitive advantage. Strategy can be defined as an integrated and coordinated set of commitments and actions designed to exploit core competencies and gain a competitive advantage. So long as a firm can sustain (or maintain) a competitive advantage, investors will earn above-average returns. Above-average returns represent returns that exceed returns that investors expect to earn from other investments with similar levels of risk (investor uncertainty about the economic gains or losses that will result from a particular investment). In other words, above average-returns exceed investors’ expected levels of return for given risk levels. Teaching Note: Point out that in the long run, firms must earn at least average returns and provide investors with average returns if they are to survive. If a firm earns below-average returns and provides investors with below-average returns, investors will withdraw their funds and place them in investments that earn at least average returns. At this point it may be useful to highlight the role institutional investors play in regulating above average performances. In smaller new venture firms, performance is sometimes measured in terms of the amount and speed of growth rather than more traditional profitability measures—new ventures require time to earn acceptable returns. A framework that can assist firms in their quest for strategic competitiveness is the strategic management process, the full set of commitments, decisions and actions required for a firm to systematically achieve strategic competitiveness and earn above-average returns. This process is illustrated in Figure 1.1. FIGURE 1.1 The Strategic Management Process Figure 1.1 illustrates the dynamic, interrelated nature of the elements of the strategic management process and provides an outline of where the different elements of the process are covered in this text. Feedback linkages among the three primary elements indicate the dynamic nature of the strategic management process: strategic inputs, strategic actions, and strategic outcomes. • Analysis, in the form of information gained by scrutinizing the internal environment and scanning the external environment, are used to develop the firm's vision and mission. • Strategic actions are guided by the firm's vision and mission, and are represented by strategies that are formulated or developed and subsequently implemented or put into action. • Desired performance—strategic competitiveness and above-average returns—result when a firm is able to successfully formulate and implement value-creating strategies that others are unable to duplicate. • Feedback links the elements of the strategic management process together and helps firms continuously adjust or revise strategic inputs and strategic actions in order to achieve desired strategic outcomes. In addition to describing the impact of globalization and technological change on the current business environment, this chapter also discusses two approaches to the strategic management process. The first, the industrial organization model, suggests that the external environment should be considered as the primary determinant of a firm’s strategic actions. The second is the resource-based model, which perceives the firm’s resources and capabilities (the internal environment) as critical links to strategic competitiveness. Following the discussion in this chapter, as well as in Chapters 2 and 3, students should see that these models must be integrated to achieve strategic competitiveness. 2 Describe the competitive landscape and explain how globalization and technological changes shape it. THE COMPETITIVE LANDSCAPE The competitive landscape can be described as one in which the fundamental nature of competition is changing in a number of the world’s industries. Further, the boundaries of industries are becoming blurred and more difficult to define. Consider recent changes that have taken place in the telecommunication and TV industries— e.g., not only cable companies and satellite networks compete for entertainment revenue from television, but telecommunication companies also are stepping into the entertainment business through significant improvements in fiber-optic lines. Partnerships further blur industry boundaries (e.g., MSNBC is co-owned by NBC, itself owned by General Electric and Microsoft). The contemporary competitive landscape thus implies that traditional sources of competitive advantage—economies of scale and large advertising budgets—may not be as important in the future as they were in the past. The rapid and unpredictable technological change that characterizes this new competitive landscape implies that managers must adopt new ways of thinking. The new competitive mind-set must value flexibility, speed, innovation, integration, and the challenges that evolve from constantly changing conditions. A term often used to describe the new realities of competition is hypercompetition, a condition that results from the dynamics of strategic moves and countermoves among innovative, global firms: a condition of rapidly escalating competition that is based on price- quality positioning, efforts to create new know-how and achieve first-mover advantage, and battles to protect or to invade established product or geographic markets (discussed in more detail in Chapter 5). The Global Economy A global economy is one in which goods, services, people, skills, and ideas move freely across geographic borders. The emergence of this global economy results in a number of challenges and opportunities. For instance, Europe is now the world’s largest single market (despite the difficulties of adapting to multiple national cultures and the lack of a single currency. The European Union has become one of the world’s largest markets, with 700 million potential customers. Today, China is seen as an extremely competitive market in which local market-seeking MNCs (multinational corporations) fiercely compete against other MNCs and local low-cost producers. China has long been viewed as a low-cost producer of goods, but here’s an interesting twist. China is now an exporter of local management talent. Procter & Gamble actually exports Chinese management talent; it has been dispatching more Chinese abroad than it has been importing expatriates to China. Teaching Note: The relative competitiveness of nations can be found in the World Economic Forum’s Global Competitiveness Report, which can be accessed for free on the Internet. It is useful to assemble these data into an overhead or PowerPoint slide and show it in class. Students find it interesting to see where their country stands relative to the others listed. Allow enough time for them to see these numbers and sort out what it all means. STRATEGIC FOCUS Starbucks is a New Economy Multinational Starbucks is a large and innovative multinational firm with growth expectations in both its domestic and international markets. It plans to significantly increase its presence in Asian markets and has tailored its strategy to local conditions to position itself for growth (store size, flavors, and teas). In fact, Starbucks expects China to become its second largest market in the very near future. Vietnam and India are additional markets the company is targeting. On the other hand, the company’s experience in Europe has been mixed. The European ‘coffee culture,’ built around the café experience, was difficult for the company to penetrate with its traditional business model. To grow in Europe, Starbucks is now building larger stores to improve seating and encourage customers to linger, and developed products to appeal to local (country) cultures and tastes. In addition, the company has set its sights on other markets (instant coffee, single-serving coffee, tea, juice, and bakery). Teaching Note: Starbucks helps illustrate just how global business has become and how companies must adapt strategy to align with local conditions. A one- size-fits-all approach probably has limited potential for success, especially in consumer products. Ask students if they have visited a Starbucks in another country and, if so, to identify some of the ways the company caters to local conditions. Ask students to evaluate the importance of the Starbucks brand as it continues to expand and what might hinder the company’s expansion efforts in the countries profiled in the Strategic Focus. The March of Globalization Globalization is the increasing economic interdependence among countries as reflected in the flow of goods and services, financial capital, and knowledge across country borders. This is illustrated by the following: • Financial capital might be obtained in one national market and used to buy raw materials in another one. • Manufacturing equipment bought from another market produces products sold in yet another market. • Globalization enhances the available range of opportunities for firms. Global competition has increased performance standards in many dimensions, including quality, cost, productivity, product introduction time, and operational efficiency. Moreover, these standards are not static; they are exacting, requiring continuous improvement from a firm and its employees. Thus, companies must improve their capabilities and individual workers need to sharpen their skills. In the twenty-first century competitive landscape, only firms that meet, and perhaps exceed, global standards are likely to earn strategic competitiveness. Teaching Note: As a result of the new competitive landscape, firms of all sizes must re-think how they can achieve strategic competitiveness by positioning themselves to ask questions from a more global perspective to enable them to (at least) meet or exceed global standards: • Where should value-adding activities be performed? • Where are the most cost-effective markets for new capital? • Can products designed in one market be successfully adapted for sale in others? • How can we develop cooperative relationships or joint ventures with other firms that will enable us to capitalize on international growth opportunities? Although globalization seems an attractive strategy for competing in the current competitive landscape, there are risks as well. These include such factors as: • The “liability of foreignness” (i.e., the risk of competing internationally) • Overdiversification beyond the firm’s ability to successfully manage operations in multiple foreign markets A point to emphasize: entry into international markets requires proper use of the strategic management process. Though global markets are attractive strategic options for some companies, they are not the only source of strategic competitiveness. In fact, for most companies, even for those capable of competing successfully in global markets, it is critical to remain committed to and strategically competitive in the domestic market. And domestic markets can be testing grounds for possibly entering an international market at some point in the future. Teaching Note: Indicate that the risks that often accompany internationalization and strategies for minimizing their impact on firms are discussed in more detail in Chapter 8. Teaching Note: As a result of globalization and the spread of technology, competition will become more intense. Some principles to consider include the following: • Customers will continue to expect high levels of product quality at competitive prices. • Global competition will continue to pressure companies to shorten product development-introduction time frames. • Strategically competitive companies successfully leverage insights learned both in domestic and global markets, modifying them as necessary. • Before a company can hope to achieve any measure of success in global markets, it must be strategically competitive in its domestic market. Technology and Technological Changes Three technological trends and conditions are significantly altering the nature of competition: • Increasing rate of technological change and diffusion • The information age • Increasing knowledge intensity Technologic Diffusion and Disruptive Technologies Both the rate of change and the introduction of new technologies have increased greatly over the last 15 to 20 years. A term that is used to describe rapid and consistent replacement of current technologies by new, information-intensive technologies is perpetual innovation. This implies that innovation—discussed in more detail in Chapter 13—must be continuous and carry a high priority for all organizations. The shorter product life cycles that result from rapid diffusion of innovation often means that products may be replicated within very short time periods, placing a competitive premium on a firm’s ability to rapidly introduce new products into the marketplace. In fact, speed-to-market may become the sole source of competitive advantage. In the computer industry during the early 1980s, hard disk drives would typically remain current for four to six years, after which a new and better product became available. By the late 1980s, the expected life had fallen to two to three years. By the 1990s, it was just six to nine months. The rapid diffusion of innovation may have made patents a source of competitive advantage only in the pharmaceutical and chemical industries. Many firms do not file patent applications to safeguard (for at least a time) the technical knowledge that would be disclosed explicitly in a patent application. Disruptive technologies (in line with the Schumpeterian notion of “creative destruction”) can destroy the value of existing technologies by replacing them with new ones. Current examples include the success of iPods, PDAs, and WiFi. The Information Age Changes in information technology have made rapid access to information available to firms all over the world, regardless of size. Consider the rapid growth in the following technologies: personal computers (PCs), cellular phones, computers, personal digital assistants (PDAs), artificial intelligence, virtual reality, and massive databases. These examples show how information is used differently as a result of new technologies. The ability to access and use information has become an important source of competitive advantage in almost every industry. • There have been dramatic changes in information technology in recent years. • The number of PCs is expected to grow to 2.3 billion by 2015. • The declining cost of information technology. • The Internet provides an information-carrying infrastructure available to individuals and firms worldwide. The ability to access a high level of relatively inexpensive information has created strategic opportunities for many information-intensive businesses. For example, retailers now can use the Internet to provide shopping to customers virtually anywhere. Increasing Knowledge Intensity It is becoming increasingly apparent that knowledge—information, intelligence, and expertise—is a critical organizational resource, and increasingly, a source of competitive advantage. As a result, • Many companies are working to convert the accumulated knowledge of employees into a corporate asset; • Shareholder value is increasingly influenced by the value of a firm’s intangible assets, such as knowledge; • There is a strong link between knowledge and innovation. Note: Intangible assets are discussed more fully in Chapter 3. Teaching Note: This means that to achieve competitive advantage in the information-intensive competitive landscape, firms must move beyond accessing information to exploiting information by: • Capturing intelligence • Transforming intelligence into usable knowledge • Embedding it as organizational learning • Diffusing it rapidly throughout the organization The implication of this discussion is that to achieve strategic competitiveness and earn above-average returns, firms must develop the ability to adapt rapidly to change or achieve strategic flexibility. Strategic flexibility represents the set of capabilities—in all areas of their operations—that firms use to respond to the various demands and opportunities that are found in dynamic, uncertain environments. This implies that firms must develop certain capabilities, including the capacity to learn continuously, that will provide the firm with new skill sets. However, those working within firms to develop strategic flexibility should understand that the task is not an easy one, largely because of inertia that can build up over time. A firm’s focus and past core competencies may actually slow change and strategic flexibility. Teaching Note: Firms capable of rapidly and broadly applying what they learn achieve strategic flexibility and the resulting capacity to change in ways that will increase the probability of succeeding in uncertain, hypercompetitive environments. Some firms must change dramatically to remain competitive or return to competitiveness. How often are firms able to make this shift? Overall, does it take more effort to make small, periodic changes, or to wait and make more dramatic changes when these become necessary? Two models describing key strategic inputs to a firm's strategic actions are discussed next: the Industrial Organization (or externally focused) model and the Resource-Based (or internally focused) model. 3 Use the industrial organization (I/O) model to explain how firms can earn above-average returns. THE I/O MODEL OF ABOVE AVERAGE RETURNS Teaching Note: The recommended teaching strategy for this section is to first discuss the assumptions underlying the I/O model. Then use Figure 1.2 to introduce linkages in the I/O model and provide the background for an expanded discussion of the model in Chapter 2. The I/O or Industrial Organization model adopts an external perspective to explain that forces outside of the organization represent the dominant influences on a firm's strategic actions. In other words, this model presumes that the characteristics of and conditions present in the external environment determine the appropriateness of strategies that are formulated and implemented in order for a firm to earn above-average returns. In short, the I/O model specifies that the choice of industries in which to compete has more influence on firm performance than the decisions made by managers inside their firm. The I/O model is based on the following four assumptions: 1. The external environment—the general, industry, and competitive environments impose pressures and constraints on firms and determine strategies that will result in superior returns. In other words, the external environment pressures the firm to adopt strategies to meet that pressure while simultaneously constraining or limiting the scope of strategies that might be appropriate and eventually successful. 2. Most firms competing in an industry or in an industry segment control similar sets of strategically relevant resources and thus pursue similar strategies. This assumption presumes that, given a similar availability of resources, most firms competing in a specific industry (or industry segment) have similar capabilities and thus follow strategies that are similar. In other words, there are few significant differences among firms in an industry. 3. Resources used to implement strategies are highly mobile across firms. Significant differences in strategically relevant resources among firms in an industry tend to disappear because of resource mobility. Thus, any resource differences soon disappear as they are observed and acquired or learned by other firms in the industry. 4. Organizational decision-makers are assumed to be rational and committed to acting only in the best interests of the firm. The implication of this assumption is that organizational decision-makers will consistently exhibit profit-maximizing behaviors. According to the I/O model, which was a dominant paradigm from the 1960s through the 1980s, firms must pay careful attention to the structured characteristics of the industry in which they choose to compete, searching for one that is the most attractive to the firm, given the firm's strategically relevant resources. Then, the firm must be able to successfully implement strategies required by the industry's characteristics to be able to increase their level of competitiveness. The five forces model is an analytical tool used to address and describe these industry characteristics. FIGURE 1.2 The I/O Model of Above-Average Returns Based on its four underlying assumptions, the I/O model prescribes a five-step process for firms to achieve above-average returns: 1. Study the external environment—general, industry, and competitive—to determine the characteristics of the external environment that will both determine and constrain the firm's strategic alternatives. 2. Locate an industry (or industries) with a high potential for returns based on the structural characteristics of the industry. A model for assessing these characteristics, the Five Forces Model of Competition, is discussed in Chapter 2. 3. Based on the characteristics of the industry in which the firm chooses to compete, strategies that are linked with above-average returns should be selected. A model or framework that can be used to assess the requirements and risks of these strategies (the generic strategies called cost leadership & differentiation) are discussed in detail in Chapter 4. 4. Acquire or develop the critical resources—skills and assets—needed to successfully implement the strategy that has been selected. A process for scrutinizing the internal environment to identify the presence or absence of critical skills is discussed in Chapter 3. Skill-enhancement strategies, including training and development, are discussed in Chapter 11. 5. The I/O model indicates that above-average returns will accrue to firms that successfully implement relevant strategic actions that enable the firm to leverage its strengths (skills and resources) to meet the demands or pressures and constraints of the industry in which it has elected to compete. The implementation process is described in Chapters 10 through 13. The I/O model has been supported by research indicating: • 20% of firm profitability can be explained by industry characteristics • 36% of firm profitability can be attributed to firm characteristics and the actions taken by the firm • Overall, this indicates a reciprocal relationship—or even an interrelationship—between industry characteristics (attractiveness) and firm strategies that result in firm performance STRATEGIC FOCUS The Airlines Industry Exemplifies the I/O Model – Imitation and Poor Performance The airline industry is a real-world example of the I/O model. Airlines are very similar with respect to services, routes, and performance since the industry was deregulated. When an airline does adapt something new, it is commonly imitated very quickly. A major characteristic of the industry, both in the U.S. and Europe, is consolidation. This does little to spur differentiation among competitors. The primary source of competitive advantage comes from making fewer mistakes such as lost bags, flight cancellations, and delays. In the current environment, most airlines are trying to cut costs (sometimes through scale), and generate revenue by charging for amenities that used to be provided at no cost to travelers. In the Strategic Focus, Southwest Airlines is noted as a strong performer due to the fact that it is both efficient and has developed resources and capabilities over time that its more traditional rivals have not. Teaching Note: The airline industry has not been an attractive industry for quite some time. Even the best performers produce results that are much weaker than the average performers of many other industries. Ask students to compare some of the airlines profiled in the Strategic Focus. Ask them what factors are most important to them when they purchase a ticket and what airlines might be able to do to get their business. 4 Use the resource-based model to explain how firms can earn above average-returns. THE RESOURCE-BASED MODEL OF ABOVE-AVERAGE RETURNS Teaching Note: The recommended teaching strategy for this section is similar to that suggested for the I/O model. First explain the assumptions of the resource-based model. Then use Figure 1.3 to introduce linkages in the resource-based model and provide the background for an expanded discussion of the model in Chapter 3. The resource-based model adopts an internal perspective to explain how a firm's unique bundle or collection of internal resources and capabilities represent the foundation on which value-creating strategies should be built. Resources are inputs into a firm's production process, such as capital equipment, individual employee's skills, patents, brand names, finance, and talented managers. These resources can be tangible or intangible. Capabilities are the capacity for a set of resources to perform—integratively or in combination—a task or activity. Teaching Note: Thus, according to the resource-based model, a firm's resources and capabilities—found in its internal environment—are more critical to determining the appropriateness of strategic actions than are the conditions and characteristics of the external environment. So, strategies should be selected that enable the firm to best exploit its core competencies, relative to opportunities in the external environment. One example of this is the experience of Amazon that used its capabilities to market and distribute books using the Internet successfully to capture a 20-month first-mover advantage in this new marketplace. However, Amazon’s capabilities may be imitable. In fact, many experts expect that Barnes & Noble will continue to be a formidable competitor due to its extensive resources. Core competencies are resources and capabilities that serve as a source of competitive advantage for a firm. Often related to functional skills (e.g., marketing at Philip Morris), core competencies—when developed, nurtured, and applied throughout a firm—may result in strategic competitiveness. FIGURE 1.3 The Resource-Based Model of Above-Average Returns The resource-based model of above-average returns is grounded in the uniqueness of a firm's internal resources and capabilities. The five-step model describes the linkages between resource identification and strategy selection that will lead to above-average returns. 1. Firms should identify their internal resources and assess their strengths and weaknesses. The strengths and weaknesses of firm resources should be assessed relative to competitors. 2. Firms should identify the set of resources that provide the firm with capabilities that are unique to the firm, relative to its competitors. The firm should identify those capabilities that enable the firm to perform a task or activity better than its competitors. 3. Firms should determine the potential for their unique sets of resources and capabilities to outperform rivals in terms of returns. Determine how a firm’s resources and capabilities can be used to gain competitive advantage. 4. Locate an attractive industry. Determine the industry that provides the best fit between the characteristics of the industry and the firm’s resources and capabilities. 5. To attain a sustainable competitive advantage and earn above-average returns, firms should formulate and implement strategies that enable them to exploit their resources and capabilities to take advantage of opportunities in the external environment better than their competitors. Resources and capabilities can lead to a competitive advantage when they are valuable, rare, costly to imitate, and non-substitutable. • Resources are valuable when they support taking advantage of opportunities or neutralizing external threats. • Resources are rare when possessed by few, if any, competitors. • Resources are costly to imitate when other firms cannot obtain them inexpensively (relative to other firms). • Resources are non-substitutable when they have no structural equivalents. 5 Describe vision and mission and discuss their value. VISION AND MISSION Teaching Note: Refer students to Figure 1.1 that indicates the link or relationship between identifying a firm's internal resources and capabilities and the conditions and characteristics of the external environment with the development of the firm's vision and mission. Vision Vision is a picture of what the firm wants to be, and in broad terms, what it wants to ultimately achieve. Vision is “big picture” thinking with passion that helps people feel what they are supposed to be doing. Vision statements: • Reflect a firm’s values and aspirations • Are intended to capture the heart and mind of each employee (and hopefully, many of its other stakeholders) • Tend to be enduring, whereas its mission can change in light of changing environmental conditions • Tend to be relatively short and concise, easily remembered • Rely on input from multiple key stakeholders Examples of vision statements: • Our vision is to be the world’s best quick service restaurant. (McDonald’s) • To make the automobile accessible to every American (Ford’s vision when established by Henry Ford) The CEO is responsible for working with others to form the firm’s vision. However, experience shows that the most effective vision statement results when the CEO involves a host of people to develop it. A vision statement should be clearly tied to the conditions in the firm’s external and internal environments and it must be achievable. Moreover, the decisions and actions of those involved with developing the vision must be consistent with that vision. Mission A firm's mission is an externally focused application of its vision that states the firm's unique purpose and the scope of its operations in product and market terms. As with the vision, the final responsibility for forming the firm’s mission rests with the CEO, though the CEO and other top-level managers tend to involve a larger number of people in forming the mission. This is because middle- and first-level managers and other employees have more direct contact with customers and their markets. A firm's vision and mission must provide the guidance that enables the firm to achieve the desired strategic outcomes—strategic competitiveness and above-average returns— illustrated in Figure 1.1 that enable the firm to satisfy the demands of those parties having an interest in the firm's success: organizational stakeholders. Earning above-average returns often is not mentioned in mission statements. The reasons for this are that all firms want to earn above-average returns and that desired financial outcomes result from properly serving certain customers while trying to achieve the firm’s intended future. In fact, research has shown that having an effectively formed vision and mission has a positive effect on performance (growth in sales, profits, employment, and net worth). 6 Define stakeholders and describe their ability to influence organizations. STAKEHOLDERS Stakeholders are the individuals and groups who can affect and are affected by the strategic outcomes achieved and who have enforceable claims on a firm's performance. Classification of Stakeholders The stakeholder concept reflects that individuals and groups have a "stake" in the strategic outcomes of the firm because they can be either positively or negatively affected by those outcomes and because achieving the strategic outcomes may be dependent on the support or active participation of certain stakeholder groups. Figure Note: Students can use Figure 1.4 to visualize the three stakeholder groups. FIGURE 1.4 The Three Stakeholder Groups Figure 1.4 provides a definition of a stakeholder and illustrates the three general classifications and members of each stakeholder group: • Capital market stakeholders • Product market stakeholders • Organizational stakeholders Note: Students can use Figure 1.4 while you discuss the challenges of meeting conflicting stakeholder expectations. Teaching Note: The following table was developed from the text’s presentation (and more) to assist you in organizing a discussion of each stakeholder group's expectations or demands, potential conflicts, and stakeholder management strategies. Stakeholder Groups, Membership and Primary Expectation or Demand Stakeholder group Membership Primary expectation/demand Capital market Shareholders Wealth enhancement Lenders Wealth preservation Product market Customers Product reliability at lowest possible price Suppliers Receive highest sustainable prices Host communities Long-term employment, tax revenues, minimum use of public support services Unions Ideal working conditions and job security for membership Organizational Employees Secure, dynamic, stimulating, and rewarding work environment Teaching Note: From reviewing the primary expectations or demands of each stakeholder group, it becomes obvious that a potential for conflict exists. For instance, shareholders generally invest for wealth-maximization purposes and are therefore interested in a firm's maximizing its return on investment or ROI. However, if a firm increases its ROI by making short-term decisions, the firm can negatively affect employee or customer stakeholders. If the firm is strategically competitive and earns above-average returns, it can afford to simultaneously satisfy all stakeholders. When earning average or below-average returns, tradeoffs must be made. At the level of average returns, firms must at least minimally satisfy all stakeholders. When returns are below average, some stakeholders can be minimally satisfied, while others may be dissatisfied. For example, reducing the level of research and development expenditures (to increase short- term profits) enables the firm to pay out the additional short-term profits to shareholders as dividends. However, if reducing R&D expenditures results in a decline in the long-term strategic competitiveness of the firm's products or services, it is possible that employees will not enjoy a secure or rewarding career environment (which violates a primary union expectation or demand for job security for its membership). At the same time, customers may be offered products that are less reliable at unattractive prices, relative to those offered by firms that did not reduce R&D expenditures. Thus, the stakeholder management process may involve a series of tradeoffs that is dependent on the extent to which the firm is dependent on the support of each affected stakeholder and the firm's ability to earn above-average returns. Teaching Note: Stakeholder management has introduced some interesting notions into business practice. For example, business schools typically teach that there are three main stakeholder groups (owners, customers, and employees) and that they should be tended to in that order. That is, it is important to begin with the idea that the primary purpose of the firm is to maximize shareholder wealth (i.e., tend to the interests of the owners first). Then it is common to introduce notions such as, “The customer is always right.” This suggests that customer interests are to be tended to next. Finally, we get around to looking to the needs of employees, if resources make that possible. This is the standard approach, but some firms have turned this idea on its head. For example, Southwest Airlines has been extremely successful by taking great efforts to select the right employees and treat them well, which then spills over into appropriate treatment of the customer. As you might guess, the company assumes that these emphases will naturally lead to positive outcomes for stockholders as well (as has been the case). This issue can lead to interesting discussions with students about their thoughts on the topic. 7 Describe the work of strategic leaders. STRATEGIC LEADERS Teaching Note: One way of covering this section is through a series of questions and answers as presented in the following format. Who are strategic leaders? Although it depends on the size of the organization, all organizations have a CEO or top manager and this individual is the primary organizational strategist in every organization. Small organizations may have a single strategist: the CEO or owner. Large organizations may have few or several top-level managers, executives, or a top management team. All of these individuals are organizational strategists. What are the responsibilities of strategic leaders? Top managers play decisive roles in firms’ efforts to achieve their desired strategic outcomes. As organizational strategists, top managers are responsible for deciding how resources will be developed or acquired, at what cost, and how they will be used or allocated throughout the organization. Strategists also must consider the risks of actions under consideration, along with the firm’s vision and managers’ strategic orientations. Organizational strategists also are responsible for determining how the organization does business. This responsibility is reflected in the organizational culture, which refers to the complex set of ideologies, symbols, and core values shared throughout the firm and that influences the way it conducts business. The organization’s culture is the social energy that drives—or fails to drive—the organization. The Work of Effective Strategic Leaders Though it seems simplistic, performing their role effectively requires strategists to work hard, perform thorough analyses of available information, be brutally honest, desire high performance, exercise common sense, think clearly, and ask questions and listen. In addition, strategic leaders must be able to “think seriously and deeply … about the purposes of the organizations they head or functions they perform, about the strategies, tactics, technologies, systems, and people necessary to attain these purposes and about the important questions that always need to be asked.” Additionally, effective strategic leaders work to set an ethical tone in their firms. Strategists work long hours and face ambiguous decision situations, but they also have opportunities to dream and act in concert with a compelling vision that motivates others in creating competitive advantage. Predicting Outcomes of Strategic Decisions: Profit Pools Top-level managers try to predict the outcomes of their strategic decisions before they are implemented, but this is sometimes very difficult to do. Those firms that do a better job of anticipating the outcomes of strategic moves will obviously be in a better position to succeed. One way to do this is by mapping out the profit pools of an industry. Profit pools are the total profits earned in an industry at all points along the value chain. Four steps are involved: 1. Define the pool’s boundaries 2. Estimate the pool’s overall size 3. Estimate the size of the value-chain activity in the pool 4. Reconcile the calculations 8 Explain the strategic management process. THE STRATEGIC MANAGEMENT PROCESS Teaching Note: The final section of this chapter reviews Figure 1.1 (The Strategic Management Process), providing both an outline of the process and the framework for the next 12 chapters. Thus, students should refer back to Figure 1.1 as you present the material to come next. Chapters 2 and 3 provide more detail regarding the strategic inputs to the strategic management process: analysis of the firm's external and internal environments that must be performed so that sufficient knowledge is developed regarding external opportunities and internal capabilities. This enables the development of the firm's vision and mission. Chapters 4 through 9 discuss the strategy formulation stage of the process. Topics covered include: • Deciding on business-level strategy, or how to compete in a given business (Chapter 4) • Understanding competitive dynamics, in that strategies are not formulated and implemented in isolation but require understanding and responding to competitors' actions (Chapter 5) • Setting corporate-level strategy, or deciding in which industries or businesses the firm will compete, how resources will be allocated, and how the different business units will be managed (Chapter 6) • The acquisition of business units and the restructuring of the firm’s portfolio of businesses (Chapter 7) • Selecting appropriate international strategies that are consistent with the firm's resources, capabilities and core competencies, and external opportunities (Chapter 8) • Developing cooperative strategies with other firms to gain competitive advantage (Chapter 9) The final section of the text, Chapters 10–13, examines actions necessary to effectively implement strategies. Effective implementation has a significant impact on firm performance. Topics covered include: • Methods for governing to ensure satisfaction of stakeholder demands and attainment of strategic outcomes (Chapter 10) • Structures that are used and actions taken to control a firm's operations (Chapter 11) • Patterns of strategic leadership that are most appropriate given the competitive environment (Chapter 12) • Linkages among corporate entrepreneurship, innovation, and strategic competitiveness (Chapter 13) Teaching Note: Students should realize that none of the chapters stands alone, just as no single step or facet of the strategic management process stands alone. If the strategic management process is to result in a firm being strategically competitive and earning above-average returns, all facets of the process must be treated as both interdependent and interrelated. Chapter 2 The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis LEARNING OBJECTIVES 1. Explain the importance of analyzing and understanding the firm’s external environment. 2. Define and describe the general environment and the industry environment. 3. Discuss the four parts of the external environmental analysis process. 4. Name and describe the general environment’s seven segments. 5. Identify the five competitive forces and explain how they determine an industry’s profit potential. 6. Define strategic groups and describe their influence on firms. 7. Describe what firms need to know about their competitors and different methods (including ethical standards) used to collect intelligence about them. CHAPTER OUTLINE Opening Case The Coca-Cola Co and Pepsico: Rivals Competing in a Challenging Environment THE GENERAL, INDUSTRY, AND COMPETITOR ENVIRONMENTS EXTERNAL ENVIRONMENTAL ANALYSIS Scanning Monitoring Forecasting Assessing SEGMENTS OF THE GENERAL ENVIRONMENT The Demographic Segment The Economic Segment The Political/Legal Segment The Sociocultural Segment The Technological Segment The Global Segment Strategic Focus The Informal Economy: What It Is and Why It Is Important The Physical Environment Segment INDUSTRY ENVIRONMENT ANALYSIS Threat of New Entrants Bargaining Power of Suppliers Bargaining Power of Buyers Threat of Substitute Products Intensity of Rivalry among Competitors INTERPRETING INDUSTRY ANALYSES STRATEGIC GROUPS Strategic Focus German Performance/Luxury Cars: If You Have Seen One, Have You Seen Them All? COMPETITOR ANALYSIS ETHICAL CONSIDERATIONS SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES VIDEO CASE LECTURE NOTES Chapter Introduction: This chapter can be introduced with a general statement regarding the importance of understanding what is happening outside of the firm itself and how what is happening can affect the firm’s ability to achieve strategic competitiveness and earn above-average returns. This importance is illustrated by the Opening Case, which discusses the impact events in the external environment can have on a firm’s performance. OPENING CASE The Coca-Cola Co and Pepsico: Rivals Competing in a Challenging Environment The opening case illustrates how both Coca-Cola and Pepsico can use information from the general environment to develop plans for the future. Rivalry between these two companies is intense and it plays out on a global stage. However, these companies have not followed identical paths. Pepsico is more diversified than Coca-Cola due to its presence in the snack food industry (Frito Lay). Coca-Cola has focused more on beverages, including juice and juice products, where it is the largest producer in the world. Changing environmental conditions are driving both companies’ evolution in terms of businesses they are competing in, products/services they are developing, and how they structure their value chains to achieve competitive advantage. Taken together, one can see that assessing the influence of factors in the general environment is important for planning for future success. Teaching Note: The opening case lays out how Coca-Cola and Pepsico use information from the general environment to make strategic decisions. The case provides a vehicle for discussing how the environment affects both corporate-level strategy and business-level strategy. As an opening discussion question, ask students to identify and discuss examples of how these companies might base their strategies on information from the general environment that is NOT included in the text. Are there other industries that they might want to get into? Are there other products/services that either company could develop to address changing conditions? 1 Explain the importance of analyzing and understanding the firm’s external environment. Teaching Note: Given that the external environment will continue to change—and that change may be unpredictable in terms of timing and strength—a firm’s management is challenged to be aware of, understand the implications of, and identify patterns represented in these changes by taking actions to improve the firm’s competitive position, to improve operational efficiency, and to be effective global competitors. External environmental factors—like war and political unrest, variations in the strength of national economies, and new technologies—affect firm growth and profitability in the US and beyond. Environmental conditions in the current global economy differ from those previously faced by firms: • Technological advances require more timely and effective competitive actions and responses. • Rapid sociological changes abroad affect labor practices and product demand of diverse consumers. • Governmental policies and laws affect where and how firms may choose to compete. • Changes to nations’ financial regulatory systems. Understanding the external environment helps build the firm’s base of knowledge and information that can be used to: (1) help build new capabilities and core competencies, (2) buffer the firm from negative environmental impacts, and (3) pursue opportunities to better serve stakeholders’ needs. Teaching Note: This section introduces definitions, Figure 2.1 (which deals with the external environment), and the competitor/industry environment. Because of the chapter layout, it is best to delay a detailed presentation or discussion of the general environment until after discussing the external environmental analysis process because the characteristics of the general environment are presented in more detail later in the chapter. 2 Define and describe the general environment and the industry environment. Teaching Note: The firm’s understanding of the external environment is matched with knowledge about its internal environment (discussed in Chapter 3) to form its vision, to develop its mission, and to take strategic actions that result in strategic competitiveness and above-average returns. This is an important point to make. THE GENERAL, INDUSTRY, AND COMPETITOR ENVIRONMENTS FIGURE 2.1 The External Environment Figure 2.1 illustrates the three components of a firm’s external environment and the elements or factors that are part of each component. They are: 1. The general environment • Demographic • Political/Legal • Sociocultural • Economic • Technological • Global • Physical 2. The industry environment • Threat of New Entrants • Power of Buyers • Power of Suppliers • Intensity of Rivalry • Product Substitutes 3. The competitor environment (Note: These components of the external environment and their elements or factors and how they are related to each and to firm performance will be discussed in detail in later sections of the chapter.) The general environment is composed of elements in the broader society that can indirectly influence an industry and the firms within the industry. But firms cannot directly control the general environment’s segments and elements. TABLE 2.1 The General Environment: Segments and Elements Table 2.1 lists elements that characterize each of the seven segments of the general environment: demographic, economic, political/legal, sociocultural, technological, global, and physical. Each of these segments is discussed in more detail later in this chapter, following a discussion of the external environmental analysis process. The industry environment is the set of factors—threat of new entrants, suppliers, buyers, product substitutes, and the intensity of rivalry among competitors—that directly influence a firm and its competitive decisions and responses. Competitor analysis represents the firm’s understanding of its current competitors. This understanding will complement information and insights derived from investigating the general and industry environments. The following are important distinctions to make regarding different external analyses: • Analysis of the general environment focuses on the future. • Industry analysis focuses on factors and conditions influencing firm profitability within its industry. • Competitor analysis focuses on predicting the dynamics of rivals’ actions, responses, and intentions. Performance improves when the firm integrates the insights provided by analyses of the general environment, the industry environment, and the competitor environment. Teaching Note: It should be noted that, although firms cannot directly control the elements of the external environment, they may be able to influence, and will be influenced by, these factors. The strategic challenge is to develop an understanding of the implications of these elements and factors for a firm’s competitive position. Processes and frameworks for the analysis of the external environment are provided in this chapter. Teaching Note: Global implications should be—and are—integrated into the discussion of the general environment whereas global issues related to a firm’s industry environment are integrated throughout the text. Chapter 8 covers this topic in detail. 3 Discuss the four activities of the external environmental analysis process. EXTERNAL ENVIRONMENTAL ANALYSIS In addition to increasing a firm’s awareness and understanding of an increasingly turbulent, complex, and global general environment, external environmental analysis also is necessary to enable the firm’s managers to interpret information to identify opportunities and threats. Opportunities represent conditions in the general environment that may help a company achieve strategic competitiveness by presenting it with possibilities, whereas threats are conditions that may hinder or constrain a company’s efforts to achieve strategic competitiveness. Information used to analyze the general environment can come from multiple sources: publications, observation, attendance at trade shows, or conversations with customers, suppliers, and employees of public-sector organizations. And this information can be formally gathered by individuals occupying traditional “boundary spanning” roles (such as a position in sales, purchasing, or public relations) or by assigning information-gathering responsibility to a special group or team. Teaching Note: According to a recent comment by an industry analyst from a national firm, the Internet is becoming an increasingly valuable source of data and information for analyzing the general environment. Showing students how to do this in class or via an assignment can be a very helpful exercise. One strategy that firms can use to enhance their awareness of conditions in the external environment is to establish an analysis process involving scanning, monitoring, forecasting, and assessing (see Table 2.2). TABLE 2.2 Parts of the External Environmental Analysis Table 2.2 identifies the four parts of the external environmental analysis: scanning, monitoring, forecasting, and assessing. Scanning Scanning entails the study of all segments in the general environment. Firms use the scanning process to either detect early warning signals regarding potential changes or to detect changes that are already underway. In most cases, information and data being collected or observed are ambiguous, incomplete, and appear to be unconnected. Scanning is most important in highly volatile environments, and the scanning system should fit the organizational context (e.g., scanning systems designed for volatile environments are not suitable for firms competing in a stable environment). Teaching Note: Scanning may signal a future change in the needs and lifestyles of baby boomers as they approach retirement age. This may not only provide opportunities for financial institutions as they prepare for an increase in the number of retirees, but also may provide opportunities for packagers and marketers of retirement communities and other products specifically targeted to this segment. The Internet provides significant opportunities to obtain information. For example, Amazon.com records significant information about individuals visiting its website, particularly if a purchase is made. Amazon then welcomes the individual by name when he or she visits the website again. It even sends messages to the individual about specials and new products similar to that purchased in previous visits. Additionally, many websites and advertisers on the Internet obtain information surreptitiously from those who visit their sites via the use of “cookies.” Monitoring Monitoring represents a process whereby analysts observe environmental changes over time to see if, in fact, an important trend begins to emerge. The critical issue in monitoring is that analysts be able to detect meaning from the data and information collected during the scanning process. (Remind students that these data are generally ambiguous, incomplete, and unconnected.) Effective monitoring requires the firm to identify important stakeholders. Because the importance of different stakeholders can vary over a firm’s life cycle, careful attention must be given to the firm’s needs and its stakeholder groups over time. Scanning and monitoring can also provide information about successfully commercializing new technologies. Forecasting The next step is for analysts to take the information and data gathered during the scanning and monitoring phases and attempt to project forward. Forecasting represents the process where analysts develop feasible projections of what might happen—and how quickly—as a result of the changes and trends detected through scanning and monitoring. Because of uncertainty, forecasting events and outcomes accurately is a challenging task. Assessing Assessing represents the step in the external analysis process where all of the other steps come together. The objective of assessing is to determine the timing and significance of the effects of changes and trends in the environment on the strategic management of a firm. Getting the strategy right will depend on the accuracy of the assessment. Teaching Note: It is good to alert students to the fact that a major challenge for managers and firms engaging in the process of external analysis is to recognize biases and assumptions that may affect the analysis process. This is important because these may limit the accuracy of forecasts and assessments. For example, managers may choose to disregard certain information, thus missing critical indicators of future environmental changes. Or, past experiences may prejudice the ways that opportunities or threats are perceived—if they are perceived at all. One solution might be to solicit multiple inputs so a single source is not able to manipulate the information and to seek frequent feedback regarding the accuracy or usefulness of forecasts and assessments. 4 Name and describe the general environment’s seven segments. SEGMENTS OF THE GENERAL ENVIRONMENT As outlined in Table 2.1, the general environment consists of seven segments: demographic, economic, political/legal, sociocultural, global, technological, and the physical environment. The challenge is to scan, monitor, forecast, and assess all six segments of the general environment, focusing the primary effort on those elements in each segment of the general environment that have the greatest potential impact on the firm. External analysis efforts should focus on segments most important to the firm’s strategic competitiveness to identify environmental changes, trends, opportunities, and threats that can be matched with the firm’s core competencies so that it can achieve strategic competitiveness and earn above-average returns. The Demographic Segment The demographic segment is concerned with a population’s size, age structure, geographic distribution, ethnic mix, and distribution of income. Teaching Note: Though each of the elements of this segment are discussed below, you might note that the challenge for analysts (and managers) is to determine what the changes that have been identified in the demographic characteristics or elements of a population imply for the future strategic competitiveness of the firm. Population Size Though population size itself may be important to firms that require a “critical mass” of potential customers, changes in the specific make-up of a population’s size may have even more critical implications. One of the most important changes in a population’s size is changes in a nation’s birth rate and/or family size, as well as demographic changes in the population of developed versus developing countries. Age Structure Changes in a nation’s birth rate or life expectancy can have important implications for firms. Are people living longer? What is the life expectancy of infants? These will impact the health care system (and firms serving that segment) and the development of products and services targeted to an older (or younger) population. Geographic Distribution Population shifts—as have occurred in the US—from one region of a nation to another or from metropolitan to non-metropolitan areas may have an impact on a firm’s strategic competitiveness. Issues that should be considered include: • The attractiveness of a firm’s location may be influenced by governmental support, and a shrinking population may imply a shrinking tax base and a lesser availability of official financial support. • Firms may have to consider relocation if tax demands require it. • Advances in communications technology will have a profound effect on geographic distribution and the workforce. Ethnic Mix This reflects the changes in the ethnic make-up of a population and has implications both for a firm’s potential customers and for the workforce. Issues that should be addressed include: • Will new products and services be demanded or can existing ones be modified? • How will changes in the ethnicity of a population affect the composition of the workforce? • Are managers prepared to manage a more culturally diverse workforce? • How can the firm position itself to take advantage of increased workforce heterogeneity? Income Distribution Changes in income distribution are important because changes in the levels of individual and group purchasing power and discretionary income often result in changes in spending (consumption) and savings patterns. Tracking, forecasting, and assessing changes in income patterns may identify new opportunities for firms. The Economic Segment The economic segment of the general environment refers to the nature and direction of the economy in which a firm competes or may compete. Analysts must scan, monitor, forecast, and assess a number of key economic indicators or elements, including levels and trends of • Inflation rates and interest rates • Trade deficits and surpluses • Budget deficits and surpluses • Personal savings rates • Business savings rates • Gross domestic product • Currency valuation • Unemployment rates • Energy and commodity prices for both domestic and key international markets. In addition, the implications of changes and trends in the economic segment may affect the political/legal segment both domestically and in other global markets. This may be of critical importance as nations eliminate or reduce trade barriers and integrate their economies. The Political/Legal Segment The political/legal segment is the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regulations guiding the interactions among nations as well as between firms and various local governmental agencies. In other words, this segment is concerned with how interest groups and organizations attempt to influence representatives of governments (and governmental agencies) and how they, in turn, are influenced by them. This segment is also concerned with the outcomes of legal proceedings in which the courts interpret the various laws and regulations. Because of the influence that this segment can have on the nature of competition as well as on the overall profitability of industries and individual firms, analysts must assess changes and trends in administration philosophies regarding: • Anti-trust regulations and enforcement • Tax laws • Industry deregulation • Labor training laws • Commitments to education • Free trade versus protectionism Teaching Note: It would be good to comment (using examples from the text or examples that may be even more current) on strategies followed by firms as they attempt to manage or influence the political/legal segment. • How can firms in the electric utility industry manage the costs of deregulation, including write-offs of inefficient plants? Who will pay these costs? Consumers? Governmental units? Stockholders? Bondholders? • How can individual firms and industries manage the effects of free trade that will lower entry barriers for new, lower-cost competitors? How might firms position themselves to take advantage of emerging, free-market economies? • What is likely to be the competitive impact of loosening governmental controls in the entertainment industry? In the telecommunications industry? What strategies can firms use to manage or influence deregulation to their advantage? The Sociocultural Segment The sociocultural segment is concerned with different societies’ social attitudes and cultural values. This segment is important because the attitudes and values of society influence and thus are reflected in changes in a society’s economic, demographic, political/legal, and technological segments. Analysts are especially cautioned to pay attention to sociocultural changes and effects that they may have on: • Workforce composition, and the implications for managing, resulting from an increase in the number of women, and increased ethnic and cultural diversity • Changes in attitudes about the growing number of contingency workers • Shifts in population toward suburban life, and resulting transportation issues • Shifts in work and career preferences, including a trend to work from home made possible by technology advances The Technological Segment As noted in many of the other segments of the general environment, and as discussed in Chapter 1 as a key driver of the new competitive landscape, technological changes can have broad effects on society. The technological segment includes institutions and activities involved with creating new knowledge and translating that knowledge into new outputs, products, processes, and materials. Firms should pay careful attention to the technological segment, since early adopters can gain market share and above-average returns. Important technology-related issues that might affect a broad variety of firms include: • Increasing plant automation • Internet technologies and their application to commerce and data gathering • Uses of wireless technology The Global Segment Among the global factors that should be assessed are: • The potential impact of significant international events such as peace in the Middle East or the recent entry of China into the WTO • The identification of both important emerging global markets and global markets that are changing • The trend toward increasing global outsourcing • The differences between cultural and institutional attributes of individual global markets (the focus in Korea on inhwa, or harmony, based on respect for hierarchical relationships and obedience to authority; the focus in China on guanxi, or personal relationships; the focus in Japan on wa, or group harmony/social cohesion) • Global market expansion opportunities • The opportunities to learn from doing business in other countries • Expanding access to the resources firms need for success (e.g., capital) Teaching Note: Globalfocusing is a cautious approach to globalization in which firms with a moderate level of international operations increase their internationalization by focusing on global niche markets (and/or limiting opertations/sales to one geographical region of the world). This approach allows firms to build on and use their core competencies while limiting their risks within the niche market. STRATEGIC FOCUS The Informal Economy: What It Is and Why It Is Important The Strategic Focus introduces students to the informal economy – commercial activities that occur at least partly outside a governing body’s observation, taxation, and regulation. People choose to work in the informal economy because of choice or out of necessity. Evidence suggests that informal employment is linked to poor employment conditions and increased worker poverty. The informal economy accounts for varying degrees of activity from country to country, with activity in developing countries being much higher (up to 75%). Even in the U.S., it is estimated that the informal economy generates $2 trillion of annual economic activity. Two conditions significantly contribute to the informal economy - economic activity insufficient to create a significant number of jobs and governments’ inability to facilitate growth. Teaching Note: Students should realize that the informal economy exists and that it does have the potential to impact firms in many industries. As students if they have every participated in the informal economy and the reason(s) for doing so. Ask them to identify some of the ways that the informal economy specifically impacts firms operating in the formal economy. Follow up by asking students to identify ways that firms in the formal economy are adapting to competition from informal economy organizations. The Physical Environment Segment The physical environment segment refers to potential and actual changes in the physical environment and business practices that are intended to positively respond to and deal with those changes. Ecological, social, and economic systems interact to influence what happens in this segment. Global warming, energy consumption, and sustainability are all examples of issues related to the physical environment. 5 Identify the five competitive forces and explain how they determine an industry’s profit potential. INDUSTRY ENVIRONMENT ANALYSIS An industry is a group of firms producing products that are close substitutes for each other. As they compete for market share, the strategies implemented by these companies influence each other and include a broad mix of competitive strategies as each company pursues strategic competitiveness and above-average returns. It should be noted that, unlike the general environment, which has an indirect effect on strategic competitiveness and firm profitability, the effect of the industry environment is more direct. Industry—and individual firm—profitability and the intensity of competition in an industry are a function of five competitive forces as presented in Figure 2.2. Figure Note: Students should refer to Figure 2.2 as it provides a framework that can be used to analyze competition in an industry. A broader discussion of the five competitive forces and other factors follows Figure 2.2. FIGURE 2.2 The Five Forces Model of Competition The Five Forces Model of Competition indicates that these forces interact to determine the intensity or strength of competition, which ultimately determines the profitability of the industry. • Threat of New Entrants • Threat of Substitute Products • Bargaining Power of Buyers (Customers) • Bargaining Power of Suppliers • Rivalry Among Competing Firms in an industry Assessing the relative strength of the five competitive forces is important to a firm’s ability to achieve strategic competitiveness and earn above-average returns. Viewed differently, competition should be seen as groupings of alternative ways that customers can obtain desired results. Thus, any analysis of an industry must expand beyond the traditional practice of concentrating on direct competitors to include potential competitors. For example: • Suppliers can become competitors by integrating forward. • Buyers or customers can become competitors by integrating backward. • Firms that are not competitors today could produce products that serve as substitutes for existing products offered by firms in an industry, transforming themselves into competitors. Threat of New Entrants New entrants to an industry are important because with new competitors, the intensity of competitive rivalry in an industry generally increases. This is because new competitors may bring substantial resources into the industry and may be interested in capturing a significant market share. If a new competitor brings additional capacity to the industry when product demand is not increasing, prices that can be charged to consumers generally will fall. One result may be a decline in sales and lower returns for many firms in the industry. Teaching Note: To help students grasp the potential impact of new entrants on an industry, it is helpful to illustrate this effect by referring to a number of examples that may be familiar to them, such as: • The transformation of the steel industry when mini-mills (such as Nucor and Birmingham Steel) entered the industry in competition with integrated domestic producers such as US Steel and Bethlehem Steel • The impact of the increase in the number of cell phone providers on the cost of having a cell phone (and the long-range, potential impact on the cost of local telephone service) • The increase in the number of Internet access providers and the effects of increased competition on such firms as CompuServe and America Online The seriousness or extent of the threat of new entrants is affected by two factors: barriers to entry and expected reactions from—or the potential for retaliation by—incumbent firms in the industry. Barriers to Entry Barriers to entering an industry are present when entry is difficult or when it is too costly and places potential entrants at a competitive disadvantage (relative to firms already competing in the industry). Seven factors represent potentially significant entry barriers that can emerge as an industry evolves or might be explicitly “erected” by current participants in the industry to protect profitability by deterring new competitors from entry. Economies of Scale refers to the relationship between quantity produced and unit cost. As the quantity of a product produced during a given time period increases, the cost of manufacturing each unit declines. Economies of scale can serve as an entry barrier when existing firms in the industry have achieved these scale economies and a potential new entrant is only able to enter the industry on a small scale (and produce at a higher cost per unit). Economies of scale can be overcome as a potential entry barrier by firms that produce multiple customized products or that enter an industry on a large-enough scale. New manufacturing technology facilitated by advanced information systems has allowed the development of “mass customization” in an increasing number of industries, and online ordering has enhanced the ability of customers to obtain customized products (often referred to as “markets of one”). Product Differentiation: Customers may perceive that products offered by existing firms in the industry are unique as a result of service offered, effective advertising campaigns, or being first to offer a product of service to the market. If customers perceive a product or service as unique, they generally are loyal to that brand. Thus, new entrants may be required to spend a great deal of money over a long period of time to overcome customer loyalty to existing products. Though new entrants may be able to overcome perceived uniqueness and brand loyalty, the cost of such strategies generally will be high: offering lower prices, adding additional features, or allocating significant funds to a major advertising and promotion campaign. In the short run, new entrants that try to overcome uniqueness and brand loyalty may suffer lower profits or may be forced to operate at a loss. Capital Requirements: Firms choosing to enter any industry must commit resources for facilities—to purchase inventory, to pay salaries and benefits, etc. Though entry may seem attractive (because there are no apparent barriers to entry), a potential new entrant may not have sufficient capital to enter the industry. Switching Costs: These are the one-time costs customers will incur when buying from a different supplier. They can include such explicit costs as retraining of employees or retooling of equipment as well as the psychological cost of changing relationships. Incumbent firms in the industry generally try to establish switching costs to offset new entrants that try to win customers with substantially lower prices or an improved (or, to some extent, different) product. Access to Distribution Channels: As existing firms in an industry generally have developed effective channels for distributing products, these same channels may not be available to new firms entering an industry. Thus, access (or lack thereof) may serve as an effective barrier to entry. This may be particularly true for consumer nondurable goods (because of the limited amount of shelf space available in retail stores) and in international markets. In the case of some durable goods or industrial products, to overcome the barrier, new entrants must again incur costs in excess of those paid by existing firms, either through lower prices or price breaks, costly promotion campaigns, or advertising allowances. New entrants may have to incur significant costs to establish a proprietary distribution channel. As in the case of product differentiation or uniqueness barriers, new entrants may suffer lower profits or operate at a loss as they battle to gain access to distribution channels. Cost Disadvantages Independent of Scale: Existing firms in an industry often are able to achieve cost advantages that cannot be costlessly duplicated by new entrants (i.e., other than those related to economies of scale and access to distribution channels). These can include proprietary process (or product) technology, more favorable access to or control of raw materials, the best locations, or favorable government subsidies. Potential entrants must find ways to overcome these disadvantages to be able to effectively compete in the industry. This may mean successfully adapting technologies from other industries and/or non-competing products for use in the target industry, developing new sources of raw materials, making product (or service) enhancements to overcome location- related disadvantages, or selling at a lower price to attract customers. Government Policy: Governments (at all levels) are able to control entry into an industry through licensing and permit requirements. For example, at the firm level, entry into the banking industry is regulated at both the federal and state levels, whereas liquor sales are regulated at the state and local levels. In some cases, state and/or federal licensing requirements limit entry into the personal services industry (securities sales and law), while in others only state requirements may limit entry (barbers and beauticians). Teaching Note: Students should be reminded of the monopolistic nature (on a market-by-market basis) of the public utility industry, including local telephone service, water, electric power, and cable television. The “regulated monopolies” will provide helpful illustrations to make sense of this section. Expected Retaliation Even if a firm concludes that it can successfully overcome all of the entry barriers, it still must take into account or anticipate reactions that might be expected from existing firms. Strong retaliation is likely when existing firms have a heavy investment in fixed assets (especially when there are few alternative uses for those assets) or when industry growth is slow or declining. Retaliation could take the form of announcements of anticipated future investments to increase capacity, new product plans, price-cutting or a study to assess the impact of lower prices (this might imply price-cutting as a “promised” entry barrier-creation strategy by existing firms). Small entrepreneurial firms can avoid retaliation by identifying and serving neglected market segments. For example, Honda first entered the US market by concentrating on small-engine motorcycles, a market that firms such as Harley-Davidson ignored. After consolidating its position, Honda went on the offensive by introducing larger motorcycles and competing in the broader market. Bargaining Power of Suppliers The bargaining power of suppliers depends on suppliers’ economic bargaining power relative to firms competing in the industry. Suppliers are powerful when firm profitability is reduced by suppliers’ actions. Suppliers can exert their power by raising prices or by restricting the quantity and/or quality of goods available for sale. Suppliers are powerful relative to firms competing in the industry when: • The supplier segment of the industry is dominated by a few large companies and is more concentrated than the industry to which it sells • Satisfactory substitute products are not available to industry firms • Industry firms are not a significant customer group for the supplier group • Suppliers’ goods are critical to buyers’ marketplace success • Effectiveness of suppliers’ products has created high switching costs for buyers • Suppliers represent a credible threat to integrate forward into the buyers’ industry, especially when suppliers have substantial resources and provide highly differentiated products In the airline industry, suppliers’ bargaining power is changing. There are few suppliers, but demand for the major aircraft is also low. Boeing and Airbus compete strongly for most orders of major aircraft. However, China recently announced plans to enter the market by building large commercial aircraft, significant in a country that is projected to purchase thousands. Bargaining Power of Buyers While firms seek to maximize their return on invested capital, buyers are interested in purchasing products at the lowest possible price (the price at which sellers will earn the lowest acceptable return). To reduce cost or maximize value, customers bargain for higher quality or greater levels of service at the lowest possible price by encouraging competition among firms in the industry. Buyer groups are powerful relative to firms competing in the industry when: • Buyers are important to sellers because they purchase a large portion of the supply industry’s total sales • Products purchased from a supply industry represent a significant portion of the seller’s annual revenues • Buyers are able to switch to another supplier’s product at little, if any, cost • Suppliers’ products are undifferentiated and standardized, and the buyers represent a real threat to integrate backward into the suppliers’ industry using resources or expertise Armed with greater amounts of information about the manufacturer’s costs and the power of the Internet as a shopping and distribution alternative, consumers appear to be increasing their bargaining power in many industries. One reason for this shift is that individual buyers incur virtually zero switching costs when they decide to purchase from one manufacturer rather than another or from one dealer as opposed to a second or third one. Threat of Substitute Products All firms must recognize that they compete against firms producing substitute products, those products that are capable of satisfying similar customer needs but come from outside the industry and thus have different characteristics. In effect, prices charged for substitute products represent the upper limit on the prices that suppliers can charge for their products. The threat of substitute products is greatest when: • Buyers or customers face few, if any switching costs • Prices of the substitute products are lower • Quality and performance capabilities of substitutes are equal to/greater than those of the industry’s products Firms can offset the attractiveness of substitute products by differentiating their products in ways that are perceived by customers as relevant. Viable strategies might include price, product quality, product features, location, or service level. Examples of Traditional and Substitute Products and Their Usage Traditional product Substitute product Usage Overnight delivery Fax machines/e-mail Document delivery Sugar NutraSweet Sweetener Glass Plastic Containers Coffee Tea Beverages Paper bags Plastic bags Flexible packaging Intensity of Rivalry Among Competitors The intensity of rivalry in an industry depends on the extent to which firms in an industry compete with one another to achieve strategic competitiveness and earn above-average returns because success is measured relative to other firms in the industry. Competition can be based on price, quality, or innovation. Because of the interrelated nature of firms’ actions, action taken by one firm generally will result in retaliation by competitors (also known as competitive response). In addition to actions and reactions that result as firms attempt to offset the other competitive forces in the industry—threat of new entry, power of suppliers and buyers, and threat of substitute products—the intensity of competitive rivalry is also a function of a number of other factors. Numerous or Equally Balanced Competitors Industries with a high number of firms can be characterized by intense rivalry when firms feel that they can make competitive moves that will go unnoticed by other firms in the industry. However, other firms will generally notice these moves and offer countermoves of their own in response. Patterns of frequent actions and reactions often result in intense rivalry, such as in local restaurant, retailing, or dry-cleaning industries. Rivalry also is intense in an industry that has only a few firms of equivalent resources and power. The firms’ resource bases enable each to take frequent action to improve their competitive positions which, in turn, produce a reaction or countermove by competitors. Battles for market share in the fast food industry between McDonald’s and Burger King; in the automobile industry between such firms as General Motors, Ford, and Toyota; and in athletic shoes between Nike and Reebok are examples of intense rivalry between relatively equivalent competitors. Of course, Boeing versus Airbus is an especially useful example. Slow Industry Growth When a market is growing at a level where there seem to be “enough customers for everyone,” competition generally centers around effective use of resources so that a firm can effectively serve a larger, growing customer base. Because of sufficient growth in the market, firms do not concentrate on taking customers away from other firms. The intensity of competition often results in a reduction in industry profitability as observed in the fast-food industry with the battle for a slower growing traditional, US customer base between McDonald’s, Burger King, and Wendy’s. The intensity of competition can be illustrated by the various competitive strategies followed by firms in the fast-food industry: • Rapid and continuous introduction of new products and new packaging schemes • The introduction of innovative-pricing strategies • Product and/or service differentiation High Fixed Costs or High Storage Costs When an industry is characterized by high fixed costs relative to total costs, firms produce in quantities that are sufficient to use a large percentage, if not all of their production capacity so that fixed costs can be spread over the maximum volume of output. Though this may lower per unit costs, it also can result in excess supply if market growth is not sufficient to absorb the excess inventory. The intensity of competitive rivalry increases as firms use price reductions, rebates, and other discounts or special terms to reduce inventory as observed in the automobile industry from the 1980s to the present. High storage costs, especially those related to perishable or time-sensitive products (such as fruits and vegetables) also can result in high levels of competitive intensity as such products rapidly lose their value if not sold within a given time period. Pricing strategies often are used to sell such products. Lack of Differentiation or Low Switching Costs Products that are not characterized by brand loyalty or perceived uniqueness are generally viewed by buyers as commodities. For such products, industry rivalry is more intense and competition is based primarily on price, service, and other features of interest to consumers. Switching costs can be used to decrease the likelihood that customers will switch to competitors’ products. Products for which customers incur no or few switching costs are subject to intense price- and service-based competition, similar to undifferentiated products. High Strategic Stakes The intensity of competitive rivalry increases when success in an industry is important to a large number of firms (such as the domestic airline industry following deregulation). For example, the success of a diversified firm may be important to its effectiveness in other industries, especially when the firm is in interdependent or related industries. Geographic stakes may also be high. The importance of geographic stakes can be illustrated by the intense rivalry in the US automobile industry as Japanese manufacturers recognized the strategic importance of a US marketplace presence and US manufacturers responded. High Exit Barriers Exit barriers—created by economic, strategic, and emotional factors that cause companies to remain in an industry even though the profitability of doing so is in question—also can increase the intensity of competition in an industry. The higher the barriers to exit, the greater the probability that competitive actions and reactions will include price cuts and extensive promotions. Some sources of exit barriers include: • Investments in specialized assets, or assets whose value is linked to use in a particular industry or location, with little or no value as salvage or in other uses • Fixed costs of exit, such as labor agreements or a requirement to repay federal, state, or local aid packages • Strategic relationships, interdependencies within the organization (e.g., shared facilities, market access) • Emotional barriers, such as loyalty to employees or fear for one’s own career • Government and/or social restrictions based on concern for job losses or the economic impact of exit Teaching Note: One way to get students to recognize the industry forces Porter presents is to allow them to learn about a given industry and report on these forces as they see them and assess their strength. For example, one adopter of the text shows students the first segment of a PBS video series by Daniel Yergin called “The Prize.” This one-hour video profiles the formation of the oil industry and its rapid transformation in the early days. Students are asked to identify the many illustrations of “Porter’s Five Forces in action” as they watch the video (e.g., profits were much greater early in the first part of the industry’s first decade than in the last years of that period because barriers to entry were low and the rapid influx of new entrants expanded supply and depressed prices). As an incentive for diligent observation, the student who identifies the greatest number of legitimate illustrations is rewarded with bonus points. INTERPRETING INDUSTRY ANALYSES Effective industry analyses are products of careful study and interpretation of data from multiple sources. Because of globalization, international markets and rivalry must be included in the firm’s analyses; in fact, research shows international variables may have more impact on strategic competitiveness than domestic ones, in some cases. Following a study of the five industry forces, the firm has the insights required to determine an industry’s attractiveness in terms of the potential to earn adequate or superior returns on its invested capital. In general, the stronger the competitive forces, the lower the profit potential for an industry’s firms. An unattractive industry has low entry barriers, suppliers and buyers with strong bargaining positions, strong competitive threats from product substitutes, and intense rivalry among competitors, which make it difficult for firms to achieve strategic competitiveness and earn above-average returns. An attractive industry has the mirror image of these features and offers little potential for favorable performance. Characteristics of attractive and unattractive industries are summarized below. Industry Characteristic Attractive Unattractive Threat of New Entry Low High Bargaining Power of Suppliers Low High Bargaining Power of Buyers Low High Threat of Substitute Products Low High Intensity of Competitive Rivalry Low High Teaching Note: It may be helpful to explain that the relationship between the strength of industry forces and prices/profits in the industry is an inverse one. When the forces are strong, prices/profits in the industry tend to be low, whereas weak forces usually lead to higher prices/profits. The mental image is one of a playground “teeter-totter” or balance scale. 6 Define strategic groups and describe their influence on firms. STRATEGIC GROUPS As implied by the previous discussion, not all firms in an industry may adopt the same strategies in their quest for strategic competitiveness and above-average returns. However, many firms in an industry may follow similar strategies. These firms are generally classified as strategic groups, or groups of firms in an industry following the same or similar strategies along the same strategic dimensions. Membership in a particular strategic group is determined by the essential characteristics of a firm’s strategy, which may include the • Extent of technological leadership • Degree of product quality • Pricing policies • Choice of distribution channels • Degree and type of customer service Teaching Note: It may be helpful to assign students (or student teams) the task of developing a strategic group map of an industry with which they are familiar (e.g., fast food, automobile manufacturing, computers, or the financial services industry). Teaching Note: Many strategy experts believe that the strategic group concept provides a useful tool for analyzing an industry from firm-specific perspectives in order to learn how to compete successfully. However, some critics indicate that there is no convincing evidence that (1) strategic groups exist or (2) that firm performance is dependent on membership in a particular group. Others contend that little additional understanding can be gained from industry analysis by looking at strategic groups, but recent research provides some evidence to support the usefulness of this analysis. The strategic group concept can be useful in analyzing the competitive structure of an industry and can serve as a framework for assessing competition, positioning alternatives, and potential profitability of firms in an industry. High mobility barriers, high rivalry, and low resources among the firms within an industry will limit the formation of strategic groups. However, research suggests that once formed, strategic group membership remains relatively stable over time, making analysis easier and more useful. Use of the strategic group concept requires that analysts be aware of several implications: • A firm’s major or primary competitors are those in its strategic group, thus competitive rivalry within the strategic group is expected to be more intense than rivalry with other firms in the industry. • The relative strengths of the five competitive forces will differ among groups, thus firms in different groups may adopt different competitive strategies. • The closer the strategic groups on the relevant dimensions, the greater the likelihood of their rivalry. STRATEGIC FOCUS German Performance/Luxury Cars: If You Have Seen One, Have You Seen Them All? The Strategic Focus profiles the strategic group consisting of Audi, BMW, and Mercedes- Benz. There are many similarities among these competitors, including markets served (target customers and geographic emphasis) and the many dimensions of performance/ luxury of the products themselves. Rivalry is intense among this group and, as is often the case with strategic groups, has remained stable over a long period of time. Teaching Note: The Strategic Focus provides a good discussion vehicle for competitor analysis with a strategic group (and within a very turbulent industry that is continually being redefined as environments change and new technologies emerge). Ask students to compare the Audi, BMW, and Mercedes-Benz brands and the customers that each is vying for. How do these firms try to position themselves to appeal to buyers by delivering value to a very demanding segment of the market? 7 Describe what firms need to know about their competitors and different methods (including ethical standards) used to collect intelligence about them. COMPETITOR ANALYSIS Competitor analysis represents a necessary adjunct to performing an industry analysis. An industry analysis provides information regarding potential sources of competition (including the possible strategic actions and reactions and effects on profitability for all firms competing in an industry). However, a structured competitor analysis enables the firm to focus its attention on those firms with which it will directly compete, and is especially important when a firm faces a few powerful competitors. Competitor analysis is interested ultimately in developing a profile on how competitors might be expected to respond to a firm’s strategic moves. The process involves developing answers to a series of questions about competitors such as: • Competitors’ future objectives • Competitors’ current strategy • Competitors’ assumptions about the industry • Capabilities, as shown by competitors’ strengths and weaknesses Competitor intelligence is critical to competitor analysis because it helps a firm understand competitors’ intentions and the strategic implications resulting from them. Competitor intelligence is performed both for domestic and international competitors. FIGURE 2.3 Competitor Analysis Components Figure 2.3 shows how the components of competitor analysis help the firm prepare an anticipated response profile for each competitor. Components Response Future Objectives What will our competitors do in the future? Current Strategy Where do we hold an advantage over our competitors? Assumptions How will this change our relationship with our Capabilities competitors? Teaching Note: To help students understand the usefulness of competitor analysis, have them develop a profile of another university or college, assume the role of a Pepsi product manager and develop a competitive profile of Coca-Cola, or take the perspective of Intel and describe AMD’s competitive characteristics. A specific case that contains the bulk of the required information also could be used to perform an in-class competitor analysis. Another significant component are the complementors of a firm’s products and strategy. These are the networks of companies that sell goods and services compatible with the firms own product or service. ETHICAL CONSIDERATIONS A major concern of many managers is the methods used to gather data on competitors, a process generally referred to as competitor intelligence. The illustration of Microsoft’s struggle to understand Google is especially helpful in explaining this concept. It is a great managerial challenge to ensure that all data and information related to competitors are gathered both legally and ethically. This is important because many employees may feel pressure to rely on techniques that are questionable from an ethical perspective to gather information that may be valuable to their firm, especially if they perceive value to their own careers from successfully obtaining such information. It seems obvious that information that (1) is either publicly available (annual reports, regulatory filings, brochures, advertising and promotional materials) or (2) is obtained by attending trade shows and conventions can be used without ethical or legal implications. However, information obtained illegally (as a result of activities such as theft, blackmail, or eavesdropping) cannot—or, at least, should not—be used since its use is unethical as well as illegal. Teaching Note: It might be useful and insightful to require students to develop (and bring to class) their own lists of questionable intelligence- gathering techniques or formulate an argument as to the circumstances (if any) under which these techniques might be considered ethical. This could make for a lively discussion of the issue. Instructor Manual for Strategic Management: Concepts and Cases: Competitiveness and Globalization Michael A. Hitt, R. Duane Ireland, Robert E. Hoskisson 9781285425184, 9781285425177, 9780538753098, 9781133495239, 9780357033838, 9781305502208, 9781305502147