CH-5-6 Business-Level Strategy – Strategic Management: Theory: An Integrated Approach : Book Guide

This Document Contains Chapters 5 to 6 CHAPTER 5 Business-Level Strategy Synopsis of Chapter The purpose of this chapter is to discuss the various business level strategies that a company can use to compete effectively in a business and in an industry. This chapter argues that the basis of all successful business models is the choice of business-level strategies that work together to provide competitive advantage. At the most basic level a company can adopt two strategies; one is to lower its costs, and the second is differentiation. Although, in actuality, a company that adopts both these strategies will eventually emerge at the top. This leads to the concept of “value innovation.” Value innovation implies greater efficiency, and greater value through superior differentiation at a lower cost. Innovators can push frontiers in any industry. An important component of this chapter is market segmentation. Companies segment or group customers based on important differences to gain a competitive advantage. Market segmentation directly impacts a company’s business-level strategy. This chapter discusses four generic business-level strategies—broad low-cost, focus low-cost, broad differentiation, and focus differentiation. Every company must adopt the most appropriate strategy suited to them to achieve a competitive advantage in the market. However, for competitive advantage, implementing the business-level strategy is as important as identifying it. There must be an alignment between business-level strategy, functional strategy, and organization for the implementation to be accomplished. Most successful companies build their competitive advantage by redefining their product offering, creating value innovation, and pioneering a new market space. This process of finding a new market where a company can innovate, and pave its own way is known as “searching for a blue ocean.” Finally, the chapter ends with a good example of a company that successfully implements a business-level strategy which summarizes all the concepts in the text. Learning Objectives 1. Explain the difference between low-cost and differentiation strategies. 2. Articulate how the attainment of a differentiated or low-cost position can give a company a competitive advantage. 3. Explain how a company executes its business-level strategy through function level strategies and organizational arrangements. 4. Describe what is meant by the term “value innovation.” 5. Discuss the concept of blue ocean strategy, and explain how innovation in business-level strategy can change the competitive game in an industry, giving the innovator a sustained competitive advantage. Opening Case Nordstrom’s Success Story Nordstrom is one of America’s biggest fashion retailers. For over 100 years, their tradition for customer service, selection, quality, and value have built the business from scratch. Nordstrom targets the affluent customer base, and their shops and merchandise give an impression of luxury that not everyone can afford. However, the one fact that differentiates them from their rivals is their topnotch customer service. Nordstrom’s salespeople are class apart. They are employed because of their exceptional potential for serving customers. Nordstrom believes that the customer is always right. Customer service is pivotal to the business, and their needs must always be fulfilled. The CEO, Blake Nordstrom, puts his salespeople above himself, and believes that they are the reason for the company’s success. Despite continual growth and success, Nordstrom believes in maintaining and improving efficiency and customer service. Teaching Note: Nordstrom’s success comes from its topnotch customer service, and continual efficiency. However, is Nordstrom’s success partly based on the fact that their current customer base constitutes the wealthy? You could ask students if they know of other such success stories, and to share it with the rest of the class. Lecture Outline I. Overview This chapter looks at the formulation of business-level strategy. Business-level strategy refers to the overarching competitive theme of a company in a given market. At its most basic, business-level strategy is about who a company decides to serve (which customer segments), what customer needs and desires the company is trying to satisfy, and how the company decides to satisfy those needs and desires. This chapter looks at how managers decide what business-level strategy to pursue, and how they go about executing that strategy in order to attain a sustainable competitive advantage. The chapter starts by looking at two basic ways that companies chose how to compete in a market—by lowering costs and by differentiating their good or service from that offered by rivals so that they create more value. Next, it considers the issue of customer choice and market segmentation, and discusses the choices that managers must make when it comes to their company’s segmentation strategy. Then it discusses the various business-level strategies that an enterprise can adopt and what must be done to successfully implement those strategies. The chapter closes with a discussion of how managers can think about formulating an innovative business-level strategy that gives their company a unique and defendable position in the marketplace. II. Low Cost and Differentiation Strategy is about the search for competitive advantage. At the most fundamental level, a company has a competitive advantage if it can lower costs relative to rivals and/or if it can differentiate its product offering from those of rivals, thereby creating more value. A. Lowering Costs In commodity markets, competitive advantage goes to the company that has the lowest costs. Low costs will enable a company to make a profit at price points where its rivals are losing money. Low costs can also allow a company to undercut rivals on price, gain market share, and maintain or even increase profitability. Being the low-cost player in an industry can be a very advantageous position. Although lowering costs below those of rivals is a particularly powerful strategy in a pure commodity industry, it can also have great utility in other settings. 5.1 Strategy in Action: Southwest Airlines Forges Ahead Southwest Airlines has long been the most profitable U.S. airline. It is famous for its low fares, generally some 30% below those of its major rivals, which are balanced by an even lower cost structure, which has enabled it to record superior profitability even in bad years such as 2008–2009 when the industry faced slumping demand. A major source of Southwest’s low-cost structure seems to be its very high employee productivity. Southwest runs its operation with fewer people than competitors and does so successfully because of the following reasons: • Southwest’s managers devote enormous attention to whom they hire. • Southwest also reduces its costs by striving to keep its operations as simple as possible. • Another major difference between Southwest and most other airlines is that Southwest flies point to point rather than operating from congested airport hubs. Teaching Note: This case describes the business model of Southwest Airlines. Southwest’s strategies have helped it stay ahead of its competitors. You could discuss with the students how companies can increase their profits by eliminating unnecessary costs, and sticking to the basics. 1. Differentiation Differentiation implies distinguishing oneself from rivals by offering something that they find hard to match. There are many ways that a company can differentiate itself from rivals. A product can be differentiated by superior reliability, better design, superior functions and features, better point-of-sale service, better after sales service and support, etc. Differentiation gives a company two advantages: • It can allow the company to charge a premium price for its good or service, should it chose to do so. • It can help the company to grow overall demand and capture market share from its rivals. It is important to note that differentiation often (but not always) raises the cost structure of the firm. On the other hand, there are situations where successful differentiation, because it increases primary demand so much, can actually lower costs. Figure 5.1: Options for Exploiting Differentiation 2. The Differentiation–Low Cost Tradeoff The thrust of the discussion so far is that a low cost position and a differentiated position are two very different ways of gaining a competitive advantage. The enterprise that is striving for the lowest costs does everything it can to be productive and drive down its cost structure, whereas the enterprise striving for differentiation necessarily has to bear higher costs to achieve that differentiation. However, presenting the choice between differentiation and low costs in these terms is something of a simplification. The successful differentiator might be able to subsequently reduce costs if differentiation leads to significant demand growth and the attainment of scale economies. But in actuality, the relationship between low cost and differentiation is subtler than this. In reality, strategy is not so much about making discrete choices as it is about deciding what the right balance is between differentiation and low costs. The convex curve in Figure 5.2 illustrates what is known as an efficiency frontier (also known in economics as a production possibility frontier). The efficiency frontier shows all of the different positions that a company can adopt with regard to differentiation and low cost, assuming that its internal functions and organizational arrangements are configured efficiently to support a particular position. The efficiency frontier has a convex shape because of diminishing returns. Diminishing returns imply that when an enterprise already has significant differentiation built into its product offering, increasing differentiation by a relatively small amount requires significant additional costs. The converse also holds: when a company already has a low-cost structure, it has to give up a lot of differentiation in its product offering to get additional cost reductions. Figure 5.2: The Differentiation-Low Cost Tradeoff The essential point here is that there are often multiple positions on the differentiation–low cost continuum that are viable in the sense that they have enough demand to support an offering. The task for managers is to identify a position in the industry that is viable and then configure the functions and organizational arrangements of the enterprise so that they are run as efficiently and effectively as possible, and enable the firm to reach the frontier. To successfully implement a business-level strategy and get to the efficiency frontier, a company must be pursuing the right functional-level strategies, and it must be appropriately organized. Business-level strategy, functional-level strategy, and organizational arrangement must all be aligned with each other. 3. Value Innovation: Greater Differentiation at a Lower Cost The efficiency frontier is not static; it is continually being pushed outwards by the efforts of managers to improve their firm’s performance through innovation. The term value innovation is used to describe what happens when innovation pushes out the efficiency frontier in an industry, allowing for greater value to be offered through superior differentiation at a lower cost than was previously thought possible. When a company is able to pioneer process innovations that lead to value innovation, it effectively changes the game in an industry and may be able to outperform its rivals for a long period of time. Figure 5.3: Value Innovation in the PC Industry III. Who are Our Customers? Market Segmentation Business-level strategy begins with the customer. It starts with deciding who the company is going to serve, what needs or desires it is trying to satisfy, and how it is going to satisfy those needs and desires. One of the most fundamental questions that any company faces is whether to recognize differences in customers, and if it does, how to tailor its approach depending on which customer segment or segments it decides to serve. The first step toward answering these questions is to segment the market according to differences in customer demographics, needs, and desires. Market segmentation refers to the process of subdividing a market into clearly identifiable groups of customers with similar needs, desires, and demand characteristics. Customers within these segments are relatively homogenous, whereas they differ in important ways from customers in other segments of the market. 1. Three Approaches to Market Segmentation There are three basic approaches to market segmentation that companies adopt: • One is to choose not to tailor different offerings to different segments, and instead produce and sell a standardized product that is targeted at the average customer in that market. • A second approach is to recognize differences between segments and create different product offerings for the different segments. • A third approach is to target only a limited number of market segments, or just one, and to become the very best at serving that particular segment. When managers decide to ignore different segments, and produce a standardized product for the average consumer, they are said to be pursuing a standardization strategy. When they decide to serve many segments, or even the entire market, producing different offerings for different segments, they are said to be pursuing a segmentation strategy. When they decide to serve a limited number of segments, or just one segment, they are said to be pursuing a focus strategy. 2. Market Segmentation, Costs and Revenues It is important to understand that the different approaches to market segmentation have different implications for costs and revenues: • A standardization strategy is typically associated with lower costs than a segmentation strategy. A standardization strategy involves the company producing one basic offering, and trying to attain economies of scale by achieving a high volume of sales. • In contrast, a segmentation strategy requires that the company customize its product offering to different segments, producing multiple offerings, one for each segment. Customization can drive up costs for two reasons: o The company may sell less of each offering, making it harder to achieve economies of scale o Products targeted at segments at the higher-income end of the market may require more functions and features, which can raise the costs of production and delivery It is important not to lose sight of the fact that advances in production technology, and particularly lean production techniques, have allowed for mass customization—that is, the production of more product variety without a large cost penalty. In addition, by designing products that share common components, some manufacturing companies are able to achieve substantial economies of scale in component production, while still producing a variety of end products aimed at different segments. Although a standardization strategy may have lower costs than a segmentation strategy, a segmentation strategy does have one big advantage—it allows the company to capture incremental revenues by customizing its offerings to the needs of different groups of consumers, and thus selling more in total. A company pursuing a standardization strategy where the product is aimed at the average consumer may lose sales from customers who desire more functions and features, and are prepared to pay more for that. Similarly, it may lose sales from customers who cannot afford to purchase the average product, but might enter the market if a more basic offering was available. As for a focus strategy, here the impact on costs and revenues is subtler. Companies that focus on the higher-income or higher-value end of the market will tend to have a higher cost structure for two reasons: • They will have to add features and functions to their product to appeal to higher-income consumers, and this will raise costs. • The relatively limited nature of demand associated with serving just a segment of the market may make it harder to attain economies of scale. For companies focusing on the lower-income end of the market, or a segment that desires value for money, a different calculus comes into play. Such companies tend to produce a more basic offering that is relatively inexpensive to produce and deliver. This may help them to drive down their cost structures. IV. Business -Level Strategy Choices The basic business-level strategy choices that companies make are sometimes called generic business-level strategy. The various choices are illustrated in Figure 5.4. Figure 5.4: Generic Business-Level strategies Companies that pursue a standardized or segmentation strategy both target a broad market. However, those pursuing a segmentation strategy recognize different segments, and tailor their offering accordingly, whereas those pursuing a standardization strategy just focus on serving the average consumer. Companies that target the broad market can either concentrate on lowering their costs so that they can lower prices and still make a profit, in which case they are said to be pursuing a broad low-cost strategy, or they can try to differentiate their product in some way, in which case they are pursuing a broad differentiation strategy. Companies that decide to recognize different segments, and offer different product to each segment, are by default pursuing a broad differentiation strategy. Companies that target a few segments, or more typically, just one, are pursuing a focus or niche strategy. These companies can either try to be the low-cost player in that niche, in which case they are pursuing a focus low-cost strategy, or they can try to customize their offering to the needs of that particular segment through the addition of features and functions, in which case they are pursuing a focus differentiation strategy. There is often no one best way of competing in an industry. The important thing for managers is to know what their business-level strategy is, to have a clear logic for pursuing that strategy, to have an offering that matches their strategy, and to align the functional activities and organization arrangements of the company with that strategy so that the strategy is well executed. Michael Porter, who was the originator of the concept of generic business-level strategies, has argued that companies must make a clear choice between the different options outline in Figure 5.4.6 If they don’t, Porter argues, they may become “stuck in the middle” and experience poor relative performance. At the limit, there is considerable value in this perspective. On the other hand, there are some important caveats to this argument: • Through improvements in process and product, a company can push out the efficiency frontier in its industry, redefining what is possible, and deliver more differentiation at a lower cost than its rivals. o In such circumstances, a company might find itself in the fortunate position of being both the differentiated player in its industry and having a low-cost position. o Ultimately its rivals might catch up, in which case it may well have to make a choice between emphasizing low cost and differentiation. • It is important for the differentiated company to recognize that it cannot take its eye off the efficiency ball. o Similarly, the low-cost company cannot ignore product differentiation. o The task facing a company pursuing a differentiation strategy is to be as efficient as possible given its choice of strategy. o The differentiated company should not cut costs so far that it harms its ability to differentiate its offering from that of rivals. o At the same time, it cannot let costs get out of control. 5.2 Strategy in Action: Microsoft Office versus Google Apps Microsoft rose to fame because of an important innovation in 1989. It was the first company to offer word processing, spreadsheet, and presentation programs in an interoperable bundle. The package was also priced affordably. Microsoft expanded its market position using thoughtful strategies, and this helped it achieve a monopoly position for almost two decades. However, in 2006 Google introduced Google Apps. This was an online version of the Office suite. Google’s approach was not to match Office on features, but to be good enough for the majority of users. This helped reduce development costs. Google followed a low-cost strategy, and quickly made its presence felt in many small and large enterprises. Microsoft still has a stronghold on the industry, but it cannot ignore Google Apps. Nevertheless, Microsoft remains competitive, and it came up with its own cloud-based Office 365. As both companies are currently on-par with one another, the market is yet to see who emerges as the leader. Teaching Note: Both Microsoft and Google Apps are competing to offer the best cloud-based Office suite. You could initiate a discussion with the students on what either of the companies must do to emerge as the leader in the market. Also, you could ask the students to express their opinions on what today’s businesses are required to do in order to succeed. V. Business-Level Strategy, Industry and Competitive Advantage Properly executed, a well-chosen and well-crafted business-level strategy can give a company a competitive advantage over actual and potential rivals. More precisely, it can put the company in an advantageous position relative to each of the competitive forces. A low-cost enterprise can make profits at price points that its rivals cannot profitably match. This makes it very hard for rivals to enter its market. In other words, the low-cost company can build an entry barrier into its market. A low-cost position and the ability to charge low prices and still make profits also give a company protection against substitute goods or services. Low costs can help a company to absorb cost increases that may be passed on downstream by powerful suppliers. Low costs can also enable the company to respond to demands for deep price discounts from powerful buyers and still make money. The low-cost company is often best positioned to survive price rivalry in its industry. Indeed, a low-cost company may deliberately initiate a price war in order to grow volume and drive its weaker rivals out of the industry. A successful differentiator is also protected against each of the competitive forces. The brand loyalty associated with differentiation can constitute an important entry barrier, protecting the company’s market from potential competitors. Because the successful differentiator sells on non-price factors, it is also less exposed to pricing pressure from powerful buyers. The successful differentiator may be able to implement price increases without encountering much, if any, resistance from buyers. The brand loyalty enjoyed by the differentiated company also gives it protection from substitute goods and service. The differentiated company is protected from intense price rivalry within its industry by its brand loyalty, and by the fact that non-price factors are important to its customer set. At the same time, the differentiated company often does have to invest significant effort and resources in non-price rivalry, such as brand building through marketing campaigns or expensive product development efforts, but to the extent that it is successful, it can reap the benefits of these investments in the form of stable or higher prices. Focused companies often have an advantage over their broad market rivals in the segment or niche that they compete in. The same can be true for a differentiated company. By focusing on a niche, and customizing the offering to that segment, a differentiated company can often outsell differentiated rivals that target a broader market. VI. Implementing Business–Level Strategy For a company’s business-level strategy to translate into a competitive advantage, it must be well implemented. This means that actions taken at the functional level should support the business-level strategy, as should the organizational arrangements of the enterprise. There must be an alignment or fit between business-level strategy, functional strategy, and organization (Figure 5.5). Figure 5.5: Strategy is Implemented through Function and Organization 1. Lowering Costs through Functional Strategy and Organization Companies achieve a low-cost position primarily through pursuing functional level strategies that result in superior efficiency and superior product reliability. The following are clearly important: • Achieving economies of scale and learning effects • Adopting lean production and flexible manufacturing technologies • Implementing quality improvement methodologies to ensure that the goods or services the company produces are reliable, so that time, materials, and effort are not wasted producing and delivering poor-quality products that have to be scrapped, reworked, or produced again from scratch • Streamlining processes to take out unnecessary steps • Using information systems to automate business process • Implementing just-in-time inventory control systems • Designing products so that they can be produced and delivered at as low a cost as possible • Taking steps to increase customer retention and reduce customer churn In addition, to lower costs the firm must be organized in such a way that the structure, control systems, incentive systems, and culture of the company all emphasize and reward employee behaviors and actions that are consistent with, or lead to, higher productivity and greater efficiency. The kinds of organizational arrangements that are favored in such circumstances include a flat organizational structure with very few levels in the management hierarchy, clear lines of accountability and control, measurement and control systems that focus on productivity and cost containment, incentive systems that encourage employees to work in as productive a manner as possible. 2. Differentiation through Functional-Level Strategy and Organization As with low costs, to successfully differentiate itself a company must pursue the right actions at the functional level, and it must organize itself appropriately. Pursuing functional-level strategies that enable the company to achieve superior quality in terms of both reliability and excellence are important, as is an emphasis upon innovation in the product offering, and high levels of customer responsiveness. Superior quality, innovation, and customer responsiveness are three of the four building blocks of competitive advantage, the other being efficiency. Specific functional strategies designed to improve differentiation include the following: • Customization of the product offering and marketing mix to different market segments • Designing product offerings that have high perceived quality in terms of their functions, features, and performance, in addition to being reliable • A well-developed customer care function for quickly handling and responding to customer inquiries and problems • Marketing efforts focused on brand building and perceived differentiation from rivals • Hiring and employee development strategies designed to ensure that employees act in a manner that is consistent with the image that the company is trying to project to the world As for organizing, creating the right structure, controls, incentives, and culture can all help a company to differentiate itself from rivals. In a differentiated enterprise, one key issue is to make sure that marketing, product design, customer service, and customer care functions all play a key role. Making sure that control systems, incentive systems, and culture are aligned with the strategic thrust is also extremely important for differentiated companies. VII. Competing Differently: Searching for a Blue Ocean Sometimes companies can fundamentally shift the game in their industry by figuring out ways to offer more value through differentiation at a lower cost than their rivals. This is referred to as value innovation, term that was first coined by Chan Kim and Renee Mauborgne. Their basic proposition is that many successful companies have built their competitive advantage by redefining their product offering through value innovation and, in essence, creating a new market space. They describe the process of thinking through value innovation as searching for the blue ocean—which they characterize as a wide open market space where a company can chart its own course. Kim and Mauborgne use the concept of a strategy canvas to map out how value innovators differ from their rivals. When thinking about how a company might redefine its market and craft a new business-level strategy, Kim and Mauborgne suggest that managers ask themselves the following questions: • Eliminate: Which factors that rivals take for granted in our industry can be eliminated, thereby reducing costs? • Reduce: Which factors should be reduced well below the standard in our industry, thereby lowering costs? • Raise: Which factors should be raised above the standard in our industry, thereby increasing value? • Create: What factors can we create that rivals do not offer, thereby increasing value? Figure 5.6: A Strategy Canvas for Southwest Airlines This is a useful framework, and it directs managerial attention to the need to think differently than rivals in order to create an offering and strategic position that are unique. If such efforts are successful, they can help a company to build a sustainable advantage. One of the great advantages of successful value innovation is that it can catch rivals off guard and make it difficult for them to catch up. In sum, value innovation, because it shifts the basis of competition, can result in a sustained competitive advantage for the innovating company due to the relative inertia of rivals and their inability to respond in a timely manner without breaking prior strategic commitments. Teaching Note: Ethical Dilemma This question should be used to discuss how Costco’s actions have impacted its business-level strategy, and also how it can rebuild its manufacturing base in the U.S. You could initiate a discussion on this ethical dilemma, and emphasize how a low-cost business level strategy does not mean that product quality must be compromised. Answers to Discussion Questions 1. What are the main differences between a low cost strategy and a differentiation strategy? In commodity markets, competitive advantage goes to the company that has the lowest costs. Low costs will enable a company to make a profit at price points where its rivals are losing money. Low costs can also allow a company to undercut rivals on price, gain market share, and maintain or even increase profitability. Being the low-cost player in an industry can be a very advantageous position. Differentiation implies distinguishing oneself from rivals by offering something that they find hard to match. There are many ways that a company can differentiate itself from rivals. A product can be differentiated by superior reliability (it breaks down less often, or not at all), better design, superior functions and features, better point-of-sale service, better after sales service and support, better branding, and so on. Differentiation gives a company two advantages: • It can allow the company to charge a premium price for its good or service, should it chose to do so. • It can help the company to grow overall demand and capture market share from its rivals. Differentiation often (but not always) raises the cost structure of the firm. On the other hand, there are situations where successful differentiation, because it increases primary demand so much, can actually lower costs. 2. Why is market segmentation such an important step in the process of formulating a business level strategy? Market segmentation refers to the process of subdividing a market into clearly identifiable groups of customers with similar needs, desires, and demand characteristics. Market segmentation is an important step in the process of formulating a business level strategy because it helps companies identify the basic business-level strategy choices that they make. 3. How can a business-level strategy of (a) low cost and (b) differentiation offer some protection against competitive forces in a company’s industry? (a) Low cost business-level strategy A low-cost enterprise can make profits at price points that its rivals cannot profitably match. This makes it very hard for rivals to enter its market. In other words, the low-cost company can build an entry barrier into its market. It can, in effect, erect an economic moat around its business that keeps higher-cost rivals out. A low-cost position and the ability to charge low prices and still make profits also give a company protection against substitute goods or services. Low costs can help a company to absorb cost increases that may be passed on downstream by powerful suppliers. Low costs can also enable the company to respond to demands for deep price discounts from powerful buyers and still make money. The low-cost company is often best positioned to survive price rivalry in its industry. Indeed, a low-cost company may deliberately initiate a price war in order to grow volume and drive its weaker rivals out of the industry. (b) Differentiation business-level strategy A successful differentiator is also protected against each of the competitive forces. The brand loyalty associated with differentiation can constitute an important entry barrier, protecting the company’s market from potential competitors. Because the successful differentiator sells on non-price factors, it is also less exposed to pricing pressure from powerful buyers. Indeed, the converse may be the case—the successful differentiator may be able to implement price increases without encountering much, if any, resistance from buyers. The differentiated company can also fairly easy absorb price increases from powerful suppliers and pass those on downstream in the form of higher prices for its offerings, without suffering much, if any, loss in market share. The brand loyalty enjoyed by the differentiated company also gives it protection from substitute goods and service. The differentiated company is also protected by the fact that non-price factors are important to its customer set. At the same time, the differentiated company often does have to invest significant effort and resources in non-price rivalry, such as brand building through marketing campaigns or expensive product development efforts, but to the extent that it is successful, it can reap the benefits of these investments in the form of stable or higher prices. 4. What is required to transform a business-level strategy from an idea into reality? The following functional strategies and organizational arrangements are required to transform a business-level strategy from an idea into reality: • Lowering costs through functional strategy and organization o Companies achieve a low-cost position primarily through pursuing those functional level strategies that result in superior efficiency and superior product reliability. o The firm must be organized in such a way that the structure, control systems, incentive systems, and culture of the company all emphasize and reward employee behaviors and actions that are consistent with, or lead to, higher productivity and greater efficiency. o The kinds of organizational arrangements that are favored in such circumstances include a flat organizational structure with very few levels in the management hierarchy, clear lines of accountability and control, measurement and control systems that focus on productivity and cost containment, incentive systems that encourage employees to work in as productive a manner as possible. • Differentiation through functional-level strategy and organization o Pursuing functional-level strategies that enable the company to achieve superior quality in terms of both reliability and excellence are important, as is an emphasis upon innovation in the product offering, and high levels of customer responsiveness. o The differentiated firm cannot ignore efficiency; by virtue of its strategic choice, the differentiated company is likely to have a higher cost structure than the low-cost player in its industry. o As for organizing, creating the right structure, controls, incentives, and culture can all help a company to differentiate itself from rivals. o In a differentiated enterprise, one key issue is to make sure that marketing, product design, customer service, and customer care functions all play a key role. 5. What do we mean by the term value innovation? Can you identify a company not discussed in the text that has established a strong competitive position through value innovation? Value innovation is used to describe what happens when innovation pushes out the efficiency frontier an industry, allowing for greater value to be offered through superior differentiation at a lower cost than was previously thought possible. Students’ choice of companies will differ. Practicing Strategic Management Small-Group Exercise: Identifying a Company That Has Achieved A Competitive Advantage Through Value Innovation The students are asked to break up into groups of three to five each and appoint one group member as a spokesperson who will communicate the group’s findings to the class when called on to do so by the instructor. They are asked to discuss the following scenario: Identify a company that you are familiar with that seems to have gained a competitive advantage by being a value innovator within its industry. Explain how this company has (a) created more value that rivals in its industry, and (b) simultaneously been able to drive down its cost structure. How secure do you think this company’s competitive advantage is? Explain your reasoning. Teaching Note: This exercise will give students a better understanding on value innovation, competitive advantage, and business-level strategy. As the students present their findings to the class you may probe them to elicit more information about the company being discussed. This will give the class a better insight into the discussion. You may also encourage the class to ask questions, or challenge the opinions of the presenter. Strategy Sign-On Article File 5 Have students find examples of companies that are pursuing each of the generic business-level strategies. They should discuss how successful has each of these companies been at pursuing its chosen strategy. Teaching Note: Almost every company, with the exception of those that are stuck in the middle, is pursuing one or more of the generic strategies, so examples will be abundant. As they complete the exercise, students will see how the generic strategies are built upon a series of strategic choices. They will also become aware of the impact of strategy upon company success. To extend this exercise, when a student chooses a firm pursuing one strategy, ask others to give examples of other firms in that same industry that are pursuing a different strategy. The students can then note the differences in strategic choices. They will also find that the advantages and disadvantages of opposite strategies are often mirror images—that is, one strategy’s advantage is another strategy’s disadvantage. Strategic Management Project: Developing Your Portfolio 5 This module deals with the business-level strategy pursued by the companies the students chose. They are required to answer the following questions: 1. Which market segments is your company serving? 2. What business-level strategy is your company pursuing? 3. How is your company executing its business-level strategy through actions at the functional level, and through organizational arrangements? How well is it doing? Are there things it could do differently? 4. Take a blue ocean approach to the business of your company, and ask if it could and/or should change its business-level strategy by eliminating, reducing, raising, or creating factors related to its product offering. Teaching Note: This module asks students to investigate every major component of a business-level strategy. It tests students’ understanding on market segmentation, value innovation, and product offering. You may also ask the students to provide a short report based on the answers to the above questions. You could ask the students to discuss what they would do differently if they were the managers of their chosen company. Would they take a drastically different approach from what the company is currently taking? If so, you could ask the students to state appropriate reasons for their decision. Closing Case A Different Approach: Lululemon Back in 1998, self-described snowboarder and surfer dude Chip Wilson took his first commercial yoga class. For Wilson, who had worked in the sportswear business and had a passion for technical athletic fabrics, wearing cotton clothes to do sweaty, stretchy power yoga exercises seemed totally inappropriate. And so the idea for Lululemon was born. Wilson’s vision was to create high-quality and stylishly designed clothing for yoga and related sports activities using the very best technical fabrics. He built up a design team, but outsourced manufacturing to low-cost producers, primarily in South East Asia. The first store opened in Vancouver, Canada, in 2000. It quickly became a runaway success, and other stores soon followed. As it has evolved, Lululemon’s strategy focuses on a number of key issues. Getting the product right is undoubtedly a central part of the company’s strategy. The company’s yoga-inspired athletic clothes are well designed, stylish, comfortable, and use the very best technical fabrics. An equally important part of the strategy is to only stock a limited supply of an item. New colors and seasonal items, for example, get 3- to 12-week life cycles, which keeps the product offerings feeling fresh. The scarcity strategy has worked; Lululemon never holds sales, and its clothing sells for a premium price. Lululemon continues to hire employees who are passionate about fitness. Employees are trained to eavesdrop on customers, who are called “guests.” CEO Christine Day is not a fan of using “big data” to analyze customer purchases. She believes that software-generated data can give a company a false sense of security about the customer. Instead, Day personally spends hours each week in Lululemon stores observing how customers shop, listening to their complaints, and then using their feedback to tweak product development efforts. Despite the company’s focus on providing quality, it has not all been plain sailing for Lululemon. In 2010, Wilson caused a stir when he had the company’s tote bags emblazoned with the phrase “Who is John Galt,” the opening line from Ayn Rand’s 1957 novel, Atlas Shrugged. Atlas Shrugged has become a libertarian bible, and the underlying message that Lululemon supported Rand’s brand of unregulated capitalism did not sit too well with many of the stores’ customers. In early 2013, Lululemon found itself dealing with another controversy when it decided to recall some black yoga pants that were apparently too sheer, and effectively “see through” when stretched due to the lack of “rear-end coverage.” Despite this, however, most observers in the media and financial community believe that the company will deal with this issue, and be able to continue its growth trajectory going forward. Answers to Case Discussion Questions 1. How would you describe Lululemon’s market segmentation strategy? Who do you think are Lululemon’s typical customers? Lululemon chose the third approach to market segmentation, the focus strategy, where it targeted one market segment to become the very best at serving that particular segment. Lululemon targets people who are fitness conscious. Moreover, because it uses stylish, high-quality, and technically superior fabric, the price of the product is high, so the customers would ideally belong to the upper-middle and upper class. 2. What generic business-level strategy is Lululemon pursuing? Does this strategy give it an advantage over its rivals in the athletic clothing business? If so, how? Students’ answers may vary. Lululemon is pursuing the broad differentiation strategy because it differentiates its product by offering a unique product to one segment of the market. This strategy is advantageous to Lululemon because the quality and consistency of their product keep customers happy. Also, its high-priced items make sure that they have no competitors in the same segment. 3. In order to successfully implement its business level strategy; what does Lululemon need to do at the functional level? Has the company done these things? Students’ answers may vary. To successfully implement its business level strategy Lululemon must try to achieve superior quality in terms of reliability and excellence, keep innovating the product offering, and elicit customer responsiveness. Lululemon has already been doing these things, and this is why its business-level strategy has proved to be successful. 4. How might the marketing and product missteps cited in the case impact upon Lululemon’s ability to successfully execute its business-level strategy? What should Lululemon do to make sure that it does not make similar mistakes going forward? Students’ answers may vary. Lululemon’s support for Rand’s brand of unregulated capitalism did not sit well with the store’s customers, and customer’s being mistreated by the store’s employees also cost the company a great deal. These missteps could be seen as a lack of care toward customer responsiveness. To make sure that these mistakes are not repeated, the company must be more sensitive to the needs and desires of its customers, and customer service should be prioritized. CHAPTER 6 Business-Level Strategy and The Industry Environment Synopsis of Chapter This chapter extends the analysis of business-level strategy by considering the different competitive strategies that firms can and should adopt as they enter different industry environments. The formulation of business-level strategy does not take place in a vacuum; companies have to consider the reaction of other firms to their competitive moves. The chapter is therefore a necessary addition to Chapter 5 and provides a building block to the chapters on corporate-level strategy. The chapter mainly examines the challenges of managing a generic business-level competitive strategy in different kinds of industry environments: fragmented industries, embryonic and growth industries, mature industries, and finally declining industries. In each type of industry, there is a discussion of the competitive problems associated with that particular environment and the appropriate strategies that firms can use to tackle those problems. Learning Objectives 1. Identify the strategies managers can develop to increase profitability in fragmented industries. 2. Discuss the special problems that exist in embryonic and growth industries and how companies can develop strategies to effectively compete. 3. Understand competitive dynamics in mature industries and discuss the strategies managers can develop to increase profitability even when competition is intense. 4. Outline the different strategies that companies in declining industries can use to support their business models and profitability. Opening Case How to Make Money in Newspaper Advertising The U.S. newspaper business is a declining industry, with the drop accelerating in recent years. The fall in advertising revenue has been very steep. The reasons for the declines in circulation and advertising revenue are not hard to find; digitalization has disrupted the industry, news consumption has moved to the Web, and advertising has followed suite. The industry has responded by downsizing newsrooms, shutting down unprofitable newspaper properties, including numerous local newspapers, and expanding Web-based news properties as rapidly as possible. Whereas consumers were once happy to subscribe to their daily print newspaper, they seem to loathe paying for anything on the Web, particularly given the large amount of “free” content that they can access. Against this background, one local newspaper company is swimming against the tide, and making money at it. The company, Community Impact Newspaper, produces 13 hyper- local editions that are delivered free each month to 855,000 homes in the Austin, Houston, and Dallas areas. The paper was the brainchild of John Garrett who noticed that local newspapers in Texas did not cover news that was relevant to smaller neighborhoods. Today the paper has a staff of 30 journalists, about 35% of the total workforce. The reporting is pretty straight stuff, although Impact will do in-depth stories on controversial local issues, but it is careful not to take sides as it will cause them to lose business. About half of each edition is devoted to local advertisements, and this is where Impact makes its money. For their part, the advertisers seem happy with the paper. It seems that Impact is making very good money for its owners in an industry where most players are struggling just to survive. Teaching Note: This case illustrates the need for business level strategies in a declining industry. Students should continue to understand the advantages and disadvantages of using a product development strategy and how and why strategies may need to change according to industry and competitive moves. You might ask students about the advantages of the niche market. Lecture Outline I. Overview This chapter looks at the different strategies that companies can pursue to strengthen their competitive position in each of these different stages of the industry life cycle. Each stage in the evolution of its industry raises some interesting challenges for a business. Managers must adopt the appropriate strategies to deal with these challenges. II. Strategy in a Fragmented Industry A fragmented industry is composed of a large number of small- and medium-sized companies, such as the dry-cleaning and restaurant industries. An industry may be fragmented for several reasons. A. Reasons for Fragmentation Reasons for fragmentation are as follows: •A lack of scale economies may mean that there are few, if any, cost advantages to large size. In Some industries there may even be diseconomies of scale, such as when customers prefer the unique food and style of a popular local restaurant rather than the standardized offerings of some chain restaurants. •Brand loyalty in the industry may primarily be local. It may be difficult to build a brand through differentiation that transcends a particular location or region. •The lack of scale economies and national brand loyalty implies low entry barriers. When this is the case, a steady stream of new entrants may keep the industry fragmented. Companies may specialize by customer group, customer need, or geographic region. Many small specialty companies may operate in local or regional markets. All kinds of specialized or custom-made products—furniture, clothing, hats, boots, houses, and so forth—fall into this category, as do all small service operations that cater to personalized customer needs, including dry-cleaning services, landscaping services, hair salons, and massage services. B. Consolidating a Fragmented Industry Through Value Innovation Business history is full of examples of entrepreneurial organizations that have pursued strategies to create meaningful scale economies and national brands where none previously existed. In the process they have consolidated industries that were once fragmented, reaping enormous gains for themselves and their shareholders in the process. For example, until the 1980s the office supplies business was a highly fragmented industry composed of many small “mom-and-pop” enterprises that served local markets. The typical office supplies enterprise in those days had a limited selection of products, low inventory turnover, limited operating hours, and a focus on providing personal service to local businesses. Then along came Staples, started by executives who had cut their teeth in the grocery business; they opened a big-box store with a wide product selection, long operating hours, and a self-service business model. They implemented computer information systems to track product sales and make sure that inventory was replenished just before it was out of stock, which drove up inventory turnover. Fragmented industries are wide open market spaces just waiting for entrepreneurs to transform them through the pursuit of value innovation. A key to understanding this process is to recognize that in each case, the value innovator defines value differently than established companies, and finds a way to offer that value that lowers costs through the creation of scale economies. C. Chaining and Franchising There are two strategies that enterprises use to replicate their offering once they get it right. One is chaining and the other is franchising. Chaining involves opening additional locations that adhere to the same basic formulae, and that the company owns. By expanding through chaining, a value innovator can quickly build a national brand. At the same time, by rapidly opening locations, and by knitting those locations together through good information systems, the value innovator can start to realize many of the cost advantages that come from large size. Franchising is similar in many respects to chaining, except that in the case of franchising the founding company—the franchisor—licenses the right to open and operate a new location to another enterprise—franchisee—in return for a fee. There are some advantages to using a franchising strategy: •Normally the franchisee puts up some or all of the capital to establish his or her operation. This helps to finance the growth of the system, and can result in more rapid expansion. •As franchisees are the owners of their operations, and because they often put up capital, they have a strong incentive to make sure that their operations are run as efficiently and effectively. •Franchisees have an incentive to improve the efficiency and effectiveness of their operations by developing new offerings and/or processes. The drawbacks of a franchising strategy are threefold: •There may not be the same tight control that can be achieved through a chaining strategy. •In a franchising system the franchisee captures some of the economic profit from a successful operation. •As franchisees are small relative to the founding enterprise, they may face a higher cost of capital, which raises system costs and lowers profitability. Given these various pros and cons, the choice between chaining and franchising depends on managers evaluating which is the best strategy given the circumstances facing the founding enterprise. D. Horizontal Mergers Another way of consolidating a fragmented industry is to merge with or acquire competitors, combining them together into a single larger enterprise that is able to realize scale economies and build a more compelling national brand. Focus On: Wal-Mart Value Innovation at Wal-Mart: Consolidating a Fragmented Market When Sam Walton opened the first Wal-Mart store in 1967 there were no large-scale general merchandise retailers. The industry was very fragmented. Walton’s vision was simple: Provide a wide selection of merchandise, stay open seven days a week, and have long operating hours. Buy in bulk to drive down the costs of goods sold, and then pass those cost savings on to customers in the form of lower prices. Reduce costs further by switching from a full-service format to a self-service format. Use good information systems to track what is sold in a store, and make sure that desired products are never out of stock. Gain further efficiencies by chaining, opening additional stores in a cluster around a common distribution center. It was a brilliant vision. Execution required the development of processes that did not exist at the time, including state-of-the-art information systems to track store sales and inventory turnover, and a logistics system to optimize the flow of inventory from distribution centers to stores. Over the years, as Wal-Mart did grew and built these systems, it was able to offer its customer set more value on the attributes that mattered to them. Due to its increasingly low cost structure, it was able to offer all this at prices significantly below those of its smaller rivals, effectively driving them out of business. Through such value innovation, Wal-Mart was able to consolidate what was once a fragmented market, building a powerful national brand wrapped around the concept of everyday low prices and wide product selection. Teaching Note: Wal-Mart did a fantastic job consolidating a once fragmented market, through the process of value innovation. Although faced with initial difficulties, Wal-Mart was able to achieve all its goals. Ask students to think of other examples of companies that successfully expanded by chaining the way. To initiate a class discussion, students may be asked to share about the difficulties these companies may have faced. III. Strategies in Embryonic and Growth Industries An embryonic industry is one that is just beginning to develop, and a growth industry is one in which first-time demand is rapidly expanding as many new customers enter the market. Choosing the strategies needed to succeed in such industries poses special challenges for because new groups of customers with different kinds of needs start to enter the market. Managers must be aware of the way competitive forces in embryonic and growth industries change over time because they frequently need to build and develop new kinds of competencies, refine their business strategy, in order to effectively compete in the future. Most embryonic industries emerge when a technological innovation creates a new product opportunity. Customer demand for the products in embryonic industries is initially limited for a variety of reasons. Reasons for slow growth in market demand include: •The limited performance and poor quality of the first products •Customer unfamiliarity with what the new product can do for them •Poorly developed distribution channels to get the product to customers •A lack of complementary products that might increase the value of the product for customers •High production costs because of small volumes of production An industry moves from the embryonic stage to the growth stage when a mass market starts to develop for its product. A mass market is one in which large numbers of customers enter the market. Mass markets start to emerge when three things happen: Ongoing technological progress makes a product easier to use, and increases its value for the average customer Complementary products are developed that also increases its value Companies in the industry work to find ways to reduce the costs of producing the new products so they can lower their prices and stimulate high demand. A. The Changing Nature of Market Demand Managers who understand how the demand for a product is affected by the changing needs of customers can focus on developing new strategies that will protect and strengthen their competitive position, such as building competencies to lower production costs or speed product development. Figure 6.1: Market Development and Customer Groups Different groups of customers with different needs enter the market over time. Growth follows an S-curve because as the stage of market development moves from embryonic to mature, customer demand first accelerates then decelerates as the market approaches the saturation point—where most customers have already purchased the product for the first time, and demand is increasingly limited to replacement demand. This curve has major implications for a company’s differentiation, cost, and pricing decisions. Following are the different groups of customers with different needs: •Innovators are “technocrats” or “gadget geeks”; people who are delighted to be the first to purchase and experiment with a product based on a new technology. •Early adopters understand that the technology may have important future applications and are willing to experiment with it to see if they can pioneer new uses for the technology. Early adopters are often people who envision how the technology may be used in the future, and they try to be the first to profit from its use. •The early majority forms the leading wave or edge of the mass market and their entry into the market signifies the beginning of the growth stage. Customers in the early majority are practical, generally understand the value of new technology, and weigh the benefits of adopting its new products against their costs and wait to enter the market until they are confident they will benefit. •The late majority are customers who purchase a new technology or product only when it is obvious the technology has great utility and is here to stay. A typical late majority customer group is a somewhat “older” and more behaviorally conservative set of customers. •Laggards, the last group of customers to enter the market, are people who are inherently conservative and unappreciative of the uses of new technology. Laggards frequently refuse to adopt new products even when the benefits are obvious, or unless they are forced to do so by circumstances—for example, due to work-related reasons. Figure 6.2: Market Share of Different Customer Segments B. Strategic Implications: Crossing the Chasm Pioneering companies are often unable to create a business model that allows them to be successful over time and remain as market leaders because innovators and early adopters have very different customer needs from the early majority. In an influential book, Geoffrey Moore argues that because of the differences in customer needs between these groups, the business-level strategies required for companies to succeed in the emerging mass market are quite different from those required to succeed in the embryonic market. New strategies are often required to strengthen a company’s business model as a market develops over time for the following reasons: •Innovators and early adopters are technologically sophisticated customers willing to tolerate limitations of the product, but the early majority values ease of use and reliability. •Innovators and early adopters can be reached through specialized distribution channels and products are often sold by word of mouth, but the early majority uses mass-market distribution channels and mass-media advertising campaigns that require a different set of marketing and sales strategies. •Innovators and early majority are few and are not price sensitive, so companies serving them typically pursue a focus model, produce small quantities of a product, and price high. To serve the rapidly growing mass-market, large-scale mass production may be critical to ensure that a high-quality product can be reliably produced at a low price point. The business models and strategies required to compete in an embryonic market populated by early adopters and innovators are very different from those required to compete in a high-growth mass market populated by the early majority. As a consequence, moving from an embryonic market to a mass market is not easy and smooth; instead, it represents a competitive chasm. Thus, although embryonic markets are typically populated by a large number of small companies, once the mass market begins to develop, the number of companies sharply decreases. 6.1 Strategy in Action Crossing the Chasm in the Smartphone Market The first smartphones started to appear in the early 2000s. The early market leaders included Research in Motion (RIM), with its blackberry line of smartphones, and Microsoft with Windows Mobile operating systems. These phones were sold to business users. Although they had an ability to send and receive e-mails, browse the Web, and so on, there was no independent applications market, and consequently, the utility of the phones was very limited and they were not easy to use. The market changed dramatically after the introduction of the apple iPhone in 2007. This phone was aimed not at power business users, but at a broader consumer market; it was easy to use, with a large touch-activated screen and a virtual keyboard that vanished when not in use; and it was stylishly designed, with an elegance that appealed to many consumers. Also, Apple made it very easy for independent developers to write applications that could run on the phone, and they set up an App store that made it easy for developers to market their apps. Clearly, the iPhone was a device aimed squarely not at business users, but at consumers. The ease of use and utility of the iPhone quickly drew the early majority into the market, and sales surged. Meanwhile, sales of Blackberry devices and Windows Mobile phones started to spiral downward. Both Microsoft and blackberry were ultimately forced to abandon their existing phone platforms and strategies, and reorient themselves. Teaching Note: Microsoft and Blackberry did a decent job of attracting early adopters, but stumbled when making the transition to a mass market. However, they weren’t as successful as they thought they would be as they failed to consider the needs of mass-market customers. In addition, they were cautious in making changes and let their rivals get ahead in innovation. Finally, they realized their mistakes and imitated their competitors, and changed what they offered to the consumers. This case depicts how important it is for a company to pay close attention to consumer needs to cross the chasm. Ask students if they know of any examples of companies that did not successfully cross the chasm. Then ask them to come up with suggestions for these companies to succeed. Figure 6.3: The Chasm in the Smartphone Business Managers in embryonic and growth industries must learn how to compete for the mass market and to cross the chasm successfully. •They must correctly identify the customer needs of the first wave of early majority users—the leading edge of the mass market. •They must adjust their business models by developing new strategies to redesign products and create distribution channels and marketing campaigns to satisfy the needs of the early majority. •They must have a suitable product available at a reasonable price to sell to the early majority when they begin to enter the market in large numbers. At the same time, the industry pioneers must abandon their outdated, focused business models directed at the needs of innovators and early adopters. •They need to develop the strategies necessary to pursue a differentiation or cost-leadership business model in order to remain a dominant industry competitor. C. Strategic Implications of Differences in Market Growth Rates Managers must understand a final important issue in embryonic and growth industries: different markets develop at different rates. A number of factors explain the variation in market growth rates for different products, and thus the speed with which a particular market develops. •The first factor that accelerates customer demand is a new product’s relative advantage—the degree to which a new product is perceived as better at satisfying customer needs than the product it supersedes. •A second factor of considerable importance is complexity. Products that are viewed by consumers as being complex and difficult to master will diffuse more slowly than products that are easy to master. •Another factor is compatibility, which refers to the degree to which a new product is perceived as being consistent with the current needs or existing values of potential adopters. •Complexity, the degree to which a new product is perceived as difficult to understand and use, is another factor. •Another factor is trialability, which is the degree to which potential customers can experiment with a new product during a hands-on trial basis. •A final factor is observability, which refers to the degree to which the results of using and enjoying a new product can be clearly seen and appreciated by other people. When a market is rapidly growing, and the popularity of a new product increases or spreads in a way that is analogous to a viral model of infection, a related strategic issue arises. Lead adopters (the first customers who buy a product) in a market become “infected” or enthused with the product, as exemplified by iPhone users. Subsequently, lead adopters infect other people by telling others about the advantages of products. After observing the benefits of the product, these people also adopt and use the product. Companies promoting new products can take advantage of viral diffusion by identifying and aggressively courting opinion leaders in a particular market—the customers whose views command respect. IV. Strategy in Mature Industries A mature industry is commonly dominated by a small number of large companies. Although a mature industry may also contain many medium-sized companies and a host of small, specialized companies, the large companies often determine the nature of competition in the industry because they can influence the six competitive forces. In mature industries, business-level strategy revolves around understanding how established companies collectively attempt to moderate the intensity of industry competition in order to preserve both company and industry profitability. A. Strategies to Deter Entry There may be cases in which scale and brand, although significant, are not sufficient to deter entry. In such circumstances there are other strategies that companies can pursue to make new entry less likely. These strategies include product proliferation, limit pricing, and strategic commitments. 1. Product Proliferation One way in which companies try to enter a mature industry is by looking for market segments or niches that are poorly served by incumbent enterprises. The entry strategy involves entering these segments, gaining experience, scale and brand in that segment, and then progressively moving upmarket. A product proliferation strategy involves incumbent companies attempting to forestall entry by making sure that every niche or segment in the marketplace is well served. A product proliferation strategy therefore, because it gives new entrants very little opportunity to find an unoccupied niche in an industry, can effectively deter entry. 2. Limit Price A limit price strategy may be used to deter entry when incumbent companies in an industry enjoy economies of scale, but the resulting cost advantages are not enough to keep potential rivals out of the industry. A limit price strategy involves charging a price that is lower than that required to maximize profits in the short run, but is above the cost structure of potential entrants. Figure 6.4: Limit Pricing If incumbents charge the price that the market will bear, this will be above the unit cost structure of new entrants, allowing them to enter and still make a profit under the pricing umbrella set by incumbents. In this situation, the best option for incumbents might be to charge a price that is still above their own cost structure, but just below the cost structure of any potential new entrants. As it deters entry, the limit price might be thought of as the long-run profit-maximizing price. Because it deters entry, the limit price might be thought of as the long-run profit-maximizing price. 3. Strategic Commitments Strategic commitments are investments that signal an incumbent’s long-term commitment to a market, or a segment of that market. It involves raising the perceived costs of entering a market, thereby reducing the likelihood of entry. Other strategic commitments that might act as an entry deterrent include making significant investments in basic research, product development, or advertising beyond those necessary to maintain a company’s competitive advantage over its existing rivals. Incumbents might also be able to deter entry if they have a history of responding aggressively to new entry through price cutting, accelerating product development efforts, increased advertising expenditures, or some combination of these. One thing to note here is that when making strategic commitments, a company must be careful not to fall foul of antitrust law. B. Strategies to Manage Rivalry Beyond seeking to deter entry, companies also wish to develop strategies to manage their competitive interdependence and decrease price rivalry. Unrestricted competition over prices reduces both company and industry profitability. Several strategies are available to companies to manage industry rivalry which include price signaling, price leadership, non-price competition, and capacity control. 1. Price Signaling A company’s ability to choose the price option that leads to superior performance is a function of several factors, including the strength of demand for a product and the intensity of competition between rivals. Price signaling is the process by which companies increase or decrease product prices to convey their intentions to other companies and influence the way other companies price their products. Companies use price signaling to improve industry profitability. Companies may use price signaling to announce that they will vigorously respond to hostile competitive moves that threaten them. For example, they may signal that if one company starts to aggressively cut prices, they will respond in kind. A tit-for-tat strategy is a well-known price signaling maneuver in which a company does exactly what its rivals do: if its rivals cut prices, the company follows; if its rivals raise prices, the company follows. By consistently pursuing this strategy over time, a company sends a clear signal to its rivals that it will mirror any pricing moves they make; sooner or later, rivals will learn that the company will always pursue a tit-for-tat strategy. a tit-for-tat strategy also signals to rivals that price increases will be imitated, growing the probability that rivals will initiate price increases to raise profits. Thus, a tit-for-tat strategy can be a useful way of shaping pricing behavior in an industry. 2. Price Leadership When one company takes the responsibility of setting prices that maximizes industry profitability, that company assumes the position as price leader. Formal price leadership, or when companies jointly set prices, is illegal under antitrust laws; therefore, the process of price leadership is often very subtle. The price set by the weakest company—that is, the company with the highest cost structure—is often used as the basis for competitors’ pricing. Although price leadership can stabilize industry relationships by preventing head-to head competition and raising the level of profitability within an industry, it has its dangers. It helps companies with high cost structures, allowing them to survive without needing to implement strategies to become more efficient. In the long term, such behavior makes them vulnerable to new entrants that have lower costs because they have developed new low-cost production techniques. 3. Nonprice Competition A third very important aspect of product and market strategy in mature industries is the use of non-price competition to manage rivalry within an industry. The use of strategies to try to prevent costly price cutting and price wars does not preclude competition by product differentiation. In many industries, product-differentiation strategies are the principal tools companies use to deter potential entrants and manage rivalry within their industries. Product and market segment dimensions are used to identify four non-price-competitive strategies based on product differentiation: market penetration, product development, market development, and product proliferation. Figure 6.5: Four Nonprice Competitive Strategies 4. Market Penetration When a company concentrates on expanding market share in its existing product markets, it is engaging in a strategy of market penetration. This strategy uses heavy advertising to promote and build product differentiation. In a mature industry, advertising aims to influence customers’ brand choice and create a brand-name reputation for the company and its products. In this way, a company can increase its market share by attracting its rival’s customers. Because brand-name products often command premium prices, building market share in this situation is very profitable. In some mature industries—for example, soap and detergent, disposable diapers, and brewing—a market-penetration strategy becomes a long-term strategy. 5. Product Development Product development involves consistently creating new or improved products to replace existing ones. Product development is crucial for maintaining product differentiation and building market share. Refining and improving products is a crucial strategy companies use to fine-tune and improve their business models in a mature industry, but this kind of competition can be as vicious as a price war because it is very expensive and can dramatically increase a company’s cost structure. 6. Market Development Market development involves finding new market segments for a company’s products. A company pursuing this strategy wants to capitalize on the brand name it has developed in one market segment by locating new market segments in which to compete. 6.2 Strategy in Action Toyota Uses Market Development to Become the Global Leader Beginning as a focused cost leader, Toyota has risen to making an ever-increasing range of reasonably priced vehicles tailored to different segments of the car market. Toyota has been a leader in positioning its entire range of vehicles to take advantage of new, emerging market segments.. Evolving to a broad differentiation business model, Toyota is geared toward making a range of vehicles that optimizes the amount of value it can create for different groups of customers. The company remains constrained by costs to maximize revenues and profits as are all industry competitors aiming for suiting the needs of different customers. Teaching Note: This case demonstrates the use of price competitive strategies coupled with market development as strategies to manage rivalry. Ask students how market development plays a crucial role in Toyota’s success. How can Toyota’s broad differentiation business model help in generating maximum revenues and profits? 7. Product proliferation The strategy of product proliferation generally means that large companies in an industry all have a product in each market segment (or niche). Product proliferation thus allows the development of stable industry competition based on product differentiation, not price—that is, non-price competition based on the development of new products. 6.3 Strategy in Action Non-Price Competition at Nike The way in which Nike has used non-price-competitive strategies to strengthen its differentiation strategy is highly instructive. Bowerman’s, co-founder of Nike, dream was to create a new type of sneaker tread that would enhance a runner’s traction and speed, and after studying the waffle iron in his home, he came up with the idea for Nike’s “waffle tread.” The founders of Nike began by selling it out of car trunks at track meets. Nike’s amazing success came from its business model, which was always based on differentiation; its strategy was to innovate state-of-the-art athletic shoes and then to publicize the qualities of its shoes through dramatic “guerrilla” marketing. Nike’s marketing is designed to persuade customers that its shoes are not only superior, but also a high-fashion statement and a necessary part of a lifestyle based on sporting or athletic interests. Nike’s strategy to emphasize the uniqueness of its product obviously paid off, as its market share soared. However their market shares started to fall when they found it difficult to create new shoes—its strategy of market penetration and product development was no longer paying off. Nike initially shunned sports like golf, soccer, etc, but when its market shares started to fall it began to pursue market development and product proliferation as well as the other non-price strategies. This strategy significantly strengthened its differentiation business model, which is why its market share and profitability have continued to increase, and also why Nike is the envy of competitors. Teaching Note: This case demonstrates the strategies used to manage rivalry, more specifically, market development and product proliferation strategies coupled with non-price strategies. Emphasize to students the need to look at changing strategies in a mature industry. Ask students about the impact of Nike’s brand name in its success at market development. How did Nike demonstrate product proliferation? 8. Control Capacity Excess capacity arises when companies collectively produce too much output; to dispose of it, they cut prices. When one company cuts prices, other companies quickly do the same because they fear that the price cutter will be able to sell its entire inventory, while they will be left with unwanted goods. The result is a developing price war. To prevent the accumulation of costly excess capacity, companies must devise strategies that let them control—or at least benefit from—capacity expansion programs. 9. Factors Causing Excess Capacity The problem of excess capacity often derives from technological developments. Excess capacity occurs because new technology can produce more than the old. In addition, new technology is often introduced in large increments, which generates overcapacity. Overcapacity may also be caused by competitive factors within an industry. Entry into an industry is one such a factor. The recent economic recession caused global overcapacity and the price of steel plunged; with global recovery the price has increased. Sometimes the age of a company’s physical assets is the source of the problem. 10. Choosing a Capacity-Control Strategy Given the various ways in which capacity can expand, companies clearly need to find some means of controlling it. Companies have two strategic choices: •Each company must try to preempt its rivals and seize the initiative. To preempt rivals, a company must forecast a large increase in demand in the product market and then move rapidly to establish large-scale operations that will be able to satisfy the predicted demand. This is a risky strategy because it involves investing resources before the extent and profitability of the future market are clear. •Companies must collectively find indirect means of coordinating with each other so that they are all aware of the mutual effects of their actions. To coordinate with rivals as a capacity-control strategy, caution must be exercised because collusion on the timing of new investments is illegal under antitrust law. V. Strategy in Declining Industries Sooner or later, many industries enter into a decline stage, in which the size of the total market begins to shrink. A. The Severity of Decline When the size of the total market is shrinking, competition tends to intensify in a declining industry, and profit rates tend to fall. Four critical factors determine the intensity of competition in a declining industry: •The intensity of competition is greater in industries in which decline is rapid, as opposed to industries such as tobacco, in which decline is slow and gradual. •The intensity of competition is greater in declining industries in which exit barriers are high. •Related to the previous point, the intensity of competition is greater in declining industries in which fixed costs are high. •The intensity of competition is greater in declining industries in which the product is perceived as a commodity in contrast to industries in which differentiation gives rise to significant brand loyalty. Figure 6.6: Factors That Determine the Intensity of Competition in Declining Industries Segments within an industry may decline at different rates. In some segments, demand may remain reasonably strong despite decline elsewhere. B. Choosing a Strategy Companies can adopt the following four main strategies to deal with decline: •A leadership strategy, by which a company seeks to become the dominant player in a declining industry. •A niche strategy, which focuses on pockets of demand that are declining more slowly than the industry as a whole. •A harvest strategy, which optimizes cash flow. •A divestment strategy, by which a company sells the business to others. Figure 6.7: Strategy Selection in a Declining Industry 1. Leadership Strategy A leadership strategy aims at growing in a declining industry by picking up the market share of companies that are leaving the industry. This strategy makes most sense when a company has distinctive strengths that allow it to capture market share in a declining industry and when the speed and intensity of competition in the declining industry are moderate. The tactical steps companies might use to achieve a leadership position include aggressive pricing and marketing to build market share, acquiring established competitors to consolidate the industry, and raising the stakes for other competitors. The leadership strategy signals to competitors that a firm is willing to stay and compete, and may speed up exit of competitors from the industry. 2. Niche Strategy A niche strategy focuses on pockets of demand where demand is stable, or declining less slowly than the industry as a whole. This strategy makes sense when the company has some unique strengths relative to those niches in which demand remains relatively strong. 3. Harvest Strategy A harvest strategy is the best choice when a company wishes to exit a declining industry and optimize cash flow in the process. This strategy makes the most sense when the firm anticipates a very steep decline and intense future competition, or when it lacks strengths relative to remaining pockets of demand in the industry. A harvest strategy requires the company to halt all new investments in capital equipment, advertising, research and development and so forth. In practice, this strategy may be difficult to implement because employee morale suffers, and if customers realize what is happening, they may defect rapidly and hasten the decline. 4. Divestment Strategy A divestment strategy rests on the idea that a company can recover most of its investment in an underperforming business by selling it early, before the industry has entered into a steep decline. This strategy is appropriate when the company has few strengths relative to whatever pockets of demand are likely to remain in the industry and when the competition in the declining industry is likely to be intense. The best option may be to sell to a company that is pursuing a leadership strategy in the industry. The drawback of the divestment strategy is that its success depends upon the ability of the company to spot industry decline before it becomes detrimental, and to sell while the company’s assets are still valued by others. Teaching Note: Ethical Dilemma This dilemma illustrates a common practice in highly-competitive U.S. consumer goods marketing. Students will have ample examples of companies who practice all of the strategies suggested in the case. Breakfast cereal is an example of a product in a mature industry that competing companies continually try to differentiate using these tactics. Instead, the leadership of the companies should be pursuing strategies to deter entry of rivals including targeting every segment in the market, reducing prices, and maintaining excess capacity. The tactics suggested in this feature box are risky as customer switching costs are low and availability of substitutes high: should the public perceive they are getting less utility and quality for their money, they will choose to spend elsewhere. Furthermore, because of the proliferation of social media, consumers have more power than ever to spread negative perceptions of products and companies, potentially igniting a public relations disaster should the tactic backfire. Answers to Discussion Questions 1. Why are industries fragmented? What are the primary ways in which companies can turn a fragmented industry into a consolidated industry? Industries may be fragmented because of the following reasons: •Lack of economies of scale may mean there are few cost advantages to large size. •Brand loyalty in the industry may primarily be local. It may be difficult to build a brand through differentiation that transcends a particular location or region. •The lack of scale economies and national brand loyalty implies low entry barriers. The main ways in which companies can turn fragmented industries into consolidated ones include value innovation, chaining, franchising, and horizontal mergers. To pursue value innovation, the value innovator defines value differently than established companies, and finds a way to offer that value that lowers costs through the creation of scale economies. Chaining is a strategy designed to obtain the advantages of cost leadership by establishing a network of linked merchandising outlets interconnected by information technology that functions as one large company. Franchising is a strategy in which the franchisor grants to its franchisees the right to use the franchisor’s name, reputation, and business model in return for a franchise fee and often a percentage of the profits. A horizontal merger is a way of consolidating a fragmented industry by merging with or acquiring competitors, combining them together into a single larger enterprise that is able to realize scale economies and build a more compelling national brand. 2. What are the key problems in maintaining a competitive advantage in embryonic and growth industry environments? What are the dangers associated with being the leader in an industry? The key to profiting from innovation in a growth environment is to create, exploit, and sustain a competitive advantage over industry rivals. Over time, rivals will also be developing their technical competencies, so to maintain their advantage companies need to defend their reputation, which has built them brand loyalty; quickly move down the experience curve to keep ahead of rivals; develop control over scarce assets, including inputs, and over distribution networks; and strive to retain customers by making it very difficult for them to switch products. The dangers associated with being a leader include the high costs of start-up, which can leave a company with a crippling debt burden, and the likelihood that the company’s innovative ideas may be copied by later entrants at lower cost. 3. What investment strategies should be made by: (a) differentiators in a strong competitive position, and (b) differentiators in a weak competitive position, while managing a company’s growth through the life cycle? Differentiators in a strong competitive position should follow the strategies of share building, then growth, and then share increasing to consolidate their position. Then, depending on the level of industry competition and the strength of the five forces, they should pursue either a hold and maintain or a profit strategy. In the decline stage, their choice depends on the strength of their competitive advantage and might consist of market reduction, harvest, or turnaround strategies. Those in a weak competitive position should select strategies that allow them to obtain the maximum revenue advantages from their strategy at an investment cost consistent with maintaining their competitive advantage. Generally, they should not become broad differentiators (that is, companies that compete in many market segments) and should engage in share building and market concentration in a directed set of market niches. As conditions become worse, they should systematically retrench and choose a harvest strategy or a liquidation strategy to maximize profitability under unfavorable circumstances. 4. Discuss how companies can use (a) product differentiation and (b) capacity control to manage rivalry and increase an industry’s profitability. (a) The virtue of product differentiation as a competitive weapon is that it reduces the risk that companies will compete for customers on price. Price competition decreases the level of industry profitability. In many industries, product-differentiation strategies are the principal tools companies use to deter potential entrants and manage rivalry within their industries. Product differentiation allows industry rivals to compete for market share by offering products with different or superior features, such as smaller, more powerful, or more sophisticated computer chips, or by applying different marketing techniques. Product and market segment dimensions are used to identify four non-price-competitive strategies based on product differentiation: market penetration, product development, market development, and product proliferation. Market penetration involves using advertising and marketing to create a differentiation advantage to increase market share. This also raises barriers to entry, thus increasing industry profitability and reducing rivalry because companies can forecast their rivals’ actions. Product development means creating new and improved products to sustain consumer demand for products. It keeps companies on their toes and lessens the likelihood that a new entrant will be able to come into the industry with a superior product to seize market share. In this sense, product development acts like a barrier to entry. At the same time, it builds reputation and brand loyalty. Market development involves finding new market segments in which to exploit a company’s products or distinctive competencies. Market development and the development of niche marketing can cause intense rivalry between firms as new spheres of competition are created. Moreover, market development may provide a means for competitors to enter the market, for it opens a niche through which they can enter. Thus market development is probably the most competitive of the four product differentiation strategies, since it creates the most opportunity for gain or loss in market share. Product proliferation is an effort to stabilize the uncertainty created by market development. By filling all the market niches, companies are trying to respond to competitors’ actions in order to stabilize the industry situation. At the same time, product proliferation also promotes barriers to entry since it makes it difficult for competitors to enter the market by finding a new niche. It therefore also helps stabilize competition in the industry. (b) Capacity control strategies also allow the firm to manage rivalry and promote industry profitability. Capacity control can be used to deter rivals, since it provides companies with a credible threat that they will respond to the threat of entry by increasing capacity and driving down price. Inside the industry, the need is for a strategy that lets firms indirectly coordinate their capacity decisions and avoid the wasteful excess capacity, which can occur if all firms make the decision to build new plant capacity. Such a strategy stabilizes competition and industry profitability. 5. What kinds of strategies might: (a) a small pizza place operating in a crowded college market, and (b) a detergent manufacturer seeking to unveil new products in an established market use to strengthen their business models? Students’ answers may vary. In both cases, managers should try to accurately make an estimation to know their rivals’ strengths and weaknesses, and to seek a dominant strategy. For the pizza place’s managers, this would mean taking actions such as differentiating their product in some way from the other products, such as offering more varieties, using tastier or fresher ingredients or having faster delivery. Another possible action would be to single out just one competitor and then focus on driving them from the industry. This would work if the competitors were also small, local firms. For the detergent maker, the principles are the same but the choices would be quite different, due to different industry structures. For example, when competing against powerful rivals niche strategies may be effective. The detergent maker could consider developing specialty products, such as extra-mild soaps for fragile fabrics or baby clothes. In neither case would a price war be recommended, due to its negative long-term effects on the entire market. Practicing Strategic Management Small-Group Exercise: Creating a Nationwide Health Club This exercise asks students to break into small groups. One group member is appointed as a spokesperson who will communicate the findings to the class. You are the founders of a health club. The health club industry is quite fragmented, with many small players, and just a few larger players. Your backers want you to devise a strategy for growing their business, quickly establishing a nationwide chain of health clubs. 1. Is there scope for value innovation in this industry? What might a value innovation strategy look like? 2. Describe how your chosen strategy would enable you to create a national brand and/or attain scale economies. 3. What would your growth strategy be: chaining or franchising? Be sure to justify your answer. Teaching Note: This exercise focuses students’ attention on the problems associated with competition in an industry dominated by smaller rivals as well as larger, more powerful rivals. They should describe if there is scope for value innovation in this industry and what might a value innovation strategy look like. They should describe how their chosen strategy would enable them to create a national brand and/or attain scale economies. Ask your students what their growth strategy would be: chaining or franchising? Also, ask them to justify their answers. Strategy Sign-On Article File 6 This exercise asks students to choose a company (or group of companies) in a particular industry environment and explain how it has adopted a competitive strategy to protect or enhance its business-level strategy. Teaching Note: Students will readily find examples as virtually all firms use competitive strategies to protect their overall generic strategy. You can then ask students to describe how the competitive strategy gives these benefits. For example, consider the choice of a firm in a mature industry that has adopted the nonprice competitive strategy of market penetration, which Whirlpool used in introducing its electric appliances into eastern Europe. Students can describe how this strategy allowed Whirlpool to sell more products than its competitors that did not enter the industry, enabling economies of scale and learning curve effects. Whirlpool also gained first-mover advantages, and had valuable expertise in the regional market before others. Finally, Whirlpool was able to leverage its existing investments in advertising and product R&D to increase its capital productivity. Strategic Management Project: Developing Your Portfolio 6 This part of the project continues the analysis of the student’s company’s business-level strategy and examines how the nature of the industry environment affects the company. Remind students to link this analysis to their analysis in the previous module. With the information you have available, perform the tasks and answer the questions listed: 1. I n what kind of industry environment (e.g., embryonic, mature, etc.) does your company operate? Use the information from Strategic Management Project: Module 2 to answer this question. 2. Discuss how your company has attempted to develop strategies to protect and strengthen its business model. For example, if your company is operating in an embryonic industry, how has it attempted to increase its competitive advantage over time? If it operates in a mature industry, discuss how it has tried to manage industry competition. 3. What new strategies would you advise your company to pursue to increase its competitive advantage? For example, how should your company attempt to differentiate its products in the future, or lower its cost structure? 4. On the basis of this analysis, do you think your company will be able to maintain its competitive advantage in the future? Why or why not? Teaching Note: Use this module to reinforce the linkages between a firm’s competitive environment, its choice of strategy, and its performance. You can point out to students that even the best strategy will not lead to success if it is inappropriate for its environment. Also remind students that competitors’ actions can have a very important effect on a strategy’s outcome. CLOSING CASE Consolidating Dry Cleaning No large companies dominate the U.S. dry-cleaning industry. The industry is a favored starting point for many immigrants, who are attracted by the low capital requirements. More than 80% of industry revenues can be attributed to individual retail customers, with hospitals, hotels, and restaurants accounting for much of the balance. A weak economy shrunk the demand for dry cleaners. Convenience is what makes the consumer choose one dry cleaner over the other. The founders of Staples established a dry-cleaning chain called Zoots. They had visions of transforming the dry-cleaning industry, consolidating a fragmented industry and creating enormous economic value for themselves in the process. Zoots promised to get dry-cleaning done right, reliably, and conveniently, and to do this at a reasonable price. They later found out that the nature of dry cleaning made it impossible to standardize the process. Costs were significantly higher than anticipated, quality was not as good as management hoped, employee turnover was high, and demand came in below forecasts. Today Zoots has less than 40 stores and remains concentrated in the Boston area. The founders are no longer involved in the business and, clearly, it did not come close to transforming the industry. Teaching Note: The case of Zoots shows how easily a business can fail and not be as profitable as it promises to be due to strategic inattention. Ask your students what will it take for Zoots to be better than the other dry cleaners. Will adopting the chaining strategy help Zoots become successful and what might be the possible risks? Ask them to think of other examples of companies who faced the same issues as Zoots. Answers To Case Discussion Questions 1. Why do you think that the dry-cleaning industry has a fragmented structure? Students’ answers may vary. The dry-cleaning industry does not have one company that dominates it. It is mostly started by immigrants who are attracted to businesses with low- capital requirements. As there is no one company that dominates the industry, an individual who is starting their own dry-cleaners need not be worried about the competition. This is also true because individuals mostly choose dry-cleaners out of convenience. Dry cleaning has been described as a classic low-interest category as there is very little about dry cleaning that excites consumers. These could be the reasons for the dry-cleaning industry to have a fragmented structure. The industry has also defied all efforts to consolidate it. 2. The larger enterprises in the industry seem to serve large customers with standardized needs, such as hotels and hospitals. Why do you think this is the case? Students’ answers may vary. The larger enterprises in the industry seem to serve larger customers with standardized needs such as hotels and hospitals because they have the revenue, the infrastructure, and the resources to back their standardized process. A smaller enterprise may have more difficulty doing this as they may not have the resources to support such a process. Smaller enterprises would be able to serve individuals better as they may find it easier to appease their specific needs. 3. Why do you think that Zoots was unable to consolidate the dry-cleaning industry, despite adequate capital and the managerial talent that created Staples? Students’ answers may vary. Despite the adequate capital and managerial talent that Zoots had, they were unable to consolidate the dry-cleaning industry because they promised a standardized, low-cost, and reliable process without taking into account the service intensity of the dry-cleaning and the variable nature of clothing. The costs incurred by Zoots were significantly higher than anticipated, quality was not as good as management hoped, employee turnover was high, and demand came in below forecasts. Zoots failed at consolidation because it failed to take in all the factors involved in the process of dry-cleaning. 4. If you were to try to consolidate the dry-cleaning industry, what strategy would you pursue and why? To consolidate the dry-cleaning industry, I would pursue a strategy of acquiring smaller, independent operators to create a network of centralized processing facilities. This would reduce operational costs through economies of scale, enhance service offerings with added convenience like pick-up and delivery, and leverage technology for efficiency and customer engagement12. Solution Manual for Strategic Management: Theory: An Integrated Approach Charles W. L. Hill, Gareth R. Jones, Melissa A. Schilling 9781285184494