This Document Contains Chapters 7 to 8 CHAPTER 7 Strategy and Technology Synopsis Of Chapter The goal of this chapter is to describe the strategies and concepts that are unique to high-technology industries. High-tech industries are growing in number and many formerly low-technology industries are becoming more high-tech. In addition, high-technology industries face similar industry conditions, and thus tend to employ a similar range of strategies. One of the most important concepts in understanding high-technology industries is the idea of technical standards. These standards emerge as a new technology evolves rapidly in its early days. Typically, many alternate technologies are tried before a new standard is chosen. The existing technology is usually completely replaced by the new technology in time. The contest is to decide which firm will own the technical standard which is called a “format war.” Standards may emerge as a result of government policy or through an agreement made by firms within an industry, or gradually emerge based on consumer buying patterns. A critical part of a new technology’s success is often the support of complementary products. A network of interrelated buyer and supplier firms creates a support system for new technology. Winning the format wars require a company to build the installed base for its standard as rapidly as possible, thereby leveraging the positive feedback loop, inducing consumers to bear switching costs, and ultimately locking the market into its technology. A number of strategies for winning a format war include ensuring a supply of complements, leveraging killer applications, being aggressive in marketing and pricing, cooperating with competitors, and licensing formats. Such activities contribute to the cost of being present in high-tech industries. The cost structure is reflected in comparative cost economics and its strategic significance. First movers typically have an economic benefit, due to the early monopoly and the opportunity to gain technology-specific knowledge, driving down costs and increasing sales. Sometimes, however, firms that follow first movers can benefit from the first mover’s experience without the steep up-front investment. There are first mover disadvantages which include bearing significant pioneering costs, mistakes because of the uncertainties in new markets, risk of building the wrong resources and capabilities, and investment in inferior or obsolete technologies. In addition, high-tech products are increasingly digitized, which makes it easier to steal the product through piracy. Therefore, intellectual property rights are an important concern of high-tech firms. Also, high-technology industries tend to have high fixed costs and low marginal costs. Therefore, strategies for success in high-tech industries include being a first mover, owning the technical standard, building demand early by dropping price, riding down the experience curve, and being open to strategic alliances with firms that possess complementary assets. The last part of the chapter examines various strategies for use in high-technology industries and the nature of the technological paradigm shifts. Strategies for exploiting first-mover advantages include having complementary assets, higher barriers to imitation, being aware of capable competitors, and investing in innovation. Technological paradigm shifts require companies to adopt new strategies in order to survive. Paradigm shifts are more likely to occur in industries when there are limits to technology and when there is disruptive technology. All the more reason that established companies have access to knowledge of disruptive technology and invest in technologies that may produce disruptive technologies. New entrants, on the other hand, can just focus on the opportunities available with disruptive technology. Learning Objectives 1. Understand the tendency toward standardization in many high-technology markets. 2. Describe the strategies that firms can use to establish their technology as the standard in a market. 3. Explain the cost structure of many high-technology firms and articulate the strategic implications of this structure. 4. Explain the nature of technological paradigm shifts and their implications for enterprise strategy. Opening Case A Battle Emerging in Mobile Payments In 2012, more than 75% of the world population was using mobile phones, and 80% of those accessed the mobile Web. Mobile payment systems offered the potential of enabling all of these users to perform financial transactions on their phones, similar to how they would perform those transactions using personal computers. The mobile web is similar to using the web on a laptop, but there was no dominant mobile payment system in place then. Top firms began developing Near Field Communication (NFC) chips for smartphones that can facilitate wireless transactions and enable purchase without contact. Other companies that did not require NFC chips used a downloadable application and the web to transmit customer information. Companies like PayPal had a clear advantage because customers could simply complete purchases by entering their phone numbers and a pin number, or use their PayPal-issued card. In other parts of the world where mobile phones are used more than banks, intriguing alternatives for mobile banking were gaining traction even faster. The opportunity, then, of giving such people access to fast and inexpensive funds transfer is enormous. The leading system in India is Inter-bank Mobile Payment Service was developed by National Payments Corporation of India (NPCI). This system uses a unique identifier for each individual that links directly to his or her bank account. With such far reaching impact, by 2013, it was realized that mobile payments was an opportunity like no other. It could accelerate e-commerce, smartphone adoption, and promote global financial services. However, obstacles still exist due to the lack of compatibility between many mobile payment systems. Teaching Note: This case illustrates that global developments take place rapidly, and competition in technology is especially fast. Ask the students if similar technological developments can take place at the same time in all parts of the world, or does technology have to mold itself to suit a particular place? Also, discuss with the students if smartphones have facilitated communication among people, or have they led to a lack of personal contact. Lecture Outline I. Overview Technology refers to “the body of scientific knowledge used in the production of goods or services.” High-technology industries (also called high-tech industries) are ones in which the scientific knowledge used by companies in the industry is advancing rapidly, and, by implication, so are the attributes of the products and services that result from its application. Examples of high-tech industries include the computer industry, telecommunications, consumer electronics, pharmaceuticals, power generation, and aerospace, among others. The circle of high-technology industries is both large and expanding, and technology is revolutionizing aspects of the product or production system even in industries not typically considered high-tech. Although high-tech industries may produce very different products, when developing a business model and strategies that will lead to a competitive advantage and superior profitability and profit growth, they often face a similar situation. II. Technical Standards and Format Wars Technical standards are a set of technical specifications that producers adhere to when making the product or a component of it that can be an important source of competitive advantage. Battles to set and control technical standards in a market are referred to as format wars—essentially, battles to control the source of differentiation, and the value that such differentiation can create for the customer. 7.1 Strategy in Action “Segment Zero”—A Serious Threat to Microsoft? For over two decades Microsoft dominated the computer operating systems market. However, in 2013, Microsoft faced a great threat as serious competitors had begun to emerge. The CEO of Intel said that technologies improve faster than the customers’ demand of it. Although, customers expect better and improved products over time, their ability to use these features is slowed by the need to learn how to use it, and make it part of their lifestyle. This explains that the trajectory of technological development and customer demands are upward sloping, but technology improvements are steeper. Most part of the market may feel that they overpay for technology that they do not value. Whereas, another part of the market may feel that they pay a lot more than they need or go without it. This is referred to as segment zero. Firms can make best use of this “segment zero” by balancing their trajectory of technological development with the trajectory of customer demands. The threat to Microsoft came when 90% of the worldwide market for smartphones was from Apple, Google, and Blackberry in 2013. Soon these companies launched tablet operating systems, and fully functional computers. Although, Microsoft still possessed an impressive set of resources, it still faced competition from a disadvantaged position for the first time. Teaching Note: This case talks about “Segment Zero,” and how Microsoft, the leader in computer operating systems, is fighting to save its market position. The instructor may use this case and ask the students to express their opinions on what Microsoft can do to regain their market, and how they could use the segment zero to their benefit. Figure 7.1: Trajectories of Technology Improvement and Customer Requirements Figure 7.2: Low-End Technology’s Trajectory Intersects Mass-Market Trajectory A. Examples of Standards A familiar example of a standard is the layout of a computer keyboard. The standard format (QWERTY) makes it easy for people to move from computer to computer because the input medium, the keyboard, is set in a standard way. Examples of products that rely on technical standards include the dimensions of shipping containers such as trucks and railcars, and the components included in a personal computer. When an industry relies upon a common set of features or design characteristics it is called a dominant design. Embedded in this design are several technical standards. Figure 7.3: Technical Standards for Personal Computers B. Benefits of Standards Standards emerge because there are economic benefits associated with them. Following are the benefits: • A technical standard helps to guarantee compatibility between products and their complements. • Standards help reduce consumer confusion. • The emergence of a standard can help to reduce production costs. Once a standard emerges, products that are based on the standard design can be mass produced, enabling the manufacturers to realize substantial economies of scale while lowering their cost structures. • The emergence of standards can help reduce risks associated with supplying complementary products, and thus increase the supply for those complements. C. Establishment of Standards Standards emerge in an industry in three primary ways: • When the benefits of establishing a standard are recognized, companies in an industry might lobby the government to mandate an industry standard. • Technical standards are often set by cooperation among businesses, without government help, and often through the medium of an industry association. • When the government or an industry association sets standards, these standards fall into the public domain, meaning that any company can freely incorporate the knowledge and technology upon which the standard is based into its products. Often, however, the industry standard is selected competitively by the purchasing patterns of customers in the marketplace—that is, by market demand. In this case, the strategy and business model a company has developed for promoting its technological standard are of critical importance because ownership of an industry standard that is protected from imitation by patents and copyrights is a valuable asset—a source of sustained competitive advantage and superior profitability. Format wars are common in high-tech industries where standards are important. D. Network Effects, Positive Feedback, and Lockout There has been a growing realization that when standards are set by competition between companies promoting different formats, network effects are a primary determinant of how standards are established. Network effects arise in industries where the size of the “network” of complementary products is a primary determinant of demand for an industry’s product. Network effects are important in the establishment of standards. The classic example of a format war can be considered: the battle between Sony and Matsushita to establish their respective technologies for videocassette recorders (VCRs) as the standard in the marketplace. Sony was first to market with its Betamax technology, followed by JVC with its VHS technology. As more prerecorded VHS tapes were made available for rental, the VHS player became more valuable to consumers, and therefore the demand for VHS players increased. A large number of companies signed on to manufacture VHS players, and soon far more VHS players were available for purchase in stores. Before long, it was clear to anyone who entered a video rental store that there were more VHS tapes available for rent, and fewer Betamax tapes available. This served to reinforce the positive feedback loop, and ultimately Sony’s Betamax technology was shut out of the market. The pivotal difference between the two companies was strategy: JVC and Matsushita chose a licensing strategy, and Sony did not. As a result, JVC’s VHS technology became the de facto standard for VCRs, whereas Sony’s Betamax technology was locked out. Figure 7.4: Positive Feedback in the Market for VCRs When two or more companies are competing with each other to get technology adopted as a standard in an industry, and when network effects and positive feedback loops are important, the company that wins the format war will be the one whose strategy best exploits positive feedback loops. As the market settles on a standard, an important implication of the positive feedback process occurs: companies promoting alternative standards can become locked out of the market when consumers are unwilling to bear the switching costs required to abandon the established standard and adopt the new standard. In this context, switching costs are the costs that consumers must bear to switch from a product based on one technological standard to a product based on another technological standard. However, consumers will bear switching costs if the benefits of adopting the new technology outweigh the costs of switching. III. Strategies for Winning a Format War Firms benefit when they exploit network effects and when positive feedback loops are in operation. The various strategies that companies should adopt in order to win format wars are centered upon finding ways to make network effects work in their favor and against their competitors. Winning a format war requires a company to build the installed base for its standard as rapidly as possible, thereby leveraging the positive feedback loop, inducing consumers to bear switching costs, and ultimately locking the market into its technology. A. Ensure a Supply of Complements It is important for the company to make sure that there is an adequate supply of complements. One way for companies to ensure a supply of complements is to diversify into the production of complements and seed the market with sufficient supply to help jump-start demand for their format. Also, companies may create incentives or make it easy for independent companies to produce complements. B. Leverage Killer Applications Killer applications are applications or uses of a new technology or product that are so compelling that they persuade customers to adopt the new format or technology in droves, thereby “killing” demand for competing formats. Killer applications often help to jumpstart demand for the new standard. C. Aggressive Pricing and Marketing One common tactic to jump-start demand is to adopt a razor and blade strategy: pricing the product (razor) low in order to stimulate demand and increase the installed base, and then trying to make high profits on the sale of complements (razor blades), which are priced relatively high. This strategy owes its name to Gillette, the company that pioneered this strategy to sell its razors and razor blades. Aggressive marketing is also a key factor in jump-starting demand to get an early lead in an installed base. Substantial upfront marketing and point-of-sales promotion techniques are often used to try to attract potential early adopters who will bear the switching costs associated with adopting the format. If these efforts are successful, they can be the start of a positive feedback loop. D. Cooperate with Competitors Companies have been close to simultaneously introducing competing and incompatible technological standards a number of times. Understanding that the nearly simultaneous introduction of such incompatible technologies can create significant confusion among consumers, and often lead them to delay their purchases. E. License the Format Licensing the format to other enterprises so that those others can produce products based on the format is another strategy often adopted. The correct strategy to pursue in a particular scenario requires that the company consider all of these different strategies and tactics and pursue those that seem most appropriate given the competitive circumstances prevailing in the industry and the likely strategy of rivals. Although there is no single best combination of strategies and tactics, the company must keep the goal of rapidly increasing the installed base of products based on its standard at the front of its mind. By helping to jump-start demand for its format, a company can induce consumers to bear the switching costs associated with adopting its technology and leverage any positive feedback process that might exist. It is also important not to pursue strategies that have the opposite effect. IV. Costs in High-Technology Industries In most high-tech industries, the fixed costs of product development are very high, but the costs of producing one extra unit of the product are very low. Many other high-technology products have similar cost economics: very high fixed costs and very low marginal costs. Most software products share these features, although if the software is sold through stores, the costs of packaging and distribution will raise the marginal costs, and if it is sold by a sales force direct to end-users, this too will raise the marginal costs. Many consumer electronics products have the same basic economics. A. Comparative Cost Economics To grasp why this cost structure is strategically important, company must understand that, in many industries, marginal costs rise as a company tries to expand output (economists call this the law of diminishing returns). To produce more of a good, a company must hire more labor and invest in more plant and machinery. At the margin, the additional resources used are not as productive, so this leads to increasing marginal costs. Figure 7.5: Cost Structures in High-Technology Industries B. Strategic Significance If a company can shift from a cost structure where it encounters increasing marginal costs to one where fixed costs may be high but marginal costs are lower, its profitability may increase. When a high-tech company faces high fixed costs and low marginal costs, its strategy should emphasize the low-cost structure option: companies should deliberately drive prices down in order to increase volume. 7.2 Strategy in Action Lowering the Cost of Ultrasound Equipment Through Digitalization The ultrasound unit is an important diagnostic tool, producing images of organs. The technology is very valuable, but the equipment is bulky, heavy, and expensive, so it is used primarily in dedicated hospital facilities. ATL, a leading ultrasound company, decided to reduce the size of an ultrasound set-up to about the size and weight of a laptop computer. This would be accomplished by replacing many of the machine’s solid circuits with software (in a process called “digitalizing”), reducing size and costs. The researchers reasoned that a portable and inexpensive ultrasound unit would find market opportunities in totally new niches. Smaller size and lower cost would allow the units to be placed on ambulances or into physician’s offices—market niches that were impossible to reach with the technology of the day. The researchers later became part of a project team within ATL, and thereafter became an entirely new company, SonoSite. Late in 1999, SonoSite introduced its first unit, which weighed just 6 pounds and cost about $25,000. SonoSite targeted niches that full-sized ultrasound products could not reach: ambulatory care and foreign markets that could not afford the more expensive equipment. In 2010, the company sold over $275 million of product. Teaching Note: This case shows how a company reached a previously untapped market niche by digitalizing a product, which also allows the firm to reduce expenses. Thus, digitalizing can support a firm that is pursuing a simultaneous advantage in differentiation and cost leadership. Ask students to discuss in detail how companies are coming up with strategies to exploit and benefit from this new era of digitalization. V. Capturing First-Mover Advantages In high-technology industries, companies often compete by striving to be the first to develop revolutionary new products, that is, to be a first mover. First movers initially have a monopoly position. If the new product satisfies unmet consumer needs and demand is high, the first mover can capture significant revenues and profits. Such revenues and profits signal to potential rivals that imitating the first mover makes money. Figure 7.6: The Impact of Imitation on Profits of a First Mover Despite imitation, some first movers have the ability to capitalize on and reap substantial first-mover advantages—the advantages of pioneering new technologies and products that lead to an enduring advantage. Some first movers can reap substantial advantages from their pioneering activities that lead to an enduring competitive advantage. They can, in other words, limit or slow the rate of imitation. But there are plenty of counterexamples suggesting that first-mover advantages might not be easy to capture and, in fact, that there might be first-mover disadvantages—the competitive disadvantages associated with being first. A. First-Mover Advantages There are five primary sources of first-mover advantages: • The first mover has an opportunity to exploit network effects and positive feedback loops, locking consumers into its technology. • The first mover may be able to establish significant brand loyalty, which is expensive for later entrants to break down. • The first mover may be able to increase sales volumes ahead of rivals, and thus reap cost advantages associated with the realization of scale economies and learning effects. • The first mover may be able to create customer switching costs for its customers that subsequently make it difficult for rivals to enter the market and take customers away from the first mover. • The first mover may be able to accumulate valuable knowledge related to customer needs, distribution channels, product technology, process technology, and so on. B. First-Mover Disadvantages Balanced against the first-mover advantages are a number of disadvantages: • They have to bear significant pioneering costs that later entrants do not. • They are more prone to make mistakes because there are so many uncertainties in a new market. • They run the risk of building the wrong resources and capabilities because they are focusing on a customer set that is not going to be characteristic of the mass market. • They may invest in inferior or obsolete technology. C. Strategies for Exploiting First-Mover Advantages First movers must strategize and determine how to exploit their lead and capitalize on first mover advantages to build a sustainable long-term competitive advantage while simultaneously reducing the risks associated with first-mover disadvantages. There are three basic strategies available: • Develop and market the innovation. • Develop and market the innovation jointly with other companies through a strategic alliance or joint venture. • License the innovation to others and allow them to develop the market. The optimal choice of strategy depends on the answers to three questions: • Does the innovating company have the complementary assets to exploit its innovation and capture first-mover advantages? • How difficult is it for imitators to copy the company’s innovation? In other words, what is the height of barriers to imitation? • Are there capable competitors that could rapidly imitate the innovation? 1. Complementary Assets Complementary assets are the assets required to exploit a new innovation and gain a competitive advantage. Among the most important complementary assets are competitive manufacturing facilities capable of handling rapid growth in customer demand while maintaining high product quality. Complementary assets also include marketing knowhow, an adequate sales force, access to distribution systems, and an after-sales service and support network. All of these assets can help an innovator build brand loyalty and more rapidly achieve market penetration. 2. Height of Barriers to Imitation Barriers to imitation are factors that prevent rivals from imitating a company’s distinctive competencies and innovations. Barriers to imitation give an innovator time to establish a competitive advantage and build more enduring barriers to entry in the newly created market. 3. Capable Competitors Capable competitors are companies that can move quickly to imitate the pioneering company. Competitors’ capability to imitate a pioneer’s innovation depends primarily on two factors: • Research and development (R&D) skills • Access to complementary assets In general, the greater the number of capable competitors with access to the R&D skills and complementary assets needed to imitate an innovation, the more rapid imitation is likely to be. 4. Three Innovation Strategies The competitive strategy of developing and marketing the innovation alone makes most sense when: • The innovator has the complementary assets necessary to develop the innovation. • The barriers to imitating a new innovation are high. • The number of capable competitors is limited. Table 7.1 Strategies for Profiting from Innovation Complementary assets allow rapid development and promotion of the innovation. High barriers to imitation give the innovator time to establish a competitive advantage and build enduring barriers to entry through brand loyalty or experience-based cost advantages. The fewer capable competitors there are, the less likely it is that any one of them will succeed in circumventing barriers to imitation and quickly imitating the innovation. The competitive strategy of developing and marketing the innovation jointly with other companies through a strategic alliance or joint venture makes most sense when: • The innovator lacks complementary assets. • Barriers to imitation are high. • There are several capable competitors. Licensing makes most sense when: • The innovating company lacks the complementary assets. • Barriers to imitation are low. • There are many capable competitors. VI. Technological Paradigm Shifts Technological paradigm shifts occur when new technology revolutionizes the structure of an industry, dramatically alter the nature of competition and require companies to adopt new strategies in order to survive. An example is the current trend toward digital photography in replacing chemical photography. For over half a century, the large incumbent enterprises in the photographic industry such as Kodak and Fujifilm have generated most of their revenues from selling and processing film using traditional silver halide technology. The rise of digital photography has been a huge disruptive threat to their business models. A. Paradigm Shifts and the Decline of Established Companies Paradigm shifts appear to be more likely to occur in an industry when one, or both, of the following conditions are in place: • The established technology in the industry is mature and approaching or at its “natural limit” • A new “disruptive technology” has entered the marketplace and is taking root in niches that are poorly served by incumbent companies using the established technology. 1. The Natural Limits to Technology The relationship between the performance of a technology and time is called the technology S-curve. This curve shows the relationship over time of cumulative investments in R&D and the performance (or functionality) of a given technology. Figure 7.7: The Technology S-Curve Figure 7.8: Established and Successor Technologies 2. Disruptive Technology The term disruptive technology refers to a new technology that gets its start away from the mainstream of a market, and then as its functionality improves over time, invades the main market. Such technologies are disruptive because they revolutionize industry structure and competition, often causing the decline of established companies. They cause a technological paradigm shift. Established companies are often aware of the new alternatives, but do not invest in it because they listen to their customers, and their customers do not want it. Established companies decline to invest in new disruptive technologies because initially they serve such small market niches that it seems unlikely there would be an impact on the company’s revenues and profits Figure 7.9: Swarm of Successor Technologies . 7.3 Strategy in Action Disruptive Technology in Mechanical Excavators Excavators are used to dig foundations and trenches, and for years the dominant technology was a system of cables and pulleys that lifted a large bucket of earth. In the 1940s, however, hydraulic technology presented a more efficient and convenient design, but it could not lift as large a load. Excavator manufacturers surveyed customers and found that most did not want to use the new technology because of the limits on load size. This created an opportunity for new entrants into the industry. Manufacturers such as Case, Deere, and Caterpillar initially focused on small hydraulic excavators, but as their expertise grew, they solved the engineering limitations of the hydraulic design. They were able to make hydraulic excavators with larger buckets, and ultimately they rose to dominate the industry. Teaching Note: This case describes an example of a disruptive technology revolutionizing an industry. A class discussion can be initiated in which students are asked to describe other examples of paradigm shifts to reinforce this concept. Examples might include PCs and word processing software replacing typewriters (along with correction fluid and ink erasers), calculators replacing slide rules, automobiles replacing horse-drawn buggies (and horseshoes and harnesses), and many more. A book that discusses one case in extended detail is The Victorian Internet: The Remarkable Story of the Telegraph and the Nineteenth Century’s On-Line Pioneers (by Tom Standage, published by Berkley Publishing Group, October 1999). This book tells a wonderfully modern story of industrial espionage, wildly ambitious entrepreneurs, and the development of complementary products—such as the development and placement of a 1,600-mile-long cable at the bottom of the Atlantic. B. Strategic Implications for Established Companies Established companies must meet the challenges created by the emergence of disruptive technologies: • Companies should have access to knowledge about how disruptive technologies can revolutionize markets because it is a valuable strategic asset. • Established companies should invest in newly emerging technologies that may ultimately become disruptive technologies. • When established companies undertake R&D investments in potentially disruptive technologies, they often fail to commercialize those technologies because of internal forces that suppress change C. Strategic Implications for New Entrants The new entrants or attackers have several advantages over established enterprises. New entrants must manage the organizational problems associated with rapid growth; most important, they may need to find a way to take their technology from a small out-of-the-way niche into the mass market. One of the most important issues facing new entrants is the choice of whether to partner with an established company or go it alone in an attempt to develop and profit from a new disruptive technology. Although a new entrant may enjoy all of the advantages of the attacker, it may lack the resources required to fully exploit them. In such a case, the company might want to consider forming a strategic alliance with a larger, established company to gain access to those resources. Teaching Note: Ethical Dilemma This question should solicit an interesting discussion of various opinions. However, the instructor should re-emphasize the advantages of being a first-mover. From this, the instructor can solicit opinions on the ways the company could be more accepted in the marketplace by its competitors. This can be used as a homework assignment in which the students would be asked to investigate real-world situations similar to this and identify the company first-mover advantages and strategies it could have used to be more accepting in the market. Answers to Discussion Questions 1. What is different about high-tech industries? Were all industries once high tech? High-technology industries rely heavily on rapidly advancing scientific knowledge, whereas other industries’ technologies are more stable and evolve slowly and predictably. Thus, high-tech industries are unstable, chaotic, and prone to sudden disruption. The implications for managers are that high-tech firms must be extremely innovative, flexible, and forgiving of mistakes. Every technology was new at some point in human history; thus every industry was rapidly evolving and chaotic at some time. Even the wheel was a new technology—about 5,500 years ago in ancient Mesopotamia. The astonishing new invention underwent several further refinements as it swept the known world, revolutionizing transportation. 2. Why are standards so important in high-tech industries? What are the competitive implications of this? Standards are important in every industry, but in high-tech industries they are still evolving and thus require a great deal of managerial attention. The development of standards marks an important transition point in an industry because after standards are developed, industry evolution will slow. Some early industry competitors may fail to adopt the new standard in time, and may exit the industry. Establishment of standards will draw new entrants, and for the first time price competition will become important. Managers also care about standards because the company that establishes the standard may be able to use that standard as a significant source of revenue. Thus, the establishment of standards will affect industry participants, the intensity of rivalry, the basis of rivalry, the strategies used by participants, and the industry’s profit potential. 3. You work for a small company that has the leading position in an embryonic market. Your boss believes that the company’s future is ensured because it has a 60% share of the market, the lowest cost structure in the industry, and the most reliable and highest-valued product. Write a memo to your boss outlining why the assumptions posed might be incorrect. In answering this question, students should focus on the following points: • The embryonic nature of the industry means that the technology is still undergoing major changes, and therefore the company cannot afford to be complacent, but must continue to innovate. • A high market share, low cost, and a high-quality product are no guarantee of future success when the industry may experience rapid and drastic changes. In fact, the company’s early success may make it more difficult for it to adapt when the large changes come. The manager should be encouraged to continue to look for improvements and to monitor the actions of competitors closely. 4. You are working for a small company that has developed an operating system for PCs that is faster and more stable than Microsoft’s Windows operating system. What strategies might the company pursue to unseat Windows and establish its own operating system as the dominant technical standard in the industry? There are several large hurdles that must be overcome if the company is to succeed with this high-risk strategy; however, if the product is truly superior to Windows, there are opportunities to compete against a powerful “standard”. The company could employ an aggressive pricing strategy (offer it for free, perhaps) with financial incentives to early-adopters, and/or seek partnerships to develop industry complementers. Business level strategies such as an innovative marketing campaign could stimulate demand. The company could license its technology to Microsoft to exploit Microsoft’s size and market position and avoid the enormous costs of a format battle. 5. You are a manager for a major music record label. Last year, music sales declined by 10%, primarily because of very high piracy rates for CDs. Your boss has asked you to develop a strategy for reducing piracy rates. What would you suggest that the company do? One strategy is to work to develop an encryption scheme that will reduce piracy. However, these are typically not very effective. In one recent case, Sony spent months developing a new CD encryption scheme, which consumers were able to defeat less than 24 hours with an ordinary marking pen. Another strategy would be to give something away with each purchase, such as a poster or collectible, that isn’t easily duplicated. However, this strategy adds to product and distribution costs. A third possibility is to reduce the price so low that consumers are willing to pay for convenience. Continue to lobby congress for stronger copyright infringement laws and penalties, and prosecute offenders. At the same time, promote positive music-buying experiences and innovate delivery channels and pricing. 6. Reread the Opening Case on the emerging standards battles in mobile payments. Which mobile payment system do you think will become dominant? Students’ answers may vary. Mobile payment systems offer the potential of enabling all users to perform financial transactions on their phones, similar to how they would perform those transactions using personal computers. However, in 2012, there was no dominant mobile payment system, and a battle among competing mobile payment mechanisms and standards was unfolding. In other parts of the world, intriguing alternatives for mobile banking were gaining traction even faster. In India and Africa, for example, there are enormous populations of “unbanked” or “underbanked” people (individuals who do not have bank accounts or make limited use of banking services). Therefore, although by early 2013, it was clear that mobile payments represented a game-changing opportunity that could accelerate e-commerce, smartphone adoption, and the global reach of financial services, lack of compatibility between many of the mobile payment systems and uncertainty over what type of mobile payment system would become dominant still posed significant obstacles to consumer and merchant adoption. Practicing Strategic Management Small-Group Exercise: Digital Books The students are asked to break up into groups of three to five and discuss the following scenario. Ask them to appoint one group member as a spokesperson who will communicate their findings to the class. The students must enact a group of managers and software engineers at a small start-up that has developed software that enables customers to easily download and view digital books on a variety of digital devices, including PCs, iPods, and e-book readers. The same software also allows customers to share digital books using peer-to-peer technology (the same technology that allows people to share music files on the Web), and to “burn” digital books onto DVDs. 1. How do you think the market for this software is likely to develop? What factors might inhibit adoption of this software? 2. Can you think of a strategy that your company might pursue in combination with book publishers that will enable your company to increase revenues and the film companies to reduce piracy rates? Teaching Note: Through work on these tasks, students will come to understand that, although the specific technology changes, the process by which new technologies are adopted follow a strikingly similar path. This exercise also highlights the desirability of win-win strategies, such as the type of actions that would increase sales and reduce piracy, benefiting both firms. You can initiate discussion by asking students to consider what would be the likely consequences if their firm decided not to cooperate with the book publishers. Strategy Sign-On Article File 7 Find an example of an industry that has undergone a technological paradigm shift in recent years. What happened to the established companies as that paradigm shift unfolded? Teaching Note: You may have to point students to industries that have experienced recent paradigm shifts. One possibility is the telecommunications industries in developing countries, where consumers are choosing to adopt wireless technology before wired technology, reversing the process in developed nations. Another good example would be the handheld communications industry, where cell phones can now act like computers or Internet browsers, in addition to their other functions. Conversely, you can ask students to describe industries that have not undergone a recent paradigm shift. Do the students see any potential for such industries to change, and will the change be a radical or an incremental one? Or will they simply continue as is indefinitely? Strategic Management Project: Developing Your Portfolio 7 This module requires students to analyze the industry environment in which their choice of company is based and determine if it is vulnerable to a technological paradigm shift. With the information at their disposal, students must answer the following questions: 1. What is the dominant product technology used in the industry in which your company is based? 2. Are technical standards important in your industry? If so, what are they? 3. What are the attributes of the majority of customers purchasing the product of your company (e.g., early adopters, early majority, late majority)? What does this tell you about the strategic issues that the company is likely to face in the future? 4. Did the dominant technology in your industry diffuse rapidly or slowly? What drove the speed of diffusion? 5. Where is the dominant technology in your industry on its S-curve? Are alternative competing technologies being developed that might give rise to a paradigm shift in your industry? 6. Are intellectual property rights important to your company? If so, what strategies is it adopting to protect those rights? Is it doing enough? Teaching Note: You can point out to students that every industry is vulnerable to paradigm shifts, whether the potential for those shifts is apparent or not. Paradigm shifts are typically radical, unexpected changes. When students speculate about possible paradigm shifts, they may be concerned that their ideas sound too extreme, but they may in fact not be extreme enough. For example, who could have predicted in 1910, as automobiles were just coming into use for long-distance transportation, that 30 years later flight would replace driving as the dominant method of travel? Therefore, they may have trouble identifying new technologies, just as managers do. Closing Case The Rise of Cloud Computing Cloud computing is creating a paradigm shift beginning in the world of computing. Co-located and interlinked computer servers will contribute to individual business cost advantages. Early adopters of cloud computing services include InterContinental Hotel Group, Netflix, and Starbucks. Early leaders and providers of cloud services include Amazon, Microsoft, and Google. They realized they could rent out capacity on their server farms or clouds to other businesses and essentially created cloud computing. As the competition becomes fierce, a format ware in cloud computing is developing. Estimations are that only 2-3 formats will survive. Teaching Note: This case illustrates the importance of standards in determining the winners in the technology marketplace. There are clear battles in format wars and the stakes are high due to enormous R&D and infrastructure costs. To draw parallels, students should have examples of format wars they have witnessed in other tech markets (e.g., in the gaming systems market, Sony PlayStation won dominance for a time and/or the eBook market—Sony vs. Kindle). Also the importance of product innovation (iPhone) can be seen in the environment and shifts in market demand (from primarily business users to everyone). In addition to describing benefits of standards to companies, students should be asked about the benefits of standards to end-users. If a company loses the format war in its market, what alternative strategies are available to companies to remain profitable? Answers to Case Discussion Questions 1. What are the advantages and disadvantages of using cloud services for individuals and businesses? Students’ answers may vary. There are significant cost advantages associated with shifting data and applications to the cloud. Business will no longer need to invest in information technology hardware that rapidly becomes obsolete. Cloud providers will instead be responsible for maintenance costs of servers and hardware. Moreover, businesses will no longer need to purchase many software applications. However, cloud services also threatened to redistribute who earned those revenues in information technology, attracting the attention of companies such as Microsoft and Google. Software applications that are written for one cloud-based operating system will not run on another cloud operating system without a complete rewrite—meaning that there will be significant switching costs involved in moving an application from one cloud provider to another. 2. How does the adoption of cloud services affect the revenues for computer and software makers? Which companies will “win” and “lose” if individuals and businesses continue to shift to using cloud services? Students’ answers may vary. Adoption of cloud services means that businesses will no longer need to purchase many software applications. Instead, businesses will utilize a pay-as-you go pricing model for any applications that they use, which also holds out the promise of reducing costs. Some studies have concluded that 70% of software purchased by corporations is either underutilized or not used at all. The Brookings Institute estimates that companies could reduce their information technology costs by as much as 50% by moving to the cloud. Right now the cloud is small—IDC indicates that worldwide, cloud services accounted for $40 billion in 2012 (just over 1% of the 3.6 trillion spent worldwide on information technology in 2012), and expects that number to grow to 100 billion by 2016. However, cloud services also threatened to redistribute who earned those revenues in information technology, attracting the attention of companies such as Microsoft and Google. 3. What forces would create pressure for a dominant cloud-based operating system to emerge? A format war is a strong reason for a dominant cloud-based operating system to emerge. Companies are constantly developing a cloud-based system which allows clients to efficiently run their custom software applications on the cloud. This strongly suggests that the beginnings of a format war in cloud computing, much like the format war during the early 1990s between Microsoft, IBM, and Apple to dominate the desktop computer—a war that Microsoft won with its Windows operating system. According to business history there cannot be more than three formats that can survive at a time. Therefore, if companies fail in the race most of their formats will lose market. 4. What individual advantages do you think Microsoft, Amazon, and Google have in promoting their cloud-based operating systems? Students’ answers may vary. Software applications that are written for one cloud-based operating system will not run on another cloud operating system without a complete rewrite—meaning that there will be significant switching costs involved in moving an application from one cloud provider to another. Microsoft has developed an operating system, known as Windows Azure, which is designed to run software applications very efficiently on server farms, allocating workloads and balancing capacity across hundreds of thousands of servers. Microsoft is rewriting many of its own applications, such as Office and SQL server, to run on Azure. Google has developed a cloud-based operating system, Google App Engine, which allows clients to efficiently run their custom software applications on the cloud, and also offers the Chrome OS for individuals to use on dedicated Chrome tablets. Amazon, too, has its own cloud-based operating system, known as Elastic Compute Cloud, or “EC2.” Thus it is advantageous for each company to promote their own cloud-based operating system. CHAPTER 8 Strategy in the Global Environment Synopsis of Chapter This chapter looks at the strategies companies adopt when they expand outside their domestic marketplace and start to compete on a global basis. The chapter opens by discussing how global expansion creates value for a company. The focus is on the ability of global companies to transfer distinctive competencies across national markets, to realize location economies from basing individual value creation activities in the optimal location for that activity, and to ride down the experience curve more rapidly than competitors that are focused on just their domestic market. Next, the chapter examines two types of competitive pressures that firms competing in the global marketplace typically face: pressures for cost reductions and pressures to be responsive to local conditions. These pressures place conflicting demands on a company. The discussion then turns to the different strategies that companies can pursue in the global arena. Four different strategies are reviewed in some detail, and a link is made between the appropriateness of different strategies and the pressures for cost reductions and local responsiveness. This chapter then discusses the basic entry decisions a company faces when going international. In particular, the chapter looks at decisions about which markets to enter, when to enter, and on what scale to enter. In the next section, which reviews various options that a company has for entering a foreign market, the five basic options—exporting, licensing, franchising, joint ventures, and the establishment of a wholly owned subsidiary—are compared and contrasted. A discussion of global strategic alliances closes the chapter. It assesses the advantages and disadvantages of entering into strategic alliances with global competitors and highlights ways of improving the probability of a successful alliance. Learning Objectives 1. Understand the process of globalization and how it impacts a company’s strategy. 2. Discuss the motives for expanding internationally. 3. Review the different strategies that companies use to compete in the global market place. 4. Explain the pros and cons of different modes for entering foreign markets. Opening Case Ford’s Global Strategy When Alan Mullaly, the CEO of Ford, arrived he was shocked to learn that the company produced one Ford Focus for Europe and a completely different one for the United State. The strategy of designing and building different cars for different regions was the standard approach at Ford, due to which, Ford was unable to buy common parts for the vehicles and could not share development costs. The result was high costs. Ford based this strategy upon the assumption that consumers in different regions had different tastes and preferences, which required considerable local customization. When the global financial crisis rocked the automobile industry in 2008-2009, Mullaly decided it was time to change their strategy in order to control their costs. He also believed there was no way Ford could compete in large developing markets like India and China unless it produced low-cost cars. The result was Mulally’s “One Ford” strategy, which aims to create a handful of car platforms that Ford can use everywhere in the world. Under this strategy, new models share a common design, are built on a common platform, use the same parts, and will be built in identical factories around the world. Ultimately, Ford hopes to have only five platforms to deliver sales of more than 6 million vehicles by 2016. Ford hopes that this strategy will bring down costs sufficiently to enable Ford to make greater profit margins in developed markets, and be able to make good margins at lower price points in hypercompetitive developing nations. Teaching Note: This case illustrates how a firm can face problems due to its attention on local customization for its customers which affected production costs. Ask students to discuss how later the firm changed its strategy to lower production costs and to make a bigger impact on the global market. What are the benefits that Ford received from both strategies? What precaution should Ford take to be aware of the current global conditions? Are there any potential weaknesses that must be addressed? Lecture Outline I. Overview This chapter opens with a discussion of ongoing changes in the global competitive environment and discusses models managers can use for analyzing competition in different national markets. II. The Global and National Environments Barriers to international trade and investment have tumbled, huge global markets for goods and services have been created, and companies from different nations are entering each other’s home markets on an unprecedented scale, increasing the intensity of competition. Rivalry can no longer be understood merely in terms of what happens within the boundaries of a nation; managers now need to consider how globalization is impacting the environment in which their company competes and what strategies their company should adopt to exploit the unfolding opportunities and counter competitive threats. A. The Globalization of Production and Markets Globalization of production has been increasing as companies take advantage of lower barriers to international trade and investment to disperse parts of their production around the world. This allows them to take advantage of national differences in cost and quality of factors of production such as labor, energy, land, and capital, which allows companies to lower their cost structures and boost profits. Increasingly, customers around the world demand and use the same basic product offerings. The trend toward the globalization of production and markets has several important implications for competition within an industry: • Industry boundaries do not stop at national borders. Managers who analyze only their home market can be caught unprepared by the entry of efficient foreign competitors. • The shift from national to global markets has intensified competitive rivalry in many industries. • Globalization has also created opportunities for companies to grow outside of their national markets. B. National Competitive Advantage Despite the globalization of production and markets, many of the most successful companies in certain industries are still clustered in a small number of countries. Nation-state within which a company is based may have an important bearing on the competitive position of that company in the global marketplace. Michael Porter identified four attributes of a national or country-specific environment that have an important impact on the global competitiveness of companies located within that nation: • Factor endowments: A nation’s position in factors of production such as skilled labor or necessary infrastructure for competing in a given industry. • Local demand conditions: The nature of home demand for the industry’s product or service. • Related and supporting industries: The presence or absence in a nation of supplier industries and related industries that are internationally competitive. • Firm strategy, structure, and rivalry: The conditions in the nation governing how companies are created, organized, and managed, and the nature of domestic rivalry. Figure 8.1: National Competitive Advantage 1. Factor Endowments: Factor endowments—the cost and quality of factors of production—are a prime determinant of the competitive advantage that certain countries might have in certain industries. Factors of production include basic factors such as land, labor, capital, and raw materials, and advanced factors, such as technological know-how, managerial sophistication, and physical infrastructure. 2. Local Demand Conditions: Companies are typically most sensitive to the needs of their closest customers. The characteristics of home demand are important in shaping the attributes of domestically made products and creating pressures for innovation and quality. A nation’s companies gain competitive advantage if their domestic customers are sophisticated and demanding, and pressure local companies to meet high standards of product quality and produce innovative products. 3. Competitiveness of Related and Supporting Industries The benefits of investments in advanced factors of production by related and supporting industries can spill over into an industry, thereby helping it achieve a strong competitive position internationally. 4. Intensity of Rivalry Porter makes two important points regarding the intensity of rivalry of firms that exists within a nation: • Different nations are characterized by different management ideologies which either help them or do not help them to build national competitive advantage. • There is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. 5. Using the Framework The framework can help managers to identify from where their most significant global competitors are likely to originate and help managers to decide where they might want to locate certain productive activities. The framework can help a company assess how tough it might be to enter certain national markets. If a nation has a competitive advantage in certain industries, it might be challenging for foreigners to enter those industries. III. Increasing Profitability and Profit Growth Through Global Expansion There are a number of ways in which global expansion can enable companies to increase and rapidly grow profitability. At the most basic level, global expansion increases the size of the market in which a company is competing, thereby boosting profit growth. Global expansion offers opportunities for reducing the cost structure of the enterprise or adding value through differentiation, thereby potentially boosting profitability. A. Expanding the Market: Leveraging Products A company can increase its growth rate by taking goods or services developed at home and sell them internationally. However, the success of many multinational companies is based not just on the goods or services that they sell in foreign nations, but also upon the distinctive competencies (unique skills) that underlie the production and marketing of those goods or services. Because distinctive competencies are the most valuable aspects of a company’s business model, the successful global expansion of manufacturing companies such as Toyota and P&G was based on the ability to transfer aspects of the business model and apply it to foreign markets. Focus on: Wal-Mart Wal-Mart’s Global Expansion In the early 1990s, managers at Wal-Mart realized that the company’s opportunities for growth in the United States were becoming more limited. Management calculated that by the early 2000s, domestic growth opportunities would be constrained due to market saturation. So, when the company decided to expand globally, critics scoffed saying that they were too American a company to succeed globally. It had to tie up with local producers and retailers to make sure they appeal to the local tastes and preferences. This helped Wal-Mart succeed in markets out of the United States. In addition to greater growth, expanding internationally has brought it two other major benefits. First, it has been able to reap significant economies of scale from its global buying power and, it has been able to use its enhanced size to demand deeper discounts from the local operations of its global suppliers, increasing the company’s ability to lower prices to consumers, gain market share, and ultimately earn greater profits. Second, Wal-Mart has found that it is benefiting from the flow of ideas across the countries in which it now competes. For all of its success, Wal-Mart has hit some significant speed bumps in its drive for global expansion. In certain countries it failed to outdo the local retailers and match discount pricing, and it has sometimes failed to decode the shopping habits of the locals. Teaching Note: You could ask students to explain how Wal-Mart’s strategy enabled it to succeed in its goal of global expansion. What could have Wal-Mart done to avoid the difficulties that it faced in the process of its expansion? B. Realizing Cost Economies from Global Volume Firms can also realize cost savings from economies of scale, thereby boosting profitability, by expanding its sales volume through international expansion. Such scale economies come from several sources: • By spreading the fixed costs associated with developing a product and setting up production facilities over its global sales volume, a company can lower its average unit cost. • By serving a global market, a company can potentially utilize its production facilities more intensively, which leads to higher productivity, lower costs, and greater profitability. • As global sales increase the size of the enterprise, its bargaining power with suppliers increases, which may allow it to bargain down the cost of key inputs and boost profitability that way. • Companies that sell to a global rather than a local marketplace may be able to realize further cost savings from learning effects. C. Realizing Location Economies Some locations are more suited than others for producing certain goods and services. Location economies are the economic benefits that arise from performing a value creation activity in the optimal location for that activity, wherever in the world that might be. Locating a value creation activity in the optimal location for that activity can have one of two effects: • It can lower the costs of value creation, helping the company achieve a low-cost position. • It can enable a company to differentiate its product offering, which gives it the option of charging a premium price or keeping prices low and using differentiation as a means of increasing sales volume. Introducing transportation costs and trade barriers can complicate the process of realizing location economies. D. Leveraging the Skills of Global Subsidiaries Initially, many multinational companies develop the valuable competencies and skills that underpin their business model in their home nation and then expand internationally, primarily by selling products and services based on those competencies. However, for more mature multinational enterprises that have already established a network of subsidiary operations in foreign markets, the development of valuable skills can just as well occur in foreign subsidiaries. Leveraging the skills created within subsidiaries and applying them to other operations within the firm’s global network may create value. This creates important new challenges for managers. • Managers must have the humility to recognize that valuable skills can develop anywhere within the firm’s global network, not just at the corporate center. • The firm must have an incentive system that encourages local employees to acquire new competencies. • Managers must be able to identify when valuable new skills have been created in a subsidiary. • Managers need to act as facilitators in helping to transfer valuable skills within the firm. IV. Cost Pressures and Pressures for Local Responsiveness Companies that compete in the global marketplace face two types of competitive pressures: pressures for cost reductions and pressures to be locally responsive. These competitive pressures place conflicting demands on a company. Responding to pressures for cost reductions requires that a company attempt to minimize its unit costs. To accomplish this, a company must base its productive activities at the most favorable low-cost location, wherever in the world that might be. It must also offer a standardized product to the global marketplace in order to realize the cost savings that come from economies of scale and learning effects. On the other hand, reacting to pressures to be locally responsive requires a company to differentiate its product offering and marketing strategy from country to country. It must try to accommodate the diverse demands arising from national differences, which can lead to significant duplication and a lack of standardization, raising costs. Figure 8.2: Pressures for Cost Reductions and Local Responsiveness A. Pressures for Cost Reductions In competitive global markets, international businesses often face pressures for cost reductions. To respond to these pressures, a firm must try to lower the costs of value creation. Pressures for cost reductions can be particularly intense in industries producing commodity-type products that serve universal needs. For these products, differentiation on nonprice factors is difficult and price is the main competitive weapon. Pressures for cost reductions also exist for many industrial and consumer products—for example, hand-held calculators, semiconductor chips, personal computers, and liquid crystal display screens. Pressures for cost reductions are also strong in industries where major competitors are based in low-cost locations, where there is persistent excess capacity, and where consumers are powerful and face low switching costs. Liberalization of the world trade and investment environment in recent decades has generally increased cost pressures by facilitating greater international competition. B. Pressures for Local Responsiveness: Pressures for local responsiveness arise from differences in consumer tastes and preferences, infrastructure and traditional practices, distribution channels, and host government demands. Responding to pressures to be locally responsive requires that a company differentiate its products and marketing strategy from country to country to accommodate these factors, all of which tend to raise a company’s cost structure. 1. Differences in Customer Tastes and Preferences Strong pressures for local responsiveness emerge when consumer tastes and preferences differ significantly between countries, for historic or cultural reasons. In such cases, a multinational company’s products and marketing messages have to be customized for local tastes and preferences, leading to the delegation of production and marketing functions to national subsidiaries. However, some observers claim that consumer demands for local customization are on the decline worldwide because modern communications and transport technologies have led to a convergence of tastes and preferences. The result is the emergence of enormous global markets for standardized consumer products. This may not hold in many consumer goods markets. Significant differences in consumer tastes and preferences still exist across nations and cultures. Managers in international businesses do not yet have the luxury of being able to ignore these differences, and they may not for a long time to come. 8.1 Strategy in Action Local Responsiveness at MTV Networks MTV Networks has become a symbol of globalization. Despite its international success, MTV’s global expansion got off to a weak start. In the 1980s, when the main programming fare was still music videos, it piped a single feed across Europe almost entirely composed of American programming with English-speaking veejays. The network’s U.S. managers thought Europeans would flock to the American programming. Although viewers in Europe shared a common interest in a handful of global superstars, their tastes turned out to be surprisingly local. This cost MTV to lose their shares to local competitors. MTV changed it strategy. It broke its service into “feeds” aimed at national or regional markets. Although MTV Networks exercises creative control over these different feeds, and although all the channels have the same familiar frenetic look and feel of MTV in the United States, a significant share of the programming and content is now local. Although many programming ideas still originate in the United States, staples have equivalents in different countries, an increasing share of programming is local in conception. This localization push reaped big benefits for MTV, allowing the network to capture viewers back from local imitators Teaching Note: This case demonstrates how a company, like MTV, discovers how important pressures for local responsiveness can still be. Discuss in class the strategy that MTV came up with to handle local responsiveness pressures. Ask students to share their opinion on how the strategy can benefit the company. 2. Differences in Infrastructure and Traditional Practices Pressures for local responsiveness also emerge when there are differences in infrastructure and traditional practices between countries, creating a need to customize the products accordingly. This may necessitate the delegation of manufacturing and production functions to foreign subsidiaries. 3. Differences in Distribution Channels Pressures for local responsiveness may arise when a company’s marketing strategies have to be responsive to differences in distribution channels among countries. This may necessitate the delegation of marketing functions to national subsidiaries. 4. Host Government Demands Economic and political demands imposed by host country governments may require a local responsiveness. Examples of threats from host governments include protectionism, economic nationalism, and regulations to ensure local content. V. Choosing a Global Strategy Companies typically choose among four main strategic postures when competing internationally: • Global standardization strategy • Localization strategy • Transnational strategy • International strategy The appropriateness of each strategy varies with the extent of pressures for cost reductions and local responsiveness. Figure 8.3: Four Basic Strategies A. Global Standardization Strategy Companies pursuing a global standardization strategy focus on increasing profitability by reaping the cost reductions that come from economies of scale and location economies; that is, their business model is based on pursuing a low-cost strategy on a global scale. The production, marketing, and R&D activities of companies pursuing a global strategy are concentrated in a few favorable locations. Global companies do not customize their products and marketing strategy to local conditions because customization raises costs. Instead, global companies market a standardized product worldwide so that they can reap the maximum benefits from the economies of scale. Global companies use their cost advantage to support aggressive pricing. A global strategy makes most sense when there are strong pressures for cost reductions, but minimal demands for local responsiveness. These conditions prevail in many industrial goods industries, but are not as common in consumer goods. B. Localization Strategy A localization strategy focuses on increasing profitability by customizing the company’s goods or services so that the goods provide a favorable match to tastes and preferences in different national markets. Localization is most appropriate when there are substantial differences across nations with regard to consumer tastes and preferences, and where cost pressures are not too intense. However, it involves some duplication of functions and smaller production runs and limits the ability of the company to capture the cost reductions associated with mass-producing a standardized product for global consumption. Localization makes sense if the added value associated with local customization supports higher pricing enabling the company to recoup its higher costs, or if it leads to substantially greater local demand, enabling the company to reduce costs through the attainment of scale economies in the local market. C. Transnational Strategy Companies that pursue a transnational strategy are trying to develop a business model that simultaneously achieves low-cost, differentiates the product offering across geographic markets, and fosters a flow of skills between different subsidiaries in the company’s global network of operations. The transnational strategy is not an easy one to pursue because pressures for local responsiveness and cost reductions place conflicting demands on a company. To deal with cost pressures, companies can redesign their products to use identical components. Another tactic is to invest in a few large-scale manufacturing facilities sited at favorable locations and then augment those with assembly plants in each of its major markets, which allows for tailoring the finished product to local needs. D. International Strategy Sometimes it is possible to identify multinational companies that find themselves in the fortunate position of being confronted with low cost pressures and low pressures for local responsiveness. Typically these enterprises are selling a product that serves universal needs, but because they do not face significant competitors, they are not confronted with pressures to reduce their cost structure. Historically, companies like Xerox have followed a similar developmental pattern as they build their international operations. International companies create value by transferring differentiated product offerings developed at home to new markets overseas. They centralize product development functions at home. However, international companies also establish manufacturing and marketing functions in each major country. They undertake limited local customization of products and marketing strategy, but the head office retains tight control over these. An international strategy can be very profitable if a company has a valuable distinctive competency that indigenous competitors lack and if the pressures for local responsiveness and cost reductions are relatively weak. E. Changes in Strategy over Time When pressures for local responsiveness are strong, companies pursuing an international strategy lose out to companies that customize products for local conditions. Moreover, because they must duplicate manufacturing facilities, international companies suffer from high operating costs. An international strategy may not be viable in the long term, and to survive, companies that are able to pursue it need to shift toward a global standardization strategy, or a transnational strategy ahead of competitors. Localization may give company a competitive edge, but aggressive competitors will lend a company to reduce its cost structure and adopt a transnational strategy. As competition intensifies, international and localization strategies tend to become less viable, and managers need to orientate their companies toward either a global standardization strategy or a transnational strategy. Figure 8.4: Changes over Time 8.2 Strategy in Action The Evolving Strategy of Coca-Cola Coca-Cola has long been the most international of enterprises. Since 1902, Coca-Cola has expanded into 200 countries. Coca-Cola’s strategy had one of localization. Local operations were granted a high degree of independence to manage their own operations as they saw fit. However, new leadership pursued global company initiatives through aggressive management, marketing, focusing on core brands, and taking equity stakes in foreign bottlers so that the company could exert more strategic control over them. This one-size-fits-all strategy was built around standardization and the realization of economies of scale by using the same advertising message worldwide. However, such strategy changed again back to a more localized approach. At this time, Coca-Cola failed to produce expected growth and expanded its strategic approach to encompass pricing, product offerings, and non-standardized marketing messages. The result was international strategic alliances, new international drink ideas. Teaching Note: This case illustrates the way in which a firm that experienced success in its home country began the process of globalization. To discuss this case in class, ask students to consider the benefits that Coca-Cola has received from its globalization efforts. Then ask them to describe Coca-Cola’s current global strategy, and point out any potential weaknesses that must be addressed. VI. The Choice of Entry Mode Any firm contemplating entering a different national market must determine the best mode or vehicle for such entry. There are five primary choices of entry mode: exporting, licensing, franchising, entering into a joint venture with a host country company, and setting up a wholly owned subsidiary in the host country. Each mode has its advantages and disadvantages, and managers must weigh these carefully when deciding which mode to use. A. Exporting Most manufacturing companies begin their global expansion as exporters and only later switch to one of the other modes for serving a foreign market. Exporting has two distinct advantages: • It avoids the costs of having to establish manufacturing operations in the host country. • It is consistent with scale economies and location economies. There are also a number of drawbacks to exporting: • Exporting from the company’s home base may not be appropriate if there are lower-cost locations for manufacturing the product abroad. • High transport costs can make exporting uneconomical, particularly in the case of bulk products. One way of alleviating this problem is to manufacture bulk products on a regional basis, thereby realizing some economies from large-scale production while limiting transport costs. • Tariff barriers also can make exporting uneconomical, and a government’s threat to impose tariff barriers can make the strategy very risky. • Also, many exporters rely on local sales agents, and it is difficult for the company to ensure that the agents act in the company’s best interests. Some exporters establish wholly owned market subsidiaries in the host country to eliminate this concern. B. Licensing International licensing is an arrangement whereby a foreign licensee purchases the rights to produce a company’s product in the licensee’s country for a negotiated fee. Companies that lack capital to develop operations overseas or that are unwilling to make a significant investment in a risky country choose licensing as their entry mode. Like exporting, licensing is a fairly low-risk strategy. Licensing involves a company selling the rights to certain intangibles, such as product design or brand name, to foreign licensees in return for royalty payments. The advantage of licensing is that the company does not have to bear the development costs and risks associated with opening up a foreign market. Licensing has three serious drawbacks. • The lack of tight control over manufacturing, marketing, and strategic functions, which can hinder the firm’s ability to realize scale economies and location economies. • Competing in a global marketplace may require a company to coordinate strategic moves across countries so that the profits earned in one country can be used to support competitive attacks in another. Licensing severely limits a company’s ability to do so. • By licensing its technology, a company often gives away valuable know-how to future competitors. To limit this risk, some companies use a cross-licensing agreement. This agreement asks the foreign licensee to license some of its valuable technology to the licensor in addition to royalty payments. C. Franchising This strategy occurs when a company sells limited rights to franchisees to use its brand name in return for a lump sum payment and a share of the franchisee’s profits. Franchising involves the sale of intangible assets, but also typically imposes strict rules on the franchisee. Franchising is often for a longer period of time than is licensing. Licensing is common among manufacturing companies, whereas franchising is used primarily by service companies. The advantages of franchising are similar to those of licensing. The franchiser doesn’t bear the development costs and risks. Therefore, a global presence can be built quickly and inexpensively. The disadvantages of franchising are somewhat less than those of licensing. One disadvantage is that franchising may inhibit global strategic coordination. Another disadvantage is that foreign franchisees may not be as concerned about quality as the franchiser is, and poor quality may mean not only lost sales, but also a decline in the company’s worldwide reputation. To alleviate this concern, some companies set up subsidiaries in each country, which then oversee the franchisees to ensure that quality is maintained. D. Joint ventures Establishing a joint venture with a foreign company has long been a favored mode for entering a new market. Joint ventures require a sharing of ownership, along with the sharing of all attendant costs and benefits, between a company in the home country and one in the host country. To maintain control, some multinational firms maintain a majority share of ownership. Joint ventures have a number of advantages: • A multinational can benefit from a local partner’s knowledge of a host country’s competitive conditions, culture, language, political systems, and business systems. • The sharing of costs and risk of setting up business with a local partner. • In many countries, political considerations make joint ventures the only feasible entry mode. Major disadvantages of joint ventures are as follows: • The risk of losing control over technology. Some companies cope with this threat by not allowing foreign partners to own a majority stake in the venture. However, some foreign partners may not be willing to accept ownership. • A joint venture does not give a firm the tight control over subsidiaries that it might need to realize experience curve or location economies. E. Wholly Owned Subsidiaries A wholly owned subsidiary is created when the parent company owns 100 % of its subsidiary’s stock. A company can establish a wholly owned subsidiary either by acquisition or by setting up a completely new operation. Advantages of wholly owned subsidiaries are as follows: • The tight control the company maintains over its distinctive competencies, which can be especially important when the competitive advantage is based on control over a technological competency. • A wholly owned subsidiary gives a company the kind of tight control over operations in different countries that are necessary for pursuing a global strategy—supporting competitive attacks in one country with profits from another. • A wholly owned subsidiary may be the best choice if a company wants to realize location economies and the scale economies that flow from producing a standardized output from a single or limited number of manufacturing plants. However, a wholly owned subsidiary is the most costly method of serving a foreign market, and companies taking this approach bear the full costs and risks associated with setting up overseas operations. These costs and risks can be diminished somewhat by using acquisition, rather than setting up a new operation. However, acquisitions raise a host of additional problems, such as trying to integrate two disparate operations and cultures. F. Choosing an Entry Strategy Inevitably, choosing an entry mode involves tradeoffs. Therefore, it is difficult to make specific recommendations as to what a company should do. A number of rough generalizations can be made, however. Table 8.1 The Advantages and Disadvantages of Different Entry Modes 1. Distinctive Competencies and Entry Mode When companies expand internationally to earn greater returns from their differentiated product offerings, entering markets where indigenous competitors lack comparable products, the companies are pursuing an international strategy. The optimal entry mode for such companies depends to some degree upon the nature of their distinctive competency. If a company’s competitive advantage—its distinctive competency—derives from its control of proprietary technological knowhow, licensing and joint-venture arrangements should be avoided if possible to minimize the risk of losing control of that technology. Thus, if a high-tech company is considering setting up operations in a foreign country in order to profit from a distinctive competency in technological knowhow, it should probably do so through a wholly owned subsidiary. However, this should not be viewed as a hard-and-fast rule. For instance, a licensing or joint-venture arrangement might be structured in such a way as to reduce the risks that licensees or joint-venture partners will expropriate a company’s technological knowhow. For example, considering a situation where a company believes its technological advantage will be short lived, and expects rapid imitation of its core technology by competitors. In this situation, the company might want to license its technology as quickly as possible to foreign companies in order to gain global acceptance of its technology before imitation occurs. Such a strategy has some advantages. By licensing its technology to competitors, the company may deter them from developing their own, possibly superior, technology. It also may be able to establish its technology as the dominant design in the industry, ensuring a steady stream of royalty payments. Such situations aside, however, the attractions of licensing are probably outweighed by the risks of losing control of technology, and therefore licensing should be avoided. 2. Pressures for Cost Reduction and Entry Mode The greater the pressures for cost reductions, the more a company should pursue some combination of exporting and wholly owned subsidiaries. By manufacturing in those locations where factor conditions are optimal and then exporting to the rest of the world, a company may be able to realize substantial location economies and substantial scale economies. Wholly owned subsidiaries are preferable to joint ventures because they give the company tighter control over marketing, increasing coordination and allowing the profits generated in one market to be used to improve competitive position in another. VII. Global Strategic Alliances Global strategic alliances are cooperative agreements between companies from different countries that are actual or potential competitors. Strategic alliances range from formal joint ventures, in which two or more companies have an equity stake, to short-term contractual agreements. A. Advantages of Strategic Alliances Companies enter into strategic alliances with competitors to achieve a number of strategic objectives. • Strategic alliances may facilitate entry into a foreign market. • Strategic alliances allow companies to share the fixed costs and associated risks that arise from the development of new products or processes. • Alliances bring together complementary skills and assets that neither company could easily develop on its own. • It can make sense to form an alliance that will help firms establish technological standards for the industry that will benefit the firm. B. Disadvantages of Strategic Alliances One problem with global strategic alliances is that they can give a firm’s competitors a low-cost route to gaining new technology and market access. Unless it is careful, a company can give away more than it gets in return. C. Making Strategic Alliances Work The failure rate of global strategic alliances is quite high. One study of 49 international strategic alliances found that two-thirds have some initial problems, and one-third are eventually rated as failures. The success of an alliance seems to be a function of three main factors: partner selection, alliance structure, and the manner in which the alliance is managed. 1. Partner Selection One of the keys to making a strategic alliance work is to select the right kind of partner. A good partner has three principal characteristics. • The partner must be able to help the company achieve its strategic goals through the possession of capabilities that the company lacks but values. • The partner must share the company’s vision for the purpose of the alliance. • The partner must be unlikely to try to opportunistically exploit the alliance for its own ends, expropriating the company’s technological know-how while giving little in return. Therefore, companies must thoroughly research potential alliance partners. 2. Alliance Structure Having selected a partner, the alliance should be structured so that the company’s risk of giving too much away to the partner is reduced to an acceptable level. • Alliances can be designed to make it difficult to transfer technology that is not meant to be transferred. Specifically, the product or process may be structured so as to “wall off” the most sensitive technologies and prevent their leakage to others. • Contractual safeguards can be written into an alliance agreement to diminish the risk of opportunism—seeking one’s own self-interest, often through the use of guile—by a partner. • Both parties can agree in advance to exchange skills and technologies that the other wants, thereby ensuring an equitable gain. Cross-licensing agreements are one way of achieving this goal. • The risk of opportunism can be decreased if the company extracts a significant credible commitment in advance, requiring each partner to make such a substantial and long-term investment that the chances of opportunism are sharply reduced. 3. Managing the Alliance Once a partner has been selected and an appropriate alliance structure agreed on, the task facing the company is to maximize the benefits from the alliance. Important management tactic is to develop sensitivity to cultural differences. Managers must take differences into account when dealing with their partner. Beyond this, maximizing the benefits from an alliance seems to involve building trust between partners and learning from partners. Managing an alliance successfully requires building interpersonal relationships between the firms’ managers, or what is sometimes referred to as relational capital. The belief is that the resulting friendships help build trust and facilitate harmonious relations between the two firms. Personal relationships also foster an informal management network between the firms. This network can then be used to help solve problems arising in more formal contexts (such as in joint committee meetings between personnel from the two firms). When entering an alliance, a company must take some measures to ensure that it learns from its alliance partner and then puts that knowledge to good use within its own organization. One suggested approach is to educate all operating employees about the partner’s strengths and weaknesses and make clear to them how acquiring particular skills will bolster their company’s competitive position. For such learning to be of value, the knowledge acquired from an alliance must be diffused throughout the organization. To spread this knowledge, the managers involved in an alliance should be used as a resource in familiarizing others within the company about the skills of an alliance partner. Teaching Note: Ethical Dilemma This question should solicit an interesting discussion of various opinions regarding the appropriateness of taking advantage of localized labor. The instructor could use this opportunity to stimulate further discussion regarding the impacts of NAFTA on global strategies. However, the instructor should emphasize on how to balance domestic demands and localization allowances. Ask the students how they would succumb to cost pressures and recognize that other locals may permit what is not acceptable domestically. Ultimately, this question should wind up with an examination of the many facets of company value chains that could be utilized to deal with cost pressures and the need to look at those that would not border on ethical demise and have a potentially negative long-term effect on company image. Answers to Discussion Questions 1. Plot the position of the following companies on Figure 8.3: Microsoft, Google, Coca-Cola, Dow Chemicals, Pfizer, and McDonald’s. In each case, justify your answer. Students’ answers may vary. Microsoft would be plotted between international strategy and global standardization strategy, but closer to global standardization as cost pressures are becoming more intense over time. McDonald’s would be plotted between localization and transnational strategies. McDonald’s has always faced pressure to be locally responsive (because of consumers’ food tastes and local customs) but cost pressures are increasing so a more transnational strategy would be appropriate. Google would be plotted between the international strategy quadrant and the localization strategy quadrant because customer responsiveness is important to their business, and cost pressures are low. Dow Chemicals and Coca-Cola produce commodity-type products, where price competition is intense and where local differentiation is relatively unimportant; thus they will be positioned in the global standardization quadrant. Pfizer is perhaps less likely to experience cost pressures or pressures for local responsiveness so it should fall in the lower left quadrant under international strategy. 2. Are the following global standardization industries, or industries where localization is more important: bulk chemicals, pharmaceuticals, branded food products, moviemaking, television manufacture, personal computers, airline travel, fashion retailing? Global standardization industries are those where the pressures for local responsiveness are low (but not zero) because the product serves universal needs. Cost pressures can be intense and a global strategy is appropriate. Bulk chemicals, pharmaceuticals, television manufacture, personal computers, and airline travel all have these characteristics. In contrast, localization strategy industries are those where pressures for local responsiveness are paramount—that is, where the product demands customization for local preferences. Moviemaking, branded food products and fashion retailing also fall toward this end of the spectrum. However, even here the trend is for a shift toward a more global industry. Thus certain foods are becoming much more universal—hamburgers, pizza, sushi, french fries—whereas Hollywood movies may be helping to create a more uniform global culture by exporting American culture. Fashion retailers like Zara and H&M are expanding globally. 3. Discuss how the need for control over foreign operations varies with the strategy and distinctive competencies of a company. What are the implications of this relationship for the choice of entry mode? If a company’s competitive advantage (its distinctive competency) is based on control over proprietary technological know-how, licensing and joint venture arrangements should be avoided, if possible, in order to minimize the risk of losing control over that technology. Thus, if a high-tech company is considering setting up operations in a foreign country in order to profit from a core competency in technological know-how, it should probably do so through a wholly-owned subsidiary. However, this is not a hard-and-fast rule. An exception is a licensing or joint venture arrangement that is structured in a way that reduces the risks of a company’s technological know-how being expropriated by licensees or joint-venture partners. Furthermore, when a company perceives its technological advantage as being only transitory and when it expects rapid imitation of its core technology by competitors, the company might want to license its technology as quickly as possible to foreign companies in order to gain global acceptance of this technology before imitation occurs. Such a strategy has some advantages. By licensing its technology to competitors, the company may deter them from developing their own, possibly superior, technology; and by licensing its technology the company may be able to establish its technology as the dominant design in the industry (as Matsushita did with its VHS format for VCRs). In turn, this may ensure a steady stream of royalty payments. These situations apart, however, the attractions of licensing are probably outweighed by the risks of losing control over technology, and licensing should be avoided. In contrast, the competitive advantage (distinctive competency) of many service companies is based on management know how (for instance, McDonald’s, Hilton International). For such companies, the risk of losing control over their management skills to franchisees or joint-venture partners is not that great because the valuable asset of such companies is their brand name, and brand names are generally well protected by international laws pertaining to trademarks. Consequently, many of the issues that arise in the case of technological know how do not arise in the case of management know how. Hence many service companies favor a combination of franchising and subsidiaries to control franchisees within a particular country or region. The subsidiary may be wholly owned or a joint venture. By and large, however, service companies have found that entering into a joint venture with a local partner in order to set up a controlling subsidiary in a country or region works best. This is because a joint venture is often politically more acceptable and brings a degree of local knowledge to the subsidiary. 4. Licensing proprietary technology to foreign competitors is the best way to give up a company’s competitive advantage. Discuss. International licensing is an arrangement whereby a foreign licensee buys the rights to produce a company’s product in the licensee’s country for a negotiated fee (normally, royalty payments on the number of units sold). The licensee then puts up most of the capital necessary to get the overseas operation going. The advantage of licensing is that the company does not have to bear the development costs and risks associated with opening up a foreign market. Licensing therefore can be a very attractive option for companies that lack the capital to develop operations overseas. It can also be an attractive option for companies that are unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market where political risks are particularly high. Licensing does not give a company the tight control over all functions that it needs to have in order to realize experience-curve cost economies and location economies—as companies pursuing both global and transnational strategies try to do. This leads to the problem with licensing mentioned in the question: the risk associated with licensing technological know-how to foreign companies. For many multinational companies, technological know-how forms the basis of their competitive advantage, and they would want to maintain control over the use to which it is put. There are ways of reducing this risk—for example, by entering into a cross-licensing agreement with a foreign firm. Such agreements are designed to reduce the risks associated with licensing technological know-how because the licensee realizes that if it violates the spirit of a licensing contract by using the knowledge obtained to compete directly with the licensor, the licensor can do the same to it. In summary, there is no clear-cut answer to this discussion. 5. What kind of companies stand to gain the most from entering into strategic alliances with potential competitors? Why? Companies enter into strategic alliances with actual or potential competitors in order to achieve a number of strategic objectives: to facilitate entry into a foreign market, to share the costs and risks of a new product, to bring together complementary skills, or to set technological standards for the industry. The benefits that a company derives from a strategic alliance seem to be a function of three factors: partner selection, alliance structure, and the way in which the alliance is managed. One important ingredient of success appears to be a sensitivity to cultural differences. Differences in management style can often be attributed to cultural differences. Managers need to make allowances for such differences when dealing with their partner. In addition, managing an alliance successfully means building interpersonal relationships among managers from the different companies. Another major factor that determines how much a company gains from an alliance is its ability to learn from alliance partners. When entering an alliance, a company must take some measures to ensure that it learns from its alliance partner and then puts that knowledge to good use within its own organization. One suggested approach is to educate all operating employees about the partner’s strengths and weaknesses and make clear to them how acquiring particular skills will bolster their company’s competitive position. Practicing Strategic Management Small-Group Exercise: Developing a Global Strategy Students are asked to break into groups of three to five people and discuss the following scenario. One group member is to be appointed as a spokesperson to communicate the findings to the class. You work for a company in the soft drink industry that has developed a line of carbonated fruit-based drinks. You have already established a significant presence in your home market, and now you are planning the global strategy development of the company in the soft drink industry. You need to decide the following: 1. What overall strategy to pursue: a global standardization strategy, a localization strategy, an international strategy, or a transnational strategy? 2. Which markets to enter first? 3. What entry strategy to pursue (e.g., franchising, joint venture, wholly owned subsidiary) 4. What information do you need to make this kind of decision? Considering what you do know, what strategy would you recommend? Teaching Note: To answer question number one, the groups should consider the tradeoffs between pressures for cost reductions versus pressures for local responsiveness. The choice of an overall strategy also depends on the group’s analysis of the global market for carbonated fruit-based beverages, as does the choice of which markets to enter. Depending on the overall strategy, certain entry strategies are a better match than others—for example, a company choosing a localization strategy might consider building wholly owned subsidiaries in foreign countries. It is helpful to discuss with each group and with the entire class the importance of matching an overall strategy with a mode of entry. Strategy Sign-On Article File 8 Students should find an example of a multinational company that in recent years has switched its strategy from a localization, international, or global standardization strategy to a transnational strategy. They should determine why the company made the switch and identify any problems that the company may be encountering as it tries to change its strategic orientation. Teaching Note: Most likely candidates for this type of switch are larger firms. Some good examples might be banks, foods, or personal products manufacturers. This exercise will reinforce the students’ understanding of the importance of carefully considering the switch to a transnational strategy, as well as illustrate for them the many challenges that come from following this demanding strategy. Strategic Management Project: Module 8 This module requires students to explore how their company might profit from global expansion and to identify the strategy that their company should pursue globally, as well as the entry mode that it might favor. If the student’s company is already doing business overseas, the students are asked to describe the way it creates value, its attention to national differences, its pressures for cost reduction and local responsiveness, and its current global strategy, including which markets and which modes of entry it chose and why. Students are also asked to evaluate the effectiveness of the current global strategy. If the student’s company is not already doing business overseas, the students are asked to describe the potential value their firm could create through global expansion, the pressures for cost reduction and local responsiveness that are experienced by other firms in their industry, and the implications those pressures have on choice of strategy, and to suggest markets and modes of entry that their firm should use when it chooses to globalize. Teaching Note: Students’ answers to these questions should reflect an understanding of the ways in which distinctive competencies, business-level generic strategy, cost and responsiveness pressures, and global strategy interact. Although there are no right or wrong answers, if students choose combinations that are likely to be ineffective, ask them to carefully think through the consequences of their choices, and then steer them in the direction of a better choice. Closing Case Avon Products Avon’s rapid global expansion had given global managers too much autonomy and authority to control operations in their respective countries and world regions. This resulted in decision making that benefitted global divisions while hurting overall company performance. The organizational structure resulted in a lack of consistency in marketing strategy from nation to nation, extensive duplication of manufacturing operations and supply chains, and a profusion of new products—many of which were not profitable. This prompted CEO, Andrea Jung, to lay off global managers and restructure the organizational hierarchy to reduce costs and regain control. In doing so, she took away she hired seasoned managers, restructured the organization to improve employee communication, performance visibility, and accountability, reduced management layers, consolidated manufacturing, eliminated duplication, reduced costs. discontinued products, centralized new product decisions, invested in centralized product development for global brands, emphasized the value proposition, increased salespeople in developing nations, instituted aggressive pricing strategy, redesigned packaging, utilized social networking sites as a medium. Avon’s strategy resulted in global market share gains and improved financial performance. Teaching Note: This case illustrates the way in which a firm that experienced success in its home country began the process of globalization. Avon’s duplication strategy needed adjustment for global markets. To discuss this case in class, ask students to consider the benefits that Avon has received from its globalization efforts. Then ask them to indicate what Avon should have been aware of in current global conditions, and to point out any potential weaknesses that must be addressed. Answers To Case Discussion Questions 1. What strategy was Avon pursuing until the mid-2000s? What were the advantages of this strategy? What were the disadvantages? Until the mid-2000s, Avon was using the direct sales model. When it entered a nation, it gave country managers considerable autonomy. All used the Avon brand name and adopted the direct sales model that has been the company’s hallmark. The result was an army of 5 million Avon representatives around the world, all independent contractors, who sold the company’s skin care and makeup products. Many country managers also set up their own local manufacturing operations and supply chains, were responsible for local marketing, and developed their own new products. The advantage of this strategy was that the product and brand was extensively marketed and promoted by mere word-of-mouth alone. Purchasing the product was relatively easier and also helped the unemployed. The disadvantage of this model was that there was a lack of consistency in marketing strategy from nation to nation, extensive duplication of manufacturing operations and supply chains, and a profusion of new products, many of which were not profitable. There was also a problem in accountability and communication. There was also a distinct lack of data-driven analysis of new-product opportunities. 2. What changes did Andrea Jung make in Avon’s strategy after 2005? What were the benefits of these changes? Can you see any drawbacks? Students’ answers may vary. Jung’s turnaround strategy involved several elements. To help transform Avon, she hired seasoned managers from well-known global consumer product companies. She flattened the organization to improve communication, performance visibility, and accountability, reducing the number of management layers to just eight and laying off 30% of managers. Manufacturing was consolidated in a number of regional centers, and supply chains were rationalized, eliminating duplication and reducing costs by more than $1 billion a year. Rigorous return-on-investment criteria were introduced to evaluate product profitability. As a consequence, 25% of Avon’s products were discontinued. The goal was to develop and introduce blockbuster new products that could be positioned as global brands. Also, Jung pushed the company to emphasize its value proposition in every national market, which could be characterized as high quality at a low price. By 2007 this strategy was starting to yield dividends. The company’s performance improved and growth resumed. The drawbacks to this strategy were that 30% managers were laid off and 25% of Avon’s products were discontinued. 3. In terms of the framework introduced in this chapter, what strategy was Avon pursuing by the late 2000s? Students’ answers may vary. In terms of the framework introduced in this chapter, by the late 2000s Avon was pursuing the transnational model. It is a business model that simultaneously achieves low costs, differentiates the product offering across geographic markets, and fosters a flow of skills between different subsidiaries in the company’s global network of operations. 4. Do you think that Avon’s problems in 2010 and 2011 were a result of the changes in its strategy, or were there other reasons for this? Students’ answers may vary. When the company started to stumble again in 2010 and 2011, the reasons were complex. In many of Avon’s important emerging markets the company found itself increasingly on the defensive against rivals such as P&G that were building a strong retail presence there. Meanwhile, sales in developed markets sputtered in the face of persistently slow economic growth. To complicate matters, there were reports of numerous operational mistakes—problems with implementing information systems, for example—that were costly for the company. Avon also came under fire for a possible violation of the Foreign Corrupt Practices Act when it was revealed that some executives in China had been paying bribes to local government officials. Solution Manual for Strategic Management: Theory: An Integrated Approach Charles W. L. Hill, Gareth R. Jones, Melissa A. Schilling 9781285184494
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