Chapter 6: Competitive Strategy and the Industry Environment 1
CHAPTER 6
Competitive Strategy and the Industry Environment
Synopsis of Chapter
This chapter extends the analysis of business-level strategy by considering the different competitive strategies that firms can and should adopt as they enter different industry environments. The formulation of business-level strategy does not take place in a vacuum; companies have to consider the reaction of other firms to their competitive moves. The chapter is therefore a necessary addition to Chapter 5 and provides a building block to the chapters on corporate-level strategy.
The chapter begins with an examination of the problems of managing a generic business-level competitive strategy in different kinds of industry environments: fragmented industries, embryonic and growth industries, mature industries, and finally in declining industries. In each type of industry, there is a discussion of the competitive problems associated with that particular environment and the appropriate strategies that firms can use to tackle those problems.
Teaching Objectives
1.Familiarize students with the different kinds of competitive problems that exist in different industry environments.
2.Discuss the problems of developing a competitive advantage in a fragmented industry and the solutions to such problems.
3.Discuss the problems of maintaining a first-mover advantage in embryonic and growth industries.
4.Examine the main kinds of competitive strategies that firms use to manage competitive industry relations in mature industries.
5.Familiarize students with the main strategies for handling a declining industry environment.
Opening Case: Information Technology, the Internet, and Changing Strategies in the Fashion World
Fashion houses, such as Armani and Gucci, produce highly differentiated, expensive clothes that are affordable only to the very rich. They supplement their sales by producing a line of upscale ready-to-wear fashion for sale in luxury department stores. However, in recent years, fashion houses’ position as the industries differentiators has been challenged by new firms that use information technology (IT) to lower costs and speed time to market with new designs. These new designers sell their clothes through mid-price retailers such as Dillard’s or Macy’s, or through their own retail outlets, as new start-up Zara does. Zara, headquartered in Spain, has designers that closely watch fashion houses’ offerings each season. Then, the designers link with low cost suppliers, manufacturers, and shippers from overseas, to produce a new product line and have it in the stores in about six weeks. The firm also uses IT to monitor each product line’s sales, constantly change its product mix, and minimize inventory. Zara is thus able to charge low prices, increasing demand, and leading to high ROIC. Zara’s profitability led to a very successful IPO in 2001, and rivals are now copying the firm’s techniques, hoping to improve their own performance.
Teaching Note: The clothing design industry is relatively fragmented, with a few large design houses, both upscale and mass market, and thousands of smaller designers. The success of Zara shows the firm’s understanding of the factors leading to high performance, including the use of IT to reduce costs, the ability to offer high-quality products at relatively low prices, and the flexibility to continually innovate and introduce new products quickly. Zara’s recent actions, including the IPO and opening of more retail outlets, demonstrates the firm’s eagerness to make the industry more consolidated.
Lecture Outline
I.Overview
A.This chapter examines the development of a firm’s strategy to manage its industry environment.
B.Firms have to manage competitive relations with other firms, and these relationships differ depending on the nature of the competitive industry environment. First, strategies to compete in fragmented industries are described. Next, strategies that are appropriate for embryonic, growth, mature, and declining industry environments are discussed.
II.Strategies in Fragmented Industries
A.A fragmented industry comprises a large number of small- and medium-sized companies, such as the dry cleaning or restaurant industries.
B.An industry may be fragmented for several reasons.
1.It may be fragmented because of lack of economies of scale leading to low barriers to entry. For example, customers prefer to deal with local real estate agents.
2.Some industries are fragmented due to diseconomies of scale, such as occurs when customers prefer the taste of local restaurant food to the standardized offerings of chain restaurants.
3.Low barriers to entry allow a constant influx of entrepreneurs in some specialized industries.
4.High transportation costs, such that local production is the only efficient method, can contribute to fragmentation.
5.Specialized customer needs mean that companies cannot take advantage of mass production and encourage fragmentation.
C.A focused strategy is an appropriate competitive choice in a fragmented industry. Examples are small specialty or “custom-made” companies and service organizations.
D.However, if a way can be found to overcome the factors that cause industry fragmentation and to let the industry consolidate, the potential returns are high. This is what firms like Wal-Mart and McDonald’s and chains of health clubs, lawyers, and accountants have done.
1.Chaining involves establishing a network of linked merchandise outlets to obtain the advantages of a cost-leadership or differentiation strategy. It allows bulk purchasing, economies of scale in advertising, increased ability to serve customers, and so on. Examples include restaurant chains, discount store chains, and supermarket chains.
2.In franchising, the local outlets of a chain are owned and managed by the same person. Thus there is a strong motivation for the owner-manager to control costs and maintain quality. The personal service they offer is especially helpful for differentiators. Franchising also permits quick expansion and thus growth. The franchisers’ operations can be small and local, while still taking advantage of the same opportunities that larger firms enjoy.
3.When one firm in an industry takes over and merges with another firm, a horizontal merger has occurred. The result of horizontal mergers is less competition and greater ability to influence price and output decisions, which increases industry profitability. Chapter 9 contains a more expanded discussion of horizontal mergers.
4.The Internet is the latest means by which companies have been able to consolidate a fragmented industry. Good examples of this approach are eBay in the auction industry and amazon.com in the bookstore industry.
Strategy in Action 6.1: Clear Channel Creates a National Chain of Local Radio Stations
In just seven years, Clear Channel has gone from owning a single radio station to ownership of over 1,200 compared to the second-largest radio broadcaster, Citadel with 205 stations. Before 1996, U.S. regulators allowed one firm to own no more than 40 stations, but Clear Channel acted quickly when the law was repealed. The firm sought to grow as a way to increase quality, listeners, and advertising revenues, while reducing expenses. Radio listeners enjoy a station’s local ties, and the firm had to find a way to keep that link, while still gaining the advantages of standardization. To obtain economies of scale, Clear Channel used IT to develop a new method called voice tracking. This allows the company to employ just a few popular DJs to produce standard output for all markets, and also to contribute some customized product for each local market. The firm also developed KISS as its brand name across all its radio stations. These measures created a differentiated product that appealed to many customer segments, while also lowering costs.
Teaching Note: Before Clear Channel’s phenomenal growth, the radio industry was highly fragmented, with hundreds of local broadcasters. Clear Channel found a way to pursue both cost leadership and differentiation simultaneously, giving the firm higher profitability. When combined with a change in legislation, this strategy allowed the firm to consolidate the once-fragmented industry. Ask students to describe which of the four strategies for consolidation Clear Channel has adopted. Then, ask if they know of any other firms that are using one or more of those methods to consolidate industries that were previously consolidated. (Examples might include Dell in the PC industry or Yum! Brands—which owns Kentucky Fried Chicken, Long John Silver’s, Pizza Hut, Taco Bell, and A&W Root Beer—in restaurants.)
III.Strategies in Embryonic and Growth Industries
A.Embryonic and growth industries pose special challenges for strategists because customer attributes change as markets develop. Also, the rate of market growth exercises a significant influence over the success of the chosen strategy.
B.Embryonic industries typically arise through innovations by pioneering companies.
C.Customer demand in embryonic industries is typically limited, due to the limited performance and poor quality of the first products, customer unfamiliarity with what the new product can do for them, poorly developed distribution channels to get the product to customers, a lack of complementary products to increase the value of the product for customer, and high production costs because of small volumes of production.
D.Embryonic industries become growth industries as a mass market develops for the firm’s products. This occurs when technological progress increases the value of the product to the customer, key complementary products are developed, and companies reduce production costs and set a low price, stimulating demand.
E.Understanding changes in market demand is critical for firms in the embryonic and growth stages.
1.Growth follows an S-curve, with demand first accelerating and then decelerating.
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Figure 6.1: Market Development and Customer Groups
a.The first customers to enter a market are innovators, who enjoy tinkering with new products and are willing to pay high prices.
b.Early adopters follow the innovators. They are visionaries, and see the possibility of using the new product in diverse and ingenious ways.
c.These are followed by the early majority, who constitute the leading edge and signal of the arrival of the mass market. They are practical, weighing product benefits against costs. They arrive in large numbers.
d.After about 30 percent of potential customers have entered the market, the late majority enters. This is a more cautious group of customers, but it is as large as the early majority.
e.Finally, the laggards, who tend to be very conservative and perhaps even techno-phobic, arrive.
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Figure 6.2: Market Share of Different Customer Groups
2.Pioneering companies that fail often attract innovators and early adopters, but fail to attract the majority, leading to few sales and ultimately, the firm’s failure. Companies that attract the majority, on the other hand, are likely to experience very high sales and high profits.
3.Geoffrey Moore argues that innovators and early adopters have very different needs than the early majority, and thus firms need a different set of competencies to serve them effectively.
a.Innovators tolerate technical problems, but the early majority favors ease of use and reliability.
b.Innovators can be reached through specialty retailers, but the early majority uses mass distribution channels.
c.Innovators are few and are not price sensitive, so skills in mass production are not required. When the early majority arrives, mass production is necessary to insure quality at a lower cost.
d.Moving from an embryonic market to a mass market is not easy and smooth; instead, it represents a competitive chasm. Thus, embryonic markets consist of many small firms, but most fall into the chasm and disappear, leaving only a few firms in a mass market.
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Figure 6.3: The Chasm: AOL and Prodigy
Strategy in Action 6.2: How Prodigy Fell Into the Chasm
Prodigy, founded in 1984 and nurtured by major investors Sears and IBM, was once the leader in online networks. The match of retailing and technological expertise seemed to be made in heaven. Prodigy was very successful and had little competition, except from CompuServe, which was focused on financial services (it was founded by H&R Block). Ten years later, AOL was the dominant online network and Prodigy was gone, after Sears and IBM together lost $1.2 billion. Prodigy had a very accurate vision of the future of the Internet—driven by the mass market for online retailing—but its business model was not as good. It charged customers for e-mail and censored chat rooms, fearful of lawsuits. Prodigy was also slow to adopt a new Windows interface, due to the competition between IBM and Microsoft. In contrast, AOL offered free e-mail, uncensored chat rooms, and easy-to-use Microsoft interfaces. By 1996, the competition was over and Prodigy was through.
Teaching Note: Prodigy did a wonderful job of attracting innovators and early adopters, but stumbled when making the transition to a mass market. They failed to consider how the needs of mass-market customers differed from those that they had served so well in the past. In addition, they were cautious in making changes and let their rivals get ahead in innovation. Finally, they failed to update their business model, even when other models were demonstrably superior. This is a cautionary tale for students about how a successful firm can go horribly wrong, and quickly. Ask students if they know of other examples of companies that did not successfully cross the chasm.
4.Managers in embryonic and growth industries must learn how to compete for the mass market.
a.One important focus for these managers is to correctly identify the needs of the first members of the early majority very early on, while the growth is still primarily being driven by innovators and early adopters.
b.Managers must then alter their business model and their value chain activities so as to effectively reach the early majority.
c.Managers must also not become too focused on meeting the needs of innovators and early adopters, who don’t contribute significant sales.
d.Managers must be aware of and respond effectively to their competitors’ actions. Game theory is useful here.
e.Managers must understand the S-curve of growth, and realize that industries develop at different rates. By their strategic choices and actions, managers can change their industry’s growth rate, and thus, its profitability.
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Figure 6.4: Differences in Diffusion Rates
(1)A factor that accelerates customer demand is a new product’s relative advantage, that is, the degree to which a new product is perceived as better at satisfying customer needs than the product it supersedes.
(2)Another factor is compatibility, which refers to the degree to which a new product is perceived as being consistent with the current needs or values of potential adopters.
(3)Complexity, the degree to which a new product is perceived as difficult to understand and use, is another factor.
(4)A fourth factor is trialability, which is the degree to which a new product can be experimented with on a hands-on trial basis.
(5)A fifth factor is observability, which refers to the degree to which the results of adopting a new product can be clearly seen and appreciated by other people.
(6)A final factor that is very important in the growth of many new products is the availability of complementary products.
f.Therefore, one way for managers to help their industries grow rapidly is to use these six factors to their advantage. For example, increase the product’s compatibility, reduce its complexity, and so on.
g.Another concept that can be helpful to managers is to think of the spread of demand for a new product as analogous to a viral infection. Thus, companies can identify and court community opinion leaders.
IV.Strategy in Mature Industries
A.A mature industry becomes consolidated so that it comprises a small number of large companies that are interdependent; they recognize that their actions affect one another.
B.Thus, the main issue facing a company in a mature industry is to adopt a competitive strategy that simultaneously enables it to maximize its profitability given the strategies that all other companies in the industry are likely to pursue.
C.Firms in a mature industry can pursue strategies based on game theory principles to increase the profitability of all competitors in the industry.
1.One important goal of firms in mature industries is to deter potential entrants.
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Figure 6.5: Strategies for Deterring Entry of Rivals
a.One method for deterring potential entrants is product proliferation, which occurs when a company tries to broaden its product line and provide products for all market segments in order to make it very hard for a potential competitor to enter the market. Such an effort is also called “filling the niches.” When the niches are filled, it is hard to enter except at a disadvantage.