Session 1: Industry Analysis and Strategy ID

Transcription

1 The University of Chicago Graduate School of Business Crown Cork and Seal: What happened? (1) Session 1: Industry Analysis and Strategy ID Major acquisitions: 1990: Continental Can Canada for $330 M Continental US food and beverage metal container lines $336m 1991: Continental Can International $125m (Asia, Mideast, SouthAm) General Packaging Canadian business from Ball Citrus Central small acquisitions of engineering services, machining 1992: beverage closure operations from Tredegar Molded Products; CONSTAR International --world's largest manufacturer of plastic containers [IPO d out in fall 2002] 1996 Carnaud Metalbox double size Sales growth from 1989 to 1996: from $1.7 billion to $8 billion. Chicago GSB, Spring 06 Garicano, Page 1 Chicago GSB, Spring 06 Garicano, Page 2 Update (2) 1: Industry Analysis By 2000, diversification strategy considered a failure. Declining EBITDA and free cash flow as a result of margin pressure. $5 billion in debt. Major asbestos liabilities from a long-closed insulation division Debt downgraded to junk status facing bankruptcy Crown suspended dividend, shares down 70% -- removed from the S&P Avery resigns in 2000, CCK in similar position to 1957 pre- John Connelly Restructuring plan new CEO Conway: (1) improve the company s balance sheet conservative financial strategy (2) lead in rigid packaging containers and closures, (3) use R&D to improve products, (4) improve its global presence, an (5) strive to be the low cost provider. Economic Profitability Explanation for profitability Market Attractiveness Competitive Advantage or Disadvantage Measurable indicators or causes Direct Competition from Rivals Entry Threats Competition from Substitutes Complements Supplier Power Buyer Power Regulatory pressures Cost Position in Served Market Benefit Position in Served Market Root conditions Market Economics and Opportunities Firm s Strategy for Creating Value ( Value-Creation Proposition ) Firm s Resources and Capabilities The Market The firm s valuecreation proposition matches the firm s resources and capabilities to market opportunities The Firm and its Position in the Market Chicago GSB, Spring 06 Garicano, Page 3 Chicago GSB, Spring 06 Garicano, Page 4

2 Industry Analysis I. Substitutes Industry Analysis: Description of the economic structure of an industry. Industry analysis is useful because Understand context of firm decisions to take decisions within context-- building block of strategy formulation Essential to making effective decisions about entry, exit, expansion, product positioning, cost reduction, it helps identify potentially attractive/unattractive arenas for growth. Change Context? Understanding the current rules of the game in the industry is a precondition for eventually changing them. Question: To what extent does competition from substitute products outside the defined boundaries of the industry erode the profitability of a typical firm in the industry? Identifying substitutes depends on how finely you draw the boundaries of the analyzed market Is Amtrak (railroads) a competitor to Airlines or a substitute product. But it does not matter: you either have a substitute or a rival; both ways need to consider it e.g. in CCS plastics and glass Substitutes limit the profits of an industry by placing a ceiling on industry prices. The more attractive the price-performance tradeoff offered by substitutes, the more important the substitute product. Chicago GSB, Spring 06 Garicano, Page 5 Chicago GSB, Spring 06 Garicano, Page 6 II. Threats from Competitors: Rivalry Two basic questions: How do firms compete? price competition product competition technological innovations marketing To what extent does price competition or non-price competition (e.g., advertising) erode the profitability of a typical firm in the industry? Intense rivalry erodes profitability by reducing price-cost margins (price competition) increasing programmed costs (e.g., advertising) (non-price competition) Focus now on price rivalry, since it is most costly and important for profitability. Chicago GSB, Spring 06 Garicano, Page 7 Pricing Rivalry Bertrand Model: One shot competition with homogeneous goods and constant unit costs. Results in prices equal to unit costs How do we get away from this?: Capacity constraints Differentiated products Repeated interaction tacit coordination Chicago GSB, Spring 06 Garicano, Page 8

3 Switching costs/search costs Tacit coordination Switching costs/search costs also decrease responsiveness to price Thus they also reduce price competition May create differentiation/switching costs on purpose Example: Frequent Flyer Program Will see other examples during program Brand Loyalty plays a similar role decreases rivalry by creating a switching cost from consumer perspective Conditions that facilitate tacit coordination Concentrated market Facilitating practices used Public sales terms; firms have good info. about competitors Small, frequent orders Strong capacity utilization Rapidly growing demand Exit barriers increase rivalry unprofitable firms stick around Chicago GSB, Spring 06 Garicano, Page 9 Chicago GSB, Spring 06 Garicano, Page 10 III. Barriers to Entry When does capital constitute a BTE? The key question: To what extent does the threat or incidence of entry erode the profitability of a typical firm in the industry? Factors that restrict entry into an industry: Economies of Scale Large Sunk Expenditures Incumbent advantages: learning curve effects; patents and licenses; switching costs Expectation of aggressive response to entry When it creates large economies of scale But large capital expenditures are neither necessary nor sufficient for there to large economies of scale Key: MES relative to market size When investment is large and sunk Chicago GSB, Spring 06 Garicano, Page 11 Chicago GSB, Spring 06 Garicano, Page 12

4 Economies of Scale and MES Production economies due to lumpy capital, specialization of labor/ capital, technological factors. Best measured by comparing minimum efficient scale to market size (approximates number of efficient scaled firms that can be sustained) Fixed Cost 1 Getting to the Bottom of MES (Constant Variable Costs Penalty for Operating at Half MES 1 Limits number of firms plus creates lumpiness whereby incumbents can make profits but any additional entry would spoil the market. Average Cost 1 Variable Cost q*/2 q*=mes Q (Output per period) Chicago GSB, Spring 06 Garicano, Page 13 Chicago GSB, Spring 06 Garicano, Page 14 Sunk Costs If investment made is specific to this opportunity, cannot recover it. To the extent that investment made is irreversible, hit and run entry impossible Large sunk investment is a barrier to entry, since if exit is costly, more unlikely to enter under uncertainty Some firm investments create barriers to entry by increasing the amount of sunk investments required to enter industry Investments in brand building (advertising) -- entirely sunk Investments in R&D IV. Bargaining Power of Suppliers The key question: To what extent do the input prices facing a typical firm in this industry deviate from those that would prevail in perfectly competitive input markets because of the bargaining power of input suppliers? The power of suppliers increases if: Input is a critical component of production Supplier industry more concentrated than the industry it sells to. Firms in the analyzed industry purchase relatively small volumes relative to other customers of the supplier. Suppliers can credibly threaten to forward integrate. Switching costs are high Chicago GSB, Spring 06 Garicano, Page 15 Chicago GSB, Spring 06 Garicano, Page 16

5 V. Bargaining Power of Buyers (VI) Complementary products The key question To what extent do purchase prices in this market differ from those that would prevail in a market with a large number of fragmented buyers in which buyers act as price takers. The power of buyers increases if: input is a not a critical component of production buyers are large and few in numbers input is relatively standardized switching costs for buyers are low lots of substitutes buyers can credibly threaten to backward integrate Question: How does availability/ price of complementary products affects demand for the product.? Two aspects: Market for complementary market affects demand for own product Need for complementary products limits own ability to capture value PIE must be shared Examples: Soda Cans and Sodas Intel/Microsoft Automobiles/ Roads Chicago GSB, Spring 06 Garicano, Page 17 Chicago GSB, Spring 06 Garicano, Page 18 Outline 2: Strategy Identification 1. Industry Analysis 2. Strategy Identification 3. Competitive Advantage 4. Organization and Competitive Advantage A coherent business strategy has a clear statement of: Objectives: where are we going? Scope: in which products, markets, and activities will we participate? Competitive advantage: how will we: Make our products more attractive than real or potential competitors? Be more efficient than real or potential competitors? An underlying logic: why will we succeed in gaining the CA and retaining it? Chicago GSB, Spring 06 Garicano, Page 19 Chicago GSB, Spring 06 Garicano, Page 20

6 Strategy Evaluation Strategy Evaluation The logic of a strategy is evaluated by querying its: (1) Internal consistency: Does the firm s various organizational practices cohere with one another and with the purported competitive advantages? The logic of a strategy is evaluated by querying its: (2) External consistency: Do they really achieve competitive advantage? How successfully do the purported competitive advantages and supporting organizational practices address key environmental challenges? To what extent will the competitive advantage survive competition? Chicago GSB, Spring 06 Garicano, Page 21 Chicago GSB, Spring 06 Garicano, Page 22