Organization & Strategy Tools & Concepts I
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1 Tools & Concepts I February 2003
2 Contents 1 Introduction to the Strategic Process 2 Industry 3 Micro-economics for strategists 4 Industry analysis 1
3 Introduction to the Strategic Process What is the Strategic Process? Superior long-run Return on Investment Attractive Industry Structure Competitive Advantage Unique Competitive Position Operational Effectiveness Location 2
4 Contents 1 Introduction to the Strategic Process 2 Industry 3 Micro-economics for strategists 4 Industry analysis 3
5 Industry What is an industry? An industry consists of a set of firms vying to sell similar goods to a similar set of customers Industry definition is always a matter of degree Nuances Segment vs industry differences Geographic scope of industry boundaries 4
6 Contents 1 Introduction to the Strategic Process 2 Industry 3 Micro-economics for strategists 4 Industry analysis 5
7 Micro-economics for Strategists Demand Segments and price discrimination Demand is composed of many distinct segments Example: Laser printers industry Segments differ in their willingness to pay for speed additional fonts extra memory ---> Successful product development and marketing initiatives require a deep understanding of the segments comprising this market demand curve Ideally, a seller would like to charge each consumer exactly his willingness to pay for each unit of the good. Firms employ a number of clever tactics to achieve similar ends by charging different prices to different buyers, a practice known as price discrimination. 6
8 Micro-economics for Strategists Application for Strategy Nature of demand aids the strategists in understanding how a price change affects output how such changes alter the mix of buyers who are actively purchasing a product Analysis of the segments can be helpful in understanding how to expand the market Design special products or pricing schemes to bring buyers with lower willingness to pay into the market (American Express credit card for students) In real markets, firms take actions to influence the size of demand and the shape of the demand curve Nike s advertising has greatly expanded the demand for athletic shoes and has perhaps made consumers less price-sensitive Sales efforts by pharmaceutical makers shape demand curves for drugs by communicating their safety and efficacy to prescribing physicians. Microsoft has invested in Internet-related technologies in part to boost demand for its Windows operating system 7
9 Micro-economics for Strategists Supply analysis A supply curve describes how much of a good a supplier will choose to provide at each price A firm s supply decision really consists of two decisions: whether to compete in the market at all short-run choice of how much to produce in light of current market conditions, givent that the firm is in the market 8
10 Micro-economics for Strategists Price sensitivity or Elasticity of Supply Where the price elasticity of supply is high, the supply curve is nearly flat. Industries where facilities for other things can be converted to producing the good in question, where capacity can be expanded easily, or where new firms can enter the business readily Other industries have a low elasticity of supply. Hotel room rates in case of major events in a city A supply curve can be more elastic in one region than in another supply curve becomes inelastic as firms in the industry run into capacity constraints 9
11 Micro-economics for Strategists Application for Strategy Nature of supply aids the strategists in understanding how an industry will react to shifts in input costs and technology how responsive the quantities supplied will be to prices Analysis of the marginal cost curve shows that firms with high marginal cost curves will be the ones squeezed out of a market when the market falls into a slump, especially in commodity markets 10
12 Micro-economics for Strategists Perfect Competition The model of market equilibrium holds when: products are identical many, small participants (price-taking) full information The idea that competition and imitation tend to erode profits is captured by models of perfect competition: identical sellers free entry free exit 11
13 Contents 1 Introduction to the Strategic Process 2 Industry 3 Micro-economics for strategists 4 Industry analysis 12
14 Industry analysis Five forces analysis Threat of Substitute Products or Services Bargaining Power of Suppliers Rivalry Among Existing Competitors Bargaining Power of Buyers Threat of New Entrants 13
15 Industry analysis Five forces I: Bargaining Power of Suppliers Suppliers have bargaining power when: Their products have few substitutes and are important to buyers. The buyer s industry is not an important customer to the supplier. Differentiation makes it costly for buyers to switch suppliers. Suppliers can vertically integrate forward to compete with buyers and buyers can t integrate backward to supply their own needs. 14
16 Industry analysis Five forces II: Bargaining Power of Channels & End Users Buyers are most powerful when: There are many small sellers and few large buyers. Buyers purchase in large quantities. A single buyer is a large customer to a firm. Buyers can switch suppliers at low cost. Buyers purchase from multiple sellers at once. Buyers can easily vertically integrate to compete with suppliers. 15
17 Industry analysis Five forces III: Concentrate Producers The intensity of competitive rivalry in an industry arises from: competitors are numerous or are roughly equal in size and power industry growth is slow the product or service lacks differentiation or switching costs capacity is augmented in large increments exit barriers are high the rivals are diverse in strategies and origins. 16
18 Industry analysis Five forces IV: Threat of substitute Products or Services Products that are subject to trends improving their price-performance trade-off with the industry s product Products that are made by industries earning high profits Must consider full range of substitutes Relative value/price of each substitute 17
19 Industry analysis Five forces V: Threat of New Entrants New entrants into an industry threaten incumbent companies. Barriers to entry: Brand loyalty Absolute cost advantages Economies of scale Switching costs Government regulation Access to distribution channels 18
20 Industry analysis Five forces Five forces framework is general and flexible Emphasizes long-run structure and profit potential versus current price and quantity a systematic way of thinking about departures from perfect competition Helps understanding of who benefits from supply/demand imbalances - in industries with intense rivalry or powerful buyers, small amounts of excess supply lead to big price wars 19
21 Industry analysis Industry Structural Change Industry structure changes, though it normally changes relatively slowly The basic tool for analyzing industry structural change is the Five Forces - Must see an industry as a system, where one change often begets others There is often scope for multiple industry outcomes - Coke/Pepsi, Intel Companies can not only respond to structural change (passive) but shape industry structure - DRAM vs micropressors 20
22 Industry analysis Examples: Pharmaceutical Industry Threat of Substitute Products or Services Over-the-counter medications Drugs replace costly, labor-intensive services Bargaining Power of Suppliers Rivalry Among Existing Competitors Bargaining Power of Distributors Bargaining Power of Providers Largely commodity raw materials Price pressure fueling rivalry Generic substitution Buyer consolidation Increasing price sensitivity Threat of New Entrants Biotechnology companies Joint marketing arrangements 21
23 Industry analysis Reacting to versus Shaping Industry Structure Reacting to Structural Change Lobbying Cutting costs Acquiring competitors Focusing on therapeutic areas of strength Shaping Industry Structure Entering into generic drugs Reformulating products from ethical to OTC Marketing directly to patients Disease management Forming alliances with biotechnology 22
24 Industry analysis Shaping Industry Structure: Two Approaches Expanding the Pie Expanding the size of value created by the industry Re-dividing the pie Shifting the relative bargaining power, thus changing the division of profits among players 23
25 Industry analysis Expanding the Industry Pie Threat of Substitute Products or Services Complementary Products Bargaining Power of Suppliers Raise the cost effectiveness of suppliers Improve relative value vis-à-vis subsitutes to expand the industry Rivalry Among Existing Competitors Find a way to lower intrinsic industry cost structure Threat of New Entrants Improve the price/performance of complementary products and services Bargaining Power of Buyers Expand the quantity purchased per customer Find latent buyers who are not currently being served 24
26 Industry analysis Re-Dividing the Industry Pie Threat of Substitute Products or Services Improve value relative to subsitute products to relax price pressures Bargaining Power of Suppliers Multisourcing to limit supplier leverage Catalyze entry into supplier industries to mitigate supplier bargaining power Rivalry Among Existing Competitors Industry consolidation to shift relative bargaining power Threat of New Entrants Raise the investmemt/technology threshold for new entrants Bargaining Power of Buyers Create switching costs to limit buyer power Market to end users to reduce channel power Eliminate the need for powerful channels 25
27 Industry analysis Principles of Industry Transformation Expanding the pie reduces the risk of destructive rivalry compared to efforts to gain market share - a central agenda for industry leaders To restructure an industry, competitor imitation is often desirable Ideally, industry transformation should shift competition in directions where the company can gain a competitive advantage Transformation can just as easily undermine industry attractiveness as enhance it 26
28 Industry analysis Framework for Industry Structure Analysis Define the industry: what is in, what is out Identify the participants and participants groups - who are the customers, really? Who are the competitors? Assess the strength of each force - which are the controlling forces for profitability? Consistency testing - Is the industry analysis consistent with actual profitability? - Are more profitable players better positioned vis-à-vis the Five Forces? Analyze recent and likely future changes in each force How can industry structure be influenced in positive directions? Typical pitfalls Confusing cyclical/transient and structural Confusing effect (price sensitivity) and cause (buyer economics) Static analysis 27
29 Summary Summary First Session Industry analysis is a basic building block of strategy development Industry analysis tools allow a holistic understanding of the external environment Industry analysis should be done first/early in the strategy development process 28
30 Next Step What s Next? Session II Competitive Advantage and Competitive Positioning How can a firm position itself to perform better than its direct rivals? Superior long-run Return on Investment Attractive Industry Structure Competitive Advantage Unique Competitive Position Operational Effectiveness Location 29
31 Course Structure Structure Industry Structure Foundations of competitive strategy Competitive positioning Competitive dynamics Competition and Location Corporate Strategy 30
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