Introduction to BCG

Competitive Intelligence (CI) often requires a great deal of analysis to convert gathered information into useable intelligence. Several different analytical techniques can be utilized in order to accomplish this task. This pro ect looks at t!o analytical techniques" the #oston Consulting $roup (#C$) %atri& and the $'(%c)insey %atri&" their respective advantages and disadvantages" !hat CI situations they are best suited for" and provides an e&ample of their use !hen applied to the CI scenario of the Smartphone industry.

Background
The #C$ %atri& ($ro!th*Share %atri&) !as created in the late +,-.s by the founder of the #oston Consulting $roup" #ruce /enderson" as a tool to help his clients !ith efficient allocation of resources among different business units. It has since been used as a portfolio planning and analysis tool for marketing, brand management and strategy development. In order to ensure successful long*term operation" every business organization should have a portfolio of products(services rather than ust one product or service. This portfolio should contain both high-growth and low-growth products/services. /igh* gro!th products have the potential to generate lots of cash but also require substantial amounts of investment. 0o!*gro!th products !ith high market share" on the other hand" generate lots of cash !hile needing minimal investment.

How it Works
The #C$ %atri& helps a company !ith multiple business units(products by determining the strengths of each business unit(product and the course of action for each business unit(product. 1n understanding of these factors !ill give the company the highest probability of !inning against its competitors" since the intelligence generated can be used to develop portfolio management strategies. The #C$ %atri& helps managers classify business units(products as lo! or high performers using the follo!ing criteria2

+. 3elative market share (strength of a business unit4s position in that market) 5. %arket gro!th rate (attractiveness of the market in !hich a business unit operates)

3elative market share (3%S) is the percentage of the total market that is being controlled by the company being analyzed. It is calculated using the follo!ing formula2 RMS = Unit sa es this year ! Unit sa es this year "y a eading ri#a The relative market share is measured on a scale !here +.. is considered a cut*off point. 1n 3%S of more than +.. indicates that this company(product(business unit has a higher market share than the leading competitor. %arket gro!th (%$3) is used as a measure of a market6s attractiveness. It is calculated using the follo!ing formula2 MGR = $Indi#idua sa es this year % indi#idua sa es ast year& ! Indi#idua sa es ast year /igh gro!th markets are the ones !here the total available markets share is e&panding" offering plenty of opportunity for everyone to make money. Traditionally" a market gro!th rate of +.7 has been used as a cut*off point for the purpose of classifying the units in the business portfolio. 1ny unit !ith a gro!th rate of more than +.7 !ould be placed in the high gro!th segment of the #C$ %atri&. This classification places business units(products in the follo!ing four categories2 '. Stars 8 #9s(products characterized by high*gro!th and high* market share. They often require heavy e&ternal investment to sustain their rapid gro!th as they may not be producing any positive cash flo!. 'ventually" their gro!th !ill slo!" and they !ill turn into cash co!s. (. Cash Cows * #9s(products characterized by lo!*gro!th" high*market share. These are !ell established and successful #9s that do not require substantial investment to keep their market share. They produce a lot of cash to be used for other business units (Stars and :uestion %arks) of the company. ). *uestion Marks * #9s(products characterized by lo!*market share in high* gro!th markets. They require a lot of financial resources to increase their share since they cannot generate enough cash themselves. The crucial decision is to decide !hich :uestion %arks to phase out and !hich ones to gro! into Stars. +. ,ogs * #9s(products !ith lo!*gro!th" lo!*market share. In addition" they often have poor profitability. The business strategy for a ;og is most often to divest. /o!ever" occasionally management might make a decision to hold a ;og for possible strategic repositioning as a :uestion %ark or Cash Co!.

-he BCG mode .o ows the .o owing ma/or steps0

+. Identify ma or organizational business units (#9s) and identify 3%S and %$3 for each #9 5. <lot the #9s on the #C$ %atri& =. Classify the #9s as :uestion %arks" Stars" Cash Co!s and ;ogs >. ;evelop strategies for each #9 based on their position and movement trends !ithin the matri&

1igure '0 2n e3amp e o. the BCG Matri3

Strengths o. the BCG Mode 0

The #C$ %atri& allo!s for a visual presentation of the competitive position of all units in a business portfolio. The #C$ model allo!s companies to develop a customized strategy for each product or business unit instead of having a one*size*fits*all approach. Simple and easy to understand. It !orks !ell for companies !ith multiple divisions and products 1llo!s for quick and simple screening of business opportunities in order to determine investment priorities in the portfolio of products(business units. It is used to identify ho! corporate cash resources can be best allocated to ma&imize a company6s future gro!th and profitability. seful for the development of investment, marketing and operating decisions! o a. Investment in the business unit in order to build its market share o b. Sufficient investment to maintain the business unit4s market share at the current level o c. ;etermine !hich business unit(product !ill function as a cash co! to provide necessary cash flo! for the other business units(products o d. ;ivest a business unit

Weaknesses o. the BCG Mode 0

The #C$ model assumes that high market share and market growth are the only success factors. #ased on numerous real life e&amples" !e can conclude that high market share does not al!ays lead to profitability. #usinesses !ith lo! market share can be highly profitable as !ell. 3elative market strength is also determined by the follo!ing factors !hich the #C$ does not take into account2 a. Technological competence b. 1bility to maintain lo! manufacturing costs c. ?inancial strength of competition d. ;istribution capabilities e. /uman resources

The #C$ model focuses on ma"or competitors !hen analyzing the relative market share of a company. /o!ever" it neglects some small competitors !ith fast gro!ing market shares. It is a rather short-term model that doesn6t fully sho! ho! characteristics of business units change over the long term. #ssumes that high rates of profit are directly related to high market share #C$ is a primarily $ualitative model

The @ a&is represents the annual market gro!th !hich fails to see the full picture that goes beyond a one year span It does not take into consideration other important factors such as2 market barriers(restrictions" market density" profitability" politics

2pp ication to Competiti#e Inte igence0 2utomoti#e Industry

The #C$ model could be helpful in situations !here big economic s!ings produce significant changes in the original classification of companies" #9s and products. ?or e&ample" +.*+A years ago" the automobile manufacturers in the 9S dismissed the market for small economy cars in favour of big S9Bs. 1t that time" small cars !ere considered ;ogs !hile S9Bs !ere Stars. That happened because car manufacturers did not take into consideration the important factors of rising oil(gasoline prices and the changes in the environmental consciousness of the society. Chat if the management of ma or car manufacturers in the 9S had ran the #C$ model under different scenarios (high gas pricesD increased environmental a!areness) to decide !hich cars !ould be Stars and ;ogs under each of those scenariosE Ce believe that doing so !ould have better prepared the individual players in the industry for the rising competition !ith foreign car manufacturers. It is also important to constantly analyze business ne!s to look at !hat other companies are selling(divesting or acquiring. If they are selling a product(#9 !ith a small market share in a declining market then !e kno! they are most probably selling a ;og. The question is !hy are they selling itE ;o they need the cash to fund a ne! StarE If $% tomorro! announces that they are selling its hybrid vehicle division" does it mean that they are in possession of a ne! technology that !ill revolutionize the entire industryE 0ooking at the competition through the prism of the #C$ %atri& !ould help managers ask the right questions and then collect necessary intelligence in the process of ans!ering them. The #C$ %atri& could also be used by business analysts for the purpose of forecasting future trends. These analysts !ould analyze !hole industries(technologies using the #C$ %atri& in order to predict future changes. ?or e&ample" business analysts at $% could develop various scenarios to predict the future of the automobile. Cith the price of oil and other commodities rising" they need to look beyond traditional technologies and sources of energy and evaluate other alternatives. ?rom this point of vie!" the analysts could plot various traditional and breakthrough technologies on the #C$ %atri& in order to determine the current :uestion %arks" Starts" Cash Co!s and ;ogs and forecast ho! the %atri& !ill change in the ne&t A*+. years under various scenarios (high inflation" scarcity of resources" change in consumer tastes and demands). 1nother application of the #C$ %atri& in CI !ould be to see !here the currently emerging technologies !ill be five years from no! from the point of vie! of relative market share and market gro!th. %ost of the breakthrough technologies today !ould appear in the :uestion %ark quadrant of the #C$ %atri&. /o! !ill this picture change in 5*= years from no!E #y

monitoring and plotting these changes the business leaders at $% could get an insight into !hat !ill drive the future of the automotive industry in the future. In fact" in this conte&t the #C$ %atri& could become an important part of the business foresight !hich combines deep analysis of the past patterns and emerging trends !ith business insight. Those !ho are able to come up !ith the most accurate foresight and timely capitalization on it !ill be the future leaders in the industry.

G4!Mc5insey Matri3
Background
The $'(%c)insey %atri& !as developed ointly by %c)insey and $eneral 'lectric in the early +,F.s as a derivation of the #C$ %atri&. $'" by that time" had appro&imately +A. different business units and !as disappointed !ith the profits derived from its investments. This raised internal concerns about the approach the organization had to investment decision making. Chile e&ploring ne! models to implement" $' started to be interested in visual strategic frame!orks like the $ro!th*Share %atri& created by the #oston Consulting $roup (#C$) a fe! years before. /o!ever" the #C$ %atri& sho!ed to have some limitations. It !as considered not fle&ible enough to include all the broader issues that a company !as facing !hile operating in a fast changing global environment. The $'(%c)insey %atri& solves most of the issues of the #C$ model and proposes a more sophisticated and comprehensive approach to investment decision making.

How it Works
The $'(%c)insey %atri& is a nine*cell (= by =) matri& and it is primary used to perform business portfolio analysis on the strategic business units (S#9) of a corporation. 1 business portfolio is the collection of all the business units !ithin a corporation and a large corporation has normally many S#9s. 'ach S#9 is a distinctive and unique unit that falls under the same strategic hat. 1 !ell balanced portfolio is one of the top priorities of a large organization. The strategic business units are the basic blocks that compose a business portfolio. 1 unit can be a divisions or even a !hole company o!ned by the parent organization. The nine*bo& matri& provides decision makers !ith a systematic and effective frame!ork for a decentralized corporation to make better supported investment decisions and for developing strategies for future product development or ne! market segment entries. Instead of looking solely at each unit4s future prospects" a corporation can adopt a multi* dimensional approach based on t!o components that !ill indicate ho! !ell the unit !ill perform in the future. The t!o components used to evaluate businesses" !hich also serve as the a&es of the matri&" are the 4attractiveness4 of the relevant industry and the unit4s 4competitive strength4 !ithin the same industry. 'ach a&is is then divided into 0o!" %edium and /igh.

1igure (0 1actors that in. uence the a3es o. the G4!Mc5insey Matri3 Si3 steps are necessary to imp ement the G4!Mc5insey ana ysis0

+. ;etermine !hich factors are relevant for the corporation in the industry !here it operates 5. 1ssign a !eight to each factor =. Score each factor >. %ultiply the relative scores and !eights A. Sum all up and interpret the graph -. <erform a revie! ( sensitivity analysis

The plotted circles convey the information in the follo!ing !ay2

The size of the circle represents the market size of the S#9 The share o!ned by the S#9 is e&pressed as a pie slice !ith its relative percentage inside The e&pected future direction of the S#9 is represented !ith an arro!

The circles representing S#9s are then placed !ithin the matri&. 1s a result" the e&ecutives of the corporation !ill have a clear and po!erful analytic map for understanding and managing their entire multi*unit business. The units that fall above the diagonal indicate the investment and gro!th to be pursuedD the units along the diagonal

require a thorough analysis and individual selection for investmentD finally the units belo! the diagonal might indicate divestments are necessary or other!ise that businesses can be kept only for cash reasons. The placement of the units !ithin the matri& is a necessary first step before the analysis phase that requires human udgement can begin. ?or e&ample" a strong unit in a !eak industry is in a very different situation than a !eak unit in a highly attractive industry.

1igure )0 2n e3amp e o. the G4!Mc5insey Matri3

Strengths and Weaknesses

The $'(%c)insey %atri&" as an e&tension of the #C$ frame!ork" shares the aforementioned advantages of the #C$ model. Though the $'(%c)insey %atri& is more sophisticated than the #C$ matri& and can provide higher value information for the e&ecutive management" it has several fla!s and limitations2

Go proven relationship bet!een market attractiveness and business position. The relationships bet!een different units are not taken into account. The core*competencies that lead to value creation are not taken into consideration. The approach requires e&tensive data gathering. Scoring is personal and sub ective (risk of bias) There is no hard and fast rule on ho! to !eight elements. The $'(%c)insey %atri& offers a broad strategy and does not indicate ho! best to implement it.

%or the above limitations and issues, the &'/(c)insey (atri* can serve more as a $uick strategic visual framework rather than as a resource allocation tool.

2pp ication to Competiti#e Inte igence0 2pp e Inc.

1pple Inc. is a large technology company !ith several business units operating in different markets" including desktop computers" laptops" tablet computers (i<ads)" portable music players (i<ods)" smartphones (i<hones) and soft!are to support these products. 1 competitor !ishing to gain competitive intelligence on the activities of 1pple Inc. could do so by placing its business units into a $'(%c)insey %atri&. #y analyzing this matri&" it could determine !hich business units 1pple is likely to invest in heavily" develop selectively" or divest. The market attractiveness a*is would be relatively easy for the competitor to assess if it is currently operating in that market, since this consists of factors e*ternal to #pple. This includes easily obtainable information such as the current market size and market gro!th rate. /o!ever" some factors !ould have to be assessed sub ectively" such as barriers to entry and the state of technological development. In contrast, the business unit strength a*is would be more difficult to assess since it consists of factors internal to the company, such as customer loyalty, access to resources, and management strength. /o!ever" a great deal of information could be obtained from secondary sources" such as the Internet" the media" and shareholder reports.

1igure +0 2ssessment o. 2pp e "usiness units in the G4!Mc5insey Matri3

?rom an assessment of the above $'(%c)insey %atri&" it becomes clear that 1pple is at least moderately strong in each of its business units and it competes in a number of attractive and fast*gro!ing segments" such as tablet computers and Smartphone6s. 1 competitor performing this analysis !ould realize that 1pple is unlikely to divest any of these business units and is likely using its personal computer and music products as cash co!s in order to fund 3H; and gro!th in the faster*gro!ing markets. The barriers to entry in all of these markets are considerable" since entry !ould require a large amount of funding for either 3H; or the acquisition of the necessary technology and e&pertise. If the company performing this analysis decides to compete !ith 1pple" it should do so in the ne!est" fastest*gro!ing markets (tablets and smartphones)" as these represent the areas of greatest opportunity" despite 1pple6s early dominance.

BCG Matri3 #s. G4!Mc5insey Matri3

The #C$ and the $'(%c)insey analytical models have been created and used for the last >. years as portfolio analysis frame!orks" !ith the main ob ective of supporting managers in taking more informed investment and(or divestment decisions. #oth models adopt visual frame!orks that map internal strategic business units versus predetermined e&ternal factors. 1lthough these models strongly focus on strategic decisions for large corporations" they can also be effectively used in the more comprehensive competitive intelligence environment. +ompetitive intelligence is often wrongly identified with marketing practices or competitive analysis. Competitive intelligence does not deal only !ith products and competitors" and it is a broader sub ect. It can be defined as the action of defining" gathering" analyzing" and distributing intelligence about products" customers" competitors and any aspect of the environment needed to support e&ecutives and managers in making strategic decisions for an organization. $oing back to the models being analyzed" a fe! differences have to be considered. The &'/(c)insey (atri* is a far more sophisticated and powerful tool than the ,+& (atri* because it takes into consideration more factors to measure the market attractiveness -e*ternal factors. and the strength of each S, -internal factors.. In the $'(%c)insey %atri&" market attractiveness and competitive strength substitute the #C$4s market gro!th and market share" respectively. #nother difference is that &'/(c)insey is a /0/ matri* while the ,+&1s is a 202. This allo!s for more sophistication. #eing more comple&" the frame!ork takes a longer time to be implemented since the retrieval of all the necessary information could be lengthy. #ecause of that" in certain cases corporations can either loose the proper time to market or at the end of the collection process the data could be already old and thus not useful anymore.

1nother dra!back of the tool is that it could be misleading if not used properly. 1ssigning !eights and scoring factors can be a very difficult !ork" and has to be done by e&pert hands. Chen these are not done in the right !ay" results can lead e&ecutives in the !rong direction. Iften companies need to rely on e&ternal consultant organizations to get the necessary professionalism. The #C$ %atri&4s advantage is being a simple and effective tool. The market size of the business unit and the market share of the business under analysis are easily retrievable factors and the frame!ork provides e&ecutives !ith a quick and valuable overvie! of the S#94s position. The $'(%c)insey and the #C$ models can be effectively used in intelligence pro ects in different !ays. Instead of considering only internal S#9s compared to the market" an effective approach !ould be to use the frame!orks in analyzing the competitive landscape. This !ay" corporations can see !here internal S#9s stand compared to competitors4. Ideally" the t!o tools can be used together in sequence to take advantage of each other4s strengths. ?or e&ample" initially !hen considering a large number of competitor4s products" the #C$ %atri& can be adopted as a first step. The easy and quick approach that is the main advantage of this model" !ould let corporations perform a first skim" thus reducing the number of S#9s under analysis from many to ust a fe!. The remaining competitors can be thoroughly analyzed !ith the $'(%c)insey %atri&" !hich provides a better and more inclusive frame!ork. Chen running intelligence pro ects" a particular attention should be given to the type and quality of data that is used !ith these tools. The data has to al!ays be validated !ith a non*correlated secondary source of information and corporations should tap both into internal and e&ternal data to get a broader picture. #elo! is an e&ample of internal and e&ternal sources that could be used2 J Inside <eople (Internal to the organization) J Inside ;ocuments (Internal to the organization) J Iutside <eople ('&ternal to the organization) J Iutside ;ocuments ('&ternal to the organization)

Conc usion
#oth the #C$ and $'(%c)insey %atri& have proven over the years to be useful tools in order to assess the strength of a company6s portfolio of products relative to the attractiveness of the market they inhabit. They can be used both internally as a strategy tool and e&ternally as a competitive intelligence technique" !ith their strength lying in their ease of use and interpretation. ;espite these strengths" users must be a!are of their limitations and !ould be !ise to use them primarily as an overvie! or as a complement to other analytical techniques.

Boston Consu ting Group6s 2d#antage Matri3

To understand the #oston %atri&(by #39C' /'G;'3SIG(#ISTIG) +,F.)" you need to understand ho! market share and market gro!th interrelate. %arket share is the percentage of the total market that is being serviced by your company" measured either in revenue terms or unit volume terms. The higher your market share" the higher the proportion of the market you control. The #oston %atri& assumes that if you en oy a high market share you !ill be making money. (This assumption is based on the idea that you !ill have been in the market long enough to have learned ho! to be profitable" and !ill be en oying scale economies that give you an advantage). The question it asks is" KShould you be investing additional resources into a particular product line ust because it is making you moneyEK The ans!er is" Knot necessarily.K This is !here market gro!th comes into play. %arket gro!th is used as a measure of a market4s attractiveness. %arkets e&periencing high gro!th are ones !here the total market is e&panding" meaning that it6s relatively easy for businesses to gro! their profits" even if their market share remains stable. #y contrast" competition in lo! gro!th markets is often bitter" and !hile you might have high market share no!" it may be hard to retain that market share !ithout aggressive discounting. This makes lo! gro!th markets less attractive.http2((!!!.mindtools.com(pages(article(ne!T';L,F.htm The business portfolio is the collection of businesses and products that make up the company. The best business portfolio is one that fits the company4s strengths and helps e&ploit the most attractive opportunities. The company must2 (5) ;evelop gro!th strategies for adding ne! products and businesses to the portfolio" !hilst at the same time deciding !hen products and businesses should no longer be retained.http2((tutor5u.net(business(strategy(bcgLbo&.htm %ethods of <ortfolio <lanning The t!o best*kno!n portfolio planning methods are from the #oston Consulting $roup (the sub ect of this revision note) and by $eneral 'lectric(Shell. In each method" the first step is to identify the various Strategic #usiness 9nits (KS#94sK) in a company portfolio. 1n S#9 is a unit of the company that has a separate mission and ob ectives and that can be planned independently from the other businesses. 1n S#9 can be a company division" a product line or even individual brands * it all depends on ho! the company is organised. The #oston Consulting $roup #o& (K#C$ #o&K) 9sing the #C$ #o& (an e&ample is illustrated above) a company classifies all its S#94s according to t!o dimensions2

In the horizontal a&is2 relative market share * this serves as a measure of S#9 strength in the market In the vertical a&is2 market gro!th rate * this provides a measure of market attractiveness #y dividing the matri& into four areas" four types of S#9 can be distinguished2 Stars * Stars are high gro!th businesses or products competing in markets !here they are relatively strong compared !ith the competition. Iften they need heavy investment to sustain their gro!th. 'ventually their gro!th !ill slo! and" assuming they maintain their relative market share" !ill become cash co!s. Cash Co!s * Cash co!s are lo!*gro!th businesses or products !ith a relatively high market share. These are mature" successful businesses !ith relatively little need for investment. They need to be managed for continued profit * so that they continue to generate the strong cash flo!s that the company needs for its Stars. :uestion marks * :uestion marks are businesses or products !ith lo! market share but !hich operate in higher gro!th markets. This suggests that they have potential" but may require substantial investment in order to gro! market share at the e&pense of more po!erful competitors. %anagement have to think hard about Kquestion marksK * !hich ones should they invest inE Chich ones should they allo! to fail or shrinkE ;ogs * 9nsurprisingly" the term KdogsK refers to businesses or products that have lo! relative share in unattractive" lo!*gro!th markets. ;ogs may generate enough cash to break*even" but they are rarely" if ever" !orth investing in. 9sing the #C$ #o& to determine strategy Ince a company has classified its S#94s" it must decide !hat to do !ith them. In the diagram above" the company has one large cash co! (the size of the circle is proportional to the S#94s sales)" a large dog and t!o" smaller stars and question marks. Conventional strategic thinking suggests there are four possible strategies for each S#92 (+) #uild Share2 here the company can invest to increase market share (for e&ample turning a Kquestion markK into a star) (5) /old2 here the company invests ust enough to keep the S#9 in its present position (=) /arvest2 here the company reduces the amount of investment in order to ma&imise the short*term cash flo!s and profits from the S#9. This may have the effect of turning Stars into Cash Co!s. (>) ;ivest2 the company can divest the S#9 by phasing it out or selling it * in order to use the resources else!here (e.g. investing in the more promising Kquestion marksK).

1fter its !ell kno!n growth-share matrix the #oston Consulting $roup subsequently developed another" much less !idely reported" matri& !hich approached the Meconomies of scale4 decision rather more directly. This is their 72d#antage Matri36 N+O" also in the form of a quadrant (four bo&es) but !hich takes as its Ma&es4 the t!o contrasting Malternatives4" Meconomies of scale4 (described by them as Mpotential size of advantage4) against Mdifferentiation4 (sho!n as Mnumber of approaches to achieving advantage4). In essence" the former category covers the approach described in the more popular (#oston) gro!th*share matri&" !hile the latter represents the approach (described by %ichael <orter) of Mdifferentiating4 products so that they do not compete head*on !ith their competitors.

8o ume "usiness. In this case there are considerable economies of scale" but fe! opportunities for differentiation. This is the classic situation in !hich organizations strive for economies of scale by becoming the volume" and hence cost" leader. '&amples are volume cars and consumer electronics. Sta emated "usiness. /ere there is neither the opportunity for differentiation nor economies of scaleD e&amples are te&tiles and shipbuilding. The main means of competition" therefore" has been reducing the Mfactor costs4 (mainly those of labour) by moving to locations !here these costs are lo!er" even to different countries in the developing !orld. Specia i9ed "usiness. These businesses gain benefits from both economies of scale and differentiation (often characterized by e&perience effects in their o!n" differentiated" segment)D e&amples being branded foods and cosmetics. The main strategies are focus and segment leadership. 1ragmented "usiness. These organizations also gain benefit from differentiation" particularly in the services sector" but little from economies of scaleD e&amples being restaurants and ob*shop engineering. Competition may be minimized by innovatory differentiation.

1part from the fact that it has not suffered as badly at the hands of later popularizers" the particular advantage of this matri& is that it highlights the assumptions that are hidden in the #oston %atri&. It may also give a better feel for the optimum strategy and the likely profits" but it does not give any feel for the cashflo!" !hich !as the main feature of the original matri&.

PORTERs Five-Force Model (Refer pdf) The model of pure competition implies that risk-adjusted rates of return should be constant across firms and industries. However, numerous economic studies have affirmed that different industries can sustain different levels of profitability; part of this difference is explained by industry structure. Michael orter provided a framework that models an industry as bein! influenced by five forces. The strate!ic business mana!er seekin! to develop an ed!e over rival firms can use this model to better understand the industry context in which the firm operates.

Diagram of Porter's 5 Forces

S PP!"ER PO#ER
"upplier concentration #mportance of volume to supplier $ifferentiation of inputs #mpact of inputs on cost or differentiation "witchin! costs of firms in the industry resence of substitute inputs Threat of forward inte!ration %ost relative to total purchases in industry

T$RE%T OF &E# E&TR%&TS

'arriers to E(tr) &bsolute cost advanta!es roprietary learnin! curve &ccess to inputs 'overnment policy (conomies of scale %apital re)uirements *rand identity "witchin! costs &ccess to distribution (xpected retaliation roprietary products

T$RE%T OF S 'ST"T TES

-"witchin! costs -*uyer inclination to substitute - rice-performance trade-off of substitutes

' *ER PO#ER

*ar!ainin! levera!e *uyer volume *uyer information *rand identity rice sensitivity Threat of backward inte!ration roduct differentiation *uyer concentration vs. industry "ubstitutes available *uyers+ incentives

DE+REE OF R",%!R* -(xit barriers -#ndustry concentration -,ixed costs-.alue added -#ndustry !rowth -#ntermittent overcapacity - roduct differences -"witchin! costs -*rand identity -$iversity of rivals -%orporate stakes

"- Rivalr)

#n the traditional economic model, competition amon! rival firms drives profits to /ero. *ut competition is not perfect and firms are not unsophisticated passive price takers. 0ather, firms strive for a competitive advanta!e over their rivals. The intensity of rivalry amon! firms varies across industries, and strate!ic analysts are interested in these differences. (conomists measure rivalry by indicators of industry concentration. The %oncentration 0atio 1%02 is one such measure. The *ureau of %ensus periodically reports the %0 for major "tandard #ndustrial %lassifications 1"#%+s2. The %0 indicates the percent of market share held by the four lar!est firms 1%0+s for the lar!est 3, 45, and 56 firms in an industry also are available2. & hi!h concentration ratio indicates that a hi!h concentration of market share is held by the lar!est firms - the industry is concentrated. 7ith only a few firms holdin! a lar!e market share, the competitive landscape is less competitive 1closer to a monopoly2. & low concentration ratio indicates that the industry is characteri/ed by many rivals, none of which has a si!nificant market share. These fragmented markets are said to be competitive. The concentration ratio is not the only available measure; the trend is to define industries in terms that convey more information than distribution of market share. #f rivalry amon! firms in an industry is low, the industry is considered to be disciplined. This discipline may result from the industry+s history of competition, the role of a leadin! firm, or informal compliance with a !enerally understood code of conduct. (xplicit collusion !enerally is ille!al and not an option; in lowrivalry industries competitive moves must be constrained informally. However, a maverick firm seekin! a competitive advanta!e can displace the otherwise disciplined market. 7hen a rival acts in a way that elicits a counter-response by other firms, rivalry intensifies. The intensity of rivalry commonly is referred to as bein! cutthroat, intense, moderate, or weak, based on the firms+ a!!ressiveness in attemptin! to !ain an advanta!e. #n pursuin! an advanta!e over its rivals, a firm can choose from several competitive moves8

%han!in! prices - raisin! or lowerin! prices to !ain a temporary advanta!e. #mprovin! product differentiation - improvin! features, implementin! innovations in the manufacturin! process and in the product itself. %reatively usin! channels of distribution - usin! vertical inte!ration or usin! a distribution channel that is novel to the industry. ,or example, with hi!h-end jewelry stores reluctant to carry its watches, Timex moved into dru!stores and other non-traditional outlets and cornered the low to midprice watch market.

(xploitin! relationships with suppliers - for example, from the 9:56+s to the 9:;6+s "ears, 0oebuck and %o. dominated the retail household appliance market. "ears set hi!h )uality standards and re)uired suppliers to meet its demands for product specifications and price.

The intensity of rivalry is influenced by the followin! industry characteristics8 9. % larger (.m/er of firms increases rivalry because more firms must compete for the same customers and resources. The rivalry intensifies if the firms have similar market share, leadin! to a stru!!le for market leadership. 4. Slo0 mar1et gro0t2 causes firms to fi!ht for market share. #n a !rowin! market, firms are able to improve revenues simply because of the expandin! market. <. $ig2 fi3ed costs result in an economy of scale effect that increases rivalry. 7hen total costs are mostly fixed costs, the firm must produce near capacity to attain the lowest unit costs. "ince the firm must sell this lar!e )uantity of product, hi!h levels of production lead to a fi!ht for market share and results in increased rivalry. =. $ig2 storage costs or 2ig2l) peris2a/le prod.cts cause a producer to sell !oods as soon as possible. #f other producers are attemptin! to unload at the same time, competition for customers intensifies. 5. !o0 s0itc2i(g costs increases rivalry. 7hen a customer can freely switch from one product to another there is a !reater stru!!le to capture customers. >. !o0 levels of prod.ct differe(tiatio( is associated with hi!her levels of rivalry. *rand identification, on the other hand, tends to constrain rivalry. ;. Strategic sta1es are 2ig2 when a firm is losin! market position or has potential for !reat !ains. This intensifies rivalry. 3. $ig2 e3it /arriers place a hi!h cost on abandonin! the product. The firm must compete. Hi!h exit barriers cause a firm to remain in an industry, even when the venture is not profitable. & common exit barrier is asset specificity. 7hen the plant and e)uipment re)uired for manufacturin! a product is hi!hly speciali/ed, these assets cannot easily be sold to other buyers in another industry. ?itton #ndustries+ ac)uisition of #n!alls "hipbuildin! facilities illustrates this concept. ?itton was successful in the 9:>6+s with its contracts to build @avy ships. *ut when the .ietnam war ended, defense spendin! declined and ?itton saw a sudden decline in its earnin!s. &s the firm restructured, divestin! from the shipbuildin! plant was not feasible since such a lar!e and hi!hly speciali/ed investment

could not be sold easily, and ?itton was forced to stay in a declinin! shipbuildin! market. :. % diversit) of rivals with different cultures, histories, and philosophies make an industry unstable. There is !reater possibility for mavericks and for misjud!in! rival+s moves. 0ivalry is volatile and can be intense. The hospital industry, for example, is populated by hospitals that historically are community or charitable institutions, by hospitals that are associated with reli!ious or!ani/ations or universities, and by hospitals that are forprofit enterprises. This mix of philosophies about mission has lead occasionally to fierce local stru!!les by hospitals over who will !et expensive dia!nostic and therapeutic services. &t other times, local hospitals are hi!hly cooperative with one another on issues such as community disaster plannin!. 96. "(d.str) S2a1eo.t- & !rowin! market and the potential for hi!h profits induces new firms to enter a market and incumbent firms to increase production. & point is reached where the industry becomes crowded with competitors, and demand cannot support the new entrants and the resultin! increased supply. The industry may become crowded if its !rowth rate slows and the market becomes saturated, creatin! a situation of excess capacity with too many !oods chasin! too few buyers. & shakeout ensues, with intense competition, price wars, and company failures. *%' founder *ruce Henderson !enerali/ed this observation as the 0ule of Three and ,our8 a stable market will not have more than three si!nificant competitors, and the lar!est competitor will have no more than four times the market share of the smallest. #f this rule is true, it implies that8
o o o o o

#f there is a lar!er number of competitors, a shakeout is inevitable "urvivin! rivals will have to !row faster than the market (ventual losers will have a ne!ative cash flow if they attempt to !row &ll except the two lar!est rivals will be losers The definition of what constitutes the AmarketA is strate!ically important.

7hatever the merits of this rule for stable markets, it is clear that market stability and chan!es in supply and demand affect rivalry. %yclical demand tends to create cutthroat competition. This is true in the disposable diaper industry in which demand fluctuates with birth rates, and in the !reetin! card industry in which there are more predictable business cycles.

""- T2reat Of S./stit.tes #n orter+s model, substitute products refer to products in other industries. To the economist, a threat of substitutes exists when a product+s demand is affected by the price chan!e of a substitute product. & product+s price elasticity is affected by substitute products - as more substitutes become available, the demand becomes more elastic since customers have more alternatives. & close substitute product constrains the ability of firms in an industry to raise prices. The competition en!endered by a Threat of "ubstitute comes from products outside the industry. The price of aluminum bevera!e cans is constrained by the price of !lass bottles, steel cans, and plastic containers. These containers are substitutes, yet they are not rivals in the aluminum can industry. To the manufacturer of automobile tires, tire retreads are a substitute. Today, new tires are not so expensive that car owners !ive much consideration to retreadin! old tires. *ut in the truckin! industry new tires are expensive and tires must be replaced often. #n the truck tire market, retreadin! remains a viable substitute industry. #n the disposable diaper industry, cloth diapers are a substitute and their prices constrain the price of disposables. 7hile the threat of substitutes typically impacts an industry throu!h price competition, there can be other concerns in assessin! the threat of substitutes. %onsider the substitutability of different types of T. transmission8 local station transmission to home T. antennas via the airways versus transmission via cable, satellite, and telephone lines. The new technolo!ies available and the chan!in! structure of the entertainment media are contributin! to competition amon! these substitute means of connectin! the home to entertainment. (xcept in remote areas it is unlikely that cable T. could compete with free T. from an aerial without the !reater diversity of entertainment that it affords the customer.

"""- '.)er Po0er The power of buyers is the impact that customers have on a producin! industry. #n !eneral, when buyer power is stron!, the relationship to the producin! industry is near to what an economist terms a mo(opso() - a market in which there are many suppliers and one buyer. Bnder such market conditions, the buyer sets the price. #n reality few pure monopsonies exist, but fre)uently there is some asymmetry between a producin! industry and buyers. The followin! tables outline some factors that determine buyer power. Buyers are :ower.u i.0 43amp e

#uyers are concentrated * there are a fe! buyers !ith ;I; purchases from defense contractors significant market share #uyers purchase a significant proportion of output * distribution of purchases or if the product is standardized Circuit City and Sears4 large retail market provides po!er over appliance manufacturers

#uyers possess a credible back!ard integration threat 0arge auto manufacturers4 purchases of tires * can threaten to buy producing firm or rival

Buyers are Weak i.0

43amp e

<roducers threaten for!ard integration * producer can %ovie*producing companies have integrated for!ard take over o!n distribution(retailing to acquire theaters Significant buyer s!itching costs * products not standardized and buyer cannot easily s!itch to another product #uyers are fragmented (many" different) * no buyer has any particular influence on product or price <roducers supply critical portions of buyers4 input * distribution of purchases I#%4s =-. system strategy in the +,-.4s

%ost consumer products Intel4s relationship !ith <C manufacturers

",- S.pplier Po0er & producin! industry re)uires raw materials - labor, components, and other supplies. This re)uirement leads to buyer-supplier relationships between the industry and the firms that provide it the raw materials used to create products. "uppliers, if powerful, can exert an influence on the producin! industry, such as sellin! raw materials at a hi!h price to capture some of the industry+s profits. The followin! tables outline some factors that determine supplier power.

Supp iers are :ower.u i.0

Credible for!ard integration threat by suppliers Suppliers concentrated Significant cost to s!itch suppliers Customers <o!erful

43amp e
#a&ter International" manufacturer of hospital supplies" acquired 1merican /ospital Supply" a distributor ;rug industry4s relationship to hospitals %icrosoft4s relationship !ith <C manufacturers #oycott of grocery stores selling non*union picked grapes

Supp iers are Weak i.0

43amp e

%any competitive suppliers * product is standardized <urchase commodity products Credible back!ard integration threat by purchasers Concentrated purchasers Customers Ceak

Tire industry relationship to automobile manufacturers $rocery store brand label products Timber producers relationship to paper companies $arment industry relationship to ma or department stores Travel agents4 relationship to airlines

,- T2reat of &e0 E(tra(ts a(d E(tr) 'arriers #t is not only incumbent rivals that pose a threat to firms in an industry; the possibility that new firms may enter the industry also affects competition. #n theory, any firm should be able to enter and exit a market, and if free entry and exit exists, then profits always should be nominal. #n reality, however, industries possess characteristics that protect the hi!h profit levels of firms in the market and inhibit additional rivals from enterin! the market. These are barriers to entry. *arriers to entry are more than the normal e)uilibrium adjustments that markets typically make. ,or example, when industry profits increase, we would expect additional firms to enter the market to take advanta!e of the hi!h profit levels, over time drivin! down profits for all firms in the industry. 7hen profits decrease, we would expect some firms to exit the market thus restorin! a market e)uilibrium. ,allin! prices, or the expectation that future prices will fall, deters rivals from enterin! a market. ,irms also may be reluctant to enter markets that are extremely uncertain, especially if enterin! involves expensive start-up costs. These are normal accommodations to market conditions. *ut if firms individually 1collective action would be ille!al collusion2 keep prices artificially low as a strate!y to prevent potential entrants from enterin! the market, such e(tr)deterri(g prici(g establishes a barrier. *arriers to entry are uni)ue industry characteristics that define the industry. *arriers reduce the rate of entry of new firms, thus maintainin! a level of profits for those already in the industry. ,rom a strate!ic perspective, barriers can be created or exploited to enhance a firm+s competitive advanta!e. *arriers to entry arise from several sources8 9. +over(me(t creates /arriers- &lthou!h the principal role of the !overnment in a market is to preserve competition throu!h anti-trust actions, !overnment also restricts competition throu!h the !rantin! of monopolies and throu!h re!ulation. #ndustries such as utilities are considered natural monopolies because it has been more efficient to have

one electric company provide power to a locality than to permit many electric companies to compete in a local market. To restrain utilities from exploitin! this advanta!e, !overnment permits a monopoly, but re!ulates the industry. #llustrative of this kind of barrier to entry is the local cable company. The franchise to a cable provider may be !ranted by competitive biddin!, but once the franchise is awarded by a community a monopoly is created. ?ocal !overnments were not effective in monitorin! price !ou!in! by cable operators, so the federal !overnment has enacted le!islation to review and restrict prices. The re!ulatory authority of the !overnment in restrictin! competition is historically evident in the bankin! industry. Bntil the 9:;6+s, the markets that banks could enter were limited by state !overnments. &s a result, most banks were local commercial and retail bankin! facilities. *anks competed throu!h strate!ies that emphasi/ed simple marketin! devices such as awardin! toasters to new customers for openin! a checkin! account. 7hen banks were dere!ulated, banks were permitted to cross state boundaries and expand their markets. $ere!ulation of banks intensified rivalry and created uncertainty for banks as they attempted to maintain market share. #n the late 9:;6+s, the strate!y of banks shifted from simple marketin! tactics to mer!ers and !eo!raphic expansion as rivals attempted to expand markets. 4. Pate(ts a(d proprietar) 1(o0ledge serve to restrict e(tr) i(to a( i(d.str)- #deas and knowled!e that provide competitive advanta!es are treated as private property when patented, preventin! others from usin! the knowled!e and thus creatin! a barrier to entry. (dwin ?and introduced the olaroid camera in 9:=; and held a monopoly in the instant photo!raphy industry. #n 9:;5, Codak attempted to enter the instant camera market and sold a comparable camera. olaroid sued for patent infrin!ement and won, keepin! Codak out of the instant camera industry. <. %sset specificit) i(2i/its e(tr) i(to a( i(d.str)- &sset specificity is the extent to which the firm+s assets can be utili/ed to produce a different product. 7hen an industry re)uires hi!hly speciali/ed technolo!y or plants and e)uipment, potential entrants are reluctant to commit to ac)uirin! speciali/ed assets that cannot be sold or converted into other uses if the venture fails. &sset specificity provides a barrier to entry for two reasons8 ,irst, when firms already hold speciali/ed assets they fiercely resist efforts by others from takin! their market share. @ew entrants can anticipate a!!ressive rivalry. ,or example, Codak had much capital invested in its photo!raphic e)uipment business and a!!ressively resisted efforts by ,uji to intrude in its market. These assets are both lar!e and industry specific. The second reason is that potential entrants are reluctant to make investments in hi!hly speciali/ed assets.

=. Orga(i4atio(al ("(ter(al) Eco(omies of Scale- The most cost efficient level of production is termed Mi(im.m Efficie(t Scale 1M("2. This is the point at which unit costs for production are at minimum - i.e., the most cost efficient level of production. #f M(" for firms in an industry is known, then we can determine the amount of market share necessary for low cost entry or cost parity with rivals. ,or example, in lon! distance communications rou!hly 96D of the market is necessary for M(". #f sales for a lon! distance operator fail to reach 96D of the market, the firm is not competitive. The existence of such an economy of scale creates a barrier to entry. The !reater the difference between industry M(" and entry unit costs, the !reater the barrier to entry. "o industries with hi!h M(" deter entry of small, start-up businesses. To operate at less than M(" there must be a consideration that permits the firm to sell at a premium price - such as product differentiation or local monopoly.

*arriers to exit work similarly to barriers to entry. (xit barriers limit the ability of a firm to leave the market and can exacerbate rivalry - unable to leave the industry, a firm must compete. "ome of an industry+s entry and exit barriers can be summari/ed as follows8

4asy to 4nter i. there is0

,i..icu t to 4nter i. there is0

Common technology 0ittle brand franchise 1ccess to distribution channels 0o! scale threshold

<atented or proprietary kno!*ho! ;ifficulty in brand s!itching 3estricted distribution channels /igh scale threshold

4asy to 43it i. there are0

,i..icu t to 43it i. there are0

Salable assets 0o! e&it costs Independent businesses

Specialized assets /igh e&it costs Interrelated businesses

D*&%M"5 &%T RE OF "&D STR* R",%!R*

Eur descriptive and analytic models of industry tend to examine the industry at a !iven state. The nature and fascination of business is that it is not static. 7hile we are prone to !enerali/e, for example, list 'M, ,ord, and %hrysler as the A*i! <A and assume their dominance, we also have seen the automobile industry chan!e. %urrently, the entertainment and communications industries are in flux. hone companies, computer firms, and entertainment are mer!in! and formin! strate!ic alliances that re-map the information terrain. "chumpeter and, more recently, orter have attempted to move the understandin! of industry competition from a static economic or industry or!ani/ation model to an emphasis on the interdependence of forces as dynamic, or punctuated equilibrium, as orter terms it. #n "chumpeter+s and orter+s view the dynamism of markets is driven by innovation. 7e can envision these forces at work as we examine the followin! chan!es8 Top 67 ';'< + 9S Steel 5 S!ift = 1rmour A Standard Iil *GP - #ethlehem Steel F ?ord Q ;u<ont , 1merican Sugar +. $eneral 'lectric S "(d.strial Firms /) Sales 6869 - 68:: ';>>
'&&on $eneral %otors %obil Te&aco ?ord I#% Socal (Iil) ;u<ont $ulf Iil ?ord Standard Iil *GP ('&&on) $eneral 'lectric

';+=
9S Steel Standard Iil *GP

';?)
?ord

';??
$eneral %otors

$eneral %otors $eneral %otors

'&&on I#% $eneral 'lectric %obil Chrysler Te&aco ;u<ont

> 1merican Smelting 9S Steel

S!ift 1rmour Curtiss*Cright Chrysler ?ord

#ethlehem Steel Chrysler %obil Te&aco 9S Steel I#% $ulf Iil

Standard Iil of Indiana <hilip %orris

67 !argest S Firms /) %ssets; 6878 a(d 68:9 ';@; + 9S ST''0 5 ST1G;13; II0" GP (Go!" 'RRIG S=) = 1%'3IC1G TI#1CCI (Go!" 1merican #rands SA5) ';?<
$% (Got listed in +,.,) S'13S (+,., T >A) 'RRIG (Standard Iil trust broken up in +,++)

> 1%'3IC1G %'3C1GTI0' %13IG' (3enamed 9S 0inesD acquired by I#% (3anked -Q" +,>Q)

)idde" Inc." +,-,D sold to %c0ean Industries" +,FQD bankruptcy" +,Q-

A farm equipment

IGT'3G1TIIG10 /13B'ST'3 (3enamed Gavistar S+Q5)D divested

?I3; (0isted in +,+,) %I#I0 II0 $'G'310 '0'CT3IC (+,.,T +-) C/'B3IG (Got listed in +,.,) T'R1CI (+,.,T ,+) ;9 <IGT (+,.,T 5,)

- 1G1CIG;1 CI<<'3 (acquired by 13CI in +,FF) F 9S 0'1T/'3 (0iquidated in +,=A) Q +,Q= sold to Con1gra)
13%I93 (%erged in +,-Q !ith $eneral /ostD in +,-, by $reyhoundD 1%'3IC1G S9$13 3'?IGIG$ (3enamed 1%ST13. In +,-F T=5.) <900%1G" IGC (1cquired by Cheelabrator ?rye" +,Q.D spun*off as

, 0everaged buyout and sold in pieces)

+. <ullman*<eabody" +,Q+D +,Q> sold to Trinity Industries)

+E&ER"5 STR%TE+"ES TO 5O &TER T$E F",E FOR5ES "trate!y can be formulated on three levels8

corporate level business unit level functional or departmental level.

The business unit level is the primary context of industry rivalry. Michael orter identified three !eneric strate!ies 1cost leadership, differentiation, and focus2 that can be implemented at the business unit level to create a competitive advanta!e. The proper !eneric strate!y will position the firm to levera!e its stren!ths and defend a!ainst the adverse effects of the five forces.