STRATEGIC MANAGEMENT

What is Strategy?

Strategy is a firm’s answer to 2 fundamental questions –

1. Where should we compete and
2. How should we compete

The purpose of strategy is to create ‘competitive advantage’ that generates superior, sustainable financial returns.

Requirements for doing this successfully–

1. The first is an understanding of the business landscape: the forces that shape competition, the dynamics
among players and the drivers of industry evolution. This informs where the firm chooses to engage with its
competition.
2. The second is the choice of a position on this landscape. The firm’s positioning shapes the choice of a business
model and the underlying set of activities that sustains it.

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 What is Strategy?

Strategy as you can see consists of choices.

It is the integrated set of choices that positions the business in its industry so as to generate superior
financial returns over the long run.

A strategy can fail because –

u The firm has chosen a particularly difficult place on the business landscape and is not able to
adapt to, or change, its environment.
u The firm’s choices are not truly integrated and so its intended business model and positioning do
not fully align.

A SUCCESSFUL STRATEGY DEMONSTRATES CONSISTENCY

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What is competitive advantage?

A firm’s ability to create a large gap between the amount its customers are willing to
pay and the costs it incurs. To create this advantage, a firm must perform activities
more effectively and distinctively than its industry rivals.

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Concept of strategy

A business may have what it calls as –

u Marketing strategy
u Innovation strategy
u Technology strategy
u Implementing a balanced scorecard
u Strategic outsourcing
u Process re-engineering program
u Operational effectiveness & boosting productivity
u Cutting costs

Each of the above is a strategy in a general sense that they comprise a broad plan supported by underlying
actions.

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Concept of strategy

Economies of scale: The decline in the cost of production per unit as the
volume grows.
Economies of scope: The decline in the cost of production due to sharing of
resources across products and services.
SWOT framework: A theory that matches a company’s strengths against its
weaknesses and its opportunities against its threats.

IT IS CRITICAL TO UNDERSTAND STRATEGY IN ITS ORIGINAL SENSE AS

‘COMPETITIVE STRATEGY’

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Structural Forces

Ralph Waldo Emerson declared that “if a man make a better mousetrap than
his neighbour, the world will make a beaten path to his door”

Warren Buffet famously stated – “When an industry’s underlying economics

are crumbling , talented management may slow the rate of decline.
Eventually, though, eroding fundamentals will overwhelm managerial
brilliance.”

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Threat of new entrants

New entrants in an industry can quickly erode profits by increasing competition,

introducing alternative products, and capturing market share.
New players are best able to make inroads when the incumbent players do not
benefit from -

u economies of scale
u a strong brand identity
u proprietary knowledge

In such environments, we say that there are low barriers to entry. Ex- Apps

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Bargaining power of suppliers

If suppliers offer -
u a unique product
u have made it difficult to switch to other suppliers
u are more concentrated than the industry they serve

then they can raise the prices at which they supply the industry. A powerful supplier
group can drive up costs that industry players are unable to pass on to their
customers. Ex- Soft drinks

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Bargaining power of buyers

Powerful customers can also affect industry profitability. An industry’s buyers are pow
erful if -
u they are concentrated
u are free to direct their purchases elsewhere

The U.S. retail industry has seen buyer power increasingly consolidated to Walmart,
Target, and several drugstore chains. The many industries that sell through those
channels have seen their profit margins squeezed because they have no other
customers of comparable size and those retailers have the wherewithal to switch
vendors.

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Threat of substitute products

When multiple products from different industries all serve the same purpose for custo
mers, they are called substitutes. They place a ceiling on an industry’s ability to
increase prices and grow. Taxi fares, for example, are kept in check in cities with
robust public transportation.

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Intensity of rivalry

Players in almost every industry compete with one another, but if that competition
manifests itself in aggressive actions, everyone’s profits can suffer. Intense rivalry is
common when -
u the competitors are of similar size
u sell undifferentiated products
u when industry growth is slow
u high fixed costs
u overcapacity in the industry
u investments in assets that cannot be repurposed

Competition is most harmful when it results in aggressive, sustained price wars, which
decrease the available profit pool for everyone.

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 Opportunity of complements

A firm has a complement when its goods are made more valuable by those of another firm.

Businesses can create significant value when they complement one another, even while
competing to claim that value.

The key factor in the power of complements is how easily buyers and the complements
themselves are able to switch to alternatives. Buyers who cannot easily switch to another
platform, as was the case with most PC manufacturers as well as end users, give the
complements significant power. If they cannot take their business elsewhere, the
complementors are free to set a high price for their goods and services. Between
complementors, the ability of one to switch weakens the claims of the other.

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 Structural forces

When it comes to creating strategy, understanding structural forces provides nothing more
than the starting point. Firms must choose how they respond to these forces.

Performance differences among industry participants are the result of where and how they
have each chosen to engage with their environment.

The questions the strategist faces-

u Which market segments are the most attractive?

u How can other companies be discouraged from entering the market?
u How can leverage over buyers or suppliers be increased?
u How will the structural forces evolve?

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 Integrated set of choices (achieving
internal consistency)

The firm decides how to compete with its business model, which is the underlying logic of
the firm, how it operates, and how it creates and captures value.

The business model itself consists of many other choices. The stronger the fit of those choices
, the more robust the business model is and the more difficult it is to replicate.

Also implicit in these choices is the need to make tradeoffs, recognizing that the most
important choices, if they are to be executed effectively, usually involve a decision not to
do something else.

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 Business models

Maruti vs BMW
Marks & Spencers vs John Players

There are two fundamental considerations in any business model: the value proposition and
the target market. The value proposition, in its most generic sense, can be based on either
differentiation or low cost.

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Fit

For a business model to work, the firm’s chosen activities need to demonstrate fit.

First, and most obviously, they need to fit the firm’s value proposition
(differentiated or low cost?) and its target market (broad or narrow?).

This is simple consistency.

Second, the choices should be mutually reinforcing.

Finally, the choices should fit in a way that enables optimization of effort,
thereby enabling cost efficiencies among its activities. Each decision makes
the others easier to execute and therefore strengthens the business model.

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Trade-offs

Of course, activities that fit together imply that the converse is true: There are
other activities that would not fit.
A well conceived business model invariably demands trade-offs.

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Final word

Few businesses can succeed in being all things to all people. Those that can, and
can make money at it, find success is fleeting. Inevitably, segment
specific needs will emerge and more focused competitors will find ways to
meet those needs more capably.

A firm’s business model succeeds when it can profitably meet market demand with
choices that are consistent, mutually reinforcing, and collectively optimal. It works
best when tradeoffs are recognized and accepted, ensuring that parts of the
business are not working at cross purposes. This is the essence of making an integrat
ed set of choices, and this is the key to allowing the firm to establish and defend its
place on the business landscape.

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Positioning on the Business Landscape:
Achieving External Consistency

Firms aim to maximize the wedge between their supplier opportunity cost and
their customers’ willingness to pay.

Firms that command and sustain a larger wedge than their peers are said to
have a competitive advantage.

The business landscape metaphor suggests that there are areas (that is, market
segments) of higher potential profit where the wedge has been widened. Occupying
those spots requires the right strategy, one that exhibits consistency on all fronts. The
business model must be internally consistent and must fit with the realities of the
environment—
that is, it must also be externally consistent. Finding and occupying these points on the
landscape is strategic positioning.

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Performance over the Long Run:
Dynamic Consistency

For a firm that has created a competitive advantage, maintaining dynamic

consistency is a matter of dealing with threats. As discussed earlier, a firm creates and
captures value through its positioning and business model. Neither the position nor the
model is permanent; however, with enough time and pressure, outside forces can
prove disruptive.

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Performance over the Long Run:
Dynamic Consistency

Imitation
Any profitable success by one firm will lead other firms to try to replicate it; profits draw
a crowd.

It is, of course, possible to create barriers to imitation. If a firm achieves economies of

scale or scope (that is, if it is large in a specific market or in interrelated markets), would-
be imitators may be deterred.
Long:term contracts and relationships, institutional knowledge, network externalities, a
credible threat of retaliation, and strategic complexity can also convince potential
competitors that profitable imitation will be difficult.

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Performance over the Long Run:
Dynamic Consistency

Substitution
Threats from substitute offerings are generally difficult to predict and manage. They
occur when demand shifts as a result of changes in technology or customer needs.

Threats from substitution can be quite dramatic, as when a wholly new paradigm
reshapes the business landscape, uncovering new areas of value and destroying others.

Businesses that face the threat of substitution can fight back by further differentiating or
incorporating thebenefits that are shifting demand. If the shift is unavoidable, a firm may
even choose to encourage substitution, but on its own terms, for example, by using an
established brand and superior cost position to accelerate substitution while protecting
market share.

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Performance over the Long Run:
Dynamic Consistency

Holdup

Holdup occurs when the bargaining power of a firm’s buyers, suppliers, or complements
increases, allowing them to capture more value. Growing dependence on, or
interdependence among, these parties can lead to greater overlap and conflict in
claiming value.

Firms can mitigate the threat of holdup by broadening their base of suppliers or
customers, establishing contractual protections, or pursuing vertical integration (that is,
taking over more of the activities in their supply chains).

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Performance over the Long Run:
Dynamic Consistency

Slack

The final threat is internal: It comes from poor management and suboptimal
performance. Slack is waste and inefficiency that ultimately weaken the firm. Lack of
discipline and accountability can lead to slack, resulting in unwise investments or a
bloated cost structure.

Careful performance monitoring, alignment of managerial incentives, and commitments

to return cash to shareholders can reduce this type of waste.

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Fundamental dynamics of strategy

The Why of strategy: Value

The How of strategy: Imitation
The What of strategy: Perimeter

A truly strategic decision occurs only at the nexus of three organizational considerations
— where it adds value, how it handles and employs imitation and how it defines its
perimeter.

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 Fundamental dynamics of strategy

Source: MIT Sloan Management Review

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 Fundamental dynamics of strategy

Source: MIT Sloan Management Review

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Your strategy needs a strategy

Adaptive Shaping
Predictability

Classical Visionary

Malleability Source HBSP

Source: HBR

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Types of strategy: Which fits your
business?

u Low-cost leadership
u Product/service differentiation
u Customer centricity/relationship
u Network effect

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 Low-cost leadership

Making this strategy work

u Continuous improvement in operating
efficiency
u Exploitation of the experience curve
u An unbeatable supply chain
u Product redesign

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Differentiation

u Differentiating a commodity product

u Effective differentiation (customers value the difference)

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Customer centricity/relationship

u Simplifying customers’ lives or work

u Ongoing benefits
u Personalized service
u Customized solutions
u Personal contact
u Continuous learning

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Network effect strategy

A phenomenon in which the value of a product increases as more products

are sold and the network of users increases.

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Facebook was not originally created to be a company. It was built to accom
plish a social mission—to make the world more open and connected.–
Mark Zuckerberg

u What is the purpose of your life?

u What do you want to achieve before you die?
u What do you value most?

aspirations The fundamental purpose and ultimate goals of an individual or

organization.
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Because organizations have aspirations, too, and organizational aspirations
can provide an important connection between an individual’s motivations and
behavior and the organization’s strategy. Aspirations can also guide the development
of a business strategy.

For people and for organizations, one way to express an aspiration is to articulate a
mission, a purpose.

The mission of Patagonia, a maker of highquality outdoor apparel, is to “build the best
product, cause no unnecessary harm, and use business to inspire and implement soluti
ons to the environmental crisis.”

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 Mission, Vision & Values

Organizational aspirations comprise mission, vision, and values. These have different purposes. A
mission is the fundamental reason for the organization’s existence.

an organization’s mission “spells out the underlying motivation for being in business in the first pla
ce—the contribution to society that the firm aspires to make.”

A vision describes what the future will look like when the organization has achieved its mission, or
part of it.

Values reflect an organization’s culture. They specify what is important to the organization about
how it conducts itself as it pursues its mission and works to achieve its vision,15 and they describe
the behaviors that are rewarded.
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 Aspirations & strategy

Aspirations and strategy are complementary. Aspirations are concerned with pe

ople: with their motivation, direction, and purpose. Strategy is concerned with co
mpetition.

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 2 dimensions of organisational
aspirations

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Benefits of organisational aspirations

u They establish boundary conditions for strategy decisions.

u They motivate.
u They provide a stable purpose to guide the organization through changing
times.
u They help with coordination.
u They communicate to stakeholders.

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A useful mission statement should:

u Transcend product and market life cycles.

u Be motivating.
u Reflect a choice.
u Be short, clear, and easy to remember.

Mission of Medtronic: To contribute to human welfare through the application

of biomedical engineering to restore health, extend life and alleviate pain

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A useful vision statement should:

u Be consistent with a well-researched strategy.

u Reflect a choice about how to compete.
u Articulate an inspiring future.
u Be specific and measurable.
u Be short, clear, and concise.

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Useful values statements should:

u Reflect choices that are consistent with the strategy.

u Be aligned with employees’ and (ideally) customers’ values.

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Aspirations and Brands

One of the purposes of an aspiration statement is to communicate to stakeholders.

Aspirations are designed to be inspiring—

to motivate employees and to make customers more inclined to deal with the
organization. In industries where brands are important, the brand also communicates
what the company stands for. Because aspirations and the brand both reflect on the
company, they need to send the same message.

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“We create happiness by providing the finest in entertainment to people of all ages,
everywhere.”

“to help our clients make distinctive, lasting, and substantial improvements in their perfor
mance and to build a great firm that attracts, develops, excites and “to help our clients
make distinctive, lasting, and substantial improvements in their performance and to build
a great firm that attracts, develops, excites and retains exceptional people.”

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 The strategy process

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The strategy process

1 What business are we in and why? (mission, vision, and values)

2 Where are we going? (strategic goals)
3 What are the key issues that our strategy must address? (strategic analysis)
4 How can we best compete? (strategy formulation)

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Perils of the Misuse of Aspirations

u Confusing a mission statement with a sense of mission.

u Confusing aspirations with strategy.
u Assuming that visions are self-fulfilling.
u Developing cookie-cutter aspirations.
u Using aspirations as public relations (PR).
u Creating conflict between aspirations and financial objectives.

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Industry analysis

Every industry exists in an industry environment, which comprises suppliers, customers,

and other firms, including those that may enter the industry and those that may offer
either substitute or complementary products.

Industry analysis is a tool for understanding how profits are distributed among market
participants. A firm’s profitability depends partly on the intensity of competition from
rivals in the industry and partly on the influence of players in the industry environment
. All those market participants engage in a continual struggle for a share of industry p
rofits.

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Industry analysis

u To identify opportunities to increase profits

u To discern threats to existing profits and develop ways to counter them
u To decide whether to enter a market
u To decide whether to exit a market
u To position their firm to succeed in a given industry
u To assess the effect of a major change (such as deregulation, new technology, c
omplements, demographic shifts)
u To shape the industry environment

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Industry analysis: 6 steps

1. Define the industry

2. Identify the players (the market participants)
3. Analyze the players’ influence on profitability
4. Test the analysis
5. Develop a way to deal with the industry environment
6. Analyze how the factors influencing profitability may change and the response
required

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The Five Forces Framework implies that
while the lessprofitable industries are su
bject to powerful forces that make it diff
icult for industry participants to appropri
ate profits, such forces are muted in the
more profitable industries.

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The Methodology of Five Forces Analysis

The best way to use Porter’s framework is to focus not only on the forces, but
also on the economic factors that underlie them and how these factors might
change.

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Potential entrants

u Profits encourage
u Barriers to entry

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The Bargaining Power of Suppliers

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The Bargaining Power of Buyers

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The Threat of Substitutes

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Rivalry among Existing Competitors

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Extending the Analysis to Address Coo-
peration and Complements

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Applying Industry Analysis

The principal application of industry analysis is in developing a way to profit within the
industry environment. There are two ways to do this-
u The first is by finding or creating an attractive environment.
u The second is by developing a competitive advantage that enables the company
to be more profitable than its competitors, despite the environment.

As Porter explains, “Strategy can be viewed as building defenses against the competi
tive forces or as finding a position in an industry where the forces are weakest.”

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When you start to think about what to do in
response to your industry analysis, bear in
mind the following points:

u It is possible to make good money in a tough industry. Companies like Ryanair, The E
conomist Group, and Apple are able to do so. The key is to find a way to deal effec
tively with the five forces.
u There are different ways to react to competitive forces. A strategist may be able to i
dentify a profitable position that is not yet occupied.
u It is possible to profit by spotting changes in industry structure before others do.
u It is possible to influence industry structure.
u Innovators can use their understanding of how technology affects competitive forc
es to craft a strategy to protect their profits from imitators.
u Industry analysis is particularly important when moving to new geographic areas or
going into new businesses.
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Turn Threats into Opportunities

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An Example of Performing and Applying
Industry Analysis

The most effective way to approach industry analysis—or any analysis—

is by using the scientific method. Instead of collecting data and then “doing an industry an
alysis,” the strategic issue is identified, hypotheses about the answer are developed, and a
n analysis is conducted that tests the hypotheses. The analysis that must be conducted will
determine the data that are needed.

WALMART
We could specify two common strategic questions:
u Where are the most attractive opportunities to increase the company’s profits?
u What are the potential threats to existing profits and how should Walmart counter them
?

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An Example of Performing and Applying
Industry Analysis

With these questions in mind, we could develop several hypotheses, which are potent
ial answers to the questions. The hypotheses should suggest specific actions. For exam
ple:
u There are significant new profit opportunities in opening more stores in the United
States.
u There are significant new profit opportunities in introducing new services in existing
locations.
u The primary threat to existing profits comes from higher labor costs.

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An Example of Performing and Applying
Industry Analysis

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Define the Industry

In what industry does Walmart compete?

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Define the Industry

The company sells household goods and groceries, but so do supermarkets, convenience
stores, and specialty retailers.
Are all these businesses in the same industry? What matters is not what industry analysts or
business managers think, it’s what customers think.

Price vs convenience

3 dimensions - customer groups, customer needs, and alternative technologies.

Customer groups define “who” is being satisfied, customer needs define “what” is being
satisfied, and alternative technologies define “how” the need is satisfied.

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Define the Industry

So what’s the best way to define the industry?

First, the definition should be unambiguous.
Second, the definition should be useful in addressing the issue at hand:
Where are the new profit opportunities?
The industry analysis needs to be specific enough to be able to direct action. It’s not eno
ugh to say that the new profit opportunities are in “new store openings” (if indeed they ar
e). The question is, “In which locations should Walmart open new stores, and in what
formats?”

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Define the Industry

One approach would be to define Walmart’s industry as th

e “superstore” industry in the United States: largeformat disc
ount retailers selling both household goods and groceries to
the U.S. market.

Thinking about the dimensions along which we define the in

dustry starts to give us insights into positioning. One dimensio
n of positioning is physical location. Other dimensions are pr
oduct range, pricing, and technology (physical stores versus
online stores).

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 Identify the Players

The next step is to identify the “players” in the industry: the companies and organizations that influence W
almart’s profitability. Start with Porter’s classification.
Based on our conclusion that Walmart is in the U.S. superstore industry, we might identify the key players a
s follows:
Industry rivals: Walmart, Kmart, and Target.
Suppliers: Walmart’s suppliers include manufacturers of groceries and household goods. These include not
just manufacturers of branded consumer goods such as Procter & Gamble and CocaCola, but also man
ufacturers of Walmart’s Great Value and Sam’s Choice store-brand goods.
Other key suppliers: Importantly, this category also includes suppliers of labor and of land. Suppliers of lan
d include not only property owners but also local authorities that provide zoning and
building permits. Where labor is organized, suppliers of labor include unions.
Further suppliers: These include suppliers of IT hardware and services, transportation and logistics, marketin
g services, fixtures and fittings, as well as cleaning, electricity, communications, andother services.
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 Identify the Players

Customers: While most customers are individual or family consumers, Walmart also has corporate cu
stomers.
Substitutes: Substitutes include local supermarkets, warehouse clubs, online retailers, and convenien
ce stores. They also include home food delivery services, restaurants, and diets. For some product c
ategories, hardware and electronics stores are substitutes.
Potential entrants: Potential entrants into the U.S. superstore industry include major domestic and for
eign supermarket chains, such as Tesco, Aldi, and Safeway.
Complements: Superstores sell such a wide range of goods that there are thousands of complemen
ts, but two apply to all their products: transportation and financial services.
Nonmarket actors: Labor unions, local government authorities, federal authorities, and special inter
est groups can all affect Walmart’s profit opportunities.
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Analyze the Players’ Influence on Profitability

Threat of new entrants: In markets not yet served by superstores, the threat of new
entrants may be high. On the other hand, the threat of new superstore entrants in
small markets dominated by an existing superstore seems low. There are barriers to
entry in terms of distribution and economies of scale.
u Economies of scale and scope come from several sources: regional economies
of scale and scope from distribution centers; store economies of scale and sco
pe from fixed costs; and national or even global economies of scale in purchasi
ng. Customer acquisition costs, parking for customers, and customer travel time
all exhibit economies of scope. Information technology investments also
exhibit economies of scale and scope. Economies of scope suggest an opport
unity to broaden the product range.
u Network effects are not significant in this business.
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 Analyze the Players’ Influence on Profitability

u Customer switching costs are influenced by driving distance and the opportunity cost of lost savi
ngs. Switching costs will be greatest in markets dominated by one large-
scale store, because switching will involve driving a significant distance. Loyalty programs may
also increase switching costs.
u Capital costs are not high enough to deter entry in this industry. A Walmart superstore required a
n initial investment of $15.5 million in 2003.
u Incumbency advantages independent of size include superior access to scarce large-
format retail space, particularly in densely populated areas. First movers can develop relationshi
ps with local planning and zoning authorities.

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 Analyze the Players’ Influence on Profitability

u Restrictive government policy can be a barrier to entry. Nonmarket actors such as unions can influen
ce planning and zoningauthorities.
u Barriers to exit are not high. Store locations can be used by other stores or for other purposes.
u Fixed costs are not so high that incumbents are likely to cut prices significantly.

Bargaining power of suppliers:

u Product suppliers: Suppliers are important drivers of cost in this industry. From Walmart’s income state
ment, we can calculate that the cost of goods sold (the amount the company pays suppliers for the
products it sells) is 76% of its superstore sales. But how muchbargaining power do suppliers have? Supp
lier concentration varies by category. Branded product suppliers like CocaCola and Procter & Gambl
e have more bargaining power than suppliers of unbranded commodity products. For example, the
haircare market in the United States is relatively concentrated. The branded consumer goods market
features continual product innovation and heavy marketing investment. Consequently, the bargainin
g power of branded product suppliers is generally high in this industry.

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 Analyze the Players’ Influence on Profitability

u Suppliers of labor: Labor costs are a critical factor in this low-

margin industry. Supercenters have 220 to 550 employees, or associates. Payroll expenses are a
bout 8% or 9% of sales. Because the majority of employees are low-
skilled, they do not have much individual bargaining power, particularly in regions where there
are few other low-
skilled jobs. The bargaining power of labor will be greater in regions with established labor unions
. Regulations such as minimum-wage laws will affect labor costs.
u Suppliers of land: The average size of a supercenter is 185,000 square feet. Suppliers of land will
be less powerful in small towns surrounded by underdeveloped property. Suburban and urban
markets will have fewer suitable locations, and that relative scarcity increases the bargaining po
wer of property suppliers. Lease agreements often restrict leasing to industry rivals on the same p
roperty, further increasing the bargaining power of property owners. Nonmarket actors such as
neighborhood groups and labor unions may pressure local governments to deny planning perm
ission.
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 Analyze the Players’ Influence on Profitability

u Bargaining power of buyers: Customer bargaining power is high. Superstore customers are price-
sensitive; purchases of groceries and household goods represent a substantial proportion of the expe
nditure of lower-income families.
u Threat of substitutes: The threat of substitutes is high. As we discovered in defining the industry, substitu
tes for superstores are legion. Warehouse clubs, local supermarkets, specialty markets, “category killer
” retailers such as Toys R Us and Home Depot, dollar stores,convenience stores, and online retailers ar
e all substitutes. Many substitutes offer identical products, sometimes at higher prices but often with
more convenience. In some categories, large online retailers such as Amazon.com have achieved si
gnificant economies of scale. The threat of less obvious substitutes, such as farmers’ markets, dieting, r
estaurants, and takeout food, is generally low.
u Rivalry among existing firms: Rivalry among existing firms is strong. Rivals compete on price to sell mostl
y undifferentiated products. The limited life of food encourages price discounting. New entrants may
expand capacity in large increments within a neighborhood, providing yet another incentive to com
pete on price in order to capture market share. However, rivalry has been muted somewhat in the Uni
ted States by Kmart’s bankruptcy and reorganization. Target aims for a more upscale market segmen
t and prices at a 10% to 15% premium.
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 Analyze the Players’ Influence on Profitability

u Complements: Driving and payment are complementary to superstore shopping. That suggests
an opportunity for gasoline sales, auto parts, and auto services. Payment services and basic ba
nking transactions represent another opportunity. Complements, however, are not a powerful f
orce in this industry.
This analysis suggests that profitability in this industry will generally be low. The U.S. superstore industr
y faces a powerful threat from substitutes: warehouse clubs, local supermarkets, and “category kill
er” retailers. Suppliers and customers have significant bargaining power. Industry rivalry is often pric
e-based.

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 Test the Analysis

The best way to test an industry analysis is to compare its predictions with observed levels of profitability. If
an industry has generally low profitability, the analysis should have identified at least one powerful force
that shrinks the profit pie. It should be possible to explain superior levels of profitability among some indust
ry participants by how they deal with the competitive forces.
In the U.S. superstore industry, Kmart’s losses and its subsequent bankruptcy and reorganization suggest t
hat this is indeed a tough industry. From our analysis, we would expect that some combination of hard-
bargaining suppliers, price-
sensitive customers, a potent threat of substitutes, and intense industry rivalry caused the company’s de
mise.
But that is not the whole story. Walmart’s return on equity has consistently been around 20%. Target’s ROE
is about 17.5%. Walmart’s return on invested capital is around 16%, while—according to Porter—
the average return on invested capital for industries in the United States from 1992 to 2006 was about 15%
.
The financial performance of Walmart and Target suggests that it is possible to mitigate the threat of the
competitive forces in this industry. Now we need to pivot from analyzing the industry and its environment
to understanding how to succeed in that environment.
Source HBSP
 Develop a Way to Deal with the Industry Environment

The first caveat is to beware of declaring an industry “attractive” or “unattractive,” which tends to r
aise questions such as these:
u If the industry is not attractive, why should I even bother to analyze it?
u If the industry is attractive, it’s because there are barriers to entry. If I can’t enter the industry, wh
at’s the point of analyzing it?

The point of industry analysis is not to declare an industry attractive or unattractive; it is first to spot
profit opportunities and develop a strategy to exploit them, and then to identify threats to profits a
nd develop a strategy to counter those threats.

Source HBSP
 Develop a Way to Deal with the Industry Environment

We started the Walmart analysis with two strategic questions:

u Where are the most attractive opportunities to increase the company’s profits?
u What are the potential threats to existing profits and how should Walmart counter them?

To answer these questions, we need to understand Walmart’s current sources of profit. The compa
ny seems to have a competitive advantage. In 2003 Walmart’s superstore SG&A (sales, general, an
d administrative) costs were about 18% of sales, compared with 21% for Kmart and 26% for Target.
Walmart’s greater scale (it was nearly six times the size of Target in 2003) suggests that the compan
y may have an advantage in sourcing goods. And its supply chain outperformed those of rivals: In
ventory turns were 7.6 in 2003, compared with 6.1 at Target and 5.4 at Kmart.

Source HBSP
 Develop a Way to Deal with the Industry Environment

Treating 5 forces as an opportunity-

Positioning for the Threat of New Entry
The superstore industry exhibits economies of scale and scope. Consequently, one profitable positi
oning should be large-scale stores offering a wide range of products.
By one estimate, a superstore needs a potential customer base of 76,000 people to be viable.23 Dis
tribution centers serve approximately 150 stores within an average radius of 150 miles. This suggests
that a profitable position for superstores will be in local markets with about 76,000 to 150,000 potenti
al customers. These locations will be large enough to support one superstore but too small to supp
ort two.
Even at this stage, the analysis is pointing to a positioning that looks like Walmart’s: large-
scale stores with a wide range of products saturating regions with numerous small towns. In 2003 m
ore than 80% of Walmart’s Supercenters were in regions classified by one analyst as “small-
town living” or “rural America.”
Source HBSP
 Develop a Way to Deal with the Industry Environment

Treating 5 forces as an opportunity-

Positioning to Counter the Bargaining Power of Suppliers
The opportunity in bargaining with suppliers comes from being a bigger purchaser than your comp
etitors. “Category killer” retailers like Home Depot achieve this by becoming the largest purchaser i
n one product category. And as mentioned before, companies can also weaken suppliers’ power
by developing alternative sources. Walmart uses both tactics.
Walmart has substantial bargaining power with suppliers because so much of its suppliers’ business
depends on it. Walmart typically represents a much larger share of the supplier’s business than the
supplier represents for Walmart. For example, by 2003 Walmart was by far P&G’s largest customer,
accounting for 17% of P&G’s total revenue, but P&G’s share of Walmart’s total revenue was less th
an 3%.
Walmart increases competition in many product segments through selling store brands and buying
directly from manufacturers.
Source HBSP
 Develop a Way to Deal with the Industry Environment

Walmart does not face significant costs in switching suppliers. And in most categories, there is little
danger of suppliers integrating forward into retailing. Taking all these factors together, product sup
pliers have relatively low bargaining power with Walmart.
Walmart’s “small town” positioning reduces the bargaining power of property owners. Suppliers of l
and have more power where land is scarce, but that threat is mitigated when Walmart locates in l
ess-developed areas, such as small towns surrounded by open land.
Reducing the bargaining power of labor suppliers suggests positioning in states with weaker unions
and lower minimum wages.

Source HBSP
 Develop a Way to Deal with the Industry Environment

Treating 5 forces as an opportunity-

Positioning to Counter the Bargaining Power of Buyers
Where Walmart has entered an area early enough to be the dominant superstore, switching costs s
hould provide the company with some pricing power, although it will be constrained by substitutes.
Customers in rural locations face larger switching costs—in terms of driving distances—
than those in suburban and urban areas.

Source HBSP
 Develop a Way to Deal with the Industry Environment

Treating 5 forces as an opportunity-

Positioning to Counter the Threat of Substitutes
Locating in rural or smalltown markets where it has a local monopoly mutes the threat of substitutes
. Walmart has also entered industry substitutes: Sam’s Club competes in the warehouse club industr
y with Costco and others, and Walmart.com competes with online retailers such as Amazon.com.

Source HBSP
 Develop a Way to Deal with the Industry Environment

Treating 5 forces as an opportunity-

Positioning to Counter Industry Rivalry
Walmart’s competitive advantage and willingness to compete on price have muted industry rivalry
. Rivalry has been further weakened in the United States by Kmart’s bankruptcy and reorganization.
Given Walmart’s position as the lowcost industry participant, rivals are unlikely to win a price war. Fi
xed costs are not so high that incumbents are likely to cut prices significantly. Rivals have avoided
headtohead competition. Target, for example, aims for a more upscale market segment and price
s at a 10% to 15% premium.

Source HBSP
 Develop a Way to Deal with the Industry Environment

Walmart’s Integrated Set of Positioning Choices

We can summarize Walmart’s positioning in the superstore industry: largescale stores, large product
range, rural and smalltown locations, regional saturation, national scale, store brands, everyday lo
w pricing, lowest cost in the industry.

This is an integrated set of choices, because the decisions are mutually reinforcing. Rural and small-
town locations create local monopolies, which reduce the threat of entry, reduce competition for l
abor and land, and increase pricing power. But without regional saturation, economies of scale fro
m distribution centers would be lost. Regional saturation allows the company to reduce the threat
of entry by preempting neighboring markets. The regional and national economies of scale help to
make the lowcost position possible, which mutes industry rivalry. The lowcost position makes the ev
eryday low-pricing position possible. That increases customers’ switching costs.

Source HBSP
 Develop a Way to Deal with the Industry Environment

Identifying New Profit Opportunities

Now that we understand how Walmart’s positioning creates profits, we can return to the hypothese
s we developed earlier:
u There are significant new profit opportunities in opening more stores in the United States.
u There are significant new profit opportunities in introducing new services in existing locations.
To test the first hypothesis, we would need to analyze local markets and infrastructure, and target (i
n the first instance) regions with dispersed small towns with good transport infrastructure that are no
t already served by superstores. Walmart could continue to look to dominate regions and avoid co
mpeting head-to-head with warehouse stores in urban environments.
Exploiting economies of scope by introducing new products and services to existing customers see
ms likely to be a profitable opportunity. Walmart could exploit its dominance of local markets to go
od effect. To test this idea for specific products and services, we would need to analyze the industr
y environment, for example, to estimate how profitable banking services are likely to be.
Source HBSP
 Exploit Industry Change

The final step is to look at change in the industry and its environment. Companies can exploit chan
ge and even act to shape the industry and its environment in their favor.

Sometimes change can be influenced by -

u market participants
u new regulations
u development of new technologies

Industry analysis helps companies analyze how such changes can affect profitability, develop a str
ategy to compete over time, and explore opportunities to change the industry structure.

Source HBSP
 Exploit Industry Change

Analyze How Profitability May Change Over Time

Let’s see how changes may create profit opportunities or threaten existing profits. That will allow us
to test the hypothesis that “the primary threat to existing profits comes from higher labor costs.”

Source HBSP
 Exploit Industry Change

Changes in the Threat of Entry

The threat of new superstore entrants in small markets already served by Walmart Supercenters see
ms small given the barriers to entry presented by distribution and economies of scale. If Walmart Su
percenters are at the minimum efficient scale in a local market and can serve the entire market, th
e company has no need to fear entry by a rival operating at larger scale. If necessary, Walmart ca
n deter entry by initiating price cuts. The company has taken care to enter at the minimum efficien
t scale in many of its markets, particularly in small towns. As the low-
cost incumbent, it is difficult to dislodge.

Source HBSP
 Exploit Industry Change

Changes in the Bargaining Power of Suppliers

As Walmart develops more store brands and increases its scale, the bargaining power of product s
uppliers is likely to decrease. On the other hand, the power of suppliers of labor and land is likely to
increase.
The company, a frequent target of unionization efforts, is likely to face even more powerful labor su
ppliers as it expands into urban areas with higher living costs and into states with higher minimum-
wage laws, stronger unions, and less flexible workforces. Laws mandating benefits such as health c
are also represent a risk.
Strategies to deal with those challenges could include experimenting with models requiring fewer e
mployees, such as warehouse stores, and targeting regions with less stringent labor laws. Nonmarke
t strategies, such as lobbying and developing community relationships, are likely to be increasingly i
mportant in more densely populated markets.

Source HBSP
 Exploit Industry Change

Changes in the Bargaining Power of Buyers

Customers’ bargaining power is lower where Walmart dominates the local market.
Walmart could attempt to increase switching costs by targeting locations that are relatively close t
o substitutes in distance but relatively far in terms of travel time.
The threat to growth is market entry at scale by other firms into markets not yet served by Walmart s
uperstores. As Walmart’s model is well-known, others may move to preempt it in unserved markets.

Source HBSP
 Exploit Industry Change

Changes in the Threat of Substitutes

The appeal of the Walmart brand may wane in markets where affluence is growing. Demographic
shifts towards urbanization increase the threat of substitutes. Traffic congestion makes nearby substi
tutes relatively more attractive. Online competitors and home delivery may become increasingly i
mportant, especially in densely populated areas. Walmart could consider experimenting with new
delivery models in those markets.
Changes in Industry Rivalry
Rivalry is likely to increase as Walmart attempts to expand into new markets. Competition is likely to
take the form of a battle for dominance in specific local markets, rather than head-to-
head competition between neighboring superstores.
Changes in the Influence of Complements
As population density increases, parking becomes more valuable, which suggests opportunities for
partnerships with parking lot owners and operators.
Source HBSP
 Exploit Industry Change

Threats to Walmart’s Profitability

To return to our hypothesis, labor costs are likely to continue to be a threat, but perhaps not the mo
st important one. The biggest threats are likely to come from increasing costs, increasing rivalry, an
d decreasing distribution efficiencies in urban markets. Walmart could continue to experiment with
smaller formats in more densely populated environments and consider rebranding Sam’s Clubs for t
he more affluent urban and suburban markets.

Source HBSP