Strategic Management

Prof. Anirvan Pant

The Zone of Strategic Decisions

Source: Rosenzweig, 2013

 Ingredients of Strategic Problem Solving

 Tradeoffs
 Goals
 Nested choices
 Relative performance
 Assumptions
 Analysis and Judgment
 The SCP Model

Focus of Industrial Organization

Firm Performance = f(Firm Conduct) = f(Industry Structure)

Focus of Structural
Analysis (Strategic
Management)
 Forces that Impinge on Firm Profitability

Vertical
(Value Chain)
Power

Horizontal Horizontal
Competition Competition

Vertical
(Value Chain)
Power
 Porter’s Five Forces that shape Competitive Strategy

Power of
Suppliers

Rivalry Among
Existing Firms
Threat of Threat of
Entry Substitutes

Power of
Buyers

Source: Porter, 1980

 Specifying the Relevant Industry

 Look for the Market, not the Industry!

 Close substitutes
 Substitutability on the demand side
 Substitutability on the supply side
 Examine Product Scope

 Examine Geographic Scope

 Porter’s rule of thumb: Check for size and scope of

differences in five forces
 The Problem of Complementary Products
Threat of New Entry

 New entrants bring new capacity & a desire to earn

market share
 The lower the barriers to entry, the higher the
threat
 The lower the expected retaliation from
incumbents, the higher the threat
Barriers to Entry

 Supply-Side Economies of Scale

 Demand-Side Benefits of Scale
 Product Differentiation
 Capital Requirements
 Customer Switching Costs
 Learning Curve Cost Advantages
 Incumbency advantages independent of
size
 Access to Distribution Channels
 Restrictive Government Policy
 Expected Retaliation
Threat of Substitute Products

 Substitutes perform the same function as the

industry’s product or service, but by different
means, and may often appear to be very
different from the industry’s product
 Subject to trends improving price-performance
tradeoff
 Produced by an industry earning high profits
 Low costs of switching to substitute
Bargaining Power of Suppliers

 Powerful suppliers can charge higher prices, limit

quality or services, or shift costs to industry
participants
 Dominated by a few large companies; more
concentrated than buyer industry
 Substitute products unavailable
 Buyers not significant customers
 High switching costs
 Credible threat of forward integration
 Technology Leader
Bargaining Power of Buyers
 Powerful buyers can force down prices, demand
better quality or more service (pushing up costs),
and play off industry participants against one
another
 Purchase a large portion of industry’s total output
 Product accounts for a large portion of the buyers’
costs, does not affect the quality of the buyers’
output significantly, has little effect on buyers’ other
costs
 Low or no switching costs
 Products undifferentiated or standardized
 Credible threat of backward integration
Rivalry amongst Incumbents
Intensity of Rivalry Basis of Rivalry
 Numerous or balanced  Low product
competitors differentiation
 Slow industry growth  High Fixed Costs &
 Commitments & Low Marginal Costs
Aspirations  Chunky Capacity
 Lack of Familiarity  Product Perishability
 Divergence of goals
 High Exit Barriers
 Entry/Exit Barriers

EXIT BARRIERS

LOW HIGH

LOW Profits: Low and Stable Profits: Low and

Unstable
ENTRY
BARRIERS
Profits: High and
HIGH Profits: High and Stable Unstable
 Porter’s Five Forces Model: Summary

THE FORCE ITS IMPACT WHY

If Threat of Entry Profitability Prices Costs

If Supplier Power Profitability Costs

Buyer Power Profitability Prices Costs

If Substitutes Profitability Prices Costs

If Rivalry Profitability Prices Costs

 Exogenous Factors that Influence the Five Forces

Industry Complementors
Growth Rate Power of
Suppliers

Rivalry Among
Existing Firms
Threat of Threat if
Entry Substitutes

Power of
Buyers
Technology &
Innovation Government

Source: Porter, 1980

The Purpose of Five Forces Structural Analysis

The purpose of structural

analysis is not to pass verdict
on whether an industry is
attractive or unattractive, but
to understand changes over
time in the drivers of
profitability in a given industry
 Industry Structure is Dynamic….

Incumbents can seek to alter the industry structure in their

favour by -
 Erecting barriers to entry
 Competing on bases other than price
 Improving product attractiveness compared to substitutes
 Reducing supplier uniqueness
 Reducing buyer uniqueness

Source: Barney, 2011

 Porter’s Five Forces Model: Key Principles

 Competitive strategy needs to focus on average industry

profitability
 The drivers of profitability are the same in every industry

 Industry structure is surprisingly sticky; Structural

change, and thereby, change in average industry
profitability, usually take a long time
Conducting Structural Analysis: Things to Remember

 Define the relevant industry carefully

 Specify the appropriate time horizon

 The strength of the forces directly affects prices, costs,

and the investments required to compete in that industry

 Five Forces structural analysis is, typically, conducted

from the perspective of the incumbent, not the entrant

 Get a sense of industry profitability in overall, systemic

terms; not just as pluses and minuses

 Identify the one (or two) forces that impinge most

strongly on profitability in a given industry
 How is Structural Analysis Useful?

 Understanding current drivers of industry profitability

 Anticipating future changes in industry profitability by

analyzing ongoing structural changes

Thereby…..

 Making entry and exit decisions

 Managing corporate business portfolios

 Positioning firm to capture superior value in industry

 Focusing strategic action on improving industry

profitability
 The Principal Insight of Five Forces Analysis…..

Value Creation Value Capture

Industry structure, as manifested in the strength of the five competitive

forces, determines the industry’s long-run profit potential because it
determines how the economic value created by the industry is divided – how
much is retained by companies in the industry versus bargained away by
customers and suppliers, limited by substitutes, or constrained by potential
new entrants. (Porter, 2008; italics added)
 Challenges…..

 Does Five Forces Analysis assume a zero sum game?

 Can it account for firms operating across multiple

industries
 Does it explain competitive dynamics or merely
competitive statics?
 THE TWIN FUNDAMENTAL QUESTIONS FOR THE STRATEGIST

How Do We Compete? Where Do We Compete?

 Business Model  Product Scope

 Competitive  Value Chain
Positioning Activities
 Resource  Geographic
Configuration Markets

BUSINESS STRATEGY CORPORATE STRATEGY

 Moving from Industry (Structural) Analysis to Strategic Positioning

Average Industry Average Industry Average Industry Costs

Profitability = Prices -

But, firms jockey for positioning

within the industry….
Competitive
Advantage Cost Leadership

Relative Firm Profits Relative Firm Prices Relative Firm Costs

= -

Differentiation
 Competitive Advantage: Moving from Manifestations to Sources

Value Appropriation Value Creation

Competitive
Advantage Cost Leadership

Relative Firm Profits Relative Firm Prices Relative Firm Costs

= -

Differentiation
The Logic of Value Creation

Willingness to Pay can be enhanced by managing:

1. Tangible characteristics 2. Quantity & characteristics of
the services or complementary goods offered 3.
Characteristics associated with the sale or delivery of the
product / service 4. Characteristics that shape consumer
perceptions or expectations of the product’s performance 5.
The subjective image of the product

Opportunity costs can be lowered by managing:

1. Cost drivers related to economies of scale & scope and to
cumulative experience 2. Cost drivers independent of
economies of scale, scope, & experience (e.g., firm input
prices, economies of density, government policies) 3. Cost
drivers related to the organization of the transactions)
 Porter’s Generic Strategies

Broad

Cost Differentiation
Leadership

Competitive
Scope

Focus

Narrow
Cost Competitive Advantage Differentiation

Source: Porter, 1985

 ‘Stuck in the Middle’
“…when a company tries to be all things to all customers and is outflanked
by cost leaders on one side, who meet ‘just enough’ of their customers’
needs, and by differentiators on the other side, who do a better job of
satisfying customers who ‘want more’ (of some particular attribute they
value).” )
(Source: Magretta, 2012: 114)

Creation of Dual Advantage is

rare – it requires the firm to
break the conventional trade-
off between willingness to pay
and costs
 What is Value Chain Analysis?

 The sequence of activities a company performs to design, produce,

sell, deliver, and support its products is called the value chain.
 In turn, the value chain is part of a larger value system: the larger set
of activities involved in creating value for the end user, regardless of
who perform those activities.
 Value chain analysis aims to get to the managerially relevant sources
of competitive advantage – activities that managers can control
Template for Value Chain Analysis

firm infrastructure

human resource management

technological development
support
activities procurement

service
operations

marketing
outbound

& sales
logistics
inbound

logistics

primary activities

Source: Porter, 1985

 Key Steps in Value Chain Analysis

1. Lay out the industry value chain

2. Compare the focal firm’s value chain to that of the
industry
3. Identify price drivers, i.e., those activities that have a
high current or potential impact on differentiation
4. Identify cost drivers, i.e., those activities that represent
a large or growing percentage of costs.
Why Are Some Firms More Profitable Than Others?

Two sources of firm performance:

Industry Structure Relative Position

Framework Five Forces Value Chain
Focus of Analysis Drivers of Industry Differences in
Profitability Activities
Outcome of Analysis Industry Average price Relative (Firm) price &
& cost cost
 Trade-offs are the strategic equivalent of a fork
in the road. If you take one path, you cannot
simultaneously take the other. Whether the fork
in the road is about the characteristics of the
product itself, or about the configuration of
activities in the value chain, a trade off means
that you cant have it both ways because the
choices are incompatible

Source: Magretta, 2012

 Trade-off: The Linchpin of Strategy

1. Strategic equivalent of a fork in the road

2. Incorporates an understanding of limits and that ‘more’ is not

always ‘better.’

3. Trade-offs exist because

a. product features may be incompatible
b. activities may be incompatible
c. Image / reputation may be incompatible

4. Choosing ‘what not to do’ is an important aspect of managing a

trade-off.

(Source: Magretta, 2012: 114)

 The Pursuit of Competitive Advantage

 Seek to provide a unique mix of value, not the ‘best’

value, to customers
 Develop a distinctive positioning in your industry based
upon a unique configuration of activities
 Identify trade-offs involved in developing your distinctive
positioning and make commitment-intensive choices

 Ensure Fit amongst the different elements of your

activity configuration such that they are consistent,
reinforcing, and optimizing

At general management’s core is

strategy: defining a company’s
position, making trade-offs, and
forging fit among activities.
Source: Porter, 1996
 Five Tests in Business Strategy
Do You Have a Distinctive Value Proposition? [Customers? Needs? Relative
Price?]

Do You Have a Value Chain Tailored to Deliver Exactly that Value

Proposition? [Activities]

Do You Have Trade Offs Embedded in Your Value Chain Activities? [What
Not to Do]

Do You Have Fit across your Value Chain Activities, such that the value or
cost of one activity is affected by the way other activities are
performed? [The Amplifier] [Mapping Activity System]

Do You Have Continuity over Time, such that the core of your strategy is
stable and allows your organization to get good at what it does?

Source: Magretta, 2012