Chapter 6: Business-Level Strategy and the Industry Environment

Fragmented Industry

An industry composed of a large number of small- and medium-sized companies.

What are the three reasons for fragmentation?

1) A lack of scale economies may mean that there are few, if any, cost advantages to large size.

2) Brand loyalty in the industry may primarily be local.

3) The lack of scale economies and national brand loyalty implies low entry barriers. when this is the case, a steady stream of new entrants may keep the industry fragmented.

What are the two strategies that enterprises use to replicate their offering once they get it right?

Chaining and Franchising

Chaining

A strategy designed to obtain the advantages of cost leadership by establishing a network of linked merchandising outlets interconnected by information technology that functions as one large company.

Franchising

A strategy in which the franchisor grants to its franchisees the right to use the franchisor’s name, reputation, and business model in return for a franchise fee and often a percentage of the profits.

What are the advantages to usin ga franchising strategy?

1) Normally the franchisee puts up some or all of the capital to establish his or her operation. This helps to finance the growth of the system and can result in more rapid expansion.

2) Because franchisees are the owners of their operations, and because they often put up capital, they have a strong incentive to make sure that their operations are run as efficiently and effectively as possible.

3) Because the franchisees are entrepreneurs who own their own businesses, they have an incentive to improve the efficiency and effectiveness of their operations by developing new offerings and/or processes. Typically, the franchisor will give them some latitude to do this, as long as they do not deviate too much from the basic business model. Ideas developed in this way may then be transferred to other locations, improving the performance of the entire system.

What are the disadvantages of using a franchising strategy?

1) It may allow less control than can be achieved through a chaining strategy, because, by definition, a franchising strategy delegates some authority tot he franchisee.

2) In a franchising system the franchisee captures' some of the economic profit form a successful operation, whereas in a chaining strategy it all flows to the company.

3) Because franchisees are small relative to the founding enterprise, they may face a higher cost of capital, which raises system costs and lowers profitability.

Why is customer demand for the produces of an embryonic industry initially limited?

1) The limited performance and poor quality of the first products.

2) The customer unfamiliarity with what the new product can do for them.

3) Poorly developed distribution channels to get the product to customers.

4) A lack of complementary products that might increase the value of the product for customers.

5) High production costs because of small volumes of production.

Mass Market

One in which large numbers of customers enter the market.

Mass markets emerge when what three things happen?

1) Ongoing technological progress makes a product easier to use, and increases its value for the average customer.

2) Complementary products are developed that also increase its value.

3) Companies in the industry work to find ways to reduce the costs of producing the new products so they can lower their prices and stimulate high demand.

What is the order of different customer segments?

Innovators → Early Adopters → Early Majority → Late Majority → Laggards

When does the late majority typically enter the market?

These customers typically enter when the mass market reaches a critical mass, with about 30% of the potential market penetrated.

When do the highest market demands a industry profits arise?

This occurs when the early and late majority groups enter the market.

What factors accelerate consumer demand?

1) A new product’s relative advantage; that is, the degree to which a new product is perceived as being better at satisfying customer needs than the product it supersedes.

2) Complexity. Products that are viewed by consumers as being complex and difficult to master will diffuse more slowly than products that are easy to master.

3) Compatibility. The degree to which a new product is perceived as being consistent with the current needs or existing values of potential adopters.

4) Trialability. The degree to which potential customers can experiment with a new product during a hands-on trial basis.

5) Observability. The degree to which the results of using and enjoying a new product can be seen and appreciated by other people.

What strategies can companies pursue to make new entry less likely?

1) Proliferation

2) Limit Pricing

3) Technology Upgrading

4) Strategic Commitments

Product Proliferation

The strategy of “filling the niches” or catering to the need of customers in all market segments to deter entry by competitors.

Limit Price Strategy

Charging a price that is lower than that required to maximize profits in the short run to signal to new entrants that the incumbent has a low-cost structure that the entrant likely cannot match.

Technology Upgrading

Incumbent companies deterring entry by investing in costly technology upgrades that potential entrants have trouble matching.

Strategic Commitments

Investments that signal an incumbent’s long-term commitment to a market or a segment of that market.

What may a strategic commitment invovle?

This may involve:

1) Raising the perceived costs of entering a market, thereby reducing the likelihood of entry.

2) Making significant investments in basic research, product development, or advertising beyond those necessary to maintain a company’s competitive advantage over its existing rivals.

Credible Commitment

This occurs when established companies succeed in signaling this position to potential rivals through past actions.

What are strategies to manage rivalry?

1) Price Signaling

2) Price Leadership

3) Non-Price Competition

4) Capacity Control

Price Signaling

The process by which companies increase or decrease product prices to convey their intentions to other companies and influence the price of an industry’s products.

Tit-for-Tat Strategy

A well-known price signaling maneuver in which a company exactly mimics its rivals.

Price Leadership

When one company assumes the responsibility for determining the pricing strategy that maximizes industry profitability.

Non-Price Competition

The use of product differentiation strategies to deter potential entrants and manage rivalry within an industry.

What are the four non-price competitive strategies based on product differentiation?

1) Market Penetration

2) Product Development

3) Market Development

4) Product Proliferation

Market Penetration

When a company concentrates on expanding market share in its existing product markets.

Product Development

The creation of new or improved products to replace existing products.

Market Development

When a company searches for new market segments for its existing products in order to increase sales.

Product Proliferation

Generally means that large companies in an industry have a product in each market segment (or niche). It allows the development of stable industry competition based on product differentiation- not price.

Capacity Control

Although non-price competition helps mature industries avoid the cutthroat price cutting that reduces company and industry levels of profitability, price competition does periodically occur when excess capacity exists in tan industry. it can arise when companies collectively produce too much output; to dispose of it, they cut prices. It may also be caused by a shortfall in demand.

What are two general choices for managing capacity?

1) Each company must try to preempt its rivals and seize the initiative

2) The companies must collectively find indirect means of coordinating with each other so that they are all aware of the mutual effects of their actions.

How can a company preempt rivals?

In order to do this, a company must forecast a large increase in demand in the product market and then move rapidly to establish large-scale operations that will be able to satisfy the predicted demand. by achieving a first-mover advantage, the company may deter other firms from entering the market because the preemptor will usually be able to move down the experience curve, reduce its costs, and therefore reduce its prices as well…

How can a company coordinate with rivals?

Caution must be exercised because collusion on the timing of new production capacity investments is illegal under antitrust low. However, tacit coordination is practiced in many industries as companies attempt to understand and forecast one another’s competitive moves. Generally, companies use market signaling to secure this.

What are some examples of reasons an industry may decline?

Examples include technological change, social trends, and demographic shifts.

What happens to competition and profits in a declining industry.

In this type of industry, competition tends to intensify and profit rates tend to fall.

What factors determine the intensity of competition in declining industries?

1) Speed of Decline

2) Height of Exit Barriers

3) Level of Fixed Costs

4) Commodity Nature of Product

What are the four main strategies that companies can adopt to deal with decline?

1) Leadership Strategy

2) Niche Strategy

3) Harvest Strategy

4) Divestment Strategy

Leadership Strategy

When a company develops strategies to become the dominant player in a declining industry. These companies want to pick up the market share of companies that are leaving the industry.

Niche Strategy

When a company focuses on pockets of demand that are declining more slowly than the industry as a whole to maintain profitability.

Harvest Strategy

When a company reduces to a minimum the assets it employs in a business to reduce its cost structure and extract (“milk”) maximum profits from its investment.

Divestment Strategy

When a company exits an industry by selling its business assets to another company.

When does pursuing a leadership strategy in a declining industry make the most sense?

This strategy makes sense when 1) The company has distinctive strengths that allow it to capture market share in a declining industry, and 2) the speed of decline and the intensity of competition in the declining industry are moderate.

When does pursuing a niche strategy in a declining industry make the most sense?

This strategy makes sense when the company has unique strengths relative to those niches in which demand remains relatively strong.

When does pursuing a harvest strategy in a declining industry make the most sense?

This is the best choice when companies wish to exit a declining industry and optimize cash flow in the process. This makes the most sense when the company foresees a steep decline and intense future competition, or when it lacks strengths relative to remaining pockets of demand in the industry.

When does pursuing a divestment strategy in a declining industry make the most sense?

This strategy rests on the idea that a company can recover most of its investment in an underperforming business by selling it early, before the industry has entered into a steep decline. This strategy is appropriate when the company has few strengths relative to whatever pockets of demand are likely to remain in the industry, and when the competition in the declining industry is likely to be intense.