The University of Chicago
Graduate School of Business
Crown Cork and Seal: What happened? (1)
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Session 1: Industry Analysis and Strategy ID
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Chicago GSB, Spring 06
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Update (2)
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1: Industry Analysis
By 2000, diversification strategy considered a failure .
– Declining EBITDA and free cash flow as a result of margin pressure.
– $5 billion in debt.
– Major asbestos liabilities from a long-closed insulation division
– Debt downgraded to junk status – facing bankruptcy
– Crown suspended dividend, shares down 70% -- removed from the S&P
Avery resigns in 2000,
– CCK in similar position to 1957 – pre- John Connelly
– Restructuring plan –new CEO Conway:
(1) improve the company’s balance sheet – “conservative financial
strategy”
(2) lead in rigid packaging containers and closures,
(3) use R&D to improve products,
(4) improve its global presence, an
(5) strive to be the low cost provider.
Chicago GSB, Spring 06
Major acquisitions:
– 1990:
• Continental Can Canada for $330 M
• Continental US food and beverage metal container lines $336m
– 1991:
• Continental Can International $125m (Asia, Mideast, SouthAm)
• General Packaging Canadian business from Ball Citrus Central
• small acquisitions of engineering services, machining
– 1992:
• beverage closure operations from Tredegar Molded Products;
• CONSTAR International --world's largest manufacturer of
plastic containers [IPO’d out in fall 2002]
– 1996
• Carnaud Metalbox double size
Sales growth from 1989 to 1996: from $1.7 billion to $8 billion.
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Explanation
for profitability
Market
Attractiveness
Economic
Profitability
Measurable indicators
or causes
Root conditions
• Direct Competition
from Rivals
Market
The Market
• Entry Threats
Economics
• Competition
and
Opportunities
from Substitutes
• Complements
• Supplier Power
• Buyer Power
• Regulatory pressures Firm’s Strategy for The firm’s valueCreating Value
creation proposition
(“Value-Creation matches the firm’s
resources and capabilities
Proposition”)
to market opportunities
• Cost Position in
Competitive
Advantage
or Disadvantage
Chicago GSB, Spring 06
Served Market
• Benefit Position
in Served Market
Firm’s Resources
and Capabilities
The Firm and
its Position
in the Market
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Industry Analysis
I. Substitutes
• Industry Analysis: Description of the economic structure of an
industry.
• Industry analysis is useful because …
– Understand context of firm decisions to take decisions within
context-- building block of strategy formulation
• Essential to making effective decisions about entry, exit,
expansion, product positioning, cost reduction, …
• it helps identify potentially attractive/unattractive arenas for
growth.
– Change Context?
• Understanding the current “rules of the game” in the industry
is a precondition for eventually changing them.
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II. Threats from Competitors: Rivalry
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– To what extent does competition from substitute products outside the
defined boundaries of the industry erode the profitability of a typical firm
in the industry?
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Identifying substitutes depends on how “finely” you draw the
boundaries of the analyzed market
– Is Amtrak (railroads) a competitor to Airlines or a substitute product.
– But it does not matter: you either have a substitute or a rival; both ways
need to consider it – e.g. in CCS plastics and glass
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Substitutes limit the profits of an industry by placing a ceiling on
industry prices.
– The more attractive the price-performance tradeoff offered by substitutes,
the more important the substitute product.
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Pricing Rivalry
Two basic questions:
– How do firms compete?
• price competition
• product competition
• technological innovations
• marketing
– To what extent does price competition or non-price competition
(e.g., advertising) erode the profitability of a typical firm in the
industry?
• Intense rivalry erodes profitability by
– reducing price-cost margins (price competition)
– increasing programmed costs (e.g., advertising) (non-price
competition)
Focus now on price rivalry, since it is most costly and important
for profitability.
Chicago GSB, Spring 06
Question:
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Bertrand Model:
• One shot competition with homogeneous goods and
constant unit costs.
• Results in prices equal to unit costs
How do we get away from this?:
• Capacity constraints
• Differentiated products
• Repeated interaction – tacit coordination
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Switching costs/search costs
Tacit coordination
• Switching costs/search costs also decrease responsiveness to
price
• Thus they also reduce price competition
– May create differentiation/switching costs on purpose
• Example: Frequent Flyer Program
• Will see other examples during program
– Brand Loyalty plays a similar role
• decreases rivalry by creating a switching cost from consumer
perspective
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Conditions that facilitate tacit coordination
– Concentrated market
– Facilitating practices used
– Public sales terms; firms have good info. about competitors
– Small, frequent orders
– Strong capacity utilization
– Rapidly growing demand
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Exit barriers increase rivalry
– unprofitable firms stick around
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III. Barriers to Entry
When does ‘capital’ constitute a BTE?
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The key question: To what extent does the threat or incidence of
entry erode the profitability of a typical firm in the industry?
Factors that restrict entry into an industry:
– Economies of Scale
– Large Sunk Expenditures
– Incumbent advantages:
• learning curve effects; patents and licenses; switching costs
– Expectation of aggressive response to entry
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When it creates large economies of scale
– But large capital expenditures are neither necessary nor sufficient for
there to large economies of scale
– Key: MES relative to market size
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When investment is large and ‘sunk’
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Getting to the Bottom of MES
Economies of Scale and MES
(Constant Variable Costs
• Production economies due to lumpy capital,
specialization of labor/ capital, technological factors.
– Best measured by comparing minimum efficient scale
to market size (approximates number of efficient scaled
firms that can be sustained)
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Fixed
Cost1
Penalty for Operating at Half
MES1
Limits number of firms plus creates “lumpiness”
whereby incumbents can make profits but any
additional entry would “spoil the market”.
Average Cost1
Variable
Cost
q*/2
q*=MES
Q (Output per period)
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Sunk Costs
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IV. Bargaining Power of Suppliers
• If investment made is specific to this opportunity, cannot
recover it.
– To the extent that investment made is irreversible, hit
and run entry impossible
• Large sunk investment is a barrier to entry, since if exit is
costly, more unlikely to enter under uncertainty
• Some firm investments create barriers to entry by
increasing the amount of sunk investments required to
enter industry
– Investments in brand building (advertising) -- entirely
sunk
– Investments in R&D
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• The key question:
– To what extent do the input prices facing a typical firm in this
industry deviate from those that would prevail in perfectly
competitive input markets because of the bargaining power of
input suppliers?
• The power of suppliers increases if:
– Input is a critical component of production
– Supplier industry more concentrated than the industry it sells to.
– Firms in the analyzed industry purchase relatively small volumes
relative to other customers of the supplier.
– Suppliers can credibly threaten to forward integrate.
– Switching costs are high
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V. Bargaining Power of Buyers
(VI) Complementary products
• The key question
– To what extent do purchase prices in this market differ from those
that would prevail in a market with a large number of fragmented
buyers in which buyers act as price takers.
Question:
How does availability/ price of complementary products affects demand
• The power of buyers increases if:
– input is a not a critical component of production
– buyers are large and few in numbers
– input is relatively standardized
– switching costs for buyers are low
– lots of substitutes
– buyers can credibly threaten to backward integrate
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for the product.?
Two aspects:
• Market for complementary market affects demand for own product
• Need for complementary products limits own ability to capture value –
PIE must be shared
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Examples:
– Soda Cans and Sodas
– Intel/Microsoft
– Automobiles/ Roads
Chicago GSB, Spring 06
Outline
2: Strategy Identification
1. Industry Analysis
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2. Strategy Identification
3. Competitive Advantage
4. Organization and Competitive Advantage
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A coherent business strategy has a clear statement of:
– Objectives: where are we going?
– Scope: in which products, markets, and activities will we
participate?
– Competitive advantage: how will we:
• Make our products more attractive than real or potential
competitors?
• Be more efficient than real or potential competitors?
– An underlying logic: why will we succeed in gaining the CA and
retaining it?
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Strategy Evaluation
Strategy Evaluation
• The logic of a strategy is evaluated by querying its:
(1) Internal consistency: Does the firm’s various
organizational practices cohere with one another and
with the purported competitive advantages?
• The logic of a strategy is evaluated by querying its:
(2) External consistency:
• Do they really achieve competitive advantage?
• How successfully do the purported competitive
advantages and supporting organizational practices
address key environmental challenges?
• To what extent will the competitive advantage
survive competition?
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