MODULE 6
Strategic Management
SESSION TOPIC 6: Business-Level Strategy and the Industry Environment
LEARNING OUTCOMES:
The f ollowing specif ic learning objectives are expected to be realized at the end of the session:
1. To identif y the strategies managers can develop to increase prof itability in f ragmented industries
2. To discuss the special problems that exist in embryonic and growth industries and how companies can develop
strategies to ef f ectively compete
KEY POINTS
Chaining
Franchising
Market development
Product
strategy
prolif eration
CORE CONTENT
Introduction:
This module looks at dif f erent strategies that companies can pursue to strengthen their competitive position in
each of these dif f erent stages of the industry lif e cycle. What we will see is that each stage in the evolution of its industry
raises some interesting challenges f or a business. Managers must adopt the appropriate strategies to deal with these
challenges.
STRATEGY IN A FRAGMENTED INDUSTRY
A f ragmented industry is one composed of a large number of small - and medium-sized companies. Examples of
f ragmented industries include the dry-cleaning, hair salon, restaurant, health club, massage, and legal services industries.
There are several reasons that an industry may consist of many small companies rather than a f ew large ones
Reasons for Fragmentation
1. A lack of scale economies may mean that there are f ew, if any, cost advantages to large size. There are no
obvious scale economies in landscaping and massage services, f or example, which helps explain why these
industries remain highly f ragmented. In some industries customer needs are so specialized that only a small
amount of a product is required; hence, there is no scope f or a large mass -production operation to satisf y the
market. Custom-made jewelry or catering is an example of this.
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2. Brand loyalty in the industry may primarily
be local. It may be dif f icult to build a brand
through dif f erentiation that transcends a
particular location or region. Many
homebuyers, f or example, pref er dealing
with local real estate agents, whom they
perceive as having better local knowledge
than national chains.
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
f ragmented. The massage services industry
exemplif ies this situation. Due to the absence of scale requirements, the costs of opening a massage services
business are minor and can be shouldered by a single entrepreneur.
Consolidating a Fragmented Industry through Value Innovation
Business history is f ull of examples of entrepreneurial organizations that have pursued strategies to create meaningf ul
scale economies and national brands where none previously existed. In the process they have consolidated industries
that were once f ragmented, reaping enormous gains f or themselves and their shareholders in the process . The lesson is
clear; f ragmented industries are wide open market spaces —blue oceans—just waiting f or entrepreneurs to transf orm
them through the pursuit of value innovation. A key to understanding this process is to recognize that in each case, the
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value innovator def ines value dif f erently than established companies, and f inds a way to of f er that value that lowers costs
through the creation of scale economies.
In f ast f ood, for example, McDonald’s offers reliable, quick, and convenient f ast f ood,
and does so at a low cost. The low cost comes f rom two sources —f irst the
standardization of processes within each store, which boosts labor productivity, and
second, the attainment of scale economies on the input side due to McDonald’s
considerable purchasing power (which has gotten bigger and bigger over time as
McDonald’s grew). McDonald’s, then, was also a value innovator in its day, and
through its choice of strategy the company helped to drive consolidation in the f astf ood segment of the restaurant industry.
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Chaining and Franchising
In many f ragmented industries that have been consolidated through value innovation, the transf orming company of ten
starts with a single location, or just a f ew locations. The key is to get the strategy right at the f irst f ew locations, and then
expand as rapidly as possible to build a national brand and realize scale economies bef ore rivals move into the market.
If this is done right, the value innovator can build f ormidable barriers to new entry by establishing strong brand loyalty and
enjoying the scale economies that come f rom large size (of ten, these scale economies are associated with purchasing
power).
There are two strategies that enterprises use to replicate their of f ering once they get it right. One is chaining and the
other is f ranchising.
▪
▪
Chaining involves opening additional locations that adhere to the same basic f ormulae, and that the company
owns.
Franchising is similar in many respects to chaining, except that in the case of f ranchising the f ounding
company—the f ranchisor—licenses the right to open and operate a new location to another enterprise—
f ranchisee—in return f or a f ee. Typically, f ranchisees must adhere to some strict rules that require them to adopt
the same basic business model and operate in a certain way. Thus, a McDonald’s f ranchisee has to have the
same basic look, f eel, of f erings, pricing, and business processes as other restaurants in the system, and has to
report standardized f inancial inf ormation to McDonald’s on a regular basis.
Horizontal Mergers
Another way of consolidating a f ragmented industry is to merge with or acquire competitors, combining them together into
a single larger enterprise that is able to realize scale economies and build a more compelling national brand.
STRATEGIES IN EMBRYONIC AND GROWTH INDUSTRIES
An embryonic industry is one that is just beginning to develop, and a growth industry is one in which f irst-time demand is
rapidly expanding as many new customers enter the market. Managers must be aware of the way competitive f orces in
embryonic and growth industries change over time because they f requently need to build and develop new kinds of
competencies, and ref ine their business strategy, in order to ef f ectively compete in the f uture.
Customer demand f or the products of an embryonic industry is initially limited f or a variety of reasons. Reasons f or slow
growth in market demand include:
1. the limited perf ormance and poor quality of the f irst products;
2. customer unf amiliarity with what the new product can do f or 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 f or customers; and
5. high production costs because of small volumes of production
An industry moves f rom the embryonic stage to the growth stage when a mass market starts to develop f or its product (a
mass market is one in which large numbers of customers enter the market).
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Mass markets start to emerge when three things happen:
1. ongoing technological progress makes a product easier to use, and increases its value f or the average customer;
2. complementary products are developed that also increase its value; and
3. companies in the industry work to f ind ways to reduce the costs of producing the new products so they can lower
their prices and stimulate high demand
The Changing Nature of Market Demand
Managers who understand how the demand f or a
product is af f ected by the changing needs of
customers can f ocus on developing new
strategies that will protect and strengthen their
competitive
position,
such
as
building
competencies to lower production costs or speed
product development.
In most product markets, the changing needs of
customers lead to the S-shaped growth curve.
The curve is S-shaped because as the stage of
market development moves f rom embryonic to
mature, customer demand f irst accelerates then
decelerates as the market approaches the
saturation point—where most customers have
already purchased the product f or the f irst time,
and
demand
is
increasingly limited to
replacement demand. This curve has major
implications f or a company’s dif f erentiation, cost,
and pricing decisions.
The f irst group of customers to enter the market is ref erred to as innovators. Innovators are “technocrats” or “gadget
geeks”; people who are delighted to be the f irst to purchase and experiment with a product based on a new technology —
even if it is imperf ect and expensive.
Early adopters are the second group of customers to enter the market; they understand that the technology may have
important f uture applications and are willing to experiment with it to see if they can pioneer new uses f or the technology.
Early adopters are of ten people who envision how the technology may be used in the f uture, and they try to be the f irst to
prof it f rom its use. Jef f Bezos, the f ounder of Amazon.com, was an early adopter of Web technology. In 1994, bef ore
anyone else, he saw that the Web could be used in innovative ways to sell books. Both innovators and early adopters
enter the market while the industry is in its embryonic stage.
The next group of customers, the early majority, f orms the leading wave or edge of the mass market. Their entry into the
market signif ies the beginning of the growth stage. Customers in the early majority are practical and generally understand
the value of new technology. They weigh the benef its of adopting new products against the costs, and wait to enter the
market until they are conf ident they will benef it. When the early majority decides to enter the market, a large number of
new buyers may be expected.
When the mass market reaches a critical mass, with about 30% of the potential market penetrated, the next group of
customers enters the market. This group is characterized as the late majority, the customers who purchase a new
technology or product only when it is obvious the technology has great utility and is here to stay. A typical late majority
customer group is a somewhat “older” and more behaviorally conservative set of customers. They are f amiliar with
technology that was around when they were younger, but are of ten unf amiliar with the advantages of new technology. The
late majority can be a bit nervous about buying new technology, but they will do so once they see large numbers of people
adopting it and getting value out of it.
Laggards, the last group of customers to enter the market, are people who are inherently conservative and
unappreciative of the uses of new technology. Laggards f requently ref use to adopt new products even when the benef its
are obvious, or unless they are f orced to do so by circumstances—f or example, due to work-related reasons. People who
use typewriters rather than computers to write letters and books are an example of laggards.
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STRATEGIC IMPLICATIONS: CROSSING THE CHASM
Why are pioneering companies of ten unable to create a business model that allows them to be successf ul over time and
remain as market leaders? Innovators and early adopters have very dif f erent customer needs f rom the early majority. In
an inf luential book, Geof f rey Moore argues that because of the dif f erences in customer needs between these groups, the
business-level strategies required f or companies to succeed in the emerging mass market are quite dif f erent f rom those
required to succeed in the embryonic market. Pioneering companies that do not change the strategies they use to pursue
their business model will theref ore lose their competitive advantage to those companies that implement new strategies
aimed at best serving the needs of the early and late majority. New strategies are of ten required to strengthen a
company’s business model as a market develops over time f or the f ollowing reasons:
1.
2.
3.
Innovators and early adopters are technologically sophisticated customers willing to tolerate the limitations of the
product. The early majority, however, values ease of use and reliability. Companies competing in an embryonic
market typically pay more attention to increasing the perf ormance of a product than to its ease of use and
reliability. Those competing in a mass market need to make sure that the product is reliable and easy to use.
Thus, the product development strategies required f or success are dif f erent as a market develops over time.
Innovators and early adopters are typically reached through specialized distribution channels, and products are
of ten sold by word of mouth. Reaching the early majority requires mass -market distribution channels and massmedia advertising campaigns that require a dif f erent set of marketing and sales strategies.
Because innovators and the early majority are relatively f ew in number and are not particularly price sensitive,
companies serving them typically pursue a f ocus model, produce small quantities of a product, and price high. To
serve the rapidly growing mass-market, large-scale mass production may be critical to ensure that a high-quality
product can be reliably produced at a low price point.
In sum, the business models and
strategies required to compete in an
embryonic market populated by early
adopters and innovators are very
dif f erent f rom those required to
compete in a high-growth mass
market populated by the early
majority. As a consequence, the
transition between the embryonic
market and the mass market is not a
smooth, seamless one. Rather, it
represents a competitive chasm or
gulf that companies must cross.
According to Moore, many companies
do not or cannot develop the right
business model; they f all into the
chasm and go out of business. Thus,
although embryonic markets are
typically populated by a large number
of small companies, once the mass
market begins to develop, the number
of companies sharply decreases.
STRATEGY IN MATURE INDUSTRIES
A mature industry is commonly dominated by a small number of large companies. Although a mature industry may also
contain many medium-sized companies and a host of small, specialized companies, the large companies of ten determine
the nature of competition in the industry because they can inf luence the six competitive f orces . In mature industries,
business-level strategy revolves around understanding how established companies collectively attempt to moderate the
intensity of industry competition in order to preserve both company and industry prof itability. Interdependent companies
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can help protect their competitive advantage and prof itability by adopting strategies and tactics, f irst, to deter entry into an
industry, and second, to reduce the level of rivalry within an industry.
Strategies to Deter Entry
In mature industries successf ul enterprises have normally gained substantial economies of scale and established strong
brand loyalty. The economies of scale and brand loyalty enjoyed by incumbents in an industry constitute strong barriers to
new entry. However, there may be cases in which scale and brand, although signif icant, are not suf f icient to deter entry. In
such circumstances there are other strategies that companies can pursue to make new entry less likely.
➢
Product Proliferation One way in which companies try to enter a mature industry is by looking f or market
segments or niches that are poorly served by incumbent enterprises. The entry strategy involves entering these
segments, gaining experience, scale and brand in that segment, and then progressively moving upmarket. This is
how Japanese automobile companies f irst entered the U.S. market in the late 1970s and early 1980s. They
targeted segments at the bottom end of the market f or small inexpensive cars that were f uel -ef f icient. These
segments were not well served by large American manuf acturers such as Ford and GM. Once companies like
Toyota and Honda had gained a strong position in these segments, they started to move upmarket with larger
of f erings, and ultimately entering the pick-up truck and SUV segments, which historically had been the most
prof itable parts of the automobile industry f or American companies. A product proliferation strategy involves
incumbent companies attempting to f orestall entry by making sure that every niche or segment in the marketplace
is well served.
➢
Limit Price A limit price strategy may be used to deter entry when incumbent companies in an industry enjoy
economies of scale, but the resulting cost advantages are not enough to keep potential rivals out of the industry.
A limit price strategy involves charging a price that is lower than that required to maximize prof its in the short run,
but is above the cost structure of potential entrants.
➢
Strategic Commitments Incumbent companies can deter entry by engaging in strategic commitments that send
a signal to any potential new entrants that entry will be dif f icult. Strategic commitments are investments that signal
an incumbent’s long-term commitment to a market, or a segment of that market. As an entry -deterring strategy,
strategic commitments involve raising the perceived costs of entering a market, thereby reducing the likelihood of
entry. To the extent that such actions are successf ul, strategic commitments can help to protect an industry and
lead to greater long-run prof its f or those already in the industry.
Strategies to Manage Rivalry
Beyond seeking to deter entry, companies also wish to develop strategies to manage their competitive interdependence
and decrease price rivalry. Unrestricted competition over prices reduces both company and industry prof itability. Several
strategies are available to companies to manage industry rivalry.
➢
Price Signaling A company’s ability to choose the price option that leads to superior perf ormance is a f unction of
several f actors, including the strength of demand f or a product and the intensity of competition between rivals.
Price signaling is a method by which companies attempt to control rivalry among competitors to allow the industry
to choose the most f avorable pricing option. price signaling is the process by which companies increase or
decrease product prices to convey their intentions to other companies and inf luence the way other companies
price their products. Companies use price signaling to improve industry prof itability. A tit-f or-tat strategy is a wellknown price signaling maneuver in which a company does exactly what its rivals do: if its rivals cut prices, the
company f ollows; if its rivals raise prices, the company f ollows. By consistently pursuing this strategy over time, a
company sends a clear signal to its rivals that it will mirror any pricing moves they make; sooner or later, rivals will
learn that the company will always pursue a tit-f or-tat strategy.
➢
Price Leadership When one company assumes the responsibility f or setting the pricing option that maximizes
industry prof itability, that company assumes the position as price leader—a second tactic used to reduce price
rivalry between companies in a mature industry. Formal price leadership, or when companies jointly set prices, is
illegal under antitrust laws; theref ore, the process of price leadership is of ten very subtle
➢
Non-price Competition A third very important aspect of product and market strategy in mature industries is the
use of non-price competition to manage rivalry within an industry. The use of strategies to try to prevent costly
price cutting and price wars does not preclude competition by product dif f erentiation. In many industries, product -
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dif f erentiation strategies are the principal tools companies use to deter potential entrants and manage rivalry
within their industries.
➢ Market Penetration When a company
concentrates on expanding market share in its
existing product markets, it is engaging in a
strategy
of
market
penetration.
Market
penetration involves heavy advertising to promote
and build product dif f erentiation. In a mature
industry, advertising aims to inf luence customers’
brand choice and create a brand-name reputation
f or the company and its products. In this way, a
company can increase its market share by
attracting its rival’s customers. Because brand name products of ten command premium prices,
building market share in this situation is very
prof itable.
➢
Product Development Product development is the creation of new or improved products to replace existing
ones.
➢
Market Development Market development f inds new market segments f or a company’s products. A company
pursuing this strategy wants to capitalize on the brand name it has developed in one market segment by locating
new market segments in which to compete.
➢
Product Proliferation We have already seen how product prolif eration can be used to deter entry into an
industry. The same strategy can be used to manage rivalry within an industry. As noted earlier, product
prolif eration generally means that large companies in an industry have a product in each market segment (or
niche) If a new niche develops, such as SUVs, designer sunglasses, or shoe-selling websites, the leader gets a
f irst-mover advantage—but soon thereaf ter, all the other companies catch up. Once again, competition is
stabilized, and rivalry within the industry is reduced.
STRATEGIES IN DECLINING INDUSTRIES
Sooner or later, many industries enter into a decline stage, in which the size of the total market begins to shrink.
Examples are the railroad industry, the tobacco industry, the steel industry, and the newspaper business. Industries start
declining f or a number of reasons, including technological change, social trends, and demographic shif ts
The Severity of Decline
When the size of the total market is shrinking, competition tends to intensif y in a declining industry, and prof it rates tend to
f all. The intensity of competition in a declining industry depends on f our critical f actors, which are indicated in the f igure
below. First, the intensity of competition is greater in industries in which decline is rapid, as opposed to industries such as
tobacco, in which decline is slow and gradual. Second, the intensity of competition is greater in declining industries in
which exit barriers are high. High exit barriers keep companies locked into an industry, even when demand is f alling. The
result is the emergence of excess productive capacity, and hence an increased probability of f ierce price competition.
Third, and related to the previous point, the intensity of competition is greater in declining industries in which f ixed costs
are high (as in the steel industry). The reason is that the need to cover f ixed costs, such as the costs of maintaining
productive capacity, can make companies try to use any excess capacity they have by slashing prices, which can trigger a
price war. Finally, the intensity of competition is greater in declining industries in which the product is perceived as a
commodity (as it is in the steel industry) in contrast to industries in which dif f erentiation gives rise to signif icant brand
loyalty, as was true (until very recently) of the declining tobacco industry.
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Choosing a Strategy
There are f our main strategies that companies can adopt to deal with decline:
▪
Leadership Strategy A leadership strategy aims at growing in a declining industry by picking up the market share
of companies that are leaving the industry. A leadership strategy makes most 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. Philip Morris used this strategy in the tobacco
industry. Through strong marketing, Philip Morris increased its market share in a declining industry and earned
enormous prof its in the process.
▪
Niche Strategy A niche strategy f ocuses on pockets of demand in the industry in which demand is stable, or
declining less rapidly than the industry as a whole. This strategy makes sense when the company has some
unique strengths relative to those niches in which demand remains relatively strong.
▪
Harvest Strategy As we noted earlier, a harvest strategy is the best choice when a company wishes to exit a
declining industry and optimize cash f low in the process. This strategy makes the most sense when the company
f oresees a steep decline and intense f uture competition, or when it lacks strengths relative to remaining pockets
of demand in the industry. A harvest strategy requires the company to halt all new investments in capital
equipment, advertising, research and development (R&D), and so f orth. The inevitable result is that the company
will lose market share, but because it is no longer investing in the business, initially its positive cash f low will
increase. Essentially, the company is accepting cash f low in exchange f or market share. Ultimately, cash f low will
start to decline, and when that occurs, it makes sense f or the company to liquidate the business.
▪
Divestment Strategy A divestment strategy rests on the idea that a company can recover most of its investment
in an underperf orming business by selling it early, bef ore the industry has entered into a steep decline. This
strategy is appropriate when the company has f ew 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. The best option
may be to sell to a company that is pursuing a leadership strategy in the industry. The drawback of the divestment
strategy is that its success depends upon the ability of the company to spot industry decline bef ore it becomes
detrimental, and to sell while the company’s assets are still valued by others.
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IN-TEXT ACTIVITY
Chaining
A strategy designed to obtain the advantages of cost leadership by establishing a network of linked merchandising
outlets interconnected by inf ormation technology that f unctions as one large company.
Franchising
A strategy in which the f ranchisor grants to its f ranchisees the right to use the f ranchisor’s name, reputation, and business
model in return f or a f ranchise f ee and of ten a percentage of the prof its.
Market development
When a company searches f or new market segments f or a company’s existing products to increase sales
Product proliferation strategy
The strategy of “f illing the niches,” or catering to the needs of customers in all market segments to deter entry by
competitors.
SESSION SUMMARY
In f ragmented industries composed of a large number of small- and medium-sized companies, the principal f orms of
competitive strategy are chaining, f ranchising, and horizontal merger. There are f our main strategies a company can
pursue when demand is f alling: leadership, niche, harvest, and divestment. The strategic choice is determined by the
severity of industry decline and the company’s strengths relative to the remaining pockets of demand.
SELF-ASSESSMENT
Case study:
A team of marketing managers f or a major dif f erentiated consumer products company has been instructed by top
managers to develop new strategies to increase the prof itability of the company’s products. One idea is to lower the cost
of ingredients, which will reduce product quality; another is to reduce the content of the products while maintaining the
size of the packaging; a third is to slightly change an existing product and then of f er it as a “new” premium brand that can
be sold at a higher price.
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Do you think it is ethical to pursue these strategies and present them to management? In what ways could these
strategies backf ire and cause the company harm?
REFERENCES
Ref er to the ref erences listed in the syllabus of the subject.
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