CHAPTER 6
Competitive Strategy and the Industry
Environment
SYNOPSIS OF CHAPTER
This chapter extends the analysis of business-level strategy by considering the different competitive strategies that
firms can and should adopt as they enter different industry environments. The formulation of business-level
strategy does not take place in a vacuum; companies have to consider the reaction of other firms to their
competitive moves. The chapter is therefore a necessary addition to Chapter 5 and provides a building block to the
chapters on corporate-level strategy.
The chapter begins with an examination of the problems of managing a generic business-level competitive
strategy in different kinds of industry environments: fragmented industries, embryonic and growth industries,
mature industries, and finally in declining industries. In each type of industry, there is a discussion of the
competitive problems associated with that particular environment and the appropriate strategies that firms can use
to tackle those problems.
TEACHING OBJECTIVES
1.
Familiarize students with the different kinds of competitive problems that exist in different industry
environments.
2.
Discuss the problems of developing a competitive advantage in a fragmented industry and the solutions to
such problems.
3.
Discuss the problems of maintaining a first-mover advantage in embryonic and growth industries.
4.
Examine the main kinds of competitive strategies that firms use to manage competitive industry relations in
mature industries.
5.
Familiarize students with the main strategies for handling a declining industry environment.
OPENING CASE: INFORMATION TECHNOLOGY, THE INTERNET,
AND CHANGING STRATEGIES IN THE FASHION WORLD
Fashion houses, such as Armani and Gucci, produce highly differentiated, expensive clothes that are affordable
only to the very rich. They supplement their sales by producing a line of upscale ready-to-wear fashion for sale in
luxury department stores. However, in recent years, fashion houses’ position as the industries differentiators has
been challenged by new firms that use information technology (IT) to lower costs and speed time to market with
new designs. These new designers sell their clothes through mid-price retailers such as Dillard’s or Macy’s, or
through their own retail outlets, as new start-up Zara does. Zara, headquartered in Spain, has designers that closely
watch fashion houses’ offerings each season. Then, the designers link with low cost suppliers, manufacturers, and
shippers from overseas, to produce a new product line and have it in the stores in about six weeks. The firm also
uses IT to monitor each product line’s sales, constantly change its product mix, and minimize inventory. Zara is
thus able to charge low prices, increasing demand, and leading to high ROIC. Zara’s profitability led to a very
successful IPO in 2001, and rivals are now copying the firm’s techniques, hoping to improve their own
performance.
Teaching Note: The clothing design industry is relatively fragmented, with a few large design houses, both
upscale and mass market, and thousands of smaller designers. The success of Zara shows the firm’s understanding
of the factors leading to high performance, including the use of IT to reduce costs, the ability to offer high-quality
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Chapter 6: Competitive Strategy and the Industry Environment
71
products at relatively low prices, and the flexibility to continually innovate and introduce new products quickly.
Zara’s recent actions, including the IPO and opening of more retail outlets, demonstrates the firm’s eagerness to
make the industry more consolidated.
LECTURE OUTLINE
I.
II.
Overview
A. This chapter examines the development of a firm’s strategy to manage its industry environment.
B.
Firms have to manage competitive relations with other firms, and these relationships differ depending
on the nature of the competitive industry environment. First, strategies to compete in fragmented
industries are described. Next, strategies that are appropriate for embryonic, growth, mature, and
declining industry environments are discussed.
Strategies in Fragmented Industries
A. A fragmented industry comprises a large number of small- and medium-sized companies, such as the
dry cleaning or restaurant industries.
B.
An industry may be fragmented for several reasons.
1.
It may be fragmented because of lack of economies of scale leading to low barriers to entry. For
example, customers prefer to deal with local real estate agents.
2.
Some industries are fragmented due to diseconomies of scale, such as occurs when customers
prefer the taste of local restaurant food to the standardized offerings of chain restaurants.
3.
Low barriers to entry allow a constant influx of entrepreneurs in some specialized industries.
4.
High transportation costs, such that local production is the only efficient method, can contribute
to fragmentation.
5.
Specialized customer needs mean that companies cannot take advantage of mass production and
encourage fragmentation.
C.
A focused strategy is an appropriate competitive choice in a fragmented industry. Examples are small
specialty or “custom-made” companies and service organizations.
D. However, if a way can be found to overcome the factors that cause industry fragmentation and to let
the industry consolidate, the potential returns are high. This is what firms like Wal-Mart and
McDonald’s and chains of health clubs, lawyers, and accountants have done.
1.
Chaining involves establishing a network of linked merchandise outlets to obtain the
advantages of a cost-leadership or differentiation strategy. It allows bulk purchasing, economies
of scale in advertising, increased ability to serve customers, and so on. Examples include
restaurant chains, discount store chains, and supermarket chains.
2.
In franchising, the local outlets of a chain are owned and managed by the same person. Thus
there is a strong motivation for the owner-manager to control costs and maintain quality. The
personal service they offer is especially helpful for differentiators. Franchising also permits
quick expansion and thus growth. The franchisers’ operations can be small and local, while still
taking advantage of the same opportunities that larger firms enjoy.
3.
When one firm in an industry takes over and merges with another firm, a horizontal merger
has occurred. The result of horizontal mergers is less competition and greater ability to
influence price and output decisions, which increases industry profitability. Chapter 9 contains
a more expanded discussion of horizontal mergers.
4.
The Internet is the latest means by which companies have been able to consolidate a fragmented
industry. Good examples of this approach are eBay in the auction industry and amazon.com in
the bookstore industry.
STRATEGY IN ACTION 6.1: CLEAR CHANNEL CREATES A NATIONAL CHAIN
OF LOCAL RADIO STATIONS
In just seven years, Clear Channel has gone from owning a single radio station to ownership of over 1,200
compared to the second-largest radio broadcaster, Citadel with 205 stations. Before 1996, U.S. regulators allowed
one firm to own no more than 40 stations, but Clear Channel acted quickly when the law was repealed. The firm
sought to grow as a way to increase quality, listeners, and advertising revenues, while reducing expenses. Radio
listeners enjoy a station’s local ties, and the firm had to find a way to keep that link, while still gaining the
advantages of standardization. To obtain economies of scale, Clear Channel used IT to develop a new method
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72
Chapter 6: Competitive Strategy and the Industry Environment
called voice tracking. This allows the company to employ just a few popular DJs to produce standard output for
all markets, and also to contribute some customized product for each local market. The firm also developed KISS
as its brand name across all its radio stations. These measures created a differentiated product that appealed to
many customer segments, while also lowering costs.
Teaching Note: Before Clear Channel’s phenomenal growth, the radio industry was highly fragmented, with
hundreds of local broadcasters. Clear Channel found a way to pursue both cost leadership and differentiation
simultaneously, giving the firm higher profitability. When combined with a change in legislation, this strategy
allowed the firm to consolidate the once-fragmented industry. Ask students to describe which of the four
strategies for consolidation Clear Channel has adopted. Then, ask if they know of any other firms that are using
one or more of those methods to consolidate industries that were previously consolidated. (Examples might
include Dell in the PC industry or Yum! Brands—which owns Kentucky Fried Chicken, Long John Silver’s, Pizza
Hut, Taco Bell, and A&W Root Beer—in restaurants.)
III.
Strategies in Embryonic and Growth Industries
A. Embryonic and growth industries pose special challenges for strategists because customer attributes
change as markets develop. Also, the rate of market growth exercises a significant influence over the
success of the chosen strategy.
B.
Embryonic industries typically arise through innovations by pioneering companies.
C.
Customer demand in embryonic industries is typically limited, due to the limited performance and
poor quality of the first products, customer unfamiliarity with what the new product can do for them,
poorly developed distribution channels to get the product to customers, a lack of complementary
products to increase the value of the product for customer, and high production costs because of small
volumes of production.
D. Embryonic industries become growth industries as a mass market develops for the firm’s products.
This occurs when technological progress increases the value of the product to the customer, key
complementary products are developed, and companies reduce production costs and set a low price,
stimulating demand.
E.
Understanding changes in market demand is critical for firms in the embryonic and growth stages.
1.
Growth follows an S-curve, with demand first accelerating and then decelerating.
Show Transparency 37
Figure 6.1: Market Development and Customer Groups
a.
b.
c.
d.
e.
The first customers to enter a market are innovators, who enjoy tinkering with new
products and are willing to pay high prices.
Early adopters follow the innovators. They are visionaries, and see the possibility of
using the new product in diverse and ingenious ways.
These are followed by the early majority, who constitute the leading edge and signal of
the arrival of the mass market. They are practical, weighing product benefits against
costs. They arrive in large numbers.
After about 30 percent of potential customers have entered the market, the late majority
enters. This is a more cautious group of customers, but it is as large as the early majority.
Finally, the laggards, who tend to be very conservative and perhaps even techno-phobic,
arrive.
Show Transparency 38
Figure 6.2: Market Share of Different Customer Groups
2.
3.
Pioneering companies that fail often attract innovators and early adopters, but fail to attract the
majority, leading to few sales and ultimately, the firm’s failure. Companies that attract the
majority, on the other hand, are likely to experience very high sales and high profits.
Geoffrey Moore argues that innovators and early adopters have very different needs than the
early majority, and thus firms need a different set of competencies to serve them effectively.
a.
Innovators tolerate technical problems, but the early majority favors ease of use and
reliability.
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Chapter 6: Competitive Strategy and the Industry Environment
b.
c.
d.
73
Innovators can be reached through specialty retailers, but the early majority uses mass
distribution channels.
Innovators are few and are not price sensitive, so skills in mass production are not
required. When the early majority arrives, mass production is necessary to insure quality
at a lower cost.
Moving from an embryonic market to a mass market is not easy and smooth; instead, it
represents a competitive chasm. Thus, embryonic markets consist of many small firms,
but most fall into the chasm and disappear, leaving only a few firms in a mass market.
Show Transparency 39
Figure 6.3: The Chasm: AOL and Prodigy
STRATEGY IN ACTION 6.2: HOW PRODIGY FELL INTO THE CHASM
Prodigy, founded in 1984 and nurtured by major investors Sears and IBM, was once the leader in online networks.
The match of retailing and technological expertise seemed to be made in heaven. Prodigy was very successful and
had little competition, except from CompuServe, which was focused on financial services (it was founded by
H&R Block). Ten years later, AOL was the dominant online network and Prodigy was gone, after Sears and IBM
together lost $1.2 billion. Prodigy had a very accurate vision of the future of the Internet—driven by the mass
market for online retailing—but its business model was not as good. It charged customers for e-mail and censored
chat rooms, fearful of lawsuits. Prodigy was also slow to adopt a new Windows interface, due to the competition
between IBM and Microsoft. In contrast, AOL offered free e-mail, uncensored chat rooms, and easy-to-use
Microsoft interfaces. By 1996, the competition was over and Prodigy was through.
Teaching Note: Prodigy did a wonderful job of attracting innovators and early adopters, but stumbled when
making the transition to a mass market. They failed to consider how the needs of mass-market customers differed
from those that they had served so well in the past. In addition, they were cautious in making changes and let their
rivals get ahead in innovation. Finally, they failed to update their business model, even when other models were
demonstrably superior. This is a cautionary tale for students about how a successful firm can go horribly wrong,
and quickly. Ask students if they know of other examples of companies that did not successfully cross the chasm.
4.
Managers in embryonic and growth industries must learn how to compete for the mass market.
a.
One important focus for these managers is to correctly identify the needs of the first
members of the early majority very early on, while the growth is still primarily being
driven by innovators and early adopters.
b.
Managers must then alter their business model and their value chain activities so as to
effectively reach the early majority.
c.
Managers must also not become too focused on meeting the needs of innovators and early
adopters, who don’t contribute significant sales.
d.
Managers must be aware of and respond effectively to their competitors’ actions. Game
theory is useful here.
e.
Managers must understand the S-curve of growth, and realize that industries develop at
different rates. By their strategic choices and actions, managers can change their
industry’s growth rate, and thus, its profitability.
Show Transparency 40
Figure 6.4: Differences in Diffusion Rates
(1)
(2)
A factor that accelerates customer demand is a new product’s relative advantage,
that is, the degree to which a new product is perceived as better at satisfying
customer needs than the product it supersedes.
Another factor is compatibility, which refers to the degree to which a new product
is perceived as being consistent with the current needs or values of potential
adopters.
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74
Chapter 6: Competitive Strategy and the Industry Environment
(3)
IV.
Complexity, the degree to which a new product is perceived as difficult to
understand and use, is another factor.
(4) A fourth factor is trialability, which is the degree to which a new product can be
experimented with on a hands-on trial basis.
(5) A fifth factor is observability, which refers to the degree to which the results of
adopting a new product can be clearly seen and appreciated by other people.
(6) A final factor that is very important in the growth of many new products is the
availability of complementary products.
f.
Therefore, one way for managers to help their industries grow rapidly is to use these six
factors to their advantage. For example, increase the product’s compatibility, reduce its
complexity, and so on.
g.
Another concept that can be helpful to managers is to think of the spread of demand for a
new product as analogous to a viral infection. Thus, companies can identify and court
community opinion leaders.
Strategy in Mature Industries
A. A mature industry becomes consolidated so that it comprises a small number of large companies that
are interdependent; they recognize that their actions affect one another.
B.
Thus, the main issue facing a company in a mature industry is to adopt a competitive strategy that
simultaneously enables it to maximize its profitability given the strategies that all other companies in
the industry are likely to pursue.
C.
Firms in a mature industry can pursue strategies based on game theory principles to increase the
profitability of all competitors in the industry.
1.
One important goal of firms in mature industries is to deter potential entrants.
Show Transparency 41
Figure 6.5: Strategies for Deterring Entry of Rivals
a.
One method for deterring potential entrants is product proliferation, which occurs when
a company tries to broaden its product line and provide products for all market segments
in order to make it very hard for a potential competitor to enter the market. Such an effort
is also called “filling the niches.” When the niches are filled, it is hard to enter except at a
disadvantage.
Show Transparency 42
Figure 6.6: Product Proliferation in the Restaurant Industry
b.
Another way to deter potential entrants is through the use of pricing games.
(1) Companies can deter entry by cutting prices every time a potential entrant
contemplates entering, sending a strong signal. However, firms must be careful to
avoid illegal predatory pricing, in which a large company uses revenue generated
in one market to support pricing below the cost of production in another market.
(2) Another pricing game is the use of limit pricing, in which existing companies with
scale economies can set prices above their cost of production, but under the new
entrant’s cost of production, which will be higher due to their smaller size and lack
of experience. However, firms that plan to enter and use a new, lower-cost
technology will not be deterred by limit pricing.
Show Transparency 43
Figure 6.7: Limit Pricing Strategy
(3)
Both of these strategies will be unsuccessful against a powerful new entrant, for
example, a firm that is already successful in another industry and now wishes to
enter other industries.
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Chapter 6: Competitive Strategy and the Industry Environment
75
STRATEGY IN ACTION 6.3: TOYS “R” US’S NEW COMPETITORS
Toys “R” Us rapidly opened a nationwide chain of retail stores and pursued a cost-leadership strategy to
outperform its rivals and consolidate a previously fragmented industry. Originally, its low cost strategy relied on
efficient materials management techniques and low levels of customer service. As the company grew in size, it
also decided to add more products, which raised inventory expenses. However, new rivals like Wal-Mart and
Target saw the profitability of the toy market and began to focus more attention on toys. Toy “R” Us had lost its
cost advantage and couldn’t drop prices to the levels that the big discounters could. In response, Toys “R” Us
concentrated on lowering costs further through the use of IT and a reduction in the number of items sold. They
also created other types of stores, which focus on different customer segments and try to differentiate in addition
to following cost leadership. It also went online, partnering with amazon.com in offering toys online.
Teaching Note: Toys “R” Us used pricing games to attack its competitors in the toy industry, driving several of its
major rivals out of business. Successful pursuit of that strategy was enabled by the firm’s very low expenses—it
could cut prices and still be profitable. However, the firm became complacent, and soon found that other, stronger
firms were using its own strategy. This case demonstrates the difficulty of competing on a price basis, namely,
that there will always be someone who can find a way to drive down costs further. Cost advantages are often
based on factors, such as economies of scale, which can be duplicated by powerful rivals. Point out to students
that this is a continual strategic threat—the possibility that a rival will adopt one’s own strategy and do it better.
With that in mind, ask students if they think that market leaders in other industries will ever lose their leadership.
What does it take to unseat a leader?
c.
2.
A third way to deter potential entrants is by maintaining excess capacity. Existing firms
threaten potential entrants on notice with the possibility that they will increase production
and drive down prices to a level at which new entry would be unprofitable.
Another important goal of firms in mature industries is to reduce industry rivalry.
a.
Price signaling is the process by which firms convey their intentions to rivals concerning
pricing strategy and how they will compete in the future or how they will react to the
competitive moves of their rivals.
(1) For example, firms can announce that they will follow along with other firms’ price
cuts or increases. This is called a tit-for-tat strategy.
b.
Price leadership, in which one company takes the responsibility of setting industry
prices, is another way of using price signaling to enhance industry profitability. By
setting prices, the leader creates a model that other firms can follow.
(1) The price leader is generally the strongest firm in the industry, so it can best
threaten other companies that might cut prices.
(2) Such price setting is illegal, so the process is often very subtle. For example,
frequently, the weakest firms—those with the highest cost structures, are used as a
price model for the other competitors.
(3) Price leadership stabilizes industry relationships, giving weaker firms more time to
strengthen. However, it can lead to complacency and makes existing firms
vulnerable to competitors with new, lower-cost technologies.
c.
A third way that companies try to reduce industry rivalry is by the use of nonprice
competition, such as product differentiation. Nonprice competition reduces rivalry
because it keeps a competitor from gaining access to its customers and from attacking its
market share. Product differentiation also reduces rivalry because it minimizes the risk
that companies will compete by price, which hurts everybody.
Show Transparency 44
Figure 6.8: Four Nonprice Competitive Strategies
(1)
(2)
Market penetration is one type of nonprice competition. It occurs when a
company expands into more segments of its existing market. This strategy uses
heavy advertising to promote and build product differentiation.
Product development involves consistently creating new or improved products to
replace existing ones. This strategy relies on extensive R&D and can be expensive.
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76
Chapter 6: Competitive Strategy and the Industry Environment
(3)
(4)
In some industries, preemptive signaling, or announcing a product development
that is not yet ready for sale, is widely used.
Market development involves finding new market segments to exploit a
company’s products. The firm is seeking to capitalize on its brand name in new
markets, as the Japanese did in entering the luxury segment of the car market.
Product proliferation can also be used to reduce rivalry. Here each firm in the
industry makes sure that it is in every niche to prevent any firm from gaining a
competitive advantage, and if a new niche develops, it rushes to provide a product
to fill the niche and reestablish industry stability.
STRATEGY IN ACTION 6.4: FAST FOOD IS A RUTHLESS BUSINESS
Prices are very important in the fast food industry, where customers often make decisions based purely on price.
Taco Bell introduced 99¢ tacos, shocking competitors who then scrambled to find a way to meet that price with
their products. When all competitors had prices in the very low range, they then looked to nonprice competition
for advantages, trying tactics such as offering a bigger burger. The firms also began to aggressively open outlets
in previously untapped segments of the market, for example in airports, gas stations, and Wal-Marts. The fast food
rivals are also busily developing new products and allowing stores to customize products for local tastes. They are
also trying to become a one-stop food shop, offering fare such as pizza and salads. The quest for next “must-have”
fast food product continues.
Teaching Note: The mature, saturated, highly competitive fast food industry has every type of competition: price,
market penetration, product development, market development, and product proliferation. Ask students to look
through the case and find examples of each of the above. Then, choose another industry that is also highly
competitive and ask students to give examples from that industry.
d.
3.
Although firms prefer nonprice competition, price competition is likely to break out when
industry overcapacity exists, due to overbuilding, falling demand, technological
advancements, or entry into the industry.
e.
Firms control industry capacity preemptively, when one first-mover rapidly increases
capacity and deters others from doing so.
(1) This strategy is risky because it involves committing to investment before the
market demand is clear.
(2) It is also risky because it may fail to deter competitors.
f.
Firms may instead choose to control capacity through a coordination strategy in which
firms signal to one another their intentions concerning their future capacity. By indirectly
informing one another of their plans, they seek to ensure jointly that capacity does not
become so large that it promotes a price war. However, they must avoid overt signaling,
which is considered to be illegal tacit collusion under antitrust law.
Another important goal of firms in mature industries is to effectively manage its relationships
with buyers and suppliers.
a.
Companies in mature industries tend to have high power over buyers and suppliers. Both
buyers and suppliers tend to become dependent on the firm in a consolidate industry.
b.
One common strategy is for companies to own their supply or distribution operations,
which is called “vertical integration.” Vertical integration is covered more extensively in
Chapter 9.
c.
Another common strategy is for the firm to outsource some of its functions in order to
lower costs.
d.
There are important reasons to control supplier-distributor relationships. The firm can
safeguard its ability to dispose of its outputs or acquire inputs in a timely, reliable
manner, thereby reducing costs and improving product quality.
(1) One type of relationship between a firm and its buyers or suppliers is the
anonymous approach, in which the two parties have an arms-length, short-term
relationship. This type of relationship has been the norm in American business for
years.
(2) Another type of relationship is the relational approach, in which the two parties
develop a long-term, mutually supportive relationship built on trust. This type of
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Chapter 6: Competitive Strategy and the Industry Environment
e.
77
relationship offers benefits to both parties and is becoming more common in the
U.S.
There are several ways to distribute products. The company can sell to an independent
distributor that sells to retailers, or the firm may sell directly to retailers or even directly
to the customer.
RUNNING CASE: COMPAQ AND DELL GO HEAD-TO-HEAD IN CUSTOMER
SERVICE
In the competitive PC industry, Compaq first followed a differentiation strategy based on technological expertise
and extensive customer support, and it became the premier provider of business machines. Dell was the first
company to directly market personal computers to consumers, bypassing the middleman to keep costs low and
undercut its rivals. Dell saw itself as a distribution company, not an engineering one. In 1993, Compaq announced
that it would also pursue this strategy, and the two are now in direct competition. However, Compaq was not as
successful as Dell in its on-line distribution strategy, both because Dell was first to engage in such distribution and
established a first-mover advantage, and because Dell has established a more customer-friendly web site and
enjoys the record for fewest customer complaints. With Compaq’s merger with Hewlett Packard, however, all that
may change. Compaq now has the resources to upgrade its customer service.
Teaching Note: Dell’s direct sales model is built upon an advantage in the efficient use of IT resources. The
company can use its web site to sell direct to customers, which also reduces the labor expenses associated with
maintaining a large, skilled sales force. Whether Compaq can leverage the advantages it has gained by the merger
with HP remains to be seen. For class discussion, ask students to make suggestions as to how Compaq should use
its new resources to help it better compete with Dell.
(1)
V.
The complexity of the product and the amount of information it requires will
determine which method a company will use to distribute its products. The more
complex the product, the more likely a company is to try to control the way its
products are sold and serviced.
(2) However, large firms that sell nationwide usually sell directly to the retailer
because they save the profit that would otherwise have gone to the wholesaler or
distributor.
Strategy in Declining Industries
A. Once demand starts to fall, an industry is in decline, and competitive pressures become even more
intense. Industries usually decline due to changes in technology, social trends, or demographics.
B.
Four critical factors determine the intensity of competition in a declining industry. Rapid decline, high
exit barriers, high fixed costs, and commodity products generate more competition. Also, segments
within an industry may decline at different rates.
Show Transparency 45
Figure 6.9: Factors that Determine the Intensity of Competition in Declining Industries
C.
Companies have different strategies available to deal with decline.
Show Transparency 46
Figure 6.10: Strategy Selection in a Declining Industry
1.
One strategy for dealing with decline is the leadership strategy, which is an attempt to pick up
the market share of companies leaving an industry. This makes most sense when a company has
distinctive strengths that give it a competitive advantage and the rate of decline is moderate.
a.
The tactical steps companies might use to achieve a leadership position include
aggressive pricing and marketing to build market share, acquiring established competitors
to consolidate the industry, and raising the stakes for other competitors.
b.
The leadership strategy signals to competitors that a firm is willing to stay and compete,
and may speed up exit of competitors from the industry.
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78
Chapter 6: Competitive Strategy and the Industry Environment
STRATEGY IN ACTION 6.5: HOW TO MAKE MONEY IN THE VACUUM TUBE
BUSINESS
In the declining vacuum tube industry, Richardson bought the stocks and business of large companies like
Westinghouse. Richardson then became the dominant (in fact, the only) company in the industry. As such, it is
able to charge customers high prices and reap profits of 35 to 40 percent. Although vacuum tubes have been
replaced by transistors in most consumer electronics, they are still in demand from customers who are maintaining
older equipment. They also are preferred in some limited applications, such as radar and welding equipment.
Richardson has focused on efficient and speedy delivery—when a customer like GE is facing a loss of thousands
of dollars due to a broken welding machine, cost isn’t the most important consideration. Thus, Richardson is able
to earn enviable results even in a declining industry.
Teaching Note: Declining industries are often perceived of as “dead ends,” and this case can be used to
demonstrate for students that declining industries may still contain opportunities. Richardson’s leadership strategy
is one approach to decline; you can spark a classroom discussion by asking students to consider other declining
industries and the strategies that firms in those industries might use. One good example is the baking soda
industry, which was declining as consumers baked less, until Arm & Hammer thought up new uses for baking
soda, such as for a deodorant or a carpet cleaner, which revitalized that industry.
2.
3.
4.
Another strategy for decline is the niche strategy, which focuses on pockets of demand where
demand is stable or declining less slowly than in the industry as a whole. This strategy makes
sense when the company has distinctive competencies in that particular segment of the market.
A third decline strategy is the harvest strategy, which involves a company optimizing its cash
flow as it exits an industry. This strategy makes sense when the firm anticipates a very steep
decline or when it lacks distinctive competencies.
a.
Tactical steps for achieving a harvest strategy include cutting all investment in the
business, then continuing to produce until sales decline, after which divestiture follows.
b.
In practice, this strategy may be difficult to implement because employee morale suffers,
and if customers realize what is happening, they may defect rapidly and hasten the
decline.
A fourth strategy is the divestment strategy. Once a company has recognized that an industry
is in decline, it moves early to sell the business to maximize the value that it can get for it.
Often it might sell to the leadership company, which is best positioned to weather the storms
ahead.
ANSWERS TO DISCUSSION QUESTIONS
1.
Why are industries fragmented? What are the main ways in which companies can turn a fragmented
industry into a consolidated one?
Industries may be fragmented because (a) there are few economies of scale to be achieved; (b) entry barriers
into the industry are low; (c) customer needs vary from region to region; (d) customer needs are so
specialized that only small job lots of products are required and therefore mass production is not possible;
and (e) transportation costs are high.
The main ways in which companies can turn fragmented industries into consolidated ones include chaining,
franchising, horizontal mergers, and the Internet. Chaining occurs when linked networks of merchandising
outlets are formed and are connected by an efficient distribution system. Franchising means growth through
the establishment of outlets that are both owned and managed locally and are also served by a central
distribution and marketing organization. A horizontal merger occurs when firms take over and merge with
others. The Internet can give even a small firm a large scale of operations, quickly and easily. All four ways
are used in most industries as entrepreneurs strive to maximize the profits they can earn from the industry
environment.
2.
What are the key problems involved in maintaining a competitive advantage in embryonic and growth
industry environments? What are the dangers associated with being the leader?
The key to profiting from innovation in a growth environment is to create, exploit, and sustain a competitive
advantage over industry rivals. Over time, rivals will also be developing their technical competencies, so to
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Chapter 6: Competitive Strategy and the Industry Environment
79
maintain their advantage companies need to defend their reputation, which has built them brand loyalty;
quickly move down the experience curve to keep ahead of rivals; develop control over scarce assets,
including inputs, and over distribution networks; and strive to retain customers by making it very difficult
for them to switch products.
The dangers associated with being a leader include the high costs of start-up, which can leave a company
with a crippling debt burden, and the likelihood that the company’s innovative ideas may be copied by later
entrants at lower cost.
3.
Discuss how companies can use (a) product differentiation and (b) capacity control to manage rivalry and
increase an industry’s profitability.
The virtue of product differentiation as a competitive weapon is that it reduces the risk that companies will
compete on price for customers. Price competition decreases the level of industry profitability.
Market penetration involves using advertising and marketing to create a differentiation advantage to
increase market share. This also raises barriers to entry, thus increasing industry profitability and reducing
rivalry because companies can forecast their rivals’ actions.
Product development means creating new and improved products to sustain consumer demand for products.
It keeps companies on their toes and lessens the likelihood that a new entrant will be able to come into the
industry with a superior product to seize market share. In this sense, product development acts like a barrier
to entry. At the same time, it builds reputation and brand loyalty.
Market development involves finding new market segments in which to exploit a company’s products or
distinctive competencies. Market development and the development of niche marketing can cause intense
rivalry between firms as new spheres of competition are created. Moreover, market development may
provide a means for competitors to enter the market, for it opens a niche through which they can enter. Thus
market development is probably the most competitive of the four product differentiation strategies, since it
creates the most opportunity for gain or loss in market share.
Product proliferation is an effort to stabilize the uncertainty created by market development. By filling all
the market niches, companies are trying to respond to competitors’ actions in order to stabilize the industry
situation. At the same time, product proliferation also promotes barriers to entry since it makes it difficult
for competitors to enter the market by finding a new niche. It therefore also helps stabilize competition in
the industry.
Capacity control strategies also allow the firm to manage rivalry and promote industry profitability.
Capacity control can be used to deter rivals, since it provides companies with a credible threat that they will
respond to the threat of entry by increasing capacity and driving down price. Inside the industry, the need is
for a strategy that lets firms indirectly coordinate their capacity decisions and avoid the wasteful excess
capacity, which can occur if all firms make the decision to build new plant capacity. Such a strategy
stabilizes competition and industry profitability.
SMALL-GROUP EXERCISE: HOW TO KEEP THE HOT SAUCE HOT
This exercise asks students to break into small groups and act as managers of a company that has produced an
innovative and highly popular hot sauce product. Competitors are starting to imitate the sauce. The exercise asks
students to describe their business-level strategy and the industry structure. Students then should describe ways to
protect the firm’s competitive advantage against powerful rivals and make suggestions about strategies for the
future.
Teaching Note: This exercise focuses students’ attention on the problems associated with competition in an
industry dominated by larger, more powerful rivals. Students should recognize the hot sauce firm’s focused
differentiation strategy. They should describe the industry as highly competitive, consolidated, and mature.
Suggestions may range from development of an entire line of products based on the hot sauce to an intense
advertising campaign aimed at establishing the relative quality of the firm’s product as compared to the larger
firms’ products. It’s unlikely that a smaller firm could successfully unseat a broad differentiator such as Kraft
Foods, so students will probably not recommend that. They should realize that focused differentiation is the only
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80
Chapter 6: Competitive Strategy and the Industry Environment
viable option for this firm. Alternatively, however, the firm’s owners may decide to sell or license the product to
one of the larger firms. The proceeds could then be used by the company to develop the next great product.
ARTICLE FILE 6
This exercise asks students to find an example of a company or group of companies that has adopted a
competitive strategy to protect or enhance its business-level strategy.
Teaching Note: Students will readily find examples as virtually all firms use competitive strategies to protect their
overall generic strategy. You can then ask students to describe how the competitive strategy gives these benefits.
For example, consider the choice of a firm in a mature industry that has adopted the nonprice competitive strategy
of market penetration, such as Whirlpool used in introducing its electric appliances into Eastern Europe. Students
can describe how this strategy allowed Whirlpool to sell more products than its competitors who did not enter the
industry, enabling economies of scale and learning curve effects. Whirlpool also gained first-mover advantages,
and had valuable expertise in the regional market before others. Finally, Whirlpool was able to leverage its
existing investments in advertising and product R&D to increase its capital productivity.
STRATEGIC MANAGEMENT PROJECT: MODULE 6
This part of the project continues the analysis of the students’ company’s business-level strategy and examines
how the nature of the industry environment affects the company. Remind students to link this analysis to their
analysis in the previous module. Students are asked to describe their firm’s industry environment and competitive
strategies. They are then asked to recommend future strategies and to predict whether their firm will be able to
maintain its competitive advantage into the future.
Teaching Note: Use this module to reinforce the linkages between a firm’s competitive environment, its choice of
strategy, and its performance. You can point out to students that even the best strategy will not lead to success if it
is inappropriate for its environment. Also remind students that competitors’ actions can have a very important
effect on a strategy’s outcome.
EXPLORING THE WEB: VISITING WAL-MART
Students are asked to examine Wal-Mart’s web site to discover how the firm’s competitive strategy has developed
over time. In the General Task, students are asked to find a company that has recently experienced a change in
strategy, and to describe the changes and the events that led to the change.
Teaching Note: This exercise provides the students with practice in applying the concepts of this chapter. Students
will find that Wal-Mart’s strategy has changed as the retailing industry has grown and matured. In addition,
changes in competitors (new entrants such as Costco, the bankruptcy of K-Mart) have changed the competitive
landscape, and therefore have changed Wal-Mart’s strategy. This is also a good time to reiterate the idea that
successful companies can only continue their success if they are willing to change and adapt. A static strategy, no
matter how good, will eventually be imitated and the competitive advantage lost.
CLOSING CASE: HOW EBAY REVOLUTIONIZED THE AUCTION
BUSINESS
In the early 1990s, Pierre Omidyar had an idea for an online auction company that would revolutionize the selling
of all kinds of products by bringing buyers and sellers together through the Internet. The company charges a small
fee and makes its money from the millions of products that are listed every day. Of course, eBay’s profitability
has generated many imitators. However, eBay’s early start has given it a first mover advantage in reputation.
Other online companies, however, are not willing to give away the lucrative online auction market to eBay; they
are searching for new ways to fight back. The question arises whether eBay can sustain its competitive advantage.
Teaching Note: This case sums up many of the important concepts of this chapter, including
competition in fragmented versus consolidated industries, the changing nature of competition as
industries mature, and price and nonprice competition.
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Chapter 6: Competitive Strategy and the Industry Environment
81
Answers to Case Discussion Questions
1.
Describe the nature of competition and the industry environment of the online auction industry.
The online auction industry did not exist before eBay, and that company quickly grew to become the largest
firm in the young industry, using the Internet. There are numerous other smaller firms, some of which serve
niche markets, such as fine art auctions online. Other smaller firms are attempting to compete with eBay
directly, but they have not yet been able to overcome eBay’s first-mover advantages. Due to its expertise in
online transactions, the firm is able to keep expenses very low. Therefore, it also keeps prices low, which
tends to discourage new entrants and makes it hard for smaller firms to remain competitive.
2.
Go to eBay’s web site, and analyze the strategies it has been pursuing to protect its competitive position (for
example, different kinds of auction sites and services).
eBay clearly uses price competition, because it charges very little for its services. However, competitors
have offered services for free and still cannot attract customers. Therefore, eBay must be competing on
more than just price. Nonprice competition at eBay includes market penetration, as the firm moves into
every segment of its industry. This is shown on eBay’s web site by the number of categories of products
offered, as well as by the global sites, which cover 20 countries in addition to the U.S. eBay is also using
market development, when it teams with automakers and Sotheby’s art auction house to offer more products
under the eBay name.
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