4_External Environment

Question 1

What is a strategy ?

Answer 1

• A strategy is the integrated set of choices
• that positions the business in its industry
• so as to generate a sustainable competitive advantage

“integrated set of choices” => internal & external consistency of activities

Question 2

What does sustainable a competitive advantage mean ?

Answer 2

A sustainable competitive advantage means that the business generates superior financial returns over the long run.

to know if you are generating superior financial returns you have to also understand the industry !

Question 3

Starting from the business winning aspiration, which quetsions does a strategy answer ?

Answer 3

A strategy must answer to key questions:

1. In which markets do we want to play?
2. How can we win in these markets?

Question 4

Why is it important to understand markets ?

Answer 4

Because:

• Industry-level profitability persistently differs
• firm-level profitability within the same industry differs!
  
  • Why do they deffer and how can firms exploit/avoid the industry forces ? To understand this, see Porter’s five forces

Question 5

What is the background behind Porter’s 5 Forces ?

What did people do before ?

Answer 5

• Porter’s key insight in the 1970s was that managers defined competition too narrowly
• Porter’s 5 forces provides framework to anticipate and influence future profitability
  • His framework is the most popular strategy framework
• Framework reveals roots of industry’s current profitability
  
  • By looking at the current profitability of an industry, you can understand WHY they are profitable.
• While all industries are influenced by these forces, their relative influence differs
  
  • It is a broad network, that you can apply to every industry. But the influence of these powers is going to differ accross the industries.

Question 6

What is the value system of Porter

or so called vertical chain in a single-industry firm?

In which direction can a firm go ?

Answer 6

• Firms form a value system (vertical chain) with each other
  • Firm is part of an vertical chain - Porter called this a “value system”.
• *Upstream** = what comes earlier: suppliers with their own value chain > provide input factors to firm.
• *Downstream** = additional firms with each of them having their own value chain: channel and buyers.
• Each firm in this value system operates its own value chain
• Forward Integration: a firm can forward integrate itself by extending its activities downstream (channel value chains, Buyer value chains)
  
  • Supplier extends value chain to buyer activities
  • E.g. when the cupcake maker wants to sell himself his cupcakes. Manufacterer sends to end consumers
• Backward integration: a firm can backward integrate itself by extending its activities upstream (supplier value chains)
  
  • Buyer extends value chain to supplier activities
  • Backery shop doesn’t want to buy from an independent supplier but decides to produce them themselves

Question 7

What are Porter’s Five forces ?

Answer 7

1. Threat of Entry
2. Power of Suppliers
3. Power of Buyers
4. Threat os Substitutes
5. Direct Rivalry
6. Additional Force:
   
   • NOT PESTEL analysis & MACROENVIRONMENT. These only create opportunities and threats for firms in an industry. They are factors !
   • Complements ?

Question 8

What can be the effects of (threat of) new entrants?

When can you at best enter a market ?

Give an example of low and high barrier to entry

First force of Porter’s 5 Forces

Answer 8

New entrants in an industry can quickly erode (=affaiblir) profits by increasing competition, introducing alternative products, and capturing market share.

New players are best able to make inroads (=percer) when the incumbent (=actual) players do not benefit from economies of scale, a strong brand identity, or proprietary knowledge in such environments: low barriers to entry

Threat of entrance is low when new entrance cannot get good distribution chanels or they are at a specific disadvantage at entry.

Illustration of concept:

Starbucks: If Starbucks decided to be more expensive, other people could decide to start selling coffee (and not as quite expensive). But because Starbucks anticipate this, they cannot overcharge their customers and must constantly innovate so that no body thinks that there is a potential to enter in the market. Thus Starbucks must constantly keep their prices in a range. Entry barrier is low !

Illustration High vs Low Force:

Low threat of entrance (high barrier): entrace cannot get good distribution channels or a specific disadvantage when entering

high barrier to entry: retailer of one country can’t enter an other country easily, because all the good positions are already taken ! When you want to open a new retail shop in Lucern, it will be difficult, because all the great spots (location) are taken. So you have to offer them something extra (in order for costumers to go to a less attractive spot)

low barrier entry with Apps. There are relatively low barriers to developing applications (apps) for Android smartphones and the Apple iPhone; all it takes are a few software developers and an idea. This makes it possible for startup developers to enter and quickly grow, and makes it difficult for existing app providers to charge a significant price premium, which explains in part the low prices of most apps.

High barrier (possible response to stop new entrance) Consumer Switcher Costs = if you switch to an other software, you have to learn how to use them - the higher the switching costs are, the more difficult it is to enter.

Question 9

What are the influence factors for the threat of entry ?

Give more barriers to Entry

First Force of Porter’s 5 Forces

Answer 9

1. Supply side economies of scale and scope or experience (exploit network effects and economies of scale)
   
   • FedEx has a lower cost per package than a potential new entrant because of its large scale
2. Demand side benefits of scale
   
   • eBay is more attractive to buyers than smaller competitors because of its large number of sellers (sellers also benefit from more buyers)
3. Create customer switching costs
   
   • Microsoft Windows users who may want to switch to another operating system must buy new software and learn how to use the new operating system
4. Capital costs
   
   • a large required capital commitment can deter new entrants
5. Invest to preempt (=empêcher) entry
6. Incumbency advantages
   
   • incumbent mining companies may have locked up the best reserves
7. Unequal access (lock in) distribution channels
   
   • Movie producers with a track record and established relationships have an advantage in getting cinema distribution
8. Anticipated vigorous incumben response
   
   • the threat of price cuts or expensive advertising campaigns by deeppocketed incumbents can deter entry
9. Develop a reputation for retaliation (=menace, sanction, victime?)
10. Restrictive government policies: exploit patent protection
    
    • patents can deter market entry by imitators
11. ​High barriers to exit:
    
    • ​​high labor severance costs can deter market entry
12. ​Slow indutry growth
    
    • ​​Newcomers must take share from incumbents

Thus possible responses to the threat of new entrants are: exploit network and economies of scale. Create customer switching costs. invest to preempt entry. Lock in distribution channels. Develope a reputation for retaliation. Exploit patent protection.

Question 10

Generally, when is supplier bargaining power high ?

Give an example/illustration of a powerful supplier

Second force of Porter’s 5 Forces

Answer 10

If suppliers offer a unique product, have made it difficult to switch to other suppliers, or are more concentrated than the industry they serve, then they can raise the prices at which they supply the industry.

A powerful supplier group can drive up costs that industry players are unable to pass on to their customers.

Examples:

Coca-Cola, with its powerful brand and flavor, is a perfect example. It sells its exclusive, proprietary soda concentrate to bottlers – there are relatively many of them – which have limited flexibility to raise prices, thus constraining industry profits.

Illustration of concept:

Windows 10: no other operating system for PC - microsoft = powerful and can lead the prices.

High vs Low illustration of concept:

Pharma industry: much greater power in bargaining than manufacturer of generics.

Bloomberg: if the consumer has big switching costs, he’ll pay more to avoid the switching costs and can stay where he once is.

Question 11

Specifically, what are the influence factors for the power of suppliers ?

Give more barriers to entry of suppliers

Second force of Porter’s 5 Forces

Answer 11

1. Suppliers are more concentrated than the industry rivals
   
   • Ex: Microsoft and Intel have bargining power because of their dominant market shares and fragmented PC manufacturing customers
   • Marktstruktur bei den Lieferanten lässt dem Unternehmen wenig Ausweichmöglichkeiten zu alternativen Lieferanten und erleichtert es den Lieferanten, hohe Preise durchzusetzen
2. Industry participants face switching costs
   
   • Ex: A supplier has more bargaining power if it is difficult for customers to switch to competing suppliers
3. Suppliers offer differentiated products / unique product
   
   • If customers believe suppliers products differ significantly, competition is reduced and prices tend to increase
4. Few substitutes for supplier products
   
   • Suppliers of patented pharmaceuticals with unique benefits have significant bargaining power
5. Credible threat of forward integration
   
   • Suppliers who can credibly threaten to compete with their customers have more bargaining power than those who cannot
6. Suppliers do not depend heavily on the industry
   
   • Suppliers who do not depend on the industry have less incentive to moderate price demands

Thus possible responses to threats to profitability because of bargaining power of suppliers are: Use standard instead of proprietary products. Secure multiple sources. Encourage mutual dependence.

Question 12

When are buyers powerful?

Third force of Porter’s 5 Forces

Answer 12

Powerful customers can also affect industry profitability.

An industry’s buyers are powerful if they are concentrated or are free to direct their purchases elsewhere.

The U.S. retail industry has seen buyer power increasingly consolidated to Walmart, Target, and several drugstore chains. The many industries that sell through those channels have seen their profit margins squeezed because they have no other customers of comparable size and those retailers have the wherewithal to switch vendors.

Everything that makes the supplier powerful, makes the buyer less powerful

Ilustration of concept

Bananas in the UK Market

What makes the buyer more powerful: Buyers are more concentrated and are going to buy a large chunk of the supplier. With the example of the banana, the retailers keep the bigger value (40%). Because there are relatively few retailers (or relatively large retailers like Carrefour), they can dictate the price to the suppliers and keep a larger piece of the revenue for themselves.

Illustration High vs Low Force: key question: when are buyers less price sensitive ?

Whenever a buyer requires an input factor from a supplier that really has an input on the buyers quality, then he is going to be less price sensitive.

E.g. Hollywoord studio which is making motion pictures. The quality of the movie is going to depend on the quality of the cameras. So they are going to be less sensitive to the price of cameras, because the cameras have an impact on the final quality of the movie.

When the quality of the product has an impact on other costs of the buyer, then there might be less price sensitivy. E.g. Industry of dishwashes for restaurants. A good machine then requires less labour costs.

Question 13

Specifically, what are the influence factors for the power of buyers ?

Give more examples of when barriers to entry is high

Third force of Porter’s 5 Forces

Answer 13

1. Customers are more concentrated than the industry they buy from
   
   • Retailers such as Walmart are more concentrated than their suppliers, and have significant bargaining power = Eine oligopolistische (oder gar monopolistische) Marktstruktur bei den Abnehmern lässt dem Unternehmen wenig alternative Absatzmöglichkeiten und erleichtert es den Kunden, niedrige Preise durchzusetzen.
2. Customers face few switching costs
   
   • Airline customers have substantial bargaining power because they have low switching costs
3. Industry products are undifferentiated
   
   • If customers believe suppliers products do not differ significantly, the customer has more pricing power
4. Credible threat of backward integration
   
   • Customers who can credibly threaten to manufacture their own inputs have more bargaining power than those who cannot
5. Industry purchases represent a significant fraction of their cost
   
   • Customers will be more sensitive to the price of inputs that have a bigger impact on their bottom line
   • Hohe Bedeutung des jeweiligen Verkaufs für das Unternehmen, d.h. das Einkaufsvolumen eines Kunden macht einen hohen Anteil am Gesamtumsatz des Unternehmens aus
6. Customers earn low profits
   
   • Inputs have a proportinally greater impact on the profits of low-profit customers than they do on those of high-profit customers
7. Customers quality is not substantially affected by the industry
   
   • Where quality in not affected the customer has no incentive to accept a higher-priced, higher quality input

Thus possible responses to threats to profitability because of bargaining power of buyers are: Build customer loyalty. Traget small customers. “Lock in” customers to increase switching costs. DIfferentiate the product. Target customer segments that are less sensitive to price.

Question 14

When are substitutes powerful?

Fourth force of Porter’s 5 Forces

Answer 14

When multiple products from different industries all serve the same purpose for customers, they are called substitutes.

They place a ceiling on an industry’s ability to increase prices and grow.

Taxi fares, for example, are kept in check in cities with robust public transportation.

Illustration of concept:

Phones (Nowadays): phones are substiutes for cameras

Zoom: using zoom is a substitute for business travels virtual meetings (threat for airlines)

High vs Low Force llustration: high, when the subsitiute offers a better value for money

Train/Bus: switching costs to move to the subsitute - travelling by bus or train: switching costs are low.

Train/ Motorbike: switching from train to motorcycle, costs are high (Töffbillet etc.) because need a licence etc.

The switching cost may not always be uniformly distributed, in the sense that everybody suffers from the same switching costs but there are different groups of people which might be affected differently according to the substitutes

Question 15

Specifically, what are the factors for the threat of substitutes ?

Give more barriers to entry of substitutes

Fourth force of Porter’s 5 Forces

Answer 15

1. “closeness” of substitute
   
   • The closer the substitue, the easier it is to switch to it
2. Performance / Price ratio of substitute
   
   • A substitute that offers slightly lower performance at a much lower price is more of a threat than one that offers slightly lower performance with only a small reduciton in price

Thus possible responses to threats to profitability because of substitutes are: Cannibalize the business before others do. Target consumers of substitutes with new product offerings. Exploit complements.

Question 16

What is direct rivalry ?

Fifth of Porter’s 5 Forces

Answer 16

Players in almost every industry compete with one another, but if that competition manifests itself in aggressive actions, everyone’s profits can suffer.

Intense rivalry is common when the competitors are of similar size and sell undifferentiated products, or when industry growth is slow. Other contributing factors include high fixed costs, overcapacity in the industry, and investments in assets that cannot be repurposed.

Competition is most harmful when it results in aggressive, sustained price wars, which decrease the available profit pool for everyone.

Illustration of concept:

The global automobile industry, for example, has significantly more production capacity than the market’s ability to absorb new vehicles. The shift in consumer preference to small, fuel-efficient, and lower-priced vehicles has further contributed to very intense competition.

High vs Low Force Illustration:

Price competition for airline seats: if the airplane flies with few booked seats = loss, they cannot make up for this loss later. They always want to have a high usage of the seats That is why they engage in price competition.

Intensity is higher when all different industry are relatively equal size, because then it will be difficult for them not to steal market share. E.g. the distribution of revenues accross diff fast food providers is not to different from each other. BUT when you look at MCDonalds, there is less insentive of other competitors to steal market shares of the other small ones, because it is so unlikely to beat McDonalds (thus McDo is also not so price sensitive)

Question 17

Specifically, what are the infleunce factors for the direct rivalry ?

Give more barriers to entry of rivalry among existing competitors

Fifth force of Porter’s 5 Forces

Answer 17

• Intensity of rivalry and basis of competition.
• Price as a basis for competition is particularly problematic. Airline has for example taught consumers to chose upon the price -> Price being the most important thing. This is then increasing the problem.

1. Products lacks differentiation
   
   • ​​If products are not very different, rivals must compete on price
   • Produktdifferenzierung: Unterscheiden sich die Angebote der Wettbewerber erheblich, sinkt die Austauschbarkeit der Produkte / Leistungen, wodurch auch der Preisdruck abgeschwächt wird
2. ​Fixed costs are high and marginal costs are low
   
   • ​​Rivals have an incentive to rpice below average cost
   • Anteil der Fixkosten an den Gesamtkosten: Bei hohen Fixkostenanteilen besteht ein starker Anreiz, eine hohe Auslastung zu erzielen, um wenigstens einen Teil der Fixkosten zu decken. Durch den hohen Angebotsdruck sinken die Preise dann häufig fast bis auf das Niveau der variablen Kosten
3. ​Capacity must expand in large increments
   
   • ​​Owners of unused capacity have an incentive to cut prices
   • Überkapazitäten/Auslastung: Übersteigen die Kapazitäten die Nachfrage wesentlich, so werden die Anbieter darum kämpfen, eine hohe Auslastung zu erzielen. Dies führt zu Preisdruck und damit sinkender Branchenattraktivität
4. ​Product is perishable
   
   • ​​Rivals have an incentive to cut price as the product approaches the end of its saleable life
5. ​Competitors are numerous and roughly equal in size
   
   • ​​Numerous and equal competitors reduce the potential for tacit collusion
6. ​Industry growth is slow
   
   • ​​Rivals must take others markets share to grow
   • Branchenwachstum: In schnell wachsenden Branchen ist der Wettbewerb oft geringer als in langsam wachsenden oder gar schrumpfenden Branchen, da eine Ausdehnung des eigenen Absatzes möglich ist, ohne Wettbewerbern Marktanteile abnehmen zu müssen
7. ​Exit barriers are high
   
   • ​​High exit barriers then to slow reduciton of industry overcapacity, which then produces price competition
   • Austrittsbarrieren: Zum Abbau von Überkapazitäten ist häufig der Austritt von Wettbewerbern aus dem Markt notwendig. Dieser wird jedoch erschwert oder verzögert, wenn hohe Umstellungs- oder Stilllegungskosten auftreten, das Geschäftsfeld für die betreffenden Wettbewerber aus strategischen Gründen wichtig ist (bspw. Synergieeffekte mit anderen Geschäftsfeldern), oder Investitionen in der Vergangenheit zu einer (irrationalen) Bindung an das Geschäftsfeld führen („sunk costs”)
8. ​Rivals have diverse approaches
   
   • ​​Diverse approaches reduce the potential for collusion

Thus possible responses to threats to profitability because of rivalry are: Target less-competitive market segments. Differentiate the product. Create switching costs. Seek to dominate a market segment.

Question 18

Is there an additional force ?

Answer 18

Sometimes, you can hear people talk about PESTEL (Political, Economical, Social, Technological, Ecological and Legal factors) analysis and the macroenvironment (which affects all players in an industry) and how they create Opportunities and Threats for firms in an industry (Example: oil industry).

Problem: they often read as ‘good’ or/& ’bad’. But they lack analytical clarity on how and why they matter! You should ask yourself for each of these influences how they affect the 5 forces! Example: lower car usage increases threat from substitutes and increases direct rivalry (high fixed costs, low marginal costs). With high fix cost and low marginal cost, you have an incentive to price below average cost, so that you still have a kind of margin to make up for the fix cost

Note: Per se, these influences are neither good nor bad for industry participants’ profitability. Factors, not forces!

Porter applied the same reasoning to exclude complements. Still, people have come to frequently include complements as a 6th force.

A product becomes more valuable through the availability of other products. E.g. App Store, more game developers make app stores more intersting which allows apple to sell more Iphone. But because people are using the app store more, than it is also increasing the profitability of the game developpers.
—> Having both at the same time, increases the value of both at the same time.

Question 19

What are the influence factors for complements ?

A sixth force of Porter’s 5 Forces (?)

Answer 19

1. Complements are concentrated
   
   • a dominant complementor can exert more influence on an industry than many smaller complementors that compete with each other
2. ​Relative switching costs
   
   • ​​If it is easier for users to switch across competitors than it is across complements have signicant power
3. ​Ease of unbundling
   
   • ​​If a product and its complement are difficult to undbundle, the compelment has more influence over the product’s customers
4. ​Influence on demand
   
   • ​​Content providers such as the UK’s Premier League football have a powerful influence on the demand for complementary products such as cable channels
5. ​Asymmetric threats
   
   • ​​A complementor that can easily enter the product-maker’s industry has more than one that cannot
6. ​Rate of growth of the profit opportunity
   
   • ​​Industries with low-profit growth are more likely to be influenced by complements, as there are fewer alternatives to grow profit

Question 20

What is the purpose of industry analyzes ?

Answer 20

The purpose of the industry analyzes is to evaluate the attractiveness of an industry based on the profitability and learn about strategic opportunities in this market thanks to the five forces or 5+1 forces (incl. Compliments e.g.) of Porter.

=> INSIGHTS AND STRATEGY IMPLICATIONS

• Attractiveness of an industry is not about being sexy or hot! Use economic insights, not psychology! see example of airlines industry where everyone wanted to go in.
• Based on the 6 forces you can give 0 (hard competition) to 6 (very profitabel industry) stars to these industries.
• Forces are not independent (same action helping to shield from one force, my also shield you for an other force)
• Industry analysis is just a means (not and end) to give you an idea about what positioning may work in this industry. The goal is not per say to say: “this is an attractive or not attractive industry” ! We can come to the conclusion that some industries or relatively more profitable than others.

Question 21

What are the options to develop a strategy for enhancing long-term financial performance ?

Answer 21

1. Position yourself where the forces are weakest
   
   • Example Paccar Trucks: In this industry, usual customers buy in very large amount. They are very powerful and price sensitive. Paccar found a very different segment of customers (than these large companies): independent truck drivers. These independent would derive their identity from these trucks, they were less price sensitive and wanted mor luxurious interior designs. They had a higher willingness to pay. These customers also had less bargaining power because they would only buy one truck !
2. ​Exploit changes in the forces
   
   • ​Example Apple iTunes: buy a song legaly for only 0.99. The market environment had huge music labels which were facing new substitutes on the market: pirating downloading plateforms. These music labels adressed this problem by starting their own plateform download for music but problem for them: competitors never wanted to offer their music on a rival plateform. And ITUNES came which didn’t belong to any of these labels which made it very convenient for people to download for a very low price. Itunes change the perception of the substitute: from illegal download to legal download- people didn’t have to fear any law suits or copy rights problems. Itunes offered in a way legal protection for relatively low price.
3. ​Reshape the forces in your favor
   
   • ​​Example Coke: In the soft drink industry there are relatively many substitutes! For example Tap Water is very cheap, but the problem was that the soft drinks were not always available - so coke did a great job with the vending machines (easier and convenient to drink coke products than substitutes) - Coke change the availability.
   • Example Mutti: make high level premium based tomatoe products. They changed the supply chain and the value system. So they actively collaborated with the suppliers to be more efficient (helping farmers to grow high quality tomatoes with less water & less waste of water). They help the suppliers to reduce their costs and they help value system to get rid of inneficiencies.
     Consequences: Mutti can offer their products to a relatively lower price (they have more demand for the same margins and and better situation for everyone).

TAKE OUT: You try to make the whole industry less competitive and more collaboration between different parties and thereby reshape the force in your favour.

Question 22

What are the general guidelines for industry analysis in practice ?

Answer 22

1. Good industry analysis looks rigorously at the structural underpinnings of profitability. A first step is to understand the appropriate time horizon. You should focus on the full business cycle.
2. The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability.
3. The strength of the competitive forces affects prices, costs, and the investment required to compete; thus, the forces are directly tied to the income statements and balanced sheets of industry participants. Ex suppliers: if they become more powerful, how much are there going to charge me and what are the effects on the bottom line ?
4. Good industry analysis does not just list pluses and minuses but sees an industry in overall, systemic terms.

Question 23

What are the key Takeaways of the chapter external environment?

Answer 23

1. Industry profitability differs consistently, but firm-level profitability within a given industry differs as well.
2. Porter’s 5 Forces helps us to understand the fundamentals of an industry, and which positioning strategies may work to enhance long-term financial performance
3. You should distinguish between forces and factors that influence these forces
4. At the end, we want to achieve internal and external consistency between our business activities. We want to select business activities which help us to achieve superior performance in a given market. This is also why a BUSINESS MODEL IS NOT A STRATEGY ! Because the busines model tells us about the activities that are going on INSIDE the Business but doesn’t tell us anything about the EXTERNAL consistency of these activites with the market environment !
5. Industry analysis is thus one key input in strategy creation

Question 24

When would it really be optimal to enter in the market ?

My notes

Answer 24

• It is possible to make good money in a tough industry. Companies like Ryanair, The Economist Group, and Apple are able to do so. The key is to find a way to deal effectively with the five forces.
• There are different ways to react to competitive forces. A strategist may be able to identify a profitable position that is not yet occupied.
• It is possible to profit by spotting changes in industry structure before others do.
• It is possible to influence industry structure.
• Innovators can use their understanding of how technology affects competitive forces to craft a strategy to protect their profits from imitators.
• Industry analysis is particularly important when moving to new geographic areas or going into new businesses.
• One approach to positioning is to treat every threat as an opportunity.
• Erect barriers to entry and look for ways to increase customer switching costs.
• To increase your bargaining power with suppliers, either secure multiple sources or design products using standard components.
• Counter substitutes by producing your own substitutes (a practice known as cannibalization) or by exploiting complements.