Great Course-Critical biz skills-Competitive Strategy Flashcards
Two factors impact profitability of a company: industry and the company’s competitive advantages.
Industry structure like concentration or fragmented is a factor. for industrials which see fast-moving technological landscape and innovations, the top players in that industry are unlikely to be the top ones after a few years as competitive advantages are fleeting fast. but in mature and low-tech industry such as beverages, paper mill, cigarettes, there are some persistence in high profits in big players.
Strategic planning process is different from strategy. Strategic planning process is to set direction and decide what to do and what not to do. some scholars are skeptical about the explicit strategic planning process saying that the process is a dance to beg for a weather which has no influence on it but the dancers thought the weather is under their control.
there are two levels of strategy: business strategy and corporate strategy.
business strategy is about business unit and corporate strategy is about defining where to play.
Questions for plotting strategy:
what is your winning aspiration? (vision)
where will you play?
how are you going to win?
what capabilities must be in place?
what management systems are required to implement the strategy?
Micheal E Porter’s 5 forces can help us make entry/exit decisions. it can also help us position the company in font of the threats, think about how we might shape a more favorable industry structure. can we do sometime to raise the barriers for entry to make the whole industry more profitable?
Using airline industry as an example:
barriers to entry - Low,
buying power - high
Supplier power - high (Boeing and airbus, labor forces in powerful unions, fuel suppliers like OPEC cartel)
thread of substitutes - high (car, trains, video conferencing)
rivalry among competitors - high (price wars)
airlines have high fixed cost but low marginal cost, so there is a great competition to fill the seats and filling the seat is perishable.
so this is five-star horrible industry. all the forces are all working to diminish profitability.
Assumption in perfect competition: free entry and exit
many buyers and sellers who are relatively small or equal in size; complete information about goods and services; homogeneous/undifferentiated goods; each firm trying to maximize profits;
result of perfect competition: maximum social welfare.
Contribution margin: dollars that could go toward covering fixed expenses and profitability
Accounting profits: do not include opportunity costs for labor and capital deployed in a firm.
Economic profits: account for opportunity costs
so in a perfectly competitive world, economic profits add to zero in the fundamental economic models for years. for industrial economists, they tend to examine the markets characterized by imperfect competition from the perspective of the consumer. i.e. antitrust issues
Michael E porter looked at the markets from the perspective of a company and said the company should not want the competition to be perfect and the economic profits to be zero, instead, they should want high earnings. they should want the competition to be imperfect but not too imperfect so that government won’t sue the company.
By Porter, the CEO should look for businesses where there are barriers to entry/exit, you’d like your business not homogeneous but differentiated, then you can drive economic profits higher.
How to use the 5 forces:
- identify the industry. sometimes it’s not straightforward where to set the boundaries to define the “industry”. but it’s important for the mgmt team to have one set of understanding and the languages.
- identify the players. buyers (incl. end-customers, distributors), suppliers and substitutes
- assess the strengthen of each force
- use quantitative evidences
- understand the critical trends in your business and project where the business will be
Pharmaceuticals:
Barriers to entry - high, taking huge front-loaded investment, strong intellectual property rights, regulations,
Thread of substitutes - low
Buyer power - low, doctors make the decision for us
Suppliers power - low, companies who provide compounds which are commodities and the parma companies can buy them from anyone
Rivalry among competitors - low, since they are patents’ protections and they don’t have to compete on prices
Wintel world: the market for assembling and selling personal computers that operate on the Windows platform and largely off on Intel microprocessors. Barriers to entry - low Buyer power - high Supplier power - high Thread of substitutes - high Rivalry among competitors - high
But how Apple raises competitive barriers to entry for personal computer business?
they build their own operating system, which is a fundamental differentiation vs other products.
they build their own stores, mitigating the retain chain and other online retailers.
they are willing to cannibalize themselves by building tablets, smartphones and they’ve gotten into the substitute business rather than letting other eat their lunch.
Common mistakes:
- only look its company instead of whole industry
- only look at the past, not the future
- miss substitutes
- look at the forces in a linear way
- miss geographic attributes which can impact the industry structures at different regions of the world
Limitation of the framework:
- boundaries of the industry: now it’s getting more difficult in draw clear ones following the development of technologies. many of them are converging. i.e. smartphone, personal computers.
- dangerous to apply on a global basis
- limited tools and techniques for understanding the rivalry - not clear on differences between price rivalry and non-price competition
- does not address the nature and important of complement (product/services that add value on the original’s offering - co-opetition, when a rivalry but also suppliers of complements to your products, there are instances when competitors cooperate to achieve strategic objectives.
Gillettes: razors-and-blades business model, by spending investment getting razors into people’s hand and sell expensive blades down the use life of the razors
Apple: blades and razors model. they sell expensive phones with a lot of free apps for use.
High growth doesn’t equal to high profits.
stable relative low-growth industry can be very profitable business. like industrial gas market.
with appropriate competitive positioning, firms can mitigate negative forces and make healthy earnings.
Strategy is about matching a firm’s resources and capabilities to opportunities that arise in the external environment.
gaining competitieve advantages is about achieving higher economic value than competitors by widening the wedge between customers’ willingness to pay (perceived value) vs the cost. Two paths. i.e. Mercedes: create a much higher perceived value at the slightly higher cost than industry average. Dell/Walmart serves their products at a lower price than average but at a much lower cost.
3 types of competitive advantages: low cost, differentiated, dual advantages: low cost + premium price. companies playing dual advantages can be easily attacked by either low cost players or differentiated players.
Competitive scope: very focused one (niche players), broad player (product, global player, wider target customers)
Nordstrom: high profit margin, higher S&GA expenses, lower inventory turnover
TJX: low gross margins, lower S&GA expenses, higher inventory turnover,
4 Generic strategies in format of 2 by 2: on x axis is low cost or differentiation, y axis is broad or focused
don’t fail to choose to be stuck in the middle and dilute the brand.
be careful to adapt strategies to new emerging customers which represent a different segment vs current position
Straddling between two very different strategies: i.e. legacy carriers creates low-cost subsidiaries to compete with cheap airlines, but eventually the hybrid model got them straddled and failed.
Competitive advantages involves an integrated, self-reinforcing system of activities that enable you to achieve advantages.
Walmart: everyday low-price strategy, little national advertising, focused in rural locations, use satellite technology to connect to stores; grew by creating dense networks of stores around distribution centers; frugal travel policies, no regional offices.
Judo Strategy: since core competence can become rigid as the environment is changing, Judo strategy is to its speed and agility to mitigate the effect of its competitors. this strategy anticipates and leverages changes in the market through new product offerings.
External threats: imitation, substitution, holdup by suppliers/buyers.
Trader Joes: its success comes from having a clear targeting on well-educated people willing to try new and healthy recipes.
there is always a tension for a company between having a narrowed market and a long list of “not to do” list and being able to grow continuously, since the niche market can quickly grow saturated. Making trade offs constrains top lines, so it’s difficult to make decisions to turn off some customers, especially for a publicly listed firm.
mathematic “72 rule”: using 72 yo divide the CAGR, the result is the number of the years which companies takes to double the size. i.e. if a company grows at 20% a year, then it takes 3.6 years to double its size (72/20=3.6).
Being differentiated and being different is different. differentiation is about increasing customers’ willingness to pay and being able to charge premium price than average players in the same space. this is often misused by people.
Blue ocean strategy: how to create uncontested market space and make competition irrelevant.
4 actions framework:
Eliminate: Which factors that the industry has long competed on should be eliminated?
Raise: Which factors should be raised well above the industry’s standard?
Create: Which factors should be created that the industry has never offered?
Reduce: Which factors should be reduced well below the industry’s standard?
first-mover advantages: economies of scale, economies of scope, network effects, learning curve effect.
economies of scale: marginal cost of producing one more unit falls when more and more units are produced.
economies of scope:
Network effects: it occurs when the value per user rise as the total number of users rises.
the first-mover can tap into network effects by connecting a lot of users.
when the switching cost is so high, it can create a lock-in effect and the customers will continue to stay with the company.
so there are lot of startup use get-big-fast strategy to create network effects for growth.
Sources of switching costs: durable purchases, brand-specific trading, specialized suppliers, contractual commitments, loyalty programs
if there is a high demand for variety and a heterogeneous customer base, the first mover alone doesn’t win.
A downside as the first-mover: pioneering cost, the cost of blazing a new trail technologically, educating customers, navigating uncertainties in the market. while fast followers can watch out the mistakes the first movers made and catapult them beyond the pioneers (supersede the pioneers). there is also sunk-cost trap. you are beholden to what you have already invested in and with the particular technologies and structure you are committed, you cannot easily shift strategy even you get negative feedback from the market - you can become overcommitted to your initial course of action, the emotion, the efforts and investments.
when should a company pioneer?
- when the expected life of a product category is short
- brand image is important
- perception of the product is highly subjective and intangible
- when imitation cost is high
Economies of scale can be overestimated. Since costs per unit can eventually rise again as you get too big, too complex and too bureaucratic.
In situations where we can’t protect what we’ve learned, the learning curve is no longer a source of first-move advantages. this can happen in economies where there is spillover effect due to less intellectual property protection, workers are more mobile and second movers can grab the knowledge easily.
Indiscriminate growth often undermines the network effects you want to achieve.
Freemium business model can serve the first-move advantage. free products + premium offering. especially for products/services when the marginal unit cost of adding one more user is minimal.
two reasons that incumbent companies are struggling i terms of innovation: market research and resource allocation processes.
market research: they usually use focus group, who are current customers, to learn about expectations of existing product and services. this method constrains innovation to be incremental.
resource allocation process: oftentimes companies use financial modeling, cost benefit analysis to project the profitable investments in innovation and the bias toward uncertainty/ambiguity is already built in. in a bleeding-edge technological situation, it’s hard to come up with a precise financial model. the company ends up with channeling its resources to business which can come up with a good financial model.
fear for cannibalization of existing products/services.
mental lock-in.
Long-tail: the idea that you can generate a lot of revenue from products that are low in popularity (hard-to-find items) instead of only selling large volumes of a reduced number of popular items.
Netflix is an example. since the cost of adding one more movie is so low, even it will be sold to one customer, it will pay off.
Jill Lepore’s harsh critique (“The Disruption Machine” in new yorker) of Clay Christensen’s disruptive innovation
Analyzing your competitor is a multi-faceted task. we have to understand the economic and financial incentives of your competitors. learn about their past, current strategy, their goals, customer service strategy, capabilities, distribution, R&D, what are the cost of price war for them? where they are sub-standard, also need to get into the heads of senior leaders in that organization, which industry they worked for, their education background, how that might shape their experiences, were there any failures in previous careers. also understand their non-economic motives: more attractive workplace, increase in market share, pressure from wall street, understand the bias of the competitors (sunk-cost trap etc.) to predict their moves. also look at broader context: political factors effect competitors’ response, contextual factors shape their behavior.
Game theory to help understand competitors’ responses. use backward induction: looking forward and reasoning back. “what will my rivals do in the future based on what i’m doing now?” but we also need to be careful that the rival may be not rational, since some companies have non-economic motives.
Key principles for incumbents: identify customers who are most likely to defect to a new entry; what signals are we sending to other potential entrants by your behaviors? what are the aspirations of the new entrant?
Clorox vs P&G about bleach products : when P&G tried to enter bleach product markets, Clorox made pre-empt moves by dropping prices of its bleach products to signal to P&G about its determination to fight the battle. P&G dropped the entry idea.
Key principles for entrants: is this a slow-growth market where an incumbent might fight to preserve customers? is this a commodity product and not differentiated? does the competitor have high fixed costs relative to marginal costs? (fi yes, they will fight hard to keep volume high to cover the costs). does they have deep pockets? what has the incumbent done when other entrepreneurs tried to enter this market? Can the incumbent target the fight? (do they need to cut the price broadly to stop our entry or they can target on one specific segment to be more cost effective). if the incumbent has a strong cost advantages, the incumbent can fight hard.
