Strategic Management: Industry Analysis, Competitive Positioning, and Corporate Strategy

Posted on Dec 26, 2024 in Economy

What is Strategy?

Strategic management is a process of decision-making with the intention to cause improvements in the firm’s performance over the long run, relative to an appropriately defined reference group. Strategic decisions are difficult to reverse, affect multiple areas, and consider the behavior of other agents. The core of strategy is a plan to create value. Strategy seeks to explain why some firms perform better over time than others and uncover systematic factors that cause persistent performance differences (PPD). Strategy is not operational effectiveness (choosing a point on the productivity frontier) but choosing to perform activities differently or to perform different activities with tradeoffs. To consider strategic fit, ask: are activities consistent and reinforcing? Is there an optimization of effort at the system level?

Porter’s Five Forces

Industry analysis is about recognizing the main structural features of an industry and understanding how they impact profitability and competition overall (economic asymmetries). Structure (number of firms, barriers to entry) determines conduct (price, quantity), which determines performance. New entrants and incumbents influence how economic value is captured, while substitutes, suppliers, and buyer power influence the amount of value created.

Can buyers influence the price? This depends on bargaining leverage and price sensitivity. If yes, then firms will be forced to charge low prices. Factors that influence buying power include:

  • Size and concentration of buyers
  • Price sensitivity
  • Switching costs
  • Volume
  • Capacity for backward integration
  • Differentiation

To mitigate buyer power, focus on loyalty, a diverse client base, and differentiation.

Supplier power factors include:

  • Volume
  • Vertical integration
  • Concentration
  • Costs of bargaining
  • Switching costs
  • Differentiation

To limit supplier power, deal with multiple parties, consider backward integration, and lock in advantageous rates.

A product is a substitute if it performs the same or a similar function by different means. Substitutes put downward pressure on prices and upward pressure on quality. Rivalry depends on intensity and basis (price or non-price). Main factors include concentration and slow industry growth. Other factors include exit barriers, scope for differentiation, unused capacity with high fixed costs and low marginal costs, and perishability.

Low barriers to entry increase competition (threat to entry, not actual entry). This depends on whether it’s hard to enter, whether new firms will try anyway, and if they do try, whether it hurts industry profits. Entry is made difficult through:

  • Economies of scale
  • Economies of scope (network effects)
  • Incumbency advantages (patents, brand identity, access to channels)
  • Government/legal barriers
  • Threat of retaliation
  • High buyer switching costs

To better analyze industries, define them clearly, identify players, assess the strength of each force, make an overall assessment, and identify pressure points.

Industry Analysis: Carbonated Soft Drinks

In the Carbonated Soft Drink (CSD) industry, barriers to entry include:

  • Differentiation through advertising
  • Scale economies
  • Saturation of distribution channels
  • Semi-exclusive bottler systems
  • Retaliation

CSD substitutes include other beverages. CSDs have made themselves available at any time, positioning themselves as an impulse buy, a lifestyle choice, and even an addiction. Supplier power is low since the concentrate ingredients are secret, and forward integration is unlikely. Buyers have low bargaining power due to high switching costs and being locked into exclusive deals. The industry is almost a duopoly, with perceived differentiation, a measured war without undercutting prices but rather lifestyle advertising, selective discounting, innovation, and shelf space. The bottling industry is less profitable due to high forces.

Competitive Positioning

Competitive positioning involves creating a unique and valuable position that drives a wider wedge between buyers’ Willingness To Pay (WTP) and firms’ costs. WTP is the highest price the buyer is willing to pay, and Opportunity Cost (OC) is the smallest amount a firm will accept. Total value created = WTP – OC. The value a firm captures is the price minus the cost on the value stick.

Differentiation strategy: Raise WTP with a slight increase in costs.

Low-cost strategy: Reap large cost savings with a slight decrease in WTP.

Differentiation is about boosting WTP.

Cost-based positioning strives to achieve lower overall costs by performing activities differently (cost leadership).

Differentiation-based positioning commands a premium by performing different activities (benefit leadership).

To generate a cost advantage:

  • Economies of scale
  • Learning and experience
  • Proprietary knowledge
  • Lower input costs
  • Different business model

Deliver a product of acceptable quality at the lowest possible cost.

To generate a WTP advantage:

  • Create features valued by buyers
  • Branding
  • Customization

Deliver a valuable product at the highest acceptable cost.

Competitive scope refers to the segments that the firm competes in. Broad scope means competing in all or most customer segments. Narrow scope means focusing on one or a few segments and tailoring the strategy accordingly. Firms choose a focus strategy due to:

  • Large firms may overlook niches
  • Ability to serve more effectively
  • Building competitive advantage
  • Lack of resources

Walmart is a cost leader through:

  • Economies of scale (bulk buying)
  • Economies of scope (supercenters)
  • Economies of density (hub and spoke)

Walmart offers other advantages (market research and inventory management) that raise the OC/Willingness To Sell (WTS) for suppliers. Walmart has a first-mover advantage, a culture of cost reduction, and highly integrated activities. When considering upscaling, ask if the WTP and price increase will be more than the cost increase. In summary, good strategies deploy consistent activities that are sustainable and integrated. Growth opportunities leverage the existing activity system.

Sustainability: The Case of Zara

Zara employs a differentiation strategy, achieving a higher WTP for affordable fashion with quality, coupled with higher costs due to its quick response to trends. While other companies are fashion bettors, Zara is a fashion follower and has a large design team with a quick development process using technology. It is vertically integrated, with nearby factories producing in small batches using long-time suppliers. New merchandise is delivered to stores twice a week, using a hub-and-spoke distribution system. Zara features highly designed stores in prestigious locations, and managers have autonomy.

Zara’s approach to fashion differs from conventional wisdom: no specialization, integrated production, little advertising, owning everything, and locating production in prime areas. Its activities are aligned for a quick reaction to decrease misses, which requires higher costs but results in a higher WTP.

Zara is protected from imitation by:

  • Vertical integration (reducing the bullwhip effect)
  • Low levels of inventory
  • Continuous renewal
  • Minimal advertising
  • Using expensive shipping
  • Owning stores and factories that are more responsive

Both Zara and Walmart own all production, but in retail, it lowers costs/WTS, while in fashion, it increases WTP/price. Similar activities in different industries can create different competitive advantages. Zara faces two major threats: imitation (Shein) and substitution (CSR/ESG concerns). Online sales have boosted rather than cannibalized in-store sales. ESG concerns impact the value stick: WTP goes down, the price goes down depending on willingness to substitute and competitor practices, costs of PR/monitoring go up, and WTS goes down since debt/equity suppliers increasingly care.

Zara has invested in external CSR initiatives, a code of conduct, monitoring, and wage increases. It is ranked AA in the MSCI ESG ratings.

x3jx5+6 <img src=The Pyramid Principle

The Pyramid Principle is a hypothesis-led approach (answer first). A good logical structure must be MECE (Mutually Exclusive, Collectively Exhaustive). Each generation should have 3-6 branches; less than 3 means it’s not collectively exhaustive. To generate more thoughts, look at the same problem from different angles. More than 6 suggests not being mutually exclusive. Hypotheses for the prioritized branches/drivers should be worded like:

  1. Event causing the observable phenomenon
  2. Observable phenomenon
  3. Event caused by the observable phenomenon

Corporate Strategy

There are two types of strategy:

Business-level strategy: A business unit in a diversified firm chooses a business-level strategy as it competes in individual product markets.

Corporate-level strategy: Actions taken by the firm to gain a competitive advantage by selecting and managing a group of different businesses competing in several industries and product markets.

Corporate strategy asks what mix of businesses generates higher value. It expands the scope of the sectors in which the firm competes. There are three types of scope:

  1. Horizontal scope: The extent to which firms participate in related segments outside of their existing activities. Horizontal diversification is the expansion into multiple businesses that share inputs. Firms choose horizontal diversification to hedge against volatility, achieve higher growth/profit margins, mimic/squeeze out rivals, and gain a competitive advantage.
  2. Vertical scope: How much the firm is vertically integrated. This can be backward/upstream integration or forward integration. Firms choose vertical integration due to necessity, to control the supply of critical inputs, and for value creation opportunities.
  3. Geographic scope: The breadth and diversity of geographic areas in which a firm operates. Firms choose geographic expansion for economies of scale, location advantages, and growth opportunities.

Related diversification involves entering a market that has commonalities with firm operations. Unrelated diversification involves entering markets that have little to do with firm operations. Types of related diversification include:

  1. Same customers or end-users (e.g., Nike)
  2. Same type of products (e.g., Apple)
  3. Same resource capabilities (e.g., Disney)

Between 70-90% of mergers and acquisitions fail due to:

  • Lack of strategic fit
  • Overpaying for the merger
  • Cultural mismatch
  • Integration challenges
  • Employee turnover
  • Regulatory/legal challenges
  • Failure to meet financial expectations
  • Overemphasis on short-term gains
  • Market conditions

To evaluate scope decisions, use the attractiveness test and the cost of entry test. Corporate Advantage is the extent to which it enhances the competitive advantage of its component businesses. Competition occurs at the business unit level. Value creation comes from improving the competitive advantages of each business, and being part of a diversified company involves inevitable costs for the business units. To gain a corporate advantage, a corporate strategy must produce a clear and offsetting gain in the competitive advantage of the business units.

The better-off test: Business units must create and capture more value together than they could separately. This increase comes from economies of scope (sharing resources with high fixed costs, lowering total costs) and cross-selling benefits (one-stop-shop, bundling of complements, umbrella branding).

Is ownership necessary? The potential risks of owning include:

  • Diseconomies of scope
  • Costs of conflict and coordination
  • Mixed motives
  • Cognitive conflicts for customers
  • Reputational risks
  • Integration costs

Costs of contracting (not owning) include:

  • Finding a qualified partner
  • Negotiating and writing a contract
  • Opportunism (tailoring products/processes reduces the value of outside options)
  • Sharing of intangible resources

The best alternative test: Is ownership necessary to get the added value, or can the same benefit be obtained through a joint venture, alliance, agreement, or contract? We need to own the other business if the activity is central to the competitive advantage and:

  • The interests of both parties are not entirely aligned (partnership not likely)
  • Writing and enforcing the contract is difficult