Transcript Document 7322334

Strategy: Key Concepts and Open
Questions
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As in finance, the goal of the firm is value maximization
“Strategy” may be defined as the way the firm deploys
its resources and capabilities within its environment to
maximize its value
The strategy literature typically takes a less quantitative
approach than finance or industrial organization;
analyses are more descriptive and somewhat less
analytical
Key Concerns
Key concerns:
1. Industry Attractiveness: Which industries should the firm
be in?
2. Competitive Advantage: How should the firm compete?
What does it have that its competitors, suppliers, buyers,
potential entrants, and complementors do not?
3. Boundaries of the Firm: What should the firm do, how
large should it be (make vs. buy; scope)
4. Internal Organization: How should the firm organize its
structure and systems internally?
Relation to Other Fields
• The strategy literature borrows heavily from finance,
industrial organization, and the theory of the firm
• Value maximization and the associate computations (aftertax cash flows, net present values) are key concepts from
finance
• The frameworks for analyzing industry attractiveness
emerged from industrial organization
• Work on the boundaries of the firm follows the theory of
the firm; transaction costs are referred to frequently in the
strategy literature
Relation to Other Fields
• The concept of competitive advantage is directly related to
the notions of “positive economic profits” in economics
and “profits in excess of the opportunity cost of capital” in
finance
• Competitive advantage can be defined as: A firm possesses
a competitive advantage when it earns a persistently higher
rate of profit than its competitors
Industry Attractiveness
Porter Competitive Strategy (1980)
The Five Forces Framework for Industry Analysis:
Buyers
Entrants
Competitors
Suppliers
Substitutes
The Five Forces Framework
The Five Forces Framework is primarily used to assess the
profitability of different industries, not the profitability of
specific firms, but it is useful for both
Estimates vary, but most suggest that 10 to 20% of the
variation in firm profitability is accounted for by the
industries firms operate in
Rivalry among existing firms is the main focus of industrial
organization and strategy, but the other forces cannot be
ignored
Applying the Framework
• Strategy texts provide long lists of factors that affect
industry profitability in the five forces framework
• For any particular analysis, it is useful to focus on a small
number of key factors determined on a case-by-case basis
• Most of the factors are based on findings in the industrial
organization literature
• For example, the main factors that affect the threat of entry
and the threat from substitutes are barriers to entry and the
cross-price elasticities of demand
Factors
Factors that Affect Rivalry Between Existing Competitors:
1. Brand Identity
2. Concentration: the number of competitors and their
variation in size
3. Fixed Costs
4. Industry Growth
5. Intermittent Overcapacity
6. Product Differentiation
7. Switching Costs
Factors that Affect the Bargaining Power of Buyers
1. Ability to Backward Integrate
2. Buyer Concentration
3. Information
4. Price-sensitivity
5. Product Differentiation
6. Switching Costs
Factors that Affect the Bargaining Power of Suppliers
1. Differentiation of Inputs
2. Impact of Inputs on Cost or Differentiation
3. Size of Purchase
4. Supplier Concentration
5. Switching Costs
6. Threat of Forward/Backward Integration
The Five Forces Framework is incomplete because it does not
recognize the role of allies, collaborators, and other partners
Brandenburger and Nalebuff Coopetition (1996)
The Value Net adds “Complementors”:
Customers
Competitors
The Firm
Complementors
Suppliers
Complementors are the mirror image of competitors: they increase
buyers’ willingness to pay for the firm’s products and decrease the
price that suppliers require for their inputs
Examples of Complementors:
Doctors: Doctors influence the success of pharmaceutical products by
prescribing drugs, but they are not buyers
Intel/Microsoft: Microsoft’s software runs on computers equipped with
Intel microprocessors, and it’s more valuable when combined with
better processors
Drug/Biotech Allies: Small biotechnology companies form alliances
with large drug companies to develop and market products
Any given firm may play multiple roles in the value net – this is
particularly important for large firms. For example, in its relationship
with small software companies Microsoft may be a supplier, potential
competitor, complementor, and buyer
Dynamics
Key features of the environment change over time
1. Buyers and their needs
2. Regulations
3. Relationships between players
4. Suppliers and their products
5. Technology
Competitive Advantage is Temporary
Ghemawat Commitment (1991) analyzes return on investment
(ROI) reported over a ten-year period by 692 business
units
Splitting the sample into two equally sized groups based on
ROI revealed that the top group’s ROI in year 1 was 39%
and the bottom group’s ROI in year 1 was 3%
After ten years over 90% of the 36 point gap between the two
groups was eliminated
Thus, most of competitive advantage depends on a temporary
firm or business unit effect
Industry vs. Firm Effects
McGahan (.) assesses the relative importance of the following
types of effects in explaining variation in firm
profitability:
1. Permanent industry effects: 11%
2. Temporary industry effects: insignificant
3. Permanent firm effects: 24%
4. Temporary firm effects: 57%
Her study uses Compustat, which is not as disaggregated as
possible, but the results still suggest that firm effects are
more important
Firm Effects: Resources and Capabilities
• The basic finding that industry effects appear to account
for little of the variation in firm and business unit
profitability has led strategy researchers to focus more on
firm effects
• Achieving superior profitability within an industry is
emphasized more than finding profitable industries
• This has led to increasing focus on firm-level resources
and capabilities
Resources and Capabilities
• Strategy can be oriented around demand or internal
resources and capabilities
• In environments with rapid change, it is better to formulate
strategies around resources and capabilities
• For example, when PCs began to replace typewriters in the
early 1980s, typewriter firms that attempted to follow their
customers by trying to enter the PC market generally failed
• Typewriter firms that pursued other products where their
existing skills could be useful were more successful (small
electronic appliances, etc.)
Resources and Capabilities
Establishing a competitive advantage is concerned with
formulating and implementing a strategy that recognizes
and exploits the unique features of each firm
Basic units of analysis are the resources of each firm:
Items of capital equipment, skills of individual employees,
patents, brands, and so on
Resources work together to create capabilities, which are
basically “what the firm is good at”
Establishing and Sustaining Competitive
Advantage
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In order to establish a competitive advantage, a resource or
capability must be scarce; if every firm can acquire the resource or
capability then the outcome is much like perfect competition
In order to sustain a competitive advantage, their must be barriers to
imitation
Are the resources or capabilities transferable (can they be traded or
spread through employee mobility?)? Can they be replicated?
Intangible resources become important: brands, reputation
Plants and equipment and even patents become obsolete relatively
quickly
Capabilities based on complex organizational routines are less
vulnerable to imitation (like FedEx’s next-day delivery service)
Emergence of Competitive Advantage
• Dynamics are important for explaining the emergence of
competitive advantage
• Some firms have greater innovative capabilities
• Some firms are better able to respond to change, either
because of intrinsic change management capabilities or
because their resources or capabilities are well-suited for
the particular type of change occurring
• External sources of change include changing tastes, prices,
and technological change
• Competitive advantages emerge when firms innovate or
benefit from external change
First Mover Advantages
First movers accept the risk that the market may not
materialize, but if the market materializes the first mover
may acquire resources and capabilities:
1. Resources like store locations may be scarce
2. A reputational asset is created with suppliers and buyers
3. Where standardization is an issue, the first mover may
be able to set the standard
4. The first mover can learn by doing and move down the
learning curve ahead of followers
Industry Evolution and the Life Cycle
• Competition is a dynamic process in which firms attempt
to obtain competitive advantages only to see them eroded
by imitation, innovation, and external change
• The industry environment is reshaped by the forces of
competition
• The industry life cycle is a common pattern of industry
development: industries can be classified according to their
stage, and we can determine which strategies are
appropriate in each stage
Product Life Cycles
• Products are born, their sales grow, they reach maturity,
they go into decline, and they eventually disappear
• The industry life cycle follows the product life cycle and
thus depends on how broadly defined the product is
• 64-bit video games have a relatively short life cycle but
video games in general have a long life cycle
• Strategy researchers generally divide the life cycle into
four stages: introduction, growth, maturity, and decline
• Demand growth and the production and diffusion of
knowledge varies over the life cycle
Demand Growth
• Think of an S-shaped growth curve
• In the introduction stage, quality and sales are low and
costs and prices are relatively high; customers tend to be
high-income innovation oriented risk accepting individuals
• In the growth stage, quality improves, costs and prices
come down and sales increase dramatically; the product
obtains mass market appeal
• In the maturity stage market saturation increases and
increasingly demand is replacement demand
• In the decline stage the industry is threatened by a
replacement
Diffusion of Knowledge
• Knowledge diffusion drives the industry’s evolution
• In the introduction stage, there may be no clear standard and product
improvements and changes occur rapidly
• Standardization often leads to the growth stage; mass market appeal
requires a product that is unlikely to become obsolete quickly
• In the growth stage, obtaining scale and access to distribution is key
• Product and process innovation depend on technological opportunities
and may persist or vary throughout the life cycle, but in the maturity
stage there may be a shift to process innovation if opportunities for
further product improvements diminish
• In the decline stage the orderly exit of capacity is important to prevent
price wars; industry consolidation is critical
Key Open Questions
• Understanding resource, capability, and strategic
heterogeneity in dynamic environments could use much
additional work
• In depth studies of particular firms in their industry context
could provide additional insights about how particular
resources, capabilities, and strategies are advantageous at
different points in the life cycle
• For example, I have a working paper that uses a simple
model to study mergers in declining industries
• Few other studies have even bothered to investigate
mergers in this environment, although consolidation is a
critical strategic objective
Key Open Questions
• The key insights from the strategy field have not been fully
incorporated into industrial organization
• Dynamic models of industry evolution should incorporate
greater differences between firms in terms of their
resources, capabilities, and strategies
• Models should be consistent with the result that the vast
majority of profitability depends on firm effects and that
most of profitability is transitory
• Key resources, capabilities, and strategies should also
affect firm valuations; studies of stock prices and returns
can investigate these relationships