The power of the matrix lies in that it can be used for any industry. Ansoff created a vocabulary to communicate a strategic direction in a few words. If Hershey Foods Corporation wanted to sell more chocolate bars in the United States, that would be a penetration strategy (existing product, existing market). If they intended to sell chocolate in Eastern Europe, that’s an expansion strategy (existing product, new market). Using a related diversification strategy, Hershey could develop a new bubble gum and sell it in the United States (new product, existing market). If it wanted to sell automobiles in Nepal (new product, new market), that would be unrelated diversification. A company always has a menu of expansion options. The catch is that there has to be enough money and management time to expand effectively. If Hershey’s management were to decide to expand in all four of the directions described above, they could end up with many businesses that are inadequately managed. There are only so many hours in an executive day. Even if managers could run the new ventures, the company might lack the cash to fund them adequately.
THE ANSOFF MATRIX
Adapted with the permission of Harvard Business Review. An exhibit from “Strategies for Diversification” by H. Igor Ansoff, Volume 35, No. 5 (September/October 1957). Copyright © 1957 by the President and Fellows of Harvard College; all rights reserved.
INDUSTRY ANALYSIS
Along with the language to discuss expansion (integration and diversification), you also need tools to help develop a strategy to survive. Michael Porter of Harvard has developed the Five Forces Theory of Industry Structure to help companies survive in a competitive environment. His books, Competitive Strategy and Competitive Advantage, are truly cornerstones of strategic thinking. If you must buy business books (other than this one), they are the ones to purchase. Porter’s theories can be used to formulate survival strategies for your current business, as well as to evaluate the “attractiveness” of other industries for expansion. Porter offers tools for investigating the five forces that determine the level of competition and, consequently, the level of profit in an industry.
The five forces that drive industry competition are:
Threat of Substitutes
Threat of New Entrants
Bargaining Power of Suppliers
Bargaining Power of Buyers
Intensity of Rivalry Among Competitors
A FIVE-FORCES EXAMPLE
Let’s apply the model to the tin can industry, which would be viewed by Porter as extremely competitive because of the array of forces at play within the industry. The suppliers of steel have many other industries to sell their steel to. Therefore, the canning industry does not have much leverage in the market. Porter focuses on power, the ability of one participant in the value chain to force its will on others in the chain.
The users of cans are primarily the small group of large food processors. Users can wield their power to force the can industry to reduce prices by playing one competitor against another.
Processors the size of Del Monte can also threaten to substitute plastic packaging for cans. Many food processors have moved to plastic packaging. Consequently, competition intensifies as the demand for cans shrinks.
Making matters worse is that can-making machines can easily be purchased by new entrants. Efficient can production is accomplished at low cost and at relatively low volumes. This opens the industry up to new competitors if profit margins are at an attractive level. Del Monte, if it wished, could buy packaging equipment and produce for itself. Because the manufacturing technology is widely available and reasonably priced, the barriers to entry are low. Ease of entry increases the level of potential competition.
PORTER’S FIVE FORCES THEORY OF INDUSTRY STRUCTURE
Reprinted with the permission of The Free Press, a division of Macmillan, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985 by Michael E. Porter.
Because these four forces make the industry highly competitive, the fifth force, rivalry among existing firms, is equally intense. Salespeople know their competition well because they compete for orders from a shrinking group of customers. This competitive force includes the possibility of bitter price wars. Under certain circumstances, competitors will adopt artificially low prices regardless of the impact on profit because they want to win the account at all cost. The industry’s competitive intensity results from all five forces exerting their pressures on the industry as seen in Porter’s model.
What’s a company to do in this sort of competitive environment? Crown Cork & Seal of Philadelphia has pursued a strategy of adding value to its product. It offers expert consulting services to solve clients’ packaging problems, quick delivery to lower clients’ inventory costs, and customized and innovative packaging modifications to meet specific clients’ needs. On the cost side, Crown Cork & Seal has focused on low-cost production, which allows it to price its products competitively. Not only has the company survived, it has prospered.
PORTER’S FIVE FORCES THEORY OF INDUSTRY STRUCTURE
Reprinted with the permission of The Free Press, a division of Macmillan, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985 by Michael E. Porter.
As a prospective entrant into the tin can industry, one should ask:
Is this an attractive industry for me to be in?
Can I duplicate the Crown Cork & Seal strategy?
Can I win in a price battle if I choose to enter?
What is the profit potential for me if I choose to enter?
Could my money be better invested elsewhere?
Regardless of the industry, the same questions must be asked when a manager wishes to expand into a new field. Even if expansion is not contemplated, the Porter model offers insight on how to compete more effectively within one’s own industry. Please review the determinants of the Five Forces in the detailed Porter model very carefully. Those are the questions that MBAs ponder to gain competitive advantage.
The forces at play in an industry are dynamic. The essence of strategy is to understand the current forces and to use them to your advantage. In waste disposal, Waste Management Inc. lobbies hard for enactment of stringent environmental regulations. Why? Because only a few companies are able to comply with them. In that way, regulation simultaneously assists Waste Management and hinders its competitors. Stringent regulation creates barriers to entry for new entrants and, most important, increases the profits of the remaining waste disposal players. Pharmaceutical companies press for the regulation of the vitamin and nutritional-supplement industry for the same reason.
GENERIC STRATEGIES
There are many ways for a company to analyze its competitive challenges. One such way is the Five Forces framework outlined by Porter that we have just discussed. But most options for action fall into what are called generic strategies. A generic strategy is one that can be used across many industries, from dish towels to computers. Porter has aptly captured the three major strategies in a matrix of functional and business strategic possibilities:
Cost Leadership
Differentiation
Focus
THREE GENERIC STRATEGIES
Reprinted with the permission of The Free Press, a division of Macmillian, Inc., from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980 by The Free Press.
COST LEADERSHIP AND THE LEARNING CURVE
The simplest strategy is cost leadership. By achieving the lowest cost of production in an industry, a company can either reduce its prices or keep the increased profits to invest in research to develop new and better products. Low-cost producers (LCPs) can also choose to use their profits to advertise and market their products more vigorously.
An operations concept related to cost leadership is economies of scale. This means that as one produces more, costs per unit fall. As factories produce more, they learn and become more efficient in
several ways.
These “learning” efficiencies can come from six sources:
Labor Efficiency—Learning through repetition or automation. Tremendous progress has been made in factory automation by using robots and computer-aided manufacturing (CAM).
New Processes and Improved Methods—Less costly ways to do the same task
Product Redesign—Redesign to lower costs of materials and labor. If a computer is used to design the product, it is called computer-aided design (CAD).
Product Standardization—Decreasing the variations of a product’s components
Efficiencies of Scale—Doubling factory capacity does not cost twice as much. Adding machines or additional space is not as expensive as starting from scratch.
Substitution—Using less expensive but adequate materials
To be useful, the learning concept must be quantifiable. The learning curve, sometimes called the experience curve, does just that. It was developed by the Boston Consulting Group (BCG) in the 1960s to attach numbers to economies-of-scale benefits believed to exist. They found that each time the “cumulative” volume of production doubled, the cost of manufacturing fell by a constant and predictable percentage.
For example, a consultant’s investigation of a manufacturing task could identify an “80 percent learning curve.” This means that for every doubling of accumulated production, the next unit produced would cost 80 percent of the first unit, or 20 percent less. Computer spreadsheet models exist to perform the mathematics. The important point to remember is that “accumulated production” starts with unit one, not the first produced that month or year, but the very first one off the assembly line using that manufacturing method.
To demonstrate the math involved, I have hypothesized what the effects of an 80 percent learning curve would have been on the cost of producing disposable razors for Gillette.
THE LEARNING CURVE EFFECT COST OF PRODUCTION OF RAZOR BLADES
The math demonstrates that after the razor production doubles twenty-one times, the cost per unit decreases 20 percent each time from a cost of $10.00 to $.09. A simple learning curve can also be seen graphically as shown:
RAZOR BLADE LEARNING CURVE
The strategic implications of the learning curve lie in moving down the learning curve before competitors do. A firm wishing to maintain cost leadership will strive to produce more units than its competition. That way its production costs will be decreased more quickly.
The concept of “dumping” products below cost is a tactic the Japanese have used in the electronics industry while pursuing a cost leadership strategy. These forward-thinking companies sold video recorders at low prices, expecting to realize profits as they increased production at a lower cost. Japanese manufacturers calculated their profits using a five-year rather than a one-year time horizon. Therefore, they planned losses for their first year, so that larger profits could be realized in years three and four. American competitors saw the industry as unattractive and plagued by irrational pricing, while the strategic-minded Japanese companies walked away with the market. As the older products matured, the Japanese used the profits from their sale to develop new products like DVDs.
As a product matures in its product life cycle and becomes widely adopted, as described in the marketing chapter, the curve becomes less useful. To double accumulated production would require tremendous increases in volume that are simply not realistic. Profits are also likely to be low. In this situation, the remaining competitors have the chance to catch up, if they haven’t given up.
Learning curves are not static. A new process or material may increase worker productivity and thus alter the curve. In the razor instance, a new curve may be at work at, say, “75 percent learning” because of a new assembling machine, instead of 80 percent as shown. That is called jumping to a new curve. In this situation, the running total of accumulated units produced is set to zero, and the new curve takes effect. When production doubles, the next unit produced will cost 75 percent of the first one using the new process, or 25 percent less. With products that are continuously innovated, the learning curve is of little use. New curves are formed all the time, and there is not much time to “move down” any of them.
DIFFERENTIATION
As discussed earlier, differentiation is a prime marketing objective. It involves making your product or service appear different in the mind of the consumer. With products, this means offering better design, reliability, service, and delivery. With services, a point of differentiation can be employee courtesy, availability, expertise, and location. Products and services can be differentiated via advertising, even if they are virtually the same. A media campaign can convince the consumer that one is better. For instance, consumers could be persuaded that Nike shoes are better than Converse because of a celebrity endorsement.
FOCUS
Using a focus strategy, a company concentrates on either a market area, a market segment, or a product. The strength of a focus strategy is derived from knowing the customer and the product category well. Companies establish a “franchise” in the marketplace. In the beer market, dominated by titans such as Anheuser-Busch, Coors, and Miller, little Hudepohl Beer (“Hudy”) holds its own in Ohio. The giants can boast lower costs and slick marketing, but they do not enjoy the local “cult” following. Hudy pursued a loyal following over the years through local exposure and community involvement. Hudy focuses on Ohio.
BLUE OCEAN STRATEGY
In the 2005 book Blue Ocean Strategy, the authors popularized the idea that high growth and profits come when an organization creates new demand in an uncontested market space called a “blue ocean.” The goal is to avoid direct competition over existing products and customers in a well-defined industry. Combining the strategies of cost leadership and differentiation, companies can create new industries. Nintendo is said to have used “blue ocean” strategies to develop the Nintendo DS portable game device and the Wii game player that tracks users’ body movements.
COMPETITIVE TACTICS: SIGNALING
Signaling is a key strategic tool. It involves letting your competitors know what’s on your mind. Combatants signal what they plan to do or what steps they will take in response to a competitor’s move. Of course, a company can also bluff. Signaling is used to prevent disastrous (and costly) price wars. Direct contact with the competition to set prices or allocate markets is illegal! Antitrust laws forbid this behavior. But by judiciously signaling, companies can achieve the desired outcome without time behind bars.
In the airline industry, signaling is commonplace. On reservation screens across the country, a daily cat-and-mouse game goes on. For example, Delta may briefly lower fares significantly on its prized routes from Atlanta to Los Angeles in response to United Airlines’ price cuts along the same route. The Delta price move says, “United, if you want to play games on this route, it’ll be bloody.” If United responds by raising prices, in effect they are signaling, “Let’s call a truce.” If United keeps the low fare, it is signaling its intention to do battle. It’s just like poker.
Six common types of legal signals are:
Price Movements—to signal intentions and to penalize unacceptable behavior
Prior Announcements—to threaten, to test competitors’ resolve, and to avoid surprises. In the retailing industry announcements that a strong company will “meet or beat any competitor’s price” sends a strong signal of a company’s resolve. A smaller and weaker competitor should probably not compete only on price.
Media Discussions—to communicate your rationale for actions and to convey your thoughts to the competition. Because executives of competing companies are barred from communicating with each other directly, they do it indirectly via the media. An ExxonMobil executive, for example, could express his weariness with fruitless price wars and his hope that “marketing messages” would constitute the basis of competition. In this way, ChevronTexaco and BP would be put on notice to observe ExxonMobil’s price climb and act accordingly.
Counterattack—to hit your competitor’s home market with a price cut or promotion in retaliation for their encroachment on your turf. Say New York was Maxwell House coffee’s best market, and Folgers best was California. If the Maxwell House brand manager attacked Folgers turf with aggressive pricing and promotion, his counterpart at Folgers would be up in arms, to put it mildly. He would have two options: one, to defend California aggressively; or two, to take the offensive and attack Maxwell House’s New York market. If he chose the second option, he would be signaling his anger and suggesting that a truce might benefit them both.
Announce Results—to communicate clearly to the competition the results of an action to avoid a costly misunderstanding. In test-market situations a manufacturer could clearly announce a failure in hopes of dissuading a competitor from counterattacking other established products. In pricing battles, a competitor could announce that the price cut is for only a limited time, in an effort to avoid signaling a long-term intention to keep prices low.
Litigation—to tie up a competitor in court. When Kodak entered the instant-photography business, Polaroid made it clear through the courts that it considered Kodak’s camera and film a patent infringement. Polaroid also publicly announced that it would pursue its claims with all the resources at its disposal. Eventually Kodak withdrew from the market, and in 1991 the company agreed to pay Polaroid a $1 billion settlement and abandon instant photography.
The Ten-Day MBA 4th Ed. Page 30
