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Select a company in which you are interested. Conduct at least two Internet sources that will

enable you to answer the following questions:

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● How well is the company’s strategy working?

● What are the company’s competitively important resources and capabilities?

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3 c

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LEARNING OBJECTIVES

After reading this chapter, you should be able to:

LO3-1 Identify factors in a company’s broad macro-environment that may have strategic significance.

LO3-2 Recognize the factors that cause competition in an industry to be fierce, more or less normal, or relatively weak.

LO3-3 Map the market positions of key groups of industry rivals.

LO3-4 Determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability.

Evaluating a Company’s External Environment

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In Chapter 2, we learned that the strategy formulation, strategy execution process begins with an appraisal of the company’s present situation. The company’s situation includes two facets: (1) its external environment—most notably, the competitive condi- tions in the industry in which the company operates; and (2) its internal environment— particularly the company’s resources and organizational capabilities.

Charting a company’s long-term direction, conceiving its customer value proposi- tion, setting objectives, or crafting a strategy without first gaining an understanding of the company’s external and internal environments hamstrings attempts to build com- petitive advantage and boost company performance. Indeed, the first test of a winning strategy inquires, “How well does the strategy fit the company’s situation?”

This chapter presents the concepts and analytical tools for zeroing in on a single- business company’s external environment. Attention centers on the competitive arena in which the company operates, the drivers of market change, the market positions of rival companies, and the factors that determine competitive success. Chapter 4 explores the methods of evaluating a company’s internal circumstances and competitiveness.

Assessing the Company’s Industry and Competitive Environment Thinking strategically about a company’s industry and competitive environment entails using some well-validated concepts and analytical tools to get clear answers to seven questions:

1. Do macro-environmental factors and industry characteristics offer sellers opportu- nities for growth and attractive profits?

2. What kinds of competitive forces are industry members facing, and how strong is each force?

3. What forces are driving industry change, and what impact will these changes have on competitive intensity and industry profitability?

4. What market positions do industry rivals occupy—who is strongly positioned and who is not?

5. What strategic moves are rivals likely to make next?

6. What are the key factors of competitive success?

7. Does the industry outlook offer good prospects for profitability?

Analysis-based answers to these questions are prerequisites for a strategy offering good fit with the external situation. The remainder of this chapter is devoted to describ- ing the methods of obtaining solid answers to these seven questions.

Question 1:  What Are the Strategically Relevant Components of the Macro-Environment?

Identify factors in a company’s broad macro-environment that may have strategic significance.LO3-1

A company’s external environment includes the immediate industry and competi- tive environment and broader macro-environmental factors such as general economic

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38 Part 1 Section B: Core Concepts and Analytical Tools

conditions, societal values and cultural norms, political factors, the legal and regulatory environment, ecologi- cal considerations, and technological factors. These two levels of a company’s external environment—the broad outer ring macro-environment and immediate inner ring industry and competitive environment—are illustrated in Figure 3.1. Strictly speaking, the macro-environment encompasses all of the relevant factors making up the broad environmental context in which a company oper- ates; by relevant, we mean the factors are important enough that they should shape management’s decisions regarding the company’s long-term direction, objectives, strategy, and business model. The relevance of macro- environmental factors can be evaluated using PESTEL analysis, an acronym for the six principal components of the macro-environment: political factors, economic

conditions in the firm’s general environment, sociocultural forces, technological fac- tors, environmental forces, and legal/regulatory factors. Table 3.1 provides a descrip- tion of each of the six PESTEL components of the macro-environment.

The impact of outer ring macro-environmental factors on a company’s choice of strategy can be big or small. But even if the factors of the macro-environment change slowly or are likely to have a low impact on the company’s business situation, they still merit a watchful eye. Changes in sociocultural forces and technological factors have begun to have strategy-shaping effects on companies competing in industries ranging from news and entertainment to taxi services. As company managers scan the exter- nal environment, they must be alert for potentially important outer ring developments,

CORE CONCEPT The macro-environment encompasses the broad environmental context in which a com- pany is situated and is comprised of six prin- cipal components: political factors, economic conditions, sociocultural forces, technological factors, environmental factors, and legal/regula- tory conditions.

PESTEL analysis can be used to assess the strategic relevance of the six principal com- ponents of the macro-environment: political, economic, sociocultural, technological, environ- mental, and legal forces.

Ind ustry

and Competitive Environment

Company

Macro-Environment

Suppliers

Rival Firms

New Entrants

Buyers

Substitute Products

Economic Conditions

Sociocultural Forces

Political Factors

Legal/Regulatory Factors

Environmental Forces

Technological Factors

The Components of a Company’s External EnvironmentFIGURE 3.1

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assess their impact and influence, and adapt the company’s direction and strategy as needed.

However, the factors and forces in a company’s external environment that have the biggest strategy-shaping impact typically pertain to the company’s immediate inner ring industry and competitive environment—the competitive pressures brought about by the actions of rival firms, the competitive effects of buyer behavior, supplier-related com- petitive considerations, the impact of new entrants to the industry, and availability of acceptable or superior substitutes for a company’s products or services. The inner ring industry and competitive environment is fully explored in Question 2 of this chapter using Porter’s Five Forces Model of Competition.

TABLE 3.1

The Six Components of the Macro-Environment Included in a PESTEL Analysis

Component Description

Political factors These factors include political policies and processes, including the extent to which a government inter- venes in the economy. They include such matters as tax policy, fiscal policy, tariffs, the political climate, and the strength of institutions such as the federal banking system. Some political factors, such as bail- outs, are industry-specific. Others, such as energy policy, affect certain types of industries (energy pro- ducers and heavy users of energy) more than others.

Economic conditions Economic conditions include the general economic climate and specific factors such as interest rates, exchange rates, the inflation rate, the unemployment rate, the rate of economic growth, trade deficits or surpluses, savings rates, and per capita domestic product. Economic factors also include conditions in the markets for stocks and bonds, which can affect consumer confidence and discretionary income. Some industries, such as construction, are particularly vulnerable to economic downturns but are positively affected by factors such as low interest rates. Others, such as discount retailing, may benefit when gen- eral economic conditions weaken, as consumers become more price-conscious. Economic characteristics of the industry such as market size and growth rate are also important to evaluate when assessing an industry’s prospects for growth and attractive profits.

Sociocultural forces Sociocultural forces include the societal values, attitudes, cultural factors, and lifestyles that impact businesses, as well as demographic factors such as the population size, growth rate, and age distribu- tion. Sociocultural forces vary by locale and change over time. An example is the trend toward healthier lifestyles, which can shift spending toward exercise equipment and health clubs and away from alcohol and snack foods. Population demographics can have large implications for industries such as health care, where costs and service needs vary with demographic factors such as age and income distribution.

Technological factors Technological factors include the pace of technological change and technical developments that have the potential for wide-ranging effects on society, such as genetic engineering and nanotechnology. They include institutions involved in creating knowledge and controlling the use of technology, such as R&D consortia, university-sponsored technology incubators, patent and copyright laws, and government control over the Internet. Technological change can encourage the birth of new industries, such as those based on nanotechnology, and disrupt others, such as the recording industry.

Environmental forces These include ecological and environmental forces such as weather, climate, climate change, and associ- ated factors such as water shortages. These factors can directly impact industries such as insurance, farming, energy production, and tourism. They may have an indirect but substantial effect on other indus- tries such as transportation and utilities.

Legal and regulatory factors

These factors include the regulations and laws with which companies must comply such as consumer laws, labor laws, antitrust laws, and occupational health and safety regulations. Some factors, such as banking deregulation, are industry-specific. Others, such as minimum wage legislation, affect certain types of industries (low-wage, labor-intensive industries) more than others.

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40 Part 1 Section B: Core Concepts and Analytical Tools

Question 2: How Strong Are the Industry’s Competitive Forces?

Recognize the factors that cause competition in an industry to be fierce, more or less normal, or relatively weak.

LO3-2

After an understanding of the industry’s general economic characteristics is gained, industry and competitive analysis should focus on the competitive dynamics of the industry. The nature and subtleties of competitive forces are never the same from one industry to another and must be wholly understood to accurately assess the com- pany’s current situation. Far and away the most powerful and widely used tool for assessing the strength of the industry’s competitive forces is the five forces model of competition.1 This model, as depicted in Figure 3.2, holds that competitive forces affecting industry attractiveness go beyond rivalry among competing sellers and

Rivalry among Competing

Sellers Competitive pressures

created by the jockeying of rival sellers for

better market position and competitive

advantage

Buyers

Competitive pressures stemming

from seller- buyer

collaboration and

bargaining

Competitive pressures stemming

from supplier-

seller collaboration

and bargaining

Competitive pressures coming from the threat of entry of new rivals

Suppliers of Raw Materials, Parts,

Components, or Other

Resource Inputs

Competitive pressures coming from the market attempts of outsiders to win buyers over to their products

Firms in Other Industries O�ering Substitute Products

Potential New Entrants

Sources: Based on Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (March–April 1979), pp. 137–45; and Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review 86, no. 1 (January 2008), pp. 80–86.

The Five Forces Model of CompetitionFIGURE 3.2

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include pressures stemming from four coexisting sources. The five competitive forces affecting industry attractiveness are listed.

1. Competitive pressures stemming from buyer bargaining power.

2. Competitive pressures coming from companies in other industries to win buyers over to substitute products.

3. Competitive pressures stemming from supplier bargaining power.

4. Competitive pressures associated with the threat of new entrants into the market.

5. Competitive pressures associated with rivalry among competing sellers to attract customers. This is usually the strongest of the five competitive forces.

The Competitive Force of Buyer Bargaining Power Whether seller-buyer relationships represent a minor or significant competitive force depends on (1) whether some or many buyers have sufficient bargaining leverage to obtain price concessions and other favorable terms, and (2) the extent to which buyers are price sensitive. Buyers with strong bargaining power can limit industry profitabil- ity by demanding price concessions, better payment terms, or additional features and services that increase industry members’ costs. Buyer price sensitivity limits the profit potential of industry members by restricting the ability of sellers to raise prices without losing volume or unit sales.

The leverage that buyers have in negotiating favorable terms of the sale can range from weak to strong. Individual consumers, for example, rarely have much bargain- ing power in negotiating price concessions or other favorable terms with sellers. The primary exceptions involve situations in which price haggling is customary, such as the purchase of new and used motor vehicles, homes, and other big-ticket items such as jewelry and pleasure boats. For most consumer goods and services, individual buyers have no bargaining leverage—their option is to pay the seller’s posted price, delay their purchase until prices and terms improve, or take their business elsewhere.

In contrast, large retail chains such as Walmart, Best Buy, Staples, and Lowe’s typi- cally have considerable negotiating leverage in purchasing products from manufacturers because retailers usually stock just two or three competing brands of a product and rarely carry all competing brands. In addition, the strong bargaining power of major supermar- ket chains such as Kroger, Publix, and Albertsons allows them to demand promotional allowances and lump-sum payments (called slotting fees) from food products manufac- turers in return for stocking certain brands or putting them in the best shelf locations. Motor vehicle manufacturers have strong bargaining power in negotiating to buy original equipment tires from Goodyear, Michelin, Bridgestone, Continental, and Pirelli not only because they buy in large quantities but also because tire makers have judged original equipment tires to be important contributors to brand awareness and brand loyalty.

Even if buyers do not purchase in large quantities or offer a seller important market expo- sure or prestige, they gain a degree of bargaining leverage in the following circumstances:

• If buyers’ costs of switching to competing brands or substitutes are relatively low. When the products of rival sellers are virtually identical, it is relatively easy for buyers to switch from seller to seller at little or no cost. The potential for buyers to easily switch from one seller to another encourages sellers to make concessions to win or retain a buyer’s business.

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42 Part 1 Section B: Core Concepts and Analytical Tools

• If the number of buyers is small or if a customer is particularly important to a seller. The smaller the number of buyers, the less easy it is for sellers to find alternative buyers when a customer is lost to a competitor. The prospect of losing a customer who is not easily replaced often makes a seller more willing to grant concessions of one kind or another.

• If buyer demand is weak. Weak or declining demand creates a “buyers’ market”; conversely, strong or rapidly growing demand creates a “sellers’ market” and shifts bargaining power to sellers.

• If buyers are well informed about sellers’ products, prices, and costs. The more infor- mation buyers have, the better bargaining position they are in. The mushrooming availability of product information on the Internet (and is readily available on smartphones) has given added bargaining power to consumers.

• If buyers pose a credible threat of integrating backward into the business of sell- ers. Anheuser-Busch InBev has integrated backward into metal can manufacturing to gain bargaining power in obtaining the balance of its can requirements from otherwise powerful metal can manufacturers.

Figure 3.3 summarizes factors causing buyer bargaining power to be strong or weak. It is important to recognize that not all buyers of an industry’s product have equal

degrees of bargaining power with sellers, and some may be less sensitive than others to price, quality, or service differences. For example, apparel manufacturers confront significant bargaining power when selling to big retailers such as Macy’s, T. J. Maxx, or Kohl’s, but they can command much better prices selling to small owner-managed apparel boutiques.

Rivalry among

Competing Sellers

Buyers How strong are competitive pressures stemming from buyer bargaining power and seller-buyer collaboration? Buyer bargaining power is stronger when: •Buyer switching costs to competing brands or substitute products

are low. •Buyers are large and can demand concessions when purchasing

large quantities. •Large volume purchases by buyers are important to sellers. •Buyer demand is weak or declining. • There are only a few buyers—so that each one’s business is

important to sellers. •Identity of buyer adds prestige to the seller’s list of customers. •Quantity and quality of information available to buyers improves. •Buyers have the ability to postpone purchases until later if they

do not like the prices o�ered by sellers. •Some buyers are a threat to integrate backward into the business

of sellers. Buyer bargaining power is weaker when: •Buyers purchase the item infrequently or in small quantities. •Buyer switching costs to competing brands or substitutes are high. • There is a surge in buyer demand that creates a “sellers’ market.” • A seller’s brand reputation is important to the buyer. • A particular seller’s product delivers quality or performance that is

not matched by other brands.

Suppliers

Substitutes

New Entrants

Factors Affecting the Strength of Buyer Bargaining PowerFIGURE 3.3

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The Competitive Force of Substitute Products Companies in one industry are vulnerable to competitive pressure from the actions of companies in another industry whenever buyers view the products of the two indus- tries as good substitutes. For instance, the producers of sugar experience competitive pressures from the sales and marketing efforts of the makers of Splenda, Truvia, and Sweet’N Low. Similarly, cable television networks and providers are finding it more difficult to maintain their relevance to subscribers who find greater value in streaming devices and services.

Just how strong the competitive pressures are from the sellers of substitute products depends on three factors:

1. Whether substitutes are readily available and attractively priced. The presence of readily available and attractively priced substitutes creates competitive pressure by placing a ceiling on the prices industry members can charge. When substitutes are cheaper than an industry’s product, industry members come under heavy competi- tive pressure to reduce their prices and find ways to absorb the price cuts with cost reductions.

2. Whether buyers view the substitutes as comparable or better in terms of quality, perfor- mance, and other relevant attributes. Customers are prone to compare performance and other attributes as well as price. For example, consumers have found smart- phones to be a superior substitute to digital cameras because of constant availabil- ity of smartphones and superior ease of use in managing images.

3. Whether the costs that buyers incur in switching to the substitutes are high or low. High switching costs deter switching to substitutes, whereas low switching costs make it easier for the sellers of attractive substitutes to lure buyers to their prod- ucts. Typical switching costs include the inconvenience of switching to a substi- tute, the costs of additional equipment, the psychological costs of severing old supplier relationships, and employee retraining costs.

Figure 3.4 summarizes the conditions that determine whether the competitive pres- sures from substitute products are strong, moderate, or weak. As a rule, the lower the price of substitutes, the higher their quality and performance, and the lower the user’s switching costs, the more intense the competitive pressures posed by substitute products.

The Competitive Force of Supplier Bargaining Power Whether the suppliers of industry members represent a weak or strong competitive force depends on the degree to which suppliers have sufficient bargaining power to influence the terms and conditions of supply in their favor. Suppliers with strong bar- gaining power can erode industry profitability by charging industry members higher prices, passing costs on to them, and limiting their opportunities to find better deals. For instance, Microsoft and Intel, both of which supply PC makers with essential com- ponents, have been known to use their dominant market status not only to charge PC makers premium prices but also to leverage PC makers in other ways. The bargaining power possessed by Microsoft and Intel when negotiating with customers is so great that both companies have faced antitrust charges on numerous occasions. Before a legal agreement ending the practice, Microsoft pressured PC makers to load only Microsoft

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44 Part 1 Section B: Core Concepts and Analytical Tools

products on the PCs they shipped. Intel has also defended against antitrust charges resulting from its bargaining strength but continues to give PC makers that use the big- gest percentages of Intel chips in their PC models top priority in filling orders for newly introduced Intel chips. Being on Intel’s list of preferred customers helps a PC maker get an early allocation of Intel’s latest chips and thus allows a PC maker to get new models to market ahead of rivals.

The factors that determine whether any of the industry suppliers are in a position to exert substantial bargaining power or leverage are fairly clear-cut:

• If the item being supplied is a commodity that is readily available from many sup- pliers. Suppliers have little or no bargaining power or leverage whenever industry members have the ability to source from any of several alternative and eager suppliers.

Firms in Other Industries O�ering Substitute Products

How strong are competitive pressures coming from substitute products from outside the industry?

Competitive pressures from substitutes are stronger when:

Competitive pressures from substitutes are weaker when:

• Good substitutes are readily available or new ones are emerging. • Substitutes are attractively priced. • Substitutes have comparable or better performance features. • End users have low costs in switching to substitutes. • End users grow more comfortable with using substitutes.

• Good substitutes are not readily available or don’t exist. • Substitutes are higher priced relative to the performance they deliver. • End users have high costs in switching to substitutes.

Signs That Competition from Substitutes Is Strong • Sales of substitutes are growing faster than sales of the industry being analyzed (an indication that the sellers of substitutes are drawing customers away from the industry in question). • Producers of substitutes are moving to add new capacity. • Profits of the producers of substitutes are on the rise.

Rivalry among

Competing Sellers

Suppliers

New Entrants

Buyers

Factors Affecting Competition from Substitute ProductsFIGURE 3.4

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• The ability of industry members to switch their purchases from one supplier to another or to switch to attractive substitutes. High switching costs increase supplier bargain- ing power, whereas low switching costs and the ready availability of good substi- tute inputs weaken supplier bargaining power.

• If certain inputs are in short supply. Suppliers of items in short supply have some degree of pricing power.

• If certain suppliers provide a differentiated input that enhances the performance, qual- ity, or image of the industry’s product. The greater the ability of a particular input to enhance a product’s performance, quality, or image, the more bargaining leverage its suppliers are likely to possess.

• Whether certain suppliers provide equipment or services that deliver cost savings to industry members in conducting their operations. Suppliers who provide cost-saving equipment or services are likely to possess some degree of bargaining leverage.

• The fraction of the costs of the industry’s product accounted for by the cost of a particu- lar input. The bigger the cost of a specific part or component, the more opportu- nity for competition in the marketplace to be affected by the actions of suppliers to raise or lower their prices.

• If industry members are major customers of suppliers. As a rule, suppliers have less bargaining leverage when their sales to members of this one industry constitute a big percentage of their total sales. In such cases, the well-being of suppliers is closely tied to the well-being of their major customers.

• Whether it makes good economic sense for industry members to vertically integrate backward. The make-or-buy decision generally boils down to whether suppliers are able to supply a particular component at a lower cost than industry members could achieve if they were to integrate backward.

Figure 3.5 summarizes the conditions that tend to make supplier bargaining power strong or weak.

The Competitive Force of Potential New Entrants New entrants into an industry place additional competitive pressure on existing firms since they are likely to compete fiercely to establish market share and will add to the industry’s production capacity. But even the threat of new entry can be an impor- tant competitive force. This is because credible threat of entry often prompts industry members to lower their prices and initiate defensive actions in an attempt to deter new entrants. Just how serious the threat of entry is in a particular market depends on two classes of factors: (1) the expected reaction of incumbent firms to new entry and (2) barriers to entry. The threat of entry is low in industries where incumbent firms are likely to retaliate against new entrants with sharp price discounting and other moves designed to make entry unprofitable. The threat of entry is also low when entry barri- ers are high.

The most widely encountered barriers that entry candidates must hurdle include:2

• The presence of sizable economies of scale in production or other areas of operation. When incumbent companies enjoy cost advantages associated with large-scale operations, outsiders must either enter on a large scale (a costly and perhaps risky move) or accept a cost disadvantage and consequently lower profitability.

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46 Part 1 Section B: Core Concepts and Analytical Tools

• Cost and resource disadvantages not related to scale of operation. Aside from enjoy- ing economies of scale, industry incumbents can have cost advantages that stem from the possession of proprietary technology, partnerships with the best and cheapest suppliers, low fixed costs (because they have older facilities that have been mostly depreciated), and experience/learning-curve effects. Manufacturing unit costs for microprocessors tend to decline about 20 percent each time cumulative production volume doubles. With a 20 percent experience-curve effect, if the first 1 million chips cost $100 each, once production volume reaches 2 million, the unit cost would fall to $80 (80 percent of $100), and by a production volume of 4 million, the unit cost would be $64 (80 percent of $80).3 The bigger the learning- or experience-curve effect, the bigger the cost advantage of the company with the largest cumulative production volume.

• Strong brand preferences and high degrees of customer loyalty. The stronger the attachment of buyers to established brands, the harder it is for a newcomer to break into the marketplace.

• High capital requirements. The larger the total dollar investment needed to enter the market successfully, the more limited the pool of potential entrants. The most obvious capital requirements for new entrants relate to manufacturing facilities and equip- ment, introductory advertising and sales promotion campaigns, working capital to finance inventories and customer credit, and sufficient cash to cover start-up costs.

Rivalry among

Competing Sellers

Suppliers of Resource Inputs

How strong are the competitive pressures stemming from supplier bargaining power and seller-supplier collaboration?

Supplier bargaining power is stronger when:

Supplier bargaining power is weaker when:

• Industry members incur high costs in switching their purchases to alternative suppliers. • Needed inputs are in short supply (which gives suppliers more leverage in setting prices). • A supplier has a di�erentiated input that enhances the quality, performance, or image of sellers’ products or is a valuable or critical part of sellers’ production processes. • There are only a few suppliers of a particular input.

• The item being supplied is a “commodity” that is readily available from many suppliers at the going market price. • Seller switching costs to alternative suppliers are low. • Good substitute inputs exist or new ones emerge. • There is a surge in the availability of supplies (thus greatly weakening supplier pricing power). • Industry members account for a big fraction of suppliers’ total sales and continued high-volume purchases are important to the well-being of suppliers. • Industry members are a threat to integrate backward into the business of suppliers and to self-manufacture their

own requirements.

New Entrants

Buyers

Substitutes

Factors Affecting the Strength of Supplier Bargaining PowerFIGURE 3.5

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• The difficulties of building a network of distributors-retailers and securing adequate space on retailers’ shelves. A potential entrant can face numerous distribution chan- nel challenges. Wholesale distributors may be reluctant to take on a product that lacks buyer recognition. Retailers have to be recruited and convinced to give a new brand ample display space and an adequate trial period. Potential entrants some- times have to “buy” their way into wholesale or retail channels by cutting their prices to provide dealers and distributors with higher markups and profit margins or by giving them big advertising and promotional allowances.

• Patents and other forms of intellectual property protection. In a number of industries, entry is prevented due to the existence of intellectual property protection laws that remain in place for a given number of years. Often, companies have a “wall of pat- ents” in place to prevent other companies from entering with a “me too” strategy that replicates a key piece of technology.

• Strong “network effects” in customer demand. In industries where buyers are more attracted to a product when there are many other users of the product, there are said to be “network effects.” Video game systems are an example, since many users prefer multiplayer games and sharing games. When incumbents have a large exist- ing base of users, new entrants with otherwise comparable products face a serious disadvantage in attracting buyers.

• Restrictive regulatory policies. Government agencies can limit or even bar entry by requiring licenses and permits. Regulated industries such as cable TV, telecom- munications, electric and gas utilities, and radio and television broadcasting entail government-controlled entry.

• Tariffs and international trade restrictions. National governments commonly use tariffs and trade restrictions (antidumping rules, local content requirements, local ownership requirements, quotas, etc.) to raise entry barriers for foreign firms and protect domestic producers from outside competition.

• The ability and willingness of industry incumbents to launch vigorous initiatives to block a newcomer’s successful entry. Even if a potential entrant has or can acquire the needed competencies and resources to attempt entry, it must still worry about the reaction of existing firms.4 Sometimes, there’s little that incumbents can do to throw obstacles in an entrant’s path. But there are times when incumbents use price cuts, increase advertising, introduce product improvements, and launch legal attacks to prevent the entrant from building a clientele. Taxicab companies across the world are aggressively lobbying local governments to impose regulations that would bar ride-sharing services such as Uber or Lyft.

Figure 3.6 summarizes conditions making the threat of entry strong or weak.

The Competitive Force of Rivalry Among Competing Sellers The strongest of the five competitive forces is nearly always the rivalry among compet- ing sellers of a product or service. In effect, a market is a competitive battlefield where there’s no end to the campaign for buyer patronage. Rival sellers are prone to employ whatever weapons they have in their business arsenal to improve their market posi- tions, strengthen their market position with buyers, and earn good profits. The strategy formulation challenge is to craft a competitive strategy that, at the very least, allows a company to hold its own against rivals and that, ideally, produces a competitive edge

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48 Part 1 Section B: Core Concepts and Analytical Tools

over rivals. But competitive contests are ongoing and dynamic. When one firm makes a strategic move that produces good results, its rivals typically respond with offensive or defensive countermoves of their own. This pattern of action and reaction produces a continually evolving competitive landscape in which the market battle ebbs and flows and produces winners and losers. But the current market leaders have no guarantees of continued leadership. In every industry, the ongoing jockeying of rivals leads to one or more companies gaining or losing momentum in the marketplace according to whether their latest strategic maneuvers succeed or fail.5

Figure 3.7 shows a sampling of competitive weapons that firms can deploy in bat- tling rivals and indicates the factors that influence the intensity of their rivalry. Some factors that influence the tempo of rivalry among industry competitors include:

• Rivalry is stronger in industries when the number of competitors increases and they become more equal in size and capability. Competitive rivalry in the quick-service restaurant industry is particularly strong where there are numerous relatively equal-sized hamburger, deli sandwich, chicken, and taco chains. For the most part,

Rivalry Among

Competing Sellers

Potential New Entrants

How strong are the competitive pressures associated with the entry threat from new rivals?

Substitutes

BuyersSuppliers

Entry threats are weaker when:Entry threats are stronger when: The pool of entry candidates is small. Entry barriers are high. Existing competitors are struggling to earn good profits.

The industry’s outlook is risky or uncertain. Buyer demand is growing slowly or is stagnant. Industry members will strongly contest the e�orts of

new entrants to gain a market foothold.

The pool of entry candidates is large and some have resources that would make them formidable market contenders.

Entry barriers are low or can be readily hurdled by the likely entry candidates.

Existing industry members are looking to expand their market reach by entering product segments or geographic areas where they currently do not have a presence.

Newcomers can expect to earn attractive profits. Buyer demand is growing rapidly. Industry members are unable (or unwilling) to strongly contest the entry of newcomers.

Factors Affecting the Threat of EntryFIGURE 3.6

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McDonald’s, Burger King, Taco Bell, Arby’s, Chick-fil-A, and other national fast- food chains have comparable capabilities and are required to compete aggressively to hold their own in the industry.

• Rivalry is usually stronger when demand is growing slowly or declining. Rapidly expanding buyer demand produces enough new business for all industry members to grow. But in markets where growth is sluggish or where buyer demand drops off unexpectedly, it is not uncommon for competitive rivalry to intensify significantly as rivals battle for market share and volume gains.

• Rivalry increases as it becomes less costly for buyers to switch brands. The less costly it is for buyers to switch their purchases from one seller to another, the easier it is for sellers to steal customers away from rivals. Switching costs include not only monetary costs but also the time, inconvenience, and psychological costs involved in switching brands. For example, retailers may not switch to the brands of rival manufacturers because they are hesitant to sever long-standing supplier relation- ships or incur the additional expense of retraining employees, accessing technical support, or testing the quality and reliability of the new brand.

• Rivalry increases when sellers find themselves with excess capacity and/or inventory. Excess supply conditions create a “buyers’ market,” putting added competitive

Rivalry among Competing Sellers

How strong is seller-related competition?

Rivalry is generally stronger when:

Rivalry is generally weaker when:

BuyersSuppliers

Substitutes

New Entrants

Typical “Weapons” for Battling Rivals and Attracting Buyers

• Buyer demand is growing slowly.

• Diversity of competitors increases in terms of long-term directions, objectives, strategies, and countries of origin.

• Buyer demand falls o� and sellers find themselves with excess capacity and/or inventory.

• The number of rivals increases and rivals are of roughly equal size and competitive capability.

• The products of rival sellers are commodities or else weakly di�erentiated. • Buyer costs to switch brands are low. • High exit barriers keep unprofitable firms from leaving the industry.

• Buyer demand is growing rapidly. • The products of rival sellers are strongly di�erentiated and customer

loyalty is high. • Buyer costs to switch brands are high.• Lower prices

• More or di�erent features • Better product performance • Higher quality • Stronger brand image • Wider selection of models • Bigger/better dealer network • Low-interest-rate financing • Higher levels of advertising • Better customer service • Product customization

Factors Affecting the Strength of Competitive RivalryFIGURE 3.7

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50 Part 1 Section B: Core Concepts and Analytical Tools

pressure on industry rivals to scramble for profitable sales levels (often by price discounting).

• Rivalry increases as the products of rival sellers become less strongly differentiated. When the offerings of rivals are identical or weakly differentiated, buyers have less reason to be brand loyal—a condition that makes it easier for rivals to persuade buyers to switch to their offering.

• Rivalry becomes more intense as the diversity of competitors increases in terms of long-term directions, objectives, strategies, and countries of origin. A diverse group of sellers often contains one or more mavericks willing to try novel or rule-breaking market approaches, thus generating a more volatile and less predictable competi- tive environment. Globally competitive markets are often more rivalrous, espe- cially when aggressors have lower costs and are intent on gaining a strong foothold in new country markets.

• Rivalry is stronger when high exit barriers keep unprofitable firms from leaving the industry. In industries where the assets cannot easily be sold or transferred to other uses, where workers are entitled to job protection, or where owners are committed to remaining in business for personal reasons, failing firms tend to hold on longer than they might otherwise—even when they are bleeding red ink. Deep price dis- counting of this sort can destabilize an otherwise attractive industry.

Rivalry can be characterized as cutthroat or brutal when competitors engage in protracted price wars or habitually employ other aggressive tactics that are mutually destructive to profitability. Rivalry can be considered fierce to strong when the battle for market share is so vigorous that the profit margins of most industry members are squeezed to bare-bones levels. Rivalry can be characterized as moderate or normal when the maneuvering among industry members, while lively and healthy, still allows most industry members to earn acceptable profits. Rivalry is weak when most companies in the industry are relatively well satisfied with their sales growth and market share and rarely undertake offensives to steal customers away from one another.

The Collective Strengths of the Five Competitive Forces and Industry Profitability Scrutinizing each of the five competitive forces one by one provides a powerful diag- nosis of what competition is like in a given market. Once the strategist has gained an understanding of the competitive pressures associated with each of the five forces, the next step is to evaluate the collective strength of the five forces and determine if compa- nies in this industry should reasonably expect to earn decent profits.

As a rule, the stronger the collective impact of the five competitive forces, the lower the combined profitability of industry participants. The most extreme case of a “competitively unattractive” industry is when all five forces are producing strong competitive pres- sures: Rivalry among sellers is vigorous, low entry barriers allow new rivals to gain a market foothold, competition from substitutes is intense, and both suppliers and cus- tomers are able to exercise considerable bargaining leverage. Fierce to strong competi- tive pressures coming from all five directions nearly always drive industry profitability to unacceptably low levels, frequently producing losses for many industry members and forcing some out of business. But an industry can be competitively unattractive without all five competitive forces being strong. Fierce competitive pressures from just one of

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the five forces, such as brutal price competition among rival sellers, may suffice to destroy the conditions for good profitability.

In contrast, when the collective impact of the five competitive forces is moderate to weak, an industry is competitively attractive in the sense that industry members can reasonably expect to earn good profits and a nice return on investment. The ideal competitive environment for earning superior profits is one in which both suppliers and customers are in weak bargaining positions, there are no good substitutes, high barriers block further entry, and rivalry among present sellers generates only moderate competitive pressures. Weak competition is the best of all possible worlds for companies with mediocre strategies and second-rate implementation because even they can expect a decent profit.

Question 3: What Are the Industry’s Driving Forces of Change, and What Impact Will They Have? The intensity of competitive forces and the level of industry attractiveness are almost always fluid and subject to change. It is essential for strategy makers to understand the current competitive dynamics of the industry, but it is equally important for strategy makers to consider how the industry is changing and the effect of industry changes that are under way. Any strategies devised by management will play out in a dynamic indus- try environment, so it’s imperative that such plans consider what the industry environ- ment might look like during the near term.

The Concept of Industry Driving Forces Industry and competitive conditions change because forces are enticing or pressuring certain industry participants (competitors, customers, suppliers) to alter their actions in important ways. The most powerful of the change agents are called driving forces because they have the biggest influences in reshaping the industry landscape and altering competitive conditions. Some driving forces originate in the outer ring of the company’s macro-environment (see Figure 3.1), but most originate in the company’s more immediate industry and competitive environment.

Driving forces analysis has three steps: (1) identify- ing what the driving forces are, (2) assessing whether the drivers of change are, individually or collectively, acting to make the industry more or less attractive, and (3) determining what strategy changes are needed to prepare for the impact of the driving forces.

Identifying an Industry’s Driving Forces Many developments can affect an industry powerfully enough to qualify as driving forces, but most drivers of industry and competitive change fall into one of the follow- ing categories:

• Changes in an industry’s long-term growth rate. Shifts in industry growth have the potential to affect the balance between industry supply and buyer demand, entry and exit, and the character and strength of competition. An upsurge in buyer

The stronger the forces of competition, the harder it becomes for industry members to earn attractive profits.

CORE CONCEPT Driving forces are the major underlying causes of change in industry and competitive conditions.

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52 Part 1 Section B: Core Concepts and Analytical Tools

demand triggers a race among established firms and newcomers to capture the new sales opportunities. A slowdown in the growth of demand nearly always brings an increase in rivalry and increased efforts by some firms to maintain their high rates of growth by taking sales and market share away from rivals.

• Increasing globalization. Competition begins to shift from primarily a regional or national focus to an international or global focus when industry members begin seeking customers in foreign markets or when production activities begin to migrate to countries where costs are lowest. The forces of globalization are sometimes such a strong driver that companies find it highly advantageous, if not necessary, to spread their operating reach into more and more country mar- kets. Globalization is very much a driver of industry change in such industries as energy, mobile phones, steel, social media, and pharmaceuticals.

• Changes in who buys the product and how they use it. Shifts in buyer demographics and the ways products are used can alter competition by affecting how customers perceive value, how customers make purchasing decisions, and where customers purchase the product. The burgeoning popularity of streaming video has affected broadband providers, wireless phone carriers, and television broadcasters, and cre- ated opportunities for such new entertainment businesses as Hulu and Netflix.

• Product innovation. An ongoing stream of product innovations tends to alter the pattern of competition in an industry by attracting more first-time buyers, rejuve- nating industry growth, and/or creating wider or narrower product differentiation among rival sellers. Philips Lighting Hue bulbs allow homeowners to use a smart- phone app to remotely turn lights on and off, blink if an intruder is detected, and create a wide range of white and color ambiances.

• Technological change and manufacturing process innovation. Advances in technol- ogy can cause disruptive change in an industry by lowering costs, introducing new substitutes, or opening new industry frontiers. For instance, revolutionary change in autonomous system technology has put Google, Tesla, Apple, and every major automobile manufacturer into a race to develop viable self-driving vehicles.

• Marketing innovation. When firms are successful in introducing new ways to market their products, they can spark a burst of buyer interest, widen industry demand, increase product differentiation, and lower unit costs—any or all of which can alter the competitive positions of rival firms and force strategy revisions.

• Entry or exit of major firms. The entry of one or more foreign companies into a geographic market once dominated by domestic firms nearly always shakes up competitive conditions. Likewise, when an established domestic firm from another industry attempts entry either by acquisition or by launching its own start-up ven- ture, it usually pushes competition in new directions.

• Diffusion of technical know-how across more companies and more countries. As knowledge about how to perform a particular activity or execute a particular manufacturing technology spreads, the competitive advantage held by firms origi- nally possessing this know-how erodes. Knowledge diffusion can occur through scientific journals, trade publications, on-site plant tours, word of mouth among suppliers and customers, employee migration, and Internet sources.

• Changes in cost and efficiency. Widening or shrinking differences in the costs among key competitors tend to dramatically alter the state of competition.

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Declining costs to produce tablet computers have enabled price cuts and spurred tablet sales by making them more affordable to users.

• Growing buyer preferences for differentiated products instead of a commodity product (or for a more standardized product instead of strongly differentiated products). When a shift from standardized to differentiated products occurs, rivals must adopt strat- egies to outdifferentiate one another. However, buyers sometimes decide that a standardized, budget-priced product suits their requirements as well as a premium- priced product with lots of snappy features and personalized services.

• Regulatory influences and government policy changes. Government regulatory actions can often force significant changes in industry practices and strategic approaches. New rules and regulations pertaining to government-sponsored health insurance programs are driving changes in the health care industry. In interna- tional markets, host governments can drive competitive changes by opening their domestic markets to foreign participation or closing them.

• Changing societal concerns, attitudes, and lifestyles. Emerging social issues and changing attitudes and lifestyles can be powerful instigators of industry change. Consumer concerns about the use of chemical additives and the nutritional con- tent of food products have forced food producers to revamp food-processing tech- niques, redirect R&D efforts into the use of healthier ingredients, and compete in developing nutritious, good-tasting products.

While many forces of change may be at work in a given industry, no more than three or four are likely to be true driving forces powerful enough to qualify as the major deter- minants of why and how the industry is changing. Thus, company strategists must resist the temptation to label every change they see as a driving force. Table 3.2 lists the most common driving forces.

Assessing the Impact of the Industry Driving Forces The second step in driving forces analysis is to determine whether the prevailing driving forces are acting to make the industry environment more or less attractive. Getting a handle on the

TABLE 3.2

Common Driving Forces

1. Changes in the long-term industry growth rate 2. Increasing globalization 3. Emerging new Internet capabilities and applications 4. Changes in who buys the product and how they use it 5. Product innovation 6. Technological change and manufacturing process innovation 7. Marketing innovation 8. Entry or exit of major firms 9. Diffusion of technical know-how across more companies and more countries 10. Changes in cost and efficiency 11. Growing buyer preferences for differentiated products instead of a standardized commodity

product (or for a more standardized product instead of strongly differentiated products) 12. Regulatory influences and government policy changes 13. Changing societal concerns, attitudes, and lifestyles

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54 Part 1 Section B: Core Concepts and Analytical Tools

collective impact of the driving forces usually requires look- ing at the likely effects of each force separately, because the driving forces may not all be pushing change in the same direction. For example, two driving forces may be acting to spur demand for the industry’s product, while one driving force may be working to curtail demand. Whether the net effect on industry demand is up or down hinges on which driving forces are the more powerful.

Determining Strategy Changes Needed to Prepare for the Impact of Driving Forces The third step of driving forces analysis—where the real payoff for strategy making comes—is for managers to draw some conclusions about what strategy adjustments will be needed to deal with the impact of the driving forces. Without understanding the forces driving industry change and the impacts these forces will have on the industry environment over the next one to three years, managers are ill prepared to craft a strat- egy tightly matched to emerging conditions. Similarly, if managers are uncertain about the implications of one or more driving forces, or if their views are off-base, it will be

difficult for them to craft a strategy that is responsive to the consequences of driving forces. So driving forces analysis is not something to take lightly; it has practical value and is basic to the task of thinking strategically about where the industry is headed and how to prepare for the changes ahead.

Question 4: How Are Industry Rivals Positioned?

Map the market positions of key groups of industry rivals.LO3-3

The nature of competitive strategy inherently positions companies competing in an industry into strategic groups with diverse price/quality ranges, different distribution

channels, varying product features, and different geo- graphic coverages. The best technique for revealing the market positions of industry competitors is strategic group mapping. This analytical tool is useful for compar- ing the market positions of industry competitors or for grouping industry combatants into like positions.

Using Strategic Group Maps to Assess the Positioning of Key Competitors A strategic group consists of those industry members with similar competitive approaches and positions in the market. Companies in the same strategic group can resemble one another in any of several ways: they may have comparable product-line breadth, sell in the same price/quality range, emphasize the same distribution channels, use essentially the same product attributes to appeal to similar types of buyers, depend

An important part of driving forces analysis is to determine whether the individual or collective impact of the driving forces will be to increase or decrease market demand, make competi- tion more or less intense, and lead to higher or lower industry profitability.

The real payoff of driving forces analysis is to help managers understand what strategy changes are needed to prepare for the impacts of the driving forces.

CORE CONCEPT Strategic group mapping is a technique for displaying the different market or competitive positions that rival firms occupy in the industry.

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on identical technological approaches, or offer buyers similar services and technical assistance.6 An industry with a commodity-like product may contain only one strategic group whereby all sellers pursue essentially identical strategies and have comparable market posi- tions. But even with commodity products, there is likely some attempt at differentiation occurring in the form of varying delivery times, financing terms, or lev- els of customer service. Most industries offer a host of competitive approaches that allow companies to find unique industry positioning and avoid fierce competition in a crowded strategic group. Evaluating strategy options entails examining what strategic groups exist, identifying which companies exist within each group, and determining if a competitive “white space” exists where industry competitors are able to create and capture altogether new demand.

The procedure for constructing a strategic group map is straightforward:

• Identify the competitive characteristics that delineate strategic approaches used in the industry. Typical variables used in creating strategic group maps are the price/ quality range (high, medium, low), geographic coverage (local, regional, national, global), degree of vertical integration (none, partial, full), product-line breadth (wide, narrow), choice of distribution channels (retail, wholesale, Internet, mul- tiple channels), and degree of service offered (no-frills, limited, full).

• Plot firms on a two-variable map based upon their strategic approaches.

• Assign firms occupying the same map location to a common strategic group.

• Draw circles around each strategic group, making the circles proportional to the size of the group’s share of total industry sales revenues.

This produces a two-dimensional diagram like the one for the U.S. casual dining industry in Concepts & Connections 3.1.

Several guidelines need to be observed in creating strategic group maps. First, the two variables selected as axes for the map should not be highly correlated; if they are, the circles on the map will fall along a diagonal and strategy makers will learn nothing more about the relative positions of competitors than they would by considering just one of the variables. For instance, if companies with broad product lines use multiple distribution channels, while companies with narrow lines use a single distribution chan- nel, then looking at product line-breadth reveals just as much about industry positioning as looking at the two competitive variables. Second, the variables chosen as axes for the map should reflect key approaches to offering value to customers and expose big dif- ferences in how rivals position themselves in the marketplace. Third, the variables used as axes do not have to be either quantitative or continuous; rather, they can be discrete variables or defined in terms of distinct classes and combinations. Fourth, drawing the sizes of the circles on the map proportional to the combined sales of the firms in each strategic group allows the map to reflect the relative sizes of each strategic group. Fifth, if more than two good competitive variables can be used as axes for the map, multiple maps can be drawn to give different exposures to the competitive positioning in the industry. Because there is not necessarily one best map for portraying how competing firms are positioned in the market, it is advisable to experiment with different pairs of competitive variables.

CORE CONCEPT A strategic group is a cluster of industry rivals that have similar competitive approaches and market positions.

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56 Part 1 Section B: Core Concepts and Analytical Tools

COMPARATIVE MARKET POSITIONS OF SELECTED COMPANIES IN THE CASUAL DINING INDUSTRY: A STRATEGIC GROUP MAP EXAMPLE

&Concepts Connections 3.1

Note: Circles are drawn roughly proportional to the sizes of the chains, based on revenues.

Few U.S. Locations

Low

Moderate

High

Many U.S. Locations

Geographic Coverage

P ri

ce /S

e rv

ic e

/R e

st a

u ra

n t

A m

b ie

n ce

International

Maggiano’s Little Italy, P.F.

Chang’s

Olive Garden, Longhorn

Steakhouse

Hard Rock Café, Outback

Steakhouse

Applebee’s, Chili’s, On the Border,

TGI Friday’s

Cracker Barrel, Red Lobster, Golden

Corral

Five Guys, Bu�alo Wild Wings, Firehouse

Subs, Moe’s Southwest Grill

Jason’s Deli, McAlister’s Deli, Fazoli’s

BJ’s Restaurant & Brewery, The

Cheesecake Factory, Carrabba’s Italian

Grill

Corner Bakery Café, Atlanta Bread

Company

Panera Bread

Company

California Pizza

Kitchen

The Value of Strategic Group Maps Strategic group maps are revealing in several respects. The most important has to do with identifying which rivals are similarly positioned and are thus close rivals and which are distant rivals. Generally, the closer strategic groups are to each other on the map, the stronger the cross-group competitive rivalry tends to be. Although firms in the

same strategic group are the closest rivals, the next closest rivals are in the immediately adjacent groups.7 Often, firms in strategic groups that are far apart on the map hardly compete. For instance, Walmart’s cli- entele, merchandise selection, and pricing points are much too different to justify calling Walmart a close competitor of Neiman Marcus or Saks Fifth Avenue in

Some strategic groups are more favorably positioned than others because they confront weaker competitive forces and/or because they are more favorably impacted by industry driving forces.

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retailing. For the same reason, Timex is not a meaningful competitive rival of Rolex, and Kia is not a close competitor of Porsche or BMW.

The second thing to be gleaned from strategic group mapping is that not all positions on the map are equally attractive. Two reasons account for why some positions can be more attractive than others:

1. Industry driving forces may favor some strategic groups and hurt others. Driving forces in an industry may be acting to grow the demand for the products of firms in some strategic groups and shrink the demand for the products of firms in other strategic groups—as is the case in the news industry where Internet news services and cable news networks are gaining ground at the expense of newspapers and net- work television. The industry driving forces of emerging Internet capabilities and applications, changes in who buys the product and how they use it, and changing societal concerns, attitudes, and lifestyles are making it increasingly difficult for traditional media to increase audiences and attract new advertisers.

2. Competitive pressures may cause the profit potential of different strategic groups to vary. The profit prospects of firms in different strategic groups can vary from good to poor because of differing degrees of competitive rivalry within strategic groups, differing degrees of exposure to competition from substitute products outside the industry, and differing degrees of supplier or customer bargaining power from group to group. For instance, the competitive battle between Walmart and Target is more intense (with consequently smaller profit margins) than the rivalry among Tory Burch, Carolina Herrera, Dolce & Gabbana, and other high-end fashion retailers.

Thus, part of strategic group analysis always entails drawing conclusions about where on the map is the “best” place to be and why. Which companies or strategic groups are in the best positions to prosper, and which might be expected to struggle? And equally important, how might firms in poorly positioned strategic groups reposition themselves to improve their prospects for good financial performance?

Question 5: What Strategic Moves Are Rivals Likely to Make Next? Unless a company pays attention to the strategies and situations of competitors and has some inkling of what moves they will be making, it ends up flying blind into competitive battle. As in sports, scouting the business opposition is an essential part of game plan development. Having good information about the strategic direction and likely moves of key competitors allows a company to prepare defensive countermoves, to craft its own strategic moves with some confidence about what market maneuvers to expect from rivals in response, and to exploit any openings that arise from competitors’ missteps. The question is where to look for such information, since rivals rarely reveal their strategic intentions openly. If information is not directly available, what are the best indicators?

Michael Porter’s Framework for Competitor Analysis points to four indicators of a rival’s likely strategic moves. These include a rival’s current strategy, objectives, capabilities, and assumptions about itself and the industry. A strategic profile of a rival that provides good clues to its behavioral proclivities can be constructed by characterizing the rival along these four dimensions.

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Current Strategy To succeed in predicting a competitor’s next moves, company strategists need to have a good understanding of each rival’s current strategy. Questions to consider include: How is the competitor positioned in the market? What is the basis for its competitive advantage? What kinds of investments in infrastructure, technology, or other resources is it making?

Objectives An appraisal of a rival’s objectives should include not only its financial objectives but strategic objectives as well. What is even more important is to consider the extent to which the rival is meeting these objectives and if its management is under pressure to improve. Rivals with good financial performance are likely to continue their present strategy with only minor fine-tuning. Poorly performing rivals are virtually cer- tain to make fresh strategic moves.

Capabilities A rival’s strategic moves and countermoves are both enabled and con- strained by the set of capabilities it has at hand. Thus a rival’s capabilities (and efforts to acquire new capabilities) serve as a strong signal of future strategic actions.

Assumptions How a rival’s top managers think about their strategic situation can have a big impact on how they behave. Managers of casual dining chains convinced that sociocultural forces and economic con- ditions will drive industry growth may turn to franchis- ing to vastly expand a chain’s footprint and number of

units. Assessing a rival’s assumptions entails considering their assumptions about itself as well as the industry it participates in.

Information regarding these four analytical components can often be gleaned from company press releases, information posted on the company’s website (especially inves- tor presentations), and such public documents as annual reports and 10-K filings. Many companies also have a competitive intelligence unit that sifts through the available information to construct up-to-date strategic profiles of rivals.

Doing the necessary detective work can be time-consuming, but scouting competi- tors well enough to anticipate their next moves allows managers to prepare effective countermoves and to take rivals’ probable actions into account in crafting their own strategic offensives.

Question 6: What Are the Industry Key Success Factors? An industry’s key success factors (KSFs) are those competitive factors that most affect industry members’ ability to prosper in the marketplace. Key success factors may include

particular strategy elements, product attributes, resources, competitive capabilities, or intangible assets. KSFs by their very nature are so important to future competitive success that all firms in the industry must pay close atten- tion to them or risk an eventual exit from the industry.

In the ready-to-wear apparel industry, the KSFs are appealing designs and color combinations, low-cost

Studying competitors’ past behavior and prefer- ences provides a valuable assist in anticipating what moves rivals are likely to make next and outmaneuvering them in the marketplace.

CORE CONCEPT Key success factors are the strategy elements, product attributes, competitive capabilities, or intangible assets with the greatest impact on future success in the marketplace.

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TABLE 3.3

Common Types of Industry Key Success Factors

Technology- related KSFs

• Expertise in a particular technology or in scientific research (important in pharmaceuticals, Internet applications, mobile communications, and most high-tech industries)

• Proven ability to improve production processes (important in industries where advancing technology opens the way for higher manufacturing efficiency and lower production costs)

Manufacturing- related KSFs

• Ability to achieve scale economies and/or capture experience curve effects (important to achieving low production costs)

• Quality control know-how (important in industries where customers insist on product reliability) • High utilization of fixed assets (important in capital-intensive/high-fixed-cost industries) • Access to attractive supplies of skilled labor • High labor productivity (important for items with high labor content) • Low-cost product design and engineering (reduces manufacturing costs) • Ability to manufacture or assemble products that are customized to buyer specifications

Distribution- related KSFs

• A strong network of wholesale distributors/dealers • Strong direct sales capabilities via the Internet and/or having company-owned retail outlets • Ability to secure favorable display space on retailer shelves

Marketing-related KSFs

• Breadth of product line and product selection • A well-known and well-respected brand name • Fast, accurate technical assistance • Courteous, personalized customer service • Accurate filling of buyer orders (few back orders or mistakes) • Customer guarantees and warranties (important in mail-order and online retailing, big-ticket pur-

chases, and new-product introductions) • Clever advertising

Skills- and capability-related KSFs

• A talented workforce (superior talent is important in professional services such as accounting and investment banking)

• National or global distribution capabilities • Product innovation capabilities (important in industries where rivals are racing to be first to market with

new product attributes or performance features) • Design expertise (important in fashion and apparel industries) • Short delivery time capability • Supply chain management capabilities • Strong e-commerce capabilities—a user-friendly website and/or skills in using Internet technology

applications to streamline internal operations

Other types of KSFs

• Overall low costs (not just in manufacturing) to be able to meet low-price expectations of customers • Convenient locations (important in many retailing businesses) • Ability to provide fast, convenient, after-the-sale repairs and service • A strong balance sheet and access to financial capital (important in newly emerging industries with

high degrees of business risk and in capital-intensive industries) • Patent protection

manufacturing, a strong network of retailers or company-owned stores, distribution capabilities that allow stores to keep the best-selling items in stock, and advertisements that effectively convey the brand’s image. These attributes and capabilities apply to all brands of apparel ranging from private-label brands sold by discounters to premium- priced ready-to-wear brands sold by upscale department stores. Table 3.3 lists the most common types of industry key success factors.

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60 Part 1 Section B: Core Concepts and Analytical Tools

An industry’s key success factors can usually be deduced through identifying the industry’s dominant characteristics, assessing the five competitive forces, considering the impacts of the driving forces, comparing the market positions of industry members, and forecasting the likely next moves of key rivals. In addition, the answers to three questions help identify an industry’s key success factors. Those questions are:

1. On what basis do buyers of the industry’s product choose between the competing brands of sellers? That is, what product attributes are crucial?

2. Given the nature of the competitive forces prevailing in the marketplace, what resources and competitive capabilities does a company need to have to be competi- tively successful?

3. What shortcomings are almost certain to put a company at a significant competi- tive disadvantage?

Only rarely are there more than five or six key factors for future competitive success. Managers should therefore resist the temptation to label a factor that has only minor importance a KSF. To compile a list of every factor that matters even a little bit defeats the purpose of concentrating management attention on the factors truly critical to long- term competitive success.

Question 7: Does the Industry Offer Good Prospects for Attractive Profits?

Determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability.

LO3-4

The final step in evaluating the industry and competitive environment is boiling down the results of the analyses performed in Questions 1 through 6 to determine if the industry offers a company strong prospects for attractive profits.

The important factors on which to base such a conclusion include:

• The industry’s growth potential.

• Whether powerful competitive forces are squeezing industry profitability to subpar levels and whether competition appears destined to grow stronger or weaker.

• Whether industry profitability will be favorably or unfavorably affected by the pre- vailing driving forces.

• The company’s competitive position in the industry vis-à-vis rivals. (Well- entrenched leaders or strongly positioned contenders have a much better chance of earning attractive margins than those fighting a steep uphill battle.)

• How competently the company performs industry key success factors.

It is a mistake to think of a particular industry as being equally attractive or unat- tractive to all industry participants and all potential entrants. Conclusions have to be drawn from the perspective of a particular company. Industries attractive to insiders may be unattractive to outsiders. Industry environments unattractive to weak compet- itors may be attractive to strong competitors. A favorably positioned company may

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survey a business environment and see a host of oppor- tunities that weak competitors cannot capture.

When a company decides an industry is fundamen- tally attractive, a strong case can be made that it should invest aggressively to capture the opportunities it sees. When a strong competitor concludes an industry is relatively unattractive, it may elect to simply protect its present position, investing cautiously, if at all, and begin looking for opportunities in other industries. A competitively weak company in an unat- tractive industry may see its best option as finding a buyer, perhaps a rival, to acquire its business.

The degree to which an industry is attractive or unattractive is not the same for all industry partici- pants and potential new entrants. The attractive- ness of an industry depends on the degree of fit between a company’s competitive capabilities and industry key success factors.

KEY POINTS

Thinking strategically about a company’s external situation involves probing for answers to seven questions:

1. What are the strategically relevant components of the macro-environment? Industries differ as to how they are affected by conditions in the broad macro-environment. PESTEL analysis of the political, economic, sociocultural, technological, environmental/ecological, and legal/regulatory factors provides a framework for approaching this issue systematically.

2. What kinds of competitive forces are industry members facing, and how strong is each force? The strength of competition is a composite of five forces: (1) competitive pressures stem- ming from buyer bargaining power and seller-buyer collaboration, (2) competitive pres- sures associated with the sellers of substitutes, (3) competitive pressures stemming from supplier bargaining power and supplier-seller collaboration, (4) competitive pressures associated with the threat of new entrants into the market, and (5) competitive pressures stemming from the competitive jockeying among industry rivals.

3. What forces are driving changes in the industry, and what impact will these changes have on competitive intensity and industry profitability? Industry and competitive conditions change because forces are in motion that create incentives or pressures for change. The first phase is to identify the forces that are driving industry change. The second phase of driving forces analysis is to determine whether the driving forces, taken together, are acting to make the industry environment more or less attractive.

4. What market positions do industry rivals occupy—who is strongly positioned and who is not? Strategic group mapping is a valuable tool for understanding the similarities and differ- ences inherent in the market positions of rival companies. Rivals in the same or nearby strategic groups are close competitors, whereas companies in distant strategic groups usu- ally pose little or no immediate threat. Some strategic groups are more favorable than oth- ers. The profit potential of different strategic groups may not be the same because industry driving forces and competitive forces likely have varying effects on the industry’s distinct strategic groups.

5. What strategic moves are rivals likely to make next? Scouting competitors well enough to anticipate their actions can help a company prepare effective countermoves and allows managers to take rivals’ probable actions into account in designing their own company’s best course of action. Using a Framework for Competitor Analysis that considers rivals’

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62 Part 1 Section B: Core Concepts and Analytical Tools

current strategy, objectives, resources and capabilities, and assumptions can be helpful in this regard.

6. What are the key factors for competitive success? An industry’s key success factors (KSFs) are the particular product attributes, competitive capabilities, and intangible assets that spell the difference between being a strong competitor and a weak competitor—and some- times between profit and loss. KSFs by their very nature are so important to competitive success that all firms in the industry must pay close attention to them or risk being driven out of the industry.

7. Does the outlook for the industry present the company with sufficiently attractive prospects for profitability? Conclusions regarding industry attractiveness are a major driver of company strategy. When a company decides an industry is fundamentally attractive and presents good opportunities, a strong case can be made that it should invest aggressively to capture the opportunities it sees. When a strong competitor concludes an industry is relatively unattractive and lacking in opportunity, it may elect to simply protect its present position, investing cautiously, if at all, and looking for opportunities in other industries. A competi- tively weak company in an unattractive industry may see its best option as finding a buyer, perhaps a rival, to acquire its business. On occasion, an industry that is unattractive overall is still very attractive to a favorably situated company with the skills and resources to take business away from weaker rivals.

ASSURANCE OF LEARNING EXERCISES

1. Prepare a brief analysis of the organic food industry using the information provided by the Organic Trade Association. Based upon information provided in the Organic Report magazine, draw a five-forces diagram for the organic food industry and briefly discuss the nature and strength of each of the five competitive forces.

2. Based on the strategic group map in Concepts & Connections 3.1, which casual dining chains are Applebee’s closest competitors? With which strategic group does California Pizza Kitchen compete the least, according to this map? Why do you think no casual din- ing chains are positioned in the area above the Olive Garden’s group?

3. The National Restaurant Association publishes an annual industry fact book that can be found at www.restaurant.org. Based on information in the latest report, does it appear that macro-environmental factors and the economic characteristics of the industry will present industry participants with attractive opportunities for growth and profitability? Explain.

EXERCISES FOR SIMULATION PARTICIPANTS

1. Which of the five competitive forces is creating the strongest competitive pressures for your company?

2. What are the “weapons of competition” that rival companies in your industry can use to gain sales and market share? See Figure 3.7 to help you identify the various competitive factors.

3. What are the factors affecting the intensity of rivalry in the industry in which your com- pany is competing? Use Figure 3.7 and the accompanying discussion to help you in pin- pointing the specific factors most affecting competitive intensity. Would you characterize the rivalry and jockeying for better market position, increased sales, and market share among the companies in your industry as fierce, very strong, strong, moderate, or relatively weak? Why?

LO3-2

LO3-3

LO3-1, LO3-4

LO3-1, LO3-2, LO3-3, LO3-4

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4. Are there any driving forces in the industry in which your company is competing? What impact will these driving forces have? Will they cause competition to be more or less intense? Will they act to boost or squeeze profit margins? List at least two actions your company should consider taking to combat any negative impacts of the driving forces.

5. Draw a strategic group map showing the market positions of the companies in your industry. Which companies do you believe are in the most attractive position on the map? Which companies are the most weakly positioned? Which companies do you believe are likely to try to move to a different position on the strategic group map?

6. What do you see as the key factors for being a successful competitor in your industry? List at least three.

7. Does your overall assessment of the industry suggest that industry rivals have sufficiently attractive opportunities for growth and profitability? Explain.

1. Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980), chapter 1; Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review 86, no. 1 (January 2008).

2. J. S. Bain, Barriers to New Competition (Cambridge, MA: Harvard University Press, 1956); F. M. Scherer, Industrial Market Structure and Economic Perfor- mance (Chicago: Rand McNally & Co., 1971).

3. Pankaj Ghemawat, “Building Strategy on the Experience Curve,” Harvard

Business Review 64, no. 2 (March–April 1985).

4. Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Busi- ness Review 57, no. 2 (March–April 1979).

5. Pamela J. Derfus, Patrick G. Maggitti, Curtis M. Grimm, and Ken G. Smith, “The Red Queen Effect: Competitive Actions and Firm Performance,” Acad- emy of Management Journal 51, no. 1 (February 2008).

6. Mary Ellen Gordon and George R. Milne, “Selecting the Dimensions That

Define Strategic Groups: A Novel Market-Driven Approach,” Journal of Managerial Issues 11, no. 2 (Summer 1999).

7. Avi Fiegenbaum and Howard Thomas, “Strategic Groups as Reference Groups: Theory, Modeling and Empirical Exami- nation of Industry and Competitive Strategy,” Strategic Management Journal 16 (1995); S. Ade Olusoga, Michael P. Mokwa, and Charles H. Noble, “Strate- gic Groups, Mobility Barriers, and Com- petitive Advantage,” Journal of Business Research 33 (1995).

ENDNOTES

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Evaluating a Company’s Resources, Capabilities, and Competitiveness

4 c

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p te

r

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

LO4-1 Assess how well a company’s strategy is working.

LO4-2 Understand why a company’s resources and capabilities are centrally important in giving the company a competitive edge over rivals.

LO4-3 Grasp how a company’s value chain activities can affect the company’s cost structure and customer value proposition.

LO4-4 Evaluate a company’s competitive strength relative to key rivals.

LO4-5 Understand how a comprehensive evaluation of a company’s external and internal situations can assist managers in making critical decisions about their next strategic moves.

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Chapter 3 described how to use the tools of industry and competitive analysis to assess a company’s external environment and lay the groundwork for matching a company’s strategy to its external situation. This chapter discusses the techniques of evaluating a company’s internal situation, including its collection of resources and capabilities, its cost structure and customer value proposition, and its competi- tive strength versus that of its rivals. The analytical spotlight will be trained on five questions:

1. How well is the company’s strategy working?

2. What are the company’s competitively important resources and capabilities?

3. Are the company’s cost structure and customer value proposition competitive?

4. Is the company competitively stronger or weaker than key rivals?

5. What strategic issues and problems merit front-burner managerial attention?

The answers to these five questions complete management’s understanding of the company’s overall situation and position the company for a good strategy-situation fit required by the “The Three Tests of a Winning Strategy” (see Chapter 1).

Question 1: How Well Is the Company’s Strategy Working?

Assess how well a company’s strategy is working.LO4-1

The two best indicators of how well a company’s strategy is working are (1) whether the company is recording gains in financial strength and profitability, and (2) whether the company’s competitive strength and market standing are improving. Persistent short- falls in meeting company financial performance targets and weak performance relative to rivals are reliable warning signs that the company suffers from poor strategy making, less-than-competent strategy execution, or both. Other indicators of how well a com- pany’s strategy is working include:

• Trends in the company’s sales and earnings growth.

• Trends in the company’s stock price.

• The company’s overall financial strength.

• The company’s customer retention rate.

• The rate at which new customers are acquired.

• Changes in the company’s image and reputation with customers.

• Evidence of improvement in internal processes such as defect rate, order fulfill- ment, delivery times, days of inventory, and employee productivity.

The stronger a company’s current overall performance, the less likely the need for radical changes in strategy. The weaker a company’s financial performance and market standing, the more its current strategy must be questioned. (A compilation of financial ratios most commonly used to evaluate a company’s financial performance and balance sheet strength is presented in the Appendix.)

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Question 2: What Are the Company’s Competitively Important Resources and Capabilities?

Understand why a company’s resources and capabilities are centrally important in giving the company a competitive edge over rivals.

LO4-2

As discussed in Chapter 1, a company’s business model and strategy must be well matched to its collection of resources and capabilities. An attempt to create and deliver customer value in a manner that depends on resources or capabilities that are deficient and cannot be readily acquired or developed is unwise and positions the company for failure. A company’s competitive approach requires a tight fit with a company’s internal situation and is strengthened when it exploits resources that are competitively valuable, rare, hard to copy, and not easily trumped by rivals’ substitute resources. In addition, long-term competitive advantage requires the ongoing develop- ment and expansion of resources and capabilities to pursue emerging market oppor- tunities and defend against future threats to its market standing and profitability.1

Sizing up the company’s collection of resources and capabilities and determin- ing whether they can provide the foundation for competitive success can be achieved through resource and capability analysis. This is a two-step process: (1) identify the company’s resources and capabilities, and (2) examine them more closely to ascertain which are the most competitively important and whether they can support a sustainable competitive advantage over rival firms.2 This second step involves applying the four tests of a resource’s competitive power.

Identifying Competitively Important Resources and Capabilities A company’s resources are competitive assets that are owned or controlled by the com- pany and may either be tangible resources such as plants, distribution centers, manufactur-

ing equipment, patents, information systems, and capital reserves or creditworthiness, or intangible assets such as a well-known brand or a results-oriented organizational culture. Table 4.1 lists the common types of tangible and intangible resources that a company may possess.

A capability is the capacity of a firm to compe- tently perform some internal activity. A capability may also be referred to as a competence. Capabili- ties or competences also vary in form, quality, and

competitive importance, with some being more competitively valuable than others. Organizational capabilities are developed and enabled through the deployment of a company’s resources or some combination of its resources.3 Some capabilities rely heav- ily on a company’s intangible resources such as human assets and intellectual capital. For example, Nestlé’s brand management capabilities for its 2,000+ food, beverage, and pet care brands draw upon the knowledge of the company’s brand managers, the expertise of its marketing department, and the company’s relationships with retailers in nearly 200 countries. W. L. Gore’s product innovation capabilities in its fabrics,

CORE CONCEPT A resource is a competitive asset that is owned or controlled by a company; a capability is the capacity of a company to competently perform some internal activity. Capabilities are devel- oped and enabled through the deployment of a company’s resources.

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medical, and industrial products businesses result from the personal initiative, creative talents, and technological expertise of its associates and the company’s culture that encourages accountability and creative thinking.

Determining the Competitive Power of a Company’s Resources and Capabilities What is most telling about a company’s aggregation of resources and capabilities is how powerful they are in the marketplace. The competitive power of a resource or capability is measured by how many of four tests for sustainable competitive advantage it can pass.4

The tests are often referred to as the VRIN tests for sustainable competitive advantage— an acronym for valuable, rare, inimitable, and nonsubstitutable. The first two tests deter- mine whether the resource or capability may contribute to a competitive advantage. The last two determine the degree to which the competitive advantage potential can be sustained. 1. Is the resource or capability competitively valuable?

All companies possess a collection of resources and capabilities—some have the potential to contribute to a competitive advantage, while others may not. Google failed in converting its technological resources and software innovation capabilities into success for Google Wallet, which incurred losses of more than $300 million before being abandoned in 2016. While these resources and capabilities have made Google the world’s number- one search engine, they proved to be less valuable in the mobile payments industry.

TABLE 4.1

Common Types of Tangible and Intangible Resources

Tangible Resources

• Physical resources—state-of-the-art manufacturing plants and equipment, efficient distribution facilities, attractive real estate locations, or ownership of valuable natural resource deposits

• Financial resources—cash and cash equivalents, marketable securities, and other financial assets such as a company’s credit rating and borrowing capacity

• Technological assets—patents, copyrights, superior production technology, and technologies that enable activities

• Organizational resources—information and communication systems (servers, workstations, etc.), proven quality control systems, and a strong network of distributors or retail dealers

Intangible Resources

• Human assets and intellectual capital—an experienced and capable workforce, talented employees in key areas, collective learning embedded in the organization, or proven manage- rial know-how

• Brand, image, and reputational assets—brand names, trademarks, product or company image, buyer loyalty, and reputation for quality, superior service

• Relationships—alliances or joint ventures that provide access to technologies, specialized know-how, or geographic markets, and trust established with various partners

• Company culture—the norms of behavior, business principles, and ingrained beliefs within the company

CORE CONCEPT The VRIN tests for sustainable competitive advantage ask if a resource or capability is valu- able, rare, inimitable, and nonsubstitutable.

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2. Is the resource or capability rare—is it something rivals lack? Resources and capabili- ties that are common among firms and widely available cannot be a source of com- petitive advantage. All makers of branded cookies and sweet snacks have valuable marketing capabilities and brands. Therefore, these skills are not rare or unique in the industry. However, the brand strength of Oreo is uncommon and has provided Kraft Foods with greater market share as well as the opportunity to benefit from brand extensions such as Golden Oreo cookies, Oreo Thins, and Mini Oreo cookies.

3. Is the resource or capability inimitable or hard to copy? The more difficult and more expensive it is to imitate a company’s resource or capability, the more likely that it can also provide a sustainable competitive advantage. Resources tend to be dif- ficult to copy when they are unique (a fantastic real estate location, patent pro- tection), when they must be built over time (a brand name, a strategy-supportive organizational culture), and when they carry big capital requirements (a cost- effective plant to manufacture cutting-edge microprocessors). Imitation by rivals is most challenging when capabilities reflect a high level of social complexity (for example, a stellar team-oriented culture or unique trust-based relationships with employees, suppliers, or customers) and causal ambiguity, a term that signifies the hard-to-disentangle nature of complex processes such as the web of intricate activi- ties enabling a new drug discovery.

4. Is the resource or capability nonsubstitutable or is it vulnerable to the threat of sub- stitution from different types of resources and capabilities? Resources that are com- petitively valuable, rare, and costly to imitate may lose much of their ability to offer competitive advantage if rivals possess equivalent substitute resources. For example, manufacturers relying on automation to gain a cost-based advantage in production activities may find their technology-based advantage nullified by rivals’ use of low-wage offshore manufacturing. Resources can contribute to a competi- tive advantage only when resource substitutes do not exist.

Very few firms have resources and capabilities that can pass all four tests, but those that do enjoy a sustain- able competitive advantage with far greater profit poten- tial. Costco is a notable example, with strong employee incentive programs and capabilities in supply chain man- agement that have surpassed those of its warehouse club competitors for over 35 years. Lincoln Electric Com- pany, less well known but no less notable in its achieve- ments, has been the world leader in welding products for over 100 years as a result of its unique piecework incen-

tive system for compensating production workers and the unsurpassed worker productiv- ity and product quality that this system has fostered.5

If management determines that the company does not possess a resource that inde- pendently passes all four test with high marks, it may have a bundle of resources that can pass the tests. Although PetSmart’s supply chain and marketing capabilities are matched well by rival Petco, the company has and continues to outperform competi- tors through its customer service capabilities (including animal grooming, veterinary, and day care services). Nike’s bundle of styling expertise, marketing research skills, professional endorsements, brand name, and managerial know-how has allowed it to

CORE CONCEPT Social complexity and causal ambiguity are two factors that inhibit the ability of rivals to imi- tate a firm’s most valuable resources and capa- bilities. Causal ambiguity makes it very hard to figure out how a complex resource contributes to competitive advantage and therefore exactly what to imitate.

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remain number one in the athletic footwear and apparel industry for more than 20 years.

The Importance of Dynamic Capabilities in Sustaining Competitive Advantage Resources and capabilities must be continually strength- ened and nurtured to sustain their competitive power and, at times, may need to be broadened and deepened to allow the company to position itself to pursue emerging mar- ket opportunities.6 Organizational resources and capabilities that grow stale can impair competitiveness unless they are refreshed, modified, or even phased out and replaced in response to ongoing market changes and shifts in company strategy. In addition, disruptive environmental change may destroy the value of key strategic assets, turning static resources and capabilities “from diamonds to rust.”7

Management’s organization-building challenge has two elements: (1) attending to ongoing recalibration of existing capabilities and resources, and (2) casting a watchful eye for opportunities to develop totally new capabilities for delivering better customer value and/or outcompeting rivals. Companies that know the importance of recalibrat- ing and upgrading resources and capabilities make it a routine management function to build new resource configurations and capabilities. Such a managerial approach allows a company to prepare for market changes and pursue emerging opportunities. This ability to build and integrate new competitive assets becomes a capability in itself—a dynamic capability. A dynamic capability is the ability to modify, deepen, or reconfigure the company’s existing resources and capa- bilities in response to its changing environment or mar- ket opportunities.8

Management at Toyota has aggressively upgraded the company’s capabilities in fuel- efficient hybrid engine technology and constantly fine-tuned the famed Toyota Produc- tion System to enhance the company’s already proficient capabilities in manufacturing top-quality vehicles at relatively low costs. Likewise, management at BMW developed new organizational capabilities in hybrid engine design that allowed the company to launch its highly touted i3 and i8 plug-in hybrids. Resources and capabilities can also be built and augmented through alliances and acquisitions.9 Bristol- Myers Squibb’s famed “string of pearls” acquisition strategy has enabled it to replace degraded resources such as expiring patents with new patents and newly acquired capabilities in drug discovery for new disease domains.

Is the Company Able to Seize Market Opportunities and Nullify External Threats? An essential element in evaluating a company’s overall situation entails examining the company’s resources and competitive capabilities in terms of the degree to which they enable it to pursue its best market opportunities and defend against the external

CORE CONCEPT Companies that lack a standalone resource that is competitively powerful may nonetheless develop a competitive advantage through resource bundles that enable the superior performance of important cross-functional capabilities.

CORE CONCEPT A dynamic capability is the ability to modify, deepen, or reconfigure the company’s exist- ing resources and capabilities in response to its changing environment or market opportunities.

A company requires a dynamically evolving portfolio of resources and capabilities in order to sustain its competitiveness and position itself to pursue future market opportunities.

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threats to its future well-being. The simplest and most easily applied tool for conducting this examination is widely known as SWOT analysis, so named because it zeros in on a company’s internal Strengths and Weak- nesses, market Opportunities, and external Threats. A company’s internal strengths should always serve as the basis of its strategy—placing heavy reliance on a company’s best competitive assets is the soundest route to attracting customers and competing successfully against rivals.10

As a rule, strategies that place heavy demands on areas where the company is weakest or has unproven competencies should be avoided. Plainly, managers must look toward correcting competitive weaknesses that make the company vulnerable, hold down prof- itability, or disqualify it from pursuing an attractive opportunity. Furthermore, a com- pany’s strategy should be aimed squarely at capturing those market opportunities that are most attractive and suited to the company’s collection of capabilities. How much atten- tion to devote to defending against external threats to the company’s future performance hinges on how vulnerable the company is, whether defensive moves can be taken to lessen their impact, and whether the costs of undertaking such moves represent the best use

of company resources. A first-rate SWOT analysis pro- vides the basis for crafting a strategy that capitalizes on the company’s strengths, aims squarely at capturing the company’s best opportunities, and defends against the threats to its well-being. Table 4.2 lists the kinds of factors to consider in compiling a company’s resource strengths and weaknesses.

The Value of a SWOT Analysis A SWOT analysis involves more than making four lists. The most impor- tant parts of SWOT analysis are:

1.  Drawing conclusions from the SWOT listings about the company’s overall situation.

2. Translating these conclusions into strategic actions to better match the company’s strategy to its strengths and market opportunities, correcting problematic weak- nesses, and defending against worrisome external threats.

Question 3: Are the Company’s Cost Structure and Customer Value Proposition Competitive?

Grasp how a company’s value chain activities can affect the company’s cost structure and customer value proposition.

LO4-3

Company managers are often stunned when a competitor cuts its prices to “unbeliev- ably low” levels or when a new market entrant comes on strong with a great new prod- uct offered at a surprisingly low price. Such competitors may not, however, be buying market positions with prices that are below costs. They may simply have substantially

CORE CONCEPT SWOT analysis is a simple but powerful tool for sizing up a company’s internal strengths and competitive deficiencies, its market oppor- tunities, and the external threats to its future well-being.

Basing a company’s strategy on its strengths resulting from most competitively valuable resources and capabilities gives the company its best chance for market success.

Simply listing a company’s strengths, weak- nesses, opportunities, and threats is not enough; the payoff from SWOT analysis comes from the conclusions about a company’s situa- tion and the implications for strategy improve- ment that flow from the four lists.

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TABLE 4.2

Factors to Consider When Identifying a Company’s Strengths, Weaknesses, Opportunities, and Threats

Potential Internal Strengths and Competitive Capabilities • Core competencies in _____ • A strong financial condition; ample financial resources to grow the business • Strong brand-name image/company reputation • Economies of scale and/or learning and experience curve advantages over rivals • Proprietary technology/superior technological skills/important patents • Cost advantages over rivals • Product innovation capabilities • Proven capabilities in improving production processes • Good supply chain management capabilities • Good customer service capabilities • Better product quality relative to rivals • Wide geographic coverage and/or strong global distribution capability • Alliances/joint ventures with other firms that provide access to valuable technology, compe-

tencies, and/or attractive geographic markets

Potential Internal Weaknesses and Competitive Deficiencies • No clear strategic direction • No well-developed or proven core competencies • A weak balance sheet; burdened with too much debt • Higher overall unit costs relative to key competitors • A product/service with features and attributes that are inferior to those of rivals • Too narrow a product line relative to rivals • Weak brand image or reputation • Weaker dealer network than key rivals • Behind on product quality, R&D, and/or technological know-how • Lack of management depth • Short on financial resources to grow the business and pursue promising initiatives

Potential Market Opportunities • Serving additional customer groups or market segments • Expanding into new geographic markets • Expanding the company’s product line to meet a broader range of customer needs • Utilizing existing company skills or technological know-how to enter new product lines or new

businesses • Falling trade barriers in attractive foreign markets • Acquiring rival firms or companies with attractive technological expertise or capabilities

Potential External Threats to a Company’s Future Prospects • Increasing intensity of competition among industry rivals—may squeeze profit margins • Slowdowns in market growth • Likely entry of potent new competitors • Growing bargaining power of customers or suppliers • A shift in buyer needs and tastes away from the industry’s product • Adverse demographic changes that threaten to curtail demand for the industry’s product • Vulnerability to unfavorable industry driving forces • Restrictive trade policies on the part of foreign governments • Costly new regulatory requirements

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lower costs and therefore are able to offer prices that result in more appealing customer value propositions. One of the most telling signs of whether a company’s business posi- tion is strong or precarious is whether its cost structure and customer value proposition are competitive with those of industry rivals.

Cost comparisons are especially critical in industries where price competition is typ- ically the ruling market force. But even in industries where products are differentiated, rival companies have to keep their costs in line with rivals offering value propositions based upon a similar mix of differentiating features. But a company must also remain competitive in terms of its customer value proposition. Patagonia’s value proposition, for example, remains attractive to customers who value quality, wide selection, and cor- porate environmental responsibility over cheaper outerwear alternatives. Target’s cus- tomer value proposition has withstood the Walmart low-price juggernaut by attention to product design, image, and attractive store layouts in addition to efficiency. The key for managers is to keep close track of how cost-effectively the company can deliver value to customers relative to its competitors. If the company can deliver the same amount of

value with lower expenditures (or more value at a similar cost), it will maintain a competitive edge. Two analytical tools are particularly useful in determining whether a company’s value proposition and costs are competitive: value chain analysis and benchmarking.

Company Value Chains Every company’s business consists of a collection of activities undertaken in the course of designing, producing, marketing, delivering, and supporting its product or

service. All of the various activities that a company performs internally combine to form a value chain, so called because the underlying intent of a company’s activities is to do things that ultimately create value for buyers.

As shown in Figure 4.1, a company’s value chain con- sists of two broad categories of activities that drive costs

and create customer value: the primary activities that are foremost in creating value for customers and the requisite support activities that facilitate and enhance the perfor- mance of the primary activities.11 For example, the primary activities and cost drivers for a department store retailer such as Nordstrom include merchandise selection and buying, store layout and product display, advertising, and customer service; its support activities that affect customer value and costs include hiring and training, store mainte- nance, plus the usual assortment of administrative activities. The primary value chain activities and costs of a hotel operator like Marriott International are mainly comprised of reservations and hotel operations (check-in and check-out, maintenance and house- keeping, dining and room service, and conventions and meetings); principal support activities that drive costs and impact customer value include accounting, hiring and training hotel staff, and general administration. Supply chain management is a crucial activity for Boeing and Amazon.com but is not a value chain component at LinkedIn or DirectTV. Sales and marketing are dominant activities at Ford Motor Company and J. Crew but have minor roles at oil and gas drilling and exploration companies and pipeline companies. With its focus on value-creating activities, the value chain is an

Competitive advantage hinges on how cost- effectively a company can execute its customer value proposition.

CORE CONCEPT A company’s value chain identifies the pri- mary activities that create customer value and related support activities.

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Operations Distribution Sales and Marketing

Service Profit

Margin

Supply Chain

Manage- ment

Primary Activities

and Costs

Support Activities

and Costs

General Administration

Human Resources Management

Product R&D, Technology, and Systems Development

PRIMARY ACTIVITIES

SUPPORT ACTIVITIES

Supply Chain Management—Activities, costs, and assets associated with purchasing fuel, energy, raw materials, parts and components, merchandise, and consumable items from vendors; receiving, storing, and disseminating inputs from suppliers; inspection; and inventory management.

Operations—Activities, costs, and assets associated with converting inputs into final product form (production, assembly, packaging, equipment maintenance, facilities, operations, quality assurance, environmental protection).

Distribution—Activities, costs, and assets dealing with physically distributing the product to buyers (finished goods warehousing, order processing, order picking and packing, shipping, delivery vehicle operations, establishing and maintaining a network of dealers and distributors).

Sales and Marketing—Activities, costs, and assets related to sales force e�orts, advertising and promotion, market research and planning, and dealer/distributor support.

Service—Activities, costs, and assets associated with providing assistance to buyers, such as installation, spare parts delivery, maintenance and repair, technical assistance, buyer inquiries, and complaints.

Product R&D, Technology, and Systems Development—Activities, costs, and assets relating to product R&D, process R&D, process design improvement, equipment design, computer software development, telecommunications systems, computer-assisted design and engineering, database capabilities, and development of computerized support systems.

Human Resources Management—Activities, costs, and assets associated with the recruitment, hiring, training, development, and compensation of all types of personnel; labor relations activities; and development of knowledge-based skills and core competencies.

General Administration—Activities, costs, and assets relating to general management, accounting and finance, legal and regulatory a�airs, safety and security, management information systems, forming strategic alliances and collaborating with strategic partners, and other “overhead” functions.

A Representative Company Value Chain FIGURE 4.1

Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), pp. 37–43.

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ideal tool for examining how a company delivers on its customer value proposition. It permits a deep look at the company’s cost structure and ability to offer low prices. It reveals the emphasis that a company places on activities that enhance differentiation and support higher prices, such as service and marketing.

The value chain also includes a profit margin component; profits are necessary to compensate the company’s owners/shareholders and investors, who bear risks and provide capital. Tracking the profit margin along with the value-creating activities is critical because unless an enterprise succeeds in delivering customer value profitably (with a sufficient return on invested capital), it cannot survive for long. Attention to a company’s profit formula in addition to its customer value proposition is the essence of a sound business model, as described in Chapter 1. Concepts & Connections 4.1 shows representative costs for various activities performed by Boll & Branch, a maker of luxury linens and bedding sold directly to consumers online.

Benchmarking: A Tool for Assessing Whether a Company’s Value Chain Activities Are Competitive Benchmarking entails comparing how different companies perform various value chain activities—how materials are purchased, how inventories are managed, how products

THE VALUE CHAIN FOR BOLL & BRANCH

R&P: ©Bohbeh/Shutterstock

&Concepts Connections 4.1 A KING-SIZE SET OF SHEETS FROM BOLL & BRANCH IS MADE FROM 6 METERS OF FABRIC, REQUIRING 11 KILOGRAMS OF RAW COTTON. Raw Cotton $   28.16 Spinning/Weaving/Dyeing 12.00 Cutting/Sewing/Finishing 9.50 Material Transportation 3.00 Factory Fee 15.80 Cost of Goods $   68.46 Inspection Fees 5.48 Ocean Freight/Insurance 4.55 Import Duties 8.22 Warehouse/Packing 8.50 Packaging 15.15 Customer Shipping 14.00 Promotions/Donations* 30.00 Total Cost $154.38 Boll & Brand Markup About 60% Boll & Brand Retail Price $250.00 Gross Margin** $   95.62

Source: Adapted from Christina Brinkley, “What Goes into the Price of Luxury Sheets?” The Wall Street Journal, March 29, 2014, www.wsj .com/articles/SB10001424052702303725404579461953672838672 (accessed February 16, 2016).

*A $5 donation for every set of sheets sold is paid to an anti–human- trafficking organization. **Gross margin covers overhead, advertising costs, and profit.

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are assembled, how customer orders are filled and shipped, and how maintenance is performed—and then making cross-company comparisons of the costs and effectiveness of these activities.12 The objectives of benchmarking are to identify the best practices in performing an activity and to emulate those best prac- tices when they are possessed by others.

A best practice is a method of performing an activity or business process that consistently delivers superior results compared to other approaches.13 To qualify as a legiti- mate best practice, the method must have been employed by at least one enterprise and shown to be consistently more effective in lowering costs, improving quality or performance, shortening time requirements, enhancing safety, or achieving some other highly positive operating outcome. Best practices thus identify a path to operating excellence with respect to value chain activities.

Xerox led the way in the use of benchmarking to become more cost-competitive by deciding not to restrict its benchmarking efforts to its office equipment rivals, but by comparing itself to any company regarded as “world class” in performing activities relevant to Xerox’s business. Other companies quickly picked up on Xerox’s approach. Toyota managers got their idea for just-in-time inventory deliveries by study- ing how U.S. supermarkets replenished their shelves. Southwest Airlines reduced the turnaround time of its aircraft at each scheduled stop by studying pit crews on the auto-racing circuit. More than 80 percent of Fortune 500 companies reportedly use benchmarking for comparing themselves against rivals on cost and other competitively important measures.

The tough part of benchmarking is not whether to do it, but rather how to gain access to information about other companies’ practices and costs. Sometimes bench- marking can be accomplished by collecting information from published reports, trade groups, and industry research firms and by talking to knowledgeable industry ana- lysts, customers, and suppliers. Sometimes field trips to the facilities of competing or noncompeting companies can be arranged to observe how things are done, compare practices and processes, and perhaps exchange data on productivity and other cost components. However, such companies, even if they agree to host facilities tours and answer questions, are unlikely to share competitively sensitive cost information. Fur- thermore, comparing two companies’ costs may not involve comparing apples to apples if the two companies employ different cost accounting principles to calculate the costs of particular activities.

However, a fairly reliable source of benchmarking information has emerged. The explosive interest of companies in benchmarking costs and identifying best practices has prompted consulting organizations (e.g., Accenture, A. T. Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC) and several councils and associ- ations (e.g., the Qualserve Benchmarking Clearinghouse and the Strategic Planning Institute’s Council on Benchmarking) to gather benchmarking data, distribute informa- tion about best practices, and provide comparative cost data without identifying the names of particular companies. Having an independent group gather the information and report it in a manner that disguises the names of individual companies avoids the

CORE CONCEPT Benchmarking is a potent tool for learning which companies are best at performing particular activities and then using their techniques (or “best practices”) to improve the cost and effectiveness of a company’s own internal activities.

CORE CONCEPT A best practice is a method of performing an activity that consistently delivers superior results compared to other approaches.

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disclosure of competitively sensitive data and lessens the potential for unethical behav- ior on the part of company personnel in gathering their own data about competitors.

The Value Chain System for an Entire Industry A company’s value chain is embedded in a larger system of activities that includes the value chains of its suppliers and the value chains of whatever distribution channel allies it utilizes in getting its product or service to end users. The value chains of for- ward channel partners are relevant because (1) the costs and margins of a company’s distributors and retail dealers are part of the price the consumer ultimately pays, and (2) the activities that distribution allies perform affect the company’s customer value proposition. For these reasons, companies normally work closely with their suppliers and forward channel allies to perform value chain activities in mutually beneficial ways. For instance, motor vehicle manufacturers work closely with their forward channel allies (local automobile dealers) to ensure that owners are satisfied with dealers’ repair and maintenance services.14 Also, many automotive parts suppliers have built plants near the auto assembly plants they supply to facilitate just-in-time deliveries, reduce

warehousing and shipping costs, and promote close col- laboration on parts design and production scheduling. Irrigation equipment companies, suppliers of grape- harvesting and winemaking equipment, and firms mak- ing barrels, wine bottles, caps, corks, and labels all have facilities in the California wine country to be close to the nearly 700 winemakers they supply.15 The lesson

here is that a company’s value chain activities are often closely linked to the value chains of its suppliers and the forward allies.

As a consequence, accurately assessing the competitiveness of a company’s cost struc- ture and customer value proposition requires that company managers understand an indus- try’s entire value chain system for delivering a product or service to customers, not just the company’s own value chain. A typical industry value chain that incorporates the value- creating activities, costs, and margins of suppliers and forward channel allies, if any, is shown in Figure 4.2. However, industry value chains vary significantly by industry. For example, the primary value chain activities in the pulp and paper industry (timber farm- ing, logging, pulp mills, and papermaking) differ from those for the home appliance industry (parts and components manufacture, assembly, wholesale distribution, retail sales) and yet again from the cloud computing industry (IT hardware infrastructure, systems software infrastructure, application development, and application hosting, management, and security services).

Strategic Options for Remedying a Cost or Value Disadvantage The results of value chain analysis and benchmarking may disclose cost or value dis- advantages relative to key rivals. These competitive disadvantages are likely to lower a company’s relative profit margin or weaken its customer value proposition. In such instances, actions to improve a company’s value chain are called for to boost profit- ability or to allow for the addition of new features that drive customer value. There are three main areas in a company’s overall value chain where important differences between firms in costs and value can occur: a company’s own internal activities, the

A company’s customer value proposition and cost competitiveness depend not only on inter- nally performed activities (its own company value chain), but also on the value chain activi- ties of its suppliers and forward channel allies.

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suppliers’ part of the industry value chain, and the forward channel portion of the industry chain.

Improving Internally Performed Value Chain Activities Managers can pur- sue any of several strategic approaches to reduce the costs of internally performed value chain activities and improve a company’s cost competitiveness.

1. Implement the use of best practices throughout the company, particularly for high- cost activities.

2. Try to eliminate some cost-producing activities by revamping the value chain. Many retailers have found that donating returned items to charitable organizations and taking the appropriate tax deduction results in a smaller loss than incurring the costs of the value chain activities involved in reverse logistics.

3. Relocate high-cost activities (such as manufacturing) to geographic areas such as China, Latin America, or Eastern Europe where they can be performed more cheaply.

4. Outsource certain internally performed activities to vendors or contractors if they can perform them more cheaply than can be done in-house.

5. Invest in productivity-enhancing, cost-saving technological improvements (robotics, flexible manufacturing techniques, state-of-the-art electronic networking).

6. Find ways to detour around the activities or items where costs are high. Computer chip makers regularly design around the patents held by others to avoid paying royalties; automakers have substituted lower-cost plastic for metal at many exterior body locations.

7. Redesign the product and/or some of its components to facilitate speedier and more economical manufacture or assembly.

8. Try to make up the internal cost disadvantage by reducing costs in the supplier or forward channel portions of the industry value chain—usually a last resort.

Supplier-Related Value Chains

Activities, costs, and margins of suppliers

Internally performed activities,

costs, and

margins

Activities, costs, and margins of

forward channel

allies and strategic partners

Buyer or end-user

value chains

Forward Channel Value Chains

A Company’s Own Value Chain

Representative Value Chain for an Entire IndustryFIGURE 4.2

Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), p. 35.

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Rectifying a weakness in a company’s customer value proposition can be accom- plished by applying one or more of the following approaches:

1. Implement the use of best practices throughout the company, particularly for activities that are important for creating customer value—product design, product quality, or customer service.

2. Adopt best practices for marketing, brand management, and customer relationship management to improve brand image and customer loyalty.

3. Reallocate resources to activities having a significant impact on value delivered to customers—larger R&D budgets, new state-of-the-art production facilities, new dis- tribution centers, modernized service centers, or enhanced budgets for marketing campaigns.

Additional approaches to managing value chain activities that drive costs, unique- ness, and value are discussed in Chapter 5.

Improving Supplier-Related Value Chain Activities Supplier-related cost disadvantages can be attacked by pressuring suppliers for lower prices, switching to lower-priced substitute inputs, and collaborating closely with suppliers to identify mutual cost-saving opportunities.16 For example, just-in-time deliveries from suppliers can lower a company’s inventory and internal logistics costs, eliminate capital expen- ditures for additional warehouse space, and improve cash flow and financial ratios by reducing accounts payable. In a few instances, companies may find that it is cheaper to integrate backward into the business of high-cost suppliers and make the item in-house instead of buying it from outsiders.

Similarly, a company can enhance its customer value proposition through its sup- plier relationships. Some approaches include selecting and retaining suppliers that meet higher-quality standards, providing quality-based incentives to suppliers, and inte- grating suppliers into the design process. When fewer defects exist in components pro- vided by suppliers, this not only improves product quality and reliability, but it can also lower costs because there is less disruption to production processes and lower warranty expenses.

Improving Value Chain Activities of Forward Channel Allies There are three main ways to combat a cost disadvantage in the forward portion of the indus- try value chain: (1) Pressure dealers-distributors and other forward channel allies to reduce their costs and markups; (2) work closely with forward channel allies to iden- tify win-win opportunities to reduce costs—for example, Walmart and Target require suppliers to meet a two-day shipping arrival window, which not only improves distri- bution center operating efficiency but also reduces costly unloading wait times for the shipper; and (3) change to a more economical distribution strategy or perhaps integrate forward into company-owned retail outlets.

A company can improve its customer value proposition through the activities of forward channel partners by the use of (1) cooperative advertising and promotions with forward channel allies; (2) training programs for dealers, distributors, or retailers to improve the purchasing experience or customer service; and (3) creating and enforcing operating standards for resellers or franchisees to ensure consistent store operations. Papa John’s International, for example, is consistently rated highly by customers for

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its pizza quality, convenient ordering systems, and responsive customer service across its 5,100 company-owned and franchised units. The company’s marketing campaigns and extensive employee training and development programs enhance its value propo- sition and the unit sales and operating profit for its franchisees in all 50 states and 45 countries.

How Value Chain Activities Relate to Resources and Capabilities A close relationship exists between the value-creating activities that a company per- forms and its resources and capabilities. When companies engage in a value-creating activity, they do so by drawing on specific company resources and capabilities that underlie and enable the activity. For example, brand-building activities that enhance a company’s customer value proposition can depend on human resources, such as experi- enced brand managers, as well as organizational capabilities related to developing and executing effective marketing campaigns. Distribution activities that lower costs may derive from organizational capabilities in inventory management and resources such as cutting-edge inventory tracking systems.

Because of the linkage between activities and enabling resources and capabilities, value chain analysis complements resource and capability analysis as another tool for assessing a company’s competitive advantage. Resources and capabilities that are both valuable and rare provide a company with the necessary preconditions for competitive advantage. When these assets are deployed in the form of a value-creating activity, that potential is realized. Resource analysis is a valuable tool for assessing the competitive advantage potential of resources and capabilities. But the actual competitive benefit provided by resources and capabilities can only be assessed objectively after they are deployed in the form of activities.

Question 4: What Is the Company’s Competitive Strength Relative to Key Rivals?

Evaluate a company’s competitive strength relative to key rivals.LO4-4

An additional component of evaluating a company’s situation is developing a compre- hensive assessment of the company’s overall competitive strength. Making this determi- nation requires answers to two questions:

1. How does the company rank relative to competitors on each of the important fac- tors that determine market success?

2. All things considered, does the company have a net competitive advantage or dis- advantage versus major competitors?

Step 1 in doing a competitive strength assessment is to list the industry’s key suc- cess factors and other telling measures of competitive strength or weakness (6 to 10 measures usually suffice). Step 2 is to assign a weight to each measure of competitive strength based on its perceived importance in shaping competitive success. (The sum of the weights for each measure must add up to 1.0.) Step 3 is to calculate weighted

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strength ratings by scoring each competitor on each strength measure (using a 1-to-10 rating scale where 1 is very weak and 10 is very strong) and multiplying the assigned rating by the assigned weight. Step 4 is to sum the weighted strength ratings on each factor to get an overall measure of competitive strength for each company being rated. Step 5 is to use the overall strength ratings to draw conclusions about the size and extent of the company’s net competitive advantage or disadvantage and to take spe- cific note of areas of strength and weakness. Table 4.3 provides an example of a competitive strength assessment using the hypothetical ABC Company against four rivals. ABC’s total score of 5.95 signals a net competitive advantage over Rival 3 (with a score of 2.10) and Rival 4 (with a score of 3.70) but indicates a net competi- tive disadvantage against Rival 1 (with a score of 7.70) and Rival 2 (with an overall score of 6.85).

Interpreting the Competitive Strength Assessments Competitive strength assessments provide useful conclusions about a company’s com- petitive situation. The ratings show how a company compares against rivals, factor by factor or capability by capability, thus revealing where it is strongest and weakest. More- over, the overall competitive strength scores indicate whether the company is at a net competitive advantage or disadvantage against each rival.

In addition, the strength ratings provide guidelines for designing wise offensive and defensive strategies. For example, consider the ratings and weighted scores in Table 4.3. If ABC Co. wants to go on the offensive to win additional sales and market share, such an offensive probably needs to be aimed directly at winning customers

away from Rivals 3 and 4 (which have lower overall strength scores) rather than Rivals 1 and 2 (which have higher overall strength scores). ABC’s advantages over Rival 4 tend to be in areas that are moderately important to competitive success in the industry, but ABC outclasses Rival 3 on the two most heavily weighted strength factors—relative cost posi- tion and customer service capabilities. Therefore, Rival 3 should be viewed as the primary target of ABC’s offensive strategies, with Rival 4 being a secondary target.

A competitively astute company should utilize the strength scores in deciding what strategic moves to make. When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense to consider offensive moves to exploit rivals’ competitive weaknesses. When a company has competitive weaknesses in important areas where one or more rivals are strong, it makes sense to consider defen- sive moves to curtail its vulnerability.

Question 5: What Strategic Issues and Problems Must Be Addressed by Management?

Understand how a comprehensive evaluation of a company’s external and internal situations can assist managers in making critical decisions about their next strategic moves.

LO4-5

The final and most important analytical step is to zero in on exactly what strategic issues company managers need to address. This step involves drawing on the results of

A company’s competitive strength scores pin- point its strengths and weaknesses against rivals and point to offensive and defensive strat- egies capable of producing first-rate results.

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81

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82 Part 1 Section B: Core Concepts and Analytical Tools

KEY POINTS

In analyzing a company’s own particular competitive circumstances and its competitive position vis-à-vis key rivals, consider five key questions:

1. How well is the present strategy working? This involves evaluating the strategy in terms of the company’s financial performance and competitive strength and market standing. The stronger a company’s current overall performance, the less likely the need for radical strat- egy changes. The weaker a company’s performance and/or the faster the changes in its external situation (which can be gleaned from industry and competitive analysis), the more its current strategy must be questioned.

2. Do the company’s resources and capabilities have sufficient competitive power to give it a sus- tainable advantage over competitors? The answer to this question comes from conducting the four tests of a resource’s competitive power—the VRIN tests. If a company has resources and capabilities that are competitively valuable and rare, the firm will have the potential for a competitive advantage over market rivals. If its resources and capabilities are also hard to copy (inimitable) with no good substitutes (nonsubstitutable), then the firm may be able to sustain this advantage even in the face of active efforts by rivals to overcome it.

SWOT analysis can be used to assess if a company’s resources and capabilities are suf- ficient to seize market opportunities and overcome external threats to its future well-being. The two most important parts of SWOT analysis are (1) drawing conclusions about what story the compilation of strengths, weaknesses, opportunities, and threats tells about the company’s overall situation, and (2) acting on the conclusions to better match the com- pany’s strategy to its internal strengths and market opportunities, to correct the important internal weaknesses, and to defend against external threats. A company’s strengths and competitive assets are strategically relevant because they are the most logical and appeal- ing building blocks for strategy; internal weaknesses are important because they may repre- sent vulnerabilities that need correction. External opportunities and threats come into play because a good strategy necessarily aims at capturing a company’s most attractive opportu- nities and at defending against threats to its well-being.

both industry and competitive analysis and the evaluations of the company’s internal situation. The task here is to get a clear fix on exactly what industry and competitive challenges confront the company, which of the company’s internal weaknesses need fixing, and what specific problems merit front-burner attention by company managers. Pinpointing the precise things that management needs to worry about sets the agenda for deciding what actions to take next to improve the company’s performance and business outlook.

If the items on management’s “worry list” are rela- tively minor, which suggests the company’s strategy is mostly on track and reasonably well matched to the company’s overall situation, company managers sel- dom need to go much beyond fine-tuning the present

strategy. If, however, the issues and problems confronting the company are serious and indicate the present strategy is not well suited for the road ahead, the task of crafting a better strategy has got to go to the top of management’s action agenda.

Compiling a “worry list” of problems and issues creates an agenda for managerial strategy making.

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3. Are the company’s cost structure and customer value proposition competitive? One telling sign of whether a company’s situation is strong or precarious is whether its costs are competi- tive with those of industry rivals. Another sign is how it compares with rivals in terms of its customer value proposition. Value chain analysis and benchmarking are essential tools in determining whether the company is performing particular functions and activities well, whether its costs are in line with competitors, whether it is able to offer an attractive value proposition to customers, and whether particular internal activities and business processes need improvement. Value chain analysis complements resource and capability analysis because of the tight linkage between activities and enabling resources and capabilities.

4. Is the company competitively stronger or weaker than key rivals? The key appraisals here involve how the company matches up against key rivals on industry key success factors and other chief determinants of competitive success and whether and why the company has a competitive advantage or disadvantage. Quantitative competitive strength assessments, using the method presented in Table 4.3, indicate where a company is competitively strong and weak and provide insight into the company’s ability to defend or enhance its market position. As a rule, a company’s competitive strategy should be built around its competitive strengths and should aim at shoring up areas where it is competitively vulnerable. When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense to consider offensive moves to exploit rivals’ competitive weaknesses. When a company has important competitive weaknesses in areas where one or more rivals are strong, it makes sense to consider defensive moves to curtail its vulnerability.

5. What strategic issues and problems merit front-burner managerial attention? This analytical step zeros in on the strategic issues and problems that stand in the way of the company’s success. It involves using the results of both industry and competitive analysis and com- pany situation analysis to identify a “worry list” of issues to be resolved for the company to be financially and competitively successful in the years ahead. Actually deciding upon a strategy and what specific actions to take comes after the list of strategic issues and prob- lems that merit front-burner management attention has been developed.

Good company situation analysis, like good industry and competitive analysis, is a valuable precondition for good strategy making.

ASSURANCE OF LEARNING EXERCISES

1. Using the financial ratios provided in the Appendix and the following financial statement information for Macy’s, Inc., calculate the following ratios for Macy’s for both 2015 and 2016.

1. Gross profit margin

2. Operating profit margin

3. Net profit margin

4. Times interest earned coverage

5. Return on shareholders’ equity

6. Return on assets

7. Long-term debt-to-equity ratio

8. Days of inventory

9. Inventory turnover ratio

10. Average collection period

Based on these ratios, did Macy’s financial performance improve, weaken, or remain about the same from 2015 to 2016?

LO4-1

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84 Part 1 Section B: Core Concepts and Analytical Tools

Consolidated Statements of Income for Macy’s, Inc., 2015–2016 (in millions, except per share amounts)

2016 2015

Net sales $25,778 $27,079 Cost of sales (15,621) (16,496) Gross margin 10,157 10,583 Selling, general and administrative expenses (8,265) (8,256) Impairments, store closing and other costs (479) (288) Settlement charges (98) — Operating income 1,315 2,039 Interest expense (367) (363) Premium on early retirement of debt — — Interest income 4 2 Income before income taxes 952 1,678 Federal, state, and local income tax expense (341) (608) Net income 611 1,070 Net loss attributable to noncontrolling interest 8 2 Net income attributable to Macy’s, Inc., shareholders 619 1,072

Basic earnings per share attributable to Macy’s, Inc., shareholders $ 2.01 $ 3.26

Diluted earnings per share attributable to Macy’s, Inc., shareholders $ 1.99 $ 3.22

Consolidated Balance Sheets for Macy’s, Inc., 2015–2016 (in millions)

2016 2015

ASSETS

Current Assets: Cash and cash equivalents $ 1,297 $ 1,109 Receivables 522 558 Merchandise inventories 5,399 5,506 Prepaid expenses and other current assets 408 479 Total Current Assets 7,626 7,652 Property and Equipment – net 7,017 7,616 Goodwill 3,897 3,897 Other Intangible Assets – net 498 514 Other Assets 813 897 Total Assets $19,851 $20,576

LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilties: Short-term debt $309 $642 Merchandise accounts payable 1,423 1,526 Accounts payable and accrued liabilities 3,563 3,333 Income taxes 352 227 Total Current Liabilities 5,647 5,728 Long-Term Debt 6,562 6,995 Deferred Income Taxes 1,443 1,477 Other Liabilities 1,877 2,123

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2016 2015

Shareholders’ Equity: Common stock (304.1 and 310.3 shares outstanding) 3 3 Additional paid-in capital 617 621 Accumulated equity 6,088 6,334 Treasury stock (1,489) (1,665) Accumulated other comprehensive loss (896) (1,043) Total Macy’s, Inc., Shareholders’ Equity 4,323 4,250 Noncontrolling interest (1) 3 Total Shareholders’ Equity 4,322 4,253 Total Liabilities and Shareholders’ Equity $19,851 $20,576

Source: Macy’s, Inc., 2016 10-K.

2. REI operates more than 140 sporting goods and outdoor recreation stores in 36 states. How many of the four tests of the competitive power of a resource does the retail store network pass? Explain your answer.

3. Review the information in Concepts & Connections 4.1 concerning Boll & Branch’s aver- age costs of producing and selling a king-sized sheet set, and compare this with the repre- sentative value chain depicted in Figure 4.1. Then answer the following questions:

a. Which of the company’s costs correspond to the primary value chain activities depicted in Figure 4.1?

b. Which of the company’s costs correspond to the support activities described in Figure 4.1?

c. What value chain activities might be important in securing or maintaining Boll & Branch’s competitive advantage? Explain your answer.

4. Using the methodology illustrated in Table 4.3 and your knowledge as an automobile owner, prepare a competitive strength assessment for General Motors and its rivals Ford, Chrysler, Toyota, and Honda. Each of the five automobile manufacturers should be evalu- ated on the key success factors/strength measures of cost competitiveness, product-line breadth, product quality and reliability, financial resources and profitability, and customer service. What does your competitive strength assessment disclose about the overall com- petitiveness of each automobile manufacturer? What factors account most for Toyota’s competitive success? Does Toyota have competitive weaknesses that were disclosed by your analysis? Explain.

EXERCISES FOR SIMULATION PARTICIPANTS

1. Using the formulas in the Appendix and the data in your company’s latest financial state- ments, calculate the following measures of financial performance for your company:

1. Operating profit margin

2. Return on total assets

3. Current ratio

4. Working capital

5. Long-term debt-to-capital ratio

6. Price-earnings ratio

LO4-2

LO4-3

LO4-4

LO4-1

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86 Part 1 Section B: Core Concepts and Analytical Tools

2. Based on your company’s latest financial statements and all of the other available data regarding your company’s performance that appear in the Industry Report, list the three measures of financial performance on which your company did “best” and the three measures on which your company’s financial performance was “worst.”

3. What hard evidence can you cite that indicates your company’s strategy is working fairly well (or perhaps not working so well, if your company’s performance is lagging that of rival companies)?

4. What internal strengths and weaknesses does your company have? What external market opportunities for growth and increased profitability exist for your company? What external threats to your company’s future well-being and profitability do you and your co-managers see? What does the preceding SWOT analysis indicate about your company’s present situ- ation and future prospects—where on the scale from “exceptionally strong” to “alarmingly weak” does the attractiveness of your company’s situation rank?

5. Does your company have any core competencies? If so, what are they?

6. What are the key elements of your company’s value chain? Refer to Figure 4.1 in developing your answer.

7. Using the methodology illustrated in Table 4.3, do a weighted competitive strength assessment for your company and two other companies that you and your co-managers consider to be very close competitors.

LO4-1

LO4-1

LO4-2

LO4-2 LO4-3

LO4-4

1. Birger Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal 5, no. 5 (September–October 1984); Jay Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17, no. 1 (1991); Margaret A. Peteraf, “The Cornerstones of Competitive Advantage: A Resource- Based View,” Strategic Management Journal 14, no. 3 (March 1993).

2. Birger Wernerfelt, “A Resource-Based View of the Firm,” Strategic Manage- ment Journal 5, no. 5 (September– October 1984), pp. 171–80; Jay Barney, “Firm Resources and Sustained Com- petitive Advantage,” Journal of Manage- ment 17, no. 1 (1991); and Margaret A. Peteraf, “The Cornerstones of Com- petitive Advantage: A Resource-Based View,” Strategic Management Journal 14, no. 3 (March 1993).

3. R. Amit and P. Schoemaker, “Strate- gic Assets and Organizational Rent,” Strategic Management Journal 14, no. 1 (1993).

4. David J. Collis and Cynthia A. Mont- gomery, “Competing on Resources: Strategy in the 1990s,” Harvard Business Review 73, no. 4 (July–August 1995).

5. Margaret A. Peteraf and Mark E. Bergen, “Scanning Dynamic Competitive Landscapes: A Market-Based and Resource-Based Framework,” Strategic Management Journal 24 (2003), pp. 1027-42.

6. David J. Teece, Gary Pisano, and Amy Shuen, “Dynamic Capabilities and Strategic Management,” Strategic Man- agement Journal 18, no. 7 (1997); and Constance E. Helfat and Margaret A. Peteraf, “The Dynamic Resource-Based View: Capability Lifecycles,” Strategic Management Journal 24, no. 10 (2003).

7. C. Montgomery, “Of Diamonds and Rust: A New Look at Resources” in Resource-Based and Evolutionary Theories of the Firm, ed. C. Montgomery (Boston: Kluwer Academic Publishers, 1995), pp. 251–68.

8. D. Teece, G. Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Management,” Strategic Management Journal 18, no. 7 (1997); K. Eisenhardt and J. Martin, “Dynamic Capabilities: What Are They?” Strategic Management Journal 21, nos. 10–11 (2000); M. Zollo and S. Winter, “Deliberate Learning and the Evolution of Dynamic Capabilities,”

Organization Science 13 (2002); and C. Helfat et al., Dynamic Capabilities: Understanding Strategic Change in Organizations (Malden, MA: Blackwell, 2007).

9. W. Powell, K. Koput, and L. Smith- Doerr, “Interorganizational Collabora- tion and the Locus of Innovation,” Administrative Science Quarterly 41, no. 1 (1996).

10. M. Peteraf, “The Cornerstones of Competitive Advantage: A Resource- Based View,” Strategic Management Journal, March 1993, pp. 179–91.

11. Michael E. Porter, Competitive Advantage (New York: Free Press, 1985).

12. Gregory H. Watson, Strategic Bench- marking: How to Rate Your Company’s Performance Against the World’s Best (New York: John Wiley & Sons, 1993); Robert C. Camp, Benchmarking: The Search for Industry Best Practices That Lead to Superior Performance (Milwau- kee: ASQC Quality Press, 1989); Christopher E. Bogan and Michael J. English, Benchmarking for Best Practices: Winning through Innovative Adaptation (New York: McGraw-Hill, 1994); and Dawn Iacobucci and Christie

ENDNOTES

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Chapter 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 87

gam27636_ch04_064-087.indd 87 01/09/18 07:41 PM

Nordhielm, “Creative Benchmarking,” Harvard Business Review 78, no. 6 (November–December 2000).

13. www.businessdictionary.com/definition /best-practice.html (accessed June 5, 2017).

14. M. Hegert and D. Morris, “Account- ing Data for Value Chain Analysis,”

Strategic Management Journal 10 (1989); Robin Cooper and Robert S. Kaplan, “Measure Costs Right: Make the Right Decisions,” Harvard Business Review 66, no. 5 (September–October 1988); and John K. Shank and Vijay Govindarajan, Strategic Cost Management (New York: Free Press, 1993).

15. Michael E. Porter, “Clusters and the New Economics of Competition,” Harvard Business Review 76, no. 6 (November–December 1998).

16. Reuben E. Stone, “Leading a Supply Chain Turnaround,” Harvard Business Review 82, no. 10 (October 2004).

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