Introduction to Industry Analysis

1. Introduction to Industry Analysis

2. Industry Structure • How can we explain why some industries are more profitable than others? • Industry analysis is a technique that can help to explain differences in average performance levels. • Step 1: Identify the “industry” to be analyzed. • Step 2: Ask “is this industry attractive to an incumbent?” • Note: Do not answer this question by looking at profitability. Performance is the consequence; we are looking for the cause.

3. Four questions: 1. If a firm were a monopolist, how profitable would it be? (What are the PIE?) 2. If potential profits are high, can they be retained? (Are buyers or suppliers powerful?) 3. If potential profits are realized, can they be sustained? (Are there entry barriers?) 4. Now what if the firm is not a monopolist? (Is there competition?)

4. Sizing up the PIE • How profitable would a monopolist be? • How elastic is demand? • How are costs relative to demand? • Are there substitutes or complements? • How are these variables changing? • How is the market changing over time? • Distinguish both technical and normative causes.

5. Supplier power • If potential profits are high, can they be retained? • Technical: For any given factor, we want to know the structure of exchange between suppliers and producers: • Can suppliers coordinate pricing? (e.g., concentration) • Are you a major customer for the good or can you coordinate your purchases with others? (bargaining power) • Can you free ride on the bargaining power of others? (only if not differentiated/no possibility of price discrimination or arbitrage is unlikely) • Are there close substitutes? • Normative: Relative status of buyer and supplier • Across all factors, we want to know what proportion of a producer’s costs a particular factor represents.

6. Buyer power • Technical: What is the structure of exchange between producers and buyers? • How concentrated are buyers? • Can small buyers free ride on the bargaining power of others? (only if not differentiated/no possibility of price discrimination or arbitrage is unlikely) • Technical: How price-sensitive are customers? • What proportion of a buyer’s purchases is your product? • Does the buyer care mostly about non-price characteristics? (e.g., quality, service) • Normative: Relative status of buyer and supplier • Who has the brand? (leverage regarding end user)

7. Entry barriers • Anything that makes an industry less attractive to an entrant than to an existing firm • Technical: Are there economies of scale? • What is MES relative to the size of the market? • Are there firm-level economies of scale? • Are scope economies available? • Technical: Are there experience economies? • What does the shape of the experience curve look like? • Was experience driven by prior competition? • Is prior learning outdated? Can the experience be imitated? • Normative: Entrant vs. incumbent status and identity

8. Entry barriers (cont.) • We want to know about the switching costs of suppliers and customers: • Are relevant resources controlled by incumbents? • Can an entrant gain access to distribution channels? • How strong are consumer loyalties? (relationships, brands) • We want to know about the likelihood of fierce resistance: • How significant are barriers to exit? • What reputations for rivalry have incumbents cultivated?

9. Competition • Does industry structure allows price coordination (on technical and normative grounds)? • How many players are there? • What are the size and status distributions of the players? (possibilities for price leadership) • How diverse are the players in their competitive styles? (parent organizations, age of industry) • Are incumbents insulated from price competition? • What is the extent of product/market differentiation or customer loyalties? (switching costs)

10. The Basic Situation: Exchange Partners with Alternatives ? ? Sellers Buyers

11. The Value Chain Supply Industry 1 Industry Buyers Supply Industry 2

12. Entrants and Substitutes: ‘Five Forces’ Producers of Substitutes Supply Industry 1 Industry Buyers Supply Industry 2 Potential Entrants

13. Other Users The Essence of Industry Analysis Producers of Substitutes Other Products/ Potential Complements Supply Industry 1 Supply Industry 2 Industry Buyers End-User Potential Entrants Other Users

14. Other Users The Essence of Competitive Advantage Producers of Substitutes Other Products/ Potential Complements Supply Industry 1 Supply Industry 2 Firm Buyers End-User Competitors Other Users

15. Framework for Strategic Analysis Industry Evolution Industry Structure Organizational Performance Organizational Evolution Organizational Strategy

16. Strategy Definition and Identification

17. What is Strategy? • Traditional view: Business strategy is the logic that gives direction to the activities of the organization. • Represents the firm to external constituencies. • Guides the actions of organizational members. • Corporate strategy is the rationale for grouping together various businesses in the same corporation. • Helps manage investor relations. • Encourages “synergy” across business units. • Strategy is articulated by top management in plans that are implemented at lower levels and updated over time.

18. What really comes first? • The emergent-strategy view: “I'll know what I am when I see what I do.” • Honda motor company in the U.S. • Generally, where markets and technologies are uncertain. • From this view, the strategic manager is a sense-maker. • Retrospective rationalization of the organization’s actions. • Strategy exists de facto, whether or not recognized. • “Learning from samples of 1 or fewer.” • Market success is decided by natural selection, causing (not caused by) the fact that some strategies are better.

19. Strategy as Managed Evolution • Strategy guides the organization’s evolution. • Opportunities and threats emerge from experience. • Strategic managers discover these and shape the response. • Three stages of the strategy process: • 1. Strategy Identification • 2. Strategy Evaluation • 3. Strategic Adaptation • Strategic management is involved throughout.

20. Strategy Identification • The strategic manager has a broad view. • Not confined to any one functional area. • Identify business strategy by discovering: • The long-term objectives of the firm. • The the scope of business activities. • The sources of competitive advantage. • The organizational logic that fits the firm's functional tactics to its scope and advantage. • Strategy includes tactics, but is not just a list of tactics.

21. Strategy Evaluation • Evaluate strategy based on current consistency: • 1. Internal consistency of organization. • Is the whole more than the sum of its parts? • 2. Consistency with capabilities. • Does it match the firm’s capabilities? • 3. Environmental consistency. • Does it fit the competitive environment? • Explicit current-time evaluation allows: • Coordination and incentive alignment • Increased efficiencies

22. Strategy Adaptation • Evaluate strategy based on future trajectory: • 1. Internal direction of organization. • Are changes adding value? • 2. Change in capabilities. • Is strategy developing the right capabilities? • 3. External direction of organization. • Are changes improving fit with the competitive environment? • Explicit adaptive evaluation allows: • Benchmarking to guide organizational learning. • Drive, rather than react to, technology and market change.

23. Framework for Strategic Analysis Industry Evolution Industry Structure Organizational Performance Organizational Evolution Organizational Strategy

24. Competitive Advantage

25. Strategic Capabilities • How can we explain why some firms are more profitable than others in the same industry? • “Capabilities”: what an organization can do. • They may or may not be good for the firm. • They are valuable to a firm if they bring value to its customers. • Generally, they are valuable to a firm if they help it overcome today’s strategic challenges. • Embodied in organization • Products or technologies are consequences, not causes.

26. The Problem of Uniqueness • The most valuable capabilities are unique. • Such capabilities are inherently less understandable. • Tacit • Ambiguous to rivals, analysts, and managers • Unique capabilities emerge over time. • “Know what you are when you see what you do” • The result of organizational evolution. • How to manage? • Manage the development process, not its consequence.

27. How Capabilities Evolve • Competitors cause you problems. • Your organization’s solution is another organization’s new problem to be solved • …And their solution is your new problem… • Over time, this process accounts for the evolution of capable firms.

28. When Capabilities are Harmful • Fact: Managers apply known solutions when problems arise. • Consequence: The “competency trap.” • New rivals may offer challenges that your organization did not coevolve to deal with. • Consequence: “Blindspots” among established firms.

29. Strategic Position • Positional advantage results from who you are, not what you do. • There are many forms of valuable strategic position, but all stem from a company’s location in the economic or social structure. • Social status, reputation, and legitimacy • Social network position • Legal and political advantages • Market incumbency: costs, standardization, or legitimacy • Robust versus fragile strategic positions.

30. How Strategic Position Evolves • Strategic position is difficult to develop. • Market position is costly • Social position is elusive • Others resist you at all costs • Capability may generate strategic position. • Position typically is gained by adding value • Use today’s capabilities as leverage • Affiliation may generate social position. • Deference is the flow, status is the stock

31. When Position is Harmful • Compensatory fitness. • Position as a shield against capability-creating competition • The leverage curse. • An advantaged position may open doors too readily • Through these mechanisms, position can damage capability generation over time. • Through organizational design, strategic management can affect these harmful processes

32. Framework for Strategic Analysis Industry Evolution Industry Structure Organizational Performance Organizational Evolution Organizational Strategy

33. Role of Organization in Competitive Advantage: Exploration

34. Organizational Evolution: VSR Framework Variation Selection Retention Generate diversity of solutions looking for problems Membrane between two processes that determines which solutions / capabilities to retain and scale-up Efficiently apply known solutions to existing & new problems Premises: • Development of capabilities through trial & error learning • Variation / retention processes - independent & somewhat incompatible

35. Both Explorer and Exploiter Engage in VSR Variation Selection Retention Explorer Exploiter R&D Driven by external & internal Driven by external Control System for Resource Allocation Filter conserves on scarce retention resources Filter conserves on scarce variation resources Operations (Mfg / Mktg / Sales) Time to market Feed relevant variation Efficiency Feed relevant variation Explorer Exploiter

36. How to Recognize an Exploiter / Explorer • R&D % of Sales • BP 1992 – less than 1% of sales • 3M 1991 – 6.8% of sales • All US manufacturing 1990 – 3.1% • Chemicals – 5.3% • Rubber products – 2.1 % • Stone, clay and glass - 1.7% • Primary metals - .8% • Professional / scientific instruments – 7.1%

37. Organization and the Key to Exploitation • Know what you have to exploit and transfer • May exist is disparate parts of the organization • Match knowledge of problem with knowledge of solution • Imprint know-how on to acquisition • Emphasize efficiency over experimentation through PARC • High short-term accountability • Clear lines of responsibility / quick decision-making • Established procedures / policies • Centralized directed change • Investment in the “D” of R&D • Strong socialization that emphasizes conformity • Exploitation suggests hierarchical orientation, but not always

38. PARC objectives Tolerance for some sort-term failure Tolerance for some ambiguity / slower decision-making Loosely coupled, organic change Some tolerance for radicals Encourage boundary spanners / spanning activities Connect parts of the technology tree Bring in new market problems looking for solutions Develop tools for reinvention – Learning how to learn Organization and the Key to Exploration • Goal: Keep variation within an “acceptable” window • Too little: The creative engine stops • Too much: • Cumulative learning no longer possible • No longer a firm, but an “adhocracy”

39. Performance (Profit) t Time Which is Optimal? Exploit vs. Explore Explore Exploit • Scenarios • A. Incremental environmental change • A1. Time < t Exploit wins • A2. Time > t Explore starts to win • Radical environmental change • Exploiter has bankroll from earlier successes to fuel retooling • Explorer has diverse portfolio of capabilities, some of which still viable

40. Additional Opportunity for Explorer Performance (Profit) Explore Exploit t Time Obtain temporal advantage from creation of new market

41. Why Exploration is Hard for Firms • Given with exploration: • Slack – i.e. suboptimal, short-term performance • Greater variance in performance • Runs counter to preference for short-term reliability • Financial markets • Manager’s tools and cognition oriented towards short-term • Second-order learning is difficult

42. Big verses Small Firms as Explorers • Big Firms • Potential upsides • Variation aided by “stew” of capabilities • Can be better at selection than market if has special knowledge • Potential downsides • Past successes lead to competency trap • Bureaucracy smothers the innovator • Small Firms • Upside – not have downsides of bigness • Downside – Your small firm may not benefit • Variation occurs across population of firms • Selection on organizations

43. Options for Hybrid Exploiters / Explorers • Create separate business units with variation in practices • Represent a set of simultaneous experiments • Each unit exploits • Across the portfolio of units we would have corporate exploration • Outsource approach • Exploiter outsources exploration • Explorer outsources exploitation • Positional advantage enhances the viability of this approach

44. Summary of Tensions in Organizational Design • Hierarchy vs. Market orientation • Coordination vs. Initiative • Exploit vs. Explore • Optimize for Today vs. Tomorrow • Knowledge generation vs. knowledge capture • Consistency in PARC vs. Need for tailoring / change • Over time • Over different parts of the organization • Cost of suboptimal design vs. cost of change

45. Framework for Strategic Analysis Industry Evolution Industry Structure Organizational Performance Organizational Evolution Organizational Strategy

46. Organizational Evolution: VSR Framework Variation Selection Retention Generate diversity of solutions looking for problems Membrane between two processes that determines which solutions / capabilities to retain and scale-up Efficiently apply known solutions to existing & new problems

47. Resource Partitioning and “Niche” Strategies

48. Industrial Heterogeneity • Tremendous differences exist within industries among parts of the market • Geography • Taste characteristics • Differences also exist among organizations • Degree of integration (vertical and horizontal) • Forms of organization • Capability and position differences result

49. Why these differences matter • Different “niches” emerge, where market and organizational differences correspond • Competitive threats appear within a given niche, and between them “in the middle” • Growth, performance, and failure rates are strongly affected by your position on this landscape • “Good” strategies often face the strongest rivalry • The consequences of strategic change often hinges on this distinction

50. Analyzing niches • Step one: Dimensionalizing the landscape • The more dimensions, the greater the opportunities for successful differentiation • Some dimensions can be shaped by the firm • Step two: Identify mobility barriers • Is it possible to straddle multiple niches? • Is it possible to leverage capabilities in one niche to invade another? • Important: Note both technical and normative barriers!