Competitive Advantage in Mature Industries

1. Competitive Advantage in Mature Industries • Key success factors in mature industries • Strategic Implementation: Structure, Systems, Style • Strategies for declining industries OUTLINE

2. Competitive Advantage in Retailing: Retailers with the Highest and Lowest Valuation Ratios Toys-R-Us 0.6 11.3 J.C. Penny (US) 0.732.3 Federated Dept.Stores (US) 1.1 15.4 J. Sainsbury (UK) 1.129.8 Ito-Yokado (Japan) 1.128.0 Ahold 1.2 78.3 Safeway plc (UK) 1.3 29.8 Pinault-Printemps -Redoute (France) 1.4 32.2 Sears Roebuck (US) 1.441.4 DixonsGroup (UK) 1.4 8.0 Albertson’s (US) 1.5 35.6 May Department Stores (US) 1.7 11.9 Office Depot (US) 1.7 11.4 CVS 1.9 24.2 Kingfisher (UK) 2.0 17.6 TOP 15ValuationSales Ratio ($,bil.) Amazon.com (US) n.a. 3.9 Caremark Rx (US) 18.0 6.8 Expedia 16.6 0.6 Autozone (US) 13.1 5.3 Hennes & Mauritz (Swe.) 10.5 5.9 Next (UK) 10.1 3.6 Bed, Bath & Beyond (US) 8.5 3.7 Woolworth (Australia) 8.0 16.0 Gap (US) 4.1 14.5 TJX (US) 6.9 12.0 Inditex (Spain) 6.8 4.7 Wal-Mart (US) 5.7 244.5 Radio Shack 5.6 4.6 Family Dollar Stores 5.1 4.2 Best Buy (US) 5.0 20.9 BOTTOM 15ValuationSales Ratio($, bil.)

3. Key Success Factors in Mature Industries • Opportunities for sustainable -- limited potential for differentiation competitive advantage are -- technology stable and well diffused limited -- ease of entry due to well developed industry infrastructure and powerful distributors -- international competition : domestic cost advantage vulnerable • Sources of -- Economies of scale cost advantage -- Low-cost inputs -- Low overheads • Segment and customer -- As general industry environment selection deteriorates, important to locate attractive segments and woo good customers. • Sources of differentiation -- Emphasis on image differentiation and advantage differentiation through complementary services. • Sources of innovation -- Limited opportunity for product and process innovation but considerable opportunity for strategic innovation

4. Sources of Strategic Innovation in Mature Industries • Reconfiguring the value chain: - Benetton and Zara in clothing • - Southwest & Ryanair in airlines • - Dell in PCs • Redefining markets and products - Swatch in watches - Starbucks in coffee shops • - Barnes & Noble in book retailing • Innovative approaches to - Virgin Atlantic in air travel • differentiation - Sephora in cosmetics retailing • Who are the strategic innovators? • New entrants -CNN in news broadcasting • - Nucor in the U.S. steel industry • Existing firms on the periphery -Sun Records in rock ‘n roll music • Firms from adjacent industries - Apple in consumer electronics • Why not leading incumbents? • They are constrained by “industry recipes,” relationships with existing • customers, investments in resources & capabilities linked to past • strategies.

5. Product, Process, and Strategic Innovation over the Life Cycle Product innovation Strategic innovation RATE OF INNOVATION Process innovation TIME

6. Strategy Implementation in Mature Industries:The Traditional Model STRATEGY - Pursuit of cost efficiency through mass production STRUCTURE - Functional departments - Line and staff distinction - Job specialization CONTROLS - Quantitative, short-term performance targets - Hierarchical monitoring and control - Standard, formalized operating procedures, reporting, and management by exception. INCENTIVES - Emphasis on financial incentives linked to individual performance TOP - Primary functions are control and MANAGEMENT strategic decision making - Two main styles: politician and autocrat

7. The Competitive Environment of Declining Industries • Features - Excess capacity of declining - Lack of technological change industries - Consolidation (but some new entry as old firms exit) - Old machines and employees • Smooth adjustment - Predictability of decline of capacity Durable assets depends upon Costs of closure - Barriers to exitManagement commitment - Strategies of surviving firms {

8. Strategy Options in Declining Industries LEADERSHIP Establish dominant market position -encourage exit of rivals -buy market share through acquisition -acquire capacity -demonstrate commitment -dispel optimism about the industry’s future -raise the stakes NICHE Identify an attractive segment and dominate it. HARVEST Maximize cash flow from existing sources DIVEST Get out while there is still a market for industry assets

9. Strategy Alternatives for a Declining Industry COMPANY’S COMPETITIVE POSITION Strengths in remaining demand pockets Lacks strength in remaining demand pockets Favorable to decline INDUSTRY STRUCTURE Unfavorable to decline

10. Vertical Integration and The Scope of the Firm • Transactions Costs and the Scope of the Firm --Why does the firm exist? --The evolution of firms and markets • The Costs and Benefits of Vertical Integration • Designing Vertical Relationships • Recent Trends OUTLINE

11. From Business Strategy to Corporate Strategy: The Scope of the Firm • Business Strategy is concerned with how a firm computes within a particular market • Corporate Strategy is concerned with where a firm competes, i.e. the scope of its activities • The dimensions of scope are • geographical scope • vertical scope • product scope

12. Transactions Costs and the Scope of the Firm Vertical Product Geographical Scope Scope Scope [A] Single Integrated Firm V1 V2 V3 P1 P2 P3 C1 C2 C3 [B] Several Specialized Firms linked by Markets V1 P1 P2 P3 C1 C2 C3 V2 V3 In situation [A] the business units are integrated within a single firm. In situation [B] the business units are independent firms linked by markets. Are the administrative costs of the integrated firm less than the transaction costs of markets?

13. Transactions Costs and The Existence of the Firm • Transaction cost theory explains not just the boundaries of firms, also the existence of firms. • In 18th century English woollen industry, no firms – independent spinners and weavers linked by merchants. • Residential remodeling industry -- mainly independent self- employed builders, plumbers, electricians, painters. • Key issue -- transaction costs of the market vs. administrative costs of firms. • Where transaction costs high—firm is more efficient means of organization Note: transaction costs comprise costs of search and contract negotiation and enforcement

14. Aggregate Concentration in US Manufacturing, 1947-97

15. Determinants of Changes in Corporate Scope • 1800 – 1980Expanding scale and scope of industrial corporations due to • declining administrative costs of firms: • Advances in transportation, information and communication • technologies • Advances in management—accounting systems, decision sciences, • financial techniques, organizational innovations, scientific management 1980 – 1995Shrinking size and scope of biggest industrial corporations. Increasingly Increased no. of managerial Admin.costs of turbulent decisions. Need for fast firms rise relative external responses to external to transaction environment change costs of markets 1995 – 2007Rapid increase in global concentration (steel, aluminium, oil, beer, banking, cement). Key drivers: quest for market power and scale economies. Also, large corporations better at reconciling size with agility

16. The Costs and Benefits of Vertical Integration: BENEFITS • Technical economies from integrating processes e.g. iron and steel production —but doesn’t necessarily require common ownership • Superior coordination • Avoids transactions costs of market contracts in situations where there are: -- small numbers of firms -- transaction-specific investments -- opportunism and strategic misrepresentation -- taxes and regulations on market transactions

17. Williamson (1975) • Complete vs incomplete contracts • Bounded rationality • Measurement problems • Information asymmetry Ensure all contracts are incomplete • Asset specificity creates quasi-rents • the difference in value of an asset in its best and next best use (fundamental transformation to small N bargaining or bilateral monopoly) • Site specificity – assets located side by side to save costs • Physical asset specificity – customized to a particular transaction • Human asset specificity – workers have specialized skills

18. Holdup • The existence of quasi-rents creates the incentive for opportunism in the form of hold-up • E.g. If I make you the exclusive supplier of a critical part then I expose myself to your demands • Firms integrate to avoid the threat of hold-up or the costs of avoiding it (e.g. litigation, distrust) • Integration is efficient if the transaction costs of hold-up exceed governance costs • In theory, hold-up should be very rare because potential victims will integrate before being held up.

19. The Costs and Benefits of Vertical Integration: COSTS • Differences in optimal scale of operation between different stages prevents balanced VI • Strategic differences between different vertical stages creates management difficulties (dominant logic) • Inhibits development of and exploitation of core competencies • Limits flexibility -- in responding to demand cycles -- in responding to changes in technology, customer preferences, etc. (But, VI may be conducive to system-wide flexibility) • Compounding of risk • Also lack of market prices increases inefficiency (may result in tapered integration –part internal, part market)

20. When is Vertical Integration More Attractive than Outsourcing? How many firms are available The fewer the companies to undertake the activities? the more attractive is VI Is transaction-specific investment If yes, VI more attractive needed? Does limited information permit VI can limit opportunism cheating? Are taxes or regulation imposed VI can avoid them on transactions? Do the different stages have similar Greater the similarity, the optimal scales of operation? more attractive is VI Are the two stages strategically Greater the strategic similar? similarity ---the more attractive is VI How great the need for entrepreneurship Greater the need, the greater & continual upgrading of capabilities the disadvantages of VI How uncertain is market demand? Greater the unpredictability ----the more costly is VI Are risks compounded byVI increases risk. linkages between vertical stages

21. The value chain for steel cans Canning of food, drink, oil, etc. Iron ore mining Steel production Steel strip production Can making VERTICAL INTEGRATION, ANDMARKET CONTRACTS VERTICAL INTEGRATION MARKET CONTRACTS MARKET CONTRACTS What factors explain why some stages are vertically integrated, while others are linked by market transactions?

22. More brainteasers • Why do car manufacturers not own dealerships anymore? • Why don’t Hollywood studios produce or exhibit films anymore? Why were they completely integrated before WWII?

23. Designing Vertical Relationships: Long-Term Contracts and Quasi-Vertical Integration • Intermediate between spot transactions and vertical integration are several types of vertical relationships ---such relationships may combine benefits of both market transactions and internalization • Key issues in designing vertical relationships -- How is risk allocated between the parties? -- Are the incentives appropriate?

24. Recent Trends in Vertical Relationships • From competitive contracting to supplier partnerships, e.g. in autos • From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services). • Diffusion of franchising • Technology partnerships (e.g. IBM- Apple; Canon- HP) • Inter-firm networks General conclusion:- boundaries between firms and markets becoming increasingly blurred.

25. Different Types of Vertical Relationship Low Long-term contracts Franchises Joint ventures Agency agreements Spot sales/ purchases Low Formalization High Supplier/ customer partnerships Informal supplier/ customer relationships Vertical integration Low Degree of Commitment High

26. Birdseye Case • Why did Birds Eye develop as a vertically integrated producer the way it did? • Did a vertically integrated producer have a competitive advantage over more vertically specialized suppliers of frozen foods during the early 1980s? • What should Birds Eye have done in 1979?