BUSINESS STRATEGY Summary

(Slides+Notes+Book+Articles)
Structure of the exam: 10 multiple choice questions, 2 theoretical open questions, 1 case open question
[case to be read during the exam, not one given in class] Time: 1.15h
INTRO
What? We are interested in: firms, entrepreneurs. We are not interested in: markets, economic
transactions, industries.
Some definitions:
Firm: autonomous administrative unit; a set of resources organized to offer goods and-or services; directed
to profit. (Penrose)
Entrepreneur: the individual who is carrying out the new combinations of means of production.
(Schumpeter)
In order to pursue their aims, firms and entrepreneurs interact with: other firms (customers, suppliers,
competitors, producers of complementary goods/services), other organizations (public organizations, no-
profit organizations, NGOs), individuals and civil society.


HISTORY : Strategy and Strategic Thinking (CH.1)
Some definitions:
If we wish to increase the yield of grain in a certain field and on analysis it appears that the soil lacks
potash, potash may be said to be the strategic (or limiting) factor. Barnard, 1930s. The strategic factor is
needed, otherwise its absence limits the survival of an organization.
Strategic decisions deal more with factors external to the firm than with internal factorsspecifically with
the selection of the product mix which the firm will produce and the markets to which it will sell. Ansoff,
1960s. Decisions are concerned mainly with external factors and specifically with product mix selection.
Strategy can be defined as the determination of the basic long-term goals and objectives of an enterprise,
and the adoption of courses of action and the allocation of resources necessary for carrying out those
goals. - Chandler, 1960s. The idea is that strategy has to do with something having an impact on the long
term development and goals of an organization.

The origins

Strategy didn't start with Igor Ansoff, neither did it start with Machiavelli. It probably did not even start
with Sun Tzu. Strategy is as old as human conflict. (Hamel,1990s). It involves individuals.
Military origins from Ancient Greece, strategos: chief magistrate or military commander in chief.
Carl von Clausewitzs definition: tactics involve the use of armed forces in the engagement, strategy is the
use of engagements for the objective of the war.

First Industrial Revolution (mid-1700s to mid-1800s) It failed to introduce strategic thinking or behavior:
the idea of strategy was not formalized yet. Intense competition among firms was such that companies
lacked power to influence market outcomes, as they were too small and they had no impact at all on the
environment. Their structure was still too weak and fragile. The chaotic markets of this era led Adam Smith
to describe market forces as an invisible hand. Firms required no or little strategy.

Second Industrial Revolution (second half of 19
th
Century) The emergence of strategic thinking as a way
to shape market forces follows some major innovations, like the railroad one (US, 1850), which allowed to
build mass markets (1850) as one was able to reach even far markets; the improved access to capital and
credit allowed economies of scale to emerge, large scale investments to exploit economies of scale and
economies of scope in distribution. Alfred D. Chandlers, Jr.s visible hand of professional managers
superseded the invisible hand: the management started to have a strong role in companies. By this time,
large vertically integrated companies emerged in the U.S. first, then in Europe. Those companies invested
heavily in manufacturing and marketing and in management hierarchies to coordinate those functions.
Captains of industry articulated strategic thinking, meaning that the men responsible for the creation of
such companies were the ones who took into consideration the concept of strategic thinking: examples are
Alfred Sloan for General Motors (1923-1946), who introduced the idea that strengths and weaknesses need
to be identified for a firm to be competitive; and Chester Barnard for New Jersey Bell (1930s), who argued
that managers should pay very close attention to strategic factors which depend on personal or
organizational action.

World War II era (1939 1945) Resources were scarce. Allocating them across the economy was
problematic. The concept of learning curves was introduced (1920s 1930s): increasing the number of
units produced, the cost per unit decreases by a certain percentage. This was discovered at first in the
aircraft industry: manufacturers realized that direct labor costs decreased by a constant percentage as the
cumulative number of aircraft produced doubled.
Use of quantitative analysis in formal strategic planning: In 1944, the Theory of Games and Economic
Behavior was written by John von Neumann and Oskar Morgenstern: through game theory, one tries to
anticipate the behavior of competitors. It solved the problem of zero sum games.
Not only new tools and techniques, but also use of formal strategic thinking to guide management
decisions: If you want to manage a company, you must be guided by strategic thinking: managers started
to focus on long term goals as strategic thinking guides management decisions. Peter Drucker recognized
the active role of entrepreneurs: the decision process and strategic reasoning were formalized. Huge
formalization in strategy too: company could exert positive control over market forces by using formal
planning, strongly needed to do strategy.

Post WWII In the US army there was many military costly divisions (Army, Navy, Marines, Air Force).
Many argued that they would be more efficient if unified into a single organization.
The system was reorganized according to the distinctive competence concept, according to which within
the divisions were merged according to some shared capability and in each of them there were really
strong competencies. The concept: Find distinct competencies of each division and combine them keeping
in mind that they need to be optimized. In the same way, an organization through its competencies must
be able to distinguish itself from the others. Distinctive competence had great resonance for strategic
management.

The early academic contribution and Business Schools

Eminent economists produced earliest academic writings about strategy: John Commons (1934, on
strategic or limiting factors); Chester Barnard; Ronald Coase (1937, on why firms exist); Joseph Schumpeter
(1942, idea that business strategy encompassed more than the price setting contemplated in orthodox
microeconomics) ; Edith Penrose (1959, growth of business firms is related to the resources under their
control and the administrative framework used to coordinate their use).
Elite U.S. business schools emerged: Wharton (1881) and Harvard (1908). In the latter, it was though that
managers should be trained to think strategically and not act as mere administrators. In the second year a
course in Business Policy was introduced at Harvard (1912): designed to integrate the knowledge gained in
functional areas. Students gained a broader perspective, as they faced corporate executives in class as
teachers.
1950s, Kenneth Andrews argued that every organization, subunit and individual have a clear set of
purposes or goal which keeps it moving in a deliberately chosen direction. He thought the primary function
of general managers is the supervision of the continuous process of determining the nature of the
enterprise and setting, revising, and attempting to achieve its goals.
The case-study method was applied: theory was merging out from discussion of cases, through a lot of
empiricism. There was a very rapid development of the discipline, leading to some concepts as the SWOT
analysis, market myopia and the mission of the firm.


The SWOT analysis
By Andrews, 1960s. Classroom discussion focused on matching a companys strengths and weaknesses with
opportunities and threats faced on the market place. Andrews emphasized that competencies or resources
had to match environmental needs to have value.



Andrews strategy Framework


Market myopia

By Levitt, 1960s. Levitt was critical about any firm focusing too narrowly on delivering a specific product,
exploiting its distinct competence and not consciously serving the customer. When companies fail, it means
the product fails to adapt to the constantly changing patterns of consumer needs and tastes, to new and
modified marketing institutions and practices or to product developments in complementary industries.
It is about trying to understand how the market is evolving. Attention is given to the customer, as an
important element of any strategy developed by the firm.

The mission of the firm

You must develop an idea of where your company is going and what it will become. This idea will have a
strong impact on the mission of the company. By Ansoff, 1960s: I begged, borrowed and stole concepts
and theoretical insights from psychology, sociology and political science. And I attempted to integrate them
into a holistic explanation of strategic behavior. First you should ask if a new product has a common
thread (=firms mission, its commitment to exploit and existing need in the market as a whole) with its
existing products. The customer is not the thread of a business. The firm must maintain its strategic focus:
Ansoffs Product/Mission Matrix.



Examples:
Ducati mission statement: Ducati exceeds the demands of even the most fanatical enthusiasts and
riders
IBM Mission Statement: At IBM, we strive to lead in the invention, development and manufacture of the
industry's most advanced information technologies, including computer systems, software, storage systems
and microelectronics. We translate these advanced technologies into value for our customers through our
professional solutions, services and consulting businesses worldwide.

The Rise of Strategy Consultants

Some consulting firms emerged as international service organizations. One of them was the Boston
Consulting Group (BCG), founded in 1963 by Bruce Henderson. Those were organizations responsible for
the adoption of a new tool for the strategy. The approach at the time was too qualitative: the consulting
firms attempted to introduce a more meaningful quantitative approach, applying research methods to
business strategy. Idea that a good strategy must be based on logic, not on experience derived from
intuition. The aim was to be able to give some prescriptions and suggestions to the companies analyzed.
Again, we see the use of experience and learning curves, even within the BCG. BCG was known as a
strategic boutique.

The experience curve/learning curve

The experience or learning curve (1965-1966, developed by BCG) was developed to try to explain price and
competitive behavior in the extremely fast growing segments of industries (ex. Texas Instruments, Black
and Decker). The idea is that cumulative production will decrease the whole cost of production by a certain
percentage. For each doubling of cumulated output, total costs would decline (10 to 30%, roughly 20%) due
to economies of scale, organizational learning and technological innovation. This curve is a good tool for
planning: you have the opportunity to become large with costs decreasing. In the future, you may be able
to increase profits and attract more customers.


Experience Curve for Fords Model T (1910-1926)



Growth Share Matrix

Early 1970s. The matrix represented the first use of portfolio planning.
This matrix gives an idea of prescriptions and suggestions that a company in a specific situation would
receive. The basic strategy recommendation was to maintain a balance between cash cows (mature
businesses) and stars, while allocating some resources to fund question marks.
BCG Basic strategy recommendation when Cash Cows: try to get the best out of the situation; Stars:
keep on investing; Question Marks: allocate resources; Dogs: try to sell off your company.
If the market is growing fast, you will need to follow its speed and invest, contributing a lot.
A higher market share company expects a larger profit.



Strategic Business Unit and Portfolio Analysis

Some argued that the BCG Matrix was too simple. The competitors of BCG, McKinsey & Company, tried to
develop another matrix, more general and applicable to different kinds of situations. They thought in terms
of Strategic Business Units (SBUs) and the GE/McKinsey nine-block matrix. (Story: GE asked McKinsey for
help in re-organizing and examining GE corporate structure and they recommended a formal strategic
planning system to divide the company into natural business units, SBUs.)
In the BCG matrix, market share and growth were used to measure the strength of a company. So there
were only two measures of performance. In SBU and Portfolio Analysis, they used some more different
measures to screen industry attractiveness and to screen for competitive position, although weights
attached to each measure were not specified.
Strategy is made at different levels: business (unit) strategy, to reach a competitive advantage at the
product/market level (SBU), and corporate strategy, to create value through the combination and the
coordination of SBUs (a portfolio of SBUs).

The Industry Attractiveness-Business Strength Matrix :


Problems and criticism

1. Experience curve criticisms: What if the technology changes? What if the demand decreases?
Technology can change and the curve totally relies on it. You need to look at possible changes and
evolution in technology and demand. high inflation and excess capacity of the oil shocks of 1973
and 1979 disrupted historical experience curves in many industries. Also, costs reductions were
thought as automatic rather than something that could be managed, for assuming experience could
be kept proprietary, for mixing up different sources of cost reduction with very different strategic
implications.
2. Portfolio analysis under attack: Too much subjectivity. Can new options emerge? The McKinsey tool
was open ot any kind of situation but was relying on too much subjectivity especially concerning
attractiveness. Also, it was limited in the kind of prescriptions provided. strategic
recommendations for SBU were sensitive to the specific portfolio planning technique employed.
Also, even if one could figure out the right technique, the mechanical determination of resources-
allocation patterns on the basis of historical data was problematic because of the assumption that
financial capital was the scarce resource on which top management had to focus.
Gluck: successful companies strategies progress through 4 phases involving grappling with
increasing levels of dynamism, multidimensionality and uncertainty, becoming less amenable to
routine quantitative analysis.



3. Financial capital: The only scarce resource on which top management had to focus?
Hayes and Abernathy: portfolio planning criticized as a tool that led managers to focus on
minimizing financial risks rather than investing in new opportunities that required a long term
commitment of resources.
4. Backward focused.

Nevertheless, portfolio planning put the basis for a more careful analysis of the two basic dimensions:
industry attractiveness and competitive position. A business performance could be thought of as the sum of
the average profitability of the industry in which it operated plus its competitive advantage relative to the
average competitor within that industry.



Key Terms

Distinctive competence
Experience (learning) curve
Strategic Business Units (SBUs)
Portfolio Analysis
Strategy
SWOT




THE BUSINESS MODEL TOOL (ARTICLE)

The business model is a model where a common language is shared to communicate and be able to
describe a firm. It is different from strategy because it is a combination of the relevant decisions the
company decides to take, while strategy turns those decision into practice.

Questions addressed: How can we describe and classify businesses? How can we help (present and future)
managers and entrepreneurs to create, manage and innovate? How can we present a firm for scientific
investigation?

The business model: a tool that spread very quickly in the past. Business idea-Norman and Business
definition-Abel. Different structures of these tools available can be used to think, design and test business
model, strategy and tactics.

Business model (Osterwalder, Pigneur, 2010).



Customer part: Customer Segments, Value Proposition, Channels, Customer Relationship, Revenue
Streams.
Back office, internal structure: Key Resources, Key Activities, Key Partners, Cost structure.

Customer segments

We need to create value in order to be competitive. The customer may be a mass market or may belong to
a niche. The segments may be more than one (different) and very similar or diverse. Also, they may be
interdependent : a decision taken may affect one segment but not another one.

Mass market
Niche market
Different segments
Very diverse segments
Interdependent segments

Value proposition

Why should customers choose our product/service? It makes a reference to products and services
advertised by the firm. Newness is a really good value provided. Products may be competitive in terms of
price. Products may be customizable. There may be the possibility to reduce costs for your customer.
Improved performance for the customer. Risk reduction as well (ex. Broken components provided soon by
the firm). Availability. Design. Status.

Newness
Price
Customization
Cost reduction
Improved performance
Risk reduction
Availability
Design
Status

Channels

How can we reach the customer? Through own/partner channels, direct /indirect. Channels can be
independent or integrated. Then you must consider the initial awareness of customers in order to consider
all the steps until after sales.

Own/partner
Direct/indirect
Independent/integrated

Customer relationship

How do we keep relationships with customers? Personally, or through a dedicated personal relationship:
having a person at your service to develop trust and a communication on a daily basis. Also self-service,
which provides benefits, as well as communities involving customers. Co-creation also involves customers
in the creation of something new, development of new products and opportunities.

Personal relationship
Dedicated personal relationship
Self-service
Communities
Co-creation

Revenue streams

Once you have decided customers, channels, propositions and relationshipHow are customers paying?
One-time payment. Subscription fee; renting/leasing; licensing; usage fee; after sale; brokerage fee;
advertising; fixed and dynamic pricing (ex. Auctions, flights, hotels).
How would they be willing to pay?

One-time payment
Subscription fee; renting/leasing; usage fee; after sale; brokerage fee; advertising
Fixed and dynamic pricing

Key resources

The resources contributing to value proposition. Tangible/intangible (as brand, patents, reputation);
Resources and competencies (employees and their skills).

Tangible/Intangible
Resources and competencies

Key activities

Activities contributing to value propositions. Direct activities or indirect ones.

Direct
Indirect

Key partners

Network of partners that allows the fulfillment of the value proposition for customers. Identify who they
are and what they guarantee (it may be access to resources, access to status/legitimacy and uncertainty
reduction).

Network of partners
Who
What is guaranteed: -access to resources
-access to status/legitimacy
-uncertainty reduction

Cost structure

All the decisions taken in terms of products and services have implications in terms of costs. This impact
depends on our value proposition (Cost or value driven), fixed versus variable costs, access to different
economies of costs (reductions related to quantities like economy of scale, scope, experience).

Value proposition
Fixed vs variable costs
Access to economies of cost

Innovation can come from different building blocks.

Resource driven (GlaxoSmithKline and patent pools)
Offer-driven (Skype and Ryanair- emerging and development phase)
Customer-driven (Apple and I-pod)
Finance-driven (Xerox and paper copiers, Gillette and razor-blades)
Multiple epicenter-driven (Nintendo-wii and Ryanair -mature phase)

Skype:

Apple i-pod:

Gillette:

Nintendo-wii:


Business Model Archetypes
Un-bundling Business Model There have been re-definitions of business models according to three
different businesses: one based on customers, one based on innovation, one based on infrastructures.
Those three models were all together before, but due to privatization and other factors, they were
unbundled. In order to avoid conflicts/trade-offs they are ideally separated.

Example: Vodafone has three different business models: one for equipment manufacturers, one for mobile
business (the core one) and one for content providers.


Multi-sided platform business model Used when there is two or more interdependent customer
segments. The created value depends on the interactions between segments and new attracted customers.
Key resource: the platform. Major cost: the platform management. Different revenue streams for different
segments.

Example: Google.
A service: AdWords for advertisers.
AdSense: allows third parties to earn a portion of Googles adv. revenues, by displaying Google.

The Long Tail Business Model Usually, 20% of the products are responsible for a large part of the sales.
The other part is realized by the remaining 80%, with products addressing niches (limited number of
products). The 20% represents more profitable clients, mass production ones. The 80% mirrors niches.
Clients are, taken individually, less profitable, but once combined they do become profitable.
New value proposition + Key activities and resources+ Cost of platform.



Example: User-generated content from 2005. Lego Factory with a new software: Lego Digital Designer.
From helping users to design own Lego sets to helping them to sell the sets: Lego user catalog. Possible
benefits for mass- market model (multisided platform business model).

Free Business Model One Customer segment benefits from a free-of-charge offer and doesnt pay for a
product. Non-paying customers are financed by either other customer segments or another part of the
business model.

Example: The large majority of Skype users subscribe to the free service. Subscribers to prepaid SkypeOut
finance other customers. Other sales contribute, as well as advertising.


Open Business model Focus on new ideas and innovations. Its not pure internal R&D, but also the
development of strategic partnerships with other entities (outside firms, institutions) in order to to
collaborate and create more value. A lot of focus is set on key resources and key partners and activities in
an optimal combination.
Example: P&G. Technology manager in contact with Universities and other firms. Internet platform
InnoCentives with external technology scientific advisors. In the platform prizes for best solutions. Solicited
knowledge from retirees through platform YourEncore.

Nescaf business model




EXAMPLE IN CLASS

Nespresso. Household consumption in Switzerland changed in two years by 600% to 800% at the world
level average growth of 30% p.a. since 2000. One of the fastest growing businesses in the Nestl Group.
Over 3 billion CHF annualr evenue with one product line.
Which is the Nespresso Business Model?



Customer segment: High-income, upper middle class/Hotels, restaurants/Businesses. Niches.
Value proposition: Machine, capsule. High quality, unique innovative design, variety,
personalization of the service. Status.
Channels: stores/boutiques, Nespresso website, call center, some appliance stores, online stores.
Customer relationships: Communities (Club Nespresso)
New streams: sales of Nespresso capsules, pods and machines (one-time payment, fixed prices).
Key resources: patents (intangibles), production facilities and distribution channels. Brand.
Key activities: marketing, advertisement, R&D (direct)..
Key partners: Brewers and producers of coffee. Main coffee machine manufacturers.
Cost structure: production costs, marketing costs, B2C.



COMPETITIVE ENVIRONMENT (CH. 2)

The environment where a firm works matters. In this context, environment means industry.
The industry in which a firm operates has a strong influence on its economic performance.
A way of visualizing the profit potential afforded by a business environment is mapping it into a landscape
in which the vertical dimension captures the level of economic profitability.
Two-Dimensional Landscape: Average Economic Profits of U.S. Industry Groups (19892006)
In the two dimensional, one can include just one dimension of choice (in this case: industry in which you
compete).


Three-Dimensional Landscape: A Three-Dimensional Business Landscape
In the three dimensional, one can choose for two dimensions.



Businesses are best envisioned as operating in a high dimension space of choice and each location in the
space represents a different strategy. A business landscape maps each strategys elevation according to its
economic profitability. Central challenge: guide a business to a high point on the landscape.


Main questions: How can we analyze and understand our competitive environment? How can we evaluate
its attractiveness? How can we evaluate a new competitive environment as an opportunity for investment?
Three frameworks: Supply-Demand Analysis; The five forces framework; The value net framework and its
extensions.

Supply-Demand Analysis

Middle Ages: idea that interplay of demand and supply determines a natural price.
The concept was formalized by Alfred Marshall (late 19
th
Century): first supply-demand diagram,
Marshallian scissors. The price was determined by equilibrium point at which the demand curve for a
particular product (summed across its buyers in decreasing order of their willingness to pay) intersected
with its supply curve (summed across its suppliers in increasing order of their costs of production).
The downward sloping demand curve was treated as self-evident. Introduction of the concept of price-
elasticity of demand: demand is said to be relatively price elastic if changes in price induce relatively large
changes in the aggregate quantity demand (horizontal demand curve); inelastic if close to vertical.
The supply side is upward sloping and it tends to become flatter as the period lengthens.
The basic assumptions are that there is a large number of small actors in relation to the size of the overall
market and that they are homogeneous: a given buyer would have the same willingness to pay for the
product of each supplier and a given buyer would face the same costs in supplying its product to each
buyer.


The five forces framework

Origins
1838: Cournot provided first analytical characterizations of equilibrium prices under monopoly and duopoly
independently deciding how much to produce. The assumption of homogeneity was then relaxed by
Chamberlain and Robinson (1933) with monopolistic competition: situation in which individual firm
monopolizes the its own products but confronts a large number of competitors offering substitute
products. These attempts to posit a large number of firms with different products resembling one another
offered limited benefits and missed the oligopolistic competition.
Edward S. Mason, Harvard Economics Department (1939). The framework comes from the economic
evolution on economic thought and a development of the idea of roles and conducts of buyers and sellers
(influenced by the industry structure). So different industries were thought to have an influence on the the
way actors acted in the market framework and by implication on the industrys performance in terms of
profitability, efficiency and innovation.
Joe Bain, Harvard Economics Department (1950s), tried to uncover relationships between industry
structure and performance. He addressed the issue of entry barriers: they created situations for some
companies that made them more profitable. Three main types identified:
1. absolute cost advantage by an established firm
2. a significant degree of product differentiation
3. economies of scale.
Bains insight enabled the rapid growth of Industrial Organization, exploring structural reasons why some
industries were more profitable than others. IOs impact on business was limited by Bains focus on the role
of public policy rather than private and by the emphasis on using a short list of structural variables to
explain industry profitability (ex. Managerial behavior according to different industries) in a way that
slighted business strategy.
Porters Note on the Structural Analysis of Industries (1974) focused on the business policy objective of
profit maximization, rather than the public policy objective of minimizing excess profits.
The book Competitive Strategy (1980): five forces framework. He tried to relate the average profitability
of an industry to five competitive forces. The framework generalized the supply-demand analysis of
individual markets. It relaxed the assumptions of both large numbers and homogeneity, shifting attention
from two-stage vertical chains (supplier-buyer) to three-stage vertical chains (suppliers-rivals-buyers).
Potential entrants and substitutes are seen as direct rivals. Though the focus is not only on the present
competitors. It extends the idea of competition to other actors who may have an impact on the profitability
of the firm: namely, extended competition for value, rather than just competition among existing rivals.
Bain survey (1993) : 25% usage rate of the model.

Porters framework:





Example: Competition in Italian shoes industry.
Chinese production is directly competing with Italian shoes since late 90s. Chinese shoes have prices lower
than Italian shoes. How do Italian firms react? Which is the most dangerous reaction for firms profit?
Which environment conditions bring firms to use this dangerous reaction?

Force 1: Degree of Rivalry Industry Competitors

It influences the extent to which the value captured by an industry will be dissipated through direct
competition. Rivalry in the same industry with firms addressing the same customer segments or producing
the same goods. Several determinants of rivalry exist:

Number and size of direct competitors
Rate of growth of the market
High fixed costs
Capacity utilization
Differentiation of offer and switching costs
Behavioral determinants
Exit barriers

Number and size of direct competitors: when there is a large number of companies and
competitors you may think that you are going to benefit because the others are not going to do the
same thing. Though, because the rationality of firms is limited, most of them would use the same
strategy (ex. Price competition). That happens if the size of companies is homogeneous. If instead
there are many small companies and one big leader only, then the leader is the one who can set
and regulate competition, usually not too much towards the use of price.
The more concentrated the industry, the more likely that competitors will
recognize their mutual interdependence and so will restrain their rivalry. If in
contrast there are many small players, each will think like its effect on others will
go unnoticed and will be tempted to grab additional market share, disrupting the
market. The presence of one dominant competitor may lessen rivalry: the
dominant player may be able to set industry prices and discipline defectors, while
equally sized players may try to outdo one another to gain an advantage. (ex. p.24)
Rate of growth of the market: the market is more competitive when companies are mature.
High fixed costs: high fixed costs means high competition.
Capacity utilization: if the demand is not increasing, it happens that you produce more than
demanded. In order to increase the utilization of your investment and sell, you may want to lower
your selling price.
In capital intensive industries, the level of capacity utilization directly influences
firms incentives to engage in price competition.
Differentiation of offer and switching costs.
Behavioral determinants: related to understanding how our actions lead to which reaction from
competitors and to how much companies are able to anticipate and understand the behavior of
other companies in the industry.
If competitors are diverse, face high exit barriers or attach high strategic value to
their position in an industry, they are more likely to compete aggressively.(ex.p.25)
Exit barriers: if high exit barriers exist, many companies stay in the industry even if they
could/should leave it because of low profits or bad results.

Example: The beer industry in USA in 1980s.
Many SMEs with local markets. Philip Morris acquires Miller, a mediumsized producer of beer. Miller
becomes the leader producer in USA, with a national market. How did the competitive environment change
for U.S. producers? What would have limited the Philip Morris entry?
} Industrys basic conditions all increasing degree of rivalry.(ex.p.24)
Force 2: Threat of Entry

Industry profitability is influenced by existing competitors and new potential ones. Entry barriers matter as
they prevent an influx of firms into an industry whenever profits rise above zero. Entry barriers exist
whenever it is difficult or not feasible economically for an outsider to replicate the incumbents position.
The main ones are:

Economy of scale
Product differentiation
Need of capital
Switching costs
Access to key resources
Public policy

Economies of scale: they make it more difficult for newcomers to come in.
Product differentiation: if companies can differentiate through brand or other ways, they are better
protected against new entrants. You need to invest more to be more attractive for a consumer.
When incumbent firms have well established brand names and clearly
differentiated products, a potential entrant may find it uneconomical to undertake
the marketing campaign necessary to introduce its own products effectively
because of the magnitude of required expenditures.
Need of capital: to promote and invest in marketing campaigns. To be a new entrant, one needs a
pretty high initial capital.
Switching costs; if customers have to pay to change the product they use from a brand to another,
they wont.
Access to key resources (ex. patents).
Public policy.
Incumbents reactions may matter. An entry barriers could be such for one incumbent, but nor for
another one.

Barriers to entry can change over time depending on firms strategies. Ex. with strategic groups p.25.

Example: Napster and the file sharing.
Fall 1999: the start-up Napster and the service of file sharing.
December 1999: Major record companies took legal action against Napster for copyright infringement.
February 2001: 13,6 million Napster users.
1999-2001: dozens of Napsters clones are created.
March 2001: Bertelsman makes an agreement with Napster.
May 2002: Bertelsman buys Napster.
Sony and Vivendi start their subscription services.many Napsters imitators (Kazaa, Gnutella.) and
the record industry is the first to experiment the impact of internet with 2digit drops of sales and profits.

Force 3: Threat of Substitutes

It depends on price-to-performance ratios of the different types of products or services to which customers
can turn to satisfy the same basic need. Having substitutes lowers the profitability of an industry, as one
needs to make promotions or take strategies to gain a competitive advantage.
Switching costs for customers also affects threat of substitutes, that is costs that derive from retraining,
retooling and redesign. S curve of the substitution process: it starts slowly, picks up steam if other
customers follow suit and finally levels off when all of the cost effective substitution possibilities have been
exhausted.
The analysis of threat of substitution must look broadly at all the different ways of performing similar
functions for customers, not just at physically similar products. The analysis should be supplemented by
considering the possibilities available to suppliers. Supply side substitutability reduces suppliers willingness
to provide required inputs just as demand side substitutability reduces buyers willingness to pay for a
product.

Now we move to the vertical competition of the model: possible threats to profitability coming from
suppliers or customers.

Force 4: Buyer Power

The buyer may be the customer, the distributor or a combination of them. The majority of firms nowadays
faces the power of the distributors. Buyer power allows customers to squeeze industry margins by
compelling competitors to either reduce prices or raise the level of service offered without compensating
price increases. The main determinants of bargaining power are:

Size and concentration of customers
Customers buy in large volumes from single vendor
Customers buy standardized products/
Customers have good information
Customers threaten to integrate backward

Size and concentration of customers: any time they are large, the power of buyers will be high.
Buyers tend to be powerful if there are a few of them.
Customers buy in large volumes from single vendor: when companies sales depend very much on
some buyers, they have power. Ex: if they refuse to buy your product, then you would need to
decrease your price or offer more services.
Buyers tend to be powerful if each one purchases in volumes that are large relative
to the size of a single vendor.
Customers buy standardized products: high power.
Customers have good information: this represents high buyer power as customers are able to
understand the cost structure, meaning companies cannot negotiate too much with them.
Consumers will be strong price negotiators. The same happens when customers know as you or
more than you.
Buyers tend to be powerful it they have good information about prices and the
other attributes of vendors products.
Customers threaten to integrate backward or upward: this means he would start using phases of
the production chain it didnt use before; he starts producing.
Buyers tend to be powerful if they face few switching costs or can credibly threaten
to integrate backwards.

It is useful to distinguish between potential buyer power from the buyers willingness or incentive to use
buyer power. There may be behavioral conditions for which buyers do or do not have incentives to use
their inherent power: examples are the nature of cost from the perspective of the purchasing industry or
the perceived risk of failure associated with a products use.

Force 5: Supplier Power

Its the mirror image of buyer power. It involves suppliers of components, product, services, labor.
Determinants of bargaining power:
relative size and concentration of suppliers relative to industry participants
degree of differentiation in the inputs supplied / switching costs
Suppliers threaten to integrate downward
The ability to charge competitors different prices in line with differences in the
value created for each of them usually indicates that the market is characterized by
high supplier power. (ex. p. 28)

Critics to the Porters framework

It was criticized for being a static model, where the relationships among different actors were competitive
and resulting in a zero-sum game. Also, the role of innovation was limited. Starting from those critics,
other models were taken into consideration. Some more factors were considered as well as nonzero sum
games.

CASE STUDY IN CLASS



QUESTIONS: Which are the major entry barriers? Do you know any European example of firms able to
circumvent barriers in the industry?

The Value Net framework

After Porter, there have been rearrangements and incorporations of additional variables into the
determinants of the intensitivity of each of the forces. The new model by Brandenburger and Nalebuff
includes new types of players into the analysis. The need for a new type of actors, complementors (mirror
image of competitors, namely participants from whom customers buy complementary products or services
or to whom suppliers sell complementary resources), influences business success or failure from two
different perspectives: on the demand side, they increase buyers willingness to pay for products and on
the supply side they decrease price that suppliers require for their inputs. (ex.p.29)



Determinants of the relative bargaining power of complementors. Several are based on how much
competition there is among complementors vs among rivals.

relative concentration: calculated with market shares: complementors are more likely to have the
power to pursue their own agenda when they are concentrated relative to competitors and are less
likely to be able to do so when they are fragmented.
relative buyer/supplier switching costs: when the cost to buyers or suppliers of switching across
complementors are greater than the costs of switching across competitors, that increases
complementors ability to pursue their own goals.
relative complementor/competitor switching costs: the ease with which complementors
themselves can switch to working with different competitors vs the ease with which competitors
can switch to working with different complementors also matter. If complementors play a
significant role through demand, their power is likely to expand.
asymmetric integration threats: if a company has the possibility to integrate, then it has an
advantage with respect to those that cannot: complementors tend to have more power when they
can threaten to invade competitors turf more credibly than competitors can threaten to invade
theirs.
rate of growth of the pie: if the market is growing fast, there are no pressures on reciprocal
competition. There are plenty of opportunities. From behavioral perspective: competition with
complementors to claim value is likely to be less intensive when the size of the pie available to be
divided among competitors and complementors is growing rapidly.

The competitive environment: Supply-Demand Analysis; The five forces framework; The value net
framework; Strategic groups in industries.

Can additional improvements be achieved by further broadening the types of actors considered?
Yes; it is often important to take into account for non-market relationships (government, media,
activist/interest groups, public) that, in addition to involving non-profit players and organizations, may be
distinguished from market relationships by such characteristics as strong norms of fairness, broad
participation and majority rule.

Strategic Groups
Strategic groups are clusters of firms belonging to the same industry, sharing similar strategies.
It is a concept used in strategic management that groups companies within an industry that have similar
business models or similar combinations of strategies. The number of groups within an industry and their
compositions depends on the dimensions used to define the groups.
Basic assumption for Strategic Group Analysis: no two firms are totally different or exactly the same.
Hunt (1972): studying the appliance industry, he came across a high degree of rivalry than suggested by
industry concentration ratios. This was attributed to the existence of subgroups within the industry that
competed along different dimensions making tacit collusion more difficult. These asymmetrical strategic
groups caused the industry to have more rapid innovation, lower prices, higher quality and lower
profitability than traditional economic models would predict.
Porter (1980) developed and applied the concept: strategic groups were explained in terms of mobility
barriers (=similar to entry barriers that exist in industries, except that they apply to groups within an
industry).
Strategic Group Analysis aims to identify organizations with similar strategic characteristics, with similar
strategies and competing on similar basis. This:
Helps identify ho the most direct competitors are and on what basis they compete
Helps identify opportunities
Helps identify strategic problems
Raises the questions of how likely or possible it is for another organization to move from one
strategic group to another.

The Process of Mapping the Competitive Environment

The purpose of mapping the business landscape is to understand the reasons for variations and to
incorporate them into strategic action. Six Step Process:
1. Gathering Information
2. Drawing the Boundaries
3. Identifying Groups of Players
4. Understanding Group-Level Bargaining Power
5. Thinking Dynamically
6. Adapting to/Shaping the Business Landscape

1- Gathering Information: Mapping the business landscape requires a great deal of information. There is
thus a premium thinking broadly about sources of information. Some of the public ones for industry
analysis are:



Points to be made about the list:
The amount of publicly available information in many situations is staggering. Information overload
is a problem as well as information unavailability. There is often no alternative to information
filtering.
The selection and prioritization of sources of public information must account for variations in their
content, quality and accessibility.
The need of supplement public information with external private information varies.
Given fixed costs of undertaking such analyses from scratch, emphasis is placed on system for
scanning the external environment on an ongoing basis.
The process of mapping the competitive landscape should leverage on the extensive amounts of
information about the external environment generated internally by employees accomplishing
their day to day activities.
The information assembled must be analyzed and must have the potential to influence action to be
of any use.

2- Drawing the Boundaries: Another issue is to decide which part of the business landscape to focus on,
also known as the problem of industry definition. The strategist needs to decide how broadly to draw the
boundaries. This can be done with general-purpose industry classification schemes or with an inside-out
approach. Boundaries should be drawn a bit more broadly to include also unserved segments, with which
the landscape shares customers or technologies, and complements maybe. These issues all focus attention
on the choice of the horizontal scope across products or market segments. Vertical and geographical scope
raise different analytical issues. Vertical scope: key issue is how many vertically linked stages of the
supplier-buyer chain to consider. In general, if a competitive market for a third party sales exists between
vertical stages or could be created, the stages should be analyzed separately. If not, they should be
analyzed together. Geographic scope: key issue is to how broadly to define the business landscape in terms
of physical locations covered. The degree of market integration is key to determining whether geographies
should be looked at together or separately.
Given all the scope complexities, there often isnt any perfect way of drawing boundaries. It is more useful
to focus on ensuring that boundaries are drawn clearly and that there is consistency in the treatment of
what is in versus out instead of looking for the right way of drawing boundaries.

3- Identifying Groups of Players: direct competitors, potential entrants, substitutes, complements, buyers,
suppliers, other players, existing players vs new/potential players. Some procedural guidelines:
Groups of players must be clearly and consistently labeled from the perspective of the business.
Distinguish within the groups of players: the objective is to pick up variations in the bargaining
power that more aggregated perspectives may obscure.
There is tendency to focus on existing players: try to counteract such biases by explicitly directing
attention toward new or potential players.

4- Understanding Group-Level Bargaining Power: The core objective of attempts to map the business
landscape is understanding group level bargaining power. It is useful to focus on groups/sub-groups that
are able to influence a businesss payoffs: for example, suppliers that hold large percentage of cost
structure, buyers that represent substantial share of market or outlier groups on important structural
dimensions such as the degree of market concentration.
Group-level analysis is driven by the idea that structural analysis can help identify which groups of players
will on average get how much of the economic pie. Extending the analysis to other kinds of players (like
governments or nonprofits) requires some modifications of the analysis as actors now should not be
thought as value maximizers.
Final point: it is now useful to test the emerging understanding of the structural determinants of
profitability against data about the average profitability of different groups of players or patterns in the
decisions that they make. Given the constraints on the information available and the reliance on rules of
thumb, there is always judgment involved in assessing group-level bargaining power and a need for cross-
checking.

5- Thinking Dynamically: The point of the analysis is to understand how the landscape will be. Dynamic
thinking about how the business landscape will change can prove valuable, just as a failure to anticipate
changes in the business landscape can be disastrous. In thinking dynamically, it is useful to distinguish
between different time horizons, especially short run and long run.
Short run: they track phenomena as industry cycles and economy-wide business cycles. Industry cycles are
related to lags in the commercialization of the new generations of products or the installation of new, and
their duration can vary significantly even within the same broad sector. Economy-wide business cycles can
also vary greatly in the extent of their impact on different parts of the economy. The service sector
generally exhibits less sensitivity to such cycles than the manufacturing sector because of the difficulties of
stocking services and their typically lower physical capital requirements. There are also huge variations
within sectors. It is worth understanding two of the ways in which general economic weakness
fundamentally reshapes competitive interactions. First, financial constraints can have effects on product
market competition. Second, the interactions between labor markets and product markets are also of
interest during cyclical downturns because firms often look to reduce labor or at least labor costs at such
times.
Long run: product/industry life cycle based on the idea that opportunities for innovation (product one
especially) are likely to be depleted as an industry matures. Also, focus on long run trends such as market
growth, changes in scale required to compete and in input costs. Some trends emanate from within an
industry and some originate outside.

It is important to understand how general economic weakness fundamentally reshapes strategic options;
also, consider potential for resetting industry structure.
Two models: PEST analysis and Industry life cycle model.

PEST ANALYSIS
Political, Economic, Social and Technological factors.



Political factors: to what degree the government intervenes in the economy.
Economic factors: have major impact on how businesses operate and make decisions.
Social factors: cultural aspects. Trends affect the demand for a companys products and how that company
operates. Companies may vary management strategies to adapt to social trends.
Technological factors: they can determine barriers to entry, minimum efficient production levels and
influence outsourcing decisions. Technological shifts can affect costs, quality, and lead to innovation.

The PEST factors, combined with external environmental factors and internal drivers, can be classified as
opportunities and threats in a SWOT analysis.



INDUSTRY LIFE CYCLE


Concept relating to the different stages an industry will go through. There are typically 5 stages in the
industry life cycle.
Early stages phase: alternative product design and positioning, establishing the range and
boundaries of the industry itself.
Innovation phase: product innovation declines, process innovation begins and a dominant design
will arrive.
Cost or shakeout phase: companies settle on the dominants design; economies of scale are
achieved, forcing smaller players to be acquired or exit altogether. Barriers to entry become very
high, as large-scale consolidation occurs.
Maturity: growth is no longer the main focus, market share and cash flow become the primary
goals of the companies left in space.
Decline: revenues declining, the industry as a whole may be supplanted by a new one.



6- Adapting to/Shaping the Competitive environment: many possible uses of landscape analysis:
Anticipating: Anticipating long-run performance
Adapting: Identifying groups of players/forces that must be countered to achieve good
performance
Testing decisions to enter, invest in, or exit from an industry
Assessing the effects of a major change in the business landscape in order to adapt
Shaping: Identifying ways to shape the business landscape and creating new business models.
(ex. p. 40)
The process of mapping the competitive environment:



Key Terms

buyer power
competitive environment
complementors
cooperation
demand curve
dynamic thinking
entry barriers
extended competition
five forces framework
geographic scope
horizontal scope
industrial organization or IO
industry life-cycle
nonmarket relationships
price-elasticity of demand
rivalry
substitutes
supplier power
supply curve
supply-demand analysis
value net
vertical scope










CASE STUDY IN CLASS





QUESTIONS: 1.Identify key dynamic factors in industry evolution.
2. How did CC address the industry in 1995 and in the 2000s?

DISCUSSION: Applying the PEST Analysis, we notice the influence of the political factor. In 1996, there was
the liberalization of the industry. First it was fragmented, so the market share of each company was really
small. Each market had its own radio station, not too much competition. Also, the technological factor:
digital technology emergence. It allows for economies of scale. Use of technology to change the industry.
Each of the new stations of CC could adapt to the local market and suit its needs.

In terms of Porters forces: the new technology allowed them to create economies of scale. Entry barriers
led to an increase in rivalry but at the same time the first one who could use the opportunity was the first
one to benefit. The combination of DJs and economies of scale allows Brand Identity: this also is a barrier to
entry. So they change the rivalry in the industry and also create barriers to entry.

The situation then changes again in 2000. Once more, technological facto: MP3 makes it easier for
substitutes to emerge. It satisfies the same needs of customers.

In general, by using new technology, CC was able to change the competitive environment.


COMPETITIVE ADVANTAGE AND COMPETITIVE STRATEGIES (CH.3)

Two-Dimensional Landscape: Average Economic Profits of U.S. Industry Groups (19892006)
[Spread between returns on equity and equity cost of capital]



Differences in Competitive Advantage: Average Economic Profits in the Pharmaceutical Industry (1988-
2007)



Competitive advantage

A firm has a competitive advantage over its rivals if it is more profitable, namely if it has driven a wider
wedge between willingness to pay and costs than its competitors have achieved.
There are companies performing well and others badly in terms of profitability. We need to try to
understand how and why different firms from the same industry can get a different profitability. Namely,
strategic groups help explain differences in performance (due to differences in barriers to entry or barriers
to within-industry mobility).
Systematic research confirms within-industry performance differences are widespread and substantial.
Within-industry differences in profitability may be larger than differences in the averages across industries.

Our main questions: How can we explain intra-industry differences in competitive advantage? Which are
the sources of competitive advantage? How firms can access them? Which are the key decisions? Is it
possible to pursue different sources of competitive advantage?

Two approaches for competitive advantage. It depends on:
1. Competitive positioning in industry and strategic group (Porter and other IO scholars, consultants)
2. Resources and distinctive competences (Rummelt and other resource-based view scholars)

Competitive advantages depends on competitive position

The actors in the industry are considered as forces you have to face. You have rivals and the environment is
hard: you will be able to succeed only if you occupy a position you can protect.
A competitive strategy is based on offensive and defensive actions aimed at creating a competitive position
against competitive forces (Porter).

Competitive positioning

Major issues in competitive positioning:
1. competitive cost
2. differentiation
3. cost vs differentiation: youre able to do either one or the other.
4. added value

Michael Hunt (Harvard B-School) 1970s: he was the first one to introduce the strategic group idea that
companies were linked to some dimension. Namely, he grouped industry competitors by broadline or
narrowline strategies and he suggested that competitors within particular industries could be grouped in
terms of their competitive strategies in ways that explain their interactions and relative profitability.
Then, Dan Schendl (Purdue University) explored heterogeneity of competitive positions, strategies, and
performance in brewing and other industries.
Consultants also played a key role in the development of techniques for competitive cost analysis.

Cost Analysis (1)

Acceptance of experience curve in the 60s, strategists turn to cost analysis as the basis for assessing
competitive positions. Then with the declining popularity of the experience curve in the 70s, cost analysis
was reshaped: greater attention for disaggregating businesses and their components as well as assessment
of how costs are shared across businesses AND enriched menu of cost drivers, expanded beyond
experience. The disaggregation of business was motivated by attempts to fix the experience curve as a
consequence of an increase in prices of raw materials in the 70s. The idea was to split costs into the costs of
purchased materials and cost added(=value added profit margins), applying the experience curve only
to the latter category. The next step was to disaggregate the whole businesss entire cost structure into
parts (functions, processes, activities) whose costs might be expected to behave differently. This activity
based analysis also was a way of circumventing the conception of individual businesses built into the
concept of SBUs, which often shared elements of their cost structure with one another.
Consulting firms (McKinsey, Bain & associates) started to emphasize the development of field maps or
matrices that identified shared costs at the level of individual activities that were linked across businesses.
They used concepts developed during previous periods (cost analysis: experience, scope, scale economies
and diseconomies) which became then famous and useful.
In the 70s-80s also a richer menu of cost drivers included scale effects, economies of scope, capacity
utilization effects.

Ex. McKinseys Business System, a template for activity analysis.



Differentiation Analysis (2)

Late 70s: greater attention to customers in the process of analyzing competitive position. Strategists
started to reconsider the idea that attaining low costs and offering customers low prices was always the
best way to compete. Instead they focused more closely on differentiated ways of competing that might let
a business command a price premium by improving customers performance or reducing their other costs.
The idea to use differentiation in a cross-functional competitive context alongside cost levels emerged.
Joe Bains writings involving the concepts of costs and differentiation were used at Harvard for discussions.
McKinsey also applied the distinction between cost and value in its consulting activities.
Porter: 1985, Competitive Advantage: analysis of cost and differentiation via the value chain. {See below
for a focus on the value chain} Resemblance to McKinseys business system, but emphasis on the
importance of regrouping functions into the activities actually performed to produce, market, deliver, and
support products, thinking about linkages among activities, connecting the value chain to the determinants
of its competitive position:
Competitive advantage cannot be understood by looking at a firm as a whole. It stems from the many
discrete activities a firm performs in designing, producing, marketing, delivering, and supporting its
product. Each of these activities can contribute to a firms relative cost position and create a basis for
differentiation. The value chain disaggregates a firm into its strategically relevant activities in order to
understand the behavior of costs and the existing and potential sources of differentiation.

Value chain for an Internet Start-Up:



Advances in integration of cost analysis and differentiation not only disaggregated businesses into activities
but also split customers into segments based on cost-to-serve as well as customer needs and suggested
new way to segment customers. Starting in the late 80s, Bain&Co built a customer retention practice on the
notion that it costs more to capture new customers than to retain existing ones.

Cost Versus Differentiation (3)



Porter and Hall were the first two strategists to talk about cost and differentiation, arguing that a successful
company has to choose to compete either on the basis of low cost or by differentiating products through
quality and performance characteristics. Porter addresses two generic strategies (low cost or
differentiation) and also identified a focus strategy that cut across the two basic generic strategies and
linked these strategy options to his work on industry analysis. Competitive strategies in this framework are
to be considered as alternatives: either one or the other. Positioning can be dome at two levels: addressing
the whole industry or even only one segment. Some companies become leaders even just for a niche (in
terms of either cost or differentiation).

These generic strategies were appealing because:
1. They captured a common tension between cost and differentiation. Firms must incur higher costs
to deliver a product or service for which customers are willing to pay more.
2. Capabilities, organizational structure, corporate culture and leadership style needed to make a low
cost strategy succeed are contrary to those required for differentiation. For internal consistency
and to maintain a single minded purpose, a firm might have to choose to compete either in one
way or the other.
The strategies provoked a debate. There was still the possibility for some firms to have a dual competitive
advantage: interplay between cost and differentiation.



How common are companies with a dual competitive advantage? Porter argues they are rare, typically
based on operational differences across firms that are easily copied. Others think that rejecting the trade-
off cost-differentiation represents a way to transform competition in an industry. The debate still goes on
today.
Another challenge to the generic strategies is that the desire for internal consistency may drive companies
to the extremes of low cost and high differentiation, but external considerations may pull firms back
toward the center. If most customer do not want anything too basic or too elaborated, then the best
strategy would be to offer a product of intermediate quality and cost. (Ex. Zara pg. 51)
Strategists have generally stopped being dogmatic about the generic strategies of any particular stripe.
They embrace the idea that any analysis of competitive position must consider both relative cost and
differentiation and recognize the tension between the two. Positioning is or should be about driving the
largest possible wedge between cost and differentiation. As differentiation rises, so does cost. The largest
gap between the two need not occur at the extremes of low costs or high price premia. The optimal
position represents a choice from a spectrum of trade-offs between cost and differentiation rather than a
choice between mutually exclusive generic strategies. (Ex. pg. 52: Southwest Airlines, Accenture, Cirque du
Soleil)

Cost leadership Strategy

Example: Ford Modello T
In 1908 Ford introduces the T Model using assembly chains and mass production (45.000 cars in 1908- 15
million cars in 1924). It aimed at producing a car that could be accessible for large part of the population as
cars at that time were very expensive. The production system was such that it could provide a car at a very
low cost. The goal was producing more decreasing costs. A huge production plan was created in Ireland.
The production time and costs dropped: indeed, cost of assembly of one car: from 12 hours to 2 hours
and 40 minutes. Prices fell from 700$ a 300$. In 1918 50% of USA cars were Ford T Model.

A typical example of such a strategy is having the capability to create product at lower cost. The basis for
the strategy is an economy of scale (less hours worked with consequent lower costs) and of experience
(fundamental contribution of workers and their expertise). Experience and innovation are considered at the
same time in production; both suppliers and customers are involved in a new way.
So, heavy investments must be made to access experience and scale economies.
Then, the focus is not anymore on the market but on production, more specifically on process innovation,
mainly in assembly line: this increases productivity. Great attention is drawn to costs of different activities.
Measurements and reward systems based on quantity.

Example: Ryanair

ADVANTAGES DISADVANTAGES
Higher profits for the cost-leader
Cost-leader defends better from
competitive forces
Innovation technology may disrupt its
competitive advantage: sometimes
companies too much involved or too
heavily investing in enlarging
size/increasing productivity may lose
perception or control of the market;
Competitors imitate;
Inertial focus on cost and the evolution of
the market: cost leaders most of the times
are not able to understand that the market
is changing and face some problems.



Differentiation Strategy

Differentiation: creation of new products, made unique for some features.

Example (contd): Ford Modello T
From 1919 Fords market share started to decline. In 1908, "Any customer can have a car painted any
colour that he wants so long as it is black: strong idea of standardization, no possibility to have changes on
the product. As people started to buy cars, in the 1920s customers ask for differentiation. Competitors such
as GM and Chrysler understood this need and started producing more innovative and differentiated cars.
Ford had to close some factories. They are examples of differentiation strategy.

Product innovation is different from process innovation: the products need to be changed so customers can
perceive them as unique. Also, if a product is unique, you may be able to sell it at a higher cost. The
attention is now on activities to sustain uniqueness: marketing strategies (promotion, distribution, pricing).
Overall: search for uniqueness, focus on product innovation, great attention to marketing, measurements
and reward systems based on quality.


ADVANTAGES DISADVANTAGES
Higher profits for the firm that
differentiates: increase revenues, reach
high ones;
Firm that differentiates defends better from
competitive forces: strong defense.

Difficult to sustain uniqueness;
Competitors imitate;
Premium-price might become too high for
customers.



Focus strategy

Strategy based on market segmentation. It involves the two main decisions relevant to Porters competitive
strategies framework: the decision to operate on one or a few segments and the decision of the generic
strategy (cost leadership or differentiation).

ADVANTAGES DISADVANTAGES
Difference between prices in the segment
and the whole market may become too
high;
Excessive costs;
The segment disappears or becomes
crowded.



Conditions sustaining in the strategies.

Cost leadership strategy:
Customers are price-sensitive;
Products/services are standardized or poorly differentiable.

Differentiation strategy:
Customers need are heterogeneous;
More technological or/and managerial options exist to differentiate product/service.


A summary of Porters competitive strategies

Again: Tension captured between cost and differentiation. Elements necessary for low-cost strategy to
succeed are contrary to those required for differentiation: capabilities, organizational structure, reward
system, corporate culture, leadership style.
The need for internal consistency: firms must choose to compete one way or the other (again, alternatives).
In organizations:




The debate about the dual-competitive advantage.
External considerations may pull firms back toward the center.
A competitive analysis must consider relative cost and differentiation and must recognize the tension
between the two.
The optimal position implies choice of trade-offs rather than between mutually exclusive competitive
strategies.

Added Value (4)

By Brandenburger and Stuart (mid-1990s). They considered a three-stage vertical chain (suppliers
competitors buyers) and were precise about the monetary quantities of interest. On the demand side,
they mapped differentiation into buyer willingness to pay for products/services. On the supply side, they
used the symmetric notion of opportunity costs (the smallest amount that suppliers would accept for the
services and resources required to produce specific inputs). Given these, the total value created by a
transaction is the difference between the customers willingness to pay and the suppliers opportunity cost.
The division of this value among three levels of the vertical chain is indeterminate. Though, an upper bound
on the value captured by any player is provided by its added value (the maximum value that can be created
by all the participants in the vertical chain minus the maximum value that would be created without that
particular player).
The amount of value that a firm can claim cannot exceed its added value under unrestricted bargaining:
indeed the element influencing more the division of the value created among participants is the actors
bargaining power, responsible for the added value. Assume that a lucky firm does strike a deal that allows it
to capture more than its added value. The value left over for the other participants is then less than the
value that they could generate by arranging a deal among themselves. The remaining participants could
break off and form a separate pact that improves their collective lot. Any deal granting a firm more than its
added value it vulnerable to such breakaway possibilities.
Example HSC pg. 53: graph with willingness to pay and relevant post entry costs.



The concept of added value also helps tie together intra-industry analysis of competitive advantage and
industry-level analysis of average profitability. In an industry with unattractive structure, competitors
added values tend to be low, with exceptions arising only in the case of firm that have managed to create
competitive advantages for themselves (that is, driven bigger wedges than most of their competitors
between buyers willingness to pay and costs. In an attractive industry, a firm may expect to do better than
its competitive advantage alone would guarantee, through two mechanisms:
1. The added values of individual competitors tend to be large than their competitive advantages in
such industry environments.
2. Some industries seems to make it feasible for competitors to engage in recognition of mutual
dependence/tacit collusion.

In general, if the company is strong and willing to play its power, it might be able to have a very large value.
If it is too high though, the situation wont be stable: suppliers or buyers will disintermediate the company.
The advantage could be reduced and the company could suffer.

A FOCUS ON The value chain: A model to analyze value

Used to describe value a company has. It usually focuses on activities that are contributing directly or
indirectly to the creation of value.
Michael Porters Competitive Advantage (1985): analyzed cost and differentiation via the value chain;
regrouped functions into activities performed; recognized linkages among activities; connected the value
chain to the determinants of competitive position. We see how every activity is contributing to
differentiation.



Margin: value added that the company is able to access and is influenced by the bargaining power of a
company.

Primary activities

Directly and tangibly contribute to creation of value.
Inbound logistic: any activity involving inputs
Operations: any transformation of inputs in outputs
Outbound logistics: any activity involving output
Marketing: marketing planning, distribution, promotion, price definition..
Services

Support activities

Not contributing directly but useful to sustain other activities.
Procurement
Technology development
Human resource management.
Infrastructure

Value chains depend on: industry, business model, history of the firm.
How to identify activities: Technological and economic basis; Capability to impact on present and potential
differentiation; Represent present or potential, high portion of cost.

Example: (Again) Value Chain for Internet Start-Up



How do we use the value chain to create value?
Optimizing individual activities;
Optimizing linkages among activities;
Optimizing linkages with activities of the value chains of suppliers, customers, competitors,
complementors.

Example: Logistics Optimization in Benetton.
Large investments in automation of inbound and outbound logistic from the management of orders to the
packaging to the delivery system to the shops.
In 1996 the new system eliminates fragmentation : three sorting centers (US, Italy and Far East).
The automatic distribution system handles over 40,000 packages a day and is managed by a 10-member
staff, rather than a traditional system that requires a staff of 400.
These new automated systems have improved the efficiency and speed of customer service, and reduced
transport costs by more than 10 billion lire in 1996.

Example: Sony and Walkman.
In 1979 the Walkman was introduced in Japan . Sony sold 220 million of Walkman, of which 150 million in
USA. Sony stopped producing and distributing the Walkman in 2010. Sony defined it as the product of
the century .

Optimizing linkages among activities in Sony.

This represents overlapping phases of development.

Optimizing linkages with activities of the value chains of customers: development of key product functions
for the customer and co-definition of critical parameters.



That is: A company that is producing packaging machinery for some key producers. This company has to
create products that fit to requirements of that particular company, based on the requirements. Example of
how a company of this kind tries to relate its marketing and sales (part responsible for contact with
customers with the production of the object. Strong interaction. Technological background, interface with
the customers. The two responsible for production and customer interact and codify the parameter of the
new machinery, effort to identify the key characteristics of the machine.



Optimizing linkages with activities of the value chains of customers can be done through problem solving,
emergency repairing, producer as resident for new machineries, training of customers technicians and
direct Hot lines.


The value system
Definition: the network of suppliers and customers of the firm whose activities are linked to the firms value
chain.


Value creation depends on the linkages among the activities of different value chains of suppliers,
customers, competitors and complementors of the firm.



Example: Benetton vs Inditex Zara



From competitive positioning to strategic planning and action: a process for analysis

Now we need a process to link such concepts to strategic planning and action. Question: How can
managers identify opportunities to raise willingness to pay by more than costs or drive down costs without
sacrificing too much willingness to pay?
Strategists analyzing competitive advantage usually break a firm down into discrete activities or processes
and then examine how each contributes to the firms relative cost position or comparative willingness to
pay. The activities undertaken are what actually incur costs and generate buyers willingness to pay.
Differences across activities (in what firms do on a day-to-day basis) produce disparities in cost and
willingness to pay and hence dictate its added value. By analyzing a firm activity managers can understand
why the firm does or does not have added value, spot opportunities to improve its added value and foresee
likely shifts in its added value.
Starting point of the analysis: catalog a businesss activities into a limited number of economically
significant categories that a business performs (using for example Porters value chain). Generic templates
are helpful but cannot be used blindly as not all of the activities they identify will be relevant in any given
situation and data often come prepackaged so as to favor a particular way of cataloging activities.
The rest of the analysis is divided in three steps:
[To illustrate their application, the example is: snack cake market in western part of Canada. Little Debbie
grew its market share from 1 to 20%. Hostess from 45 to 25%.]

1. Using activities to Analyze Relative Costs. how and why costs differ from the competition.
Managers examine the costs associated with each activity to understand how and why their costs
differ from those of competitors.
In a pure commodity business, customers refuse to pay a premium for any product. So a low cost
position is the key to added value and competitive advantage. Even in industries that are not pure
commodities, differences in cost often exert a large influence on differences in profitability.

Hostess: managers struggled to understand why their financial performance was poor. They
cataloged the elements of their value chain and calculated the costs associated with each class of
activities. The remaining profit was really low. Hostesss cost components in sub-activities:



After calculating this, the managers determined the set of cost drivers associated with each activity
(the factors that increase or decrease the cost of any activity).
Examples: the larger the share, the greater the number of cakes delivered per stop; urban
deliveries more expensive; the larger the share, the lower outbound logistics costs; the higher the
variety, the higher outbound logistics costs; the nature of the product affected inbound logistics.
Managers developed numerical relationships between activity costs and drivers for outbound
logistics activities and for the others.
Little Debbie: advantage on raw materials, scale economies, operation costs.

In general, step 1 implies analyzing cost component in sub-activities and compare present costs
with opportunity- costs of suppliers. Even if it is difficult to observe competitors costs, studying
cost drivers is critical, as you can indirectly study their costs through cost drivers.

Managers performed a relative cost analysis:


Some general points on relative cost analysis:
Managers examine actual costs (more concrete and available data) rather than opportunity
costs. They are usually assumer to track on another closely.
When reviewing cost analysis: important to focus on differences in individual activities and
not only in total costs.
Good cost analyses typically focus on a subset of a firms activities. Effective ones break out
in greatest detail and pay attention to cost categories that pick up on significant differences
across competitors or strategic options, that correspond to technically separable activities
and are large enough to influence the overall cost position to a significant extent.
Activities that account for a larger proportion of costs deserve more in-depth treatment in
terms of cost drivers (focus on the ones with major impact).
A cost driver should be modeled only if its likely to vary across the competitors or in terms
of the strategic options that will be considered.
Sensitivity analysis is crucial: it identifies which assumptions really matter and therefore
need to be honed. It also tells the analyst how much confidence to have in the results.

The catalog of potential drivers includes size, location, functional policies, timing, institutional
factors, resources .

Pitfalls of cost analysis:
Many firms have inadequate costing systems, as they may overemphasize manufacturing
costs or poorly allocate overhead and other indirect costs: costing systems should be
cleaned up before being used as a reference point for estimating competitors costs.
Firms have a tendency to compare costs as a percentage of sales rather than in absolute
terms: this mixes up cost and price differences.
Some firms mix together recurring costs and one-time investments.

Overall, a focus on costs should not crowd out consideration of customer willingness to pay.

The catalog of potential drivers includes size of the firm, differences in location, functional policies, timing,
institutional factors, resources

2. Using activities to Analyze Relative Willingness to Pay more or less for the goods or services of
rivals.
Managers analyze how each activity generates customer willingness to pay, studying differences in
activities to see how and why customers are willing to pay more for the goods or services of rivals.
The activities of a firm do not just generate costs, but also make customers willing to pay for the
firms product or service. Differences in activities = differences in willingness to pay = differences in
added value and profitability. Those account for more of the variation in profitability observed
among competitors than do disparities in cost levels.
Any activity in the value chain can affect customers willingness to pay for a product. Most obvious:
product design, manufacturing activities for product characteristics (quality, performance,
aesthetics). Characteristics from sales and delivery activities: ease of purchase, speed of delivery,
availability, terms of credit, convenience, quality of presale advice. Other activities associated with
post sale service or complementary goods matter, as well as support activities.
A company lack a precise willingness to pay calculator: willingness to pay depends on intangible
factors and perception that are hard to measure. Also, when a company sells products through
intermediaries and not directly, its still harder. Managers need to use simplified methods. Typical
procedure:
A. Think carefully about who the real buyer is: tricky determination.
B. Understand what the buyers want. Question: Who is the real customer? It may be a
distributor, a simple user or a final decision maker. It is important also to understand what
customers are willing to pay for. This step should reveal the needs that are most important
to consumers and determine how they trade them off.
C. Assess how successful the firm and its competitors are at fulfilling customer needs.
Little Debbie: stands out on attribute that customers value highly (low price)
Hostess: not superior on any of customer needs.
The relative success in satisfying customer needs for the industry:



D. Relate differences in success in meeting customer needs back to company activities.
At this point managers should have an idea of how activities translate into willingness to
pay throughout customer needs. They also should know how activities alter costs and are
prepared to take the final step: analysis of different strategic options.

Major challenge in analyzing willingness to pay: narrowing the long list of customer needs down to
a manageable roster. We can ignore needs with little bearing on customer choice, as well as need
equally well satisfied by all current and contemplated products.
So far we have treated customers as identical. In reality customers may differ.
Some definitions:
Horizontal differentiation: disparity in which different customers rank products differently.
Vertical differentiation: arises when customers agree on which product is better, but differ in how
much they will pay for the better product.
Segmentation: identify clusters of customers who share preferences and then analyze willingness
to pay on a segment-by-segment basis.
Mass customization: companies tailor their products to individual customers.

Limits to analyzing willingness to pay: quantifying willingness to pay precisely is difficult especially
when buyer choice includes a large subjective component, when customer preferences are evolving
rapidly and when product benefits are hard to quantify.
Market research techniques (surveys, hedonic pricing, attribute ratings) have been designed to
overcome such problems.

3. Exploring strategic options and choices identify changes that will widen the wedge between
costs and willingness to pay.
Managers consider changes in the firms activities with the objective of identifying changes that will
widen the wedge between costs and willingness to pay.
Final step in the analysis: search for ways to widen the wedge between cost and willingness.
Management researches how changes in activities will affect added value. Goal: finding favorable
options.
A few patterns from past experience suggest guidelines:
Question: What drives each competitor?
Question: Which are the competitor reactions?
A firm needs to avoid narrow focus. This is done looking for optimization of activities and
linkages within the value chain and within the chains

of the firms network and
remembering that changes in the scope of the business and of business model might be
valuable options.
In rapidly developing markets it is often valuable to pay attention to leading edge
customers if their demands anticipate the needs of broader market.
Adjusting the scope of its operations is one of the best ways for a firm to alter its added
value. Broad scope in industry: advantageous when significant economies of scale, scope
and learning, when customer needs are uniform across market segments and when it is
possible to charge different prices in different segments. Broader is not always better.
Our process goes from development of a comprehensive grasp of how activities affect costs
and willingness to pay and then consider options to widen the wedge between the two. In
practice, it is more efficient to reverse the process through reverse-engineering.

Key Terms
added value
choice
competitive advantage
competitive position
cost analysis
cost drivers
differentiation
dual competitive advantage
focus strategy
Generic/competitive strategies
horizontal differentiation
opportunity costs
resources
segmentation
strategic options
trade-offs
value chain
Value system
vertical differentiation
willingness to pay

TOYOTA CASE


QUESTIONS:
1.Which is Toyota competitive strategy?
Not a focus strategy. They address a really large number of segments. (Ex. Ferrari is addressing a focused
segments). They recognize that the market is made of different segments where customers within
segments have the same needs in terms of some of the factors they are stressing. They see the market is
highly differentiated and they develop cars addressing them to subsegments belonging to the same
category.
Are they pursuing differentiation or cost leadership? Both. They try to follow different willingness to pay of
the customers with each product. To be competitive in such an industry, you need to be able to work on
both sides.
2.How does it create value?
3.What does its added value depend on? Definition of added value. Value chain.



ANTICIPATING COMPETITIVE DYNAMICS (CH.4)

Historical antecedents:
Know your enemy, know yourself, and you can fight a hundred battles with no danger of defeat. When
you are ignorant of the enemy but know yourself, your chances of winning and losing are equal. If you dont
know your enemy or yourself, you are bound to perish in all battles. Sun Tzu, The Art of War.
Mapping the business landscape and pursuing a peak or advantaged position on it are necessary but not
sufficient for business success over time. A firm needs to recognize that competitors may try to maximize
their own payoffs (as it does) and that players try to improve their own positions. The new challenge:
anticipating important interactions with all these types of players.
7075 percent consider competitors in making product and pricing decisions, but only 8 percent think
through future competitive behavior in the context of product introductions and 15 percent in the context
of price changes. Strategists must anticipate interactions with buyers, suppliers, complementors and
substitutes, as well as with direct competitors striving to improve their own positions.
Question: Which are the tools to anticipate interactions with direct competitors?
Anticipating Competitive Dynamics means using detailed information about players to forecast what they
will do and to prevent moves that harm ones interests while promoting those that help.
Two broad complementary approaches to competitive dynamics:
1. Game theory: economics perspective, focus on incentives under conditions of competition and
on what competitors should do under some (reasonable) baseline assumptions. What would
they rationally do if..?
2. Competitor profiling: identifies competitors predispositions, with a strong assumption of
bounded rationality. What do they really want?

Games

Game theory is the study of interactions among players whose payoffs depend on one anothers choice and
who recognize the interdependence in trying to maximize their respective payoffs.
Coalitional/Cooperative game theory was formalized in 1944 by Neumann and Morgenstern, who also
advanced the analysis of strategic/non-cooperative game theory (the theory of moves, two-person zero-
sum games in which one players gain is exactly equal to the other players loss. A few games though seem
to be zero sum ones: focus on nonconstant-sum games that afford opportunities for cooperation as well as
competition. In 1950-51 Nash published papers proving the existence of a strategic equilibrium for non-
cooperative games (Nash equilibrium) and proposed that cooperative games be studied by reducing the to
the non-cooperative form.

Simultaneous game: A simultaneous game is one in which all players make decisions (or select a strategy)
without knowledge of the strategies that are being chosen by other players. Even though the decisions may
be made at different points in time, the game is simultaneous because each player has no information
about the decisions of others; thus, it is as if the decision are made simultaneously. Simultaneous games
are represented by the normal form and solved using the concept of a Nash equilibrium. (Ex. rock-paper-
scissors, Chinese Morra and closed auctions)

Sequential (or dynamic): Card games, Chess, war games, auctions open to sequential bids.

Simple Games

Game Theory: the study of interactions among players whose payoffs depend on one others choices, and
who recognize the interdependence in trying to maximize their respective payoffs.
So, rational players maximize payoffs and there is perfect information on choices and payoffs.
The structure: 3 steps.
Step 1: identify the players
Step 2: specify possible actions (strategies) of both players
Step 3: payoffs assigned to different combination strategies for players The payoff matrix.
Rule definition: Players simultaneously and independently chose strategies.

The prisoners dilemma
Two are suspected of murder, they are examined separately. Possible actions: Betray and do not betray.
Payoffs: set by the police: arrested with a partial or a full punishment.



The solution to a simple game is to identify dominated strategies: they do not maximize their payoffs,
independently from the knowledge of other player action. Iterated elimination of dominated strategies.
Then there is the choice of the dominant strategy, i.e. the strategy that maximize payoff, independently
from the knowledge of other players action.
Nash equilibrium: when there is a strategy pair, one for each player and neither player has an incentive to
deviate unilaterally.

The pharmaceutical case study
I: Incumbent. One of its products dominated its category but faced the introduction of a substitute product.
E: Entrant. As later mover, E was expected to launch the product at large discount. It was uncertain how
low price E would be and whether I should reduce price I in anticipation or reaction. Careful analysis of the
options.
1. Specification of the players in the game: I and E. Total of 5 players including them, but two were
excluded as they were marginal players without a discernible impact on market outcomes and a
third one as well because it had unique product characteristics so it insulated it from any
interaction. The point: sometimes the number of players can be reduced by aggregating players
with similar economics and objectives.
2. Specification of possible actions of both players: their strategies. Four strategies involving different
levels of discounting for Es launch price and four strategies for Is own relative price. The latter
were bounded by the alternatives of holding Is price constant and neutralizing Es price advantage.
3. Payoffs assigned to different combinations of strategies for I and E. This involves assessing the
players objectives: does E want to maximize its profits or grow and gain market share? (E was
deemed to be a profit maximizer). Then, players objectives mapped into numerical payoffs
associated with each outcome from each players perspective. NPVs calculated for the two
products of the two players with estimates of Es costs and knowledge of Is.
Since only two players, all captured in a payoff matrix. With this representation, firms select
strategies and not individual outcomes. The payoff matrix captures the dependence of each firms
payoff on its rivals strategy as well as its own.


4. Use of the payoff matrix to derive strategic recommendations required additional specification of
the rules of the game: critical timing of moves. Simultaneous moves assumed: I and E would
simultaneously and independently choose their pricing strategies.
I thought about strategies before E entered the market. The payoff matrix raises questions about
the business plan I had in place, which assumed E would launch with a high price and that I would
not change its price at all [NO PRICE CHANGE-HIGH]. This base case though was unlikely to
materialize: if E launched with a high price, leaving the price unchanged was not a best response
for I. I could achieve more neutralizing Es advantage [NEUTRALIZATION-HIGH]. Same for E, with
incentive to charge a very low price [NO PRICE CHANGE-VERY LOW]. Neither firm would actually be
using its best response, so the base case is an implausible outcome.
The game theoretic idea of eliminating dominated strategies (strategies that do not maximize
payoffs for one player no matter what the other player does) is used to further narrow possible
outcomes. Charging a high price is a dominated strategy for E (E would do always better by setting
a moderate one no matter what I does). All outcomes with E-HIGH eliminated.
The idea of iterated elimination of dominated strategies used: Is dominant strategy became
leaving E a small price advantage regardless of Es choice among three remaining. Everything
eliminated but first three cells in third row.
Another round of iterated elimination of dominated strategies, Es perspective this time, led to a
Nash Equilibrium: a strategy pair, one for each player, from which neither player had an incentive
to deviate unilaterally.
Is managers began to explore whether they could make a credible pre-commitment to a relative
pricing strategy for their product before E committed to a particular launch price. If feasible, this
would change the rules of the game from simultaneous moves to sequential moves, with I
becoming the first mover. The commitment could convince E to launch with a low price rather than
a very low one, increasing Is payoffs. If E entered with a medium price, Is payoffs would increase
even more.

Broad contribution of game theory to business strategy: game theory forced Is managers to think
about the launch price that would maximize Es profits (Es best response) instead of fixating on the
high price that they would have liked to see E set. E also had to recognize that I could have reacted
to its entry and not just leave its price unchanged. Each firm had to derive a reaction function
identifying its rivals best responses to different pricing choices that it might take.

Dynamic games

Strategic decision making takes place over time, not once for all time. Game theory does the same: study of
strategic interactions over time, as dynamic games with multiple moves over time, as uncertainty about
competitor behavior or other elements of the environment is progressively resolved. Dynamic extension to
more explicit dynamic competitive interactions is essential to study timing advantages, credible threats and
promises and the implications of commitment or irreversibility for strategy.

When players interact by playing a similar stage game numerous times, the game is called a dynamic, or
repeated game. Unlike simultaneous games, players have at least some information about the strategies
chosen by others and thus may contingent their play on past moves. It is possible to change rules of a
simultaneous game to transform it in a repeated game (for example, credible pre-commitments to a
strategy can be used). Dynamic games can be adapted to different situations by varying assumptions and
rules and allowing for uncertainty.

Steps in dynamic games. (Example: Sirius and XM Radio pg. 7378)
1. Structuring the game;
2. Estimating payoffs;
3. Solving the game: Equilibrium;
4. Leveraging the game (varying the assumptions, reasoning further back, changing the game,
allowing for uncertainty).

Competitor Profiling

Relax assumptions about competitors: they may not be out to maximize value, or they may hold different
beliefs about the (shifting) competitive environment and their behavior may reflect more inertia than
purposeful choice. The main questions: What do competitors really want? How do they believe to be
pursuing their goals? What have they tended to do historically?
The framework used for the analysis of competitor profiling is the goals-beliefs-routines one: all the aspects
of competitors involved are in-depth examined.



Goals: different firms may have different goals. Some may be profit maximizing, some others may just want
to gain acceptance when entering a market. The importance of thinking about goals of competitors is
directly related to the scope for deliberate departures from firm value maximization. Such departures may
reflect some characteristics of organizations. Taking into consideration different kinds of ownership, a firm
may be public (on stock market: short term aim, firm must meet some goals in terms of profits because the
market requires it to do that) or private (it may pursue an aim to get even very low profits if the firm is
willing to gain something else); the organizations charter: profit or non-profit maximizing (with social
aims); family owned or state owned. Also governance needs to be taken into account: for example, for the
role of managers when there are agency problems. Top managers tend to be the ones who matter the most
in determining the direction of the departure from firm value maximization. Their motivations are often
complex (self-serving behavior, etc). At the organizational level instead, attention is paid to a corporations
desired portfolio of businesses/segments, to competitive position, other operating goals and its financial
target.

Beliefs: need to think through competitors beliefs, those of managers and people taking decisions for the
company. There may be difficulties in understanding competitors. The importance of thinking about beliefs
rest on room to see the world in different ways because of either the inherent ambiguity of a situation or
embedded beliefs, so deeply held that they do not change much with new information. Also it is useful to
synthetize differences in beliefs into different mental models.
One way to access beliefs of competitors is to use statements and history of top management and the way
they address issues in the industry (for example, introductory speech in the balance statement): they are a
very good pool in which to fish for insights into beliefs as well as to seek to pin down overall mental
models.

Routines: the need to think through competitors routines is contingent to the possibility that the
competitors behavior may not be entirely purposeful even in relation to its true goals and beliefs.
Selznicks analysis: commitments to ways of acting and responding are built into the organization, that is
organizations exhibit inertial tendencies. The precise mechanism underlying inertia are diverse,
encompassing not only the active routines by Selznick but also passivity/inactivity and systematic individual
and group-level biases that are observed even when choices are made mindfully. These mechanisms make
the broader point that looking at behavior in the past may allow the identification of a pattern repeated
over time, allowing a possible prediction of future behavior. It is also important to identify blind spots, area
that competitors tend not to see or not to cover.

Ways to grasp the overall goals-beliefs-routines framework and the individual elements:
Applying it to an organization that you have worked for or know well.
Use a detailed example to illustrate the application of the framework (Accentures India Strategy
pg. 81-82-83)

Example: 1960s in UK and USA
The success of Honda, Suzuki and Yamaha was positive for us. Customers start buying one of these
Japanese low price scraps. They start enjoying streets and open air and end buying one of our more
expensive and powerful motorcycles. (Eric Turner, president BSA)
Ultimately we do not believe in low-powered motorcycles. We think that motorcycles are high speed
vehicles, not transport vehicles. Who bought a motorcycle as a transport vehicle, uses it for leisure. A low-
powered motorcycle is only supplementary. In the past, during the first war period, some firms started
producing these motorcycles. We too had a model. We had a new one in 1947, but it was a flop. We know
what happens with these small motorbikes. (William Davidson, president Harley Davidson)

Conclusion

Game theory assumes:
symmetric value-maximization;
similar beliefs about how the industry is developing and how the landscape should be addressed;
zero inertia or routinized behavior;
Competitor profiling relaxes assumptions about competitors:
What competitors really want;
How they believe to be pursuing their goals;
What they have tended to do historically.

But how should we think about the relationship between game-theoretic effects and the kinds of
considerations flagged by competitor profiling? Use analysis and practice as complementary: possibility to
combine them.
The broader assumptions about goals, beliefs and routines can be accommodated within the formal
structure of game theory: there is no fundamental incompatibility.
Routines can be embedded into game theory with game-theoretic models in the form of preprogrammed
behavior in certain situations or by certain types of players (ex. focus of considerable research in
evolutionary game theory). Predictive power wont go down if two frameworks are considered rather than
one: this is the logic behind integrating insights from game theory and competitor profiling.
How is integrations achieved? It is possible to bring considerations to a common denominator and things
will remain simple if the framework point in the same direction.
The kind of integration that is most important is not between different types of analysis but between
analysis and action.


The analytical Process

Step 1: Start with the decision at stake then identify the players whose actions/reactions matter for the
local firms payoffs.
Step 2: understand other players objectives and beliefs then explore what they are likely to do or not do
on past form.
Step 3: Choose the best of ones own strategic options based on predictions about where things are likely
to settle down given these assessments of competitors actions/reactions.

Classical game theory presupposes a closed world in which it is possible to prepare a complete list of
possible states, strategies, probabilities and payoffs and to rule out unforeseen contingencies. The real
world though is open: too complex to consider exhaustively. This gives room to creativity when coming up
with strategic options and applying a broader range of models of analysis to them.

Principles

1. Think broadly about the set of strategic options.
In an open world, being creative in coming up with strategic options to be evaluated is often a
premium. Creativity can never completely be systematized, but both game theoretic thinking
and competitor profiling can help enrich the set of strategic options considered.
Variables: very broad array of variables.
Asymmetries: Game theory identifies effects of various asymmetries (leaders vs
followers, incumbent vs entrants) on interactions across a broad array of variables. It
may help surface non obvious options for developing or unwinding such asymmetries.
Commitment postures: In addition to emphasizing long-run commitments or choices
about variables, game theory offers various types of commitment postures. There
generic postures can be helpful in devising new strategic options and so can the
underlying distinction between strategic substitutes (for which the best response to
more aggressive play by one player is less aggressive play by its rivals) and strategic
complements (for which aggression is met with aggression).
Information: in addition to recognizing the possibility of asymmetric information, game
theory puts emphasis on bluffs, feints and strategic misinterpretations or concealment
of information.

An in depth analysis would highlight additional variables that the competitors is leveraging that the
company doing the analysis is not. It can shed more light on critical asymmetries: both where the
competitor is vulnerable or sensitive (loose bricks) and where it is strong (foundations). This would help the
articulation and evaluation of a range of commitment postures.

Competitor profiling also can trigger new thinking by challenging the information or mental model of the
company doing the analysis. It can be helpful to commission a competitor profile of ones own company
from the outside.
Game theory and competitors profiling are not the only ways of enriching the set of options considered.
Others: scope changes, shifts in perspective, organizational enablers.

2. Augment the toolkit for dynamic analysis.
In a complex open world, it makes sense to supplement the frameworks with insights from
other tools for dynamic analysis. A specific line of development is the scenario analysis, which
uses structural reasoning to build distinct but internally consistent representations of the
future of an industry. Simulation represents a tried and tested technique for dynamic analysis
about which there seems to be some more fresh excitement.
Wargaming and roleplaying are another established approach to sorting through competitive
dynamics, less structured than simulations and in which unforeseen contingencies and actions
represent a real possibility as a result. This approach spans a number of sub-approaches
arrayed in terms of the extent to which they incorporate the specifics of the situation into
which insights is being sought.
There is the possibility of market testing, taking actions in the real world, as opposed to in
some simplified representation of it, in order to generate real data. When implementation is
staggered or sequenced, there is the possibility to learn about competitive dynamics by looking
at the pattern of actions and responses in the first few submarkets entered and making
adjustments in the course of a sequenced rollout. On the other hand, learning by doing of this
sort is costly, both in direct operating terms and in terms of what it may disclose about ones
own plans.
To sum up: moving from scenario analysis to wargaming and roleplaying we move from
relatively schematic modes of learning to more realistic ones and from offline/off-the-shelf
modes of learning to online/experiential learning.

3. Match the analytics to the industry and company context.
The first two principle suggested sources of new ideas and additional tools for dynamic
analysis. Given the risk of analysis-paralysis , one must be able to narrow down possibilities.
This principle emphasizes ways of doing so by matching analytics with the company context.
Precise conclusions from model of interactions depend on and are sensitive to the details of
the context. Matching also helps build a bridge between analysis and action.
Question: If game theory and the other tools are so potentially valuable, why havent they
caught on more quickly? Three reasons:
1) The S-shaped curve for diffusion of new ideas and product substitution is known for long,
slow take-offs. Even simpler tools widely diffused took decades to move from classroom to
the executive suite.
2) Several dynamics favor the diffusion of dynamic tools.
3) A fundamental force for the diffusion of dynamic tools is related to the observation that
thinking through actions and responses is, in a sense, a dominant strategy. As more
competitors apply such tools to strategy, not doing so may become even more consistently.