Business Strategy Analysis Skill

Industry Analysis

• Step 1: Complete Five Forces Analysis• Step 2: Identify All the Major Competitors

in the Industry• Step 3: Map the Strategic Group

New Entrants

Industry CompetitorsSuppliers Buyers

Substitutes

Threat of New Entrants

Threat of Substitutes

Bargaining Power of Suppliers Bargaining Power of Buyers

Porter’s Five Forces ModelStep 1

New Entrants

Industry CompetitorsSuppliers Buyers

Substitutes

Threat of New Entrants

Threat of Substitutes

Bargaining Power of Suppliers Bargaining Power of Buyers

Entry Barriers1.Economics of scale2.Proprietary product differences3.Brand identity4.Switching costs5.Capital requirements6.Access to distribution7.Absolute cost advantage

• Proprietary learning curve• Access to necessary inputs• Proprietary low-cost product design

8.Government policy9.Expected retaliation

New Entrants

Industry CompetitorsSuppliers Buyers

Substitutes

Threat of New Entrants

Threat of Substitutes

Bargaining Power of Suppliers Bargaining Power of Buyers

Rivalry Determinants1. Industry growth2. Cost structure3. Intermittent overcapacity4. Product differences5. Brand identity6. Switching costs7. Concentration and balance8. Informational complexity9. Diversity of competitors10. Corporate stakes11. Exit barriers

New Entrants

Industry CompetitorsSuppliers Buyers

Substitutes

Threat of New Entrants

Threat of Substitutes

Bargaining Power of Suppliers Bargaining Power of Buyers

Determinants of Supplier Power1.Differentiation of inputs2.Switching costs of suppliers and firms3.Presence of substitute inputs4.Supplier concentration5.Importance of volume to supplier6.Cost relative to total purchase in the industry7.Impact of inputs on cost8.Threat of forward integration

New Entrants

Industry CompetitorsSuppliers Buyers

Substitutes

Threat of New Entrants

Threat of Substitutes

Bargaining Power of Suppliers Bargaining Power of Buyers

Determinants of Substitution Threat1.Relative price performance of substitutes2.Switching costs3.Buyer propensity to substitute

New Entrants

Industry CompetitorsSuppliers Buyers

Substitutes

Threat of New Entrants

Threat of Substitutes

Bargaining Power of Suppliers Bargaining Power of Buyers

Determinants of Buyer Power1.Bargaining Leverage

• Buyer concentration vs. firm concentration

• Buyer volume• Buyer switching costs relative to

firm switching cost• Buyer information• Ability to backward integrate• Substitute product• Pull-through

Determinants of Buyer Power1.Price Sensitivity

• Price/total purchases• Product differences• Brand identity• Impact on quality/performance• Buyer profits• Decision maker’s incentive

Step 2

Identify all of major competitors in the industry based on competitive variables.Following variables could be used to identify competitors.•Specialization•Brand identification•Push vs. pull•Channel selection•Product quality•Technological leadership•Vertical integration•Cost position•Service•Price policy•Leverage•Relationship with parent company•Relationship to home and local government

Strategic Dimension Ethical Drug Makers Over-The-Counter Generic Brand

Proprietary technology Yes Some licensing None

Capital intensity Highest Moderate Moderate/Low

Level of innovation High Moderate Low

R&D capacity Advanced Low Very Low

% of products needed prescription

High Low Moderate

Consumer advertising Low High Low

Distribution Doctor-Direct medical channel

Drug stores/Discount retailers

Pharmacies

Timing of entry First Second Third

Cost structure High Moderate Low

Application of Strategic Group in the Pharmaceutical Drug Industry

Step 3

Over-the-Counter

Drug makers

Ethical Pharmaceutical

Companies

Generic Drug

Companies

High

Low

% of Products Require ring Prescription

LowHigh

Blindspot Analysis• Blindspot analysis examines the underlying

reasons for inaccuracies or flaws in the business strategy.

• Seven Common Sources of Blindspots– Invalid Assumption– Winner’s Curve/Hubris Hypothesis– Escalating Commitment– Constrained Perspective/Limited Frame of Reference– Overconfidence– Representativeness Heuristic/Reasoning by Analogy– Informational Filtering

Invalid Assumption• Blindspots are caused by faulty assumptions. There are three types of

dangerous assumptions that take root inside of firms, with disastrous effects on competitive position.

• The first type is termed an unchallenged assumption that is basically an incorrect assumption about diverse elements in the firm's competitive environment. Unchallenged assumptions may include invalid assumptions that the firm holds about its competitors, customers, suppliers, or any other member of the firm's value chain. They are presumed to be valid by default because no one in the firm challenges them.

• The second type of flawed assumption is referred to as a corporate myth, which is an incorrect assumption about the firm's competitive capabilities. Often, these types of assumptions cloud internal scrutiny by completely disengaging internal analysis from any relevance to the realities of the film's competitive environment.

• The third type of invalid assumption is the corporate taboo. Corporate taboos are those untouchable assumptions that are regarded as sacred cows within the firm's organizational culture. These flawed assumptions manage to escape most challenges. Often, this type of blindspot is rooted in the strongly held convictions of senior management.

Invalid Assumption• Apple Co. Case• In 1983, Apple recruited a former top executive from Pepsi

who immediately transferred his tried-and-true strategy of premium pricing to Apple's strategy. The expected high margins were planned for reinvestment into R&D and advertising. Unfortunately, these high margins never materialized, as customers preferred lower-cost IBM and PC-based machines. It wasn't until IBM developed a low-cost alternative that exceeded Apple's technological superiority that the new CEO decided to abandon his pet strategy of premium pricing that had worked so well at Pepsi. Despite persistent challenges by Apple sales staff to reduce prices, this corporate taboo of premium pricing was not relinquished until severe damage to Apple's competitive position forced a strategic change.

Winner’s Curve/Hubris Hypothesis• Often, the winner in a bidding auction will unsuspectingly pay too

much. Sellers know the true economic value of the item and, in the absence of pressure, generally won't sell below this amount. In their keenness to acquire, the winning bidders will be the ones who have recognized an unrealistically optimistic value to the bid item. The strategic implications of the winner's curse do much to explain the persistence of unprofitable acquisitions. Without foreknowledge and explicit recognition of the winner's curse, decision makers will tend to overpay for things such as patents, companies, or personnel, resulting in profitless acquisitions that fail to yield expected returns.

• The winner's curse has been extended to the common scenario where firms also "overpay" for other strategic goals such as capacity expansion, market share, and new business entry. In these contexts, the winner's curse often shadows successful firms by eventually causing their downfall. That is, it is more common to see firms in the top tier of their industry lose competitive position rather than maintain it for long periods of time.

Escalating Commitment• Resource investments will yield negative return either

because the initial analysis was flawed, the competitive environment has changed, or internal capabilities have eroded. Three rational responses to this common scenario would dictate retrenchment, a change in strategy, or intensified resource allocation. The observed result, however, shows a disproportionate bias for the latter; strategic decision makers exhibit a strong tendency to intensify resource investment in the hopes of averting strategic disaster. Ironically, this behavior of throwing good money after bad often precipitates further losses and eventual policy failure. This phenomenon is termed the escalating commitment to a losing course of action and is one of the leading causes of blindspots in competitive analysis and strategic decision making.

Constrained Perspective/Limited Frame of Reference

• In contrast, prospect theory challenges the traditional explanation of escalating commitment to a course of action. Prospect theory suggests a reason why decision makers often display irrational behavior toward risk, often leading to an escalating commitment to a course of action.

• Another common source of the limited frame problem concerns the fact that decision makers, quite naturally, will often look at a strategic challenge only from the firm's perspective. That is, they may operate from a limited frame of reference that only considers the strategic implications for their firm. Innovative strategies, however, often require an explicit consideration of the strategies of rivals. This has always been true of traditional competitive analysis. It is also becoming increasingly vital in the era of cooperation and alliance building that requires an explicit knowledge and perspective of competitor strategies. Without broadening the frame of reference, the firm is at risk of being taken by rivals in the race to secure competitive advantage through cooperation with other firms in the industry value chain.

Overconfident• Many managers are overconfident of the knowledge and expertise

that they bring to the decision-making process. The flip side of this overconfidence is the common phenomenon that managers are quite unaware of what they don't know; often an equally important parameter in a strategic decision.

• The failure of decision makers to accurately measure the confidence range of their analysis and decisions reflects their ignorance of what they don't know. The result is another potentially lethal blindspot - underestimating risk.

• The root causes of overconfidence lie in the fundamental psychological responses to complexity and uncertainty associated with many strategic decisions. In order to cope with this complexity and uncertainty, cognitive simplification is used as a coping mechanism. Strategic decision makers often engage in this process on a subconscious level and eventually believe their simplified depictions of reality to be accurate. Hence, they are lulled into overconfidence regarding their abilities to successfully conduct analysis and the strategic decisions it supports.

Representativeness Heuristic/Reasoning by Analogy• The representativeness heuristic causes managers to make rash

generalizations from limited samples or incomplete information. This blindspot can manifest itself in several ways, including the assumption that past strategic challenges are similar to present decisions confronting the firm, and the assumption that the firm is able to predict future outcomes with reasonable accuracy. This belief in "the law of small numbers” lures decision makers into making invalid inferences based on sample sizes that are too small to support such analytical demands.

• An important contributing factor to the representativeness heuristic is the pronounced tendency for managers to be much more influenced by colorful anecdotal stories than by strictly quantitative statistical analysis.

• The related concept of reasoning by analogy is an operational mode of the representativeness heuristic because it allows managers to simplify reality and add color to anecdotal stories. Unfortunately, the analogies used to support a strategic decision may not be analogous or representative of the strategic parameters of the decision at hand. The results are blindspots rooted in oversimplification of the complexities and uncertainties of the firm's competitive environment.

Informational Filtering

• Top management often receives their decision support analysis from lower levels of management in the firm's hierarchy. As such, the impact of the previous six sources of blindspots will also filter back up to distort the decision-making process of top management.

New Business Entry Through Internal Development

• As with industry capacity decisions, considerations around new business entry through internal development are also often widespread with blindspots:

• Overconfidence: Managers are often overconfident of their ability to successfully enter a new market because they underestimate contingent competitive reaction.

• Limited Frame of Reference: Analysis supporting new business entry decisions often assumes that the industry's attractiveness will remain the same after the firm enters. In reality, basing the justifying financial analysis on industry structure that exists prior to the firm's entry is not an accurate portrayal of competitive reality. Instead, the financial analysis should explicitly incorporate how the firm's entry will instigate competitive and customer reactions and change the industry's attractiveness.

• Escalating Commitment to a Course of Action: Once the firm enters the market, managers often fall prey to escalating their commitment to their original course of action despite being blindsided by unexpected competitive retaliation or customer reluctance.

• Winner's Curse: Strategic decision makers often underestimate the willingness of rival firms in a new industry to retaliate. For example, rivals may have invested in unrecoverable assets, creating barriers to exit that force them to aggressively protect their existing market shares by lowering their prices below the prospective firm‘s profitability pricing point. As a result, when the firm enters the market, the expected profitability does not flow from market share gains.

New Business Entry Through Acquisition• Similar to new business entry by internal development, acquisitions are also not immune to

blindspots:• Overconfidence: As indicated by persistent overpayment relative to market value, many

managers are overconfident in their abilities to achieve synergies post-acquisition.• Limited Frame of Reference: When analyzing potential acquisitions, managers often suffer

from a limited decision frame because their point of reference is based on fully exploiting expected synergy gains. The reality that these gains are usually bargained away to the target firm's shareholders via the bidding process is usually ignored.

• Escalating Commitment to a Course of Action: Overconfidence in the firm's ability to realize expected synergies may lead the firm to ignore the possibility that rival bidders may also expect to achieve similar synergies. As a result, managers get caught in a trap of escalating commitment where multiple bidders exist in the market for corporate control.

• Winner's Curse: As a result of the preceding blindspots, the acquiring firm often enjoys doubtful success, as most of the expected synergies will have been eroded by overpayment.

• Through these three strategic decisions, the source of many blindspots lies in the absence of adequate consideration of contingent competitor reaction to planned strategies.