Chapter 5

Competing Over Time

5-1

Three Stages of Industry Growth

Growth Entry rate exceeds the exit rate

Shakeout Exit rate exceeds the entry rate

Maturity Entry and exit rates are about the same

Industry disruption Technological substitutes or disruptive technologies offer a

stronger buyer surplus to the industry’s customers, drawing them away (e.g., DVDs vs. videotapes)

5-2

Industry Evolution All industries evolve over time as new firms enter and

failing firms exit Industry evolution threatens all sources of competitive

advantage The more a firm resists the forces of industry evolution,

the less likely it is to survive Product life cycle

Not the same as industry evolution but often linked closely to it

5-3

Guided Missiles

0

0.2

0.4

0.6

0.8

1

0 10 20 30 40

Year from Birth of Product

Sta

ndar

dize

d V

alue

s

Exit Entry Number

Paints

0

0.2

0.4

0.6

0.8

1

0 10 20 30 40 50 60Year from Birth of Product

Sta

ndar

dize

d V

alue

s

Exit Entry Number

Nuclear Reactors

0

0.2

0.4

0.6

0.8

1

0 10 20 30 40

Year from Birth of Product

Sta

ndar

dize

d V

alue

s

Exit Entry Number

Radiant Heating Baseboards

0

0.2

0.4

0.6

0.8

1

0 10 20 30 40 50Year from Birth of Product

Sta

ndar

dize

d V

alue

s

Exit Entry Number

The Industry Life Cycles of Four Representative Industries

5-4

Entries, Exits and Total Firms in the U.S. Automobile Industry 1880-1974

5-5

Total Production of U.S. Automobile Firms (in millions)

5-6

Total Automobile and Model T Production, 1909-1927

5-7

Figure 4.1

Dynamic Growth Cycle

Firm Size Innovation in Processes or Products

Improved Market Position Through Higher Value,

Lower Cost or Both

Capacity Expansion

Increased Profitability

5-8

Dynamic growth cycle The cycle of firm growth linking size, innovation, productivity,

profitability, and capacity expansion Dynamic capability

The ability of a firm, as it grows, to build its innovative potential and exploit it effectively

Path dependence The tendency of a firm over time to invest in innovations that

are upwardly compatible with each other, thereby creating a relatively unique path of product and process development

Key Concepts in Developing and Maintaining Dynamic Capability

5-9

Absorptive capacity The ability of the firm to adopt innovations developed

by other organizations based on its prior experience with similar or related practices or technologies

Core rigidity The inability of a firm to adapt to changing market or

technological conditions because of its attachment to its core practices and customers

Key Concepts in Developing and Maintaining Dynamic Capability

(cont’d)

5-10

Samsung’s Virtuous Cycle in 2003

Investment Ahead of the Competition

Market Leadership

High Profits

Cash Flows andBalance Sheet Flexibility

5-11

Customer Segmentation over the Product Life Cycle

5-12

Expansion During the Growth Stage

Developing scale-based value drivers Which drivers are adopted depends on the purchasing

criteria of the majority of buyers For example: brand, service, network externalities, qualityMoving from early adopters to the early majority is crossing

the chasm Developing scale-based cost drivers in specific value

chain activities Economies of scale Economics of scope Learning curve

5-13

Early Mover Advantage Defined by a combination of competitive

advantage (short term) and dynamic capability (long term)

Opportunity to establish and defend a strong market position

Opportunity to grow over a longer period of time Higher chances of being exposed to opportunities

for growth and innovation

5-14

Strategic Pricing Strategic pricing

Pricing below marginal cost in order to attract additional buyers

Strategic pricing makes sense under two conditions When increases in volume are sustainable through customer

loyalty due to higher switching costs When increased demand leads to lower costs for the firm

through scale-driven cost drivers such as the learning curve and scale economies

5-15

Risks of Strategic Pricing Cost reduction due to learning or scale does not make up

for the profits lost by setting a lower price Poor understanding of technologies or other activities

Inability to protect cost advantages Higher demand does not materialize Customers cannot be retained

5-16

What Determines a Shakeout? Shakeout

Due to the emergence of a dominant, sustainable business model (value minus cost)

The strongest competitors use their higher productivity to drive out weaker firms

Shakeouts can occur in the same time frame As the product life cycle shifts toward maturity

The product life cycle does not explain which firms will survive the shakeout

As a dominant design emerges A dominant design is the culmination of a series of innovations in a

product’s components and architecture and in related value drivers, such as service, network externalities, complements, or breadth of line

For example, the IBM PC, the general purpose tractor, the piano

5-17

Figure 4.3Source: Adapted from James Utterback, Mastering the Dynamics of Innovation, (Cambridge, MA: Harvard Business School Press, 1994), p. 82.

Rates of Product and Process Innovation over the History of the

Industry

5-18

What Determines a Shakeout’s Severity?

Expectations about future market demand and the degree of sunk costs

Ease of imitation of the dominant firms’ market position

The existence of defendable niche markets

About six percent of the firms in an industry exit during the shakeout every year

5-19

Indicators of Industry Maturity The long-term leveling-off or decline in the market

growth rate Rising buyer experience with industry products The high concentration of market share among large,

relatively similar firms The persistence of niche markets

5-20

An Increase in Buyer Experience

Firms attempt to counter the growing power of experienced buyers by: Introducing innovations that increase search and transition

costs for buyers: Improved serviceHigher qualityBreadth of line and product customization

Lowering prices

5-21

Industry Concentration Industry concentration depends on

The ratio of market size to the minimum scale required to compete

The lower the scale, the more firms are viable Sunk cost investments in value drivers that have increasing

returns to scaleHigher sunk costs force out smaller rivals and deter entry

5-22

Hypercompetition Hypercompetition is the combination of:

Multipoint competition Industries in which large firms compete across many products in

a product line and across geographical regionsMutual footholds in the core market of rival firms ensure

competitive stability An arms race

The requirement to develop product and process innovations to keep up with competitors

Returns on innovations become lower innovations are copied by competitors

5-23

Niche Markets Competition in niche markets is affected by:

Size of the niche Growth rate of the niche Barriers to entry Changes in niche buyers’ preferences toward core market

products Minimum level of scale required to compete Ability to improve non-scale based cost and value drivers Increase in the buyer switching costs

5-24

Types of Industry Disruption Technological substitution

Introduction of a radically new technology that has a higher rate of return on investment in R&D than the current technology in the industry

Disruptive innovation Introduction of a new product with lower value but much

lower cost than the incumbent product Typically based on standard components Exploits emergent customer price sensitivity

Radical institutional change A radical shift in the regulation of competition that opens the

market to firms with innovative capabilities5-25

Adapting to Industry Disruption When can incumbents adapt to disruption?

When they control assets (e.g., distribution) that are critical for competing in the industry

When isolating mechanisms protecting the innovation are weak When incumbents do not suffer large short-term opportunity

costs in switching to the innovation

5-26

Figure 4.5

Industry Disruption from Technological Substitution

5-27

Figure 4.6

Trends in VCR and DVD sales in the United States by quarter, 1998-2003

5-28

Incumbents Adaptation to Technological Substitutes

Incumbents delay adopting technological substitutes for the following reasons Emphasis on total (rather than marginal) return on investment

in R & D Potential cannibalization by the new technology of profits from

the traditional technology Poor absorptive capacity to adopt new technology

5-29

Disruptive Technology Characteristics include:

Technology initially introduced by start-ups into niche market too small to attract incumbents’ attention

Product based on technology has relatively lower initial functionality and also a lower cost

Price-value profile of new product does not initially attract customers in industry’s core market

5-30

Disruptive Technology (cont’d)

Over time, preferences of incumbents’ customers shift toward value-price profile of new product

Complementary assets (distribution) necessary for market penetration of disruptive technology not controlled by incumbents

Start-ups selling new product develop a dynamic growth cycle which allows them to penetrate core market rapidly through scale-based cost drivers

5-31

Table 4.4

Deregulation typically leads to: Entry Industry consolidation Decline in incumbents

Disruption by Regulatory Change

5-32

Chapter 6

Strategy Execution

6-33

What Is Strategy Execution? Strategy execution

Building the resources and capabilities that lead to competitive advantage through critical value and cost drivers

Not the same as strategic planningA relatively simple business with a valuable protected resource

may not need planning—but it must execute.

6-34

Characteristics of Resources Resources:

Observable Tradable Contribute to the firm’s

market position by improving value or lowering cost, or both.

Produce an economic advantage if difficult to imitate or neutralize.

Examples: Patents Natural resources Brand Distribution network Proprietary process Geographic location

6-35

Characteristics of a Capability Cannot be readily observed Not tradable separately from whole unit Contributes to higher value, lower cost or both Developed by people through coordinated action Less stable than a resource Developed independently of resources Can derive its strategic value from its use in support of

the firm’s resources

6-36

Linking Resources and Capabilities Capabilities contribute to performance by supporting

resources A firm’s expertise in exploiting a resource strongly

influences how much it is worth to the company Resource Complementarity

Complementarity between the asset being auctioned and the existing resources of the bidding firms determines the least amount each will bid

6-37

Makadok’s Model for Relating Resources and Capabilities

How can a firm become more profitable than competitors after bidding for a resource? Have stronger complementarities between the resources

of the firm and the resource being auctionedHigher complementarity allows the firm to raise its bid

Develop a better forecast of economic returns to the resource after it is acquired (resource picking)

Bid depends on forecast Have stronger capabilities that increase the returns to

the target’s resourceRaises the firm’s bid

6-38

Building Capabilities Capabilities are produced by specific activities and

policies Two frameworks for mapping activities and policies are:

Value chain framework Activity system framework

6-39

Figure 5.1

Porter’s Value Chain

6-40

Activity Systems Interconnected components of a firm that contribute to

its market position Policies Programs Value chain activities Product characteristics Key resources Firm’s structure and culture

6-41

Figure 5.2

Vanguard’s Activity System at the Beginning of 1997

6-42

Vanguard Activity System Core elements:

The fund family’s mutual structure (not stock) Direct distribution (no brokers) Focus on conservatively managed funds (low risk) Low transaction and account maintenance cost Candid communication (strong culture) Focus on long-term performance High-quality service (higher retention rates)

Supporting elements

6-43

Figure 5.3

The Elements of Strategy Execution

6-44

Organizational Dimensions of Strategy Execution

Complementarity and consistency among the firm’s resources, tasks and policies in support of a firm’s market position

Control and coordination systems for the design and execution of tasks

Compensation and incentive systems Culture and learning behavior

6-45

Complementarity and Consistency Complementary resources or capabilities

Produce a more effective outcome together than independentlyExample: Stores and catalogue operations for internet retailing

Consistency (fit) Resources or capabilities are jointly aligned with the

requirements of the firm’s market positionExample: The alignment of Vanguard’s activity system with its

low cost position

6-46

Control and Coordination Systems Coordination mechanisms

Standardized procedures Joint planning Liaison personnel Task forces with members from multiple activities Teams that institutionalize the task forces Hierarchical referral up the chain of command

6-47

Types of Hierarchical Structure

Figure 5.4

6-48

Benefits of a Functional Structure

Lower costs Reduced overhead Standardized procedures within functions Continuous process innovation within functions Power over suppliers through increased scale in purchasing

Increased expertise within functions that may result in value to the customer Specific technology development Skills in sales and marketing research Quality improvements in operations, logistics and service

6-49

Benefits of a Geography-based Structure

Increased focus on the characteristics of geographical regions Unique local competitors Unique local suppliers Unique local customer preferences

6-50

Benefits of aCustomer-Based Organization

Increases focus on unique characteristics of customer segments Unique marketing requirements

Example: Knowledge of customer industry Unique customer preferences

Example: Products tied to unique practices in each segment

6-51

Matrix Organization Organized on two or more dimensions:

Function and geography, function and customer Managers report to both functional and geographical

executives who report to president Avoids problems of putting one dimension over another

in the hierarchy: Dimensions are roughly equal in importance

Can be hard to manage because of conflicting demands of different dimensions

6-52

Incentive Systems Incentive compensation systems contribute to strategy

execution Goals

Measure outcomes for tasks that affect the firm’s market position

Goal setting and rewards Set appropriate targets for each outcome Reward managers for achieving targets

6-53

Problems Inherent in Incentive Systems

Controllability Occurs when managers are unable to identify how much of the

firm’s performance is due to skill, effort or luck Alignment

Occurs when crucial tasks that contribute to performance are not measurable, leading to overweighting of tasks that can be measured

Interdependency Occurs when performance depends on the effort of a team and

it is hard to identify individual contributions

6-54

Dilemmas of Noise and Distortion Noise = measurement error

Controllability and interdependency increase noise that lowers the ability of management to measure its current progress in achieving important results

Distortion = misalignment of measurement Distortion is increased through the improper weighting of tasks

There is an inevitable tradeoff between these dilemmas

6-55

Piece-Rate Piece-rate pay

Pay related to the quantity of output of a person over a period of time

Piece-rate systems are appropriate when there is: Employees control the pace of production Performance standards are perceived as fair Group members preferences are similar Cooperation and innovation are rewarded Lower bound on quality is explicit

6-56

Culture and Learning Culture

Can be seen as the development and maintenance of focal points for decision making

Learning Single loop learning occurs within the constraints of a problem Double loop learning raises questions about the task

parameters Effective strategy execution requires know-how and

involvement in both types of problem solving

6-57

Target market position-Desired value drivers-Desired cost drivers

Capability planning-Product-Process

Desired operational capabilities

Design of activities and tasks

Design organizational dimensions of execution

-Control and coordination-Compensation and incentives-Complementarity and consistency-Culture

Actual execution

Identify -Knowledge gaps-Cooperation problems-Coordination problems

Single loop learning: -Problem solve

Double loop learning:-Discover new processes, practices and policies

Capability Planning and Learning

Revise target

Revise planning

6-58