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Formulation of Strategy

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The Road to Competition in the Building Improvement Industry

Community News. Find out more. Strategic Advisory Council. Member Events. That costs decline with experience in some industries is not news to corporate executives. The significance of the experience curve for strategy depends on what factors are causing the decline. If costs are falling because a growing company can reap economies of scale through more efficient, automated facilities and vertical integration, then the cumulative volume of production is unimportant to its relative cost position.

Here the lowest-cost producer is the one with the largest, most efficient facilities. A new entrant may well be more efficient than the more experienced competitors; if it has built the newest plant, it will face no disadvantage in having to catch up. Whether a drop in costs with cumulative not absolute volume erects an entry barrier also depends on the sources of the decline.

If costs go down because of technical advances known generally in the industry or because of the development of improved equipment that can be copied or purchased from equipment suppliers, the experience curve is no entry barrier at all—in fact, new or less experienced competitors may actually enjoy a cost advantage over the leaders.

Free of the legacy of heavy past investments, the newcomer or less experienced competitor can purchase or copy the newest and lowest-cost equipment and technology. If, however, experience can be kept proprietary, the leaders will maintain a cost advantage. But new entrants may require less experience to reduce their costs than the leaders needed.

All this suggests that the experience curve can be a shaky entry barrier on which to build a strategy. While space does not permit a complete treatment here, I want to mention a few other crucial elements in determining the appropriateness of a strategy built on the entry barrier provided by the experience curve:. The newcomer on the block must, of course, secure distribution of its product or service.

A new food product, for example, must displace others from the supermarket shelf via price breaks, promotions, intense selling efforts, or some other means. The more limited the wholesale or retail channels are and the more that existing competitors have these tied up, obviously the tougher that entry into the industry will be. Sometimes this barrier is so high that, to surmount it, a new contestant must create its own distribution channels, as Timex did in the watch industry in the s.

The government can limit or even foreclose entry to industries with such controls as license requirements and limits on access to raw materials. Regulated industries like trucking, liquor retailing, and freight forwarding are noticeable examples; more subtle government restrictions operate in fields like ski-area development and coal mining.

The government also can play a major indirect role by affecting entry barriers through controls such as air and water pollution standards and safety regulations. The company is likely to have second thoughts if incumbents have previously lashed out at new entrants or if:. From a strategic standpoint there are two important additional points to note about the threat of entry. First, it changes, of course, as these conditions change. It is not surprising that Kodak plunged into the market. Product differentiation in printing has all but disappeared. Conversely, in the auto industry economies of scale increased enormously with post-World War II automation and vertical integration—virtually stopping successful new entry.

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Second, strategic decisions involving a large segment of an industry can have a major impact on the conditions determining the threat of entry. For example, the actions of many U. Similarly, decisions by members of the recreational vehicle industry to vertically integrate in order to lower costs have greatly increased the economies of scale and raised the capital cost barriers.

Suppliers can exert bargaining power on participants in an industry by raising prices or reducing the quality of purchased goods and services.

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Powerful suppliers can thereby squeeze profitability out of an industry unable to recover cost increases in its own prices. By raising their prices, soft drink concentrate producers have contributed to the erosion of profitability of bottling companies because the bottlers, facing intense competition from powdered mixes, fruit drinks, and other beverages, have limited freedom to raise their prices accordingly. Customers likewise can force down prices, demand higher quality or more service, and play competitors off against each other—all at the expense of industry profits.

The power of each important supplier or buyer group depends on a number of characteristics of its market situation and on the relative importance of its sales or purchases to the industry compared with its overall business. Most of these sources of buyer power can be attributed to consumers as a group as well as to industrial and commercial buyers; only a modification of the frame of reference is necessary.

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Consumers tend to be more price sensitive if they are purchasing products that are undifferentiated, expensive relative to their incomes, and of a sort where quality is not particularly important. The buying power of retailers is determined by the same rules, with one important addition. A company can improve its strategic posture by finding suppliers or buyers who possess the least power to influence it adversely.

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Most common is the situation of a company being able to choose whom it will sell to—in other words, buyer selection. Rarely do all the buyer groups a company sells to enjoy equal power.

Even if a company sells to a single industry, segments usually exist within that industry that exercise less power and that are therefore less price sensitive than others. For example, the replacement market for most products is less price sensitive than the overall market. As a rule, a company can sell to powerful buyers and still come away with above-average profitability only if it is a low-cost producer in its industry or if its product enjoys some unusual, if not unique, features.

If the company lacks a low cost position or a unique product, selling to everyone is self-defeating because the more sales it achieves, the more vulnerable it becomes.

The company may have to muster the courage to turn away business and sell only to less potent customers. They focus on the segments of the can industry where they can create product differentiation, minimize the threat of backward integration, and otherwise mitigate the awesome power of their customers. In the ready-to-wear clothing industry, as the buyers department stores and clothing stores have become more concentrated and control has passed to large chains, the industry has come under increasing pressure and suffered falling margins.

The industry has been unable to differentiate its product or engender switching costs that lock in its buyers enough to neutralize these trends. By placing a ceiling on prices it can charge, substitute products or services limit the potential of an industry. Unless it can upgrade the quality of the product or differentiate it somehow as via marketing , the industry will suffer in earnings and possibly in growth. Sugar producers confronted with the large-scale commercialization of high-fructose corn syrup, a sugar substitute, are learning this lesson today.

Substitutes not only limit profits in normal times; they also reduce the bonanza an industry can reap in boom times. In the producers of fiberglass insulation enjoyed unprecedented demand as a result of high energy costs and severe winter weather. These substitutes are bound to become an even stronger force once the current round of plant additions by fiberglass insulation producers has boosted capacity enough to meet demand and then some.

Substitutes often come rapidly into play if some development increases competition in their industries and causes price reduction or performance improvement. Rivalry among existing competitors takes the familiar form of jockeying for position—using tactics like price competition, product introduction, and advertising slugfests. Intense rivalry is related to the presence of a number of factors:.

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As an industry matures, its growth rate changes, resulting in declining profits and often a shakeout. In the booming recreational vehicle industry of the early s, nearly every producer did well; but slow growth since then has eliminated the high returns, except for the strongest members, not to mention many of the weaker companies. The same profit story has been played out in industry after industry—snowmobiles, aerosol packaging, and sports equipment are just a few examples.

Technological innovation can boost the level of fixed costs in the production process, as it did in the shift from batch to continuous-line photo finishing in the s.

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While a company must live with many of these factors—because they are built into industry economics—it may have some latitude for improving matters through strategic shifts. A focus on selling efforts in the fastest-growing segments of the industry or on market areas with the lowest fixed costs can reduce the impact of industry rivalry. If it is feasible, a company can try to avoid confrontation with competitors having high exit barriers and can thus sidestep involvement in bitter price cutting. Where does it stand against substitutes?

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Against the sources of entry barriers? I shall consider each strategic approach in turn. Strategy can be viewed as building defenses against the competitive forces or as finding positions in the industry where the forces are weakest. If the company is a low-cost producer, it may choose to confront powerful buyers while it takes care to sell them only products not vulnerable to competition from substitutes. The success of Dr Pepper in the soft drink industry illustrates the coupling of realistic knowledge of corporate strengths with sound industry analysis to yield a superior strategy. Dr Pepper chose a strategy of avoiding the largest-selling drink segment, maintaining a narrow flavor line, forgoing the development of a captive bottler network, and marketing heavily.