External and Internal Environments
Overview
In this assignment, you are to use the same corporation you selected and focused on for Assignment 1.
Using the corporation you chose from Assignment 1: Strategic Management and Strategic Competitiveness, examine the industry in which the entity operates. Use any or all of the following resources to conduct research on the company:
- Company website.
- Public filings from the Securities and Exchange Commission EDGAR database.
- Strayer University’s online databases.
- The Nexis Uni database,
- Other miscellaneous sources. Note: the company’s annual report will often provide insights that other resources may not include.
Requirements
Write a four- to six-page paper in which you do the following:
- Choose the two segments of the general environment that would rank highest in their influence on the corporation you chose. Assess how these segments affect the corporation you chose and the industry in which it operates.
- Considering the five forces of competition, choose two forces of competition that you estimate are the most significant for the corporation you chose. Evaluate how well the company has addressed these forces in the recent past.
- With the same two forces in mind, predict what the company might do to improve its ability to address these forces in the near future.
- Assess the external threats affecting this corporation and the opportunities available to the corporation. Give your opinions on how the corporation should deal with the most serious threat and the greatest opportunity. Justify your answer.
- Give your opinion on the corporation’s greatest strengths and most significant weaknesses. Choose the strategy or tactic the corporation should select to take maximum advantage of its strengths, and the strategy or tactic the corporation should select to fix its most significant weakness. Justify your choices.
- Determine the company’s resources, capabilities, and core competencies.
- Go to Basic Search: Strayer University Online Library to locate quality references. Note: Wikipedia and similar websites do not qualify as academic resources.
Your assignment must follow these formatting requirements:
- This course requires use of new Strayer Writing Standards (SWS). The format is different than other Strayer University courses. Please take a moment to review the SWS documentation for details.
- Be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides; references must follow SWS or school-specific format. Check with your professor for any additional instructions.
- Include a cover page containing the title of the assignment, the student’s name, the professor’s name, the course title, and the date. The cover page and the reference page are not included in the required page length.
Use the
Assignment 2 Template [DOC]
to ensure that your assignment meets the above requirements.
The specific course learning outcome associated with this assignment is as follows:
- Analyze the effects of the general environment, competition, threats, opportunities, strengths, and weaknesses relative to a corporation.
Grading for this assignment will be based on answer quality, logic and organization of the paper, and language and writing skills, using the scoring rubric.
1
Figures title: 8
Week 6 Assignment 2
Student’s Full Name
BUS499 Business Administration Capstone
Professor’s Name
Date
Template Instructions (delete this page before submitting)
This template is provided to help you meet the assignment requirements.
This page should NOT be submitted with your assignment, as it is not part of an academically written paper. Note the “Clarity, writing mechanics, and formatting requirements” section of the grading rubric.
HOW TO USE THIS TEMPLATE
· Read the explanations provided in the template for each section of your paper.
· The explanations are in blue font below.
· You should have already read the assignment instructions in Blackboard.
· Type your response to each of the assignment requirements within the designated sections.
· Each assignment requirement is identified using a section Heading that is in black font
· DO NOT add extra spaces between sections.
· DO NOT change the margins.
· You are required to have a heading for each of the sections in your paper.
· The required headings have been provided for you.
· Follow the instructions below to customize the Headings as directed.
· DO NOT type the assignment instructions into the sections.
· After typing your responses, change the font color to black and make sure it is not in bold.
· Be sure to change the font color on the title page to black after typing your name, professor’s name, and date.
· Everything in blue font below should be deleted and replaced with your responses.
· DELETE this entire page before you submit your assignment to avoid losing points. Do not leave a blank page here.
REMINDERS
· The assignment is due in week 6. Late submissions negatively impact your grade.
· Use the same public corporation you used for assignment 1.
· Do not copy content from other assignments in this class or others.
· Include at least 4 full and complete academically written pages that address the requirements. The title page, this instruction page, and the source page do not count.
· Use at least 3 quality sources, one of which MUST be the course textbook.
· Strayer uses SafeAssign – an automated plagiarism checker. It is advised that you do your own writing and use external resources to support what you have written in your own words.
Week 6 Assignment 2
Write your introduction here. Include one (1) paragraph (not more than 6 lines of text) that explains what your paper will discuss. Much of your introduction may be taken from the assignment instructions (in your own words). Read all assignment resources to understand what should be included in your paper. Be sure to review the assignment instructions in Blackboard, the grading rubric, and relevant course announcements to understand the requirements. Do not exceed 6 lines of text in this introduction. There should be no direct quotes in this section. After reading these instructions, replace this blue text with your introduction and change the font color to black.
General Environment
In this section you will choose the two (2) segments of the general environment that would rank highest in their influence on the public corporation you chose for assignment 1. You must select from the segments discussed in the course. Hint: see table 2.1 in the textbook. Do not assess all the segments—only assess the two (2) segments that rank highest in influencing your corporation. You will then assess how these segments affect the corporation and the industry in which it operates. There are two (2) subsections below, each has a heading. The heading “Segment 1” should be changed to the first segment of the general environment you select. The heading “Segment 2” should be changed to the second segment of the general environment you select. Replace this paragraph with a very brief introduction that includes the identification of the two (2) segments of the general environment you selected and change the font color to black.
Segment 1
This subsection is where you assess the first of the two (2) segments of the general environment you think ranks highest in its influence on the public corporation you chose for assignment 1. Change the subheading for this section, which currently says “Segment 1” to the name of the selected segment. Assess how this segment affects the corporation and the industry in which it operates. Remember that to assess a concept, you will weigh all aspects to judge the importance or relevance of that concept. Do not simply define the segment. Do not copy from you assignment 1 submission.
Your assessment should demonstrate that you have read, understand, and can apply the concepts covered in the course resources regarding the segment. Your writing here should thoroughly assess how the selected segment influences your corporation. Do not write about the general environment in general terms. Your assessment should be directly related to your selected corporation. A thorough assessment is defined as providing a complete response that is not superficial or partial regarding the various details of the concepts as described in the course. You will need to apply and incorporate key concepts from the course material to your assessment. Do not Google “segments of the general environment” or provide high-level summaries. You must display, in specific detail, an understanding based on what is studied in this course and demonstrate your ability to apply the concepts in a real-world assessment of a corporation. Read chapter 2 in the course textbook. Review the Week 2 Learn Reading for supporting content. Properly cite your sources and avoid the use of direct quotes. After reading these instructions, replace this blue text with your assessment and change the font color to black.
Segment 2
This subsection is where you assess the second of the two (2) segments of the general environment you selected. Change the subheading for this section, which currently says “Segment 2” to the name of the selected segment of the general environment that would rank highest in its influence on the public corporation you chose for assignment 1. Repeat the evaluation instructions provided in the “Segment 1” subsection above for this second segment of the general environment. Re-read the instructions above to ensure you have covered all of the requirements for this second segment of the general environment. After completing this section, replace this blue text with your evaluation and change the font color to black.
Five Forces of Competition
In this section you will consider the five (5) forces of competition and choose the two (2) that you estimate are the most significant for the corporation you chose in assignment 1. Hint: see figure 2.2 in the textbook. You will then, evaluate how well the company has addressed each of these two (2) forces in the recent past. There are two (2) subsections below, each has a heading. The heading “Force 1” should be changed to the first of the two forces of competition you select. The heading “Force 2” should be changed to the second of the two forces of competition you select. Replace this paragraph with a very brief introduction that includes the identification of the two (2) forces of competition you selected and change the font color to black.
Force 1
This subsection is where you evaluate the first of two (2) forces of competition that you estimate to be the most significant to the corporation you chose. Change the subheading for this section, which currently says “Force 1” to the name of your selected force. Provide a thorough assessment of why you think the selected force is significant to your corporation. A thorough assessment is defined as providing a complete response that is not superficial or partial regarding the various details of the concept as described in the course. Do not Google “five forces of competition” or simply provide a definition. You will need to apply and incorporate key concepts from the course material in your assessment.
Evaluate how well the company addressed the selected force in the recent past. This will require some research. Remember that to evaluate a concept, you will break down all components to determine or analyze facts, value, or views. Your evaluation should demonstrate that you have read, understand, and can apply the concepts covered in the textbook and course resources. Do not write about the selected force in general terms. Your evaluation should be directly related to your selected corporation and include a thorough evaluation of how the company has addressed the force recently. You must display an understanding based on what is studied in this course and demonstrate an ability to apply the concepts in a real-world evaluation of a corporation. You will need to read the chapters and listen to the lectures to understand the key concepts for each force. Read chapter 2 in the course textbook and review the Week 2 Learn Reading for supporting content. Cite all sources and limit the use of direct quotes. After reading these instructions, replace this blue text with your evaluation and change the font color to black.
Force 2
Choose another one (1) of the five (5) forces of competition that you estimate to be the most significant for the corporation you chose. This should not be the same force assessed in the “Force 1” section above. Change the subheading for this section, which currently says “Force 2” to the name of the selected force. This subsection is where you evaluate the second of the two forces of competition that you selected. Repeat the evaluation instructions provided in the “Force 1” subsection above for this second force of competition. Re-read the instructions above to ensure you have covered all of the requirements for this second force of competition. After completing this section, replace this blue text with your evaluation and change the font color to black.
Future Improvements
With the same two (2) forces assessed and evaluated in the previous two (2) sub-sections above, predict what the company might do to improve its ability to address the forces in the near future. Your writing here should provide a thorough prediction of what the company should do to address impacts from the selected forces. Do not simply discuss company information published by your sources. This section should be your prediction of what the corporation should do. Your prediction should be your own, not predictions or recommendations from your sources or actions your corporation has already taken or plans to take. Remember that a thorough evaluation is defined as providing a complete response that is not superficial or partial regarding the various details of the concepts as described in the course. Your prediction should be specific to your selected corporation, relevant to the evaluation you conducted, and directly related to improvements the corporation could make to address the two forces you selected in the two (2) sub-sections above. Read chapter 2 in the course textbook and review the Week 2 Learn Reading for supporting content. Cite your sources and avoid the use of direct quotes. After reading these instructions, replace this blue text with your prediction and change the font color to black.
Greatest External Threat
Identify what you consider to be the greatest external threat to the corporation you selected. The threat should be specific to your corporation. Justify why you consider the threat to be the greatest. Support your justification with an assessment of the impact the threat has on the corporation. For example, your justification could include a comparison of other threats or an evaluation of facts that support the magnitude of the threat’s impact. Follow this justification with a discussion on how the corporation should address the threat. Specifically describe the strategy and provide a justification that supports why you believe the strategy will be successful in combating the threat. This section must include both a clearly identified external threat and a clearly articulated action\strategy the corporation should take to address the threat. Do not write in general terms. Your writing here should be specific and incorporate the course concepts relating to threats and the external environment. Read chapter 2 in the course textbook. The textbook provides a solid background for this section. Review the Week 2 Learn Reading for supporting content. Cite your sources and avoid the use of direct quotes. After reading these instructions, replace this blue text with your response and change the font color to black.
Greatest Opportunity
Identify what you consider to be the greatest opportunity to the corporation you selected. The opportunity should be specific to your corporation. Justify why you consider the opportunity to be the greatest. Support your justification with an assessment of the impact the opportunity could have on the corporation. For example, your justification could include a comparison of other opportunities or an evaluation of facts that support the magnitude of the opportunity’s impact. Follow this justification with a discussion on how the corporation could best take advantage of the opportunity. Specifically describe the strategy and provide a justification that supports why you believe the strategy will be successful in adding value to the corporation. This section must include both a clearly identified opportunity and a clearly articulated action the corporation should take to take advantage of the opportunity. Do not write in general terms. Your writing here should be specific and incorporate the course concepts relating to opportunities and the external environment. Read chapter 2 in the course textbook. The textbook provides a solid background for this section. Review the Week 2 Learn Reading for supporting content. Cite your sources and avoid the use of direct quotes. After reading these instructions, replace this blue text with your response and change the font color to black.
Strengths and Weaknesses
Give your opinion on the corporation’s greatest strengths and most significant weaknesses. Keep in mind that strengths and weaknesses are internal to the organization (i.e. the internal environment). You will need to address both the greatest strengths and most significant weaknesses. Do not choose one or the other. Both the greatest strengths and most significant weaknesses must be addressed. Do not write in general terms. The identified strengths and weaknesses should be specific to your selected corporation. Include a justification that supports your opinions. This section must include both clearly identified strengths and clearly identified weaknesses. Read Chapter 2 and 3 in the course textbook. The textbook provides a solid background for this section. Review the Week 2 and Week 3 Learn Reading for supporting content. Cite your sources and avoid the use of direct quotes. After reading these instructions, replace this blue text with your application and change the font color to black.
Strategy or Tactic
Choose the strategies or tactics the corporation should select to take maximum advantage of the strengths you identified in the section above, and the strategies or tactics the corporation should select to fix the most significant weaknesses you identified. You will need to select strategies/tactics for both the strengths and weaknesses. Do not choose one or the other. Strategies/tactics for both the strengths and weaknesses must be addressed. Justify your choices. Your justifications should be sound and thoroughly explained. For example, do not simply state that the corporation should choose a selected strategy, but rather explain why the strategy is a good choice for your corporations’ specific strengths or weaknesses. Read Chapter 2 and 3 in the course textbook. The textbook provides a solid background for this section. Review the Week 2 and Week 3 Learn Reading for supporting content. Cite your sources and avoid the use of direct quotes. After reading these instructions, replace this blue text with your responses and change the font color to black.
Resources, Capabilities, and Core Competencies
Determine the company’s resources, capabilities, and core competencies. Your determination should include an explanation of the relevance of each resource, capability, and core competency. Do not simply list the resources, capabilities, and core competencies. Remember that a thorough determination will provide a complete response that is not superficial or partial regarding the various details of the concepts as described in the course. Use your course materials to demonstrate your understanding of the key course concepts regarding resources, capabilities, and core competencies. Do not write in general terms. Your determination should display that you can apply the course concepts to your selected corporation.
R
ead Chapter 3 in the course textbook. The textbook provides a solid background to this section. Review the Week 3 Learn Reading for supporting content. Cite your sources and avoid the use of direct quotes. After reading these instructions, replace this blue text with your determination and change the font color to black.
Sources
1. Hitt, Ireland, & Hoskisson. 2020. Strategic management: Concepts and cases: Competitiveness and globalization (13th ed.). Mason, OH: South-Western Cengage Learning
2. Author. Publication Date. Title. Page # (written as p. #). How to Find (e.g. web address)
3. Author. Publication Date. Title. Page # (written as p. #). How to Find (e.g. web address)
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Chapter 2: The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis: 2-1 The General,
Industry, and Competitor Environments
Book Title: Strategic Management: Competitiveness & Globalization: Concepts and Cases
Printed By: Veronica Powell (veronicapowell3@aol.com)
© 2020 Cengage Learning, Inc.
2-1 The General, Industry, and Competitor Environments
The general environment (composed of dimensions in the broader society that influence
an industry and the firms within it.) is composed of dimensions in the broader society that
influence an industry and the firms within it. We group these dimensions into seven
environmental segments: demographic, economic, political/legal, sociocultural,
technological, global, and sustainable physical. Examples of elements analyzed in each of
these segments are shown in Table 2.1.
Table 2.1
The General Environment: Segments and Elements
Demographic segment Population size
Age structure
Geographic distribution
Ethnic mix
Income distribution
Economic segment Inflation rates
Interest rates
Trade deficits or
surpluses
Budget deficits or
surpluses
Personal savings rate
Business savings rates
Gross domestic product
Political/Legal segment Antitrust laws
Taxation laws
Deregulation
philosophies
Labor training laws
Educational philosophies
and policies
Sociocultural segment Women in the workforce
Workforce diversity
Attitudes about the
quality of work life
Shifts in work and career
preferences
Shifts in preferences
regarding product and
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service characteristics
Technological segment Product innovations
Applications of
knowledge
Focus of private and
government-supported
R&D expenditures
New communication
technologies
Global segment Important political events
Critical global markets
Newly industrialized
countries
Different cultural and
institutional attributes
Sustainable physical
environment segment
Energy consumption
Practices used to
develop energy sources
Renewable energy
efforts
Minimizing a firm’s
environmental footprint
Availability of water as a
resource
Producing
environmentally friendly
products
Reacting to natural or
man-made disasters
Firms cannot directly control the general environment’s segments. Accordingly, what a
company seeks to do is recognize trends in each segment of the general environment and
then predict each trend’s effect on it. For example, it has been predicted that over the next
10 to 20 years, millions of people living in emerging market countries will join the middle
class. In fact, by 2030, it is predicted that two-thirds of the global middle class, about 525
million people, will live in the Asia-Pacific region of the world. Of course, this is not
surprising given that almost 60 percent of the world’s population is located in Asia. No
firm, including large multinationals, is able to control where growth in potential customers
may take place in the next decade or two. Nonetheless, firms must study this anticipated
trend as a foundation for predicting its effects on their ability to identify strategies to use that
will allow them to remain successful as market conditions change.
The industry environment (the set of factors that directly influences a firm and its
competitive actions and responses: the threat of new entrants, the power of suppliers, the
power of buyers, the threat of product substitutes, and the intensity of rivalry among
competing firms.) is the set of factors that directly influences a firm and its competitive
actions and responses: the threat of new entrants, the power of suppliers, the power of
buyers, the threat of product substitutes, and the intensity of rivalry among competing firms.
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In total, the interactions among these five factors determine an industry’s profitability
potential; in turn, the industry’s profitability potential influences the choices each firm makes
about its competitive actions and responses. The challenge for a firm is to locate a position
within an industry where it can favorably influence the five factors or where it can
successfully defend itself against their influence. The greater a firm’s capacity to favorably
influence its industry environment, the greater the likelihood it will earn above-average
returns.
How companies gather and interpret information about their competitors is called
competitor analysis (How companies gather and interpret information about their
competitors) . Understanding the firm’s competitor environment complements the insights
provided by studying the general and industry environments. This means, for example,
that McDonald’s needs to do a better job of analyzing and understanding its general and
industry environments.
An analysis of the general environment focuses on environmental trends and their
implications, an analysis of the industry environment focuses on the factors and conditions
influencing an industry’s profitability potential, and an analysis of competitors is focused on
predicting competitors’ actions, responses, and intentions. In combination, the results of
these three analyses influence the firm’s vision, mission, choice of strategies, and the
competitive actions and responses it will take to implement those strategies. Although we
discuss each analysis separately, the firm can develop and implement a more effective
strategy when it successfully integrates the insights provided by analyses of the general
environment, the industry environment, and the competitor environment.
Chapter 2: The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis: 2-1 The General,
Industry, and Competitor Environments
Book Title: Strategic Management: Competitiveness & Globalization: Concepts and Cases
Printed By: Veronica Powell (veronicapowell3@aol.com)
© 2020 Cengage Learning, Inc.
© 2020 Cengage Learning Inc. All rights reserved. No part of this work may by reproduced or used in any form or by any means –
graphic, electronic, or mechanical, or in any other manner – without the written permission of the copyright holder.
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Chapter Introduction
iStock.com/DNY59
Learning Objectives
Studying this chapter should provide you with the strategic management knowledge needed to:
· 2-1Explain the importance of analyzing and understanding the firm’s external environment.
· 2-2Define and describe the general environment and the industry environment.
· 2-3Discuss the four parts of the external environmental analysis process.
· 2-4Name and describe the general environment’s seven segments.
· 2-5Identify the five competitive forces and explain how they determine an industry’s profitability potential.
· 2-6Define strategic groups and describe their influence on firms.
· 2-7Describe what firms need to know about their competitors and different methods (including ethical standards) used to collect intelligence about them.
Cracks in the Golden Arches and Mcdonald’s New Glue
McDonald’s is the largest restaurant chain in the world. It has 14,155 restaurants in the United States, and 36,899 restaurants worldwide—in more than 100 countries. It employs 1.5 million people and serves approximately 69 million customers daily. It sells 9 million pounds of french fries daily and sells 550 million Big Macs annually. Over the years, McDonald’s was a leader, not only in market share, but also with the introduction of new menu items to the fast food market. For example, it first introduced breakfast items to this market, and its breakfast menu now accounts for about 25 percent of its sales. It successfully introduced Chicken McNuggets to this market, and also successfully introduced gourmet coffee products and began to compete against Starbucks. With all this success, what is the problem?
The problems revolve around competition and changing consumer tastes. Consumers have become more health-conscious, and competitors have been more attuned to customer desires. As a result, McDonald’s suffered a decline in its total sales revenue of 18.9 percent from its high point in 2013 of $28.1 billion to $22.8 billion in 2017. It seems that McDonald’s did a poor job of analyzing its environment and especially its customers and competitors. During this same time, some of McDonald’s competitors flourished. For example, Sonic and Chipotle recorded significant increases in their annual sales. Other specialty burger restaurants, such as Smashburger, have stolen business from McDonald’s even though their burgers are priced higher. The quality of these competitors’ products is perceived to be higher, and many are “made to order” and thus customized to the customer’s desires. And, partly because the volume and complexity of the McDonald’s menu items have grown, the time required to provide service has also increased.
Healthier choice options now available at McDonald’s to satisfy the more health-conscious consumer.
Ruaridh Stewart/ZUMA Press/Newscom
Failing to understand the changing market and competitive landscape, McDonald’s was unable to be proactive and thus tried to be reactive but without much success. Because of these problems, McDonald’s hired a new CEO in 2015, hoping to overcome its woes. With a thorough analysis of its customers and competition and its products and services, McDonald’s developed a strategy to achieve a multi-year turnaround. It is adding new products to its menu and has enhanced the healthiness of those products along with enhancing their quality. For example, McDonald’s announced that it will now use only chickens raised without antibiotics to be sensitive to human health concerns. Changing vegetables in Happy Meals (e.g., adding baby carrots) and implementing new wraps that require additional (new) vegetables (such as cucumbers) are meant to enhance the healthiness of the McDonald’s menu. It has also introduced signature sandwiches, Quarter Pounders cooked with fresh meat only (not frozen), new espresso-based drinks, and other quality items.
Other parts of its multi-year strategy include renovated restaurants, digital ordering, and new delivery services. McDonald’s was once a leader, and now it is fighting regain its position, trying to stem the downturn. It is now responding to its external environment, especially its customers and competitors. Sales began to pick up in the last part of 2017. Within the next few years, we will know whether these changes succeed.
Sources: C. Smith, 2018, 40 Interesting McDonald’s facts and statistics, DMR Business Statistics, https://expandedramblings.com/index.php/mcdonalds-statistics/, February 19; J. Wohl, 2018, McDonald’s makes happy meals (slightly) healthier, AdAge, http://adage.com, February 15; J. Wohl, 2018, McDonald’s CMO bullish on tiered value menu amid competition, AdAge, http://adage.com, January 5; K. Taylor, 2017, McDonald’s makes 6 major changes that totally turned business around, Business Insider, www.businessinsider.com, October 24; S. Whitten, 2017, 4 ways McDonald’s is about to change, CNBC, www.cnbc.com; A. Gasparro, 2015, McDonald’s new chief plots counter attack, Wall Street Journal, www.wsj.com, March 1; D. Shanker, 2015, Dear McDonald’s new CEO: Happy first day. Here’s some (unsolicited) advice, Fortune, www.Fortune.com, March 2; S. Strom, 2015, McDonald’s seeks its fast-food soul, New York Times, www.nytimes.com, March 7; S. Strom, 2015, McDonald’s tests custom burgers and other new concepts as sales drop, New York Times, www.nytimes.com, January 23; B. Kowitt, 2014, Fallen Arches, Fortune, December, 106–116.
As suggested in the Opening Case and by research, the external environment (which includes the industry in which a firm competes as well as those against whom it competes) affects the competitive actions and responses firms take to outperform competitors and earn above-average returns. For example, McDonald’s has been experiencing a reduction in returns in recent times because of changing consumer tastes and enhanced competition. McDonald’s is attempting to respond to the threats from its environment by changing its menu, revising the types of supplies it purchases, remodeling its restaurants, and implementing digital sales and home delivery of food orders. The sociocultural segment of the general environment (discussed in this chapter) is the driver of some of the changing values in society that are now placing greater emphasis on healthy food choices. As the Opening Case describes, McDonald’s is responding to these changing values by, for example, using only antibiotic-free chicken and making its Happy Meals healthier.
As noted in
Chapter 1
, the characteristics of today’s external environment differ from historical conditions. For example, technological changes and the continuing growth of information gathering and processing capabilities increase the need for firms to develop effective competitive actions and responses on a timely basis. (We fully discuss competitive actions and responses in
Chapter 5
.) Additionally, the rapid sociological changes occurring in many countries affect labor practices and the nature of products that increasingly diverse consumers demand. Governmental policies and laws also affect where and how firms choose to compete. And, changes to several nations’ financial regulatory systems were enacted after the financial crisis in 2008–2009 that increased the complexity of organizations’ financial transactions. (However, in 2018 the Trump administration weakened or eliminated some of those regulations in the United States.)
Firms understand the external environment by acquiring information about competitors, customers, and other stakeholders to build their own base of knowledge and capabilities. On the basis of the new information, firms take actions, such as building new capabilities and core competencies, in hopes of buffering themselves from any negative environmental effects and to pursue opportunities to better serve their stakeholders’ needs.
In summary, a firm’s competitive actions and responses are influenced by the conditions in the three parts (the general, industry, and competitor) of its external environment (see
Figure 2.1
) and its understanding of those conditions. Next, we fully describe each part of the firm’s external environment.
Figure 2.1The External Environment
2-1The General, Industry, and Competitor Environments
The
general environment
is composed of dimensions in the broader society that influence an industry and the firms within it. We group these dimensions into seven environmental segments: demographic, economic, political/legal, sociocultural, technological, global, and sustainable physical. Examples of elements analyzed in each of these segments are shown in
Table 2.1
.
Table 2.1
The General Environment: Segments and Elements
Demographic segment |
· Population size · Age structure · Geographic distribution |
· Ethnic mix · Income distribution |
Economic segment |
· Inflation rates · Interest rates · Trade deficits or surpluses · Budget deficits or surpluses |
· Personal savings rate · Business savings rates · Gross domestic product |
Political/Legal segment |
· Antitrust laws · Taxation laws · Deregulation philosophies |
· Labor training laws · Educational philosophies and policies |
Sociocultural segment |
· Women in the workforce · Workforce diversity · Attitudes about the quality of work life |
· Shifts in work and career preferences · Shifts in preferences regarding product and service characteristics |
Technological segment |
· Product innovations · Applications of knowledge |
· Focus of private and government-supported R&D expenditures · New communication technologies |
Global segment |
· Important political events · Critical global markets |
· Newly industrialized countries · Different cultural and institutional attributes |
Sustainable physical environment segment |
· Energy consumption · Practices used to develop energy sources · Renewable energy efforts · Minimizing a firm’s environmental footprint |
· Availability of water as a resource · Producing environmentally friendly products · Reacting to natural or man-made disasters |
Firms cannot directly control the general environment’s segments. Accordingly, what a company seeks to do is recognize trends in each segment of the general environment and then predict each trend’s effect on it. For example, it has been predicted that over the next 10 to 20 years, millions of people living in emerging market countries will join the middle class. In fact, by 2030, it is predicted that two-thirds of the global middle class, about 525 million people, will live in the Asia-Pacific region of the world. Of course, this is not surprising given that almost 60 percent of the world’s population is located in Asia. No firm, including large multinationals, is able to control where growth in potential customers may take place in the next decade or two. Nonetheless, firms must study this anticipated trend as a foundation for predicting its effects on their ability to identify strategies to use that will allow them to remain successful as market conditions change.
The
industry environment
is the set of factors that directly influences a firm and its competitive actions and responses: the threat of new entrants, the power of suppliers, the power of buyers, the threat of product substitutes, and the intensity of rivalry among competing firms. In total, the interactions among these five factors determine an industry’s profitability potential; in turn, the industry’s profitability potential influences the choices each firm makes about its competitive actions and responses. The challenge for a firm is to locate a position within an industry where it can favorably influence the five factors or where it can successfully defend itself against their influence. The greater a firm’s capacity to favorably influence its industry environment, the greater the likelihood it will earn above-average returns.
How companies gather and interpret information about their competitors is called
competitor analysis
. Understanding the firm’s competitor environment complements the insights provided by studying the general and industry environments. This means, for example, that McDonald’s needs to do a better job of analyzing and understanding its general and industry environments.
An analysis of the general environment focuses on environmental trends and their implications, an analysis of the industry environment focuses on the factors and conditions influencing an industry’s profitability potential, and an analysis of competitors is focused on predicting competitors’ actions, responses, and intentions. In combination, the results of these three analyses influence the firm’s vision, mission, choice of strategies, and the competitive actions and responses it will take to implement those strategies. Although we discuss each analysis separately, the firm can develop and implement a more effective strategy when it successfully integrates the insights provided by analyses of the general environment, the industry environment, and the competitor environment.
2-2External Environmental Analysis
Most firms face external environments that are turbulent, complex, and global—conditions that make interpreting those environments difficult. To cope with often ambiguous and incomplete environmental data and to increase understanding of the general environment, firms complete an external environmental analysis. This analysis has four parts: scanning, monitoring, forecasting, and assessing (see
Table 2.2
).
Table 2.2
Parts of the External Environment Analysis
Scanning |
· Identifying early signals of environmental changes and trends |
Monitoring |
· etecting meaning through ongoing observations of environmental changes and trends |
Forecasting |
· Developing projections of anticipated outcomes based on monitored changes and trends |
Assessing |
· Determining the timing and importance of environmental changes and trends for firms’ strategies and their management |
Identifying opportunities and threats is an important objective of studying the general environment.
An
opportunity
is a condition in the general environment that, if exploited effectively, helps a company reach strategic competitiveness. Most companies—and certainly large ones—continuously encounter multiple opportunities as well as threats.
In terms of possible opportunities, a combination of cultural, political, and economic factors is resulting in rapid retail growth in parts of Africa, Asia, and Latin America. Accordingly, Walmart, the world’s largest retailer, and the next three largest global giants (France’s Carrefour, UK–based Tesco, and Germany’s Metro) are expanding in these regions. Walmart is expanding its number of retail units in Chile (404 units), India (20 units), and South Africa (360 units). Interestingly, Carrefour exited India after four years and in the same year that Tesco opened stores in India. While Metro closed its operations in Egypt, it has stores in China, Russia, Japan, Vietnam, and India in addition to many eastern European countries.
A
threat
is a condition in the general environment that may hinder a company’s efforts to achieve strategic competitiveness. Intellectual property protection has become a significant issue not only within a country but also across country borders. For example, in 2018 President Trump placed tariffs on goods exported from China into the United States. The primary reason given for the tariffs was the theft of U.S. firms’ intellectual property by Chinese firms. As is common in these cases, China responded by placing tariffs on a large number of U.S. products exported to China, sparking fears of a potential trade war between the two countries with the largest economies in the world. This type of threat obviously deals with the political/legal segment.
Firms use multiple sources to analyze the general environment through scanning, monitoring, forecasting, and assessing. Examples of these sources include a wide variety of printed materials (such as trade publications, newspapers, business publications, and the results of academic research and public polls), trade shows, and suppliers, customers, and employees of public-sector organizations. Of course, the information available from Internet sources is of increasing importance to a firm’s efforts to study the general environment.
2-2aScanning
Scanning entails the study of all segments in the general environment. Although challenging, scanning is critically important to the firms’ efforts to understand trends in the general environment and to predict their implications. This is particularly the case for companies competing in highly volatile environments.
Through scanning, firms identify early signals of potential changes in the general environment and detect changes that are already under way. Scanning activities must be aligned with the organizational context; a scanning system designed for a volatile environment is inappropriate for a firm in a stable environment. Scanning often reveals ambiguous, incomplete, or unconnected data and information that require careful analysis.
Many firms use special software to help them identify events that are taking place in the environment and that are announced in public sources. For example, news event detection uses information-based systems to categorize text and reduce the trade-off between an important missed event and false alarm rates. Increasingly, these systems are used to study social media outlets as sources of information.
Broadly speaking, the Internet provides a wealth of opportunities for scanning. Amazon.com, for example, records information about individuals visiting its website, particularly if a purchase is made. Amazon then welcomes these customers by name when they visit the website again. The firm sends messages to customers about specials and new products similar to those they purchased in previous visits. A number of other companies, such as Netflix, also collect demographic data about their customers in an attempt to identify their unique preferences (demographics is one of the segments in the general environment). Approximately 4 billion people use the Internet in some way, including more than 738 million in China and 287 million in the United States. So, the Internet represents a healthy opportunity to gather information on users.
2-2bMonitoring
When monitoring, analysts observe environmental changes to see if an important trend is emerging from among those spotted through scanning. Critical to successful monitoring is the firm’s ability to detect meaning in environmental events and trends. For example, those monitoring retirement trends in the United States learned that the median retirement savings of U.S. workers was only $5000. And for those who are aged 56-61, the median savings for retirement was only $17,000. For a reasonable retirement, Fidelity estimates that people should have saved 10 times their annual salary. Firms seeking to serve retirees’ financial needs will continue monitoring workers’ savings and investment patterns to see if a trend is developing. If, say, they identify that saving less for retirement (or other needs) is indeed a trend, these firms will seek to understand its competitive implications.
Effective monitoring requires the firm to identify important stakeholders and understand its reputation among these stakeholders as the foundation for serving their unique needs. (Stakeholders’ unique needs are described in
Chapter 1.) One means of monitoring major stakeholders is by using directors that serve on other boards of directors (referred to as interlocking directorates). They facilitate information and knowledge transfer from external sources. Scanning and monitoring are particularly important when a firm competes in an industry with high technological uncertainty. Scanning and monitoring can provide the firm with information. These activities also serve as a means of importing knowledge about markets and about how to successfully commercialize the new technologies the firm has developed.
2-2cForecasting
Scanning and monitoring are concerned with events and trends in the general environment at a point in time. When forecasting, analysts develop feasible projections of what might happen, and how quickly, as a result of the events and trends detected through scanning and monitoring. For example, analysts might forecast the time that will be required for a new technology to reach the marketplace, the length of time before different corporate training procedures are required to deal with anticipated changes in the composition of the workforce, or how much time will elapse before changes in governmental taxation policies affect consumers’ purchasing patterns.
Forecasting events and outcomes accurately is challenging. Forecasting demand for new technological products is difficult because technology trends are continually shortening product life cycles. This is particularly difficult for a firm such as Intel, whose products go into many customers’ technological products, which are frequently updated. Thus, having access to tools that allow better forecasting of electronic product demand is of value to Intel as the firm studies conditions in its external environment.
2-2dAssessing
When assessing, the objective is to determine the timing and significance of the effects of environmental changes and trends that have been identified. Through scanning, monitoring, and forecasting, analysts are able to understand the general environment. Additionally, the intent of assessment is to specify the implications of that understanding. Without assessment, the firm has data that may be interesting but of unknown competitive relevance. Even if formal assessment is inadequate, the appropriate interpretation of that information is important.
Accurately assessing the trends expected to take place in the segments of a firm’s general environment is important. However, accurately interpreting the meaning of those trends is even more important. In slightly different words, although gathering and organizing information is important, appropriately interpreting that information to determine if an identified trend in the general environment is an opportunity or threat is critical.
2-3Segments of the General Environment
The general environment is composed of segments that are external to the firm (see
Table 2.1). Although the degree of impact varies, these environmental segments affect all industries and the firms competing in them. The challenge to each firm is to scan, monitor, forecast, and assess the elements in each segment to predict their effects on it. Effective scanning, monitoring, forecasting, and assessing are vital to the firm’s efforts to recognize and evaluate opportunities and threats.
2-3aThe Demographic Segment
The
demographic segment
is concerned with a population’s size, age structure, geographic distribution, ethnic mix, and income distribution. Demographic segments are commonly analyzed on a global basis because of their potential effects across countries’ borders and because many firms compete in global markets.
Population Size
The world’s population doubled (from 3 billion to 6 billion) between 1959 and 1999. Current projections suggest that population growth will continue in the twenty-first century, but at a slower pace. In 2018, the world’s population was 7.6 billion, and it is projected to be 9.2 billion by 2040 and roughly 10 billion by 2055. In 2018, China was the world’s largest country by population with slightly more than 1.4 billion people. By 2050, however, India is expected to be the most populous nation in the world followed by China, the United States, Indonesia, and Pakistan. Firms seeking to find growing markets in which to sell their goods and services want to recognize the market potential that may exist for them in these five nations.
Firms also want to study changes occurring within the populations of different nations and regions of the world to assess their strategic implications. For example, 28 percent of Japan’s citizens are 65 or older, while the figures for the United States and China are 15 percent and 11 percent, respectively. However, the population in both countries is aging rapidly and could match that in Japan by 2040. Aging populations are a significant problem for countries because of the need for workers and the burden of supporting retirement programs. In Japan and some other countries, employees are urged to work longer to overcome these problems.
Age Structure
The most noteworthy aspect of this element of the demographic segment is that the world’s population is rapidly aging, as noted above. For example, predictions are that the number of centenarians worldwide will double by 2023 and double again by 2035. Projections suggest life expectancy will surpass 100 in some industrialized countries by the second half of this century—roughly triple the lifespan of the population in earlier years. In the 1950s, Japan’s population was one of the youngest in the world. However, 45 is now the median age in Japan, with the projection that it will be 55 by 2040. With a fertility rate that is below replacement value, another prediction is that by 2040 there will be almost as many Japanese people 100 years old or older as there are newborns. By 2050, almost 25 percent of the world’s population will be aged 65 or older. These changes in the age of the population have significant implications for availability of qualified labor, health care, retirement policies, and business opportunities among others.
This aging of the population threatens the ability of firms to hire and retain a workforce that meets their needs. Thus, firms are challenged to increase the productivity of their workers and/or to establish additional operations in other nations in order to access the potential working age population. A potential opportunity is represented by delayed retirements; older workers with extended life expectancies may need to work longer in order to eventually afford retirement. Delayed retirements may help companies to retain experienced and knowledgeable workers. In this sense, “organizations now have a fresh opportunity to address the talent gap created by a shortage of critical skills in the marketplace as well as the experience gap created by multiple waves of downsizing over the past decade.” Firms can also use their older, more experienced workers to transfer their knowledge to younger employees, helping them to quickly gain valuable skills. There is also an opportunity for firms to more effectively use the talent available in the workforce. For example, moving women into higher level professional and managerial jobs could offset the challenges created by decline in overall talent availability. And, based on research, it may even enhance overall outcomes.
Geographic Distribution
How a population is distributed within countries and regions is subject to change over time. For example, over the last few decades, the U.S. population has shifted from states in the Northeast and Great Lakes region to states in the West (California), South (Florida), and Southwest (Texas). Based on data in 2018, California’s population has grown by approximately 2.3 million since 2010, while Texas’s population has grown by 3.2 million in the same time period. These changes are characterized as moving from the “Frost Belt” to the “Sun Belt.” Outcomes from these shifts include the fact that the gross domestic product (GDP) of California in 2017 was slightly more than $2.75 trillion, an amount that makes California the sixth-largest economy in the world. In this same year, at a value of $1.6 trillion, Texas’ GDP was second to that of California.
The least popular states are Illinois, Vermont, and West Virginia, which experienced population declines between 2010 and 2018. During the same time period, the population of Connecticut, Maine, Michigan, Mississippi, Pennsylvania and Rhode Island grew less than one percent. In the coming years, California, Florida and Texas are forecasted to have the largest gains in population.
Firms want to carefully study the patterns of population distributions in countries and regions to identify opportunities and threats. Thus, in the United States, current patterns suggest the possibility of opportunities in states on the West Coast and some in the South and Southwest. In contrast, firms competing in the Northeast and Great Lakes areas may concentrate on identifying threats to their ability to operate profitably in those areas.
Of course, geographic distribution patterns differ throughout the world. For example, in past years, the majority of the population in China lived in rural areas; however, growth patterns have been shifting to urban communities such as Shanghai and Beijing. In fact, in 2006, there were 148.7 million more people living in rural areas than in urban areas in China. However, by 2016, 203.2 million more people lived in urban than in rural areas within China, a substantial shift in a only ten-year period. Recent shifts in Europe show small population gains for countries such as France, Germany, and the United Kingdom, while Greece experienced a small population decline. Overall, the geographic distribution patterns in Europe have been reasonably stable.
Ethnic Mix
The ethnic mix of countries’ populations continues to change, creating opportunities and threats for many companies as a result. For example, Hispanics have become the largest ethnic minority in the United States. In fact, the U.S. Hispanic market is the third largest “Latin American” economy behind Brazil and Mexico. Spanish is now the dominant language in parts of the United States such as Texas, California, Florida, and New Mexico. Given these facts, some firms might want to assess how their goods or services could be adapted to serve the unique needs of Hispanic consumers. Interestingly, by 2020, more than 50 percent of children in the United States will be a member of a minority ethnic group, and the population in the United States is projected to have a majority of minority ethnic members by 204
4.
And, by 2060, whites are projected to compose approximately 44 percent of the U.S. population. The ethnic diversity of the population is important not only because of consumer needs but also because of the labor force composition. Interestingly, research has shown that firms with greater ethnic diversity in their managerial team are likely to enjoy higher performance.
Additional evidence is of interest to firms when examining this segment. For example, African countries are the most ethnically diverse in the world, with Uganda having the highest ethnic diversity rating and Liberia having the second highest. In contrast, Japan and the Koreas are the least ethnically diversified in their populations. European countries are largely ethnically homogeneous while the Americas are more diverse. “From the United States through Central America down to Brazil, the ‘new world’ countries, maybe in part because of their histories of relatively open immigration (and, in some cases, intermingling between natives and new arrivals) tend to be pretty diverse.”
Income Distribution
Understanding how income is distributed within and across populations informs firms of different groups’ purchasing power and discretionary income. Of particular interest to firms are the average incomes of households and individuals. For instance, the increase in dual-career couples has had a notable effect on average incomes. Although real income has been declining in general in some nations, the household income of dual-career couples has increased, especially in the United States. These figures yield strategically relevant information for firms. For instance, research indicates that whether an employee is part of a dual-career couple can strongly influence the willingness of the employee to accept an international assignment. Worldwide it is estimated that there were almost 57 million expatriates in 2017, with Saudi Arabia, United Arab Emirates, and the United States as the top three destinations.
The growth of the economy in China has drawn many firms, not only for the low-cost production, but also because of the large potential demand for products, given its large population base. However, in recent times, the amount of China’s gross domestic product that makes up domestic consumption is the lowest of any major economy at less than one-third. In comparison, India’s domestic consumption of consumer goods accounts for two-thirds of its economy, or twice China’s level. For this reason, many western multinationals are interested in India as a consumption market as its middle class grows extensively; although India has poor infrastructure, its consumers are in a better position to spend. Because of situations such as this, paying attention to the differences between markets based on income distribution can be very important. These differences across nations suggest it is important for most firms to identify the economic systems that are most likely to produce the most income growth and market opportunities. Thus, the economic segment is a critically important focus of firms’ environmental analysis.
2-3bThe Economic Segment
The
economic environment
refers to the nature and direction of the economy in which a firm competes or may compete. In general, firms seek to compete in relatively stable economies with strong growth potential. Because nations are interconnected as a result of the global economy, firms must scan, monitor, forecast, and assess the health of their host nation as well as the health of the economies outside it.
It is challenging for firms studying the economic environment to predict economic trends that may occur and their effects on them. There are at least two reasons for this. First, the global recession of 2008 and 2009 created numerous problems for companies throughout the world, including problems of reduced consumer demand, increases in firms’ inventory levels, development of additional governmental regulations, and a tightening of access to financial resources. Second, the global recovery from the economic shock in 2008 and 2009 was persistently slow compared to previous recoveries. Firms must adjust to the economic shock and try to recover from it. And although the world economic prospects appear to be good in 2018, the recovery has been uneven across countries. For example, the economies in several European countries continue to struggle (e.g., Greece, Spain). And, perhaps partly due to political uncertainties (e.g., in the United States), there continue to be concerns about economic uncertainty. And again, according to some research, “it is clear that (economic) uncertainty has increased in recent times.” This current degree of economic uncertainty makes it challenging to develop effective strategies.
When facing economic uncertainty, firms especially want to study closely the economic environment in multiple regions and countries throughout the world. Although economic growth remains relatively weak and economic uncertainty has been strong in Europe, economic growth has been better in the United States in recent times. For example, the projected average annual economic growth in Europe for 2018–2020 is 1.75 percent, while in the United States it is 2.25 percent. Alternatively, the projected average annual economic growth for 2018–2020 is 6.3 percent in China, 7.45 percent in India, 2.25 percent in Brazil, and 2.45 percent in Mexico. These estimates highlight the anticipation of the continuing development of emerging economies. Ideally, firms will be able to pursue higher growth opportunities in regions and nations where they exist while avoiding the threats of slow growth periods in other settings.
A marijuana Budtender sorts strands of marijuana for sale at a retail and medical cannabis dispensary in Boulder, Colorado.
AP Images/Brennan Linsley
2-3cThe Political/Legal Segment
The
political/legal segment
is the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regulations guiding interactions among nations as well as between firms and various local governmental agencies. Essentially, this segment is concerned with how organizations try to influence governments and how they try to understand the influences (current and projected) of those governments on their competitive actions and responses. Commonly, firms develop a political strategy to specify how they will analyze and the political/legal to develop approaches they can take (such as lobbying efforts) to successfully deal with opportunities and threats that surface within this segment of the environment.
Regulations formed in response to new national, regional, state, and/or local laws that are legislated often influence a firm’s competitive actions and responses. For example, the state of California in the United States recently legalized the retail selling of cannabis (also known as marijuana). This action follows similar laws legalizing the sale of cannabis in other states such as Colorado and Washington. The immediate concern is the risk that firms take to invest capital in this business, given that it is unknown whether the U.S. Department of Justice will allow the states to proceed without enforcing federal law against the sale of this product. Thus, the relationship between national, regional, and local laws and regulations creates a highly complex environment within which businesses must navigate.
For interactive, technology-based firms such as Facebook, Google, and Amazon, among others, the effort in Europe to adopt the world’s strongest data protection law has significant challenges. Highly restrictive laws about consumer privacy could threaten how these firms conduct business in the European Union. Alternatively, firms must deal with quite different challenges when they operate in countries with weak formal institutions (e.g., weak legal protection of intellectual property). Laws and regulations provide structure to guide strategic and competitive actions; without such structure, it is difficult to identify the best strategic actions.
2-3dThe Sociocultural Segment
The
sociocultural segment
is concerned with a society’s attitudes and cultural values. Because attitudes and values form the cornerstone of a society, they often drive demographic, economic, political/legal, and technological conditions and changes.
Individual societies’ attitudes and cultural orientations are relatively stable, but they can and often do change over time. Thus, firms must carefully scan, monitor, forecast, and assess them to recognize and study associated opportunities and threats. Successful firms must also be aware of changes taking place in the societies and their associated cultural values in which they are competing. Indeed, firms must identify changes in cultural values, norms, and attitudes in order to “adapt to stay ahead of their competitors and stay relevant in the minds of their consumers.” Research has shown that sociocultural factors influence the entry into new markets and the development of new firms in a country.
Attitudes about and approaches to health care are being evaluated in nations and regions throughout the world. For Europe, the European Commission has developed a health care strategy for all of Europe that is oriented to preventing diseases while tackling lifestyle factors influencing health such as nutrition, working conditions, and physical activity. This Commission argues that promoting attitudes to take care of one’s health is especially important in the context of an aging Europe, as shown by the projection that the proportion of people over 65 living in Europe and in most of the developed nations throughout the world will continue to grow. At issue for business firms is that attitudes and values about health care can affect them; accordingly, they must carefully examine trends regarding health care in order to anticipate the effects on their operations.
The U.S. labor force has evolved to become more diverse, with significantly more women and minorities from a variety of cultures entering the workplace. For example, women were 46.8 percent of the workforce in 2014, a number projected to grow to 47.2 percent by 2024. Hispanics are expected to be about 20 percent of the workforce by 2024. In 2005, the total U.S. workforce was slightly greater than 148 million, and it is predicted to grow to approximately 164 million by 2024.
However, the rate of growth in the U.S. labor force has declined over the past two decades largely because of slower growth of the nation’s population and because of a downward trend in the labor force participation rate. More specifically, data show that the overall participation rate (the proportion of the civilian non-institutional population in the labor force) peaked at an annual average of 67.1 percent in 2000. But the rate has declined since that time and is expected to fall to 58.5 percent by 2050. Other changes in the U.S. labor force between 2010 and 2050 are expected. During this time, Asian membership in the labor force is projected to more than double in size, while the growth in Caucasian members of the labor force is predicted to be much slower compared to other racial groups. In contrast, people of Hispanic origin are expected to account for roughly 80 percent of the total growth in the labor force.
Healthcare is becoming increasingly important as the proportion of people older than 65 is growing larger in many nations throughout the world.
Alexander Raths/ Shutterstock.com
Greater diversity in the workforce creates challenges and opportunities, including combining the best of both men’s and women’s traditional leadership styles. Although diversity in the workforce has the potential to improve performance, research indicates that diversity initiatives must be successfully managed to reap these organizational benefits.
Although the lifestyle and workforce changes referenced previously reflect the attitudes and values of the U.S. population, each country is unique with respect to these sociocultural indicators. National cultural values affect behavior in organizations and thus also influence organizational outcomes such as differences in managerial styles. Likewise, the national culture influences a large portion of the internationalization strategy that firms pursue relative to one’s home country. Knowledge sharing is important for dispersing new knowledge in organizations and increasing the speed in implementing innovations. Personal relationships are especially important in China; the concept of guanxi (personal relationships or good connections) is important in doing business within the country and for individuals to advance their careers in what is becoming a more open market society. Understanding the importance of guanxi is critical for foreign firms doing business in China.
2-3eThe Technological Segment
Pervasive and diversified in scope, technological changes affect many parts of societies. These effects occur primarily through new products, processes, and materials. The
technological segment
includes the institutions and activities involved in creating new knowledge and translating that knowledge into new outputs, products, processes, and materials.
Given the rapid pace of technological change and risk of disruption, it is vital for firms to thoroughly study the technological segment. The importance of these efforts is shown by the fact that early adopters of new technology often achieve higher market shares and earn higher returns. Thus, both large and small firms should continuously scan the general environment to identify potential substitutes for technologies that are in current use, as well as to identify newly emerging technologies from which their firm could derive competitive advantage.
New technology and innovations are changing many industries. These changes are exemplified by the change to digital publishing (e.g., electronic books) and retail industries moving from brick and mortar stores to Internet sales. As such, firms in all industries must become more innovative in order to survive, and must develop new or at least comparable technology—and continuously improve it. In so doing, most firms must have a sophisticated information system to support their new product development efforts. In fact, because the adoption and efficient use of new technology has become critical to global competitiveness in many or most industries, countries have begun to offer special forms of support, such as the development of technology business incubators, which provide several types of assistance to increase the success rate of new technology ventures.
As a significant technological development, the Internet offers firms a remarkable capability in terms of their efforts to scan, monitor, forecast, and assess conditions in their general environment. Companies continue to study the Internet’s capabilities to anticipate how it may allow them to create more value for customers and to anticipate future trends. Additionally, the Internet generates a significant number of opportunities and threats for firms across the world. As noted earlier, there are approximately 4 billion Internet users globally.
Despite the Internet’s far-reaching effects and the opportunities and threats associated with its potential, wireless communication technology has become a significant technological opportunity for companies. Handheld devices and other wireless communications equipment are used to access a variety of network-based services. The use of handheld computers (of many types) with wireless network connectivity has become the dominant form of communication and commerce, and additional functionalities and software applications are generating multiple opportunities—and potential threats—for companies of all types.
2-3fThe Global Segment
The
global segment
includes relevant new global markets and their critical cultural and institutional characteristics, existing markets that are changing, and important international political events. For example, firms competing in the automobile industry must study the global segment. The fact that consumers in multiple nations are willing to buy cars and trucks “from whatever area of the world” supports this position.
When studying the global segment, firms should recognize that globalization of business markets may create opportunities to enter new markets, as well as threats that new competitors from other economies may also enter their market. In terms of an opportunity for automobile manufacturers, the possibility for these firms to sell their products outside of their home market would seem attractive. But what markets might firms choose to enter? Currently, automobile and truck sales are expected to increase in Brazil, Russia, India, China, and Eastern Europe. In contrast, sales are expected to decline, at least in the near term, in the United States, Western Europe, and Japan. These markets, then, are the most and least attractive ones for automobile manufacturers desiring to sell outside their domestic market. At the same time, from the perspective of a threat, Japan, Germany, Korea, Spain, France, and the United States appear to have excess production capacity in the automobile manufacturing industry. In turn, overcapacity signals the possibility that companies based in markets where this is the case will simultaneously attempt to increase their exports as well as sales in their domestic market. Thus, global automobile manufacturers should carefully examine the global segment to precisely identify all opportunities and threats.
In light of threats associated with participating in international markets, some firms choose to take a more cautious approach to globalization. For example, family business firms, even the larger ones, often take a conservative approach to entering international markets in a manner very similar to how they approach the development and introduction of new technology. They try to manage their risk. These firms participate in what some refer to as globalfocusing. Globalfocusing often is used by firms with moderate levels of international operations who increase their internationalization by focusing on global niche markets. This approach allows firms to build onto and use their core competencies while limiting their risks within the niche market. Another way in which firms limit their risks in international markets is to focus their operations and sales in one region of the world. Success with these efforts finds a firm building relationships in and knowledge of its markets. As the firm builds these strengths, rivals find it more difficult to enter its markets and compete successfully.
Firms competing in global markets should recognize each market’s sociocultural and institutional attributes. For example, Korean ideology emphasizes communitarianism, a characteristic of many Asian countries. Alternatively, the ideology in China calls for an emphasis on guanxi—personal connections—while in Japan, the focus is on wa—group harmony and social cohesion. The institutional context of China suggests a major emphasis on centralized planning by the government. The Chinese government provides incentives to firms to develop alliances with foreign firms having sophisticated technology, in hopes of building knowledge and introducing new technologies to the Chinese markets over time. As such, it is important to analyze the strategic intent of foreign firms when pursuing alliances and joint ventures abroad, especially where the local partners are receiving technology that may in the long run reduce the foreign firms’ advantages.
Increasingly, the informal economy as it exists throughout the world is another aspect of the global segment requiring analysis. Growing in size, this economy has implications for firms’ competitive actions and responses in that increasingly, firms competing in the formal economy will find that they are competing against informal economy companies as well.
2-3gThe Sustainable Physical Environment Segment
The
sustainable physical environment segment
refers to potential and actual changes in the physical environment and business practices that are intended to positively respond to those changes in order to create a sustainable environment. Concerned with trends oriented to sustaining the world’s physical environment, firms recognize that ecological, social, and economic systems interactively influence what happens in this particular segment and that they are part of an interconnected global society.
Companies across the globe are concerned about the physical environment, and many record the actions they are taking in reports with names such as “Sustainability” and “Corporate Social Responsibility.” Moreover, and in a comprehensive sense, an increasing number of companies are investing in sustainable development.
There are many parts or attributes of the physical environment that firms consider as they try to identify trends in the physical environment. Because of the importance to firms of becoming sustainable, certification programs have been developed to help them understand how to be sustainable organizations. As the world’s largest retailer, Walmart’s environmental footprint is huge, meaning that trends in the physical environment can significantly affect this firm and how it chooses to operate. Because of this, Walmart’s goal is to produce zero waste and to use 100 percent renewable energy to power its operations. Environmental sustainability is important to all societal citizens and because of its importance, customers react more positively to firms taking actions such as those by Walmart. To build and maintain sustainable operations in companies that directly service retail customers requires sustainable supply chain management practices. Thus, top managers must focus on managing any of the firm’s practices that have effects on the physical environment. In doing so, they not only contribute to a cleaner environment but also reap financial rewards from being an effective competitor due to positive customer responses.
As our discussion of the general environment shows, identifying anticipated changes and trends among segments and their elements is a key objective of analyzing this environment. With a focus on the future, the analysis of the general environment allows firms to identify opportunities and threats. It is necessary to have a top management team with the experience, knowledge, and sensitivity required to effectively analyze the conditions in a firm’s general environment—as well as other facets such as the industry environment and competitors. In fact, as you noted in the Strategic Focus on Target, the lack of a commitment to analyzing the environment in depth can have serious, company-wide ramifications.
Strategic Focus
Target (Tar-zhey) Is Trying to Navigate in a New and Rapidly Changing Competitive Landscape
Target became known by consumers as Tar-zhey, the retailer of cheaper but ‘chic’ products. The firm offered a step up in quality goods at a slightly higher price than discount retailers such as Walmart, but was targeted below major, first line retailers such Macy’s and Nordstrom. Additionally, it promoted its stores to offer one-stop shopping with clothing, toys, health products, and food goods, among other products. For many years, Tar-zhey “hit the bullseye” and performed well serving this large niche in the market. But the company took its eye off the target and began losing market share (along with other poor strategic actions).
The first major crack in the ship appeared with the announcement of a massive cyberattack on Target’s computer system that netted customers’ personal information. Not only was this a public relations disaster, it drew a focus on Target that identified other problems. For example, careful analysis showed that Target was losing customers to established competitors and new rivals, especially Internet retailers (e.g., Amazon.com).
Target’s marketing chief stated that “it’s not that we became insular. We were insular.” This suggests that the firm was not analyzing its environment. By allowing rivals, and especially Internet competitors, to woo the company’s customers, it lost sales, market share, and profits. It obviously did not predict and prepare for the significant competition from Internet rivals that is now reshaping most all retail industries. Competitors were offering better value to customers (perhaps more variety and convenience through online sales). Thus, Target’s reputation and market share were simultaneously harmed.
Because of all the problems experienced, Target hired a new CEO, Brian Cornell, in 2014. Cornell has made a number of changes, but the continued revolution in the industry, largely driven by Amazon, continued to gnaw away Target’s annual sales. Target’s annual sales declined by approximately 5 percent in 2017 and its stock price suffered as a result. Target was forced to develop a new strategy, which involves a major rebranding. It launched four new brands late in 2017, including A New Day, a fashionable line of women’s clothes, and Goodfellow & Co, a modern line of menswear, with the intent to make an emotional connection with customers. It also plans to remodel 100 of its stores and change in-store displays to improve customer experiences. It will add 30 small stores that offer innovative designs and, to compete with Amazon, is emphasizing its digital sales and delivery of products. Up to now its digital strategy has not been highly successful, so it is narrowing its focus to increase its effectiveness.
Goodfellow & Co menswear, a new line introduced by Target in late 2017.
Glen Stubbe/ZUMA Press/Minneapolis/Minnesota/USA
Target plans to discontinue several major brands by 2019 and will continue to introduce new brands (12 in total are planned). The intent is to increase the appeal of Target and its products to millennials. These actions alone suggest the importance of gathering and analyzing data on the market and competitors’ actions. The next few years will show the fruits of all of Target’s changes. If they are successful, Target will still face substantial competition from Amazon and Walmart; if they are not successful, Target suffer the same fate of of many other large and formerly successful retailers that no exist.
Sources: A. Pasquarelli, 2017, Our strategy is working: Target plows into the holidays, AdAge, http://adage.com, October 19; S. Heller, 2017, Target’s biggest brands are about to disappear from stores, The Insider, www.theinsider.com, July 6; 2017, Rebranding its wheel: Target’s new strategy, Seeking Alpha, http://seekingalpha.com, July 4;K. Safdar, 2017, Target’s new online strategy: Less is more, Wall Street Journal, www.wsj.com, May 15; 2015, What your new CEO is reading: Smell ya later; Target’s new CEO, CIO Journal/Wall Street Journal, www.wsj.com/cio, March 6; J. Reingold, 2014, Can Target’s new CEO get the struggling retailer back on target? Fortune, www.fortune.com, July 31; G. Smith, 2014, Target turns to PepsiCo’s Brian Cornell to restore its fortunes, Fortune, www.fortune.com, July 31; P. Ziobro, M. Langley, & J. S. Lublin, 2014, Target’s problem: Tar-zhey isn’t working. Wall Street Journal, www.wsj.com, May 5.
As described in the Strategic Focus, Target failed to maintain a good understanding of its industry and hence, lost market share to Internet company rivals and other more established competitors. We conclude that critical to a firm’s choices of strategies and their associated competitive actions and responses is an understanding of its industry environment, its competitors, and the general environment of the countries in which it operates. Next, we discuss the analyses firms complete to gain such an understanding.
2-4Industry Environment Analysis
An
industry
is a group of firms producing products that are close substitutes. In the course of competition, these firms influence one another. Typically, companies use a rich mix of different competitive strategies to pursue above-average returns when competing in a particular industry. An industry’s structural characteristics influence a firm’s choice of strategies.
Compared with the general environment, the industry environment (measured primarily in the form of its characteristics) has a more direct effect on the competitive actions and responses a firm takes to succeed. To study an industry, the firm examines five forces that affect the ability of all firms to operate profitably within a given industry. Shown in
Figure 2.2
, the five forces are: the threats posed by new entrants, the power of suppliers, the power of buyers, product substitutes, and the intensity of rivalry among competitors.
Figure 2.2The Five Forces of Competition Model
The five forces of competition model depicted in Figure 2.2 expands the scope of a firm’s competitive analysis. Historically, when studying the competitive environment, firms concentrated on companies with which they directly competed. However, firms must search more broadly to recognize current and potential competitors by identifying potential customers as well as the firms serving them. For example, the communications industry is now broadly defined as encompassing media companies, telecoms, entertainment companies, and companies producing devices such as smartphones. In such an environment, firms must study many other industries to identify companies with capabilities (especially technology-based capabilities) that might be the foundation for producing a good or a service that can compete against what they are producing.
When studying the industry environment, firms must also recognize that suppliers can become a firm’s competitors (by integrating forward) as can buyers (by integrating backward). For example, several firms have integrated forward in the pharmaceutical industry by acquiring distributors or wholesalers. In addition, firms choosing to enter a new market and those producing products that are adequate substitutes for existing products can become a company’s competitors.
Next, we examine the five forces the firm needs to analyze in order to understand the profitability potential within an industry (or a segment of an industry) in which it competes or may choose to compete.
Main content
2-4aThreat of New Entrants
Identifying new entrants is important because they can threaten the market share of existing competitors. One reason new entrants pose such a threat is that they bring additional production capacity. Unless the demand for a good or service is increasing, additional capacity holds consumers’ costs down, resulting in less revenue and lower returns for competing firms. Often, new entrants have a keen interest in gaining a large market share. As a result, new competitors may force existing firms to be more efficient and to learn how to compete in new dimensions (e.g., using an Internet-based distribution channel).
The likelihood that firms will enter an industry is a function of two factors: barriers to entry and the retaliation expected from current industry participants. Entry barriers make it difficult for new firms to enter an industry and often place them at a competitive disadvantage even when they can enter. As such, high entry barriers tend to increase the returns for existing firms in the industry and may allow some firms to dominate the industry. Thus, firms competing successfully in an industry want to maintain high entry barriers to discourage potential competitors from deciding to enter the industry.
Barriers to Entry
Firms competing in an industry (and especially those earning above-average returns) try to develop entry barriers to thwart potential competitors. In general, more is known about entry barriers (with respect to how they are developed as well as paths firms can pursue to overcome them) in industrialized countries such as those in North America and Western Europe. In contrast, relatively little is known about barriers to entry in the rapidly emerging markets such as those in China.
There are different kinds of barriers to entering a market to consider when examining an industry environment. Companies competing within a particular industry study these barriers to determine the degree to which their competitive position reduces the likelihood of new competitors being able to enter the industry to compete against them. Firms considering entering an industry study entry barriers to determine the likelihood of being able to identify an attractive competitive position within the industry. Next, we discuss several significant entry barriers that may discourage competitors from entering a market and that may facilitate a firm’s ability to remain competitive in a market in which it currently competes.
Economies of Scale Economies of scale are derived from incremental efficiency improvements through experience as a firm grows larger. Therefore, the cost of producing each unit declines as the quantity of a product produced during a given period increases. A new entrant is unlikely to quickly generate the level of demand for its product that in turn would allow it to develop economies of scale.
Economies of scale can be developed in most business functions, such as marketing, manufacturing, research and development, and purchasing. Firms sometimes form strategic alliances or joint ventures to gain scale economies. And, other firms acquire rivals in order to build economies of scale in the operations and to increase their market share as well.
Becoming more flexible in terms of being able to meet shifts in customer demand is another benefit for an industry incumbent and a possible entry barrier for the firms considering entering the industry. For example, a firm may choose to reduce its price with the intention of capturing a larger share of the market. Alternatively, it may keep its price constant to increase profits. In so doing, it likely will increase its free cash flow, which is very helpful during financially challenging times.
Some competitive conditions reduce the ability of economies of scale to create an entry barrier such as the use of scale free resources. Also, many companies now customize their products for large numbers of small customer groups. In these cases, customized products are not manufactured in the volumes necessary to achieve economies of scale. Customization is made possible by several factors, including flexible manufacturing systems. In fact, the new manufacturing technology facilitated by advanced information systems has allowed the development of mass customization in an increasing number of industries. Online ordering has enhanced customers’ ability to buy customized products. Companies manufacturing customized products can respond quickly to customers’ needs in lieu of developing scale economies.
Product Differentiation Over time, customers may come to believe that a firm’s product is unique. This belief can result from the firm’s service to the customer, effective advertising campaigns, or being the first to market a good or service. Greater levels of perceived product uniqueness create customers who consistently purchase a firm’s products. To combat the perception of uniqueness, new entrants frequently offer products at lower prices. This decision, however, may result in lower profits or even losses.
The Coca-Cola Company and PepsiCo have established strong brands in the markets in which they compete, and these companies compete against each other in countries throughout the world. Because each of these competitors has allocated a significant amount of resources over many decades to build its brands, customer loyalty is strong for each firm. When considering entry into the soft drink market, a potential entrant would be well advised to pause and determine actions it would take to try to overcome the brand image and consumer loyalty each of these giants possesses.
Capital Requirements Competing in a new industry requires a firm to have resources to invest. In addition to physical facilities, capital is needed for inventories, marketing activities, and other critical business functions. Even when a new industry is attractive, the capital required for successful market entry may not be available to pursue the market opportunity. For example, defense industries are difficult to enter because of the substantial resource investments required to be competitive. In addition, because of the high knowledge requirements of the defense industry, a firm might acquire an existing company as a means of entering this industry, but it must have access to the capital necessary to do this.
Switching Costs Switching costs are the one-time costs customers incur when they buy from a different supplier. The costs of buying new ancillary equipment and of retraining employees, and even the psychological costs of ending a relationship, may be incurred in switching to a new supplier. In some cases, switching costs are low, such as when the consumer switches to a different brand of soft drink. Switching costs can vary as a function of time, as shown by the fact that in terms of credit hours toward graduation, the cost to a student to transfer from one university to another as a freshman is much lower than it is when the student is entering the senior year.
Occasionally, a decision made by manufacturers to produce a new, innovative product creates high switching costs for customers. Customer loyalty programs, such as airlines’ frequent flyer miles, are intended to increase the customer’s switching costs. If switching costs are high, a new entrant must offer either a substantially lower price or a much better product to attract buyers. Usually, the more established the relationships between parties, the greater the switching costs.
Access to Distribution Channels Over time, industry participants commonly learn how to effectively distribute their products. After building a relationship with its distributors, a firm will nurture it, thus creating switching costs for the distributors. Access to distribution channels can be a strong entry barrier for new entrants, particularly in consumer nondurable goods industries (e.g., in grocery stores where shelf space is limited) and in international markets. New entrants have to persuade distributors to carry their products, either in addition to or in place of those currently distributed. Price breaks and cooperative advertising allowances may be used for this purpose; however, those practices reduce the new entrant’s profit potential. Interestingly, access to distribution is less of a barrier for products that can be sold on the Internet.
Cost Disadvantages Independent of Scale Sometimes, established competitors have cost advantages that new entrants cannot duplicate. Proprietary product technology, favorable access to raw materials, desirable locations, and government subsidies are examples. Successful competition requires new entrants to reduce the strategic relevance of these factors. For example, delivering purchases directly to the buyer can counter the advantage of a desirable location; new food establishments in an undesirable location often follow this practice. Spanish clothing company Zara is owned by Inditex, the largest fashion clothing retailer in the world. From the time of its launching, Zara relied on classy, well-tailored, and relatively inexpensive items that were produced and sold by adhering to ethical practices to successfully enter the highly competitive global clothing market and overcome that market’s entry barriers. It is successful because it has used a novel business model in the industry. It also sells quality merchandise for less, offers good stores and store locations, and is well positioned in the industry. Business model innovation may be the key to survival and success in current retail industries.
Government Policy Through their decisions about issues such as the granting of licenses and permits, governments can also control entry into an industry. Liquor retailing, radio and TV broadcasting, banking, and trucking are examples of industries in which government decisions and actions affect entry possibilities. Also, governments often restrict entry into some industries because of the need to provide quality service or the desire to protect jobs. Alternatively, deregulating industries, such as the airline and utilities industries in the United States, generally results in additional firms choosing to enter and compete within an industry. It is not uncommon for governments to attempt to regulate the entry of foreign firms, especially in industries considered critical to the country’s economy or important markets within it. Governmental decisions and policies regarding antitrust issues also affect entry barriers. For example, in the United States, the Antitrust Division of the Justice Department or the Federal Trade Commission will sometimes disallow a proposed merger because officials conclude that approving it would create a firm that is too dominant in an industry and would thus create unfair competition. For example, the U.S. Department of Justice filed a suit in 2017 to block the merger of AT&T and Time Warner with the trial initiated in March 2018. The actions of the Department of Justice were unsuccessful and in June 2018, the merger was approved and completed. Such a negative ruling would obviously be an entry barrier for an acquiring firm.
Expected Retaliation
Companies seeking to enter an industry also anticipate the reactions of firms in the industry. An expectation of swift and vigorous competitive responses reduces the likelihood of entry. Vigorous retaliation can be expected when the existing firm has a major stake in the industry (e.g., it has fixed assets with few, if any, alternative uses), when it has substantial resources, and when industry growth is slow or constrained. For example, any firm attempting to enter the airline industry can expect significant retaliation from existing competitors due to overcapacity.
Locating market niches not being served by incumbents allows the new entrant to avoid entry barriers. Small entrepreneurial firms are generally best suited for identifying and serving neglected market segments. When Honda first entered the U.S. motorcycle market, it concentrated on small-engine motorcycles, a market that firms such as Harley-Davidson ignored. By targeting this neglected niche, Honda initially avoided a significant amount of head-to-head competition with well-established competitors. After consolidating its position, Honda used its strength to attack rivals by introducing larger motorcycles and competing in the broader market.
2-4bBargaining Power of Suppliers
Increasing prices and reducing the quality of their products are potential means suppliers use to exert power over firms competing within an industry. If a firm is unable to recover cost increases by its suppliers through its own pricing structure, its profitability is reduced by its suppliers’ actions. A supplier group is powerful when:
· It is dominated by a few large companies and is more concentrated than the industry to which it sells.
· Satisfactory substitute products are not available to industry firms.
· Industry firms are not a significant customer for the supplier group.
· Suppliers’ goods are critical to buyers’ marketplace success.
· The effectiveness of suppliers’ products has created high switching costs for industry firms.
· It poses a credible threat to integrate forward into the buyers’ industry. Credibility is enhanced when suppliers have substantial resources and provide a highly differentiated product.
Honda’s entry into the large motorcycle market is changing the competitive landscape especially for the traditional competitors in this market such as Harley-Davidson.
DWImages Northern Ireland/Alamy Stock Photo
Some buyers attempt to manage or reduce suppliers’ power by developing a long-term relationship with them. Although long-term arrangements reduce buyer power, they also increase the suppliers’ incentive to be helpful and cooperative in appreciation of the longer-term relationship (guaranteed sales). This is especially true when the partners develop trust in one another.
The airline industry is one in which suppliers’ bargaining power is changing. Though the number of suppliers is low, the demand for major aircraft is also relatively low. Boeing and Airbus aggressively compete for orders of major aircraft, creating more power for buyers in the process. When a large airline signals that it might place a “significant” order for wide-body airliners that either Airbus or Boeing might produce, both companies are likely to battle for the business and include a financing arrangement, highlighting the buyer’s power in the potential transaction. And, with China’s entry into the large commercial airliner industry, buyer power has increased.
2-4cBargaining Power of Buyers
Firms seek to maximize the return on their invested capital. Alternatively, buyers (customers of an industry or a firm) want to buy products at the lowest possible price—the point at which the industry earns the lowest acceptable rate of return on its invested capital. To reduce their costs, buyers bargain for higher quality, greater levels of service, and lower prices. These outcomes are achieved by encouraging competitive battles among the industry’s firms. Customers (buyer groups) are powerful when:
· They purchase a large portion of an industry’s total output.
· The sales of the product being purchased account for a significant portion of the seller’s annual revenues.
· They could switch to another product at little, if any, cost.
· The industry’s products are undifferentiated or standardized, and the buyers pose a credible threat if they were to integrate backward into the sellers’ industry.
Consumers armed with greater amounts of information about the manufacturer’s costs and the power of the Internet as a shopping and distribution alternative have increased bargaining power in many industries. 2-4dThreat of Substitute Products
Substitute products are goods or services from outside a given industry that perform similar or the same functions as a product that the industry produces. For example, as a sugar substitute, NutraSweet (and other sugar substitutes) places an upper limit on sugar manufacturers’ prices—NutraSweet and sugar perform the same function, though with different characteristics. Other product substitutes include e-mail and fax machines instead of overnight deliveries, plastic containers rather than glass jars, and tea instead of coffee.
Newspaper firms have experienced significant circulation declines over the past 20 years. The declines are a result of the ready availability of substitute outlets for news including Internet sources and cable television news channels, along with e-mail and cell phone alerts. Likewise, satellite TV and cable and telecommunication companies provide substitute services for basic media services such as television, Internet, and phone. The many electronic devices that provide services overlapping with the personal computer (e.g., laptops) such as tablets, watches (iWatch), etc. are changing markets for PCs, with multiple niches in the market.
In general, product substitutes present a strong threat to a firm when customers face few if any switching costs and when the substitute product’s price is lower or its quality and performance capabilities are equal to or greater than those of the competing product. Interestingly, some firms that produce substitutes have begun forming brand alliances, which research shows can be effective when the two products are of relatively equal quality. If there is a differential in quality, the firm with the higher quality product will obtain lower returns from such an alliance. Differentiating a product along dimensions that are valuable to customers (such as quality, service after the sale, and location) reduces a substitute’s attractiveness.
2-4eIntensity of Rivalry among Competitors
Because an industry’s firms are mutually dependent, actions taken by one company usually invite responses. Competitive rivalry intensifies when a firm is challenged by a competitor’s actions or when a company recognizes an opportunity to improve its market position.
Firms within industries are rarely homogeneous; they differ in resources and capabilities and seek to differentiate themselves from competitors. Typically, firms seek to differentiate their products from competitors’ offerings in ways that customers value and in which the firms have a competitive advantage. Common dimensions on which rivalry is based include price, service after the sale, and innovation. More recently, firms have begun to act quickly (speed a new product to the market) in order to gain a competitive advantage.
Next, we discuss the most prominent factors that experience shows affect the intensity of rivalries among firms.
Numerous or Equally Balanced Competitors
Intense rivalries are common in industries with many companies. With multiple competitors, it is common for a few firms to believe they can act without eliciting a response. However, evidence suggests that other firms generally are aware of competitors’ actions, often choosing to respond to them. At the other extreme, industries with only a few firms of equivalent size and power also tend to have strong rivalries. The large and often similar-sized resource bases of these firms permit vigorous actions and responses. The competitive battles between Airbus and Boeing and between Coca-Cola and PepsiCo exemplify intense rivalry between relatively equal competitors.
Slow Industry Growth
When a market is growing, firms try to effectively use resources to serve an expanding customer base. Markets increasing in size reduce the pressure to take customers from competitors. However, rivalry in no-growth or slow-growth markets becomes more intense as firms battle to increase their market shares by attracting competitors’ customers. Certainly, this has been the case in the fast-food industry as explained in the Opening Case about McDonald’s. McDonald’s, Wendy’s, and Burger King use their resources, capabilities, and core competencies to try to win each other’s customers. The instability in the market that results from these competitive engagements may reduce the profitability for all firms engaging in such battles. As noted in the Opening Case, McDonald’s has suffered from this competitive rivalry but is taking actions to rebuild its customer base and achieve a competitive advantage or at least competitive parity.
High Fixed Costs or High Storage Costs
When fixed costs account for a large part of total costs, companies try to maximize the use of their productive capacity. Doing so allows the firm to spread costs across a larger volume of output. However, when many firms attempt to maximize their productive capacity, excess capacity is created on an industry-wide basis. To then reduce inventories, individual companies typically cut the price of their product and offer rebates and other special discounts to customers. However, doing this often intensifies competition. The pattern of excess capacity at the industry level followed by intense rivalry at the firm level is frequently observed in industries with high storage costs. Perishable products, for example, lose their value rapidly with the passage of time. As their inventories grow, producers of perishable goods often use pricing strategies to sell products quickly.
Lack of Differentiation or Low Switching Costs
When buyers find a differentiated product that satisfies their needs, they frequently purchase the product loyally over time. Industries with many companies that have successfully differentiated their products have less rivalry, resulting in lower competition for individual firms. Firms that develop and sustain a differentiated product that cannot be easily imitated by competitors often earn higher returns. However, when buyers view products as commodities (i.e., as products with few differentiated features or capabilities), rivalry intensifies. In these instances, buyers’ purchasing decisions are based primarily on price and, to a lesser degree, service. Personal computers are a commodity product, and the cost to switch from a computer manufactured by one firm to another is low. Thus, the rivalry among Dell, Hewlett-Packard, Lenovo, and other computer manufacturers is strong as these companies consistently seek to find ways to differentiate their offerings.
High Strategic Stakes
Competitive rivalry is likely to be high when it is important for several of the competitors to perform well in the market. Competing in diverse businesses (such as petrochemicals, fashion, medicine, and plant construction, among others), Samsung is a formidable foe for Apple in the global smartphone market. Samsung has committed a significant amount of resources to develop innovative products as the foundation for its efforts to try to outperform Apple in selling this particular product. Only a few years ago, Samsung held a sizable lead in market share. But in 2017, in the U.S. market, it was estimated that the iPhone achieved a holiday period market share of 31.3 percent while Samsung’s Galaxy held 28.9 percent. Overall, these firms are in a virtual dead heat in the smartphone market. Because this market is extremely important to both firms, the smart-phone rivalry between them (and others) will likely remain quite intense.
High strategic stakes can also exist in terms of geographic locations. For example, several automobile manufacturers have established manufacturing facilities in China, which has been the world’s largest car market since 2009. Because of the high stakes involved in China for General Motors and other firms (including domestic Chinese automobile manufacturers) producing luxury cars (including Audi, BMW, and Mercedes-Benz), rivalry among them in this market is quite intense.
High Exit Barriers
Sometimes companies continue competing in an industry even though the returns on their invested capital are low or even negative. Firms making this choice likely face high exit barriers, which include economic, strategic, and emotional factors causing them to remain in an industry when the profitability of doing so is questionable.
Common exit barriers that firms face include the following:
· Specialized assets (assets with values linked to a business or location)
· Fixed costs of exit (such as labor agreements)
· Strategic interrelationships (relationships of mutual dependence, such as those between one business and other parts of a company’s operations, including shared facilities and access to financial markets)
· Emotional barriers (aversion to economically justified business decisions because of fear for one’s own career, loyalty to employees, and so forth)
· Government and social restrictions (often based on government concerns for job losses and regional economic effects; more common outside the United States)
Exit barriers are especially high in the airline industry. Fortunately, profitability has returned to the industry following the global financial crisis and is expected to reach its highest level in 2018. Industry consolidation and efficiency enhancements regarding airline alliances helped reduce airline companies’ costs. This, combined with improving economic conditions in several countries, resulted in a greater demand for travel. This has helped eased the pressures on several firms that may have been contemplating leaving the airline travel industry.
2-5Interpreting Industry Analyses
Effective industry analyses are products of careful study and interpretation of data and information from multiple sources. A wealth of industry-specific data is available for firms to analyze to better understand an industry’s competitive realities. Because of globalization, international markets and rivalries must be included in the firm’s analyses. And, because of the development of global markets, a country’s borders no longer restrict industry structures. In fact, in general, entering international markets enhances the chances of success for new ventures as well as more established firms.
Analysis of the five forces within a given industry allows the firm to determine the industry’s attractiveness in terms of the potential to earn average or above-average returns. In general, the stronger the competitive forces, the lower the potential for firms to generate profits by implementing their strategies. An unattractive industry has low entry barriers, suppliers and buyers with strong bargaining positions, strong competitive threats from product substitutes, and intense rivalry among competitors. These industry characteristics make it difficult for firms to achieve strategic competitiveness and earn above-average returns. Alternatively, an attractive industry has high entry barriers, suppliers and buyers with little bargaining power, few competitive threats from product substitutes, and relatively moderate rivalry. Next, we explain strategic groups as an aspect of industry competition.
2-6Strategic Groups
A set of firms emphasizing similar strategic dimensions and using a similar strategy is called a
strategic group
. The competition between firms within a strategic group is greater than the competition between a member of a strategic group and companies outside that strategic group. Therefore, intra-strategic group competition is more intense than is inter-strategic group competition. In fact, more heterogeneity is evident in the performance of firms within strategic groups than across the groups. The performance leaders within groups can follow strategies similar to those of other firms in the group and yet maintain strategic distinctiveness as a foundation for earning above-average returns.
The extent of technological leadership, product quality, pricing policies, distribution channels, and customer service are examples of strategic dimensions that firms in a strategic group may treat similarly. Thus, membership in a strategic group defines the essential characteristics of the firm’s strategy.
The notion of strategic groups can be useful for analyzing an industry’s competitive structure. Such analyses can be helpful in diagnosing competition, positioning, and the profitability of firms competing within an industry. High mobility barriers, high rivalry, and low resources among the firms within an industry limit the formation of strategic groups. However, after strategic groups are formed, their membership remains relatively stable over time. Using strategic groups to understand an industry’s competitive structure requires the firm to plot companies’ competitive actions and responses along strategic dimensions, such as pricing decisions, product quality, distribution channels, and so forth. This type of analysis shows the firm how certain companies are competing similarly in terms of how they use similar strategic dimensions.
Strategic groups have several implications. First, because firms within a group offer similar products to the same customers, the competitive rivalry among them can be intense. The more intense the rivalry, the greater the threat to each firm’s profitability. Second, the strengths of the five forces differ across strategic groups. Third, the closer the strategic groups are in terms of their strategies, the greater is the likelihood of rivalry between the groups.
Strategic Focus
Toys ‘R’ Us Exemplifies the Apocalypse in the Retail Industries
More than 10,000 stores closed in the United States in 2017. The companies that have gone bankrupt or are in serious financial trouble read like a list of Who’s Who in retailing, The ones that could default in the near term include Sears, Neiman Marcus, Payless, J. Crew, PetSmart, and Steak ‘n Shake, among others. But, perhaps the bankruptcy of Toys ‘R’ Us in 2018 caused the most angst among consumers because they remember what it used to be and know what it could have been.
Toys ‘R’ Us was a dominant retailer of toys that had devoted customers and toy manufacturers. The stores had every conceivable toy and became a ‘one-stop-shopping destination’ for most parents. It also reached out to and fostered the development of many small and medium sized toy manufacturers who largely owed their existence to Toys ‘R’ Us. At one time it was perhaps the most significant toy retailer in the world. As it grew, many of its competitors went out of business. Yet, after the founder stepped down from the CEO position, a succession of CEOs became complacent. Toys ‘R’ Us stopped analyzing its competitors, didn’t invest in and update its stores, and began to lose the devotion of its customers. This made it vulnerable to new competition. Essentially, by ignoring competition and maintaining the status quo, it let competitors take advantage by better serving its customer base.
Large retailers such as Walmart and Target began to grow their toy sales and take market share away from Toys ‘R’ Us. And then Internet sales began to take market share. To respond, Toys ‘R’ Us signed an exclusive agreement to sell its toys over the Internet with Amazon. The contract was expensive (about $50 million annually), and Amazon did not only sell the toys from Toys ‘R’ Us. In fact, Amazon created an Internet marketplace selling multiple brands’ and companies’ toys. As such, Toy ‘R’ Us paid Amazon to become a substantial competitor.
Toys ‘R’ Us filed for bankruptcy in 2018, closing all of its stores.
Andrew Harrer/Bloomberg/Getty Images
At the height of these problems, Toys ‘R’ Us was sold to private equity investors who completed a leveraged buyout that saddled the company with substantial debt. With large debt payments, fewer resources were available to invest in the stores and to respond to competitors. Thus, in 2018 it filed for bankruptcy, closing all of its stores.
The exit of Toys ‘R’ Us leaves its two biggest competitors, Walmart and Amazon, now locked in a rivalry of their own.
Sources: H. Peterson, 2018, Retailers are filing for bankruptcy at a staggering rate—and these 19 companies could be the next to default. Business Insider, www.msn.com, March 18; 2018, Toys R Us built a kingdom and the world’s biggest toy store. Then, they lost it, MSN, www.msn.com, March 17; 2018, Nostalgic shoppers shed tears over Toys ‘R’ Us demise, CNBC, wwwcnbc.com, March 15; M. Corkery, 2018, Toys ‘R’ Us case is test of private equity in age of Amazon, New York Times, nyti.ms/2DvabV5, March 15; M. Boyle, K. Bhasin & L. Rupp, 2018, Walmart-Amazon battle takes to Manhattan with dueling showcases, Bloomberg, Bloomberg.com, February 28; K Taylor, 2017, Here are the 18 biggest bankruptcies of the ‘retail apocalypse’ of 2017, Business Insider, www.businessinsider.com, December 20.
As explained in the Strategic Focus, there is a massive ‘train wreck’ occurring in the retail industries. Former stalwarts such as Sears, Macy’s, JCPenney, and Toys ‘R’ Us are all failing, largely because they ignored competition and it eventually caught up to them. Although other rivals began to erode their market share, the current problem revolves around the formidable Amazon. Amazon has been winning competitive battles against these weakened retailers, and even against other more formidable rivals Google and Walmart. Toys ‘R’ Us sowed the seeds of its demise a number of years ago by ignoring its competition. It was dominant in its industry, and then focused on growing its store base while paying little or no attention to what new competitors were doing. In fact, unknowingly it helped Amazon become a major competitor. The lesson in this for Amazon is that even highly successful firms must continuously analyze and understand their competitors if they are to maintain their current market leading positions. If Amazon continues to effectively analyze its competition across industries, the question becomes, can any of its rivals beat it?
2-7Competitor Analysis
The competitor environment is the final part of the external environment requiring study. Competitor analysis focuses on each company against which a firm competes directly. The Coca-Cola Company and PepsiCo, Home Depot and Lowe’s, Carrefour SA and Tesco PLC, and Amazon and Google are examples of competitors that are keenly interested in understanding each other’s objectives, strategies, assumptions, and capabilities. Indeed, intense rivalry creates a strong need to understand competitors. In a competitor analysis, the firm seeks to understand the following:
· What drives the competitor, as shown by its future objectives.
· What the competitor is doing and can do, as revealed by its current strategy.
· What the competitor believes about the industry, as shown by its assumptions.
· What the competitor’s capabilities are, as shown by its strengths and weaknesses.
Knowledge about these four dimensions helps the firm prepare an anticipated response profile for each competitor (see
Figure 2.3
). The results of an effective competitor analysis help a firm understand, interpret, and predict its competitors’ actions and responses. Understanding competitors’ actions and responses clearly contributes to the firm’s ability to compete successfully within the industry. Interestingly, research suggests that executives often fail to analyze competitors’ possible reactions to competitive actions their firm takes, placing their firm at a potential competitive disadvantage as a result.
Figure 2.3Competitor Analysis Components
Critical to an effective competitor analysis is gathering data and information that can help the firm understand its competitors’ intentions and the strategic implications resulting from them. Useful data and information combine to form
competitor intelligence
, which is the set of data and information the firm gathers to better understand and anticipate competitors’ objectives, strategies, assumptions, and capabilities. In competitor analysis, the firm gathers intelligence not only about its competitors, but also regarding public policies in countries around the world. Such intelligence facilitates an understanding of the strategic posture of foreign competitors. Through effective competitive and public policy intelligence, the firm gains the insights needed to make effective strategic decisions regarding how to compete against rivals.
When asked to describe competitive intelligence, phrases such as “competitive spying” and “corporate espionage” come to mind for some. These phrases underscore the fact that competitive intelligence appears to involve trade-offs. The reason for this is that “what is ethical in one country is different from what is ethical in other countries.” This position implies that the rules of engagement to follow when gathering competitive intelligence change in different contexts. To avoid the possibility of legal entanglements and ethical quandaries, firms must govern their competitive intelligence gathering methods by a strict set of legal and ethical guidelines. Ethical behavior and actions, as well as the mandates of relevant laws and regulations, should be the foundation on which a firm’s competitive intelligence-gathering process is formed.
When gathering competitive intelligence, a firm must also pay attention to the complementors of its products and strategy.
Complementors
are companies or networks of companies that sell complementary goods or services that are compatible with the focal firm’s good or service. When a complementor’s good or service contributes to the functionality of a focal firm’s good or service, it in turn creates additional value for that firm.
There are many examples of firms whose good or service complements other companies’ offerings. For example, firms manufacturing affordable home photo printers complement other companies’ efforts to sell digital cameras. Intel and Microsoft are perhaps the most widely recognized complementors. The two firms do not directly buy from or sell to each other, but their products are highly complementary.
Alliances among airline companies such as Oneworld and Star involve member companies sharing their route structures and customer loyalty programs as a means of complementing each other’s operations. (Alliances and other cooperative strategies are described in
Chapter 9
.) In this example, each of the two alliances is a network of complementors. American Airlines, British Airways, Finnair, Japan Airlines, and Royal Jordanian are among the airlines forming the Oneworld alliance. Air Canada, Brussels Airlines, Croatia Airlines, Lufthansa, and United Airlines are five of the members forming the Star alliance. Both alliances constantly adjust their members and services offered to better meet customers’ needs.
As our discussion shows, complementors expand the set of competitors that firms must evaluate when completing a competitor analysis. In this sense, American Airlines and United Airlines examine each other both as direct competitors on multiple routes but also as complementors that are members of different alliances (Oneworld for American and Star for United). In all cases though, ethical commitments and actions should be the foundation on which competitor analyses are developed.
2-8Ethical Considerations
Firms must follow relevant laws and regulations as well as carefully articulated ethical guidelines when gathering competitor intelligence. Industry associations often develop lists of these practices that firms can adopt. Practices considered both legal and ethical include:
1. Obtaining publicly available information (e.g., court records, competitors’ help-wanted advertisements, annual reports, financial reports of publicly held corporations, and Uniform Commercial Code filings)
2. Attending trade fairs and shows to obtain competitors’ brochures, view their exhibits, and listen to discussions about their products
In contrast, certain practices (including blackmail, trespassing, eavesdropping, and stealing drawings, samples, or documents) are widely viewed as unethical and often are illegal as well.
Some competitive intelligence practices may be legal, but a firm must decide whether they are also ethical, given the image it desires as a corporate citizen. Especially with electronic transmissions, the line between legal and ethical practices can be difficult to determine. For example, a firm may develop website addresses that are like those of its competitors and thus occasionally receive e-mail transmissions that were intended for those competitors. The practice is an example of the challenges companies face in deciding how to gather intelligence about competitors while simultaneously determining how to prevent competitors from learning too much about them. To deal with these challenges, firms should establish principles and take actions that are consistent with them.
Professional associations are available to firms as sources of information regarding competitive intelligence practices. For example, while pursuing its mission to help firms make “better decisions through competitive intelligence,” the Strategy and Competitive Intelligence Professionals association offers codes of professional practice and ethics to firms for their possible use when deciding how to gather competitive intelligence.
Open discussions of intelligence-gathering techniques can help a firm ensure that employees, customers, suppliers, and even potential competitors understand its convictions to follow ethical practices when gathering intelligence about its competitors. An appropriate guideline for competitor intelligence practices is to respect the principles of common morality and the right of competitors not to reveal certain information about their products, operations, and intentions.
Chapter Review
Chapter Review
Summary
· The firm’s external environment is challenging and complex. Because of its effect on performance, firms must develop the skills required to identify opportunities and threats that are a part of their external environment.
· The external environment has three major parts:
1. The general environment (segments and elements in the broader society that affect industries and the firms competing in them)
2. The industry environment (factors that influence a firm, its competitive actions and responses, and the industry’s profitability potential)
3. The competitor environment (in which the firm analyzes each major competitor’s future objectives, current strategies, assumptions, and capabilities)
· Scanning, monitoring, forecasting, and assessing are the four parts of the external environmental analysis process. Effectively using this process helps the firm in its efforts to identify opportunities and threats.
· The general environment has seven segments: demographic, economic, political/legal, sociocultural, technological, global, and sustainable physical. For each segment, firms have to determine the strategic relevance of environmental changes and trends.
· Compared with the general environment, the industry environment has a more direct effect on firms’ competitive actions and responses. The five forces model of competition includes the threat of entry, the power of suppliers, the power of buyers, product substitutes, and the intensity of rivalry among competitors. By studying these forces, a firm can identify a position in an industry where it can influence the forces in its favor or where it can buffer itself from the power of the forces in order to achieve strategic competitiveness and earn above-average returns.
· Industries are populated with different strategic groups. A strategic group is a collection of firms following similar strategies along similar dimensions. Competitive rivalry is greater within a strategic group than between strategic groups.
· Competitor analysis informs the firm about the future objectives, current strategies, assumptions, and capabilities of the companies with which it competes directly. A thorough competitor analysis examines complementors that support forming and implementing rivals’ strategies.
· Different techniques are used to create competitor intelligence: the set of data, information, and knowledge that allow the firm to better understand its competitors and thereby predict their likely competitive actions and responses. Firms absolutely should use only legal and ethical practices to gather intelligence. The Internet enhances firms’ ability to gather insights about competitors and their strategic intentions.
Chapter Review
Key Terms
·
competitor analysis
·
competitor intelligence
·
complementors
·
demographic segment
·
economic environment
·
general environment
·
global segment
·
industry
·
industry environment
·
opportunity
·
political/legal segment
·
sociocultural segment
·
strategic group
·
sustainable physical environment segment
·
threat
·
technological segment
Chapter Review
Mini-Case Watch out All Retailers, Here Comes Amazon; Watch out Amazon, Here Comes Other Competitors
Amazon’s sales in 2014 were $88.99 billion, an increase of 19.4 percent over 2013. In fact, its sales in 2014 were a whopping 160 percent more than its sales in 2010, only four years prior. Amazon has been able to achieve remarkable gains in sales by providing high quality, rapid, and relatively inexpensive (relative to competitors) service. Amazon has taken on such formidable competitors as Walmart, Google, and Barnes & Noble, among others, and has come out of it as a winner, particularly in the last 4–5 years.
Walmart has been emphasizing its online sales as well. In 2014, it grew online sales by about $3 billion, for a 30 percent increase. That seems like excellent progress, until one compares it to Amazon’s sales increase in 2014 of about $14.5 billion. Much opportunity remains for both to improve as total 2014 online sales were $300 billion.
Google is clearly the giant search engine with 88 percent of the information search market. However, when consumers are shopping to purchase goods, Amazon is the leader. In the third quarter of 2014, 39 percent of online shoppers in the United States began their search on Amazon, compared to 11 percent for Google. Interestingly, in 2009 the figures were 18 percent for Amazon and 24 percent for Google. So, Amazon appears to be winning this competitive battle with Google.
Barnes & Noble lost out to Google before by ignoring it as a threat. Today, B&N has re-established itself in market niches trying not to compete with Google. For example, its college division largely sells through college bookstores, which have a ‘monopoly’ location granted by the university. However, Amazon is now targeting the college market by developing agreements with universities to operate co-branded websites to sell textbooks, university t-shirts, etc. Most of the students already shop on Amazon, making the promotion easier to market to universities and to sell to students.
A few years ago, Amazon was referred to as the Walmart of the Internet. But, Amazon has diversified its product/service line much further than Walmart. For example, Amazon now competes against Netflix and other services providing video entertainment. In fact, Amazon won two Golden Globe Awards in 2015 for programs it produced. Amazon also markets high fashion clothing for men and women. Founder and CEO of Amazon, Jeff Bezos, stated that Amazon’s goal is to become a $200 billion company, and to do that, the firm must learn how to sell clothes and food.
It appears that Amazon is beating all competitors, even formidable ones such as Google and Walmart. But, Amazon still needs to carefully watch its competition. A new company, Jet.com, is targeting Amazon. Jet.com was founded by Marc Lore, who founded the highly successful Diaper.com and a former competitor of Amazon, Quidsi. Amazon hurt Quidsi in a major price war and eventually acquired the company for $550 million. Lore worked for Amazon for two years thereafter but eventually quit to found Jet.com. Jet.com plans to market 10 million products and guarantee the lowest price. Its annual membership will be $50 compared to Amazon Prime’s cost of $99. Competing with Amazon represents a major challenge. However, Jet.com has raised about $240 million in venture funding with capital from such players as Bain Capital Ventures, Google Ventures, Goldman Sachs, and Norwest Venture partners. Its current market value is estimated to be $600 million. The future competition between the two companies should be interesting.
Sources: G. Bensinger, 2015, Amazon makes a push on college campuses, Wall Street Journal, www.wsj.com, February 1; K. Bhasin & L. Sherman, 2015, Amazon Coutre: Jeff Bezos wants to sell fancy clothes, Bloomberg, www.bloomberg.com, February 18; L. Dormehl, 2015, Amazon and Netflix score big at the Golden Globe, Fast Company, www.fastcomany.com, January 12; S. Soper, 2015, Amazon.com rival Jet.com raises $140 million in new funding, Bloomberg, www.bloomberg.com, February 11; B. Stone, 2015, Amazon bought this man’s company. Now he is coming for him, Bloomberg, www.bloomberg.com, January 7; M. Kwatinetz, 2014, In online sales, could Walmart ever top Amazon? Fortune, www.fortune.com, October 23; R. Winkler & A. Barr, 2014, Google shopping to counter Amazon, Wall Street Journal, www.wsj.com, December 15.
Mini-Case Questions
1. Can any firm beat Amazon in the marketplace? If not, why not? If so, how can they best do so?
2. How formidable a competitor is Google for Amazon? Please explain.
3. What are Amazon’s major strengths? Does it have any weaknesses? Please explain.
4.
Is Jet.com a potential concern for Amazon? Why or why not?
The Internal Organization: Resources, Capabilities, Core Competencies, and Competitive Advantages
·
Chapter Introduction
· 3-1
Analyzing the Internal Organization
· 3-1a
The Context of Internal Analysis
· 3-1b
Creating Value
· 3-1c
The Challenge of Analyzing the Internal Organization
· 3-2
Resources, Capabilities, and Core Competencies
· 3-2a
Resources
· 3-2b
Capabilities
· 3-2c
Core Competencies
· 3-3
Building Core Competencies
· 3-3a
The Four Criteria of Sustainable Competitive Advantage
· 3-3b
Value Chain Analysis
· 3-4
Outsourcing
· 3-
5
Competencies, Strengths, Weaknesses, and Strategic Decisions
·
Chapter Review
·
Summary
·
Key Terms
·
Review Questions
·
Mini-Case Is Strengthening the Superdry Brand a Foundation to Strategic Success?
Chapter Introduction
iStock.com/DNY5
9
Learning Objectives
Studying this chapter should provide you with the strategic management knowledge needed to:
· 3-1Explain why firms need to study and understand their internal organization.
· 3-2Define value and discuss its importance.
· 3-3Describe the differences between tangible and intangible resources.
· 3-4Define capabilities and discuss their development.
· 3-5Describe four criteria used to determine if resources and capabilities are core competencies.
· 3-
6
Explain how firms analyze their value chain to determine where they are able to create value when using their resources, capabilities, and core competencies.
· 3-
7
Define outsourcing and discuss reasons for its use.
· 3-
8
Discuss the importance of identifying internal strengths and weaknesses.
· 3-9Describe the importance of avoiding core rigidities.
Large Pharmaceutical Companies, Big Data Analytics, Artificial Intelligence and Core Competencies: A Brave New World
To date, and perhaps surprisingly, the idea of using data strategically remains somewhat novel in some organizations. However, the reality of “big data” and “big data analytics” (which is “the process of examining big data to uncover hidden patterns, unknown correlations, and other useful information that can be used to make better decisions”) is becoming increasingly popular in business. Indeed, in the current competitive landscape, most businesses must use big data analytics (BDA) across all customer channels (mobile, Web, e-mail, and physical stores) throughout their supply chain to help them become more innovative.
This is the situation for large pharmaceutical companies (the firms often called “big pharma”) in that many have been working to develop a core competence in BDA. (We define and discuss core competencies in this chapter.) There are several reasons they are doing this. In addition to the vast increases in the amounts of data that must be studied and interpreted for competitive purposes, “health care reform and the changing landscape of health care delivery” systems throughout the world are influencing these firms to think about developing BDA as a core competence.
AI can help analyze data on clinical trials, health records, genetic profiles, and preclinical studies. China has a goal to become the world leader in AI.
Creativa Images/ Shutterstock.com
Many benefits can accrue to big pharma firms that develop BDA as a core competence. For example, having BDA as a core competence can help a firm quickly identify trial candidates and accelerate their recruitment, develop improved inclusion and exclusion criteria to use in clinical trials, and uncover unintended uses and indications for products. In terms of customer functionality, superior products can be provided at a faster pace as a foundation for helping patients live better and healthier lives.
In developing their BDA capabilities, many of the big pharma companies are investing in artificial intelligence (AI). AI provides the capability to analyze many different sets of information. For example, AI can help analyze data on clinical trials, health records, genetic profiles, and preclinical studies. AI can analyze and integrate these data to identify patterns in the data and suggest hypotheses about relationships. A new drug generally requires a decade of research and $2.6 billion of investment. And only about 5 percent of the drugs that enter experimental research make it to the market and are successful. Eventually, it is expected that the use of AI could reduce the early research development time from 4-6 years to 1 year, not only greatly reducing the time of development but also the costs.
As we discuss in this chapter, capabilities are the foundation for developing core competencies. There are several capabilities big pharma companies need for BDA to be a core competence. Supportive architecture, the proper mix of data scientists, and “technology that integrates and manages new types and sources of data flexibility and scalability while maintaining the highest standards of data governance, data quality, and data security” are examples of capabilities that big pharma need if they wish to develop BDA as a core competence. Of course, using artificial intelligence provides strong support for the application of BDA.
Having a strong BDA competence could be critical for pharmaceutical firms in the future. Most Chinese pharmaceutical firms are medium-sized and sell generic drugs and therapeutic medicines, investing in R&D at only about 25% of the amount invested by big pharma in developed countries. However, China has a plan to develop large, competitive pharmaceutical firms by 2025. In 2017, for example, China’s second largest class of investments was biopharma. Interestingly, the largest Chinese investment that year was in information systems, including AI. China has a goal to become the world leader in AI.
In recent years, big pharma has been earning mediocre returns of about 3 percent ROI, down from 10 percent a decade earlier. Thus, big pharma executives feel pressure especially with the initial costs of developing BDA and AI. Hopefully, they soon will be able to reduce their costs and experience higher rates of success in the development of new drugs. Until then, however, analysts are predicting record numbers of mergers and acquisitions in the pharmaceutical industry, with big pharma acquiring successful medium-sized pharmaceuticals and biotechnology firms.
Sources: S. Mukherjee, 2018, How big pharma is using AI to make better drugs, Fortune, fortune.com, March 19: Z. Torrey, 2018, China prepares for big pharma, thediplomat.com, March 14; E. Corbett, 2018, European mid-sized pharma companies-biotechs and big pharma? The Pharmaletter, www.thepharmaletter.com, March 9; M. Jewel, 2018, Signs that 2018 will be a record year for pharma M&A, The Pharmaletter, www.thepharmaletter.com, March1; B. Nelson, 2018, Why big pharma and biotech are betting big on AI, NBC News, www.nbc.news, March 1; Big data analytics: What it is & why it matters, 2015, SAS, www.sas.com, April 2; Big data for the pharmaceutical industry, Informatica, www.informatica.com, March 17; B. Atkins, 2015, Big data and the board, Wall Street Journal Online, www.wsj.com, April 16; S. F. DeAngelis, 2014, Pharmaceutical big data analytics promises a healthier future, Enterrasolutions, www.enterrasolutions.com, June 5; T. Wolfram, 2014, Data analytics has big pharma rethinking its core competencies, Forbes Online, www.forbes.com, December 22.
As discussed in the first two chapters, several factors in the global economy, including the rapid development of the Internet’s capabilities and globalization in general, are making it difficult for firms to develop competitive advantages. Increasingly, innovation appears to be a vital path to efforts to develop competitive advantages, particularly sustainable ones. Innovative actions are required by big pharma companies, and they need to develop new drugs more quickly and at lower costs while improving the success of the drugs that they develop. As the Opening Case shows, they are trying to use artificial intelligence to help develop capabilities in big data analytics that hopefully can become a core competence.
As is the case for big pharma companies, innovation is critical to most firms’ success. This means that many firms seek to develop innovation as a core competence. We define and discuss core competencies in this chapter and explain how firms use their resources and capabilities to form them. As a core competence, innovation has long been critical to Boeing’s success, too. Today, however, the firm is focusing on incremental innovations as well as developing new technologies that are linked to major innovations and the projects they spawn, such as the 787 Dreamliner. The first delivery of the 787-10 Dreamliner was made to Singapore Airlines on March 26, 2018. Boeing believes its incremental innovations enable the firm to deliver reliable products to customers more quickly and at a lower cost. As we discuss in this chapter, firms and organizations—such as those we mention here—achieve strategic competitiveness and earn above-average returns by acquiring, bundling, and leveraging their resources for the purpose of taking advantage of opportunities in the external environment in ways that create value for customers.
Even if the firm develops and manages resources in ways that create core competencies and competitive advantages, competitors will eventually learn how to duplicate the benefits of any firm’s value-creating strategy; thus, all competitive advantages have a limited life. Because of this, the question of duplication of a competitive advantage is not if it will happen, but when. In general, a competitive advantage’s sustainability is a function of three factors:
1. The rate of core competence obsolescence because of environmental changes
2. The availability of substitutes for the core competence
3. The imitability of the core competence
For all firms, the challenge is to effectively manage current core competencies while simultaneously developing new ones. Only when firms are able to do this can they expect to achieve strategic competitiveness, earn above-average returns, and remain ahead of competitors in both the short and long term.
We studied the general, industry, and competitor environments in
Chapter 2
. Armed with knowledge about the realities and conditions of their external environment, firms have a better understanding of marketplace opportunities and the characteristics of the competitive environment in which those opportunities exist. In this chapter, we focus on the firm. By analyzing its internal organization, a firm determines what it can do. Matching what a firm can do (a function of its resources, capabilities, and core competencies in the internal organization) with what it might do (a function of opportunities and threats in the external environment) yields insights for the firm to select strategies from among those we discuss in
Chapters 4
, 5, 6, 7, 8, and 9.
We begin this chapter by briefly describing conditions associated with analyzing the firm’s internal organization. We then discuss the roles of resources and capabilities in developing core competencies, which are the sources of the firm’s competitive advantages. Included in this discussion are the techniques firms use to identify and evaluate resources and capabilities and the criteria for identifying core competencies from among them. Resources alone typically do not provide competitive advantages. Instead, resources create value when the firm uses them to form capabilities, some of which become core competencies, and hopefully competitive advantages. Because of the relationship among resources, capabilities, and core competencies, we also discuss the value chain and examine four criteria that firms use to determine if their capabilities are core competencies and, as such, sources of competitive advantage. The chapter closes with comments about outsourcing as well as the need for firms to prevent their core competencies from becoming core rigidities. The existence of core rigidities indicates that the firm is too anchored to its past, a situation that prevents it from continuously developing new capabilities and core competencies.
3-1Analyzing the Internal Organization
3-1aThe Context of Internal Analysis
One of the conditions associated with analyzing a firm’s internal organization is the reality that in today’s global economy, some of the resources that were traditionally critical to firms’ efforts to produce, sell, and distribute their goods or services—such as labor costs, access to financial resources and raw materials, and protected or regulated markets—although still important, are now less likely to be the source of competitive advantages. An important reason for this is that an increasing number of firms are using their resources to form core competencies through which they successfully implement an international strategy (discussed in
Chapter 8
) as a means of overcoming the advantages created by more traditional resources.
Given the increasing importance of the global economy, those analyzing their firm’s internal organization should use a global mind-set to do so. A
global mind-set
is the ability to analyze, understand, and manage an internal organization in ways that are not dependent on the assumptions of a single country, culture, or context. Because they are able to span artificial boundaries, those with a global mind-set recognize that their firms must possess resources and capabilities that allow understanding of and appropriate responses to competitive situations that are influenced by country-specific factors and unique cultures. Using a global mind-set to analyze the internal organization has the potential to significantly help the firm in its efforts to outperform rivals.
Finally, analyzing the firm’s internal organization requires that evaluators examine the firm’s entire portfolio of resources and capabilities. This perspective suggests that individual firms possess at least some resources and capabilities that other companies do not—at least not in the same combination. Resources are the source of capabilities, some of which lead to the development of core competencies; in turn, some core competencies may lead to a competitive advantage for the firm. Understanding how to leverage the firm’s unique bundle of resources and capabilities is a key outcome decision makers seek when analyzing the internal organization.
Figure 3.1
illustrates the relationships among resources, capabilities, core competencies, and competitive advantages and shows how their integrated use can lead to strategic competitiveness. As we discuss next, firms use the resources in their internal organization to create value for customers.
Figure 3.1Components of an Internal Analysis
3-1bCreating Value
Firms use their resources as the foundation for producing goods or services that will create value for customers.
Value
is measured by a product’s performance characteristics and by its attributes for which customers are willing to pay. Firms create value by innovatively bundling and leveraging their resources to form capabilities and core competencies. Firms with a competitive advantage create more value for customers than do competitors. Walmart uses its “every day low price” approach to doing business (an approach that is grounded in the firm’s core competencies, such as information technology and distribution channels) to create value for those seeking to buy products at a low price compared to competitors’ prices for those products. The stronger these firms’ core competencies, the greater the amount of value they’re able to create for their customers.
Ultimately, creating value for customers is the source of above-average returns for a firm. What the firm intends regarding value creation affects its choice of business-level strategy (see
Chapter 4
) and its organizational structure (see
Chapter 1
1
). In Chapter 4’s discussion of business-level strategies, we note that value is created by a product’s low cost, by its highly differentiated features, or by a combination of low cost and high differentiation compared to competitors’ offerings. A business-level strategy is effective only when it is grounded in exploiting the firm’s capabilities and core competencies. Thus, the successful firm continuously examines the effectiveness of current capabilities and core competencies while thinking about the capabilities and competencies it will require for future success.
At one time, firms’ efforts to create value were largely oriented toward understanding the characteristics of the industry in which they competed and, in light of those characteristics, determining how they should be positioned relative to competitors. This emphasis on industry characteristics and competitive strategy underestimated the role of the firm’s resources and capabilities in developing core competencies as the source of competitive advantages. In fact, core competencies, in combination with product-market positions, are the firm’s most important sources of competitive advantage. A firm’s core competencies, integrated with an understanding of the results of studying the conditions in the external environment, should drive the selection of strategies. As Clayton Christensen noted, “successful strategists need to cultivate a deep understanding of the processes of competition and progress and of the factors that undergird each advantage. Only thus will they be able to see when old advantages are poised to disappear and how new advantages can be built in their stead.” By emphasizing core competencies when selecting and implementing strategies, companies learn to compete primarily on the basis of firm-specific differences. However, while doing so they must be simultaneously aware of changes in the firm’s external environment.
3-1cThe Challenge of Analyzing the Internal Organization
The strategic decisions managers make about the internal organization are nonroutine, have ethical implications, and significantly influence the firm’s ability to earn above-average returns. These decisions involve choices about the resources the firm needs to collect and how to best manage and leverage them.
Making decisions involving the firm’s assets—identifying, developing, deploying, and protecting resources, capabilities, and core competencies—may appear to be relatively easy. However, this task is as challenging and difficult as any other with which managers are involved; moreover, the task is increasingly internationalized. Some believe that the pressure on managers to pursue only decisions that help the firm meet anticipated quarterly earnings makes it difficult to accurately examine the firm’s internal organization.
The challenge and difficulty of making effective decisions are implied by preliminary evidence suggesting that one-half of organizational decisions fail. Sometimes, mistakes are made as the firm analyzes conditions in its internal organization. Managers might, for example, think a capability is a core competence when it is not. This may have been the case at Polaroid Corporation, as decision makers continued to believe that the capabilities it used to build its instant film cameras were highly relevant at the time its competitors were preparing to introduce digital cameras. In this instance, Polaroid’s decision makers may have concluded that superior manufacturing was a core competence, as was the firm’s ability to innovate in terms of creating value-adding features for its instant cameras. If a mistake is made when analyzing and managing a firm’s resources, decision makers must have the confidence to admit it and take corrective actions.
At one time, Polaroid’s cameras created a significant amount of value for customers. Poor decisions may have contributed to the firm’s subsequent inability to create value and its initial filing for bankruptcy in 2001.
Gene Blevins/Polaris/Newscom
A firm can improve by studying its mistakes; in fact, the learning generated by making and correcting mistakes can be important in the creation of new capabilities and core competencies. One capability that can be learned from failure is when to quit. Polaroid should have obviously changed its strategy earlier than it did, so it could have been able to avoid demise. Another potential example concerns News Corp.’s Amplify unit (founded 2011), which was created to change the way children are taught. As of mid-2015, the firm had invested over $1 billion in the unit, which makes tablets, sells online curricula, and offers testing services. In 2014, Amplify generated a $193 million loss, facing competition from well-established textbook publishers enhancing their own ability to sell similar digital products. In September 2015, News Corp. decided to sell Amplify to a team of managers and private investors, incurring a significant loss.
As we discuss next, three conditions—uncertainty, complexity, and intraorganizational conflict—affect managers as they analyze the internal organization and make decisions about resources (see
Figure 3.2
).
Figure 3.2Conditions Affecting Managerial Decisions about Resources, Capabilities, and Core Competencies
When studying the internal organization, managers face uncertainty because of a number of issues, including those of new proprietary technologies, rapidly changing economic and political trends, transformations in societal values, and shifts in customers’ demands. Environmental uncertainty increases the complexity and range of issues to examine when studying the internal environment. Consider how uncertainty affects the ways to use resources at coal companies such as Peabody Energy Corp. and Murray Energy Corp. Coal companies have been suffering in the last decade or more with significant regulations and the competition from cleaner forms of energy such as natural gas. They have been aided some by the reduction of regulations by the Trump administration, but the competition from cleaner and cheaper forms of energy remains. Thus, they still have to deal with a complex and uncertain environment.
Biases regarding how to cope with uncertainty affect decisions made about how to manage the firm’s resources and capabilities to form core competencies. Additionally, intraorganizational conflict may surface when decisions are made about the core competencies a firm should develop and nurture. Conflict might surface in the energy companies mentioned above about the degree to which resources and capabilities should be used to form new core competencies to support newer “clean technologies.”
In making decisions affected by these three conditions, judgment is required. Judgment is the capability of making successful decisions when no obviously correct model or rule is available or when relevant data are unreliable or incomplete. In such situations, decision makers must be aware of possible cognitive biases, such as overconfidence. Individuals who are too confident in the decisions they make about how to use the firm’s resources may fail to fully evaluate contingencies that could affect those decisions.
When exercising judgment, decision makers often take intelligent risks. In the current competitive landscape, executive judgment can become a valuable capability. One reason is that, over time, effective judgment that decision makers demonstrate allows a firm to build a strong reputation and retain the loyalty of stakeholders whose support is linked to above-average returns.
Finding individuals who can make the most successful decisions about using the organization’s resources is challenging, and important. The quality of decisions regarding resources and their management affect a firm’s ability to achieve strategic competitiveness. Individuals holding such key decision-making positions are called strategic leaders. Discussed fully in
Chapter 12
and for our purposes in this chapter, we can think of strategic leaders as individuals with an ability to examine the firm’s resources, capabilities, and core competencies and make effective choices about their use.
Next, we consider the relationships among a firm’s resources, capabilities, and core competencies. While reading these sections, keep in mind that organizations have more resources than capabilities and more capabilities than core competencies.
3-2Resources, Capabilities, and Core Competencies
Resources, capabilities, and core competencies are the foundation of competitive advantage. Resources are bundled to create organizational capabilities. In turn, capabilities are the source of a firm’s core competencies, which are the basis of establishing competitive advantages. We show these relationships in Figure 3.1 and discuss them next.
3-2aResources
Broad in scope, resources cover a spectrum of individual, social, and organizational phenomena. By themselves, resources do not allow firms to create value for customers as the foundation for earning above-average returns. Indeed, resources are combined to form capabilities. For example, Subway links its fresh ingredients with several other resources, including the continuous training it provides to those running the firm’s fast food restaurants, as the foundation for customer service as a capability; customer service is also a core competence for Subway.
As its sole distribution channel, the Internet is a resource for Amazon.com. The firm uses the Internet to sell goods at prices that typically are lower than those offered by competitors selling the same goods through more costly brick-and-mortar storefronts. By combining other resources (such as access to a wide product inventory), Amazon has developed a reputation for excellent customer service. Amazon’s capability in terms of customer service is a core competence as well in that the firm creates unique value for customers through the services it provides to them.
Some of a firm’s resources (defined in
Chapter 1 as inputs to the firm’s production process) are tangible while others are intangible.
Tangible resources
are assets that can be observed and quantified. Production equipment, manufacturing facilities, distribution centers, and formal reporting structures are examples of tangible resources. For energy giant Kinder Morgan, its stock of oil and gas pipelines are a key tangible resource.
Intangible resources
are assets that are rooted deeply in the firm’s history, accumulate over time, and are relatively difficult for competitors to analyze and imitate. Because they are embedded in unique patterns of routines, intangible resources are difficult for competitors to analyze and imitate. Knowledge, trust between managers and employees, managerial capabilities, organizational routines (the unique ways people work together), scientific capabilities, the capacity for innovation, brand name, the firm’s reputation for its goods or services and how it interacts with people (such as employees, customers, and suppliers), and organizational culture are intangible resources.
Intangible resources require nurturing to maintain their ability to help firms engage in competitive battles. For example, brand has long been a valuable intangible resource for Coca-Cola Company. The same is true for “logo-laden British brand Superdry,” a case highlighted at the end of the chapter. As you will read, SuperGroup PLC, the owner of Superdry, encountered problems a few years ago in its efforts to maintain and enhance the value of the Superdry brand. New management and a new approach are attempting to renew the Superdry brand.
As noted in the Strategic Focus, intangible resources may be even more important in the development of core competencies. Of course, three of the firms described in the Strategic Focus—Fainsbert Mase Brown & Susmann, Genpact, and Document Security Systems—were service firms, which commonly base their core competencies on their human capital. However, even Hecla Mining Company, which has significant investments in specialized mining equipment, must also have valuable human capital for its core competence in “high grade, narrow-vein underground mining.”
For each analysis, tangible and intangible resources are grouped into categories. The four primary categories of tangible resources are financial, organizational, physical, and technological (see
Table 3.1
). The three primary categories of intangible resources are human, innovation, and reputational (see
Table 3.2
).
Table 3.1
Tangible Resources
Financial Resources |
· The firm’s capacity to borrow · The firm’s ability to generate funds through internal operations |
Organizational Resources |
· Formal reporting structures |
Physical Resources |
· The sophistication of a firm’s plant and equipment and the attractiveness of its location · Distribution facilities · Product inventory |
Technological Resources |
· Availability of technology-related resources such as copyrights, patents, trademarks, and trade secrets |
Sources: Adapted from J. B. Barney, 1991, Firm resources and sustained competitive advantage, Journal of Management, 17: 101; R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge: U.K.: Blackwell Business, 100–102.
Table 3.2
Intangible Resources
Human Resources
· Knowledge
· Trust
· Skills
· Abilities to collaborate with others
Innovation Resources
· Ideas
· Scientific capabilities
· Capacity to innovate
Reputational Resources
· Brand name
· Perceptions of product quality, durability, and reliability
· Positive reputation with stakeholders such as suppliers and customers
Sources: Adapted from R. Hall, 1992, The strategic analysis of intangible resources, Strategic Management Journal, 13: 136–139: R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge: U.K.: Blackwell Business, 101–104.
Strategic Focus
Tangible and Intangible Resources as the Base for Core Competencies
While tangible resources are important, intangible resources are perhaps even more important in the development of firms’ core competencies. Understandably, most professional service firms have few tangible resources but can have high market value primarily because of their intangible resources. For example, Fainsbert Mase Brown & Susmann, LLP is a premier law firm located in Los Angeles, California. Obviously, its goal is to provide superior legal services to its clients. Within this broad frame, however, there is a core competence. The firm provides legal advice and support on significant real estate, business, and corporate transactions for large institutions, high net-worth individuals, and privately owned businesses. For example, in 2018 the firm provided the legal services to conclude the negotiations for the Industrial Realty Group’s purchase of the 3.1 million square foot IBM technology campus in Rochester, Minnesota. This complex transaction required more than one year to negotiate with a multi-level corporate legal team.
Likewise, other major service firms are heavily dependent on their intangible assets. For example, Genpact requires highly knowledgeable human capital for its core competence. Genpact provides solutions to major process problems for its clients. Genpact describes its competence as providing “digital-led innovation and digitally enabled intelligent operations” for clients. The firm solves clients’ problems using data analytics, helping its clients transform their operations. Another technology-based service firm is Document Security Systems, Inc. (DSS). DSS has a core competence in the development of anti-counterfeit, authentication, and diversion software that protects organizations against Internet fraud and theft. And it tries to remain a leader in this field through continued investment in research and new technology. In 2018, it announced an agreement to partner with the Hong Kong R&D Center for Logistics and Supply Chain to develop the next generation of protection products using blockchain technology.
Firms with larger amounts of tangible resources also need valuable intangible resources. For example, Hecla Mining Company has a core competence in “high grade, narrow-vein underground mining.” Obviously, the company has significant investments in specialized mining equipment in order to employ this core competence. But significant engineering and mining knowledge and expertise is required to successfully engage in this type of mining. This knowledge and expertise resides in the human capital (intangible assets) within the firm.
It is important to note that firms’ reputations are often significant intangible assets. For example, professional service firms must be considered not only highly knowledgeable in the areas in which they compete, but also must be considered honest and highly trustworthy. In meeting this challenge, Genpact was selected as one of the “World’s Most Ethical Companies” in 2018. Companies can also enhance intangible assets, such as their reputation, through use of their core competencies. For example, in the aftermath of Hurricane Harvey in 2017, Johnson & Johnson provided medical supplies, FedEx provided logistical support to provide bottled water, and Butterball provided 40,000 pounds of canned turkey to help citizens in the recovery. Companies that are ethical and good corporate citizens often are highly respected and are called on to use their core competencies to serve an increasing number of customers.
In 2018, Genpact announced an agreement to partner with the Hong Kong R&D Center for Logistics and Supply Chain to develop the next generation of protection products using blockchain technology.
360b/Alamy Stock Photo
Sources: Document Security Systems, Inc., 2018, DSS Partners with Hong Kong R&D Centre for logistics and supply chain management enabling technologies for blockchain research, globenewswire.com, March 19; StreetInsider, 2018, Hecla Mining (HL) Announces $462 million Acquisition of Klondes Mines, Ltd. (K), www.streetinsider.com, March 19; BusinessInsider, 2018, Genpact named one of the 2018 world’s most ethical companies by the Ethisphere Institute, markets.businessinsider.com, March14; Cision PR Newswire, 2018, Fainsbert Mase Brown & Sussmann, LLP completes acquisition closing on 3.1 million sq. ft. IBM campus in Minnesota, www.prnewswire, February 23; P. N. Danziger, 2018, Fire, floods, hurricanes: How and why corporations must help, Forbes, www.forbes.com, October 20.
Tangible Resources
As tangible resources, a firm’s borrowing capacity and the status of its physical facilities are visible. The value of many tangible resources can be established through financial statements, but these statements do not account for the value of all of the firm’s assets because they disregard some intangible resources. The value of tangible resources is also constrained because they are hard to leverage—it is difficult to derive additional business or value from a tangible resource. For example, an airplane is a tangible resource, but “you can’t use the same airplane on five different routes at the same time. You can’t put the same crew on five different routes at the same time. And the same goes for the financial investment you’ve made in the airplane.”
Although production assets are tangible, many of the processes necessary to use them are intangible as in the case of Hecla Mining Company described in the Strategic Focus. Thus, the learning and potential proprietary processes associated with a tangible resource, such as manufacturing facilities, can have unique intangible attributes, such as quality control processes, unique manufacturing processes, and technologies that develop over time.
Intangible Resources
Compared to tangible resources, intangible resources are a superior source of capabilities and subsequently, core competencies. In fact, in the global economy, a firm’s intellectual capital often plays a more critical role in corporate success than do physical assets. Because of this, being able to effectively manage intellectual capital is an increasingly important skill for today’s leaders to develop.
Because intangible resources are less visible and more difficult for competitors to understand, purchase, imitate, or substitute for, firms prefer to rely on them rather than on tangible resources as the foundation for their capabilities. In fact, the more unobservable (i.e., intangible) a resource is, the more valuable that resource is to create capabilities. Another benefit of intangible resources is that, unlike most tangible resources, their use can be leveraged. For instance, sharing knowledge among employees does not diminish its value for any one person. To the contrary, two people sharing their individualized knowledge sets often can be leveraged to create additional knowledge that, although new to each individual, contributes potentially to performance improvements for the firm.
Reputational resources (see
Table 3.2) are important sources of a firm’s capabilities and core competencies. Indeed, some argue that a positive reputation can even be a source of competitive advantage. Earned through the firm’s actions as well as its words, a value-creating reputation is a product of years of superior marketplace competence as perceived by stakeholders. A reputation indicates the level of awareness a firm has been able to develop among stakeholders and the degree to which they hold the firm in high esteem.
Developing capabilities in specific functional areas can give companies a competitive edge. The effective use of social media to direct advertising to specific market segments has given some firms an advantage over their rivals.
iStock.com/Courtney Keating
A well-known and highly valued brand name is a specific reputational resource. A continuing commitment to innovation and aggressive advertising facilitates firms’ efforts to take advantage of the reputation associated with their brands. Harley-Davidson has a reputation for producing and servicing high-quality motorcycles with unique designs. Because of the desirability of its reputation, the company also produces a wide range of accessory items that it sells based on its reputation for offering unique products with high quality. Sunglasses, jewelry, belts, wallets, shirts, slacks, and hats are just a few of the large variety of accessories customers can purchase from a Harley-Davidson dealer or from its online store.
Taking advantage of today’s technologies, some firms are using social media as a means of influencing their reputation. Recognizing that thousands of conversations occur daily throughout the world and that what is being said can affect its reputation, Coca-Cola company encourages its employees to be a part of these social media-based discussions as a means of positively influencing the company’s reputation. Driving the nature of these conversations is a set of social media principles that Coca-Cola employees use as a foundation for how they will engage with various social media. Being transparent and protecting consumers’ privacy are examples of the commitments the firm established.
3-2bCapabilities
The firm combines individual tangible and intangible resources to create capabilities. In turn, capabilities are used to complete the organizational tasks required to produce, distribute, and service the goods or services the firm provides to customers for the purpose of creating value for them. As a foundation for building core competencies and hopefully competitive advantages, capabilities are often based on developing, carrying, and exchanging information and knowledge through the firm’s human capital. Hence, the value of human capital in developing and using capabilities and, ultimately, core competencies cannot be overstated. In fact, it seems to be “well known that human capital makes or breaks companies.” At pizza-maker Domino’s, human capital is critical to the firm’s efforts to change how it competes. Describing this, CEO Patrick Doyle says that, in many ways, Domino’s is becoming “a technology company … that has adapted the art of pizza-making to the digital age.”
As illustrated in
Table 3.3
, capabilities are often developed in specific functional areas (such as manufacturing, R&D, and marketing) or in a part of a functional area (e.g., advertising). Table 3.3 shows a grouping of organizational functions and the capabilities that some companies are thought to possess in terms of all or parts of those functions.
Table 3.3
Example of Firms’ Capabilities
Functional Areas
Capabilities
Examples of Firms
Distribution
· Effective use of logistics management techniques
· Walmart
Human Resources
· Motivating, empowering, and retaining employees
· Microsoft
Management Information Systems
· Effective and efficient control of inventories through point-of-purchase data collection methods
· Walmart
Marketing
· Effective promotion of brand-name products
· Effective customer service
· Innovative merchandising
· Procter & Gamble
· Ralph Lauren Corp.
· McKinsey & Co.
·
No
rdstrom Inc.
· Crate & Barrel
Management
· Ability to envision the future of clothing
· Hugo Boss
· Zara
Manufacturing
· Design and production skills yielding reliable products
· Product and design quality
· Miniaturization of components and products
· Komatsu
· Witt Gas Technology
· Sony
Research & Development
· Innovative technology
· Development of sophisticated elevator control solutions
· Rapid transformation of technology into new products and processes
· Digital technology
· Caterpillar
· Otis Elevator Co.
· Chaparral Steel
· Thomson Consumer Electronics
Table 3.3
Example of Firms’ Capabilities
Functional Areas
Capabilities
Examples of Firms
Distribution
· Effective use of logistics management techniques
· Walmart
Human Resources
· Motivating, empowering, and retaining employees
· Microsoft
Management Information Systems
· Effective and efficient control of inventories through point-of-purchase data collection methods
· Walmart
Marketing
· Effective promotion of brand-name products
· Effective customer service
· Innovative merchandising
· Procter & Gamble
· Ralph Lauren Corp.
· McKinsey & Co.
· Nordstrom Inc.
· Crate & Barrel
Management
· Ability to envision the future of clothing
· Hugo Boss
· Zara
Manufacturing
· Design and production skills yielding reliable products
· Product and design quality
· Miniaturization of components and products
· Komatsu
· Witt Gas Technology
· Sony
Research & Development
· Innovative technology
· Development of sophisticated elevator control solutions
· Rapid transformation of technology into new products and processes
· Digital technology
· Caterpillar
· Otis Elevator Co.
· Chaparral Steel
· Thomson Consumer Electronics
Main content
3-2cCore Competencies
Defined in Chapter 1, core competencies are capabilities that serve as a source of competitive advantage for a firm over its rivals. Core competencies distinguish a company competitively and reflect its personality. Core competencies emerge over time through an organizational process of accumulating and learning how to deploy different resources and capabilities. As the capacity to take action, core competencies are the “crown jewels of a company,” the activities the company performs especially well compared to competitors and through which the firm adds unique value to the goods or services it sells to customers. Thus, if a big pharma company (such as Pfizer) developed big data analytics as a core competence, one could conclude that the firm had formed capabilities through which it was able to analyze and effectively use huge amounts of data in a competitively superior manner.
Innovation is thought to be a core competence at Apple. As a capability, R&D activities are the source of this core competence. More specifically, the way Apple has combined some of its tangible (e.g., financial resources and research laboratories) and intangible (e.g., scientists and engineers and organizational routines) resources to complete research and development tasks creates a capability in R&D. By emphasizing its R&D capability, Apple can innovate in ways that create unique value for customers in the form of the products it sells, suggesting that innovation is a core competence for Apple.
Excellent customer service in its retail stores is another of Apple’s core competencies. In this instance, unique and contemporary store designs (a tangible resource) are combined with knowledgeable and skilled employees (an intangible resource) to provide superior service to customers. A number of carefully developed training and development procedures are capabilities on which Apple’s core competence of excellent customer service is based. The procedures that are capabilities include specification of how employees are to interact with customers, carefully written training manuals to describe on-site tech support that is to be provided to customers, and deep thinking about every aspect of the store’s design including music that is played. Apple has a special training program designed to build associates’ knowledge of Apple products and how to sell them.
3-3Building Core Competencies
Two tools help firms identify their core competencies. The first consists of four specific criteria of sustainable competitive advantage that can be used to determine which capabilities are core competencies. Because the capabilities shown in
Table 3.3 have satisfied these four criteria, they are core competencies. The second tool is the value chain analysis. Firms use this tool to select the value-creating competencies that should be maintained, upgraded, or developed and those that should be outsourced.
3-3aThe Four Criteria of Sustainable Competitive Advantage
Capabilities that are valuable, rare, costly to imitate, and nonsubstitutable are core competencies (see
Table 3.4
). In turn, core competencies help firms to gain competitive advantages over their rivals. Capabilities failing to satisfy the four criteria are not core competencies, meaning that although every core competence is a capability, not every capability is a core competence. In slightly different words, for a capability to be a core competence, it must be valuable and unique from a customer’s point of view. For a core competence to be a potential source of competitive advantage, it must be inimitable and nonsubstitutable by competitors.
Table 3.4
The Four Criteria of Sustainable Competitive Advantage
Valuable Capabilities
· Help a firm neutralize threats or exploit opportunities
Rare
Capabilities
· Are not possessed by many others
Costly-to-Imitate Capabilities
· Historical: A unique and a valuable organizational culture or brand name
· Ambiguous cause: The causes and uses of a competence are unclear
· Social complexity: Interpersonal relationships, trust, and friendship among managers, suppliers, and customers
Nonsubstitutable
Capabilities
· No strategic equivalent
A sustainable competitive advantage exists only when competitors are unable to duplicate the benefits of a firm’s strategy or when they lack the resources to attempt imitation. For some period of time, the firm may have a core competence by using capabilities that are valuable and rare, but imitable. For example, some firms are trying to develop a core competence and potentially, a competitive advantage by out-greening their competitors. (Interestingly, developing a “green” core competence can contribute to the firm’s efforts to earn above-average returns while benefitting the broader society.) For many years, Walmart has been committed to using its resources in ways that support environmental sustainability while pursuing a competitive advantage in the process. In this regard, Walmart has three major end goals: to create zero waste, operate with 100 percent renewable energy, and sell products that sustain our resources and the environment. To facilitate these efforts, Walmart recently labeled over 10,000 products on its e-commerce site as products that are “Made by a Sustainability Leader.” Initially, these items were batched into roughly 80 product categories. In addition to seeking a competitive advantage through these actions, Walmart hoped to make it easier for customers to make “sustainable choices” when purchasing products. Walmart is also working to lead the industry in deploying clean technologies as a means of reducing fuel consumption and air pollution. Of course, Walmart competitors such as Target are engaging in similar actions. Time will reveal the degree to which Walmart’s green practices can be imitated.
The length of time a firm can expect to create value by using its core competencies is a function of how quickly competitors can successfully imitate a good, service, or process. Value-creating core competencies may last for a relatively long period of time only when all four of the criteria we discuss next are satisfied. Thus, Walmart would know that it has a core competence and possibly, a competitive advantage in terms of green practices if the ways the firm uses its resources to complete these practices satisfy the four criteria.
Valuable
Valuable capabilities
allow the firm to exploit opportunities or neutralize threats in its external environment. By effectively using capabilities to exploit opportunities or neutralize threats, a firm creates value for customers. For example, Groupon created the “daily deal” marketing space; the firm reached $1 billion in revenue faster than any other company in history. In essence, the opportunity Groupon’s founders pursued was to create a marketplace through which businesses could introduce their goods or services to customers who would be able to experience them at a discounted price. Restaurants, hair and nail salons, and hotels are examples of the types of companies making frequent use of Groupon’s services. Young, urban professionals desiring to affordably experience the cities in which they live are the firm’s target customers. But, Groupon’s financial performance has been lower than desired by investors primarily because of competition. While offering value to customers, the capabilities to offer its services can be imitated and its initial success invited rivals to enter the market. Competing daily-deal websites such as LivingSocial quickly surfaced and offered similar and often less expensive deals. In fact, many competitors have entered the market, to include Yipit, Woot, RetailMeNot, Tanga, and Ebate in addition to LivingSocial.
Rare
Rare capabilities
are capabilities that few, if any, competitors possess. A key question to be answered when evaluating this criterion is “how many rival firms possess these valuable capabilities?” Capabilities possessed by many rivals are unlikely to become core competencies for any of the involved firms. Instead, valuable but common (i.e., not rare) capabilities are sources of competitive parity. Competitive advantage results only when firms develop and exploit valuable capabilities that become core competencies and that differ from those shared with competitors. The central problem for Groupon is that its capabilities to produce the “daily deal” reached competitive parity quickly. Similarly, Walmart has developed valuable capabilities that it uses to engage in green practices; but, as mentioned previously, Target seeks to develop sustainability capabilities through which it can duplicate Walmart’s green practices. Target’s success in doing so, if this happens, suggests that Walmart’s green practices are valuable but not rare.
Costly to Imitate
Costly-to-imitate capabilities
are capabilities that other firms cannot easily develop. Capabilities that are costly to imitate are created because of one reason or a combination of three reasons (see Table 3.4). First, a firm sometimes is able to develop capabilities because of unique historical conditions. As firms evolve, they often acquire or develop capabilities that are unique to them. A firm with a unique and valuable organizational culture that emerged in the early stages of the company’s history “may have an imperfectly imitable advantage over firms founded in another historical period,” one in which less valuable or less competitively useful values and beliefs strongly influenced the development of the firm’s culture. Briefly discussed in Chapter 1, organizational culture is a set of values that are shared by members in the organization. An organizational culture is a source of advantage when employees are held together tightly by their belief in it and the leaders who helped to create it. Historically, emphasizing cleanliness, consistency, and service and the training that reinforces the value of these characteristics created a culture at McDonald’s that some thought was a core competence and a competitive advantage for the firm. However, as explained in Chapter 2’s Opening Case, McDonald’s has experienced problems with a number of strategic actions taken by competitors. McDonald’s hired a new CEO in 2015 and is now making a number of menu changes to make its food offerings healthier and more attractive overall to customers. McDonald’s hopes these changes along with others will help it to reinvigorate its historically unique culture as a core competence.
Southwest Airlines crew hold puppies who became homeless after Hurricane Maria damaged the island of Puerto Rico. The flight, which was donated by Southwest Airlines, carried 14,000 pounds of supplies.
The Washington Post/Getty Images
A second condition of being costly to imitate occurs when the link between the firm’s core competencies and its competitive advantage is causally ambiguous. In these instances, competitors can’t clearly understand how a firm uses its capabilities that are core competencies as the foundation for competitive advantage. As a result, firms are uncertain about the capabilities they should develop to duplicate the benefits of a competitor’s value-creating strategy. For years, firms tried to imitate Southwest Airlines’ low-cost strategy, but most have been unable to do so, primarily because they can’t duplicate this firm’s unique culture.
Social complexity is the third reason that capabilities can be costly to imitate. Social complexity means that at least some, and frequently many, of the firm’s capabilities are the product of complex social phenomena. Interpersonal relationships, trust, friendships among managers and between managers and employees, and a firm’s reputation with suppliers and customers are examples of socially complex capabilities. Southwest Airlines is careful to hire people who fit with its culture. This complex interrelationship between the culture and human capital adds value in ways that other airlines cannot, such as jokes on flights by the flight attendants or the cooperation between gate personnel and pilots.
Nonsubstitutable
Nonsubstitutable capabilities
are capabilities that do not have strategic equivalents. This final criterion “is that there must be no strategically equivalent valuable resources that are themselves either not rare or imitable. Two valuable firm resources (or two bundles of firm resources) are strategically equivalent when they each can be separately exploited to implement the same strategies.” In general, the strategic value of capabilities increases as they become more difficult to substitute. The more intangible, and hence invisible, capabilities are, the more difficult it is for firms to find substitutes and the greater the challenge is to competitors trying to imitate a firm’s value-creating strategy. Firm-specific knowledge and trust-based working relationships between managers and nonmanagerial personnel, such as has existed for years at Southwest Airlines, are examples of capabilities that are difficult to identify and for which finding a substitute is challenging. However, causal ambiguity may make it difficult for the firm to learn and may stifle progress because the firm may not know how to improve processes that are not easily codified and thus are ambiguous.
In summary, only using valuable, rare, costly-to-imitate, and nonsubstitutable capabilities has the potential for the firm to create sustainable competitive advantages.
Table 3.5
shows the competitive consequences and performance implications resulting from combinations of the four criteria of sustainability. The analysis suggested by the table helps managers determine the strategic value of a firm’s capabilities. The firm should not emphasize capabilities that fit the criteria described in the first row in the table (i.e., resources and capabilities that are neither valuable nor rare and that are imitable and for which strategic substitutes exist). Capabilities yielding competitive parity and either temporary or sustainable competitive advantage, however, should be supported. Some competitors such as Coca-Cola and PepsiCo and Boeing and Airbus may have capabilities that result in competitive parity. In such cases, the firms will nurture these capabilities while simultaneously trying to develop capabilities that can yield either a temporary or sustainable competitive advantage.
Table 3.5
Outcomes from Combinations of the Criteria for Sustainable Competitive Advantage
Is the Capability Valuable? |
Is the Capability Rare? |
Is the Capability Costly to Imitate? |
Is the Capability Nonsubstitutable? |
Competitive Consequences |
Performance Implications |
|||||
No |
· Competitive disadvantage |
· Below-average returns |
||||||||
Yes |
Yes/no |
· Competitive parity |
· Average returns |
|||||||
· Temporary competitive advantage |
· Average returns to above-average returns |
|||||||||
· Sustainable competitive advantage |
· Above-average returns |
3-3bValue Chain Analysis
Value chain analysis allows the firm to understand the parts of its operations that create value and those that do not. Understanding these issues is important because the firm earns above-average returns only when the value it creates is greater than the costs incurred to create that value.
The value chain is a template that firms use to analyze their cost position and to identify the multiple means that can be used to facilitate implementation of a chosen strategy. Today’s competitive landscape demands that firms examine their value chains in a global rather than a domestic-only context. In particular, activities associated with supply chains should be studied within a global context.
We show a model of the value chain in
Figure 3.3
. As depicted in the model, a firm’s value chain is segmented into value chain activities and support functions.
Value chain activities
are activities or tasks the firm completes in order to produce products and then sell, distribute, and service those products in ways that create value for customers.
Support functions
include the activities or tasks the firm completes in order to support the work being done to produce, sell, distribute, and service the products the firm is producing. A firm can develop a capability and/or a core competence in any of the value chain activities and in any of the support functions. When it does so, it has established an ability to create value for customers. In fact, as shown in Figure 3.3, customers are the ones firms seek to serve when using value chain analysis to identify their capabilities and core competencies. When using their unique core competencies to create unique value for customers that competitors cannot duplicate, firms have established one or more competitive advantages. Deutsche Bank believes that its application development and information security technologies are proprietary core competencies that are a source of competitive differentiation for the firm. As explained in a Strategic Focus about outsourcing later in the chapter, Deutsche Bank will not outsource these two technologies given that the firm concentrates on them as a means of creating value for customers.
Figure 3.3A Model of the Value Chain
The activities associated with each part of the value chain are shown in
Figure 3.4
, while the activities that are part of the tasks firms complete when dealing with support functions appear in
Figure 3.5
. All items in both figures should be evaluated relative to competitors’ capabilities and core competencies. To become a core competence and a source of competitive advantage, a capability must allow the firm to either:
1. Perform an activity in a manner that provides value superior to that provided by competitors, or
2. Perform a value-creating activity that competitors cannot perform.
Only under these conditions does a firm create value for customers and have opportunities to capture that value.
Figure 3.4Creating Value through Value Chain Activities
Figure 3.5Creating Value through Support Functions
Creating value for customers by completing activities that are part of the value chain often requires building effective alliances with suppliers (and sometimes others to which the firm outsources activities, as discussed in the
next section
) and developing strong positive relationships with customers. When firms have strong positive relationships with suppliers and customers, they are said to have social capital. The relationships themselves have value because they lead to transfers of knowledge as well as to access to resources that a firm may not hold internally. To build social capital whereby resources such as knowledge are transferred across organizations requires trust between partners. Indeed, partners must trust each other to allow their resources to be used in such a way that both parties will benefit over time while neither party will take advantage of the other.
Evaluating a firm’s capability to execute its value chain activities and support functions is challenging. Earlier in the chapter, we noted that identifying and assessing the value of a firm’s resources and capabilities requires judgment. Judgment is equally necessary when using value chain analysis, because no obviously correct model or rule is universally available to help in the process.
What should a firm do about value chain activities and support functions in which its resources and capabilities are not a source of core competence? Outsourcing is one solution to consider.
3-4Outsourcing
Concerned with how components, finished goods, or services will be obtained,
outsourcing
is the purchase of a value-creating activity or a support function activity from an external supplier. Not-for-profit agencies as well as for-profit organizations actively engage in outsourcing. Firms engaging in effective outsourcing increase their flexibility, mitigate risks, and reduce their capital investments. Moreover, in some industries virtually all firms seek the value that can be captured through effective outsourcing. However, as is the case with other strategic management process decisions, careful analysis is required before the firm decides to outsource. And if outsourcing is to be used, firms must recognize that only activities where they cannot create value or where they are at a substantial disadvantage compared to competitors should be outsourced. Experience suggests that virtually any activity associated with the value chain functions or the support functions may fall into this category. We discuss different activities that some firms outsource in the Strategic Focus. We also consider core competencies that firms to whom others outsource activities may try to develop to satisfy customers’ future outsourcing needs.
Outsourcing can be effective because few, if any, organizations possess the resources and capabilities required to achieve competitive superiority in each value chain activity and support function. For example, research suggests that few companies can afford to internally develop all the technologies that might lead to competitive advantage. By nurturing a smaller number of capabilities, a firm increases the probability of developing core competencies and achieving a competitive advantage because it does not become overextended. In addition, by outsourcing activities in which it lacks competence, the firm can fully concentrate on those areas in which it has the potential to create value.
There are concerns associated with outsourcing. Two significant ones are the potential loss in a firm’s ability to innovate and the loss of jobs within the focal firm. When evaluating the possibility of outsourcing, firms should anticipate possible effects on their ability to innovate in the future as well as the impact of losing some of their human capital. On the other hand, firms are sometimes able to enhance their own innovation capabilities by studying how the companies to which they’ve outsourced complete those activities. Because a focal firm likely knows less about a foreign company to which it chooses to outsource, concerns about potential negative outsourcing effects in these cases may be particularly acute, requiring careful study and analysis as a result. Deciding to outsource to a foreign supplier is commonly called offshoring.
3-5Competencies, Strengths, Weaknesses, and Strategic Decisions
By analyzing the internal organization, firms identify their strengths and weaknesses as reflected by their resources, capabilities, and core competencies. If a firm has weak capabilities or does not have core competencies in areas required to achieve a competitive advantage, it must acquire those resources and build the needed capabilities and competencies.
As noted in the Strategic Focus, some firms decide to outsource a function or activity where it is weak in order to improve its ability to use its remaining resources to create value. Many financial institutions are outsourcing functions that support cashless transaction because their IT systems cannot handle these activities efficiently. Some governments are outsourcing services to increase the quality and efficiency with which the services are delivered (e.g., U.K. outsourcing some surgeries to French healthcare providers). Outsourcing decisions must be made carefully, considering all of the options. However, when done effectively, outsourcing can provide access to needed resources.
In considering the results of examining the firm’s internal organization, managers should understand that having a significant quantity of resources is not the same as having the “right” resources. The “right” resources are those with the potential to be formed into core competencies as the foundation for creating value for customers and developing competitive advantages because of doing so. Interestingly, decision makers sometimes become more focused and productive when seeking to find the right resources when the firm’s total set of resources is constrained.
Tools such as outsourcing help the firm focus on its core competencies as the source of its competitive advantages. However, evidence shows that the value-creating ability of core competencies should never be taken for granted. Moreover, the ability of a core competence to be a permanent competitive advantage can’t be assumed. The reason for these cautions is that all core competencies have the potential to become core rigidities. Typically, events occurring in the firm’s external environment create conditions through which core competencies can become core rigidities, generate inertia, and stifle innovation.
After studying its external environment to determine what it might choose to do (as explained in
Chapter 2) and its internal organization to understand what it can do (as explained in this chapter), the firm has the information required to select a business-level strategy that it will use to compete against rivals. We describe different business-level strategies in the
next chapter
.
Strategic Focus
The Extreme Specialization of Outsourcing: Who Is Doing It and Who Is Not?
Outsourcing activities and functions has been growing dramatically over the last decade. With the election of Donald Trump, companies in some industries—particularly manufacturing—have reduced their outsourcing outside of the United States for fear of government actions against them. However, outsourcing remains strong in other sectors of the economy.
As we discussed in the Opening Case, big pharma companies are using some of their resources and capabilities to develop “big data analytics” as a core competence because of the value of these analytics to these firms. In contrast, these same firms are outsourcing drug safety processes and procedures to other firms, many of which are located in India or have offices located there. In fact, monitoring drug safety is “one of outsourcing’s newest frontiers, and the now $2 billion business is booming as regulators require closer tracking of rare side effects and interactions between medicines.” Accenture, Cognizant, and Tata Consultancy Services Ltd. are some of the firms to which big pharma companies AstraZeneca PLC, Novartis AG, and Bristol-Myers Squibb Co. are outsourcing the monitoring of drug safety. Thus, the big pharma firms have decided that data analytics processes are an activity in which they can capture value while monitoring drug safety is not.
Similar examples exist within firms competing in other industries. Deutsche Bank has outsourced some data center services to Hewlett-Packard; however, it is retaining control over certain technology application areas it believes are proprietary and, as such, are core competencies through which the firm creates value. In fact, outsourcing information technology activities has been growing in banking and the financial sector. This is due to the rapid move to cashless transaction and mobile banking. Many of the banks have “legacy” information technology systems that are difficult to change over to handle these new functions. As such, they are outsourcing many activities such as commercial credit card payments to what is referred to as fintech firms. The number of these specialized fintech firms is growing dramatically because of the increasing amount of cashless transactions and the need for help by banks and other financial institutions such as credit unions.
Interestingly, government has become a major outsourcer. Governments are trying to outsource the provision of services from government agencies to private and non-profit organizations who can perform the services more efficiently and with higher quality. In fact, even the British Health Service is outsourcing some health services (e.g., surgeries) to healthcare organizations in other European countries (e.g., France), trying to manage its own backlog of requests for healthcare services.
Wipro and Infosys have historically been successful as firms to whom others outsource activities. However, this success has been largely a product of being able to employ relatively inexpensive programmers to complete tasks lacking significant amounts of complexity. The technology service needs have become more sophisticated and challenging. And, with the reductions of outsourcing in some sectors, some of these firms are struggling. For example, Infosys and Cognizant have laid off many employees in India and Infosys is trying to establish operations in the United States.
These individuals are working in a firm to which other companies have outsourced certain activities for completion.
Stuart Forster/Alamy Stock Photo
Therefore, the nature of outsourcing is changing and firms are becoming more specialized. Additionally, some industries are outsourcing less (e.g., manufacturing) and others are outsourcing more (financial institutions). Nevertheless, outsourcing remains a critical means for firms to gain access to valuable resources that they need to seize and maintain a competitive advantage.
Sources: R. Koczkar, 2018, Governmental outsourcing a boon for service providers, The Australian, www.australian.com, March 22; K. Ferguson, 2018, Why outsourcing can leave a lasting mark on the US banking industry, Payments Journal, paymentsjournal.com, March 23; A. Frazzetto, 2018, Outsourcing in the new normal: Three trends reshaping the global industry, Forbes, www.forbes.com, March 21; K. de Freytas-Tamura, 2018, U.K., Land of ‘brexit’, quietly outsources some surgeries to France, New York Times, www.nytimes.com, March 17; A. Jain, 2018, This global fintech enabler has a strategy to enter India’s crowded payment space, Entrepreneur, www.entrepreneur.com, March 9; L. Joyce, 2018, Six Strategic keys to becoming a mobile-centric bank, The Financial Brand, thefinancialbrand.com, March 6; 2015, Deutsche Bank, H-P divide IT responsibility in cloud deal, Wall Street Journal Online, www.wsj.com, February 25; D. A. Thoppil, 2015, Indian outsourcers struggle to evolve as growth slows, Wall Street Journal Online, www.wsj.com, February 22; S McLain, 2015, Big Pharma farms out drug safety to India, Wall Street Journal Online, www.wsj.com, February 2; S. McLain, 2015, New outsourcing frontier in India: Monitoring drug safety, Wall Street Journal Online, www.wsj.com, February 1.
Chapter Review
Summary
· In the current competitive landscape, the most effective organizations recognize that strategic competitiveness and above-average returns result only when core competencies (identified by studying the firm’s internal organization) are matched with opportunities (determined by studying the firm’s external environment).
· No competitive advantage lasts forever. Over time, rivals use their own unique resources, capabilities, and core competencies to form different value-creating propositions that duplicate the focal firm’s ability to create value for customers. Because competitive advantages are not permanently sustainable, firms must exploit their current advantages while simultaneously using their resources and capabilities to form new advantages that can lead to future competitive success.
· Effectively managing core competencies requires careful analysis of the firm’s resources (inputs to the production process) and capabilities (resources that have been purposely integrated to achieve a specific task or set of tasks). The knowledge the firm’s human capital possesses is among the most significant of an organization’s capabilities and ultimately provides the base for most competitive advantages. The firm must create an organizational culture that allows people to integrate their individual knowledge with that held by others so that, collectively, the firm has a significant amount of value-creating organizational knowledge.
· Capabilities are a more likely source of core competence and subsequently of competitive advantages than are individual resources. How a firm nurtures and supports its capabilities to become core competencies is less visible to rivals, making efforts to understand and imitate the focal firm’s capabilities difficult.
· Only when a capability is valuable, rare, costly to imitate, and nonsubstitutable is it a core competence and a source of competitive advantage. Over time, core competencies must be supported, but they cannot be allowed to become core rigidities. Core competencies are a source of competitive advantage only when they allow the firm to create value by exploiting opportunities in its external environment. When this is no longer possible, the company shifts its attention to forming other capabilities that satisfy the four criteria of sustainable competitive advantage.
· Value chain analysis is used to identify and evaluate the competitive potential of resources and capabilities. By studying their skills relative to those associated with value chain activities and support functions, firms can understand their cost structure and identify the activities through which they are able to create value.
· When the firm cannot create value in either a value chain activity or a support function, outsourcing is considered. Used commonly in the global economy, outsourcing is the purchase of a value-creating activity from an external supplier. The firm should outsource only to companies possessing a competitive advantage in terms of the particular value chain activity or support function under consideration. In addition, the firm must continuously verify that it is not outsourcing activities through which it could create value.
Chapter Review
Key Terms
·
costly-to-imitate capabilities
·
global mind-set
·
intangible resources
·
nonsubstitutable capabilities
·
outsourcing
·
rare capabilities
·
support functions
·
tangible resources
·
valuable capabilities
·
value
·
value chain activities
Chapter Review
Mini-Case Is Strengthening the Superdry Brand a Foundation to Strategic Success?
British-based SuperGroup, owner of Superdry and its carefully banded product lines, is taking actions to deal with recent performance problems. These problems manifested themselves in various ways, including the need for the firm to issue three profit warnings in one six-month period and a 34 percent decline in the price of its stock in 2014 compared to 2013.
Founded in 1985, the firm is recognized as a distinctive, branded fashion retailer selling quality clothing and accessories. In fact, the firm says that “the Superdry brand is at the heart of the business.” The brand is targeted to discerning customers who seek to purchase “stylish clothing that is uniquely designed and well made.” In this sense, the company believes that its men’s and women’s products have “wide appeal, capturing elements of ‘urban’ and ‘streetwear’ designs with subtle combinations of vintage Americana, Japanese imagery, and British tailoring, all with strong attention to detail.” Thus, the firm’s brand is critical to the image it conveys with its historical target customer—teens and those in their early twenties. Those leading SuperGroup believe that customers love the Superdry products as well as the “theatre and personality” of the stores in which they are sold. These outcomes are important given the company’s intention of providing customers with “personalized shopping experiences that enhance the brand rather than just selling clothes.”
As noted above, problems have affected the firm’s performance. What the firm wants to do, of course, is correct the problems before the Superdry brand is damaged. Management turmoil is one of the firm’s problems. In January of 2015, the CEO abruptly left. Almost simultaneously, the CFO was suspended for filing for personal bankruptcy, and the Chief Operating Officer left to explore other options. Some analysts believe that the firm’s growth had been ill-conceived, signaling the possibility of ineffective strategic decisions on the part of the firm’s upper-level leaders. As one analyst said: “The issue with SuperGroup is that they’ve expanded too quickly, without the supporting infrastructure.”
Efforts are now underway to address these problems. In particular, those now leading SuperGroup intend to better control the firm as a means of protecting the value of its brand. A new CEO has been appointed who believes that “the business is very much more in control” today than has been the case recently. A well-regarded interim CFO has been appointed, and the firm’s board has been strengthened by added experienced individuals. Commenting about these changes, an observer said that SuperGroup has “moved from an owner-entrepreneurial style of management to a more professional and experienced type of management. The key thing is, it is much better now than it was.”
Direct actions are also being taken to enhance the Superdry brand. The appointment of Idris Elba, actor from The Wire, is seen as a major attempt to reignite the brand’s image. In fact, SuperGroup says that Elba epitomizes what the Superdry brand is—British, grounded, and cool. The thinking here, too, is that Elba, who at the time of his selection was 42, would appeal to the customer who was “growing up” with the Superdry brand. For these customers, who are 25 and older, SuperGroup is developing Superdry products with less dramatic presentations of the brand’s well-known large logos. Additional lines of clothing, for skiing and rugby for example, are being developed for the more mature Superdry customer. After correcting the recently encountered problems, SuperGroup intends to expand into additional markets, including China. In every instance though, the firm will protect the brand when entering new competitive arenas and will rely on it as the foundation for intended success.
Sources: About SuperGroup, 2015, SuperGroupPLC.com, www.supergroup.co.uk, April 5; S. Chaudhuri, 2015, Superdry brand works to iron out problems, Wall Street Journal Online, www.wsj.com, April 15; S. Chaudhuri, 2015, Superdry looks to U.S. to drive growth, Wall Street Journal Online, www.wsj.com, March 26; H. Mann, 2015, SuperGroup strategy oozes Hollywood glamour, Interactive Investor, www.iii.co.uk, March 26; A. Monaghan & S. Butler, 2015, Superdry signs up Idris Elba, The Guardian Online, www.theguardian.com, March 26; A. Petroff, 2015, Is this the worst CFO ever? CNNMoney, www.money.cnn.com, February 25.
Case Discussion Questions
1. What influences from the external environment over the next several years do you think might affect SuperDry’s ability to compete?
2. Does Superdry have one or more capabilities that are valuable, rare, costly to imitate, and nonsubstitutable? If so, what are they? If not, on which criteria do they fall short?
3. Will the actions that Superdry is taking solve its problems? Why or why not?
4. What value does Superdry create for its customers?
5. What actions would you recommend the management of Superdry take to resolve its problems and turn around the performance of the firm?
Figure 2.2The Five Forces of Competition Model
The five forces of competition model depicted in
Figure 2.2
expands the scope of a firm’s competitive analysis. Historically, when studying the competitive environment, firms concentrated on companies with which they directly competed. However, firms must search more broadly to recognize current and potential competitors by identifying potential customers as well as the firms serving them. For example, the communications industry is now broadly defined as encompassing media companies, telecoms, entertainment companies, and companies producing devices such as smartphones. In such an environment, firms must study many other industries to identify companies with capabilities (especially technology-based capabilities) that might be the foundation for producing a good or a service that can compete against what they are producing.
When studying the industry environment, firms must also recognize that suppliers can become a firm’s competitors (by integrating forward) as can buyers (by integrating backward). For example, several firms have integrated forward in the pharmaceutical industry by acquiring distributors or wholesalers. In addition, firms choosing to enter a new market and those producing products that are adequate substitutes for existing products can become a company’s competitors.
Next, we examine the five forces the firm needs to analyze in order to understand the profitability potential within an industry (or a segment of an industry) in which it competes or may choose to compete.