Innovation & Strategy MODULE 4
Formulation
Gospel Reading
“Forget the former things; do not dwell on the past. See, I am doing a new thing! Now it springs up; do you not
perceive it?
I am making a way in the wilderness and streams in the wasteland”
Isaiah 43:18-19
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Learning Objectives
Illustrate the strategy concepts on
The ‘Five Forces’ that shape strategy.
Discuss the cornerstones of
competitive advantage
Explain resource accumulation
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Module Overview
This module will help identify and evaluate strategies and structures that are more
likely to lead to success. Michael Porter’s Five Forces will be the main tool to be used
for Industry Analysis
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What is Business Strategy
Strategy is the pattern of decisions any company that determines and reveals its objectives, purposes,
or goals, produces the principal policies and plans for achieving these goals, and defines the range of
business the company is to pursue; the kind of economic and human organization it is or intends to
be, and the nature of the economic and noneconomic contribution it intends to make to its
shareholders, employees, customers, and communities
Kenneth Andrews, The concept of Corporate Strategy (Homewood, IL: Richard D. Irwin, 1971)
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Fundamental Principle of Business Strategy
"If everyone can do it, it's difficult to create and capture value
from it."
or alternatively
"In a perfectly competitive market, no firm realizes economic
profits (rents)"
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The Role of
Industry Stucture
Premise that industry structure matters
most
Economic rents due to barriers to
competition (i.e. monopoly rents)
Some industies are more profitable than
others
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Industry
Average ROA
Different Industries have different
ROAs
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Five Porter's Analysis
Threat of new
entrant
Bargaining
Bargaining Intensity of
Power of
Power of Buyer Rivalry Supplier
Threat of
Substitute
Products
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Threat of New Entry
Barriers to Entry
[Link] of Scale
[Link] Differentiation
(Competitive Advantage)
[Link] Requirements
[Link] disadvantages independent
of size
[Link] to distribution channel
[Link] policy
[Link] of retaliation
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Competitive Advantage
Patents and Licenses
Pioneering Brands
Large economies of scale (relative to demand)
Pre-commitment contracts
Steep learning (experience curves)
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Likelihood of Retaliation
Excess Capacity of Incumbents
Economies of Scale
Substantial exit cost
Aggressive reputation of incumbents
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Bargaining Power of Supplier
Supplier is powerful if:
1. Dominated by few companies
2. Product is unique / differentiated, high
switching cost
3. Not obliged to contend with other products
for sale to the industry
4. Credible threat to do forward integration
5. Industry is not an important customer of
the supplier group
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Supplier are less of a Threat when
Sellers are not concentrated (no monopoly)
Firms have many alternatives
Many substitutes for suppliers products
Firms faces low switching cost
Supplier cannot forward integrate
Sellers may not treat segments differently
Price information is widely available
Price discrimination is not possible
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Bargaining Power of Buyer
Buyer is Powerful if:
1. Purchase in bulk volume
2. Products it purchases from the industry form a
component of its product and it represents
significant fraction of its cost
3. Earns low profits, which create greater incentive to
lower its purchasing cost
4. Industry’s product is unimportant to the quality of
buyers’ products or services
5. Industry’s product does not save the buyer money
6. Buyer can do backward integration
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Buyers have less power if
1. Buyers are not concentrated (no monopsony)
◦ Many potential buyers
◦ Each accounts for a small fraction of sales
2. Buyers have few options
• products are differentiated
• high switching cost
• buyer cannot backward integrate
3. Buyers are segmented
• Price information is not widely available
• Price discrimination possible
• Bundling possible
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Strategic Action to Address Supplier and Buyer’s Bargaining
Power
A company can improve its strategic posture by finding suppliers or buyers who possess the least power
to influence it adversely.
Most common is the situation of a company being able to choose whom it will sell to – buyer selection
A company can sell to powerful buyers and still come away with above-average profitability only if it is
a low-cost producer in its industry or if its product enjoys some unusual, if not unique, features
If company lacks a low cost position or a unique product, selling to everyone is self-defeating because
the more sales it achieves, the more vulnerable it becomes
Buyer selection can help a company focus on the segments of the industry where they can create
product differentiation, minimize threat of backward integration, or mitigate the power of their customers
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Threat of Substitute Products
Substitute Products –
Threat of substitute is low:
o Cross-price elasticity of demand is low
o Switching costs are high
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Cross-Price Elasticity
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Intensity of Rivalry
Rivalry is high if:
Competitors are numerous or are roughly equal in
size and power
Industry growth is slow (mature market)
Product lacks differentiation or switching cost
Fixed cost is high or product is perishable, creating
strong temptation to cut prices
Capacity is augmented in large increments
Exit barriers are high
Rivals are diverse in strategies, origins, and
personalities
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Cornerstones of Competitive Advantage
Heterogeneity
Heterogeneity
Rents
(Monopoly or
or Ricardian)
Ricardian)
Ex
Ex Post
Post Limits
Limits
Imperfect
Imperfect Competitive to
Mobility to
Mobility Advantage Competition
Competition
Rents Sustained within the firm Rents Sustained
Ex
Ex Ante
Ante Limits
Limits
to
to
Competition
Competition
Rents not offset by cost
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Resource Accumulation
Resource based model fundamentally concerned with internal accumulation of
assets, asset specificity, and less directly with transaction costs
Barney (1988) – abnormal returns from diversification depend on how rare and
imitable resulting combination of resources
Montgomery and Hariran (1991) shown that firms with broad resource bases tend to
pursue diversification
Theory of diversification is resource based – diversification is the result of excess
capacity in which resources have multiple uses and for which there is market failure
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Application – Resource Accumulation
Montgomery & Wernerfelt (1989) diversification viewed as matching a firm’s
resources to the set of market opportunities
Firms with more specialized resources are more constrained to enter into
widely different product markets – and specialized resources relatively scarce,
thus higher rents
Firms with more generalizable resources may face a wide opportunity set –
yet lower rents
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Thank You!