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Presentation Agenda
Readings for Block 1&2: Reading 4: Analyzing the industry environment : pp69-81
Block 3: Unit 1: Sections 1.1, 1.2, 1.3 & 1.4
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Suppliers of leading brands (e.g. Sony and Pioneer) have sought to limit the buying power of discount chains by refusing to supply those chains that advertise cut prices or that do not display their products within an appropriate retailing environment. Efforts to improve industry profitability include mergers and attempts at product differentiation. Excess capacity has also been a major problem. Through a series of bilateral plant exchanges, the number of companies producing each product group has been reduced and capacity rationalization has been facilitated. Building entry barriers is a vital strategy for preserving high profitability in the long run (American Medical Association)
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Hence, the key to defining industry boundaries is identifying the relevant market.
By focusing on the relevant market, we do not lose sight of the critical relationship among firms within an industry: competition. A markets boundaries are defined by substitutability, both on the demand side and on the supply side.
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Beyond the Five Forces model: dynamics, game theory, and cooperation
Economists criticize its theoretical foundations. Its basis is the structureconductperformance approach to industrial organization economics. Researchers have identified a number of assumptions in the structureconductperformance approach which do not hold in practice. For example, business relationships are not always armslength. Many relationships are characterized by privilege through affection or trust; others are co-dependent systems formed by networks (webs) of companies, where competition exists between webs and within webs. 9 Copyright Material Arab Open University
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Beyond the Five Forces model: dynamics, game theory, and cooperation
The Five Forces model is also limited by its static nature: it views industry structure as stable and externally determined. This determines the intensity of competition, which in turn influences the level of industry profitability.
But competition is not some constrained process that determines prices and profits and leaves industry structure unchanged.
Competition is a dynamic process through which industry structure itself changes through evolution and transformation. Porters model does not take these features into account
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Beyond the Five Forces model: dynamics, game theory, and cooperation
Thus, Porters model fails to recognize that competition changes industry structure both
a. consciously by firms strategic decisions and b. as an outcome of the resulting competitive interaction
The essence of competition, then, is a dynamic process in which equilibrium is never reached and in the course of which industry structures are continually reformed. This is evident in the structural transformation of deregulated industries Copyright Material Arab Open University
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Beyond the Five Forces model: dynamics, game theory, and cooperation
Schumpeterian competition: creative destruction Joseph Schumpeter was the first to recognize and analyze the dynamic interaction between competition and industry structure. Schumpeter focused on innovation as the central component of competition and the driving force behind industry evolution. Innovation represents a perennial gale (recurrent wind ) of creative destruction through which favorable industry structures (monopoly in particular) contain the seeds of their own destruction by providing incentives for firms to attack established positions through new approaches to competing. The key issue raised by Schumpeter is whether we can use current industry structures as a reliable guide to the nature of competition and industry performance in the future. 12
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Beyond the Five Forces model: dynamics, game theory, and cooperation
Schumpeterian competition: creative destruction The relevant consideration is the speed of structural change in industry: If the pace of transformation is rapid, If entry rapidly undermines the market power of dominant firms, If innovation speedily transforms industry structure by changing process technology, by creating new substitutes, and by shifting the basis on which firms compete, then there is little merit in using industry structure as a basis for analyzing competition and profit. 13 Copyright Material Arab Open University
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Beyond the Five Forces model: dynamics, game theory, and cooperation
Schumpeterian competition: creative destruction However, many empirical studies of changes over time in industry structure and profitability do not support Schumpeters process of creative destruction. Overall, these studies show a fairly consistent picture of the rate of change of profitability and structure.
Both at the firm and at the industry level, profits tend to be highly persistent in the long run.
Structural change notably concentration, entry, and the identity of leading firms also appears to be, on average, slow. Some industries, however, conform closely to Schumpeters model Schumpeterian industries.
In computers, telecommunication services, Internet access, and electronic games, using current trends in industry structure to forecast profitability several years ahead is unreliable
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Beyond the Five Forces model: dynamics, game theory, and cooperation
The contribution of game theory Central to the criticisms of Porters Five Forces as a static framework is its failure to take full account of competitive interactions among firms The essence of strategic competition is the interaction among players such that the decisions made by any one player are dependent on the actual and anticipated decisions of the other players. The Five Forces analysis offers little insight into firms choices of whether to compete or to cooperate; sequential competitive moves; and the role of threats, promises, and commitments. Game theory has two especially valuable contributions to make to strategic management.
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Beyond the Five Forces model: dynamics, game theory, and cooperation
The contribution of game theory 1. It permits the framing of strategic decisions: Apart from any theoretical value of the theory of games, the description of the game in terms of:
a. Identifying the players b. Specifying each players options c. Establishing the payoffs from every combination of options
d. Defining sequences of decisions using game trees permits us to understand the structure of the competitive situation and facilitates a systematic, rational approach to decision making.
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Beyond the Five Forces model: dynamics, game theory, and cooperation
The contribution of game theory
2. Through the insight it offers into situations of competition and bargaining, game theory can predict the equilibrium outcomes of competitive situations and the consequences of strategic moves by any one player.
One of the greatest benefits of game theory is its ability to view business interactions as comprising both competition and cooperation. A key deficiency of the Five Forces framework is in viewing rivalry and bargaining as competitive in nature.
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Beyond the Five Forces model: dynamics, game theory, and cooperation
The contribution of game theory Whereas Coca-Colas relationship with Pepsi-Cola is essentially competitive, that between Intel and Microsoft is primarily complementary. Thus,
A player is your complementor if customers value your product more when they have the other players product than when they have your product alone. A player is your competitor if customers value your product less when they have other players product than when they have your product alone.
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Beyond the Five Forces model: dynamics, game theory, and cooperation
The contribution of game theory The most important insights that game theory provides are its ability to identify opportunities for a player to change the structure of a game in order to improve payoffs. Consider the following examples: The benefits of repeated games
Deterrence (Discouragement) The payoffs in a game can be changed through increasing the costs to other players of choices that are undesirable to the firm.
Bringing in competitors establishing alliances and agreements with competitors can increase the value of the game by increasing the size of the market and building strength against other competitors.
The key is converting winlose (or even loselose) games into winwin games.
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Beyond the Five Forces model: dynamics, game theory, and cooperation
The contribution of game theory
Game theory permits considerable insight into the nature of situations involving interactions among multiple players.
It clarifies the structure of relationships and nature of interactions among players, and it identifies the alternative actions available to different players and relates these to possible outcomes.
Game theory has provided valuable decision support in negotiations and in simulating competitive patterns of action and reaction.
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Our discussion of hyper competition and game theory has taken us well beyond the connes of the Five Forces framework
Remember that the primary purpose of the Five Forces framework is to analyze industry attractiveness in order to forecast industry profitability.
Hyper-competition explicitly recognizes that competition is a battle for competitive advantage. Game theory also focuses on positioning and maneuvering for advantage. The purpose of this section is to look explicitly at the analysis of competitive advantage to identify the potential for competitive advantage within an industry in terms of the factors that determine a firms ability to survive and prosper its Key Success Factors 21
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What do our customers want? What does the firm need to do to survive competition?
See Table 3 pp; 79
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To answer the first question we need to look more closely at customers of the industry and to view them
(i) as the basic rationale for the existence of the industry and
(ii) as the underlying source of profit.
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The second question requires that the firm examine the basis of competition in the industry.
How intense is competition and what are its key dimensions? If competition in an industry is intense, then, even though the product may be highly differentiated and customers may choose on the basis of design and quality rather than price, low cost may be essential for survival.
A basic framework for identifying Key Success Factors is presented in Figure 5.
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There is no universal blueprint for a successful strategy, and even in individual industries, there is no generic strategy that can guarantee superior profitability. However, each market is different in terms of what motivates customers and how competition works. Understanding these aspects of the industry environment is a prerequisite for an effective business strategy. This does not imply that firms within a industry adopt common strategies. Since every firm comprises a unique set of resources and capabilities, every firm must pursue unique key success factors.
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Summary
In this chapter, we examined concepts and frameworks to assist us in understanding the business environment of the firm.
A key assumption is that to understand competition and the determinants of protability within an industry, we are not restricted to acquiring experience-based, industry- specic learning over a long period of time. Instead, draw on concepts, principles, and theories that can be applied to any industry.
Although every industry is unique, the patterns of competitive behavior can be explained using common analytical frameworks. The underlying premise of this chapter is that the structural characteristics of an industry play a key role in determining the nature and intensity of the competition within it and the rate of Copyright Material Arab Open University 16-3-2013 it earns. 28 profit Egypt Branch_B301A
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Our framework for linking industry structure to competition and profitability is Porters Five Forces of Competition model. This provides a simple, yet powerful, organizing framework for classifying the relevant features of an industrys structure and predicting their implications for competitive behavior. The framework is particularly useful for:
Predicting industry profitability
Indicating how the firm can influence industry structure in order to moderate competition and improve profitability.
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The Porter framework suffers from some critical limitations. In particular, It does not take adequate account of the dynamic character of competition.
Competition is a powerful force that changes industry structure. In hypercompetitive industries, competing strategies create a process of creative destruction that continually transforms industry structure.
As for the theoretical weaknesses of the Porter framework, game theory provides a broader theoretical basis for analyzing both competition and cooperation, but, in providing a basis for strategy formulation, its potential has yet to be realized.
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Summary
Though the Porter framework permits analysis of competition and profitability at the industry level, our industry analysis is also directed toward understanding the opportunities for competitive advantage.
Our approach has been to show that by understanding customer demand, the competitive process, and the determinants of firm-level profitability, we can identify Key Success Factors: the prerequisites for survival and success with an industry.
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Introduction
If strategic management is all about managing to achieve outstan success, then the essentials task of strategy are to identify the s of superior business performance and to formulate and impleme strategy that exploits these sources of superior performance. Johnson (2006) views a strategic process involves three interrelated stages;
Analysis, where strategies explore the environment where their organization exists, with resources and capabilities. Choice, where strategies survey the data gained from reviewing their operating environment and make rational decisions. Implementation, where the organisation sets about seeking to Analysis implement that strategic decision. As follows;
Implementing Choosing
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Introduction
Understanding the environment in which the organization operates is the crucial first element of a rational approach to strategy. The rational approach suggests that organizations need to appreciate the various factors in their operating environment, AND how they may conceivably impact upon them, as they go about making decisions about the nature and content of organizational strategy. This phase of the strategy process has produced some of the most famous and controversial tools in frequent use in classrooms and boardrooms across the world.
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Introduction
The aims of organizations using these tools are twofold: A. They aim to identify opportunities in their operating environments in order to create strategy to take advantage of those opportunities. B. They aim to identify threats in their operating environments in order to create strategy which nullifies the challenge such threats pose.
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Introduction
In each case,
you will be introduced to the authors original motivations for developing these tools, discuss how these tools have been used by academics and businesses, and any developments or extensions to the original models which have been suggested to improve their performance, then discuss any criticisms of these models and their ability to deliver insight for students and business people alike.
Each framework is an attempt to produce a general understanding of the circumstances facing an organisation, how can one tool work in every situation?
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Introduction
By the end of this unit, you should be able to:
A. analyze the far environment of an organisation, making observations on the potential effect that macro-environmental factors can have on an organizations strategy process B. analyze the near environment of an organisation, making observations on the potential effect that industry factors can have on an organizations strategy process C. understand the influence of competitors on an organizations strategy process D. start to develop your own perspective on what are the critical issues facing an organisation preparing for a strategic choice, through reflection on your own experience and by reference to the various cases and examples used in this unit.
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Before we start to introduce the tools, it is probably a good idea to make sure we all understand the terminology used here. External; a simple definition of external implies merely being outside. organisation cannot assume it can control that phenomenon, so it needs to understand it and develop respo and contingencies to deal with it. Environment; there are various environments that are importa an organisation which you may see described as its operatin environment or its competitive environment, Analysis; my favourite definition of an analyst comes from the nineteenth-century American gothic author Edgar Allan Poe, analyst, Poe suggests, makes a host of observations and inferences.
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Before we start to introduce the tools, it is probably a good idea to make sure we all understand the terminology used here. Industry; Michael Porter suggests the following definition: the group of firms producing products that are close substitutes f each other (Porter, 1980, p. 5), which is perhaps a good wor definition of what we traditionally understand to constitute an industry. Market; Is a structure enabling goods and services to be boug and sold. The concept can be used to classify a specific geographic location, or a particular product segment, within a wider industry. Dynamic; Teece et al.,(1997) Dynamic capabilities analysis attempts to understand how organisations are able to build competitive advantage in regimes of rapid change.
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Some observations on the environment One of the roles of strategists is to develop an awareness of t uncertaintie in the environment so that organisations face up them and ensure they ar not ignored. Why is this important? The task of the strategist is complicated by the argument that the environment is becoming increasingly dynamic, and that change is rapid, more frequent and more complex than was previously the case. This suggests that organisations can take nothing for granted DAveni (1994), provided hypercompetition where it is argue that any advantage an organisation enjoys will inevitably be temporary, due to the rate and pace of change. Authors suggest that in most industries competitive advantage necessarily short-lived.
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As you progress through Unit 1, you might like to consider Figure as your map, providing you with a structure for the analysis you be asked to undertake.
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Figure 1.1(P18): A map of an organisations external environment Copyright Material Arab Open University
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The effects can potentially be felt at both a strategic and an operational level.
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The most recent extended model is therefore known as the STEEPL or PESTLE framework and should provide a useful overview of truly significant factors facing all organisations.
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1.3 analysing the near environment Reading 1, Michael Porters model: The five competitive forces that shape strategy
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Michael Porter; continues to be identified as a leading exponent o the market positioning school of strategy, basing his views upo industrial organisation economic (IOE). Porter argues that; it is critical to understand the position of the firm within its industry, as industry structure has a strong influence in determining the competitive rules of the game as well as the strategies potentially available to the firm. the economic structure of an industry is a product of five force whose collective strength determines the ultimate profit pote in the industry.
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1.3: Analysing the near environment Porter acknowledges that the impact of each force will be clear to each firm operating in that industry; what is critical is for the firm to delve (investigate) below the surfa and analyse the sources of each force, developing responses which either nullify the potential threats po by some forces or accentuate the advantages offered by others The five forces approach can be used to analyse two scenari The analysis can be from the perspective of an incumbent. Or it can be from the perspective of a potential new entrant.
Review pp; 28 & 29 VIP
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RBV is a central theoretical contribution emphasising the importance of internal analysis in the strategy process. However, it is important here to note that the RBV represents a significant critique of industrial organisation economic (IOE) approaches to identifying and developing business-level strategy. Jay B. Barney (1991) outlines two major assumptions underlying Porters work which, explicitly, RBV theorists believe are evidence of its weakness if it is not undertaken alongside an internal analysis of capabilities and competencies. These assumptions are that:
Organizations within an industry are identical in terms of their strategic resources and the strategies they pursue. If resource heterogeneity is present in an industry then that heterogeneity will be short-lived (for example if a new entrant arrives, or an incumbent develops new and valuable resources) i.e., resources tend to be imitable or mobile, and hence the advantages they bring will inevitably only be temporary.
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Resource-based criticisms
Jay B. Barney (1991), notes that the RBV, as it seeks to link internal characteristics with performance, is a challenge to these assumptions. Indeed the RBV adopts contrary assumptions First that there will be resource heterogeneity between organizations, and Second that there is no inevitability that resource heterogeneity will disappear, along with any advantage that heterogeneity brings
as competitive advantage is a product of superior resources and capabilities, and occasionally an organizations resources and capabilities are so superior that competitive advantage becomes sustainable over the longer term. 59
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Dynamic criticisms
Robert Grant (2008) has suggested the addition of a new force that of the complement or complementor.
Grants perspective is that the issue of whether organizations can or should cooperate with competitors needs to be acknowledged during a five forces analysis. He argues that an organization is often so interconnected with other organizations that they may have merged value chains,
so that to exclude complementors from a five forces analysis is to risk underestimating their importance to an organizations understanding of its industry structure.
To Grant, therefore, a complementor is much more than a simple supplier, as a complementor is the co-creator of an organizations product or service offering and needs to be acknowledged as 61 such. 16-3-2013 Copyright Material Arab Open University Egypt Branch_B301A
A considerable critique has recently emerged based upon the argued dangers of assuming that it is possible to generalize about the experiences of organizations even similar organizations within an industry. Among the potential practice-based criticisms is a suggestion that a focus upon the five forces identified by Porter cannot help an organisation to make a judgement about industry attractiveness, because to do so requires an impossible level of abstraction in deciding upon the relative power of each and their implications.
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Practice-based criticisms
Porters conclusion (that understanding these forces enables a firm to make effective strategic choices) is often watered down to simply suggest that undertaking such analysis may help managers to take better decisions.
A second criticism concerns the tendency of Porters model to encourage analysts to group various suppliers, buyers, and so on together, when not all suppliers or buyers are alike.
An individual and a petroleum refinery may both be customers of an electric utility, but they cannot be said to share many characteristics, so encouraging them to be considered alike is seen as a serious failing of Porters Copyright Material Arab Open University 63 approach. 16-3-2013 Egypt Branch_B301A
Sector-based criticisms
The industries studied and referred to in Porters original model were overwhelmingly American organizations and from a manufacturing sector, such as automobiles, or the emerging high-technology industries, such as computing. The model was also developed at the end of the 1970s, an era where the certainty of industry boundaries was much greater than the increasingly connected global economy within which we live today; while it did acknowledge the convergence of industries such as telecommunications and computing, the model did not anticipate the extent of such convergence and the increasing and rapid blurring of industry boundaries. But a valid general question remains: to what extent can a framework developed at a particular time and based upon observations of a particular industry be likely to work in a differing context? Copyright Material Arab Open University
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Sector-based criticisms
Public sector criticisms often suggest that there is a need for a sixth force government in any application of the five forces model to a public sector body, in order to enable it to make sense of the context within which it operates. Similarly, industries which are largely competitive but heavily regulated, such as utilities, pharmaceuticals and (increasingly) finance, may also need a more explicit recognition of the role of the government actor in order to enable any five forces analysis to meaningfully reflect the structural arrangement of their industry.
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Porter suggests that analysts, while not ignoring government, should refine their understanding of any or all of the five forces that government affects.
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Homework
Homework Block 3: activities 1.1, 1.3, 1.6, 1.7, 1.8 Case study 1.1
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