Chapter 2 Mapping the Business Landscape

MGMT 5303 Corporate and Business Strategy

Environment Matters

When an industry with a reputation for difficult economics meets a manager with a reputation for excellence, it is usually the industry that keeps its reputation intact. Warren Buffet

The industry in which a company operates has a strong influence on its economic performance 10% 20% of the variation in businesses accounting profitability reflects the industries in which they operate

Two-Dimensional Landscape
Exhibit 2.1 Average Economic Profits of U.S. Industry Groups (1989 2006)

Three-Dimensional Landscape
Exhibit 2.2 A Three-Dimensional Business Landscape

Landscape Metaphor
The profitability of direct competitors tends to have a common industry-specific component Businesses in some industry groups (e.g., pharmaceuticals) have generally operated on profit plateaus Others (e.g., airlines) have mostly remained stuck in deep troughs

Landscape Metaphor
Past industry performance is not always a predictor of what will occur in the future Managers need to understand the reasons behind such effects in order to:
decide where and how their firms will compete assess the implications of major changes in the relevant parts of the business landscape, and adapt to or, better yet, shape the business landscape

Supply-Demand Analysis
Alfred Marshall (late 19th Century)
created the first supply-demand diagram price determined by equilibrium point in supply and demand debated whether Marshallian scissors values are governed by
supply-side costs demand-side utility

introduced concept of price-elasticity of demand

Supply-Demand Analysis
Exhibit 2.3 Supply-Demand Analysis

Supply-Demand Analysis
Incorporated relatively quickly into economics and marketing courses at business schools Less impact on teaching and practice of business strategy until the recessions of the 1970s and early 1980s

Supply - Demand Analysis

Exhibit 2.4 Supply Curve for Boston Hospitals

Supply-Demand Analysis
Limitations of Marshallian supply-demand analysis
Pushes boundaries of reality to treat the hospitals in the local market as:
individually small lacking market power

Violates the assumption of homogeneity Useful to generalize assumptions associated with supply-demand analysis

The Five Forces Framework

Antoine Cournot 1838 Edward Chamberlin, Joan Robinson 1933 Harvard School Economists Edward S. Mason, Harvard Economics Department
industry s structure determines the conduct of buyers and sellers

The Five Forces Framework

Joe Bain, Harvard Economics Department (1950s)
Three basic barriers to entry
an absolute cost advantage by an established firm a significant degree of product differentiation economies of scale

Enabled growth of industrial organization (IO) Several hundred empirical studies by IO economists (mid1970s)

The Five Forces Framework

Michael Porter - Richard Caves
Porter s Note on the Structural Analysis of Industries (1974)
focused on the business policy objective of profit maximization rather than the public policy objective of minimizing excess profits16

Competitive Strategy (1980)

five forces framework
16. Michael E. Porter, Note on the Structural Analysis of Industries (Harvard Business School Case no. 376 054, Boston, 1975).

The Five Forces Framework

The Five Forces Framework

1980s IO survey revealed that only a few of the influences Porter flagged commanded strong empirical support17 Despite its problems, the five forces framework
focuses on business concerns, rather than public policy emphasizes extended competition for value, rather than just competition among existing rivals application is relatively easy to use Bain survey (1993) 25% usage rate18
17. Richard Schmalensee, Inter-Industry Studies of Structure and Performance, in Handbook of Industrial Organization, ed. Richard Schmalensee and Robert D. Willig (Amsterdam: North-Holland, 1989), chap. 16, pp. 951 1009. The elements in Porter s framework that are supported by Schmalensee s review of the evidence appear in bold print in Exhibit 2.5. 18. Darrell K. Rigby, Managing the Management Tools, Planning Review, September-October 1994.

Force 1: Degree of Rivalry

Most obvious of forces Strategists have historically focused on rivalry Several determinants of rivalry exist
Number and size of direct competitors Capacity utilization influences pricing Behavioral determinants

Force 2: Threat of Entry

Industry profitability influenced by
Potential competitors Existing competitors

Entry barriers

prevent influx of firms into an industry rest on irreversible resource commitments

Strategic Groups Barriers to entry can change over time

Force 3: Threat of Substitutes

Price-to-performance ratios
different products or services customers can use to satisfy the same basic need

Switching costs incurred

Retraining Retooling Redesign

Process follows an S-Shaped Curve

Force 4: Buyer Power

Vertical force
influences appropriation of value created by industry allows customers to squeeze industry margins

Determinants of bargaining power

size and concentration of customers willingness or incentive to use buyer power perceived risk of failure associated with product s use

Force 5: Supplier Power

Mirror image of buyer power Focuses on
relative size and concentration of suppliers relative to industry participants degree of differentiation in the inputs supplied

Ability to charge customers different prices

market characterized by high supplier power low buyer power

The Five Forces Framework

The Value Net and Other Generalizations

Since developing Porter s Framework
rearrangement and incorporation of additional variables generalized as necessary by bringing new types of players into the analysis

The Value Net and Other Generalizations

Value Net Framework (Brandenburger & Nalebuff)
Complementors
mirror image of competitors influences business success or failure
demand side increases buyers willingness to pay for products supply side decreases price that suppliers require for their inputs

The Value Net and Other Generalizations

Exhibit 2.6 The Value Net

The Value Net and Other Generalizations

Heuristics for assessing the relative bargaining power of complementors
relative concentration relative buyer/supplier switching costs relative complementor/competitor switching costs asymmetric integration threats rate of growth of the pie

The Value Net and Other Generalizations

Templates for landscape analysis
supply-demand analysis the five forces framework the value nets

Each generalizes its predecessor(s) by bringing new types of players into the analysis Can additional improvements be achieved by further broadening the types of players considered?
non-market relationships

The Process of Mapping Business Landscapes

Principal purpose of mapping the business landscape
not to identify the profitability of your own industry

To understand the reasons for such variations To incorporate them into strategic action

The Process of Mapping Business Landscapes

Six Step Process
1. Gathering Information 2. Drawing the Boundaries 3. Identifying Groups of Players 4. Understanding Group-Level Bargaining Power 5. Thinking Dynamically 6. Adapting to/Shaping the Business Landscape
30. While the basic ideas on which this subsection draws are well established, the adapter/shaper dichotomy used here and elsewhere in this book is based on recent work by the consulting firm of McKinsey &Company, as discussed at the McKinsey Strategy Forum.

The Process of Mapping Business Landscapes

1. Gathering Information
Use public sources of information
beware of information overload select and prioritize information according to content, quality, and accessibility supplement public information with private information spread costs of analysis across other types of analysis develop processes to capture information assemble and analyze information

The Process of Mapping Business Landscapes

Exhibit 2.7 Public Sources of Information for Industry Analysis

The Process of Mapping Business Landscapes

2. Drawing the Boundaries
industry definition horizontal scope vertical and geographical scope

The Process of Mapping Business Landscapes

3. Identifying Groups of Players
direct competitors potential entrants substitutes complements buyers suppliers existing players vs. new/potential players

The Process of Mapping Business Landscapes

4. Understanding Group-Level Bargaining Power
groups/sub-groups that influence payoffs
suppliers that hold large percentage of cost structure buyers that represent substantial share of market degree of market concentration

The Process of Mapping Business Landscapes

5. Thinking Dynamically
Failure to anticipate changes in the business landscape can be disastrous
distinguish between short run and long run understand how general economic weakness fundamentally reshapes strategic options consider potential for resetting industry structure

The Process of Mapping Business Landscapes

Exhibit 2.9 Trends Influencing Industry Structure

The Process of Mapping Business Landscapes

6. Adapting to/Shaping the Business Landscape
Anticipating long-run performance Identifying groups of players/forces that must be countered to achieve good performance Testing decisions to enter, invest in, or exit from an industry Assessing the effects of a major change in the business landscape in order to adapt Identifying ways to shape the business landscape

Summary
Landscape analysis elucidates opportunities and threats
not confined to direct competitors involves looking beyond them to the generality of the analytical framework employed

Supply-demand analysis focuses attention on product markets

exchange relationships between suppliers and buyers

Summary
Five forces framework extends the analysis to three-stage vertical chains
supplier competitor buyer

Includes explicit consideration of substitution possibilities

Summary
The value net draws complementary relationships into the picture
more groups of players may need to be added, depending on the context fit the framework used to the situation being studied, rather than the other way around

Summary
Group-level profitability analysis must be dynamic
relationships between groups of players can and do change over time
cycles, trends, shocks, and other factors

Perceptions of common opportunities and threats

must be integrated with consideration of the strengths and weaknesses of individual players

Key Terms
business landscape buyer power complementors cooperation demand curve dynamic thinking entry barriers extended competition five forces framework geographic scope horizontal scope industrial organization or IO nonmarket relationships oligopolistic competition price-elasticity of demand rivalry strategic groups substitutes supplier power supply curve supply-demand analysis value net vertical scope