Chap - 4 the Industry and Market Envioronment

The Institute of Chartered Accountants in England and Wales, March 2009 113

Contents

chapter 4

The industry and marketenvironment

Introduction

Examination context

Topic List1 Industries, companies, markets and

technologies

2 Porter's Five Forces approach

3 Product life cycles and international activities

4 Industry segments and strategic groups

Summary and Self-test

Answers to Self-test

Answers to Interactive questions

Business strategy

114 The Institute of Chartered Accountants in England and Wales, March 2009

Introduction

Learning objectives Tick off Analyse a business's current markets, highlighting relevant issues in terms of their likely

impact on the strategy of the business

Analyse the external factors which may impact on a business's performance and identifysignificant issues in the following areas

Industry developments Current markets

The specific syllabus reference for this chapter is 1b.

Practical significanceThe competitive pressures of the industry affect the level of profitability of the business as a whole. Thestage of the industry in its lifecycle affects cash flows and the competitive challenges the industry membersface.

Understanding how these stand and how they may develop within the strategic horizon is essential to amanagement team that wishes to deliver competitive success.

Stop and thinkShare prices are influenced by the long-term earnings available in the industry as a whole and the perceivedability of the particular firm's management team to succeed better than rivals in the industry.

Which industries do you think have their best years still to come?

Which industries do you think have their best years behind them?

Working contextThe management approaches you will encounter will differ between firms according to the stage they are inthe industry lifecycle. The 'new economy' firm will base its financial decisions on the future potential it sees.It will be scaling up for growth. The 'mature' firm will be seeking to extract value from what it owns already.

Syllabus linksThis chapter covers some of the same objectives as Chapter 3 through the use of additional models. Someof the models covered here will be familiar to you from section 6 of the Business and Finance syllabus.

THE INDUSTRY AND MARKET ENVIRONMENT


4

Examination content

Exam requirementsThis chapter looks at techniques such as Porter's Five Forces and life cycle analysis. Applying theappropriate models to the scenario in the exam will help you understand the wider context in which theorganisation is operating and the factors that are likely to impact on business performance.

Business strategy


1 Industries, companies, markets and technologies

Section overview Strategic analysis requires management to consider the competitive forces in the organisation's

industry, although defining the industry can be difficult in practice.

Industries pass through life cycles that will affect current performance and prospects.

1.1 Defining an industry

DefinitionIndustry: A group of organisations supplying a market offering similar products using similar technologiesto provide customer benefits.

1.2 Industry life cycles

The concept of life cycle analysis is popular in strategic management. In later chapters life cycle analysis willbe used to describe the stages products pass through from their first introduction to the market through totheir withdrawal and replacement.

The present section considers the application of life cycles at a higher level, that of the industry as a whole.

The stages of the industry life cycle are:

Introduction newly invented product or service is made available for purchase

Growth a period of rapid expansion of demand or activity as the industry finds a market

Maturity a relatively stable period of time where there is little change in sales volumes year to yearbut competition between firms intensifies

Decline a falling off in activity levels as firms leave the industry and the industry ceases to exist or isabsorbed into some other industry.

Worked example: Recorded musicThe following graphs represent the life cycle for recorded music from the 1930s to the present day.

1930sSALESVOLUME

Sheet musicPianola

Gramophone records

TIME



4

1960sSALESVOLUME

Sheet musicGramophone records

TIME

1/ inch tapes4

1980sSALESVOLUME

Gramophone records

TIME

8 track cassettes

Cassette tapes

Video cassettes (VCR)

Compact Discs (Cds)

2000sSALESVOLUME

TIME

(VCR)DVD

MP3/MP4

Video on demand

The industry life cycle has been characterised by:

Accelerating pace of change. The CD had only 15 years of dominance compared to 40 years forgramophone records.

Meta-technology waves. The replacement of analogue gramophone by digital CD was part of the meta-technology wave that also replaced typewriter with PCs and fixed line telephone with digital mobiles.

Consequent industrial restructuring following technological convergence. Sony the electronicsmanufacturer bought CBS records, the ISP firm America On Line merged with Time-Warner, VirginMedia combined with cable provider NTC.

Industry life cycle

Some industry life cycles are identical in pattern and timing to that of their product (e.g. in the hat industry,or steel industry). Others have longer life cycles than the particular products, e.g. the music industry whichhas endured from sheet music till MP3, merely releasing (and re-releasing) its music as new products as theformat changes.

Business strategy


The industry life cycle is analysed into these phases.

Introduction Growth Shakeout Maturity Decline

Customers Experimenters,innovators

Early adopters Growingselectivity ofpurchase

Mass market,for branded

Pricecompetition,

Commodityproduct

R&D High Extendproductbeforecompetition

Seek lower costways to supplyto access newmarkets

Low

Company Early mover

Productionfocused

React to morecompetitorswith increasedmarketing

Potentialconsolidationthrough buyingrivals

Battles overmarket share

Cost controlor exit

Competitors A few More entrantsto the market

Manycompetitors,price cutting butwinnowing out ofweaker players

Depending onindustry, a fewlargecompetitors

Price-basedcompetition,fewercompetitors

Profitability Low, as aninvestment

Growing Levelling off Stable, high orunderpressure

Falling, unlesscost control

1.3 Strategic implications of industry life cyclesThe financial returns to firms in an industry vary according to the stage.

Salesvolume

Introduction Growth Shakeout Maturity Decline

Cash flow

Management must pursue different strategies at each stage:

Introduction stage

Support product despite poor current financial results

Review investment programme periodically in light of success of launch (e.g. delay or bring forwardcapacity increases)

Monitor success of rival technologies and competitor products



4

Worked example: Betamax & VHSIn 1974 Sony released its Betamax format Video Cassette Recorders (VCR). In 1976 JVC/Matsushitareleased its rival VHS format. The years that followed were characterised by a 'battle of formats' betweenBetamax and VHS. Sony and Betamax are widely regarded as the better product that lost the competitivebattle in the 1980s, despite its selling some 18 million units over the ensuring 27 years. It is suggested thatthe following mistakes were made by Sony during the introductory stage.

Refusal to license the use of Betamax technology to third party manufacturers of machines andcassettes

Being first in the market Sony had to fight legal actions from film studios concerned over copyrightbreach

Holding a blinkered view of the market which saw VCR as a way to play films and didn't see the majorvalue in allowing households to time-shift their viewing (VHS machines used larger tapes and hadbetter recording functionality early on)

Production capacity didn't keep pace with demand because Sony refused to contract-out production.

The 'battle of the formats' is being rerun in 2007 in relation to High Definition DVD (HD-DVD) whereSony is championing its Blu-ray format against HD-DVD formats supported by a consortium of majorelectronics and media companies.

Growth stage

Ensure capacity expands sufficiently to meet firm's target market share objectives

Maintain barriers to entry (e.g. fight patent infringements, keep price competitive)

Ensure investors are aware of potential of new products to ensure support for financial strategy

Search for additional markets and product refinements

Consider methods of expanding and reducing costs of production (e.g. contract manufacturingoverseas, building own factory in a low cost location)

Shakeout phase

Monitor industry for potential mergers and rationalisation behaviour Seek potential merger candidates Periodic review of production and financial forecasts in light of sales growth rates Shift business model from customer acquisition to extracting revenue from existing customers Seek to extend growth by finding new markets or technologies

Worked example: Slowdown in mobile phone industryGlobal mobile phone subscriber growth ran at 25% pa between 2004 and 2006. It fell to 12.8% in 2007 andis forecast to fall to 5.8% by 2010.

The consequences for the industry are:

Fall-off in growth of handset production from 20% in 2007 to 3% in 2010

Shift of focus of wireless carriers (i.e. the network operators) towards markets with present lowpenetrations such as Latin America, China, Africa, Australia and India

Price pressure with operators offering heavily discounted phones to attract subscribers from otherfirms

Requirement for 'low end' handsets to attract developing markets

Source: Electronic News February 2007

Business strategy


Maturity phase

Maximise current financial returns from product

Leverage the existing customer database to gain additional incomes (e.g. mobile phone operatorsseeking to earn from content management)

Engage in integration activities with rivals (e.g. mergers, mutual agreements on competition)

Ensure successor industries are ready for launch to pick up market

Decline phase

Evaluate exit barriers and identify the optimum time to leave the industry (e.g. leases ending, need forrenewal investment)

Seek potential exit strategy (e.g. buyer for business, firms willing to buy licenses etc)

2 Porter's Five Forces approach

Section overview One of the most influential models used in strategic analysis to assess the state of competition in an

industry. Long term profitability determined by the extent of competitive rivalry and pressure on an industry. By considering the strength of each force and the implications for the organisation, management can

develop strategies to cope. Like all models of analysis it has limitations particularly in industries that are rapidly changing.

2.1 The basic modelAccording to Porter, five competitive forces influence the state of competition in an industry. Thesecollectively determine the profit (i.e. long-run return on capital) potential of the industry as a whole.

Source: adapted from Porter M, Competitive Strategy (1980) New York: Free Press

Porter claims that the intensity of the fifth force, competitive rivalry, is driven by the intensity of the otherfour forces. If these other forces are driving profitability down the firms in the industry will compete moreintensely to restore their own profits.



4

2.2 The threat of new entrantsA new entrant into an industry will bring extra capacity and more competition. The strength of this threat islikely to vary from industry to industry, depending on the strength of the barriers to entry. Barriers toentry discourage new entrants and influence the likely response of existing competitors to the new entrant.

Barrier to entry

Scale economiesIf the market as a whole is not growing, the new entrant has tocapture a large slice of the market from existing competitors, to makesales to cover high fixed costs.

Product differentiation Existing firms in an industry may have built up a good brand image andstrong customer loyalty over a long period of time. A few firms maypromote a large number of brands to crowd out the competition.

Capital requirements When capital investment requirements are high, the barrier againstnew entrants will be strong, particularly when the investment wouldpossibly be high-risk.

Switching costs Switching costs refer to the costs (time, money, convenience) that acustomer would have to incur by switching from one supplier'sproducts to another's. Although it might cost a consumer nothing toswitch from one brand of frozen peas to another, the potential costsfor the retailer or distributor might be high.

Access to distributionchannels

Distribution channels carry a manufacturer's products to the end-buyer. New distribution channels are difficult to establish, and existingdistribution channels hard to gain access to.

Cost advantages of existingproducers, independent ofeconomies of scale

These include:

Patent rights

Experience and know-how (the learning curve)

Government subsidies and regulations

Favoured access to raw materials

Response of incumbents Incumbents have substantial resources including cash to fight back

May cut prices to keep market share

Slow growth in a mature market may mean all companies' profitsare reduced.

Entry barriers might be lowered by:

Changes in the environment Technological changes Novel distribution channels for products or services

Generally an industry with low barriers to entry will be characterised by a large number of small firms.

Business strategy


Worked examples: Confectionery and soft drinks

Confectionery

The UK confectionery market is dominated by three organisations - Mars, Nestl and Cadbury each withlarge shares of the market. Some smaller organisations survive, but there are significant barriers to entry,which include:

(a) The minimum efficient size, particularly in the chocolate sector, needed to adequately compete

(b) The advertising expenditure needed to establish brand awareness in a market where advertising spendis huge

(c) The need to penetrate the supermarket distribution network

(d) The experience of the main competitors in production and marketing.

Soft drinks

The traditional soft-drinks supplier Morgan is based in Southwold, a small town on the Suffolk coast. Withinthe surrounding area it has held a near monopoly for years, with a sufficiently strong competitive positionto withstand the pressure from the large national manufacturers. This is not solely on account of the qualityof its product.

Drinks manufacturing is subject to considerable economies of scale in manufacture. However, distributingdrinks over large distances adds considerably to the cost, since most of the cargo is water. Morgans base inSouthwold is sufficiently remote that the production cost disadvantage it suffers from its relatively smallscale is offset by its relatively low distribution costs. Major suppliers, based for example in London, find thecost of transporting bottled and canned drinks all the way to the edge of Suffolk to be too high to make itan attractive market for them.

Morgan is thus able to enjoy virtual market dominance in its own area, in spite of being a very small playerin the industry as a whole.

New e-commerce entrants into markets such as CDs and books (e.g. amazon.com) have threatenedtraditional retailers. The Internet is good at providing information based services at low cost so newentrants delivering information such as share prices have had a significant impact.

2.3 The threat from substitute productsA substitute product is a product /service produced by another industry which satisfies the same customerneeds.

Substitutes affect profitability of an industry through:

Putting a ceiling on prices e.g. air fares will determine the maximum level of train fares over similarroutes

Affecting volumes of demand

Forcing expensive investments and service improvements e.g. CDs + DVDs supplied with booklets,posters and other offers to make them more attractive as artefacts compared to virtual downloads.

Threat from substitutes determined by:

Relative price/performance e.g. speed of plane travel against the speed of train travel may be higherbut does it justify the higher price?

Switching costs from one to another e.g. download may be cheaper than CD but necessitates buyingan MP3 player.



4

Interactive question 1: Record stores [Difficulty level: Exam standard]Sony Music became the largest record label to start selling music on-line in 1997 hoping to ape Amazon'ssuccess with books. Most pundits smugly argued it would end in tears. Book stores, they said, were deadbecause they could not compete with Amazon's millions of titles. Customers would stay loyal to musicshops because buying on-line would deprive them of the joy of browsing the aisles and impressingdauntingly hip sales staff with their insight into obscure acts.

A decade later new book stores are popping up across Britain while record stores are in danger of dyingout. On January 11th (2007) HMV, Britain's biggest music retailer, posted a first-half loss. Music Zone, whose104 shops specialise in cut-price CDs and DVDs, went into administration on January 3rd 2007.

The assault has come on two fronts. Supermarkets have been selling music aggressively in the past five yearsand now account for a quarter of sales and by concentrating on no more than 100 bestsellers that accountfor about a third of total album sales. The second threat to high street music shops is the Internet whichhas made copying and stealing music easier but also allowed customers to sample, legally, a wider choice ofalbums than even the biggest music stores stock. Online music sellers such as Amazon have more thandoubled their sales to about 11% over the last five years. Legal download services, including Apple's iTunes,account for less than 3% of the market.

Source: Economist January 2007

HMV seeks to revitalise business

Shares in music and book retailer HMV Group have fallen 16% after the firm issued a profit warning as itlaunched a 'radical' review of the business.

HMV said sales had deteriorated further since the start of 2007 and that annual profits would be lower thanexpected.

The retailer is likely to close loss-making stores following a review of its entire estate of 421 HMV outletsand 329 Waterstone's book stores.

Changing trends in the music market, with more and more consumers downloading songs rather thanbuying physical copies, has hit HMV hard.

'Waterstone's and HMV are great brands but have not adapted quickly enough to the way customers arenow buying and consuming media,' said chief executive Simon Fox. 'Our performance has suffered as aconsequence.'

HMV said group like-for-like sales - which strip out the impact of store openings and closures - were down3% in the nine weeks to 10 March. As part of a three-year turnaround plan, HMV plans to save 40m by2010 by reviewing all aspects of its business, including its stores, supply chain and administrative operations.

Unprofitable stores plus those deemed surplus to requirements following Waterstone's purchase ofOttakar's last year are likely to be closed. HMV also plans to refurbish its stores and introduce newproducts including portable music players and gift stationery at Waterstone's.

It will also launch a social networking site for music and film enthusiasts and increase investment behind itsown online retail site.

HMV shares closed down 15.9%, or 24.25 pence, at 128.5p.

'Investor hopes have again been dashed via another downward estimate to profits,' said Keith Bowman,from Hargreaves Lansdown Stockbrokers.

'Today's update leaves investors requiring a further leap of faith in the group's potential turnaroundprospects.' Source: BBC Website March 2007

Requirements

(a) Identify the factors that have enabled substitutes to cause the financial decline of record stores.(b) Identify reasons for the apparent continuing success of bookshops.(c) Suggest strategies that may help the management of record stores to improve earnings.

See Answer at the end of this chapter.

Business strategy


2.4 The bargaining power of buyers (customers)Buyers (customers) may include:

Industrial customers and distributors seeking to obtain lower costs to boost their own margins, orbetter inputs and smoother transactions with suppliers

Governmental or other not-for-profit organisations seeking to gain more benefit for their clients

Consumers wanting better quality products and services at a lower price

Satisfying their wants may lead them to trade around the industry, forcing down the profitability of theindustry. Buyer power is increased by:

The customer buying a large proportion of total industry output

The product not being critical to the customer's own business and a lack of proprietary productdifferences which would otherwise make them favour or be locked into one supplier

Low switching costs (i.e. the cost of switching suppliers)

Products are standard items and hence easily copied

Low customer profitability forcing them to prioritise cost reductions

Ability to bypass (or acquire) the supplier

The skills of the customer's purchasing staff

High degrees of price transparency in the market

Worked example: Retail pressureIn the UK market for fresh fruit and vegetables, one of the most prized possessions of a grower is acontract to supply Marks & Spencer. Many small farmers commit large proportions of their acreage to suchcontracts, and subsequently risk huge losses if the resulting produce does not meet the stringent qualitycriteria of the customer.

Powerful buyers put pressure on industry profits. Buyers are particularly powerful when:

(a) Purchasers are large, relative to suppliers

(b) Purchases represent a significant proportion of the buyer's costs, in which case these costs will besubject to great scrutiny

(c) Purchases are undifferentiated. Customer bargaining power is greatly increased when using theInternet to evaluate products and compare prices. This is particularly true for standardised products

(d) There are few switching costs incurred by the buyer in changing to an alternative supplier, and anychange involves few risks. Thus, if the products of alternative suppliers have similar characteristics,then the buyer would not need to switch its own processes to accommodate a different type ofinput/material. (For example, if a car manufacturer sources brakes from a new supplier, then there arelow switching costs if the new brakes are compatible with the cars' existing wheels, tyres, suspensionand with the factory's production line machinery.)

(e) The buyer earns low profits, in which case it will pressure supplier prices down in an attempt toincrease margins

(f) The buyer has the potential to take over the supplier (backward integration)

(g) The buyer's product is not strongly affected by the quality of the supplier's product

(h) The buyer has full information about the supplier's cost structure or the supplier's competitiveposition.



4

2.5 The bargaining power of suppliersSuppliers can exert pressure for higher prices but this depends on a number of factors.

Are there just one or two dominant suppliers to the industry, able to charge monopoly or oligopolyprices?

The threat of new entrants or substitute products to the supplier's industry.

Whether the suppliers have other customers outside the industry, and do not rely on the industry forthe majority of their sales.

The importance of the supplier's product to the customer's business.

Whether the supplier has a differentiated product which buyers need to obtain.

Would switching costs for customers be high?

The level of switching costs for their customers.

Worked example: Manchester UnitedManchester United earns far more money than any other football club in the world, yet its players' wagesare comparable to those at other Premier League clubs, and considerably less than those at some leadingSpanish and Italian clubs. It is able to do this despite employing some of the leading players in the world because the prospect of regularly winning trophies, and the prestige of playing for the club, counters thebargaining power of individual players and their agents. There is a deeply-held perception within theorganisation that 'no player is bigger than the club'.

Industry profitability can also be squeezed by powerful suppliers. This is so under the following conditions:

(a) Where there are few suppliers and the opportunity exists to establish a cartel

(b) Where there are few substitutes and switching is not a viable alternative. The Internet tends to lessensupplier power, reducing barriers to different supplier migration

(c) Where the industry supplied is not an important customer, suppliers may be unwilling to negotiate ordiscount

(d) Where the supplier's product is an important component and the buyer cannot risk a disruption ofsupply

(e) Where the supplier's product is differentiated or unique, and changes would have to be made to thebuyer's product in order to switch

(f) Where suppliers threaten takeover (forward integration).

Business strategy


2.6 Competitive rivalryThe intensity of competition will depend on the following factors.

Market growth Rivalry is intensified when firms are competing for a greater market sharein a total market where growth is slow or stagnant.

Cost structure High fixed costs may lead a company to compete on price, as in the shortrun any contribution from sales is better than none at all.

Switching Suppliers will compete if buyers switch easily (e.g. Coke vs Pepsi).

Capacity A supplier might need to achieve a substantial increase in output capacity,in order to obtain reductions in unit costs.

Uncertainty When one firm is not sure what another is up to, there is a tendency torespond to the uncertainty by formulating a more competitive strategy.

Strategic importance If success is a prime strategic objective, firms will be likely to act verycompetitively to meet their targets.

Exit barriers These make it difficult for an existing supplier to leave the industry.

Non-current (fixed) assets with a low break-up value (e.g. there may beno other use for them, or they may be old)

The cost of redundancy payments to employees

If the firm is a division or subsidiary of a larger enterprise, the effect ofwithdrawal on the other operations within the group

Worked example: Games consolesThere are three main competitors in the market for video games: Sony (with its PlayStation), Nintendo Wii,and Microsoft (Xbox). Microsoft is a relatively new entrant. Sony took over as market leader fromNintendo.

Every so often, with more powerful computing capacity, new generations of gaming consoles are produced,which shakes up the market. With the consoles, there have to be attractive games to enthuse customers totrade up.

Key factors in winning this battle are getting the product out to market, the games the consoles supportand functionality.

In 2006, Sony announced it would be launching its PlayStation 3 console in November rather than May. Itwould be more expensive than its competitors' products. Sony appeared to have borrowed some ideas,such as motion sensors, from Nintendo, and some ideas, such as enabling users to download extra contentfrom the Internet, from Microsoft.

According to The Economist (13th May 2006): 'Having been the industry leader for many years, Sonysuddenly looks like a follower. It will have to catch up with Microsoft in sales: by the time the PS3 islaunched, Xbox 360 will have been available for over a year. The stakes are high for Sony: it is banking onthe success of the PS3 not just to maintain its dominance in video gaming, but also to boost the fortunes ofits Blu-Ray technology, one of the two rivals to become the high definition successor to DVD'.

Not all industries are equally competitive. Factors which encourage strong competition include:

(a) The presence of many equally-balanced competitors which continually 'jockey for position' byadvertising or innovating. The Internet may increase rivalry by making price comparisons easier andfacilitating faster innovation and new product development.

(b) A slow rate of growth in the industry, which means that companies must compete by attracting eachother's customers rather than new customers (the slow growth may be as a result of maturity in themarket).

(c) High fixed or storage costs, which encourage fast turnover of inventory.



4

(d) A lack of differentiation, which reduces customers' brand loyalty.

(e) When capacity can only be increased by large amounts. In this case companies will fight to protecttheir share, or compete aggressively to increase it substantially.

(f) High 'strategic stakes' are tied up in capital equipment, research or marketing.

(g) High exit barriers such as redundancy payments, penalty clauses or tax losses.

Interactive question 2: Profitability of airlines [Difficulty level: Intermediate]The airline industry as a whole is loss making (i.e. adding profits of successful airlines to losses ofunsuccessful ones). Even successful airlines struggle to get an operating margin above 10%.

Using the following models identify contributory factors to the low rates of profits in airlines.

1. Industry life cycle

2. Porter's Five Forces.

Identify potential strategies to restore profitability in the light of your analysis.

See Answer at the end of this chapter.

2.7 Using the Five Forces frameworkThe Five Forces framework should be used to identify the key forces affecting an organisation and hencethe opportunities available and threats to be considered. The key forces will tend to differ by industry so,for example, for manufacturers of own-branded products the power of the buyers (of large retailers e.g.Sainsbury's, Tesco, ASDA, Marks & Spencer, etc.) will be very important.

Consideration should be given to whether the forces will change over time and if so, how. Strategies willneed to be developed to adapt to these changes.

It is essential for an organisation to determine not only how it stands in relation to the forces but also howits competitors stand.

Competitive strategy will be concerned with how an organisation can influence the competitive forces, e.g.can competitive rivalry be diminished? Can barriers to entry be created?

The ideal market, in which profits are easiest to make, is one where there is:

Low supplier power Low customer power Little prospect of substitutes emerging High barriers to entry Weak inter-firm competition.

2.8 Limitations of the Five Forces model Ignores the role of the state: In many countries, the state is a positive actor in the industry via

ownership, subsidy, or presentation or regulation of competition. The Five Forces model seems topresent government as just as a rule setter which is country-specific and reflects the US experience.However, another view is that the government can influence each of the other forces by legislationand economic policies.

Not helpful for not-for-profit organisations: The Five Forces are those which determine industryprofitability. If profitability is not a key objective for managers, they might not consider five forcesanalysis to be helpful.

Business strategy


Positioning view and not resource-based: assumes profitability will be determined by dealingbetter with the five forces i.e. outside-in. Individual business', strategic decision-makers should focuson product-market strategy. This ignores competence building for innovation to enter new industries.

Assumes management are required to maximise shareholders' wealth: In some countries,companies pursue market share objectives instead, as has been the case in Japan, traditionally, andSouth Korea, where large groups, with easy access to credit (and in the 1980s in Japan almost zerocost of capital) did not overtly pursue profit objectives.

Ignores potential for collaboration to raise profitability: The model underplays the potentialfor collaboration (e.g. supply chain collaboration) to build long-term relationships with suppliers,customers or distributors, joint ventures, to avoid substitutes, and so on.

Dynamic industries: The model is less useful in industries that are rapidly changing as it is difficult topredict how the forces may change. Dynamic industries may require a greater focus on riskmanagement.

Worked example: Collaboration in automobile industry Supplier/manufacture collaboration over design of parts for new cars and in supply chain management.

Supplier/buyer collaboration garages selling the cars also receive assistance with technology toservice cars in order to help them resist independent service centres and on-line sellers.

Manufacture/Manufacture collaboration many car firms work together to develop models andtechnologies for each to use. They also join forces to resist legislation aimed at the industry.

2.9 Competition in different types of industryThe intensity of competition will vary between industries according to the nature of what is being traded.

Industries can be classified as:

1. Primary: involved in agriculture, forestry and extraction of minerals including oil

2. Secondary: processing materials by manufacture into final finished products

3. Tertiary: industries engaged in the provision of services

Primary industries

Competitive forces tend to be stronger in primary industries for the following reasons:

Undifferentiated products: this leads to competition upon price (commodity competition)

Large number of producers

High level of fixed or sunk costs (e.g. a crop in a field will rot if not sold so any price is better thannone)

Lack of alternative products available to produce (e.g. monoculture)

This reduces the levels of profit available to the producers.

Examples include commodities such as tea, coffee and cocoa, timber, vegetables and meat.

Firms engaged in primary industries may adopt the following strategies to raise their profits:

Form collective marketing bodies to improve bargaining strength against the buyers, e.g. farmer co-operatives, Association of Oil Producing and Exporting Countries (OPEC)

Create brand differentiation for their products or for the produce of their country e.g. Appellationd'origine contrle (French wine).

Seek to set up value-adding processing activities to improve the value of the commodity.



4

Secondary industries

Profits will tend to be greater than in many primary industries due to:

The possibility of greater differentiation in processing and manufacture owing to the application ofdesign or branding

Lower number of producers

Potential to use capital equipment to make alternative products

However, in many secondary industries the power of the five forces is sufficient to reduce profitability tobare long-run minimum levels. High exit barriers in the form of writing off capital equipment and payingredundancy and other costs on the cessation of business may cause firms to continue in loss-makingindustries for many years.

Tertiary industries

In some tertiary industries high degrees of differentiation allow high profitability. Examples includeaccounting and business services, football and entertainment and some retailing.

Other tertiary industries feature intense competition and low profitability, e.g. logistics and parcel delivery,office cleaning, call centre services.

Worked example: Battle of the food chainThe following article demonstrates the shift of concentration from primary industries of crop growing tosecondary food processors towards the tertiary industries of retail and the pervasive influence ofglobalisation.

'In the last half century, nothing short of a revolution has taken place in the world of food. Never has somuch power over the global food system been concentrated into the hands of so few.

Until the second world war, it was the farmers who were the major players in food. But no longer is itthose who produce the raw food that control the food supply chain. Instead, power is being concentratedat a staggering rate into the hands of a few giant companies who process the raw product and a few knownas supermarkets who control the gateways to our mouths. And all are internationalising, most regionally,some globally.

The rise of the big processors has been phenomenal. In the USA just 100 firms now account for 80% of allvalue-added that's the increase in price over and above raw farm food prices. Be it in Europe or the US,the concentration of manufacturing power is the same, it is just the names that are different. In the UK it isNestl and Unilever, in the USA Altria (created by the merger between Kraft and General Foods). Thesecompanies operate on a vast scale.

Concentration is almost entirely a result of manufacturer's buying each other to get their hands on thesuccessful brands. 'National' brands like Kit-Kat once owned by Rowntree's of York has been turned byNestl into a global brand.

The level of manufacturing concentration is now remarkable whether one looks nationally, regionally orglobally. Take meat. In the mid 1970s, the top four US beef packers controlled around a quarter of theAmerican market. Today just 20 feedlots feed half of the cattle in the US and these are directly connectedto the four processing firms that control 81% of beef processing, either by direct ownership or throughformal contracts. In this sort of food system the farmer becomes a contractor, providing the labour andoften some capital, but never owning the product as it moves (as rapidly as possible) through the foodsystem. They never make the major management decisions.

But even the global, household-name, hugely profitable manufacturers can no longer claim control of thefood supply chain. That has been wrestled from them by the global, household-name, hugely profitablecompanies that control access to the consumer: the retailers. In the UK, the top five supermarket chainsnow account for two thirds of food sales, while half of the country's food is now sold from just 1,000 giantstores.

Business strategy


Even the biggest manufacturers rely on the supermarkets to get their products to the consumer. And to dothat they have to agree forward contracts with the retailers, whose logistics systems demand tightspecifications, delivery times and margins.

These corporations now divide the world into three segments: the rich economies of western Europe andNorth America; the rapidly catching-up economies such as Thailand and Hungary; and the developing worldmarkets such as India, Brazil and China. Again, Tesco provides a useful illustration of this global push. It isorganised into three divisions: UK and Ireland; central Europe; and the Far East.'

Source: Guardian Unlimited website

3 Product life cycles and international activities

Section overview Global firms recognise that markets develop at different rates.

These differences in stage of development mean that products can be managed differently across theworld.

3.1 Extending product life cycles through operating abroadSome firms prefer domestic operations providing performance there is satisfactory. Then, when domesticperformance declines, they try to close the gap by exporting.

This is possible only if there are different product life cycle patterns in different countries as shown inthe diagrams below.

Product life cycles in different countries

International business must consider many markets simultaneously, with a view to implementing a globalintroduction and manufacture. The financial returns to an investment may depend on the roll-out of thisstrategy.



4

Worked example: Film industryWhy do passengers on transatlantic flights often see films before they are released?

SolutionThe product life cycle for a film can be characterised as:

Introduction: Premiere and advance screenings

Growth: General release to major cinemas

Maturity: DVD release

Scheduled television programming

Sequels and prequels

Declines: Sold as multi-package DVD or to television stations.

The international product life cycle for Hollywood films has tended to be

Phase I to US MarketPhase 2 to other Anglophone countries (e.g. UK, Eire, Australia)Phase 3 dubbed for non-Anglophone countries for mass release

3.2 International Trade Life CycleThe International Trade Life Cycle is used in developing long-term product strategy. It postulates that manyproducts pass through a cycle during which high income, mass-consumption countries are initially exportersbut subsequently lose their export markets and ultimately become importers of the product from lower-cost economies.

From the perspective of the initiator high income country, the pattern of development is as follows.

Phase 1. The product is developed in the high income country (e.g. the USA). There are twomain reason for this.

High income countries provide the greatest demand potential

It is expedient to locate production close to the market during the early period so that the firmcan react quickly in modifying the product according to customer preferences

Phase 2. Overseas production starts. Firms in the innovator's export markets (such as the UK)start to produce the product domestically. Thus, for example, the UK market is then shared by theinnovative US firm and the UK firms.

Business strategy


Phase 3. Overseas producers compete in export markets. The costs of the UK producersbegin to fall as they gain economies of scale and experience. They may also enjoy lower costs oflabour, materials etc than the US firms. The UK firms now start to compete with the US producers inthird-party export markets such as, say, Greece or Brazil.

Phase 4. Overseas producers compete in the firm's domestic market. The UK firms becomeso competitive, due to their lower production costs that they start to compete with the US firms inthe US domestic market. The cycle is now complete.

Worked example: Fender guitarsThe electric guitar industry is dominated by two main US brands, Fender and Gibson, both trading on theirheritages of having developed the earliest commercial electric guitars in the 1950s and having been theguitars of choice for many influential players.

From the 1950s until the late 1970s both guitar brands were sold predominantly in the USA and wereexpensive as imports into Europe. In the early 1980s a copycat range to Fender was developed by a rival inJapan under the brand name Tokai and sold there. The Tokai was widely held to be superior in build qualityand tone to the products being made in the USA and so Tokai guitars began to appear in Europe and USA.In 1983 Fender commenced production in Japan of identical guitars to its USA made models and sold thesein Japan and Europe. A further wave of copycat products from South Korea and Thailand in the 1990s ledFender to establish a third factory in Mexico producing a parallel line of products for sale in USA andEurope, still under the Fender name. It also developed a flanker brand 'Squier by Fender' which was initiallymade in Japan before being put out to contract manufacture across Indo-China later. Gibson took adifferent route, acquiring a minor rival, Epiphone, in the 1970s and continuing to make Gibson guitarsexclusively in the USA whilst also selling copies, made in Japan and later under contract elsewhere, underthe 'Epiphone by Gibson' brand.

4 Industry segments and strategic groups

Section overview Returning to concepts of an industry it is possible to see segments or strategic groups within the

same industry.

Competitive strategy should be based on choosing the right segments for the organisation to operatein, and achieving success in each chosen segment by defending the firm's position there.

4.1 Industry segment recognitionAssessing the environment at industry level ignores the existence of segments within an industry. Acompany needs to segment the market, target its customers, and implement a marketing mix to satisfythem. The grid below identifies some of the key issues.

Benefits to management from recognising strategic segments are:

Better tailoring of products and marketing mix to the wants of customers within a group (this is calledmarket segmentation and targeting and is covered in detail in Chapter 7)

Closer definition of competitors, i.e. those within the same segment, from others in the same industrybut serving different sub-groups

Identification of mobility barriers, i.e. factors preventing potential rivals entering the segment orpreventing management from taking firm into new segments



4

4.2 Key considerationsThe grid below identifies some of the key considerations in identifying strategic segments:

The productWhat category of product is it?

E.g. consumer product, consumer service, specialist business product, businessservice, component, raw material etc

The customer

Who is the primary customer?

E.g. consumer, business, organisation, government

What is the location of the customer?

E.g. local, national, regional or global basis

SegmentationIs industry divided naturally by country or region?

Does the industry effectively straddle several borders?

CompetitorsWhere is rivalry strongest?

Are there any niches with less competition?

4.3 Strategic segments in business to business industriesBusiness-to-business industries can be segmented in many different ways.

(a) By region

Is it a global market?

If so, a global supplier to a global industry would see no point insegmenting by country. However there may be different groups ofcustomers with different buying characteristics.

However, if there are many competitors, a potential supplier mightprefer to stay close to one particular market. A supplier may,because of its size or because of transportation differences, beunable to serve the entire industry.

Is it mainly regional? A company might chose to target the EU or the NAFTA areas.

Enforced segmentation Tariff and non-tariff barriers may enforce segmentation on a countryor regional basis.

(b) By method of buying

The decision-making unit (DMU) in an organisation is the group of people responsible for making thedecisions whether to buy a product. Some issues related to DMUs are outlined below.

Authority

In some organisations, individuals have clearly defined areas ofauthority and decision-making power. However in some cultures,decisions have to be referred upwards to more senior figures, sothe person doing the negotiating may not have the right to make thedecision.

Clarity and ceremonyClarity of authority. In some cultures, managerial decision-makingis taken by consensus. The challenge is to manipulate this consensuson your behalf.

Structure

Does the organisation buy on a global basis? If buying is centralised,then support at a high level is needed. If the organisation buys on alocal basis, then this may offer an opportunity to sell to otherbusiness units in the organisation.

The level of centralisation and delegation is thus significant.

Business strategy


Decision process

Does the DMU judge proposals according to the 'rational model'?i.e. are a number of alternatives evaluated according to strictlyrational criteria, or do other 'political' considerations intrude? If thefirm is part of a network of other firms, it might be under pressureto buy from a group company. There might be politicalconsiderations, internally and externally.

Management cultures

These are the views about managing held by managers from theirshared educational experiences and the 'way business is done'.

Obviously this reflects wider cultural differences between countriesbut conversely national cultures can sometimes be subordinated tothe corporate culture of the organisation.

Negotiation

Cultural differences might affect buying behaviour, especially innegotiation.

How do you establish the salesperson's credibility?

Is the style of negotiation communicative or manipulative? Inother words, do you want to exchange facts or manipulatethe other party?

To what extent are oral agreements the basis for business,and to what extent are contracts or written agreementspreferred?

Implications for strategy

The identification of industry segments can enable firms to defend niche segments against larger, lessfocused, rivals.

A difference in behaviour may necessitate a difference in approach to a relationship e.g. theappointment of go-betweens.

The cost of complying with the decision process will affect segment profitability.

The potential to make some segments into partners willing to consult and advise firm on products andexpansion strategy.

4.4 Government buyersDeveloping business in industrial segments where governmental institutions are significant buyers raisesspecial considerations:

Public accountability: Governmental use of public money is often subject to controls and scrutinythat would be unthinkable in private corporations. This will vary from country to country according tothe extent to which public accountability for expenditure is deemed to be important to the politicalsystem.

Governments are rarely monolithic: Different government departments may have differentcultures, agendas and resources. Regional political variations mean that local government purchasingunits may have different processes.

Political considerations: Public procurement will look at the whole social benefit and not merelycosts. Therefore employment effects, and factors such as pollution will be considered. Governmentbodies may also require that its suppliers can show they conform to its own policies in matters of non-discrimination, sustainability etc.

Purchasing by tender: Usual forms of buying procedure are the open tender and the selectivetender. For a selective tender process, the firm needs to be accepted on the appropriate list. In somecountries, it takes considerable persistence to get to that stage, since it may take several visits toappropriate government officials to establish a good working relationship.



4

4.5 Identifying country clustersIn choosing which groups of countries to enter, a firm might focus on particular countries or regions orgroups of countries with similar characteristics using the following bases.

Basic data Issues

Level of economicdevelopment,infrastructure and so on.

For example, the lack of a fixed line telecommunications network inAfrica may encourage take-up of mobile telecommunications.

Cultural similarities (e.g.for intellectual property,common language).

It is easy to overestimate the similarities between two countries thatmight be assumed because they speak the same language. Forexample, despite the common use of English, there are distinctcultural differences between the US and the UK.

Member of economicgroupings (e.g. a strategyfor the EU).

Economic groupings such as the EU have tariff barriers for someexternal goods. They may have common product standards whichmust be adhered to.

Similar market orregulatory structures.

This suggests similar marketing mixes may be appropriate to morethan ones market. American credit card companies have expandedin the UK because UK consumers use credit cards. Germanconsumers tend not to use credit cards as frequently.

Inter-market timingdifferences: life cycles.

Certain markets have similar demand patterns for similar goods butthat one leads and the other lags. For example, it is assumed thatInternet penetration will rise in the developed world, but that theUS will lead, and other countries will follow as innovations spread.

If countries are deemed to be similar, then it may be possible to use one country to 'predict' the behaviourof another.

4.6 Mobility barriersThese are factors that make it hard for a firm in one strategic group to develop or migrate to another. Theyfunction as barriers to entry and, as such, can enable superior rates of profit to be enjoyed by firms within astrategic group.

They relate to the following.

Characteristics, such as branding, user technologies and so on, specific to markets overseas or togeographical regions within a country.

Industry characteristics: To move into a mass volume end of the market might require economiesof scale and large production facilities. To move to the quality end might require greater investmentin research and development.

The organisation may lack the distinctive skills and competences in the new market area.

Legal barriers.

Business strategy


Summary and Self-test

Summary



4

Self-testAnswer the following questions.

1 Mr Mavers runs a small newspaper and sweet shop in the centre of a large city. Will his customersexert a high or low bargaining power over him? Justify your answer.

2 'Large companies often exert a high bargaining power over their suppliers.' What type of suppliers willthe following have?

(a) A large, mid-price chain of clothes shops

(b) A large top division football club.

Discuss the quotation above in the context of these two businesses.

3 'Audit fees for Bangladesh companies have fallen by 20% in real terms over the last ten years.' Giventhe intensity of competition within the industry, why do accountancy firms not withdraw from auditand focus their efforts instead on more profitable areas of work?

4 Horsley Foods Inc

Horsley Foods Inc was incorporated in 1891 and is currently established as a leading producer,distributor and retailer of foodstuffs in the USA. It produces its own chocolate which is a brand leaderin the USA and recently it has shown interest in expanding its activity to Britain. The project is stillvery much at the drawing-board stage and you have been engaged as a management consultant toassist in the assessment of its viability and the construction of a strategic plan to achieve its objective.

The chairman's view

Your initial interview with the chairman, Hank Langford, took place two months ago. The chairmanwas optimistic about the venture as the following summary of his comments shows. 'We're a bigplayer in the US but you can't stand still in this game. We've got to spread our wings and I want to seeus playing around the globe. Europe is our first target and establishing in Britain gets us our foot in thedoor with the single European Market opening the way to the rest.

Our big strength is our chocolate a lot of our success in the US is based on cracking the chocolatemarket there. We sell all sorts of branded chocolates. And your big vice is chocolate! Did you knowthat you Brits are the second largest consumers of chocolate in Europe, behind the Swiss? Last yearyou ate 8.8 kg per head.

So taking our chocolates into Britain as the first step makes strategic sense.' Prior to writing yourpreliminary report you undertake some investigation into the nature of the UK chocolate market.

The products of the chocolate industry

The UK chocolate industry produces three main categories of chocolate.

'Blocks' which are generally moulded blocks of chocolate with or without any additionalingredients. These products are sold in standard sizes and are distributed mainly through groceryoutlets.

'Countlines' which are chocolate products sold by count rather than by weight, e.g. Snickers,Kit-Kat and Smarties. These, unlike block chocolates, have a wide range of products which aredistinct from each other in size, shape and weight, tend to have a strong brand image and aredistributed mainly through non-grocery outlets such as newsagents and kiosks.

'Boxed chocolates' which are individually branded products, such as Black Magic, and aremostly sold as gifts, about 80% in holiday periods such as Christmas and Easter. During theseperiods they are mostly sold through grocery outlets, while over the rest of the year sales aremainly through non-grocery outlets.

Business strategy


The main competitors in the UK market

Your research produced the following findings.

Name of firm Key brand names Market shareUK % Europe %

Bradbury-Repps (UK) Dairy MilkCreme EggsCrunchieFlakeMilk Tray 30 10

Restler (Swiss) Milky BarKit-KatAfter EightsSmarties 28 20

Venus (US) Venus BarMilky WayGalaxyTwixSnickers 26 16

Blosoft (Swiss/US) Toblerone 2 12Others 14 42

100 100

The economics of competition

Companies in the confectionery sector have to be competitive in three key areas to be successful inthe long run.

(1) They have to be cost-conscious, both when purchasing raw materials and during the productionprocess.

(2) They have to distribute and market their products in the most effective way.

(3) They have to compete by bringing out new products when possible and desirable. Your analysisof the breakdown of the total costs of the 'Big Three' showed the following components.

Your analysis of the breakdown of the total costs of the 'Big Three' showed the following components.

Component % Comment

Raw material and production costs 55 Fluctuating cocoa prices usually absorbed byproducers to preserve relatively stable retail pricesPackaging and distribution costs 15

Marketing costs 20

Venus was the seventh highest UK advertiser lastyear, spending CU33 million, closely followed byRestler with CU32 million and Bradbury-ReppsCU29 million.

Other absorbed costs 10100

Requirements

Prepare a memorandum for the main board of Horsley Foods Inc which:

(a) Assesses the nature of the competitive forces (using Porter's Five Forces model so far as theinformation allows) which Horsley would face if it were to expand into the UK chocolate market.

(12 marks)

(b) Identifies the different competitive advantage strategies which Horsley could pursue if it is topenetrate the UK chocolate market. (8 marks)

(c) Recommends a strategic way forward for the company in this matter. (5 marks)

(25 marks)



4

5 Lumber Ltd

Lumber is a Bangladesh-based juice-making company whose origins are in farming. It has wellestablished brand names and farming remains at the core of its business. Over the years the companyhas expanded its operations in products closely associated with fruit juice and its by-product pectin.The company has also expanded abroad by acquisition.

Structure

The company is structured along divisional lines of responsibility split into three key operatingsections.

The Bangladesh drinks division, responsible for the production and sale of fruit juice inBangladesh, and the wholesale distribution of other drinks in Bangladesh.

The Overseas drinks division, responsible for fruit juice operations in Asia, Australia and theUSA, and fruit juice and associated exports from Bangladesh.

The Pectin division, responsible for the citrus and apple pectin production and their sales inBangladesh and overseas, and also responsible for pectin operations in Brazil and the Bahamas.

Each division of the company has a divisional board with its own managing director, financial directorand other functional directors. The three divisions report to the main board of the company based inJamalpur.

The company is an independent drinks company with more than half the equity controlled by theLumber family. Lumber Ltd is a firm advocate of industrial participation and has a central corporateaim 'the satisfaction of the needs of the shareholders, customers and employees'. The stated strategicaim of the group is to achieve sustained growth through the progressive development of the businessand its brands, and to maintain leadership in all of its key activities. A further aim is to stayindependent from the large drinks groups that dominate the market. Lumber believes that success canonly be achieved if every employee understands and supports the objectives that the company strivesto achieve, and through consultation with its employees it hopes to build co-operative team spirit.The Bangladesh drinks division

In order to halt a recent decline in the sales of fruit juice, the company has launched a number of newbrands, including Special Quality for the premium end of the market catering for home consumption,and Woodbow 1080, a premium brand to be distributed through the restaurant trade. Both of thesehave been extensively supported by promotion and advertising. The restaurant trade in fruit juice isbelieved to have reached its optimum level. Lumber still believes in the fruit juice market and has plansto expand its extraction capacity in Jamalpur using more locally-grown fruit.

Soft drinks

Lumber has developed a range of soft drinks to cater for the Bangladesh market. Most of the Lumberbrands are in the premium sector and are based around apple juice. More recently Lumber has beendeveloping other juices to increase its range, orange and lemon being the two most important.Carbonated and still juice markets are growing and Lumber has an agency in Bangladesh for the FrenchPerrier range of mineral waters and these brands play an important role in the Lumber business.

Wines, spirits and other drinks

The wines and spirits business made progress in 20X5/X6 after a slow start. The market is verycompetitive and in some cases showing little sign of growth. Lumber is represented by agencybusinesses in whisky, French brandy, French champagne and other liqueurs. Lumber is also themarketing company for Domecq sherry. The sherry market showed a decline of 2 per cent last yearand margins are under severe pressure. Lumber imports a Caribbean beer under the brand Red Stripe.This brand is slowly making progress, using Dhaka as the first area to be covered.

Requirement

As an outside management consultant, write a report to the managing director examining separatelythe competitive nature of the fruit juice and 'other drinks' industries as faced by Lumber Ltd.

(20 marks)

Business strategy


6 Gizmo Petrol Company

The Gizmo Petrol Company is a large company selling petrol through approximately 200 petrolstations, half of which are concentrated in the North and North-West regions of Bangladesh.

It has always maintained a strong presence in residential locations, as the managing director of thefirm, Mr Macari, has always felt that people are more likely to purchase petrol as they leave for workor when they return home from work.

Gizmo operates its petrol stations via a five year agreement with a single petrol supplier. Theagreement is such that there is a minimum level of petrol which Gizmo has to purchase; at present theamount purchased is twice the minimum level. There are a number of other suppliers in the marketshould Gizmo require a new supplier in the future.

The company has been able to fund its expansion policy by borrowing from the bank and at presentthe company's gearing ratio stands at 32%. The company benefits from a strong positive cash flowwhich has allowed it easily to meet its repayment requirements and earn a reasonable profit margin.However, this margin has been eroded in recent years with the recession and as consumers becomemore price-conscious.

The market as a whole has seen consolidation over recent years with small independent petrolstations finding it difficult to compete with the large multi-nationals. The company is now faced withcompetition from two slightly larger national companies, local independent petrol stations andsupermarkets which are supplying cheap petrol to customers in an effort to attract them into theirstores.

The product range offered by Gizmo at present is made up of the following items.

Unleaded petrol 44% of company salesLead replacement petrol 31% of company salesDiesel 23% of company salesNon-petrol sales 2% of company sales

The move towards environmentally-friendly products within society and the taxation system benefitingunleaded petrol have allowed Gizmo to expand its sales of this product at the expense of leadreplacement petrol.

The transport system within Britain is still largely dominated by cars, as individuals enjoy the freedomand flexibility of the motor vehicle and the government has maintained its road building policy.Competitors have also taken the lead in the development of improved petrol stations offering moreservices than selling petrol only. Gizmo has never been at the leading edge of developments within theindustry and still largely sees the purpose of a petrol station as merely providing petrol. Gizmo's non-petrol sales are mainly made up of confectionery and cold snacks.

Requirement

Prepare briefing notes for Mr Macari containing an analysis of the external position of Gizmo withinthe marketplace.

(16 marks)

Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achievedthese objectives, please tick them off.



4

Answers to Self-test

1 High bargaining power.

Presumably there are many other similar shops nearby, so customers will go elsewhere if he does notstock the products they want.

2 (a) Chain store

Suppliers will be small independent manufacturers of clothes

Many suppliers will exist

All suppliers will have very similar products

High bargaining power over suppliers is likely, given that if the chain store is dissatisfied withone supplier, there is unlikely to be a problem finding an alternative.

(b) Football club

Main suppliers are players

Players are highly skilled individuals

Each player's specific attributes will differ

Low bargaining power is therefore likely, given that some players will not be easilyreplaceable

This contradicts the quotation, but the situation arises because the suppliers, although small,do not offer a standard service.

3 Accountancy firms have a strategic need to offer audit in the sense that clients will expect a range ofservices. The audit is often the loss leader that introduces the client to the firm. Other moreprofitable services can then be offered.

All large companies are obliged by law to have an audit, so accountancy firms will always have amarket.

4 Horsley Foods Inc

Memorandum

To The Board of Directors, Horsley Foods Inc

From A Consultant

Date Today

Subject Proposed entry into UK chocolate market

1 Analysis of competitive forces within the UK chocolate market

The UK chocolate market is currently dominated by three companies which between themaccount for 84% of total sales as follows.

Marketshare %

Bradbury-Repps 30Restler 28Venus 26

84

All three firms have wide product portfolios with strong representation in blocked chocolate,countlines and boxed chocolate.

The nature of the competition within this oligopolistic industry is shaped by three key factors.

Business strategy


The nature of the barriers to entry into the market.

The nature of the competition between the rivals.

The power of the large retail buyers.

These will be considered in turn.

(a) Barriers to entry

The most significant barrier to entry lies with the strengths of the established brand names.The chocolate industry engages in extensive advertising geared both to strengthening brandimages and to differentiating one company's products from another's, e.g. a 'Kit-Kat'(Restler) has to be differentiated from a 'Twix' bar (Venus), even though their ingredientsare broadly similar.

Both Venus and Restler spent over CU30 million last year on promoting their brandedproducts. At the same time as strengthening existing brand images, this level of advertisingmakes it difficult for new products to be successful.

Other barriers to entry are as follows.

(i) Economies of scale

With little scope for cost savings on raw material inputs, companies must try to lowercosts through economies of scale from their production. Production is therefore highlyautomated, particularly with the relatively capital-intensive block and countlinechocolates.

(ii) Distribution systems

With many of the products, particularly block and countline chocolates, having a highrate of inventory turnover and with the retail outlets for chocolate being so diversified(supermarket, newsagent, vending machine, etc) an efficient national in-housedistribution network is essential.

(b) Competition between the rivals

As with most UK oligopolistic markets (petrol retailing, high street banking and volume carmanufacturing being other examples) competition between the rivals is conducted on non-price grounds. Prices are kept relatively stable despite fluctuations in raw material costs.

The non-price competition is intense and can take the following forms.

(i) Massive advertising to establish and reinforce differential brand images (see above).

(ii) Augmenting the actual product by means of

10% extra weight free

Coupon-based competitions.

The intensity of the competition is evidenced by the size of the respective advertisingbudgets.

(c) Power of buyers

Both block chocolate and boxed chocolate are retailed predominantly through groceryoutlets which are increasingly dominated by supermarkets such as Tesco, Sainsbury,Safeway, etc. A firm wishing to break into this sector needs to be aware of the buying cloutwielded by such firms at the expense of the producers' margins.

In conclusion it should be noted that chocolate manufacturers do not face competitivethreats from

Powerful suppliers raw materials are purchased at going world commodity prices

Substitute products.



4

2 Strategic difficulties to overcome

The major issue which Horsley Foods Inc must resolve before embarking on a UK chocolateventure is the nature of the competitive advantage it intends to secure over its rivals. There areseveral possible avenues to explore.

(a) Low cost strategy

Competitive advantage is secured by operating at lower unit costs and thus retailingproducts at lower prices than those of rivals.

It is difficult to see how Horsley Foods Inc could gain an advantage here.

(i) Raw materials (cocoa beans, sugar, etc) are secured at prices based on worldcommodity markets.

(ii) Bradbury-Repps, Restler and Venus already experience economies of scale with regardto purchasing, production, marketing and finance.

(iii) It is doubtful whether chocolate is a price-elastic product.

(b) Product differentiation strategy

Competitive advantage is secured by encouraging a perception among buyers that theproducts are qualitatively superior to those of rivals.

However, it has previously been emphasised that this is already the basis of competitionwithin the industry. Vast sums are spent on promoting brand images for wide productranges and many possible angles for the mass market producer have probably already beenexplored. However, web sites offer the opportunity to reinforce brands encouraging loyaltyand repeat purchases.

(c) Product focus strategy

Competitive advantage is secured by concentrating on a narrow product range targeted at aspecific market segment. An example in the chocolate industry is Ferro Rocher's boxedchocolates.

This is a possible avenue to explore but it would involve Horsley Foods Inc in developing astrategy for the UK at odds with its wide range, mass market US strategy.

3 Conclusion a way forward

The conclusion from the above analysis is that the UK chocolate market is stable and dominatedby three large firms which have come close to 'sewing up' the market in terms of

Successfully establishing a wide range of household brand names

Obtaining economies of scale which render penetration pricing more viable as a long termstrategy

Operating efficient distribution networks.

Given the extent of the entry barriers, it is doubtful whether a fourth player could be successfullyestablished.

It is recommended, therefore, that if the proposed strategy of breaking into the UK chocolatemarket as a prelude to eventual expansion into Europe is to proceed, Horsley Foods Inc consideran acquisition in order to obtain immediate brand power and market share.

To serve the company's longer-term plans, consideration should be given to acquiring Venus Inc,another US firm. Such an acquisition offers

Greater market power in the USA

Significant market shares in both UK and the rest of Europe

Knowledge and experience of breaking into Europe from the USA

Operating, investment and management synergy

Business strategy


5 Lumber Ltd

Report

To Managing director

From A Consultant

Date Today

Subject Lumber Ltd Competitive position of drinks business

1 Terms of reference

As requested the following report analyses the competitive nature of the drinks industry. Itcovers Lumber's relationships with suppliers, buyers and competitors, and the potential threatsfrom new entrants and substitute products.

2 Introduction

Within its drinks operations Lumber is involved in several products and markets. These can becategorised as fruit juice, soft drinks and imported alcoholic drinks, for home and overseas sales.This report will analyse the competitive nature of Lumber's industry, first within the fruit juicemarket and then its other business activities.

3 Fruit juice operations

Fruit juice is Lumber's core business, the firm being involved in manufacture and distribution onan international basis.

3.1 Suppliers

Industry profitability can be threatened by the presence of powerful suppliers. Althoughlittle information is available on suppliers to the fruit juice business, the following pointsshould be noted.

Fruit growers in the Jamalpur region are likely to be the most important suppliers.

Suppliers are likely to be small in relation to Lumber Ltd.

Within the region, alternative sources of supply are likely to exist.

In conclusion, powerful suppliers are unlikely to prove a threat.

3.2 Buyers

Powerful buyers can also pressurise industry profit margins. The major buyers of Lumber'sfruit juice appear to be the Bangladesh restaurant trade, supermarkets and retail foodchains. Details on fruit juice sales overseas are sketchy but sales are likely to be made tosimilar businesses. The following points should be noted.

Some purchasers may be much larger than Lumber.

Few switching costs exist.

Buyers' profit margins are likely to be low.

Backward integration by restaurant chains is possible.

There does appear to be a threat from powerful buyers. Lumber's major protectionhere is the strength of its brand names, which could dissuade buyers from switching.

3.3 Substitutes

Fruit juice is a traditional product and substitutes could come in many forms. These includethe following.

Other soft drinks.

Home-made alternatives in periods of recession.

The recent decline in fruit juice sales is of concern and more details are required as towhether this is a market trend, representing a switch away from the drinking of fruit juice. If



4

the switch is towards other alternative products Lumber has some protection due to itsother operations.

4573.4 New entrants

New entrants to an industry can make that industry more competitive by price cutting,promotional activities to build market share and bidding-up the costs of factors ofproduction. Barriers to entry to an industry protect against new entrants. Barriers to entryto fruit juice manufacturing and distribution include the following.

Economies of scale Lumber believes it is operating at an optimal level in theproduction of fruit juice; this could be high enough to deter new entrants.

Product differentiation through its existing brand names.

Access to distribution channels Lumber has established relationships with therestaurant and retail trades; it is also building up a world-wide distribution network.

Whether these barriers would be sufficient to deter a new entrant is open to question. Theindustry has a low technology level and capital requirements are likely to be small.However, if fruit juice consumption is falling the existence of excess capacity might deternew entrants because of the fear of a price war with existing producers.

3.5 Competitors

Little information is available on Lumber's competitors. However, the company appearsrelatively small as compared to the large drinks groups that dominate the market. Athorough analysis of other fruit juice manufacturers is therefore required. The followingpoints are worthy of note.

Decline in fruit juice sales is likely to increase competition.

Current advertising campaigns by Lumber and innovation in fruit juice productioncould be a sign of increased competition.

4 Conclusion

The major potential threats to Lumber appear to come from

Suppliers of goods through agency agreements

The highly competitive nature of its markets

A decline in sales in several markets

The major advantages held by the firm are

Its brand name

Its established relationships with distribution channels

Its manufacturing capabilities

These factors should be considered in designing a strategy for the drinks business.

Business strategy


6 Gizmo Petrol Company

Briefing notes

To Mr Macari

From Mr Smith

Date Today

Subject Analysis of the external position of the Gizmo Petrol Company within the market place

Gizmo's external position

Gizmo's position within the market place can be analysed according to the opportunities and threatsthat it faces.

(a) Opportunities

(i) Product range

The company should follow the lead of competitors and take advantage of the move byconsumers towards convenience shopping. The provision of essential everyday householditems, such as light bulbs, should be seriously considered, given the company's location inresidential areas.

(ii) Expansion

Gizmo's operations are largely concentrated in the North and North-West of Bangladesh.Given the company's experience, consideration should be given to moving towards otherareas.

(iii) Political

The government's road building policy should provide motorists with improved transportfacilities and hence ensure that petrol is still a highly desired product.

(iv) Independent retailers

The increased competition within the market place has already seen many smallindependent petrol firms ceasing to trade. This situation is likely to continue in the futureand therefore Gizmo should use this as an opportunity to purchase petrol stations at areasonable price to aid its nationwide expansion.

(v) Location

Given that Gizmo has the opportunity to expand, it should look towards locating in areasother than residential, e.g. sites near towns would provide consumers with convenientplaces to fill up with petrol.

(b) Threats

(i) Substitutes

The privatisation of the railways may present motorists with an improved rail network, andmay lead many of them to abandon the car and use the railways.

(ii) Political

The government may influence the price of petrol by tax rises to aid rail privatisation.

(iii) Competitors

Supermarkets may further drive down the price of petrol or offer cheaper petrol to attractcustomers in order to improve their sales. As customers are also becoming more price-conscious prices may also generally fall, putting pressure on margins and cash flows.

(iv) Technology

Gizmo's lack of technological development may leave it open to attacks from competitorswho may develop improved service stations. At present no alternative power supply for



4

cars has been discovered but in the future, with the move towards green ideas, it may bethat petrol will be replaced as the fuel for cars.

(v) Supplier

The fact that Gizmo is supplied by only one company may cause future problems withquality and price flexibility if the market price fluctuates.

(vi) Social attitudes

Consumers may turn towards public transport as being more environmentally friendly.

Business strategy


Answers to Interactive questions

Answer to Interactive question 1

(a) The main substitutes cited in the extract are:

Supermarket sales of most popular titles

On-line shops such as Amazon able to provide CDs and DVDs

Downloads

Piracy of tracks by unregulated download sites, file sharing and copying of CDs.

These substitutes have been able to reduce the customers visiting the shops with the consequencethat sales revenues have fallen from CDs and other spontaneous purchases (magazines, apparel etc.)

The principal reason is the improvement in price/performance of these substitutes.

Supermarkets may be cheaper but are, importantly, convenient because households shop there eachweek and so simply add the album to their trolley. Where the household are not minded to follow themusic scene they will not be aware of new albums by popular artists and so will not think of visitingmusic-stores. They will buy it if they see it.

Downloads may be free or cheaper, particularly if the listener only wants a few tracks from the album.They are also more convenient because no special visit to a store is needed, they can be sampled andthey are immediately available for listening on personal digital stereos.

Amazon may be cheaper but also provides samples and customer reviews which enable buyers to havemore information before buying than could be gained by a visit to the music-store.

Surprisingly the extract ignores a further substitute, the market for used CDs which is present oneBay and Amazon marketplace.

(b) Bookshops may be more successful for several reasons:

A clientele that is prepared to put more effort into searching for the right item. This means theywill want to handle the book, and to read some parts of it.

An enhanced range of services. Many bookshops have coffee shops, reading areas, printed art andcrafts and author signings to generate footfall and interest. This enables them to differentiatethemselves and so avoid buying solely on price. It also boosts earnings.

Higher margins. Book prices vary considerably between paperback novels, hardback earlyeditions and texts. A text book may cost in excess of CU35 whereas CD's are much moreuniform in price.

(c) Record stores should try to differentiate themselves on service and avoid price comparisons.Offering coffee areas, live music, clothing and band accessories would create a betterenvironment for music lovers.

Record stores should provide a 'custom burned' disc or digital download service in-store.

Record store management should develop web-based alternatives to capitalise on their brand.

Record store management should consider adding books to their product ranges.

[HMV (the record store) is part of the same company as Waterstone's the bookshop having beenformed in 1998 when HMV was sold by EMI Music and Waterstone's by W H Smith. It boughtOttakar's bookshops in 2006 following a series of inquiries by the competition authorities.]



4

Answer to Interactive question 2Industry life cycle

The industry seems to be at the shakeout phase with overcapacity due t

Chap - 4 the Industry and Market Envioronment

Documents

Transcript of Chap - 4 the Industry and Market Envioronment