Study Guide for Test 1

Why analyzing the external environment is important?

493  

Know and understand the definition of strategy that we covered the first  week of class.

Chapter 2 (External Analysis)  

∙ Understand why analyzing the external environment is important  o It is important to analyze elements outside the firm that can impacts  its’ fate

o Frameworks helps ensure that the analysis of these elements is  systematic

o The analysis of the external environment allows manager to identify  important opportunities and threats for the firm

o Last Step – External frameworks allow you identify key opportunities  and threats

o You want to identify opportunities in business environment not  

being fully exploited by the competition

What is the purpose of the general environment (pest) analysis?

∙ Be familiar with the three frameworks that are commonly used to  analyze an organization’s external environment and be able to  identify what kind of information is learned from conducting each of  these analyses.  

 o General Environment (PEST) Analysis 

o Used by firms to systematically scan, monitor, forecast, and  

assess factors that are of the greatest importance to them

o Should help firms recognize environmental changes, trends,  

opportunities and threats

o The segments of PEST are: Political, Economic, Social,  

Technological Don't forget about the age old question of What is the test-retest reliability?
Don't forget about the age old question of What is a change in the allele frequencies in a population - evolution doesn’t involve changing the genetics or physical features of individuals?

o Need to distinguish the ‘vital’ from the ‘merely important We also discuss several other topics like What are the visceral effector organs?

 o Industry Analysis 

An attractive “profitable” industry when there is?

o You conduct an industry analysis because you want to analyze,  

select, predict, & manipulate the profit potential of an industry

o An attractive “profitable” industry when there is:

 Low competitive rivalry

 Low bargaining power of suppliers

 Low bargaining power of buyers

 Low threat of substitute  

 High barriers of entry  Don't forget about the age old question of Which international legal response is in place to suppress terrorist attacks on embassies and diplomats?
Don't forget about the age old question of Based on the goal to predict foot length from forearm length, which variable is the explanatory variable?

 Advantages

o Advantages:

∙ Allows a manager to forecast industry profitability by  examining emerging structural trends to help decide if  

now is the time to make long-term resource investments ∙ Allows managers to position the company to focus on  aspects of the market that are attractive or avoid areas of the market that are unattractive  We also discuss several other topics like What happened to minnie foster?

∙ Allows managers to identify opportunities to alter the  industry’s structural characteristics to make it more  

attractive?

 o Porter’s 5 Forces Analysis 

o Why it was developed:  

∙ If some industries are inherently more profitable (i.e.  attractive) than others, what are the structural factors in  an industry that a company can exploit to obtain a  

competitive advantage  

∙ Companies want to examine structural trends within  industries to: ‘Select’ attractive industries to compete in,  Forecast changes in competition and profitability, Develop strategies to take advantage of those trends  

∙ The basic premise that underlies industry analysis is that  the level of industry profitability is neither random nor  

entirely the result of industry-specific influences, it is  

determined by the industry’s underlying economic  

characteristics INDUSTRY STRUCTURE

∙ 5 Forces framework provides a laundry list of threats to  industry profitability  

∙ Helps to select an ‘attractive’ industry to enter

o Competitive Rivalry is intense when:

∙ Many competitors exist  

∙ Competitors are less alike in size and influence

∙ Implicit collusion is possible when more alike  

∙ Products being sold are less differentiated  

∙ When market is more like a commodity then price  

becomes the sole basis of competition

∙ Industry is over capacity; and there are barriers to exit  ∙ There are high fixed cost relative to variable costs

∙ Firms will take on marginal business at any price that  covers variable costs

o Barriers of Entry are high when:

o There are high capital requirements to get started  o High scale-based advantage increase the cost of entry  o More non-scale-based advantages exist (patents, access  

to raw materials & distribution channels, relationships,  know-how)

o When products are more differentiated new entrants have to spend heavily on adverting to gain similar levels of  brand awareness  

o When there is more limited capacity in the distribution  channel

o There are more legal barriers (e.g. Uber, Lyft)

o There is more fear of retaliation

o Threat of substitutes is high when:

o When the quality and function of the substitute is better than existing products.

o When switching costs to use substitutes are low. o Is there are high learning curve or high start-up cost to  use a substitute

o Based on the HW, identify substitutes of the car industry o Compare the following substitutes using criteria above;  which is likely to be the biggest threat for the car industry  moving forward?

o Ride sharing services

o Bicycles

o Public Transportation  

o Buyers (market for outputs) / Suppliers (market for  inputs)

o Buyers have high bargaining power when:

 Buyers are more price sensitive when:  

 When the product is a larger portion of the buyers  overall cost they are more likely to “shop around”  

or try to negotiate with the seller

 When the product is less differentiated the buyer is  more willing to switch suppliers on the basis of  

price  

 The more intense the competition among buyers is, the more eager buyers are for price reductions from their sellers (e.g. Viacom)

 The less important the product is to the buyer’s end product the more sensitive they will be to changes  

in prices  

 Buyers can refuse to deal with the other  

party when:  

 The buyers are more concentrated  

 Buyers have more complete information allowing  them to bargain better

 The more perfect information buyers have the  

better for their bargaining power

 When the buyers can vertically integrate backwards (can make their own products) they have better  

bargaining power

o LIMITATIONS OF 5 FORCES FRAMEWORK:

o Difficult to define the ‘right’ industry

 Convergence of industries (industry boundaries can be blurry)  

 Previously separate industries begin to overlap in  activities, technologies, products and customers

 Television broadcasting industry – the emergence of cable, satellite and telecommunication technologies has blurred the industries boundaries – A television  now offers different features (e.g. on-line access,  

interactive games, household security systems) so  

who really makes up this industry?

o Framework views other parties as competitors, not  potential allies (e.g. Threats versus opportunities)   Competitors are increasingly collaborating (e.g. GM  & Toyota manufacture cars together, Samsung  

provides chips to Sony)

 The opportunity for strategic alliances suggests  that you can both compete and collaborate with  

your closest competitors, customers & suppliers

o Five forces versus a sixth force (complementors)  Firms that sell products that add value to the  

products in the focal industry (e.g. Complementors  to the PC industry are firms that produce software  

applications)

 This produces the opposite effect of substitutes  

(increases value)

 The availability of apps actually improved i-phone  sales (and vice versa)

 This is especially important in “winner take all  

markets” (e.g. Microsoft, VHS)

o The framework does not fully account for all  external factors  

 For example it doesn’t fully account for government regulations and societal norms that may influence  

industry profits so it is important to do other  

analyses such as PEST

o Presupposes that industry structure is relatively  stable and determines competitive behavior in a  predictable way

 But this ignores the potential for rapid structural  transformation (hypercompetition?)

o This framework is only useful for analyzing  industries; it has nothing to say about why some  firms may outperform others within an industry

 It cannot explain the rather large differences in  

profitability within an industry (need to look  

differences between firms)  

Chapter 3 (Internal Analysis)  

∙ Understand why analyzing the internal environment is important  o (Resources and capabilities) which allow the firm to deliver unique  value to customers within that industry  

∙ Understand what the RBV of the firm tells us and key assumptions  that underpin it

o To understand why some companies outperform other companies  within an industry we need to be able to identify what causes  

performance differences between firms

 What are the unique strengths that allow a company to  

consistently offer unique value to customers?  

or

 How do firms gain competitive advantage?  

o The firm’s resources and capabilities allow it to perform activities  better than competitors  

 Resources: The productive assets owned by the firm (e.g. Plant, Equipment, Land, Brands, Patents, People)

 Capabilities: The processes the firm develops to use those  resources (e.g. Processes to help the firm manufacture at low  

costs, develop innovative new products, offer better service)

o According to RBV strategy is about understanding a firms unique  bundles of resources and capabilities that are ‘sticky’ that enable the  firm to earn above average profits for a given period of time  

∙ Understand different types of resources and how resources and  capabilities are distinct

• Resources are not productive on their own, it is necessary to look also at  capabilities  

– It is often useful to start by taking a comprehensive look at a firm’s  capabilities  

• Two common way to classify activities  

– Value Chain analysis: Separates the activities of the firm into a  sequential chain

– Functional analysis: identifies capabilities in relation to principal  functional areas of the firm

• Example on P. 137; 143 in book

∙ Understand what the Value Chain and Functional Analysis are and be able to explain and how to interpret the of information gained from  conducting each analysis  

• After you catalog the resources and capabilities it is important to determine  their profit potential (or competitive advantage)  

• And if this potential will provide the firm with a sustainable competitive  advantage

– Sustained competitive advantage is obtain by being able to maintain  the source of the firms advantage despite others attempts to imitate or substitute the advantage

∙ Understand how to conduct a VRIO analysis and how to interpret it  (Be able to evaluate the potential for a firm’s resources and  V Valuable • 

capabilities to lead to a sustainable competitive advantage) Rare •

R

imitate)

IInimitable (Costly to •

value)

O Organized (to capture •

Value: What do your customers value most?  

1. Offer customers some form of increased value or  2. Produce goods/services at a lower cost than rivals

o Sometimes things that were of value at one point are no longer  valuable now (look outside the firm to determine if it is still valuable) o e.g. IBM was superior at hardware in early 80’s but then software  became what was valued by customers and IBM’s competency  

manufacturing and servicing hardware was no longer valued by the  customer

 Sales tends to be a good indicator of whether you are offering your customers something they value

Rare: A valuable but not rare resource/capability will generate competitive parity.  – These resources/capabilities are needed to be ‘in the game’ but are  unlikely to lead to an advantage

– Not exploiting these resources/capabilities will likely put firms at a  competitive disadvantage.

• Are there substitutes for this valuable and rare resource/capability?  – At Wal-Mart low cost was valuable & rare until competitors’ costs  became relatively close resulting in some customers preferring to pay  the extra couple of cents for better service or more convenience.  • Better service and more convenience became a substitute for  low cost.  

Imitability: Is our advantage costly for others to imitate?

– Understand relative costs – Don’t ask if the resource/capability is costly or easy to implement instead ask “Is it easier for us to implement than  our competitors?”

• An advantage that is quickly imitated will only result in a temporary  advantage  

– But don’t ask if it is inimitable forever, ask inimitable for how long? If  you are competing based on a capability advantage (e.g. JIT) you can  continuously improve your capability and stay ahead of the game even as your competitors are copying you

• Toyota

Organization: Is the firm well positioned to capture value from the firm’s resources and capabilities?  

– Is your firm appropriating the value from this capability?

– Patents

– Relative Bargaining Power  

• Are suppliers and or buyers capturing most of the profit or is the  firm?  

• Pay high bonuses to investment bankers, star athletes, etc.  

means the suppliers of human capital (not the firm) are  

capturing the profit

– Embeddedness - Capabilities that are deeply embedded in the  organization tend to be appropriated by the firm  

• A complex social process among scientists at a pharmaceutical  firm that leads to consistent innovation in new drug discovery

• The knowledge that Intel applies at its wafer fabrication facilities to keep defects low

Chapter 4 (Competitive Advantage)

∙ Understand what competitive advantage is, know the two primary  ways firms can create value and the sources of competitive  advantage that unpin each

o Competitive Advantage:

 When two or more firms compete within the same market one  firms possesses a competitive advantage over its rivals when it  earns (or has the potential to earn) a persistently higher rater of  profit.  

1. Economies of Scale:

A higher volume of sales allows you to spread your fixed costs of production  over more sales  

1. May be especially important in organizations with high capital costs  (e.g. manufacturing)

2. May be important in industries with high marketing or R&D costs (e.g.  pharmaceuticals, car manufactures)

2. Economies of Learning:

The more experience you have doing something, the cheaper is to produce  (Practice makes perfect)

1. Different companies making the same product (in the same industry/markets) may have very different costs; experience is NOT consistent across an  industry or over time

– Boeing & Airbus have found that their labor costs per aircraft drop by  approximately 20% each time the volume of production doubles  3. Lower Input Costs

Input costs such as raw materials, supplies, parts, equipment, land, labor, and  capital may be lower

• Buy in large volumes from suppliers to increase your bargaining power – Wal-Mart gets discounts that no other retailers can get

• Cooperate with supplier to obtain lower costs and/or higher quality inputs  – Toyota works closely with suppliers and this results in lower  transportation & inventory costs (suppliers locate near plant), lower  contract and transaction costs (trust develops over time), and lower  the costs from rework and/or defects  

– Costco has worked with suppliers to change the shape of packaging in  order to increase the # of products that can be loaded on a pallet.  Suppliers enjoy reduced transportation costs and Costco has reduced  the # of pallets they buy by 200,000 a year

• Source inputs from lower costs locations  

– Apple outsources production of phones to places with lower labor costs • Improve Capacity Utilization  

– Improve motivation of workforce

– Eliminate slack or inefficiencies

• Meijer a large supermarket chain, worked to optimize their  

workforce by timing cashiers on how long it takes to cash out a  customer purchase; poor performers are counseled on ways to  

improve

– Lower ratio of fixed to variable costs  

• Could institute fast and flexible capacity adjustment (car  

industry is trying to develop platforms that can easily switch  

between different models)

4. Different Business Model

Eliminate activities or steps in the value chain or allow a firm to perform different activities all together  

1. Eliminate unnecessary production costs  

– Amazon noted that Barnes & Noble’s location costs were unnecessary  and eliminated them

– RyanAir doesn’t offer any low costs meals, pillows blankets and sick  bags – they don’t have to purchase these items or pay for the labor to  launder blankets and pillows

2. Eliminate or reduce standard product/service costs

– Tata made the Nano with an engine with only 35 horsepower (compare  that to the base model civic with 170 HP or the 70HP in the tiny Smart  Car)

– Original Unpackaged just opened a store in Berlin that has gotten rid of all disposable packing

Sources of Differentiation Advantage

1. Product Features

Different product features:

1. A product/service does a better “job”  

• Dyson’s cyclone has better ‘sucking’ ability  

• Greyhound less disgusting seats  

2. A product/service does more “jobs”

• Rolls-Royce is now a total solutions provider, majority of revenue now comes from servicing jet engines

3. A product/service does a “unique job”

• Champagne only comes from a small region in France

• Disneyland only place to meet Mickey Mouse or other popular  animated characters  

2. Quality or reliability

The product doesn’t necessary do a better, more or unique jobs – it  just lasts longer

∙ Honda and Toyota were perceived to offer higher quality cars for  years

3. Convenience

Products are more convenient to find or purchase

1. Easier to find

– Whole Foods brings together products traditionally only  

available through channels such as farmers markets,  

specialty stores

– Sell in unique locations, many locations  

2. Easier to purchase

– Papa John’s in Oxford accepts Ole Miss Flex Dollars

3. Added service

– LeTote customers pay $39+ a month for a customized  

selection of clothing and accessories from a variety of labels  

that stylist select and ship to them for purchase

4. Brand Image

Product or service isn’t necessarily superior in functional terms but  serves an emotional or social need (e.g. conveys status)

1. The first to create a product may become synonymous with that  product  

– Post-It’s  

– Kleenex  

2. Luxury branding tends to associate the products with positive  qualities in the minds of customers  

– Ferrari  

– Louis Vuitton

∙ Understand how the value chain might allow one to analyze sources of  advantage and to identify strategies for enhancing competitiveness  ∙ Unpacking the value proposition may help identify sources of CA  

o CA is difficult to identify, the very characteristics that make an  advantage sustainable (e.g. complexity, causal ambiguity, path  dependency), also make it difficult to identify what the resources and  capabilities that underpin it actually are.

∙ Value chain analysis can help identify CA:

1. Break down the firm into separate activities  

2. Establish the relative importance of different activities with respect to  reducing cost or increasing perceived value  

3. Benchmark each activity against competitors  

4. Identify linkages within the value chain

5. Identify opportunities for reducing costs or increasing value.

Other

∙ Understand the concept of “shared value”