Chap 6Competitor Selection

Competitive Advantage

Strategic benefits of competition

1. Increases competitive advantaged. a. Absorbs demand fluctuationsb. Enhance differentiationc. Serve unattractive marketsd. Provide a cost umbrellae. Improve bargaining position with labour and regulatorsf. Increase motivation

Strategic benefits of competition

2. Improving current industry structure

a. Increase industry demand

b. Technological credibility

c. Provide a second or third source

d. Reinforce desirable elements of industry structure

Strategic benefits of competition

• Aiding market development

a. Share the costs of market development

b. Reduce buyer’s risk

c. Help to legitimize and standardise a technology

d. Promote the image of the industry

Strategic benefits of competition

• Deterring entry of rivals

a. Increase the likelihood and intensity of retaliation

b. Symbolise the difficulty of successful entry

c. Block logical entry avenues

d. Crowd distribution channels

What makes a good competitor

• Tests of a good competitor

a. Credible and viable to the firm and customers

b. Clear and self perceived weakness

c. Understands the rules of the industry

d. Realistic assumptions about the industry

e. Knowledge about the costs

f. Inherently limiting strategic concept

g. Moderate exit barriers

What makes a good competitor

• Tests of a good competitorf. Reconcilable goals with the firm’s goalsg. Has moderate stakes in the industryh. Has a comparable return on investment targeti. Accept current profitabilityj. Desires cash generationk. Has short time horizon and does not attack firml. Is risk averse.

Firm’s tactics to influence entry

1. Technology licensing

2. Selective retaliation

3. Selective entry deterrence

4. Coalition to draw in new entrant

What is the ideal configuration ?

“A firm’s optimal share of the part of the industry it is targeting should be high enough not to tempt a competitor to attack it”

Structural characteristics of industry under which firm has to maintain high market share

1. Significant economies of scale2. A steep learning curve that is proprietary3. Few industry segments4. Buyers willing to purchase from a single source5. No distribution channels stocking multiple brands6. Competitors can share value activities and thus attack

the firm7. Other high entry barriers

Structural characteristics of industry under which firm has to maintain low market share

1. Few economies of scale2. A modest learning curve3. There are unattractive segments4. Buyers demand a second or third source5. Channels have bargaining power and desire multiple

suppliers6. Competitors are single business firms who cannot

share activities7. Followers are necessary as credible entry deterrents

against more threatening firms8. A follower needs a meaningful share to be viable9. The industry has a history of antitrust problems

Insights for the market leader

• In an industry with few segments and little differentiation or low switching costs, a large markets share is necessary.

• In an industry with many segments and high differentiation, firms can coexists profitably.

• Share not controlled by leader should be distributed between followers who are keen on competing with each other for each other’s share and not interested in the leader.

..moving towards ideal competitor configuration

• Firm has to calculate cost of gaining positioning or the risk of giving away share

• Yielding share has the risk of tempting competitors that they could take even more.

• In case of losing market share another issue is barriers to shrinkage or exit barriers.

Competitor selection...Oops…..

• Failure to distinguish good and bad rivals

• Driving rivals to desperation

• Having too big a market share

• Attacking a good leader

• Entering an industry with too many bad competitors.

Chap: 7Industry segmentation and competitive advantage

• Critical issues for a firm

a. Where in an industry to compete

c. In what segments will focus strategies be sustainable because barriers can be built between segments

Industry segmentation

• It is similar to market segmentation except for the fact that it combines purchasing behaviour of consumers with production costs and costs of serving consumers

• It targets issues like what segments to target and how to serve them

Bases of industry segmentation

• Structural base: Segments grow out from differences in buyer behaviour and the differences in economics of supplying different products to these buyers

Segmentation variables

• There are four broad variables

a. Product variety

2. Buyer type

III. Channel

e. Geographic buyer location.

Product

1. Physical size2. Price level3. Features4. Technology5. Inputs employed6. Packaging7. Performance8. New versus Replacement9. Product versus Ancillary services10. Bundled versus Unbundled

Buyers

Industrial and commercial buyersa. Buyer industryb. Buyer’s strategyc. Technological sophisticationd. OEM v/s Usere. Vertical integrationf. Decision making unit or purchasing processg. Sizeh. Ownershipi. Financial strengthj. Order pattern

Buyers

• Consumer goods buyer

1. Demographics

2. Psychographics

3. Language

4. Decision making unit or purchasing process

5. Purchase decision

Channel segments

1. Direct v/s distributors

2. Direct mail v/s retail

3. Distributors v/s brokers

4. Types of distributors or retailers

5. Exclusive v/s non exclusive outlets

Geographic segments

1. Localities in terms of regions and countries

2. Weather zones

3. Country’s stage of development or other country grouping. E.g EU, SAARC

Industry segmentation matrix

• Once segmentation variables are identified they are combined to segment the industry. The tool used is the industry segmentation matrix

For example: 1. Three categories of buyers

2. Two categories of geographic locations

Industry segmentation matrix

Big customers Midsize customers Small customers

Developedcountries

Developingcountries

Attractiveness of a segment

It is a function of the following criterias:a. It is structurally attractive ( in terms of five force model)b. Size and growthc. Firm’s position vis-à-vis segment in terms resources

and skills to deal in the segmentd. Segment interrelationship. It deals in the activities that

of the value chain that can be shared between different segments. E.g. Same manufacturing facilities can produce different product varieties.(offset by costs of coordination, compromise in terms of segment spillover and inflexibility)

Costs of Interrelationships

Broadly three costs:1. Coordination costs which are due to

complexity of operating multiple segments2. Compromise costs occur when value chain is

designed to serve one segment and is suboptimal for the other. Segment spillover is another one.

3. Inflexibility costs exist since sharing value activities limit flexibility to modify strategies in different segments.

Segment interrelationship and broadly targeted strategies

a. Firm competing in one segment is most likely to enter other segments where there are strong interrelationships.

b. Broadly targeted competitor bets that the gains from interrelationships outweigh the costs of sharing and minimise the coordination and compromise costs

c. Broadly targeted competitor should not serve all segments since benefits of sharing value activities shall be outweighed in some segments by the cost of compromise.

The choice of focus

• It can consist of more than one segment and several segments with strong interrelationships.

Sustainability of focus strategy

• It is determined by three factors:

a. Sustainability against broadly targeted competitors

b. Sustainability against imitators

c. Sustainability against segment substitution

Chapter: 8Substitution

• It is the process by which one product/ service supplants another in performing a particular function or functions for a buyer

• Substitution is one of the important five forces in Porter’s model and determines industry’s and firm’s demand.

• Understanding substitutes and the threats that they pose can be best understood by using substitution analysis.

Identifying substitution

• It requires searching for products or services that perform the same generic function or functions as an industry’s product rather than products that have the same form

• A product often affects not only buyer value activity but also other activities

• It is also important to define the function of a product in the activity generically rather than literally

• More generically the function of an industry’s product is expressed, greater the number of potential substitutes.

• A substitute may have wider or narrower range of functions than an industry’s product

Identifying substitution • Broadly there can be four substitutes:a. Buyers does not purchase anything at all to perform the functionb. Buyer lowers the usage rate of the product requiredc. Buyer uses used, recycled or reconditioned productsd. Buyer performs the functions internally or indulges in backward

integration

Interestingly multiple substitutions interact in shaping the overall substitution rate in an industry and may lead to counterintuitive consequences.( Aspartame and Saccharine help each other)

Interestingly if an industry faces no direct substitutes, it may still be affected by substitution if there is threat of substitution “downstream” ( If battery operated devices are replacing electricity run devices, the sales of spare parts of electricity run devices will fall)

Economies of Substitution• One product substitutes for another if it offers buyers an inducement

to switch and this exceeds the cost or overcomes the resistance to doing so. The substitute's relative value to price is more than that of the industry’s product.

• There is always some “cost of switching” to substitute due to the disruption and potential reconfiguration of existing buyer activities.

• The pattern of substitution is also affected by “the buyer’s propensity to switch”

• Thus the threat of substitution is a function of three factors:a. the relative value/price of a substitute compared to an industry’s productb. the cost of switching to the substitutec. the buyer’s propensity to switch

Relative Value/Price (RVP)

• The relative /price of a substitute is the value it provides to the buyer compared to the price the buyer pays for it.

• When there are no switching costs and the product is consumed quickly, the relevant RVP is a function of current conditions.

• When there are costs of switching or the product is durable, the attractiveness of a substitute is the expected RVP of the substitute over the planning horizon.

• Expected RVP over the planning horizon would consist of price changes of both (substitute and products) in terms of discounts, free ancillary products, free service etc.

List of factors that impact buyer cost/performance when comparing RVP of

substitute and producta. Usage rate: Substitute can lower buyer

cost if less of it is required compared to product

b. Delivered and Installed cost: It includes cost of transportation, installation, calibration etc.

c. Financing cost.

d. Relative variability of price or availability

List of factors that impact buyer cost/performance when comparing RVP of

substitute and product

e. Direct costs of use: It is the cost of using the substitute over its entire life. It consists of1. Cost of labour2. Consumables3. Insurance4. Frequency of cost or maintenance5. Cost of spare parts6. Salvage value7. Dismantling cost

List of factors that impact buyer cost/performance when comparing RVP of

substitute and product

f. Indirect costs of use: A substitute can affect the cost of other activities in the buyer’s value chain if:a. It affects productivity in other value activitiesb. It influences the need for other raw material or their required qualityc. It requires different ancillary equipmentd. It affects the need for inventorye. It affects the frequency and complexity of required quality control checksf. It affects the amount and type of packaging materials needed in shippingg. It affects product weight and hence transport costs

List of factors that impact buyer cost/performance when comparing RVP of

substitute and productg. Buyer performance derived from the

substitute

h. Number of functions given by the substitute

i. Cost and performance of complementary products related to the substitute

j. Uncertainty in terms of how will substitute affect buyer’s cost or performance.

List of factors that impact buyer cost/performance when comparing RVP of

substitute and productk. Perception of value: It is the buyer’s perception of the

RVP of a substitute that will determine the threat of the substitute and not the reality of the RVP.Buyers are least likely to perceive the benefits of a substitute when:a. The advantage of the substitute is in lowering the costs of use over time rather than immediatelyb. The advantages of the substitute is indirectc. Substitutes raise performance over time and not immediatelyd. Gaining advantages from substitutes requires buyer to change behaviour or use patternse. Credibility of substitute is hard to assess.

Switching Costs

a. Identifying and qualifying sources

b. Retraining and Relearning costs

c. Changing role of user

d. Risk of failure

e. New ancillary products

f. Switching costs v/s Switching back costs

Buyer propensity to substitute

It is affected by the various factors:

1. Resources

2. Risk profile

3. Technological Orientation

4. Previous substitution

5. Intensity of rivalry ( for industrial buyer)

6. Generic strategy ( for industrial buyer)

Segmentation and Substitution

• The identity and threat of substitute differ by industry segment.

• Threat of substitution will change by buyer group if RVP, switching costs or the propensity to substitute vary.

• The substitution threat can vary not only by buyer segments but also different product varieties, geographic areas and channels.

Changes in Substitution threat

The threat of a substitute often changes over time, with a corresponding impact on the pattern of substitution:-

Changes in the threat of substitution occur in five broadly defined areas:1. Changes in relative price2. Changes in relative value3. Changes in buyer perception of value4. Changes in switching costs.5. Changes in propensity to substitute

Changes in substitution threat

• Changes in substitution threat are determined by industry structure and competitor behaviour in both the substitute industry and threatened industry

Changing relative price

Relative price will change if

a. Relative costs of substitute and product change and the change is partially or completely passed on to the buyers

b. The relative profit margins of the substitute and product change.

Changing relative value

• The relative value to the buyer of a substitute will often change because of three reasons:a. Relative pace of technological change where substitute and threatened product are engaged in a technological race to see who can improve technology faster.b. The development of infrastructure where the RVP changes in favour of the substitute over time as better infrastructure develops to support it.c. The presence of institutional factors which can impact the RVP of a substitute.

Changing Buyer Perception of Value

• The perception of value by buyers frequently changes over time in substitution because time and marketing activities are working to alter the way buyers view a substitute compared to a product

• The perception of a substitute and a product can also be affected by the relative intensity and creativity of signaling activities.

• Substitute will gain in perceived value over time as buyer becomes more familiar with how to use it.

Changing Switching Costs

• The cost of switching to a substitute often change over time in a downward direction due to the development of procedures, designs or standards.

• Switching costs for substitute also fall due to redesign to increase compatibility with ancillary equipment, procedures developed by suppliers etc.

Changing propensity to switch

The propensity to switch to a successful grows over time.

Early success with substitute reduces buyer risk

The Path of Substitution

• The path of substitution in an industry is a function of how RVP, the perception of RVP, switching costs and the propensity of buyers to switch evolve over time.

• Rate of penetration differs widely from industry to industry, where some substitutes gain quick acceptance while other penetrate slowly or not at all.

The Path of Substitution

• In many industries, the path of substitution looks like an S-curve, when substitution as a percent of total demand is plotted against time

-----------------------------------------------------------Upper bound------------

PercentSubstitution Take off

Informing and Testing

Time

The Path of Substitution• In the S curved path, substitution is initially modest and often continues at low levels

for a considerable period of time which is called “ informing and testing phase”

• Later on the substitute climbs rapidly in a “take off phase” towards an upper bound that represents maximum penetration.

• This upper bound is determined by number of buyers for whom the substitute is potentially valuable.

• The S shaped curve is there for the following reasons:a. The uncertainty of perceived value and the risk of failure of the substitute both fall as early buyers have successful experiences.

b. Once a few buyers successfully switch, competitive pressures force other buyers to maintain their cost position or differentiation

c. The cost of switching may decline.

d. Rising adoption leads to increasing awareness of the substitute and raises its credibility

e. Rising penetration of the substitute often reduces its cost through economies of scale and learning

f. Introduction of new varieties of the substitute opens up new industry segments

Substitution Forecasting Models

• The most commonly used diffusion model is the “logistic function” – a form of exponential function

= F/1 – F Where F= fraction of the total potential market that has

switched to the substitute K= a constant set equal to the early growth of a substituteThere are two assumptions:1. If the substitution has progressed a few percent, it will

proceed to completion2. The fractional rate of fractional substitution of a

substitute for the product is proportional to the remaining amount of the product left to be subsituted

A typical logistic curve

F/1-F ---------------------- 50% ------------- Infection

point

Time(years) Time(years)

Promoting SubstitutionA firm can trigger substitution through strategic moves that

enhance RVP, lower switching costs or raise the propensity of buyers to switch. Some examples for promoting substitution are given below:

a. Target early switchersb. Improve firm’s offering in areas with the highest RVP impactsc. Reduce or subsdise switching costsd. Invest in signallinge. Use tapered forward integration or induce backward

integration to create pull throughf. Ensure multiple sources and/or adequate capacityg. Promote improvement in complementary products or

infrastructureh. Price to balance capturing RVP against creating barriersi. Conceive new functions to widen a substitute’s marketj. Harvest if competitive position in the substitute is not

sustainable.

Defense against substitution

a. Find new uses unaffected by the substitute

b. Redefine competition away from the strengths of the substitute

c. Enlist suppliers to help least vulnerable to substitution

d. Harvest instead of defend

e. Enter the substitute industry