strategy formulation in declining industries

8/3/2019 Strategy Formulation in Declining Industries

1/7

ot Management Review 1980, Vot. 5, No. 4, 599-604

Strategy Formulation inDeclining Industries^KATHRYN RUDIE HARRIGANUniversity of TexasDallas

Because the environments of declining industries differ, many dif-ferent strategies could be appropriate for coping with declining de-mand. Demand and customer traits, product traits, supplierbehavior, competitor traits, and exit barriers must be taken into ac-count by a firm in a declining industry. Strategy alternatives includeearly exit, milking the company's investment, shrinking selectively,holding the present position, and increasing investments. Somepossible strategies must be adopted early if they are to succeed.

The structural environments of declining in-and the experiences of compet i tors

it is not surprising that manyferent strategies cou ld be appropriate for copingdemand. What issomewhat surpris-however, is the successes some companiesby increasing their investment in

I discussas well as less ag-be appropr iateponses for firms w ithin industries facing declin-and, in relation to the types of decline andin order to suggestne strategies m ight be most effective,ven the presence of key industry struc tural traits.

Firms have renovated plants and machinery, ac-the assets of competitors, or otherwise in-eased their com mitme nt to a business for whose

is falling due to ob-or cultural changes,

is taken from my dissertat ion. I wish tothesupport of Michael E. Porter and the Divi-of Research, Harvard Business School, of Walterand of the Office of Sponsoredts, university of Texas at Dallas, in completing thistjy the Academy of Management 0363-7425

favorable. Some of these firms have accurateldiagnosed the outlook for the various markesegments of their business and analyzed wherenduring demand might exist despite a genera"Chicken Little" attitude regarding the overall industry's fortunes.Demand could endure where produc ts appealeto customers who would switch products witgreat reluctance or only if use of the substitutproduct were clearly more desirable. Examples osuch lucrative niches of demand include: electronic receiving tubes for high fidelity am plificatiouses, or as replacement components in colotelevision; leather goods and apparel designed anmerchandised for the haute couture markepremium-branded cigars (retailing for $2.00 pecigar) ; bel ted, nonradial t i res merchandisethrough discount outlets; hypoallergenic infant formula; sterling silver electric percolator coffeemakers and plastic peres; shiny acetate fabrics fodisco wear and rayon filament fibers for highquality menswear l ining fabrics; and leathemilitary boots.

Identification of these types of market niches idesirable, but they do not exist in all declininbusinesses. A framework suggesting strategialternatives suitable for various combinations oindustry traits is desirable in order for a firm t599


2/7

recognize where the industry's context offers littlehope for carving out an advantageous pos ition dur-ing decline, and when to exit if the industry is notfavorable.An industry would be favorable for continuedcompetition if (1) demand were somew hat p rice in-sensitive, (2) it were clear that replacement unitswould be needed for a predictable time into thefuture, and (3) cadres of loyal customers existedand were l ikely to endure. It would be lessfavorable if (1) demand were highly price sensitiveand a history of volatile price wars was established,(2) demand for the declining product plummetedabruptly, creating sizeable w rite-off losses for firm sthat were forced to exit, (3) substantial reinvest-ment requirements (such as pollution controldevices) could force firms to exit prem aturely, or (4)great uncertainty regarding the duration of demandinduced other firms to increase their investmentsin the industry, thus exacerbating the deterrent ef-fect of exit barriers.

Demand CharacteristicsIf there were relative certainty regarding (1)which pockets of demand would decline first, (2)how rapidly demand would decline for differentmarket niches, and (3) whether demand would be

likely to revitalize, then competition within thedeclining industry would be less likely to bevolatile and the timing of exits wou ld be more likelyto be orderly. But where there is substan tial uncer-ta in ty conce rn ing whe the r demand wou ldrevitalize and when and who should exit, chaos ismore likely to ensue.If firms experience great uncertainty concerningthe duration of demand, they might increase ormaintain the levels of their asset and managerialcommitments to the troubled business. These in-

vestments can constitute exit barriers [Porter,1976] that could make a timely exit difficult if de-mand suddenly soured. Ownership of underutil-ized assets that are costly to retire m ight induce re-maining firms to cut prices, increase promotionalactivities, and heat up competition in the industryin order to fill the excess capacity. Particularlydamaging behaviors are likely to occur if single-business firms choose to fight for a larger per-

centage of a shrinking customer base. If petitors were strongly committed to being in aticular business and were expecting demanrevitalize, but were uncertain when it would dthey would be more likely to continue to opetheir plants at low capac ities for many years rthan sell them, retire them, or otherwise retheir commitment to the business.The presence of pockets of demand wcustomers' switching costs are financially higare perceived as being high ow ing to the disadtage of a degradation of quality) would determwhe the r the dec l i n ing i ndus t ry wou ldhospitable to a range of strategies that mighclude reinvestment. Favorable declining busienvironments contain at least one pocket of eing product demand of viable size.

Structural CharacteristicsIn addition to demand traits, the follow ing stural characteristics of the industry will deterwhether these desirable pockets of demand and can be defended by the "right" f irm.

Product TraitsThe market niche that protects the firm potential entrants best in a dec lining dem and

text is established when the firm has effectdifferentiated its product or holds patents deter rival products from a ttaining a similar staacceptability with the enduring customer grouthis niche is effectively fortified, competitorsbe unable to hurdle the barrier using price-cualone. Brand loyalties, a lthough effective , woueroded more rapidly than barriers based onphysical differentiation.Customer Traits

Continuing customer demand may be atageous if customers can afford to bear thcreased costs manufacturers sustain in provthe declining product while underutilizing asIf the higher costs cannot be passed ocustomers, there are fewer advantages to reming in the industry. If competitive marketing tices have formerly included financing the in600


3/7

s of dem and for declining products m ay, atbe illusory.If customers react unfavorably to a f irm'sa product by avoiding the firm'sprod ucts, the inherent market power of thoseomers can co nstitute an exit barrier that w oulday a firm's time ly exit and may result in subnor-firm.

et of demand whose true econom ic benefit to

If supplier industries are relatively dependent o ning w ithin de clining businesses for the

their sales, by advertising on their behalf,

Relatively new, unsaleable physical assets

t could be avoided (or deferred) by con tinuing to

age firm s from exiting if they are adverse toaining a su bstantial loss on disposal.Where m arginal com petitors are locked into anerse competitive situation by such exit barriers,

the assets that c onstitute barriers. Such a tac-ust be predicated on an analysis of the de clin-nt that suggests that the ac-ageously and hence is justified in in-

creasing the level of its commitment to the industry.Analysis of the potential deterrent effects of acquired assets on subsequent timely exit would beparticularly desirable before a firm contemplatedacquisition of com panies that are compo sed largely of assets used in decl in ing businessesAlthough such acquisitions frequently are consummated as a means of obtaining access to anewer, re lated technology, the obsolescenbusiness's assets could curtail the firm's overalsuccess if the expected performance of the neweventure does not materialize. Hence, analysis ofthe business outlook and structural context oeach of the major businesses constituting a potential acquisition candidate cou ld induce ca ution othe creation of provisions for asset disposaproblems that might otherwise go unheeded andproduce con torted maneuvers later when rapid exibecomes imperative.Competitors' Traits

Decisions regarding strategies for decliningbusinesses must be made with full considerationof the probable responses of the other industrymembers. The presence of single-business firmswho face substantial exit barriers could increasethe likelihood that a volatile competitive environ-ment w ill develop. The highly com mitted firms aremore likely to try to penetrate other firms' promising market niches, using price-cutting in lieu of theattractiveness of other product or service traits togain entree [Newm an, 1978].

Strategy AlternativesFrom consideration of these and other industryand competitor factors, an assessment of therelative attractiveness of the declining business

may be made. If consu mp tion levels seem likely tobe slowly declining in the niche served and pricelevels are not expected to drop precipitously, theindustry environment is relatively more attractive. Ifthe firm's objective is to earn the best return on itsasse ts, this objective sh ould be relatively easier toattain where its physical assets are already highlydepreciated, assuming that no reinvestments m usbe made for maintenance of physical assets, fo601


4/7

pollut ion con trol, or as renovations that could con -stitute undesirable exit barriers later. If the fimn'sanalysis does not determine that the industry en-vironment has undesirable condit ions that man-date immediate exit, the f irm may consider themore aggressive approaches sketched below inFigure 1 for coping with industry decline.Early exit The f irm may wish to exit from adeclining business quickly if competitors are cut-ting their prices or otherwise impairing the pro-fitability o f the indu stry. Early exit may becom e im-perative if the firm hopes to recover much of itsassets' values. If industry structural traits do notappear to make the business hospitable for otherstrategies (noted below), and if competitive vigorreduces the likelihood that later exits will not pro-duce better performan ce in the bu siness , it may beadvantageous to cash in on a declining business

early, before other firms reach the same conclu-

sions, as Raytheon did in electronic recetubes or Du Pont in rayon acetate [Harrigan, The objective of divestiture is prudent t imcould mean a sale of bu siness assets or theirdonm ent. The f irm may even sell its assets topetitors, if necessary, or junk them, as DiaSha mroc k d id in acetyle ne [Ha rrigan, 198avoid sustaining chronic losses and to reworking capital to other uses yielding breturns.

Milk the investment A firm may try to incthe return on investment by surrendering mshare or may attempt to funnel as much caspossible to other projects quickly. In such cthe firm tries to harvest its business. Mstrategies commonly occur when immediateseems too d isadvantageous to the f i rm. The rpursuing a milking strategy within a declbusiness is that if uncontrollable adverse e

ENVIRONMENTAL TRAITSdem and p r ice insensit ivereplac em ent units likely to be neededby some custome rs for a long t imeloyal custom er demand l ikely to endurerevitalization likely, albeit remo tef ir m serves protected (high entrybarriers) market niche alonesupp liers wil l ing to help f irm co mp ete

dem and price sensdem and co uld deteriorate abr

low custome r sw itching cco m pe tit ion u sually vo

com pe titors face high exit ba

custo me rs likely to exert bargaining p

AGGRESSIVE


5/7

ce a firm to shut dow n early, it may be unable to

Corn-orks in percolator coffee-makers [Har-1979].Shrink selectively I f demand within someet niches seems to be enduring , a firm pursu-

on serving the most desirable

y, as Celanese did in rayon. In order to do s o ,

as Mead, Johnson did with infant formula1980]. The most desirable customers in ang industry are those who are least likely tot soon to a subs titute product, owing to h ighching co sts.

Holding pattems Holding strategies are pur-ed when the firm decides it is already in the bestness or when the finm is waiting to take more

e for losses of operating e fficiency. The firm will

ove. Courtaulds, for example, held its pos itione forced to close [Harrigan, 1979].

A firm might pursue

e a longer-term advantage in doing so . Typical-

ly, such a firm will purchase the assets of com-petitors who wish to exit or will make other in-vestments to ensure that the declining businessdoes not become volatile when competitors ex-perience difficulty in filling their plants' capacities.(Alternatively, the firm may use price cu tting to en-courage marginal comp etitors to exit earlier.) DowChemical increased its acetylene investment,Gerber increased its baby foods investment, andGTE Sylvania helped other receiving tube com-petitors to exit from the declining industry by pur-chasing their assets [Harrigan, 1979]. In syntheticsoda ash, marginal comp etitors were squeezed outwhen prices did not rise in proportion with increas-ing energy costs.

Increased investment strategies usually occurwhere (a) there seem to be enduring pockets of de-mand for the declining product, (b) the cost ofrepositioning to serve these niches most advan-tageously seem s likely to be recovered rapidly or isnot substantial and (c) few other competitors arecapable of or positioned to serve the customerniches advantageously. Thus, a firm may chooseto increase the level of its investment in a decliningbusiness if it is quite cost-efficient in manufactur-ing the endgame product and sells a patented orbranded product to loyal customers in a decliningindustry that has relatively low exit barriers, fewmaverick competitors, high switching costs forcustomers, and other favorable characteristics.

Increased investment strategies have beenrewarding in declining industries such as babyfoods, replacement e lectronic receiving tubes , andacetylene production, among others. The attrac-tiveness of these declining industries has beenenhanced for remaining firms by their willingnessto purchase comp etitors' assets, to act as a sourcefor competitors who have discontinued productionbut continue to merchandise declining products,and to produce for private brand merchandisers.The Timing of StrategiesFor Declining Demand

Some of the strategy alternatives sketchedabove necessitate early execution if they are tosucceed. Most notably, where reinvestments orrepositioning will be required in orde rto remain inthe industry, the fimn must commit its resources603


6/7

before c omp etitors can maneuver into a m ore ad-vantageous position. Similarly, exits should be ex-ecuted before the asset resale market sours.Althou gh it may seem desirable for the firm to waitfor the situation to become less un certain, waitingcould be detrimen tal. The firm cu ts off its strategyoptions (and their respective promises of profitableperformance) by waiting.As demand shrinks, only a few competitors'plants w ill be needed to satisfy rem aining demand.If a firm could communicate its binding industrycommitment to its rivals early, it may be able toprevent competitors from occupying the mostdesirable market niches and to signal in an unam-biguous fashion that it intends to fight bitterly toretain these niches, once occup ied. The firm mayeven be able to avert bloodshed if an industry con-sensus is recognized among rivals and is con-sidered important to maintain for the mutual pro-

fitability of the remaining participants.This means that if a firm wishes to dominate adeclining business, it pays to start early. If one in-

tends to divest, it means that one should sbefore asset va lues drop too precip iAlthough desirable cash flow could be enjofirms in some de clining industries, therepirical evidence also that other competitorsuffered losses in these same industries understanding the interrelationships of the in this environment as they affect the succthe firm's strategy.

Strategy formulation for finms in declindustries should include conside ration of dustry's structure and demand characteriswell as analysis of their comp etitors' and thestrengths and weaknesses. Successful impltation of a strategy requires timely commitand appropriate tactic s. The risk of erring coformidable. In practice, exit barriers makplementation of these strategies difficult. coming these exit barriers is part of the chaof m anaging a profitable business in a declindustry.

REFERENCESBain, Joe S. Barriers to new competit ion.vard University Press, 1956. Cambridge: Har-Caves, Richard E.; & Porter, Michael E. Barriers to exit . InDavid P. Quails & Robert T. Masson (Eds.), Essays in industrialorganization in honor of Joe S. Bain. Cambridge: BallingerPublishing, 1976. Chapter 3.

Dynamic limit pricing: Optimal pricingJournal of Economic Theory, 1971,3(3),Gaskin, Darius W., Jr.under threat of en try.306-322.Harr igan, Kathryn Rud ie . Strategies for decliningbusinesses, unpublished doctoral dissertation. HarvardUniversity, 1979.Harr igan, Kathryn Rud ie . Strategies for decliningbusinesses. Lexington , Mass.: D. C. Hea th, 1980.Harrigan, Kathryn Rudie;& Porter, Michael E. A framework forlooking at endgame strategies. In William F. Glueck (Ed.),Strategic management and business policy: A book ofreadings. New York: McGraw-H ill, 1980.Harrigan, Kathryn Rudie. The effect of exit barriers uponstrategic flexibility. Strategic Management Journal, 1980,7(2)165-176.

Harrigan, Kathryn Rudie. Clustering comp etitors by sgroups. Proceedings, Southwest Academy of Mana1980.Mo digliani, Franco. New developments on the ofront. Journa i of P oiiticai Economy, 1958, 66(3), 215Newman, H. H. Strategic groups and the structu re mance relationship. Review of Economics & S tatis60(3), 417-423.Porter, Michael E. Note on the structural analysdustries. I n te rco l leg ia te Case C lea r ing #9-376054. Boston: ICCH, 1975.Porter, Michael E. Please note location of nearest ebarriers and planning. California Management Rev19(2), 21-33.Porter , Michae l E. How co m pet i t ive fo rces strategy. Harvard Business Review, 1979,57(2), 13Porter, Michael E. Industry and competitive analysisYork: Free Press, 1980.

Kathryn Rudie Harrigan is Assistant Professor ofBusiness and Social Policy in the School of Manage-ment and Administration, University of Texas at Dallas,Richardson.Received 12/21/79

60 4


7/7

Copyright of Academy of Management Review is the property of Academy of Management and its content may

not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written

permission. However, users may print, download, or email articles for individual use.

strategy formulation in declining industries

Documents