You are an executive of an American company. You have been sent to China to expand your
company’s operations in that country.
(a) From your knowledge (or research) of cultural differences between the Chinese and
Americans, what two cultural mistakes are you likely to commit in China that would irritate
the Chinese people?
(b) What can you do to minimize chances of making those cultural mistakes, so that you can be
more successful in China?
P.S. This question is not about Americans in general; it is about you, as an American, in
particular. You need to get personal and apply it to yourself. Don’t write in general terms
about Americans.
Industry Competition
W
Chapter Outline
I
3-1 Industry Life Cycle Stages
L
3-2 Industry Structure
L3-3 Intensity of Rivalry among Incumbent Firms
I 3-3a Concentration of Competitors
S 3-3b High Fixed or Storage Costs
, 3-3c Slow Industry Growth
3-3d Lack of Differentiation or Low Switching Costs
3-3e Capacity Augmented in Large Increments
K 3-3f Diversity of Competitors
A 3-3g High Strategic Stakes
S 3-3h High Exit Barriers
S3-4 Threat of Entry
3-4a Economies of Scale
A 3-4b Brand Identity and Product Differentiation
N 3-4c Capital Requirements
D 3-4d Switching Costs
R 3-4e Access to Distribution Channels
A 3-4f Cost Advantages Independent of Size
3-4g Government Policy
3-5 Pressure from Substitute Products
23-6 Bargaining Power of Buyers
13-7 Bargaining Power of Suppliers
63-8 Limitations of Porter’s Five Forces Model
13-9 Summary
Key Terms
TReview Questions and Exercises
SPractice Quiz
Notes
Reading 3-1
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
3
38
Chapter 3
T
Industry
A group of competitors
that produce similar
products or services.
his chapter marks the beginning of the strategic management process and is one of two that considers the external environment. At
this point it is appropriate to focus on factors external to the organization and to view firm performance from an industrial organization
perspective. Internal factors are considered later in the process and in future
chapters.
Each business operates among a group of companies that produces competing products or services known as an industry. The concept of an industry is a
simple one, but it is often confused in everyday conversations. The term industry
does not refer to a single company or specific firms in general. For example, in
the statement, “A new industry is moving to the community,” the word industry
should be replaced by company or firm.
Although usually differences exist among competitors, each industry has its
own set of combat rules governing such issues as product quality, pricing, and
W
distribution. This is especially
true for industries that contain a large number of
firms offering standardized
products
and services. Most competitors—but not
I
all—follow the rules. For example, most service stations in the United States
generally offer regularLunleaded, midgrade, and premium unleaded gasoline at
prices that do not differ
L substantially from those at nearby stations. Breaking the
so-called rules and charting a different strategic course might be possible, but
may not be desirable. IAs such, it is important for strategic managers to understand the structure of S
the industry(s) in which their firms operate before deciding how to compete successfully.
,
Defining a firm’s industry
is not always an easy task. In a perfect world, each
firm would operate in one clearly defined industry; however, many firms compete
in multiple industries, and strategic managers in similar firms often differ in their
K
conceptualizations of the industry environment. In addition, some companies
have utilized the Internet
A to redefine industries or even invent new ones, such
as eBay’s online auction or Priceline’s travel businesses. As a result, the process
S
of industry definition and analysis can be especially challenging when Internet
S 1
competition is considered.
Numerous outside A
sources can assist a strategic manager in determining
“where to draw the industry lines” (i.e., determining which competitors are in
Nnot, and why). Government classification systems, such
the industry, which are
as the Standardized Industrial
Classification (SIC), as well as distinctions made
D
by trade journals and business analysts may be helpful. In 1997, the U.S. Census
R system with the North American Industry Classification
Bureau replaced the SIC
System (NAICS), an alternative
system designed to facilitate comparisons of busiA
ness activities across North America. Astute managers assess all of these sources,
however, and add their own rigorous and systematic analysis of the competition
when defining the industry.
2
Numerous descriptive factors can be used when drawing the industry lines. In
1 for example, attributes such as speed of service, types of
the case of McDonald’s,
products, prices of products,
6 and level of service may be useful. Hence, one might
define McDonald’s industry as consisting of restaurants offering easy to consume,
1
moderately priced food products rapidly and in a limited service environment.
T food” are often used to describe such industries, but
Broad terms such as “fast
doing so does not eliminate the need for a clear, tight definition.
S
Some factors are usually not helpful when defining an industry, however, such
as those directly associated with strategy and firm size. For example, it is not a
good idea to exclude a “fast-food” restaurant in McDonald’s industry because it is
not part of a large chain or because it emphasizes low-priced food. Rather, these
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
factors explain how such a restaurant might be positioned vis-à-vis to McDonald’s,
a concept discussed in greater detail in Chapter 7.
The concept of primary and secondary industries may also be a useful tool in
defining an industry. A primary industry may be conceptualized as a group of close
competitors, whereas a secondary industry includes less direct competition. When
one analyzes a firm’s competition, the primary industry is loosely considered to be
“the industry,” whereas the secondary industry is presented as a means of adding
clarity to the analysis. For example, McDonald’s primary industry includes such
competitors as Burger King and Wendy’s, whereas its secondary industry might also
include restaurants that do not emphasize hamburgers and offer more traditional
restaurant seating such as Pizza Hut and Denny’s. The distinction between primary
and secondary industry may be based on objective criteria such as price, similarity
of products, or location, but is ultimately a subjective call.
Once the industry is defined, it is important to identify the market share,
which is a competitor’s share of the total W
industry sales, for the firm and its key
rivals. Unless stated otherwise, market share
I calculations are usually based on
total sales revenues of the firms in an industry rather than units produced or sold
by the individual firms. This information L
is often available from public sources,
especially when there is a high level of agreement
as to how an industry should
L
be defined.
I
When market share is not available or substantial
differences exist in industry
definitions, however, relative market share,
S or a firm’s share of industry sales
when only the firm and its key competitors are considered, can serve as a useful
,
substitute. Consider low-end discount retailer
Dollar Tree as an example and
assume that the only available market share data considers Dollar Tree to be part
of the broadly defined discount department store industry. If a more narrow
K
industry definition is proposed—perhaps one limited to deep discount retailers—
new market share calculations will be necessary.
In addition, it becomes quite
A
complicated when one attempts to include the multitude of mom-and-pop disS
counters in the calculations. In this situation, computing relative market shares
S
that consider Dollar Tree and its major competitors
can be useful. Assume for the
sake of this example that four major competitors
are
identified in this industry—
A
Dollar General, Family Dollar, Dollar Tree, and Fred’s—with annual sales
Nbillion, respectively. Relative market
of $6 billion, $5 billion, $2 billion, and $1
share would be calculated on the basis D
of a total market size of $14 billion
(i.e., 6 + 5 + 2 + 1). In this example, relative market shares for the competitors are
43 percent, 36 percent, 14 percent, and 7R
percent, respectively. From a practical
standpoint, calculating relative market share
A can be appropriate when external
data sources are limited.
A firm’s market share can also become quite complex as various industry or
market restrictions are added. Unfortunately,
2 the precise market share information most useful to a firm may be based on a set of industry factors so com1 task. In a recent analysis, the Mintel
plex that computing it becomes an arduous
International Group set out to identify the
6 size of the “healthy snack” market
in the United States, a task complicated by the fact that many products such as
1
cheese, yogurt, and cereal are eaten as snacks in some but not all instances.2 To
overcome this barrier, analysts computed T
a total for the healthy snack market by
adding only the proportion of each food category consumed as a healthy snack.
S
In other words, 100 percent of the total sales of products such as popcorn and
trail mix—foods consumed as “healthy snacks” 100 percent of the time—were
included in the total. In contrast, only 40 percent of cheese consumption, 61 percent of yogurt consumption, and 21 percent of cereal consumption were included
39
Market Share
The percentage of total
market sales attributed
to one competitor (i.e.,
firm sales divided by
total market sales).
Relative Market
Share
A firm’s share of industry
sales when only the firm
and its key competitors
are considered (i.e., firm
sales divided by total
sales of a select group
firms in the industry).
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
40
Chapter 3
Case Analysis 3-1
Step 2: Identification of the Industry and the Competitors
After the organization has been introduced, its industry must be specifically identified.
This process can be either relatively simple or difficult. For example, most would agree
that Kroger is in the “grocery store industry,” and its competition comes primarily from
other grocery stores. However, not all decisions are simple. For example, should WalMart be classified in the department store industry (competing with upscale malloriented stores) or in the discount retail industry (competing with low-end retailers such
as Family Dollar)? Is Taco Bell in the fast-food industry or in the broader restaurant
industry? To further complicate matters, many corporations are diversified and compete
in a number of different industries. For example, Anheuser Busch operates breweries
and theme parks. In cases in which multiple business units are competing in different
industries, one needs W
to identify multiple industries. Market shares or relative market
shares for the firm and its key competitors—based on the best available data—should
I
also be identified. It is important to clarify industry definition at the outset so that the
L that affect it can be realistically assessed. In addition, a
macroenvironmental forces
firm’s relative strengths and weaknesses can be classified as such only when compared
L
to other companies in the industry.
I
S
in the total. Although this approach is reasonable and can be quite useful, it can
,
only be calculated when one has access to data that may not be readily available.
Hence, analysts must use the best data available to describe the relative market
positions of the competitors in a given industry (see Case Analysis 3-1).
Industry Life Cycle
The stages (introduction, growth, shakeout,
maturity, and decline)
through which industries often pass.
K
A Life Cycle Stages
3-1 Industry
S
Like firms, industries develop and evolve over time. Not only might the group of
competitors within a fiS
rm’s industry change constantly, but also the nature and
structure of the industry can change as it matures and its markets become better
A
defined. An industry’s developmental stage influences the nature of competition
N among competitors.3 In theory, each industry passes
and potential profitability
through five distinct phases
D of an industry life cycle (see Figure 3-1).
A young industry that is beginning to form is considered to be in the introduction stage. Demand forR
the industry’s outputs is low at this time because product
and/or service awareness
A is still developing. Virtually all purchasers are first-time
buyers and tend to be affluent, risk tolerant, and innovative. Technology is a key
concern in this stage because businesses often seek ways to improve production
and distribution efficiencies
2 as they learn more about their markets.
Normally, after key technological issues are addressed and customer demand
1 enters the growth stage. Growth continues but tends to
begins to rise, the industry
slow as the market demand
6 approaches saturation. Fewer first-time buyers remain,
and most purchases tend to be upgrades or replacements. Many competitors are
FIGURE
3-1
1
T
The I n dustr y
S
Life Cy cle
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
profitable, but available funds may be heavily invested into new facilities or technologies. Some of the industry’s weaker competitors may go out of business in this
stage.
Shakeout occurs when industry growth is no longer rapid enough to support
the increasing number of competitors in the industry. As a result, a firm’s growth
is contingent on its resources and competitive positioning instead of a high
growth rate within the industry. Marginal competitors are forced out, and a small
number of industry leaders may emerge.
Maturity is reached when the market demand for the industry’s outputs is completely saturated. Virtually all purchases are upgrades or replacements, and industry growth may be low, nonexistent, or even negative. Industry standards for quality
and service have been established, and customer expectations tend to be more
consistent than in previous stages. The U.S. automobile industry is a classic example of a mature industry. Firms in mature industries often seek new uses for their
Woften through global expansion.
products or services or pursue new markets,
The decline stage occurs when demand Ifor an industry’s products and services
decreases and often begins when consumers turn to more convenient, safer, or
L industries. Some firms may divest
higher quality offerings from firms in substitute
their business units in this stage, whereas others
L may seek to “reinvent themselves”
and pursue a new wave of growth associated with a similar product or service.
I movement along the industry life
A number of external factors can facilitate
cycle. When oil prices spiked in 2005, forSexample, firms in oil-intensive industries such as airlines and carmakers began to feel the squeeze.4 When an industry
is mature, however, firms are often better, able to withstand such pressures and
survive.
Although the life cycle model is useful for analysis, identifying an industry’s
K
precise position is often difficult, and not all industries follow these exact stages
5
or at predictable intervals. For example, the
A U.S. railroad industry did not reach
maturity for many decades and extended over a hundred years before entering
S
decline, whereas the personal computer industry began to show signs of maturity
S an industry’s decline, changes in the
after only seven years. In addition, following
macroenvironment may revitalize new growth.
A For example, the bicycle industry
fell into decline some years ago when the automobile gained popularity but has
now been rejuvenated by society’s interestN
in health and physical fitness.
D
R
3-2 Industry Structure
Factors associated with industry structureAhave been found to play a dominant
role in the performance of many companies, with the exception of those that are
its notable leaders or failures.6 As such, one needs to understand these factors
2
at the outset before delving into the characteristics
of a specific firm. Michael
Porter, a leading authority on industry analysis,
proposed
a systematic means of
1
analyzing the potential profitability of firms in an industry known as Porter’s “five
6
forces” model. According to Porter, an industry’s
overall profitability, which is the
combined profits of all competitors, depends
1 on five basic competitive forces, the
relative weights of which vary by industry (see Figure 3-2).
1.
2.
3.
4.
5.
T
Intensity of rivalry among incumbent firms
S
Threat of new competitors entering the industry
Threat of substitute products or services
Bargaining power of buyers
Bargaining power of suppliers
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
41
42
Chapter 3
FIGURE
3-2
Por te r ’s F iv e Force s M ode l
W
I
L
L
I
S
These five factors combine to form the industry structure and suggest (but do
, prospects for firms that operate in the industry. Each
not guarantee) profitability
of the factors is discussed in greater detail in sections 3-3 through 3-7.
K
3-3 Intensity
of Rivalry among
A
Incumbent
Firms
S
Competition intensifies when a firm identifies the opportunity to improve its
S
position or senses competitive pressure from other businesses in its industry,
A wars, advertising battles, new product introductions or
which can result in price
modifications, and even increased customer service or warranties.7 Rivalry can
N
be intense in some industries. For example, a battle wages in the U.S. real-estate
D brokers who earn a commission of 5 to 6 percent are
industry, where traditional
being challenged by discount
brokers who charge sellers substantially lower fees.
R
Agents for the buyer and seller typically split commissions, which usually fall in
A agents when a home sells for $250,000. Discount brothe $7,000 range for both
kers argue that the primary service provided by the seller’s agent is listing the
home in a multiple listing service (MLS) database, the primary tool used by most
2to peruse available properties. Discount brokers provide
buyers and their agents
sellers with a MLS listing
1 for a flat fee in a number of markets, sometimes less
than $1,000. Traditional brokers are angry, however, and argue that discount
brokers simply do not6provide the full array of services available at a so-called
full-service broker. Traditional
brokers dominate the industry, accounting for
1
98 percent of all sales in 2005. They often control the local MLS databases, and
T
many discount brokers charge that they are not provided equal access to list their
8
properties. Hence, rivalry
S in this industry—especially between full-service and
discount brokers—remains quite intense.
Competitive intensity often evolves over time and depends on a number of
interacting factors, as discussed in sections 3-3a through 3-3h. Factors should be
assessed independently and then integrated into an overall perspective.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
3-3a Concentration of Competitors
The number of companies in the industry and their relative sizes or power levels
influence an industry’s intensity of rivalry. Industries with few firms tend to be
less competitive, but those with many firms that are roughly equivalent in size
and power tend to be more competitive, as each firm fights for dominance.
Competition is also likely to be intense in industries with large numbers of firms
because some of those companies may believe that they can make competitive
moves without being noticed.9
3-3b High Fixed or Storage Costs
When firms have unused productive capacity, they often cut prices in an effort to
increase production and move toward full capacity. The degree to which prices
(and profits) can fall under such conditions is a function of the firms’ cost structures. Those with high fixed costs are mostW
likely to cut prices when excess capacity exists, because they must operate near capacity to be able to spread their
overhead over more units of production. I
L
L
I
S
,
K
A
S
S
A
N
D
R
A
The U.S. airline industry experiences this problem periodically, as losses gen2
erally result from planes that are flying substantially
less than full or those that
are not flying at all. This dynamic often results in last-minute fare specials in an
1
effort to fill seats that would otherwise fly vacant. During the difficult times for
6 terrorist attacks, frequent price wars
U.S. airlines immediately following the 9/11
10
were often initiated by low-cost airlines such
1 as JetBlue, Southwest, and AirTran.
Interestingly, airlines filled 73.4 percent of their seats in 2003 compared to only
T
63.5 percent a decade earlier.11
3-3c Slow Industry Growth
S
Firms in industries that grow slowly are more likely to be highly competitive
than companies in fast growing industries. In slow-growth industries, one firm’s
increase in market share must come primarily at the expense of other firms’
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44
Chapter 3
shares. Competitors often attend more to the actions of their rivals than to consumer tastes and trends when formulating strategies.
Slow industry growth can be caused by a sluggish economy, as was the case for
vehicles during the early 2000s. As a result, manufacturers began to emphasize
value by enhancing features and cutting costs. Ford, DaimlerChrysler, Nissan,
Toyota, and others began to produce slightly larger trucks with additional features, while trimming prices. Producers also began to develop lower priced
luxury cars in a fierce battle for sales.12
Slow industry growth—and even declines—are frequently caused by shifts in
consumer demand patterns. For example, per capita consumption of carbonated
soft drinks in the United States fell from its peak of fifty-four gallons in 1997 to
approximately fifty-two gallons by 2004. During this same period, annual world
growth declined from 9 percent to 4 percent as consumption of fruit juices,
energy drinks, bottled water, and other noncarbonated beverages continued to
W acquired or developed a number of noncarbonated
rise. Coca-Cola and PepsiCo
brands during this time
I in efforts to counter the sluggish growth prospects in
soft drinks. Interestingly, these rivals now appear to have modified their industry
L “soft drink” focus to a broader perspective including
definitions from a narrow
noncarbonated beverages.
L 13
I
3-3d Lack of Differentiation
or Low Switching Costs
Switching Costs
One-time costs that
buyers of an industry’s
outputs incur as they
switch from one company’s products or services to another’s.
S
The more similar the offerings
among competitors, the more likely customers are
to shift from one to another.
As
a result, such firms tend to engage in price com,
petition. Switching costs are one-time costs that buyers incur when they switch
from one company’s products or services to another. When switching costs are
low, firms are under considerable
pressure to satisfy customers who can easily
K
switch competitors at any time. When products or services are less differentiated,
purchase decisions areAbased on price and service considerations, resulting in
greater competition. S
Interestingly, firms often seek to create switching costs in efforts to encourage
S Service Provider (ISP) America Online, for example,
customer loyalty. Internet
encourages users to obtain
A and use AOL e-mail accounts. Historically, these
accounts were eliminated if the AOL customer switched to another ISP. Free
N and other providers proliferated in the mid-2000s,
e-mail accounts with Yahoo
however. As a result, AOL
D loosened this restriction in 2006, suggesting that most
consumers no longer see the loss of an e-mail account as a major factor when
R
considering a switch to another ISP (see Strategy at Work 3-1). Frequent flier
Aiers who fly with one or a limited number of airlines. The
programs also reward fl
Southwest Airlines generous program rewards only customers who complete a
given number of flights within a twelve-month period, thereby effectively raising
2 another airline.
the costs of switching to
The cellular telephone
1 industry in the United States benefited from key switching costs for a number of years. Until regulations changed in late 2003, consumers
6 were not able to keep their telephone numbers. Hence,
who switched providers
many consumers were 1
reluctant to change due to the hassle associated with alerting friends and business associates of the new number. Today, however, “number
T switching costs, allowing consumers to retain their
portability” greatly reduces
original telephone number
S when they switch providers.14
3-3e Capacity Augmented in Large Increments
When production can be easily added one increment at a time, overcapacity is not a major concern. If economies of scale or other factors dictate that
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
S T R A T E G Y
A T
W O R K
3 - 1
Rivalry and Cooperation in Internet Services
Amidst a flurry of copromotion agreements between
retailers and Internet brands, Microsoft and Best Buy
embarked on a strategic alliance that includes Internet,
broadcasting, and in-store promotional projects.
Microsoft utilizes the new agreement to expand its distribution and increase subscribers to its Internet services. The agreement also displays and promotes the
Best Buy logo and BestBuy.com links at Microsoft’s
Web sites and broadcasting properties, including the
Expedia.com travel service, Microsoft’s e-mail
W services, Hotmail, WebTV Network, the new MSN eShop
online, and MSNBC. In return, Best Buy Ibecame a
major advertiser with Microsoft’s Internet L
and broadcast properties.
Wal-Mart and America Online (AOL) have also
teamed up to drive traffic to Wal-Mart’s Web site and
introduce millions of customers to the AOL brand. AOL
is most interested in the in-store promotion of its online
service in more than four thousand Wal-Mart stores in
the United States, in return for promoting Wal-Mart’s
online store to its 18 million subscribers. Under the
agreement, AOL also provides Web design assistance
to the nation’s largest retailer.
Sources: R. Spiegel, “Microsoft and Best Buy Join Alliance Frenzy,”
E-Commerce Times, 16 December, 1999; C. Dembeck, “WalMart Looking to AOL for E-Commerce Boost,” E-Commerce
Times, 13 December, 1999; C. Dembeck, “Yahoo! and Kmart
Forge Alliance to Counter AOL,” E-Commerce Times, 14
December 1999.
L
I
production be augmented in large blocks, however, then capacity additions
S
may lead to temporary overcapacity in the industry, and firms may cut prices
to clear inventories. Airlines and hotels,
, for example, usually must acquire
additional capacity in large increments because it is not feasible to add a few
airline seats or hotel rooms as demand warrants. When additional blocks of
seats or rooms become available, firms K
are under intense pressure to cover
the additional costs by filling them.
A
S
Companies that are diverse in their origins,
S cultures, and strategies often have
different goals and means of competition. Such firms may have a difficult time
A
agreeing on a set of combat rules. As such, industries with global competitors or
N to be diverse and particularly comwith entrepreneurial owner-operators tend
petitive. Internet businesses often change the rules for competition by emphasizD
ing alternative sources of revenue, different channels of distribution, or a new
business model. This diversity can sharplyR
increase rivalry.
A
3-3f Diversity of Competitors
3-3g High Strategic Stakes
Competitive rivalry is likely to be high if firms also have high stakes in achieving
success in a particular industry. For instance,
2 many strong, traditional companies cannot afford to fail in their Web-based ventures if their strategic managers
1
believe a Web presence is necessary even if it is not profitable. These desires can
often lead a firm to sacrifice profitability. 6
1
T
Exit barriers are economic, strategic, or emotional
factors that keep companies
from leaving an industry even though they
S are not profitable or may even be
3-3h High Exit Barriers
losing money. Examples of exit barriers include fixed assets that have no alternative uses, labor agreements that cannot be renegotiated, strategic partnerships
among business units within the same firm, management’s unwillingness to leave
an industry because of pride, and governmental pressure to continue operations
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46
Chapter 3
to avoid adverse economic effects in a geographic region.15 When substantial exit
barriers exist, firms choose to compete as a “lesser of two evils,” a practice that
can drive down the profitability of competitors as well.
3-4 Threat of Entry
Barriers to Entry
Obstacles to entering
an industry, including
economies of scale,
brand identity and
product differentiation,
capital requirements,
switching costs, access
to distribution channels,
cost disadvantages
independent of size, and
government policy.
An industry’s productive capacity expands when new competitors enter. Unless
the market is growing rapidly, new entrants intensify the fight for market share,
thus lowering prices and, ultimately, industry profitability. When large, established
firms control an industry, new entrants are often pelted with retaliation when
they establish their operations or begin to promote their products aggressively.
For example, when Dr. Pepper launched Like Cola directly against Coke and
Pepsi, an effort to make inroads into the cola segment of the soft drink market,
the two major competitors responded with strong promotional campaigns to
thwart the effort. If prospective
entrants anticipate this kind of response, they are
W
less likely to enter the industry in the first place. As such, entry into an industry
I
may well be deterred if the potential entering firm expects existing competitors
L
to respond forcefully. Retaliation
may occur if incumbent firms are committed to
remaining in the industry or have sufficient cash and productive capacity to meet
L
anticipated customer demand in the future.16
The likelihood thatI new firms will enter an industry is also contingent on
the extent to which barriers
to entry have been erected—often by existing
S
competitors—to keep out prospective newcomers.17 From a global perspective,
,
many barriers have declined,
as firms in countries such as India and China make
use of technology—and specifically a developing global fiber-optic network—to
gain access to industries in the West. For example, as many as half a million IRS
K annually in India. Hence, barriers are always changing
tax returns are prepared
as technology, politicalAinfluences, and business practices also change.18
The seven major barriers (obstacles) to entry are described in sections 3-4a
through 3-4g (see alsoSStrategy at Work 3-2). As with intensity of rivalry, they
should be assessed independently
and then integrated into an overall perspective
S
on entry barriers.
A
3-4a Economies N
of Scale
Economies of scale refer
D to the decline in unit costs of a product or service that
occurs as the absolute volume of production increases. Scale economies occur
R drives down costs and can result from a variety of
when increased production
factors, most namely high
A firm specialization and expertise, volume purchase discounts, and a firm’s expansion into activities once performed at higher costs by
suppliers or buyers. Substantial economies of scale deter new entrants by forcing
2 industry at a large scale—a costly course of action that
them either to enter an
risks a strong reaction from existing firms—or to suffer substantial cost disad1
vantages associated with a small-scale operation. For example, a new automobile
6 higher per-unit costs as a result of the massive investmanufacturer must accept
ment required to establish
1 a production facility unless a large volume of vehicles
can be produced at the outset.
T
3-4b Brand Identity
S and Product Differentiation
Established firms may enjoy strong brand identification and customer loyalties
that are based on actual or perceived product or service differences. Typically, new
entrants must incur substantial marketing and other costs over an extended time
to overcome this barrier. Differentiation is particularly important among products
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
S T R A T E G Y
A T
W O R K
3 - 2
Creating Barriers to Entry in the Airline Industry
U.S. airline deregulation in 1978 was intended to
encourage new start-up ventures and to foster competition. For a while, it seemed to be working; new
companies such as Southwest Airlines and AirTran
helped to lower ticket prices significantly. Over
time, however, the major airlines have succeeded
in erecting enormous barriers to entry, such as the
following:
1. The global alliances that exist among major world
carriers result in substantial control overW
hubs and
passenger-loading gates at large airports, where
I to fortysuch carriers already typically hold twentyyear leases. In addition, most airlines have
L a large
number of U.S. hub airports, a feeder system to
L
those hubs, and international routes that tie into the
I
hubs. Such systems take decades and hundreds
of
millions of dollars to acquire.
S
2. Major airlines own the computer reservation
,
systems, negotiate commission arrangements
with travel agents for bringing business to them,
and charge small carriers hefty fees for tickets
K
sold through these systems. By operating their
own Web sites, U.S. airlines have been
A able to
eliminate the commission fees paid for domestic
S
bookings.
3. All major carriers operate frequent flierSprograms
that encourage passengers to avoid switching
airA
lines. Many of the programs expire when a passenN c period
ger does not fly on the airline after a specifi
of time, often three years.
D
4. Airline computer-pricing systems enable
R them to
selectively offer low fares on certain seats and
A
to certain destinations (often purchased well in
advance or at the last minute), thereby countering a
start-up airline’s pricing edge.
5. The dominant major carriers are willing to match
or beat the ticket prices of smaller, niche airlines,
and often respond to price changes within hours.
Most are capable of absorbing some degree of
losses until weaker competitors are driven out of
business.
These barriers are designed to keep control of the
airline industry’s best routes and markets in the hands
of a few carriers, even after two decades of deregulation. As such, newly formed carriers are often limited
to less desirable routes. Although many upstarts fail
in their first year or two of operation, others such as
Southwest, AirTran, and JetBlue have been successful
and are filling viable niches in the industry. Interestingly,
the airline industry fallout from the events of 9/11
were felt the most by established competitors such as
USAir and United Airlines.
Sources: T. A. Hemphill, “Airline Marketing Alliances and U.S.
Competition Policy: Does the Consumer Benefit?” Business Horizons,
March 2000; P. A. Greenberg, “Southwest Airlines Projects $1B
in Online Sales,” E-Commerce Times, 8 December 2000; P. A.
Greenberg and M. Hillebrand, “Airlines Band Together to Launch Travel
Site,” E-Commerce Times, 8 December 2000; P. A. Greenberg,
“Six Major Airlines to Form B2B Exchange,” E-Commerce Times,
8 December 2000; P. Wright, M. Kroll, and J. A. Parnell, Strategic
Management: Concepts (Upper Saddle River, NJ: Prentice Hall,
1998); S. McCartney, “Conditions Are Ideal for Starting an Airline,
and Many Are Doing It,” Wall Street Journal, 1 April 1996, A1, A7;
“Boeing 1st-Quarter Profit Off 34%,” L.A. Times Wire Services,
30 April 1996; A. L. Velocci, Jr., “USAir Defends Aggressive Pricing,”
Aviation Week & Space Technology, 21 August 1995, 28;
T. K. Smith, “Why Air Travel Doesn’t Work,” Fortune, 3 April
1995, 42–49.
2switching to a competitive product or
and services where the risks associated with
service are perceived to be high, such as over-the-counter drugs, insurance, and
1
baby-care products.
6
3-4c Capital Requirements
1
Generally speaking, higher entry costs tend to restrict new competitors and ultiT
mately increase industry profitability.19 Large initial financial expenditures may
be necessary for production, facility construction,
research and development,
S
advertising, customer credit, and inventories. Some years ago, Xerox cleverly created a capital barrier by offering to lease, not just sell, its copiers. As a result, new
entrants were faced with the task of generating large sums of cash to finance the
leased copiers.20
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47
48
Chapter 3
3-4d Switching Costs
Switching costs are the upfront costs that buyers of one firm’s products may incur
if they switch to those of a competitor. If these costs are high, buyers may need to
test the new product first, make modifications in existing operations to accommodate the change, or even negotiate new purchase contracts. When switching costs
are low—typically the case when consumers try a new grocery store—change may
not be difficult. When switching costs are high, however, customers may be reluctant to change. For example, for a number of years, Apple has had the unenviable task of convincing IBM-compatible customers not only that Apple produces
a superior product, but also that switching from IBM to Apple justifies the cost
and inconvenience associated with software and file incompatibility. In contrast,
fast-food restaurants generally have little difficulty persuading consumers to
switch from one restaurant to another at the introduction of a new product.
W
3-4e Access to Distribution
Channels
I
In some industries, entering
existing distribution channels requires a new firm to
entice distributors through
price
breaks, cooperative advertising allowances, or
L
sales promotions. Existing competitors may have distribution channel ties based
L exclusive relationships, requiring the new entrant to
on long-standing or even
create its own channels
I of distribution. For example, certain manufacturers and
retailers have formed partnerships with FedEx or UPS to transport merchandise
S As a distribution channel, the Internet may offer an
directly to their customers.
alternative to companies
, unable to penetrate the existing channels.
3-4f Cost Advantages Independent of Size
Many firms enjoy costK
advantages emanating from economies of scale. Existing
competitors may haveA
also developed cost advantages not related to firm size,
however, that cannot be easily duplicated by newcomers. Such factors include
S
patents or proprietary technology,
favorable locations, superior human resources,
and experience in the S
industry. For example, eBay’s experience, reputation, and
technological capability in online auctions have made it difficult for prospective
A
firms to enter the industry. When such advantages exist for one or more existing
N new entrants are usually hesitant to join the industry.
competitors, prospective
D
R
Governments often control entry to certain industries with licensing requirements or other regulations.
A For example, establishing a hospital, a nuclear power
3-4g Government Policy
facility, or an airline cannot be done in most nations without meeting substantial
regulatory requirements. Although firms generally oppose government attempts
2 this is not always the case. Existing competitors often
to regulate their activity,
lobby legislators to enact
1 policies that make entry into their industry a complicated or costly endeavor.
Substitute Products
Alternative offerings
produced by firms in
another industry that
satisfy similar consumer
needs.
6
1 from Substitute Products
3-5 Pressure
Firms in one industry T
may be competing with firms in other industries that produce substitute products,
S offerings produced by firms in another industry that
satisfy similar consumer needs but differ in specific characteristics. Note that
products and services affected by a firm’s competitors (i.e., companies in the
same industry) do not represent substitutes for that firm. By definition, substitutes emanate from outside of a firm’s industry.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
Although they emanate from outside the industry, substitutes can limit the
prices that firms can charge. For instance, low fares offered by airlines can place
a ceiling on the long-distance bus fares that Greyhound can charge for similar
routes. Hence, firms that operate in industries with few or no substitutes are
more likely to be profitable.
3-6 Bargaining Power of Buyers
The buyers of an industry’s outputs can lower that industry’s profitability by bargaining for higher quality or more services and playing one firm against another.
Levi Strauss discovered this when negotiating a sizeable contract with megaretailer Wal-Mart. The famous American jean-maker was forced to create a lower
cost brand by overhauling production and distribution efforts.21
The following circumstances can raise the bargaining power of an industry’s
buyers.
W
1. Buyers are concentrated, or each one purchases a significant percentage of total
I
industry sales. If a few buyers purchase a substantial proportion of an industry’s sales,
then they will wield considerable power overLprices. This is especially prevalent in markets for components and raw materials.
L
2. The products that the buyers purchase represent a significant percentage of the
buyers’ costs. When this occurs, price will Ibecome more critical for buyers, who will
shop for a favorable price and will purchase more selectively.
S
3. The products that the buyers purchase are standard or undifferentiated. In such cases,
,
buyers are able to play one seller against another
and initiate price wars.
4. Buyers face few switching costs and can freely change suppliers.
5. Buyers earn low profits, creating pressure for them to reduce their purchasing costs.
K
6. Buyers have the ability to engage in backward integration by becoming their own supA
use the threat of self-manufacture
pliers. Large automobile manufacturers, for example,
as a powerful bargaining lever.
S
7. The industry’s product is relatively unimportant to the quality of the buyers’ products
Sthe buyers’ products is greatly affected
or services. In contrast, when the quality of
by what they purchase from the industry, the
A buyers are less likely to have significant
power over the suppliers because quality and special features will be the most important characteristics.
N
8. Buyers have complete information. The D
more information buyers have regarding
demand, actual market prices, and supplier costs, the greater their bargaining power.
Rquantity and quality of information availThe advent of the Internet has increased the
able to buyers in a number of industries.
A
3-7 Bargaining Power of Suppliers
2 and their suppliers is similar to that
The tug of war between an industry’s rivals
between the rivals and their buyers. When
1 suppliers to an industry wield collective power over the firms in the industry, they can siphon away a portion of
6
excess profits that may be gleaned. Alternatively,
when an industry’s suppliers are
weak, they may be expected frequently to cut
1 prices, increase quality, and add services. This was the case among U.S. automakers during the 1990s and early 2000s.
T
Marred by mounting financial losses, Detroit’s “Big Three” producers constantly
squeezed their suppliers for price concessions.
S By the mid to late 2000s, however,
many of these suppliers found themselves in Chapter 11 bankruptcy while others
had developed a profitable nonauto business. Hence, power shifted from the
automakers in favor of the suppliers during this time, an unwelcome reality to
struggling GM, Ford, and Chrysler.22
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49
50
Chapter 3
The struggle between U.S. service stations and their suppliers—big oil
companies—is another interesting example. When the popularity of E85
ethanol—a mixture containing 85 percent ethanol and 15 percent gasoline—
began to rise in the mid to late 2000s, many U.S. service stations were prohibited from carrying the alternative fuel. Oil companies that do not supply E85
lose sales every time a driver fills the tank with the ethanol mix. As a result,
many prohibit their franchisees from carrying fuel from other producers.
Service stations that are allowed to carry E85 are often required to dispense
it from a pump on a separate island not under the main canopy—a costly
endeavor. Because there are only a few major oil companies and thousands of
service stations in the United States, the oil companies are able to wield most
of the power.23
The conditions that make suppliers powerful are similar to those that affect
buyers. Specifically, suppliers are powerful under the following circumstances.
Wis dominated by one or a few companies. Concentrated sup1. The supplying industry
pliers typically exert considerable
control over prices, quality, and selling terms when
I
selling to fragmented buyers.
L products, weakening buyers in relation to their suppliers.
2. There are no substitute
3. The buying industry isLnot a major customer of the suppliers. If a particular industry
does not represent a significant percentage of the suppliers’ sales, then the suppliI
ers control the balance of power. If competitors in the industry comprise an important
customer, however, suppliers
tend to understand the interrelationships and are likely
S
to consider the long-term viability of their counterparts—not just price—when making
strategic decisions. ,
4. The suppliers pose a credible threat of forward integration by “becoming their own
customers.” If suppliers have the ability and resources to operate their own manufacK channels, or retail outlets, then they will possess considerturing facilities, distribution
able control over buyers.
A
5. The suppliers’ products are differentiated or have built-in switching costs, thereby
S
reducing the buyers’ ability to play one supplier against another.
S
3-8 Limitations
of Porter’s Five
A
N
Forces Model
D five forces model is based on the assumptions of the
Generally speaking, the
industrial organizationR(IO) perspective on strategy, as opposed to the resourcebased perspective. Although the model serves as a useful analytical tool, it has
several key limitations.AFirst, it assumes the existence of a clear, recognizable
industry. As complexity associated with industry definition increases, the ability
to draw coherent conclusions from the model diminishes. Likewise, the model
2 of firms in an industry and does not account for the
addresses only the behavior
role of partnerships, a1growing phenomenon in many industries. When firms
work together, either overtly or covertly, they create complex relationships that
6 into industry models.
are not easily incorporated
Second, the model1does not consider that some firms, most notably large
ones, can often take steps to modify the industry structure, thereby increasT
ing their prospects for profits. For example, large airlines have been known
to lobby for hefty safety
S restrictions to create an entry barrier to potential
upstarts. Mega-retailer Wal-Mart even employs its own team of lobbyists on
Capitol Hill.
Third, the model assumes that industry factors, not firm resources, comprise the primary determinants of firm profit. This issue continues to be
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
51
widely debated among both scholars and executives.24 This limitation reflects
the ongoing debate between IO theorists who emphasize Porter’s model and
resource-based theorists who emphasize firm-specific characteristics. The
resource-based perspective is addressed later in the strategic management
process.
Finally, a firm that competes in many countries typically must analyze and be
concerned with multiple industry structures. The nature of industry competition
in the international arena differs among nations, and may present challenges
that are not present in a firm’s host country.25 One’s definition of McDonald’s
industry may be limited to fast-food outlets in the United States, but may also
include a host of sit-down restaurants when other countries are considered.
Different industry definitions for a firm across borders can make the task of
assessing industry structure quite complex.
These challenges notwithstanding, a thorough analysis of the industry via the
W
five forces model is a critical first step in developing
an understanding of competsense,
Porter’s five forces model
itive behavior within an industry.26 In a general
I
provides insight into profit-seeking opportunities, as well as potential challenges,
within an industry (see Case Analysis 3-2).L
L
I
Case Analysis 3-2
S
,
Step 3: Potential Profitability of the Industry
Porter’s five forces model should be applied to the industry environment, as identified
in step 2, by examining threat of entry, rivalry
K among existing competitors, pressure
from substitute products, and the bargaining power of buyers and suppliers. Each of
the specific factors identified in the rivalry A
and new entrants sections (3-3 and 3-4)
should be assessed individually. In addition, S
each of the five forces should be evaluated
with regard to its positive, negative, or neutral effect on potential profitability in the
S
industry. It is also useful to provide an overall assessment (considering the composite
A that identifies the industry as either
effect of all five forces) of potential profitability
profitable, unprofitable, or somewhere in between.
N
D in the Industry, and Why? What Are
Step 4: Who Has Succeeded and Failed
the Critical Success Factors?
R
Every industry has recent winners and losers. To understand the critical success
A
factors (CSFs)—factors that tend to be essential for success for most or all competi-
tors within a given industry—one must identify the companies that are doing well and
those that are doing poorly, and determine whether their performance levels appear
2
to be associated with similar factors. For example, McDonald’s, Burger King, and Taco
1
Bell are successful players in the fast-food industry.
In contrast, Rax and Hardee’s have
been noted for their subpar performance. Are any common factors partially responsi6
ble for the differences in performance? Consider that many analysts have noted that
1success factors in the fast-food industry.
consistency and speed of service are critical
Indeed, McDonald’s, Burger King, and TacoT
Bell are all noted for their fast, consistent
service, whereas Rax and Hardee’s have struggled in this area.
S not possess a key industry CSF; howA business may succeed even if it does
ever, the likelihood of success is diminished greatly. Hence, strategies that do not
shore up weaknesses in CSF areas should be considered carefully before being
implemented.
Critical Success
Factors (CSFs)
Factors that are generally prerequisites for
success among most
or all competitors in a
given industry.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
52
Chapter 3
3-9 Summary
An industry is a group of companies that produce similar products or services.
Michael Porter has identified five basic competitive industry forces that can ultimately influence profitability at the firm level: intensity of rivalry among incumbent firms in the industry, the threat of new entrants in the industry, the threat
of substitute products or services, bargaining power of buyers of the industry’s
outputs, and bargaining power of suppliers to the industry. Firms tend to operate
quite profitably in industries with high entry barriers, low intensity of competition among member firms, no substitute products, weak buyers, and weak suppliers. These relationships are tendencies, however, and do not mean that all firms
will perform in a similar manner because of industry factors. Although Porter’s
model has its shortcomings, it represents an excellent starting point for positioning a business among its competitors.
Key Terms
barriers to entry
critical success factors
exit barriers
W
I
L
L
industry
industry life cycle
I
market share
S
,
relative market share
substitute products
switching costs
Review Questions and Exercises
K
1. Visit the Web sites of several major restaurant chains.
A
Identify the industry(s) in which each one operates.
Would you categorize them in the same industryS
or
in different industries (fast food, family restaurants,
S
etc.)? Why or why not?
A
2. Identify an industry that has low barriers to entry and
one that has high barriers. Explain how the difference
N
in entry barriers influences competitive behavior in the
D
two industries.
R
A
3. Identify some businesses whose sales have been
adversely affected by substitute products. Why has
this occurred?
4. Identify an industry in which the suppliers have
strong bargaining power and another industry in
which the buyers have most of the bargaining power.
How does this affect potential profitability in both
industries?
Practice Quiz
True or False
2
1. Each firm operates in a single, distinct industry.
1
2. All industries follow the stages of the industry life
6
cycle model.
3. The likelihood that new firms will enter an industry
1
is contingent on the extent to which barriers to entry
T
have been erected.
4. Higher capital requirements for entering an indusS
try ultimately raise average profitability within that
industry.
5. Substitute products are produced by competitors in
the same industry.
6. A key limitation of Porter’s five forces model is its
reliance on resource-based theory.
Multiple Choice
7. Industry growth is no longer rapid enough to support a large number of competitors in which stage
of industry growth?
A. growth
B. shakeout
C. maturity
D. decline
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
8. The intensity of rivalry among firms in an industry is
dependent on which of the following?
A. concentration of competitors
B. high fixed or storage costs
C. high exit barriers
D. all of the above
9. The decline in unit costs of a product or service
that occurs as the absolute volume of production
increases is known as
A. production effectiveness.
B. effective operations management.
C. economies of scale.
D. technological analysis.
W
10. When switching costs are high,
I
A. customers are less likely to try a new competitor.
B. companies spend more on technology.
L
C. companies seek new suppliers to reduce
L costs.
D. none of the above
Notes
53
11. Which of the following is not a cost advantage independent of scale?
A. proprietary technology
B. favorable locations
C. experience in the industry
D. high volume of production
12. What is occurring when those who purchase an
industry’s goods and services exercise great control
over pricing and other terms?
A. high bargaining power of suppliers
B. low bargaining power of suppliers
C. balance of power among suppliers
D. none of the above
I
S
,
1. M. E. Porter, “Strategy and the Internet,” Harvard Business
Review 29(3) (2001): 62–79; M. E. Porter, “Clusters and the
New Economics of Competition,” Harvard Business Review
76(6) (1998): 77–90.
2. P. Daniels, “The New Snack Pack,” Prepared Foods (February
2006): 11–17.
3. C. W. Hofer, “Toward a Contingency Theory of Business
Strategy,” Academy of Management Journal 18 (1975):
784–810; G. Miles, C. C. Snow, and M. P. Sharfman, “Industry
Variety and Performance,” Strategic Management Journal 14
(1993): 163–177.
4. D. Michaels and M. Trottman, “Fuel May Propel Airline
Shakeout,” Wall Street Journal (7 September 2005): C1, C5.
5. T. Levitt, “Exploit the Product Life Cycle,” Harvard Business
Review 43(6) (1965): 81–94.
6. G. Hawawini, V. Subramanian, and P. Verdin, “Is Performance
Driven by Industry- or Firm-Specific Factors? A New Look
at the Evidence,” Strategic Management Journal 24 (2003):
1–16.
7. J. R. Graham, “Bulletproof Your Business against Competitor
Attacks,” Marketing News (14 March 1994): 4–5; J. Hayes,
“Casual Dining Contenders Storm ‘Junior’ Markets,” Nations’
Restaurant News (14 March 1994): 47–52.
8. J. R. Hagerty, “Discount Real-Estate Brokers Spark a War
over Commissions,” Wall Street Journal (12 October 2005):
A1, A6.
9. See A. Taylor III, “Will Success Spoil Chrysler?” Fortune
(10 January 1994): 88–92.
10. S. Carey and E. Perez, “Traveler’s Dilemma: When To Fly
the Cheap Seats,” Wall Street Journal (22 July 2003):
D1, D3.
11. S. McCartney, “A Middle-seat Manifesto,” Wall Street Journal
(3 December 2004): W1, W14.
K
A
S
S
A
N
D
R
A
2
1
6
1
T
S
12. L. Hawkins, Jr., “Trucks Get Bigger, Fancier and
Cheaper, Wall Street Journal (2 October 2003): D1,
D2; N. E. Boudette, “Volkswagen Stalls on Several Fronts
after Luxury Drive,” Wall Street Journal (8 May 2003): A1,
A17.
13. C. Terhune and B. McKay, “Behind Coke’s CEO Travails: A
Long Struggle over Strategy,” Wall Street Journal (4 May
2004): A1, A10.
14. J. Drucker, “How to Dump Your Cellphone Company,” Wall
Street Journal (18 November 2003): D1, D4.
15. P. Wright, M. Kroll, and J. A. Parnell, Strategic
Management:Concepts (Upper Saddle River, NJ:
Prentice Hall, 1998).
16. K. C. Robinson and P. P. McDougall, “Entry Barriers and
New Venture Performance: A Comparision of Universal and
Contingency Approaches,” Strategic Management Journal 22
(2001): 659–685.
17. J. K. Han, N. Kim, and H. Kim, “Entry Barriers: A Dull-,
One-, or Two-Edged Sword for Incumbents? Unraveling
the Paradox from a Contingency Perspective,” Journal of
Marketing 65 (2001): 1–14.
18. T. L. Friedman, The World Is Flat (New York: Farrar, Straus
and Giroux, 2005).
19. M. Pietz, “The Pro-Competitive Effect of Higher Entry Costs,”
International Journal of Industrial Organization 20 (2002):
353–364.
20. Wright et al., Strategic Management.
21. Corporate author, “In Bow to Retailers’s New Clout, Levi
Strauss Makes Alterations,” Wall Street Journal (17 June
2004): A1, A15.
22. J. McCracken and P. Glader, “New Detroit Woe: Makers of
Parts Won’t Cut Prices,” Wall Street Journal (20 March 2007):
A1, A16.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
54
Chapter 3
23. L. Meckler, “Fill up with Ethanol? One Obstable Is Big Oil,”
Wall Street Journal (2 April 2007): A1, A14.
24. S. F. Slater and E. M. Olson, “A Fresh Look at Industry and
Market Analysis,” Business Horizons (January–February
2002): 15–22; Hawawini et al., “Is Performance Driven by
Industry- or Firm-Specific Factors?”
25. Y. Li and S. Deng, “A Methodology for Competitive Advantage
Analysis and Strategy Formulation: An Example in a
Transitional Economy,” European Journal of Operational
Research 118 (1999): 259–270.
26. Porter, “Clusters and the New Economics of Competition”;
Slater et al., “A Fresh Look at Industry Analysis.”
W
I
L
L
I
S
,
K
A
S
S
A
N
D
R
A
2
1
6
1
T
S
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Industry Competition
R E A D I N G
55
3 - 1
Insight from strategy+business
The airline industry has undergone remarkable changes during the past two decades, particularly
after the 9/11 terrorist attacks. In this chapter’s strategy+business reading, Hansson and associates
challenge the wisdom of the business models employed by traditional airlines. They argue that the
structure of the industry has changed and that astute airlines will tailor their approaches to the new
reality.
Flight for Survival
A New Business Model for the W
Airline Industry
To pare down their colossal operating costs, giant U.S. and European carriers must restructure the
I
hub-and-spoke system and eliminate complexity.
L Markus Franke
By Tom Hansson, Jürgen Ringbeck, and
S
L
ince the 1970s, traditional market leaders in
I
industry after industry, saddled with complex,
high-cost business models, have S
been under
attack by companies with new, simpler ways to
,
manage their operations and contain costs.
This scenario occurred in the steel industry when
minimills took on traditional smelters; in automobile
K
manufacturing when more standardized Japanese cars
Ain retailing
won out over customized U.S. vehicles; and
when superstores overtook conventional grocery
S stores.
In each instance, the established companies struggled,
often in vain, to rationalize operations andSstill deliver
products and services to satisfy customer desires,
A defend
their market positions, and reestablish profitability.
N mature,
The lesson is fundamental: As markets
incumbent companies that have developed
D sophisticated, but complex, business models face tremendous
pressure to find less costly approaches thatR
meet broad
customer needs with minimal complexity in products
and
A
processes.
The trouble is, many companies – manufacturers and
service providers alike – have increased the
2 scope and
variety of their products and services over the years by
1
layering on new offerings to serve ever larger and more
6
diverse customer bases. Although each individual
business decision to enhance a product line or1service can
usually be justified on its own, the result often is a cost
T
structure that is sustainable only if the principal
competitors take a similar approach. More often
than
not,
S
though, as incumbents expand the breadth and depth of
their offerings, leveraging their sophisticated business
infrastructure, they are undermined by smaller, nimbler
competitors that supply a more focused product, usually
to a specific set of customers, at a substantially lower
cost. In these situations, the incumbent may know that
the cost of complexity is dragging it down, but finds
changing its business model easier said than done.
No companies illustrate this dilemma more vividly
than the large U.S. and European hub-and-spoke airlines. Their business model – essentially designed to
seamlessly take anyone from anywhere to everywhere –
was a great innovation. But this model is no longer competitively sustainable in its current form. Tied to massive
physical infrastructure, complex fleets of aircraft, legacy
information systems, and large labor pools, the major
carriers in both regions now face a double whammy:
some of the worst economic conditions in the industry’s
history, and low-cost carriers that dictate prices in large
and growing parts of the market.
U.S. carriers lost more than $10 billion in 2002, according to the Air Transport Association, up from $8 billion in
the disastrous year of 2001. Worldwide, losses topped
$50 billion. Bankruptcies litter the industry. Sabena,
Swissair, US Airways, United Air Lines, and Hawaiian
Airlines have all sought protection from their creditors.
Others are likely to follow. The need for a new, less complex business model among hub-and-spoke carriers is
growing stronger with each boom and bust cycle.
Source: Reprinted with permission from strategy + business, the award-winning management quarterly published by Booz Allen Hamilton.
http://www.strategy-business.com.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
56
Chapter 3
EXHIBIT
1
Av e r ag e C o s t p e r S e a t M ile ( in 2 0 0 0 )
W
I
In this article, we examine the significant downL
side of business complexity and provide a formula that
L
would allow the airlines to simplify their operations, cut
expenses, and compete with their low-cost competitors.
I
It’s not incremental change, but a fundamental overhaul.
S
Complexity Costs
,
Source: Booz Allen Hamilton
While the major carriers face a future of red ink, low-cost
carriers such as Southwest Airlines, JetBlue Airways,
K
and Ryanair are prospering by exploiting a huge cost-ofoperations advantage. Low-cost carriers spend seven A
to
eight cents per seat mile to complete a 500- to 600-mile
flight, according to our analysis. That’s less than half S
of
what it costs the typical hub-and-spoke carrier to flySa
flight of the same duration and distance. (See Exhibit 1.)
A
It is easy to see how costs mount quickly in the huband-spoke airlines’ intricate system of operations. Their
N
business model is predicated on offering consumers
D
a larger number of destinations, significant flexibility (ranging from last-minute seat reassignments and
R
upgrades to complete itinerary and routing changes),
A
and “frills” (e.g., specialty meals, private lounges, and
in-flight entertainment). It is a model burdened by the
built-in cost penalties of synchronized hub operations,
2
with long aircraft turnaround times and slack built into
schedules to increase connectivity by ensuring there1is
time for passengers and baggage to make connections.
6
It’s a system that implicitly accepts a slower business
1
pace to accommodate continual change. In addition,
the hub-and-spoke business model relies on highly
T
sophisticated information systems and infrastructure
S
to optimize its complex operations. By contrast, lowcost carriers have designed a focused, simple, highly
productive business model around nonstop air travel to
and from medium- to high-density markets at a significantly lower price point.
We have analyzed the cost gap between large full-service airlines and low-cost carriers (LCCs) on both sides
of the Atlantic, and the similarities are striking. On both
continents, cost differences exist across the board; pilots,
onboard services, sales and reservations, maintenance,
aircraft ownership, ground handling. The low-cost carriers
are not simply paying lower salaries or using cheaper airports, they are leveraging all resources much more effectively. In fact, the cost differential between the full-service
and low-cost carriers is 2 to 1 for the same stage length
and aircraft, even after adjustments for differences in pay
scales, fuel prices, and seat density are made.
Surprisingly, only about 5 percent of this cost differential can be attributed to the extra amenities the huband-spoke carriers offer. Some 65 percent of the LCCs’
cost advantage is the result of other production-model
choices; another 15 percent comes from work rules and
labor agreements; and 12 percent can be attributed
to differences in balance-sheet structure and financial
arrangements. (See Exhibit 2.)
Of the costs attributable to production-model differences, the largest contributing factors are business pace,
process complexity, and ticket distribution. In fact, “no
frills” and “full service” are misleading labels to describe
the distinction between the two types of carriers. It is the
relative simplicity or complexity of their operations that
truly distinguishes them.
Most debilitating for the major carriers is the inability to
overcome their cost burden with boom period pricing, as
they did in the second half of the 1990s. As corporations
tightened their belts and reduced the frequency of travel,
business travelers, who have traditionally accounted for
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
EXHIBIT
2
57
Bre a k o u t of the Cost pe r S e a t M ile Ga p Be twe e n FullS e r v ice a n d Low- Cost Ca r r ie r s ( in 2 0 0 0 )
W
I
L
L
I
S
,
K
A
S
as much as 60 percent of mainline airline revenues
S – and
well over 100 percent of their profits – were no longer
willing to pay the high fares they tolerated inA
the dot-com
boom. Weakened by this fundamental changeN
in customer
choice as well as “industry leading” labor agreements and
rising fuel prices, the U.S. hub-and-spoke D
airlines’ cost
per seat mile (CASM) rose above revenue per
R seat mile
(RASM) by the third quarter 2000, a full year before the
A
September 11 terrorist attack slashed air travel further.
Source: Booz Allen Hamilton
This eventually increased to an unprecedented costto-revenue gap of close to 2 cents per seat mile at the
2
beginning of 2002 in the U.S.
1 By our
That revenue outlook is likely to get worse.
conservative estimates, low-cost carriers could6potentially—
and successfully – participate in more than 70 percent
1 typically
of the U.S. domestic market. Southwest Airlines
prices 50 percent lower than large carriers
T in one- to
two-hour nonstop markets. Even though traditional airS the lowlines have attracted a richer business mix than
cost carriers, they still stand to lose 25 to 35 percent
price realization in those markets.
Recently, huh-and-spoke airlines have been trying to
lower operating costs through new, less onerous labor
agreements – American Airlines, United Air Lines, and US
Airways have led the way in eking out pay concessions
from their employees; negotiating better deals with intermediaries and financiers; eliminating discretionary costs;
and, in some cases, smoothing out hub operations. Major
carriers in the U.S. and Europe have also announced that
they will add low-cost airline subsidiaries to their business portfolios to compete with the likes of Ryanair and
Southwest Airlines.
A New Path
Many of these restructuring initiatives are clearly valuable and necessary, but they will likely not prove to be
enough. Core airline operations need to become competitive with those of low-cost carriers, especially as LCC
market penetration grows in the U.S. and makes inroads
in Europe. The steps large carriers have taken so far
do not address the fundamental productivity differences
between themselves and the low-cost airlines. Traditional
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
58
Chapter 3
airlines will not achieve a competitive cost structure if they
do not tackle the fundamental cost penalties associated
with their business models. But they must do so without
compromising the services, service quality, and coverage
that distinguish them from their new rivals.
Although making such fundamental changes in a longstanding business model is difficult and risky, it is not
without precedent. Successful change in other industries—
such as manufacturing and financial services—provides
important insights into the ways the burden and cost of
complexity can be reduced. Not long ago, a major U.S.based manufacturer of a highly engineered product
W
realized that its policy of allowing extensive customization was increasing operating cost without delivering
I
commensurate revenue benefits. Certain elements of
this company’s products required customization, but L
by
a natural progression of complexity, customization had
L
become an unintentional—and unnecessary—centerI
piece of the manufacturing process. Inventory, scheduling, delivery logistics, and the like were built around
S
the ability to alter specifications quickly. The company’s
,
operational resources directed toward the most complicated features of manufacturing, rather than the simplest. And that was introducing significantly higher costs
K
into its business model.
The manufacturer did an exhaustive study and found,
A
to its surprise, that about 70 percent of the features in
S
its products were never customized. The company introS
duced engineering controls to these less complicated
aspects of the manufacturing process. By taking that
A
step, the manufacturer was able to strategically apply
N
complex systems–such as manufacturing resource planning, inventory, and expediting programs–to only the 30
D
percent of the design and plant processes that required
R
customization. These segmented operations are called
tailored business streams (TBS). Because of this action,
A
which did not hamper service for those customers needing customization, the company is on course to slash 15
percent from its operational expense.
2
Large carriers must seriously consider three critical
1
elements when restructuring the hub-and-spoke model
and eliminating complexity from their business model.6
•
Remove Scheduling Constraints. At present, hub1
and-spoke airlines generally schedule flights in a so-called
T
wave system, which means that departures and arrivals are
concentrated in peak periods to maximize effective pasS
senger connections. However, the approach causes long
aircraft turnarounds (to allow passengers and baggage to
connect to their next flight), traffic congestion, and aircraft
downtime at the origin cities, resulting in low labor and aircraft utilization. This system, which is structured around the
needs of the least profitable connecting passengers, also
necessitates more complicated logistics and provides significantly lower yields–up to 45 percent less revenue per
mile than for passengers traveling nonstop. Nevertheless,
because of current pricing strategies and fleet structures,
airlines rely on connecting passengers to fill seats that otherwise would be empty.
By redesigning the airline’s network around the
needs of nonstop passengers, and making connections
a byproduct of the system as Southwest Airlines does,
large carriers should be able to cut turnaround times
by as much as half, increase aircraft utilization, reduce
congestion, and significantly improve labor productivity.
A large portion of manpower costs is driven by how long
an aircraft is at the gate. Shorter turns would mean that
pilots, flight attendants, baggage handlers, maintenance
staff, and other personnel could be much more productive, and still in compliance with safety regulations.
Moreover, with aircraft ready to take off more quickly,
airlines could schedule more flights and provide more
attractive timetables for nonstop passengers.
The trade-off between efficient operations and connectivity has to be evaluated carefully, however. Most
likely the solution will involve “continuous” or “rolling”
hubs, which would allow for more operationally efficient,
continuous flight schedules throughout the day. The
approach would be particularly suited for “mega-hubs,”
where the local “point-to-point” market is sufficiently
large to support more frequent flights without relying as
much on connecting traffic. Some airlines are already
experimenting with rolling hubs. To fully realize the cost
reduction opportunities created by this approach, and to
justify the scheduling change, airlines will need to fundamentally alter airport operations, through such innovations as compressed turns and simplified baggage
handling.
•
Implement Tailored Business Streams. In other
industries, such as manufacturing, complexity reduction has been achieved by applying a TBS approach.
The basic principle is to segment operations into distinct business streams: Separate processes are created
to handle routine and complex activities; capabilities
and approaches are tailored to the inherent complexity of the chosen task and based on what customers
are willing to pay. That often entails standardizing or
“industrializing” the routine and stable processes, while
segmenting and isolating the parts of the operation that
are more complicated and variable.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
Industry Competition
59
By and large, the hub-and-spoke airlines have done
exactly the opposite. Airlines have sophisticated, universally
applicable processes for handling most, if not all, possible
situations. It doesn’t matter whether the passenger is on a
simple one-hour flight or is traveling from one continent to
another. This has added unnecessary costs to processes,
and made them hard to automate and change, requiring
massive retraining of personnel when a process is altered.
If the airlines embraced TBS, simplified their policies, and
streamlined their core processes to address the basic needs
of the majority of customers, they could drastically reduce
the number of activities performed at airports. Furthermore,
they could automate many more of them, W
saving huge
amounts of time and money. In this environment,
I the reservation and passenger-handling process would be designed
so that passengers wouldn’t need last-minuteLchanges or
long, multiple interactions with airline staff at
Lthe airport.
Instead, travelers would be able to get to the gates faster.
I still deal
At airports, dedicated processing staff would
with the small percentage of travelers who need
S to change
itineraries, connect to a different airline, or request other
, (except
special services. And customers who require extras
for perhaps the most frequent flyers) would potentially pay
for them in the ticket price or through a transaction fee.
K
Efficiency improvements would be systemwide, cascading
from reservations to front-line staff Overall, theA
product and
experience would be better, and the organization would be
S
much more efficient at delivering it.
approach would enable greater product distinction than
there is today. The objective is twofold: Change the business model to serve all customers better by providing a
more efficient and less time-consuming experience; and
provide dedicated services (and flexibility) to the customer segments prepared to pay for them.
These proposed restructuring elements are highly
interdependent. If they’re effectively coordinated, they
will increase the pace of airline operations, reduce and
isolate complexity, and increase service specialization–
all results that are necessary for carriers to fly beyond
the industry turbulence they’re experiencing today. We
estimate that by adopting these approaches, the major
airlines would bring costs more in line with those of lowcost carriers, reducing their unit cost disadvantage for
leisure travel by 70 to 80 percent.
It won’t be easy to achieve. Any industry that undertakes such change faces the fear that not only will
revenue premiums be lost, but costs will not fall commensurately. It is difficult to reduce fixed-cost structures.
Existing infrastructure may be underutilized with the new
business model, and the current aircraft base may not
fit the new requirements. Another key challenge for airlines would be the potential drop in revenue in connecting markets. But they could make up this loss by using
their lower cost base to stimulate market growth, and by
offering viable new services that are not economically
feasible at current cost levels.
•
The Horizon
S
Create Separate Business Systems for Distinct
A business
Customer Segments. In simplifying their
model, large carriers have to be careful to retain the
N
loyalty of their most profitable and frequent customers
by providing more differentiated amenities,D
lounges, and
services on the ground and in the air than they do today.
This could mean separating both airport R
and onboard
services into two (or more) classes, focused
A on either
leisure or business passengers. Other industries’ experiences suggest that mingling complex and simple operations, each of which has distinct objectives and missions,
2
often increases costs and lowers service standards. This
must be avoided: The goal is to offer a higher
1 service
level where it is needed, at a low operating cost. Besides
providing more amenities, this approach6would help
create purer business streams that reflect1the distinct
needs of different customer segments.
T
It will be important for large carriers to retain the
S carrikey service advantages they have over low-cost
ers, including destination breadth, superior loyalty programs, and select onboard amenities. At a minimum, this
To survive, major airlines have no choice but to change
course. With a fundamentally lower cost structure, the
large airlines would be far better positioned to become
profitable, grow, and launch a marketplace offensive
against low-cost carriers.
At this point, the outlook for the industry is highly
uncertain. If the hub-and-spoke carriers stick to the current business model, and attempt to reduce costs within
today’s operational framework, they risk facing continued
market share loss to LCCs, a round robin of bankruptcies, and a struggle for survival. The large U.S. airlines’
early 1990s crisis was a cyclical, economy-based downturn.
LCCs were not a major issue then. When the economy
and their performance improved, the airlines largely
ignored the threat posed by the lower-cost format. That
inaction only hid the real emerging problem.
This time the crisis is again cyclical, but it is exacerbated by the presence of low-cost carriers. If the economic
picture brightens significantly, it’s possible that the large
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
60
Chapter 3
airlines will rebound, and that the fundamental business
model problems will not be addressed. If that happens,
the next cyclical crisis will be so much worse. In the U.S.,
the low-cost carriers could then dictate pricing in more
than 70 percent of the domestic market, as opposed to
the current 40 to 45 percent. At that point, a turnaround
would be significantly more challenging than it is today.
Alternatively, if a few large carriers adopt the new
business model that we suggest, the industry could be
led by a couple of thriving carriers in the U.S. and Europe,
with one to two random hubs each serving intercontinental and small community markets, a more differentiW
ated service offering, and a number of centers of mass
similar to those operated by Southwest Airlines.
I
The risk of inaction is much greater than the risk of
L
change. The first traditional airline to apply a fundamentally new business model will reshape the industry’s comL
petitive landscape. The first prize that awaits the boldest
I
flyers is significant, not just in terms of cost reduction,
but also in considerable growth and future market leadS
ership opportunities.
Resources
,
Tom Hansson, Jürgen Ringbeck, and Markus Franke. “Flight
for Survival: A New Operating Model for Airlines,” s + b enews.
December 6, 2002;
K
A
S
S
A
N
D
R
A
w w w. s t r a t e g y - b u s i n e s s . c o m / p r e s s / e n e w a r t i c l e / ? a r t =
19050189&pg=0
David Newkirk, Brad Corrodi, and Alison James. “Catching Travels
on the Fly,” s + b, Fourth Quarter 2001; www.strategy.-business.
com/press/article/?art=24979&pg=0
Susan Carey and Scott McCartney; “United’s Bid to Cut Labor Costs
Could Force Rivals to Follow,” Wall Street Journal, February 25, 2003;
http://online.wsj.com/home/us
Darin Lee, “An Assessment of Some Recent Criticisms of the U.S.
Airline Industry,” The Review of Network Economics, March 2003;
www.rnejournal.com/archives.html
Shawn Tully, “Straighten Up and Fly Right,” Fortune, February 17,
2003; www.fortune.com
Tom Hansson (hansson_tom@bah.com) is a vice president
in Booz Allen Hamilton’s Los Angeles office. He focuses on
strategy and operational restructuring in the airlines and travel
arena.
Jürgen Ringbeck (ringbeck_jurgen@bah.com) is a vice president in Booz Allen Hamilton’s Düsseldorf office. He focuses on
strategy and transformation for companies in global transportation
industries, such as airlines, tourism operators, postal and logistics
companies, and railways.
Markus Franke (franke_markus@bah.com is a principal in Booz
Allen Hamilton’s Düsseldorf office. He focuses on strategy, network management, sales, and distribution in the airline, transportation, logistics, and rail industries.
2
1
6
1
T
S
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
External Environment
W
Chapter Outline
I
4-1 Analysis of the Macroenvironment
L
4-2 Political-Legal Forces
L4-3 Economic Forces
I 4-3a Gross Domestic Product
S 4-3b Inflation Rates
, 4-3c Interest Rates
4-3d Exchange Rates
4-4 Social Forces
K
4-4a Case 1: Eating Habits
A 4-4b Case 2: Automobiles
S 4-4c Global Concerns
S4-5 Technological Forces
A4-6 Environmental Scanning
N4-7 Summary
Key Terms
D
Review Questions and Exercises
RPractice Quiz
ANotes
Reading 4-1
2
1
6
1
T
S
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
4
62
Chapter 4
FIGURE
Macroenvironment
The general environment that affects all
business firms in an
industry and includes
political-legal, economic, social, and
technological forces.
PEST
An acronym referring to
the analysis of the four
macroenvironmental
forces: Political-legal,
Economic, Social, and
Technological.
4-1
M a croe n v iron me n t a l Force s
W
I
L
After the industry hasLbeen clearly defined and its prospects for profits identified, forces outside the industry should be considered. Constant changes in these
I
forces present numerous opportunities and challenges to strategic managers.
Hence, it is importantS
to understand how these forces collectively influence the
industry.
,
Every organization exists within a complex network of external forces. Together,
these elements comprise the organization’s macroenvironment. The four categories of macroenvironmental
K forces are political-legal, economic, social, and technological (see Figure 4-1). The analysis of macroenvironmental factors may be
Aacronym derived from the first letter of each of the four
referenced as PEST, an
categories of forces. The
S effects of macroenvironmental forces on a firm’s industry should be well understood before strategic options are evaluated.
S
A of the Macroenvironment
4-1 Analysis
N
Each macroenvironmental force embodies a number of key issues that vary
D issues are specific to a single force whereas others are
across industries. Some
related to more than R
one force. Automobile safety, for example, has politicallegal (e.g., legislation requiring that safety standards be met), social (e.g., conA vehicles), and technological (e.g., innovations that may
sumer demands for safe
improve safety) dimensions. In such situations, one needs to understand how the
various macroenvironmental forces combine to influence industry behavior and
2
performance.
Firms operating in 1
multiple markets may be affected in different manners by
macroenvironmental forces in each market. For example, wide roads and rela6(i.e., political-legal factors), a culture that reinforces the
tively modest fuel taxes
automobile as a means1of personal expression (i.e., a sociocultural factor), and
a high standard of living (i.e., an economic factor) suggest higher demand for
T in the United States. In contrast, narrow roads, higher
moderate to large vehicles
fuel taxes, a view that aSvehicle is more about transportation than about personal
expression, and less disposable income suggest higher demand for smaller cars
in Latin American countries. Hence, the application of Porter’s model to firms
operating in many different industry structures within a single nation or, most
notably, many different nations can be quite cumbersome.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
External Environment
Although large organizations and trade associations often attempt to influence change in the macroenvironment, these forces are usually not under the
direct control of business organizations. On occasion, a large, dominant firm
such as Wal-Mart may be able to exert some degree of influence over one or
more aspects of the macroenvironment. For example, the giant retailer’s political action committee contributed about $1 million to candidates and parties in
the United States in both 2003 and 2004.1 However, this level of influence is not
common because strategic managers typically seek to enable a firm to operate
effectively within largely uncontrollable environmental constraints while capitalizing on the opportunities provided by its environment.
The key distinction here is strategic managers must first identify and analyze
these national and global macroenvironmental forces and understand how each
force affects the industries in which they operate before addressing firm-specific
strategy concerns. Hence, understanding a force’s broad effects should precede
W of these forces that are unique
understanding its specific effects. Applications
or specific to the firm are considered as Iopportunities and threats later in the
strategic management process.
L
L
4-2 Political-Legal Forces
I
Political-legal forces include such factors as the outcomes of elections, legislation,
and judicial court decisions, as well as the S
decisions rendered by various commissions and agencies at every level of government.
Some regulations affect many or
,
all organizations. When the Massachusetts state legislature passed a bill in 2006 to
require that businesses provide health insurance for its workers, all firms operating
in the state were affected.2 When the U.S.K
Supreme Court ruled in 2007 that the
Clean Air Act applies to car and truck carbon dioxide emissions, carmakers knew
A standards were likely forthcoming.3
immediately that higher federal fuel economy
Industries are often affected by legislation
S and other political events specific
to their line of business, however. Consider the following examples. The U.S.
S
Highway Traffic Safety Administration constantly tests cars and trucks sold in
the United States and pressures carmakersAto improve safety performance.4 Fuel
economy standards can require that producers develop new vehicles or modify
N
existing ones to meet average fuel economy targets, which can be a costly venD higher minimum standards for
ture. When the Bush administration proposed
fuel economy, analysts estimated that theRindustry would spend more than $6
billion to comply, adding $275 to the price tag of a large truck by 2011.5
Acertain industries operate, especially
Military conflicts can also influence how
those with tight global ties. For example, during the 2003 war in Iraq, many firms
modified their promotional strategies, fearing that their television advertisements
2
might be considered insensitive if aired alongside
breaking coverage of the war.
At the same time, others began to plan for1meeting the anticipated future needs
in Iraq for such products as cell phones, refrigerators, and automobiles. After
6
the previous Iraqi regime was ousted in mid-2003,
U.S. firms began to compete
6
vigorously for lucrative reconstruction contracts.
1
It is not safe to assume that firms always seek less regulation. In some instances,
T boundaries established by governfirm leaders prefer to operate within clear
ments. In 2004, for example, Ford chief Bill
S Ford said he would support higher
fuel taxes in exchange for incentives to produce more energy-efficient vehicles.7
In another example, following the sharp declines in air travel in the United
States, airlines on the verge of bankruptcy campaigned for and received $15 billion
in government support in 2002 and an additional $2.9 billion in 2003.8
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
63
64
Chapter 4
In more cases than not, however, regulation can prove costly for firms in an
industry. When mad-cow disease—a rare disease of the brain passed through
tainted meat—began to show up in the United Kingdom in early 2001, most of
Europe responded by banning the import of British beef. Financial losses for the
industry were staggering.9 Beginning in 2005, U.S. packaged food manufacturers
were required to disclose the amount of trans fats in the products they distribute
through grocery stores.10 As health advocates renewed attempts in that same year to
secure governmental regulation, the U.S. food industry continued its long struggle
to cut back on the use of salt. Critics warn of the link between salt and high blood
pressure. Deeply ingrained in the food production process, however, salt is all but
impossible to eliminate because of its many benefits. Salt is inexpensive, enhances
the taste of myriad foods, and extends the shelf life of many foods.11
While most agree that regulations are necessary in many instances, they can
be cumbersome. In 2006, the U.S. Food and Drug Administration (FDA) issued
guidelines concerningW
when food companies can reference their products as
“whole grain.” Food companies
can use the label if their products are made of rye,
I
oats, popcorn, and wild rice, but not soybeans, chickpeas, and pearled barley. Use
of terms such as “goodLsource” and “excellent source” to describe the amount of
whole grains included L
in a product are also subject to debate and FDA rulings.12
All societies have laws and regulations that affect business operations. A major
I in the late 1970s and the 1980s in favor of deregulation,
shift in U.S. policy occurred
eliminating a number S
of legal constraints in such industries as airlines, trucking,
and banking; however, not all industries were deregulated. By 1990, a reversal of
, strong governmental influence in business operations
trade protectionism and
began to take place. In the United States, new economic policies reduced governmental influence in business operations by deregulating certain industries, lowK
ering corporate taxes, and relaxing rules against mergers and acquisitions. This
trend has continued into
A the twenty-first century, although not as forcefully as in
the late 1990s. Table 4-1 summarizes some of the major laws in the United States.
S
Many broad regulations such as those listed in Table 4-1 affect multiple indusS however, are designed specifically for a single industry
tries. Other regulations,
or category of firms. A
In 2005, for example, eighteen U.S. states implemented
the Streamlined Sales Tax Project in an effort to remove obstacles preventing
N sales taxes with online sales. Estimated potential taxes
retailers from collecting
associated with Internet
Dsales was more than $15 billion across the United States
in 2003 and was expected to surpass $20 billion in 2008.13
R
Consider a second example.
In 2006, a U.S. federal court ruled that cigarette
manufacturers cannotAuse the adjectives “light” or “low tar” to describe their
products. This ruling requires firms not only to rename some of their products,
but also to reposition them and hope that smokers do not assume that other
aspects of the cigarettes
2 have been changed as well. Hence, familiar brands
such as Altria’s Marlboro Lights and Reynolds American’s Camel Lights must be
1 the ruling.14
changed to accommodate
It is interesting to consider
broad global trends toward regulation in recent
6
decades. At the global level, the period from World War II to the late 1980s was
1
marked by increased trade protection. Many countries protected their indusT import duties, and other restrictions. Import duties in
tries by imposing tariffs,
many Latin American countries ranged from less than 40 percent to more than
S
100 percent,15 but this trend was not limited to developing nations. Countries
in Europe and Asia—and even the United States—have imposed import fees on
a variety of products, including food, steel, and cars. In the 1980s, the United
States also convinced Japanese manufacturers to voluntarily restrict exports of
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
External Environment
TA B L E
4-1
Se l e c t e d E x a mp le s of Gov e r n me n t Re gula tion
o f B u s i n e s s in th e U n ite d S t a te s
Legislation
Purpose
Sherman Antitrust Act (1890)
Clayton Act (1914)
Prohibits monopoly or conspiracy in restraint of trade
Forbids contracts that tie the sale of one product to
the sale of another
Stops unfair methods of competition, including
deceptive advertising, selling practices, and pricing
Permits selected U.S. firms to form monopolies in
order to compete with foreign firms
Sets minimum wage rates, regulations for overtime
pay, and child labor laws
Makes the buying of competitors illegal when it
W
lessens competition
Prohibits discrimination
in wages on the basis of
I
gender when men and women are performing jobs
requiring equal
L skill, effort, and responsibility under
similar working conditions
L
Directs the Environmental Protection Agency to create emission
I standards for potential pollutants
Requires employers to provide a hazard-free
S
working environment
Sets standards
, on selected products, requires
warning labels, and orders product recalls
Forbids discrimination in all areas of employer–
employee K
relations
Requires accuracy in product warranties
A
Outlaws direct payoffs and bribes of foreign
governments
S or business officials
Protects those who are physically and mentally
S job discrimination
disabled from
Offers workers
A up to twelve weeks of unpaid leave
after childbirth or adoption, or to care for a seriN spouse, or parent
ously ill child,
Reduces the
Damount of carcinogenic pesticides
allowed in foods
R more freedom to diversify their investGives workers
ments and greater access to quality investment
A
advice concerning their 401(k) plans
Prescribes rules and penalties for e-mail “spammers,” although enforcement is difficult
Federal Trade Commission
Act (1914)
Webb-Pomerene Export
Trade Act (1918)
Fair Labor Standards
Act (1938)
Antimerger Act (1950)
Equal Pay (1963)
Clean Air Act (1970)
Occupational Safety and
Health Act (1970)
Consumer Product Safety
Act (1972)
Equal Employment
Opportunity Act (1972)
Magnuson-Moss Act (1975)
Foreign Corrupt Practices
Act (1978)
Americans with Disabilities
Act (1992)
Family and Medical
Leave Act (1993)
Food Quality Protection
Act (1996)
Pension Security Act (2002)
CAN SPAM Act (2003)
2
1
cars to the United States in lieu of a tariff.
6 Interestingly, this particular tariff
may be largely responsible for Japanese automobile manufacturers establishing
1
a large number of production facilities in the United States, thereby blurring
T
the concept of the “foreign car.”
During this time, however, leaders from many nations recognized that all
S
countries would likely benefit if trade barriers could be reduced across the board.
After the end of World War II, twenty-three countries entered into the cooperative General Agreement on Tariffs and Trade (GATT), working to relax quota
and import license requirements, introduce fairer customs evaluation methods,
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
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Chapter 4
TA B L E
4-2
M a jor Re gion a l Tr a de Agre e me n ts
Asia-Pacific Economic
Cooperation (APEC)
European Union (EU)
North American Free Trade
Agreement (NAFTA)
Asian Free Trade Area (AFTA)
Mercosur
Australia, Brunei, Canada, ...
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