Strategy and Entrepreneurship

What is Strategy?

Summary: Business strategy is a planned approach toward a commercial activity. It involves the direction of the organization in achieve a short-term goal or long-term mission. Strategy considers the use or configuration of resource within the business environment to achieve an intended goal. It is not specific actions, rather it is a general method of approaching the business activity in order to achieve and intended outcome or goal. Strategy is largely mental and it entails approaching each business task (operations, marketing, sales, financing, etc.) from this strategic perspective. Strategy employs tactics, which are the actual tasks or procedural maneuvers used to achieve a strategic objective.

Strategy can be understood as a process or general orientation toward achieving an intended outcome. The strategy is drawn from a purpose and provides direction in carrying out that purpose. Perhaps the best way of defining strategy is by comparing it to tactics. If a person wants to achieve an objective, they will develop an approach for achieving that objective. The individual actions the individual takes in furtherance of achieving that objective are tactics. Here are some examples to illustrate the distinction between strategy and tactics:

• I am in a negotiation with you. I know that I will need to uncover specific information about your bargaining position. I then plan on using that uncovered information to persuade you to see my point of view. Uncovering information with the objective of persuading is a strategy. My tactic in the initial strategy may be to get you intoxicated and talking haphazardly.
• An alternative strategy would be to leverage your lack of information and attempt to coerce you against your will. In this scenario, my tactic may be to lie about information and threaten to expose that information if you do not comply with my demands.

In summary, strategy is a planned course of action that is general in nature, but the purpose of the course of action is clearly understood. A tactic is an individual action taken as part of that general plan.

Strategy and Business

Businesses develop strategies for achieving organizational goals or objectives. Managers develop strategy at every level of the organization, from the board of directors to the lowest-level supervisor. Strategic planning starts with organizational goals and maps out clear plan for achieving those goals. The plan will generally lay out milestones or clear performance measurements to gauge progress. Employees employ tactics consistent with the managers strategy. This includes employing learned methods and applying situationally relevant information to achieve the task at hand. Here are some examples to illustrate the distinction between strategy and tactics in the business context:

• My strategy is to increase company market share in a particular product segment. I achieve this strategic objective by employing numerous tactics, such as lowering prices.
• My strategy is build awareness of my brand as luxury. My tactic is to dramatically raise prices and market to the yachting community.
• My strategy may be to build the companies technical superiority. My tactic may be to higher managers with engineering or computer science backgrounds.
• My strategy may be to expand into new market segments. My tactic may be to vary features of my product that better align with target markets.

It is important to understand that tactics are born from an established strategy. Any number of different tactics may be used to achieve the same objective. Likewise, the same tactics may further different strategies. Remember, however, it is poor practice to develop a strategy around tactics that achieve a favorable objective. This is often referred to as short-term thinking. The strategy of a firm should align with the ground purpose of vision of the organization. These larger purposes are the guiding forces for developing strategies, in the same way that strategy is the guiding force for employing tactics.

Strategy & Operations

Having reviewed the concept of strategy as distinct from tactics, it is important to also define strategy in the context of business operations. Strategy is carried out through operations, which employs any number of tactics. Strategy drives operations toward better or greater efficiency, which can be a source of competitiveness or competitive advantage for a business.

Operations concerns the delivery of value by the company. That is, it concerns the value chain. It consists of all of the activities that generally characterize business practice: engineering, manufacturing, logistics, information technology and infrastructure, finance, accounting, marketing, sales, customer service, etc. All of these make up the daily activities that constitute delivering the value proposition to the customer and receiving value in return.

Strategy seeks to orient operations in the manner necessary to achieve the businesss goals or objectives. For example, strategy may employ operational resources in a particular manner, sequence, or timeframe in order to achieve the business objective of expanding market share. Strategy can also transform operations by making it more efficient or employing new methods of carrying out operations – all with the purpose of achieving a company goal, such as creating a competitive advantage. The competitive advantage achieved through operations may include lower costs of production, greater supply capability, or creating additional value propositions for the customer.

Concept Test Your Idea

Early in the idea evaluation phase, you should work diligently to concept test your business idea. This means questioning whether the business idea will make sense conceptually to the intended customer(s). It involves identifying the proposed value proposition of the product or service for the customer. If you product or service (no matter how neat or cool) fails to provide a value proposition for the intended customer segment(s), then the idea will not yield the required or desired financial return to the entrepreneur or investor.

 

Determining the Value Proposition

Below are some questions designed to help you conceptualize your product in the mind of the intended customer. These questions will also help you to further explore the value or intended value for the customer.

• What does my product or service do?
  • Note: Focus. Your produces does a dozen things. Diversity is fine but are you going to sell it as doing.)
• How does is my product work or how is product carried out?
  • Does this make sense to the customer? It does something amazing, but does it do it in a way that consumers will see as logical.
• What consumer need or want does my product meet?
  • Note: Determining whether it is a want or a need allows you to assess the level of consumer priority?
• Why does this need or want exist? (This is getting inside the consumers head to cut their thought process off at the pass.)
• How strong is the need or want?
  • Note: This question corresponds to, how strong is the customer priority?
• Can the need or want be strengthened?
  • Note: Is there room for increased demand through product improvement?
• Could the need or want diminish under certain circumstances?
  • Note: What are the threats of other products or services better meeting the need of want of the customer.
• What is the life cycle on this need or want?
  • Note: A product that is part of a fad or trend has a limited life cycle.
• What are the Benefits of the Product?
  • Note: A product or service provides some benefit to the customers. Even wants provide a benefit through entertainment, self-actualization, status, etc.
• Why are these benefits?
  • Note: Where do these benefits show up on the hierarchy of needs? Identifying why a benefit exists will help in identifying the strength and longevity of the benefit.
• Can the benefits be segmented?
  • Note: Often a product or service will provide multiple benefits. Each of these benefits will have a higher or more direct value proposition for a customer group or segment. Segmenting benefits will allow you to determine which benefits are most valuable to a given customer segment and should therefor the be the primary focus of marketing or future development.
• Can you exceed the expectations?
  • Note: Is there room for improvement in the product or service related to that specific customer benefit? If so, you can raise the value proposition and customer priority by improving upon this benefit.
• Is there value in exceeding the expectations?
  • Note: In contrast to the above note, some benefits meet a baseline customer expectation. Improving upon this benefit may not improve or increase the customers priority for the product. In such a case, investing more resources in improving this benefit would have diminishing returns.
• Are there additional benefits to using the product/service?
  • Note: As noted above, a product or service may provide numerous benefits. Benefits come in a variety of forms (ex., ease of use; speed; durability; attractiveness; ease of storage; etc.). Think outside of the box in identifying potential benefits. Often benefits can be introduced in combination to improve the overall benefit to a customer segment. These combinations may increase the priority of the customer for the product or service.
• Is there a perceived risk to a potential consumer to change or adopt?
  • Note: Focus on the customers perspective in purchasing your product or service above a different product or service. If the customer is familiar with an alternative, then there may be a risk in changing to your product or service. For example, there may be a risk that the product or service does not work or that the cost of the product does not return an equal value.

For the reasons indicated above, understanding a product or services value proposition for an intended customer is essential to effectively turning the business idea into a viable commercial activity.

Porters Generic Strategies

The study of business strategy was strongly influenced Michael Porter, Harvard Professor, and author. In 1985, he wrote the seminal text, Competitive Advantage: Creating and Sustaining Superior Performance, concerning business strategy. In his text he proposed 3 (or 4) categories of generic strategies for approaching a product market. Per Porter, any one of these strategies is capable of producing a competitive advantage for a business in a given market. It is important to note that, every strategy is not possible for a single firm. However, if the firm is capable and execute a strategy sufficiently, then it can achieve a competitive advantage in the market.

In summary, the strategies were as follows:

• Cost Leadership Minimizing the costs incurred in providing value (product or service) to a customer or client.
• Differentiation This means making ones product unique or special, compared to other competitor or substitute products in the market.
• Focus:
  • Cost Focus Note: This does not mean a focus on cost. It meansminimizing costs in a focused market.
  • Differentiation Focus Note: This does not mean a focus on differentiation. It means an orientation toward differentiation from other competitors/products within a focused market.

Lets take a deeper look at each of Porters Generic Strategies.

The Cost Leadership Strategy

Cost leadership means being an industry leader in low-cost production. Remember, this does not concern cost for the consumer. It concerns cost of production for the business. The strategic position serves one of two purposes at any stage of execution:

1. It produces higher profit margins for the business at a given price, or

2. It allows for an overall lower price to consumers, which can be used to increase market share.

In order to employ this strategic approach, you must be able to establish and maintain a lower cost structure than any competitor. This includes the cost structure of competitors producing similar (and sometimes, substitute) goods.

Note: This strategic approach is the genesis of out-sourced production of products to countries where the cost of manufacturing and shipping is lower than the costs within the United States.

 

 

Techniques for effectuating this strategy vary. As noted above, outsourcing is a common way of lowering production costs of products and services. Companies often employ new technologies in hopes of bringing down traditional cost structure (e.g., Wal- Mart). Operations managers study efficiency theories, such a Lean Sigma in order to determine ways of cutting waste (i.e., costs) in the production process.

The downside of cost leadership strategy is that competitors will enter the market (new entrants) when old cost structures are replaced by more efficient structures (ex. Southwest Airlines). The existing business may be stuck at old cost rates (such as fuel) where new entrants have the benefit of lower rates.

The Differentiation Strategy

Differentiation is the strategic tactic of separating your produce or service from others in the industry. Unlike cost leaders, differentiation strategy focuses on the value proposition to customers. That is, the product or service has some unique character of feature that differentiates it from other competitors where the value proposition is greater to certain customers. Examples of differentiation substrategies include:

• Product performance (Speed, strength, etc.)
• Quality of how product is made.
• Durability of product
• Appearance
• Functionality (e.g., ease of use, features, etc.)
• Brand Image (e.g., luxury goods Rolex)
• Novelty of Innovation
• Operational Effeciency
• Support for Customer (Warranty, Guarantee, Customer Service)
• To employ this strategy a business will have to find unique qualities about its product or service that can set it apart from other products or services in the market. This requires an in-depth understanding of ones own product, as well as an understanding of all of the available products in the market.

The Focus Strategy

The focus strategy is a third category that is split into 2 categories that modify the cost leadership and differentiation strategy. In either case the focus strategy involves concentrating efforts on customers who have unique needs or wants, commonly referred to as a niche market. This level of customer focus allows a business to either produce a given product in a lower cost structure or to produce a product or service with unique features or characteristics that meet the needs or wants of the focus market. Either subcategory of the focus strategy allows for distinct advantage:
Example: A cost focus strategy may uncover ways of producing a generally accepted product at a lower cost that allows for creating a cost advantage for the customer in the niche market.

• Example: A differentiation focus strategy may allow the business to uncover previously unrecognized needs or wants and meet those needs or want through unique product features.

As in the above explanations, a business will likely have to pursue one or the other subcategory of focus strategy. Trying to accomplish both can lead to a lack of focus or effectiveness with either strategy.

Expanding Upon Porter

Porters Generic Strategies have been the subject of considerable student and expansion since their introduction in 1985. One notable expansion was that offered by Cliff Bowman and David Faulkner in 1996. They expanded (or rather re-divided) Porters three strategic positions to eight identifiable positions, by focusing on the value proposition to customers. They created a diagram know as the Bowmans Strategic Clock. This breakdown has been very influential on strategic theory, so below we give a brief introduction.

 

Low Price/Low Value

This strategic position focuses on volume of sales. A low price/low value model necessarily must command a higher share of the market in order to produce adequate returns to make the business profitable. Companies with products or services with a low perceived value (inferior goods) to customers often compete in this space.

Note: Dont confuse retailers of lowest-consumer-cost products (ex. Wal-Mart) with the company that actually produces the product. Think of it as the generic or no-name brand of product on the shelf at a lower price than the brand-name product.

Low Price

 

This strategy, like the low price/low value strategy, depends upon attracting customers by having the lowest price. However, this strategy does not involve producing a notably inferior product; rather, it focuses on undercutting equally or less valuable competitor products via lower costs. Because prices are pushes down, the margins for the company is lower. These companies have to compete on volume.

• Example: Larger retailers, such as Wal-Mart, push down prices by offering the lowest price available. Wal-Marts profit margin is equally low and the store depends on selling large volumes of products in order to be profitable.

Hybrid (moderate price/moderate differentiation)

The Hybrid strategic model straddles the low-cost and differentiation strategies. They generally produce a lower-cost product or service and also offer some form of product differentiation. Porter warned that this technique was difficult to accomplish and could give rise to lack of focus.

• Note: Many small businesses fall into this model. They cannot compete on price with larger businesses in the same market. Also, they may not have the ability to produce extremely high value (luxury) goods or products. Rather, they focus on producing good, dependable products and services at a fair price. Small businesses typically depend on customer convenience and loyalty to succeed.

Differentiation

Differentiation, as contemplated by Bowman and Faulkner, is the same as under Porters Generic Strategies. By differentiating the product or service, the business is creating some unique form of value for the customer. The unique value can be similar to the value proposition of another product or service, but some aspect of the differentiated product makes the value proposition higher. This unique value allows for the profit margin charged by the business.

• Example: Apple computer differentiates its laptop products from PC makers by offering a unique user experiences (simple operating system). The product serves the same function as a PC, but does it in a manner that differentiates it.

Focused Differentiation

As described above, focused differentiation concerns the unique attributes of a product or service in comparison to others in the market that are focused toward a specific customer segment. These unique aspects create a higher value proposition for the target market segment. The higher value proposition allows for a higher price on the product. The business will seek to ensure that the higher price also means a higher margin, given the additional cost incurred in differentiating the product. Luxury goodsgenerally follow a focused differentiation strategy

• Example: A Rolex watch is a luxury good. The quality of the product is very high in order to build a brand image. The differentiating feature is the quality combined with the brand name. Rolex targets a smaller market who has the capability of paying a premium for the luxury watch.

Increased Price/Standard Product

The increased price/standard product approach is a short-term strategy generally used to take advantage of some market supply disequilibrium. It involves taking a standard (non-differentiated) product and applying a higher price. The value proposition to the consumer does not warrant the higher price. A certain number of customers will continue to purchase until they identify a suitable replacement or substitute product. Over time less consumers will buy the product. In a market where substitutes are not readily available, this strategy can grab a higher margin for a temporary period. However, this situation readily attracts competitors or substitute products into the market. In some situations a business will use this strategy in an attempt to signal that a non-differentiated product is of higher quality. The pricing technique may serve to build product brand.

High Price/Low Value

The high price/low value strategy is effective when there are no other competitors or substitute products in the market. Consumers are forced to purchase the product at the given price in order to fulfill their need or want. This situation often arises in highly isolated markets or in product monopoly situations. This strategy is generally more effective with regards to products or services that are needs rather than wants. A want is an emotional reaction or desire for a product or service, where the need has some level of consequence. In an isolated market needs have a higher priority, leading to continued sales at the higher price. Because the product does not have a high value proposition, consumers are less likely to pay the higher prices for a want.

• Example: In a market where only one pharmaceutical drug is available, due to intellectual property rights, the price of the drug will rise considerably. Even if there are far better drugs on the market, the low quality (low-value) drug will be able to charge higher prices due to its power in the isolate market.

Low Value/Standard Price

This strategy generally involves taking an inferior product and pricing it to match the value proposition of superior competitor or substitute products. This strategy may be effective in short-term or trend markets. Over time, however, this tactic will alienate customers and lose market share.

What Strategy to Pursue

Choosing a competitive strategy is not as simple as setting a course and following it. Rather, you have to take into account all of the internal and external conditions of your business and the industry. Perhaps a market exists for a differentiated, low-volume product, but not for a low-cost, high-volume product. Likewise, you may be incapable of producing a low-cost product that compares with industry competitors. In any event, it is important to choose a single strategy that matches both with market opportunity and business capability.

Below we introduce and explain the most widely accepted methods of internal and external business and industry evaluation.

Understanding Your Business

The mostly widely known and accepted method of strategically evaluating a business is known as the SWOT analysis (developed in 1960 by Albert Humphrey). SWOT is an acronym for the components of the analysis:

• Strength
• Weakness
• Opportunity
• Threat

The SWOT analysis allows you to understand each of these components, as they exist internally (i.e., within your business). Further, you can use this understanding to adopt a business strategy that allows you to compete effectively within the market.

• Note: The SWOT Analysis looks primarily to internal aspects of the business. Following the SWOT analysis, we discuss the TOWS analysis. TOWS is a variation of SWOT that take a more environmental or external look at factors affecting the business.

Strengths

In this portion you are trying to identify the core competencies of the business or the internal team. Understanding these competencies allows the entrepreneur to assess the advantages that he or she can leverage in the market. That is, how can you use your core competencies to offer a product or service that customers value. Going back to Porters Generic Strategies, core competency is the basis for creating a product or service that is differentiated from others in the market. (Note: Without a differentiated product, firms must compete on price.) The business must leverage its competency to produce or offer the produce or service in a manner that offers a unique valueproposition for the customer.

• What are the key strengths of the business or, collectively, the members?
  • Note: Sometimes it is difficult to determine what are your business strengths. You may start by looking at the main attributes that characterize your business.
  • Examples: Speed, Efficiency, Access to Resources, Connections, Funding, Brand/Goodwill, etc.
• Do any of those strengths provide an advantage in your core business?
• How do these strengths translate into a unique aspect of your business that customers value?
• Are any of these strengths related to the core competency of the business (i.e., the one thing that the business must do well in order to be successful in the market or industry)?
  • Note: This forces you to examine whether your strengths are adequately employed to benefit your business.
• Are your key strengths easy to imitate or is it unique to your business?
  • Note: A strength that is unique to your business gives you a competitive advantage. If it is difficult to imitate, then it means you stand in a favorable position to maintain your competitive advantage going forward.
• Can your strengths be leveraged to expand the business?
  • Note: You have likely heard the expression, in business, if youre not growing your dying.

Further, this text has reiterated the importance of growth to a startup venture. Your strengths may provide you an advantage in your core business processes and within the current market. Eventually, however, those strengths will have to move you forward into new or larger markets in order to grow.

Try to look at the strength analysis from the perspective of an internal member and an external customer or competitor. This may require assistance from an outsider who has knowledge of the market, but is less entrenched in your business.

Weaknesses

In this section you are trying to identify aspects of the business or team that need improvement. This will help you understand the aspects of the business that do not create or detract from the creation of value. The purpose of understanding your weaknesses is two fold:

1. To help you focus on the attributes of the business that require improvement, and
2. To allow you employ a strategy that avoids these deficiencies.

Again, it is important to view your weaknesses both internally and from the perspective of your customers and competitors. Examples of areas of weakness include:

• General Business Knowledge or Experience
• Operational Knowledge or Experience
• Technological Knowledge or Resources
• Financial Resources and Availability
• Research and Development Capabilities
• Internal relations (conflicts) and governance issues
• Marketing Deficiency (Brand Image and Notoriety)
• Sales Experience
• Legal Constraints (Lawsuits, Personal Debt, etc.)

Opportunities

We previously discussed the concept of a valid business opportunity. We also examined the opportunity within the context of determining whether your business idea is feasible. In that sense, we looked at whether, in the existing market, the business idea could feasibly create the type and amount of desired value. Here, we are looking for potential opportunities to create customer value that is generated from the business core competencies.

Now that you understand your strengths, you need to determine how these strengths propel the business within its core business. You should also determine how those strengths could open up additional opportunities. Do not confine your analysis to the present market. Your strengths may open up opportunities in other markets. In the previous chapter we discussed the concept of the strategic pivot. Many businesses begin in one industry and pivot strategically to either serve a different target market or to enter a completely new industry.

• Note: Many opportunities arise from large environmental changes. Below we discuss environmental changes and how they can be relevant to new opportunities, as well as new business threats.

Threats

Threats are any internal or external factors that could jeopardize the present operations or future intentions of the business. Most people think of threats in terms of external occurrences, such as competitor action or regulatory changes; however, it is critical to examine internal threats as well. Internal threats include the risk of occurrence of any event that could disrupt operations. For example, the risk of a bank calling a line of credit that hinders the ability to make payroll. Further, it includes the non-occurrence of any assumptions made in plan for the business future operations. For example, your business ventures growth path may include assumptions about the availability of debt financing or equity investments at a given rate of interest. The equity market drying up for your size of business or specific industry is an external threat.

Here are some tips for helping you identify potential internal and external threats:

• Internal: Look for any hurdles that are currently causing you problems in your business operations and extrapolate on the potential effects.
  • Examples: Cash Flow Problems, Operational Issues, Team & Employee Issues, Resource Issues (Equipment).
• External: Look to the operations of your competitors and see what, if any, factors are causing them significant problems.
  • Example: Competition (Competitors), Market Demand (Trends), PESTEL (discussed next).
  • Note: You will also want to look at the competitors themselves to determine if they are the source of a problem for your business. For example, they could be ready to stage a price war to compete for market share.

Below we discuss multiple external environmental factors (PESTEL) that could cause new threats (or opportunities) to arise.

Incorporating the TOWS Analysis

As stated above, the SWOT analysis focuses primarily upon the internal business. A variation of SWOT, known as TOWS uses the same factors as the SWOT analysis, but take a primarily environmental look at external opportunities and threats. These threats and opportunities are then assessed against the internal strengths and weaknesses. Each risk factor may, in some way, increase or decrease an identified strength or weakness of the firm.

 

Putting It all Together

Incorporating external threats and opportunities (identified by the PESTEL Approach) into the SWOT analysis yields a comprehensive model for employing the TOWS framework. Below is a matrix to use to compare the external threats and opportunities against the internal strengths and weaknesses.

 

TOWS Strategic Alternatives Matrix

This helps you identify strategic alternatives that address the following additional questions:

• Strengths and Opportunities (SO) How can you use your strengths to take advantage of the opportunities?
• Strengths and Threats (ST) How can you take advantage of your strengths to avoid real and potential threats?
• Weaknesses and Opportunities (WO) How can you use your opportunities to overcome the weaknesses you are experiencing?
• Weaknesses and Threats (WT) How can you minimize your weaknesses and avoid threats?

What is PEST (PESTEL) Analysis of Business Strategy?

The PEST (or PESTEL) analysis is a method or approach to identifying the external factors that affect a firms operations or ability to enter into a business market or industry. This analysis was introduced by Dr. Francis Aguilar in 1967. PEST is an acronym that stands for Political, Economic, Socio-Cultural, and Technological factors. The PESTEL analysis adds Environmental and Legal considerations to the analysis. Other variations include adding Demographic and Ethic factors (STEEPLED analysis), or International and Demographic factors (PESTLIED), or Local, National, and Global factors (LONGPESTLE analysis). These tests identify environmental factors affecting the business.

The PEST analysis is outward looking (unlike the SWOT analysis, which is inward looking) and evaluates the business environment. This can help the firm to identify opportunities and threats created by the environment. It also allows a firm to modify its strategy to fit in an existing market or develop a strategy for a market that it intends to enter.

Breaking Down the PESTEL Factors

• Political and Legal Factors – These factors are quite similar; so I will deal with them collectively. These two factors concern the state of the law and political opinion towards issues. Laws are constantly changing and evolving. Statutory law comes from legislators, regulations come from the executive branch, and common law interpretations of business issues come from the courts. This mix leads to a regularly changes in the business law environment. Examples of political or legal factors include government spending (program funding, grants, government contracts), tax policy, securities laws, employment or labor law, financial regulations, environmental regulations, specific industry regulations, etc. The best way to stay apprised of political or legal opportunities and threats is to regularly read newspapers and magazines about politics and the state of the law.
• Economic Factors Economic factors include the health of the relevant economy (local, national, international). The state of the economy affects many factors that are important to business, such as consumer demand, government spending, tax rates, interest rates, etc. Each of these sub-factors is important for unique reasons. Some of the factors are positive and create opportunities. For example, increased customer demand may signal a chance for hire prices or new hiring to meet the demand. Other factors are negative and raise the cost structure of the business. For example, rising interest rates may cause the cost of capital to rise and ultimately raise the cost of production.
• Socio-Cultural Factors This includes psychological preferences or dispositions that change in the business environment that are attributable to some sociological or cultural change. Examples of such changes include: an aging population, population growth rate, new information on healthy living (diets, exercise, medicine, etc.), educational standards, growth of communication methods (e.g., Facebook), job or career shifts (manufacturing to service economy), etc.
• Technological Factors Technological factors change the way things are done. Robotics effects manufacturing the way the information technology affects communication methods. These changes affect barriers to entry, cost structures, geographic reach, forming new business models, worker locations, etc.
• Environmental Factors Environmental factors change the operating environment or the requirements on businesses. Lesser regulations may lower operational costs, while heavier regulations may raise costs and add administrative burdens to carrying on business. On the other hand, a focus on green living has sparked many new businesses, ranging from recycling of products to green product development.

Summary Diagram of the PEST Analysis

Understanding Your Business Position in the Industry

The previous discussion analyzes the business and the overarching environment affecting the business. Now we turn our sights to understanding our business place in the industry. The most common and well-known tool for examining the business situation is Porters Five Forces (PFF), again introduced by Harvard Business Professor Michael Porter. The overall purpose of the PFF analysis is to allow you to use your knowledge to strengthen your position in the market. Particularly, it is useful in determining whether a new strategy, product, or business model will be successful in the relevant market.

Porters Five Forces

PFF breaks down a given business position into five distinct forces. The forces are as follows:

• Supplier Power
• Buyer Power
• Competitive Rivalry
• Threat of Substitution
• Threat of New Entry

Breaking Down the Forces

The PFF analysis demonstrates the market power of the business with regard to this business force. The following diagram displays the interrelation of the forces.

Here is a brief overview of each force.

 

Origin of Figure: “How Competitive Forces Shape Strategy” in Harvard Business Review 57, March April 1979, pages 86-93.

Supplier Power

Supplier power addresses the relative strength of suppliers in the industry. A supplier with more power has a greater ability to bargain for and capture value in the exchange of value between them and the customer (your business). That is, the higher the supplier power the more control they have over prices (ability to drive up costs). If your business is not capable of passing the costs along to customers, then it lowers your profit margin and your competitive position in the market. Dont think of the supplier analysis as examining a single supplier; rather, it involves the entire group of suppliers in the market. Supplier power is generally a product of the number of factors, including:

• The number of suppliers in the market.
  • Note: If the suppliers are more concentrated the customer market(businesses) then they buyer has greater power. o The value proposition of any suppliers goods.
  • Note: Certain suppliers may have a differentiated product with a higher value proposition)
• Competitive advantage to any individual suppliers.
  • Note: Certain suppliers have competitive advantages that allow them to monopolize larger shares of a given market. Examples of competitive advantage include, intellectual property rights, lower cost structures, geographical location, established infrastructure, etc.)
• Lack of substitute products on the market.
  • Note: A lack of substitute products on the market gives a group of suppliers increased power. If this lack of substitutes is combined with competitive advantage among individual suppliers, then the supplier power is very high.
• The Cost of switching to a different supplier.
  • Note: If switching costs are high, suppliers have much greater power in the short-run. If the customer business is able to establish a long-term relationship with a new supplier, then the impact of the switching costs are less and the supplier power is lessened.
• Diversification of the Suppliers.
  • Note: If the suppliers have multiple revenue sources in the industry, then it is diversified in its customer base. Since the suppliers does not depend strictly on the revenue from supplying you or business like you in the industry, then the supplier has greater power.
• Threat of Supplier Integration.
  • Note: Does the supplier have the ability and desire to become a competitor? If a supplier decided to join with a competitor or begin competing in the market, then they have greater supplier power. If the customer business tries to exercise too much power over the supplier, then the supplier will simply forgo supplying to the customer and enter the market as a competitor. This is known as integrating forward in the business.

Buyer Power

Buyer power regards the ability of customers to control product prices in your market. The more power customer is able to grab more value in an exchange by either driving up costs or demanding higher levels of service or quality of product. Buyer power is important for both B2B (business-to-business) and B2C (business-to-customer) businesses. Here are some situations in which buyers possess greater power to control prices:

• Number of Buyers
• Important Individual Customers
• Low Cost of Switching
  • Note: If the cost of changing to another product or service provider is low, then the buyer has leverage to bargain for more value. This option concerns the presence of competitors or the availability of substitute products in the market. Buyers are often able to make competitors compete for their business by offering lower prices or greater benefits.
• Price Sensitivity of the Buyer
  • Note: This factor concerns more the preference of the buyer, rather than ability. A more price sensitive buyer will have a greater incentive to demand more value in the transaction. I less price sensitive buyer will be concerned less with price than other factors, such as quality of service, difficulty of switching, etc.

Competitive Rivalry

Competitive rivalry concerns the ability of your competitors to increase their market share. If you have numerous competitors or any competitors with superior value propositions (lower price, higher quality product, etc.) then your competitors have strong market power. Below are some common scenarios where competitors have high levels of market power:

• A Large Number of Competitors in the Market
  • Note: A large number of competitors in the market allows consumer many options. Through the availability of consumer options, these competitors can affect sales. Further, a large number of competitors generally increases supply. Remember basic economics, an increase in supply means lower prices at the corresponding level of demand.
• Competition Through Price
  • Note: Price wars between competitors (a tactic to gain marketshare) shifts value to the buyer as prices lower. This is most common when: all products are relatively similar, the industry has low marginal costs, or the products are perishable or part of a weakening trend.
• Competition through Differentiation
  • Note: Competitors in the market may attempt to gain market share via product differentiation. This includes any feature that is more attractive (higher value proposition) to customers than your product feature. Examples would include higher quality, convenience, ease of use, unique feature, customer service, etc. The benefit to this type of competition is that it often raises barrier of entry to potential new competitors.

Threat of Substitutes

The threat of substitutes or substitution regards the ability of other (non-industry) products or services to meet the wants or needs of your customer base. It also concerns the ability and motivation of customers to figure out a way to fulfill the need or want without your product or service. If this is possible, then it weakens your business market power by placing limits on prices of your product or service.

• Note: The very existence of substitute products may be difficult to identify. Identifying customer substitutes is an indication in itself that your business may have lost market power. The presence of substitutes becomes most critical when switching costs are low.

Threat of New Entry

This concerns the ability of new competitors to enter the market. As we discussed above, new competitors increases competition and ultimately pushes down prices. Further, new competitors will occupy some portion of the market, which may diminish your business existing market share. So, the ability of new competitors to enter the market easily indicates lower market power.

• Note: Competitors are generally able to enter into the market when barriers to entry are low (such as the capital costs of entering the market). Other barriers to entry include: brand loyalty of customers; there are few switching costs, there is no intellectual property protection in the business (i.e., trade secrets or patents), open distribution channels, strong capital base; low regulatory or licensing requirements, or the business does not benefit from economies of scale. If none of these barriers exist, then a business must employ a strategic reaction to new entrants that will put pressure on the entrant and discourage new entrants.

Summary Model of Porter’s Five Forces

]Components of Strategic Analysis

A detailed and organized approach to Strategic Analysis might follow the following steps:

Customer Analysis

– Market Segmentation

– Target Markets

– Customer Demand & Priority

Company analysis

– Value Proposition

– Business Operations (Value Chain)

– Business Model

– SWOT Analysis

– Business Strategy (Product/Market Matrix; BCG Matrix; GE/McKinsey Matrix)

– Competitive Advantages

Competitor Analysis

– Revenue drivers

– Cost structure

– Price/Value Curve

– Profitability Matrix

– Budget and Cash Flow

– Price/Value curve

– Competitive positioning map

Industry and Market Analysis

– Porters Five Forces

– Competitor Advantages

Future Trends and Analysis

– PESTEL Factors

– Customer & Demographic Changes

– Competitive Changes

Using the Analysis to Develop Choose or Develop a Strategy

The above analyses should provide sufficient information to choose or develop a strategy that meets with your business ability and improves your position in the market. In any event, you will want to choose a strategy that:

• Is within your business current or potential strengths,
• Minimizes or avoids your business identified weaknesses,
• Works to capitalize upon identified market opportunities, and
• Avoids the identified internal and external threats associated with a strategic
  position.

In order to employ this information in choosing a strategy, there are certain assumptions one must recognize about a business and industry. The underlying drivers of profit are the same across businesses and industries. And, Competition within any industry is the primary factor in determining profitability in an established or emerging market. Remember for a strategy to be effective it should do any or all of the following:

• Reduce supplier power,
• Reduce consumer power,
• Avoid or reduce the threat of substitutions,
• Raise the barriers for new entry,
• And out maneuver market competitors.

What is competitive advantage?

Competitive advantage, as the name implies, is an advantage that a company or market participant has over other competitor market participants in a given function or industry. Plainly stated, it concerns the ability of a company to better provide a value proposition to consumers than competitors who provide the same or a similar value proposition. Competitive advantage generally arises in the following contexts:

• Efficiencies & Quality – A business that has a method of delivering a value proposition in a manner that is superior to other competitors may give rise to a competitive advantage. Operational efficiencies may lower cost of production/delivery, which allows for lower prices to customers or higher profit margins to the provider. For example, Wal-Mart gained a long-term competitive advantage over competitors through its real-time inventory system. Efficiencies may also give rise to a differentiated product that stands out from competitor products. For example, Mercedes-Benz depends upon quality of engineering to stand out compare to other competitor luxury automobiles?
• Knowledge & Ownership – The ability to provide something that others cannot provide (or provide well) is often linked to proprietary knowledge or ownership of a functional article, method, or design. This is generally the subject of intellectual property law. A business may establish a competitive advantage by employing a trade secret (a protected form of knowledge), such as a secret formula. Likewise, owning a trademark for a product or brand may provide a sustainable advantage over market competitors. Copyrights exclude others from reproducing a creative work that is recorded to a tangible medium. Design and utility patents allow individuals the sole right to commercialize a design or useful invention.
• Relationships – Having legal or personal relationships with suppliers of buyers to the exclusion of other competitors can give rise to a competitive advantage. For example, SouthWest Airlines achieved a competitive advantage in the market by locking in long-term contract with fuel suppliers before the price of fuel spiked. For years, US Steel Corp has exclusive supply contracts for many commercial builders (purchasers of steel).

Examples of Competitive Advantage

Examples of factors producing a competitive advantage include:

• Intellectual Property or Other Strategic Assets
  • Strategic assets can provide a temporary or long-term advantage over competitors. Notably, IP rights exclude others from imitating or copying a process or design. This can effectively block or hinder direct competition for the duration of the intellectual property rights.
• First Mover Advantages
  • First mover advantage is generally a limited competitive advantage. This position may allow you to acquire a larger percentage of the potential customer market at a rapid pace and at lower cost. Later competitors now face your business as a primary barrier to entering the market.
• Business Size or Capitalization
  • Business size allows for economies of scale in operations. Heavy capitalization provides the financial resources to undertake the operational and marketing tasks necessary to effectively compete with or beat other competitors. Further, it can give rise to marketing and pricing power.
• Brand Recognition
  • Brand recognition is a powerful temporary competitive advantage. Brand recognition reduces the future customer acquisition cost and provides operational opportunities within an established value chain. Brand recognition generally entails a level of customer loyalty that can serve as a barrier to entry for competitors.
• Geographic Location
  • Geographic location can provide temporary or permanent operational advantages that effectively hinder or exclude competition. Think of a person owning land adjoining a waterway that has far more efficient ingress and egress that other options. Other times legal rights will establish a geographic advantage through contractual arrangement. A good example is the anti-encroachment rights included in many franchise agreement. This grants an exclusive right to carry on the franchise business in a given area.
• Distribution Advantages
  • A business may have a superior operational structure that provides a temporary advantage. These operational efficiencies can arise through supply-chain agreements or long-term contracts for low-price material cost. A great example of massive success through supply-chain efficiency is Wal-Mart.
• Management or Personnel
  • Often individuals can be a key resource that provides a long-term or short-term competitive advantage. These individuals through intelligence, ingenuity, or other ability provide immense value to the business that is capable of duplication by competitors.
• Legal Advantages
  • The law may provide a barrier to entry to competitors that provides a temporary competitive advantage. Think of highly regulated industries, such as finance, medicine, and law. The regulatory hurdles in place to carrying on these types of business may make market entry difficult (prohibitively costly or complicated) for new competitors.
• Industry Relationship
  • Sometimes who you know means everything. Establishing close or exclusive relationships with suppliers or service providers can effectively provide a temporary or long-term competitive advantage.

The important thing to note about competitive advantages is that they are rarely sustainable. That is most competitive advantages provide only a temporary benefit over other competitors. In any event, the effect of the above attributes or resources is to effect the power struggle between the forces identified by Porter. Some of these attributes or resources are sustainable and others are not.

Strategic Management and Competitive Advantage

Strategic management is largely concerned with competitive advantage. That is, the strategic manager will plan and implement a strategy that seeks to establish, maintain, or grow the businesss competitive advantage. The objective or intended result of those decisions are to exceed the profits or incur less loses than competitors.

Sustained Competitive Advantage and Strategy

Markets are, by nature, competitive. Sustained competition tends to erode any advantage that one market participant has over others. This may happen because competitors copy the advantaged competitor, or the competitors create their own unique competitive advantage that outpaces others. So, competitive advantage is generally limited in time. Managers seek to maintain, establish new, and increase competitive advantage through strategic planning. This requires the manager to constantly assess the company, the value proposition, the market, the competitors, and the customer. The manager must develop new objectives, value propositions, and methods.