Strategic Alternatives

Industry attractiveness and a firm's competitive position within the industry are interrelated. More importantly, even though industry structure tends to change slowly over time, changes do occur. Such change can occur due to changes within the industry, or from larger macroeconomic changes. It is important for the analyst to be alert for fundamental changes that can affect the strength or weakness of the five forces. When this happens, the firm needs to be in a position to act to capitalize on the change. Here we explore three strategies that can be employed by a firm to use the five forces in its favor.

LOS 38.e: Show how positioning a compajiy, exploiting industry change, and the ability to shape industry structure are creative strategies for achieving a competitive advantage.

Altering the Firm's Existing Position

A firm can improve its attractiveness through its choice of competitive strategy.

Managers should attempt to intentionally create changes in Porter's Five Forces by reducing:

• Customer power. For example, increasing service or bypassing the middleman and selling directly to end users (as pharmaceutical companies reduced physician power by direct advertising to consumers).

• Supplier power. For example, using standardized parts that can be sourced from many vendors or outsourcing labor to more favorable markets (as some health care providers have outsourced reading x-rays to overseas radiologists).

• Substitutes. For instance, making the product more widely available or enhancing product features. Cellular telephone makers compere against land lines by adding text messaging, music, photography, and various other features not feasible in wired telephones.

• Threat of entry. Raise the barriers to entry, for instance by raising fixed costs (through increased R&D or mechanization) or lobbying regulators (for more restrictive licensing or better patent protection). Certain banks have raised entry barriers by investing in large branch networks that make it difficult for smaller banks to compete.

• Rivalry. Rivalry tends to increase over time as industry growth slows and products converge to new industry standards. Companies should avoid price wars and focus on differentiating products and finding or creating new market niches and geographic segments.

Capitalizing on Changes in the Industry

Industry structure and profitability tend to be very stable. However, change does occur over time, either because of decisions made by firms in the industry or because of changes in external factors. Examples include:

• Forward or backward integration, such as clothing retailers' development of their own designer labels.

• External forces such as improvements in a substitute, like cellular and internet telephones as alternatives to land lines.

• Sudden and dramatic change like the impact e-mail had on document delivery services.

These types of change offer opportunities to firms that are positioned to capitalize on them. Whether these opportunities are seized by industry leaders, smaller competitors, or new entrants depends upon the nature of the opportunity and the industry structure.

Creating Changes in the Industry Structure

A firm can move the entire industry in directions that improve industry attractiveness, either by enhancing industry value added overall (for instance, eliminating inefficiencies in the supply chain or distribution network) or by redistributing the value added in favor of industry participants (for example, improving pricing by reducing customer power). Industry leaders arc best positioned to reshape the industry because of their ability to absorb the related costs and the fact that they generally benefit most from improved industry conditions.

A firm should try to move the industry in directions that play to its strengths and enhance its competitive advantage (for instance, creating barriers to entry by raising fixed costs and increasing economies of scale if it is the largest competitor). Managers should be careful not to engage in practices that improve their competitive position in the short run but that undermine industry attractiveness in the long run (for instance, price discounting by the low-cost competitor).

Professor's Note: The information in this topic review has been from the perspective of an existing, or incumbent, company. While not directly addressed in any LOS for this topic review, many of the points discussed could also apply to investors or analysts. In addition to analyzing financial information, Porter argues that investors should perform a five forces analysis that includes the issues discussed in this topic review.

Study Session 11

Cross-Reference to CFA Institute Assigned Reading #38 - The Five Competitive Forces That Shape Strategy Steps in Using the Forces in an Industry Analysis

There are six seeps when using Porter's Five Forces in analyzing an industry:

Step 1: Define the industry:

• This should be done in terms of the products/services sold, and the geographical area over which the products/services are sold.

• The products should then be examined in rhe context of the Five Forces.

• If two products appear similar but have different industry structure in cerms of the Five Forces (e.g., che basic product is rhe same, but the buyers are vastly different), they should be considered separate industries.

Step 2: Identify che participants:

• Competitors

• Potential entrants

• Substitutes

Step 3: Determine strength or weakness of each force, what drives it, and why. Be careful to focus on the more important forces and analyze chem thoroughly. Step 4: Determine indusrry srructure using an analytical framework and how che

Five Forces come co bear on marcers such as pricing and input cost structure. Distinguish between cause (ease of entry) and effect (price competition). Which forces are rhe most important determinants of profitability? Step 5: Assess current and potencial shifts in each force. Discinguish becween transienc blips and long-term structural changes in the induscry and the forces. Make sure to incorporate trends and noc use static analysis. Step 6: Decide which forces can be alcered in ways that will affecc the value of che industry or firm.

example: analyzing the competitive forces for Wal-Mart

Synopsis

Wal-Mart is che world's largest retailer, selling a wide range of products targeted to consumers and small businesses. The firm serves approximately 150 million cusromers per week in the Americas, Asia, and rhe United Kingdom.

Wal-Mart is widely viewed as having the lowesr prices on a broad variety of frequently-purchased consumer products.

Principal competitors includc other broad-based discount stores, grocery stores, as well as small retailers operating in its geographic region. The smaller specialty retailers and single-location boutiques compete with Wal-Marr in limited product lines.

Wal-Mart has a reputation as a formidable competitor, and many retailers have been forced to change their business models in order to stay profitable once Wal-Mart enters their markets.

A major development in recent years at Wal-Mart has been the deterioration in its market image because of accusations of unfair labor practices. The firm is currently defending several lawsuits involving its employment practices, and these have generated significant and damaging press coverage.

Competitive Forces and Wal-Mart

Threat of new entrants. Wal-Mart's cost advantage arises from a famously efficient distribution system, which requires enormous scale and massive capital investment. The barriers to entry for a broad-based discounter are very high. However, Wal-Mart competes with a large variety of specialized retailers in specific types of products, where barriers to entry may be quite low.

Threat of substitutes. The threat of substitutes in the retailing industry arises largely from the potential elimination of brick-and-mortar retailers by Internet-based retailing. To mitigate this threat, Wal-Mart has launched its own Internet-based sales effort.

Bargaining power of buyers. The bargaining power of buyers is virtually non-existent. Individual consumers have essentially no bargaining leverage against global corporate retailers, and Wal-Mart does not target corporate customers. Wal-Mart is sufficiently large enough that even its biggest customers account for an infinitesimal proportion of its sales.

Bargaining power of suppliers. The bargaining power of suppliers has historically been very low. Wal-Mart is well known for vigorous bargaining with its suppliers of borh labor and products. Its enormous presence in the retail sales industry makes it the largest purchaser for many of its suppliers, giving them virtually no bargaining leverage against Wal-Mart. Wal-Mart has also vigorously resisted efforts to unionize its workers, who have historically had very little bargaining power. That is changing somewhat as accusations of unfair labor practices have cost Wal-Mart market prestige and position, giving labor more leverage with the firm. Even so, the bargaining power of suppliers of labor remains quite low.

Rivalry among existing competitors. Competition among existing competitors in the retail sales industry is very high. An indication of the competitiveness is in Wal-Mart's global market share, which is approximately 3%. The vast majority of other firms have market share too small to be significant on a global basis. Competition in retailing is focused on geographic region, and Wal-Mart's market position varies widely, in the United States, Wal-Mart is the largest retailer of many items it sells and commands 20% of the grocery marker. It has a much smaller presence in markets such as Germany, which it eventually abandoned after achieving only 2% share in foods against Aldi's 19%.

Conclusion

Wal-Mart drives its competitive strategy through its enormous scale, which provides significant barriers to entry, low supplier bargaining power, and low buyer bargaining power. Substitutes are available for all products Wal-Mart sells but usually ac higher prices. Wal-Marr's scale has historically enabled it to enjoy high profits for its industry.

A principal threat to Wal-Mart's long-term profitability is the increase in supplier power in the form of the influence of its suppliers of labor on the court system, the press, and public opinion. Wal-Mart should take action to reduce the impact of these labor difficulties on the firm. In fact, it has made steps to improve its public relations through actions such as increased and more visible charitable giving.

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