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MODULE 2
Analyze your firm’s external fit
Introduction to Strategy Audit and Evaluating External Fit
Three types of fit to evaluate a strategy
Content: Positioning,
Activities, Capabilities …
Process: Incentives, Org
structure …
Internal
External
Industry,
Competition,
Regulation …
Dynamic fit
Competitor reactions,
Technological change,
Demand changes …
The elements of a strategy Strategy = Distinctive array of interdependent choices that
address
• A desired outcome
• Where to compete (market positioning)
Product
Customers
Geography
• Value proposition
• Source of CA (strategic positioning)
• High-level (cost vs. differentiation)
• Detailed level (activities, resources, capabilities)
Strategy Audit
Industry
Background
Firm
Positioning
Activities,
Resources,
Capabilities
Drivers of profitability
By how much is profitability of a firm driven by: – Industry effects?
– Positioning effects?
– Corporate effects?
Average Return on Invested Capital in U.S. Industries, 1992–2006
0
5
10
15
20
25
30
35
40
45
0% 5% 10% 15% 20% 25% 30% 35% 40%
Nu
mb
er
of
Ind
us
trie
s
ROIC
10th percentile
7.0%
25th percentile
10.9%
Median
14.3%
75th percentile
18.6%
90th percentile
25.3%
or lower
ROIC = EBIT/(Average invested capital – excess cash)
or higher
Source: Porter, 1996)
Source: “The Five Competitive Forces That Shape Strategy” Porter, Harvard Business Review, 2008
5.9%
5.9%
10.4%
10.5%
11.7%
12.6%
13.4%
13.4%
13.7%
13.8%
13.9%
15.0%
15.4%
15.6%
16.0%
16.5%
17.0%
17.6%
19.0%
19.2%
19.5%
19.5%
21.0%
21.3%
26.4%
27.3%
28.6%
31.7%
37.6%
37.6%
40.9%
Catalog, Mail-Order Houses
Airlines
Hotels
Knitting Mills
Soft Drink Bottling
Oil and Gas Machinery
Book Publishing
Laboratory Equipment
Engines and Turbines
Bakery Products
Wine and Brandy
Mobile Homes
Cookies and Crackers
Iron and Steel Foundaries
Grocery Stores
Drug Stores
Household Furniture
Child Day Care Services
Malt Beverages
Household Appliances
Men's and Boys' Clothing
Tires
Medical Instruments
Semiconductors
Distilled Spirits
Advertising Agencies
Perfums, Cosmetics, Toiletries
Pharmaceuticals
Soft Drinks
Prepackaged Software
Security Brokers and Dealers
Source: “The Five Competitive Forces That Shape Strategy” Porter, Harvard Business Review, 2008
Average ROIC, 1992–2006
Note: Return on Equity = Net Income / Year End Shareholders’ Equity
8.7%
22.3%
20.5%
14.0%
12.3%
7.2%7.0%
3.0%
-1.6%
Positioning
Arkansas
Best Pfizer
Ave
rag
e R
etu
rn o
n E
qu
ity,
1
98
2–
1993
Hunt Roadway Carolina
Freight Consolidated
Freightway
Arnold Yellow Central
Freight
Builders
Transport
18.3%19.3%
23.6%23.8%
28.9%
33.6%
22.2%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
Merck Schering-
Plough
Eli Lilly
Marion
Merrell Dow Bristol-Meyers Upjohn
Pharmaceuticals Trucking
Industry Average 10.4%
Industry Average 24.2%
Value creation
Strategy Audit
Industry
Background
Firm
Positioning
Activities,
Resources,
Capabilities
Value creation and appropriation
Utility (in money)
[Willingness to pay]
Price
Cost
Supplier’s cost
Value
created
Buyer’s share
Firm’s share
Supplier’s share
Value appropriation
Industry analysis
Value appropriation—Industry Analysis: 5 Forces
Who wants to appropriate value?
– Buyers => lower price
– Suppliers => increase cost
Who else limits the amount you can appropriate? – Current competitors => lower price
– New competitors => lower price
– Substitution => lower price
– Complementors => lower WTP, or higher cost
What other factors determine profitability in your industry? – Regulation?
Supply
chain
Drivers of appropriation threats
Customer Power – Price sensitivity (volume; importance to their cost)
– Switching costs/customer lock-in (technical; brand)
– Ability to backward integrate
– For instance, shipping managers buying trucking services.
Supplier Power – How important are our sales to them?
– Switching costs for you
– Ability to forward integrate
For instance, Intel
Drivers of appropriation threats (2)
Barriers to Entry (new entry & substitutes) – Scale-based benefits; Experience, learning effects
– Capital requirements
– Value of reputation, brand
– Access to distribution
– For instance, pharma detailing to doctors vs. TL trucking.
Rivalry (existing competitors) – Number of effective competitors
– Market growth
– Degree of differentiation
– Strategic stakes
– Patents
For instance, full-service US domestic airlines
Value proposition
Strategy Audit
Industry
Background
Firm
Positioning
Activities,
Resources,
Capabilities
The elements of a strategy
Strategy = distinctive array of choices that address
– A desired outcome
– Where to compete (market positioning)
• Product
• Customers
• Geography
– Value proposition
– Source of CA (strategic positioning)
High-level (cost vs. differentiation)
Detailed level (activities, resources, capabilities)
Value Proposition
Customers care about (WTP – Price), not just one or the other
One can create value by increasing the customer’s willingness to pay or by
decreasing cost (iPod vs. Southwest)
What factors drive willingness to pay?
What factors drive cost?
Willingness to pay
Price
Cost
Value
created
Value
appropriated by
customer
How to assess WTP
Engineering estimate: – WTP = Current price + (non-price) cost savings – switching costs
Focus groups: – Assess indifference point between $ and the product
Quantitative analysis: – Survey of potential customers: give various options of features and prices and customers
make (hypothetical) choices; from this one can estimate elasticities
– E.g., refrigerator: $1 annual savings from energy consumption = $2.45 higher WTP
Auctions
Competitive advantage
What is the size of your competitive advantage?
CA = (WTP – Cost)you – (WTP – Cost)strongest competitor
Or
CA = (WTP – WTPcompetitor) + (Costcompetitor – Costyou)
Why is Porsche still around?
The role of nationality in buying cars
Cup holders
Implications
CA = (WTP – Cost)you – (WTP – Cost)strongest competitor
To appropriate value, you need to create more value than your competitors
You need to create some asymmetry in WTP and/or in Cost
Being different, i.e., doing different things, is what is at the heart of strategy.
Positioning
Strategic Positioning
Relative Cost Position
WTP
Low
High
High Low
Productivity Frontier
(State of Best Practice)
Source: “What Is Strategy?” Porter, Harvard Business Review, 1996
Strategic Positioning in the Airline Industry
Cost
WTP
SQ
US SWA
BA
LOW
LOW
HIGH
HIGH
Differentiation and Cost Drivers
WTP drivers
Brand
Technological performance
After-sale services, etc.
WTP(a, b, c, ..)
WTP = “a*a + b*b + g*c + …“
Different segments differ in their weights
Cost drivers
Production costs
Logistical costs
Transportation costs
Service costs
WTP drivers for airlines
Worst in
industry Average
Best in
industry
1 2 3 4 5
Drivers of WTP:
Number of flights/Coverage
Point-to-point
On-time arrival/departure
Bags arrive
Meals
Lounges
Quality of frequent flier program
Friendly service; quality of seats
Market positioning
The elements of a strategy
Strategy = distinctive array of choices that address – A desired outcome
– Where to compete (market positioning)
• Product
• Customers
• Geography
– Value proposition
– Source of CA (strategic positioning)
High-level (cost vs. differentiation)
Detailed level (activities, resources, capabilities)
Market Positioning
Identify the two, three dimensions on which firms differentiate themselves in
the market
Plot your position vs. those of your competitors
Provides an idea of where in the market space strategic convergence is likely
to happen and where there might be opportunities
Market Positioning in US Fast Food
High
Price
High
Quality
Low
Price
Low
Quality
Strategy Audit Summary
Strategy Audit Summary
What is the condition of the industry today?
Where is the industry going?
What are the WTP and cost drivers for different segments?
Where are we positioned? Where are our competitors positioned?
Where are our competitors moving?
How strong are our capabilities vs. competitors vs. world-class?
What are our key activities? Are they OE or SP?
How are we using corporate? How are we leveraging other divisions?
Strategy Audit
Industry
Background
Firm
Positioning
Activities,
Resources,
Capabilities
Strategic
Initiatives
• Industry
Analysis
• Scenarios
• Drivers of Cost
and WTP
• Strategic
Positioning
• Value Chain
• Activity System
Tools
Analyze the Structure of Your Industry Assignment
Industry Attractiveness
Highly
Unattractive
Mildly
Unattractive
Neutral Mildly
Attractive
Highly
Attractive
Threat of Value
Appropriation
by Customers
Size of key customers:
Price sensitivity:
Switching costs (technical):
Switching costs (brand):
Ability to backward integrate:
High
Customer
Power
Large
High
Low
Low
Easy
Low
Customer
Power
Small
Low
High
High
Difficult
Threat of Value
Appropriation
by Suppliers
Size of key suppliers:
Price sensitivity:
Your switching costs (technical):
Your switching costs (brand):
Ability to forward integrate:
High
Supplier
Power
Large
High
High
High
Easy
Low
Supplier
Power
Small
Low
Low
Low
Difficulty
Rivalry among
competitors
Number of effective competitors:
Market growth:
Degree of differentiation:
Strategic stakes:
Patents protect profits:
High Rivalry
Large
Slow
Little
High
No
Low Rivalry
Small
Fast
High
Low
Yes
Industry Attractiveness
Highly
Unattractive
Mildly
Unattractive
Neutral Mildly
Attractive
Highly
Attractive
Barriers to
Entry
Scale-based benefits:
Experience, learning effects:
Capital requirements:
Value of reputation, brand:
Access to distribution:
Low Entry
Barriers
Little
Little
Small
Unimportant
Unimportant
High Entry
Barriers
Large
Large
Large
Important
Important
Substitutes
Availability of close substitutes
for product or services:
Many
substitutes
Few
substitutes
Regulatory
Factors
Impact of regulatory
Changes:
Negative Positive
Industry Attractiveness
Highly
Unattractive
Mildly
Unattractive
Neutral Mildly
Attractive
Highly
Attractive
Complementors Other firms have exclusive
relationships with
complementors vs. we
have these relationships:
Negative Positive
Other Factors Negative Positive
Other Factors Negative Positive
Industry Attractiveness
Current Future
Factors: Un-
attractive Neutral Attractive Un-
attractive Neutral Attractive
Power of Customers
(make this industry…)
Power of Suppliers
Rivalry among
Competitors
Barriers to Entry
Availability of Substitutes
Regulatory Factors
Growth Rates
(make this industry…)
Understanding the Industry
Make a mark in each row for “the average firm” and for “your firm.”
Understanding the Industry
The two most significant factors affecting industry attractiveness are:
1.
2.
The two factors most likely to change significantly are:
1.
2.
The factors for which our firm is much better/much worse positioned (if any):
1.
2.
Evaluate the Positioning of your Organization Assignment
Differentiation
Make a mark in each row for “your firm” and 2–3 competitors.
Worst in
industry Average
Best in
industry
1 2 3 4 5
Drivers of WTP:
(fill in relevant dimension)
Cost
Make a mark in each row for “your firm” and 2–3 competitors.
Worst in
industry Average
Best in
industry
1 2 3 4 5
Cost drivers:
Strategic Positioning— Now and Future
1) Where are we located?
2) Where are our competitors currently located?
3) Where do we believe our competitors are moving toward?
4) Where do we see ourselves going?
high low
relative cost position
high
low
WTP