Managing for Competitive Advantage (part 3)

The External Environment (part B)

By

Charles Lamson

FIGURE 1
The External Environment

The Competitive Environment

All organizations are affected by the general components of the macroenvironment we discussed in the last post (see Figure 1). Each organization also functions in a closer, more immediate competitive environment. The competitive environment includes the specific organizations with which the organization interacts. As shown in Figure 2, the competitive environment includes rivalry among current competitors, threat of new entrants, threat of substitutes, power of suppliers, and power of customers. This model was originally developed by Michael Porter, a Harvard professor and a noted authority on strategic management. According to Porter, successful managers do more than simply react to the environment: they act in ways that actually shape or change the organization's environment. In strategic decision-making, Porter's model is an excellent method for analyzing the competitive environment in order to adapt or influence the nature of competition.

FIGURE 2

The Competitive Environment

Competitors

Among the various components of the competitive environment, competitors within the industry must first deal with one another. When organizations compete for the same customers and try to win market share at the others' expense, all must react to anticipate their competitors' actions.

The first question to consider is: who is the competition? Sometimes answers are obvious. Coca-Cola and PepsiCo are competitors, as are the Big Three automakers General Motors, Ford, and DaimlerChrysler. But sometimes organizations focus too exclusively on traditional rivalries and miss the emerging ones. Historically, Sears and Roebuck focused on its competition with JCPenney. However, Sears real competitors were Kmart and Walmart at the low end, Target in the middle, Nordstrom at the high end, and a variety of catalogers, such as LL Bean, and Eddie Bauer.

Thus, as the first step in understanding their competitive environment, organizations must identify their competitors. Competitors may include (1) small domestic firms, especially their entry into tiny, premium markets; (2) overseas firms, especially their efforts to solidify positions and small niches (a traditional Japanese Japanese tactic); (3) big new domestic companies exploring new markets; (4) strong regional competitors; and (5) unusual entries such as Internet shopping. 

Once competitors have been identified, the next step is to analyze how they compete. Competitors used tactics such as price reductions, new product introductions, and advertising campaigns to gain advantage over their rivals. It is essential to understand what competitors are doing when you are holding your own strategy. Competition is most intense when there are many direct competitors including foreign contenders, when industry growth is slow, and when the product or service cannot be differentiated in some way.

New high growth industries offer enormous opportunities for profits. When an industry matures and growth slows, profits drop. Then, intense competition causes an industry shakeout: Weaker companies are eliminated, and the strong companies survive.

Threat of New Entrants

New entrants into an industry compete with established companies. If many factors prevent new companies from entering the industry, the threat to established firms is less serious. If there are few such barriers to entry, the threat of new entrants is more serious. Some major barriers to entry are government policy, capital requirements, brand identification, cost disadvantages, and distribution channels. The government can limit or prevent entry as occurs when the FDA forbids a new drug entrant. Some Industries such as trucking and liquor retailing, are regulated; more subtle government controls operate in fields such as mining and ski area development. Patents are also entry barriers. When a patent expires, other companies can then enter the market. For example, when the pharmaceutical firm Eli Lilly and Co.'s patent on its antidepressant drug Prozac expired, it lost its U.S. monopoly on the drug and its sales plunged. Barr Laboratories Inc. what the right to be the exclusive seller of a generic version of Prozac for 6 months. After that, other copycats flooded the market, eroding Barr's sales of the drug.

Other barriers are less formal but can have the same effect. Capital requirements may be so high that companies will not risk or try to raise such large amounts of money. Brand identification forces new entrants to spend heavily to overcome customer loyalty. The cost advantages established companies hold due to large size, favorable locations, existing assets, and so forth also can be formidable entry barriers.

Finally, existing competitors may have such tight distribution channels that new entrants have difficulty getting their products or services to customers. For example, established food products already have super supermarket shelf space. New entrants must displace existing products with promotions, price breaks, intensive selling, and other tactics.

Threat of Substitutes

Technological advances and economic efficiencies are among the ways that firms can develop substitutes for existing products. For example, although Southwest Airlines has developed strong rivalries with other airlines, it also competes as a substitute with bus companies such as Greyhound and rental car companies such as Avis. Southwest has gotten its cost base down to such a low point that it is now cheaper to fly from Los Angeles to Phoenix than it is to take a bus or rent a car. This particular example shows that substitute products or services can limit another industry's revenue potential. Companies in those industries are likely to suffer growth and earnings problems unless they improve quality or launch aggressive marketing campaigns.

In addition to current substitutes, companies need to think about potential substitutes that may be viable in the near future. For example, as alternatives to fossil fuels, experts suggest that nuclear fusion, solar power, and wind energy may prove useful one day. The advantages promised by each of these technologies are many: inexhaustible fuel supplies, electricity "too cheap to meter," zero emissions, universal public acceptance, and so on. Yet, while they may look good on paper and give us a warm, fuzzy feeling inside, they often come up short in terms of economics and/or technical viability. Table 1 shows a list of products and potential substitutes. 

TABLE 1
Potential Substitutes for Products

Suppliers

Organizations must acquire resources from their environment and convert those resources into products or services to sell. Suppliers provide the resources needed for production and may come in the form of people supplied by trade schools and universities, raw materials supplied by producers, wholesalers, and distributors, information supplied by researchers and consulting firms, and financial capital supplied by banks and other sources. But suppliers are important to an organization for reasons that go beyond the resources they provide. Suppliers can raise their prices or provide poor quality goods and services. Labor unions can go on strike or demand higher wages. Workers may produce defective work. Powerful suppliers, then, can reduce an organization's profits, particularly if the organization cannot pass on price increases to its customers.

One particularly noteworthy set of suppliers to some Industries is the international labor unions. Although unionization in the United States has dropped to about 10% of the private labor force, labor unions are still particularly powerful in industries such as steel, autos, and transportation. Even the Screen Actors Guild, the union representing workers in the entertainment industry, exerts considerable power on behalf of its members. For example, Tiger Woods was fined $100,000 for making a non-union Buick commercial during a strike by the American Federation of Television and Radio Artists. Labor unions represent and protect the interests of their members with respect to hiring, wages, working conditions, job security, and due process appeals. Historically, the relationship between management and labor unions has been adversarial; however, the relationship between management and labor unions has been adversarial however, both sides seem to realize that to increase productivity and competitiveness, management and labor must work together in collaborative relationships. Troubled labor relations can create higher costs and productivity declines and eventually lead to layoffs.

Organizations are at a disadvantage if they become overly dependent on any powerful supplier. A supplier is powerful if the buyer has few other sources of supply or if the supplier has many other buyers. For example, if computer companies can go only to Microsoft for software or only to Intel for microchips, those suppliers can exert a great deal of pressure. In many cases, companies build up switching costs. Switching costs are fixed costs buyers face if they change suppliers. For example, once a buyer learns how to operate a suppliers equipment, such as computer software, the buyer faces both economic and psychological costs in changing to a new supplier.

Choosing the right supplier is an important strategic decision. Suppliers can affect manufacturing time, product quality, and inventory levels. The relationship between suppliers and the organization is changing in some companies. The close supplier relationship has become a new model for many organizations, such as Ford Motor, that are using a just-in-time manufacturing approach.

Customers

Customers purchase the products or services an organization offers. Without customers, a company will not survive. You are a final consumer when you buy a McDonald's hamburger or a pair of jeans from a retailer at the mall. Intermediate consumers buy raw materials or wholesale products and then sell to final customers. Intermediate customers usually make more purchases than individual final consumers do. Examples of intermediate customers include retailers, who buy clothes from wholesalers and manufacturers representatives before selling them to their customers, and Industrial buyers, who buy raw materials such as chemicals before converting them into final product.

Like suppliers, customers are important to organizations for reasons other than the money they provide for goods and services. Consumer customers can demand lower prices, higher quality, unique product specifications, or better service. They also can play competitors against one another, as occurs when a car customer or a purchasing agent collect different offers and negotiate for the best price.  

Customer service means giving customers what they want or need, the way they want it, the first time. This usually depends on the speed and dependability with which an organization can deliver its products or services. Actions and attitudes that mean excellent customer service include the following:

• Speed of filling and delivering normal orders.
•  Willingness to meet emergency needs.
•  Merchandise delivered in good condition.
•  Readiness to take back defective goods and resupply quickly.
• Availability of installation and repair services and parts. 
• Service charges (that is, whether services are "free" or priced separately).

In all businesses, services as well as manufacturing---strategies that emphasize good customer service provide a critical competitive advantage. The organization is at a disadvantage if it depends too heavily on powerful customers. Customers are powerful if they make large purchases or if they can easily find alternative places to buy. If you are the largest customer of a firm and there are other firms from which you can buy, you have power over that firm, and you are likely to be able to negotiate with it successfully. Your firm's biggest customers---especially if they can buy from other sources---will have the greatest negotiating power over you. 

*SOURCE: MANAGEMENT: THE NEW COMPETITIVE LANDSCAPE, 6TH ED., 2004, THOMAS S. BATEMAN, SCOTT A. SNELL, PGS. 48-53*

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