The Berkeley MBA

Resource-based Strategy

This strategy approach focuses on the rents accruing to a firm that owns scarce resources rather than the economic profits from product market positioning. In this view, the competitive advantages lie upstream of product markets, and rest on the firm’s idiosyncratic and difficult-to-imitate resources. Research has shown that intra-industry differences in profits are greater, in general, than inter-industry differences in profits. This suggests that firm-specific factors might have more bearing on profits than previously thought, and also that industry conditions, competitive maneuvers and external effects might be relatively unimportant.

Comparing this approach with Porter’s Five Forces, an entry decision for a firm looks approximately as follows (Teece, 1997):

1. Pick an industry based on its structural attractiveness,
2. Choose an entry strategy based on a hypothesis of rival strategies (rational hopefully)
3. Acquire the needed assets to compete in the market

From the resource-based perspective, firms are different with respect to their capabilities, resources and endowments. Plus, the assets are sticky to the firm, in the short run the likelihood of the firm losing the added value of the differentiating capabilities is low. This also applies to a lack of assets for the firm, if that happens to be the case. They are stuck with what they have in the short run. This is necessarily true because acquiring new resources is a costly and complicated process for a firm. Further, most assets are not easily exchanged for better ones. Examples abound, but knowledge or ‘know-how’ is the most common! Also important is the firm’s ability to monetize the newly acquired asset to become profitable quickly and show high ROI.

1. An entry decision in the resources perspective looks like the following:
2. Identify the firm’s unique resources
3. Decide in which markets those resources can earn the highest returns, and
4. Decide whether the returns or rents from the assets are most efficiently utilized by integrating into related markets, selling the relevant intermediate output to related firms, or selling the assets themselves to a firm in related businesses.

In this view, managing the scarce, not easy to imitate firm-specific resources such as human capital, patents, processes and internal controls and such, clearly becomes the most crucial and fundamental strategic issue. Skill acquisition, talent management, knowledge management and learning are the strategic drivers for the firm.

Dynamic Capabilities

IBM, Texas Instruments, Philips and other well-known firms have followed a resource-based strategy of collecting technology assets, guarded by an aggressive intellectual property stance. However, this strategy alone is not enough to support a significant and sustainable competitive advantage against a changing technology landscape, extremely low barriers to entry and never-before-seen levels of market fragmentation. New competitors in the technology space pop up every single day in the market!

The winners in the global marketplace were those that could demonstrate timely responsiveness and product innovation along with the management capability to efficiently deploy resources, internal competencies and external partnerships to ensure success. Simply building an inventory of technology assets was not enough!

The abilities of a firm to achieve new flavors of competitive advantage are collectively referred to by Teece, Pisano and Sheun as “dynamic capabilities”. The term dynamic refers to the capacity to renew competences so as to achieve congruence with the changing business environment. This approach considers that capabilities cannot be bought in most cases, but must be built, and that strategy involves choosing  and committing to long-term trajectories for building competencies.

Porter’s Focus strategy, as applied to the dynamic capabilities, needs to be defined in terms of distinctive competences NOT products. Products are considered manifestation of competences. The capabilities approach places emphasis on the internal processes that a firm utilizes, how these are deployed and how these will be enhanced into future capabilities.

In comparison with Shapiro’s game theoretic strategy formulation, the capabilities approach has the benefit of indicating that competitive advantage is not just a function of how one plays the game; it is also a function of the assets available to the players, and how these assets can be deployed, and in what configurations in a changing market.

Strategy toward Buyers and Suppliers

Buyer selection

“different purchasing needs are one reason why buyers have different structural bargaining power.”

“the costs of servicing individual buyers differ..as a result.. buyer selection- the choice of target buyers- becomes an important strategic variable.”

“Buyer selection with attention to structural considerations is an especially important strategic variable in mature industries and in those where barriers caused by product differentiation or technological innovation are hard to sustain.”

“Structural position- a criterion to determine quality of buyers- includes intrinsic bargaining power, and a propensity to exercise this bargaining power in demanding low prices.”

“..unexercised power is a threat that can be unleashed by industry evolution.”

Price sensitivity of buyers

“If buyers are very well informed about the state of demand and suppliers’ costs, they can be ruthless price bargainers.”

“The motivation of the actual decision maker (buyer) is not narrowly defined as the cost of inputs.”

“large buyers are not necessarily the most price sensitive..they might be willing to pay a premium for reliability and for keeping service costs limited to one supplier.”

Buyer selection and strategy

“A firm with high product differentiation may be able to sell to good buyers that are unavailable to many of its competitors..”

“Without a cost advantage, the firm must focus its efforts on buyers who are less price sensitive if it is to outperform the industry average.. if the firm cannot achieve cost leadership, it must be careful not to become stuck in the middle by selling to powerful buyers.”

A Framework for Competitor Analysis

“There are four components to a competitor analysis: future goals, current strategy, assumptions and capabilities.”

The competitor response profile

“The first step is to predict the strategic changes the competitor might initiate.”

“a move that will allow a competitor to share costs with another division, thereby dramatically reducing its relative cost position, may be a lot more significant than a move that leads to an incremental gain in marketing effectiveness.”

“what moves have asymmetrical profit consequences, i.e., affect a competitor’s profits more or less than they affect the initiating firm’s?”

“find a strategy that competitor’s are frozen from reacting to given their present circumstances.”

“Another key strategic concept is creating a situation of mixed motives, or conflicting goals for competitors. This strategy involves finding moves for which retaliation, though effective, would hurt the competitor’s broader position.”

Market Signals

“A prerequisite to interpreting signals accurately is to develop a baseline competitor analysis.”

“Reading market signals, a second-order form of competitor analysis, rests on subtle judgments about competitors based on the comparison of known aspects of their situations with their behavior.”

“announcements can be tests of competitor sentiments, taking advantage of the fact that they need not necessarily be carried out.”

“a sixth function of announcements is to avoid costly simultaneous moves in areas like capacity additions, where bunching of new plant additions would lead to overcapacity.”

The cross-parry

“When one firm initiates a move in one area and a competitor responds in a different area with one that affects the initiating firm..”

“the cross-parry response represents a choice by the defending firm not to counter the initial move directly but to counter it indirectly.”

“the cross-parry can be a particularly effective way to discipline a competitor if there is a great divergence of market shares.”

“maintaining a small position in cross-markets can be a useful potential deterrent.”

Competitive Moves

Industry instability: the likelihood of competitive warfare

“The underlying structure of an industry determines the intensity of rivalry..”

“The greater the number of competitors, the more equal their relative power, the more standardized their products, the higher their fixed costs and other conditions that tempt them to try to fill capacity, and the slower the industry’s growth, the greater is the likelihood that there will be repeated efforts by firms to pursue their own self-interest.”

“Multiple bargaining areas, or situations where firms are interacting in more than one competitive arena, can also facilitate a stable outcome in an industry.”

“Industry structure influences the position of the competitors, the pressures on them to make aggressive moves, and the degree to which their interests are likely to conflict.”

Competitive moves

“When making moves whose success is contingent on competitors following, the risk is that competitors will not follow.”

“Lags in retaliation stem from.. an inability to pinpoint retaliation, which raises its short-run cost.”

“From a defensive point of view perceptual lags may be shortened by having a competitor monitoring system in place which continually assembles data from the field salesforce, distributors, and so on.”

“If a firm can find moves that are much less costly for it to make than they are for its competitors to respond to, it can produce lags in retaliation..”

“commitment can deter retaliation, create trust and deter threatening moves..”

Communicating commitment

“Discipline mechanisms include cash reserves, excess production capacity, a large corps of salespersons, extensive research facilities, small positions in a competitor’s other businesses, and fighting brands.”

“Thomas Schelling’s work on game theory suggests that an important part of reaching an outcome is the discovery of a focal point, or some prominent resting place on which the competitive process can converge its expectations.”

“Focal points can take the form of logical price points, percentage markup pricing rules, round-number divisions of market shares, informal sharing of the market on some basis, etc”

“firms should seek to identify a desirable focal point as early as possible.”

I have been reading the book for a few months now, albeit at a rather lethargic pace. In my defense, a lot has been going on at professional, academic and personal fronts. Here is a compilation of highlights from the book organized by topics. This is just the beginning, more posts will follow covering the later chapters.

Structural Analysis of Industries

Structural Determinants

“Competition in an industry continually works to drive down the rate of return on invested capital toward the competitive floor rate of return.”

“The focus of structural analysis is on identifying the basic, underlying characteristics of an industry rooted in its economics and technology that shape the arena in which competitive strategy can be set.”

Threat of entry

“Acquisition into an industry with intent to build market position should probably be viewed as entry even though new entirely new entity is created.”

Barriers to entry

“Economics of scale refer to declines in unit costs of a product as the absolute volume per period increases.”

“A type of economies of scale entry barrier occurs when there are economies to vertical integration, i.e., operating in successive stages of production or distribution. Here the entrant must enter integrated or face a cost disadvantage.”

“Economies of scale are dependent on volume per period, and not on cumulative volume, and are very different analytically from experience.”

Expected retaliation

“Conditions that signal the strong likelihood of retaliation to entry and hence deter it are excess cash and unused borrowing capacity.”

Intensive rivalry among existing competitors

“Firms viewing a market as an outlet for excess capacity will adopt policies contrary to those of firms viewing the market as a primary one.”

“When exit barriers are high, excess capacity does not leave the industry, and companies that lose the competitive battle do not give up.”

Pressure from substitute products

“Substitute products that deserve the most attention are those that are subject to trends improving their price-performance trade-off with the industry’s product, or are produced by industries earning high profits.”

Bargaining power

“Buyers sometimes engage in the practice of tapered integration, producing some of their needs for a given component in-house and purchasing the rest from outside suppliers.”

“We usually think of suppliers as other firms, but labor is a supplier as well, and one that exerts great power in many industries.”

Generic Competitive Strategies

Overall cost leadership

“A low-cost position protects the firm against all five competitive forces because bargaining can only continue to erode profits until those of the next most efficient competitor are eliminated, and because the less efficient competitors will suffer first in the face of competitive pressures.”

Differentiation

“is creating something that is perceived industry-wide as being unique.”

“provides insulation against competitive rivalry because of brand loyalty by customers and resulting lower sensitivity to price.”

Focus

“The entire focus strategy is built around serving a particular target industry very well, and each functional policy is developed with this in mind.”

“A firm’s focus means that the firm either has a low cost position with its strategic target, high differentiation, or both. Focus may also be used to select targets least vulnerable to substitutes or where competitors are the weakest.”

“Focus necessarily involves a trade-off between profitability and sales volume.”

Stuck in the middle

” The firm failing to develop its strategy in at least one of the three directions is a firm that is stuck in the middle. This is an extremely poor strategic situation.”

“it must take the steps necessary to achieve cost leadership or at least cost parity, or it must orient itself to a particular target (focus) or achieve some uniqueness (differentiation).”

“the U-shaped relationship between profitability and market share does not hold for every industry.  In some there is often an inverse relationship between market share and profitability. ”

“There is no single relationship between profitability and market share..”

James Moore defined a business ecosystem as a network of organizations and individuals that co-evolve their capabilities and roles and align their investments so as to create additional value and improve efficiency.

I attempt to evaluate here whether this form of organization is better to both the traditionally integrated firm and a supply network based on principal-agent relationships. I contend that a vibrant ecosystem enables rapid response to competitive pressures. In particular the following benefits accrue to participants in an ecosystem:

1. Dynamic reconfiguration of capabilities in response to competition or market changes
2. Knowledge sharing helps create products with better market fit
3. Pluggable partner model enables speedy innovations to see light of day
4. Followership encouraged rather than challenged

Advantages of an ecosystem strategy to lead firm

Assuming the leading firm implements strategies that maximize value derived from the ecosystem, there are numerous benefits attainable:

1. Meet demand for integrated solutions by mobilizing complementary capabilities
2. Diminishing need for intervention once key strategic partners are integrated into a self-organizing system
3. Avoids the costs of acquisitions and subsequent integration thereby helping keep business focus on core competencies
4. The entire activity chain is setup to harness the knowledge and joint capability of ecosystem participants.

The traditional vertical integration strategy

The strategies that create vertically integrated organizations have certain key benefits including the following:

1. Ability to align internal suppliers and implement transfer pricing
2. Reduce supplier or buyer risk
3. Lower transaction and relative costs
4. Minimize or eliminate profit leakage to partners

Integration, as Peter Drucker stated, is complexity and only works out, as a rule, if the problem of ‘wrong size’ is addressed, i.e., the firm is too big or small to venture into the area of expertize itself. Even though a firm stays in the same industry it moves into areas it does not have core expertize in and therefore it needs new skills and takes on new risks. Weighing the short and long-term costs of, and payoffs from the integration to arrive at an optimal integration balance- between opportunities and risks- is the only way to be successful using this strategy.

An ecosystem strategy ‘fits’ better

Lets return to my contention that ecosystem strategies are increasingly becoming a better fit for the changing business landscape with firms facing pressure to reduce the current set of core activities. One of the more important strategic goals for small and large firms is cash flow management that requires limiting investments in non-core activities, preferably sourcing those operations from strategic partners. However, outsourcing as a general trend is slowing down in favor of using more reliable and mutually dependent partners. This is probably due to the closer and more complicated interactions needed to best competitors today; lock step with suppliers is harder to achieve in the offshore model.

Another driver for increasing suitability of ecosystem strategies is the need for reconfiguring activity chains to meet consumer demands. Subcontracting relationships, including offshore contracts, are slow moving entities that are not easy to change or reconfigure without sufficient handholding by the lead firm. Another issue is with changing requirements that are harder to build into contracts and require a more favorable climate of partners who are amenable to changing specifications deeper into the product or service cycle. This new model of employing “pluggable partners” into the product development cycle helps decrease time to market and gives the lead firm considerable flexibility in meeting consumer demands. This also helps remove any defective inputs or parts by replacing the supplier with another one from the ecosystem with a better track record in quality.

Followership in the context of pricing and product is another lesser-known advantage of an ecosystem strategy. If the leading firm plays it right, partners do not feel threatened by the ecosystem. Their individual product niches are not invaded and they could even continue to compete with a similar product line albeit differentiated sufficiently in order to remain an ecosystem participant.