Week 2 Assignment - Compare and Contrast
Chapter 3: Evaluating the External Environment
Chapter 3: Evaluating the External Environment
3.1 Evaluating the External Environment
3.2 The Relationship between an Organization and Its Environment
3.3 Evaluating the General Environment
3.4 Evaluating the Industry
3.5 Mapping Strategic Groups
3.6 Conclusion
3.1 Evaluating the External Environment
Learning Objectives
After reading this chapter, you should be able to understand and articulate answers to the following questions:
1. What is the general environment and why is it important to organizations?
2. What are the features of Porter’s five forces industry analysis?
3. What are strategic groups and how are they useful to evaluating the environment?
Subway Is on a Roll
As shown in the highlighted countries, Subway is well on its way to building a worldwide sandwich empire.
Wikimedia Commons – CC BY-SA 3.0.
Many observers were stunned in March 2011 when news broke that Subway had surpassed McDonald’s as the biggest restaurant chain in the world. At the time of the announcement, Subway had 33,749 units under its banner while McDonald’s had 32,737 (Kingsley, 2011). Despite its meteoric growth, many opportunities remained. In China, for example, Subway had fewer than two hundred stores. In contrast, China hosts more than 3,200 Kentucky Fried Chicken stores. Overall, Subway was on a roll, and this success seemed likely to continue.
How had Subway surpassed a global icon like McDonald’s? One key factor was Subway’s efforts to provide and promote healthy eating options. This emphasis took hold in the late 1990s when the American public became captivated by college student Jared Fogle. As a freshman at Indiana University in 1998, the 425 pound Fogle decided to try to lose weight by walking regularly and eating a diet consisting of Subway subs. Amazingly, Fogle dropped 245 pounds by February of 1999.
Subway executives knew that a great story had fallen into their laps. They decided to feature Fogle in Subway’s advertising and soon he was a well-known celebrity. In 2007, Fogle met with President Bush about nutrition and testified before the US Congress about the need for healthier snack options in schools. Today, Fogle is the face of Subway and
one of the few celebrities that are instantly recognizable based on his first name alone. Much like Beyoncé and Oprah, you can mention “Jared” to almost anyone in America and that person will know exactly of whom you are speaking. Subway’s line of Fresh Fit sandwiches is targeted at prospective Jareds who want to improve their diets.
Because American diets contain too much salt, which can cause high blood pressure, salt levels in restaurant food are attracting increased scrutiny. Subway responded to this issue in April 2011 when its outlets in the United States reduced the amount of salt in all its sandwiches by at least 15 percent without any alteration in taste. The Fresh Fit line of sandwiches received a more dramatic 28 percent reduction in salt. These changes were enacted after customers of Subway’s outlets in New Zealand and Australia embraced similar adjustments. Although the new sandwich recipes cost slightly more than the old ones, Subway plans to absorb these costs rather than raising their prices (Riley, 2011). This may be a wise strategy for retaining customers, who have become very price sensitive because of the ongoing uncertainty surrounding the American economy and the high unemployment.
References
Kingsley, P. 2011, March 9. How a sandwich franchise ousted McDonald’s. The Guardian. Retrieved from
http://www.guardian.co.uk/lifeandstyle/2011/mar/09/subway-biggest -fast-food-chain.
Riley, C. 2011, April. Subway lowers salt in its sandwiches. CNNMoney. Retrieved from http://money.cnn.com/
2011/04/18/news/companies/subway_salt/index.htm.
69 Mastering Strategic Management
3.2 The Relationship between an Organization and Its Environment
Learning Objectives
1. Define the environment in the context of business.
2. Understand how an organization and its environment affect each other.
3. Learn the difference between the general environment and the industry.
What Is the Environment?
For any organization, the environment consists of the set of external conditions and forces that have the potential
to influence the organization. In the case of Subway, for example, the environment contains its customers, its
rivals such as McDonald’s and Kentucky Fried Chicken, social trends such as the shift in society toward healthier
eating, political entities such as the US Congress, and many additional conditions and forces.
It is useful to break the concept of the environment down into two components. The general environment
(or macroenvironment) includes overall trends and events in society such as social trends, technological trends,
demographics, and economic conditions. The industry (or competitive environment) consists of multiple
organizations that collectively compete with one another by providing similar goods, services, or both.
Every action that an organization takes, such as raising its prices or launching an advertising campaign, creates
some degree of changes in the world around it. Most organizations are limited to influencing their industry.
Subway’s move to cut salt in its sandwiches, for example, may lead other fast-food firms to revisit the amount of
salt contained in their products. A few organizations wield such power and influence that they can shape some
elements of the general environment. While most organizations simply react to major technological trends, for
example, the actions of firms such as Intel, Microsoft, and Apple help create these trends. Some aspects of the
general environment, such as demographics, simply must be taken as a given by all organizations. Overall, the
environment has a far greater influence on most organizations than most organizations have on the environment.
Why Does the Environment Matter?
Understanding the environment that surrounds an organization is important to the executives in charge of the
organizations. There are several reasons for this. First, the environment provides resources that an organization
needs in order to create goods and services. In the seventeenth century, British poet John Donne famously noted
that “no man is an island.” Similarly, it is accurate to say that no organization is self-sufficient. As the human
body must consume oxygen, food, and water, an organization needs to take in resources such as labor, money,
and raw materials from outside its boundaries. Subway, for example, simply would cease to exist without the
contributions of the franchisees that operate its stores, the suppliers that provide food and other necessary inputs,
and the customers who provide Subway with money through purchasing its products. An organization cannot
survive without the support of its environment.
Second, the environment is a source of opportunities and threats for an organization. Opportunities are
events and trends that create chances to improve an organization’s performance level. In the late 1990s, for
example, Jared Fogle’s growing fame created an opportunity for Subway to position itself as a healthy alternative
to traditional fast-food restaurants. Threats are events and trends that may undermine an organization’s
performance. Subway faces a threat from some upstart restaurant chains. Saladworks, for example, offers a variety
of salads that contain fewer than five hundred calories. Noodles and Company offers a variety of sandwiches,
pasta dishes, and salads that contain fewer than four hundred calories. These two firms are much smaller than
Subway, but they could grow to become substantial threats to Subway’s positioning as a healthy eatery.
Executives must also realize that virtually any environmental trend or event is likely to create opportunities for
some organizations and threats for others. This is true even in extreme cases. In addition to horrible human death
and suffering, the March 2011 earthquake and tsunami in Japan devastated many organizations, ranging from
small businesses that were simply wiped out to corporate giants such as Toyota whose manufacturing capabilities
were undermined. As odd as it may seem, however, these tragic events also opened up significant opportunities for
other organizations. The rebuilding of infrastructure and dwellings requires concrete, steel, and other materials.
Japanese concrete manufacturers, steelmakers, and construction companies are likely to be very busy in the years
ahead.
Natural disasters devastate many organizations.
Kim Seng – Monthly Newsletter – November 2011 – CC BY-NC-ND 2.0.
Third, the environment shapes the various strategic decisions that executives make as they attempt to lead
their organizations to success. The environment often places important constraints on an organization’s goals, for
71 Mastering Strategic Management
example. A firm that sets a goal of increasing annual sales by 50 percent might struggle to achieve this goal during
an economic recession or if several new competitors enter its business. Environmental conditions also need to be
taken into account when examining whether to start doing business in a new country, whether to acquire another
company, and whether to launch an innovative product, to name just a few.
Key Takeaway
• An organization’s environment is a major consideration. The environment is the source of resources that the organizations needs. It provides opportunities and threats, and it influences the various strategic decisions that executives must make.
Exercises
1. What are the three reasons that the environment matters?
2. Which of these three reasons is most important? Why?
3. Can you identify an environmental trend that no organizations can influence?
3.2 The Relationship between an Organization and Its Environment 72
3.3 Evaluating the General Environment
Learning Objectives
1. Explain how PESTEL analysis is useful to organizations.
2. Be able to offer an example of each of the elements of the general environment.
The Elements of the General Environment: PESTEL Analysis
An organization’s environment includes factors that it can readily affect as well as factors that largely lay beyond
its influence. The latter set of factors are said to exist within the general environment. Because the general
environment often has a substantial influence on an organization’s level of success, executives must track trends
and events as they evolve and try to anticipate the implications of these trends and events.
PESTEL analysis is one important tool that executives can rely on to organize factors within the general
environment and to identify how these factors influence industries and the firms within them. PESTEL is an
anagram, meaning it is a word that created by using parts of other words. In particular, PESTEL reflects the
names of the six segments of the general environment: (1) political, (2) economic, (3) social, (4) technological,
(5) environmental, and (6) legal. Wise executives carefully examine each of these six segments to identify major
opportunities and threats and then adjust their firms’ strategies accordingly (Table 3.1 “PESTEL”).
Table 3.1 PESTEL
Examining the general enviornment involves gaining an understanding of key factors and trends in broader
society. PESTEL analysis is a popular framework for organizing these factors and trends and isolating how they
influence industries and the firms within them. Below we describe each of the six dimensions associated with
PESTEL analysis: political, economic, social, technological, environmental, and legal.
P Political factors include elements such as tax policies, changes in trade restrictions and tariffs, and the stability of governments.
E Economic factors include elements such as interest rates, inflation rates, gross domestic product, unemployment rates, levels of disposable income, and the general growth or decline of the economy.
S Social factors include trends in demographics such as population size, age, and ethnic mix, as well as cultural trends such as attitudes toward obesity and consumer activism.
T Technological factors include, for example, changes in the rate of new product development, increases in automation, and advancements in service industry delivery.
E Environmental factors include, for example, natural disasters and weather patterns.
L Legal factors include laws involving issues such as employment, health and safety, discrimination, and antitrust.
P Is for “Political”
The political segment centers on the role of governments in shaping business. This segment includes elements
such as tax policies, changes in trade restrictions and tariffs, and the stability of governments (Table 3.2 “Political
Factors”). Immigration policy is an aspect of the political segment of the general environment that offers
important implications for many different organizations. What approach to take to illegal immigration into the
United States from Mexico has been a hotly debated dilemma. Some hospital executives have noted that illegal
immigrants put a strain on the health care system because immigrants seldom can pay for medical services and
hospitals cannot by law turn them away from emergency rooms.
Table 3.2 Political Factors
Examples of several key trends representing political factors in the general environment are illustrated below.
3.3 Evaluating the General Environment 74
The extent to which companies developing clean energy sources should be subsidized by the government versus being left on their own to compete with providers of traditional energy sources is currently a hotly contested political issue.
The use of child labor was once commonplace in the United States now firms face political scrutiny when using overseas suppliers that employ child labor.
The word tariff derived from an Arabic word meaning “fees to be paid.” By levying tariffs and implementing other trade restrictions, governments can — to some extent — protect domestic firms from international competition.
The stability of the US government provides a source of confidence for foreign firms who want to do business in the United States. Countries that face frequent regime change and political turmoil have a harder time attracting foreign investments.
One of the most important duties of elected officials in the United States is to debate and set new tax policies.
Proposals to provide support to businesses are often featured within political campaigns.
Meanwhile, farmers argue that a tightening of immigration policy would be harmful because farmers rely
heavily on cheap labor provided by illegal immigrants. In particular, if farmers were forced to employ only
legal workers, this would substantially increase the cost of vegetables. Restaurant chains such as Subway would
then pay higher prices for lettuce, tomatoes, and other perishables. Subway would then have to decide whether
to absorb these costs or pass them along to customers by charging more for subs. Overall, any changes in
immigration policy will have implications for hospitals, farmers, restaurants, and many other organizations.
E Is for “Economic”
The economic segment centers on the economic conditions within which organizations operate. It includes
75 Mastering Strategic Management
elements such as interest rates, inflation rates, gross domestic product, unemployment rates, levels of disposable
income, and the general growth or decline of the economy (Table 3.3 “Economic Factors”). The economic crisis
of the late 2000s has had a tremendous negative effect on a vast array of organizations. Rising unemployment
discouraged consumers from purchasing expensive, nonessential goods such as automobiles and television sets.
Bank failures during the economic crisis led to a dramatic tightening of credit markets. This dealt a huge blow
to home builders, for example, who saw demand for new houses plummet because mortgages were extremely
difficult to obtain.
Table 3.3 Economic Factors
Examples of several key trends representing economic factors in the general environment are illustrated below.
The unemployment rate is the percentage of the labor force actively lookin for employment within the last four
weeks. During the Great Depression of the 1930s, the United States suffered through an unemployment rate of
approximately 25%.
Housing starts in an economic indicator that measures the number of houses, apartments, and condos on which new construction has been started. Because construction involves a wide array of industries–concrete, steel, wood, drywall, plumbing, banks, and many others–housing starts are a carefully watched measure of economic conditions.
Gross domestic product (GDP) refers to the market value of goods and services within a country produced in a given time period and serves as a rough indicator of a country’s standard of living. The United States has a much larger GDP than China, but China has enjoyed a much higher rate of GDP growth in recent years.
The Federal Reserve System (commonly referred to as “The Fed”) is the United States’ central banking system. The Fed attempts to strengthen the economy through its decisions, such as setting short-term interest rates.
Discretionary income refers to the amount of money individuals have to spend after all necessary bills are paid. As discretionary income increases, firms such as boutique clothing retailers that sell nonessential goods and services are more likely to prosper.
Some businesses, however, actually prospered during the crisis. Retailers that offer deep discounts, such as
Dollar General and Walmart, enjoyed an increase in their customer base as consumers sought to find ways to
economize. Similarly, restaurants such as Subway that charge relatively low prices gained customers, while high-
end restaurants such as Ruth’s Chris Steak House worked hard to retain their clientele.
3.3 Evaluating the General Environment 76
Decisions about interest rates made by the Federal Reserve create opportunities for some organizations and threats for others.
S Is for “Social”
A generation ago, ketchup was an essential element of every American pantry and salsa was a relatively unknown
product. Today, however, food manufacturers sell more salsa than ketchup in the United States. This change
reflects the social segment of the general environment. Social factors include trends in demographics such as
population size, age, and ethnic mix, as well as cultural trends such as attitudes toward obesity and consumer
activism (Table 3.4 “Social Factors”). The exploding popularity of salsa reflects the increasing number of Latinos
in the United States over time, as well as the growing acceptance of Latino food by other ethnic groups.
Table 3.4 Social Factors
Examples of several key trends representing social factors in the general environment are illustrated below.
77 Mastering Strategic Management
The rise of upscale cupcake outlets reflects a current trend in American eateries: pricey specialty stores are very popular among some consumers.
Hunters remain a powerful force in American society, but their ranks shrunk by 10% between 1996 and 2006. Wildlife agencies worry about the loss of license-fee revenue will affect their ability to manage land and water resources, and lower levels of demand for their products threaten the success of gun makers.
In the 1800s, most American couples raised many children. Farmers, for example, took this approach because it supplied labor that small farms needed in order to operate. Today, most families are smaller.
One in three Americans is obese, due in part to the increasing prevalence of fast-good restaurants and the popularity of sedentary activities such as playing video games.
Hemline theory contends that women’s skirt lengths predict stock market increases and declines. The idea was born in the 1920s when economist George Taylor noticed that many women raised their skirts to reveal their silk stockings when times were good, but lowered their skirts to hide the fact that they weren’t wearing stockings when times were tough.
The tendency to collect material items while being reluctant to throw them away has led to a rise in self-storage outlets as well as awareness of a hoarding epidemic.
Sometimes changes in the social segment arise from unexpected sources. Before World War II, the American
workforce was overwhelmingly male. When millions of men were sent to Europe and Asia to fight in the war,
however, organizations had no choice but to rely heavily on female employees. At the time, the attitudes of many
executives toward women were appalling. Consider, for example, some of the advice provided to male supervisors
of female workers in the July 1943 issue of Transportation Magazine:1
• Older women who have never contacted the public have a hard time adapting themselves and are
inclined to be cantankerous and fussy. It’s always well to impress upon older women the importance of
friendliness and courtesy.
• General experience indicates that “husky” girls—those who are just a little on the heavy side—are
more even tempered and efficient than their underweight sisters.
• Give every girl an adequate number of rest periods during the day. You have to make some allowances
for feminine psychology. A girl has more confidence and is more efficient if she can keep her hair
tidied, apply fresh lipstick and wash her hands several times a day.
The tremendous contributions of female workers during the war contradicted these awful stereotypes. The main
role of women who assembled airplanes, ships, and other war materials was to support the military, of course,
but their efforts also changed a lot of male executives’ minds about what females could accomplish within
organizations if provided with opportunities. Inequities in the workplace still exist today, but modern attitudes
among men toward women in the workplace are much more enlightened than they were in 1943.
3.3 Evaluating the General Environment 78
Women’s immense contributions to the war effort during World War II helped create positive social changes in the ensuing decades.
Wikimedia Commons – public domain.
Beyond being a positive social change, the widespread acceptance of women into the workforce has created
important opportunities for certain organizations. Retailers such as Talbot’s and Dillard’s sell business attire to
women. Subway and other restaurants benefit when the scarceness of time lead dual income families to purchase
take-out meals rather than cook at home.
79 Mastering Strategic Management
A surprising demographic trend is that both China and India have more than twice as many English-speaking college graduates each
year than does the United States.
T Is for “Technological”
The technological segment centers on improvements in products and services that are provided by science.
Relevant factors include, for example, changes in the rate of new product development, increases in automation,
and advancements in service industry delivery (Table 3.5 “Technological Factors”). One key feature of the modern
era is the ever-increasing pace of technological innovation. In 1965, Intel cofounder Gordon E. Moore offered
an idea that has come to be known as Moore’s law. Moore’s law suggests that the performance of microcircuit
technology roughly doubles every two years. This law has been very accurate in the decades since it was offered.
Table 3.5 Technological Factors
Examples of several key trends representing technological factors in the general environment are illustrated
below.
3.3 Evaluating the General Environment 80
Unsuccessful technological innovations such a Smell-O-Vision (a system that would release different odors that matched the events shown on screen) highlight the risk associated with the technology sector. Image watching a show on horse stables!
The adoption rate of new technology is closely monitored by market research firms. The Internet reached 50 million users in 4 years. To reach the same number of users took 13 years for TV and 38 years for radio.
The dramatic changes in the video game industry over the past 25 years highlight the need to constantly adapt to technological factors to maintain market leadership. Once-mighty Atari has given way to current leaders Sony, Nintendo, and Microsoft.
Moore’s law suggests that the performance of microcircuit technology roughly doubles every two years.
The amount of government spending for research and development affects numerous industries. The government’s decision to dramatically scale back moon-based space programs may reduce the pace of scientific breakthroughs.
One implication of Moore’s law is that over time electronic devices can become smaller but also more powerful.
This creates important opportunities and threats in a variety of settings. Consider, for example, photography.
Just a decade ago, digital cameras were relatively large and they produced mediocre images. With each passing
year, however, digital cameras have become smaller, lighter, and better. Today, digital cameras are, in essence,
minicomputers, and electronics firms such as Panasonic have been able to establish strong positions in the market.
Meanwhile, film photography icon Kodak has been forced to abandon products that had been successful for
decades. In 2005, the firm announced that it would stop producing black-and-white photographic paper. Four
years later, Kodachrome color film was phased out.
Successful technologies are also being embraced at a much faster rate than in earlier generations. The Internet
reached fifty million users in only four years. In contrast, television reached the same number of users in thirteen
years while it took radio thirty-eight years. This trend creates great opportunities for organizations that depend on
emerging technologies. Writers of applications for Apple’s iPad and other tablet devices, for example, are able
to target a fast-growing population of users. At the same time, organizations that depend on technologies that
are being displaced must be aware that consumers could abandon them at a very rapid pace. As more and more
Internet users rely on Wi-Fi service, for example, demand for cable modems may plummet.
81 Mastering Strategic Management
Moore’s law explains how today’s iPhone can be one hundred times faster, one hundred times lighter, and ten times less expensive
than a “portable” computer built in the 1980s.
Wikimedia Commons – CC BY 2.0.
Although the influence of the technological segment on technology-based companies such as Panasonic and
Apple is readily apparent, technological trends and events help to shape low-tech businesses too. In 2009, Subway
started a service called Subway Now. This service allows customers to place their orders in advance using text
messages and avoid standing in line at the store. By offering customers this service, Subway is also responding to
a trend in the general environment’s social segment: the need to save time in today’s fast-paced society.
E Is for “Environmental”
The environmental segment involves the physical conditions within which organizations operate. It includes
factors such as natural disasters, pollution levels, and weather patterns (Table 3.6 “Environmental Factors”). The
threat of pollution, for example, has forced municipalities to treat water supplies with chemicals. These chemicals
increase the safety of the water but detract from its taste. This has created opportunities for businesses that provide
better-tasting water. Rather than consume cheap but bad-tasting tap water, many consumers purchase bottled
water. Indeed, according to the Beverage Marketing Corporation, the amount of bottled water consumed by the
average American increased from 1.6 gallons in 1976 to 28.3 gallons in 2006 (Earth911). At present, roughly one-
third of Americans drink bottled water regularly.
Table 3.6 Environmental Factors
Examples of several key trends representing enviornmental factors in the general environment are illustrated
below.
3.3 Evaluating the General Environment 82
The Subaru automotive plant in Lafayette, Indiana, was the first auto manufacturing facility to achieve zero landfill status.
Debate has raged over climate change in recent years. To the extend that more policy markers and consumers believe that human activity is increasing temperatures on the Earth, opportunities could increase for solar energy companies.
Individuals embracing the three Rs of green living–reduce, reuse, recycle–has fueled new business concepts such as Recycle Match, a firm that brings together waste products with businesses that need those materials.
Concern about the environmental effects of burning fossil fuels has contributed to the growing popularity of scooters.
The increase in the number of food cooperatives reflects growing interest in sustainable, natural foods that are produced with a high degree of social responsibility.
As is the case for many companies, bottled water producers not only have benefited from the general environment
but also have been threatened by it. Some estimates are that 80 percent of plastic bottles end up in landfills.
This has led some socially conscious consumers to become hostile to bottled water. Meanwhile, water filtration
systems offered by Brita and other companies are a cheaper way to obtain clean and tasty water. Such systems also
hold considerable appeal for individuals who feel the need to cut personal expenses due to economic conditions.
In sum, bottled water producers have been provided opportunities by the environmental segment of the general
environment (specifically, the spread of poor-tasting water to combat pollution) but are faced with threats from
the social segment (the social conscience of some consumers) and the economic segment (the financial concerns
of other consumers).
A key trend within the environmental segment is an increasing emphasis on conserving fossil fuels.
83 Mastering Strategic Management
L Is for “Legal”
The legal segment centers on how the courts influence business activity. Examples of important legal factors
include employment laws, health and safety regulations, discrimination laws, and antitrust laws (Table 3.7 “Legal
Factors”).
Intellectual property rights are a particularly daunting aspect of the legal segment for many organizations.
When a studio such as Pixar produces a movie, a software firm such as Adobe revises a program, or a video game
company such as Activision devises a new game, these firms are creating intellectual property. Such firms attempt
to make profits by selling copies of their movies, programs, and games to individuals. Piracy of intellectual
property—a process wherein illegal copies are made and sold by others—poses a serious threat to such profits.
Law enforcement agencies and courts in many countries, including the United States, provide organizations with
the necessary legal mechanisms to protect their intellectual property from piracy.
Table 3.7 Legal Factors
Examples of several key trends representing legal factors in the general environment are illustrated below.
Electronic recycling laws are creating opportunities for “green collar jobs.” A recent Missouri law, for example, requires computer electronic equipment manufacturers to develop and implement recycling plans.
The Sherman Antitrust Act of 1890 limits cartels and monopolies in the United States. Senator John Sherman was the principal author of this legislation.
In the United States, it is illegal to discriminate against anyone based on age, race, religion, gender or disability.
The role of the Occupational Safety and Health Administration (OSHA) is to prevent work-related injuries, diseases, and fatalities by enforcing standards for workplace safety and health.
Laws requiring that nutrition information must appear on the packaging of most food products are intended to protect consumers and help them make informed choices.
In other countries, such as China, piracy of intellectual property is quite common. Three other general
environment segments play a role in making piracy a major concern. First, in terms of the social segment, China is
the most populous country in the world. Second, in terms of the economic segment, China’s affluence is growing
rapidly. Third, in terms of the technological segment, rapid advances in computers and communication have made
piracy easier over time. Taken together, these various general environment trends lead piracy to be a major source
of angst for firms that rely on intellectual property to deliver profits.
3.3 Evaluating the General Environment 84
A key legal trend in recent years is forcing executives to have greater accountability for corporate misdeeds via laws such as the 2002
Sarbanes-Oxley Act.
Reproduced with permission from
Key Takeaway
• To transform an avocado into guacamole, a chef may choose to use a mortar and pestle. A mortar is a mashing device that is shaped liked a baseball bat, while a pestle is a sturdy bowl within which the mashing takes place. Similarly, PESTEL reflects the general environment factors—political, economic, social, technological, environmental, and legal—that can crush an organization. In many cases, executives can prevent such outcomes by performing a PESTEL analysis to diagnose where in the general environment important opportunities and threats arise.
85 Mastering Strategic Management
SONY DSC
Just as a mortar and pestle are used to crush food, PESTEL can crush an organization.
Wikimedia Commons – public domain.
Exercises
1. What does each letter of PESTEL mean?
2. Using a recent news article, identify a trend that has a positive and negative implication for a particular industry.
3. Can you identify a general environment trend that has positive implications for nursing homes but negative implications for diaper makers?
4. Are all six elements of PESTEL important to every organization? Why or why not?
5. What is a key trend for each letter of PESTEL and one industry or firm that would be affected by that trend?
11943 guide to hiring women. 2007, September–October. Savvy & Sage, p. 16.
3.3 Evaluating the General Environment 86
References
Earth911, Plastic recycling facts. earth911.com. Retrieved from http://earth911.com/recycling/plastic/plastic-
bottle-recycling-facts
87 Mastering Strategic Management
3.4 Evaluating the Industry
Learning Objectives
1. Explain how five forces analysis is useful to organizations.
2. Be able to offer an example of each of the five forces.
Table 3.8 Industry Analysis
Understanding the dynamics that shape how much profit potential exists within an industry is key to knowing
how likely a particular firm is to succeed within the industry. There are five key forces that determine the
profitability of a particular industry.
POTENTIAL ENTRANTS are firms that are not currently considered viable competitors in the industry but that may become viable competitors in the future. For example, Tesla Motors’ production of electric vehicles poses a threat to displace the traditional powers in the auto industry, and Chinese auto makers are rumored to be eyeing the US market.
SUPPLIERS to the auto industry include firms such as Lear Corporation who produces auto interior systems.
INDUSTRY COMPETITORS in the auto industry include firms such as Ford, Chrysler, and GM.
BUYERS are those firms that buy directly from the industry such as automobile dealerships. Automakers also have to pay careful attention to end users, of course, such as individual drivers and rental car agencies.
SUBSTITUTES for the auto industry’s products include bicycles and mass transit. Luckily for automakers competing in the US market, Americans are notoriously reluctant to embrace these substitutes.
The Purpose of Five Forces Analysis
Visit the executive suite of any company and the chances are very high that the chief executive officer and her
vice presidents are relying on five forces analysis to understand their industry. Introduced more than thirty years
ago by Professor Michael Porter of the Harvard Business School, five forces analysis has long been and remains
perhaps the most popular analytical tool in the business world (Table 3.8 “Industry Analysis”).
Porter’s Five Forces
The purpose of five forces analysis is to identify how much profit potential exists in an industry. To do so,
five forces analysis considers the interactions among the competitors in an industry, potential new entrants to the
industry, substitutes for the industry’s offerings, suppliers to the industry, and the industry’s buyers (Porter, 1979).
If none of these five forces works to undermine profits in the industry, then the profit potential is very strong. If
all the forces work to undermine profits, then the profit potential is very weak. Most industries lie somewhere in
between these extremes. This could involve, for example, all five forces providing firms with modest help or two
forces encouraging profits while the other three undermine profits. Once executives determine how much profit
potential exists in an industry, they can then decide what strategic moves to make to be successful. If the situation
looks bleak, for example, one possible move is to exit the industry.
The Rivalry among Competitors in an Industry
The competitors in an industry are firms that produce similar products or services. Competitors use a variety
of moves such as advertising, new offerings, and price cuts to try to outmaneuver one another to retain existing
buyers and to attract new ones. Because competitors seek to serve the same general set of buyers, rivalry
can become intense (Table 3.9 “Rivalry”). Subway faces fierce competition within the restaurant business, for
example. This is illustrated by a quote from the man who built McDonald’s into a worldwide icon. Former CEO
Ray Kroc allegedly once claimed that “if any of my competitors were drowning, I’d stick a hose in their mouth.”
While this sentiment was (hopefully) just a figure of speech, the announcement in March 2011 that Subway had
surpassed McDonald’s in terms of numbers of stores might lead the hostility of McDonald’s toward its rival to
rise.
89 Mastering Strategic Management
Table 3.9 Rivalry
High levels of rivalry tend to reduce the profit potential of an industry. A number of characteristics that affect
the intensity of the rivalry among competitors are illustrated below.
Rivalry among existing competitors tends to be high to the extent that…
Competitors are numerous or are roughly equal in size and power.
No one firm rules the industry, and cutthroat moves are likely as firms jockey for position.
The growth rate of the industry is slow. A shortage of new customers leads firms to steal each other’s customers.
Competitors are not differentiated from each other.
This forces firms to compete based on price rather than based on the uniqueness of their offerings.
Fixed costs in the industry are high. These costs must be covered, even if it means slashing prices in order to do so.
Exit barriers are high. Firms must stay and fight rather than leaving the industry gracefully.
Excess capacity exists in the industry. When too much of a product is available, firms must work hard to earn sales.
Capacity must be expanded in large increments to be efficient.
The high costs of adding these increments needs to be covered.
The product is perishable Firms need to sell their wares before they spoil and become worthless.
Understanding the intensity of rivalry among an industry’s competitors is important because the degree of
intensity helps shape the industry’s profit potential. Of particular concern is whether firms in an industry
compete based on price. When competition is bitter and cutthroat, the prices competitors charge—and their profit
margins—tend to go down. If, on the other hand, competitors avoid bitter rivalry, then price wars can be avoided
and profit potential increases.
Every industry is unique to some degree, but there are some general characteristics that help to predict the
likelihood that fierce rivalry will erupt. Rivalry tends to be fierce, for example, to the extent that the growth rate
of demand for the industry’s offerings is low (because a lack of new customers forces firms to compete more for
existing customers), fixed costs in the industry are high (because firms will fight to have enough customers to
cover these costs), competitors are not differentiated from one another (because this forces firms to compete based
on price rather than based on the uniqueness of their offerings), and exit barriers in the industry are high (because
firms do not have the option of leaving the industry gracefully). Exit barriers can include emotional barriers, such
as the bad publicity associated with massive layoffs, or more objective reasons to stay in an industry, such as a
desire to recoup considerable costs that might have been previously spent to enter and compete.
Table 3.10 Industry Concentration
Industry concentration refers to the extent to which large firms dominate an industry. Buyers and suppliers
generally have more bargaining power when they are from concentrated industries. This is because the firms
that do business with them have fewer options when seeking buyers and suppliers. One popular way to measure
industry concentration is via the percentage of total industry output that is produced by the four biggest
competitors. Below are examples of industries that have high (80%-100%), medium (50%-79%), and low (below
50%) levels of concentration.
3.4 Evaluating the Industry 90
High-Concentration Industries
Circuses (89%) and Breakfast cereal manufacturing (85%)
Medium-Concentration Industries
Flight training (52%) and Sugar manufacturing (60%)
Low-Concentration (or “Fragmented”) Industries
Full-service restaurants (9%), Legal services (3%), Truck driving schools (27%), and Telephone call centers (22%)
Industry concentration is an important aspect of competition in many industries. Industry concentration is the
extent to which a small number of firms dominate an industry (Table 3.10 “Industry Concentration”). Among
circuses, for example, the four largest companies collectively own 89 percent of the market. Meanwhile, these
companies tend to keep their competition rather polite. Their advertising does not lampoon one another, and they
do not put on shows in the same city at the same time. This does not guarantee that the circus industry will be
profitable; there are four other forces to consider as well as the quality of each firm’s strategy. But low levels of
rivalry certainly help build the profit potential of the industry.
In contrast, the restaurant industry is fragmented, meaning that the largest rivals control just a small fraction of
the business and that a large number of firms are important participants. Rivalry in fragmented industries tends to
become bitter and fierce. Quiznos, a chain of sub shops that is roughly 15 percent the size of Subway, has directed
some of its advertising campaigns directly at Subway, including one depicting a fictional sub shop called “Wrong
Way” that bore a strong resemblance to Subway.
Within fragmented industries, it is almost inevitable that over time some firms will try to steal customers
from other firms, such as by lowering prices, and that any competitive move by one firm will be matched by
others. In the wake of Subway’s success in offering foot-long subs for $5, for example, Quiznos has matched
Subway’s price. Such price jockeying is delightful to customers, of course, but it tends to reduce prices (and profit
margins) within an industry. Indeed, Quiznos later escalated its attempt to attract budget-minded consumers by
introducing a flatbread sandwich that cost only $2. Overall, when choosing strategic moves, Subway’s presence in
a fragmented industry forces the firm to try to anticipate not only how fellow restaurant giants such as McDonald’s
and Burger King will react but also how smaller sub shop chains like Quiznos and various regional and local
players will respond.
Table 3.11 New Entrants
The Great Wall of China effectively protected China against potential raiders for centuries. The metaphor of
a high wall as a defense against potential entrants is a key element in Porter’s five forces model. Industries with
higher barriers to entry are in a safer defensive position that industries with lower barriers. Below we describe
several factors that make it difficult for would-be invaders to enter an industry.
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Economies of scale – As the number of customers a firm seves increases, the cost of serving each customer tends to decrease. This is because fixed costs–the expenses the firm must pay, such as the loan payments on an automobile factory–are allocated across a larger number of sales. When the firms in an industry enjoy significant economies of scale, new firms struggle to be able to sell their wares at competitive prices.
Capital requirements – The more expensive it is to enter a business, the less likely a new firm is to attempt to enter it. When these capital requirements are substantial (as in the automobile and many other manufacturing industries), existing competitors have less fear of new firms entering their market. It is simply very difficult to gather up enough cash to enter certain businesses.
Access to distribution channels – The ability to get goods and services to customers can pose a significant challenge to would-be newcomers. In the auto industry, for example, a new firm would struggle to match the network of dealerships enjoyed by Ford, GM, and other auto makers.
Government policy – Decisions made by governments can deter or encourage potential new entrants. In 2009, the U.S. government kept GM afloat via a massive infusion of cash. Had GM been left to die instead, this could have opened the door for a new company to enter the industry, perhaps by buying some of GM’s factories.
Differentiation – Auto makers spend millions of dollars each year on advertising in order to highlight the unique features of their cars. A new entrant would struggle to match the differentiation that years of advertising have created for various brands.
Switching costs – Switching costs endured by consumers are one of the challenges facing the makers of alternative fuel vehicles. A massive number of gas stations and repair shops are in place to support gasoline-powered cars, but few facilities can recharge or fix electric cars. At present, few consumers are willing to live with the significant hassles and inconvenience that arise when purchasing an alternative fuel vehicle.
Expected retaliation – New firms must be concerned about whether current industry members will aggressively respond to them entering the market. If a firm succeeded in entering the automobile business, for example, existing companies might slash their prices in order to keep their market share intact.
Cost advantages independent of size – Proprietary technology, access to raw materials, and desirable geographic location are all examples of cost advantages not directly associated with size (and economies of scale). In the auto industry, the decades of engineering experience possessed by the major auto markers is an example of such an advantage. A new entrant would struggle to duplicate this know-how at any price.
The Threat of Potential New Entrants to an Industry
Competing within a highly profitable industry is desirable, but it can also attract unwanted attention from outside
the industry. Potential new entrants to an industry are firms that do not currently compete in the industry but
may in the future (Table 3.11 “New Entrants”). New entrants tend to reduce the profit potential of an industry by
increasing its competitiveness. If, for example, an industry consisting of five firms is entered by two new firms,
this means that seven rather than five firms are now trying to attract the same general pool of customers. Thus
executives need to analyze how likely it is that one or more new entrants will enter their industry as part of their
effort to understand the profit potential that their industry offers.
New entrants can join the fray within an industry in several different ways. New entrants can be start-up
companies created by entrepreneurs, foreign firms that decide to enter a new geographic area, supplier firms
that choose to enter their customers’ business, or buyer firms that choose to enter their suppliers’ business. The
likelihood of these four paths being taken varies across industries. Restaurant firms such as Subway, for example,
do not need to worry about their buyers entering the industry because they sell directly to individuals, not to firms.
It is also unlikely that Subway’s suppliers, such as farmers, will make a big splash in the restaurant industry.
3.4 Evaluating the Industry 92
The entry of chicken burger restaurant Oporto into the United States might hurt hamburger restaurants more than it hurts Subway and
other sandwich makers.
Wikimedia Commons – CC BY-SA 4.0.
On the other hand, entrepreneurs launch new restaurant concepts every year, and one or more of these concepts
may evolve into a fearsome competitor. Also, competitors based overseas sometimes enter Subway’s core US
market. In February 2011, Australia-based Oporto opened its first US store in California (Odell, 2011). Oporto
operates more than 130 chicken burger restaurants in its home country. Time will tell whether this new entrant
has a significant effect on Subway and other restaurant firms. Because a chicken burger closely resembles a
hamburger, McDonald’s and Burger King may have more to fear from Oporto than does Subway.
Every industry is unique to some degree, but some general characteristics help to predict the likelihood that new
entrants will join an industry. New entry is less likely, for example, to the extent that existing competitors enjoy
economies of scale (because new entrants struggle to match incumbents’ prices), capital requirements to enter
the industry are high (because new entrants struggle to gather enough cash to get started), access to distribution
channels is limited (because new entrants struggle to get their offerings to customers), governmental policy
discourages new entry, differentiation among existing competitors is high (because each incumbent has a group
of loyal customers that enjoy its unique features), switching costs are high (because this discourages customers
from buying a new entrant’s offerings), expected retaliation from existing competitors is high, and cost advantages
independent of size exist.
Table 3.12 Substitutes
A substitute teacher is a person who fills in for a teacher. Some substitute teachers are almost as good as the
“real” teacher while others are woefully inadequate. In business, the competitors in an industry not only must
watch each other, they must keep an eye on firms in other industries whose products or services can serve as
effective substitutes for their offerings. In some cases, substitutes are so effective that they are said to “disrupt”
the industry, meaning they kill most or all industry demand. Below we note a number of effective substitutes for
particular industries.
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Cooking at home can be an effective substitute for eating at restaurants, especially in challenging economic times.
E-mails and faxes are less expensive substitutes for some of the US Postal Service’s offerings. Meanwhile, text messages can serve as substitutes for many e-mails.
Typewriting classes were once common in schools. But once personal computers and printers became widely accepted, the typewriter industry declined dramatically.
Railroads once held almost a monopoly position on freight transportation. However, the rise of the trucking industry reduced demand for the railroad industry’s services.
DIRECTV’s commercials compare the firm’s offerings not only to what its fellow satellite television provider DISH Network provides but also to the offerings of a close substitute–cable television companies.
The Threat of Substitutes for an Industry’s Offerings
Executives need to take stock not only of their direct competition but also of players in other industries that can
steal their customers. Substitutes are offerings that differ from the goods and services provided by the competitors
in an industry but that fill similar needs to what the industry offers (Table 3.12 “Substitutes”). How strong of a
threat substitutes are depends on how effective substitutes are in serving an industry’s customers.
At first glance, it could appear that the satellite television business is a tranquil one because there are only
two significant competitors—DIRECTV and DISH Network. These two industry giants, however, face a daunting
challenge from substitutes. The closest substitute for satellite television is provided by cable television firms, such
as Comcast and Charter Communications. DIRECTV and DISH Network also need to be wary of streaming video
services, such as Netflix, and video rental services, such as Redbox. The availability of viable substitutes places
stringent limits on what DIRECTV and DISH Network can charge for their services. If the satellite television
firms raise their prices, customers will be tempted to obtain video programs from alternative sources. This limits
the profit potential of the satellite television business.
In other settings, viable substitutes are not available, and this helps an industry’s competitors enjoy profits. Like
lightbulbs, candles can provide lighting within a home. Few consumers, however, would be willing to use candles
instead of lightbulbs. Candles simply do not provide as much light as lightbulbs. Also, the risk of starting a fire
when using candles is far greater than the fire risk of using lightbulbs. Because candles are a poor substitute,
lightbulb makers such as General Electric and Siemens do not need to fear candle makers stealing their customers
and undermining their profits.
3.4 Evaluating the Industry 94
Few consumers would be willing to substitute candles for lightbulbs.
Wikimedia Commons – CC0 public domain.
The dividing line between which firms are competitors and which firms offer substitutes is a challenging issue
for executives. Most observers would agree that, from Subway’s perspective, sandwich maker Quiznos should
be considered a competitor and that grocery stores such as Kroger offer a substitute for Subway’s offerings. But
what about full-service restaurants, such as Ruth’s Chris Steak House, and “fast causal” outlets, such as Panera
Bread? Whether firms such as these are considered competitors or substitutes depends on how the industry is
defined. Under a broad definition—Subway competes in the restaurant business—Ruth’s Chris and Panera should
be considered competitors. Under a narrower definition—Subway competes in the sandwich business—Panera
is a competitor and Ruth’s Chris is a substitute. Under a very narrow definition—Subway competes in the sub
sandwich business—both Ruth’s Chris and Panera provide substitute offerings. Thus clearly defining a firm’s
industry is an important step for executives who are performing a five forces analysis.
95 Mastering Strategic Management
Table 3.13 Suppliers
A number of characteristics that impact the power of suppliers to a given industry are illustrated below.
A supplier group is powerful if it is dominated by a few companies or is more concentrated than the industry that it supplies.
The DeBeers Company of South Africa owns the vast majority of diamond mines in the world. This gives the firm great leverage when negotiating with various jewelry produces.
A supplier group is powerful if there is no substitute for what the supplier group provides.
Although artificial diamonds are fine for industrial applications, real diamonds are necessary for jewelry. Any groom who thinks otherwise is playing a risky game indeed.
A supplier group is powerful if industry members rely heavily on suppliers to be profitable.
Computer, cellular phone, and digital appliance manufacturers all rely heavily on suppliers in the microchip manufacturing industry.
A supplier group is powerful if industry members face high costs when changing suppliers.
Most computers installed in university classrooms are PCs. A university that wants to switch to using Apple computers would endure enormous costs in money and labor. This strengthens the position of PC makers a bit when they deal with universities.
A supplier group is powerful if their products are differentiated.
Dolby Laboratories offers top-quality audio systems that are backed by a superb reputation. Firms that make home theater equipment and car stereos have little choice but to buy from Dolby because many consumers simply expect to enjoy Dolby’s technology.
A supplier group is powerful if it can credibly threaten to compete (integrate forward) in the industry if motivated.
Before a rental car company drives too hard of a bargain when buying cars from an auto maker, it should remember that Ford used to own Hertz.
The Power of Suppliers to an Industry
Suppliers provide inputs that the firms in an industry need to create the goods and services that they in turn sell to
their buyers. A variety of supplies are important to companies, including raw materials, financial resources, and
labor (Table 3.13 “Suppliers”). For restaurant firms such as Subway, key suppliers include such firms as Sysco
that bring various foods to their doors, restaurant supply stores that sell kitchen equipment, and employees that
provide labor.
The relative bargaining power between an industry’s competitors and its suppliers helps shape the profit
potential of the industry. If suppliers have greater leverage over the competitors than the competitors have over
the suppliers, then suppliers can increase their prices over time. This cuts into competitors’ profit margins and
makes them less likely to be prosperous. On the other hand, if suppliers have less leverage over the competitors
than the competitors have over the suppliers, then suppliers may be forced to lower their prices over time. This
strengthens competitors’ profit margins and makes them more likely to be prosperous. Thus when analyzing the
profit potential of their industry, executives must carefully consider whether suppliers have the ability to demand
higher prices.
Every industry is unique to some degree, but some general characteristics help to predict the likelihood that
suppliers will be powerful relative to the firms to which they sell their goods and services. Suppliers tend to
be powerful, for example, to the extent that the suppliers’ industry is dominated by a few companies, if it is
more concentrated than the industry that it supplies and/or if there is no effective substitute for what the supplier
3.4 Evaluating the Industry 96
group provides. These circumstances restrict industry competitors’ ability to shop around for better prices and put
suppliers in a position of strength.
Supplier power is also stronger to the extent that industry members rely heavily on suppliers to be profitable,
industry members face high costs when changing suppliers, and suppliers’ products are differentiated. Finally,
suppliers possess power to the extent that they have the ability to become a new entrant to the industry if they
wish. This is a strategy called forward vertical integration. Ford, for example, used a forward vertical integration
strategy when it purchased rental car company (and Ford customer) Hertz. A difficult financial situation forced
Ford to sell Hertz for $5.6 billion in 2005. But before rental car companies such as Avis and Thrifty drive too hard
of a bargain when buying cars from an automaker, their executives should remember that automakers are much
bigger firms than are rental car companies. The executives running the automaker might simply decide that they
want to enjoy the rental car company’s profits themselves and acquire the firm.
Strategy at the Movies
Flash of Genius
When dealing with a large company, a small supplier can get squashed like a bug on a windshield. That is what college professor and inventor Dr. Robert Kearns found out when he invented intermittent windshield wipers in the 1960s and attempted to supply them to Ford Motor Company. As depicted in the 2008 movie Flash of Genius, Kearns dreamed of manufacturing the wipers and selling them to Detroit automakers. Rather than buy the wipers from Kearns, Ford replicated the design. An angry Kearns then spent many years trying to hold the firm accountable for infringing on his patent. Kearns eventually won in court, but he paid a terrible personal price along the way, including a nervous breakdown and estrangement from his family. Kearns’s lengthy battle with Ford illustrates the concept of bargaining power that is central to Porter’s five forces model. Even though Kearns created an exceptional new product, he had little leverage when dealing with a massive, well-financed automobile manufacturer.
Pixabay – CC0 public domain.
97 Mastering Strategic Management
Table 3.14 Buyers
A number of characteristics that impact the power of buyers to a given industry are illustrated below.
A buyer group is powerful when there are relatively few buyers compared to the number of firms supplying the industry.
Buyers that purchase a large percentage of the seller’s goods and services are more powerful, as Walmart has demonstrated by aggressively negotiating with suppliers over the years.
A buyer group is powerful when the industry’s goods or services are standardized or undifferentiated.
Subway can drive a hard bargain when purchasing commodities such as wheat and yeast is typically identical to another vendor’s.
A buyer group is powerful when they face little or no switching costs in changing vendors.
Circuses can find elephants, clowns, and trapeze artists from any source possible. This allows circus managers to shop around for the best prices.
A buyer group is powerful when the good or service purchased by the buyers represents a high percentage of the buyer’s costs, encouraging ongoing searches for lower-priced suppliers.
Most consumers pay little attention to prices when buying toothpaste, but may spend hours exhaustively searching the Internet for information on automobile prices.
A buyer group is powerful if it can credibly threaten to compete (integrate backward) in the industry if motivated.
For and General Motors are well known for threatening to self-manufacture auto parts if suppliers do not provide goods and services at acceptable prices.
A buyer group is powerful when the good or service purchased by buyer groups is of limited importance to the quality or price of the buyer’s offerings.
While stereo systems and tires are components that car buyers may be sensitive to when making a purchase decision, auto manufacturers can purchase glass and spark plugs from any vendor as long as it meets quality standards. This gives automakers leverage when negotiating with glass and spark plugs companies.
The Power of an Industry’s Buyers
Buyers purchase the goods and services that the firms in an industry produce (Table 3.14 “Buyers”). For Subway
and other restaurants, buyers are individual people. In contrast, the buyers for some firms are other firms rather
than end users. For Procter & Gamble, for example, buyers are retailers such as Walmart and Target who stock
Procter & Gamble’s pharmaceuticals, hair care products, pet supplies, cleaning products, and other household
goods on their shelves.
The relative bargaining power between an industry’s competitors and its buyers helps shape the profit potential
of the industry. If buyers have greater leverage over the competitors than the competitors have over the buyers,
then the competitors may be forced to lower their prices over time. This weakens competitors’ profit margins and
makes them less likely to be prosperous. Walmart furnishes a good example. The mammoth retailer is notorious
among manufacturers of goods for demanding lower and lower prices over time (Bianco & Zellner, 2003). In
2008, for example, the firm threatened to stop selling compact discs if record companies did not lower their prices.
Walmart has the power to insist on price concessions because its sales volume is huge. Compact discs make up a
small portion of Walmart’s overall sales, so exiting the market would not hurt Walmart. From the perspective of
record companies, however, Walmart is their biggest buyer. If the record companies were to refuse to do business
with Walmart, they would miss out on access to a large portion of consumers.
3.4 Evaluating the Industry 98
On the other hand, if buyers have less leverage over the competitors than the competitors have over the buyers,
then competitors can raise their prices and enjoy greater profits. This description fits the textbook industry quite
well. College students are often dismayed to learn that an assigned textbook costs $150 or more. Historically,
textbook publishers have been able to charge high prices because buyers had no leverage. A student enrolled in
a class must purchase the specific book that the professor has selected. Used copies are sometimes a lower-cost
option, but textbook publishers have cleverly worked to undermine the used textbook market by releasing new
editions after very short periods of time.
Of course, the presence of a very high profit industry is attractive to potential new entrants. Firms such as, the
publisher of this book, have entered the textbook market with lower-priced offerings. Time will tell whether such
offerings bring down textbook prices. Like any new entrant, upstarts in the textbook business must prove that
they can execute their strategies before they can gain widespread acceptance. Overall, when analyzing the profit
potential of their industry, executives must carefully consider whether buyers have the ability to demand lower
prices. In the textbook market, buyers do not.
College students’ lack of buyer power in the textbook industry has kept prices high for decades and created frustration for students.
anna gutermuth – 5/365 – CC BY 2.0.
Every industry is unique to some degree, but some general characteristics help to predict the likelihood that
buyers will be powerful relative to the firms from which they purchases goods and services. Buyers tend to be
powerful, for example, to the extent that there are relatively few buyers compared with the number of firms that
supply the industry, the industry’s goods or services are standardized or undifferentiated, buyers face little or no
switching costs in changing vendors, the good or service purchased by the buyers represents a high percentage of
the buyer’s costs, and the good or service is of limited importance to the quality or price of the buyer’s offerings.
99 Mastering Strategic Management
Finally, buyers possess power to the extent that they have the ability to become a new entrant to the industry if
they wish. This strategy is called backward vertical integration. DIRECTV used to be an important customer of
TiVo, the pioneer of digital video recorders. This situation changed, however, when executives at DIRECTV grew
weary of their relationship with TiVo. DIRECTV then used a backward vertical integration strategy and started
offering DIRECTV-branded digital video recorders. Profits that used to be enjoyed by TiVo were transferred at
that point to DIRECTV.
The Limitations of Five Forces Analysis
Five forces analysis is useful, but it has some limitations too. The description of five forces analysis provided
by its creator, Michael Porter, seems to assume that competition is a zero-sum game, meaning that the amount
of profit potential in an industry is fixed. One implication is that, if a firm is to make more profit, it must take
that profit from a rival, a supplier, or a buyer. In some settings, however, collaboration can create a larger pool
of profit that benefits everyone involved in the collaboration. In general, collaboration is a possibility that five
forces analysis tends to downplay. The relationships among the rivals in an industry, for example, are depicted as
adversarial. In reality, these relationships are sometimes adversarial and sometimes collaborative. General Motors
and Toyota compete fiercely all around the world, for example, but they also have worked together in joint
ventures. Similarly, five forces analysis tends to portray a firm’s relationships with its suppliers and buyers as
adversarial, but many firms find ways to collaborate with these parties for mutual benefit. Indeed, concepts such
as just-in-time inventory systems depend heavily on a firm working as a partner with its suppliers and buyers.
Key Takeaway
• “How much profit potential exists in our industry?” is a key question for executives. Five forces analysis provides an answer to this question. It does this by considering the interactions among the competitors in an industry, potential new entrants to the industry, substitutes for the industry’s offerings, suppliers to the industry, and the industry’s buyers.
Exercises
1. What are the five forces?
2. Is there an aspect of industry activity that the five forces seems to leave out?
3. Imagine you are the president of your college or university. Which of the five forces would be most important to you? Why?
3.4 Evaluating the Industry 100
References
Bianco, B., & Zellner, W. 2003, October 6. Is Wal-Mart too powerful? Bloomberg Businessweek. Retrieved from
http://www.businessweek.com/magazine/content/03_40/b3852001_mz001.htm.
Odell, K. 2011, February 22. Portuguese-influenced Australian chicken burger chain, Oporto, comes to SoCal.
Eater LA. Retrieved from http://la.eater.com/archives/2011/02/22/
portugueseinfluenced_australian_chicken_burger_chain_oporto_comes_to_socal.php.
Porter, M. E. 1979, March–April. How competitive forces shape strategy. Harvard Business Review, 137–156.
101 Mastering Strategic Management
3.5 Mapping Strategic Groups
Learning Objectives
1. Understand what strategic groups are.
2. Learn three ways that analyzing strategic groups is useful to organizations.
Table 3.15 Strategic Groups
Strategic groups are sets of firms that follow similar strategies. Understanding the nature of strategic groups within an industry is
important in part because the members of a firm’s group are usually that firm’s closest rivals. Below we illustrate several strategic
groups in the restaurant industry.
The analysis of the strategic groups in an industry can offer important insights to executives. Strategic groups
are sets of firms that follow similar strategies to one another (Hunt, 1972; Short, et. al., 2007). More specifically,
a strategic group consists of a set of industry competitors that have similar characteristics to one another but differ
in important ways from the members of other groups (Table 3.15 “Strategic Groups”).
Understanding the nature of strategic groups within an industry is important for at least three reasons. First,
emphasizing the members of a firm’s group is helpful because these firms are usually its closest rivals. When
assessing their firm’s performance and considering strategic moves, the other members of a group are often the
best referents for executives to consider. In some cases, one or more strategic groups in the industry are irrelevant.
Subway, for example, does not need to worry about competing for customers with the likes of Ruth’s Chris Steak
House and P. F. Chang’s. This is partly because firms confront mobility barriers that make it difficult or illogical
for a particular firm to change groups over time. Because Subway is unlikely to offer a gourmet steak as well as
the experience offered by fine-dining outlets, they can largely ignore the actions taken by firms in that restaurant
industry strategic group.
Second, the strategies pursued by firms within other strategic groups highlight alternative paths to success. A
firm may be able to borrow an idea from another strategic group and use this idea to improve its situation. During
the recession of the late 2000s, midquality restaurant chains such as Applebee’s and Chili’s used a variety of
promotions such as coupons and meal combinations to try to attract budget-conscious consumers. Firms such as
Subway and Quiznos that already offered low-priced meals still had an inherent price advantage over Applebee’s
and Chili’s, however: There is no tipping expected at the former restaurants, but there is at the latter. It must have
been tempting to executives at Applebee’s and Chili’s to try to expand their appeal to budget-conscious consumers
by experimenting with operating formats that do not involve tipping.
Midquality restaurants do not compete directly with pricey steakhouses, but they might be able to borrow ideas from such venues.
Tella Chen – Steak – CC BY-NC 2.0.
Third, the analysis of strategic groups can reveal gaps in the industry that represent untapped opportunities.
Within the restaurant business, for example, it appears that no national chain offers both very high-quality meals
and a very diverse menu. Perhaps the firm that comes the closest to filling this niche is the Cheesecake Factory, a
chain of approximately 150 outlets whose menu includes more than 200 lunch, dinner, and dessert items. Ruth’s
103 Mastering Strategic Management
Chris Steak House already offers very high quality food; its executives could consider moving the firm toward
offering a very diverse menu as well. This would involve considerable risk, however. Perhaps no national chain
offers both very high quality meals and a very diverse menu because doing so is extremely difficult. Nevertheless,
examining the strategic groups in an industry with an eye toward untapped opportunities offers executives a
chance to consider novel ideas.
Key Takeaway
• Examination of the strategic groups in an industry provides a firm’s executives with a better understanding of their closest rivals, reveals alternative paths to success, and highlights untapped opportunities.
Exercises
1. What other colleges and universities are probably in your school’s strategic group?
2. From what other groups of colleges and universities could your school learn? What specific ideas could be borrowed from these groups?
References
Hunt, M. S. 1972. Competition in the major home appliance industry 1960–1970. (Unpublished doctoral
dissertation). Harvard University, Cambridge, MA.
Short, J. C., Ketchen, D. J., Palmer, T., & Hult, G. T. 2007. Firm, strategic group, and industry influences on
performance. Strategic Management Journal, 28, 147–167.
3.5 Mapping Strategic Groups 104
3.6 Conclusion
This chapter explains several considerations for examining the external environment that executives must monitor
to lead their organizations strategically. Executives must be aware of trends and changes in the general
environment, as well as the condition of their specific industry, as elements of both have the potential to
change considerably over time. While PESTEL analysis provides a useful framework to understand the general
environment, Porter’s five forces is helpful to make sense of an industry’s profit potential. Strategic groups
are valuable for understanding close competitors that affect a firm more than other industry members. When
executives carefully monitor their organization’s environment using these tools, they greatly increase the chances
of their organization being successful.
Exercises
1. In groups of four or five, use the PESTEL framework to identify elements from each factor of the general environment that could have a large effect on your future career.
2. Use Porter’s five forces analysis to analyze an industry in which you might like to work in the future. Discuss the implications your results may have on the salary potential of jobs in that industry and how that could impact your career plans.
Chapter 4: Managing Firm Resources
Chapter 4: Managing Firm Resources
4.1 Managing Firm Resources
4.2 Resource-Based Theory
4.3 Intellectual Property
4.4 Value Chain
4.5 Beyond Resource-Based Theory: Other Views on Firm Performance
4.6 SWOT Analysis
4.7 Conclusion
4.1 Managing Firm Resources
Learning
Objectives
After reading this chapter, you should be able to understand and articulate answers to the following questions:
1. What is resource-based theory, and why is it important to organizations?
2. In what ways can intellectual property serve as a value-added resource for organizations?
3. How should executives use the value chain to maximize the performance of their organizations?
4. What is SWOT analysis and how can it help an organization?
Southwest Airlines: Let Your LUV Flow
Southwest Airlines’ acquisition of AirTran in 2011 may lead the
firm into stormy skies.
Wikimedia Commons – CC BY 2.0.
In 1971, an upstart firm named Southwest Airlines opened for business by offering flights between Houston, San Antonio, and its headquarters at Love Field in Dallas. From its initial fleet of three airplanes and three destinations,
4.1 Managing Firm Resources 108
Southwest has grown to operate hundreds of airplanes in scores of cities. Despite competing in an industry that is infamous for bankruptcies and massive financial losses, Southwest marked its thirty-eighth profitable year in a row in 2010.
Why has Southwest succeeded while many other airlines have failed? Historically, the firm has differed from its competitors in a variety of important ways. Most large airlines use a “hub and spoke” system. This type of system routes travelers through a large hub airport on their way from one city to another. Many Delta passengers, for example, end a flight in Atlanta and then take a connecting flight to their actual destination. The inability to travel directly between most pairs of cities adds hours to a traveler’s itinerary and increases the chances of luggage being lost. In contrast, Southwest does not have a hub airport; preferring instead to connect cities directly. This helps make flying on Southwest attractive to many travelers.
Southwest has also been more efficient than its rivals. While most airlines use a variety of different airplanes, Southwest operates only one type of jet: the Boeing 737. This means that Southwest can service its fleet much more efficiently than can other airlines. Southwest mechanics need only the know-how to fix one type of airplane, for example, while their counterparts with other firms need a working knowledge of multiple planes. Southwest also gains efficiency by not offering seat assignments in advance, unlike its competitors. This makes the boarding process move more quickly, meaning that Southwest’s jets spend more time in the air transporting customers (and making money) and less time at the gate relative to its rivals’ planes.
Organizational culture is the dimension along which Southwest perhaps has differed most from its rivals. The airline industry as a whole suffers from a reputation for mediocre (or worse) service and indifferent (sometimes even surly) employees. In contrast, Southwest enjoys strong loyalty and a sense of teamwork among its employees.
One tangible indicator of this culture is Southwest’s stock ticker symbol. Most companies choose stock ticker symbols that evoke their names. Ford’s ticker symbol is F, for example, and Walmart’s symbol is WMT. When Southwest became a publicly traded company in 1977, executives chose LUV as its ticker symbol. LUV pays a bit of homage to the firm’s humble beginnings at Love Field. More important, however, LUV represents the love that executives have created among employees, between employees and the company, and between customers and the company. This “LUV affair” has long been and remains a huge success. As recently as March 2011, for example, Southwest was ranked fourth on Fortune magazine’s World’s Most Admired Company list.
In September 2010, Southwest surprised many observers when it announced that it was acquiring AirTran Airways for $1.4 billion. Southwest and AirTran both emphasized low fares, but they differed in many ways. AirTran routed most of its passengers through a hub-and-spoke system, and it relied on a different plane than Southwest, the Boeing 717. The acquisition of AirTran thus raised important questions about Southwest’s future (Schlangenstein & Hughes, 2010). How would AirTran’s hub-and-spoke system be integrated with Southwest’s nonhub approach? Could the airlines’ respective fleets of 737s and 717s be joined without losing efficiency? Perhaps most important, could Southwest maintain its legendary organizational culture while taking over a sizable rival and integrating AirTran’s thousands of employees? When the acquisition was finalized on May 2, 2011, it remained unclear whether Southwest was flying off course or whether Southwest’s “LUV story” would continue for many years.
References
Schlangenstein, M., & Hughes, J. 2010, September 28. Southwest risks keep-it-simple focus to spur growth.
Retrieved from http://www.washingtonpost.com/wp-dyn/content/article/2010/09/28/AR2010092801578.html.
109 Mastering Strategic Management
4.2 Resource-Based Theory
Learning Objectives
1. Define the four characteristics of resources that lead to sustained competitive advantage as articulated by the resource-based theory of the firm.
2. Understand the difference between resources and capabilities.
3. Be able to explain the difference between tangible and intangible resources.
4. Know the elements of the marketing mix.
Table 4.1 Resource-Based Theory: The Basics
According to resource-based theory, organizations that own “strategic resources” have important competitive
advantages over organizations that do not. Some resources, such as cash and trucks, arenot considered to
be strategic resources because an organization’s competitors can readily acquire them. Instead, a resource is
strategic to the extent that it is valuable, rare, difficult to imitate, and nonsubstitutable.
Strategic Resources Expansion
VALUABLE resources aid in improving the organization’s effectiveness and efficiency while neutralizing the opportunities and threats of competitors.
Although the airline industry is extremely competitive, Southwest Airlines’ turns a profit virtually every year. One key reason why is a legendary organizational culture that inspires employees to do their very best.
RARE resources are those held by few or no other competitors.
Southwest Airlines’ culture provides the firm with uniquely strong employee relations in an industry where strikes, layoffs, and poor morale are common.
DIFFICULT-TO-IMITATE resources often involve legally protected intellectual property such as trademarks, patents, or copyrights. Other difficult-to-imitate resources, such as brand names, usually need time to develop fully.
Southwest’s culture arose from its very humble beginnings and has evolved across hour decades. Because of this unusual history, other airlines could not replicate Southwest’s culture, regardless of how hard they might try.
NONSUBSTITUTABLE resources exist when the resource combinations of other firms cannot duplicate the strategy provided by the resource bundle of a particular firm.
The influence of Southwest’s organizational culture extends to how customers are treated by employees. Executives at other airlines would love to attract the customer loyalty that Southwest enjoys, but they have yet to find ways to inspire the kind of customer service that the Southwest culture encourages.
Important Points to Remember: 1. Resources such as Southwest’s culture that reflect all four qualities–valuable, rare, difficult to imitate, and nonsubstitutable–are ideal because they can create sustained competitive advantages. A resource that has three or less of the qualities can provide an edge in the short term, but competitors can overcome such an advantage eventually. 2. Firms often bundle together multiple resources and strategies (that may not be unique in and of themselves) to create
uniquely powerful combinations. Southwest’s culture is complemented by approaches that individually could be copied–the airline’s emphasis on direct flights, its reliance on one type of plane, and its unique system for passenger boarding–in order to create a unique business model in which effectiveness and efficiency is the envy of competitors. 3. Satisfying only one or two of the valuable, rare, difficult to imitate, nonsubstitutable criteria will likely only lead to competitive parity or a temporary advantage.
Four Characteristics of Strategic Resources
Southwest Airlines provides an illustration of resource-based theory in action. Resource-based theory contends
that the possession of strategic resources provides an organization with a golden opportunity to develop
competitive advantages over its rivals (Table 4.1 “Resource-Based Theory: The Basics”). These competitive
advantages in turn can help the organization enjoy strong profits (Barney, 1991; Wernerfelt, 1981).
A strategic resource is an asset that is valuable, rare, difficult to imitate, and nonsubstitutable (Barney, 1991;
Chi, 1994). A resource is valuable to the extent that it helps a firm create strategies that capitalize on opportunities
and ward off threats. Southwest Airlines’ culture fits this standard well. Most airlines struggle to be profitable, but
Southwest makes money virtually every year. One key reason is a legendary organizational culture that inspires
employees to do their very best. This culture is also rare in that strikes, layoffs, and poor morale are common
within the airline industry.
Competitors have a hard time duplicating resources that are difficult to imitate. Some difficult to imitate
resources are protected by various legal means, including trademarks, patents, and copyrights. Other resources
are hard to copy because they evolve over time and they reflect unique aspects of the firm. Southwest’s culture
arose from its very humble beginnings. The airline had so little money that at times it had to temporarily “borrow”
luggage carts from other airlines and put magnets with the Southwest logo on top of the rivals’ logo. Southwest
is a “rags to riches” story that has evolved across several decades. Other airlines could not replicate Southwest’s
culture, regardless of how hard they might try, because of Southwest’s unusual history.
A resource is nonsubstitutable when competitors cannot find alternative ways to gain the benefits that a
resource provides. A key benefit of Southwest’s culture is that it leads employees to treat customers well, which in
turn creates loyalty to Southwest among passengers. Executives at other airlines would love to attract the customer
loyalty that Southwest enjoys, but they have yet to find ways to inspire the kind of customer service that the
Southwest culture encourages.
111 Mastering Strategic Management
Southwest Airlines’ unique culture is reflected in the customization of their aircraft over the years, such as the “Lone Star One”
design.
Wikimedia Commons – CC BY 2.0.
Ideally, a firm will have a culture, like Southwesta firm will own resources like Southwest’s culture#8217;s, that
embraces the four qualities shown in Table 4.1 “Resource-Based Theory: The Basics”. that have all four of these
qualities. If so, these resources can provide not only a competitive advantage but also a sustained competitive
advantage—one that will endure over time and help the firm stay successful far into the future. Resources that
do not have all four qualities can still be very useful, but they are unlikely to provide long-term advantages. A
resource that is valuable and rare but that can be imitated, for example, might provide an edge in the short term,
but competitors can overcome such an advantage eventually.
Resource-based theory also stresses the merit of an old saying: the whole is greater than the sum of its parts.
Specifically, it is also important to recognize that strategic resources can be created by taking several strategies
and resources that each could be copied and bundling them together in a way that cannot be copied. For example,
Southwest’s culture is complemented by approaches that individually could be copied—the airline’s emphasis on
direct flights, its reliance on one type of plane, and its unique system for passenger boarding—to create a unique
business model whose performance is without peer in the industry.
Resource-based theory can be confusing because the term resources is used in many different ways within
everyday common language. It is important to distinguish strategic resources from other resources. To most
individuals, cash is an important resource. Tangible goods such as one’s car and home are also vital resources.
When analyzing organizations, however, common resources such as cash and vehicles are not considered to be
strategic resources. Resources such as cash and vehicles are valuable, of course, but an organization’s competitors
can readily acquire them. Thus an organization cannot hope to create an enduring competitive advantage around
common resources.
4.2 Resource-Based Theory 112
On occasion, events in the environment can turn a common resource into a strategic resource. Consider, for
example, a very generic commodity: water. Humans simply cannot live without water, so water has inherent value.
Also, water cannot be imitated (at least not on a large scale), and no other substance can substitute for the life-
sustaining properties of water. Despite having three of the four properties of strategic resources, water in the
United States has remained cheap. Yet this may be changing. Major cities in hot climates such as Las Vegas, Los
Angeles, and Atlanta are confronted by dramatically shrinking water supplies. As water becomes more and more
rare, landowners in Maine stand to benefit. Maine has been described as “the Saudi Arabia of water” because its
borders contain so much drinkable water. It is not hard to imagine a day when companies in Maine make huge
profits by sending giant trucks filled with water south and west or even by building water pipelines to service arid
regions.
Table 4.2 Resources and Capabilities
Resources and capabilities are the basic building blocks that organizations use to create strategies. These two
building blocks are tightly linked–capabilities from using resources over time.
Tangible resources are resources than can be readily seen, touched, and quantified. Physical assets such as a firm’s property, plant, and equipment are considered to be tangible resources, as is cash.
Intangible resources are quite difficult to see, touch, or quantify. Intangible resources include, for example, the knowledge and skills of employees, a firm’s reputation, and a firm’s culture. In a nod to Southwest Airlines’ outstanding reputation, the firm ranks fourth in Fortune magazine’s 2011 list of the “World’s Most Admired Companies.” Only Apple, Google, and Berkshire Hathaway enjoy a stronger reputation.
A dynamic capability exists when a firm is skilled at continually updating its array of capabilities to keep pace with changes in its environment. General Electric, for example, buys and sells firms to maintain its market leadership over time while Coca-Cola has an uncanny knack for building new brands and products as the soft-drink market evolves. Not surprisingly, both of these firms rank among the top thirteen among the “World’s Most Admired Companies” for 2011.
From Resources to Capabilities
The tangibility of a firm’s resources is an important consideration within resource-based theory. Tangible
resources are resources that can be readily seen, touched, and quantified. Physical assets such as a firm’s property,
plant, and equipment, as well as cash, are considered to be tangible resources. In contrast, intangible resources
are quite difficult to see, to touch, or to quantify. Intangible resources include, for example, the knowledge and
skills of employees, a firm’s reputation, and a firm’s culture. In comparing the two types of resources, intangible
resources are more likely to meet the criteria for strategic resources (i.e., valuable, rare, difficult to imitate, and
nonsubstitutable) than are tangible resources. Executives who wish to achieve long-term competitive advantages
should therefore place a premium on trying to nurture and develop their firms’ intangible resources.
Capabilities are another key concept within resource-based theory. A good and easy-to-remember way to
distinguish resources and capabilities is this: resources refer to what an organization owns, capabilities refer to
what the organization can do (Table 4.2 “Resources and Capabilities”). Capabilities tend to arise over time as
a firm takes actions that build on its strategic resources. Southwest Airlines, for example, has developed the
capability of providing excellent customer service by building on its strong organizational culture. Capabilities are
important in part because they are how organizations capture the potential value that resources offer. Customers
do not simply send money to an organization because it owns strategic resources. Instead, capabilities are needed
113 Mastering Strategic Management
to bundle, to manage, and otherwise to exploit resources in a manner that provides value added to customers and
creates advantages over competitors.
Some firms develop a dynamic capability. This means that a firm has a unique capability of creating new
capabilities. Said differently, a firm that enjoys a dynamic capability is skilled at continually updating its array
of capabilities to keep pace with changes in its environment. General Electric, for example, buys and sells firms
to maintain its market leadership over time, while Coca-Cola has an uncanny knack for building new brands and
products as the soft-drink market evolves. Not surprisingly, both of these firms rank among the top thirteen among
the “World’s Most Admired Companies” for 2011.
Strategy at the Movies
That Thing You Do!
How can the members of an organization reach success “doing that thing they do”? According to resource-based theory, one possible road to riches is creating—on purpose or by accident—a unique combination of resources. In the 1996 movie That Thing You Do!, unwittingly assembling a unique bundle of resources leads a 1960s band called The Wonders to rise from small-town obscurity to the top of the music charts. One resource is lead singer Jimmy Mattingly, who possesses immense musical talent. Another is guitarist Lenny Haise, whose fun attitude reigns in the enigmatic Mattingly. Although not a formal band member, Mattingly’s girlfriend Faye provides emotional support to the group and even suggests the group’s name. When the band’s usual drummer has to miss a gig due to injury, the door is opened for charismatic drummer Guy Patterson, whose energy proves to be the final piece of the puzzle for The Wonders.
Despite Mattingly’s objections, Guy spontaneously adds an up-tempo beat to a sleepy ballad called “That Thing You Do!” during a local talent contest. When the talent show audience goes crazy in response, it marks the beginning of a meteoric rise for both the song and the band. Before long, The Wonders perform on television and “That Thing You Do!” is a top-ten hit record. The band’s magic vanishes as quickly as it appeared, however. After their bass player joins the Marines, Lenny elopes on a whim, and Jimmy’s diva attitude runs amok, the band is finished and Guy is left to “wonder” what might have been. That Thing You Do! illustrates that while bundling resources in a unique way can create immense success, preserving and managing these resources over time can be very difficult.
4.2 Resource-Based Theory 114
Liv Tyler plays Faye Dolan, the love interest of drummer Guy Patterson, in That Thing You Do!
Wikimedia Commons – CC BY 3.0.
Is Resource-Based Theory Old News?
Resource-based theory has evolved in recent years to provide a way to understand how strategic resources and
capabilities allow firms to enjoy excellent performance. But more than one wry observer has wondered aloud, “Is
115 Mastering Strategic Management
resource-based theory just old wine in a new bottle?” This is a question worth considering because the role of
resources in shaping success and failure has been discussed for many centuries.
Aesop was a Greek storyteller who lived approximately 2,500 years ago. Aesop is known in particular for
having created a series of fables—stories that appear on the surface to be simply children’s tales but that offer deep
lessons for everyone. One of Aesop’s fables focuses on an ass (donkey) and some grasshoppers. When the ass tries
to duplicate the sweet singing of the grasshoppers by copying their diet, he soon dies of starvation. Attempting to
replicate the grasshoppers’ unique singing capability proved to be a fatal mistake (Figure 4.3 “Aesop’s Fables”).
The fable illustrates a central point of resource-based theory: it is an array of resources and capabilities that fuels
enduring success, not any one resource alone.
In a far more recent example, sociologist Philip Selznick developed the concept of distinctive competence
through a series of books in the 1940s and 1950s (Selznick, 1957; Selznick, 1949). A distinctive competence
is a set of activities that an organization performs especially well. Southwest Airlines, for example, appears to
have a distinctive competency in operations, as evidenced by how quickly it moves its flights in and out of
airports. Further, Selznick suggested that possessing a distinctive competency creates a competitive advantage for
a firm. Certainly, there is plenty of overlap between the concept of distinctive competency, on the one hand, and
capabilities, on the other.
Figure 4.3 Aesop’s Fables
4.2 Resource-Based Theory 116
Adapted from Chapter 4 of Atlas Black: Managing to Succeed and Short, J. & Ketchen, D. 2005. Using classic
literature to teach timeless truths: An illustration using Aesop’s fables to teach strategic management. Journal of
Management Education, 29, 6, 816–832.
So is resource-based theory in fact old wine in a new bottle? Not really. Resource-based theory builds on past
ideas about resources, but it represents a big improvement on past ideas in at least two ways. First, resource-based
theory offers a complete framework for analyzing organizations, not just snippets of valuable wisdom like Aesop
and Selznick provided. Second, the ideas offered by resource-based theory have been developed and refined
117 Mastering Strategic Management
through scores of research studies involving thousands of organizations. In other words, there is solid evidence
backing it up.
The Marketing Mix
Table 4.4 The Marketing Mix
Much like a baker mixes together ingredients to create a delicious cake, executives need to blend together
various ways to appeal to customers. As one of the most famous business “recipes,” the marketing mix suggests
four factors that need to work together in order for a firm to achieve superior performance. The four Ps of the
marketing mix are illustrated below using Duff Goldman’s custom cake shop, Charm City Cakes.
A firm’s product is what it sells to customers. The unique cakes offered by Duff have included replicas of Radio City Music Hall and the Hubble space telescope.
The price of a good or service should provide a good match with the value offered. While a grocery store’s cake might sell for $30 or less, the uniqueness of Duff’s cakes allows him to charge upwards of $1,000 per cake.
Place can refer to a physical purchase point as well as a distribution channel. The location of Charm City Cakes is itself unique–a converted church. This adds to the hip image Duff tries to project.
Promotion consists of the communications used to market a product, including advertising, public relations, and other forms of direct and indirect selling. Duff’s popular show on The Food Network, Ace of Cakes, spread Duff’s fame and extended the reach of his cake shop dramatically.
Leveraging resources and capabilities to create desirable products and services is important, but customers must
still be convinced to purchase these goods and services. The marketing mix—also known as the four Ps of
marketing—provides important insights into how to make this happen. A master of the marketing mix was circus
impresario P. T. Barnum, who is famous in part for his claim that “there’s a sucker born every minute.” The real
purpose of the marketing mix is not to trick customers but rather to provide a strong alignment among the four
Ps (product, price, place, and promotion) to offer customers a coherent and persuasive message (Table 4.4 “The
Marketing Mix”).
A firm’s product is what it sells to customers. Southwest Airlines sells, of course, airplane flights. The airline
tries to set its flights apart from those of airlines by making flying fun. This can include, for example, flight
attendants offering preflight instructions as a rap. The price of a good or service should provide a good match
with the value offered. Throughout its history, Southwest has usually charged lower airfares than its rivals. Place
can refer to a physical purchase point as well as a distribution channel. Southwest has generally operated in cities
that are not served by many airlines and in secondary airports in major cities. This has allowed the firm to get
favorable lease rates at airports and has helped it create customer loyalty among passengers who are thankful to
have access to good air travel.
Finally, promotion consists of the communications used to market a product, including advertising, public
relations, and other forms of direct and indirect selling. Southwest is known for its clever advertising. In a recent
television advertising campaign, for example, Southwest lampooned the baggage fees charged by most other
airlines while highlighting its more customer-friendly approach to checked luggage. Given the consistent theme of
providing a good value plus an element of fun to passengers that is developed across the elements of the marketing
mix, it is no surprise that Southwest has been so successful within a very challenging industry.
4.2 Resource-Based Theory 118
Few executives in history have had the marketing savvy of P. T. Barnum.
Wikimedia Commons – public domain.
119 Mastering Strategic Management
Key Takeaway
• Resource-based theory suggests that resources that are valuable, rare, difficult to imitate, and nonsubstitutable best position a firm for long-term success. These strategic resources can provide the foundation to develop firm capabilities that can lead to superior performance over time. Capabilities are needed to bundle, to manage, and otherwise to exploit resources in a manner that provides value added to customers and creates advantages over competitors.
Exercises
1. Does your favorite restaurant have the four qualities of resources that lead to success as articulated by resource-based theory?
2. If you were hired by your college or university to market your athletic department, what element of the marketing mix would you focus on first and why?
3. What other classic stories or fables could be applied to discuss the importance of firm resources and superior performance?
References
Barney, J. B. 1991. Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120.
Chi, T. 1994. Trading in strategic resources: Necessary conditions, transaction cost problems, and choice of
exchange structure. Strategic Management Journal, 15(4), 271–290.
Selznick, P. 1957. Leadership in administration. New York: Harper; Selznick, P. 1952. The organizational
weapon. New York, NY: McGraw-Hill.
Selznick, P. 1952. The organizational weapon. New York, NY: McGraw-Hill; Selznick, P. 1949. TVA and the
grass roots. Berkeley, CA: University of California Press.
Wernerfelt, B. 1984. A resource-based view of the firm. Strategic Management Journal, 5, 171–180.
4.2 Resource-Based Theory 120
4.3 Intellectual Property
Learning Objectives
1. Define the four major types of intellectual property.
2. Be able to provide examples of each intellectual property type.
3. Understand how intellectual property can be a valuable resource for firms.
Defining Intellectual Property
The inability of competitors to imitate a strategic resource is a key to leveraging the resource to achieve long–term
competitive advantages. Companies are clever, and effective imitation is often very possible. But resources that
involve intellectual property reduce or even eliminate this risk. As a result, developing intellectual property is
important to many organizations.
Intellectual property refers to creations of the mind, such as inventions, artistic products, and symbols. The
four main types of intellectual property are patents, trademarks, copyrights, and trade secrets (Table 4.5 “Types of
Intellectual Property”). If a piece of intellectual property is also valuable, rare, and nonsubstitutable, it constitutes
a strategic resource. Even if a piece of intellectual property does not meet all four criteria for serving as a strategic
resource, it can be bundled with other resources and activities to create a resource.
A variety of formal and informal methods are available to protect a firm’s intellectual property from imitation
by rivals. Some forms of intellectual property are best protected by legal means, while defending others depends
on surrounding them in secrecy. This can be contrasted with Southwest Airlines’ well-known culture, which rivals
are free to attempt to copy if they wish. Southwest’s culture thus is not intellectual property, although some of its
complements such as Southwest’s logo and unique color schemes are.
Table 4.5 Types of Intellectual Property
The term intellectual property refers to creations of the mind, such as inventions, artistic products, and
symbols. Some forms of intellectual property by law while others can best be defended by surrounding them in
secrecy.
Patents protect inventions from direct imitation for a limited period of time. Within the pharmaceutical industry, patents protect the new drugs created by firms such as Merck and Pfizer for up to twenty years. If a new drug gains acceptance in the market, its patent creates a window of opportunity for the patent holder to enjoy excellent profits.
Trademarks are phrases, pictures, names, or symbols used to identify a particular organization. McDonald’s golden arches, the phrase “Intel Inside,” and the brand name Old Navy are examples of trademarks.
Copyrights provide exclusive rights to the creators of original artistic works such as books, movies, songs, and screenplays. Sometimes copyrights are sold and licensed. The late pop star Michael Jackson bought the rights to The Beatle’s music catalog and later licensed songs to Target and other companies for use in television advertisements.
Trade secrets refer to formulas, practices, and designs that are central to a firm’s business and that remain unknown to competitors. One famous example is the blend of eleven herbs and spices used in Kentucky Fried Chicken’s original recipe chicken. KFC protects this secret by having multiple suppliers each produce a portion of the herb and spice blend; no one supplier knows the full recipe.
Patents
Table 4.6 Patents
Patents protect inventions from direct imitation for a limited period of time. Some examples and key issues
surrounding patents are illustrated below.
To earn a patent from the U.S. Patent and Trademark Office, an inventor must demonstrate than an invention is new, non obvious, and useful.
As several different inventors raced to create a workable system for voice transmission over wires, Alexander Graham Bell was awarded a patent for the telephone in 1876.
Perhaps the greatest inventor in history was Thomas Edison, who was awarded over one thousand patents.
In a 2011 lawsuit, EBSCO alleged that Bass Pro Shops sold a product that violated EBSCO’s patent on a deer-hunting stand that helps prevent hunters from falling out of trees. EBSCO’s complaint was settled out of court.
Patents are legal decrees that protect inventions from direct imitation for a limited period of time (Table 4.6
“Patents”). Obtaining a patent involves navigating a challenging process. To earn a patent from the US Patent and
Trademark Office, an inventor must demonstrate than an invention is new, nonobvious, and useful. If the owner
of a patent believes that a company or person has infringed on the patent, the owner can sue for damages. In 2011,
for example, a private company named EBSCO alleged that retailer Bass Pro Shops sold a product that violated
EBSCO’s patent on a deer-hunting stand that helps prevent hunters from falling out of trees. Rather than endure a
costly legal fight, the two sides agreed to settle EBSCO’s complaint out of court.
Patenting an invention is important because patents can fuel enormous profits. Imagine, for example, the
potential for lost profits if the Slinky had not been patented. Shipyard engineer Richard James came up with the
idea for the Slinky by accident in 1943 while he was trying to create springs for use in ship instruments. When
James accidentally tipped over one of his springs, he noticed that it moved downhill in a captivating way. James
spent his free time perfecting the Slinky and then applied for a patent in 1946. To date, more than three hundred
million Slinkys have been sold by the company that Richard James and his wife Betty created.
4.3 Intellectual Property 122
Patenting inventions such as the Slinky helps ensure that the invention is protected from imitation.
Wikimedia Commons – public domain.
Trademarks
Trademarks are phrases, pictures, names, or symbols used to identify a particular organization (Table 4.7
“Trademarks”). Trademarks are important because they help an organization stand out and build an identity in
the marketplace. Some trademarks are so iconic that almost all consumers recognize them, including McDonald’s
golden arches, the Nike swoosh, and Apple’s outline of an apple.
Other trademarks help rising companies carve out a unique niche for themselves. For example, French shoe
designer Christian Louboutin has trademarked the signature red sole of his designer shoes. Because these shoes
sell for many hundreds of dollars via upscale retailers such as Neiman Marcus and Saks Fifth Avenue, competitors
would love to copy their look. Thus legally protecting the distinctive red sole from imitation helps preserve
Louboutin’s profits.
123 Mastering Strategic Management
Fashionistas instantly recognize the trademark red sole of Christian Louboutin’s high-end shoes.
Wikimedia Foundation – CC BY-SA 3.0.
Trademarks are important to colleges and universities. Schools earn tremendous sums of money through
royalties on T-shirts, sweatshirts, hats, backpacks, and other consumer goods sporting their names and logos. On
any given day, there are probably several students in your class wearing one or more pieces of clothing featuring
your school’s insignia; your school benefits every time items like this are sold.
Schools’ trademarks are easy to counterfeit, however, and the sales of counterfeit goods take money away from
colleges and universities. Not surprisingly, many schools fight to protect their trademarks. In October 2009, for
example, the University of Oklahoma announced that it was teaming with law enforcement officials to combat
the sale of counterfeit goods around its campus (Ward, 2009). This initiative and similar ones at other colleges
and universities are designed to ensure that schools receive their fair share of the sales that their names and logos
generate.
Table 4.7 Trademarks
An organization’s trademarks consist of phrases, pictures, names, or symbols that are closely associated with
the organization. Some examples and key issues surrounding trademarks are illustrated below.
4.3 Intellectual Property 124
To be fully protected in the United States, a trademark must be registered with the United States Patent and Trademark Office. A capital R with a circle around it denotes a registered trademark.
Many small companies use their founders’ name as the basis for a trademarked company name.
As part of the punishment for German aggression during World War I, German drug maker Bayer lost its trademark on “Aspirin” in France, Russia, the United Kingdom, and the United States. Today, Bayer still retains its trademark in Germany, Canada, Mexico and dozens of other countries.
The distinctive pattern of Burberry Ltd. is an example of a trademark that does not involve words or symbols.
Copyrights
The rights of creators of original artistic works such as books, movies, songs, and screenplays are protected by
copyrights. Some examples and key issues surrounding copyrights are illustrated below.
In China, millions of pirated DVDs are sold each year, and music piracy is estimated to account for at least 95 percent of music sales. In response, the U.S. government has pressed its Chinese counterpart to better enforce copyrights.
The presence of the copyright symbol tells consumers that they are not allowed to duplicate the product that carriers the copyright.
When it became apparent that The Verve’s 1997 hit single “Bittersweet Symphony” duplicated a Rolling Stones song, The Verve was forced to give up the copyright for the song.
Today’s cheesy television ads aimed at inventors follow a long traditional of companies offering to help individuals copyright their ideas–for a small fee, of course.
A painting such as Johannes Vermeer’s “Girl with a Pearl Earring” enters the public domain (i.e., is not subject to copyright) one hundred years after its creator’s death.
Copyrights provide exclusive rights to the creators of original artistic works such as books, movies, songs, and
screenplays (Figure 4.8 “Copyrights”). Sometimes copyrights are sold and licensed. In the late 1960s, Buick
thought it had an agreement in place to license the number one hit “Light My Fire” for a television advertisement
from The Doors until the band’s volatile lead singer Jim Morrison loudly protested what he saw as mistreating a
work of art. Classic rock by The Beatles has been used in television ads in recent years. After the late pop star
Michael Jackson bought the rights to the band’s music catalog, he licensed songs to Target and other companies.
Some devoted music fans consider such ads to be abominations, perhaps proving the merit of Morrison’s protest
decades ago.
125 Mastering Strategic Management
He looks calm here, but the licensing of a copyrighted song for a car commercial enraged rock legend Jim Morrison.
Wikimedia Commons – public domain.
Over time, piracy has become a huge issue for the owners of copyrighted works. In China, millions of pirated
DVDs are sold each year, and music piracy is estimated to account for at least 95 percent of music sales. This
piracy deprives movie studios, record labels, and artists of millions of dollars in royalties. In response to the
damage piracy has caused, the US government has pressed its Chinese counterpart and other national governments
to better enforce copyrights.
Trade Secrets
Trade secrets refer to formulas, practices, and designs that are central to a firm’s business and that remain
unknown to competitors (Table 4.9 “Trade Secrets”). Trade secrets are protected by laws on theft, but once a secret
is revealed, it cannot be a secret any longer. This leads firms to rely mainly on silence and privacy rather than the
legal system to protect trade secrets.
Table 4.9 Trade Secrets
Trade secrets are formulas, practices, and designs that are central to a firm’s business and that remain unknown
to competitors. Everyone loves a good mystery, so it is no surprise that legends have arisen around some trade
secrets. Some examples and key issues surrounding trade secrets are illustrated below.
4.3 Intellectual Property 126
Low-end fast food chain Long John Silver’s considers its “crumblies” (small bits of fried batter) to be a trade secret, but would anyone really want to solve the mystery?
In 2006, Pepsi was offered a chance to buy a stolen copy of Coca-Cola’s secret recipe. An FBI sting was created and the thieves were arrested.
WD-40 was developed to repel water and prevent corrosion, but it was later found to have over two thousand uses. Creating WD-40 took a lot of work: the product’s unusual name stands for “Water Displacement, 40th attempt.” Despite being created in 1953, the formula for making WD-40 remains unknown outside the company that sells it.
FarmVille creator Zynga alleged in a lawsuit that Disney had lured away Zynga employees to work for Disney and then urged the employees to turn over a secret “playbook” that described Zynga’s strategy. The case was settled out of court in late 2010.
In a 1995 episode of the hit comedy Sienfeld, a very successful but mean-spirited restaurateur nicknamed the “Soup Nazi” saw his business collapse when his secret recipes were revealed to customers. Individuals could now make delicious soups at home rather than endure the Soup Nazi’s verbal abuse when buying soup.
Some trade secrets have become legendary, perhaps because a mystique arises around the unknown. One famous
example is the blend of eleven herbs and spices used in Kentucky Fried Chicken’s original recipe chicken. KFC
protects this secret by having multiple suppliers each produce a portion of the herb and spice blend; no one
supplier knows the full recipe. The formulation of Coca-Cola is also shrouded in mystery. In 2006, Pepsi was
approached by shady individuals who were offering a chance to buy a stolen copy of Coca-Cola’s secret recipe.
Pepsi wisely refused. An FBI sting was used to bring the thieves to justice. The soft-drink industry has other
secrets too. Dr Pepper’s recipe remains unknown outside the company. Although Coke’s formula has been the
subject of greater speculation, Dr Pepper is actually the original secret soft drink; it was created a year before
Coca-Cola.
The recipe for Dr Pepper is a secret dating back to the 1880s.
127 Mastering Strategic Management
anyjazz65 – Dr. Pepper – CC BY 2.0.
Key Takeaway
• Intellectual property can serve as a strategic resource for organizations. While some sources of intellectual property such as patents, trademarks, and copyrights can receive special legal protection, trade secrets provide competitive advantages by simply staying hidden from competitors.
Exercises
1. What designs for your college or university are protected by trademarks?
2. What type of intellectual property provides the most protection for firms?
3. Why would a firm protect a resource through trade secret rather than by a formal patent?
References
Ward, C. 2009, October 8. OU works to prevent trademark infringement. The Oklahoma Daily. Retrieved from
http://www.oudaily.com/news/2009/oct/08/ou-works-prevent-trademark-infringement.
4.3 Intellectual Property 128
4.4 Value Chain
Learning Objectives
1. Define the primary activities of the value chain.
2. Know the different support activities within the value chain.
3. Be able to apply the value chain to an organization of your choosing.
4. Understand the difference between a value chain and supply chain.
Table 4.10 Adding Value within a Value Chain
Wikimedia Commons – public domain.
Elements of the Value Chain
When executives choose strategies, an organization’s resources and capabilities should be examined alongside
consideration of its value chain. A value chain charts the path by which products and services are created and
eventually sold to customers (Porter, 1985). The term value chain reflects the fact that, as each step of this path is
completed, the product becomes more valuable than it was at the previous step (Table 4.10 “Adding Value within
a Value Chain”). Within the lumber business, for example, value is added when a tree is transformed into usable
wooden boards; the boards created from a tree can be sold for more money than the price of the tree.
The Value Chain
Value chains include both primary and secondary activities. Primary activities are actions that are directly
involved in creating and distributing goods and services. Consider a simple illustrative example: doughnut shops.
Doughnut shops transform basic commodity products such as flour, sugar, butter, and grease into delectable treats.
Value is added through this process because consumers are willing to pay much more for doughnuts than they
would be willing to pay for the underlying ingredients.
There are five primary activities. Inbound logistics refers to the arrival of raw materials. Although doughnuts
are seen by most consumers as notoriously unhealthy, the Doughnut Plant in New York City has carved out a
unique niche for itself by obtaining organic ingredients from a local farmer’s market. Operations refers to the
actual production process, while outbound logistics tracks the movement of a finished product to customers. One
of Southwest Airlines’ unique capabilities is moving passengers more quickly than its rivals. This advantage in
operations is based in part on Southwest’s reliance on one type of airplane (which speeds maintenance) and its
avoidance of advance seat assignments (which accelerates the passenger boarding process).
Attracting potential customers and convincing them to make purchases is the domain of marketing and sales.
For example, people cannot help but notice Randy’s Donuts in Inglewood, California, because the building has
a giant doughnut on top of it. Finally, service refers to the extent to which a firm provides assistance to their
customers. Voodoo Donuts in Portland, Oregon, has developed a clever website (voodoodoughnut.com) that helps
customers understand their uniquely named products, such as the Voodoo Doll, the Texas Challenge, the Memphis
Mafia, and the Dirty Snowball.
4.4 Value Chain 130
Secondary activities are not directly involved in the evolution of a product but instead provide important
underlying support for primary activities. Firm infrastructure refers to how the firm is organized and led by
executives. The effects of this organizing and leadership can be profound. For example, Ron Joyce’s leadership
of Canadian doughnut shop chain Tim Hortons was so successful that Canadians consume more doughnuts per
person than all other countries. In terms of resource-based theory, Joyce’s leadership was clearly a valuable and
rare resource that helped his firm prosper.
Also important is human resource management, which involves the recruitment, training, and compensation
of employees. A recent research study used data from more than twelve thousand organizations to demonstrate
that the knowledge, skills, and abilities of a firm’s employees can act as a strategic resource and strongly influence
the firm’s performance (Crook, et. al., 2011). Certainly, the unique level of dedication demonstrated by employees
at Southwest Airlines has contributed to that firm’s excellent performance over several decades.
Technology refers to the use of computerization and telecommunications to support primary activities.
Although doughnut making is not a high-tech business, technology plays a variety of roles for doughnut shops,
such as allowing customers to use credit cards. Procurement is the process of negotiating for and purchasing raw
materials. Large doughnut chains such as Dunkin’ Donuts and Krispy Kreme can gain cost advantages over their
smaller rivals by purchasing flour, sugar, and other ingredients in bulk. Meanwhile, Southwest Airlines has gained
an advantage over its rivals by using futures contracts within its procurement process to minimize the effects of
rising fuel prices.
From the Value Chain to Best Value Supply Chains
“Time is money!” warns a famous saying. This simple yet profound statement suggests that organizations that
quickly complete their work will enjoy greater profits, while slower-moving firms will suffer. The belief that
time is money has encouraged the modern emphasis on supply chain management. A supply chain is a system
of people, activities, information, and resources involved in creating a product and moving it to the customer. A
supply chain is a broader concept than a value chain; the latter refers to activities within one firm, while the former
captures the entire process of creating and distributing a product, often across several firms.
Competition in the twenty-first century requires an approach that considers the supply chain concept in tandem
with the value-creation process within a firm: best value supply chains. These chains do not fixate on speed or
on any other single metric. Instead, relative to their peers, best value supply chains focus on the total value added
to the customer.
Creating best value supply chains requires four components. The first is strategic supply chain
management—the use of supply chains as a means to create competitive advantages and enhance firm
performance. Such an approach contradicts the popular wisdom centered on the need to maximize speed. Instead,
there is recognition that the fastest chain may not satisfy customers’ needs. Best value supply chains strive to excel
along four measures. Speed (or “cycle time”) is the time duration from initiation to completion of the production
and distribution process. Quality refers to the relative reliability of supply chain activities. Supply chains’ efforts
at managing cost involve enhancing value by either reducing expenses or increasing customer benefits for the
same cost level. Flexibility refers to a supply chain’s responsiveness to changes in customers’ needs. Through
balancing these four metrics, best value supply chains attempt to provide the highest level of total value added.
The value of strategic supply chain management is reflected in how firms such as Walmart have used their
supply chains as competitive weapons to gain advantages over peers. Walmart excels in terms of speed and
131 Mastering Strategic Management
cost by locating all domestic stores within one day’s drive of a warehouse while owning a trucking fleet. This
creates distribution speed and economies of scale that competitors simply cannot match. When Kmart’s executives
decided in the late 1990s to compete head-to-head with Walmart on price, Walmart’s sophisticated logistics
system enabled it to easily withstand the price war. Unable to match its rival’s speed and costs, Kmart soon
plunged into bankruptcy. Walmart’s supply chains also possess strong quality and flexibility. When Hurricane
Katrina devastated the Gulf Coast in 2005, Walmart used not only its warehouses and trucks but also its satellite
technology, radio frequency identification (RFID), and global positioning systems to quickly divert assets to
affected areas. The result was that Walmart emerged as the first responder in many towns and provided essentials
such as drinking water faster than local and federal governments could.
Meanwhile, failing to manage a supply chain effectively causes serious harm. For example, in 2003 Motorola
was unable to meet demand for its new camera phones because it did not have enough lenses available. Also,
firms whose supply chains were centered in the Port of Los Angeles collectively lost more than $2 billion a day
during a 2002 workers’ strike. In terms of stock price, firms’ market value erodes by an average of 10 percent
following the announcement of a major supply chain problem.
The second component is agility, the supply chain’s relative capacity to act rapidly in response to dramatic
changes in supply and demand (Lee, 2004). Agility can be achieved using buffers. Excess capacity, inventory,
and management information systems all provide buffers that better enable a best value supply chain to service
and to be more responsive to its customers. Rapid improvements and decreased costs in deploying information
systems have enabled supply chains in recent years to reduce inventory as a buffer. Much popular thinking depicts
inventory reduction as a goal in and of itself. However, this cannot occur without corresponding increases in buffer
capacity elsewhere in the chain, or performance will suffer. A best value supply chain seeks to optimize the total
costs of all buffers used. The costs of deploying each buffer differs across industries; therefore, no solution that
works for one company can be directly applied to another in a different industry without adaptation.
Agility in a supply chain can also be improved and achieved by colocating with the customer. This arrangement
creates an information flow that cannot be duplicated through other methods. Daily face-to-face contact for supply
chain personnel enables quicker response times to customer demands due to the speed at which information can
travel back and forth between the parties. Again, this buffer of increased and improved information flows comes at
an expense, so executives seeking to build a best value supply chain will investigate the opportunity and determine
whether this action optimizes total costs.
Adaptability refers to a willingness and capacity to reshape supply chains when necessary. Generally, creating
one supply chain for a customer is desired because this helps minimize costs. Adaptable firms realize that this
is not always a best value solution, however. For example, in the defense industry, the US Army requires one
class of weapon simulators to be repaired within eight hours, while another class of items can be repaired and
returned within one month. To service these varying requirements efficiently and effectively, Computer Science
Corporation (the firm whose supply chains maintain the equipment) must devise adaptable supply chains. In
this case, spare parts inventory is positioned in proximity to the class of simulators requiring quick turnaround,
while the less-time-sensitive devices are sent to a centralized repair facility. This supply chain configuration
allows Computer Science Corporation to satisfy customer demands while avoiding the excess costs that would be
involved in localizing all repair activities.
In situations in which the interests of one firm in the chain and the chain as a whole conflict, most executives
will choose an option that benefits their firm. This creates a need for alignment among chain members. Alignment
refers to creating consistency in the interests of all participants in a supply chain. In many situations, this can
be accomplished through carefully writing incentives into contracts. Collaborative forecasting with suppliers and
customers can also help build alignment. Taking the time to sit together with participants in the supply chain to
4.4 Value Chain 132
agree on anticipated business levels permits shared understanding and rapid information transfers between parties.
This is particularly valuable when customer demand is uncertain, such as in the retail industry (Ketchen, et. al.,
2008).
Key Takeaway
• The value chain provides a useful tool for managers to examine systematically where value may be added to their organizations. This tool is useful in that it examines key elements in the production of a good or service, as well as areas in which value may be added in support of those primary activities.
Exercises
1. If you were hired as a consultant for your university, what specific element of the value chain would you seek to improve first?
2. What local business in your town could be improved most dramatically by applying the value chain? Would improvements of primary or support activities help to improve this firm most? Could knowledge of strategic supply chain management add further value to this firm?
References
Crook, T. R., Todd, S. Y., Combs, J. G., Woehr, D. J., & Ketchen, D. J. 2011. Does human capital matter? A meta-
analysis of the relationship between human capital and firm performance. Journal of Applied Psychology, 96(3),
443–456.
Ketchen, D. J., Rebarick, W., Hult, G. T., & Meyer, D. 2008. Best value supply chains: A key competitive
weapon for the 21st century. Business Horizons, 51, 235–243.
Lee, H. L. 2004, October. The triple-A supply chain. Harvard Business Review, 83, 102–112.
Porter, M. E. 1985. Competitive advantage: Creating and sustaining superior performance. New York, NY:
Free Press.
133 Mastering Strategic Management
4.5 Beyond Resource-Based Theory: Other Views on Firm Performance
Learning Objectives
1. Be able to discuss other theories about firm success and failure beyond resource-based theory.
2. Be able to apply different theories to help explain competition in different industries.
Table 4.11 Other Theories about Firm Performance
Resource-based theory is currently perhaps the most popular way of explaining why some firms succeed and
other fail, but it is far from the only explanation. Below we illustrate several other prominent theories using
examples from the airline industry.
Enactment suggests that organizations can, in part, create their environment through outstanding strategies. This puts a firm in control of its destiny. Although no airline has ever been able to do so, Microsoft and Apple are two firms that seemed to have enacted their environments.
Environmental determinism contends that external factors drive a firm’s fate. In its early days, the federal government controlled airlines’ routes and prices. After the airline industry was deregulated in the late 1970s, a series of large airlines fell prey to bad environment conditions such as recession, overcapacity in the industry, and fuel shortages. Many industry experts claim that the demise of Braniff Airlines, and others was inevitable.
Institutional theory is interested in the extent to which firms copy each other’s strategies. After American Airlines became the first major airline to create a frequent flyer program in 1981, its competitors quickly developed their own frequent flyer programs. In the late 2000s, a new idea of charging passengers to check their luggage was copied by one airline after another.
Transaction cost economics centers on whether it is cheaper for a firm to make or to buy the products that it needs. Choosing efficient options enhances profits. No airline has ever chosen “make” when needing new airplanes. Buying airplanes from Boeing or Airbus is much more efficient than would be trying to backwardly integrate into the airplane manufacturing business.
Although resource-based theory stands as perhaps the most popular explanation of why some organizations
prosper while others do not, several other theories are popular. Enactment treats executives as the masters of
their domains. Enactment contends that an organization can, at least in part, create an environment for itself that
is beneficial to the organization. This is accomplished by putting strategies in place that reshape competitive
conditions in a favorable way (Table 4.11 “Other Theories about Firm Performance”).
By the 1990s, Microsoft had been so successful at reshaping the software industry to its benefit that the firm
was the subject of a lengthy antitrust investigation by the federal government. More recently, Apple has been able
to reshape its environment by introducing products such as the iPhone and the iPad that transcend the traditional
boundaries between the cell phone, digital camera, music player, and computer businesses. No airline has ever
been able to enact the environment, however, perhaps because the airline industry is so fragmented.
Environmental determinism offers a completely opposite view from enactment on why some firms succeed
and others fail. Environmental determinism views organizations much like biological theories view
animals—organizations (and animals) are very limited in their ability to adapt to the conditions around them.
Thus just as harsh environmental changes are believed to have made dinosaurs extinct, changes in the business
environment can destroy organizations regardless of how clever and insightful executives are.
Until 1978, the federal government regulated the airline industry by dictating what routes each airline would fly
and what prices it would charge. Once these controls were removed, airlines were subjected to a series of negative
environmental trends, including recession, overcapacity in the industry, new entrants, fierce price competition,
and fuel shortages. Perhaps not surprisingly, dozens of airlines have been crushed by these conditions.
An old saying notes that “imitation is the sincerest form of flattery.” This flattery is the focus of institutional
theory. In particular, institutional theory centers on the extent to which firms copy one another’s strategies.
Consider, for example, fast-food hamburger restaurants. Innovations such as dollar menus and drive-through
windows tend to be introduced by one firm and then duplicated by the others.
Airlines also seem to follow a “monkey see, monkey do” mentality. To build passenger loyalty, American
Airlines introduced a frequent flyer program called AAdvantage in 1981. After flying a certain number of miles
on American flights, AAdvantage members were rewarded with a free flight. The idea was to make passengers
less likely to shop around for the cheapest ticket. Ironically, AAdvantage turned out to be not much of an
advantage at all. Many of American’s rivals quickly developed their own frequent-flyer programs, and today most
airlines reward frequent passengers. In recent years, ideas such as charging passengers to check their luggage and
eliminating free food on flights have been copied by one airline after another.
Transaction cost economics is a theory that centers on just one element of business activity: whether it is
cheaper for a firm to make or to buy the products that it needs. This is an important element, however, because
choosing the more efficient option can enhance a firm’s profits. Automakers such as Ford and General Motors
face a wide variety of make-or-buy decisions because so many different parts are needed to build cars and trucks.
Sometimes Ford and GM make these products, and other times they purchase them from outside suppliers. These
firms’ financial situations are improved when these decisions are made wisely and harmed when they are made
poorly.
In contrast, airlines always buy (or rent) their airplanes. Large planes are generally bought from Boeing
or Airbus, while modest-sized airliners are purchased from companies such as Brazil’s Embraer. It would be
simply too costly for an airline to pursue a backward integration strategy and enter the airplane manufacturing
business. Insights such as these are powerful enough that the creator of transaction cost economics, Professor
Oliver Williamson, was awarded a Nobel Prize in Economic Sciences in 2009.
Each of these theories—enactment, environmental determinism, institutional theory, and transaction cost
economics—is useful for understanding some situations and some important business decisions. Thus executives
should keep these perspectives in mind as they attempt to lead their firms to greater levels of success. However,
one important advantage that resource-based theory offers over the alternatives is that only resource-based theory
does a good job of explaining firm performance across a wide variety of contexts. Thus resource-based theory
offers the point of view of business that has the strongest value for most executives.
Key Takeaway
• Although resource-based theory is the dominant perspective to predict performance in the strategic management field, other theories exist to explain firm behavior. In some industries, explanations provided
135 Mastering Strategic Management
by these theories can be very convincing.
Exercises
1. What theory of the firm do you think best explains competition in the fast-food industry?
2. What is an example of an industry in which institutional theory seems to explain the behavior of firms?
4.5 Beyond Resource-Based Theory: Other Views on Firm Performance 136
4.6 SWOT Analysis
Learning Objectives
1. Understand what SWOT analysis is.
2. Learn how SWOT analysis can help organizations and individuals, and its limitations.
Table 4.12 SWOT
Chess master Bruce Pandolfini has noted the similarities between business and chess. In both arenas, you must
understand your own abilities as well as your flaws. You must also know your opponents, try to anticipate their
moves, and deal with considerable uncertainty. A very popular management tool that incorporates the idea of
understanding the elements internal and external to the firm is SWOT (strengths, weaknesses, opportunities, and
threats) analysis. Strengths and weaknesses are assessed by examining the firm, while opportunities and threats
refer to external events and trends. These ideas can be applied to individuals too. Below we offer examples of
each element of SWOT analysis for organizations and for individuals who are seeking employment.
SWOT point Organizational Examples Individual Examples
Strenths Having high-levels of cash flow gives firms discretion to purchase new equipment if they wish to.
Strong technical and language skills, as well as previous work experience, can help individuals rise above the competition.
Weaknesses Dubious leadership and CEO scandals have plagued some corporations in recent years.
Poor communication skills keep many job seekers from being hired into sales and supervisory positions.
Opportunities The high cost of gasoline creates opportunities for substitute products based on alternative energy sources.
The U.S. economy is increasingly services based, suggesting that individuals can enjoy more opportunities in service firms.
Threats Concerns about worldwide pollution are a threat to petroleum-based products.
A tight job market poses challenges to new graduates.
Five forces analysis examines the situation faced by the competitors in an industry. Strategic groups analysis
narrows the focus by centering on subsets of these competitors whose strategies are similar. SWOT analysis takes
an even narrower focus by centering on an individual firm. Specifically, SWOT analysis is a tool that considers
a firm’s strengths and weaknesses along with the opportunities and threats that exist in the firm’s environment
(Table 4.12 “SWOT”).
Executives using SWOT analysis compare these internal and external factors to generate ideas about how their
firm might become more successful. In general, it is wise to focus on ideas that allow a firm to leverage its
strengths, steer clear of or resolve its weaknesses, capitalize on opportunities, and protect itself against threats.
For example, untapped overseas markets have presented potentially lucrative opportunities to Subway and other
restaurant chains such as McDonald’s and Kentucky Fried Chicken. Meanwhile, Subway’s strengths include
a well-established brand name and a simple business format that can easily be adapted to other cultures. In
considering the opportunities offered by overseas markets and Subway’s strengths, it is not surprising that entering
and expanding in different countries has been a key element of Subway’s strategy in recent years. Indeed, Subway
currently has operations in nearly 100 nations.
China’s huge population and growing wealth makes it an attractive opportunity for Subway and other American restaurant chains.
Johnathan – Nanjing Lu – CC BY-NC-ND 2.0.
SWOT analysis is helpful to executives, and it is used within most organizations. Important cautions need
to be offered about SWOT analysis, however. First, in laying out each of the four elements of SWOT, internal
and external factors should not be confused with each other. It is important not to list strengths as opportunities,
for example, if executives are to succeed at matching internal and external concerns during the idea generation
process. Second, opportunities should not be confused with strategic moves designed to capitalize on these
opportunities. In the case of Subway, it would be a mistake to list “entering new countries” as an opportunity.
Instead, untapped markets are the opportunity presented to Subway, and entering those markets is a way for
Subway to exploit the opportunity. Finally, and perhaps most important, the results of SWOT analysis should not
be overemphasized. SWOT analysis is a relatively simple tool for understanding a firm’s situation. As a result,
SWOT is best viewed as a brainstorming technique for generating creative ideas, not as a rigorous method for
selecting strategies. Thus the ideas produced by SWOT analysis offer a starting point for executives’ efforts to
craft strategies for their organization, not an ending point.
In addition to organizations, individuals can benefit from applying SWOT analysis to their personal situation.
A college student who is approaching graduation, for example, could lay out her main strengths and weaknesses
and the opportunities and threats presented by the environment. Suppose, for instance, that this person enjoys
and is good at helping others (a strength) but also has a rather short attention span (a weakness). Meanwhile,
opportunities to work at a rehabilitation center or to pursue an advanced degree are available. Our hypothetical
student might be wise to pursue a job at the rehabilitation center (where her strength at helping others would be
4.6 SWOT Analysis 138
a powerful asset) rather than entering graduate school (where a lot of reading is required and her short attention
span could undermine her studies).
Key Takeaway
• Executives using SWOT analysis compare internal strengths and weaknesses with external opportunities and threats to generate ideas about how their firm might become more successful. Ideas that allow a firm to leverage its strengths, steer clear of or resolve its weaknesses, capitalize on opportunities, and protect itself against threats are particularly helpful.
Exercises
1. What do each of the letters in SWOT represent?
2. What are your key strengths, and how might you build your own personal strategies for success around them?
139 Mastering Strategic Management
4.7 Conclusion
This chapter explains key issues that executives face in managing resources to keep their firms competitive.
Resource-based theory argues that firms will perform better when they assemble resources that are valuable,
rare, difficult to imitate, and nonsubstitutable. When executives can successfully bundle organizational resources
into unique capabilities, the firm is more likely to enjoy lasting success. Different forms of intellectual
property—which include patents, trademarks, copyrights, and trade secrets—may also serve as strategic resources
for firms. Examining a firm’s resources can be aided by the value chain, a tool that systematically examines
primary and secondary activities in the creation of a good or service and by a knowledge of supply chain
management that examines the value added of multiple firms working together. While resource-based theory
provides a dominant view for examining the determinants of firm success, other perspectives provide insight for
understanding specific behaviors of firms within an industry. Finally, SWOT analysis is a simple but powerful
technique for examining the interactions between factors internal and external to the firm.
Exercises
1. Divide your class into four or eight groups, depending on the size of the class. Each group should search for a patent tied to a successful product, as well as a patent associated with a product that was not a commercial hit. Were there resources tied to the successful organization that the poor performer did not seem to attain?
2. This chapter discussed Southwest Airlines. Based on your reading of the chapter, how well has Southwest done in bundling together the resources recommended by resource-based theory? What theoretical perspective best explains the competitive actions of most firms in the airline industry?
3. Conduct a SWOT analysis of your college or university. Based on your analysis, what one strategic move should your school make first, and why?
- Mastering Strategic Management
- Mastering Strategic Management
- Contents
- Publisher Information
- About the Authors
- Acknowledgments
- Dedications
- Preface
- Chapter 1: Mastering Strategy: Art and Science
- 1.1 Mastering Strategy: Art and Science
- 1.2 Defining Strategic Management and Strategy
- 1.3 Intended, Emergent, and Realized Strategies
- 1.4 The History of Strategic Management
- 1.5 Understanding the Strategic Management Process
- 1.6 Conclusion
- Chapter 2: Leading Strategically
- 2.1 Leading Strategically
- 2.2 Vision, Mission, and Goals
- 2.3 Assessing Organizational Performance
- 2.4 The CEO as Celebrity
- 2.5 Entrepreneurial Orientation
- 2.6 Conclusion
- Chapter 3: Evaluating the External Environment
- 3.1 Evaluating the External Environment
- 3.2 The Relationship between an Organization and Its Environment
- 3.3 Evaluating the General Environment
- 3.4 Evaluating the Industry
- 3.5 Mapping Strategic Groups
- 3.6 Conclusion
- Chapter 4: Managing Firm Resources
- 4.1 Managing Firm Resources
- 4.2 Resource-Based Theory
- 4.3 Intellectual Property
- 4.4 Value Chain
- 4.5 Beyond Resource-Based Theory: Other Views on Firm Performance
- 4.6 SWOT Analysis
- 4.7 Conclusion
- Chapter 5: Selecting Business-Level Strategies
- 5.1 Selecting Business-Level Strategies
- 5.2 Understanding Business-Level Strategy through “Generic Strategies”
- 5.3 Cost Leadership
- 5.4 Differentiation
- 5.5 Focused Cost Leadership and Focused Differentiation
- 5.6 Best-Cost Strategy
- 5.7 Stuck in the Middle
- 5.8 Conclusion
- Chapter 6: Supporting the Business-Level Strategy: Competitive and Cooperative Moves
- 6.1 Supporting the Business-Level Strategy: Competitive and Cooperative Moves
- 6.2 Making Competitive Moves
- 6.3 Responding to Competitors’ Moves
- 6.4 Making Cooperative Moves
- 6.5 Conclusion
- Chapter 7: Competing in International Markets
- 7.1 Competing in International Markets
- 7.2 Advantages and Disadvantages of Competing in International Markets
- 7.3 Drivers of Success and Failure When Competing in International Markets
- 7.4 Types of International Strategies
- 7.5 Options for Competing in International Markets
- 7.6 Conclusion
- Chapter 8: Selecting Corporate-Level Strategies
- 8.1 Selecting Corporate-Level Strategies
- 8.2 Concentration Strategies
- 8.3 Vertical Integration Strategies
- 8.4 Diversification Strategies
- 8.5 Strategies for Getting Smaller
- 8.6 Portfolio Planning and Corporate-Level Strategy
- 8.7 Conclusion
- Chapter 9: Executing Strategy through Organizational Design
- 9.1 Executing Strategy through Organizational Design
- 9.2 The Basic Building Blocks of Organizational Structure
- 9.3 Creating an Organizational Structure
- 9.4 Creating Organizational Control Systems
- 9.5 Legal Forms of Business
- 9.6 Conclusion
- Chapter 10: Leading an Ethical Organization: Corporate Governance, Corporate Ethics, and Social Responsibility
- 10.1 Leading an Ethical Organization: Corporate Governance, Corporate Ethics, and Social Responsibility
- 10.2 Boards of Directors
- 10.3 Corporate Ethics and Social Responsibility
- 10.4 Understanding Thought Patterns: A Key to Corporate Leadership?
- 10.5 Conclusion
- Please share your supplementary material!