"Strategy" is a synonym for a "plan". A firm's strategy takes into account contingencies. We want to study in detail how the firm brings all of its resources to bear in achieving a desired marketing outcome.Strategy formation is not an optimization bounded process. We develop a set of alternatives and select the best of them. The objective of corporate strategy is to create value. We're aiming toward something that creates value which will, in turn, create more value.
Note that a strategy to "serve all customers" is not a strategy at all. A strategy must define what market the firm intends to serve to the exclusion of other customers and markets.
What is necessary to create value in a firm?
Point of differences
Unique resources. Resources allow a firm to provide value to consumers. But:
Are they unique?
Can the firm protect them in same way?
Is there durability to the resources? In other words, are there barriers to other firms seeking to enter the market?
How do you capture value? Value capture is called appropriation. Consumers have to know that a product or service is for sale. The firm has to be a cog in the supply chain. If it isn't, then the firm is not in the value creation zone.
Unique resources include tangible assets, intangible assets, and organizational capabilities. When evaluating a firm's unique resources, one of the first things to evaluate is the firm's brand equity. How much does the brand name matter to the company?
Market for your product. Does anyone care that the firm's product or service even exists?
IBM is good example of a firm that was not able to appropriate the value of their product, the PC. They made the PC "real." But, they lost money in the PC business.
In 1980, computers were "glass houses." They were large and fit in huge glass cabinets. The market expected this kind of computer and the technology supported it. Information was retrieved from computers through terminals.
IBM noticed the emergence of PCs developed by companies such as Commodore and Apple. But, IBM didn't believe that customers were really interested in desktop computers and considered them little more than a fad. In addition, IBM did not make money on terminals used to access their mainframes; they made money on hardware and software and services. IBM's strategy with the PC was aimed at stimulating its mainframe business by lowering the cost of dumb terminals.
With this in mind, IBM developed the PC and encouraged Intel to sell the PC processors to anyone. In this way, IBM hoped that the cost of terminals would decrease significantly. Instead, the PC significantly undermined IBM's mainframe business. The strategy didn't work because IBM chose not to appropriate the value of the PC. T he PC had durability and value to customers. But, IBM did not capture the value.
However, Microsoft was able to appropriate value in the PC business. So was Intel. The problem was that IBM did not appropriate the technology; they didn't capture the value. They had a set of unique resources. But, they gave the unique resource power to Microsoft and Intel by allowing them to sell the "guts" of the PC to anybody.
A strategy is a plan of action for a firm; but it's a broad plan. It doesn't describe the firm's actions at every step along the road of value creation. A strategic plan is a long term plan. How long the term is depends on the market that the firm is in. "Long term" is 30-40yrs in the power industry. It's, perhaps, 12 months in the electronics business. Maybe "long term" is merely a few months in the toy business.
What determines what kind of planning horizon a firm should have? The answer depends on industry. The forecasting horizon depends on the response time of the firm. Yet, if a firm can meet any customers' need in 24 hours, why would it need to plan any further in the future? The reason is that another firm might be able to respond even faster.
Companies must do forecasting on a firm-wide basis. For example, Toyota found that their marketing team lagged behind the factory in response time. To improve the responsiveness of the overall organization so that shorter term forecasts could be used, it had to improve the responsiveness of the marketing team to match the factory's response times.
There are three kinds of strategy:
1. Competitive Strategy - a long term plan to create a sustainable competitive advantage in a selective product market. The competitive strategy answers the question of "How do we make money?"
2. Business Unit Strategy - Answers the question of "How should we compete?"
3. Functional Strategy - defines and develops the marketing skills needed to support the competitive strategy. It answers the question of "What capabilities are required?"
Each of these types of strategy incorporate the unique threats and opportunities of the global environment.
The strategy formulation process consists of five parts:
1. Environmental scanning --- Lets draw a circle around the firm. Everything out of the circle is the environment. Examples are competitors, regulation, political situation, consumers, etc. What is the estimate of what a firm's future is going to look like? Its "noisy." The further out a firm tries to predict its operating environment, the less accurate the picture is.
2. Internal Assessment --- What is the firm good at? What does the firm need for the future? Think of the firm as a circle. Think of the circle representing the firm as being surrounded by a triangle. The triangle represents the needs of the firm. Notice that some of the firm's capabilities are not needed. These are capabilities that the firm needs to rid itself of. But, there are needs of the firm that are outside of the firm. Likewise, there are required resources outside of the firm that the firm doesn't possess but needs to acquire for the future.
3. Strategic Alternatives -- Formulation of strategy is about forming alternatives. What alternatives do the firm have that can be used to create value?
4. Valuation and Choice - Which alternatives should the firm choose?
5. Implementation - Once a firm has developed a competitive strategy, it has to implement it.
Practical advise for a firm is that a great implementation is better than having the absolute best winning strategy. Unfortunately, firms often deemphasize implementation. Implementation is not "exciting;" so managers often only give it lip service.
Also note that acquisitions usually don't create the value predicted.
There are two ways to look at a firm's strategy:
1. Market Based View - The firm finds what a customer wants and tries to satisfy the need.
2. Resource Based View - The firm has unique resources. The firm attempts to find customers who value these unique resources and seeks to serve them in the marketplace.
Really, both the Market Based View of the firm and the Resource Based View of the firm degenerate into the same thing. Both views have to be considered when developing a competitive strategy.
Fitting Competitive Strategy into the Organization
Before examining how the firm's strategy fits into the organization and its architecture, we must first define what a "firm" is.
A "firm" is really a nexus of contracts - implicit or explicit. Whether something is inside or outside a firm's boundaries is merely a question of whether it is part of an implicit or an explicit contract.
A firm can also be thought of as a set of resources or a bundle of processes. At the heart of the organization are its values, beliefs and culture, organizational capabilities, and its vision of the future.
When framing a strategy for the firm, we must first look at the elements that make up an industry:
New entrants into the industry
Substitute products. An example is substitution of digital cameras for film. Or substituting lasik surgery for contact lenses. Or, perhaps in the future, substituting some sort of electronic paper for physical paper. If a folding monitor that goes in a consumer's pocket is developed, demand for physical paper will likely be reduced.
Note that disruptive technical substitutes for a product almost always come from outside of the industry effected. For example, buggy makers did not develop the automobile.
Competitive advantage is the ability of the firm to make economic rents in excess of those in the industry. To determine the areas where excess economic rents can be charged, first look at the industry as a whole. Then, look at firms in the industry that are not competing successfully. The issue for these firms is often poor appropriability.
Michael Porter of Harvard Business School developed a five forces model for industry analysis. His model was published in 1980 when the United States was still in the midst of a manufacturing economy. But, they are still valid today. Among his conclusions were that a firm may compete on the basis of cost leadership or on the basis of product differentiation. However, competing on both fronts is difficult.
Porter warns firms not to get stuck in the middle and try to compete on both cost leadership and differentiated product. A similar warning is also applicable to individuals striving to advance careers: Try to either participate in a successful project or in a troubled project. Don't get caught in a "middle of the road" project!
Generic strategies are strategies that are low cost and easy to implement that differentiate a product. However, there is temptation for a firm to try to be a low cost provider and also attempt to differentiate its product from those of competitors.
In some situations, Porter's theories may be breaking down over time due to technological advances. While its true that producing unique products costs more than providing tried and true standardized products, streaming and rapid (just in time) inventory can make up for the additional costs. For example, it could be argued that Dell has a superior product that is also very cost effective. In addition, Toyota has developed a built to order, rapid delivery, system for automobiles. In a sense, Dell and Toyota are value providers with very differentiated products.
The quality movement has also allowed firms to create products that are more likely to work correctly the first time. So, the costs of repairs and returns are lower for modern products than they have been in the past.
Besides Dell and Toyota, another example of mass customization is a company called Zara. Zara is a women's clothing company that is able to reduce product development and production time to just two weeks, compared to an industry standard design cycle of twelve months. Zara has invested heavily in up front product design to cut the design cycle time. Gap and H&M are Zara's major competitors. Gap and H&M have responded to Zara by streamlining their existing design cycle. This streamlining has allowed them to cut their development time to 3 or 4 months. But, Zara has people in stores and on the streets talking to customers and converting existing designs into better designs.
Most Zara products are made in Spain in home factories. Zara produces each style in low quantities. Such low quantity production in a Western country is more expensive than mass production in China. But, Zara trades off inventory and large production ability with lean production --- quick movement of inventory.
Another model introduced by Michael Porter is the Global Value Chain. The Global Value Chain consists of:
Human Resource Management
Operations such as Inbound and Outbound Logistics
Marketing, Sales, and Service
In Porter's Model, information flows from the firm to the market (Left to Right Flow). But, also important is Right to Left flow of information from the consumer back through the value chain. Right to Left flow is every bit as important as the opposite, normal, direction.
Market research for extension of existing products works well. But, asking people about products that are not aware of (outside of the consumer's experience) is likely misleading. For example, asking someone in 1975 to evaluate the idea of developing the internet would likely provide unhelpful information for a firm.
Market Based View of the Firm
One strategy is to strive to serve all of the needs of a particular customer. One example is a company that installs an oil pipeline in Saudi Arabia. In addition to actually installing the physical pipeline, the firm may be required to provide additional services such as building schools and hospitals in towns that it passes through. In this case, the capability of the company is to be able to effectively respond to various requests of the customer. That capability is a unique resource.
Using the Market Based View of the firm, a company needs to attain information from the customer, disseminate the information to the relevant parties (internal to the firm as well as subcontractors) and implement the customer's requirements.
The first step in implementing a Market Based Strategy is to define the customer or customers to be served by segmenting and re-segmenting the possible customers. Then, once customers have been identified, the firm must understand their current and latent wants. Finally, the firm must organize itself to respond to the customers' requirements. Of course, in doing so, the firm must not put itself in the position where the very life of the firm is compromised in the effort to satisfy customer requirements.
Also, in developing a Market Based Strategy, the firm has to decide how to balance focus on competitors with focus on the customers. A firm that is highly customer and highly competitor focused is deemed to be strategically integrated. If the firm ignores competitors and, instead, focuses primarily on customers, it is said to be customer preoccupied. Firms that focus mostly on discounting competitors with little emphasis on customers are said to be marketing warriors. Of course, firms that focus neither on competitors nor on customers are strategically inept.
Resource Based View of the Firm
The Resource Based View of the firm is the most important way to view the firm's strategy. It focuses on how the firm's competitive position is related to the resources of the firm. The goal is to achieve a Sustainable Competitive Advantage. What is a Sustainable Competitive Advantage? And how does a firm know if it has one or not? The answer is that a firm with a Sustainable Competitive Advantage has continuous profits/sales that are higher than others in the industry and that its profits are difficult to imitate. NOTE: If there is no producer surplus, there is no Sustainable Competitive Advantage.
Criteria for using resources of the firm to achieve a Sustainable Competitive Advantage are:
Demand: Is the resource valuable to the customer?
Is the resource scarce?
Is there imperfect imitability? How easy is the product or service to copy? A resource is difficult to imitate if it is physically unique. Its difficult to imitate if it is developed only after many other resources have to be developed first. Its difficult to imitate if there are economic barriers to entry into the trade. Finally, its difficult to imitate if there is casual ambiguity. For example, Toyota was able to develop lean production capabilities in the 1970's. But, even though it opened its factories and processes to inspection by competitors, its competitors were not able to duplicate it successfully. Likewise, if a company possesses processes and resources it doesn't need, getting rid of them can be difficult. For example, Gap and H&M were able to streamline their processes in response to Zera. But, they weren't able to achieve a two week product development cycle.
Is there imperfect tradability and substitutability? Can some other resource provide a substitute?
Competitive position: Is the product or service offering superior to the competitors'?
Appropriability: Can economic rents from the product be captured?
The history of the firm is important. Changing from one specialty to another is extremely difficult. Firms are likely to succeed in endeavors in which they have been successfully involved with in the past. In other words, the firm's ability to create value is dependent on its stock of unique resources and the organization's skill in using them. These both develop over time and depend on the firm's history.
Persistent asymmetries in real, or consumer perceived, unique resources exist during a firm's sustainable advantage. The important thing to note is that unique resources can be perceived even if they not real anymore. Because of this, a firm's competitive advantage can often continue after it no longer has a unique product. An example of this is Ivory soap. Ivory soap has been on the market since 1879. It's not unique anymore and hasn't been for quite some time. But, many customers perceive it as being "better" than other soaps. So, it continues to sell successfully.
Of course, possession of a unique resource is necessary for obtaining a competitive advantage. But, it doesn't guarantee a competitive advantage. For example, a firm may have a unique resource enabling it to produce solar powered freezers in the Arctic. But, its very unlikely that this firm would be able to appropriate this resource to obtain a competitive advantage in the market!
Economic deterrence is a way that a firm can limit a competitor's entry into the market and can protect its unique resources. Economic deterrence can be economic action or the treat of it. This kind of deterrence can be quite important in industries where large capital investments are required to create output. The IC manufacturing industry is an example of this type of industry. There is a limit to capacity in a facility to build IC's. Increased demand for IC's may necessitate building new facilities. But, too many facilities could create excess capacity. The simple threat by a big chip maker to build a new facility could put a lid on plans by smaller manufacturers to build facilities. The threat would make a new facility a bad investment for the smaller firm.
Another example of economic deterrence is Proctor and Gamble's clear signals that it will not allow another firm to tread on Tide soap's market share in the US market. If another company decided to compete head to head with Tide, Proctor and Gamble would simply lower the price of Tide as low as necessary to keep its market share, touching off a price war.
The Market Focused View of the firm and the Resource Based View of the firm are really the same concept starting from different ends of the value chain. The Market Focused View starts with the customer and asks what the firm can do for it. The Resource Based View starts with the firm's capabilities and asks which customers need those capabilities.
Expanding a Firm's Opportunities
Breakthrough opportunities are opportunities with a new set of customers as well as opportunities with a new set of products. With breakthrough opportunities, the company doesn't know the product and doesn't know the customer. As such, breakthrough opportunities are highly risky.
Market expansion involves geographic expansion of the market. Customers are new, but the products are existing.
Evolutionary goods are packaged goods. Toothpaste or other consumable goods are examples. Evolutionary products are marketed to existing customers in existing markets.
Product Expansion involves marketing new products to existing customers. Demand forecasting is done by market research metrics, demand curve creation, etc. The research identifies value created by each feature.
How does a firm trade off potential product features to maximize value? The answer is that the firm looks at the external environment. The marketing team analyzes the competitive position of the particular feature in the marketplace and the best time (market timing) to introduce a feature or product.
Out of the four choices for expanding a firm's opportunities, what are the best two to choose? Nowadays, the marketing experts drive the decision. In the past, product developers drove the decision. They would develop products and then the marketing team would be tasked with marketing them. Today, the marketing team comes up with new products and the product development team is responsible for designing them.
Besides market forecasting, firms forecast future demand through scenario planning. Scenario planning is important for an industry in the long horizon. However, along with scenario planning comes long term capital decisions and uncertain forecasts. The best company doing scenario planning is Shell Oil.
Shell Oil creates descriptions of several extreme external environments. Then, they ask, "Does our strategy hold up in those environments?" And "what will the outcome be if the scenario happens?" -- A good book discussing this is called "The Art of the Long View: Planning for the Future in an Uncertain World" by Peter Schwartz.
A final way to do demand forecasting is expeditionary marketing. Expeditionary marketing is when a company builds small quantities of a product and then tests it in limited markets. Based on the results, they decide whether to go forward with a wider product launch. This marketing technique is typically employed in the packaged goods business.
One problem with expeditionary marketing is determining how good the sample is. Another problem can occur if another company gets wind of the test and then tries to do something to sabotage it. For example, say that a company tests a new product in Australia. A second company finds out and begins simultaneously testing a really bad product, purposefully, in Australia. The first company's test product may succeed in Australia only to fall flat on its face in a wider market.
All products have three attributes:
1. Search: Characteristics of a product that can be determined before purchase.
2. Experience: Characteristics of a product that can only be determined after purchase. (Example: How does a Snickers bar taste? The customer will only know after she has tasted it!) If purchase or trial of a product is inconvenient, a substitute for experience can be endorsements. Endorsements are surrogates for experience.
3. Credence: Credence attributes are attributes that a customer may never be able to determine. Examples: "Are these vitamins really better for me?" "Did the brain surgeon really take out the bad parts of my brain that were causing my psychosis? Maybe he took some parts out that I might need for other reasons later." "Did the medicine that the doctor gave me for my cold really cure my cold?"
Some definitions of Market Leadership are:
Unaided recall by customers of the firm - regardless of whether they prefer it or not.
Brand identification if prompted.
Market share or rate of change of market share. Many people prefer this definition.
"The firm that defines the dimensions of competition." This is the best definition.
For the last 30 years or 35 years, Toyota and Honda have been the market leaders in the auto industry. Currently, they are setting the market trend for fuel efficiency. During the energy crisis in 1974, Toyota and Honda had their first successes on this front. Toyota and Honda have always had very efficient cars. So, their cars became popular in the 1970's because of their efficiency. The US auto industry scrambled to catch up in the dimension of efficiency.
Then, in the early 1980's, the energy crisis had passed. Toyota's major competitive advantage became quality: Toyota "never" has to be repaired!
In the early 1980's, Ford did a survey of its customer service compared to other companies. They thought something was wrong with the data. They found that the Toyota and Honda vehicles were significantly better quality than any cars produced in Europe or the US.
Ford, GM, and Chrysler struggled to implement their own quality programs for about ten years. The differences start to shrink. At some point, quality was no longer a major distinction between US automakers, Toyota, and Honda. Yet, Toyota and Honda maintained market leadership because they could develop a new product with half of the engineers in half of the time of the US firms. By the time GM , for example, could develop a new model, Toyota and Honda could developed four times as many models with the same number of engineers. They added more brands like Lexis and Acura to their product line GM was forced to eliminate the Oldsmobile.
Toyota and Honda successfully refined the dimensions of competition every time the US companies caught up and made the dimension of competition a non-factor. That is Market Leadership.
Dimensions of Competition
Firms compete on the basis on many things. In the arena of tangible products, competition is based on:
Conformance to specification is irrelevant because customers expect conformance to specification, unlike in the past. Today, the criteria for product or service evaluation is more subjective - almost like a piece of art.
The basis of competition in the service sector is similar. However, there are differences because much of service evaluation is subjective:
Assurance - knowledge, courtesy of employees, and ability to convey trust and confidence.
Empathy with customers needs
Tangibles include the appearance of the service personnel and the firm's facility.
These dimensions do not change much across industries - be they insurance, credit cards, or something like car repair.
Studies have shown that the most important of these competition dimensions is reliability. The least important is tangibles. Service providers tend to recognize that reliability is the most important dimension. But, they mistakenly believe that providing tangibles is closely behind. Its not.
Research has shown that suppliers are exceeding customer expectations in tangibles. But, they are failing to meet expectations in all other dimensions. The dimension they fail to meet the most is reliability. This is true in general regardless of the service industry.
Deciding Whether or Not to Develop a New Product
If a firm is trying to decide whether or not to develop a new product, it should first determine if there is demand for it or not. Next, it has to ask if it will create value for the company by effectively competing with other firms in terms of cost or product differentiation. This is often determined by computing the Net Present Value (NPV) of the product development cycle.
But, NPV may not be the best way to evaluate new product development. Perhaps a product itself will not create value for the firm but will be important to the firm's overall strategy. Modeling the value of such a development effort can be performed using option theory.
Equity options are the right to buy/sell a security at some future point at a set price. Similarly, a firm can ask how much they are willing to spend today in order to put off a decision until tomorrow. This concept drives Research and Development (R&D) and advertising budgets.
Instead of simply calculating NPV, the total value calculation for a project should include other variables as well:
Apply rules of derivatives to a two stage development cycle. Call the cost of developing the product $D. Assume that Pts is the probability of technical success for the product. $C is cost to launch the product. Pcs is the probability of commercial success once the product is launched. Only if a product is technically and commercial successful can a firm realize NPV for its development. Otherwise, the project costs are all lost.
The idea that a firm can make decisions to continue development or to stop development in the middle of the development process allows the modification of the NPV calculation as follows:
ECV = Estimated Commercial Value = (NPV * SI * Pcs - C) * Pts - D
SI is the Strategic Importance of the product to the firm. It describes how important the success of the project is to the company's future. It describes, for example, the ability to use the technology or skills developed for other projects as well.
In a sense, the SI variable is the manager's fudge factor. It makes the point that $D is not necessarily sunk cost for a dead project, if it fails. This concept allows a firm to balance its portfolio.
Note that ECV could be positive if two projects are considered together but negative if they are considered separately. The opposite is also true.
This concept applied to product development is called the "theory of real options."
Only 5% of ideas in the conceptual phase ever make it to the market place. The further development proceeds toward the marketplace, investment costs grow. They grow exponentially. So, its very important to engage in the stop/evaluate process. And it's important to identify losing products early, even if they have strategic importance. The reason is that, as a product gets closer to market, the reusability of the additional skills or developed technology decreases. Strategic importance is most important in initial stages of produce development.
Source of New Product Ideas
New product ideas come from the following sources:
Examining the alignment of new or improved products with the current customer space.
The maturity of the technology and the alignment of the customer to the product space. The new product might not be new to the world, but it might be new to the customer.
When a firm's product has a high level of alignment with the customer base and a high level of product maturity, 80%+ of new product ideas come from customers.
When technology is low and product awareness is high, new product development tends to be developer (engineer) driven.
When product awareness is low and technology is high, we see combinations of technologies or new applications of the technologies.
Technology Market Co-evolution is a term used when technology is pushing product development. Firms tend to use the axiom: "I can do it; somebody wants it." New ideas are presumed to have market demand.
Probabilities of Success with Introducing New Products
When there is an existing product technology and an existing customer base, there is a 90% chance of commercialization. An example of such a situation is toothpaste and soap.
Something that's not necessarily intuitive is that its easier to build a product than it is to build a market for a product. There is a 25% chance of success for an existing product introduced to a new market. But, there is a 50% chance of success for a new product introduced to an existing market.
Building Knowledge in an Organization
Building knowledge in an organization is much like playing a musical instrument: practice makes perfect. When a firm does something over time, the cost goes down because it get better at it. Costs decrease over time. This is called the experience curve. Note that much of the experience curve is generated around price and not cost because public data for product cost is generally unavailable.
log(Cost for the Nth Product) = -a * log(Cumulative Volume)
The slope of the curve is -a.
Note that price elasticity of demand is (Change in Demand) / (Change in Cost). This is similar to a. The slope is a percentage.
When cost has changed to 75% of what it previously was when a firm doubles the volume it has produced, the experience curve is called a 75% Experience Curve. Typical experience curves are between 70% and 85%. R&D and retailing have the flattest Experience Curves (95%). Product subassembly has steep, 70% Experience Curves. High tech products like hard drives have curves that are even steeper (54%), which indicates that they rapidly become cheaper as more are produced.
The experience curve was originally developed by the US Government based on experience during World War II. The government used it to negotiate quantity discounts for bombers.
The experience curve is different from Economies of Scale. Economies of Scale suggests that costs go down as the firm's rate of production increases. In contrast, the Experience Curve suggests that a firm's costs go down with total volume ever produced increases.
The Experience Curve basically describes the organizational capability of the firm.
Experience curves can be used to predict the future cost of a product. For example, they can be used to predict the cost of wind power versus coal power in the future as more and more energy is produced with these technologies. Interestingly, the experience curves are much steeper for solar power than for wind, while coal power experience curves are relatively flat. This indicates that wind and solar power will get progressively cheaper until power production with solar and wind are cheaper than power production with coal. There is a caveat, however. A very flat experience curve for a technology like coal power is often indicative of an industry with little competition. When competition enters the picture in the future, the price of generating power with coal may very well begin decreasing.
One might think that in the world of rapid communications, communication over distances is easy. Not so. Distance may very well make communication even more difficult now than it used to be. The reason is that know-how and know-why are hard to transmit. Evidence of this is clustering of certain industries in geographic locations. For example, financial services are largely clustered in New York and London. Movie making takes place in Hollywood or Bollywood. High tech development takes place in Silicon Valley, the Boston area, the Washington DC area, and Austin.
Experience curves become flatter as geographic distance increases. The reason is that passive knowledge is shared because of close proximity. It's very hard to pass passive knowledge over distances.
If a firm is a market share leader in an area, it can locate anywhere because it is the cluster. So, Kodak might be able to locate anywhere. But, a new chip manufacturer would be at a disadvantage to locate in Kansas; high knowledge workers tend to cluster. Its expensive to move a firm with this kind of worker because, when the firm moves, significant skill loss occurs.
However, think a firm having a 100% market share moving down the experience curve. It wishes to maintain its 100% market share; but a competitor arises. The original firm still has a cost advantage. To keep this cost advantage, the original firm strives to move down the experience curve at least as fast, if not faster, than it did before. This allows it to maintain the cost advantage - which is a sustainable competitive advantage. As long as the its market share remains larger than the next competitor, the firm is moving down the curve faster than the competitor.
A high annual market growth rate and high relative market share is a sustainable competitive advantage.
A high relative market share but a small annual growth rate of the market discourages a firm from moving down the experience curve. This means that the firm stops spending on R&D. It stops spending on advertising. The product becomes a "cash cow." The firm is still in a relatively strong position. However, as R&D is cut, the high market share can be eroded leaving the firm with low market share in a low growth market. This is a disaster for the firm, of course.
"Cash cow" businesses tend to pay large cash dividends as the proceeds from sales are not reinvested in the business. This scenario was, sadly, played out in the 1970's and a large amount of corporate value was destroyed.
The following are characteristics of service firms:
Provide something that is not a physical product.
Responds to a need.
Typically no inventory.
Site location determined by the customer. The service is performed at a place that is convenient for the customer.
In a service firm, customers get involved in the service as it is performed. This is called the joint production problem; the service is produced and consumed at the same time.
The demand function for a service is heterogeneous. That means that it is different for each consumer.
The function of marketing is to transform a tangible good into a service. If a customer buys an auto, it provides her with a service. People buy tangible goods that can provide a service. Until mid 1990's, productivity in the service industry was relatively low. Low productivity causes lower GDP. A shift began in the 1990's because of second generation IT implementation in the service businesses. That's at the heart of why the productivity of service firms increased so significantly in the late 1990's and early 2000's.
This increase in productivity is analogous to what happened when automation hit the manufacturing industry. The first generation of automation helped replace people. The second generation of automation focused on what the machine could do; not just its ability to replace people.
In the IT industry, technology first duplicated what people did. In the second generation, services were expanded by using the ability of the technology.
Myths About Service Industries
They low valued. However, services are provided by doctors, lawyers, accountants, etc. which cannot really be described as low value.
Services are not capital intensive. For most service industries, the largest investment is in IT (computing, telecommunications, etc). The firms with the largest capital budgets are banks, insurance companies and retail. All of these are service industries; service industries are capital intensive.
Service industries are small scale. On the contrary, the biggest companies in the world are in the service industry. Walmart, ATT, and Microsoft are good examples.
David Ricardo was an English economist who followed Adam Smith. In 1919, there was a serious controversy as to whether manufactured goods produced wealth. After all, manufactured goods cannot be eaten or worn. Similarly, today there is discussion as to whether service industries create wealth. There is definitely anecdotal evidence they do. Most wealthy people have made their fortune not in agriculture nor in manufacturing but in service industries: entertainment, sports, Wall Street CEO's, etc. Even the former Lehman's CEO still has a considerable amount of wealth. Not as much as before; but still a significant amount.
Service industries are industries other than manufacturing, agriculture, and government. The service industry has made up more of GDP than manufacturing in the US since 1838.
Service dominates all advanced economies and is growing. Productivity causes the shift to service based economies. The number of people in manufacturing and agriculture decreases because of increased productivity and technology even though the gross amount of goods and agricultural products products increase. For example, the US produces more food today with 1.4% of the population involved in agriculture than it did 100 years ago with 60% of people involved in farming.
After World War II, Peter Drucker, who is widely considered the father of modern management, predicted that the physical amount of material in products would shrink over time. This has turned out to be true. The importance of material in products is shrinking.
At least 50% of the activities in a manufacturing firm could be classified as service jobs if they were outsourced.
Measuring Customer Satisfaction
One of the most important goals of customer satisfaction forms is to make the customer believe that the firm cares about what they think. Surveys were rare until about 20 years ago.
When firms think of customer satisfaction, they usually think about whether customers' minimum requirements have been met. However, they should really be thinking about whether or not the customers' expectations were exceeded - to her delight.)
Customer satisfaction is extremely important because loyal customers are significantly more profitable than new customers. In addition, the value of customers increases over time. Customer satisfaction leads to future sales and referrals. But, unfortunately, sales commissions are usually paid for acquisition of new customers rather than retention of existing customers.
Remember that people respond to incentives. But incentives can only be provided effectively when the proper performance measurements are used. Its difficult to measure retention of customers and easier to measure new business acquisition.
In retail, one way to measure customer retention is bar coding. Firms can now keep track of the "door" (customers who trade, leave, and don't come back.) Some of the most advanced firms are taking advantage of this. However, most are still just using bar codes to measure inventory flows.
Net Promoter Score
The ultimate customer satisfaction survey question is: Would you refer us to a friend on a scale of 1 through 10?
Scores of 1-6 indicate that the customer is a detractor from the business. They are less likely to return and more likely to spread negative information about the firm.
Scores of 7-8 indicate reasonably satisfied customers.
But customers who indicate scores of 9-10, are promoters of the firm. They are very likely to provide the firm with repeat business and referrals.
The Net Promoter Score is defined as follows:
NPS = % Promoters - % Detractors
There is a huge correlation between net profitability and NPS!