Strategic Leadership - Class 2

Porter's Five Forces: Barriers to Entry

It is a model that helps determine an industry's weaknesses and strengths. It helps to assess where power lies.

Forces	Definition	Solution
Competitive Rivalry	More competitors offering similar products, the less power a company has.	Companies Coordination, High Switching Costs, Product Differentiation
Threat of New Entrants	How easy or difficult it is for new competitors to enter your market and weaken your position.	Protect Intellectual Property
Bargaining Power of Buyers	Power of buyers to affect prices. It is high if buyers have many alternatives. E.g. Walmart has high buying power.
Bargaining Power of Suppliers	Power of suppliers to drive up prices. E.g. Boeing and Airbus have significant supplier power.
Sustitutes and Complements	Likelihood of your customers finding a different way of doing what you do. If substitution is easy and viable, then this weakens your power. E.g. Uber vs Lyft

1. Competitive Rivalry Solutions

Companies Coordination Examples

1. Back in old days, NewYork Central and Pennsylvania Railroad Company were competitors and started building out alternate routes for connecting Midwest to East coast. However, Chase, holding significant shares in both companies, came in between and made Pennsylvania Railroad Company drop the plan to build rail lines as it would have led to price war.

   It's illegal for two competitors to plan such actions, but someone having significant stakes in both companies can do so. You can't talk horizontally, but you can vertically.

   

2. There used to be 7 big oil companies that controlled the whole oil production and distribution in the world. If you are oil extractor then you had to work with one of these 7 companies to sell your oil. An example of tacit collusion - firms coordinate their actions without explicitly communicating. Libya revolted this and stopped selling oil to these companies. Around the same time, there were new entrants in the oil industry, who were looking for oil. Libya partnered with them and this eventually led to end of long standing coordination.

   As long as you control one key link in value chain, you can be monopolist.

   Back in 90s there were 12 airlines and only 3 had computer reservation system. There was a huge competition in airlines but only 3 with computer reservation system survived.

High Switching Cost Examples

1. Apple and Google make customers perceive that it is very easy to switch-in to their product, but super hard to switch-out. It doesn't matter what's reality as long as customer perceive it as high switching cost. That's why Google photos was created so that iPhone customers can easily switch to android.

2. When Google docs came out as a free alternative to paid Microsoft Word, Microsoft made it super hard to export documents to Google docs. Microsoft did it by releasing security patches and made it harder.

3. HP printers are cheap, but cartridges are expensive. On the other hand, Brother printers are expensive but cartridges are cheap. Both companies make sure that their cartridges are not compatible with each other. Once you have bought printer, you are locked in.

4. Enterprise software is super hard to switch. Companies delibrately make it harder for companies to switch.

5. Data migration from AWS to Google Cloud is super hard.

Product Differentiation and Positioning Examples

A firm that can position itself strategically to get significant high returns has a "competitive advantage".

1. Find Economic value to the customer (EVC), which is the maximum amount a customer should be willing to pay, using the reference value and differentiation value. EVC = Reference Value (price of perceived closest sustitute) + Differentiation Value.
2. A price needs a context. Without context, a customer cannot evaluate a price.

For example, coffee beans used to be $10 per pound, but now they are almost $50 per pound. When companies started selling K-cups or nespresso shots, they didn't position these shots next to coffee beans but the actual coffee, which costs $5 per cup. All of sudden, $1 for a shot start to look cheaper. How you position your product matters.

Horizontal Product Differentiation Using Preference Maps

• It highlights how a company's product is differentiated from its competitors in the eyes of consumers.
• Companies use these to strategically position their products in a way that appeals to specific consumer segments.
• Useful in product development by highlighting attributes that are most important to consumers.

If you are looking to start a new car company where would you place in perception map?

• Avoid Completely Empty Areas - It might be empty because there's no demand or too challenging or unprofitable to serve.
• Avoid Highly Saturated Markets - Intense Competition will lead to price wars, high marketing costs, and the need for significant differentiation to capture market share.
• Targeting Niche Segments - Look for segments that are underserved and meets emerging market needs.

Case - Airline Industry in 1980s

Background

Airline industry was regulated to put a floor on prices.

Why deregulate?

• People worried about monopoly, price gouging, only one airline traveling certain routes.
• Why prices are fixed, companies don't really compete and there is a waste of resources.

Industry Segments

1. Trunks

2. Regionals

3. Local Point to Point

Feeders to trunks.

Industry Analysis

• Overstretching of segments

  • Local started to stretch into regional
  • Regional started to stretch into trunk
  • Trunk has nowhere to go as international market was still regulated

• Everyone saw profits and there were a lot of new entrants, leading to price plummet.

  • Excess capacity led everyone to bankruptcy.

How to bring back profitability?

1. Change business model to Hub and Spoke
   1. Even if you can predict average demand for a route, there will be volatility. Either your planes would go half empty or you need to say no to customers
   2. Using Hub and Spoke model you pool variability and overall operation becomes efficient. Pooling reduces standard deviation of demand.
2. Innovate by adding Consumer Reservation Systems and dynamic pricing.
   1. Price discriminate over time (last minute booking at high price), method of purchase (online, travel agent, in-person), and class (Economy, Basic Economy)
   2. This enabled revenue management leading to maximize area under demand curve.
   3. You manage short term variability using dynamic pricing. If you have limited seats left, increase price.
   4. 
3. Capture Customers using Loyalty Scheme like credit card
4. Barriers to Entry were not as high as it seemed.

How Tesla Overcame the Barriers to Entry?

• Brand - launched Roadster as advertisement.
• Plants - bought factory at discount.
• Suppliers - ev car was simple to make, requiring less suppliers.
• Capabilities - leverage existing companies and have slow learning curve.
• Distribution - own sales network so no reliance of anyone else.