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Corporate strategy addresses “where to compete” and business strategy addresses “how to compete” (Rothaermel, 2021, p. 313).  Choose one business in chapters 7 and 8 and describe one aspect of this business where you see a failure of management.  In other words, what is one thing the strategic managers of this firm should have or could have done differently to help move the company forward.  Be sure and include in your discussion how this firm addresses “where” to compete and how this firm addresses “how” to compete.  Is there a failure in the “where” to compete or is there a failure in ‘how” to compete?   Analyze that failure and offer a solution that you as the strategic manager would have implemented.  
This case may be based on your opinion.  However, you must back up your opinion with sound research and fact.

Chapter 8
Corporate Strategy: Vertical Integration and Diversification

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Learning Objectives 1-9
Define corporate strategy and describe the three dimensions along which it is assessed.
Explain why firms need to grow, and evaluate different growth motives.
Describe and evaluate different options firms have to organize economic activity.
Describe the two types of vertical integration along the industry value chain: backward and forward vertical integration.
Identify and evaluate benefits and risks of vertical integration.
Describe and examine alternatives to vertical integration.
Describe and evaluate different types of corporate diversification.
Apply the core competence-market matrix to derive different diversification strategies.
Explain when a diversification strategy creates a competitive advantage and when it does not.

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Corporate Strategy
The decisions that leaders make.
Goal-directed actions that they take in the quest for competitive advantage.
Boundaries of the firm:
Vertical integration.
Diversification.
Geographic scope.

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Vertical integration: In what stages of the industry value chain should the company participate? The industry value chain describes the transformation of raw materials into finished goods and services along distinct vertical stages.
Diversification: What range of products and services should the company offer?
Geographic scope: Where should the company compete geographically in terms of regional, national, or international markets?

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Why Firms Need to Grow
To increase profits and shareholder returns.
To lower costs and achieve economies of scale.
To increase market power.
To reduce risk through diversification.
To motivate management.

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Increase profits – results in shareholder returns.
Lower costs – growth enables efficiency.
Increase market power – fewer competitors, more bargaining power, higher profitability.
Reduce risk – low performance in one SBU can be compensated by another.
Motivate management – job security.
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Three Dimensions of Corporate Strategy
Vertical integration.
Diversification.
Geographic scope.
Underlying concepts that guide these:
Core Competencies (Chapter 4).
Economies of Scale (Chapter 6).
Economies of Scope (Chapter 6).
Transaction Costs: cost effectiveness of vertical integration vs. diversification.

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The Chapter Case discusses Amazon’s diversification over time. Bezos also decided to customize certain country-specific websites despite the instant global reach of ecommerce firms. With this strategic decision, he decided where to compete globally in terms of different geographies beyond the United States. In short, Bezos determined where Amazon competes geographically (question 3).

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Transaction Costs
Associated with an economic exchange.
External transaction costs:
Searching for contractors.
Negotiating, monitoring, and enforcing contracts.
Internal transaction costs:
Recruiting and retaining employees.
Setting up a shop floor.

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Internal transaction costs include costs pertaining to organizing an economic exchange within a firm—for example, the costs of recruiting and retaining employees; paying salaries and benefits; setting up a shop floor; providing office space and computers; and organizing, monitoring, and supervising work. Internal transaction costs also include administrative costs associated with coordinating economic activity between different business units of the same corporation such as transfer pricing for input factors, and between business units and corporate headquarters including important decisions pertaining to resource allocation, among others. Internal transaction costs tend to increase with organizational size and complexity.
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Internal and External Transaction Costs
Exhibit 8.2

Access the text alternate for slide image.

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Make or Buy?
If Costsin-house < Costsmarket, Vertically integrate. Own production of the inputs. Or own output distribution channels. If Costsmarket < Costsin-house, The firm should consider purchasing instead. © McGraw Hill 8 Organizing Economic Activity: Firms vs. Markets Exhibit 8.3 Access the text alternate for slide image. © McGraw Hill 9 The Principal-Agent Problem A major disadvantage of organizing economic activity within firms. Principal – the owner of the firm. Goal: create shareholder value. Agent – manager or employee. Should act on behalf of the principal. Problem: Agents pursue their own interests (corporate jets, golf outings, expensive hotels). One Solution: Stock options to make agents owners. © McGraw Hill 10 Information Asymmetry A situation in which: One party is more informed than another, Due to the possession of private information. Can result in the crowding out of desirable goods and services by inferior ones. Examples: used cars, e-commerce, mortgage backed securities, R&D projects. © McGraw Hill 11 Alternatives on the Make-or-Buy Continuum Exhibit 8.4 Access the text alternate for slide image. © McGraw Hill 12 Vertical Integration The ownership of inputs or distribution channels. “What percentage of a firm’s sales is generated within the firm’s boundaries?” Backward Vertical Integration: Owning inputs of the value chain. Forward Vertical Integration: Owning activities closer to the customer. © McGraw Hill The degree of vertical integration tends to correspond to the number of industry value chain stages in which a firm directly participates. 13 Backward and Forward Vertical Integration along an Industry Value Chain Exhibit 8.5 Access the text alternate for slide image. © McGraw Hill 14 The Vertical Value Chain of Your Cell Phone Raw materials: Chemicals, ceramics, metals, oil for plastic. Intermediate goods and components: Integrated circuits, displays, touchscreens, cameras, and batteries. Final Assembly and manufacturing: Assembly. Marketing, sales, after-sales service and support: Pick a service provider. Get wireless data and voice service. © McGraw Hill 15 HTC’s Backward and Forward Integration along the Industry Value Chain in the Smartphone Industry Exhibit 8.6 Access the text alternate for slide image. © McGraw Hill 16 Benefits of Vertical Integration Lowering costs. Improving quality. Facilitating scheduling and planning. Facilitating investments in specialized assets: Co-located assets, unique equipment, human capital. Securing critical supplies and distribution channels. © McGraw Hill Specialized assets have a high opportunity cost: They have significantly more value in their intended use than in their next-best use. They can come in several forms: ▪ Site specificity—assets required to be co-located, such as the equipment necessary for mining bauxite and aluminum smelting. ▪ Physical-asset specificity—assets whose physical and engineering properties are designed to satisfy a particular customer. Examples include the bottling machinery for E&J Gallo. Given the many brands of wine offered by E&J Gallo, unique equipment, such as molds and a specific production process, is required to produce the different and trademarked bottle shapes. ▪ Human-asset specificity—investments made in human capital to acquire unique knowledge and skills, such as mastering the routines and procedures of a specific organization, which are not transferable to a different employer. 17 Risks of Vertical Integration Increasing costs. Reducing quality. Reducing flexibility. Increasing the potential for legal repercussions. © McGraw Hill Amazon, featured in the Chapter Case, is facing potential legal repercussions because of its increasing scale and scope. Amazon now accounts for roughly one-half of all internet retail spending in the United States. In addition, with AWS, physical retail stores, and drone deliveries, Amazon is increasingly becoming a fully vertically integrated enterprise. Many argue that Amazon is much like a utility, providing the backbone for internet commerce, both in the business-to-consumer (B2C) as well as in the business-to-business (B2B) space. This paints a future picture in which rivals are depending more and more on Amazon’s products and services to conduct their own business. Amazon’s tremendous scale and scope can bring it increasingly into conflict with governments. Antitrust enforcers such as the Department of Justice might train their sights on Amazon. 18 When Does Vertical Integration Make Sense? When there are issues with raw materials. Example: Henry Ford ran mining operations. To enhance the customer experience. Eliminate annoyances and poor interfaces. Vertical market failure: when transactions are too risky or costly. © McGraw Hill In the early days of automobile manufacturing, Ford Motor Co. was frustrated by shortages of raw materials and the limited delivery of parts suppliers. In response, Henry Ford decided to own the whole supply chain, so his company soon ran mining operations, rubber plantations, freighters, blast furnaces, glassworks, and its own parts manufacturer. 19 Alternatives to Vertical Integration Taper Integration: Backward or forward integrated. Plus reliance on outside firms such as suppliers or distributors. Strategic Outsourcing: Moving internal value chain activities. To other firms. Example: HR management system. © McGraw Hill Taper integration has several benefits: ▪ It exposes in-house suppliers and distributors to market competition so that performance comparisons are possible. Rather than hollowing out its competencies by relying too much on outsourcing, taper integration allows a firm to retain and fine-tune its competencies in upstream and downstream value chain activities. ▪ Taper integration also enhances a firm’s flexibility. For example, when adjusting to fluctuations in demand, a firm could cut back on the finished goods it delivers to external retailers while continuing to stock its own stores. ▪ Using taper integration, firms can combine internal and external knowledge, possibly paving the path for innovation. 20 Taper Integration along the Industry Value Chain Exhibit 8.7 Access the text alternate for slide image. © McGraw Hill 21 Types of Diversification Product Diversification: Increase in variety of products / services. Active in several product markets. Geographic Diversification: Increase in variety of markets / geographic regions. Regional, national, or international markets. Product-Market Diversification: Product and geographic diversification. © McGraw Hill Coca-Cola, for example, focuses on soft drinks and thus on a single product market. Its archrival PepsiCo competes directly with Coca-Cola by selling a wide variety of soft drinks and other beverages, and also offering different types of chips such as Lay’s, Doritos, and Cheetos, as well as Quaker Oats products such as oatmeal and granola bars. Although PepsiCo is more diversified than Coca-Cola, it has reduced its level of diversification in recent years. product–market diversification strategy Corporate strategy in which a firm is active in several different product markets and several different countries. 22 Types of Corporate Diversification Single business: low level of diversification. Dominant business: additional business activity pursued. Related diversification: Constrained: all businesses share competencies. Linked: some businesses share competencies. Unrelated diversification (conglomerate): no businesses share competencies. © McGraw Hill Examples of the four main types of diversification: Single business - Coca-Cola, Google, Facebook Dominant business - Harley Davidson, Nestle, UPS Related diversification - Related Constrained: ExxonMobile, Nike; Related Linked: Amazon, Disney Unrelated diversification: (conglomerate) - Berkshire Hathaway A related-diversification strategy entails two types of costs: coordination and influence costs. Coordination costs are a function of the number, size, and types of businesses that are linked. Influence costs occur due to political maneuvering by managers to influence capital and resource allocation and the resulting inefficiencies stemming from suboptimal allocation of scarce resource. 23 The Core Competence–Market Matrix Exhibit 8.9 Source:. Adapted from G. Hamel and C.K. Prahalad (1994), Competing for the Future (Boston: Harvard Business School Press). Access the text alternate for slide image. © McGraw Hill To survive and prosper, companies need to grow. This mantra holds especially true for publicly owned companies because they create shareholder value through profitable growth. Strategic leaders respond to this relentless growth imperative by leveraging their existing core competencies to find future growth opportunities. Gary Hamel and C.K. Prahalad advanced the core competence–market matrix, depicted in Exhibit 8.9, as a way to guide managerial decisions in regard to diversification strategies. The first task for managers is to identify their existing core competencies and understand the firm’s current market situation. When applying an existing or new dimension to core competencies and markets, four quadrants emerge, each with distinct strategic implications. 24 The Diversification-Performance Relationship Exhibit 8.11 Source:. Adapted from L.E. Palich, L.B. Cardinal, and C.C. Miller (2001), “Curvilinearity in the diversification-performance linkage: An examination of over three decades of research,” Strategic Management Journal 21: 155–174.. Access the text alternate for slide image. © McGraw Hill High and low levels of diversification are generally associated with lower overall performance, while moderate levels of diversification are associated with higher firm performance. This implies that companies that focus on a single business, as well as companies that pursue unrelated diversification, often fail to achieve additional value creation. Firms that compete in single markets could potentially benefit from economies of scope by leveraging their core competencies into adjacent markets. 25 How Diversification Can Enhance Firm Performance Provides economies of scale (reduces costs). Exploits economies of scope (increases value). Reduces costs and increase value. © McGraw Hill 26 Restructuring Reorganizing and divesting business units and activities. Helps refocus a company. Helps leverage core competencies more fully. Helpful restructuring tool: BCG growth-share matrix. Guides portfolio planning. Each category warrants a different strategy. © McGraw Hill Corporate executives can restructure the portfolio of their firm’s businesses, much like an investor can change a portfolio of stocks. 27 Restructuring the Corporate Portfolio: The Boston Consulting Group Growth–Share Matrix Exhibit 8.13 Access the text alternate for slide image. © McGraw Hill Corporate executives can restructure the portfolio of their firm’s businesses, much like an investor can change a portfolio of stocks. One helpful tool to guide corporate portfolio planning is the Boston Consulting Group (BCG) growth–share matrix. This matrix locates the firm’s individual SBUs in two dimensions: Relative market share (horizontal axis). Speed of market growth (vertical axis). The firm plots its SBUs into one of four categories in the matrix: dog, cash cow, star, and question mark. Each category warrants a different investment strategy. All four categories shape the firm’s corporate strategy. 28 Internal Capital Markets Can be a source of value creation in diversification strategy. A way to allocate capital at a lower cost, if more efficient than external markets. A related-diversification strategy can enhance corporate performance. Consider coordination and influence costs. © McGraw Hill Coordination costs are a function of the number, size, and types of businesses that are linked. Influence costs occur due to political maneuvering by managers to influence capital and resource allocation and the resulting inefficiencies stemming from suboptimal allocation of scarce resources. Until recently, GE Capital brought in close to $70 billion in annual revenues and generated more than half of GE’s profits.  In combination with GE’s triple-A debt rating, having access to such a large finance arm allowed GE to benefit from a lower cost of capital, which in turn was a source of value creation in itself. In 2009, at the height of the global financial crises, GE lost its AAA debt rating. The lower debt rating and the smaller finance unit are likely to result in a higher cost of capital, and thus a potential loss in value creation through internal capital markets. GE subsequently sold its GE Capital business unit. 29 End of Main Content © 2019 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw Hill. Because learning changes everything.® www.mheducation.com Accessibility Content: Text Alternatives for Images © McGraw Hill Internal and External Transaction Costs Text Alternate Return to slide. The image has two circles, Firm A and Firm B, and shows the respective internal transactions costs within Firm A and Firm B via an arrow inside each circle. This image also shows the external transaction costs that occur when Firm A and Firm B do business with one another, with an arrow pointing externally from the circles under a title called "Market." Return to slide containing images © McGraw Hill Organizing Economic Activity: Firms vs. Markets Text Alternate Return to slide. This image has a graphic of four squares, which list each of the following: Firm Advantages: Command and control (flat & hierarchical) Coordination Transaction specific investments Community of knowledge Firm Disadvantages: Administrative costs Low powered incentives Principle agent problem Market Advantages: High powered incentives Flexibility Market Disadvantages: Search costs Opportunism (hold up) Incomplete contracting (specifying and measuring performance, and information asymmetries) Enforcement of contracts Return to slide containing images © McGraw Hill Alternatives on the Make-or-Buy Continuum Text Alternate Return to slide. Several alternative hybrid arrangements are available between these two extremes. Moving from transacting in the market (“buy”) to full integration (“make”), alternatives include short-term contracts as well as various forms of strategic alliances (long-term contracts, equity alliances, and joint ventures) and parent–subsidiary relationships. Long term contacts can include both licensing and franchising. The make side of the graph requires more integration, and the buy side of the graph requires less integration. Return to slide containing images © McGraw Hill Backward and Forward Vertical Integration along an Industry Value Chain Text Alternate Return to slide. This image shows a downward facing series of arrows that moves from upstream activities (backward integration) toward upstream activities (forward integration). The arrows move along the following sequence: Stage 1 - Raw Materials Stage 2 - Components and Intermediate Goods Stage 3 - Final Assembly & Marketing Stage 4 - Marketing and Sales Stage 5 - After-Sales Service and Support Near stage 1 includes more upstream industries and backward vertical integration, and near stage 5 includes more downstream industries and forward vertical integration. Return to slide containing images © McGraw Hill H T C’s Backward and Forward Integration along the Industry Value Chain in the Smartphone Industry Text Alternate Return to slide. Backward Vertical Integration achieved through: Stage 1, Design: Apple, Blackberry, Google, H T C, Huawei, L G, Samsung, Xiaomi Stage 2, Manufacturing: Flextronics, Foxconn, H T C, Inventec, other O E M’s Forward Vertical Integration achieved through: Stage 3, Marketing and Sales: Apple, Google, H T C, Huawei, L G, Samsung, Xiaomi Stage 4, After-Sales Service and Support: A T and T, Google (Project Fi), T Mobile, Verizon Return to slide containing images © McGraw Hill Taper Integration along the Industry Value Chain Text Alternate Return to slide. This image shows a series of boxes and interconnecting arrows. To the upper left side of the image, a box titled Outside Suppliers: Intermediate Goods and Components has an arrow pointing toward In-House Suppliers: Assembly and Manufacturing. The upper right side of the image has a box titled In-House Suppliers: Assembly and Manufacturing, which also points toward In-House Suppliers: Assembly and Manufacturing. The In-House Suppliers: Assembly and Manufacturing box points toward two different boxes on the bottom of the image. One that says In-House Distributors: Retail and Service, and another that says Outside Distributors: Retail and Service. Return to slide containing images © McGraw Hill The Core Competence: Market Matrix Text Alternate Return to slide. This image shows four quadrants, each with distinct strategic implications, to be considered when applying an existing or new dimension to core competencies and markets: The lower-left quadrant combines existing core competencies with existing markets. Here, managers must come up with ideas of how to leverage existing core competencies to improve the firm’s current market position. The lower-right quadrant combines existing core competencies with new market opportunities. Here, managers must strategize about how to redeploy and recombine existing core competencies to compete in future markets. The upper-left quadrant combines new core competencies with existing market opportunities. Here, managers must come up with strategic initiatives to build new core competencies to protect and extend the company’s current market position. Finally, the upper-right quadrant combines new core competencies with new market opportunities. Hamel and Prahalad call this combination “mega- opportunities”—those that hold significant future-growth opportunities. Return to slide containing images © McGraw Hill The Diversification-Performance Relationship Text Alternate Return to slide. This image shows an inverted U shaped relationship between the type of diversification and overall firm performance. High and low levels of diversification are generally associated with lower overall performance, while moderate levels of diversification are associated with higher firm performance. The x-axis of the image is titled Level of Diversification, and the y-axis is titled Performance. From the left to the right of the image are the words Single Business, Dominant Business, Related Diversification (related constrained or related linked), and Unrelated Diversification. Both Single Business and Unrelated Diversification are at the lower ends of the inverted u, and Dominant Business and Related Diversification are at the higher ends of the inverted u. Return to slide containing images © McGraw Hill Restructuring the Corporate Portfolio: The Boston Consulting Group Growth, Share Matrix Text Alternate Return to slide. This image shows the B C G corporate planning tool in which the corporation is viewed as a portfolio of business units, which are represented graphically along relative market share (horizontal axis) and speed of market growth (vertical axis). S B U’s are plotted into four categories (dog, cash cow, star, and question mark), each of which warrants a different investment strategy. High market growth and high market share = star. Earnings are high, stable or growing. Cash flow is neutral. The strategy is to hold or invest for growth. High market growth and low market share = question mark. Earnings are low, unstable or growing. Cash flow is negative. The strategy is to increase market share or harvest / divest. Low market growth and high market share = cash cow. Earnings are high and stable and cash flow is also high and stable. The strategy is to hold. Low market growth and low market share = dog. Earnings are low and unstable and cash flow is neutral or negative. The strategy is to harvest or divest. Return to slide containing images © McGraw Hill Chapter 7 Business Strategy: Innovation, Entrepreneurship, and Platforms © 2021 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw Hill. Because learning changes everything.® Learning Objectives Outline the four-step innovation process from idea to imitation. Apply strategic management concepts to entrepreneurship and innovation. Describe the competitive implications of different stages in the industry life cycle. Derive strategic implications of the crossing-the-chasm framework. Categorize different types of innovations in the markets-and-technology framework. Explain why and how platform businesses can outperform pipeline businesses. © McGraw Hill Innovation Is a Competitive Weapon Innovation can create and destroy value. Innovation often comes in waves: Many firms dominated an early wave of innovation, and are challenged by the next wave. Traditional networks vs. cable providers. Cable providers vs. streaming content. Typewriters to PC’s to mobile devices. Initial innovations are foundational for other rapid innovation. © McGraw Hill 3 Accelerating Speed of Technological Change Exhibit 7.1 Source:. Depiction of data from the U.S. Census Bureau, the Consumer Electronics Association, Forbes, and the National Cable and Telecommunications Association. Access the text alternate for the slide image. © McGraw Hill This image shows how many years it took for different technological innovations to reach 50 percent of the U.S. population (either through ownership or usage). For example, it took 84 years for half of the U.S. population to own a car, but only 28 years for half the population to own a TV. The pace of the adoption rate of recent innovations continues to accelerate. It took 19 years for the PC to reach 50 percent ownership, but only 6 years for MP3 players to accomplish the same diffusion rate. 4 The Four I’s: Idea, Invention, Innovation, and Imitation Exhibit 7.2 © McGraw Hill 5 Idea, Invention, Innovation and Imitation Idea: Abstract concepts or research findings. Invention: Transformation of an idea into a product. The modification and recombination of products. Innovation: Commercialization of an invention. Imitation: Copying a successful innovation. © McGraw Hill 6 Innovation: A Novel and Useful Idea That Is Successfully Implemented Exhibit 7.3 © McGraw Hill 7 Entrepreneurs The process by which change agents undertake economic risk to innovate. Create new products, processes, and organizations. Create value for society. Commercialize ideas and inventions. Examples: Reed Hastings: Netflix. Elon Musk: Tesla Motors, Solar City, SpaceX, PayPal. © McGraw Hill Reed Hastings – Netflix. Volunteered in the Peace Corps for 2 years. Educated at Stanford where he first learned about the entrepreneurial model, net worth is now $1B. Elon Musk – Tesla Motors, Solar City, SpaceX, PayPal. An engineer and serial entrepreneur. Deep passion to solve environmental, social, and economic challenges. 8 Strategic and Social Entrepreneurship Strategic Entrepreneurship: Pursuit of innovation using strategic tools and concepts. Combining entrepreneurial actions. Creating new opportunities. Exploiting existing opportunities. Social Entrepreneurship: The pursuit of social goals while creating profitable businesses. Evaluate performance by financial, ecological and social contribution metrics. © McGraw Hill 9 The Industry Lifecycle Over time: The number and size of competitors change. Different types of consumers enter the market. The supply and demand sides of the market change. Different competencies are needed for the firm to perform well. The stages: Introduction. Growth. Shakeout. Maturity. Decline. © McGraw Hill 10 Industry Life Cycle: The Smartphone Industry in Emerging and Developed Economies Exhibit 7.4 Access the text alternate for slide image. © McGraw Hill 11 Introduction Stage Core competency: research and development. Necessary to create a product category that will attract customers. Can be very capital-intensive (high costs). Barriers to entry are high. Strategic objective: market acceptance & future growth. © McGraw Hill The emphasis is on uniqueness and performance in this stage. The initial market size is small, growth is slow, and barriers to entry are high. 12 Leveraging Network Effects to Drive Demand: Apple’s iPhone Exhibit 7.5 Access the text alternate for slide image. © McGraw Hill Increased value creation is positively related to demand, which in turn increases the installed base, meaning the number of people using an iPhone. As the installed base of iPhone users further increases, this incentivizes software developers to write even more apps. Making apps widely available strengthened Apple’s position in the smartphone industry. Based on positive feedback loops, a virtuous cycle emerges where one factor positively reinforces another. 13 Growth Stage Demand increases rapidly. First-time buyers rush to purchase. Proof of concept has been demonstrated. Product / service standards emerge. A common set of features and design choices. Can emerge from competition or imposed by government or agencies. Product innovation: New / recombined aspects of a product. Process innovation: New ways to produce a product. © McGraw Hill Core competencies of focus during this stage are in manufacturing and marketing. Process innovations are made possible through advances such as the internet, lean manufacturing, Six Sigma, biotechnology, nanotechnology, and so on. 14 Product and Process Innovation throughout an Industry Life Cycle Exhibit 7.7 Access the text alternate for slide image. © McGraw Hill 15 Shakeout Stage The rate of growth declines. Firms begin to intensely compete. Weaker firms forced out. Industry consolidation. Only the strongest competitors survive. Price is an important competitive weapon. © McGraw Hill The winners in this increasingly competitive environment are often firms that stake out a strong position as cost leaders. Key success factors at this stage are the manufacturing and process engineering capabilities that can be used to drive costs down. The importance of process innovation further increases (albeit at diminishing marginal returns), while the importance of product innovation further declines. 16 Maturity Stage Only a few large firms remain. They enjoy economies of scale. Process innovation has reached a maximum. Demand: replacement or repeat purchases. Market has reached maximum size. Industry growth is zero or negative. © McGraw Hill The domestic airline industry has been in the maturity stage for a long time. The large number of bankruptcies as well as the wave of mega-mergers, such as those of Delta and Northwest, United and Continental, and American Airlines and US Airways, are a consequence of low or zero growth in a mature market characterized by significant excess capacity. 17 Decline Stage Demand falls rapidly. Innovation efforts cease. If a breakthrough emerges, it leads to a new industry or resets the life cycle. Strong pressure on prices. Four strategic options to pursue: Exit: bankruptcy / liquidation. Harvest: reduce further investments. Maintain: support at a given level. Consolidate: buy rivals. © McGraw Hill Exit. Some firms are forced to exit the industry by bankruptcy or liquidation. Harvest. In pursuing a harvest strategy, the firm reduces investments in product support and allocates only a minimum of human and other resources. Maintain. Philip Morris, on the other hand, is following a maintain strategy with its Marlboro brand, continuing to support marketing efforts at a given level despite the fact that U.S. cigarette consumption has been declining. Consolidate. Although market size shrinks in a declining industry, some firms may choose to consolidate the industry by buying rivals. 18 The Crossing-the-Chasm Framework Exhibit 7.8 Source: Adapted from G.A. Moore (1991), Crossing the Chasm: Marketing and Selling Disruptive Products to Mainstream Customers (New York: HarperCollins), 17. Access the text alternate for slide image. © McGraw Hill There is a big gulf or chasm into which companies and their innovations frequently fall. Only companies that recognize these differences and are able to apply the appropriate competencies at each stage of the industry life cycle will have a chance to transition successfully from stage to stage. 19 Technology Enthusiasts Enter the market during the introductory stage. Smallest market segment, 2.5% of the total market potential. Have an engineering mind. Proactively pursue new technology. Enjoy using beta versions. Tinker with product imperfections. Provide free feedback and suggestions. © McGraw Hill A recent example of an innovation that appeals to technology enthusiasts is Google Glass, a mobile computer that is worn like a pair of regular glasses. Instead of a lens, one side displays a small, high-definition computer screen. Google Glass allows the wearer to use the Internet and smartphone-like application. However, the company was never able to close the gap between technology enthusiasts (who rushed to sign up for testing the glasses) and early adopters. 20 Early Adopters Enter the market during the growth stage. 13.5% of the total market potential. Demand is driven by imagination and creativity. Ask themselves, “What can this new product do for me or my business?” To capture these customers: Directly communicate the product’s potential. © McGraw Hill For instance, early adopters are the people that put down thousands of dollars in deposits to reserve a new Tesla Model S or Model X when first introduced, without having been able to test-drive the vehicle or even seen it other than on the internet. They then often needed to wait a significant amount of time before receiving the new vehicle. 21 Early Majority Enter the market during the shakeout stage. 34% of the total market potential. Decision criteria, a strong sense of practicality. “What Can This Do For Me?” Weigh the benefits and costs carefully. Rely on endorsements of others. This group is key to catching the growth wave. © McGraw Hill Fisker Automotive, a California-based designer and manufacturer of premium plug-in hybrid vehicles, fell into the chasm because it was unable to transition to early adopters, let alone the mass market. Between its founding in 2007 and 2012, Fisker sold some 1,800 of its Karma model, a $100K sports car, to technology enthusiasts. It was unable, however, to follow up with a lower-cost model to attract the early adopters into the market. In addition, technology and reliability issues for the Karma could not be overcome. By 2013, Fisker had crashed into a chasm, filing for bankruptcy. The assets of Fisker Automotive were purchased by Wanxiang, a Chinese auto parts maker. In contrast, Tesla Motors, the maker of all-electric vehicles, and a fierce rival of Fisker at one time, was able to overcome some of the early chasms. 22 Late Majority Enter the market during the maturity stage. 34% of the total market potential. Not as confident in their ability to master the technology: Wait until standards have emerged. Do not like uncertainty. Represent the majority of the market. Buy from well-established firms with a strong brand. © McGraw Hill 23 Laggards Enter the market during the decline stage. 16% of total market potential. Adopt a new product only if necessary (reluctant). Generally don’t want new technology. Typically not pursued as future customers. Demand is small. Early and late majority are at this time moving on to different products and services. © McGraw Hill 24 Crossing the Chasm: The Mobile Phone Industry Exhibit 7.9 Access the text alternate for slide image. © McGraw Hill 25 Types of Innovation: Combining Markets and Technologies Exhibit 7.11 Access the text alternate for slide image. © McGraw Hill Along the horizontal axis, we ask whether the innovation builds on existing technologies or creates a new one. On the vertical axis, we ask whether the innovation is targeted toward existing or new markets. Four types of innovations emerge: incremental, radical, architectural, and disruptive. As indicated by the color coding in the exhibit, each diagonal forms a pair: incremental versus radical innovation and architectural versus disruptive innovation. 26 Incremental vs. Radical Innovation Incremental Innovation: Builds on established knowledge. Results from steady improvement. Radical Innovation: Novel methods & materials. Entirely new knowledge base or recombination of existing knowledge. Targets new markets and technology. © McGraw Hill In 1903, entrepreneur King C. Gillette invented and began selling the safety razor with a disposable blade. This radical innovation launched the Gillette Co. (now a brand of Procter & Gamble). To sustain its competitive advantage, Gillette not only made sure that its razors were inexpensive and widely available by introducing the “razor and razor blade” business model, but also continually improved its blades. In a classic example of a string of incremental innovations, Gillette kept adding an additional blade with each new version of its razor until the number had gone from one to six! Though this innovation strategy seems predictable, it worked. Gillette’s newest razor, the Fusion ProGlide with Flexball technology, a razor handle that features a swiveling ball hinge, costs $11.49 (and $12.59 for a battery-operated one) per razor! Examples of radical innovation: the iPhone, the Ford Model T, the x-ray machine, the airplane, genetic engineering, and decoding of the human genome. 27 Why Incumbent Firms Tend to Focus on Incremental Innovation Economic Incentives: They must defend their position. Organizational Inertia: They have formalized processes and structures. Innovation Ecosystem: They rely on certain suppliers, buyers, complementors. © McGraw Hill 28 Architectural vs. Disruptive Innovation Architectural Innovation: Existing technology leveraged into a new market. Known components, existing technology, used in a novel way. Disruptive Innovation: Leverages new technologies in existing markets. New product / process meets existing customer needs. © McGraw Hill Examples of Disruptive Innovation include digital photography (which has improved over time to result in higher definition pictures, and has largely replaced film photography) and laptops, (which disrupted desktops…although now tablets and large screen phones are disrupting laptops). 29 Disruptive Innovation: Riding the Technology Trajectory to Invade Different Market Segments from the Bottom Up Exhibit 7.12 Access the text alternate for slide image. © McGraw Hill The dashed lines represent different market segments, from Segment 1 at the low end to Segment 4 at the high end. Low-end market segments are generally associated with low profit margins, while high-end market segments often have high profit margins. 30 How to Respond to Disruptive Innovation Continue to innovate to stay ahead of the competition. Guard against disruptive innovation by protecting the low end of the market. Disrupt yourself rather than wait for others to disrupt you. © McGraw Hill Reverse Innovation: An innovation that was developed for emerging economies before being introduced in developed economies. Sometimes also called frugal innovation. 31 Platform vs. Pipeline Businesses Platform Business: Enables interaction between producers and consumers. Its overarching purpose is to enable matches among users. Provides infrastructure and sets governance conditions. Pipeline Business: Linear transformation through the value chain. Research and development, then design, then manufacture, then sell. © McGraw Hill The five most valuable companies globally (Apple, Alphabet, Microsoft, Amazon, and Facebook) all run platform business models. 32 The Players in a Platform Ecosystem Exhibit 7.13 Access the text alternate for slide image. © McGraw Hill From a value chain perspective, producers create or make available a product or service that consumers use. The owner of the platform controls the platform IP address and controls who may participate and in what ways. The providers offer the interfaces for the platform, enabling its accessibility online. 33 Advantages of the Platform Business Model They scale more efficiently by eliminating gatekeepers. They unlock new sources of value creation and supply. They benefit from community feedback. © McGraw Hill New sources of value creation and supply—To grow, traditional competitors such as Marriott or Hilton would need to add additional rooms to their existing stock. To add new hotel room inventory to their chains, they would need to find suitable real estate, develop and build a new hotel, furnish all the rooms, and hire and train staff to run the new hotel. This often takes years, not to mention the multimillion-dollar upfront investments required and the risks involved. In contrast, Airbnb faces no such constraints because it does not own any real estate, nor does it manage any hotels. Just like Marriott or Hilton, however, it uses sophisticated pricing and booking systems to allow guests to find a large variety of rooms pretty much anywhere in the world to suit their needs. Community feedback: TripAdvisor, a travel website, derives significant value from the large amount of quality reviews (including pictures) by its users of hotels, restaurants, and so on. This enables TripAdvisor to consummate more effective matches between hotels and guests via its website, thus creating more value for all participants. Network effects: Growing its user base is critical for Netflix to sustain its competitive advantage. Netflix has been hugely successful in attracting new users: As of 2017 it had some 95 million subscribers worldwide. Yet, while providing a large selection of high-quality streaming content is a necessity of the Netflix business model, this element can and has been easily duplicated by others such as Amazon, Hulu, and premium services on Google’s YouTube. To lock in its large installed base of users, however, Netflix has begun producing and distributing original content such as the hugely popular shows House of Cards and Orange Is the New Black. To sustain its competitive advantage going forward, Netflix needs to rely on its core competencies, including its proprietary recommendation engine, data-driven content investments, and network infrastructure management. 34 Netflix Business Model: Leveraging Network Effects to Drive Demand Exhibit 7.14 Access the text alternate for slide image. © McGraw Hill As Netflix acquires additional streaming content, it increases the value of its subscription service to customers, resulting in more people signing up. With more customers, Netflix could then afford to provide more and higher-quality content, further increasing the value of the subscription to its users. This created a virtuous cycle that increased the value of a Netflix subscription as more subscribers signed up. 35 Uber’s Business Model: Leveraging Network Effects to Increase Demand Exhibit 7.15 Access the text alternate for slide image. © McGraw Hill Uber provides incentives for drivers to sign up (such as extending credit so that potential drivers can purchase vehicles) and also charges lower than market rates for its rides. As more and more drivers sign up in each city and thus coverage density rises accordingly, the service becomes more convenient. This drives more demand for its services as more riders choose Uber, which in turn brings in more drivers. 36 Uber’s Network Effects with Feedback Loop Exhibit 7.16 Access the text alternate for slide image. © McGraw Hill To entice more drivers to work during this time, Uber has to pay them more. Higher pay will bring more drivers onto the platform. Some users complain about surge pricing, but it allows Uber to match supply and demand in a dynamic fashion. As surge pricing kicks in, fewer people will demand rides, eventually bringing supply and demand back into an equilibrium. 37 End of Main Content © 2019 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw Hill. Because learning changes everything.® www.mheducation.com Accessibility Content: Text Alternatives for Images 39 © McGraw Hill Accelerating Speed of Technological Change Text Alternate Return to slide. As an example, it took 84 years for half of the U.S. population to own a car, but only 28 years for half the population to own a TV. The pace of the adoption rate of recent innovations continues to accelerate. It took 19 years for the PC to reach 50 percent ownership, but only 6 years for MP3 players to accomplish the same diffusion rate. Return to slide containing images © McGraw Hill Industry Life Cycle: The Smartphone Industry in Emerging and Developed Economies Text Alternate Return to slide. In a stylized industry life cycle model, the horizontal axis shows time (in years) and the vertical axis market size. This image takes a snapshot of the global smartphone industry in the year 2016. This implies that we are joining two different life cycles (one for emerging economies and one for developed economies) in the same exhibit at one point in time. In emerging economies, smartphones are in the Growth stage. In developed economies however, they are in the Maturity stage. Return to slide containing images © McGraw Hill Leveraging Network Effects to Drive Demand: Apple’s iPhone Text Alternate Return to slide. This image demonstrates how the installed base of users for the iPhone result in more use of apps, which increase the value of the iPhone, which thus increases the demand for the iPhone. Return to slide containing images © McGraw Hill Product and Process Innovation throughout an Industry Life Cycle Text Alternate Return to slide. This image shows a graph with two axes: time on the X axis, and level of innovation on the Y axis. As you move from left to right on the graph, the phases of the industry life cycle are listed: introduction, growth, shakeout, maturity and decline. There are two main lines on the graph. The first line, titled Product Innovation, has a very high level of innovation during the introduction and growth stages, and begins a sharp decline during the shakeout phase. The second line, titled Process Innovation, starts out very low at the beginning of the life cycle, and increases rapidly during shakeout and maturity, only to decline again during decline. Return to slide containing images © McGraw Hill The Crossing-the-Chasm Framework Text Alternate Return to slide. This image shows a traditional bell curve, that is similar to the Industry Lifecycle, however, there are different phase names and there is a space between the Early Adopters and the Early Majority, titled The Chasm. The chasm framework breaks down the 100 percent market potential into different customer segments, highlighting the incremental contribution each specific segment can bring into the market. Technology Enthusiasts: 2.5% Early Adopters: 13.5% Early Majority: 34% Late Majority: 34% Laggards: 16% Return to slide containing images © McGraw Hill Crossing the Chasm: The Mobile Phone Industry Text Alternate Return to slide. Blackberry, while it was accepted by the early adopters and early majority, the iPhone was able to capture the late majority and laggards. In 2007, RIM’s dominance over the smartphone market began to erode quickly. The main reason was Apple’s introduction of the iPhone. Although technology enthusiasts and early adopters argue that the iPhone is an inferior product to the BlackBerry based on technological criteria, the iPhone enticed not only the early majority, but also the late majority to enter the market. For the late majority, encrypted software security was much less important than having fun with a device that allowed users to surf the web, take pictures, play games, and send and receive e-mail. Return to slide containing images © McGraw Hill 45 Types of Innovation: Combining Markets and Technologies Text Alternate Return to slide. This image shows a large square, imbedded within it are four other squares. The two characteristics that differentiates each square are its technology and market: New market and new technology = radical innovation. New market and existing technology = architectural innovation. Existing market and new technology = disruptive innovation. Existing market and existing technology = incremental innovation. Return to slide containing images © McGraw Hill Disruptive Innovation: Riding the Technology Trajectory to Invade Different Market Segments from the Bottom Up Text Alternate Return to slide. This image shows dashed lines representing different market segments, from Segment 1 at the low end to Segment 4 at the high end. Low-end market segments are generally associated with low profit margins, while high-end market segments often have high profit margins. The technology trajectory used by a disruptive innovator to invade market segments must move from the bottom up. Return to slide containing images © McGraw Hill The Players in a Platform Ecosystem Text Alternate Return to slide. This image depicts a platform ecosystem. In the middle of the platform is the owner – the controller of platform IP and arbiter of who may participate and in what ways. In addition, the platform also hosts providers, which provide interfaces for the platform. Value and data is exchanged outward from the owner to both the producers (creators of the platform’s offerings) and the consumers (buyers or users of the offerings). Return to slide containing images © McGraw Hill Netflix Business Model: Leveraging Network Effects to Drive Demand Text Alternate Return to slide. This image depicts four main concepts, connected by arrows that point from one concept to another. There are plus symbols to the outside of the arrows, suggesting that each concept adds positively to the following concept. In the image, the demand for Netflix services points toward more network subscribers, which points to more content which points to an enhanced value of a Netflix subscription, which points toward the demand for Netflix services. Return to slide containing images © McGraw Hill Uber’s Business Model: Leveraging Network Effects to Increase Demand Text Alternate Return to slide. This image depicts four main concepts, connected by arrows that point from one concept to another. There are plus symbols to the outside of the arrows, suggesting that each concept adds positively to the following concept. In the image, faster pickups point toward more demand, which point toward more drivers and then more geographic coverage, which points back to faster pickups. Return to slide containing images © McGraw Hill Uber’s Network Effects with Feedback Loop Text Alternate Return to slide. This image depicts six main concepts, connected by arrows that point from one concept to another. There are plus symbols to the outside of the arrows, suggesting that each concept adds positively to the following concept. In the image, faster pickups point toward more demand, which point toward more drivers and then more geographic coverage, which points back to faster pickups. More geographic coverage also points to a concept called less driver downtime, which points toward lower prices, which then points back toward more demand. Return to slide containing images © McGraw Hill




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