10. The industry context

Why the industry context matters

Strategy is influenced by buyers, suppliers, substitutes, new entrants and competitors; organisations that can shape their environment often gain an advantage. The industry context sets the rules of the game and can constrain strategic choices (for example, needing a strong brand to compete). Managers must understand how the industry develops, which forces shape its structure and what drives competition.

Characteristics of industry evolution

Four patterns of industry development

Industry dynamics: economic, technological, political, sociological and organisational forces that together shape the evolution of an industry. Industry rigidity arises from interdependence between firms, strong power structures, risk aversion, established industry recipes and institutional pressure (rules, subsidies). Path dependency: how an industry developed in the past influences how it can develop in the future.

The paradox of compliance and choice

Industries sometimes look proactive, but firms often simply follow existing rules and strategies in the sector. The demand for compliance: no single firm can determine the whole industry, so firms usually adapt; but they should avoid analysis paralysis (thinking too long without acting). The demand for strategic choice: a firm that only follows the rules will rarely create a unique advantage, so structures, processes and culture should stimulate new ways of working and thinking.

Managing the paradox: balancing (following rules in some situations, breaking or influencing them in others), parallel processing (managers follow existing rules while top management tries to change them) and juxtaposing (deciding which rules to follow and which to change; understanding which rules are changeable).

Reading 10.1: Industry evolution (Porter)

Understanding industry evolution helps predict strategic changes; firms that recognise changes early can build a strong position. Evolution is driven by the five competitive forces and can be analysed via changes in technology, competition and market structure. The product life cycle (S-curve) has four phases: introduction (slow market growth), growth (demand rises fast, many entrants), maturity (growth stabilises, competition intensifies) and decline (demand falls, products replaced). The cycle is not always predictable: phase duration differs, phases can be skipped, and firms can influence the cycle. Evolutionary processes include long-run growth, changes in buyer segments, reduction of uncertainty, diffusion of knowledge, economies of scale, product and process innovation, changes in costs or inputs, marketing innovation, government policy, and entry and exit. Firms can actively shape evolution.

Reading 10.2: Blue Ocean Strategy (Kim and Mauborgne)

In red oceans firms fight for the same market share, causing price pressure. Blue ocean strategy creates new market space with little or no competition, making competition temporarily irrelevant, and aims for differentiation and low cost at the same time through value innovation (more customer value at lower cost). Blue oceans often come from breaking or redefining industry boundaries, usually from existing firms and their core business, are hard to copy because they rest on strategic choices and system changes, and often require restructuring activities and the business model. Example: Cirque du Soleil combined theatre and circus and removed costly elements such as animals and star performers, creating a cheaper concept that attracted a new audience.

Reading 10.3: How industries change (McGahan)

Firms must understand which trajectory of change their industry follows. Four trajectories:

Analysis steps: define the industry and identify competitors, determine core activities and sources of profit, check whether these activities are threatened with obsolescence, and determine the phase of change. Firms that recognise their trajectory correctly can adapt their strategy and capture new opportunities.

Textbook deepening: De Wit, Ch. 10 (The industry context)

The sections below add the theory from the textbook chapter on the industry context to the lecture notes above. The key question is how a firm can move beyond adapting to shaping: setting the rules of the competitive game instead of playing by the rules set by others (industry leadership).

The issue of industry development (Figure 10.1)

Four interrelated topics: the dimensions of industry development (the state: which structural characteristics change), the paths of industry development (the direction: gradual or revolutionary), and the determinants: drivers (forces of change) and inhibitors (forces for stability). Industry development (Porter: "industry evolution") is the result of changes in one or more underlying factors of the industry structure.

Dimensions of industry development: book examples and explanations

• Convergence-divergence: convergence (insurance, airlines) results from adaptation of less successful firms to a dominant design and the selecting out of unfit firms; divergence (car retailing, restaurants) results from "mutation" of existing firms or new entrants with distinct business models. Cycles of mutation and selection occur in all industries.
• Concentration-fragmentation: concentration (aircraft, food retailing) through mergers, acquisitions or exits; fragmentation (airlines, telecom services) through new firms or entry of existing firms from elsewhere. Commonly measured with a concentration index of the four or eight largest firms.
• Vertical integration-fragmentation: integration (media, IT services) vs "back to the core" disintegration (telecom, automotive); platforms can reconfigure the whole vertical structure (travel and accommodation), but such transformations are not new (PCs in the 1980s, airplanes and travel in the 1950s).
• Horizontal integration-fragmentation: boundaries between businesses become fuzzy (consumer electronics, defence) or firms become confined to their own business (construction, airlines); also between industries (digital industries as open competitive space; complementors converging on a platform such as Android or Linux) or isolation (accountancy).
• International integration-fragmentation: geographic boundaries become less important (food retailing, business education) or competition becomes more regional (satellite TV).
• Expansion-contraction: growth, decline or cyclical alternation. The industry life cycle concept has little descriptive value (what does "mature" mean?) and even less predictive value when applied to whole industries.

Four patterns of dominant business model development (Figure 10.3)

Based on Burgelman and Grove and D'Aveni, with the book's environment labels:

Drivers of industry development (Figure 10.4)

Change drivers in the contextual environment: socio-cultural (health needs, environmental awareness, consumption habits), economic (exchange rates, growth, labour productivity), political/regulatory (trade regulation, environmental laws, privatisation) and technological (scientific breakthroughs, innovative technologies, communication standards). Change drivers in the industry environment: suppliers (innovative products, consolidation), buyers (changed needs, price sensitivity, lower loyalty), incumbent rivals (new competences, products, positioning), new entrants (new business model, diversification, alliances) and substitutes and complementors (new standards). Change can come from the interplay of many elements without a clear starting point. If one firm is the major driver, it can claim industry leadership; if development results from the complex interaction of many drivers, industry dynamics determine the path.

Inhibitors: industry rigidity versus plasticity

Industry rigidity is the lack of susceptibility to change: rules cannot be altered and positions are fixed. The opposite is industry plasticity. Sources of rigidity:

Together these historically determined factors make industry evolution path dependent: "history matters".

The paradox of compliance and choice in more detail

Firms want to change rules that are malleable while adapting to rules that are fixed; trying to break immutable rules can be "a quick way to bankruptcy". Managers must be both irreverent and respectful towards industry rules. In the literature compliance is linked to environmental determinism (adapt or be selected out) and choice to organizational voluntarism (industry development as the result of wilful actions of firms).

• Demand for firm compliance: no firm can shape the whole world; misalignment is probably the most common cause of corporate death. Firms need structures, processes and a culture of listening and adapting, becoming customer and market-oriented (reacting to market "pull" instead of "pushing" pet projects), avoiding the pitfall of organizational arrogance.
• Demand for strategic choice: compliance is "another way of saying follow a me-too strategy"; the more innovative the rule breaker and the more radical the departure from the recipe, the larger and harder to imitate the advantage. Firms must avoid the pitfall of organizational conformity and constantly question the industry recipe (Hamel and Prahalad; Kim and Mauborgne).

Example: Nintendo, a rule breaker with the NES licensing model, then a follower that lost to Sony, a rule breaker again with the DS and Wii (new demographics, motion controls), "stuck in the middle" with the Wii U, and a successful follower with Amiibo and smartphone games.

The industry dynamics perspective in more detail

The belief that one firm can shape its industry is an understandable but misplaced illusion of control. Industries are complex systems in which many forces interact; firms are small players; through selection the context determines which firms survive and through adaptation pressures how the rest behave: "the industry shapes the firm, not the other way around". Also called the industry evolution perspective: Darwin's "survival of the fittest" through variation and selection, although firms vary purposefully and can adapt, so they co-evolve with their environment rather than conquer it. Famous rule breakers suffer from survivor's bias: like lottery winners, we do not see the many who failed; even a successful rule breaker is unlikely to "win the lottery twice". The internet bubble showed rule changing is difficult, slow and hazardous, best left to venture capitalists and entrepreneurs. Profitability is largely predetermined by the industry (Porter), but firms can still beat the average by positioning better and adapting or anticipating better. Example: AB InBev, which co-evolved with a consolidating beer industry (from Prohibition to mega-mergers).

The industry leadership perspective in more detail

Some rules are immutable, but the rest can be moulded: "even within the limits of the possible, the possibilities are limitless" (Jules Deelder). Leaderless industries are not the natural state of affairs but the result of weak incumbents. Industry leadership requires:

1. Intellectual leadership: envisioning the industry of tomorrow, challenging the recipe, thinking of ways to "destroy the current business", and developing industry foresight (Hamel and Prahalad).
2. Communicating the vision so compellingly that others commit to it, making it a self-fulfilling prophecy that overcomes risk aversion and resistance.
3. A new competitive business model that attracts enough customers and support to reach critical mass.
4. New competences and standards, alone or with others, to make the model work.
5. Perseverance and commitment: industry change is a marathon, not an overnight event.

Example: Spotify, whose freemium streaming model offered a legal service "better than piracy" and reshaped the music industry.

Managing the paradox: details from the book

• Balancing: even rule breakers cannot break all rules (brands in consumer markets, scale in capital-intensive industries); the balance is industry-specific, so multi-business firms are "multi-balancing".
• Parallel processing: business unit managers play by the rules, while corporate strategists change them, e.g. through national and European industrial policy boards that set priorities for innovation funds and subsidies.
• Juxtaposing: the key attribute of corporate strategists is knowing which rules can be broken (breaking scale rules in steel is dangerous). In international firms the malleable rules differ per country, so strategists must juxtapose "country-specifically", requiring higher-level dynamic capabilities; firms often rely on local managers or expatriates who know the local context.

The industry context in international perspective

• Locus of control: people with an internal locus of control believe they control their fate (success is earned); with an external locus of control they believe fate depends on circumstances ("go with the flow"). Internal locus (US) favours the industry leadership perspective; external locus (most Asian countries) the industry dynamics perspective.
• Role of government: economic liberalism in English-speaking nations (government facilitates, firms drive industry development) favours industry leadership; "managed competition" in Japan, France and to a lesser extent Germany (industrial policy, protecting weaker parties, forcing cooperation) means industries can be shaped, but rarely without government backing.
• Network embeddedness: where the discrete organization perspective dominates, firms are free to break rules; where firms are embedded in networks, changes must be negotiated with partners, reducing the ability to shape the industry.
• Industry level: complex, heterogeneous industries with many stakeholders and heavily regulated industries (pharmaceuticals) are more rigid; business model innovation rarely comes from big incumbents, who tend to imitate (Markides); where entry requires huge capital, industry dynamics prevail because entrepreneurs cannot enter.
• To the strategist: not everyone can develop industry foresight or wants to change the rules; international firms must analyse compliance and choice country by country.

Readings in the book's framing

Reading 10.1 (Porter, Industry evolution) represents industry dynamics: profitability is heavily influenced by industry structure, determined by underlying economics that present strict rules. Two processes determine who survives as the structure evolves: natural selection (only the fittest survive) and adapting to structural changes once firms understand the drivers. Reading 10.2 (Kim and Mauborgne, Blue ocean strategy) represents industry leadership: rule breaking is superior to rule taking; much business innovation comes from value innovation; they make the less common point that incumbents can also be rule breakers, revolutionising their industries from the inside. Reading 10.3 (McGahan) bridges both: change trajectories are the outcome of two threats of obsolescence, to the core activities and to the core assets (resources, knowledge), and often differ from what strategists expect.