Business Level Strategies – CA Inter SM Notes is designed strictly as per the latest syllabus and exam pattern.
Business Level Strategies – CA Inter SM Study Material
Explain Porter’s five forces model as to how businesses can deal with the competition. (RTP Nov. 2018)
To gain a deep understanding of a company’s industry and compe-titive environment, managers do not need to gather all the information they can find and waste a lot of time digesting it. Rather, the task is much more focused.
A powerful and widely used tool for systematically diagnosing the signi-ficant competitive pressures in a market and assessing the strength and importance of each is the Porter’s five-forces model of competition.
This model holds that the state of competition in an industry is a compo-site of competitive pressures operating in five areas of the overall market:
- Competitive pressures associated with the market manoeuvering and jockeying for buyer patronage that goes on among rival sellers in the industry.
- Competitive pressures associated with the threat of new entrants into the market.
- Competitive pressures coming from the attempts of companies in other industries to win buyers over to their own substitute products.
- Competitive pressures stemming from supplier bargaining power and supplier seller collaboration.
- Competitive pressure stemming from buyer bargaining power and seller-buyer collaboration.
Explain briefly the competitive forces in any industry as identified by Michael Porter. (May 2018; 5 Marks)
Five forces model of Michael Porter is a popular tool for svstemati-cally diagnosing the significant competitive pressures in the market and assessing their strength and importance. The model holds that the state of competition in an industry is a composite of competitive pressures oper-ating in five forces as follows:
1. THREAT OF NEW ENTRANTS: New entrants place a limit on prices and affect the profitability of existing players. The new capacity and product range the new entrants bring increases competitive pressure, bigger the new entrant, the more severe the competitive effect.
2. BARGAINING POWER OF CUSTOMERS: The bargaining power of the buyers influences not only the prices that the producer can charge but also influence costs and investments of the producer. This force will become heavier depending on the possibilities of the buyers forming groups or cartels, particularly in case of industrial products.
3. BARGAINING POWER OF SUPPLIERS: Often suppliers can exercise considerable bargaining power. If the suppliers are also limited in number they stand a still better chance to exhibit their bargaining power. The bargaining power of suppliers determines the cost of raw materials and other inputs of the industry and, therefore, can affect industry attractiveness and profitability.
4. RIVALRY AMONG CURRENT PLAYERS: The rivalry among existing players is quite obvious. This is what is normally understood as com-petition. The impact is evident more at functional level in the prices being charged, advertising, and pressures on costs, product and so on.
5. THREATS FROM SUBSTITUTES: Substitute products are a latent source of competition in an industry. Substitute products offering a price advantage and/or performance improvement to the consumer can have significant impact.
The five forces together determine industry attractiveness/profitability. This is so because these forces influence the causes that underlie industry attractiveness/ profitability.
Rahul Sharma is Managing director of a company which is manufac-turing trucks. He is worried about the entry of new businesses.
What kind of barriers will help Rahul against such a new Threat? (RTP May 2019)
A firm’s profitability tends to be higher when other firms are blocked from entering the industry. New entrants can reduce industry profitability because they add new production capacity leading to increase supply of the product even at a lower price and can substantially erode existing firm’s market position.
Barriers to entry represent economic forces that slow down or impede entry by other firms.
Common barriers to entry include:
i. Capital requirements ii Economies of scale
ii Product differentiation
iii. Product differentiation
iv. Switching costs
v. Brand identity
vi Access to distribution channels
vii. Possibility of aggressive retaliation by existing players
i. Capital Requirements: When a large amount of capital is required to enter an industry, firms lacking funds are effectively barred from the industry, thus enhancing the profitability of existing firms in the industry. For example, huge investments are needed to build production facilities and establish brand awareness among people for entry into the pharmaceutical industry. This makes the entry of new companies into this sector very difficult.
ii. Economies of scale (Nov. 18; 2 Marks): Many industries are characterized by economic activities driven by economies of scale refer to the decline H in the per-unit cost of production (or other activity) as volume grows. A g large firm that enjoys economies of scale can produce high volumes of goods at successively lower costs. This tends to discourage new entrants. For example, in the semiconductor industry, larger companies, such as IBM, Intel, Samsung and Texas Instruments, enjoy substantial economies of scale in the production of advanced microprocessors, communication chips and integrated circuits that power most consumer electronics, personal computers (PCs) and cellular phones. This acts as barrier for new entrants.
iii. Product Differentiation: product differentiation refers to the physical or perceptual differences, or enhancements, that make a product special or unique in the eyes of customers. Firms in the personal care products special or unique in the eyes of customers. Firms in the personal care product and cosmetics industries actively engage in product differentiation to enhance their products’ features. Differentiation works to reinforce entry barriers because the cost of creating genuine product differences may be too high for the new entrants.
iv. Switching costs: To succeed in an industry, new entrant must persuade existing customers of other companies to switch to its products. To make a switch, buyer may need to test a new firm’s product, negotiate new purchase contracts, and train personnel to use the equipment, or modify facilities for product use. Buyers often incur substantial financial (and psychological) costs in switching between firms. When such switching costs are high, buyer are often reluctant to change. For example, high switching costs in moving away from microsoft’s windows operating systems used in personal computers and corporate servers powered the company’s stunning growth over the past decade in the software industry.
v. Brand identity: The brand identity of products or services offered by existing firms can serve as another entry barrier. Brand identity is particularly important for infrequently purchased products that carry a high unit cost to the buyer. New entrants often encounter significant difficulties in building up the brand identity, because to do so they must commit substantial resources over a long period. For example, during the 1970s, Japanese companies such as Toyota, Nissan, and Honda had to spend huge sums on new product development and promotional activities to overcome the American consumer’s preference for domestic cars.
vi. Access to Distribution Channels: The unavailability of distribution channels for new entrants poses another significant entry barrier. Despite the growing power of the internet, many firms may continue to rely on their control of physical distribution channels to sustain a barrier to entry to rivals. Often, existing firms have significant influence over the distribution channels and can retard or impede their use by new firms. For example, because of control over distribution channels in India by HUL, P & G and Godrej etc., small entrepreneurs find it very difficult to sell their products through the existing channels.
vii. Possibility of Aggressive Retaliation: Sometimes the mere threat of aggressive retaliation by incumbents can deter entry by other firms into an existing industry. For example, introduction of product by other firms into an existing industry. For example, introduction of product by a new firm may lead incumbents firms to reduce their product process and increase their advertising budgets, [incumbent means: current/existing]
Buyers can exert considerable pressure on business. Do you agree? Discuss. (RTP Nov, 2019)
Buyers of an industry’s products or services can sometimes exert con-siderable pressure on existing firms to secure lower prices or better services. This leverage is particularly evident when
- Buyers have full knowledge of the sources of products and their sub-stitutes.
- They spend a lot of money on the industry’s products ie. they are big buyers.
- The industry’s product is not perceived as critical to the buyer’s needs and buyers are more concentrated than firms supplying the product. They can easily switch to the substitutes available.
Sohan and Ramesh are two friends who are partners in their business of making biscuits. Sohan believe in making profits through selling more volume of products. Hence, he believes in charging lesser price to the customers. Ramesh, however of the opinion that higher price should be charged to create an image of exclusivity and for this, he proposes that the product to undergo some change.
Analyse the nature of generic strategy used by Sohan and Ramesh. (Nov. 2018; 5 Marks)
- Sohan and Ramesh are contemplating pricing for their product. Considering the generic strategies of Porter there are three different bases:
- cost leadership,
- differentiation, and
- Sohan is trying for cost leadership by keeping a low price and high volume are thereby trying for cost leadership. Cost leadership is for catering to price sensitive consumers wherein emphasis on producing standardized products at a very low per unit cost.
- Ramesh wishes to create perceived value for the product and charge higher prices. He is trying to adopt differentiation. Differentiation is aimed at producing products and services considered unique industry wide and directed at consumers who are relatively price insensitive.
What do you understand by cost leadership? How is it achieved? (RTP May 2019) (Nov. 2019; 5 Marks)
- It is a competitive strategy that aims at broad mass market by switching to low cost.
- It requires enthusiastic chase for cost reduction in the areas of procurement, production, storage and distribution of product or service and also economies in overhead costs.
- The reason why cost leader is able to charge a lower price for its products as compared to its competitors and still make satisfactory profits is its lower costs.
Classic example being McDonald’s fast food restaurants – who have followed a low cost strategy and successfully followed low cost lead-ership strategy.
- A primary reason for pursuing forward, backward, and horizontal integration strategies is to gain cost leadership benefits.
- However cost leadership generally must be followed in combination with differentiation.
- Determined to be the low-cost producer in an industry; can be especially effective when:
a. the market is composed of several price-sensitive buyers,
b. when there are few ways to achieve product differentiation,
c. when buyers do not care much about differences from brand to brand, or
d. when there are a large number of buyers with significant bargaining power.
- A successful cost leadership strategy usually spreads throughout the entire firms, as supported by high efficiency, low overhead, limited perks, intolerance of waste, intensive screening of budget requests, wide spans of control, rewards linked to cost containment, and broad employee participation in cost control efforts.
Gennex is a company that designs, manufactures and sells computer hardware and software. Gennex is well known for its innovative products that has helped the company to have advantage over its competitors. It also spends on research and development and concerned with innovative softwares. Often the unique features of their product, that are not available with their competitors helps them to gain competitive advantage. Gennex using the strategy is consistently gaining its position in the industry over its competitors.
Identify and explain the Porter’s generic strategy which Gennex has opted to gain the competitive advantage. (RTP Nov. 2018)
- According to Porter, strategies allow organizations to gain competitive advantage from three different bases: cost leadership, differentiation, and focus. Porter called these base generic strategies.
- Gennex has opted differentiation strategy.
- Its products are designed and produced to give the customer value and quality.
- They are unique and serve specific customer needs that are not met by other companies in the industry.
- Highly differentiated and unique hardware and software enables Gennex to charge premium prices for its products hence making higher profits and maintain its competitive position in the market.
- Differentiation strategy is aimed at broad mass market and involves the creation of a product or service that is perceived by the customers as unique.
- The uniqueness can be associated with product design, brand image, features, technology, and dealer network or customer service.
Airlines industry in India is highly competitive with several players. Businesses face severe competition and aggressively market themselves with each other. Luxury Jet is a private Delhi based company with a fleet size of 9 small aircrafts with seating capacity ranging between 6 seats to 9 seats. There aircrafts are chartered by big business houses and high net worth individuals for their personalised use. With customised tourism packages their aircrafts are also often hired by foreigners. Identify and explain the Michael Porter’s Generic Strategy followed by Luxury Jet. (RTP Nov. 2020)
- The Airlines industry faces stiff competition. However, Luxury Jet has attempted to create a specialty market by adopting focused differentiation strategy.
- A focused differentiation strategy requires offering exclusive features that fulfil the demands of a tight market.
- Luxury Jet compete in the market based on exceptionalitv and aim a tighten market which provides business houses, high net worth individuals to tolerate stringent schedules.
- The option of charter flights provided several advantages including, flexibility, privacy, luxury and many a times cost saving.
- Apart from suitability, the facility will provide time flexibility. Travelling by private jet is the most comfortable, safe and secure way of flying your company’s senior business personnel.
Chartered services in airlines can also have private use along with business by providing personalized tourism packages can be provided to those who can afford it.
Describe the Several Basis of Differentiation.
There are several basis of differentiation: product, pricing and orga-nization.
- Product: Innovation of products will have an advantage over compe-titors wherein the product meets customer needs. The quests of new product offerings can be costly as it adds up to the cost of production and distribution – due to research and development, as well as production and marketing costs.
- Pricing: It can vary based on its supply and demand, and also be im-pacted by the customer’s ideal value for the product. Companies that differentiate based on product price can either determine to offer the lowest price, or can attempt to establish dominance through higher prices.
- Organization: Organizational differentiation is yet another form of differentiation. Maximizing the power of a brand, or using the spe-cific advantages that an organization possesses can be contributory to a company’s success. Location advantage, name recognition and customer loyalty can all provide additional ways for a company differentiate itself from the competition.
What do you mean by differentiation strategy? How is it achieved? (May 2019; 5 Marks)
Achieving Differentiation Strategy
To achieve differentiation, following are the measures that could be adopted by an organization to incorporate:
- Offer effectiveness for the customers and match the products with their tastes and preferences.
- Raise the performance of the product.
- Offer the possibilities of high quality product/service for buyer satisfaction.
- Speedy product innovation.
- Taking steps for enhancing image and its brand value.
- Fixing product prices based on the unique features of the product and buying capacity of the customer.
A century-old footwear company “Mota Shoes” had an image of be-ing the footwear choice for formal occasions. In an attempt to reinvent its brand, it tied up with a foreign footwear giant “Buffrine” to manufacture and sell its Hideseek brand in the country. Putting its best foot forward, it launched extra soft, casual and relaxed footwear for young. Aiming at a brand and image makeover the “Mota Shoes” decided to price the Hide Seek products at premium.
What kind of Michael Porter business level strategy is being used by “Mota Shoe company”? State its advantages. (RTP Nov. 2019)
A differentiation strategy may help to remain profitable even with rivalry, new entrants, suppliers’ power, substitute products, and buyers’ power. Explain. (RTP May 2020)
Mota shoes is trying to use differentiation. This strategy is aimed at broad mass market and involves the creation of a product or service that is perceived by the customers as unique. The uniqueness can be associated with product design, brand image, features, technology, dealer network or customer service. Because of differentiation, the business can charge a premium for its product.
Advantage Of Differentiation Strategy
A differentiation strategy may help to remain profitable even with: rivalry, new entrants, suppliers’ power, substitute products, and buyers’ power.
- Rivalry’ – brand loyalty acts as a safeguard against competitors. It means that customers will be less sensitive to price increase, as long as the firm can satisfy the needs of its customers.
- Buyers – they do not negotiate for price as they get special features and also they have fewer options in the market.
- Suppliers – because differentiators charge a premium price, they can afford to absorb higher costs of supplies and customers are willing to pay extra too.
- Entrants – innovative features arc an expensive offer. So, new entrants generally avoid these features because it is tough for them to provide the same product with special features at a comparable price.
- Substitutes – substitute products can’t replace differentiated products which have high brand value and enjoy customer loyalty.
Eco-carry bags Ltd., a recyclable plastic bags manufacturing and trading company has seen a potential in the ever-growing awareness around hazards of plastics and the positive outlook of the society towards recycling and reusing plastics.
A major concern for Eco-carry bags Ltd. are paper bags and old cloth bags. Even though they are costlier than recyclable plastic bags, irrespective, they are being welcomed positively by the consumers.
Identify and explain that competition from paper bags and old cloth bags fall under which category of Porter’s Five Forces Model for Competitive Analysis?
- In Porters Five Forces Model for competitive analysis, Eco carry bags falls under Threat of Substitutes category as it faces competition from paper bags and old cloth bags.
- Paper and cloth bags are substitutes of recyclable plastic bags as they perform the same function as plastic bags.
- Substitute products are a underlying source of competition in an industry.
- In many cases, they become a key essential of competition.
- Substitute products offering a price advantage and/or performance improvement to the consumer can drastically alter the competitive character of an industry.
Discuss in what conditions rivalry among competitors tends to be cut-throat and profitability of the industry goes down. (Nov. 2019; 5 Marks)
The intensity of rivalry in an industry is a significant determinant of industry attractiveness and profitability. The intensity of rivalry can influence the costs of suppliers, distribution, and of attracting customers and thus directly affect the profitability. The more intensive the rivalry, the less attractive is the industry.
Rivalry among competitors tends to be cut-throat and industry profitability low when:
- An industry has no clear leader.
- Competitors in the industry are numerous.
- Competitors operate with high fixed costs.
- Competitors face high exit barriers.
- Competitors have little opportunity to differentiate their offerings.
- The industry faces slow or diminished growth.