Saturday, September 24, 2011

Structural Analysis within Industries: Strategic Groups and Mobility Barriers

Michael Porter in his work on Competitive Strategy (1980) postulates that structural analysis at the industry level provides several useful insights into the five competitive forces and the broad methodologies by which the competitive forces can be managed by individual firms. He also suggests that industry level structural analysis by itself is not adequate to explain why some firms facing the same industry environment are more profitable than others.  Porter proposes that structural analysis within industries would be a useful adjunct to structural analysis of the industries to explain differences in the performance of firms in the same industry.

Porter suggests the following thirteen strategic dimensions as being capable of providing companies within an industry with varied strategic options to differentiate themselves. These are: specialization, brand identification, push versus pull, channel selection, product quality, technological leadership, vertical integration, cost position, service, price policy, leverage, relationship with parent company,  and relationship to home and host government. Porter states that the level to which each of the strategic dimensions plays out is related to the nature of the industry while in some cases the strategic dimensions are, in fact, related.
Thereupon Porter proposes that characterization of the strategies of all significant competitors in an industry along these dimensions is the first step in structural analysis within industries. This activity, he holds, allows for mapping of the industry into strategic groups. A strategic group is defined by Porter as the group of firms in an industry following the same or similar strategy along the strategic dimensions. There could be just one strategic group in an industry, if all firms follow the same strategy or each firm could constitute a strategic group if each firm follows an entirely different strategy.
According to Porter, the strategic group is an analytical device designed to aid in structural analysis. It is an intermediate frame of reference between looking at the firm as a whole and each firm separately. Strategic groups are claimed to explain differences in performance and profitability of firms in a more perceptive manner. In a concept analogous to entry barriers, Porter proposes mobility barriers as barriers that prevent a firm shifting strategic position from one strategic group to the other. Porter hypothesizes that firms in strategic groups with high mobility barriers will have greater profit potential than those in strategic groups with lower mobility barriers. He states that strategic groups and mobility barriers change over time.
Reapplying concepts of structural analysis, Porter proposes that strategic groups experience all the concepts of industry level competitive forces, namely, bargaining power of buyers, bargaining power of suppliers, threat of substitutes, threat of entry and rivalry among firms.  The firm’s profitability is seen to be a resultant of the interplay of common industry characteristics, characteristics of the strategic group and firm’s position within its strategic group. Other related concepts relate to scale and cost position of strategic groups. Porter proposes structural analysis within industries together with the concepts of strategic groups and mobility barriers as a powerful analytical tool to explain causes of firm profitability and formulate c3B line-height: 115%; mso-bidi-font-family: Calibri;">As can be seen, the twelve dimensions of the author are more perceptive of strategy, and hence better qualifiers for strategic grouping. More interestingly, each of these can be well defined and well measured. Product specialization can be defined in terms of sales per product family. Manufacturing integration can be defined in terms of value added in-house.  Import intensity is defined as consumption of imported materials and components as a percentage of sales. Export orientation is defined as export income as a percentage of sales. R&D intensity is seen in terms of R&D expenditure (capital and revenue) as a percentage of sales. Financial leverage could be shareholder funds as a percentage of total capital employed.  There could be other leading and lagging indicators too. Patent applications made, patents granted or patents commercialized as well as new product counts could reflect the R&D intensity, for example.  
Constraints of multiple dimensions
The essence of strategic grouping is to correlate the strategic dimensions of a firm to its performance. It would be of interest to compare a group of firms which are mapped on the dimensions of product specialization and manufacturing integration to other groups at different levels in terms of their physical and financial performance. A study of the Indian automobile industry suggests that strategic groups which are high on product diversification (ie., low on product specialization) and high on manufacturing integration scored better on physical and financial performance. Similarly, groups which are low on import intensity and high on export intensity tended to do better on performance. Groups which are high on R&D intensity and low on financial leverage also scored well.
Strategic groups being two dimensional have their limitations in predicting the impact of multiple variables on firm performance. Porter tries to circumvent the limitation by suggesting that strategic groups of firms which are mapped on any two dimensions could be further elaborated by bubbles which denote the size of the business and adding other parameters into the description of the group. For example, in a strategic grouping drawn on the dimensions of specialization (narrow line, full line) and vertical integration (high vertical integration and assembler) could be further described in terms of manufacturing cost (low or high), customer service (low or high) and quality (low or high). Despite Porter’s prescription strategic groups serve as a descriptive analytical tool rather than a quantitative analytical tool.
Strategic grouping as a technique works well when firms in an industry are characterized by a few, preferably two, dominant dimensions that are the most important in terms of strategic calibration. For example, in the automobile industry, dimensions of product specialization and manufacturing integration are the two strategic dimensions that could be significantly varied across firms. Other dimensions such as quality and environmental friendliness could be seen as essential dimensions in any case. Strategic grouping also works well when there are a number of firms in an industry which facilitates plotting of the firms into several strategic groups.
Taking stock at this stage, the need to fix the foundation of Porter’s strategic grouping through more perceptive strategic dimensioning and more selective application to relevant industries needs to be noted. As with any theory, mere elegance of strategic thinking cannot translate itself into tangible analytical support that can be quantified. It would be better to recognize this limitation of strategic grouping. This awareness enables a better appreciation of the other two concepts of using strategic groups for establishing mobility barriers and analyzing competitive forces to complete the framework of structural analyv class="MsoNormal" style="margin: 0in 0in 10pt;">
Physical and financial performance, in fact, determines the mobility of firms across strategic groups. A firm in a high product specialization and low vertical integration strategic group should have high financial performance to be able to move to a strategic group that is defined by high product diversification and high vertical integration, which by the very nature requires high capital intensity. If the profitability of such a lean strategic group is weighed down by other factors, say a heavy dependence on high cost imports, the firm in such a strategic group would face high mobility barriers. Mobility barriers, therefore, are not external to strategic groups but are themselves intrinsic characteristics of strategic groups.
Just as an industry with high entry barriers enables monopolistic or duopolistic industry structure with superior profitability, a strategic group which has significant entry barriers would have higher potential for profitability. That said, compared to cross-industry movement cross-strategic group movement is a more common occurrence. A classic case is seen in white goods industry and fast moving consumer goods industry where firms constantly seek to move across strategic groups. Part of the reason is that most firms in these industries possess some common attributes in terms of product development capability, manufacturing capability, brand differentiation, investments in trade channels and so on. This enables the typical firm in these industries bridge the mobility barriers. As an axiom, mobility barriers can be interpreted in terms of core competencies required for strategic groups.
Strategic groups and derived power
Firms in strategic groups could get the energy to transcend mobility barriers through derived power. Such derived power accrues through being a subsidiary of a major corporation, being a part of a major conglomerate or being a corporation well respected by the regulatory bodies, including the governments. Access to external power as above helps firms move into different strategic groups more effortlessly, relative to standalone firms. As an example, Tata Motors would be able to introduce superior quality steel for its automotive purposes by virtue of having Tata Steel in its conglomerate fold. A subsidiary of a multinational corporation would have the ability to secure better financial leverage or hop across strategic groups requiring higher capital even if its current strategic group has little financial surplus to offer.
Inability to be mobile across strategic groups or even exit the industry drives industry consolidation. Equity relationships between needy firms and endowed firms, through mergers and acquisitions, lead to redraw of strategic groups. Shifting strategic preferences of firms also lead to structural reconfiguration. The acquisition of Henkel’s detergent business by Jyothi Laboratories is a case in point. Mobility across strategic groups has to be carefully thought through; otherwise there could be a risk of the acquiring or the acquired firm, or rather the merged entity, being in an inferior strategic group than they were in the pre-consolidation phase.
Globalization and strategic groups    
Globalization has added an entirely new strategic dimension to the theory of strategic groups. Strategic groups of the same industry tend to vary dramatically across nations. It is also not automatic that   characteristics of a multinational are exhibited in the same manner in all the countries the corporation exists. A corporation that is vertically integrated in the headquarters country need not be so in another country. Understanding of the local industrial characteristics helps companies with global corporations become better members of strategic groups. Global developments affect the principal and its subsidiaries differentially. Apart from different strategic dimensions pursued across nations, the extent to which countries are coupled (or decoupled) with global economic developments, especially of the developed world, have a major impact on how strategic groups are formed, how they perform and how they reconfigure.
Posted by Dr CB Rao on September 24, 2011      

Saturday, September 17, 2011

Supplier Power and Firm Competitiveness: Perfect Freedom versus Partnered Synergy

The bargaining power of suppliers is an important competitive force outtlined by Michael Porter in his theory of five competitive forces (Competitive Strategy, 1980). As with buyer power, supplier power arises from the singular value chain, of which the firm is a part of. It is however, interesting that the purchasing strategy of a firm to deal with supplier power has received only a perfunctory treatment rom Porter, relative to the other competitive forces or strategies. Part of the reason relates to the extensive treatment provided to some of the key purchasing and supply issues through the analytical framework on the strategic decision of vertical integration elsewhere in the book. As a result, the issues relating to supplier power are only partially addressed and that too, through the lens of buttressing the competitive position of a firm. Part of the reason also is his belief that many aspects of purchasing strategy go well beyond the scope of his book. That, unlike at least a portion of buyer groups which are individual consumers, the whole genre of suppliers are themselves firms having similar value chain of buyer-supplier has been ignored by Porter. Competitive strategy must provide a more detailed analysis of supplier issues than Porter has provided, even including
his analysis of vertical integration, and even considering that supply chain management is a different domain by itself.

According to Porter, there are four key issues in purchasing strategy from a structural standpoint. These are: stability and competitiveness of the supplier pool, optimal degree of vertical integration, allocation of purchases among qualified suppliers and creation of maximum leverage with chosen suppliers. Porter rightly hypothesizes that a firm should procure from vendors who will maintain or improve their competitive position in their own industry. He recommends the application of structural and competitor analysis which is found
throughout his work on Competitive Strategy to identify how a firm’s suppliers will fare along these dimensions. Amongst all purchasing related decisions, Porter considers the issue of vertical integration as the key strategic decision. This, however, is considered contingent on identification of items for make or buy. Porter considers that allocation of purchases by a firm among its suppliers is a key element of how bargaining power of suppliers is dealt with. He lists he conditions which create powerful suppliers such as supplierconcentration, non-dependence on customer, switching costs for customer, unique or differentiated product, and threat of forward ntegration. He advocates creation of maximum leverage through diffused purchases, avoidance of switching costs, qualification of allternate sources, promotion of standardization and use of tapered integration. He differentiates the lowering of long-run purchasing costs through such holistic purchasing strategies from the short-run increase in costs which some of the strategies may entail. He concludes, as any wise purchasing manager would, that the firm should purchase from low-cost suppliers unless there are offsetting benefits in terms of long-run bargaining power. While not contradicting theiewpoints of Porter, this blog post brings up several other interesting perspectives.

Division of labor

The development of supplier-firm differentiation, supplier-firm connectivity, behavioral aspects of supplier-firm relationship and upplier clusters are some of the fascinating aspects of structural evolution of an industry. It is a lacuna that Porter has not focused more on these aspects. Core competency in developing a component or even a whole group of components has rarely translated itself into a core competency in developing the end-product. The essence of the historical evolution of the supplier industry as an autonomous but dependent adjacent industry to the end-product industry or the original equipment manufacturer (OEM) industry is rooted in ownership and techno-economic considerations. By theory and practice, OEM requires huge investments and mega entrepreneurship, which makes OEM the preserve of the few. Component or system supplies, on the other hand, require low and mid scale investments and provide for dffusion of entrepreneurship. Government policies also encourage the reation of larger employment opportunities through small and medium scale enterprises. Separation of component and OEM industries helps OEMs access more cost-competitive components due to the lower direct costs and lower overheads of smaller enterprises. Once a component manufacturer gets established, it would prefer to diversify into the business of another component rather than forward integrate into OEM. At best, it may consider limited forward integration into systems manufacture.

The automobile industry, the world over, has been an excellent example of component and end-product manufacture dichotomy as well as symbiosis. Over the period, however, there has been a greater appreciation of integrating vendors from the very early stage of new product commercialization and ensuring seamless development of new components and end-products. In addition, the need for the OEMs to have a greater say in the development of new component systems has been felt in recent times. India offers an outstanding example of a component manufacturing group called TVS, which despite the established base to
manufacture every conceivable automotive component has restrained itself from entering into automobile manufacture. There are probably two interesting perspectives to this trend. The first one is that once omponent makers get established as the preferred vendors, they secure greater monopoly than OEMs. For example, while the automobile manufacturing arena has several companies churning out various types of automobiles, component makers are in duopoly or low oligopoly.

By remaining small and focused on research and manufacturing, with very little of marketing investments, suppliers tend to build core competencies. From Intel chips and Samsung OLED screens to Bosch spark plugs and ZF gear boxes, theomponent supplier industry structure is unmistakably concentrated. The second perspective is that being independent, yet not being visibly branded, gives suppliers complete freedom to exploit the total arket. As opposed to an industry comprising, say, thirty OEMS selling thirty million original equipment in the aggregate at an average one million end-products per manufacturer, the duopolistic component supplier industry lets the constituents enjoy an equal share each of fifteen million components, probably with greater profitability. The division of labor works advantageously to both the constituents, the end-product manufacturers and component vendors.

Integration of technology

Much as division of labor works to the advantage of suppliers and the firm, integration of technology should also work to their advantage. There are significant opportunities as well as limits to integration of echnologies. In many cases, component makers can admirably respond to firm requirements with proactive user signaling. In the automobile industry, self-cooled radiators, asbestos-free gaskets, parabolic springs, low friction oils, tight tolerance pistons, connecting rods, camshafts, and crankshafts are all examples of component makers rising to the technological challenges with component level leadership. On the other hand, there are a few areas which cannot be done without active and continuous collaboration. Vehicle control computers and
software, external trim and external lighting, for example, need complete technological integration. Concurrent engineering could be a great way to ensure collaborative development. Yet, both OEMs and
suppliers need to know the economics-deterrent integration level in each case. The OEMs must focus on the interface and optimization of equipment and component design while the component makers must focus
on similar interfacing and optimization with their materials suppliers.

Not surprisingly, the technological value chain of a component maker is more elaborate than the OEM value chain. Even evolved OEMs and component makers often tend to lose out on such a strategic view of technology. If it were not so, tablets would have got more powerful and appropriate chips from Intel, and more appropriate operating systems from Symbion, Android and Microsoft right at the time of first generation launches. Technological ntegration for optimum impact tends to be a fine balance between ensuring faster go-to market and greater proprietary confidentiality. While Porter speaks of the bargaining power of suppliers it would ppear that OEMs have a significant leeway in deciding on the direction and pace of component level technologies. OEMs can retain their proactive advantage by seeking design copyrights wherever feasible or staking claim to joint intellectual property. Suppliers can secure their bargaining power in this space even while planning a relatively more open approach by securing broad patent estates on their technologies. A good model would be for OEMs and component suppliers to dedicate a certain percentage of their developmentbudgets to integration of component level and OEM level research. Such a model could lead to a better cross-fertilization of ideas.

Collaboration of minds

As between a firm and its customers, the relationship between the firm and its suppliers needs to be more collaborative than competitive. In fact, suppliers need to have the same customer-centricity towards the
OEMs as the OEMs need to have with their customers. There are two ways in which such collaboration can be successfully nurtured. The first is through setting up of supplier-firm level steering committees to discuss field performance, customer feedback, cost competitiveness, technology vision, new product timelines, capacity plans, investment needs and so on. Such forums provide both the firm and the supplier a platform to dovetail their strategies better. If a firm is able to position itself as the complete provider of information on components, the firm would have better bargaining power over the suppliers. The other approach is for both the firm and the supplier to, individually and collectively, reach out to the customer in the marketplace directly. Direct interfacing with customers provides significant additional focus on the individual components and a more perceptive feedback. Larger and enlightened suppliers, in fact, prefer to secure irect feedback from the marketplace. In addition, the movement of fter-sales spare parts and service metrics provide valuable feedback to suppliers. Clearly, the direct feedback mechanisms can, and should, only be supplemental to the firm and customer level knowledge sharing mechanisms.

Supplier power gets enhanced when the suppliers are able to access the customers of the OEMs directly, and understand the levels of satisfaction and areas for improvement. Regardless of the methodologies adopted, it is established that collaborative planning between the firm and its suppliers brings manifold benefits such as prompt redress of performance issues, production and inventory smoothing, agility to meet market volatility,preparedness for model changes and technology upgrades, and in the overall better value chain performance and greater competitiveness. As opposed to Porter’s model of short run firm level performance maximization, a collaborative mindset between the firm and its suppliers enables long run performance maximization for both the firm and the supplier. While this is easier said than done, progressive OEMs and their vendors have traditionally sought to strengthen this approach through mechanisms such as steering committes, and annual vendor meetings. Collaborative working, however, requires greater institutionalization through processes uch as collaborative forecasting and planning, collaborative capacity planning and so on.

Dual sourcing and flexi-designing

The key challenge in the firm-supplier relationship is a fine balance between proprietory technology (as a market dominating factor) and freedom to operate (as a risk mitigating factor). Clearly, if the supplier has a unique and differentiated position, the firm would benefit from having an exclusive access to the supplier technology. At the same time, such exclusive dependence could lead to high supplier power in terms of high price or controlled delivery while the firm could face  risks associated with dependence on a sole supplier, including likely disruption in the case of force majeure conditions affecting the supplier. To be fair, the supplier is also subject to similar risks when the firm happens to be the sole buyer. While a strategic partnership between the firm and its vendor for strategic technologies and supplies is advisable to maximize the market opportunity in case of new proprietary developments, dual sourcing would always be an appropriate paradigm for a mutually beneficial and protective firm-supplier relationship.

Such an evolution of dual sourcing relationship would depend on flexi-designing being an integral component of product development philosophy of both the firm and the supplier. There are many industries which have not yet committed to the route of standardization of internal parts. Standardization does not imply dilution of
differentiation advantage. A supplier of headlamps may design his lamps to conform dimensionally to a standardized form factor, more particularly the fixing system, but could still achieve high ifferentiation in terms of lighting intensity, lighting angle, adjustments to ambient light, lamp life, cost level and so on. Industry level standards organizations can make a great deal of contribution to this effort. Certain industries such as electrical, electronics, nuclear and pharmaceutical industries are required to seek pre-registration of the products and the principal vendor supplied materials with industry level or governmental level regulatory agencies. Firms in such industries need to take more proactive steps to qualify alternate suppliers as part of the early product development and manufacturing processes. Flexi-designing and development help the firms to integrate alternate suppliers with low lead times for switching of components and supply sources in the event of exigencies.

Supplier power as partnership synergy

The goals of the end-product manufacturers or the OEMs and their suppliers are, in matter of fact, aligned. Power dynamics between the firm and its suppliers need to be harnessed in a more positive manner than articulated in the Porter model by focusing on leveraging of mutual capabilities for market competitiveness. Technological strengths of suppliers and market understanding of the OEMs must be utilized to result in better performance of the total value chain. In the contemporary model of competitive strategy, the firm should respect the technological specialization of its suppliers while the suppliers should respect the pressures on the OEMs for higher performance at lower costs. Collaboratively aligned and working together, the firm and its suppliers would achieve a more competitive presence in the marketplace for mutual benefit.

Posted by Dr CB Rao on September 17, 2011.

Saturday, September 10, 2011

Management Consulting: Customizing the Firm's Growth or Dividing the Industry's Future?

While industrial or business management has evolved as an exciting discipline of in-house endeavor to achieve objectives of efficiency and growth over the last two centuries, external management consulting has rapidly caught the fancy of corporations and leaders over the last few decades. The reasons for rapid growth of mainstream management consulting are related to the ability of the consulting model to attract and retain highly talented professionals, subscribe to expensive databases, synthesize best practices and evaluate multiple industry environments simultaneously. It would be impossible for corporations to create and maintain a huge knowledge infrastructure in a manner comparable to front-ranking management consulting firms could have. In a sense, management consulting has been one of the earliest outsourcing activities ever undertaken by corporations and their leaders. Companies such as McKinsey, BCG, AT Kearney, and Bain have emerged as the undisputed beacons of mainstream external management consulting, with a global footprint, over the last few decades. Several other consulting firms have also established themselves over the years, with national and/or international presence as appropriate to their profiles.

As with any successful activity, management consulting has also attracted its share (fair or unfair) share of criticism. Firstly, given the relatively short nature of consulting period (usually 3 to 6 working months) and the limited expert time (usually 3 to 4 full time consultants) that is devoted to a typical project, it is held that the consulting group has hardly the time and inclination to absorb the past of the corporation perceptively or the depth and breadth to delineate the future accurately. This limitation itself is due to the high cost of consulting, which makes even large corporations to resort to limited bursts of consulting assignments, which may actually be inadequate relative to the challenge. Secondly, some professionals believe that consulting studies essentially utilize the insights already known to the organization, and therefore the firms would be better off developing internal capabilities. Thirdly, some critics believe that consulting studies are just 'feel-good' palliative patchworks and do not provide sustainability. Possibly, there is a need to apply some consulting analysis to the managing consulting profession itself as well as how corporations and leaders resort to the consulting option.

Inverse of outsourcing

Surprisingly, corporate leaders do not view that resort to external management consulting is, in a sense, the outsourcing of their primary responsibility to make their businesses grow and practices efficient. On the other hand, many believe that openness to getting external consulting help is a contribution that breakthrough or transformative leaders make to their corporations. In fact, however, management consulting makes up for the deficiencies the leaders may have in institutionalizing conceptual and analytical strengths in their organizations, in developing appropriate knowledge base on environment, markets and competitors, in fostering creative thinking amongst their people, in synthesizing multiple leadership viewpoints to harmonized superior strategies and in spending personal time on the challenge and rigor of positive change management. At times, therefore, resort to management consulting appears to be an expedient way of delegating leadership and managerial responsibilities to a group of experts who can only have a transient involvement in an organization.

The evolution of management consulting has thus charted an inverse path relative to say information technology outsourcing, R&D outsourcing and manufacturing outsourcing. In these areas corporations have been able to achieve significantly lower costs while retaining specifications and quality at high levels and inducting newer technologies at a faster pace. Management consulting, in contrast, is perhaps the only outsourcing stream that has been far more expensive than a comparable inhouse activity. Three facts have supported this high cost outsourcing. Firstly, most management consulting assignments are undertaken at the behest of the top leadership of corporations. Secondly, management consultants are called upon to carry out certain change management activities in organizations which leaders could find difficult to carry out. Thirdly, management consultants offer a heady mix of efficiency and growth solutions. These three factors provide the management consulting firms sufficient aura to command a huge price premium.

Beyond the facades

Much of the distortion in management consulting arises from the erroneous perception that future vision and strategy as well as best practices are likely to be proprietary advantages which management consultants bring to the client corporation. The consulting firms cite the relative exclusivity of their clientele and the firewalls between the consultants as evidence of their closed source knowledge and prescription base. The facts are probably far distanced from the claim. In an era where even patented technical information is improved upon or circumvented, it is quite debatable if management analysis and prescriptions could really be proprietary to any one consulting organization or any corporation served by the consultants. In the current era of global value chains, networked relationships and analyst attention, management thought has ceased to be proprietary.

Like any other firm, a management consulting firm needs the largest clent base to maximize overhead absorption, reduce its costs (not necessarily its pricing!) and enhance profitability. It is, therefore, impossible for the consulting firms to serve only one firm in an industry and be viable. Management consulting firms often serve multiple clients in the same industry by choosing to wok with firms which are apparently not competing with each other and/or are utilizing different consultants for different clients in an industry. They also end up devloping, by design or default, different strategic or practice prescriptions for different clients. This is an unfortunate artificiality in the management consulting practice, which provides false security and unrealistic value to the consulting transaction. Several examples underscore the not so relevant nature of the 'closed service' or 'proprietary source' labeling of studies by the consulting organizations and its acceptance by the corporate clients.

Mirage of strategic differentiation

Management consulting firms claim a major value proposition in terms of strategic differentiation. In a competitive world, the ability and opportunity to script a path of strategic differentiation does not come easy. Consider a management consulting firm advising a telecommunications firm on strategy. Its degrees of freedom in advising strategic differentiation are limited to the choice of technologies (GSM. CDMA, 3G/4G etc.,), integration (processing hardware such as switches, transmission hardware such as towers and hardware, operating software such as routing and billing), and markets (local, global). Consulting firms tend to make a few differentiated (or more appropriately, dissected) strategies out of the available degrees of freedom in the name of different customized narrow line options offered to different clients whereas the ideal strategy for each client could be to follow an undifferentiated strategy of full line development.

Another example from the nutraceutical industry would offer similar insights. The client could specialize in vitamins, minerals and micro-nutrients, anti-oxidants, dietary supplements, food substitutes, functional foods and herbal or natural medicines. Unfortunately, the product bands and and user applications overlap so much in these categories that any strategic differentiation along any particular segment would only lead to narrow business focus and lack of sustainability - quite the antithesis of the idea of engaging the management consulting firm. If, on the fact of limited strategic options, the segmentation mindset forces the consulting firm to apportion the options to different clients, clearly no nutraceutical firm would have sustainability. It would probably be much better for the consulting firm to prescribe what each firm should embark upon without the worry of being seen as offering the same prescription to all the clients in an industry.

Competency-strategy fit
Potentially, consulting firms may have a better hold if they approach their engagements in terms of competency-strategy fit. That is because even if the strategic path for all companies in an industry could be the same, the ability of each individual firm to pursue the starategy could vary based on its capabilities and competencies. The consulting firm can then clearly articulate whether and how the competencies influence the strategy, and whether the costs and benefits of building or modifying the competencies dictate a need to segment the strategy. Understanding the competencies of the client is an essential starting block for any meaningful strategy study. However, given the expensive, time-titrated nature of high calibre management consulting firms, both clients and consultants tend to focus more on strategy rather than competency-strategy fit, leading to suboptimal results.

It would, therefore, stand to reason that any strategy study must have an essential component of understanding the competencies of its client. This, in turn, enjoins the companies to be candid and transparent about what they believe are their competencies. Such an approach reduces the time on needless diagnostics and focus more on firm level benchmarking and industry level comparators to add depth to competency profiling. Once competency profiles are established and competency-strategy fit is established through iterative analysis, consulting firms can provide another value-add by specifying how exactly the client can build competencies. This requires that consulting organizations must learn to work with the broader organization across the hierarchy as much as they enjoy working with the top leadership.

Execution, the true differentiator

In the domain of strategy, it often emerges that there is no right or wrong strategy and even great strategies can be rendered inconsequential through weak execution. This, unfortunately, has been one area where management consulting firms have failed to develop a value proposition and clients themselves are unwilling to allow any third party review of their execution. This is unfortunate. Management consulting firms need to develop divisions which have low overheads and high capabilities to track execution against agreed strategies. Such execution review should also come with soft advice on enhancing execution capability of a firm and making course corrections as required, providing simple but effective tools (not necessarily elaborate program management tools) which enable the firm to internalize such tools and become eventually independent in the domain of execution.

The other roadblock to execution advice relates to organizational dynamics. A firm's execution capabilities are often a function of its structure, systems and people. Organizations are touchy about management consulting firms lacking the real depth to analyze these issues, especially the people issues, as inadeuqate appreciation could lead to erroneous solutions that affect the morale and motivation of existing team members. There do exist several cases where consulting firms were unaware of the nuances of people development in different cultures and caused more grief than growth for the companies as they stirred the talent hornest of the organizations. This does not mean that consultants and companies need to baulk away from the essential need of organizational competence. Rather, it focuses on the need for management firms to create specializations that can handle organizational efficiency matters sensitively and perceptively.

Working with the CXOs

All top-rung management consulting firms believe that their studies provide the best results only when they work with the CXOs, and even preferably with only the CEOs, of their client organizations. This proposition is even more intense in emerging markets where the passion and aspiration of the founder-CEOs for growth and the intellect and inclination of top-rung consulting firms to script growth strategies make a natural and irresistible match. However, this mutual fascination leads both the CEO and the consultant to seek growth without an understanding of what the broader organization needs and challenges. in matter of fact. Many founders and CEOs would loathe to admit their own limitations and either attribute low performance of their organization to the limitations of the team members or seek highly aspirational growth for their organizations imbuing their teams with mythical competencies.

Management consulting firms which consider working with the CEOs as their right as well as privilege, therefore more often not, end up basing their studies on wrong foundations, leading to wrong prescriptions. It is imperative for the top class management consultants to actually leverage their intellectual stature with the CXOs to do a sanity check on the claims of founders, entrepreneurs and CEOs, and lead the leaders as well as their organizations on to the right base. A simple broad based independent diagnostic study by the consultants could be an ideal way to start any consulting project, regardless of the inputs provided by the leadership.
Efficiency consulting

Within the management consulting domain, efficiency consulting has emerged as an attractive and, if one may say, a fashionable consulting stream. The history of efficiency models has, however, in it that they are most succesful only when they are internally developed (example, Toyota Production System) and voluntarily absorbed by peers. That is because efficiency movements usually require enterprise efforts, and more importantly mindset changes. An efficiency movement to be sustainable needs to be owned by the enterprise team without exception and based on individual level and machine level understanding of operational flow and input-output conversion. While consulting organizations are useful for their tools, templates and change advocacy, an internal organization is essential to absorb, desseminate and execute those aids.

As one considers the efficiency paradigm, the choice between driving down costs and driving up value is often dramatized as a key strategic decision. Consulting firms and clients need to look at this aspect as less of a choice and more of an integration. The former is better focused as elimination of waste and the later as generation of greater utility to achieve the integration. The bridge for both is an innovative bend of mind that develops creative solutions. Assignments, therefore, need to be holistic, looking at costs as well as values, to deliver optimal impact for the firm. There is also at times a strategic price to pay for either extreme lean or extreme differentiation. Studies must provide for surge capabilities as well as moderating abilities, which could be leveraged depending on how the economy and market move.
Time to insource

While outsourcing of growth or efficiency studies has served, and would continue to serve, a great purpose, there is probably a need for the managing consulting firms as well as clients to see how the paradigm of consulting can be made more holistic and realistic. External management consulting is an internal leadership responsibility that is getting outsourced and, therefore, needs to reflect high level of value and sutainability. If some of the aspects mentioned herein are addressed by the consulting firms as well as clients, possibly there would be more sustainable value. To nudge towards that, firms should probably start focusing on internal capabilities and commence insourcing of some of the prevoiusly outsourced leadership mandates. This could provide the needed collaborative competition, on an intellectual plane, between sophisticated consulting organizations and growth or efficiency hungry clients.

Posted by Dr CB Rao on September 10, 2011

Saturday, September 3, 2011

Buyer Power and Firm Competitiveness: Fortune or Poverty in the Marketplace?

The very reason for a firm to exist is the buyer. The collective actions of the buyers to purchase the products and services of all the firms in an industry constitute the demand in the marketplace. It is therefore counterintuitive to postulate that buyer power is inimical to the interests of the individual firms or the overall industry. Michael Porter, however, postulates in his work on Competitive Strategy (1980) that buyer power is one of the five competitive forces that a firm needs to contend with. Together with the other four competitive forces, buyer power determines the level of competitiveness in an industry. Extending the theory further, Porter proposes that most industries sell their products or services not to a single buyer but to a range of different buyers. He holds that the bargaining power of the groups of buyers, viewed in aggregate terms, is one of the key competitive forces determining the potential profitability of an industry. Porter considers that the concept of different buyer groups with varying purchasing requirements is valid for producer-goods industries as much as for consumer goods industries.

Porter provides a different twist to the concept of market segmentation when he holds that different buyer groups even when they are common to an industry vary widely in terms of their purchasing needs, in respect of product quality or durability, customer service, needed information in sales presentations, and so on. Buyers are held to differ not only in their structural position but also in their growth potential, and hence in the probable growth of their volume of purchases. And for a variety reasons, the costs of servicing individual buyers differ. The concept of market segmentation is turned by Porter, in the context of buyer heterogeneity, into a concept of buyer selection by the firm. Porter argues that a key strategic implication is that a firm can not only find good buyers but also create them. Porter proposes a framework for buyer selection and strategy based on four broad criteria that determine the quality of buyers from a strategic standpoint. These are: purchasing need versus company capabilities, growth potential, structural position and cost of servicing. The structural position is expressed in terms of intrinsic bargaining power and propensity to exercise the bargaining power in demanding low prices.
Contemporary buyer dynamics
As with the other propositions in Porter’s theory of competitive strategy, the propositions on buyer power and buyer selection need to be revisited. While designating market opportunity as buyer power may be a creative way of looking at the firm’s competitive dynamics, one wonders whether it is not a case of putting the cart before the horse. The idea of a firm selecting its buyers based on its products and services appears counterintuitive given the fact that the firm ought to develop its products and services to cater to the buyer needs. The proposition of the firm trying to play on the variations or exploit the weaknesses in buyers is antagonistic to the contemporary customer-centric view of the firm. In addition, there are two principles that militate against the simplistic but opportunistic buyer power theory of Porter. Both these principles render Porter’s strategy of narrow line manufacturers searching for buyer segmentation quite sub-optimal.
The first principle is that buyers, whether individuals or firms, do not have unitary thinking; rather it is the collective thinking of professionals in a firm or members in a family influence buyers’ seemingly individualistic thinking. In developed markets the purchasing characteristics of industrial buyers are collectively mandated by elaborate firm level processes and requirements while the purchasing characteristics of retail buyers are highly individualized. On the other hand, in emerging markets, notably Asian economies, buyers in firms have great latitude to decide on their purchasing requirements while retail buyers are subject to collective influences of families and friend circles. Strategies for addressing buyer groups must not only distinguish between types of industries but also between the characteristics of buyers of producer goods and consumer goods across developed and emerging markets.
The second principle is that every buyer has multiple user needs which can be fulfilled effectively by full line manufacturers; buyers typically need product families rather than isolated products, however unique they are. Any industrial plant, for example, would need compressors of different principles (water cooled or air cooled) and in different air pressures, based on the application. It would be inappropriate for a compressor manufacturer to specialize only in the large types of compressors. Similarly, a singular buyer group such as national airports authority would require different styles and scales of baggage conveyors based on the size and build-out of the airport (metro domestic, metro international or tier 2 and tier 3 cities). Even a simple product like a writing instrument sports multiple need profiles within a single buyer group; for example, low cost ball point pens for rough work, gel pens for official or college writing, fountain pens for signature purposes and finally premium pens just for sporting.
Flipping the proposition
In contrast to the prescription provided by Porter of choosing buyers based on products or services it has, the right proposition for a firm should be to choose its  products and services based on the buyer universe that is available. Such selection cannot also remain static. As new companies come with new products to create new buyers, existing companies would need to debate and decide on tweaking their product offerings or developing new products to ride the consumer wave. Porter’s theorems on managing buyer power would provide tactical solutions to optimize product-market fit but would not be able to provide strategic solutions for achieving sustainable growth. If we consider India’s energy scene, clearly the State Electricity Boards and national energy corporations, in private and public sectors are large buyer groups. Given the existence of several national and international power plant makers as competition, there is perhaps little choice for any individual power plant manufacturer to choose or leverage its buyer group. On a related plane, looking forward, there is a great scope for all types of power plants in India, in private and public sectors covering a host of technologies: thermal, hydro, nuclear, solar and wind; micro, medium and large. Until buyer groups are formed, there is very little contribution that theorems of managing buyer power can make to competitive strategy.
Perhaps the more relevant theorem in Porter’s buyer power theory relates to the proposition of buyer growth. Rightly, Porter argues that firms should cast their lot with buyers who have greater growth potential. Buyers faced with low growth obviously would have lower budgets and would constantly seek the lowest cost products to assure themselves of some base level of cost competitiveness and profitability. Latching on to fast growing buyer groups, on the other hand, provides scale as well as some level of pricing flexibility for a firm. While the benefit of connecting with growth sectors is an obvious hypothesis, many firms fail to recognize the shifting growth trends, and more importantly the need to reengineer products to meet the newer growth needs. India, for example, is not merely at the cusp of an economic growth wave but also at the threshold of a major shift in consumer preferences due to changing demographics in favor of younger population.  Firms must therefore focus on growth direction as well as growth velocity to manage the buyer power in a constructive manner.
Combating versus collaborating
Whatever be the granulated merits and demerits of Porter’s propositions on buyer power (which incidentally is real and cannot be ignored), the underlying idea of managing the buyer dynamics to reduce buyer power is ill-placed. It is antithetical to the positive concept of the buyer being the very cause and sustenance for the genesis and growth of the firm. The more appropriate proposition for the firm would be to engage with the buyers continuously to serve them better. Such engagement could take several forms. At the most basic level of engagement is the trade channel utilized to approach the buyers. While open display formats like the Web and multi-brand retailing are cost-effective for the firms to be deployed for industrial buyers and retail consumers respectively, it is important for the firms to provide distinctive user experiences for each category. Periodic connectivity through conferences and corporate sales plazas are relevant experience generators. At the most profound level is living with the user through the various life cycle stages of the product and identifying the needs for product improvement and new product development. Somewhere, midway are the classic methodologies of customer feedback, trade channel feedback, service centre feedback and market research, all of which will provide insights to making the products and services better for the customers.   
Positive engagement and proactive collaboration with customers or buyers provide several benefits to firms. The thesis, in fact, of C K Prahalad’s landmark book “Fortune at the Bottom of the Pyramid” is that by understanding consumer needs and user characteristics in different economic strata, each having distinctive cultures and practices, firms can reengineer their products and open up completely new markets. The success of the Japanese and Korean automobile manufacturers in India during the 1980s to 2000s has been due to such a buyer-centric adaptation. Unfortunately, a new generation of European automobile makers has, over the last few months, been targeting exclusive niche segments based on the luxury car products the firms have. Sooner or later, this group of firms could discover the perils of playing on buyer dynamics, and not being in the group of positively engaged and socially sensitive full line auto makers.
Employees as buyers; leaders as designers
Many firms fail to realize that their own employees are buyers too; most firms ignore the fact that hardly any employee, save in customer-centric jobs, is provided the opportunity to interact with customers and discover how the products the employees make or are associated with fare in the hands of the customers. Letting employees share their experiences on the company and competitor products, and even encouraging them to buy the products selectively could create useful pilot projects for understanding the more universal buyer behavior. Market-centric behavior can be institutionalized in companies if employees from various departments, especially R&D and Manufacturing are moved through customer-centric departments like sales, marketing, service and market research. The Japanese companies are known to have deployed such an organizational strategy as a strategic tool to get institutional processes closer to customer, especially in the 1970s and 1980s when they were at the leading edge of global innovation. The Koreans mastered this in 1990s and 2000s. Potentially, leading emerging economies such as India and China would have the opportunity to make their organizations customer-integrated for enhanced competitiveness.
Leaders have a special role in handling the buyers as a competitive force. Wise leaders would view buyers as the group that enhances the competitiveness of the firm through higher expectations rather than as a group which has either unjustified demands on company resources or complete tolerance to whatever the companies may offer. Leaders who tend to be more internationally and cross-culturally exposed than any other group of employees have a significant role in leading their corporations on the path of product innovation and customer service. The leaders are well positioned to observe, absorb and adapt latent user expectations and latest product features that are globally available to generate creative sparks in their firms. Leaders who truly internationalize their firms on a multi-country basis (as opposed to home country-centric internationalization) provide their firms with unprecedented opportunities to develop expansive product-market configurations. There are only a few things the wise and effective leaders must focus on to lead their corporations to glory; product design and development probably ranks the highest in that list of must-do for leaders.
Buyers as corporate resource
While acknowledging Porter’s theory that buyer groups do have bargaining power vis-à-vis a company, which they tend to deploy, this blog post has argued that it is counterintuitive and antithetical to corporate genesis and growth to view buyers and the company as pitted against each other. While feeling humble that buyer power can be overwhelming, companies must find positive and proactive ways of engaging and integrating with customers for better user experience rather than managing them for just better sale of products. The former provides both tactical and strategic wins for the company with sustainable growth paradigms. Leadership in product development and delivery would be a core component of a company that treats customers as a genuine and fundamental corporate resource.
Posted by Dr CB Rao on September 3, 2011.