Dana and Prakash, for example, are the two entrepreneurs in the online role-playing simulation that accompanies this chapter, and they ask you to help them make some impor- tant decisions. They’re creating a smartphone app that will help high school students prepare for the SAT, but it’s not just another boring set of online flash cards or multiple-choice questions. Instead, it’s a game called Leveling UP! in which players gain points and advance levels as they get better and better. They are going up against some big names in
this industry, like Kaplan and The Princeton Review, and they need a very sound strategy.
This chapter explores strategy, starting with the forces that shape industry competition and why some industries are more profitable than others. You will see how entire industries are occasionally transformed by events that sweep away dying business models and unleash a flood of new opportunities for clever players like Dana and Prakash.
Whether times are calm or stormy, the reasons companies choose one strategy over another—and how they use infor- mation systems to implement them—help explain why some companies succeed and others fail.
IntroductIon
An online, interactive decision-making simulation that reinforces chapter contents and uses key terms in context can be found in MyMISLab™.
c h a p t e r
2 Information Systems and Strategy
MyMISLab™
• Online Simulation: Leveling UP! A Role-Playing Simulation on Business Strategy for a New Smartphone App
• Discussion Questions: #2-1,
#2-2, #2-3
• Writing Assignments: #2-10,
#2-12
www.freebookslides.com
LeveLIng UP!
a role-playing Simulation on Business Strategy for a new Smartphone app
S mart strategy helps explain why the search engine called Baidu dominates the Chinese market despite Google’s aggressive attempts to take hold in that market. Baidu focuses like a laser on Chinese-speaking Internet users and claims to know them better than Google.
On Baidu, they find easier ways to enter keywords and iden- tify relevant websites, all in Chinese. The written Chinese language, with its thousands of complex characters, is not easy to enter for human beings typing on keyboards with a standard QWERTY layout. And a syllable typed in English letters, such as ma, could represent different characters with quite different meanings (Figure 2-1). Baidu claims its shortcuts and intelligent interfaces make life a bit easier for Chinese speakers struggling with a keyboard whose grand- parent was the typewriter, designed in the United States by
English speakers. Baidu earns revenue from online market- ers, much as Google does, by showing paid links relevant to the user’s search terms.
The strategies companies devise to win customers, earn market share, make profits, and grow their busi- ness are tied closely to information systems, like Baidu’s search engine or the Leveling UP! game. In today’s high- tech, globalized business environment, those strategies often rely heavily on innovative information technology (IT) and its application to any area, from marketing and human resources to manufacturing and supply chains. As you will see, some of the IT-related strategies have the potential to completely transform an industry, catapulting the com- pany and its founders into stardom and pushing rivals into bankruptcy.
MyMISLab
Online Simulation
lipik/Shutterstock
Industries differ, and in some it is more difficult to make a profit—or even survive—than others. Why this is so, and how IT can be such a powerful force for strategists, will become clear, drawing especially on Michael Porter’s classic
analysis of the forces that affect industry competition and shape strategy.1, 2 We will also see how nonprofit organiza- tions develop strategies involving information systems to dramatically improve their ability to achieve their missions.
Figure 2-1
The syllable ma typed on a QWERTY keyboard can refer to many differ- ent Chinese characters with different meanings. The spoken language dis- tinguishes among them through tones, or slight changes in vocal pitch, as the syllable is pronounced.
Source: Kellerkind/Fotolia, Ksysha/
Fotolia.
porter’s Five competitive Forces
Glancing at the industries with their average net profit margins as of 2016 in Figure 2-2, you might breathe a sigh of relief if you were not in the oil and gas industry, where plummet- ing oil prices contributed to severe downturns.3 Some industries enjoyed healthy margins during this time, with many successful companies. In other industries, the firms struggled just to stay afloat, and many lost money. These conditions are not due to smart managers in the high-profit industries and boneheaded CEOs elsewhere, though the strategies these people implement certainly play a role. Instead, based on Porter’s model, the reasons lie with five interrelated forces that influence industry competition (Figure 2-3):
1. Threat of new entrants 2. Power of buyers 3. Power of suppliers 4. Threat of substitutes
5. Rivalry among existing competitors
To see how these forces play out, let’s look more closely at graduate students Prakash and Dana, who want to launch that smartphone app for high school students. Needing extra Describe Porter’s five competitive 1
forces that shape industry competition.
–60.0% –50.0% –40.0% –30.0% –30.0%
Net Profit Margin for Selected Industries
–10.0% –60.0% 10.0% 20.0%
Semiconductors Software (Systems and Applications) Restaurants Cable TV Apparel Computer Services Telecom (Wireless) Oil and Gas
Figure 2-2
Profitability of selected U.S. industries.18
network effects
the increased value of a product or service that results simply because there are more people using it.
threat of new entrants
the threat new entrants into an industry pose to existing businesses; the threat is high when start-up costs are very low and newcomers can enter easily. this is one of porter’s five competitive forces.
money, the two plan to develop an appealing way for students to prepare for the SAT. Prakash and Dana know that students are notorious procrastinators, but they also have many small slots of time—usually wasted on daydreaming, game playing, or texting—throughout the day.
To make preparation less painful and also less costly compared to hiring personal tutors for long, tiring sessions, these cofounders want to draw on some of the compelling features of cell-phone games. Rewards, fast-paced action, competition, and special ringtones to indicate a student’s advancing level should help motivate students to practice SAT problems whenever they have a spare moment. As students improve, they can make up their own questions to add to the pool. Prakash and Dana like the name Leveling UP! for their company, reflecting the game world’s jargon for advancing your skills or your character’s capabilities. Think about how the strategic concepts in this chapter apply to their innovative idea, and then log into the online simulation to help them plan.
threat of new entrants
The threat of new entrants in an industry is very high when start-ups like Leveling UP! can open shop with little capital, few employees, and next to no experience. Industry incumbents must find ways to ward off newcomers, and profitability often suffers.
Thinking too narrowly about who those new entrants might be can be dangerous. The big players in the SAT preparation business—Kaplan and The Princeton Review—know well that small start-ups can enter relatively easily. But new entrants might also come from established companies in other industries, whose leaders decide to diversify and encroach on one another.
At one time, Apple just invented and manufactured computers and consumer electronics, and companies that distributed music and videos on CDs and DVDs didn’t think of Apple as a rival. That is, they didn’t until Apple launched iTunes and cut deeply into their market.
For their part, the existing incumbents in an industry try to keep newcomers out in many different ways, often drawing on innovative use of information systems. They already have certain advantages, such as higher volumes, which can mean lower costs per unit of produc- tion. A large customer base can be significant because of network effects, which refer to the increased value of a product or service that results simply because there are more people
6JTGCV QH0GY 'PVTCPVU
6JTGCVQH 5WDUVKVWVG
2TQFWEVU
$W[GT 2QYGT
4KXCNT[
#OQPI
%QORGVKVQTU
5WRRNKGT 2QYGT Figure 2-3
The five forces that shape competition in industries.
using it. The value of Facebook, for example, is low if you can only connect a few people.
But the more people who use that social network, the more valuable it becomes to everyone.
Incumbents devise strategies to raise switching costs, which are the costs customers incur when they change suppliers. Carriers do this by offering a “free” cell phone with a 2-year contract, but the phone is not really free. They increase the monthly fees to cover the phone’s initial cost and then charge customers a hefty penalty if they terminate the contract early.
Loyalty programs also raise switching costs and discourage new entrants. Frequent fliers earn valuable rewards for racking up all their flying miles with a single airline, including automatic upgrades and free companion tickets. Travelers go out of their way to stick with their favorite airline and continue to grow their point balance.
For information systems that organizations buy to manage their own records, switching costs can be extremely high. To switch, organizations would pay new licensing fees and would also have to change their business processes, migrate their data, and train their employees on the new system. Companies that use software such as SAP or Oracle to manage their busi- ness functions are reluctant to switch, even if their licensing costs go up and competitors offer cheaper pricing. This is one reason the application software industry enjoys very high profit- ability (Figure 2-2).
Power of buyers
The power of buyers rises when they have leverage over suppliers and can demand deep discounts and special services. If a supplier has a small number of buyers, the supplier is at a disadvantage because losing even one could be devastating. Companies whose main customer is the government, for instance, deal with a very powerful buyer. Buyer power also rises when many suppliers offer similar products and the buyer can switch easily. For airline tickets on the most popular and competitive routes, buyers have high power. Unless passengers are tied to one airline with a loyalty program, they can search for the best price, a factor that holds
down the airline industry’s profitability.
The balance of power between buyers and suppliers for many industries shifted dramatically when markets went online and customers could switch from one seller to another with a single click. To make price comparisons for similar products even easier, dozens of websites gather up-to-the-minute prices from sellers so that visitors can easily compare them in a single list (Figure 2-4).
On PriceGrabber.com, visitors can enter the product they want and pull up a list of all the merchants who sell it along with their prices. To empower buyers further, the site asks visitors to rate the transaction when they purchase something from a seller on the list.
These reviews tip off prospective buyers in case the seller fails to deliver.
Power of suppliers
The power of suppliers is high when they are just about the only game in town and thus can charge more for their products and ser- vices. Microsoft is an example. Given the dominance of its Win- dows operating system on desktop computers, PC assemblers Groupon offers daily deals by email and was once praised as “the fastest growing company ever.” the founder’s decision to turn down Google’s offer of $6 billion to buy Groupon out was a big mistake. after going public, Groupon’s stock price plummeted more than 80%, and the company continues to struggle.4 the threat of new entrants is high, and the “daily deal” may be a temporary fad.
DiD YOu KnOw?
Arbus Camera 590
$249.99, free shipping Reviews Ellington Electonics
Arbus Camera 590
$259.95 free shipping Best-Deals-Now
Arbus Camera 590
$329.99, free shipping Reddy Digital Store
Figure 2-4
Price comparison website.
threat of substitutes
the threat posed to a company when buyers can choose alternatives that provide the same item or service, often at attractive savings. this is one of porter’s five competitive forces.
power of suppliers
the advantage sellers have when there is a lack of competition and they can charge more for their products and services. this is one of porter’s five competitive forces.
power of buyers
the advantage buyers have when they have leverage over suppliers and can demand deep discounts and special services. this is one of porter’s five competitive forces.
switching costs
costs that customers incur when they change suppliers.
around the world risk losing customers if they don’t install it. Not only can Microsoft demand higher prices, but it can also insist on additional perks, such as adding desktop icons for trial versions of its own software products. Windows’ lead on desktops is shrinking, though, as Apple gains share and free products attract more customers.
Walmart’s thousands of suppliers have far less power than Microsoft.
There are few products made by a single supplier for which Walmart couldn’t find an alternative close enough to please consumers. Also, Walmart’s suppliers have invested in information systems that link their inventories to the company’s legend- ary supply chain system.
High switching costs also add to supplier power. The loyalty programs described earlier do this. An even more powerful way to raise switching costs is through technology. You might spend weeks entering all the addresses and account numbers for your bills into your online banking system, and a competing bank would need to be very persuasive to get you to switch.
Companies also promote their own technology formats to raise switching costs. For example, if you wanted to switch from Microsoft Excel to the free Google Sheets, you would need to import all of your spreadsheets and then check to see what features were mangled or lost.
threat of substitutes
The threat of substitutes is high when alternative products are available, especially if they offer attractive savings. For example, high-quality videoconferencing offers an alternative to face-to-face meetings that can slash a company’s travel expenses (Figure 2-5). The techno- logical advances eliminate the distracting choppiness and poorly synched voice transmissions that turned off businesspeople in the past. With tight travel budgets, videoconferencing is a viable substitute for business travel.
Substitutes, which provide the same product or service through different means, can be quite difficult to predict and even harder to combat. What airline executives would have imagined that California-based Cisco, a leader in computer networking products, would grab
Productivity tiP
Take a close look at the software trial versions that came preinstalled on your computer to see which products the PC manufacturer is promoting with this valuable positioning. As long as you have a recovery disk in case of problems, you can uninstall the ones you don’t need to reduce clutter and improve your computer’s performance.
Figure 2-5
Videoconferencing heightens the threat of substitutes to the business travel industry.
Source: Andersen Ross/Exactostock/SuperStock.
their market with its videoconferencing products? Information technology plays a key role in many examples of substitution threats, from online learning modules that replace face-to-face training classes to Internet video that threatens cable TV companies. The number of cable subscribers has been shrinking since 2000, and analysts expect the “cord cutting” trend to continue.
The threat of substitutes may come from any direction, making it critical for strategists to pay attention to developments on a much wider scale. Although drug makers with patented products know that generic substitutes will rapidly take market share once the patent expires, other industries are taken by surprise when potent substitutes arise. The newspaper industry, for instance, failed to grasp how quickly subscribers would switch to the free news available online to save both money and trees. Cutting prices for print subscriptions or classified ads only worsened their financial situations. Today, few print newspapers enjoy healthy balance sheets.
rivalry among existing competitors
An industry’s profitability and its competitive structure are affected by the intensity of rivalry among existing competitors, particularly with respect to how they are competing and what they compete on. If firms compete mainly on price, rivalry is high and the industry as a whole becomes less profitable because price cutting triggers rounds of damaging price wars. Online, price cuts can occur with breathtaking speed, with no need to attach new price tags to physi- cal merchandise. Price wars can also affect the behavior of buyers, who pay more attention to price long after the war ends, and reduce profitability industry-wide.5 The one who strikes first in a price war may benefit somewhat, but overall, all competitors and their suppliers may suffer. Consumers enjoy terrific deals, though.
Slow growth can also lead to intense rivalry among existing competitors. If sales are flat, any competitive strategy from one company will steal market share from the others, so incum- bents will counter every competitive move.
Factors that affect how the Five Forces Operate
The five forces together determine industry structure and potential for profit. In addition to the strategies companies themselves implement, several external factors affect how those forces operate. Certain innovations, for example, can flood through an industry like a tidal wave, changing everything in their path and forcing every company to either make changes or sink.
Disruptive technology and innovations
A disruptive innovation is a new product or service, often springing from technological advances, that has the potential to reshape an industry. For example, Kodak, Casio, Olympus, and other companies began offering digital cameras that needed no film in the 1990s, trans- forming the industry within a few short years. Sales of film rolls and the cameras that used them plunged, along with the businesses that processed the film. Although the early digital cameras had lower resolutions, technological advances quickly made them a very respect- able substitute product that almost wiped out film cameras, along with all the services and products surrounding them.
Unlike sustaining technologies, which offer important improvements to streamline existing processes and give companies marginal advantages, disruptive innovation is different (Figure 2-6). Often developed by start-ups or industry outsiders, it brings a radical and unex- pected breakthrough that first replaces lower-end products but then rapidly overtakes even the high end of the market (Figure 2-7). Companies that cling to the older models may eventually be out of business, although many find ways to adapt. Figure 2-8 shows more examples.
The Internet itself is the kingpin of disruptive innovations in recent decades, and all the innovations it supports are transforming one industry after another. It fundamentally changes aspects of the five forces by, for example, reducing entry barriers for newcomers, empowering Explain how disruptive 2
innovations, government policies, complementary products and services, and other factors affect how the competitive forces operate.