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4/24/2020 onlinetext.html file:///Users/matthewfisher/Downloads/MKTG064903-S20R-Article Notes The Metrics that Marketers Muddle-359053/Marina Hamagaki_504182_assignsubmission… 1/3 Article Notes 3   Bendle, N. T., & Bagga, C. K. (2016). The metrics that marketers muddle. MIT Sloan Management Review, 57(3), 73-82. Despite their widely acknowledged importance, some popular marketing metrics are regularly misunderstood and misused. One major reason for marketing’s diminishing role is the difficulty of meaning its impact: The value marketers generate is often difficult to quantify. The main goals of this article are to understand how these marketing metrics are used and understood and to develop ideas to help marketers unmuddle their metrics. The authors conducted surveys from managers from all functions across the business-to-business and business-to-consumer industries.   5 Best Known Marketing Metrics: -       Market share -       Net Promoter Score (NPS) -       The Value of a ‘Like’ -       Consumer Lifetime Value (CLV) -       Return on Investment (ROI) Market Share Market share is a popular marketing metric. One reason for why manager value market share is that research from the 1970s suggested a link between market share and ROI; however, the linkage may be less clear: the studies have found it is often correlational rather than causal. The survey found that there were two ways managers used market share: as an ultimate objective or as an intermediate measure of success. Increasing market share is not a meaningful ultimate objective for maximizing shareholder value and stakeholder management: If the aim is to maximize the returns to shareholders, increased market share offers no benefits unless it eventually generates profits. In some markets, bigger can be better; however, economies of scale do not automatically apply all markets. Unmuddling Market Share: The authors suggest a simple set of rules for the appropriate use of the market share metric: -       Managers should not consider market share as the ultimate objective or as a proxy for absolute size. -       Managers should evaluate it from the competitors’ and consumers’ point of view. If an increase in market share is not going to get positive feedback from competitors and consumers, then an increase in market share will not lead to a productive result. -       Managers should analyze whether market share drives profitability in your industry. Companies with superior products tend to have high market share and high profitability because product superiority causes both. 4/24/2020 onlinetext.html file:///Users/matthewfisher/Downloads/MKTG064903-S20R-Article Notes The Metrics that Marketers Muddle-359053/Marina Hamagaki_504182_assignsubmission… 2/3 This means that the two metrics are correlated, BUT it does not necessarily mean that increasing market share will increase profits.   Net Promoter Score (NPS) This metric is used to measure customer loyalty to a firm. Companies among diverse industries have embraced NPS as a way to monitor their customer service operations while NPS also has been seen as a system that allows managers to use the scores to shape managerial actions. One of the advantages of NPS is its simplicity: It is easy for managers and employees to understand the goal of having more promoters and fewer detractors. However, there are weaknesses: E.g., in the net promoter literature, a customer’s worth to Apple has been described as the customer’s spending, ignoring the costs associated with serving the customer. It is also easy to imagine how to increase the net promoter score (such as making customers happier) while destroying even to-line growth (by slashing prices). Another problem with NPS as a metric is the classification system: The boundaries between scores of 6 and 7 (detractors and passives) and 8 and 9 (passive and promoters) seem somewhat arbitrary and culturally specific. Unmuddling NPS: The value of NPS depends on whether a manager sees it as a metric or as a system. The authors suggest that the NPS metric cannot change the marketing performance. However, they advise using this metric as a part of a system employed in evaluating the performance which might lead to a cultural shift within the organization.   The Value of a ‘Like’ This metric is used for measuring the social media capital of the company. New approaches are being developed all the time and they have the potential to aid understanding of how social media creates value. It is measured as the difference between the average value of customers endorsing the company and the average value of the customers who are not endorsing the company. The majority of managers link between their social media spending the value of a ‘like’. However, it does not mean that the cause of the differences in users’ value is attributable to a company’s social media strategy. And the reason that social media strategy shouldn’t be seen as the driver of value difference between fans and nonfans is because customers who are social media fans will differ from nonfans for reasons unrelated to the company’s social media strategy. Unmuddling the Value of a ‘Like’: This difference between two groups of consumers does not suggest an effect of online marketing activity or lack thereof. It should be investigated thoroughly by the managers. If the management is using the revenue to measure customer value, then this marketing metric does not give a good estimate. However, if the company does want to understand the impact of social media marketing, they should use randomized control experiments to derive causal answers. Consumer Lifetime Value (CLV) Consumer lifetime value (CLV), which is the present value of cash flows from a customer relationship, can help managers in decision making related to investment in developing customer relationships, as it is used to measure the value of the current customer base. If the management is using the customer value in their decision-making process, then CLV is a useful tool for them. Unmuddling CLV: 4/24/2020 onlinetext.html file:///Users/matthewfisher/Downloads/MKTG064903-S20R-Article Notes The Metrics that Marketers Muddle-359053/Marina Hamagaki_504182_assignsubmission… 3/3 The authors suggest that CLV calculations should not include the customer acquisition cost and the estimated CLV should be compared to the estimated acquisition cost to derive conclusions. The bigger the difference between the estimated CLV and the estimated acquisition cost, the better the acquisition campaign. Return on Investment (ROI) Return on investment is a popular and potentially important metric allowing for the comparison of disparate investments. A critical requirement for calculating ROI is knowing the net profit generated by a specific investment decision. According to the authors, there is confusion within management over the use of ROI. However, as ROI is understood across disciplines, it is a powerful metric to communicate across the organization. Unmuddling ROI: The authors advise that if a manager is assessing the financial return on an investment, then ROI is an appropriate metric and can be calculated by dividing the incremental profits by the investments. Agribusiness marketing managers who are passionate about establishing the credibility of the value created through marketing should be thorough in their use of metrics. Most importantly, they should be able to understand the metric, its use and what it represents. Strategy Ramon Casadesus-Masanell, Series Editor Industry Analysis RAMON CASADESUS-MASANELL HARVARD BUSINESS SCHOOL 8101 | Published: January 31, 2014 + INTERACTIVE ILLUSTRATIONS For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. 8101 | Core Reading: INDUSTRY ANALYSIS 2 This reading contains links to online interactive illustrations, denoted by the icon above. To access these exercises, you will need a broadband Internet connection. Verify that your browser meets the minimum technical requirements by visiting http://hbsp.harvard.edu/list.tech-specs. Ramon Casadesus-Masanell, Herman C. Krannert Professor of Business Administration, Harvard Business School, developed this Core Reading with the assistance of writer R. David Seabrook. Copyright © 2014 Harvard Business School Publishing Corporation. All rights reserved. To order copies or request permission to reproduce materials (including posting on academic sites) call 1-800-545-7685 or go to http://www.hbsp.harvard.edu. Table of Contents 1 Introduction ..................................................................................................................3 2 Essential Reading .........................................................................................................4 2.1 The Five Forces Framework ................................................................................4 2.2 The Methodology of Five Forces Analysis .......................................................9 The Threat of New Entrants................................................................................9 The Bargaining Power of Suppliers ............................................................... 11 The Bargaining Power of Buyers .................................................................... 13 The Threat of Substitutes ................................................................................ 14 Rivalry among Existing Competitors ............................................................. 15 Extending the Analysis to Address Cooperation and Complements ...... 17 2.3 Applying Industry Analysis .............................................................................. 19 Turn Threats into Opportunities ..................................................................... 19 2.4 An Example of Performing and Applying Industry Analysis ..................... 20 Define the Industry............................................................................................ 21 Identify the Players ........................................................................................... 23 Analyze the Players’ Influence on Profitability ........................................... 24 Test the Analysis................................................................................................ 26 2.5 Develop a Way to Deal with the Industry Environment ............................ 27 Exploit Industry Change ................................................................................... 29 Leveraging Industry Analysis to Compete Over Time ............................... 32 Explore Opportunities to Shape Industry Structure ................................... 32 2.6 Criticisms and Limitations ................................................................................ 33 Does the Five Forces Framework Adequately Analyze the Business Environment? ..................................................................................................... 33 Does Industry Analysis Explain Competitive Advantage? ........................ 34 Does Industry Analysis Help Companies Find Entirely New Opportunities? ................................................................................................... 34 2.7 Conclusion: The Business World Changes, but Industries Remain .......... 34 3 Supplemental Reading ............................................................................................. 35 3.1 How Much Does Industry Matter? ................................................................... 35 4 Key Terms ................................................................................................................... 37 5 For Further Reading ................................................................................................. 37 6 Endnotes ..................................................................................................................... 38 7 Index ............................................................................................................................ 40 For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. 1 INTRODUCTION o some people, the word “industry” seems old-fashioned. It conjures up images of smokestacks and Dickensian textile mills. It feels out of place in the world of Google and Zynga. Yet any organization that produces something for others is part of an industry. Google competes in the search advertising industry with Microsoft, Yahoo!, Ask, AOL, and Baidu. Zynga competes in the online game industry with Tencent Holdings Ltd., Electronic Arts, and Activision Blizzard. Greenpeace competes in the environmental protection industry with more than 40 other organizations.1 We define an industry as a group of firms producing products or services that are perceived by customers as meeting the same needs. Apple Inc. competes in the smartphone industry, as does Samsung. Every industry exists in an industry environment, which comprises suppliers, customers, and other firms, including those that may enter the industry and those that may offer either substitute or complementary products. For example, the companies that manufacture multi- touch screens and other components of smartphones are not part of the smartphone industry; they are suppliers to the industry. The retail outlets that sell smartphones to end users are the industry’s customers. Potential entrants are firms that may be considering entering the smartphone industry. Firms offering a substitute product include the makers of simpler “dumb phones” and tablets. Firms offering complementary products include wireless carriers, whose service is used with smartphones. Collectively, we will refer to the firms in the industry and in the industry environment as market participants. Industry analysis is a tool for understanding how profits are distributed among market participants. A firm’s profitability depends partly on the intensity of competition from rivals in the industry and partly on the influence of players in the industry environment. All those market participants engage in a continual struggle for a share of industry profits.a Industry analysis is an essential tool in strategy development because it helps a company understand how its industry structure influences profits. As we discussed in the introductory reading of this Core Curriculum series, a strategy is an integrated set of choices that positions the firm in its industry in a way that generates superior financial returns over the long run. Strategists need to employ industry analysis so that they can understand the economic forces at work and defend the firm from negative developments in the industry and its environment while creating or exploiting the profit opportunities that the industry presents. Industry analysis is based on a fundamental principle of economics: People (or, in our case, market participants) respond to incentives. If there are profits to be made, market participants will try to appropriate them. If an organization doesn’t have a plan for dealing with all the players scrambling to increase their share of the profits, it doesn’t have a strategy. Managers, entrepreneurs, capital providers, investment bankers, financial analysts, consultants, and even those making a career choice can benefit from industry analysis. Managers can use it in the following ways: • To identify opportunities to increase profits • To discern threats to existing profits and develop ways to counter them • To decide whether to enter a market a As we will see, firms offering complementary products compete for profits across industries. T 8101 | Core Reading: INDUSTRY ANALYSIS 3 For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. • To decide whether to exit a market • To position their firm to succeed in a given industry • To assess the effect of a major change (such as deregulation, new technology, complements, demographic shifts) • To shape the industry environment2 Industry analysis applies to business, but also to any situation where organizations are competing. In the humanitarian aid industry, the “profits”— that is, the benefits from aid donations—are distributed on the basis of the industry’s structure. This distribution is affected by the relative bargaining power of suppliers, the aid agencies, and their customers. Should these customers be corrupt governments or powerful militias, such players could capture the value of the aid intended for the distressed population. There are typically six steps in analyzing an industry and applying the results of the analysis: 1 Define the industry 2 Identify the players (the market participants) 3 Analyze the players’ influence on profitability 4 Test the analysis 5 Develop a way to deal with the industry environment 6 Analyze how the factors influencing profitability may change and the response required. In this reading we present the most widely used framework for analyzing an industry: the Five Forces Framework developed by Harvard Business School Professor Michael Porter. We then describe the applications of industry analysis. Next, using several real-world examples, including Walmart, we work through the six steps listed above to demonstrate how to analyze an industry and how to use that analysis to position a company for strategic advantage—now and in the future. We also consider the Five Forces Framework relative to other strategy development tools, discuss some of its shortcomings, and, in the Supplemental Reading, address the question, “How much does industry matter?” 2 ESSENTIAL READING 2.1 The Five Forces Framework b In a Harvard Business Review article published in 1979, “How Competitive Forces Shape Strategy,” Michael Porter coined the term “five forces” to refer to the market participants and their influence in determining who gets the profits in an industry.3 (See Figure 1.) As Porter points out, “Managers tend to view competition too narrowly.” Direct competitors, customers, suppliers, potential entrants to the industry, and producers of substitute products are all b In his classic 1980 book on strategy, titled Competitive Strategy, Michael Porter referred to his framework on industry analysis as “the five basic competitive forces that determine the ultimate profit potential in an industry.” The original framework is therefore typically referred to as “The Five Forces Framework.” While the framework presented in this reading is modified from Porter’s original framework depicting the five forces, it will nevertheless be referred to as “The Five Forces Framework” in this reading. 8101 | Core Reading: INDUSTRY ANALYSIS 4 For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. 8101 | Core Reading: INDUSTRY ANALYSIS 5 FIGURE 1 Forces Governing Competition in an Industry Source: Adapted and reprinted by permission of Harvard Business Review. Exhibit from “The Five Competitive Forces that Shape Strategy” by Michael E. Porter, January 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation; all rights reserved. competing for their share of the profits (later in this reading we augment the original Five Forces Framework to add complements). Managers who fail to consider all market participants put their firms at risk. While many management fads have come and gone, the Five Forces Framework has endured, in large part because of its foundations in economics. It allows managers to rise above the details of economic modeling and avoid trawling though thousands of pages in economics textbooks. The framework identifies the important factors affecting industry profitability and helps strategists judge their relative influence. The study of the economics of industries is called Industrial Organization (IO), sometimes called the “Harvard Tradition.” Early work in this field emphasized empirical analysis such as regression analysis and case studies. The results found relationships between structural factors, such as concentration ratio (the extent to which a small group of firms dominates an industry), barriers to entry, and measures of performance, such as profitability. Later work relied more on formal economic models, particularly using game theory. Unfortunately, the models are very sensitive to the specific assumptions used and therefore can be difficult to apply.4 Porter’s important contribution was to distill the key findings from industrial organization research into five forces that influence the profitability of an industry: the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitutes, and rivalry among existing competitors. The strength of each force depends on the economic characteristics of the industry.c, d c The Five Forces Framework captures concepts both from classical microeconomic analysis and game theory. The threat of substitutes, for example, derives from the influence of substitutes on the price elasticity of demand, which affects pricing power. Another finding from microeconomics is that rivalry among existing competitors is likely to be greater when fixed costs are high and marginal costs are low. When business is slow, such firms will be prepared to cut price below average total cost. d Game theory shows that developing a reputation for retaliating against new market entrants by lowering price can help deter market entry. The Five Forces Framework represents such a reputation as a “barrier to entry” that reduces the strength of the force of “the threat of entry.” Another result from game theory concerns a situation where rivals have diverse approaches and “personalities.” This increases rivalry and reduces the probability of cooperation. For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. 8101 | Core Reading: INDUSTRY ANALYSIS 6 How do the five forces influence profitability? Put simply, profitability is influenced by willingness to pay, the price, and the cost. For example, powerful buyers can use their negotiating strength to force industry prices down. They may also demand that industry rivals increase the value of the products they sell, which will increase their costs. Similarly, powerful suppliers will be able to charge higher prices, increasing the industry’s costs and reducing its profits.5 Using the interactive diagram shown below, you can click on the “Up” and “Down” arrows to see how each force affects price, cost, and profit. The Five Forces Framework is useful for many reasons. For one, it helps explain why profitability varies by industry. Figure 2A shows that while the median profitability of U.S. industries (measured by return on invested capital) was 14.3% from 1992 to 2006, the profitability of the top 10% of industries was more than 25%. Meanwhile, the profitability of the bottom 10% of industries was only 7%. Figure 2B shows that industries such as security brokering and dealing and soft drinks had far higher levels of profitability than the hotel and airline industries. Why? The Five Forces Framework implies that while the less-profitable industries are subject to powerful forces that make it difficult for industry participants to appropriate profits, such forces are muted in the more profitable industries. Interactive Illustration 2 shows the forces at work in selected industries. It provides an alternative view of industry profitability that is based on economic profit, which is a measure of profit that includes all costs, including the opportunity cost of capital employed in the business. You can click on the vertical bars representing the profitability of some of the industries to see an illustration of how the five forces affect profitability in that industry. In the next section, we explain how to evaluate the strength of the forces. But first, see the sidebar “Perils of Poor Industry Analysis: Global Crossing” to learn why analyzing the industry and its environment is so important. INTERACTIVE ILLUSTRATION 1 Porter’s Forces Framework Sources: Adapted and reprinted by permission of Harvard Business Review. Exhibit from "The Five Competitive Forces that Shape Strategy" by Michael E. Porter, January 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation; all rights reserved; adapted and reprinted by permission of Harvard Business School Press. From Understanding Michael Porter: The Essential Guide to Competition and Strategy by Joan Magretta. Boston, MA: 2012, p. 41. Copyright © 2012 by the Harvard Business School Publishing Corporation; all rights reserved. Scan this QR code, click the image, or use this link to access the interactive illustration: bit.ly/hbsp2pHKWuJ For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. https://s3.amazonaws.com/he-assets-prod/interactives/057_porters_forces_framework/Launch.html http://bit.ly/hbsp2pHKWuJ https://s3.amazonaws.com/he-assets-prod/interactives/057_porters_forces_framework/Launch.html 8101 | Core Reading: INDUSTRY ANALYSIS 7 FIGURE 2A Average Return on Invested Capital in U.S. Industries, 1992–2006 Source: Reprinted by permission of Harvard Business Review. Exhibit from “The Five Competitive Forces that Shape Strategy” by Michael E. Porter, January 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation; all rights reserved. FIGURE 2B Profitability of Selected U.S. Industries Source: Reprinted by permission of Harvard Business Review. Exhibit from “The Five Competitive Forces that Shape Strategy” by Michael E. Porter, January 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation; all rights reserved. For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. 8101 | Core Reading: INDUSTRY ANALYSIS 8 Perils of Poor Industry Analysis: Global Crossing “When an industry’s underlying economics are crumbling, talented management may slow the rate of decline. Eventually, though, eroding fundamentals will overwhelm managerial brilliance.”6 –Warren Buffet To see the importance of understanding the industry environment and economics, consider the case of Global Crossing, described by Richard P. Rumelt in Good Strategy Bad Strategy: The Difference and Why it Matters (Crown Business, 2011). The company was founded in 1997 to provide a trans-Atlantic cable to carry telephone and data traffic. Using high-bandwidth optical fiber, the company was able to sell capacity at less than half the price of existing competitors. As Rumelt explains, “After six months of operations, Global Crossing offered stock to the public, and the resulting price valued the firm at an astounding $19 billion. Six months later it was valued at $38 billion, more than the Ford Motor Company.”7 Unfortunately, the company (and its investors) failed to conduct a basic analysis of the industry environment. As Rumelt explains, the cable technology was not proprietary and data-carrying capacity was a commodity. That meant that customers could easily switch from one supplier to another, putting them in a powerful bargaining position. Furthermore, customers were price- sensitive. Even worse, the threat of entry was high, and other companies were entering the business, fueled by easy financing. High fixed costs but near-zero marginal costs (the cost to carry one more piece of data) led to fierce price competition within the industry. As Rumelt says, “One struggles to imagine a worse industry structure.” As new entrants came into the market and industry competition increased, the price of fiber capacity collapsed. Rumelt declared that “the collapse of prices could have been foreseen by anyone doing a simple Five Forces analysis.”8 Global Crossing declared bankruptcy in January 2002.9 Sources: Ghemawat, Pankaj E., Strategy and the Business Landscape, 3rd, © 2010. Printed and Electronically reproduced by permission of Pearson Education, Inc., Upper Saddle River, New Jersey; adapted and reprinted by permission of Harvard Business Review. Exhibit from "The Five Competitive Forces that Shape Strategy" by Michael E. Porter, January 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation; all rights reserved. INTERACTIVE ILLUSTRATION 2 Scan this QR code, click the image, or use this link to access the interactive illustration: bit.ly/hbsp2Ge7YiU For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. https://s3.amazonaws.com/he-assets-prod/interactives/074_link_between_econ_profit/Launch.html http://bit.ly/hbsp2Ge7YiU https://s3.amazonaws.com/he-assets-prod/interactives/074_link_between_econ_profit/Launch.html 8101 | Core Reading: INDUSTRY ANALYSIS 9 2.2 The Methodology of Five Forces Analysis In this section, we explain how to conduct a Five Forces analysis. The best way to use Porter’s framework is to focus not only on the forces, but also on the economic factors that underlie them and how these factors might change. The first part of this description is based on a teaching note Porter published in 2007.10 We then add an analysis of complements. Later, we will demonstrate how to apply the analysis. The Threat of New Entrants Source: Adapted and reprinted by permission of Harvard Business Review. Exhibit from “The Five Competitive Forces that Shape Strategy” by Michael E. Porter, January 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation; all rights reserved. When the potential for profit in an industry is high, companies have a powerful incentive to enter. New entrants increase competition, driving down prices and profit. The impact of potential entrants on profit depends on how easy it is to enter the industry, which in turn depends on barriers to entry. Strategists need to evaluate the size of the barriers to entry, and how they may change, by evaluating the following factors: • Supply-side economies of scale. Economies of scale exist when a company’s cost per unit decreases as the quantity supplied increases. These economies come from the ability to spread fixed costs over more units, greater efficiency, and a larger scale. They give high-volume incumbents a cost advantage over smaller entrants. Supply-side economies of scale present a barrier to entry because they force a potential entrant either to enter at scale (which is risky) or to accept a cost disadvantage. Logistics company DHL faced such a barrier when attempting to enter the U.S. logistics market against incumbents UPS and FedEx. Research and development, production, marketing, sales, and IT infrastructure can all exhibit economies of scale. Amazon.com was able to develop a strong cloud-computing services business because its large and early investment in IT infrastructure—coupled with a near zero marginal cost to serve each additional customer—created significant economies of scale, which made it difficult for others to compete. Economies of experience and economies of scope can also create barriers to entry. The sales of IT consulting projects exhibit economies of scope. Because one sales force can sell multiple projects to the same client, large incumbents have an advantage in sales cost per project over new entrants. Not surprisingly, the industry has a small number of very large, established competitors. • Demand-side benefits of scale. Better known as network effects, demand-side benefits of scale exist when the value a buyer gets from a product increases as more people buy that product. A classic example is eBay. The potential value to a customer from buying or selling on eBay depends on the number of other buyers and sellers who use it. Similarly, Facebook has withstood a well-financed challenge from Google Plus because most users’ larger established networks make it more attractive to post on Facebook For the exclusive use of X. Li, 2021. This document is authorized for use only by Xiaoyun Li in Fall 2021 Strategic Management-1 taught by Matthew Fisher, San Francisco State University from Aug 2021 to Feb 2022. than on any competitor. The existence of network effects creates a barrier to entry, as customers prefer larger incumbents. • Customer switching costs. When customers must incur costs to switch suppliers, their incentive to do so is reduced. This can present a formidable barrier to entry. Switching costs are not just monetary; they include the time required to learn how to use the new product. Users of Microsoft Windows, for example, must not only buy new software when they switch to a new operating system, they must also learn a new interface. Companies with major investments in software may be reluctant to switch for fear that new software may not work as advertised. Suppliers attempt to create switching costs by locking in customers. For example, computer printer manufacturers design printer cartridges that work only in their machines. Switching costs may be undermined by new technologies or new standards. Cloud-based applications such as Google Drive and Dropbox are platform-independent and so reduce or eliminate platform switching costs for their users. • Capital requirements. A billion-dollar upfront investment requirement presents a larger barrier to entrants than a requirement of a few hundred thousand dollars. That’s why there are few entrants into the semiconductor manufacturing industry but many in the restaurant business. Unrecoverable and risky investments such as product development and advertising present the greatest barriers. Well-financed firms can enter any industry, however, as long as the returns are attractive. • Incumbency advantages independent of size. Being first can be an advantage. Mining companies that secure access to deposits close to the surface have an advantage over latecomers who must dig deeper to extract resources. Technology inventors can use patents to deter entrants. Investments that produce cumulative benefits, such as branding or experience, present a barrier to companies that are just beginning to compete. • Unequal access to distribution channels or supplier networks. Many people can make a movie, but few can get their movie distributed to cinemas across the country. Distribution channels with limited capacity present a barrier to entry because new entrants must displace incumbents that may have contractual or other forms of preferred access. • Restrictive government policy. Governments can restrict or prohibit new entrants. Licensing requirements restrict entry by new liquor retailers. Patents provide legal barriers to imitators. Foreign investment barriers can protect local businesses. Regulations that are costly to comply with can deter new entrants. Governments’ influence over market entry provides an incentive for both incumbents and potential entrants to hire lobbyists to influence policy. • High barriers to exit. When it is easy to get out of an industry, firms will be more willing to get in. Industries that require illiquid investments or commitment to long- term contracts make exiting more difficult and therefore decrease the incentive to enter. For example, pension cost liabilities in some labor-intensive industries make exiting expensive. The barriers to entry described above …