On Strategic Groups & the 5-Forces Framework

Michael E. Porter defines a Strategic Group as ‘the group of firms in an industry following the same or a similar strategy along the strategic dimensions.’  This essentially means that a Strategic Group, within an industry, is a group of firms that operate in a similar fashion in terms of their respective Specialization and Vertical Integration. If we take the example of the Passenger Car Industry, a group of firms are characterized by broad product lines, heavy advertising, medium integration, extensive distribution, mass-market appeal and widely-available service, lets call this Group A, while another group of companies would be characterized as extremely narrow product lines, minimal, often no advertising, high integration, selective distribution and service and superior performance, lets call this Group B. The firms that fall in Group A, internationally, are to the likes of Hyundai, Ford, Chevrolet, Volkswagen, Fiat, Toyota, Renault etc., while firms like Ferrari, Bugatti, Bentley, Rolls Royce, Lamborghini, Maybach etc, belong to the latter group. Then there exists a group in between wherein performance meets mass-market appeal. This, Group C, would consist of firms like BMW, Audi, Daimler-Benz (Mercedes), Porsche, Alfa-Romeo, Nissan etc., which are a match between performance and luxury, and wide-appeal through narrow product lines. Another group of manufacturers, say Group D, such as Proton, Tata Motors, Maruti-Suzuki, Daihatsu, Mahindra & Mahindra, etc. exists which has most characteristics of the first group, barring an international appeal, meaning that manufacturers like these are broadly limited to their home countries and a few other countries, with product lines which are neither narrow nor broad, but have extensive distribution channels, at least in their home countries.  Firms in Group B are highly vertically integrated primarily because of the focus on quality in their products, which is essentially why most products from these firms are hand-built with in-house manufacturing of components unlike other groups where most, and in some cases, all components are purchased, ranging from the Chassis to the Design, and Automobiles are just assembled in the plants.

Interestingly, the Strategic Groups, as mentioned, also have a lot in common with market shares of these firms. While Group A firms tend to enjoy a high market share with their products with mass-market appeal internationally, Group B, on the other end of the spectrum, has firms with products of very limited appeal, primarily because of the exorbitant price tags. Group C firms have much smaller market shares than that of Group A, and have a middle-of-the-road appeal in terms of luxury and performance and price. Group D, on the other hand, consists of firms with large market shares in only a few markets, most commonly in the country they originate from. It is also interesting to understand the ownership patterns of firms across various Strategic Groups. Broadly, the largest Global players enjoy a presence, through one or more of their brands, in at least three of the four strategic groups. For example, Volkswagen Group has a presence in Group A with its Volkswagen brand, in Group B with Bugatti & Bentley, in Group C with Audi & Porsche, and in Group D with Skoda & SEAT. Similarly, Fiat Group has a presence in the three groups with Fiat in Group A, Ferrari in Group B and Alfa-Romeo in Group C. The benefits are primarily in the form of platform sharing and in effect, cost saving because of reduced Research & Development costs, Market Power and the sharing of critical components.

Industry Rivalry

Rivalry within a Strategic Group is likely to be more in industries where there is a great difference between product lines of firms, especially in terms of pricing. In the Automobile Industry, the rivalry among the firms within a Group is far greater than the inter-group rivalry, as opposed to an industry where the substitutes are very close and are available in plenty. The inter-group rivalry is at a far lower level internationally because of the scale and appeal of products of firms from different groups. On the customers’ part, there can be a shift from one group to another, especially when upgrading to a more expensive automobile, the firms effectively compete for customers in different market segments on their parts. For example, Ford does not compete with Ferrari, but it does, in some segments, with BMW, Audi & Mercedes. This is because Ford’s more expensive and less mass-market range of cars are in similar segments with BMW’s lesser expensive, more mass-market cars. So a Ford Focus would compete with a BMW 1-Series and not a BMW 7-Series as the target customers for both are poles apart. Similarly, firms from Group D can often compete with firms from Group A on a regional level, which is why we see Maruti-Suzuki competing with Ford, Fiat & Chevrolet because their target customers in the Indian market are broadly similar, but differ in the global context.

Bargaining Power of Suppliers

Different strategic groups enjoy different degreed of bargaining power of suppliers. In Strategic Groups where firms are primarily assemblers, the bargaining power of suppliers tends to be low primarily because of the scale of production of these firms. Often firms that operate in the mass-market enjoy market power because of their market share. This allows them to leverage their position to bargain with suppliers and have components customized for their use than that of other players. For example, Denso is a key supplier of Toyota to such an extent that Denso follows Toyota to whichever market Toyota enters. The bargaining power of Toyota over Denso is fairly high because of standardization of components and faster product development times across the industry because of which Toyota has the advantage of purchasing similar components from Bosch or Delphi. But because Denso is so dependent on Toyota for its revenues, it has to operate in a manner which suits Toyota, hence effectively lowering possibilities of serving another client. The existence of multiple-suppliers allows firms to pick and choose from a bouquet of firms and attain the lowest possible costs, keeping in mind the specification of the components in concern. In other strategic groups such as Group B, the bargaining power of suppliers is fairly high because of the focus on quality of the product. Most firms in Group B product most components of their cars and outsource only a few. The few components that they outsource come from specialist suppliers. The switching costs may not be very high, but the costs of customization of products to suit the manufacturer is very high because of the nature of the product.

Bargaining Power of Buyers

Bargaining power of buyers varies from group to group. Groups where mass-market players exist with minimal product differentiation have to deal with high bargaining power of buyers while groups with highly differentiated products enjoy low bargaining power of buyers. Strategic Group A, where firms are mass-market players with low product differentiation in most cases, have to deal with very high bargaining power of customers, primarily because of the availability of a plethora of options both from the same firm as well as from constituents of the Strategic Group. The bargaining power of buyers is slightly lower for Group C firms than that of Group A, because each Group C firm has a brand identity which is peculiar to that firm alone while others are close to achieving similar results, but are not widely known for the same. For example, BMWs are identified with their handling and performance, while Mercedes cars are identified as the more luxurious of the two. While customers pick between one of the brands, they have an agenda in mind while purchasing cars from this particular group. A customer who would like more performance than luxury is likely to go for one brand over the other, but at the same time, the customer also enjoys the presence of multiple players and can shift from one brand to another because the products are so close to each other in terms of specifications, features, luxury and performance. Firms in Group B enjoy low bargaining power of buyers, primarily because they have highly differentiated products with varied features and specifications. The products are normally either extremely high on luxury, or on performance. While all products in this strategic group are far more luxurious and better in performance than those in the other groups, they tend to have an inclination towards one side of the spectrum. While Rolls Royce cars are the epitome of luxury on wheels, Ferrari’s are the best performers of the lot, which is not to say Rolls Royce is archaic in terms of performance and Ferrari in luxury. The customers here have a clear-cut demand which can only normally be filled by one of the brands, which essentially goes to say that the bargaining power of buyers is low for Strategic Group B firms.

Threat of Substitutes

Substitutes to passenger cars are broadly based on the price points of the vehicles. While at the lower-end of the spectrum, substitutes are public transport and 2-wheelers, the higher-end of the spectrum only has air-travel as a substitute, which is only applicable for inter-city travel. Group A and Group D face the threat of substitutes such as 2-wheelers and public transport because of their price points. For example, the Tata Nano faces threat of substitutes by Motorbikes in India, especially for unmarried individuals, married without children and empty-nesters. The other threat to lower-end cars is Public Transport, primarily because of the limited spending capacity of the target customers of these products. Firms in Strategic Group B only face threat from substitutes such as Helicopters and Airplanes, the latter primarily for inter-city travel and the former for intra-city travel. The threat is low because of the scarcity of helipads in most parts of the world.

Threat of New Entrants

Threat of new entrants is low across the industry at a global level primarily because of the capital requirements for setting up of production facilities and distribution channels. The threat is low on a global level, but at a local level, threat in parts of the world is high. For example, in India, the threat of new entrants is at a medium level because of the absence of multiple global players. When these players decide to enter India, they can, and are willing to, spend Millions of dollars in setting up infrastructure to support their products. This is aided by a huge potential market for products of these firms, which are primarily members of Group A. Establishing of brands is also a very difficult task, especially for firms looking to enter Group B or Group C. Most firms in these groups have been present in the market for decades and have established their brands over years and years of existence and can hence charge a huge price tag for their offerings.

Group A:Hyundai, Ford, Chevrolet, Fiat, Volkswagen, Toyota, Renault etc.

Group B:Bentley, Rolls Royce, Ferrari, Maybach etc.

Group C:BMW, Daimler-Benz, Audi, Porsche, Nissan etc.

Group D:Maruti-Suzuki,Tata Motors, M&M, Skoda, Proton etc.

Reference:
Competitive Strategy, Michael E. Porter

On Clusters

The paper on Clusters & New Economics of Competition by Michael E. Porter, to a great extent, is an extension of his acclaimed piece of work titled ‘The Competitive Advantage of Nations’. The papers talks about Clusters – Geographic Concentrations of interconnected companies and institutions in a particular field – and how they play a vital role in a nations competitive advantage in a global economy which exists today. Porter states that companies can now tone down input cost disadvantage through global sourcing and essentially breakaway from the traditional notion of low-cost advantages. He talks about how competitive advantage now rests on productive use of inputs and the advantage of continual innovation for sustenance of competitive advantage for organisations and nations alike.

Porter mentions the importance of clusters with numerous examples from across the globe, ranging from the Italian footwear Industry, to California’s Wine industry, to the IT industry in Silicon Valley and so on. The striking feature here is the number of support and supplementary industries that have formed on account of the inherent advantages offered by the success of a fragment of the entire Cluster. Essentially, clusters play a major role in innovation through continual innovation and contribute to the foci of the cluster through education, marketing, supporting through ancillaries and so on. Further, Clusters are a hotbed for competition, which also contributes a great deal to innovation as intensity in competition drives organisations to focus more on innovations in terms of the durability of their offerings and cost-related advantages. Another significant attribute of clusters is the fact that they provide a bottomless pitcher of employees through the development of institutions of professional training and research. Not only does this allow organisations in the clusters to infuse new talent into their operations, it also ensures availability of workforce on an as-and-when basis.

On further articulation, a clear cut live example of Clusters and their contribution to competitive advantage can be seen in the Automobile Industry Cluster in the New Delhi & NCR area. It started with Maruti-Suzuki’s first production facilities in Manesar, Haryana and now accommodates two Maruti-Suzuki plants, a Hero Honda plant, Honda Motorcycles and Scooters facility, and a plethora of component manufacturers in the Gurgaon-Manesar area near New Delhi, and Honda Siel Motors and Yamaha India in Greater Noida on the other side of the capital. The factors that have attributed to this cluster are the sprouting of component manufacturers such as Sona Steering, Minda, Apollo Tyres et al around the Maruti-Suzuki facility in Manesar, and of further support organisations in areas of Delhi such as Mayapuri Industrial Area. The fact is, however, that the cluster was essentially instigated by the Government with the set up of the Maruti-Suzuki production facility in Manesar back in the mid-1980’s and the various tax and real-estate benefits offered by both the Central and State governments. This allowed for the set-up of a large number of component manufacturers since importing components at the pre-liberalisation era was just not a cost-effective option. Given the high demand for engineering graduates and management professionals, a large number of institutions were set up both by the government and private players to meet the demand through a never-ending supply of manpower. This essentially further motivated more Automobile manufacturers to set up shop around the area because of the logistical, cost and manpower advantages. A similar pattern can be seen at Pune, Maharashtra as well, which was primarily instigated by the setting up of the Tata Motors plant and Bajaj Motors plant, where the best of Automobile manufacturers are setting up shop, from Volkswagen to Daimler AG.

To conclude, the competitive advantage offered by clusters is highly beneficial for both the constituents of the clusters as well as the government as a whole. It is evident that most manufacturers can source parts from countries such as China and South Korea, but they stick to Indian component manufacturers because of the plethora of advantages offered by them.

Reference:

Clusters and the New Economics of Competition

Of Change in the Indian Auto Industry

Three launches in the past month – Maruti Suzuki Ritz, Honda Jazz and, my personal favourite, Fiat Grande Punto. Big deal in the industry, especially since they’ve been launched in the hottest segment as of now – the Premium Hatchback Segment. The segment, which was first brought about by the Hyundai Getz (Actually, if you think about it real hard, it was the Fiat Palio back in the earlier part of the decade) and taken to a level no one ever imagined by the Suzuki Swift has seen new entrants over the years by GM with the Chevrolet U-VA(Awful name, I know), Skoda with the Fabia and Hyundai again with the i20. The segment is really one which has propagated a plethora of changes in the industry, in segments above and below. Most notably with the standardization of equipment like Airbags, ABS, Integrated Stereo Systems, Steering Mounted Controls, Automatic Climatic Control and, most importantly, significant improvements in quality.

I hate to admit it, but most of these changes were propagated by one single vehicle – The Suzuki Swift. The Swift came into a market where ABS was the highest level of equipment that was offered on a hatchback (in the Getz, Santro Xing and WagonR at the time). The swift was the first to come with Airbags, ABS and Automatic Climate Control at that time in a hatchback when they weren’t even offered in cars twice the price. The swift packed in an engine which had proved its worth in a sedan – the Esteem. The swift was an all-new car which was launched in India along with the world. The Swift was leaps and bounds ahead of the Esteem in terms of quality and, most importantly, it was accepted by customers. The acceptance part was primarily because of the brand of the car – Maruti-Suzuki. The most reliable, cheapest to run and trustworthy car manufacturer in the country as per the masses. In my last post I had mentioned that the idea of a hatchback for anything above the Rs. 400,000 mark a few years back was a joke. The Swift was the car that blew that mindset into pieces, and did the cha-cha-cha over it.

What’s the point I’m trying to make? The propagator for change, at least in the Indian Auto Industry, is a locally established, trusted and reliable manufacturer. Sure price played a role in whole game, but that really isn’t the point of this post. Even though the Hyundai Getz was a very competitive product and better than the swift in a bunch of departments, people didn’t buy it even though Hyundai had established a stronghold in the Hatchback Segment with the Santro Xing. Question is, WHY?! Very complex situation for a Hyundai, or even a Chevrolet which was planning on launching the U-VA at the time – what the hell do you do to make your cars sell? How do you price it? How do you style it? My answer is that pretty much anything either of them did at the time wouldn’t have harmed the swift in any way because the swift had already had a halo above his head even before it was launched. What made it stick was the fact that it was styled radically and away from anything the Indian Customers had seen before. Heck, people would have bought it for the price even if it came with a 1.1L WagonR engine!  It was truly a historic launch, and has proved to be the change the industry needed. Let’s face it – the Swift is one of the primary reasons for the changes we’ve seen in the industry – whether its airbags being made standard on the new Honda City, or it’s the i10 having an option of Airbags and a Sunroof, or the possible introduction of world-class cars like the Volkswagen Polo, Fiat Punto, Skoda Fabia and many, many more in India. I hate to admit it, but the Swift was the change the Indian Auto Industry needed, and heck, it did it with a bang louder than what any of us could have imagined.

Of SuperMinis and Sedans

When one thinks of a Hatchback (a car without a boot or trunk), here in India, it’s difficult to have a mental price figure of over Rs. 500,000 (Around US$10,000), which, by the way, is a significant growth over the Rs. 400,000 figure that existed before the Suzuki Swift came into the picture and change the hatchback game altogether with all its bells and whistles. The Swift, along with the Hyundai Getz and Chevrolet Aveo belong to, what I like to call, the ‘luxury’ hatchback segment and are possibly the most practical cars to buy if you don’t actually need a boot, which most of us don’t. There are, of course, still a large number of people that would still like a boot, for the perceived bada gaadi (Big Car) snob value or whatever it is that people actually want a sedan (A car with a boot or trunk) for. To tap that gap in the market, Mahindra-Renault launched the Logan with a lot of hype, only to get a lukewarm response. Then came the Suzuki Swift Dzire, and again, changed the game in that sector. The point here is that both these car categories appeal to two different segments altogether. The luxury hatch at Rs. 500,000 appeals normally to the hot-shot executive buying his/her first car, to a city slicker who doesn’t actually need a boot, or to someone who already has a luxury sedan, whereas the low-end sedans appeal to families looking to replace their old WagonRs and Santros, or to people who need a boot. So, within a price bracket of, say, Rs. 450,000 to Rs. 550,000, one can choose a decent hatchback or a low-end sedan. It seemed like all the gaps in the Indian auto sector pertaining to hatchbacks and second car buyers were plugged.

Enter Skoda Fabia, followed by the Hyundai i20 and soon, the Honda Jazz, creating a spanking new segment in the Indian auto market, which I like to call, the SuperMini segment. Hatchbacks for Rs. 600,000 and above, for a market that thinks anything above Rs. 500,000 for a hatchback is absurd! Why get these cars to India? Because there is a market for SuperMinis. These hatchbacks come with features that put most sedans, sometimes twice their price, to shame. Over and above the benchmark of the luxury hatchback segment, the Hyundai i20 comes with 6 airbags, steering mounted audio controls, electric folding mirrors and a bunch of bells and whistles. The Skoda Fabia comes with a sunroof, parking sensors and interiors that can easily be compared to its elder sibling, the Skoda Laura (Priced at over Rs. 1,500,000!). These SuperMinis are high on space and style, with a clear-cut inclination towards pampering the passengers of the vehicle by offering a whole lot more space, comfort and features than most sedans below the Rs. 1,000,000 mark. Sure, the engines are no red hot fire crackers, but that is, to me, the point. These SuperMinis are meant purely for city use. They’re meant for people who already have a big sedan but want a car for everyday use that gives them the luxury they require without being a pain in the neck to drive around and park in the city. They’re mean for people who don’t actually need the extra headache of a boot on their vehicles, but want the luxury feel offered by a mid-level sedan. SuperMinis appeal to a niche market that wants everything that a sedan offers and more, but without a boot! Sure, we’d like them to have more horses under the boot, but given the excise cut they enjoy with petrol engines below the 1200cc mark and diesels below the 1500cc mark are reason enough for them to not be rocket ships. This, however, does not say that these SuperMinis are slouches, they can carry their weight around well-enough, just not well enough to make a Honda City or Ford Fiesta eat some dust.

A question rises here, at least in my head. Why would anyone who doesn’t really give a sparrows feather about a boot, purchase a SuperMini? Well, to start with, the quality and feel of these cars, specifically their interiors, are leaps and bounds ahead of cars like the Chevrolet Aveo, Ford Fiesta and even Honda City in most aspects. This, I feel, is a very conscious effort on the part of the manufacturers of these SuperMinis. I say this because the typical buyer of these SuperMinis, as described previously, is an individual who already has a sedan and is looking for an everyday city car. So pampering this person with interiors of really good quality and feel, combined with all the bells and whistles his/her existing car would already have is essential to act as variable strong enough for him/her to make the purchase. The way I see it, sooner or later, the Indian public will start appreciating the value proposition of these SuperMinis and shift from entry-level sedans to these. However, to give a person like me to spend that extra hundred grand and purchase a SuperMini, they’d have to give at least 20% more horses under that hood.