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