Chapter 12: Competitive Strategy in Declining Industries
Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
Chapter 12: Competitive Strategy in Declining Industries p. 254
A declining industry is defined as one that has experienced an absolute decline in unit sales over an extended period of time. Although the accepted product life cycle and portfolio model strategies in this situation are to harvest (i.e., eliminate investment and generate maximum cash flow), the alternative strategies available to firms in a declining industry are more complex. There are a variety of successful strategies ranging from heavy reinvestment to exiting before the decline is recognized, i.e., from heavy harvest to no harvest at all. The purpose of this chapter is to describe the competitive structure of the industry during the decline phase, the strategic alternatives that are available, and the principles for choosing a strategy.
Structural Determinants of Competition in Decline p. 255
There are a number of conditions that influence the decline in profitability, the ease of withdrawal, and the volatility of competition between the remaining firms in a declining industry.
Conditions of Demand p. 256
Uncertainty - Perceptions about the nature of the decline affect the end-game competition. If most firms believe industry demand will level off or revitalize, they will try to hold on despite shrinking sales. This situation creates a high probability of warfare. However, if most firms believe demand will continue to decline, the industry will reduce capacity in a more orderly fashion. The stronger a firm's position in the industry and the higher the exit barriers it faces, the more optimistic it will be about the future.
Rate and Pattern of Decline - A slow decline in sales might be viewed by some firms as a short-term fluctuation, rather than a downward trend. A more rapid decline makes it more difficult to misinterpret the trend, and can make the abandonment of entire plants and divisions more likely. Customers who fear the loss of a key input may also shift to substitute products, accelerating the rate of decline.
Structure of Remaining Demand Pockets - A structural analysis of the industry (Chapter 1) can reveal pockets of demand that can provide profitability to the remaining firms in a declining industry. If the pockets of demand are made up of buyers who are price-insensitive, have little bargaining power, or have high switching costs (Chapter 6), the surviving firms can remain profitable. Porter mentions the cigar, and leather industries as examples. However, these demand pockets might be vulnerable to substitutes, powerful suppliers and other threats.
Causes of Decline - Industries decline for various reasons including substitute products created from technological innovations, demographics (e.g., a decline in the customer group), or changes in buyer needs or taste.
Exit Barriers p. 259.
Exit barriers can keep firms in declining industries even though profits are low or nonexistent.
Durable and Specialized Assets - Assets that are designed specifically for a particular business, company, or location create an exit barrier because of their limited value. In some cases the liquidation value of assets is low enough to support the decision to stay in business. In other cases, specialized assets can be sold in overseas markets where the industry is at a different stage of development.
Fixed costs of Exit - Fixed costs associated with exit include the cost of labor settlements, requirements to maintain the availability of spare parts, cost of relocating managers and employees, cancellation penalties for breaking long-term contracts, and various hidden cost such as a decline in employee productivity, and customers and suppliers losing interest in keeping their promises.
Strategic Exit Barriers - Strategic exit barriers include situations where the business is part of an overall strategy involving a group of businesses, or where exiting from a business hurts the company's relationship with suppliers or distribution channels in other areas. Exiting may also hurt the firm's ability to raise capital by negatively affecting the firm's financial credibility. An additional barrier exist when the business is part of a vertically integrated business.
Information Barriers - Where the firm's business units are interrelated (e.g., sharing assets, having buyer-seller relationships), it becomes more difficult to determine the true performance of the business units.
Managerial or Emotional Barriers - Exit may become difficult because of the emotional effects on managers who equate their own success and wellbeing to the success of the business.
Government and Social Barriers - Government, community, and political pressure can make it difficult to divest, along with a manager's social concern for employees and local communities.
Mechanism for Asset Disposition - When assets in a declining industry are disposed of within the industry (sold to someone who will keep the firm competing at a lower investment base), or government subsidies are provided to underperforming firms, competition becomes worse for the original firms that remain in the industry.
Volatility of Rivalry p. 268
Price warfare among firms that remain in a declining industry will be more intense if the product is perceived as a commodity, fixed costs are high, firms are locked in by exit barriers, some firms believe it is strategically important to maintain their position, the relative strengths of firms are balanced, and firms are uncertain about their competitive strengths.
Strategic Alternatives in Decline p. 267
There are four basic alternative strategies for firms in a declining industry.
Leadership - Seek a leadership position in terms of market share. Tactics include aggressive actions (e.g., pricing, marketing), purchasing market share and retiring competitor's capacity (reducing exit barriers), reducing exit barriers in other ways (providing spare parts for competitor's products), demonstrating a strong commitment to remain in business, and raising the cost of competitors staying in business by reinvestment in new products or process improvements.
Niche - Create or defend a strong position in a particular segment. Identify and invest in a demand pocket using some of the tactics mentioned above for a leadership strategy.
Harvest - Manage a controlled disinvestment, taking advantage of the firms strengths. A harvest strategy is difficult to manage but includes an attempt to optimize cash flow, along with tactics such as eliminating or limiting investment, reducing the number of models and channels, eliminating small customers, and reducing service (delivery time, repair, sales assistance etc.).
Quick Divestment - Liquidate as early in the decline phase as possible. The underlying assumption is that the firm can maximize its investment recovery by selling early or in some cases before the decline. Exit barriers such as image and interrelationships may be a problem, but are less for those who divest early.
Choosing a Strategy for Decline p. 271
A crude framework for choosing a strategy in a declining industry is provided in the graphic below. Although it is not clear from the illustration, the framework has three dimensions. One question the firm needs to answer is whether the industry environment is conducive to an orderly decline phase. A second question relates to the firm's strengths relative to competitors for competing in the remaining demand pockets. The illustration shows the strategy choices for the four combinations of answers to these two questions. However, there is a third question that relates to the firm's strategic need to remain in the business. The answer to this question can skew the decision away from those indicated in the illustration. For example, a greater need for cash flow might push the firm toward a harvest strategy even though the other factors point to a leadership or niche strategy.
Pitfalls in Decline p. 273
Choosing a strategic position based on the framework above is not as easy as it appears and many firms tend to make an inconsistent choice. In addition, there are other potential pitfalls in a declining industry.
Failure to recognize decline - The tendency for managers to be optimistic about the industry coupled with exit barriers can prevent firms from acting objectively about the future.
A war of attrition - Competitive warfare can lead to disaster.
Harvesting without clear strengths - Firms in the lower right block of the illustration above who choose a harvest strategy usually collapse.
Preparing for Decline p. 274
Some actions in the maturity phase that may improve a firms position in the decline phase include minimizing investments or other actions that increase exit barriers, emphasize market segments where demand will be favorable during decline, and create switching costs in these segments.
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