Competitive strategy for Coping with Fragmentation

In many situations, industry fragmentation is indeed the result of underlying industry economics that cannot be overcome. Frag-mented industries are characterized not only by many competitors but also by a generally weak bargaining position with suppliers and buyers. Marginal profitability can be the result. In such an environ-ment, strategic positioning is of particularly crucial significance. The strategic challenge is to cope with fragmentation by becoming one of the most successful firms, although able to garner only a modest market share.

Since every industry is ultimately different, there is no general-ized method for competing most effectively in a fragmented indus-try. However, there are a number of possible strategic alternatives for coping with a fragmented structure that should be considered when examining any particular situation. These are specific ap-proaches to pursuing the low cost, differentiate, or focus generic strategies described in Chapter 2 in the peculiar environment of the fragmented industry. Each is directed at either better matching the firm‘s strategic posture to the particular nature of competition in fragmented industries or neutralizing the intense competitive forces that are usually the rule in these industries.

Tightly Managed Decentralization. Since fragmented indus-tries often are characterized by the need for intense coordination, local management orientation, high personal service, and close con-trol, an important alternative for competition is tightly managed de-centralization. Rather than increasing the scale of operations at one or a few locations, this strategy involves deliberately keeping indi-vidual operations small and as autonomous as possible. This ap-proach is supported by tight central control and performance- oriented compensation for local managers. This strategy is being practiced with great success by Indal in the aluminum extrusion and fabricating industry in Canada, by several growing chains of small– and medium-sized newspapers that have sprung up in the United States over the past decade, and by the highly successful Dillon Companies in the food retailing industry, just to name a few exam-ples. Dillon, for instance, has a strategy of acquiring a group of small, regional grocery chains and keeping them autonomous, each with its own name, buying group, and so on. This system is rein-forced with central control and a strong promotion-from-within pol-icy. The strategy has avoided the homogenizing of individual units and resulting insensitivity to local conditions that plague some food chains, and as a by-product, has kept unionization low.

The essential notion of this type of strategy is to recognize and cater to the causes of fragmentation but to add a degree of profes-sionalism to the manner in which local managers operate.

“Formula” Facilities. Another alternative, related to the pre-vious one, is to view the key strategic variable in the business as the building of efficient, low-cost facilities at multiple locations. This strategy involves designing a standard facility, whether it be a plant or a service establishment, and polishing to a science the process of constructing and putting the facility into operation at minimum cost. The firm thereby lowers its investment relative to competitors and/or provides a more attractive or efficient location from which to do business. Some of the most successful mobile home producers, such as Fleetwood, Inc., have followed this strategy.

Increased Value Added. Many fragmented industries produce products or services that are commodities or otherwise difficult to differentiate; many distribution businesses, for example, stock simi-lar if not identical product lines to their competitors’. In cases such as these, an effective strategy may be to increase the value added of the business by providing more service with sale, by engaging in some final fabrication of the product (like cutting to size or punching holes), or by doing subassembly or assembly of components before they are sold to the customer. Enhanced product differentiation, and thereby higher margins, that cannot be achieved on the basic product or service may be achievable through such activities. This concept has been successfully implemented by a number of metal distributors who have positioned themselves as “metal service centers,” engag-ing in simple fabrication operations and providing a great deal of ad-vice to the customer in what had historically been a purely pass- through business. Some electronic component distributors have similarly been successful in subassembly of connectors from individ-ual components or assembling kits.

Value added can also sometimes be enhanced by forward inte-gration from manufacturing into distribution or retailing. This step may neutralize buyers’ power or allow greater product differentia-tion by better controlling the conditions of sale.

Specialization by Product Type or Product Segment. When industry fragmentation results from or is accompanied by the pres-ence of numerous items in the product line, an effective strategy for achieving above-average results can be to specialize on a tightly con-strained group of products. This approach is one variant of the focus strategy described in Chapter 2. It can allow the firm to achieve some bargaining power with suppliers by developing a significant volume of their products. It may also allow the enhancement of product differentiation with the customer as a result of the special-ist‘s perceived expertise and image in the particular product area. The focused strategy allows the firm to be better informed about the product area and potentially to invest in its ability to educate customers and to provide services relating to the particular area. The cost of such a strategy of specialization may be some limitation in the growth prospects for the firm.

An intriguing example of product specialization coupled with increasing value added is provided by Ethan Allen, a highly success-ful participant in the fragmented U.S. furniture industry. Ethan Allen has specialized in early American furniture offering a line that allows the consumer to draw together individual items into profes-sionally designed rooms:

We are selling what you can do with the product, not the product itself. We offer the middle-class a service that only the rich could afford.2

The integrated concept allows Ethan Allen to charge up to a 20 percent premium for its products, which is plowed into heavy televi-sion advertising. The company also sells only through a unique net-work of independent, exclusive retail outlets, which allows it to en-hance differentiation and avoid the hard bargaining of department stores and discount houses. Although the firm‘s market share is only about 3 percent, its profitability is well above average.

Specialization by Customer Type. If competition is intense be-cause of a fragmented structure, a firm can potentially benefit by specialization on a particular category of customer in the industry— perhaps the customers with the least bargaining leverage because they purchase small annual volumes or because they are small in ab-solute size. Or the firm might specialize in the customers who are the least price sensitive3 or who most need the value added the firm can provide along with the basic product or service. Like product spe-cialization, customer specialization may limit growth prospects for the firm in return for offering higher profitability.

Specialization by Type of Order. Regardless of the customer, the firm can specialize in a particular type of order to cope with in-tense competitive pressure in a fragmented industry. One approach is to service only small orders for which the customer wants immedi-ate delivery and is less price sensitive. Or the firm can service only custom orders to take advantage of less price sensitivity or to build switching costs. Once again, the cost of such specialization may be some limitation in volume.

A Focused Geographic Area. Even though a significant indus-try-wide share is out of reach or there are no national economies of scale (and perhaps even diseconomies), there may be substantial economies in blanketing a given geographic area by concentrating facilities, marketing attention, and sales activity. This policy can economize on the use of the sales force, allow more efficient adver-tising, allow a single distribution center, and so on. Having bits and pieces of business in a number of areas, on the other hand, accentu-ates the problems of competing in a fragmented industry. The blan-keting strategy has been quite effective for food stores, which re-main a fragmented industry despite the presence of some large national chains.

Bare Bones/No Frills. Given the intensity of competition and low margins in many fragmented industries, a simple but powerful strategic alternative can be intense attention to maintaining a bare bones/no frills competitive posture—that is, low overhead, low- skilled employees, tight cost control, and attention to detail. This policy places the firm in the best position to compete on price and still make an above:average return.

Backward Integration. Although the causes of fragmentation can preclude a large share of the market, selective backward integra-tion may lower costs and put pressure on competitors who cannot af-ford such integration. Of course, the decision to integrate should be made only after a complete analysis, which is discussed in Chap-ter 14.

Source: Porter Michael E. (1998), Competitive Strategy_ Techniques for Analyzing Industries and Competitors, Free Press; Illustrated edition.

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