1. The Attractiveness of a Segment
The first issue in deciding where to compete in an industry is the attractiveness of the various segments. The attractiveness of a segment is a function of its structural attractiveness, its size and growth, and the match between a firm’s capabilities and the segment’s needs.
The structural attractiveness of a segment is a function of the strength of the five competitive forces at the segment level. The analysis of the five forces at the segment level is somewhat different than at the industry level. In a segment, potential entrants include firms serving other segments, as well as firms not presently in the industry. Substitutes for the product variety in a segment are often other product varieties in the industry, as well as products produced by other industries. Rivalry in a segment involves both firms focusing exclusively on the segment and firms that serve other segments well. Buyer and supplier power tend to be more segment-specific, but may well be influenced by buyer purchases in other segments or supplier sales to other segments. Thus the structural analysis of a segment is usually influenced heavily by conditions in other segments, more so than the structural analysis of an industry is affected by other industries.
The segments in an industry will often differ widely in structural attractiveness. In large turbine generators, for example, the segment consisting of large-capacity generators sold to large, privately-owned utilities is structurally attractive. Large-capacity generators are very sophisticated technologically and the scale and learning curve barriers to developing and producing them are high. Large units also offer many more opportunities for differentiation than smaller units. Greater thermal efficiency of large units creates lower costs of use for buyers, reducing buyer price sensitivity. Large utilities also tend to be more technologically sophisticated buyers and appreciate more features, enhancing competitors’ ability to differentiate themselves. Large utilities also command the financial resources to be less price sensitive. Finally, the selling process to private utilities involves secret negotiations rather than public bidding in which the lowest qualified bid must be selected.
Analyzing the attractiveness of each segment is an important first step in deciding where to compete. As a test of the analysis, it is often quite illuminating to compute a firm’s profitability in the various segments in which it competes and to compare this to both the structural analysis and any industry profitability data by segment that are available. Focused competitors may provide data on the profitability of the segments they occupy, for example. Differences in profitability by segment can be truly striking. Existing segment profitability is not necessarily an indication of potential profitability, however, because a firm may not be optimizing its strategy for each segment or, for that matter, for any segment.
SEGMENT SIZE AND GROWTH
Segments will frequently differ in their absolute size and growth rate. Size and growth will be important in their own right to the choice of where to compete. Size and growth also have an impact on structural attractiveness. The expected growth rate of each segment is important to rivalry and to the threat of entry, while size may affect the attractiveness of a segment to large competitors. Sometimes firms can sustain a position in smaller segments because large firms are not interested in them.
Determining the size and expected growth of segments is typically not easy. Data are hardly ever collected in ways that exactly match meaningful segment boundaries, especially segments determined by demand and cost considerations rather than industry convention. Hence a firm may need to invest in special data collection or market research to produce estimates of size and growth by segment.
FIRM POSITION VIS-A-VIS A SEGMENT
A firm’s resources and skills, reflected in its value chain, will usually be better suited to some segments than others, influencing the attractiveness of a segment for a particular firm. Each segment will have somewhat different requirements for competitive advantage that are highlighted in constructing the segmentation matrix. The tools described in Chapters 3 and 4 can be used to determine a firm’s relative position for competing in various segments and the possibilities for changing it.
2. Segment Interrelationships
Segments are often related in ways that have an important effect on the segments in which a firm wants to compete. Segments are related where activities in the value chain can be shared in competing in them—I call such opportunities segment interrelationships. There are often many opportunities to share value activities among segments. For example, the same sales force can sell to different buyer types, or the same manufacturing facilities can produce different product varieties.
Figures 7-7 and 7-8 illustrate a typical situation where interrelated value chains serve two segments. Strongly related segments are those where the shared value activities represent a significant fraction of total cost or have an important impact on differentiation. Segment interrelationships are analogous to interrelationships among business units competing in related industries. Segment interrelationships are within an industry, however, while interrelationships among business units are between industries.10 Similarly, segment interrelationships are analogous to interrelationships involved in competing in different geographic areas.
The analysis of interrelationships is treated in detail in Chapter 9, where I focus on interrelationships among business units. The same concepts apply here, and I will summarize them briefly. Interrelationships among segments are strategically important where the benefits of sharing value activities exceed the cost of sharing. Sharing value activities leads to the greatest benefit if the cost of a value activity is subject to significant economies of scale or learning, or sharing allows a firm to improve the pattern of capacity utilization of the value activity. Economies of scale or learning in a value activity imply that sharing across segments may yield a cost advantage relative to single-segment competitors. Sharing activities among segments is also beneficial where it increases differentiation in the value activity or lowers the cost of differentiation. Sharing a value activity is most important to differentiation where the value activity has a significant impact on differentiation and sharing allows a significant improvement in uniqueness or a significant reduction in the cost of providing it. The firm with a shared service organization across segments, for example, will gain an advantage over the single segment competitor if service is vital to differentiation and sharing lowers the cost of hiring better service personnel. Sharing a brand name across segments is also often a source of differentiation.
Figure 7-7. Interrelated Value Chains for Different Segments
The benefits of interrelationships among segments are offset by costs of coordination, compromise, and inflexibility in jointly serving segments with shared activities. Coordination costs simply reflect the greater complexity of operating in multiple segments with shared value activities. Compromise costs occur when the value chain designed to serve one segment is not optimal in serving another segment, and serving both undermines a firm’s ability to serve either. For example, the brand name, advertising, and image appropriate to a premium product may be inconsistent with the needs of a low-end product variety or vice versa. Here a firm has to create and advertise two separate brand names if it wants to operate in both segments. K. Hattori, for example, uses the Seiko name for higher-priced watches, and the Pulsar name for medium-priced watches. Even then, retailers often tell customers that a Pulsar is really a Seiko.
Figure 7—8: Segment Interrelationships Displayed on the Value Chain
A less extreme form of compromise cost is where the optimal value chain for serving one segment is somewhat different from the optimal value chain for serving another, but the same chain will serve both at some penalty in cost or differentiation. For example, a sales force selling to two buyer segments may not be as effective as a sales force specializing in one, or a manufacturing process with the flexibility to produce two product varieties may not be as efficient as one that is designed to produce one.
Segment spillover is a form of compromise that occurs when a firm tries to serve multiple segments. Buyers in one segment may demand the same terms as buyers in another. For example, the prices charged in one buyer segment may spill over to other segments because buyers demand equal treatment, a problem a single segment competitor does not have. Because the bases for segmentation include differences in the optimal value chain, the need to compromise in jointly serving segments is quite prevalent.
The need to compromise in jointly serving segments can partially or completely nullify the ability of a firm to gain competitive advantage from sharing value activities among segments. The firm is thus forced to trade the cost of creating parallel value activities to serve different segments (e.g., a separate production process or a different brand name) against the cost of compromise. In extreme cases, the compromise required to serve multiple segments goes beyond nullifying the advantages of sharing value activities and creates disadvantages. Because of major inconsistencies in such areas as brand image or production process, for example, competing in one segment can make it very difficult to operate in another segment even with a completely separate value chain.
The final cost of sharing activities among segments is the cost of inflexibility. Sharing value activities limits the flexibility of modifying strategies in the different segments, and may create exit barriers in leaving a segment. The cost of inflexibility, as well as the other costs of sharing, are discussed extensively in Chapter 9.
The net competitive advantage of competing in multiple segments versus focusing on one or a few is a function of the balance between the advantages of sharing value activities and the costs. In most industries the pattern of segment interrelationships is not symmetric. Some pairs of segments have stronger interrelationships than others. A firm may also be able to share some value activities across one group of segments and another group of value activities across another, perhaps overlapping, group of segments.
As a result of the pattern of segment interrelationships, firms often cluster in the group of segments they serve. In copiers, for example, Xerox, Kodak, and IBM have traditionally competed in highvolume copiers, while Ricoh, Savin, Canon, Minolta, and several others have served the low-volume convenience copiers. High-volume copiers are characterized by low unit manufacturing volumes, direct sales forces, and different technological issues than low-volume machines, which are mass-produced and sold through distributors. Only through having what amounts to a separate company (Fuji Xerox) has Xerox spanned the whole product range, while Canon has had to broaden its line upward painstakingly through major investments in the new value activities needed to compete in the high end. This example illustrates the point that the greater the cost of sharing activities among segments, the more the broadly-targeted firm is required to create essentially separate value chains if it is to be successful. Yet separate value chains negate the benefits of broad targeting.
A good way to test a firm’s understanding of interrelationships among segments is to plot competitors on the segmentation matrix (see Figure 7-9). If all competitors in one segment also compete in another, chances are good that strong interrelationships are present. By looking at the pattern of competitors, one can often gain insight into the pattern of interrelationships.11 However, competitors may well have failed to recognize or exploit all segment interrelationships.
Figure 7-9. Competitor Positions on the Segmentation Matrix
Interrelationships among segments may suggest further collapsing of the industry segmentation matrix. Segments with very strong interrelationships can be combined if a firm cannot logically serve one without serving the other. Once a firm has entered one such segment the barriers to entering the adjacent segment are low. By examining interrelationships, therefore, an industry segmentation matrix may be simplified for strategic purposes.
3. Segment Interrelationships and Broadly-Targeted Strategies
Interrelationships among segments provide the strategic logic for broadly- targeted strategies that encompass multiple segments if they lead to a net competitive advantage. Strong interrelationships among segments define the cluster of segments a firm should serve. Strong interrelationships will also define the logical paths of mobility of firms in the industry from one segment to another. A firm competing in one segment will be most likely to enter other segments where there are strong interrelationships.
The broadly-targeted competitor bets that the gains from interrelationships among segments outweigh the costs of sharing, and designs its strategy to strengthen the interrelationships and minimize the coordination and compromise costs. Developments in manufacturing technology are working today to lower the cost of compromise in serving different product segments because of enhanced flexibility to produce different varieties in the same facility. These or other developments that increase the flexibility of value activities without a cost or differentiation penalty will work toward the benefit of broadly-targeted com- petitors.
A broadly-targeted competitor should usually not serve all industry segments, however, because the benefits of sharing value activities are nearly always outweighed in some segments by the cost of compromise. Serving all segments is also often not desirable because all segments are not structurally attractive. A broadly-targeted firm may have to serve some unattractive segments, however, because they contribute to the overall cost or differentiation of shared value activities, or to defending its position in structurally attractive segments. As will be discussed further in Chapter 14, occupying some unattractive segments may prevent a competitor from establishing beachheads in those segments from which it can build on interrelationships into the firm’s segments. The gap left by U.S. automobile firms in less profitable small cars, for example, seems to have provided the Japanese automakers with the opportunity to enter the U.S. market.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.