Segment Attractiveness and Interrelationships

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.  Substi­ tutes for the product variety in a segment  are often other  product varieties in the industry, as well as products produced by other indus­ tries.   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, en­ hancing 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 m ust 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 vari­ ous 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 profitabil­ ity 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.


Segments will frequently differ in their  absolute size and  growth rate. Size and growth  will be im portant  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. D ata 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.


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 interre­ lated 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 im portant 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. Interrelation­ ships among  segments are   strategically   im portant  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 activ­ ity. 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 im portant to differentia­ tion 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.

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 m anufacturing 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 advan­ tages   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 indus­ tries 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 exam­ ple, Xerox, Kodak, and IBM have  traditionally  competed  in high- volume 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 m ajor investments in the new value activities needed to compete in the high end. This example illus­ trates 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 interre­ lationships 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 interrelation­ ships, therefore, an   industry  segmentation  matrix  may be simplified for strategic purposes.

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 interrela­ tionships among  segments outweigh  the costs of sharing,   and   designs its strategy to strengthen the interrelationships and minimize the coor­ dination and compromise costs. Developments in manufacturing tech­ nology 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 differen­ tiation penalty will work toward the benefit of broadly-targeted com­ petitors.

A broadly-targeted competitor should usually not serve all indus­ try segments, however, because the benefits of sharing  value activities are nearly always outweighed in some segments by the cost of compro­ mise. Serving all segments is also often not  desirable because all seg­ ments are not structurally  attractive. A broadly-targeted  firm   may have to serve some unattractive segments, however, because they con­ tribute 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 automak­ ers 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.

Leave a Reply

Your email address will not be published. Required fields are marked *