Business Studies 2 (2002)

Lesson 2 (2002) Business Studies

First, a note.

The more you participate, the more you learn. These lessons are not just a bunch of notes
– these are widely available throughout the web. Anyone can do that – just go to s-
cool.co.uk and print off their notes. Uniquely this group is about discussion – no-one else
on the web offers such a discussion group. There are messageboards but that’s not quite
the same.

For this to be of help to you need to participate.

It’s up to you…

OK let’s talk about strategy.

Visit the Michael Porter site.

Then this site:

http://www.quickmba.com/strategy/porter.shtml

Porter's Five Forces

A MODEL FOR INDUSTRY ANALYSIS

The model of pure competition implies that risk-adjusted rates of return should be
constant across firms and industries. However, numerous economic studies have
affirmed that different industries can sustain different levels of profitability; part of
this difference is explained by industry structure.

Michael Porter provided a framework that models an industry as being influenced

by five forces. The strategic business manager seeking to develop a competitive
advantage over rival firms can use this model to better understand the industry
context in which the firm operates.

Diagram of Porter's 5 Forces

SUPPLIER POWER
Supplier concentration
Importance of volume to supplier
Differentiation of inputs

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 Impact of inputs on cost or differentiation
Switching costs of firms in the industry
Presence of substitute inputs
Threat of forward integration
Cost relative to total purchases in industry
BARRIERS
TO ENTRY
Absolute cost advantages
Proprietary learning curve THREAT OF
Access to inputs SUBSTITUTES
Government policy -Switching costs
Economies of scale -Buyer inclination to
Capital requirements substitute
Brand identity -Price-performance
Switching costs trade-off of substitutes
Access to distribution
Expected retaliation
Proprietary products
BUYER POWER DEGREE OF RIVALRY
Bargaining leverage -Exit barriers
Buyer volume -Industry concentration
Buyer information -Fixed costs/Value added
Brand identity -Industry growth
Price sensitivity -Intermittent overcapacity
Threat of backward integration -Product differences
Product differentiation -Switching costs
Buyer concentration vs. industry -Brand identity
Substitutes available -Diversity of rivals
Buyers' incentives -Corporate stakes

I. Rivalry

In the traditional economic model, competition among rival firms drives profits to
zero. But competition is not perfect and firms are not unsophisticated passive
price takers. Rather, firms strive for a comparative and competitive advantage
over their rivals. The intensity of rivalry among firms varies across industries, and
strategic analysts are interested in these differences.

Economists measure rivalry by indicators of industry concentration. The

Concentration Ratio (CR) is one such measure. The Bureau of Census
periodically reports the CR for major Standard Industrial Classifications (SIC's).
The CR indicates the percent of market share held by the four largest firms (CR's
for the largest 8, 25, and 50 firms in an industry also are available). A high
concentration ratio indicates that a high concentration of market share is held by
the largest firms - the industry is concentrated. With only a few firms holding a
large market share, the competitive landscape is less competitive (closer to a
monopoly). A low concentration ratio indicates that the industry is characterized
by many rivals, none of which has a significant market share. These fragmented
markets are said to be competitive. The concentration ratio is not the only

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available measure; the trend is to define industries in terms that convey more
information than distribution of market share.

If rivalry among firms in an industry is low, the industry is considered to be

disciplined. This discipline may result from the industry's history of competition,
the role of a leading firm, or informal compliance with a generally understood code
of conduct. Explicit collusion generally is illegal and not an option; in low-rivalry
industries competitive moves must be constrained informally. However, a
maverick firm seeking a competitive advantage can displace the otherwise
disciplined market.

When a rival acts in a way that elicits a counter response by other firms, rivalry
intensifies. The intensity of rivalry commonly is referred to as being cutthroat,
intense, moderate, or weak, based on the firms' aggressiveness in attempting to
gain an advantage.

In pursuing an advantage over its rivals, a firm can choose from several
competitive moves:

• Changing prices - raising or lowering prices to gain a temporary advantage.

• Improving product differentiation - improving features, implementing
innovations in the manufacturing process and in the product itself.
• Creatively using channels of distribution - using vertical integration or using
a distribution channel that is novel to the industry. For example, with high-
end jewelry stores reluctant carry its watches, Timex moved into drugstores
and other non-traditional outlets and cornered the low to mid-price watch
market.
• Exploiting relationships with suppliers - for example, from the 1950's to the
1970's Sears, Roebuck and Co. dominated the retail household appliance
market. Sears set high quality standards and required suppliers to meet its
demands for product specifications and price.

The intensity of rivalry is influenced by the following industry characteristics:

1. A larger number of firms increases rivalry because more firms must

compete for the same customers and resources. The rivalry intensifies if
the firms have similar market share, leading to a struggle for market
leadership.
2. Slow market growth causes firms to fight for market share. In a growing
market, firms are able to improve revenues simply because of the
expanding market.
3. High fixed costs result in an economy of scale effect that increases
rivalry. When total costs are mostly fixed costs, the firm must produce near
capacity to attain the lowest unit costs. Since the firm must sell this large

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 quantity of product, high levels of production lead to a fight for market
share and results in increased rivalry.
4. High storage costs or highly perishable products cause a producer to
sell goods as soon as possible. If other producers are attempting to unload
at the same time, competition for customers intensifies.
5. Low switching costs increases rivalry. When a customer can freely switch
from one product to another there is a greater struggle to capture
customers.
6. Low levels of product differentiation is associated with higher levels of
rivalry. Brand identification, on the other hand, tends to constrain rivalry.
7. Strategic stakes are high when a firm is losing market position or has
potential for great gains. This intensifies rivalry.
8. High exit barriers place a high cost on abandoning the product. The firm
must compete. High exit barriers cause a firm to remain in an industry,
even when the venture is not profitable. A common exit barrier is asset
specificity. When the plant and equipment required for manufacturing a
product is highly specialized, these assets cannot easily be sold to other
buyers in another industry. Litton Industries' acquisition of Ingalls
Shipbuilding facilities illustrates this concept. Litton was successful in the
1960's with its contracts to build Navy ships. But when the Vietnam war
ended, defense spending declined and Litton saw a sudden decline in its
earnings. As the firm restructured, divesting from the shipbuilding plant was
not feasible since such a large and highly specialized investment could not
be sold easily, and Litton was forced to stay in a declining shipbuilding
market.
9. A diversity of rivals with different cultures, histories, and philosophies
make an industry unstable. There is greater possibility for mavericks and
for misjudging rival's moves. Rivalry is volatile and can be intense. The
hospital industry, for example, is populated by hospitals that historically are
community or charitable institutions, by hospitals that are associated with
religious organizations or universities, and by hospitals that are for-profit
enterprises. This mix of philosophies about mission has lead occasionally
to fierce local struggles by hospitals over who will get expensive diagnostic
and therapeutic services. At other times, local hospitals are highly
cooperative with one another on issues such as community disaster
planning.
10. Industry Shakeout. A growing market and the potential for high
profits induces new firms to enter a market and incumbent firms to increase
production. A point is reached where the industry becomes crowded with
competitors, and demand cannot support the new entrants and the
resulting increased supply. The industry may become crowded if its growth
rate slows and the market becomes saturated, creating a situation of
excess capacity with too many goods chasing too few buyers. A shakeout
ensues, with intense competition, price wars, and company failures.

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 BCG founder Bruce Henderson generalized this observation as the Rule of
Three and Four: a stable market will not have more than three significant
competitors, and the largest competitor will have no more than four times
the market share of the smallest. If this rule is true, it implies that:

o If there is a larger number of competitors, a shakeout is inevitable

o Surviving rivals will have to grow faster than the market
o Eventual losers will have a negative cash flow if they attempt to
grow
o All except the two largest rivals will be losers
o The definition of what constitutes the "market" is strategically
important.

Whatever the merits of this rule for stable markets, it is clear that market
stability and changes in supply and demand affect rivalry. Cyclical demand
tends to create cutthroat competition. This is true in the disposable diaper
industry in which demand fluctuates with birth rates, and in the greeting
card industry in which there are more predictable business cycles.

II. Threat Of Substitutes

In Porter's model, substitute products refer to products in other industries. To the
economist, a threat of substitutes exists when a product's demand is affected by
the price change of a substitute product. A product's price elasticity is affected by
subsititute products - as more substitutes become available, the demand
becomes more elastic since customers have more alternatives. A close substitute
product constrains the ability of firms in an industry to raise prices.
The competition engendered by a Threat of Substitute comes from products
outside the industry. The price of aluminum beverage cans is constrained by the
price of glass bottles, steel cans, and plastic containers. These containers are
substitutes, yet they are not rivals in the aluminum can industry. To the
manufacturer of automobile tires, tire retreads are a substitute. Today, new tires
are not so expensive that car owners give much consideration to retreading old
tires. But in the trucking industry new tires are expensive and tires must be
replaced often. In the truck tire market, retreading remains a viable substitute
industry. In the disposable diaper industry, cloth diapers are a substitute and their
prices constrain the price of disposables.
While the treat of substitutes typically impacts an industry through price
competition, there can be other concerns in assessing the threat of substitutes.
Consider the substitutability of different types of TV transmission: local station
transmission to home TV antennas via the airways versus transmission via cable,
satellite, and telephone lines. The new technologies available and the changing
structure of the entertainment media are contributing to competition among these

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substitute means of connecting the home to entertainment. Except in remote
areas it is unlikely that cable TV could compete with free TV from an aerial without
the greater diversity of entertainment that it affords the customer.

III. Buyer Power

The power of buyers is the impact that customers have on a producing industry. In
general, when buyer power is strong, the relationship to the producing industry is
near to what an economist terms a monopsony - a market in which there are
many suppliers and one buyer. Under such market conditions, the buyer sets the
price. In reality few pure monopsonies exist, but frequently there is some
asymmetry between a producing industry and buyers. The following tables outline
some factors that determine buyer power.

Buyers are Powerful if: Example

Buyers are concentrated - there are a few buyers
DOD purchases from defense contractors
with significant market share
Buyers purchase a significant proportion of output -
Circuit City and Sears' large retail market provides
distribution of purchases or if the product is
power over appliance manufacturers
standardized
Buyers possess a credible backward integration
Large auto manufacturers' purchases of tires
threat - can threaten to buy producing firm or rival

Buyers are Weak if: Example

Producers threaten forward integration - producer Movie-producing companies have integrated forward
can take over own distribution/retailing to acquire theaters
Significant buyer switching costs - products not
standardized and buyer cannot easily switch to IBM's 360 system strategy in the 1960's
another product
Buyers are fragmented (many, different) - no buyer
Most consumer products
has any particular influence on product or price
Producers supply critical portions of buyers' input -
Intel's relationship with PC manufacturers
distribution of purchases

IV. Supplier Power

A producing industry requires raw materials - labor, components, and other
supplies. This requirement leads to buyer - supplier relationships between the
industry and the firms that provide it the raw materials used to create products.
Suppliers, if powerful, can exert an influence on the producing industry, such as
selling its raw materials at a high price expropriating some of the industry's profits.
The following tables outline some factors that determine supplier power.

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Suppliers are Powerful if: Example
Baxter International, manufacturer of hospital
Credible forward integration threat by suppliers supplies, acquired American Hospital Supply, a
distributor
Suppliers concentrated Drug industry's relationship to hospitals
Significant cost to switch suppliers Microsoft's relationship with PC manufacturers
Boycott of grocery stores selling non-union picked
Customers Powerful
grapes

Suppliers are Weak if: Example

Many competitive suppliers - product is Tire industry relationship to automobile
standardized manufacturers
Purchase commodity products Grocery store brand label products
Credible backward integration threat by purchasers Timber producers relationship to paper companies
Garment industry relationship to major department
Concentrated purchasers
stores
Customers Weak Travel agents' relationship to airlines

V. Barriers to Entry / Threat of Entry

It is not only incumbent rivals that pose a threat to firms in an industry; the
possibility that new firms may enter the industry also affects competition. In
theory, any firm should be able to enter and exit a market, and if free entry and
exit exists, then profits always should be nominal. In reality, however, industries
possess characteristics that protect the high profit levels of firms in the market and
inhibit additional rivals from entering the market. These are barriers to entry.
Barriers to entry are more than the normal equilibrium adjustments that markets
typically make. For example, when industry profits increase, we would expect
additional firms to enter the market to take advantage of the high profit levels -
over time driving profits down for all firms in the industry. When profits decrease,
we would expect some firms to exit the market thus restoring a market
equilibrium. Falling prices, or the expectation that future prices will fall, deters
rivals from entering a market. Firms also may be reluctant to enter markets that
are extremely uncertain, especially if entering involves expensive start-up costs.
These are normal accommodations to market conditions. But if firms individually
(collective action would be illegal collusion) keep prices artificially low as a
strategy to prevent potential entrants from entering the market, such entry-
deterring pricing establishes a barrier.
Barriers to entry are unique industry characteristics that define the industry.
Barriers reduce the rate of entry of new firms, thus maintaining a level of profits for
those already in the industry. From a strategic perspective, barriers can be

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created or exploited to enhance a firm's competitive advantage. Barriers to entry
arise from several sources:
1. Government creates barriers. Although the principal role of the
government in a market is to preserve competition through anti-trust
actions, government also restricts competition through the granting of
monopolies and through regulation. Industries such as utilities are
considered natural monopolies because it has been more efficient to have
one electric company provide power to a locality than to permit many
electric companies to compete in a local market. To restrain utilities from
exploiting this advantage, government permits a monopoly, but regulates
the industry. Illustrative of this kind of barrier to entry is the local cable
company. The franchise to a cable provider may be granted by competitive
bidding, but once the franchise is awarded by a community a monopoly is
created. Local governments were not effective in monitoring price gouging
by cable operators, so the federal government has enacted legislation to
review and restrict prices.
The regulatory authority of the government in restricting competition is
historically evident in the banking industry. Until the 1970's, the markets
that banks could enter were limited by state governments. As a result, most
banks were local commercial and retail banking facilities. Banks competed
through strategies that emphasized simple marketing devices such as
awarding toasters to new customers for opening a checking account. When
banks were deregulated, banks were permitted to cross state boundaries
and expand their markets. Deregulation of banks intensified rivalry and
created uncertainty for banks as they attemped to maintain market share.
In the late 1970's, the strategy of banks shifted from simple marketing
tactics to mergers and geographic expansion as rivals attempted to expand
markets.
2. Patents and proprietary knowledge serve to restrict entry into an
industry. Ideas and knowledge that provide competitive advantages are
treated as private property when patented - preventing others from using
the knowledge and creating a barrier to entry. Edwin Land introduced the
Polaroid camera in 1947 and held a monopoly in the instant photography
industry. In 1975, Kodak attempted to enter the instamatic market and sold
a comparable camera. Polaroid sued for patent infringement and won,
keeping Kodak out of the instamatic industry.
3. Asset specificity inhibits entry into an industry. Asset specificity is
the extent to which the firm's assets can be utilized to produce a different
product. When an industry requires highly specialized technology or plants
and equipment, potential entrants are reluctant to commit to acquiring
specialized assets that cannot be sold or converted into other uses if the
venture fails. Asset specificity provides a barrier to entry for two reasons:
First, when firms already hold specialized assets they fiercely resist efforts
by others from taking their market share. New entrants can anticipate
aggressive rivalry. For example, Kodak had $10 million invested in its

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 photographic equipment business and aggressively resisted efforts by Fugi
to intrude in its market. These assets are both large and industry specific.
The second reason is that potential entrants are reluctant to make
investments in highly specialized assets.
4. Organizational (Internal) Economies of Scale. The most cost efficient
level of production is termed Minimum Efficient Scale (MES). This is the
point at which unit costs for production are at minimum - i.e., the most cost
efficient level of production. If MES for firms in an industry is known, then
we can determine the amount of market share necessary for low cost entry
or cost parity with rivals. For example, in long distance communications
roughly 10% of the market is necessary for MES. If sales for a long
distance operator fail to reach 10% of the market, the firm is not
competitive.
The existence of such an economy of scale creates a barrier to entry. The
greater the difference between industry MES and entry unit costs, the
greater the barrier to entry. So industries with high MES deter entry of
small, start-up businesses. To operate at less than MES there must be a
consideration that permits the firm to sell at a premium price - such as
product differentiation or local monopoly.
Barriers to exit work similarly to barriers to entry. Exit barriers limit the ability of a
firm to leave the market and can exacerbate rivalry - unable to leave the industry,
a firm must compete. Some of an industry's entry and exit barriers can be
summarized as follows:

Easy to Enter if there is: Difficult to Enter if there is:

• Common technology • Patented or proprietary know-

• Little brand franchise
• Access to distribution
channels
• Low scale threshold
Easy to Exit if there are:
how
• Difficulty in brand switching
• Restricted distribution
channels
• High scale threshold
Difficult to Exit if there are:

• Salable assets • Specialized assets

• Low exit costs • High exit costs

• Independent businesses • Interrelated businesses

DYNAMIC NATURE OF INDUSTRY RIVALRY

Our descriptive and analytic models of industry tend to examine the industry at a
given state. The nature and fascination of business is that it is not static. While we

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are prone to generalize, for example, list GM, Ford, and Chrysler as the "Big 3"
and assume their dominance, we also have seen the automobile industry change.
Currently, the entertainment and communications industries are in flux. Phone
companies, computer firms, and entertainment are merging and forming strategic
alliances that re-map the information terrain. Schumpeter and, more recently,
Porter have attempted to move the understanding of industry competition from a
static economic or industry organization model to an emphasis on the
interdependence of forces as dynamic, or punctuated equilibrium, as Porter terms
it.
In Schumpeter's and Porter's view the dynamism of markets is driven by
innovation. We can envision these forces at work as we examine the following
changes:
Top 10 US Industrial Firms by Sales 1917 - 1988

1917 1945 1966 1983 1988

1 US Steel General Motors General Motors Exxon General Motors
2 Swift US Steel Ford General Motors Ford
Standard Oil -NJ
3 Armour Standard Oil -NJ
(Exxon)
Mobil Exxon

4 American Smelting US Steel General Electric Texaco IBM

5 Standard Oil -NJ Bethlehem Steel Chrysler Ford General Electric
6 Bethlehem Steel Swift Mobil IBM Mobil
7 Ford Armour Texaco Socal (Oil) Chrysler
8 DuPont Curtiss-Wright US Steel DuPont Texaco
9 American Sugar Chrysler IBM Gulf Oil DuPont
Standard Oil of
10 General Electric Ford Gulf Oil
Indiana
Philip Morris

10 Largest US Firms by Assets, 1909 and 1987

1909 1987
1 US STEEL GM (Not listed in 1909)

2 STANDARD OIL, NJ (Now, EXXON #3) SEARS (1909 = 45)

EXXON (Standard Oil trust
3 AMERICAN TOBACCO (Now, American Brands #52) broken up in 1911)
AMERICAN MERCANTILE MARINE (Renamed US Lines; acquired
4 by Kidde, Inc., 1969; sold to McLean Industries, 1978; bankruptcy, IBM (Ranked 68, 1948)
1986

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 INTERNATIONAL HARVESTER (Renamed Navistar #182); divested
5 farm equipment FORD (Listed in 1919)

6 ANACONDA COPPER (acquired by ARCO in 1977) MOBIL OIL

GENERAL ELECTRIC
7 US LEATHER (Liquidated in 1935) (1909= 16)
ARMOUR (Merged in 1968 with General Host; in 1969 by Greyhound; CHEVRON (Not listed in
8 1983 sold to ConAgra) 1909)
AMERICAN SUGAR REFINING (Renamed AMSTAR. In 1967
9 =320) TEXACO (1909= 91)
Leveraged buyout and sold in pieces)
PULLMAN, INC (Acquired by Wheelabrator Frye, 1980; spun-off as
10 Pullman-Peabody, 1981; 1984 sold to Trinity Industries) DU PONT (1909= 29)

GENERIC STRATEGIES TO COUNTER THE FIVE FORCES

Strategy can be formulated on three levels:

• corporate level
• business unit level
• functional or departmental level.

The business unit level is the primary context of industry rivalry. Michael Porter
identified three generic strategies (cost leadership, differentiation, and focus) that
can be implemented at the business unit level to create a competitive advantage.
The proper generic strategy will position the firm to leverage its strengths and
defend against the adverse effects of the five forces.

Recommended Reading
Porter, Michael E., Competitive Strategy: Techniques for Analyzing Industries and Competitors
Competitive Strategy is the basis for much of modern business strategy. In this classic work,
Michael Porter presents his five forces and generic strategies, then discusses how to recognize
and act on market signals and how to forecast the evolution of industry structure. He then
discusses competitive strategy for emerging, mature, declining, and fragmented industries. The
last part of the book covers strategic decisions related to vertical integration, capacity expansion,
and entry into an industry. The book concludes with an appendix on how to conduct an industry
analysis.

Then here:

http://pacific.commerce.ubc.ca/ruckman/competitiveadvofnations.htm

The Competitive Advantage of Nations (Porter’s Diamond)

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 A. Overview

B. The Diamond - Four Determinants of National

Competitive Advantage

C. The Diamond as a System

D. Implications for Governments

E. Criticisms

V. The Competitive Advantage of Nations

A. Overview

• Porter is a famous Harvard business professor. He conducted a comprehensive

study of 10 nations to learn what leads to success. Recently his company was
commissioned to study Canada in a report called "Canada at the Crossroads".
• Porter believes standard classical theories on comparative advantage are
inadequate (or even wrong).
• According to Porter, a nation attains a competitive advantage if its firms are
competitive. Firms become competitive through innovation. Innovation can
include technical improvements to the product or to the production process.

B. The Diamond - Four Determinants of National Competitive Advantage

• Four attributes of a nation comprise Porter's "Diamond" of national advantage.

They are:

a. factor conditions (i.e. the nation's position in factors of production, such as

skilled labour and infrastructure),
b. demand conditions (i.e. sophisticated customers in home market),
c. related and supporting industries, and
d. firm strategy, structure and rivalry (i.e. conditions for organization of
companies, and the nature of domestic rivalry).

a. Factor Conditions

• Factor conditions refers to inputs used as factors of production - such as labour,

land, natural resources, capital and infrastructure. This sounds similar to standard
economic theory, but Porter argues that the "key" factors of production (or
specialized factors) are created, not inherited. Specialized factors of production
are skilled labour, capital and infrastructure.

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• "Non-key" factors or general use factors, such as unskilled labour and raw
materials, can be obtained by any company and, hence, do not generate sustained
competitive advantage. However, specialized factors involve heavy, sustained
investment. They are more difficult to duplicate. This leads to a competitive
advantage, because if other firms cannot easily duplicate these factors, they are
valuable.
• Porter argues that a lack of resources often actually helps countries to become
competitive (call it selected factor disadvantage). Abundance generates waste and
scarcity generates an innovative mindset. Such countries are forced to innovate to
overcome their problem of scarce resources. How true is this?

i. Switzerland was the first country to experience labour shortages. They

abandoned labour-intensive watches and concentrated on innovative/high-
end watches.
ii. Japan has high priced land and so its factory space is at a premium. This
lead to just-in-time inventory techniques (Japanese firms can’t have a lot
of stock taking up space, so to cope with the potential of not have goods
around when they need it, they innovated traditional inventory
techniques).
iii. Sweden has a short building season and high construction costs. These two
things combined created a need for pre-fabricated houses.

b. Demand Conditions

• Porter argues that a sophisticated domestic market is an important element to

producing competitiveness. Firms that face a sophisticated domestic market are
likely to sell superior products because the market demands high quality and a
close proximity to such consumers enables the firm to better understand the needs
and desires of the customers (this same argument can be used to explain the first
stage of the IPLC theory when a product is just initially being developed and after
it has been perfected, it doesn’t have to be so close to the discriminating
consumers).
• If the nation’s discriminating values spread to other countries, then the local firms
will be competitive in the global market.
• One example is the French wine industry. The French are sophisticated wine
consumers. These consumers force and help French wineries to produce high
quality wines. Can you think of other examples? Or counter-examples?

c. Related and Supporting Industries

• Porter also argues that a set of strong related and supporting industries is
important to the competitiveness of firms. This includes suppliers and related
industries. This usually occurs at a regional level as opposed to a national level.
Examples include Silicon valley in the U.S., Detroit (for the auto industry) and
Italy (leather-shoes-other leather goods industry).

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• The phenomenon of competitors (and upstream and/or downstream industries)
locating in the same area is known as clustering or agglomeration. What are the
advantages and disadvantages of locating within a cluster? Some advantages to
locating close to your rivals may be

i. potential technology knowledge spillovers,

ii. an association of a region on the part of consumers with a product and
high quality and therefore some market power, or
iii. an association of a region on the part of applicable labour force.

• Some disadvantages to locating close to your rivals are

i. potential poaching of your employees by rival companies and

ii. obvious increase in competition possibly decreasing mark-ups.

d. Firm Strategy, Structure and Rivalry

1. Strategy

(a) Capital Markets

o Domestic capital markets affect the strategy of firms. Some countries’

capital markets have a long-run outlook, while others have a short-run
outlook. Industries vary in how long the long-run is. Countries with a
short-run outlook (like the U.S.) will tend to be more competitive in
industries where investment is short-term (like the computer industry).
Countries with a long run outlook (like Switzerland) will tend to be more
competitive in industries where investment is long term (like the
pharmaceutical industry).
o What about Canada?

(b) Individuals’ Career Choices

o Individuals base their career decisions on opportunities and prestige. A

country will be competitive in an industry whose key personnel hold
positions that are considered prestigious.
o Does this appear to hold in the U.S. and Canada? What are the most
prestigious occupations? What about Asia? What about developing
countries?

2. Structure

• Porter argues that the best management styles vary among industries. Some
countries may be oriented toward a particular style of management. Those

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 countries will tend to be more competitive in industries for which that style of
management is suited.
• For example, Germany tends to have hierarchical management structures
composed of managers with strong technical backgrounds and Italy has smaller,
family-run firms.

3. Rivalry

• Porter argues that intense competition spurs innovation. Competition is

particularly fierce in Japan, where many companies compete vigorously in most
industries.
• International competition is not as intense and motivating. With international
competition, there are enough differences between companies and their
environments to provide handy excuses to managers who were outperformed by
their competitors.

C. The Diamond as a System

• The points on the diamond constitute a system and are self-reinforcing.

• Domestic rivalry for final goods stimulates the emergence of an industry that
provides specialized intermediate goods. Keen domestic competition leads to
more sophisticated consumers who come to expect upgrading and innovation. The
diamond promotes clustering.
• Porter provides a somewhat detailed example to illustrate the system. The
example is the ceramic tile industry in Italy.
• Porter emphasizes the role of chance in the model. Random events can either
benefit or harm a firm’s competitive position. These can be anything like major
technological breakthroughs or inventions, acts of war and destruction, or
dramatic shifts in exchange rates.
• One might wonder how agglomeration becomes self-reinforcing…

1. When there is a large industry presence in an area, it will increase the supply of
specific factors (ie: workers with industry-specific training) since they will tend to
get higher returns and less risk of losing employment.
2. At the same time, upstream firms (ie: those who supply intermediate inputs) will
invest in the area. They will also wish to save on transport costs, tariffs, inter-firm
communication costs, inventories, etc.
3. At the same time, downstream firms (i.e.: those use our industry’s product as an
input) will also invest in the area. This causes additional savings of the type listed
before.
4. Finally, attracted by the good set of specific factors, upstream and downstream
firms, producers in related industries (i.e.: those who use similar inputs or whose
goods are purchased by the same set of customers) will also invest. This will
trigger subsequent rounds of investment.

D. Implications for Governments

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 • The government plays an important role in Porter’s diamond model. Like
everybody else, Porter argues that there are some things that governments do that
they shouldn't, and other things that they do not do but should. He says,
"Government’s proper role is as a catalyst and challenger; it is to encourage - or
even push - companies to raise their aspirations and move to higher levels of
competitive performance …"
• Governments can influence all four of Porter’s determinants through a variety of
actions such as

a. Subsidies to firms, either directly (money) or indirectly (through

infrastructure).
b. Tax codes applicable to corporation, business or property ownership.
c. Educational policies that affect the skill level of workers.
d. They should focus on specialized factor creation. (How can they do this?)
e. They should enforce tough standards. (This prescription may seem
counterintuitive. What is his rationale? Maybe to establish high technical
and product standards including environmental regulations.)

• The problem, of course, is through these actions, it becomes clear which

industries they are choosing to help innovate. What methods do they use to
choose? What happens if they pick the wrong industries?

E. Criticisms
Although Porter theory is renowned, it has a number of critics.

1. Porter developed this paper based on case studies and these tend to only apply to
developed economies.
2. Porter argues that only outward-FDI is valuable in creating competitive
advantage, and inbound-FDI does not increase domestic competition significantly
because the domestic firms lack the capability to defend their own markets and
face a process of market-share erosion and decline. However, there seems to be
little empirical evidence to support that claim.
3. The Porter model does not adequately address the role of MNCs. There seems to
be ample evidence that the diamond is influenced by factors outside the home
country.

Click this link:

http://www.inc.com/articles/global/1102.html

16
Chaos Theory
By: David H. Freedman

The Fastest-Growing Private Company In America

Never mind playing by the rules. Justice Technology won't even commit to a
particular game

David Glickman remembers having lunch with a veteran telecommunications

executive three years ago and casually mentioning that his own long-distance
phone company had a "hot cut" planned for the next day. That is, the company's
customers' phone traffic would be rerouted from one electronic hub to a new one
over a period of a few minutes, even while customers continued to make calls.

The executive burst into laughter. "I've never heard anyone utter the phrase hot
cut so calmly," he said.

"Really? Why not?" asked Glickman, a trim, animated man who comes off like
something of a cross between Mel Gibson and Richard Simmons.

The executive peered at Glickman strangely. "Don't you know how many phone
companies have gone out of business because of hot cuts that ended up taking
days?"

Well, no--Glickman didn't. He was almost entirely ignorant about hot cuts, even
though he had bet his company's existence on one.

And that, insists Glickman, epitomizes one of Justice Technology Corp.'s keys to
success. "We never knew enough to know what it was we weren't supposed to
be able to do," he says. "We just went ahead and did it."

Tom Peters exhorted companies to embrace chaos, but even he probably didn't
have this wild a ride in mind. Not only does Justice, the #1 company on this
year's Inc. 500 list, refuse to play by the rules; it won't even commit to a particular
game. To make sure it stays that way, Glickman, who is 33, has stocked his
company with people in his own image: young, brash, and a little off-the-wall. It's
as if the cast of Rent had moved to L.A. to take over the phone industry. The
result is a restless organization that keeps redefining its products and even its
core strategy and market, letting technological innovation and personality fill in
the gaps.

17
Not surprisingly, all this tumult is a double-edged sword. There are any number
of ways Justice could get burned, including unexpected changes in regulation,
technological miscues, and a sudden urge on the part of big competitors to swat
it aside. While most successful, growing companies occasionally flirt with failure,
Justice has in a sense been at the brink of disaster since it was founded, and
hasn't strayed that far from it along the way.

The upside? Growth. A lot of growth. Incorporated in 1993, Justice has since
rocketed to revenues of $55 million, parlaying success in a teeny niche market to
virtual domination of certain segments of the global phone business. If you call
other countries, there's a good chance you've already done business with
Justice. In the not-too-distant future, if current plans pan out, you may be using
Justice to call next door. "In some ways we're starting to look like a real phone
company," says Glickman, with mixed emotions.

To show you what the world is coming to, the fastest-growing company in
America is one whose products can't be fully explained without a short course in
telecommunications.

It started with a simple-enough service. Glickman, having earned a bachelor's

degree in economics from the Wharton School and then a master's in psychology
from UCLA, had decided to live in Argentina for a while as a change of pace.
Though he was clearly not the world's most focused individual, American
Express's Argentine office hired him as a management trainee and put him in
charge of reducing overhead. Glickman, 27 at the time, quickly zeroed in on
phone costs: like almost all countries other than the United States, Argentina had
a state-run phone company that charged an arm and a leg for international calls,
and Amex Argentina was running up a monthly bill of $25,000 in international
calls. It was then that Glickman stumbled across an article that described a new
type of U.S.-based phone offering known as a "callback" service.

Here's how callback works: You're based in a country that's not the United
States, and you want to call another country. You start by dialing a number in the
United States that's connected to a callback-service-operated "switch"--that is, a
computerized version of the old-fashioned switchboards that telephone operators
used to sit in front of, manually plugging one phone line into another to make a
connection. You hang up while the phone is still ringing. Even though the switch
hasn't answered the phone, it recognizes your phone number as that of a
customer and calls you back. Your phone rings. You pick it up, and the switch
connects you to a dial tone--a U.S. dial tone. Now you can dial your international
party, and the switch will connect--or, in the parlance of the telecommunications

18
industry, "terminate"--the call. When you're through, you owe your local,
exorbitantly priced phone company nothing because your initial call to the United
States was never terminated. You owe the callback service the cost of the
switch's call from the United States to you, and the cost of your call from the
United States to your party. Since international calls placed from the United
States are dirt cheap compared with international calls from most other countries,
the cost of the two U.S.-originated calls combined is far less--typically 50% to
75% less--than it costs to call your party directly. (Would this be a bad time to
remind you that this is the simple part?)

Excited by the discovery, Glickman presented the idea of callback to his bosses,
only to be told that Amex had no interest in risking irritating Argentina's only
phone company; it essentially regarded its outrageous phone bills as insurance
that its telephone service would remain at least semireliable. "I was amazed," he
recalls. "I thought this service made so much sense that I decided I wanted to sell
it to other companies." After obtaining his bosses' approval, Glickman wrote the
callback-service provider to propose that it let him serve as what he called a
"cocktail-party rep"--that is, someone who pitches the service to businesspeople
at social gatherings.

Over the next month or so he managed to land a few customers. Then, shortly
before he was to visit the United States for a month, a job seeker--a fellow young
American in semidrift mode--landed in front of his desk. There were no openings
at Amex, but Glickman could relate to him and made him an offer: while
Glickman was out of the country, he could work from Glickman's apartment and
try to sell the callback service.

Glickman didn't have high expectations. His hire was a 22-year-old Brown liberal-
arts graduate with no experience in business; he had tried to support himself in
Argentina as a waiter but couldn't get a restaurant to hire him. He spoke just
about the worst Spanish Glickman had ever heard. The morning that Glickman
was leaving, the guy showed up in shorts, a tank top, and sandals, with his one
suit slung over his shoulder. Glickman wished him luck and took off.

When Glickman returned to Argentina, his man reported that he had signed more
than 20 corporate customers, including a few large banks. Each one had paid
from $250 to $700 as an up-front connection charge and was paying a $250
monthly fee for one line--in addition to the per-call charges, which averaged
$2,000 a customer a month. Glickman was running a real business. Adios,
American Express.

19
Glickman's new colleague, Leon Richter, continued to sell the service left and
right. Apparently, his conservative suit and atrocious, heavily accented Spanish
were taken as signs of legitimacy and often quickly landed him in the president's
office of whatever company he cold-called. "Once he was there, the president
would immediately beg him to stop speaking Spanish," explains Glickman. "It
offended them to hear their language butchered." In English, Richter would give
this simple pitch: The service would hack off roughly two-thirds of the company's
international phone bill. And here were sample bills from other multinationals to
prove it.

As customers signed on in a steady stream, Glickman got his first lesson in what
would be a series of principles for success, Justice-style, in global
telecommunications. That lesson: Pay attention to the vagaries of doing business
in a foreign culture. It turned out, for example, that impressive as the savings
detailed call by call on the bills were, some customers were horrified that the
calls were detailed at all--a standard feature of U.S. phone bills but a novelty in
Argentina. Nonplussed that customers would complain about having their calls
broken out, Glickman learned that many Argentine businesspeople keep Swiss
bank accounts that they'd just as soon not advertise to the government via phone
bills that list calls to Switzerland. Others expressed concern about their wives'
discovering multiple calls to certain numbers. And one oddly secretive company
wasn't pleased to see its bills detailing the fact that 90% of its calls went to Iran
and Nicaragua, two countries that had little in common other than that they were
of great interest to the American intelligence community. "We could have made a
lot of money charging people to not have call detail on their bills," says Glickman.

Money was pouring in from customers such as UPS, British Airways, and the
Danish embassy, but Glickman was getting to keep only 25% of the line charge.
The rest was going to the callback provider, for which Glickman was merely
acting as an agent. Why not start his own service and outsource the actual
phone switching? he thought. Glickman went back to the United States and
visited every callback provider he could find, pumping each for more and more
information. Finally, he was able to point his finger confidently at the outfit that
seemed to offer the best service at the lowest cost--a company called IDB
Worldcom. He begged for an appointment with the president and was finally told
he could have an hour at the end of the day, at which point the president was
flying out of town. Glickman flew into New York City for the meeting and made a
case for why IDB should handle Glickman's switching business for a mere 50%
of gross profits. The president was intrigued but had to leave to catch his flight.
Glickman asked him where he was flying to. Washington, D.C., said the man.
What a coincidence, said Glickman, piling into the limo with him. Glickman stuck

20
by him all the way to Washington, by which time the president was sold on the
idea. (The final agreement was that IDB Worldcom would keep 60% of gross
profits.)

Now Glickman and Richter were bringing new customers into their own full-
fledged callback company and began gradually converting all their old customers
to IDB. They were less than a year into the business, and monthly revenues were
climbing above $200,000. Sure, they had plenty of competition from other
callback services, but the market was still wide-open, and--more important--no
one could undercut them on price, thanks to the deal Glickman had wrangled out
of IDB. Lesson number two: Being the lowest-cost provider covers a lot of sins.

Then one day, out of the blue, disaster seemed to strike: the service simply
stopped working. When a customer got the U.S. dial tone and started dialing, the
line would go dead. For every customer. Every time. Finally, Glickman and
Richter realized that the state-run telephone company had programmed its
switches to listen for the sound of touch-tone dialing on calls that had come into
the country. When the tones were detected, the switch would automatically
disconnect the call. The phone company was more or less within its rights;
callback was technically illegal in Argentina at the time, as it was in many other
countries, though it wasn't really prosecutable because the service's operations
were in the United States.

Oh, said Richter. They want to play. Richter contacted an engineer and told him
he wanted a device that could be attached to the customer's phone that would
intercept the number being dialed, sending it out to the U.S. switch not as touch-
tones but as computer data. The device worked perfectly, and Richter and
Glickman were back in business. Then the phone company realized that all of
Glickman's customers' calls went to the same area code and "exchange"--the
three-digit number that leads off the seven-digit phone number. So the phone
company simply blocked all calls from Argentina to that exchange. "What did they
care if they occasionally blocked off a call to that exchange that wasn't even to
our switch?" says Glickman.

Glickman thought of a scheme to make them care. He called Pacific Bell and
bought all the phone numbers that had a certain area code and three-digit
exchange and then distributed those new numbers to his customers. The phone
company quickly moved to block all calls to the new exchange--and then
promptly removed the blocking the next day. The exchange was the same one
used by the Argentine consulate in L.A.

If Glickman and Richter had had any doubts about being in the right business
before then, they didn't anymore. What could be more fun? They were
renegades, locked in a game of cat and mouse with the hidebound, greedy

21
establishment powers that be. And they were winning. Lesson number three:
There is no problem in the phone business that can't be solved with technology
and a little flair.

If the two were doing so well in Argentina, why couldn't they clean up in other
countries? Glickman decided to head back to the United States to set the
company up as a multinational business. But first, he and Richter needed a
name. Ultimately, they agreed on Justice Technology. (See "The Game of the
Name.") They didn't actually have much technology in their company at the time,
but they might as well make it sound as if they did.

Back in the United States, Glickman rented an office above a liquor store in
Santa Monica, hired a marketing manager, summoned Richter, and geared up to
go global. There was just one question: now that they were shooting for the big
time, how would they modify their renegade, freewheeling style to suit the
buttoned-down telecommunications industry? Their conclusion: they wouldn't.
They decided to modify the industry to suit their style.

You see that dent there? There? On the light? That's from basketballs hitting it."
Matt Jarvis is explaining how a warehouse, until recently the post-liquor-store
Justice headquarters, also doubled as a basketball court until the company's
tsunamic growth forced it into new digs. Now Jarvis, in charge of retail services,
along with Glickman and most of the rest of the company's 115 employees,
works in a building in L.A.'s Culver City that's been gutted and remodeled to look
something like a colorful, ultramodern version of...the company's old warehouse.

That's typical of Justice. Glickman and Richter have worked mightily to establish
and maintain a countercultural culture, in the belief that it translates into
outrageous performance. The company offers free dog care, will subsidize
anyone who bicycles or skateboards to work, and treats the entire company to
lunch the day before payday. Pranks are legend; a group of managers once hid
high-powered speakers in the ceiling of one employee's exceptionally junk-
strewn office and rigged his computer so that the arrival of E-mail was
announced by an earsplitting, ultra-high-fidelity performance of the theme from
Sanford & Son. At trade shows, when competitors showed up in spiffy matching
golf shirts and hats, Justice's people marched in sporting matching mechanics'
jumpsuits.

More important, the company tries to hire people who have an affinity for the
offbeat challenge and then puts them straight to the test. Take Jarvis, the 27-
year-old, California-surfer-handsome fellow who joined Justice two years ago. He
was planning to leave his job as an account executive at Leo Burnett Advertising
in Chicago to travel around the world, when his old friend from Brown, Leon
Richter, got wind of the scheme and gave him a call. "What do you want to travel

22
for?" asked Richter. "Adventure," replied Jarvis. "You want adventure?" said
Richter. "Come to L.A. I'll give you adventure."

Jarvis visited the company and signed on, figuring Justice for a fun place. When
he walked in at 8 a.m. on his first day, an employee was waiting for him at the
door in a highly agitated state. "Thank God you're here," said the employee.
"You've got a really important decision to make. Quick, follow me."

A disoriented Jarvis was pulled into a roomful of anxious faces and handed a
sheaf of printed pages. It was copy for a new set of brochures that were being
rushed out, he was told, written by Glickman and due at the printer within a few
hours. Final approval was Jarvis's. Reeling, Jarvis hunkered down in a corner
and started rewriting. "I did what I could," he recalls, shrugging. The pages were
sent out. Two days later Glickman marched into Jarvis's office clutching the new
brochures and demanding to know why he had changed a key line of copy.
Jarvis, assuming he was toast, gave Glickman his reasoning. "Oh," said
Glickman. "OK." And he walked out.

That's the essence of Glickman's management style. "I don't tell people what to
do," he says. "I just want things to get done." Jarvis says that works for him. "As
long as you can explain why you did what you did, he's OK," he says. "He just
wants to make sure you're thinking." Many hires find the lack of structure
disconcerting and leave within a few weeks.

Alan Sandler, the vice-president of sales Glickman hired when he opened

Justice's first office in the United States, is one employee who thrives on the
freedom. He had been selling real estate and then medical services when his
girlfriend, Brooke Sklar--now his wife--answered an ad to share an apartment
and became Glickman's roommate and then the head of Justice's MIS
department. Intrigued by what he heard about the company, Sandler met with
Glickman, who offered him a job. But Sandler wasn't sure. "Callback seemed
pretty shady," he says. The next day, he happened to mention to his
grandmother his indecision about this strange new opportunity. "Oh, go for it,
sweetie," she told him.

He joined Justice and immediately embarked on an ambitious worldwide

marketing campaign. Its approximate budget: zero dollars. All the company's
profits were being invested in building its infrastructure, including its tracking and
billing systems and its network capacity. Sandler, working on commission, would
not see any cash for more than a year.

23
He went off to the library and scoured the U.S. Department of Commerce
database of foreign companies for multinationals that had anything to do with
phone systems and sent them each a letter soliciting them as customers and,
more important, as agents for that country. "We wanted people on the ground
who spoke the language and understood the customs," he explains. Each letter
listed Sandler's title as the coordinator for the recipient's country, as if Justice
had a massive multinational marketing department.

Of the 500 letters that went out, 50 generated responses. Callers would be put
on hold by Glickman and then told they were being transferred to the coordinator
for their country, who was always Sandler. Ten of the 50 respondents ultimately
became agents. Sandler tapped friends in South Africa to help him locate agents
there and even recruited three men as agents for other African countries when
he happened to hear them speaking among themselves in another language in a
Las Vegas hotel elevator.

Sandler offered agents commissions of 7% to 15% of net revenues collected,

depending on how hard the agent negotiated. When the agents who signed on
asked for agent agreements, customer contracts, service instructions, order-
processing routines, and so forth, Sandler promised to fax the documents over
straightaway. Then, since Justice didn't have any such documents, he'd write
them, often staying up all night, since many of the agents were eight or more
time zones away.

Sandler gradually built an in-house staff, which he refers to as his United

Nations. There's Phillipe Lenoir, one of the men from the elevator, who is from
the Congo and is part Belgian, and who speaks four languages fluently. There's
Hans Ye, who is of Chinese descent and has lived in Germany. Altogether, 22
languages are spoken at Justice.

Almost all Justice's growth was bootstrapped. Glickman put in $80,000 of his own
money over time and would occasionally make short-term loans to the company;
later his father would end up lending the company $100,000, which was paid
back in full, with interest, within a year. Other than that, Glickman borrowed
nothing and took on no investors.

One reason Glickman was able to remain free of debt and investors was the
commission policy he had instituted with agents from day one: commissions were
to be paid only on collected revenues, which in effect enlisted agents as
collectors. What's more, if a customer skipped out on its bills, 50% of the bad
debt was charged against the agent's commissions. "The agents would say,
'Why? You're the one checking their credit histories,'" recalls Sandler. "We'd say,
'Yes, but you're the one looking this person in the eye. You should be able to tell

24
if there's a problem.'" As a result, there was rarely a problem with accounts
receivable, and cash flow remained healthy.

But every time it looked as if Justice was cruising, Glickman found a way to put
the company in danger again. He seemed to suffer from a near-pathological
need to take on new business opportunities that by all accounts, including those
of his staff, Justice was incapable of handling. A large South American insurance
agency wanted 100,000 prepaid international phone cards ready to give away as
a promotion for the 1994 World Cup games in three months? Sure, no problem,
said Glickman; send out the contract. Never mind that IDB doesn't do prepaid
phone cards. We'll find a way. Customers are asking for international fax and
paging service? Sign them up. We'll figure out how. And Justice always did. The
lesson: It's better to scramble to deliver a product you've already sold than to
struggle to sell a product you've spent money preparing to deliver. "I didn't feel
comfortable unless I was bringing us out on a limb of a limb of a limb," Glickman
says. "We'd have to turn the company upside down to make it happen, but that's
when things get fun. It's what we all thrive on here."

Richter agrees--which is a good thing, because he ended up taking over product

development and operations. Looking like a mischievous teddy bear, with
sideburns that put Elvis to shame, Richter remains the number two person in the
company, running day-to-day operations. When Justice has to race to fulfill some
over-the-top promise of Glickman's, "it's hell at the time," Richter says, "but when
it's over you feel great."

That sentiment was put to its ultimate test in 1994, when IDB Worldcom was
acquired and the new owners gave Justice six weeks' notice of their intention to
pull the plug on the switch that served as the physical hub of Justice's entire
business. That wasn't nearly enough time to find another phone company that
would provide as good a deal and then to get set up on its switch. No problem,
said Glickman. Justice would get its own switch and program and operate it itself.
It would become a full-fledged phone company. "If someone told me now that a
small company with no experience or expertise had to find and set up its own
switch on such short notice, I'd tell them it was impossible," he says. "Luckily, we
didn't know that then."

Ninety days later, the hot cut--the one that had provoked astonishment from
Glickman's lunch mate--somehow went off without a hitch. Justice Technology
was actually a technology company.

25
Once the technological ice was broken, there was no stopping Glickman, Richter,
and Sandler. Sandler would alert Glickman to a new opportunity, and Glickman
would authorize him to seize it. Then, when the orders starting coming in, he'd
tell Richter to find a way to deliver whatever Sandler had sold.

Many of the opportunities were still in callback, especially in countries where

government regulation was still oppressive, such as most African and South
American nations, as well as many Asian ones. Glickman wanted no niche left
unfilled. Sandler discovered, for example, that European cell-phone users are
naturals for callback services, because in most European locations you're not
charged for airtime when you receive a call.

Still, the writing was on the wall for callback. Deregulation of the phone business
was starting to sweep the world, which meant that traditional "direct dial"
international phone service was dropping in price in many countries, eroding
callback's advantage. That was no coincidence, points out Glickman. "Callback
was one of the major catalysts for deregulation in other countries, because the
state-run phone companies couldn't compete with us," he says.

To make sure Justice didn't sink along with callback, Glickman directed Richter
and Sandler to bring the company into the direct-dial business. Justice now owns
local switches in several countries and has even bought small local phone
companies in Belgium and Argentina, allowing many of their customers to dial
straight through without callback.

Meanwhile, to keep prices down, Glickman was constantly hitting up every

international-phone-service provider he could get a hold of to try to lower what he
paid for termination, which accounted for 70% of Justice's costs. Cheap
termination was the name of the game; it was what allowed Justice to undercut
competitors and protect its gross margins, which averaged around 40%. He
promised providers long-term, exclusive deals if they would shave their lowest
prices for Justice. "I told them they should be selling to me at a lot less than they
sell to big phone companies, because we're exporting the capacity--we don't
compete with them in their home market," he says. He was so intent on making
his case that he once sneaked into an invitation-only communications conference
with bogus press credentials so he could buttonhole bigwigs.

It worked. Other industry executives told Glickman they were stunned to hear
how low he had driven his termination costs--he says that he was sometimes
paying less than half what major carriers were paying for equivalent routes. To
leverage the cost advantage, Richter learned how to monitor constantly

26
fluctuating prices and reroute calls on the fly to chase the bargains, like a
financial trader moving money from one currency or commodity into others in
sync with the complex ebb and flow of the market. He had his staff spend two
years and close to $2 million building a complex computer program called
Pipeline, which tracks the cost of every second of every call so that he can find
and stamp out any inefficiencies hiding in the traffic. The program also tells
salespeople minute to minute how low they can cut their prices and still preserve
a profit.

Then, about a year ago, it suddenly occurred to Glickman that he could make
money off other phone companies' envy of his cheap termination. He'd sell it to
them. That is, instead of buying termination cheaply just for use by Justice's
customers, he could buy everything he could get his hands on at a great price
and resell the extra capacity to other phone companies, wholesale. Though
officially launched just last May, Justice's wholesale termination business, to
which Sandler is now devoting all his time, has mushroomed to the point that it
accounts for 60% of the company's revenues.

With revenues exploding, Glickman finally grudgingly admitted that it was time to
act like a conventional business in at least one respect: managing finances. He
needed a seasoned chief financial officer. Through a friend, he heard about a
woman named Kate Greenberg, who had recently left a large company to seek a
slot with a more entrepreneurial business. He contacted her, but Greenberg told
him she was already mulling over offers from four terrific small companies. "The
next thing I know," recalls Greenberg, "I'm getting swamped with these really
sweet E-mails and calls. Finally, knowing that I was thinking of getting a dog, he
sent me flowers with a note saying that Justice wanted me and my puppy to join
them. I said yes. Wendy would come to Never-Never Land to help Peter and the
boys clean up their rooms."

Although she expected the worst, Greenberg was still stunned by what she
found: accounts payable kept in paper form in an employee's desk drawer; no
lines of bank credit; routine loans from "the bank of Dave" to the company; no
plans for raising capital. Then, upon asking Glickman if she had his OK to start
developing relationships with banks, she was abruptly introduced to his
management philosophy. "What are you asking me for?" he told her. "You're the
CFO. A year from now I'll be reviewing you on how strong our credit access is.
What do I care how you do it?" Having since set up lines of credit, Greenberg is
now trying to set the stage for Justice's inevitable transition from a bootstrapped
company to a well-capitalized one. That will probably mean either accepting a
buyout offer or going public, she says. "Knowing David, I'm not sure his

27
philosophies and style will be all that compatible with the restrictions on a publicly
held company," she says. "But I want to make sure he'll have that option."

In the meantime Justice is jealously guarding its countercultural culture. If the sun
and the waves are right, Richter and Jarvis still take their first meeting of the day
on surfboards. And Glickman is adding a three-story phone, which will cost
hundreds of thousands of dollars, to the front of the building. "It will be the world's
largest working phone," he says, beaming. "There'll be a small booth at the
bottom where anyone can make a free call to anywhere in the United States."

And despite the new emphasis on wholesale termination sales, Justice hasn't
stopped jumping at new niches. It's aggressively developing a phone-via-the-
Internet service and, Glickman says, recently helped set up U.S. TelePacific
Corp. to go after--of all things--conventional local phone business. It's starting off
focused on L.A., with the intention of growing along the California coast and then
the Northwest coast. And from there, who knows?

As for Glickman's penchant for turning the company upside down to deliver on
impossible promises, there are signs that, for better or worse, a certain
pragmatism and even maturity may be setting in. Recently, a $30-million account
came up for grabs, and Glickman told his team he wanted to go for it. As usual,
everyone howled in protest, insisting that trying to service that large an account
all at once would wreck the company. To everyone's amazement, Glickman
backed down. "Not only was it the first time I listened to them about one of these
deals," he says sheepishly, "but it was the first time I even asked them."

On the other hand, Glickman found out that the state of California had put its
billion dollars' worth of business up for bid. "If I had known about it," he says, "I
would have definitely gone for it, and I would have won it, no matter what anyone
said, no matter what it took. If you're not willing to do that sort of thing, why stay
in business?"

Apparently, the adventure continues.

Your task is to apply Porter’s Strategy to the case study above. How useful is
Porter’s theory?

Now have a go at these:

Sunday, 15 September, 2002, 13:25 GMT 14:25 UK

Lessons learned on 'Black Wednesday'

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Ten years ago the pound was forced out of the Exchange Rate Mechanism, a
system for tying its value to that of other European currencies. Black
Wednesday, as 16 September 1992 came to be known, provided one of the
most memorable failures of post-war British economic policy.

It was the defining failure of John Major's government; it was a huge boost to Euro-
scepticism; it made currency traders like George Soros rich.

Policy-makers still bear the scars from that day - when

speculators sold the pound, detaching it from its link to the
Britain's way of
deutschmark.
doing things is now
respected worldwide
The Exchange Rate Mechanism (ERM) had been the centre- - 10 years is
piece of British economic policy - tie the pound to the obviously a long
deutschmark, it was said and you will get a German-style time in economics
economy, with stability and low inflation.

In the event, the strategy DID give us low inflation, but not a stable economy.

The fact that Britain had to follow German interest rates, combined with the fact that
Germany needed tighter monetary policy than Britain at the time, meant the ERM
prolonged an already painful recession in the UK.

And leaving the ERM did not seem to hurt us.

Was it really a disaster?

At the time, it seemed that after Black Wednesday, Britain was sailing into the
unknown.

How low would the pound go? Would inflation erupt as a lower pound forced import
prices to rise? Would people ever have confidence in economic
policy again? It was a nasty taste
of a one-size-fits-all
In the event, things turned out rather well. The pound fell, but interest rate policy
then rose again. (It is now high - above its target value in the
ERM).

Inflation has stayed surprisingly benign since we left. And as for economic policy,
Britain's way of doing things is now respected worldwide - 10 years is obviously a
long time in economics.

Deliberate recession

So what lessons might we draw about the whole experience? Was it really the
disaster it is now thought to be? Was there anything to be said for it?

Well, first it is worth pointing out that statisticians now tell us our economy was
growing significantly faster in the ERM than the published figures suggested at the
time.

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After the statistics were revised and corrected, average growth was about 0.3%
faster than the statistics said in late 1992. That is a considerable difference. The
economy over these two years had 2% more growth in it than we had thought.

It also has to be said that much of the recession we endured - the 1991 recession -
was actually not a result of the ERM, but of the painful hangover from the Lawson
boom.

The recession was a deliberate, and perhaps justified, outcome, designed to get
inflation down to developed world levels.

It worked, and who knows, the ERM may have helped set a low-inflation foundation
for the subsequent decade of relative success.

Conflicting needs

But all this being said, the ERM did prolong the British slump, as it prevented UK
rates from being cut to the levels justified by the UK economy.

It was a nasty taste of a one-size-fits-all interest rate policy. Or indeed, perhaps one
should say a one-size-fitz-all interest rate policy, as it was
actually a German interest rate policy, set for Germany by the
Bundesbank, which was the anchor currency of the whole The mainstream
system. view today is that
fixing exchange
rates as we did in
That tells us that the ERM may have worked better, if the
the ERM is bound to
interest rates had been set not by Germany for Germany, but fail
by Europe for Europe (as they are in the euro).

At the time of the September 1992 crisis, most of Europe -

including Britain, France, Italy and to some extent Spain - wanted lower rates. But it
was the Bundesbank who effectively decided what rates were.

Nevertheless, even if rates had been set on a pan-European basis, the ERM would
undoubtedly have had some problems at some stage.

There are times when the economic policy needs of one country, conflict with the
needs of the other countries.

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What does it mean for the euro?

For what it is worth, the mainstream view today is that fixing exchange rates as we
did in the ERM is bound to fail, what with huge cross-border
flows of currencies.

Any strain in the system caused by conflicting policy needs

will be exploited by speculators, who will destroy the
currency parities.

In effect, that means for most large mid-sized countries

(such as Britain, Argentina, Turkey, France or Brazil) there is
a simple choice - a freely floating currency, or a shared
currency like the euro.
Chancellor Norman Lamont
Personally, I don't think the ERM experience tells us very pictured during the crisis

much about how successful the euro will be.

The euro has benefits in terms of convenience and transaction costs that the ERM
never had; and the euro can't be ripped asunder by currency speculation.

But the euro can involve totally inappropriate economic policies being imposed on
countries.

It is no wonder that while pro-and anti-euro campaigners agree the ERM was a
mistake, they do not agree on which route we should now follow.

Source: BBC Online 15 September 2002

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Questions

1. Arguably ‘black’ was ‘white’ on the Wednesday. Explain how this could be
so? (12 mks)
2. Was being in the ERM bad for British business? (12 mks)
3. Compare the Euro with the ERM. (5 mks)
4. How did being in the ERM prolong the slump? (5 mks)
5. Growth was understated. How might a policy to accelerate growth affect a
British business? (6 mks)
6. “For what it is worth, the mainstream view today is that fixing exchange
rates as we did in the ERM is bound to fail, what with huge cross-border
flows of currencies.” Explain this statement. (6 mks)

32
Friday, 6 September, 2002, 16:24 GMT 17:24 UK
Vietnam aims for quality coffee

Vietnam's coffee exporters caused a world glut

Vietnam's coffee growers plan to produce higher-quality coffee, as falling prices hit
their profits.

They want to scale back production of cheap Robusta coffee beans and increase
production of higher-quality Arabica coffee.

The country, which is the second largest coffee exporter after Brazil, has announced
plans to have 100,000 hectares (250,000 acres) of Arabica coffee beans by 2010.

This should make up for the weaker earnings from the sale of its Robusta beans.

By 2010, Vietnam should be producing 180,000 tonnes of Arabica coffee beans which
would make up a quarter of the country's coffee exports, said Vietnam Coffee
Association (Vinacofa) chairman, Doan Trieu Nhan.

Sharp losses

Coffee prices, and particularly the world price for Robusta coffee beans, have fallen
sharply in recent years to a 30-year low.

Given that Vietnam is the world's leading producer of Robusta coffee beans, the price
fall has hit its coffee farmers hard.

The country's 160 private and state-owned exporters have lost $46m during the last
two years, the finance ministry said.

"It is necessary for Vietnam to decrease the cultivation of Robusta and increase the
cultivation of Arabica because of the worldwide slump in Robusta prices," he said.

Vietnam's income from Robusta exports fell 40% to $193m during the nine months
to June when compared with the same period a year earlier.

In volume terms, exports fell 23%.

Misguided policy

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However, the fall in global coffee prices to their lowest level in 30 years has been
widely blamed on Vietnam itself after the country flooded the market with cheap
Robusta beans which are suitable for instant coffee.

Vietnam's communist authorities' policy of boosting coffee production has backfired,

with many coffee farmers selling at a loss.

Source: BBC Online 6 September 2002

Questions

1. Why would falling prices reduce profits – surely cheaper coffee, given the
low unit cost, would increase revenue and thus profits? (8 mks)
2. “Coffee prices, and particularly the world price for Robusta coffee beans,
have fallen sharply in recent years to a 30-year low.” Suggest possible
reasons for this. (6 mks)
3. Evaluate the strategy proposed to counter the fall in price. (12 mks)
4. Using demand and supply diagrams explain the movement of coffee prices.
(12 mks)

34
Tuesday, 30 May, 2000, 16:42 GMT 17:42 UK
Dot.com gold rush ends

Most e-tailers will fail like boo.com

By BBC NewsOnline's Kevin Anderson

The long predicted shake out in the super-heated dot.com sector has
begun, and few e-tailers will be left standing when the dust settles.
This is the end of the dot.com gold rush

David Cooperstein of Forrester Research

Several high-profile sites including Boo.com, DEN, online grocer Peapod and CDNow
have fallen on hard times.

"This is the end of the dot.com gold rush," said David Cooperstein with IT
consultancy Forrester Research. He is the author of the firm's recent report "The
Demise of Dot Com Retailers."

Market research predicts that the dot.com carnage will be dramatic:

• One in four UK internet companies will burn through their cash reserves in the
next six months, according to a report by PricewaterhouseCoopers, and a
majority of them will have run out of money in 15 months.
• Of the hundreds of e-tailers now in some market segments, at most only
three will be left in each niche after the shakeout, Mr Cooperstein said.
• A similar shake out will occur in business-to-business sites, according to e-
commerce executives. They point to the precipitous drop in B2B stock values
such as the 89% plunge in the price of FreeMarkets share price.

Burn rate
Predictions of the dot.com's demise began ahead the last Christmas shopping season
as hundreds of sites rushed to take advantage of the online frenzy.
Venture capital fuelled an advertising battle as sites spent millions of dollars to rise
above the fray.
Conventional wisdom was that if they were first to grab a substantial market share
that like net pioneers Yahoo! and Amazon.com, they would win and retain their
position as market leaders.

35
Frenzied spending
Ourbeginning.com paid 400% of its 1999 revenues for the ads during the American
football championshipl
The spending spree could only be sustained by continuing to secure venture funding.
Some firms secured a second round of VC money explicitly to fuel their advertising
campaigns.
But e-tailers could not sustain this "burn rate," the term analysts gave to the furious
pace that firms spent money.
Ourbeginning.com paid 400% of its 1999 revenues for the ads during the Super
Bowl, the championship game of American football.
But as more and more sites opened in the already crowded market, "they were
unable to gain consumers attention," Mr Cooperstein said. "They all sounded alike."
Consumers could not differentiate between sites such as Petopia.com Pets.com, he
said.
Growth above all else

The advertising blitz was part of the growth obsession exhibited by dot.coms, Mr
Cooperstein found. Of those companies Forrester polled, 86% of e-tailers pursued
growth above all else, even profits. "It 's too soon for profits - they 're just not
important," one dot.com told Forrester. But investors looking for returns might see
that differently in the jittery stock market.
Razor thin margins, competition from big name clicks and mortar retailers and
investor flight will drive most of today's dot.coms out of business by 2001, according
to Forrester.
Return to rationality
This will set off a wave of sites being bought or going bankrupt.
To survive, the sites will have to stop the lavish spending on ad campaigns and
plunge the money back into the business, the study says.
They will have to be focused on scaling up to meet demand, satisfying their
customers and staying agile in the rapidly changing marketplace.
The shake out will not be a complete bust but rather a return to rationality, said Mr
Cooperstein.
Executives who left traditional retailers for white-hot start-ups will return to former
employers with hat in hand, he said.
It might even help alleviate wage pressures that the Federal Reserve fears might
drive up inflation.

Source: BBC Online 30 May 2000

Questions

1. Identify and comment on the mistakes made by the dot.com failures. (15
mks)
2. How might the dot.com flop alleviate wage pressures? (8 mks)
3. Some dot.com businesses have survived. Suggest possible reasons why
this is so. (8 mks)

Next lesson will be following a more formal structure……

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