The Task Environment - Principles of Management

One of the most popular frameworks for analyzing the task or industry environment is a model developed by Michael Porter known as the five forces model . According to Porter, the ability of a firm to make a profit is influenced by five competitive forces: thethreat of entry by potential competitors, the power of buyers, the power of suppliers, the threatof substitute products, and the intensity of rivalry between firms already in the industry.

Task Environment

InPorter’s framework, the stronger each of these forces, the more difficult it will be for incumbentfirms in an industry to make profits. A strong force thus constitutes a threat, whereas aweak force often gives managers the opportunity to increase sales, raise prices, and makehigher profits. Porter also notes that by getting their firm to pursue the right strategies,managers can alter the strength of the various forces. Thus managers might pursue strategiesthat reduce the bargaining power of buyers, thereby decreasing the threat posed by this force.
In this section we look at each force in turn.

THE THREAT OF ENTRY

In general, if an industry is profitable new enterprises will enter, output will expand, priceswill fall, and industry profits will decline. Managers often strive to reduce the threat of entryby pursuing strategies that raise barriers to entry. Barriers to entry are factors that make itcostly for potential competitors to enter an industry and compete with firms already in theindustry. High entry barriers protect incumbent firms from new competition even when theyare making good profits; they reduce the threat associated with a potential increase in thenumber of competitors in a market.

Economies of scale , which are the cost reductions associated with a large output, representan important barrier to entry. When incumbent firms enjoy significant economies ofscale, they may have a cost advantage over new entrants that lack sales volume. Anotherimportant barrier to entry is the brand loyalty enjoyed by incumbents. Brand loyalty is thepreference of consumers for the products of established companies.

Other things being equal,the higher the brand loyalty enjoyed by incumbents, the harder it is to enter an industry andthe fewer competitors there will be. In the market for cola, for example, Pepsi and Coke enjoysubstantial brand loyalty. It would be expensive for another company to enter the cola marketand try to break down the brand loyalty enjoyed by these enterprises. By pursuing strategiesthat enable their firms to reap economies of scale and brand loyalty, managers in incumbententerprises can limit new entry.

For an example of an industry where incumbents are protected from competition by scaleand brand-based entry barriers, consider the small package express delivery market in theUnited States. Since the late 1980s this market has been dominated by two firms, FedEx andUPS, which together accounted for over 80 percent of the market in the early 2000s. BothFedEx and UPS have spent heavily on advertising to buildtheir brands, which has deterred entry.

Furthermore, successin this market requires substantial capital expendituresamounting to billions of dollars to purchase a nationwidenetwork of aircraft, delivery trucks, tracking systems, sortingfacilities, and drop-off locations. FedEx and UPS haveachieved the shipment volumes required to cover the fixedcosts associated with such a network and enjoy substantialeconomies of scale. As a result, from the early 1980s until2003 there was no new entry into this market: entry barrierskept competitors locked out.

In 2003 this changed when German-owned DHL enteredthe industry by purchasing Airborne Express, a strugglingenterprise in the market with a share of less than 7 percent.DHL’s entry, however, illustrates how hard it is to gain sharein this industry. The company spent $1.02 billion to acquirethe assets of Airborne Express; committed itself to spendinganother $1.2 billion to expand Airborne’s capacity; andlaunched a nationwide advertising campaign, which costanother $150 million, in an attempt to erode the brand loyaltyenjoyed by FedEx and UPS. Due to heavy spending DHL lost$638 million in the United States in 2004 and another $380 million in 2005.

What did DHLget for its money? Not much. In 2005 DHL’s share of the U.S. market stood at 7 percent,barely more than the share enjoyed by Airborne Express before DHL acquired the outfit. Itwould seem that the costs of entering the market are indeed high. DHL is finding it difficultand expensive to overcome the brand loyalty enjoyed by UPS and FedEx and to achieve thevolumes necessary for economies of scale.

BARGAINING POWER OF BUYERS

The next competitive force is the bargaining power of buyers. An industry’s buyers may be theindividual customers who ultimately consume its products (its end users) or the intermediariesthat distribute the industry’s products to end users, such as retailers and wholesalers. Forexample, although detergents made by Procter & Gamble and Unilever are ultimatelypurchased by individual consumers, the principal buyers of detergents from P&G and Unileverare supermarket chains and discount stores, which then resell the products to consumers.

Thebargaining power of buyers is the ability of buyers to bargain down prices charged byfirms in the industry or to raise the firms’ costs by demanding better product quality andservice. By lowering prices and demanding better service, powerful buyers can squeeze profitsout of an industry. Thus powerful buyers should be viewed as a threat. Alternatively, whenbuyers are in a weak bargaining position, firms in an industry may have the opportunity toraise prices and increase the level of industry profits.

Buyers are most powerful when one or more of the following conditions holds:

  1. they arefew in number and purchase large quantities,
  2. they can choose between equivalent productsfrom many different firms, and
  3. they can switch easily between the offerings of differentfirms (their switching costs are low).

Consider the power that Wal-Mart has over manufacturersof detergents. Wal-Mart is the largest retailer in the world, accounting for some 8 percent ofU.S. retail sales, so it buys in huge quantities. Its volume purchases give it considerableleverage over producers like Procter & Gamble and Unilever: Wal-Mart can demand that they lower prices in return for access to shelf space. Moreover, Wal-Mart can easily adjust theamount of shelf space it devotes to detergents from P&G and Unilever, and it uses this fact,along with the threat of devoting more shelf space to its own brands, as a bargaining tactic toget firms like P&G and Unilever to lower their prices. Thus Wal-Mart has considerablebargaining power over firms in the detergent industry. It purchases in great quantities, it canchoose between many products, and it can switch easily between different offerings.

Buyers are in a weak position when

  1. they are plentiful and purchase in small quantities,
  2. they have little choice, and
  3. they cannot switch easily between the offerings ofdifferent firms.

For an example of buyers who are in a weak position, consider the buyers ofoperating systems for personal computers. Most such buyers purchase in small amountsrelative to the size of the market, so they lack the leverage that comes from volume. Morethan 90 percent of the world’s personal computers use Microsoft’s Windows operatingsystem; the only other viable choice is Apple’s operating system. Thus buyers have littlechoice.

Moreover, if people use Microsoft’s Windows operating system and have libraries ofrelated software applications, it is expensive to switch to another computer operating systembecause in addition to purchasing the operating system itself, they would have to purchasenew software applications. 6 In other words, the switching costs facing buyers are high andtheir bargaining power is low.

As the Microsoft example illustrates, high switching costs can significantly reduce thebargaining power of buyers. Switching costs arise when it costs a buyer time, energy, andmoney to switch from a product offered by one enterprise to that offered by another. Whenswitching costs are high, buyers can be locked in to the product offerings of a firm, even ifother enterprises offer better products.

Managers often try to gain bargaining power overbuyers by trying to increase the switching costs they must bear to adopt a rival product. To theextent that they are successful, this enhances the ability of the firm to raise prices. Forexample, wireless telephone providers try to induce customers to sign multiyear contracts inreturn for new telephones—a strategy that increases switching costs.

As a result, wirelessfirms have been able to charge higher prices than would otherwise have been the case. On theother hand, anything that lowers switching costs should be viewed as a threat. In 2003 justsuch a threat emerged in the wireless telephone industry when the government allowed customersto take their phone numbers with them when they switched from one carrier to another.Prior to this legislation, the inconvenience associated with changing telephone numbers whencustomers changed carriers constituted a powerful switching cost.

BARGAINING POWER OF SUPPLIERS

Suppliers provide inputs to the firm. These inputs may be raw materials, partly finished products,or services. Suppliers include the employees of a firm, who supply their skills and timein return for pay. Whether suppliers represent an opportunity or threat to a firm depends onthe extent of their control over inputs the firm needs to function. In the extreme case, wherethere is only a single supplier of an important input, that supplier has substantial bargainingpower over the firm and can use this power to raise input prices and increase costs. Such asituation constitutes a threat.

Managers try to reduce this threat by finding alternativesuppliers. A good example of this situation has occurred in the personal computer industry,where chip maker Intel has long been the dominant supplier of microprocessors to personalcomputer makers. This has given Intel substantial bargaining power over PC manufacturersand enabled Intel to charge higher prices. Managers at PC firms have responded by encouragingIntel’s sole competitor, AMD, to increase its supply of microprocessors. This effort hasmet with limited success. Intel’s brand loyalty among consumers is high, and their preferencefor computers with Intel microprocessors has limited the ability of PC firms to develop thisalternative supply source.

Suppliers represent an opportunity when incumbent firms have bargaining power overthem and can reduce the prices they pay for inputs. As noted earlier, Wal-Mart has suchenormous bargaining power that it has been able to drive down the prices it pays suppliers forgoods and service, which increases the profitability of Wal-Mart. The bargaining power of anenterprise over its suppliers is greater if one or more of the following conditions holds:

  1. thefirm purchases in large quantities,
  2. it can choose between multiple suppliers,
  3. the costsof switching between suppliers is low, and
  4. the firm is not dependent on any single supplierfor important inputs.

Another competitive force in Porter’s model is the threat of substitute products : the goods or services of different businesses or industries that can satisfy similar customer needs. For example, firms in the coffee industry compete indirectly with those in the tea and cola drink industries because all three serve customer needs for nonalcoholic caffeinated drinks. The existence of close substitutes is a strong competitive threat because this limits the prices that companies in one industry can charge for their products, and thus industry profitability. If the price of coffee rises too much relative to that of tea or cola, coffee drinkers may switch to those substitutes.

If an industry’s products have few close substitutes, so that substitutes are a weak competitive force, then other things being equal, firms in the industry have the opportunity to raise prices and earn additional profits. For example, there is no close substitute for microprocessors, which lets companies like Intel and AMD charge higher prices.

Substitutes based on new technologies can be a particularly potent threat. Consider what happened to the typewriter industry after the spread of personal computers and word processing software during the 1980s. From the 1870s through the 1980s the typewriter industry enjoyed significant growth with firms like Smith Corona, IBM, and Olivetti deriving substantial revenues from this market. By 1996 the industry was dead. The last great typewriter manufacturer, Smith Corona, went bankrupt that year and closed its doors for good. It was killed by the rise of the substitute: personal computers with word processing software.

THE INTENSITY OF RIVALRY

Last in Porter’s model, but by no means least, is the intensity of rivalry between firms in an industry. Intense rivalry between incumbents, such as we currently see in the airline industry, is a threat that reduces the profits of established enterprises. Conversely, anything that reduces the intensity of rivalry between incumbent firms, allowing them to raise prices and make greater profits, can be seen as an opportunity. A number of different factors determine the intensity of rivalry in an industry: the nature of the product, demand and supply conditions, the cost structure of firms, and the competitive structure of the industry.

The Nature of the Product Some products can be thought of as commodities or as being commoditylike. A commodity product is one that is difficult to differentiate from those produced by rivals. Pure commodities include raw materials, such as oil, natural gas, and coal, along with many agricultural products—like wheat, corn, beef, and pork. In such cases rival firms’ products are close substitutes for each other, if not exactly the same thing.

Thus it might be difficult for a consumer to distinguish between the gasoline sold by different service stations, the wheat produced by different farmers, and the gold from different mines. An inability to differentiate a product from those produced by competitors can result in competition defaulting to the lowest common denominator: price! An inability to compete on attributes other than price tends to be a threat, because this can lead to a downward price spiral and lower profits, particularly if demand conditions are weak.

Managers try to deal with this threat by finding ways to differentiate their products. This has been a surprisingly successful strategy in some industries where the products might seem difficult to differentiate. Take the water industry: In many ways water is the ultimate commodity, yet clever marketing coupled with a little bit of natural carbonation and a slice of French cunning has enabled Perrier to successfully differentiate its carbonated bottled water from that produced by other enterprises.

Some products that are not pure commodities, such as airline travel, are commodity like because many firms provide products that are almost identical and thus are close substitutes for each other. Most airline passengers viewthe service of competing airlines as similarand thus choose between them on the basis of price. Managers in the airline industry have pursued all sorts of tactics to try to differentiate their product offerings—from frequent flyer programs to in-flight entertainment systems—but with only limited success. Those offerings are often quickly imitated by competitors, in which case competition again defaults to price.

Demand and Supply Conditions If overall customer demand for a product or service is growing, the task environment can be viewed as more favorable. Firms will have the opportunity to expand sales and raise prices, both of which may lead to higher profits. Of course the converse also holds: Stagnant or falling demand is a threat that leads to lower profits. Thus falling demand for airline travel due to an economic slowdown and the terrorist attacks of September 11th, 2001, resulted in net profits in the U.S. airline industry of $2.49 billion in 2000 turning into a net loss of $11.3 billion in 2002.

Demand trends in an industry are determined by several factors. Among the more important are economic growth and rising income levels. For example, as noted earlier, Boeing predicts that demand for air travel will grow by 4.8 percent yearly between 2005 and 2025. This is primarily because Boeing believes that the world economy will grow at 2.9 percent per year over this period; income levels will rise accordingly, and as people get richer they tend to fly more.

This is good news for Boeing, which expects robust demand for commercial aircraft over the next 20 years, with nearly 26,000 jets valued at over $2 trillion being sold. 9 It could also be good news for the beleaguered airline industry if growing demand translates into higher prices and greater profits.

In addition to demand, supply conditions are also important to consider. Specifically, a major determinant of the intensity of rivalry in an industry is the amount of productive capacity (supply) relative to demand. If demand for the goods or services produced by firms in an industry exceeds capacity (supply) in the industry—if a situation of excess demandexists—prices will be bid up by consumers and rivalry will be reduced.

Conversely, if supply exceeds demand—if a situation of excess capacity exists—firms will compete vigorously for enough sales volume to efficiently utilize their capacity, rivalry will be intense, and prices and profits will trend lower. Excess demand thus represents an opportunity and excess capacity a threat.

Between 2004 and 2006 the world oil market was experiencing excess demand. Demand had expanded faster than predicted, driven partly by surging demand from the rapidly industrializing nation of China. There was insufficient readily available supply in the world to meet this demand. So oil prices increased from around $20 a barrel in 2003 to over $70 a barrel in April 2006. This was a great environment for oil producers, who saw their profits surge.

The market for high-speed Internet bandwidth is a good example of what can occur when capacity exceeds demand (when there is a situation of excess capacity). Between 1996 and 2001 a number of enterprises, including WorldCom, Global Crossing, XO Communications, and 360 Networks, made multi-billion-dollar investments in fiber optic cable to carry Internet data. These investments were made in the belief that demand for Internet bandwidth was growing by 1,000 percent a year.

This turned out not to be the case (it was actually growingby 100 percent per year), and by 2002 it was apparent that there was far too much fiber optic cable in the ground given demand conditions (supply exceeded demand). Indeed, more than 90 percent of all fiber optic cables were “dark”—they were transmitting no data. This excess capacity resulted in plunging prices and triggered a wave of corporate bankruptcies. All of the companies just mentioned went bankrupt because they could not generate sufficient revenues to service the debt they had taken on to build their fiber optic networks.

Most industries go through periods of both excess demand and excess capacity. A critical thing for managers to understand is how long the excess is likely to persist because that helps define the scale and longevity of the associated opportunity or threat. In other words, managers need to understand how fast the market in which their organization competes adjusts and how quickly demand and supply will be brought back into balance.

The speed of the adjustment process is partly determined by barriers to entry and barriers to exit. We have already discussed barriers to entry. Barriers to exit , the opposite of barriers to entry, are factors that stop firms from reducing capacity even when demand is weak and excess capacity exists.

Barriers to exit include

  1. the fixed costs of closing down capacity, such as the financial charges that must be taken to shut down a plant and lay off employees;
  2. an unwillingness to reduce capacity due to a belief, which may be misplaced, that demand will soon rebound; and
  3. government regulations,

such as Chapter bankruptcy rules in the United States, that allow insolvent enterprises to reorganize their debt and keep operating under the protection of a bankruptcy court.

Figure summarizes the possibilities here. If excess demand exists and barriers to entry are high, the entry barriers will lock potential rivals out of the market, the intensity of rivalry within the industry will remain low, and the period of plenty will persist for some time.

excess demand

Such a situation represents a significant opportunity for the firm. Conversely, if excess demand exists but entry barriers are low, new enterprises are likely to enter the industry, attracted by the high prices and profits of incumbents; supply will expand and prices fall until supply anddemand are brought into balance. Thus the opportunity associated with excess demand in such a situation is transitory.

If excess supply (capacity) exists but barriers to exit are low, it is likely that supply will be quickly reduced until it is in line with demand, and the intense rivalry will be relatively short lived. However, if excess capacity exists and barriers to exit are high, this represents a significant threat that may persist for some time, with unfortunate consequences for enterprises in the industry.

This has long been the case in the steel industry. Demand for steel in the United States has been declining since the 1960s as other materials, including composites, plastics, and aluminum, have replaced steel in many product applications.

Excess capacity began to emerge in the 1970s and has been a persistent feature of the industry ever since, with as much as 40 percent of U.S. steel capacity standing idle at any time. Although many steel enterprises went bankrupt, Chapter 11 regulations allowed these companies to keep operating until they emerged from bankruptcy protection. As a result, the excess capacity did not go away fast.

Not until the late 1990s and early 2000sdid many of the old steel companies finally shut down. Because of these factors, the steel industry has been characterized by intense rivalry, low prices, and low or negative profits for years. Thus the combination of excess capacity and high exit barriers constituted a significant and persistent threat.

The Cost Structure of Firms Fixed costs are those that must be borne before a firm makes a single sale. For illustration, before they can offer service, cable TV companies have to lay cable in the ground; this is a fixed cost. Similarly, to offer air express service a company like FedEx has to invest in planes, package sorting facilities, and delivery trucks. These are fixed costs that require significant capital investments. In industries where the fixed costs of production are high, if sales volume is low, firms cannot cover their fixed costs and will not be profitable.

This creates an incentive for firms to cut their prices and increase promotion spending to raise sales volume, thereby covering fixed costs. In situations where demand is not growing fast enough and too many companies are cutting prices and raising promotion spending, the result can be intense competition and lower profits. 11 Thus high fixed costs should be viewed as a threat, particularly when combined with weak demand conditions or excess capacity.

Managers often look for ways to reduce the threat associated with high fixed costs. One strategy involves trying to push off high fixed costs onto another organization. Cisco Systems, the world’s largest producer of routers (the computer switches at the heart of the Internet that direct traffic), has significantly reduced its fixed costs by outsourcing much of the manufacturing of its routers to independent contract manufacturers.

Cisco concentrates on the design, marketing, sales, and support functions of the business, all of which have low fixed costs. Another strategy involves developing new methods of production that have lower fixed costs. In the automobile industry, for example, Toyota has pioneered the development of new flexible production technologies that have much lower fixed costs than the traditional mass production methods used in the industry. This has reduced the threat associated with having a high fixed cost structure and weak demand conditions.

Competitive Structure The competitive structure of an industry is the number and size distribution of incumbent firms. Industry structures vary, and different structures have different implications for the intensity of rivalry. A fragmented industry consists of many small or medium-sized companies, none of which is in a position to determine industry price.

A consolidated industry is dominated by a few large companies (an oligopoly) or in extreme cases by just one company (a monopoly); here companies often are in a position to determine industry prices. Examples of fragmented industries include agriculture, dry cleaning, and radio broadcasting. Consolidated industries include the aerospace, soft drink, and the small package express industries.

Fragmented industries are characterized by low entry barriers and commodity products that are hard to differentiate. The combination of these traits tends to result in boom and bust cycles as industry profits rise and fall. Low entry barriers imply that whenever demand is strong and profits are high, new entrants will flood the market, hoping to profit from the boom. The explosion in the number of video stores, health clubs, and sun tanning parlors during the 1980s and 1990s exemplifies this situation.

Often the flood of new entrants into abooming fragmented industry creates excess capacity, so firms cut prices to use their spare capacity. The difficulty firms face when trying to differentiate their products from those of competitors can exacerbate this tendency. The result is a price war, which depresses industry profits, forces some companies out of business, and deters potential new entrants.

For example, after a decade of expansion and booming profits, many health clubs are now finding that they have to offer large discounts to hold their members. In general, the more commodity like an industry’s product is, the more vicious will be the price war. This bust part of the cycle continues until overall industry capacity is brought into line with demand, at which point prices may stabilize again.

In general, a fragmented industry structure constitutes a threat rather than an opportunity. Most booms are relatively short-lived because of the ease of new entry; they will be followed by intense price competition and bankruptcies. Because it is often difficult to differentiate products in these industries, the best strategy for managers is to try to minimize costs so their enterprises will be profitable in a boom and survive any subsequent bust.

Alternatively, managers might try to adopt strategies that change the underlying structure of fragmented industries and lead to a consolidated industry structure in which the level of industry profitability is increased.

For example, at one time the video rental industry was very fragmented and characterized by many small independent video rental stores. In the 1990s, however, managers at two firms, Blockbuster and Hollywood Video, pursued strategies that consolidated the industry.

They built national brands though aggressive marketing, gained a differential advantage over their competitors by offering a wide availability of popular videos in large stores, and as they grew were able to use their bargaining power to drive down the costs they paid film studios for videos. In other words, by their choice of strategies, managers at Blockbuster and Hollywood Video transformed the industry structure, making it more favorable.

In consolidated industries firms are interdependent because one firm’s competitive actions or moves (with regard to price, quality, and so on) directly affect the market share of itsrivals and thus their profitability. When one firm makes a move, this generally forces aresponse from its rivals. The consequence of such interdependence can be a dangerouscompetitive spiral. Rivalry increases as firms attempt to undercut each other’s prices or offercustomers more value in their products, pushing industry profits down in the process.

Thefare wars that have periodically created havoc in the airline industry provide a goodillustration of this process. Similarly, in the automobile industry if General Motors offersdiscounts to try to sell more cars (zero rate financing and cash-back rebates, for example),this will hurt the sales of Ford, which then has to respond in kind or lose market share.

Competitive interdependence in consolidated industries is thus a threat. Managers often seek to reduce this threat by pursuing strategies to differentiate their products from those offered by rivals, thereby making demand less vulnerable to price cuts by rivals. In the automobile industry firms try to differentiate their offerings by styling and quality. This has worked for Toyota, whose reputation for superior quality has insulated the firm from price competition; but it has not worked for Ford and GM, whose products are seen by consumers as roughlyequivalent to each other.

A SIXTH FORCE: COMPLEMENTORS

Although Porter’s model is based on five forces, many observers believe that a six force is also important: complementors. 13Complementorsare firms that provide goods or services that are complementary to the product produced by enterprises in the industry. For example, a complementary product for video game consoles such as the Sony PS2 and Microsoft Xbox are the games themselves.

Complementors to Sony and Microsoft include independent firms that produce video games such as Electronic Arts and Activision. Complementors can be important drivers of demand conditions in some industries. Demand for video game consoles depends on a good supply of games from independent firms. Similarly, demand for the SoundDock speaker system produced by Bose (a set of powerful high-quality speakers that can play music from an Apple iPod) depends on the installed base of iPods. As more iPods are sold, demand increases for the speaker system produced by Bose.

As suggested by these examples, in industries where complements are important, strong complementors that make products consumers demand represent a substantial opportunity for a firm to increase its own revenues. Conversely, weak complementor product offerings can constitute a significant threat to a firm. In the early 2000s, for example, Sega introduced a powerful video game console, the Dreamcast, ahead of both Sony’s PS2 system and Microsoft’s Xbox. But demand for the Dreamcast was weak because there were few compelling games to play on the machine, and in the end Sega was forced to withdraw its console from the market.

SYNTHESIS

Figure summarizes the various elements we have discussed so far. When analyzing the task environment using Porter’s five forces model (or six forces if complementors are included), remember that the forces interact with each other, and some forces may be more important than others depending on the industry setting. Managers need to look at the big picture when trying to understand the competitive forces that determine the nature of rivalry in their industry.

For example, the task environment confronting a firm may be particularly challenging if its industry is characterized by commoditylike products, powerful buyers with low switching costs who can bargain down prices, powerful suppliers who can raise input costs (or stop them from being reduced), high fixed costs, weak demand conditions, excess capacity, and easy new entry. These were the conditions prevailing in the airline industry between 2001 and 2005, and the results were awful for many firms in this industry.

various elements

Conversely, if an industry is characterized by differentiated product offerings, relatively weak buyers who face high switching costs, an absence of powerful suppliers and substitutes, low fixed costs, high entry barriers, few rivals, and steady demand growth, it will be favorable for incumbent enterprises. Microsoft, of course, faces just such an environment in the market for computer operatingsystems and office productivity software (such as Microsoft Office). Not surprisingly, thefirm’s performance has been very strong.

The power of this approach lies not only in the identification of opportunities and threats in the task environment, but also in the help it gives managers when thinking through the various strategies they might pursue to take advantage of opportunities, and to counter threats, to better attain the goals of their enterprise. For example, an industry analysis by managers at FedEx during the early 1990s concluded that buyers were powerful due to low switching costs and their perception that the offerings of FedEx and UPS were similar.

The same analysis revealed growing demand from corporate customers who wanted FedEx to take over their logistics operations, shipping components between different manufacturing locations and finished goods to retailers. The managers at FedEx saw this as an opportunity to pursue a different strategy that would add value to their product offering and increase switching costs.

Specifically, FedEx managers realized that they could use their network to offer logistics services to customers, and that once customers had integrated their own operations with those of FedEx, it would be more difficult for them to switch—thereby reducing their tendency to periodically use the threat of switching as a device for getting volume discounts. This strategy has been successful for both FedEx and for UPS allowing both firms to increase revenues and profits.


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