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Learning Objectives HW and Panera Case study HW. 

Need 1.5-2 pages answer for Learning Objectives Ch.1-4 *keep questions on the answer sheet and need answer the question one by one, don’t put all together.

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Learning Objectives Chapters 1-4

CH.1 What Is Strategy and Why Is It Important?

LO 1 What we mean by a company’s strategy.

LO 2 The concept of a sustainable competitive advantage.

LO 3 The five most basic strategic approaches for setting a company apart from rivals and winning a sustainable competitive advantage.

LO 4 That a company’s strategy tends to evolve because of changing circumstances and ongoing efforts by management to improve the strategy.

LO 5 Why it is important for a company to have a viable business model that outlines the company’s customer value proposition and its profit formula.

LO 6 The three tests of a winning strategy.

CH. 2 Charting a Company’s Direction Its Vision, Mission, Objectives, and Strategy

LO 1 Why it is critical for company managers to have a clear strategic vision of where a company needs to head.

LO 2 The importance of setting both strategic and financial objectives.

LO 3 Why the strategic initiatives taken at various organizational levels must be tightly coordinated to achieve companywide performance targets.

LO 4 What a company must do to achieve operating excellence and to execute its strategy proficiently.

LO 5 The role and responsibility of a company’s board of directors in overseeing the strategic management process.

CH.3 Evaluating a Company’s External Environment

LO 1 How to recognize the factors in a company’s broad macro-environment that may have strategic significance.

LO 2 How to use analytic tools to diagnose the competitive conditions in a company’s industry.

LO 3 How to map the market positions of key groups of industry rivals.

LO 4 How to determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability.

CH. 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness

LO 1 How to take stock of how well a company’s strategy is working.

LO 2 Why a company’s resources and capabilities are centrally important in giving the company a competitive edge over rivals.

LO 3 How to assess the company’s strengths and weaknesses in light of market opportunities and external threats.

LO 4 How a company’s value chain activities can affect the company’s cost structure and customer value proposition.

LO 5 How a comprehensive evaluation of a company’s competitive situation can assist managers in making critical decisions about their next strategic moves.

Discussion Question (CH 1-2) (need 0.5-0.75-page answer)

Defend the need for clear operating policies in an organization and include in your discussion how “organizational practices” sometimes supersede the “written policies” of an organization. Describe how this might hinder the implementation of a strategic goal.

Discussion Question (CH 3-4) (need 0.5-0.75-page answer)

Briefly discuss the value of the “Framework for Competitor Analysis” and if you believe these four cover the basic framework for an analysis or should another dimension be added. And, if one needs to be added in your opinion, what do you suggest the fifth or even sixth dimension should be??

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CHAPTER 3

Evaluating a
Company’s
External
Environment

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 How to recognize the factors in a company’s broad macro-environment that may have
strategic significance.

LO 2 How to use analytic tools to diagnose the competitive conditions in a company’s
industry.

LO 3 How to map the market positions of key groups of industry rivals.

LO 4 How to determine whether an industry’s outlook presents a company with sufficiently
attractive opportunities for growth and profitability.

© Bull’s Eye/Image Zoo/Getty Images

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No matter what it takes, the goal of strategy is to beat
the competition.

Kenichi Ohmae—Consultant and author

There is no such thing as weak competition; it grows
all the time.

Nabil N. Jamal—Consultant and author

Sometimes by losing a battle you find a new way to
win the war.

Donald Trump—President of the United States and

founder of Trump Entertainment Resorts

Every company operates in a broad “macro-environment”  that comprises six
principal components: political factors; economic conditions in the firm’s general
environment (local, country, regional, worldwide); sociocultural forces; technologi-
cal factors; environmental factors (concerning the natural environment); and legal/
regulatory conditions. Each of these components has the potential to affect the firm’s
more immediate industry and competitive environment, although some are likely to
have a more important effect than others (see Figure 3.2). An analysis of the impact
of these factors is often referred to as PESTEL analysis, an acronym that serves as a
reminder of the six components involved (political, economic, sociocultural, techno-
logical, environmental, legal/regulatory).

THE STRATEGICALLY RELEVANT FACTORS IN
THE COMPANY’S MACRO-ENVIRONMENT

LO 1

How to recognize
the factors in a
company’s broad
macro-environment
that may have
strategic significance.

In order to chart a company’s strategic course
wisely, managers must first develop a deep under-
standing of the company’s present situation. Two
facets of a company’s situation are especially
pertinent: (1) its external environment—most nota-
bly, the competitive conditions of the industry in
which the company operates; and (2) its internal
environment—particularly the company’s resources
and organizational capabilities.

Insightful diagnosis of a company’s external
and internal environments is a prerequisite for
managers to succeed in crafting a strategy that
is an excellent fit with the company’s situation—
the first test of a winning strategy. As depicted in
Figure 3.1, strategic thinking begins with an
appraisal of the company’s external and internal

environments (as a basis for deciding on a long-
term direction and developing a strategic vision),
moves toward an evaluation of the most promising
alternative strategies and business models, and
culminates in choosing a specific strategy.

This chapter presents the concepts and analytic
tools for zeroing in on those aspects of a compa-
ny’s external environment that should be consid-
ered in making strategic choices. Attention centers
on the broad environmental context, the specific
market arena in which a company operates, the
drivers of change, the positions and likely actions
of rival companies, and the factors that determine
competitive success. In Chapter 4, we explore
the methods of evaluating a company’s internal
circumstances and competitive capabilities.

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CORE CONCEPT

PESTEL analysis can
be used to assess the
strategic relevance of the
six principal components
of the macro-environment:
Political, Economic,
Social, Technological,
Environmental, and Legal/
Regulatory forces.

FIGURE 3.1 From Thinking Strategically about the Company’s Situation to
Choosing a Strategy

Identify
promising
strategic
options
for the

company

Select the
best

strategy
and

business
model
for the

company

Form a
strategic
vision of
where the
company
needs to

head

Thinking
strategically

about a
company’s

external
environment

Thinking
strategically

about a
company’s

internal
environment

Since macro-economic factors affect different industries in different ways and
to different degrees, it is important for managers to determine which of these repre-
sent the most strategically relevant factors outside the firm’s industry boundaries.
By strategically relevant, we mean important enough to have a bearing on the deci-
sions the company ultimately makes about its long-term direction, objectives, strat-
egy, and business model. The impact of the outer-ring factors depicted in Figure 3.2
on a company’s choice of strategy can range from big to small. But even if those
factors change slowly or are likely to have a low impact on the company’s business
situation, they still merit a watchful eye.

For example, the strategic opportunities of cigarette producers to grow their
businesses are greatly reduced by antismoking ordinances, the decisions of
governments to impose higher cigarette taxes, and the growing cultural stigma
attached to smoking. Motor vehicle companies must adapt their strategies to cus-
tomer concerns about high gasoline prices and to environmental concerns about
carbon emissions. Companies in the food processing, restaurant, sports, and fit-
ness industries have to pay special attention to changes in lifestyles, eating habits,
leisure-time preferences, and attitudes toward nutrition and fitness in fashioning
their strategies. Table 3.1 provides a brief description of the components of the
macro-environment and some examples of the industries or business situations
that they might affect.

As company managers scan the external environment, they must be alert for
potentially important outer-ring developments, assess their impact and influence,

and adapt the company’s direction and strategy as needed. However, the factors in a
company’s environment having the biggest strategy-shaping impact typically pertain
to the company’s immediate industry and competitive environment. Consequently, it is
on a company’s industry and competitive environment that we concentrate the bulk of
our attention in this chapter.

CORE CONCEPT

The macro-environment
encompasses the broad
environmental context in
which a company’s industry
is situated.

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FIGURE 3.2 The Components of a Company’s Macro-Environment

Political
Factors

MACRO-E
NVIRONMENT

Economic Conditions

Legal/
Regulatory

Factors

Environmental
Forces

Technological
Factors

Sociocultural
Forces

COMPANY

Substitute
Products

Suppliers

Rival
Firms

New
Entrants

Buyers

Im
me

diat
e Ind

ustry and Competitive Environment

Thinking strategically about a company’s industry and competitive environment
entails using some well-validated concepts and analytic tools. These include the
five forces framework, the value net, driving forces, strategic groups, competitor
analysis, and key success factors. Proper use of these analytic tools can provide
managers with the understanding needed to craft a strategy that fits the company’s
situation within their industry environment. The remainder of this chapter is
devoted to describing how managers can use these tools to inform and improve their
strategic choices.

ASSESSING THE COMPANY’S INDUSTRY
AND COMPETITIVE ENVIRONMENT

LO 2

How to use analytic
tools to diagnose
the competitive
conditions in a
company’s industry.

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Component Description

Political factors Pertinent political factors include matters such as tax policy, fiscal policy, tariffs, the political
climate, and the strength of institutions such as the federal banking system. Some political
policies affect certain types of industries more than others. An example is energy policy,
which clearly affects energy producers and heavy users of energy more than other types of
businesses.

Economic
conditions

Economic conditions include the general economic climate and specific factors such as interest
rates, exchange rates, the inflation rate, the unemployment rate, the rate of economic growth,
trade deficits or surpluses, savings rates, and per-capita domestic product. Some industries,
such as construction, are particularly vulnerable to economic downturns but are positively
affected by factors such as low interest rates. Others, such as discount retailing, benefit when
general economic conditions weaken, as consumers become more price-conscious.

Sociocultural
forces

Sociocultural forces include the societal values, attitudes, cultural influences, and lifestyles
that impact demand for particular goods and services, as well as demographic factors such as
the population size, growth rate, and age distribution. Sociocultural forces vary by locale and
change over time. An example is the trend toward healthier lifestyles, which can shift spending
toward exercise equipment and health clubs and away from alcohol and snack foods. The
demographic effect of people living longer is having a huge impact on the health care, nursing
homes, travel, hospitality, and entertainment industries.

Technological
factors

Technological factors include the pace of technological change and technical developments
that have the potential for wide-ranging effects on society, such as genetic engineering,
nanotechnology, and solar energy technology. They include institutions involved in creating
new knowledge and controlling the use of technology, such as R&D consortia, university-
sponsored technology incubators, patent and copyright laws, and government control over
the Internet. Technological change can encourage the birth of new industries, such as the
connected wearable devices, and disrupt others, such as the recording industry.

Environmental
forces

These include ecological and environmental forces such as weather, climate, climate change,
and associated factors like water shortages. These factors can directly impact industries
such as insurance, farming, energy production, and tourism. They may have an indirect but
substantial effect on other industries such as transportation and utilities.

Legal and
regulatory
factors

These factors include the regulations and laws with which companies must comply, such as
consumer laws, labor laws, antitrust laws, and occupational health and safety regulation. Some
factors, such as financial services regulation, are industry-specific. Others, such as minimum
wage legislation, affect certain types of industries (low-wage, labor-intensive industries) more
than others.

TABLE 3.1 The Six Components of the Macro-Environment

The character and strength of the competitive forces operating in an industry are never
the same from one industry to another. The most powerful and widely used tool for
diagnosing the principal competitive pressures in a market is the five forces frame-
work.1 This framework, depicted in Figure 3.3, holds that competitive pressures on

THE FIVE FORCES FRAMEWORK

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companies within an industry come from five sources. These include (1) competition
from rival sellers, (2) competition from potential new entrants to the industry, (3)
competition from producers of substitute products, (4) supplier bargaining power, and
(5) customer bargaining power.

Using the five forces model to determine the nature and strength of competitive
pressures in a given industry involves three steps:

∙ Step 1: For each of the five forces, identify the different parties involved, along
with the specific factors that bring about competitive pressures.

FIGURE 3. 3 The Five Forces Model of Competition: A Key Analytic Tool

Buyers

Competitive
pressures
stemming

from supplier
bargaining

power

Competitive pressures
coming from other firms in

the industry

Competitive pressures coming from
the threat of entry of new rivals

Competitive
pressures
stemming
from buyer
bargaining

power

Potential
New Entrants

Firms in Other
Industries O�ering
Substitute Products

Rivalry among
Competing

Sellers

Competitive pressures coming
from the producers of substitute

products

Suppliers

Sources: Adapted from M. E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (1979), pp. 137–145; M. E.
Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review 86, no. 1 (2008), pp. 80–86.

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∙ Step 2: Evaluate how strong the pressures stemming from each of the five forces
are (strong, moderate, or weak).

∙ Step 3: Determine whether the five forces, overall, are supportive of high industry
profitability.

Competitive Pressures Created by the Rivalry
among Competing Sellers
The strongest of the five competitive forces is often the rivalry for buyer patronage
among competing sellers of a product or service. The intensity of rivalry among
competing sellers within an industry depends on a number of identifiable factors.
Figure 3.4 summarizes these factors, identifying those that intensify or weaken rivalry
among direct competitors in an industry. A brief explanation of why these factors
affect the degree of rivalry is in order:

FIGURE 3.4 Factors Affecting the Strength of Rivalry

Suppliers

Rivalry among Competing Sellers

Rivalry increases and becomes a stronger force when:

Rivalry decreases and becomes a weaker force under the opposite
conditions.

Substitutes

New Entrants

Buyers

• Buyer demand is growing slowly.
• Buyer costs to switch brands are low.
• The products of industry members are commodities or else
weakly di�erentiated.
• The firms in the industry have excess production capacity
and/or inventory.
• The firms in the industry have high fixed costs or high storage costs.
• Competitors are numerous or are of roughly equal size and
competitive strength.
• Rivals have diverse objectives, strategies, and/or countries of origin.
• Rivals have emotional stakes in the business or face high exit barriers.

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∙ Rivalry increases when buyer demand is growing slowly or declining. Rapidly
expanding buyer demand produces enough new business for all industry members
to grow without having to draw customers away from rival enterprises. But in
markets where buyer demand is slow-growing or shrinking, companies eager to
gain more business are likely to engage in aggressive price discounting, sales pro-
motions, and other tactics to increase their sales volumes at the expense of rivals,
sometimes to the point of igniting a fierce battle for market share.

∙ Rivalry increases as it becomes less costly for buyers to switch brands. The less
costly it is for buyers to switch their purchases from one seller to another, the
easier it is for sellers to steal customers away from rivals. When the cost of switch-
ing brands is higher, buyers are less prone to brand switching and sellers have
protection from rivalrous moves. Switching costs include not only monetary costs
but also the time, inconvenience, and psychological costs involved in switching
brands. For example, retailers may not switch to the brands of rival manufacturers
because they are hesitant to sever long-standing supplier relationships or incur the
additional expense of retraining employees, accessing technical support, or testing
the quality and reliability of the new brand.

∙ Rivalry increases as the products of rival sellers become less strongly differentiated.
When the offerings of rivals are identical or weakly differentiated, buyers have less
reason to be brand-loyal—a condition that makes it easier for rivals to convince buy-
ers to switch to their offerings. Moreover, when the products of different sellers are
virtually identical, shoppers will choose on the basis of price, which can result in
fierce price competition among sellers. On the other hand, strongly differentiated
product offerings among rivals breed high brand loyalty on the part of buyers who
view the attributes of certain brands as more appealing or better suited to their needs.

∙ Rivalry is more intense when industry members have too much inventory or
significant amounts of idle production capacity, especially if the industry’s product
entails high fixed costs or high storage costs. Whenever a market has excess supply
(overproduction relative to demand), rivalry intensifies as sellers cut prices in a des-
perate effort to cope with the unsold inventory. A similar effect occurs when a prod-
uct is perishable or seasonal, since firms often engage in aggressive price cutting to
ensure that everything is sold. Likewise, whenever fixed costs account for a large
fraction of total cost so that unit costs are significantly lower at full capacity, firms
come under significant pressure to cut prices whenever they are operating below
full capacity. Unused capacity imposes a significant cost-increasing penalty because
there are fewer units over which to spread fixed costs. The pressure of high fixed
or high storage costs can push rival firms into offering price concessions, special
discounts, and rebates and employing other volume-boosting competitive tactics.

∙ Rivalry intensifies as the number of competitors increases and they become more
equal in size and capability. When there are many competitors in a market, com-
panies eager to increase their meager market share often engage in price-cutting
activities to drive sales, leading to intense rivalry. When there are only a few com-
petitors, companies are more wary of how their rivals may react to their attempts
to take market share away from them. Fear of retaliation and a descent into a
damaging price war leads to restrained competitive moves. Moreover, when rivals
are of comparable size and competitive strength, they can usually compete on a
fairly equal footing—an evenly matched contest tends to be fiercer than a contest
in which one or more industry members have commanding market shares and
substantially greater resources than their much smaller rivals.

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∙ Rivalry becomes more intense as the diversity of competitors increases in terms
of long-term directions, objectives, strategies, and countries of origin. A diverse
group of sellers often contains one or more mavericks willing to try novel or rule-
breaking market approaches, thus generating a more volatile and less predictable
competitive environment. Globally competitive markets are often more rivalrous,
especially when aggressors have lower costs and are intent on gaining a strong
foothold in new country markets.

∙ Rivalry is stronger when high exit barriers keep unprofitable firms from leaving
the industry. In industries where the assets cannot easily be sold or transferred to
other uses, where workers are entitled to job protection, or where owners are com-
mitted to remaining in business for personal reasons, failing firms tend to hold on
longer than they might otherwise—even when they are bleeding red ink. Deep
price discounting of this sort can destabilize an otherwise attractive industry.

The previous factors, taken as whole, determine whether the rivalry in an industry
is relatively strong, moderate, or weak. When rivalry is strong, the battle for mar-
ket share is generally so vigorous that the profit margins of most industry members
are squeezed to bare-bones levels. When rivalry is moderate, a more normal state,
the maneuvering among industry members, while lively and healthy, still allows most
industry members to earn acceptable profits. When rivalry is weak, most companies in
the industry are relatively well satisfied with their sales growth and market shares and
rarely undertake offensives to steal customers away from one another. Weak rivalry
means that there is no downward pressure on industry profitability due to this particu-
lar competitive force.

The Choice of Competitive Weapons
Competitive battles among rival sellers can assume many forms that extend well
beyond lively price competition. For example, competitors may resort to such market-
ing tactics as special sales promotions, heavy advertising, rebates, or low-interest-rate
financing to drum up additional sales. Rivals may race one another to differentiate
their products by offering better performance features or higher quality or improved
customer service or a wider product selection. They may also compete through the
rapid introduction of next-generation products, the frequent introduction of new or
improved products, and efforts to build stronger dealer networks, establish positions
in foreign markets, or otherwise expand distribution capabilities and market pres-
ence. Table 3.2 displays the competitive weapons that firms often employ in battling
rivals, along with their primary effects with respect to price (P), cost (C), and value
(V)—the elements of an effective business model and the value-price-cost framework,
discussed in Chapter 1.

Competitive Pressures Associated with the Threat
of New Entrants
New entrants into an industry threaten the position of rival firms since they will
compete fiercely for market share, add to the number of industry rivals, and add to
the industry’s production capacity in the process. But even the threat of new entry
puts added competitive pressure on current industry members and thus functions as
an important competitive force. This is because credible threat of entry often prompts
industry members to lower their prices and initiate defensive actions in an attempt

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Types of Competitive Weapons Primary Effects

Discounting prices, holding
clearance sales

Lowers price (P), increases total sales volume and market share, lowers profits
if price cuts are not offset by large increases in sales volume

Offering coupons, advertising items
on sale

Increases sales volume and total revenues, lowers price (P), increases unit
costs (C ), may lower profit margins per unit sold (P − C )

Advertising product or service
characteristics, using ads to enhance
a company’s image

Boosts buyer demand, increases product differentiation and perceived value
(V ), increases total sales volume and market share, but may increase unit costs
(C) and lower profit margins per unit sold

Innovating to improve product
performance and quality

Increases product differentiation and value (V ), boosts buyer demand, boosts
total sales volume, likely to increase unit costs (C)

Introducing new or improved
features, increasing the number of
styles to provide greater product
selection

Increases product differentiation and value (V ), strengthens buyer demand,
boosts total sales volume and market share, likely to increase unit costs (C)

Increasing customization of product
or service

Increases product differentiation and value (V ), increases buyer switching
costs, boosts total sales volume, often increases unit costs (C)

Building a bigger, better dealer
network

Broadens access to buyers, boosts total sales volume and market share, may
increase unit costs (C)

Improving warranties, offering low-
interest financing

Increases product differentiation and value (V), increases unit costs (C),
increases buyer switching costs, boosts total sales volume and market share

TABLE 3.2 Common “Weapons” for Competing with Rivals

to deter new entrants. Just how serious the threat of entry is in a particular market
depends on two classes of factors: (1) the expected reaction of incumbent firms to
new entry and (2) what are known as barriers to entry. The threat of entry is low in
industries where incumbent firms are likely to retaliate against new entrants with
sharp price discounting and other moves designed to make entry unprofitable (due
to the expectation of such retaliation). The threat of entry is also low when entry
barriers are high (due to such barriers). Entry barriers are high under the following
conditions:2

∙ There are sizable economies of scale in production, distribution, advertising, or
other activities. When incumbent companies enjoy cost advantages associated
with large-scale operations, outsiders must either enter on a large scale (a costly
and perhaps risky move) or accept a cost disadvantage and consequently lower
profitability.

∙ Incumbents have other hard to replicate cost advantages over new entrants.
Aside from enjoying economies of scale, industry incumbents can have cost
advantages that stem from the possession of patents or proprietary technology,

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exclusive partnerships with the best and cheapest suppliers, favorable locations,
and low fixed costs (because they have older facilities that have been mostly
depreciated). Learning-based cost savings can also accrue from experience in
performing certain activities such as manufacturing or new product develop-
ment or inventory management. The extent of such savings can be measured
with learning/experience curves. The steeper the learning/experience curve,
the bigger the cost advantage of the company with the largest cumulative pro-
duction volume. The microprocessor industry provides an excellent example
of this:

Manufacturing unit costs for microprocessors tend to decline about 20 percent each time
cumulative production volume doubles. With a 20 percent experience curve effect, if the
first 1 million chips cost $100 each, once production volume reaches 2 million, the unit
cost would fall to $80 (80 percent of $100), and by a production volume of 4 million, the
unit cost would be $64 (80 percent of $80).3

∙ Customers have strong brand preferences and high degrees of loyalty to seller.
The stronger the attachment of buyers to established brands, the harder it is for a
newcomer to break into the marketplace. In such cases, a new entrant must have
the financial resources to spend enough on advertising and sales promotion to
overcome customer loyalties and build its own clientele. Establishing brand rec-
ognition and building customer loyalty can be a slow and costly process. In addi-
tion, if it is difficult or costly for a customer to switch to a new brand, a new
entrant may have to offer a discounted price or otherwise persuade buyers that its
brand is worth the switching costs. Such barriers discourage new entry because
they act to boost financial requirements and lower expected profit margins for new
entrants.

∙ Patents and other forms of intellectual property protection are in place. In a
number of industries, entry is prevented due to the existence of intellectual
property protection laws that remain in place for a given number of years. Often,
companies have a “wall of patents” in place to prevent other companies from
entering with a “me too” strategy that replicates a key piece of technology.

∙ There are strong “network effects” in customer demand. In industries where buy-
ers are more attracted to a product when there are many other users of the product,
there are said to be “network effects,” since demand is higher the larger the net-
work of users. Video game systems are an example because users prefer to have
the same systems as their friends so that they can play together on systems they all
know and can share games. When incumbents have a large existing base of users,
new entrants with otherwise comparable products face a serious disadvantage in
attracting buyers.

∙ Capital requirements are high. The larger the total dollar investment needed to
enter the market successfully, the more limited the pool of potential entrants.
The most obvious capital requirements for new entrants relate to manufacturing
facilities and equipment, introductory advertising and sales promotion campaigns,
working capital to finance inventories and customer credit, and sufficient cash to
cover startup costs.

∙ There are difficulties in building a network of distributors/dealers or in securing
adequate space on retailers’ shelves. A potential entrant can face numerous
distribution-channel challenges. Wholesale distributors may be reluctant to
take on a product that lacks buyer recognition. Retailers must be recruited and

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convinced to give a new brand ample display space and an adequate trial period.
When existing sellers have strong, well-functioning distributor–dealer networks,
a newcomer has an uphill struggle in squeezing its way into existing distribution
channels. Potential entrants sometimes have to “buy” their way into wholesale
or retail channels by cutting their prices to provide dealers and distributors with
higher markups and profit margins or by giving them big advertising and pro-
motional allowances. As a consequence, a potential entrant’s own profits may be
squeezed unless and until its product gains enough consumer acceptance that dis-
tributors and retailers are willing to carry it.

∙ There are restrictive regulatory policies. Regulated industries like cable TV,
telecommunications, electric and gas utilities, radio and television broadcast-
ing, liquor retailing, nuclear power, and railroads entail government-controlled
entry. Government agencies can also limit or even bar entry by requiring licenses
and permits, such as the medallion required to drive a taxicab in New York City.
Government-mandated safety regulations and environmental pollution standards
also create entry barriers because they raise entry costs. Recently enacted banking
regulations in many countries have made entry particularly difficult for small new
bank startups—complying with all the new regulations along with the rigors of
competing against existing banks requires very deep pockets.

∙ There are restrictive trade policies. In international markets, host governments
commonly limit foreign entry and must approve all foreign investment applica-
tions. National governments commonly use tariffs and trade restrictions (anti-
dumping rules, local content requirements, quotas, etc.) to raise entry barriers for
foreign firms and protect domestic producers from outside competition.

Figure 3.5 summarizes the factors that cause the overall competitive pressure
from potential entrants to be strong or weak. An analysis of these factors can
help managers determine whether the threat of entry into their industry is high
or low, in general. But certain kinds of companies—those with sizable finan-
cial resources, proven competitive capabilities, and a respected brand name—
may be able to hurdle an industry’s entry barriers even when they are high.4 For
example, when Honda opted to enter the U.S. lawn-mower market in competi-
tion against Toro, Snapper, Craftsman, John Deere, and others, it was easily able
to hurdle entry barriers that would have been formidable to other newcomers
because it had long-standing expertise in gasoline engines and a reputation for qual-
ity and durability in automobiles that gave it instant credibility with homeowners. As
a result, Honda had to spend relatively little on inducing dealers to handle the Honda
lawn-mower line or attracting customers. Similarly, Samsung’s brand reputation in
televisions, DVD players, and other electronics products gave it strong credibility in
entering the market for smartphones—Samsung’s Galaxy smartphones are now a
formidable rival of Apple’s iPhone.

It is also important to recognize that the barriers to entering an industry can
become stronger or weaker over time. For example, key patents that had prevented
new entry in the market for functional 3-D printers expired in February 2014, open-
ing the way for new competition in this industry. Use of the Internet for shopping
has made it much easier for e-tailers to enter into competition against some of the
best-known retail chains. On the other hand, new strategic actions by incumbent
firms to increase advertising, strengthen distributor–dealer relations, step up R&D,
or improve product quality can erect higher roadblocks to entry.

Whether an industry’s
entry barriers ought to be
considered high or low
depends on the resources
and capabilities possessed
by the pool of potential
entrants.

High entry barriers and
weak entry threats today
do not always translate into
high entry barriers and weak
entry threats tomorrow.

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Competitive Pressures from the Sellers
of Substitute Products
Companies in one industry are vulnerable to competitive pressure from the actions of
companies in a closely adjoining industry whenever buyers view the products of the
two industries as good substitutes. For instance, the producers of eyeglasses and con-
tact lens face competitive pressures from the doctors who do corrective laser surgery.
Similarly, the producers of sugar experience competitive pressures from the producers
of sugar substitutes (high-fructose corn syrup, agave syrup, and artificial sweeteners).
Internet providers of news-related information have put brutal competitive pressure on
the publishers of newspapers.

FIGURE 3.5 Factors Affecting the Threat of Entry

Rivalry
among

Competing
Sellers

Buyers

Substitutes

Suppliers

Competitive Pressures from Potential Entrants

Threat of entry is a stronger force when incumbents are unlikely to make retaliatory moves against new
entrants and entry barriers are low. Entry barriers are high (and threat of entry is low) when:
• Incumbents have large cost advantages over potential entrants due to:
− High economies of scale
− Significant experience-based cost advantages or learning curve e�ects
− Other cost advantages (e.g., favorable access to inputs, technology, location, or low fixed costs)
• Customers have strong brand preferences and/or loyalty to incumbent sellers.
• Patents and other forms of intellectual property protection are in place.
• There are strong network e�ects.
• Capital requirements are high.
• There is limited new access to distribution channels and shelf space.
• Government policies are restrictive.
• There are restrictive trade policies.

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As depicted in Figure 3.6, three factors determine whether the competitive pressures
from substitute products are strong or weak. Competitive pressures are stronger when:

1. Good substitutes are readily available and attractively priced. The presence of
readily available and attractively priced substitutes creates competitive pressure
by placing a ceiling on the prices industry members can charge without risking
sales erosion. This price ceiling, at the same time, puts a lid on the profits that
industry members can earn unless they find ways to cut costs.

2. Buyers view the substitutes as comparable or better in terms of quality, per-
formance, and other relevant attributes. The availability of substitutes inevi-
tably invites customers to compare performance, features, ease of use, and
other attributes besides price. The users of paper cartons constantly weigh the

FIGURE 3.6 Factors Affecting Competition from Substitute Products

Firms in Other Industries O�ering Substitute Products

Competitive pressures from substitutes are stronger when:

• Good substitutes are readily available and attractively priced.
• Substitutes have comparable or better performance features.
• Buyers have low costs in switching to substitutes.

Competitive pressures from substitutes are weaker under
the opposite conditions.

Suppliers Buyers

Rivalry
among

Competing
Sellers

New Entrants

Signs That Competition from
Substitutes Is Strong

• Sales of substitutes are
growing faster than sales of
the industry being analyzed.

• Producers of substitutes are
moving to add new capacity.

• Profits of the producers of
substitutes are on the rise.

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price-performance trade-offs with plastic containers and metal cans, for exam-
ple. Movie enthusiasts are increasingly weighing whether to go to movie theaters
to watch newly released movies or wait until they can watch the same movies
streamed to their home TV by Netflix, Amazon Prime, cable providers, and other
on demand sources.

3. The costs that buyers incur in switching to the substitutes are low. Low switch-
ing costs make it easier for the sellers of attractive substitutes to lure buyers
to their offerings; high switching costs deter buyers from purchasing substitute
products.

Before assessing the competitive pressures coming from substitutes, company
managers must identify the substitutes, which is less easy than it sounds since it
involves (1) determining where the industry boundaries lie and (2) figuring out
which other products or services can address the same basic customer needs as
those produced by industry members. Deciding on the industry boundaries is nec-
essary for determining which firms are direct rivals and which produce substitutes.
This is a matter of perspective—there are no hard-and-fast rules, other than to
say that other brands of the same basic product constitute rival products and not
substitutes.

Competitive Pressures Stemming from Supplier
Bargaining Power
Whether the suppliers of industry members represent a weak or strong competitive
force depends on the degree to which suppliers have sufficient bargaining power to
influence the terms and conditions of supply in their favor. Suppliers with strong bar-
gaining power are a source of competitive pressure because of their ability to charge
industry members higher prices, pass costs on to them, and limit their opportunities to
find better deals. For instance, Microsoft and Intel, both of which supply PC makers
with essential components, have been known to use their dominant market status not
only to charge PC makers premium prices but also to leverage their power over PC
makers in other ways. The bargaining power of these two companies over their cus-
tomers is so great that both companies have faced antitrust charges on numerous occa-
sions. Prior to a legal agreement ending the practice, Microsoft pressured PC makers
to load only Microsoft products on the PCs they shipped. Intel has defended itself
against similar antitrust charges, but in filling orders for newly introduced Intel chips,
it continues to give top priority to PC makers that use the biggest percentages of Intel
chips in their PC models. Being on Intel’s list of preferred customers helps a PC maker
get an early allocation of Intel’s latest chips and thus allows the PC maker to get new
models to market ahead of rivals.

Small-scale retailers often must contend with the power of manufacturers whose
products enjoy well-known brand names, since consumers expect to find these prod-
ucts on the shelves of the retail stores where they shop. This provides the manufac-
turer with a degree of pricing power and often the ability to push hard for favorable
shelf displays. Supplier bargaining power is also a competitive factor in industries
where unions have been able to organize the workforce (which supplies labor). Air
pilot unions, for example, have employed their bargaining power to increase pilots’
wages and benefits in the air transport industry.

As shown in Figure 3.7, a variety of factors determine the strength of suppliers’
bargaining power. Supplier power is stronger when:

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∙ Demand for suppliers’ products is high and the products are in short supply.
A surge in the demand for particular items shifts the bargaining power to the
suppliers of those products; suppliers of items in short supply have pricing power.

∙ Suppliers provide differentiated inputs that enhance the performance of the indus-
try’s product. The more valuable a particular input is in terms of enhancing the
performance or quality of the products of industry members, the more bargaining
leverage suppliers have. In contrast, the suppliers of commodities are in a weak
bargaining position, since industry members have no reason other than price to
prefer one supplier over another.

∙ It is difficult or costly for industry members to switch their purchases from one
supplier to another. Low switching costs limit supplier bargaining power by
enabling industry members to change suppliers if any one supplier attempts to
raise prices by more than the costs of switching. Thus, the higher the switching
costs of industry members, the stronger the bargaining power of their suppliers.

∙ The supplier industry is dominated by a few large companies and it is more con-
centrated than the industry it sells to. Suppliers with sizable market shares and
strong demand for the items they supply generally have sufficient bargaining
power to charge high prices and deny requests from industry members for lower
prices or other concessions.

∙ Industry members are incapable of integrating backward to self-manufacture
items they have been buying from suppliers. As a rule, suppliers are safe from the

FIGURE 3.7 Factors Affecting the Bargaining Power of Suppliers

Suppliers

Supplier bargaining power is stronger when:
• Suppliers’ products and/or services are in short supply.
• Suppliers’ products and/or services are di�erentiated.
• Industry members incur high costs in switching their
purchases to alternative suppliers.
• The supplier industry is more concentrated than the
industry it sells to and is dominated by a few large
companies.
• Industry members do not have the potential to
integrate backward in order to self-manufacture
their own inputs.
• Suppliers’ products do not account for more than
a small fraction of the total costs of the industry‘s
products.
• There are no good substitutes for what the suppliers
provide.
• Industry members do not account for a big fraction
of suppliers’ sales.

Supplier bargaining power is weaker under the
opposite conditions.

Buyers

Rivalry
among

Competing
Sellers

New Entrants

Substitutes

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threat of self-manufacture by their customers until the volume of parts a customer
needs becomes large enough for the customer to justify backward integration into
self-manufacture of the component. When industry members can threaten cred-
ibly to self-manufacture suppliers’ goods, their bargaining power over suppliers
increases proportionately.

∙ Suppliers provide an item that accounts for no more than a small fraction of
the costs of the industry’s product. The more that the cost of a particular part
or component affects the final product’s cost, the more that industry members
will be sensitive to the actions of suppliers to raise or lower their prices. When
an input accounts for only a small proportion of total input costs, buyers will
be less sensitive to price increases. Thus, suppliers’ power increases when
the inputs they provide do not make up a large proportion of the cost of the
final product.

∙ Good substitutes are not available for the suppliers’ products. The lack of readily
available substitute inputs increases the bargaining power of suppliers by increas-
ing the dependence of industry members on the suppliers.

∙ Industry members are not major customers of suppliers. As a rule, suppliers have
less bargaining leverage when their sales to members of the industry constitute
a big percentage of their total sales. In such cases, the well-being of suppliers is
closely tied to the well-being of their major customers, and their dependence upon
them increases. The bargaining power of suppliers is stronger, then, when they are
not bargaining with major customers.

In identifying the degree of supplier power in an industry, it is important to rec-
ognize that different types of suppliers are likely to have different amounts of bar-
gaining power. Thus, the first step is for managers to identify the different types of
suppliers, paying particular attention to those that provide the industry with impor-
tant inputs. The next step is to assess the bargaining power of each type of supplier
separately.

Competitive Pressures Stemming from Buyer
Bargaining Power and Price Sensitivity
Whether buyers are able to exert strong competitive pressures on industry members
depends on (1) the degree to which buyers have bargaining power and (2) the extent
to which buyers are price-sensitive. Buyers with strong bargaining power can limit
industry profitability by demanding price concessions, better payment terms, or addi-
tional features and services that increase industry members’ costs. Buyer price sensi-
tivity limits the profit potential of industry members by restricting the ability of sellers
to raise prices without losing revenue due to lost sales.

As with suppliers, the leverage that buyers have in negotiating favorable terms of
sale can range from weak to strong. Individual consumers seldom have much bar-
gaining power in negotiating price concessions or other favorable terms with sellers.
However, their price sensitivity varies by individual and by the type of product they
are buying (whether it’s a necessity or a discretionary purchase, for example). Simi-
larly, small businesses usually have weak bargaining power because of the small-
size orders they place with sellers. Many relatively small wholesalers and retailers
join buying groups to pool their purchasing power and approach manufacturers
for better terms than could be gotten individually. Large business buyers, in con-
trast, can have considerable bargaining power. For example, large retail chains like

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Walmart, Best Buy, Staples, and Home Depot typically have considerable bargain-
ing power in purchasing products from manufacturers, not only because they buy in
large quantities, but also because of manufacturers’ need for access to their broad
base of customers. Major supermarket chains like Kroger, Albertsons, Hannaford,
and Aldi have sufficient bargaining power to demand promotional allowances
and lump-sum payments (called slotting fees) from food products manufacturers
in return for stocking certain brands or putting them in the best shelf locations.
Motor vehicle manufacturers have strong bargaining power in negotiating to buy
original-equipment tires from tire makers such as Goodyear, Michelin, and Pirelli,
partly because they buy in large quantities and partly because consumers are more
likely to buy replacement tires that match the tire brand on their vehicle at the time
of its purchase.

Figure 3.8 summarizes the factors determining the strength of buyer power in an
industry. Note that the first five factors are the mirror image of those determining the
bargaining power of suppliers, as described next.

Buyer bargaining power is stronger when:

∙ Buyer demand is weak in relation to the available supply. Weak or declining demand
and the resulting excess supply create a “buyers’ market,” in which bargain-hunting
buyers have leverage in pressing industry members for better deals and special
treatment. Conversely, strong or rapidly growing market demand creates a “sellers’

FIGURE 3.8 Factors Affecting the Bargaining Power of Buyers

Buyers

Competitive pressures from buyers increase when
they have strong bargaining power and are price-
sensitive. Buyer bargaining power is stronger when:

• Buyer demand is weak in relation to industry supply.
• The industry’s products are standardized or
undi�erentiated.
• Buyer costs of switching to competing products
are low.
• Buyers are large and few in number relative to
the number of industry sellers.
• Buyers pose a credible threat of integrating backward
into the business of sellers.
• Buyers are well informed about the quality, prices,
and costs of sellers.
• Buyers have the ability to postpone purchases.

Buyers are price-sensitive and increase competitive
pressures when:

• Buyers earn low profits or low income.
• The product represents a significant fraction of
their purchases.

Competitive pressures from buyers decrease and
become a weaker force under the opposite
conditions.

Rivalry
among

Competing
Sellers

Suppliers

Substitutes

New Entrants

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market” characterized by tight supplies or shortages— conditions that put buyers in
a weak position to wring concessions from industry members.

∙ Industry goods are standardized or differentiation is weak. In such circumstances,
buyers make their selections on the basis of price, which increases price competi-
tion among vendors.

∙ Buyers’ costs of switching to competing brands or substitutes are relatively low.
Switching costs put a cap on how much industry producers can raise prices or
reduce quality before they will lose the buyer’s business.

∙ Buyers are large and few in number relative to the number of sellers. The larger
the buyers, the more important their business is to the seller and the more sellers
will be willing to grant concessions.

∙ Buyers pose a credible threat of integrating backward into the business of sell-
ers. Companies like Anheuser-Busch, Coors, and Heinz have partially integrated
backward into metal-can manufacturing to gain bargaining power in obtain-
ing the balance of their can requirements from otherwise powerful metal-can
manufacturers.

∙ Buyers are well informed about the product offerings of sellers (product features
and quality, prices, buyer reviews) and the cost of production (an indicator of
markup). The more information buyers have, the better bargaining position they
are in. The mushrooming availability of product information on the Internet (and
its ready access on smartphones) is giving added bargaining power to consumers,
since they can use this to find or negotiate better deals.

∙ Buyers have discretion to delay their purchases or perhaps even not make a pur-
chase at all. Consumers often have the option to delay purchases of durable goods
(cars, major appliances), or decline to buy discretionary goods (massages, concert
tickets) if they are not happy with the prices offered. Business customers may also
be able to defer their purchases of certain items, such as plant equipment or main-
tenance services. This puts pressure on sellers to provide concessions to buyers so
that the sellers can keep their sales numbers from dropping off.

The following factors increase buyer price sensitivity and result in greater competi-
tive pressures on the industry as a result:
∙ Buyer price sensitivity increases when buyers are earning low profits or have low

income. Price is a critical factor in the purchase decisions of low-income consum-
ers and companies that are barely scraping by. In such cases, their high price sen-
sitivity limits the ability of sellers to charge high prices.

∙ Buyers are more price-sensitive if the product represents a large fraction of their
total purchases. When a purchase eats up a large portion of a buyer’s budget or
represents a significant part of his or her cost structure, the buyer cares more about
price than might otherwise be the case.

The starting point for the analysis of buyers as a competitive force is to identify
the different types of buyers along the value chain—then proceed to analyzing the
bargaining power and price sensitivity of each type separately. It is important to rec-
ognize that not all buyers of an industry’s product have equal degrees of bargaining
power with sellers, and some may be less sensitive than others to price, quality, or
service differences. For example, apparel manufacturers confront significant bargain-
ing power when selling to big retailers like Nordstrom, Macy’s, or Bloomingdale’s,
but they can command much better prices selling to small owner-managed apparel
boutiques.

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Is the Collective Strength of the Five Competitive
Forces Conducive to Good Profitability?
Assessing whether each of the five competitive forces gives rise to strong, moderate, or
weak competitive pressures sets the stage for evaluating whether, overall, the strength
of the five forces is conducive to good profitability. Is any of the competitive forces suf-
ficiently powerful to undermine industry profitability? Can companies in this industry
reasonably expect to earn decent profits in light of the prevailing competitive forces?

The most extreme case of a “competitively unattractive” industry occurs when all
five forces are producing strong competitive pressures: Rivalry among sellers is vigor-
ous, low entry barriers allow new rivals to gain a market foothold, competition from
substitutes is intense, and both suppliers and buyers are able to exercise considerable
leverage. Strong competitive pressures coming from all five directions drive industry
profitability to unacceptably low levels, frequently producing losses for many industry
members and forcing some out of business. But an industry can be competitively unat-
tractive without all five competitive forces being strong. In fact, intense competitive
pressures from just one of the five forces may suffice to destroy the conditions for
good profitability and prompt some companies to exit the business.

As a rule, the strongest competitive forces determine the extent of the competi-
tive pressure on industry profitability. Thus, in evaluating the strength of the five
forces overall and their effect on industry profitability, managers should look to
the strongest forces. Having more than one strong force will not worsen the effect
on industry profitability, but it does mean that the industry has multiple competi-
tive challenges with which to cope. In that sense, an industry with three to five
strong forces is even more “unattractive” as a place to compete. Especially intense
competitive conditions seem to be the norm in tire manufacturing, apparel, and
commercial airlines, three industries where profit margins have historically been thin.

In contrast, when the overall impact of the five competitive forces is moderate to
weak, an industry is “attractive” in the sense that the average industry member can
reasonably expect to earn good profits and a nice return on investment. The ideal com-
petitive environment for earning superior profits is one in which both suppliers and
customers are in weak bargaining positions, there are no good substitutes, high barri-
ers block further entry, and rivalry among present sellers is muted. Weak competition
is the best of all possible worlds for also-ran companies because even they can usually
eke out a decent profit—if a company can’t make a decent profit when competition is
weak, then its business outlook is indeed grim.

Matching Company Strategy
to Competitive Conditions
Working through the five forces model step by step not only aids strategy makers
in assessing whether the intensity of competition allows good profitability but also
promotes sound strategic thinking about how to better match company strategy
to the specific competitive character of the marketplace. Effectively matching a
company’s business strategy to prevailing competitive conditions has two aspects:

1. Pursuing avenues that shield the firm from as many of the different competi-
tive pressures as possible.

2. Initiating actions calculated to shift the competitive forces in the company’s
favor by altering the underlying factors driving the five forces.

CORE CONCEPT

The strongest of the five
forces determines the extent
of the downward pressure
on an industry’s profitability.

A company’s strategy is
increasingly effective the
more it provides some
insulation from competitive
pressures, shifts the
competitive battle in the
company’s favor, and
positions the firm to take
advantage of attractive
growth opportunities.

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But making headway on these two fronts first requires identifying competitive
pressures, gauging the relative strength of each of the five competitive forces, and
gaining a deep enough understanding of the state of competition in the industry to
know which strategy buttons to push.

FIGURE 3.9 The Value Net

Customers

Suppliers

The FirmCompetitors Complementors

(Includes
substitutors and

potential entrants)

CORE CONCEPT

Complementors
are the producers of
complementary products,
which are products that
enhance the value of the
focal firm’s products when
they are used together.

Not all interactions among industry participants are necessarily competitive in nature.
Some have the potential to be cooperative, as the value net framework demonstrates.
Like the five forces framework, the value net includes an analysis of buyers, suppli-
ers, and substitutors (see Figure 3.9). But it differs from the five forces framework in
several important ways.

First, the analysis focuses on the interactions of industry participants with a par-
ticular company. Thus it places that firm in the center of the framework, as Figure 3.9
shows. Second, the category of “competitors” is defined to include not only the
focal firm’s direct competitors or industry rivals but also the sellers of substitute
products and potential entrants. Third, the value net framework introduces a new
category of industry participant that is not found in the five forces framework—that
of “complementors.” Complementors are the producers of complementary prod-
ucts, which are products that enhance the value of the focal firm’s products when
they are used together. Some examples include snorkels and swim fins or shoes and
shoelaces.

The inclusion of complementors draws particular attention to the fact that suc-
cess in the marketplace need not come at the expense of other industry participants.

COMPLEMENTORS AND THE VALUE NET

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Interactions among industry participants may be cooperative in nature rather than
competitive. In the case of complementors, an increase in sales for them is likely to
increase the sales of the focal firm as well. But the value net framework also encour-
ages managers to consider other forms of cooperative interactions and realize that
value is created jointly by all industry participants. For example, a company’s suc-
cess in the marketplace depends on establishing a reliable supply chain for its inputs,
which implies the need for cooperative relations with its suppliers. Often a firm works
hand in hand with its suppliers to ensure a smoother, more efficient operation for both
parties. Newell-Rubbermaid, for example, works cooperatively as a supplier to com-
panies such as Kmart and Kohl’s. Even direct rivals may work cooperatively if they
participate in industry trade associations or engage in joint lobbying efforts. Value net
analysis can help managers discover the potential to improve their position through
cooperative as well as competitive interactions.

CORE CONCEPT

Driving forces are the
major underlying causes
of change in industry and
competitive conditions.

INDUSTRY DYNAMICS AND THE
FORCES DRIVING CHANGE
While it is critical to understand the nature and intensity of competitive and coopera-
tive forces in an industry, it is equally critical to understand that the intensity of these
forces is fluid and subject to change. All industries are affected by new developments
and ongoing trends that alter industry conditions, some more speedily than others.
The popular hypothesis that industries go through a life cycle of takeoff, rapid growth,
maturity, market saturation and slowing growth, followed by stagnation or decline
is but one aspect of industry change—many other new developments and emerging
trends cause industry change.5 Any strategies devised by management will therefore
play out in a dynamic industry environment, so it’s imperative that managers consider
the factors driving industry change and how they might affect the industry environ-
ment. Moreover, with early notice, managers may be able to influence the direction or
scope of environmental change and improve the outlook.

Industry and competitive conditions change because forces are enticing or
pressuring certain industry participants (competitors, customers, suppliers, comple-
mentors) to alter their actions in important ways. The most powerful of the change
agents are called driving forces because they have the biggest influences in reshap-
ing the industry landscape and altering competitive conditions. Some driving forces
originate in the outer ring of the company’s macro-environment (see Figure 3.2),
but most originate in the company’s more immediate industry and competitive
environment.

Driving-forces analysis has three steps: (1) identifying what the driving forces
are; (2) assessing whether the drivers of change are, on the whole, acting to make the
industry more or less attractive; and (3) determining what strategy changes are needed
to prepare for the impact of the driving forces. All three steps merit further discussion.

Identifying the Forces Driving Industry Change
Many developments can affect an industry powerfully enough to qualify as driving
forces. Some drivers of change are unique and specific to a particular industry situa-
tion, but most drivers of industry and competitive change fall into one of the following
categories:

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∙ Changes in an industry’s long-term growth rate. Shifts in industry growth up or
down have the potential to affect the balance between industry supply and buyer
demand, entry and exit, and the character and strength of competition. Whether
demand is growing or declining is one of the key factors influencing the inten-
sity of rivalry in an industry, as explained earlier. But the strength of this effect
will depend on how changes in the industry growth rate affect entry and exit in
the industry. If entry barriers are low, then growth in demand will attract new
entrants, increasing the number of industry rivals and changing the competitive
landscape.

∙ Increasing globalization. Globalization can be precipitated by such factors as
the blossoming of consumer demand in developing countries, the availability
of lower-cost foreign inputs, and the reduction of trade barriers, as has occurred
recently in many parts of Latin America and Asia. The forces of globalization
are sometimes such a strong driver that companies find it highly advantageous,
if not necessary, to spread their operating reach into more and more country
markets.

∙ Emerging new Internet capabilities and applications. The Internet of the future
will feature faster speeds, dazzling applications, and over a billion connected gad-
gets performing an array of functions, thus driving a host of industry and com-
petitive changes. But Internet-related impacts vary from industry to industry. The
challenges are to assess precisely how emerging Internet developments are alter-
ing a particular industry’s landscape and to factor these impacts into the strategy-
making equation.

∙ Shifts in who buys the products and how the products are used. Shifts in buyer
demographics and the ways products are used can greatly alter competitive condi-
tions. Longer life expectancies and growing percentages of relatively well-to-do
retirees, for example, are driving demand growth in such industries as cosmetic
surgery, assisted living residences, and vacation travel. The burgeoning popular-
ity of streaming video has affected broadband providers, wireless phone carriers,
and television broadcasters, and created opportunities for such new entertainment
businesses as Hulu and Netflix.

∙ Technological change and manufacturing process innovation. Advances in tech-
nology can cause disruptive change in an industry by introducing substitutes or
can alter the industry landscape by opening up whole new industry frontiers. For
instance, revolutionary change in self-driving technology has enabled even com-
panies such as Google to enter the motor vehicle market.

∙ Product innovation. An ongoing stream of product innovations tends to alter the
pattern of competition in an industry by attracting more first-time buyers, reju-
venating industry growth, and/or increasing product differentiation, with con-
comitant effects on rivalry, entry threat, and buyer power. Product innovation has
been a key driving force in the smartphone industry, which in an ever more con-
nected world is driving change in other industries. Phillips Company, for example,
has introduced a new wireless lighting system (Hue) that allows homeowners to
use a smartphone app to remotely turn lights on and off and program them to
blink if an intruder is detected. Wearable action-capture cameras and unmanned
aerial view drones are rapidly becoming a disruptive force in the digital camera
industry by enabling photography shots and videos not feasible with handheld
digital cameras.

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∙ Entry or exit of major firms. Entry by a major firm thus often produces a new
ball game, not only with new key players but also with new rules for competing.
Similarly, exit of a major firm changes the competitive structure by reducing
the number of market leaders and increasing the dominance of the leaders who
remain.

∙ Diffusion of technical know-how across companies and countries. As knowledge
about how to perform a particular activity or execute a particular manufacturing
technology spreads, products tend to become more commodity-like. Knowledge
diffusion can occur through scientific journals, trade publications, onsite plant
tours, word of mouth among suppliers and customers, employee migration, and
Internet sources.

∙ Changes in cost and efficiency. Widening or shrinking differences in the costs
among key competitors tend to dramatically alter the state of competition. Declin-
ing costs of producing tablets have enabled price cuts and spurred tablet sales
(especially lower-priced models) by making them more affordable to lower-
income households worldwide. Lower-cost e-books are cutting into sales of cost-
lier hardcover books as increasing numbers of consumers have laptops, iPads,
Kindles, and other brands of tablets.

∙ Reductions in uncertainty and business risk. Many companies are hesitant to
enter industries with uncertain futures or high levels of business risk because it is
unclear how much time and money it will take to overcome various technological
hurdles and achieve acceptable production costs (as is the case in the solar power
industry). Over time, however, diminishing risk levels and uncertainty tend to
stimulate new entry and capital investments on the part of growth-minded compa-
nies seeking new opportunities, thus dramatically altering industry and competi-
tive conditions.

∙ Regulatory influences and government policy changes. Government regulatory
actions can often mandate significant changes in industry practices and stra-
tegic approaches—as has recently occurred in the world’s banking industry.
New rules and regulations pertaining to government-sponsored health insur-
ance programs are driving changes in the health care industry. In international
markets, host governments can drive competitive changes by opening their
domestic markets to foreign participation or closing them to protect domestic
companies.

∙ Changing societal concerns, attitudes, and lifestyles. Emerging social issues as
well as changing attitudes and lifestyles can be powerful instigators of industry
change. Growing concern about the effects of climate change has emerged as
a major driver of change in the energy industry. Concerns about the use of
chemical additives and the nutritional content of food products have been driv-
ing changes in the restaurant and food industries. Shifting societal concerns,
attitudes, and lifestyles alter the pattern of competition, favoring those players
that respond with products targeted to the new trends and conditions.

While many forces of change may be at work in a given industry, no more than
three or four are likely to be true driving forces powerful enough to qualify as
the major determinants of why and how the industry is changing. Thus, company
strategists must resist the temptation to label every change they see as a driving
force. Table 3.3 lists the most common driving forces.

The most important part
of driving-forces analysis
is to determine whether
the collective impact of the
driving forces will increase
or decrease market
demand, make competition
more or less intense, and
lead to higher or lower
industry profitability.

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Assessing the Impact of the Forces Driving
Industry Change
The second step in driving-forces analysis is to determine whether the prevailing
change drivers, on the whole, are acting to make the industry environment more or
less attractive. Three questions need to be answered:

• Changes in the long-term industry growth rate
• Increasing globalization
• Emerging new Internet capabilities and applications
• Shifts in buyer demographics
• Technological change and manufacturing process innovation
• Product and marketing innovation
• Entry or exit of major firms
• Diffusion of technical know-how across companies and countries
• Changes in cost and efficiency
• Reductions in uncertainty and business risk
• Regulatory influences and government policy changes
• Changing societal concerns, attitudes, and lifestyles

TABLE 3.3 The Most Common Drivers of Industry Change

The real payoff of driving-
forces analysis is to help
managers understand
what strategy changes
are needed to prepare for
the impacts of the driving
forces.

1. Are the driving forces, on balance, acting to cause demand for the industry’s
product to increase or decrease?

2. Is the collective impact of the driving forces making competition more or less
intense?

3. Will the combined impacts of the driving forces lead to higher or lower indus-
try profitability?

Getting a handle on the collective impact of the driving forces requires looking
at the likely effects of each factor separately, since the driving forces may not all be

pushing change in the same direction. For example, one driving force may be acting
to spur demand for the industry’s product while another is working to curtail demand.
Whether the net effect on industry demand is up or down hinges on which change
driver is the most powerful.

Adjusting the Strategy to Prepare for the Impacts
of Driving Forces
The third step in the strategic analysis of industry dynamics—where the real payoff
for strategy making comes—is for managers to draw some conclusions about what
strategy adjustments will be needed to deal with the impacts of the driving forces. But
taking the “right” kinds of actions to prepare for the industry and competitive changes
being wrought by the driving forces first requires accurate diagnosis of the forces
driving industry change and the impacts these forces will have on both the indus-
try environment and the company’s business. To the extent that managers are unclear

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Within an industry, companies commonly sell in different price/quality ranges, appeal
to different types of buyers, have different geographic coverage, and so on. Some are
more attractively positioned than others. Understanding which companies are strongly
positioned and which are weakly positioned is an integral part of analyzing an indus-
try’s competitive structure. The best technique for revealing the market positions of
industry competitors is strategic group mapping.

Using Strategic Group Maps to Assess the Market
Positions of Key Competitors
A strategic group consists of those industry members with similar competitive
approaches and positions in the market. Companies in the same strategic group can
resemble one another in a variety of ways. They may have comparable product-line
breadth, sell in the same price/quality range, employ the same distribution channels,
depend on identical technological approaches, compete in much the same geographic
areas, or offer buyers essentially the same product attributes or similar services and
technical assistance.6 Evaluating strategy options entails examining what strategic
groups exist, identifying the companies within each group, and determining if a com-
petitive “white space” exists where industry competitors are able to create and capture
altogether new demand. As part of this process, the number of strategic groups in an
industry and their respective market positions can be displayed on a strategic group map.

The procedure for constructing a strategic group map is straightforward:

∙ Identify the competitive characteristics that delineate strategic approaches used
in the industry. Typical variables used in creating strategic group maps are
price/quality range (high, medium, low), geographic coverage (local, regional,
national, global), product-line breadth (wide, narrow), degree of service offered
(no frills, limited, full), use of distribution channels (retail, wholesale, Inter-
net, multiple), degree of vertical integration (none, partial, full), and degree of
diversification into other industries (none, some, considerable).

∙ Plot the firms on a two-variable map using pairs of these variables.
∙ Assign firms occupying about the same map location to the same strategic group.
∙ Draw circles around each strategic group, making the circles proportional to the

size of the group’s share of total industry sales revenues.

This produces a two-dimensional diagram like the one for the U.S. casual dining
industry in Illustration Capsule 3.1.

Several guidelines need to be observed in creating strategic group maps. First,
the two variables selected as axes for the map should not be highly correlated; if they
are, the circles on the map will fall along a diagonal and reveal nothing more about
the relative positions of competitors than would be revealed by comparing the rivals

LO 3

How to map the
market positions
of key groups of
industry rivals.

CORE CONCEPT

Strategic group mapping
is a technique for displaying
the different market or
competitive positions that
rival firms occupy in the
industry.

CORE CONCEPT

A strategic group is
a cluster of industry
rivals that have similar
competitive approaches
and market positions.

about the drivers of industry change and their impacts, or if their views are off-base,
the chances of making astute and timely strategy adjustments are slim. So driving-
forces analysis is not something to take lightly; it has practical value and is basic to the
task of thinking strategically about where the industry is headed and how to prepare
for the changes ahead.

STRATEGIC GROUP ANALYSIS

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72

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ILLUSTRATION
CAPSULE 3.1

Comparative Market Positions
of Selected Companies in
the Casual Dining Industry:
A Strategic Group Map Example

Note: Circles are drawn roughly proportional to the sizes of the chains, based on revenues.

on just one of the variables. For instance, if companies with broad product lines use
multiple distribution channels while companies with narrow lines use a single dis-
tribution channel, then looking at the differences in distribution-channel approaches
adds no new information about positioning.

Second, the variables chosen as axes for the map should reflect important differ-
ences among rival approaches—when rivals differ on both variables, the locations
of the rivals will be scattered, thus showing how they are positioned differently.
Third, the variables used as axes don’t have to be either quantitative or continu-
ous; rather, they can be discrete variables, defined in terms of distinct classes and
combinations. Fourth, drawing the sizes of the circles on the map proportional to
the combined sales of the firms in each strategic group allows the map to reflect
the relative sizes of each strategic group. Fifth, if more than two good variables

Few U.S. Locations

Low

Moderate

High

Many U.S. Locations

Geographic Coverage

P
ri

ce
/S

e
rv

ic
e

/R
e

st
a

u
ra

n
t

A
m

b
ia

n
ce

International

Maggiano’s
Little Italy,P.F.

Chang’s

Olive Garden,
Longhorn

Steakhouse

Hard Rock
Café, Outback

Steakhouse

Applebee’s, Chili’s,
On the Border,

TGI Friday’s

Cracker Barrel, Red
Lobster, Golden

Corral

Five Guys, Bu�alo
Wild Wings, Firehouse

Subs, Moe’s
Southwest Grill

Jason’s Deli,
McAlister’s
Deli, Fazoli’s

BJ’s Restaurant &
Brewery, The

Cheesecake Factory,
Carrabba’s Italian

Grille

Corner Bakery Café,
Atlanta Bread

Company

Panera
Bread

Company

California
Pizza

Kitchen

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can be used as axes for the map, then it is wise to draw several maps to give differ-
ent exposures to the competitive positioning relationships present in the industry’s
structure—there is not necessarily one best map for portraying how competing
firms are positioned.

The Value of Strategic Group Maps
Strategic group maps are revealing in several respects. The most important has to do
with identifying which industry members are close rivals and which are distant
rivals. Firms in the same strategic group are the closest rivals; the next closest
rivals are in the immediately adjacent groups. Often, firms in strategic groups that
are far apart on the map hardly compete at all. For instance, Walmart’s clientele,
merchandise selection, and pricing points are much too different to justify calling
Walmart a close competitor of Neiman Marcus or Saks Fifth Avenue. For the same
reason, the beers produced by Yuengling are really not in competition with the
beers produced by Pabst.

The second thing to be gleaned from strategic group mapping is that not all posi-
tions on the map are equally attractive.7 Two reasons account for why some positions
can be more attractive than others:

1. Prevailing competitive pressures from the industry’s five forces may cause the
profit potential of different strategic groups to vary. The profit prospects of firms
in different strategic groups can vary from good to poor because of differing
degrees of competitive rivalry within strategic groups, differing pressures from
potential entrants to each group, differing degrees of exposure to competition
from substitute products outside the industry, and differing degrees of supplier or
customer bargaining power from group to group. For instance, in the ready-to-eat
cereal industry, there are significantly higher entry barriers (capital requirements,
brand loyalty, etc.) for the strategic group comprising the large branded-cereal
makers than for the group of generic-cereal makers or the group of small natural-
cereal producers. Differences among the branded rivals versus the generic cereal
makers make rivalry stronger within the generic strategic group. In the retail chain
industry, the competitive battle between Walmart and Target is more intense (with
consequently smaller profit margins) than the rivalry among Prada, Versace,
Gucci, Armani, and other high-end fashion retailers.

2. Industry driving forces may favor some strategic groups and hurt others.
Likewise, industry driving forces can boost the business outlook for some stra-
tegic groups and adversely impact the business prospects of others. In the news
industry, for example, Internet news services and cable news networks are gain-
ing ground at the expense of newspapers and networks due to changes in tech-
nology and changing social lifestyles. Firms in strategic groups that are being
adversely impacted by driving forces may try to shift to a more favorably situ-
ated position. If certain firms are known to be trying to change their competitive
positions on the map, then attaching arrows to the circles showing the targeted
direction helps clarify the picture of competitive maneuvering among rivals.

Thus, part of strategic group map analysis always entails drawing conclusions
about where on the map is the “best” place to be and why. Which companies/strategic
groups are destined to prosper because of their positions? Which companies/strategic
groups seem destined to struggle? What accounts for why some parts of the map are
better than others?

Strategic group maps
reveal which companies
are close competitors
and which are distant
competitors.

Some strategic groups are
more favorably positioned
than others because
they confront weaker
competitive forces and/
or because they are more
favorably impacted by
industry driving forces.

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Unless a company pays attention to the strategies and situations of competitors and
has some inkling of what moves they will be making, it ends up flying blind into
competitive battle. As in sports, scouting the opposition is an essential part of game
plan development. Gathering competitive intelligence about the strategic direction
and likely moves of key competitors allows a company to prepare defensive coun-
termoves, to craft its own strategic moves with some confidence about what mar-
ket maneuvers to expect from rivals in response, and to exploit any openings that
arise from competitors’ missteps. The question is where to look for such informa-
tion, since rivals rarely reveal their strategic intentions openly. If information is not

directly available, what are the best indicators?
Michael Porter’s Framework for Competitor Analysis points to four indicators

of a rival’s likely strategic moves and countermoves. These include a rival’s current
strategy, objectives, resources and capabilities, and assumptions about itself and the
industry, as shown in Figure 3.10. A strategic profile of a rival that provides good clues
to its behavioral proclivities can be constructed by characterizing the rival along these
four dimensions.

Current Strategy To succeed in predicting a competitor’s next moves, com-
pany strategists need to have a good understanding of each rival’s current strategy,
as an indicator of its pattern of behavior and best strategic options. Questions to con-
sider include: How is the competitor positioned in the market? What is the basis for

Studying competitors’ past
behavior and preferences
provides a valuable assist
in anticipating what moves
rivals are likely to make next
and outmaneuvering them
in the marketplace.

FIGURE 3.10 A Framework for Competitor Analysis

Strategic Moves
(actions and reactions)

and
Outcomes

ASSUMPTIONS

Held about itself and
the industry

OBJECTIVES

Strategic and
performance objectives

CURRENT STRATEGY

How the company is
competing currently

Key strengths
and weaknesses

RESOURCES AND
CAPABILITIES

COMPETITOR ANALYSIS

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its competitive advantage (if any)? What kinds of investments is it making (as an
indicator of its growth trajectory)?

Objectives An appraisal of a rival’s objectives should include not only its finan-
cial performance objectives but strategic ones as well (such as those concerning mar-
ket share). What is even more important is to consider the extent to which the rival is
meeting these objectives and whether it is under pressure to improve. Rivals with good
financial performance are likely to continue their present strategy with only minor fine-
tuning. Poorly performing rivals are virtually certain to make fresh strategic moves.

Resources and Capabilities A rival’s strategic moves and countermoves
are both enabled and constrained by the set of resources and capabilities the rival has
at hand. Thus a rival’s resources and capabilities (and efforts to acquire new resources
and capabilities) serve as a strong signal of future strategic actions (and reactions to
your company’s moves). Assessing a rival’s resources and capabilities involves sizing
up not only its strengths in this respect but its weaknesses as well.

Assumptions How a rival’s top managers think about their strategic situation
can have a big impact on how the rival behaves. Banks that believe they are “too big
to fail,” for example, may take on more risk than is financially prudent. Assessing a
rival’s assumptions entails considering its assumptions about itself as well as about the
industry it participates in.

Information regarding these four analytic components can often be gleaned from
company press releases, information posted on the company’s website (especially the
presentations management has recently made to securities analysts), and such public
documents as annual reports and 10-K filings. Many companies also have a competi-
tive intelligence unit that sifts through the available information to construct up-to-date
strategic profiles of rivals. Doing the necessary detective work can be time- consuming,
but scouting competitors well enough to anticipate their next moves allows managers
to prepare effective countermoves (perhaps even beat a rival to the punch) and to take
rivals’ probable actions into account in crafting their own best course of action.

KEY SUCCESS FACTORS
An industry’s key success factors (KSFs) are those competitive factors that most
affect industry members’ ability to survive and prosper in the marketplace: the par-
ticular strategy elements, product attributes, operational approaches, resources, and
competitive capabilities that spell the difference between being a strong competitor
and a weak competitor—and between profit and loss. KSFs by their very nature are
so important to competitive success that all firms in the industry must pay close
attention to them or risk becoming an industry laggard or failure. To indicate the
significance of KSFs another way, how well the elements of a company’s strategy
measure up against an industry’s KSFs determines whether the company can meet
the basic criteria for surviving and thriving in the industry. Identifying KSFs, in
light of the prevailing and anticipated industry and competitive conditions, is there-
fore always a top priority in analytic and strategy-making considerations. Company
strategists need to understand the industry landscape well enough to separate the
factors most important to competitive success from those that are less important.

CORE CONCEPT

Key success factors are the
strategy elements, product
and service attributes,
operational approaches,
resources, and competitive
capabilities that are
essential to surviving and
thriving in the industry.

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Key success factors vary from industry to industry, and even from time to time
within the same industry, as change drivers and competitive conditions change. But
regardless of the circumstances, an industry’s key success factors can always be
deduced by asking the same three questions:

1. On what basis do buyers of the industry’s product choose between the competing
brands of sellers? That is, what product attributes and service characteristics are
crucial?

2. Given the nature of competitive rivalry prevailing in the marketplace, what
resources and competitive capabilities must a company have to be competitively
successful?

3. What shortcomings are almost certain to put a company at a significant competi-
tive disadvantage?

Only rarely are there more than five key factors for competitive success. And even
among these, two or three usually outrank the others in importance. Managers should
therefore bear in mind the purpose of identifying key success factors—to determine
which factors are most important to competitive success—and resist the temptation to
label a factor that has only minor importance as a KSF.

In the beer industry, for example, although there are many types of buyers (whole-
sale, retail, end consumer), it is most important to understand the preferences and
buying behavior of the beer drinkers. Their purchase decisions are driven by price,
taste, convenient access, and marketing. Thus the KSFs include a strong network of
wholesale distributors (to get the company’s brand stocked and favorably displayed in
retail outlets, bars, restaurants, and stadiums, where beer is sold) and clever advertis-
ing (to induce beer drinkers to buy the company’s brand and thereby pull beer sales
through the established wholesale and retail channels). Because there is a potential
for strong buyer power on the part of large distributors and retail chains, competi-
tive success depends on some mechanism to offset that power, of which advertising
(to create demand pull) is one. Thus the KSFs also include superior product dif-
ferentiation (as in microbrews) or superior firm size and branding capabilities (as
in national brands). The KSFs also include full utilization of brewing capacity (to
keep manufacturing costs low and offset the high costs of advertising, branding, and
product differentiation).

Correctly diagnosing an industry’s KSFs also raises a company’s chances of
crafting a sound strategy. The key success factors of an industry point to those
things that every firm in the industry needs to attend to in order to retain custom-
ers and weather the competition. If the company’s strategy cannot deliver on the
key success factors of its industry, it is unlikely to earn enough profits to remain a
viable business.

THE INDUSTRY OUTLOOK FOR PROFITABILITY
Each of the frameworks presented in this chapter—PESTEL, five forces analysis, driv-
ing forces, strategy groups, competitor analysis, and key success factors—provides a
useful perspective on an industry’s outlook for future profitability. Putting them all
together provides an even richer and more nuanced picture. Thus, the final step in
evaluating the industry and competitive environment is to use the results of each of
the analyses performed to determine whether the industry presents the company with

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KEY POINTS

Thinking strategically about a company’s external situation involves probing for
answers to the following questions:

1. What are the strategically relevant factors in the macro-environment, and how
do they impact an industry and its members? Industries differ significantly as
to how they are affected by conditions and developments in the broad macro-
environment. Using PESTEL analysis to identify which of these factors is strate-
gically relevant is the first step to understanding how a company is situated in its
external environment.

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LO 4

How to determine
whether an industry’s
outlook presents
a company with
sufficiently attractive
opportunities
for growth and
profitability.

strong prospects for competitive success and attractive profits. The important factors
on which to base a conclusion include:

∙ How the company is being impacted by the state of the macro-environment.
∙ Whether strong competitive forces are squeezing industry profitability to subpar

levels.
∙ Whether the presence of complementors and the possibility of cooperative actions

improve the company’s prospects.
∙ Whether industry profitability will be favorably or unfavorably affected by the

prevailing driving forces.
∙ Whether the company occupies a stronger market position than rivals.
∙ Whether this is likely to change in the course of competitive interactions.
∙ How well the company’s strategy delivers on the industry key success factors.

As a general proposition, the anticipated industry environment is fundamentally
attractive if it presents a company with good opportunity for above-average profit-
ability; the industry outlook is fundamentally unattractive if a company’s profit pros-
pects are unappealingly low.

However, it is a mistake to think of a particular industry as being equally attrac-
tive or unattractive to all industry participants and all potential entrants.8 Attrac-
tiveness is relative, not absolute, and conclusions one way or the other have to be
drawn from the perspective of a particular company. For instance, a favorably posi-
tioned competitor may see ample opportunity to capitalize on the vulnerabilities
of weaker rivals even though industry conditions are otherwise somewhat dismal.
At the same time, industries attractive to insiders may be unattractive to outsiders
because of the difficulty of challenging current market leaders or because they
have more attractive opportunities elsewhere.

When a company decides an industry is fundamentally attractive and presents
good opportunities, a strong case can be made that it should invest aggressively to
capture the opportunities it sees and to improve its long-term competitive position
in the business. When a strong competitor concludes an industry is becoming less
attractive, it may elect to simply protect its present position, investing cautiously—if at
all—and looking for opportunities in other industries. A competitively weak company
in an unattractive industry may see its best option as finding a buyer, perhaps a rival,
to acquire its business.

The degree to which an
industry is attractive or
unattractive is not the same
for all industry participants
and all potential entrants.

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2. What kinds of competitive forces are industry members facing, and how strong is
each force? The strength of competition is a composite of five forces: (1) rivalry
within the industry, (2) the threat of new entry into the market, (3) inroads being
made by the sellers of substitutes, (4) supplier bargaining power, and (5) buyer
bargaining power. All five must be examined force by force, and their collective
strength evaluated. One strong force, however, can be sufficient to keep average
industry profitability low. Working through the five forces model aids strategy
makers in assessing how to insulate the company from the strongest forces, iden-
tify attractive arenas for expansion, or alter the competitive conditions so that they
offer more favorable prospects for profitability.

3. What cooperative forces are present in the industry, and how can a company har-
ness them to its advantage? Interactions among industry participants are not only
competitive in nature but cooperative as well. This is particularly the case when
complements to the products or services of an industry are important. The value
net framework assists managers in sizing up the impact of cooperative as well as
competitive interactions on their firm.

4. What factors are driving changes in the industry, and what impact will they have
on competitive intensity and industry profitability? Industry and competitive con-
ditions change because certain forces are acting to create incentives or pressures
for change. The first step is to identify the three or four most important drivers of
change affecting the industry being analyzed (out of a much longer list of poten-
tial drivers). Once an industry’s change drivers have been identified, the analytic
task becomes one of determining whether they are acting, individually and col-
lectively, to make the industry environment more or less attractive.

5. What market positions do industry rivals occupy—who is strongly positioned and
who is not? Strategic group mapping is a valuable tool for understanding the simi-
larities, differences, strengths, and weaknesses inherent in the market positions
of rival companies. Rivals in the same or nearby strategic groups are close com-
petitors, whereas companies in distant strategic groups usually pose little or no
immediate threat. The lesson of strategic group mapping is that some positions
on the map are more favorable than others. The profit potential of different strate-
gic groups may not be the same because industry driving forces and competitive
forces likely have varying effects on the industry’s distinct strategic groups.

6. What strategic moves are rivals likely to make next? Anticipating the actions of
rivals can help a company prepare effective countermoves. Using the Framework
for Competitor Analysis is helpful in this regard.

7. What are the key factors for competitive success? An industry’s key success fac-
tors (KSFs) are the particular strategy elements, product attributes, operational
approaches, resources, and competitive capabilities that all industry members
must have in order to survive and prosper in the industry. For any industry, they
can be deduced by answering three basic questions: (1) On what basis do buyers
of the industry’s product choose between the competing brands of sellers, (2) what
resources and competitive capabilities must a company have to be competitively
successful, and (3) what shortcomings are almost certain to put a company at a
significant competitive disadvantage?

8. Is the industry outlook conducive to good profitability? The last step in industry
analysis is summing up the results from applying each of the frameworks employed

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in answering questions 1 to 6: PESTEL, five forces analysis, driving forces, stra-
tegic group mapping, competitor analysis, and key success factors. Applying mul-
tiple lenses to the question of what the industry outlook looks like offers a more
robust and nuanced answer. If the answers from each framework, seen as a whole,
reveal that a company’s profit prospects in that industry are above-average, then
the industry environment is basically attractive for that company. What may look
like an attractive environment for one company may appear to be unattractive
from the perspective of a different company.

Clear, insightful diagnosis of a company’s external situation is an essential first step in
crafting strategies that are well matched to industry and competitive conditions. To do
cutting-edge strategic thinking about the external environment, managers must know
what questions to pose and what analytic tools to use in answering these questions. This
is why this chapter has concentrated on suggesting the right questions to ask, explain-
ing concepts and analytic approaches, and indicating the kinds of things to look for.

ASSURANCE OF LEARNING EXERCISES

1. Prepare a brief analysis of the organic food industry using the information pro-
vided by the Organic Trade Association at www.ota.com and the Organic Report
magazine at theorganicreport.com. That is, based on the information provided
on these websites, draw a five forces diagram for the organic food industry and
briefly discuss the nature and strength of each of the five competitive forces.

2. Based on the strategic group map in Illustration Capsule 3.1, which casual dining
chains are Applebee’s closest competitors? With which strategic group does Cali-
fornia Pizza Kitchen compete the least, according to this map? Why do you think
no casual dining chains are positioned in the area above the Olive Garden’s group?

3. The National Restaurant Association publishes an annual industry fact book that
can be found at imis.restaurant.org/store/detail.aspx?id=FOR2016FB. Based
on information in the latest report, does it appear that macro-environmental fac-
tors and the economic characteristics of the industry will present industry partici-
pants with attractive opportunities for growth and profitability? Explain.

LO 2

LO 3

LO 1, LO 4

EXERCISE FOR SIMULATION PARTICIPANTS

1. Which of the factors listed in Table 3.1 might have the most strategic relevance for
your industry?

2. Which of the five competitive forces is creating the strongest competitive pres-
sures for your company?

3. What are the “weapons of competition” that rival companies in your industry can
use to gain sales and market share? See Table 3.2 to help you identify the various
competitive factors.

LO 1, LO 2,
LO 3, LO 4

CHAPTER 3 Evaluating a Company’s External Environment 79

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ENDNOTES
Journal of Economic Behavior & Organization
15, no. 1 (January 1991).
5 For a more extended discussion of the prob-
lems with the life-cycle hypothesis, see Porter,
Competitive Strategy, pp. 157–162.
6 Mary Ellen Gordon and George R. Milne,
“Selecting the Dimensions That Define Strate-
gic Groups: A Novel Market-Driven Approach,”
Journal of Managerial Issues 11, no. 2 (Summer
1999), pp. 213–233.
7 Avi Fiegenbaum and Howard Thomas, “Stra-
tegic Groups as Reference Groups: Theory,
Modeling and Empirical Examination of

1 Michael E. Porter, Competitive Strategy (New
York: Free Press, 1980); Michael E. Porter, “The
Five Competitive Forces That Shape Strategy,”
Harvard Business Review 86, no. 1 (January
2008), pp. 78–93.
2 J. S. Bain, Barriers to New Competition
(Cambridge, MA: Harvard University Press,
1956); F. M. Scherer, Industrial Market Structure
and Economic Performance (Chicago: Rand
McNally, 1971).
3 Ibid.
4 C. A. Montgomery and S. Hariharan, “Diversi-
fied Expansion by Large Established Firms,”

Industry and Competitive Strategy,” Strategic
Management Journal 16 (1995), pp. 461–476;
S. Ade Olusoga, Michael P. Mokwa, and
Charles H. Noble, “Strategic Groups,
Mobility Barriers, and Competitive Advantage,”
Journal of Business Research 33 (1995),
pp. 153–164.
8 B. Wernerfelt and C. Montgomery, “What Is an
Attractive Industry?” Management Science 32,
no. 10 (October 1986), pp. 1223–1230.

4. What are the factors affecting the intensity of rivalry in the industry in which
your company is competing? Use Figure 3.4 and the accompanying discussion
to help you in pinpointing the specific factors most affecting competitive inten-
sity. Would you characterize the rivalry and jockeying for better market position,
increased sales, and market share among the companies in your industry as fierce,
very strong, strong, moderate, or relatively weak? Why?

5. Are there any driving forces in the industry in which your company is competing?
If so, what impact will these driving forces have? Will they cause competition to
be more or less intense? Will they act to boost or squeeze profit margins? List at
least two actions your company should consider taking in order to combat any
negative impacts of the driving forces.

6. Draw a strategic group map showing the market positions of the companies in your
industry. Which companies do you believe are in the most attractive position on the
map? Which companies are the most weakly positioned? Which companies do you
believe are likely to try to move to a different position on the strategic group map?

7. What do you see as the key factors for being a successful competitor in your
industry? List at least three.

8. Does your overall assessment of the industry suggest that industry rivals have suf-
ficiently attractive opportunities for growth and profitability? Explain.

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CHAPTER 4

Evaluating a
Company’s
Resources,
Capabilities, and
Competitiveness

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 How to take stock of how well a company’s strategy is working.

LO 2 Why a company’s resources and capabilities are centrally important in giving the
company a competitive edge over rivals.

LO 3 How to assess the company’s strengths and weaknesses in light of market opportunities
and external threats.

LO 4 How a company’s value chain activities can affect the company’s cost structure and
customer value proposition.

LO 5 How a comprehensive evaluation of a company’s competitive situation can assist
managers in making critical decisions about their next strategic moves.

© Ikon Images/Alamy Stock Photo

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Crucial, of course, is having a difference that matters
in the industry.

Cynthia Montgomery—Professor and author

If you don’t have a competitive advantage, don’t compete

Jack Welch—Former CEO of General Electric

Organizations succeed in a competitive market-
place over the long run because they can do certain
things their customers value better than can their
competitors.

Robert Hayes, Gary Pisano, and David Upton—

Professors and consultants

Chapter 3 described how to use the tools of indus-
try and competitor analysis to assess a company’s
external environment and lay the groundwork for
matching a company’s strategy to its external situ-
ation. This chapter discusses techniques for evalu-
ating a company’s internal situation, including its
collection of resources and capabilities and the
activities it performs along its value chain. Internal
analysis enables managers to determine whether
their strategy is likely to give the company a signifi-
cant competitive edge over rival firms. Combined
with external analysis, it facilitates an understand-
ing of how to reposition a firm to take advantage
of new opportunities and to cope with emerging
competitive threats. The analytic spotlight will be
trained on six questions:

1. How well is the company’s present strategy
working?

2. What are the company’s most important
resources and capabilities, and will they give the

company a lasting competitive advantage over
rival companies?

3. What are the company’s strengths and weak-
nesses in relation to the market opportunities
and external threats?

4. How do a company’s value chain activities impact
its cost structure and customer value proposition?

5. Is the company competitively stronger or weaker
than key rivals?

6. What strategic issues and problems merit front-
burner managerial attention?

In probing for answers to these questions, five
analytic tools—resource and capability analysis,
SWOT analysis, value chain analysis, benchmark-
ing, and competitive strength assessment—will be
used. All five are valuable techniques for revealing
a company’s competitiveness and for helping com-
pany managers match their strategy to the compa-
ny’s particular circumstances.

QUESTION 1: HOW WELL IS THE COMPANY’S
PRESENT STRATEGY WORKING?
In evaluating how well a company’s present strategy is working, the best way to start
is with a clear view of what the strategy entails. Figure 4.1 shows the key components
of a single-business company’s strategy. The first thing to examine is the company’s
competitive approach. What moves has the company made recently to attract cus-
tomers and improve its market position—for instance, has it cut prices, improved the

LO 1

How to take stock of
how well a company’s
strategy is working.

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design of its product, added new features, stepped up advertising, entered a new geo-
graphic market, or merged with a competitor? Is it striving for a competitive advantage
based on low costs or a better product offering? Is it concentrating on serving a broad
spectrum of customers or a narrow market niche? The company’s functional strategies
in R&D, production, marketing, finance, human resources, information technology,
and so on further characterize company strategy, as do any efforts to establish alli-
ances with other enterprises.

The three best indicators of how well a company’s strategy is working are (1)
whether the company is achieving its stated financial and strategic objectives, (2)
whether its financial performance is above the industry average, and (3) whether it is
gaining customers and gaining market share. Persistent shortfalls in meeting company
performance targets and weak marketplace performance relative to rivals are reliable
warning signs that the company has a weak strategy, suffers from poor strategy execu-
tion, or both. Specific indicators of how well a company’s strategy is working include:

∙ Trends in the company’s sales and earnings growth.
∙ Trends in the company’s stock price.
∙ The company’s overall financial strength.
∙ The company’s customer retention rate.

FIGURE 4.1 Identifying the Components of a Single-Business Company’s Strategy

E�orts to build competitively
valuable partnerships and
strategic alliances with other
enterprises within its industry

Production
strategy

Supply chain
management
strategy

Finance
strategy

BUSINESS
STRATEGY
(The action plan
for managing a
single business)

E�orts to expand or
narrow geographic
coverage

K
E

Y
F

U
N

C
TIO

N
A

L STRATEGIES

Human
resource
strategy

Information
technology
strategy

Sales, marketing,
and distribution
strategies

Moves to respond to changing
conditions in the macro-environment
or in industry and competitive
conditions

R&D, technology,
product design
strategy

Initiatives to build competitive
advantage based on:

Moves to attract customers and
outcompete rivals via improved
product design, better features,
higher quality, wider selection,
lower prices, and so on

Superior ability to serve
a market niche or
specific group of buyers?

A better product
o�ering?

Lower costs relative to
rivals?

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Sluggish financial
performance and
second-rate market
accomplishments almost
always signal weak strategy,
weak execution, or both.

∙ The rate at which new customers are acquired.
∙ Evidence of improvement in internal processes such as defect rate, order ful-

fillment, delivery times, days of inventory, and employee productivity.

The stronger a company’s current overall performance, the more likely it has a
well-conceived, well-executed strategy. The weaker a company’s financial perfor-
mance and market standing, the more its current strategy must be questioned and
the more likely the need for radical changes. Table 4.1 provides a compilation of
the financial ratios most commonly used to evaluate a company’s financial perfor-
mance and balance sheet strength.

TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean

Ratio How Calculated What It Shows

Profitability ratios

1. Gross profit
margin

Sales revenues – Cost of goods sold
________________________ Sales revenues

Shows the percentage of revenues available to
cover operating expenses and yield a profit.

2. Operating profit
margin (or
return on sales)

Sales revenues – Operating expenses

_________________________ Sales revenues

or

Operating income

_____________ Sales revenues

Shows the profitability of current operations
without regard to interest charges and income
taxes. Earnings before interest and taxes is known
as EBIT in financial and business accounting.

3. Net profit
margin (or net
return on sales)

Profits after taxes _____________ Sales revenues
Shows after-tax profits per dollar of sales.

4. Total return on
assets

Profits after taxes + Interest ____________________ Total assets
A measure of the return on total investment in the
enterprise. Interest is added to after-tax profits
to form the numerator, since total assets are
financed by creditors as well as by stockholders.

5. Net return on
total assets (ROA)

Profits after taxes _____________ Total assets
A measure of the return earned by stockholders
on the firm’s total assets.

6. Return on
stockholders’
equity (ROE)

Profits after taxes ___________________ Total stockholders’ equity
The return stockholders are earning on their
capital investment in the enterprise. A return in
the 12%–15% range is average.

7. Return on
invested
capital (ROIC)—
sometimes
referred to as
return on capital
employed
(ROCE)

Profits after taxes _______________________________ Long-term debt + Total stockholders’ equity
A measure of the return that shareholders are
earning on the monetary capital invested in
the enterprise. A higher return reflects greater
bottom-line effectiveness in the use of long-term
capital.

Liquidity ratios

1. Current ratio Current assets    _____________ Current liabilities
Shows a firm’s ability to pay current liabilities
using assets that can be converted to cash in the
near term. Ratio should be higher than 1.0.

(continued)

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Ratio How Calculated What It Shows

2. Working capital Current assets – Current liabilities The cash available for a firm’s day-to-day
operations. Larger amounts mean the company
has more internal funds to (1) pay its current
liabilities on a timely basis and (2) finance inventory
expansion, additional accounts receivable, and
a larger base of operations without resorting to
borrowing or raising more equity capital.

Leverage ratios

1. Total debt-to-
assets ratio

  Total debt   _________ Total assets
Measures the extent to which borrowed funds
(both short-term loans and long-term debt) have
been used to finance the firm’s operations. A low
ratio is better—a high fraction indicates overuse of
debt and greater risk of bankruptcy.

2. Long-term debt-
to-capital ratio

 Long-term debt
_______________________________ Long-term debt + Total stockholders’ equity

A measure of creditworthiness and balance sheet
strength. It indicates the percentage of capital
investment that has been financed by both long-
term lenders and stockholders. A ratio below
0.25 is preferable since the lower the ratio, the
greater the capacity to borrow additional funds.
Debt-to-capital ratios above 0.50 indicate an
excessive reliance on long-term borrowing, lower
creditworthiness, and weak balance sheet strength.

3. Debt-to-equity
ratio

 Total debt  ___________________ Total stockholders’ equity
Shows the balance between debt (funds borrowed
both short term and long term) and the amount that
stockholders have invested in the enterprise. The
further the ratio is below 1.0, the greater the firm’s
ability to borrow additional funds. Ratios above 1.0
put creditors at greater risk, signal weaker balance
sheet strength, and often result in lower credit ratings.

4. Long-term debt-
to-equity ratio

 Long-term debt
___________________ Total stockholders’ equity

Shows the balance between long-term debt and
stockholders’ equity in the firm’s long-term capital
structure. Low ratios indicate a greater capacity to
borrow additional funds if needed.

5. Times-interest-
earned (or
coverage) ratio

 Operating income

_____________ Interest expenses
Measures the ability to pay annual interest
charges. Lenders usually insist on a minimum ratio
of 2.0, but ratios above 3.0 signal progressively
better creditworthiness.

Activity ratios

1. Days of
inventory

Inventory
__________________ Cost of goods sold ÷ 365

Measures inventory management efficiency.
Fewer days of inventory are better.

2. Inventory
turnover

Cost of goods sold
_____________ Inventory

Measures the number of inventory turns per year.
Higher is better.

3. Average
collection
period

Accounts receivable _______________ Total sales ÷ 365

or

Accounts receivable _______________ Average daily sales

Indicates the average length of time the firm must
wait after making a sale to receive cash payment.
A shorter collection time is better.

TABLE 4.1 (continued)

(continued)

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Ratio How Calculated What It Shows

Other important measures of financial performance

1. Dividend yield
on common
stock

Annual dividends per share

_____________________ Current market price per share
A measure of the return that shareholders receive
in the form of dividends. A “typical” dividend yield
is 2%–3%. The dividend yield for fast-growth
companies is often below 1%; the dividend yield for
slow-growth companies can run 4%–5%.

2. Price-to-
earnings (P/E)
ratio

Current market price per share

_____________________ Earnings per share
P/E ratios above 20 indicate strong investor
confidence in a firm’s outlook and earnings
growth; firms whose future earnings are at risk or
likely to grow slowly typically have ratios below
12.

3. Dividend
payout ratio

Annual dividends per share
___________________ Earnings per share

Indicates the percentage of after-tax profits paid
out as dividends.

4. Internal cash
flow

After-tax profits + Depreciation A rough estimate of the cash a company’s
business is generating after payment of operating
expenses, interest, and taxes. Such amounts can
be used for dividend payments or funding capital
expenditures.

5. Free cash flow After-tax profits + Depreciation – Capital 
expenditures – Dividends

A rough estimate of the cash a company’s
business is generating after payment of operating
expenses, interest, taxes, dividends, and
desirable reinvestments in the business. The
larger a company’s free cash flow, the greater its
ability to internally fund new strategic initiatives,
repay debt, make new acquisitions, repurchase
shares of stock, or increase dividend payments.

An essential element of deciding whether a company’s overall situation is funda-
mentally healthy or unhealthy entails examining the attractiveness of its resources
and capabilities. A company’s resources and capabilities are its competitive assets
and determine whether its competitive power in the marketplace will be impres-
sively strong or disappointingly weak. Companies with second-rate competitive
assets nearly always are relegated to a trailing position in the industry.

Resource and capability analysis provides managers with a powerful tool
for sizing up the company’s competitive assets and determining whether they can
provide the foundation necessary for competitive success in the marketplace. This
is a two-step process. The first step is to identify the company’s resources and

QUESTION 2: WHAT ARE THE COMPANY’S MOST
IMPORTANT RESOURCES AND CAPABILITIES,
AND WILL THEY GIVE THE COMPANY A LASTING
COMPETITIVE ADVANTAGE OVER RIVAL COMPANIES?

CORE CONCEPT

A company’s resources
and capabilities represent
its competitive assets
and are determinants of
its competitiveness and
ability to succeed in the
marketplace.

TABLE 4.1 (continued)

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LO 2

Why a company’s
resources and
capabilities are
centrally important in
giving the company
a competitive edge
over rivals.

CORE CONCEPT

A resource is a competitive
asset that is owned or
controlled by a company; a
capability (or competence)
is the capacity of a firm
to perform some internal
activity competently.
Capabilities are developed
and enabled through the
deployment of a company’s
resources.

capabilities. The second step is to examine them more closely to ascertain which
are the most competitively important and whether they can support a sustainable
competitive advantage over rival firms.1 This second step involves applying the
four tests of a resource’s competitive power.

Identifying the Company’s Resources and
Capabilities
A firm’s resources and capabilities are the fundamental building blocks of its com-
petitive strategy. In crafting strategy, it is essential for managers to know how to
take stock of the company’s full complement of resources and capabilities. But

before they can do so, managers and strategists need a more precise definition of these
terms.

In brief, a resource is a productive input or competitive asset that is owned or con-
trolled by the firm. Firms have many different types of resources at their disposal that
vary not only in kind but in quality as well. Some are of a higher quality than others,
and some are more competitively valuable, having greater potential to give a firm a
competitive advantage over its rivals. For example, a company’s brand is a resource, as
is an R&D team—yet some brands such as Coca-Cola and Xerox are well known, with
enduring value, while others have little more name recognition than generic products.
In similar fashion, some R&D teams are far more innovative and productive than oth-
ers due to the outstanding talents of the individual team members, the team’s composi-
tion, its experience, and its chemistry.

A capability (or competence)  is the capacity of a firm to perform some inter-
nal activity competently. Capabilities or competences also vary in form, quality, and
competitive importance, with some being more competitively valuable than others.
American Express displays superior capabilities in brand management and market-

ing; Starbucks’s employee management, training, and real estate capabilities are
the drivers behind its rapid growth; LinkedIn relies on superior software innova-
tion capabilities to increase new user memberships. Organizational capabilities
are developed and enabled through the deployment of a company’s resources.2
For example, Nestlé’s brand management capabilities for its 2,000+ food, bever-
age, and pet care brands draw on the knowledge of the company’s brand managers,
the expertise of its marketing department, and the company’s relationships with
retailers in nearly 200 countries. W. L. Gore’s product innovation capabilities in
its fabrics and medical and industrial product businesses result from the personal
initiative, creative talents, and technological expertise of its associates and the com-
pany’s culture that encourages accountability and creative thinking.

Types of Company Resources A useful way to identify a company’s
resources is to look for them within categories, as shown in Table 4.2. Broadly speak-
ing, resources can be divided into two main categories: tangible and intangible
resources. Although human resources make up one of the most important parts of

a company’s resource base, we include them in the intangible category to emphasize
the role played by the skills, talents, and knowledge of a company’s human resources.

Tangible resources are the most easily identified, since tangible resources are those
that can be touched or quantified readily. Obviously, they include various types of
physical resources such as manufacturing facilities and mineral resources, but they
also include a company’s financial resources, technological resources, and organi-
zational resources such as the company’s communication and control systems. Note

Resource and capability
analysis is a powerful tool
for sizing up a company’s
competitive assets and
determining whether
the assets can support a
sustainable competitive
advantage over market
rivals.

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that technological resources are included among tangible resources, by convention,
even though some types, such as copyrights and trade secrets, might be more logically
categorized as intangible.

Intangible resources are harder to discern, but they are often among the most impor-
tant of a firm’s competitive assets. They include various sorts of human assets and
intellectual capital, as well as a company’s brands, image, and reputational assets.
While intangible resources have no material existence on their own, they are often
embodied in something material. Thus, the skills and knowledge resources of a firm
are embodied in its managers and employees; a company’s brand name is embodied
in the company logo or product labels. Other important kinds of intangible resources
include a company’s relationships with suppliers, buyers, or partners of various sorts,
and the company’s culture and incentive system. A more detailed listing of the various
types of tangible and intangible resources is provided in Table 4.2.

Listing a company’s resources category by category can prevent managers from
inadvertently overlooking some company resources that might be competitively
important. At times, it can be difficult to decide exactly how to categorize certain
types of resources. For example, resources such as a work group’s specialized exper-
tise in developing innovative products can be considered to be technological assets or
human assets or intellectual capital and knowledge assets; the work ethic and drive
of a company’s workforce could be included under the company’s human assets or its

Tangible resources

∙ Physical resources: land and real estate; manufacturing plants, equipment, and/or distribution facilities; the locations
of stores, plants, or distribution centers, including the overall pattern of their physical locations; ownership of or
access rights to natural resources (such as mineral deposits)

∙ Financial resources: cash and cash equivalents; marketable securities; other financial assets such as a company’s
credit rating and borrowing capacity

∙ Technological assets: patents, copyrights, production technology, innovation technologies, technological processes

∙ Organizational resources: IT and communication systems (satellites, servers, workstations, etc.); other planning,
coordination, and control systems; the company’s organizational design and reporting structure

Intangible resources

∙ Human assets and intellectual capital: the education, experience, knowledge, and talent of the workforce, cumula-
tive learning, and tacit knowledge of employees; collective learning embedded in the organization, the intellectual
capital and know-how of specialized teams and work groups; the knowledge of key personnel concerning important
business functions; managerial talent and leadership skill; the creativity and innovativeness of certain personnel

∙ Brands, company image, and reputational assets: brand names, trademarks, product or company image, buyer
loyalty and goodwill; company reputation for quality, service, and reliability; reputation with suppliers and partners
for fair dealing

∙ Relationships: alliances, joint ventures, or partnerships that provide access to technologies, specialized know-how,
or geographic markets; networks of dealers or distributors; the trust established with various partners

∙ Company culture and incentive system: the norms of behavior, business principles, and ingrained beliefs within the
company; the attachment of personnel to the company’s ideals; the compensation system and the motivation level
of company personnel

TABLE 4.2 Types of Company Resources

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culture and incentive system. In this regard, it is important to remember that it is not
exactly how a resource is categorized that matters but, rather, that all of the com-
pany’s different types of resources are included in the inventory. The real purpose
of using categories in identifying a company’s resources is to ensure that none of a
company’s resources go unnoticed when sizing up the company’s competitive assets.

Identifying Capabilities Organizational capabilities are more complex
entities than resources; indeed, they are built up through the use of resources and draw
on some combination of the firm’s resources as they are exercised. Virtually all orga-
nizational capabilities are knowledge-based, residing in people and in a company’s
intellectual capital, or in organizational processes and systems, which embody tacit
knowledge. For example, Amazon’s speedy delivery capabilities rely on the knowledge
of its fulfillment center managers, its relationship with the United Postal Service, and
the experience of its merchandisers to correctly predict inventory flow. Bose’s capa-
bilities in auditory system design arise from the talented engineers that form the R&D
team as well as the company’s strong culture, which celebrates innovation and beauti-
ful design.

Because of their complexity, capabilities are harder to categorize than resources
and more challenging to search for as a result. There are, however, two approaches that
can make the process of uncovering and identifying a firm’s capabilities more system-
atic. The first method takes the completed listing of a firm’s resources as its starting
point. Since capabilities are built from resources and utilize resources as they are exer-
cised, a firm’s resources can provide a strong set of clues about the types of capabili-
ties the firm is likely to have accumulated. This approach simply involves looking over
the firm’s resources and considering whether (and to what extent) the firm has built
up any related capabilities. So, for example, a fleet of trucks, the latest RFID track-
ing technology, and a set of large automated distribution centers may be indicative of
sophisticated capabilities in logistics and distribution. R&D teams composed of top
scientists with expertise in genomics may suggest organizational capabilities in devel-
oping new gene therapies or in biotechnology more generally.

The second method of identifying a firm’s capabilities takes a functional approach.
Many capabilities relate to fairly specific functions; these draw on a limited set of
resources and typically involve a single department or organizational unit. Capabili-
ties in injection molding or continuous casting or metal stamping are manufacturing-
related; capabilities in direct selling, promotional pricing, or database marketing all
connect to the sales and marketing functions; capabilities in basic research, strate-
gic innovation, or new product development link to a company’s R&D function. This
approach requires managers to survey the various functions a firm performs to find
the different capabilities associated with each function.

A problem with this second method is that many of the most important capabilities
of firms are inherently cross-functional. Cross-functional capabilities draw on a num-
ber of different kinds of resources and are multidimensional in nature—they spring
from the effective collaboration among people with different types of expertise work-
ing in different organizational units. Warby Parker draws from its cross-functional
design process to create its popular eyewear. Its design capabilities are not just due
to its creative designers, but are the product of their capabilities in market research
and engineering as well as their relations with suppliers and manufacturing compa-
nies. Cross-functional capabilities and other complex capabilities involving numer-
ous linked and closely integrated competitive assets are sometimes referred to as
resource bundles.

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It is important not to miss identifying a company’s resource bundles, since they
can be the most competitively important of a firm’s competitive assets. Resource
bundles can sometimes pass the four tests of a resource’s competitive power
(described below) even when the individual components of the resource bundle can-
not. Although PetSmart’s supply chain and marketing capabilities are matched well
by rival Petco, the company has and continues to outperform competitors through
its customer service capabilities (including animal grooming and veterinary and
day care services). Nike’s bundle of styling expertise, marketing research skills,
professional endorsements, brand name, and managerial know-how has allowed it
to remain number one in the athletic footwear and apparel industry for more than
20 years.

Assessing the Competitive Power of a Company’s
Resources and Capabilities
To assess a company’s competitive power, one must go beyond merely identifying its
resources and capabilities to probe its caliber.3 Thus, the second step in resource and
capability analysis is designed to ascertain which of a company’s resources and capa-
bilities are competitively superior and to what extent they can support a company’s
quest for a sustainable competitive advantage over market rivals. When a company has
competitive assets that are central to its strategy and superior to those of rival firms,
they can support a competitive advantage, as defined in Chapter 1. If this advantage
proves durable despite the best efforts of competitors to overcome it, then the company
is said to have a sustainable competitive advantage. While it may be difficult for a
company to achieve a sustainable competitive advantage, it is an important strategic
objective because it imparts a potential for attractive and long-lived profitability.

The Four Tests of a Resource’s Competitive Power The competi-
tive power of a resource or capability is measured by how many of four specific tests it
can pass.4 These tests are referred to as the VRIN tests for sustainable competitive
advantage—VRIN is a shorthand reminder standing for Valuable, Rare, Inimitable,
and Nonsubstitutable. The first two tests determine whether a resource or capability
can support a competitive advantage. The last two determine whether the competi-
tive advantage can be sustained.

1. Is the resource or capability competitively Valuable? To be competitively valu-
able, a resource or capability must be directly relevant to the company’s strat-
egy, making the company a more effective competitor. Unless the resource or
capability contributes to the effectiveness of the company’s strategy, it cannot
pass this first test. An indicator of its effectiveness is whether the resource
enables the company to strengthen its business model by improving its customer
value proposition and/or profit formula (see Chapter 1). Companies have to guard
against contending that something they do well is necessarily competitively valu-
able. Apple’s OS X operating system for its personal computers by some accounts
is superior to Microsoft’s Windows 10, but Apple has failed in converting its
resources devoted to operating system design into anything more than moderate
competitive success in the global PC market.

2. Is the resource or capability  Rare—is it something rivals lack? Resources and
capabilities that are common among firms and widely available cannot be a source
of competitive advantage. All makers of branded cereals have valuable marketing

CORE CONCEPT

A resource bundle is
a linked and closely
integrated set of
competitive assets centered
around one or more cross-
functional capabilities.

CORE CONCEPT

The VRIN tests for
sustainable competitive
advantage ask whether
a resource is valuable,
rare, inimitable, and
nonsubstitutable.

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capabilities and brands, since the key success factors in the ready-to-eat cereal
industry demand this. They are not rare. However, the brand strength of Oreo
cookies is uncommon and has provided Kraft Foods with greater market share
as well as the opportunity to benefit from brand extensions such as Double Stuf
Oreos and Mini Oreos. A resource or capability is considered rare if it is held by
only a small number of firms in an industry or specific competitive domain. Thus,
while general management capabilities are not rare in an absolute sense, they are
relatively rare in some of the less developed regions of the world and in some
business domains.

3. Is the resource or capability Inimitable—is it hard to copy? The more difficult
and more costly it is for competitors to imitate a company’s resource or capabil-
ity, the more likely that it can also provide a sustainable competitive advantage.
Resources and capabilities tend to be difficult to copy when they are unique (a
fantastic real estate location, patent-protected technology, an unusually talented
and motivated labor force), when they must be built over time in ways that
are difficult to imitate (a well-known brand name, mastery of a complex pro-
cess technology, years of cumulative experience and learning), and when they
entail financial outlays or large-scale operations that few industry members can
undertake (a global network of dealers and distributors). Imitation is also dif-
ficult for resources and capabilities that reflect a high level of social complex-
ity (company culture, interpersonal relationships among the managers or R&D
teams, trust-based relations with customers or suppliers) and causal ambiguity,
a term that signifies the hard-to-disentangle nature of the complex resources,
such as a web of intricate processes enabling new drug discovery. Hard-to-copy
resources and capabilities are important competitive assets, contributing to the
longevity of a company’s market position and offering the potential for sus-
tained profitability.

4. Is the resource or capability Nonsubstitutable—is it invulnerable to the threat of
substitution from different types of resources and capabilities? Even resources that
are competitively valuable, rare, and costly to imitate may lose much of their abil-
ity to offer competitive advantage if rivals possess equivalent substitute resources.
For example, manufacturers relying on automation to gain a cost-based advantage
in production activities may find their technology-based advantage nullified by
rivals’ use of low-wage offshore manufacturing. Resources can contribute to a
sustainable competitive advantage only when resource substitutes aren’t on the
horizon.

The vast majority of companies are not well endowed with standout resources
or capabilities, capable of passing all four tests with high marks. Most firms have a
mixed bag of resources—one or two quite valuable, some good, many satisfactory to
mediocre. Resources and capabilities that are valuable pass the first of the four tests.
As key contributors to the effectiveness of the strategy, they are relevant to the firm’s
competitiveness but are no guarantee of competitive advantage. They may offer no
more than competitive parity with competing firms.

Passing both of the first two tests requires more—it requires resources and capa-
bilities that are not only valuable but also rare. This is a much higher hurdle that can be
cleared only by resources and capabilities that are competitively superior. Resources
and capabilities that are competitively superior are the company’s true strategic assets.
They provide the company with a competitive advantage over its competitors, if only
in the short run.

CORE CONCEPT

Social complexity and
causal ambiguity are two
factors that inhibit the
ability of rivals to imitate
a firm’s most valuable
resources and capabilities.
Causal ambiguity makes
it very hard to figure out
how a complex resource
contributes to competitive
advantage and therefore
exactly what to imitate.

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CORE CONCEPT

A dynamic capability is
an ongoing capacity of
a company to modify its
existing resources and
capabilities or create
new ones.

To pass the last two tests, a resource must be able to maintain its competitive supe-
riority in the face of competition. It must be resistant to imitative attempts and efforts
by competitors to find equally valuable substitute resources. Assessing the availabil-
ity of substitutes is the most difficult of all the tests since substitutes are harder to
recognize, but the key is to look for resources or capabilities held by other firms or
being developed that can serve the same function as the company’s core resources and
capabilities.5

Very few firms have resources and capabilities that can pass all four tests, but those
that do enjoy a sustainable competitive advantage with far greater profit potential.
Costco is a notable example, with strong employee incentive programs and capabilities
in supply chain management that have surpassed those of its warehouse club rivals
for over 35 years. Lincoln Electric Company, less well known but no less notable in
its achievements, has been the world leader in welding products for over 100 years as
a result of its unique piecework incentive system for compensating production work-
ers and the unsurpassed worker productivity and product quality that this system has
fostered.

A Company’s Resources and Capabilities Must Be Managed
Dynamically Even companies like Costco and Lincoln Electric cannot afford
to rest on their laurels. Rivals that are initially unable to replicate a key resource may
develop better and better substitutes over time. Resources and capabilities can depreci-
ate like other assets if they are managed with benign neglect. Disruptive changes in
technology, customer preferences, distribution channels, or other competitive factors
can also destroy the value of key strategic assets, turning resources and capabilities
“from diamonds to rust.”6

Resources and capabilities must be continually strengthened and nurtured to
sustain their competitive power and, at times, may need to be broadened and deep-
ened to allow the company to position itself to pursue emerging market oppor-
tunities.7 Organizational resources and capabilities that grow stale can impair
competitiveness unless they are refreshed, modified, or even phased out and
replaced in response to ongoing market changes and shifts in company strategy.
Management’s challenge in managing the firm’s resources and capabilities dynam-
ically has two elements: (1) attending to the ongoing modification of existing com-
petitive assets, and (2) casting a watchful eye for opportunities to develop totally
new kinds of capabilities.

The Role of Dynamic Capabilities Companies that know the impor-
tance of recalibrating and upgrading their most valuable resources and capabilities
ensure that these activities are done on a continual basis. By incorporating these
activities into their routine managerial functions, they gain the experience neces-
sary to be able to do them consistently well. At that point, their ability to freshen
and renew their competitive assets becomes a capability in itself—a dynamic
capability. A dynamic capability is the ability to modify, deepen, or augment
the company’s existing resources and capabilities.8 This includes the capacity to
improve existing resources and capabilities incrementally, in the way that Toyota
aggressively upgrades the company’s capabilities in fuel-efficient hybrid engine
technology and constantly fine-tunes its famed Toyota production system. Likewise,
management at BMW developed new organizational capabilities in hybrid engine
design that allowed the company to launch its highly touted i3 and i8 plug-in hybrids.

A company requires a
dynamically evolving
portfolio of resources and
capabilities to sustain its
competitiveness and help
drive improvements in its
performance.

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A dynamic capability also includes the capacity to add new resources and capabilities
to the company’s competitive asset portfolio. One way to do this is through alliances
and acquisitions. An example is Bristol-Meyers Squibb’s famed “string of pearls”
acquisition capabilities, which have enabled it to replace degraded resources such as
expiring patents with new patents and newly acquired capabilities in drug discovery
for new disease domains.

LO 3

How to assess the
company’s strengths
and weaknesses
in light of market
opportunities and
external threats.

SWOT analysis is a simple
but powerful tool for sizing
up a company’s strengths
and weaknesses, its market
opportunities, and the
external threats to its future
well-being.

Basing a company’s strategy
on its most competitively
valuable strengths gives the
company its best chance for
market success.

QUESTION 3: WHAT ARE THE COMPANY’S STRENGTHS
AND WEAKNESSES IN RELATION TO THE MARKET
OPPORTUNITIES AND EXTERNAL THREATS?

In evaluating a company’s overall situation, a key question is whether the company
is in a position to pursue attractive market opportunities and defend against external
threats to its future well-being. The simplest and most easily applied tool for conduct-
ing this examination is widely known as SWOT analysis, so named because it zeros
in on a company’s internal Strengths and Weaknesses, market Opportunities, and
external Threats. A first-rate SWOT analysis provides the basis for crafting a strategy
that capitalizes on the company’s strengths, overcomes its weaknesses, aims squarely

at capturing the company’s best opportunities, and defends against competitive and
macro-environmental threats.

Identifying a Company’s Internal Strengths
A strength is something a company is good at doing or an attribute that enhances
its competitiveness in the marketplace. A company’s strengths depend on the qual-
ity of its resources and capabilities. Resource and capability analysis provides a
way for managers to assess the quality objectively. While resources and capabili-
ties that pass the VRIN tests of sustainable competitive advantage are among the
company’s greatest strengths, other types can be counted among the company’s
strengths as well. A capability that is not potent enough to produce a sustainable
advantage over rivals may yet enable a series of temporary advantages if used as a
basis for entry into a new market or market segment. A resource bundle that fails to
match those of top-tier competitors may still allow a company to compete success-
fully against the second tier.

Assessing a Company’s Competencies—What Activities Does
It Perform Well? One way to appraise the degree of a company’s strengths
has to do with the company’s skill level in performing key pieces of its business—
such as supply chain management, R&D, production, distribution, sales and market-
ing, and customer service. A company’s skill or proficiency in performing different
facets of its operations can range from the extreme of having minimal ability to
perform an activity (perhaps having just struggled to do it the first time) to the other
extreme of being able to perform the activity better than any other company in the
industry.

When a company’s proficiency rises from that of mere ability to perform an activ-
ity to the point of being able to perform it consistently well and at acceptable cost, it is

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CORE CONCEPT

A company’s strengths
represent its competitive
assets; its weaknesses
are shortcomings that
constitute competitive
liabilities.

said to have a competence—a true capability, in other words. If a company’s com-
petence level in some activity domain is superior to that of its rivals it is known as
a distinctive competence. A core competence is a proficiently performed internal
activity that is central to a company’s strategy and is typically distinctive as well.
A core competence is a more competitively valuable strength than a competence
because of the activity’s key role in the company’s strategy and the contribution
it makes to the company’s market success and profitability. Often, core compe-
tencies can be leveraged to create new markets or new product demand, as the
engine behind a company’s growth. Procter and Gamble has a core competence in
brand management, which has led to an ever increasing portfolio of market-leading
consumer products, including Charmin, Tide, Crest, Tampax, Olay, Febreze, Luvs,
Pampers, and Swiffer. Nike has a core competence in designing and marketing
innovative athletic footwear and sports apparel. Kellogg has a core competence in
developing, producing, and marketing breakfast cereals.

Identifying Company Weaknesses and
Competitive Deficiencies
A weakness, or competitive deficiency, is something a company lacks or does poorly
(in comparison to others) or a condition that puts it at a disadvantage in the market-
place. A company’s internal weaknesses can relate to (1) inferior or unproven skills,
expertise, or intellectual capital in competitively important areas of the business;
(2) deficiencies in competitively important physical, organizational, or intangible
assets; or (3) missing or competitively inferior capabilities in key areas. Company
weaknesses are thus internal shortcomings that constitute competitive liabilities.
Nearly all companies have competitive liabilities of one kind or another. Whether a
company’s internal weaknesses make it competitively vulnerable depends on how
much they matter in the marketplace and whether they are offset by the company’s
strengths.

Table 4.3 lists many of the things to consider in compiling a company’s
strengths and weaknesses. Sizing up a company’s complement of strengths and
deficiencies is akin to constructing a strategic balance sheet, where strengths
represent competitive assets and weaknesses represent competitive liabilities. Obvi-
ously, the ideal condition is for the company’s competitive assets to outweigh its
competitive liabilities by an ample margin—a 50–50 balance is definitely not the
desired condition!

Identifying a Company’s Market Opportunities
Market opportunity is a big factor in shaping a company’s strategy. Indeed, manag-
ers can’t properly tailor strategy to the company’s situation without first identify-
ing its market opportunities and appraising the growth and profit potential each one
holds. Depending on the prevailing circumstances, a company’s opportunities can be
plentiful or scarce, fleeting or lasting, and can range from wildly attractive to mar-
ginally interesting to unsuitable. Table 4.3 displays a sampling of potential market
opportunities.

Newly emerging and fast-changing markets sometimes present stunningly big or
“golden” opportunities, but it is typically hard for managers at one company to peer
into “the fog of the future” and spot them far ahead of managers at other companies.9

CORE CONCEPT

A competence is an activity
that a company has learned
to perform with proficiency.

A distinctive competence
is a capability that enables
a company to perform a
particular set of activities
better than its rivals.

CORE CONCEPT

A core competence is an
activity that a company
performs proficiently and
that is also central to its
strategy and competitive
success.

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Potential Strengths and Competitive Assets Potential Weaknesses and Competitive Deficiencies

• Competencies that are well matched to industry
key success factors

• Ample financial resources to grow the business
• Strong brand-name image and/or company

reputation
• Economies of scale and/or learning- and experi-

ence-curve advantages over rivals
• Other cost advantages over rivals
• Attractive customer base
• Proprietary technology, superior technological

skills, important patents
• Strong bargaining power over suppliers or buyers
• Resources and capabilities that are valuable and

rare
• Resources and capabilities that are hard to copy

and for which there are no good substitutes
• Superior product quality
• Wide geographic coverage and/or strong global

distribution capability
• Alliances and/or joint ventures that provide access

to valuable technology, competencies, and/or
attractive geographic markets

• No clear strategic vision
• No well-developed or proven core competencies
• No distinctive competencies or competitively superior

resources
• Lack of attention to customer needs
• A product or service with features and attributes that

are inferior to those of rivals
• Weak balance sheet, insufficient financial resources to

grow the firm
• Too much debt
• Higher overall unit costs relative to those of key

competitors
• Too narrow a product line relative to rivals
• Weak brand image or reputation
• Weaker dealer network than key rivals and/or lack of

adequate distribution capability
• Lack of management depth
• A plague of internal operating problems or obsolete

facilities
• Too much underutilized plant capacity
• Resources that are readily copied or for which there are

good substitutes

Potential Market Opportunities Potential External Threats to a Company’s Future
Profitability

• Meeting sharply rising buyer demand for the
industry’s product

• Serving additional customer groups or market
segments

• Expanding into new geographic markets
• Expanding the company’s product line to meet a

broader range of customer needs
• Utilizing existing company skills or technological know-

how to enter new product lines or new businesses
• Taking advantage of falling trade barriers in attrac-

tive foreign markets
• Taking advantage of an adverse change in the for-

tunes of rival firms
• Acquiring rival firms or companies with attractive

technological expertise or capabilities
• Taking advantage of emerging technological

developments to innovate
• Entering into alliances or joint ventures to expand

the firm’s market coverage or boost its competitive
capability

• Increased intensity of competition among industry rivals–
may squeeze profit margins

• Slowdowns in market growth
• Likely entry of potent new competitors
• Growing bargaining power of customers or suppliers
• A shift in buyer needs and tastes away from the indus-

try’s product
• Adverse demographic changes that threaten to curtail

demand for the industry’s product
• Adverse economic conditions that threaten critical sup-

pliers or distributors
• Changes in technology–particularly disruptive tech-

nology that can undermine the company’s distinctive
competencies

• Restrictive foreign trade policies
• Costly new regulatory requirements
• Tight credit conditions
• Rising prices on energy or other key inputs

TABLE 4.3 What to Look for in Identifying a Company’s Strengths, Weaknesses,
Opportunities, and Threats

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But as the fog begins to clear, golden opportunities are nearly always seized rapidly—
and the companies that seize them are usually those that have been actively waiting,
staying alert with diligent market reconnaissance, and preparing themselves to capi-
talize on shifting market conditions by patiently assembling an arsenal of resources to
enable aggressive action when the time comes. In mature markets, unusually attractive
market opportunities emerge sporadically, often after long periods of relative calm—
but future market conditions may be more predictable, making emerging opportuni-
ties easier for industry members to detect.

In evaluating a company’s market opportunities and ranking their attractiveness,
managers have to guard against viewing every industry opportunity as a company
opportunity. Rarely does a company have the resource depth to pursue all avail-
able market opportunities simultaneously without spreading itself too thin. Some
companies have resources and capabilities better-suited for pursuing some opportu-
nities, and a few companies may be hopelessly outclassed in competing for any of
an industry’s attractive opportunities. The market opportunities most relevant to a
company are those that match up well with the company’s competitive assets, offer
the best prospects for growth and profitability, and present the most potential for
competitive advantage.

Identifying the Threats to a Company’s Future
Profitability
Often, certain factors in a company’s external environment pose threats to its profit-
ability and competitive well-being. Threats can stem from such factors as the emer-
gence of cheaper or better technologies, the entry of lower-cost foreign competitors
into a company’s market stronghold, new regulations that are more burdensome to
a company than to its competitors, unfavorable demographic shifts, and political
upheaval in a foreign country where the company has facilities. Table 4.3 shows a
representative list of potential threats.

External threats may pose no more than a moderate degree of adversity (all
companies confront some threatening elements in the course of doing business),
or they may be imposing enough to make a company’s situation look tenuous. On
rare occasions, market shocks can give birth to a sudden-death threat that throws
a company into an immediate crisis and a battle to survive. Many of the world’s
major financial institutions were plunged into unprecedented crisis in 2008–2009
by the aftereffects of high-risk mortgage lending, inflated credit ratings on sub-
prime mortgage securities, the collapse of housing prices, and a market flooded
with mortgage-related investments (collateralized debt obligations) whose values
suddenly evaporated. It is management’s job to identify the threats to the com-
pany’s future prospects and to evaluate what strategic actions can be taken to neu-
tralize or lessen their impact.

What Do the SWOT Listings Reveal?
SWOT analysis involves more than making four lists. The two most important parts
of SWOT analysis are drawing conclusions from the SWOT listings about the com-
pany’s overall situation and translating these conclusions into strategic actions to bet-
ter match the company’s strategy to its internal strengths and market opportunities, to
correct important weaknesses, and to defend against external threats. Figure 4.2 shows
the steps involved in gleaning insights from SWOT analysis.

Simply making lists of
a company’s strengths,
weaknesses, opportunities,
and threats is not enough;
the payoff from SWOT
analysis comes from
the conclusions about a
company’s situation and the
implications for strategy
improvement that flow from
the four lists.

A company is well advised
to pass on a particular
market opportunity unless
it has or can acquire the
resources and capabilities
needed to capture it.

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FIGURE 4.2 The Steps Involved in SWOT Analysis: Identify the Four Components
of SWOT, Draw Conclusions, Translate Implications into Strategic
Actions

Identify company
strengths and
competitive
assets

Identify company
weaknesses and
competitive
deficiencies

Identify the
company’s
market
opportunities

Identify external
threats to the
company’s future
well-being

Conclusions concerning the company’s overall business
situation:
Where on the scale from “alarmingly weak” to

“exceptionally strong” does the attractiveness of the
company’s situation rank?

What are the attractive and unattractive aspects of the
company’s situation?

Implications for improving company strategy:
Use company strengths as the foundation for the

company’s strategy.
Pursue those market opportunities best suited

to company strengths.
Correct weaknesses and deficiencies that impair

pursuit of important market opportunities or heighten
vulnerability to external threats.

Use company strengths to lessen the impact of
important external threats.

What Can Be Gleaned from the
SWOT Listings?

The final piece of SWOT analysis is to translate the diagnosis of the company’s
situation into actions for improving the company’s strategy and business prospects.
A company’s internal strengths should always serve as the basis of its strategy—
placing heavy reliance on a company’s best competitive assets is the soundest route to
attracting customers and competing successfully against rivals.10 As a rule, strategies
that place heavy demands on areas where the company is weakest or has unproven
competencies should be avoided. Plainly, managers must look toward correcting
competitive weaknesses that make the company vulnerable, hold down profitability,
or disqualify it from pursuing an attractive opportunity. Furthermore, a company’s
strategy should be aimed squarely at capturing attractive market opportunities that
are suited to the company’s collection of capabilities. How much attention to devote
to defending against external threats to the company’s future performance hinges on
how vulnerable the company is, whether defensive moves can be taken to lessen their
impact, and whether the costs of undertaking such moves represent the best use of
company resources.

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Company managers are often stunned when a competitor cuts its prices to “unbeliev-
ably low” levels or when a new market entrant introduces a great new product at a
surprisingly low price. While less common, new entrants can also storm the market
with a product that ratchets the quality level up so high that customers will abandon
competing sellers even if they have to pay more for the new product. This is what
seems to have happened with Apple’s iPhone 6 and iMac computers; it is what Apple
is betting on with the Apple Watch.

Regardless of where on the quality spectrum a company competes, it must remain
competitive in terms of its customer value proposition in order to stay in the game.
Patagonia’s value proposition, for example, remains attractive to customers who value
quality, wide selection, and corporate environmental responsibility over cheaper out-
erwear alternatives. Since its inception in 1925, the New Yorker’s customer value
proposition has withstood the test of time by providing readers with an amalgam of
well-crafted, rigorously fact-checked, and topical writing.

The value provided to the customer depends on how well a customer’s needs
are met for the price paid. How well customer needs are met depends on the per-
ceived quality of a product or service as well as on other, more tangible attributes.
The greater the amount of customer value that the company can offer profitably
compared to its rivals, the less vulnerable it will be to competitive attack. For man-
agers, the key is to keep close track of how cost-effectively the company can deliver
value to customers relative to its competitors. If it can deliver the same amount of
value with lower expenditures (or more value at the same cost), it will maintain a
competitive edge.

Two analytic tools are particularly useful in determining whether a company’s
costs and customer value proposition are competitive: value chain analysis and
benchmarking.

The Concept of a Company Value Chain
Every company’s business consists of a collection of activities undertaken in the
course of producing, marketing, delivering, and supporting its product or service.
All the various activities that a company performs internally combine to form a
value chain—so called because the underlying intent of a company’s activities is
ultimately to create value for buyers.

As shown in Figure 4.3, a company’s value chain consists of two broad catego-
ries of activities: the primary activities foremost in creating value for customers
and the requisite support activities that facilitate and enhance the performance of
the primary activities.11 The kinds of primary and secondary activities that con-
stitute a company’s value chain vary according to the specifics of a company’s
business; hence, the listing of the primary and support activities in Figure 4.3 is illus-
trative rather than definitive. For example, the primary activities at a hotel operator
like Starwood Hotels and Resorts mainly consist of site selection and construction,
reservations, and hotel operations (check-in and check-out, maintenance and house-
keeping, dining and room service, and conventions and meetings); principal support

QUESTION 4: HOW DO A COMPANY’S VALUE
CHAIN ACTIVITIES IMPACT ITS COST STRUCTURE
AND CUSTOMER VALUE PROPOSITION?

LO 4

How a company’s
value chain activities
can affect the
company’s cost
structure and
customer value
proposition.

The higher a company’s
costs are above those
of close rivals, the more
competitively vulnerable
the company becomes.

The greater the amount
of customer value that a
company can offer profitably
relative to close rivals, the
less competitively vulnerable
the company becomes.

CORE CONCEPT

A company’s value chain
identifies the primary
activities and related
support activities that
create customer value.

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FIGURE 4. 3 A Representative Company Value Chain

Operations Distribution
Sales and
Marketing

Service
Profit

Margin

Supply
Chain

Manage-
ment

Primary
Activities

and
Costs

Support
Activities

and
Costs

Product R&D, Technology, and Systems Development

Human Resource Management

General Administration

PRIMARY ACTIVITIES

Supply Chain Management—Activities, costs, and assets associated with purchasing fuel, energy, raw materials,
parts and components, merchandise, and consumable items from vendors; receiving, storing, and disseminating
inputs from suppliers; inspection; and inventory management.

Operations—Activities, costs, and assets associated with converting inputs into final product form (production,
assembly, packaging, equipment maintenance, facilities, operations, quality assurance, environmental
protection).

Distribution—Activities, costs, and assets dealing with physically distributing the product to buyers (finished
goods warehousing, order processing, order picking and packing, shipping, delivery vehicle operations,
establishing and maintaining a network of dealers and distributors).

Sales and Marketing—Activities, costs, and assets related to sales force e�orts, advertising and promotion,
market research and planning, and dealer/distributor support.

Service—Activities, costs, and assets associated with providing assistance to buyers, such as installation,
spare parts delivery, maintenance and repair, technical assistance, buyer inquiries, and complaints.

SUPPORT ACTIVITIES

Product R&D, Technology, and Systems Development—Activities, costs, and assets relating to product R&D,
process R&D, process design improvement, equipment design, computer software development, telecommuni-
cations systems, computer-assisted design and engineering, database capabilities, and development of
computerized support systems.

Human Resource Management—Activities, costs, and assets associated with the recruitment, hiring, training,
development, and compensation of all types of personnel; labor relations activities; and development of
knowledge-based skills and core competencies.

General Administration—Activities, costs, and assets relating to general management, accounting and finance,
legal and regulatory a�airs, safety and security, management information systems, forming strategic alliances
and collaborating with strategic partners, and other “overhead” functions.

Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), pp. 37–43.

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activities that drive costs and impact customer value include hiring and training
hotel staff and handling general administration. Supply chain management is a cru-
cial activity for J.Crew and Boeing but is not a value chain component at Facebook,
LinkedIn, or Goldman Sachs. Sales and marketing are dominant activities at GAP
and Match.com but have only minor roles at oil-drilling companies and natural gas
pipeline companies. Customer delivery is a crucial activity at Domino’s Pizza but
insignificant at Starbucks.

With its focus on value-creating activities, the value chain is an ideal tool for
examining the workings of a company’s customer value proposition and business
model. It permits a deep look at the company’s cost structure and ability to offer low
prices. It reveals the emphasis that a company places on activities that enhance dif-
ferentiation and support higher prices, such as service and marketing. It also includes
a profit margin component, since profits are necessary to compensate the company’s
owners and investors, who bear risks and provide capital. Tracking the profit margin
along with the value-creating activities is critical because unless an enterprise suc-
ceeds in delivering customer value profitably (with a sufficient return on invested
capital), it can’t survive for long. Attention to a company’s profit formula in addi-
tion to its customer value proposition is the essence of a sound business model, as
described in Chapter 1.

Illustration Capsule 4.1 shows representative costs for various value chain activi-
ties performed by Boll & Branch, a maker of luxury linens and bedding sold directly
to consumers online.

Comparing the Value Chains of Rival Companies Value chain
analysis facilitates a comparison of how rivals, activity by activity, deliver value to
customers. Even rivals in the same industry may differ significantly in terms of the
activities they perform. For instance, the “operations” component of the value chain
for a manufacturer that makes all of its own parts and components and assembles them
into a finished product differs from the “operations” of a rival producer that buys
the needed parts and components from outside suppliers and performs only assembly
operations. How each activity is performed may affect a company’s relative cost posi-
tion as well as its capacity for differentiation. Thus, even a simple comparison of how
the activities of rivals’ value chains differ can reveal competitive differences.

A Company’s Primary and Secondary Activities Identify the
Major Components of Its Internal Cost Structure The combined
costs of all the various primary and support activities constituting a company’s value
chain define its internal cost structure. Further, the cost of each activity contributes
to whether the company’s overall cost position relative to rivals is favorable or
unfavorable. The roles of value chain analysis and benchmarking are to develop
the data for comparing a company’s costs activity by activity against the costs of
key rivals and to learn which internal activities are a source of cost advantage or
disadvantage.

Evaluating a company’s cost-competitiveness involves using what accountants
call activity-based costing to determine the costs of performing each value chain
activity.12 The degree to which a company’s total costs should be broken down
into costs for specific activities depends on how valuable it is to know the costs
of specific activities versus broadly defined activities. At the very least, cost esti-
mates are needed for each broad category of primary and support activities, but

A company’s cost-
competitiveness depends
not only on the costs
of internally performed
activities (its own value
chain) but also on costs
in the value chains of its
suppliers and distribution-
channel allies.

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ILLUSTRATION
CAPSULE 4.1 The Value Chain for Boll & Branch

© belchonock/iStock/Getty Images

A king-size set of sheets from Boll & Branch is made from
6 meters of fabric, requiring 11 kilograms of raw cotton.

Raw Cotton $ 28.16

Spinning/Weaving/Dyeing   12.00

Cutting/Sewing/Finishing     9.50

Material Transportation     3.00

Factory Fee    15.80

Cost of Goods $ 68.46

Inspection Fees    5.48

Ocean Freight/Insurance    4.55

Import Duties    8.22

Warehouse/Packing    8.50

Packaging    15.15

Customer Shipping    14.00

Promotions/Donations*     30.00

Total Cost $154.38

Boll & Brand Markup About 60%

Boll & Brand Retail Price $250.00

Gross Margin** $ 95.62

Source: Adapted from Christina Brinkley, “What Goes into the Price of Luxury Sheets?” The Wall Street Journal, March 29,
2014, www.wsj.com/articles/SB10001424052702303725404579461953672838672 (accessed February 16, 2016).

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cost estimates for more specific activities within each broad category may be needed
if a company discovers that it has a cost disadvantage vis-à-vis rivals and wants to pin
down the exact source or activity causing the cost disadvantage. However, a company’s
own internal costs may be insufficient to assess whether its product offering and cus-
tomer value proposition are competitive with those of rivals. Cost and price differ-
ences among competing companies can have their origins in activities performed by
suppliers or by distribution allies involved in getting the product to the final customers
or end users of the product, in which case the company’s entire value chain system
becomes relevant.

The Value Chain System
A company’s value chain is embedded in a larger system of activities that includes
the value chains of its suppliers and the value chains of whatever wholesale distribu-
tors and retailers it utilizes in getting its product or service to end users. This value
chain system (sometimes called a vertical chain) has implications that extend far
beyond the company’s costs. It can affect attributes like product quality that enhance
differentiation and have importance for the company’s customer value proposition,
as well as its profitability.13 Suppliers’ value chains are relevant because suppliers
perform activities and incur costs in creating and delivering the purchased inputs
utilized in a company’s own value-creating activities. The costs, performance fea-
tures, and quality of these inputs influence a company’s own costs and product dif-
ferentiation capabilities. Anything a company can do to help its suppliers drive down
the costs of their value chain activities or improve the quality and performance of
the items being supplied can enhance its own competitiveness—a powerful reason
for working collaboratively with suppliers in managing supply chain activities.14
For example, automakers have encouraged their automotive parts suppliers to build
plants near the auto assembly plants to facilitate just-in-time deliveries, reduce ware-
housing and shipping costs, and promote close collaboration on parts design and
production scheduling.

Similarly, the value chains of a company’s distribution-channel partners are rel-
evant because (1) the costs and margins of a company’s distributors and retail dealers
are part of the price the ultimate consumer pays and (2) the activities that distribu-
tion allies perform affect sales volumes and customer satisfaction. For these reasons,
companies normally work closely with their distribution allies (who are their direct
customers) to perform value chain activities in mutually beneficial ways. For instance,
motor vehicle manufacturers have a competitive interest in working closely with their
automobile dealers to promote higher sales volumes and better customer satisfaction
with dealers’ repair and maintenance services. Producers of kitchen cabinets are heav-
ily dependent on the sales and promotional activities of their distributors and build-
ing supply retailers and on whether distributors and retailers operate cost-effectively
enough to be able to sell at prices that lead to attractive sales volumes.

As a consequence, accurately assessing a company’s competitiveness entails scru-
tinizing the nature and costs of value chain activities throughout the entire value
chain system for delivering its products or services to end-use customers. A typical
value chain system that incorporates the value chains of suppliers and forward-channel
allies (if any) is shown in Figure 4.4. As was the case with company value chains, the
specific activities constituting value chain systems vary significantly from industry
to industry. The primary value chain system activities in the pulp and paper industry
(timber farming, logging, pulp mills, and papermaking) differ from the primary value

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chain system activities in the home appliance industry (parts and components manu-
facture, assembly, wholesale distribution, retail sales) and yet again from the computer
software industry (programming, disk loading, marketing, distribution).

Benchmarking: A Tool for Assessing Whether the
Costs and Effectiveness of a Company’s Value
Chain Activities Are in Line
Benchmarking entails comparing how different companies (both inside and
outside the industry) perform various value chain activities—how materials are
purchased, how inventories are managed, how products are assembled, how fast
the company can get new products to market, how customer orders are filled and
shipped—and then making cross-company comparisons of the costs and effective-
ness of these activities.15 The objectives of benchmarking are to identify the best
means of performing an activity and to emulate those best practices.

A best practice is a method of performing an activity or business process that
consistently delivers superior results compared to other approaches.16 To qualify
as a legitimate best practice, the method must have been employed by at least one
enterprise and shown to be consistently more effective in lowering costs, improving
quality or performance, shortening time requirements, enhancing safety, or achiev-
ing some other highly positive operating outcome. Best practices thus identify a
path to operating excellence with respect to value chain activities.

Xerox pioneered the use of benchmarking to become more cost-competitive,
quickly deciding not to restrict its benchmarking efforts to its office equipment

rivals but to extend them to any company regarded as “world class” in perform-
ing any activity relevant to Xerox’s business. Other companies quickly picked up on
Xerox’s approach. Toyota managers got their idea for just-in-time inventory deliver-
ies by studying how U.S. supermarkets replenished their shelves. Southwest Airlines
reduced the turnaround time of its aircraft at each scheduled stop by studying pit crews
on the auto racing circuit. More than 80 percent of Fortune 500 companies reportedly

CORE CONCEPT

Benchmarking is a potent
tool for improving a
company’s own internal
activities that is based
on learning how other
companies perform them
and borrowing their “best
practices.”

CORE CONCEPT

A best practice is a method
of performing an activity
that consistently delivers
superior results compared
to other approaches.

FIGURE 4.4 A Representative Value Chain System

Supplier-Related
Value Chains

Activities,
costs, and
margins of
suppliers

Internally
performed
activities,

costs,
and

margins

Activities,
costs, and
margins of

forward-channel
allies and
strategic
partners

Buyer or
end-user

value chains

Forward-Channel
Value Chains

A Company’s Own
Value Chain

Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York: Free Press,
1985), p. 35.

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use benchmarking for comparing themselves against rivals on cost and other competi-
tively important measures.

The tough part of benchmarking is not whether to do it but, rather, how to gain
access to information about other companies’ practices and costs. Sometimes bench-
marking can be accomplished by collecting information from published reports, trade
groups, and industry research firms or by talking to knowledgeable industry ana-
lysts, customers, and suppliers. Sometimes field trips to the facilities of competing
or noncompeting companies can be arranged to observe how things are done, com-
pare practices and processes, and perhaps exchange data on productivity and other
cost components. However, such companies, even if they agree to host facilities tours
and answer questions, are unlikely to share competitively sensitive cost information.
Furthermore, comparing two companies’ costs may not involve comparing apples to
apples if the two companies employ different cost accounting principles to calculate
the costs of particular activities.

However, a third and fairly reliable source of benchmarking information has
emerged. The explosive interest of companies in benchmarking costs and identify-
ing best practices has prompted consulting organizations (e.g., Accenture, A. T.
Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC) and
several associations (e.g., the QualServe Benchmarking Clearinghouse, and the
Strategic Planning Institute’s Council on Benchmarking) to gather benchmarking
data, distribute information about best practices, and provide comparative cost data
without identifying the names of particular companies. Having an independent
group gather the information and report it in a manner that disguises the names of
individual companies protects competitively sensitive data and lessens the potential
for unethical behavior on the part of company personnel in gathering their own data
about competitors. Illustration Capsule 4.2 describes benchmarking practices in the
cement industry.

Strategic Options for Remedying a Cost or
Value Disadvantage
The results of value chain analysis and benchmarking may disclose cost or value dis-
advantages relative to key rivals. Such information is vital in crafting strategic actions
to eliminate any such disadvantages and improve profitability. Information of this
nature can also help a company find new avenues for enhancing its competitiveness
through lower costs or a more attractive customer value proposition. There are three
main areas in a company’s total value chain system where company managers can try
to improve its efficiency and effectiveness in delivering customer value: (1) a com-
pany’s own internal activities, (2) suppliers’ part of the value chain system, and (3) the
forward-channel portion of the value chain system.

Improving Internally Performed Value Chain Activities Managers
can pursue any of several strategic approaches to reduce the costs of internally per-
formed value chain activities and improve a company’s cost-competitiveness. They
can implement best practices throughout the company, particularly for high-cost activ-
ities. They can redesign the product and/or some of its components to eliminate high-
cost components or facilitate speedier and more economical manufacture or assembly.
They can relocate high-cost activities (such as manufacturing) to geographic areas
where they can be performed more cheaply or outsource activities to lower-cost
vendors or contractors.

Benchmarking the costs
of company activities
against those of rivals
provides hard evidence
of whether a company is
cost-competitive.

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ILLUSTRATION
CAPSULE 4.2

Cement is a dry powder that creates concrete when
mixed with water and sand. People interact with con-
crete every day. It is often the building material of choice
for sidewalks, curbs, basements, bridges, and municipal
pipes. Cement is manufactured at billion-dollar contin-
uous-process plants by mining limestone, crushing it,
scorching it in a kiln, and then milling it again.

About 24 companies (CEMEX, Holcim, and Lafarge
are some of the biggest) manufacture cement at 90 U.S.
plants with the capacity to produce 110 million tons per
year. Plants serve tens of markets distributed across
multiple states. Companies regularly benchmark “deliv-
ered costs” to understand whether their plants are cost
leaders or laggards.

Delivered-cost benchmarking studies typically
subdivide manufacturing and logistics costs into five
parts: fixed-bin, variable-bin, freight-to-terminal, termi-
nal operating, and freight-to-customer costs. These cost
components are estimated using different sources.

Fixed- and variable-bin costs represent the cost of
making a ton of cement and moving it to the plant’s stor-
age silos. They are the hardest to estimate. Fortunately,
the Portland Cement Association, or PCA (the cement
industry’s association), publishes key data for every
plant that features plant location, age, capacity, tech-
nology, and fuel. Companies combine the industry data,
satellite imagery revealing quarry characteristics, and
news reports with the company’s proprietary plant-level
financial data to develop their estimates of competitors’
costs. The basic assumption is that plants of similar size
utilizing similar technologies and raw-material inputs will
have similar cost performance.

Logistics costs (including freight-to-terminal, terminal
operating, and freight-to-customer costs) are much easier
to accurately estimate. Cement companies use common

carriers to move their product by barge, train, and truck
transit modes. Freight pricing is competitive on a per-mile
basis by mode, meaning that the company’s per-ton-mile
barge cost applies to the competition. By combining
the per-ton-mile cost with origin-destination distances,
freight costs are easily calculated. Terminal operating
costs, the costs of operating barge or rail terminals that
store cement and transfer it to trucks for local delivery,
represent the smallest fraction of total supply chain cost
and typically vary little within mode type. For example,
most barge terminals cost $10 per ton to run, whereas rail
terminals are less expensive and cost $5 per ton.

By combining all five estimated cost elements, the
company benchmarks its estimated relative cost posi-
tion by market. Using these data, strategists can identify
which of the company’s plants are most exposed to vol-
ume fluctuations, which are in greatest need of invest-
ment or closure, which markets the company should
enter or exit, and which competitors are the most likely
candidates for product or asset swaps.

Delivered-Cost Benchmarking in
the Cement Industry

© Ulrich Doering/Alamy Stock Photo

Note: Developed with Peter Jacobson.

Source: w w w.cement.org (accessed January 25, 2014).

To improve the effectiveness of the company’s customer value proposition and
enhance differentiation, managers can take several approaches. They can adopt best
practices for quality, marketing, and customer service. They can reallocate resources
to activities that address buyers’ most important purchase criteria, which will have
the biggest impact on the value delivered to the customer. They can adopt new tech-
nologies that spur innovation, improve design, and enhance creativity. Additional
approaches to managing value chain activities to lower costs and/or enhance customer
value are discussed in Chapter 5.

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Improving Supplier-Related Value Chain Activities Supplier-
related cost disadvantages can be attacked by pressuring suppliers for lower prices,
switching to lower-priced substitute inputs, and collaborating closely with suppliers to
identify mutual cost-saving opportunities.17 For example, just-in-time deliveries from
suppliers can lower a company’s inventory and internal logistics costs and may also
allow suppliers to economize on their warehousing, shipping, and production schedul-
ing costs—a win–win outcome for both. In a few instances, companies may find that it
is cheaper to integrate backward into the business of high-cost suppliers and make the
item in-house instead of buying it from outsiders.

Similarly, a company can enhance its customer value proposition through its sup-
plier relationships. Some approaches include selecting and retaining suppliers that
meet higher-quality standards, providing quality-based incentives to suppliers, and
integrating suppliers into the design process. Fewer defects in parts from suppliers not
only improve quality throughout the value chain system but can lower costs as well
since less waste and disruption occur in the production processes.

Improving Value Chain Activities of Distribution Partners
Any of three means can be used to achieve better cost-competitiveness in the forward
portion of the industry value chain:

1. Pressure distributors, dealers, and other forward-channel allies to reduce their
costs and markups.

2. Collaborate with them to identify win–win opportunities to reduce costs—for
example, a chocolate manufacturer learned that by shipping its bulk chocolate in
liquid form in tank cars instead of as 10-pound molded bars, it could not only save
its candy bar manufacturing customers the costs associated with unpacking and
melting but also eliminate its own costs of molding bars and packing them.

3. Change to a more economical distribution strategy, including switching to cheaper
distribution channels (selling direct via the Internet) or integrating forward into
company-owned retail outlets.

The means to enhancing differentiation through activities at the forward end of the
value chain system include (1) engaging in cooperative advertising and promotions
with forward allies (dealers, distributors, retailers, etc.), (2) creating exclusive arrange-
ments with downstream sellers or utilizing other mechanisms that increase their incen-
tives to enhance delivered customer value, and (3) creating and enforcing standards for
downstream activities and assisting in training channel partners in business practices.
Harley-Davidson, for example, enhances the shopping experience and perceptions of
buyers by selling through retailers that sell Harley-Davidson motorcycles exclusively
and meet Harley-Davidson standards.

Translating Proficient Performance of Value Chain
Activities into Competitive Advantage
A company that does a first-rate job of managing its value chain activities relative to com-
petitors stands a good chance of profiting from its competitive advantage. A company’s
value-creating activities can offer a competitive advantage in one of two ways (or both):

1. They can contribute to greater efficiency and lower costs relative to competitors.
2. They can provide a basis for differentiation, so customers are willing to pay rela-

tively more for the company’s goods and services.

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Achieving a cost-based competitive advantage requires determined management
efforts to be cost-efficient in performing value chain activities. Such efforts have to
be ongoing and persistent, and they have to involve each and every value chain activ-
ity. The goal must be continuous cost reduction, not a one-time or on-again–off-again
effort. Companies like Dollar General, Nucor Steel, Irish airline Ryanair, T.J.Maxx,
and French discount retailer Carrefour have been highly successful in managing their
value chains in a low-cost manner.

Ongoing and persistent efforts are also required for a competitive advantage based
on differentiation. Superior reputations and brands are built up slowly over time,
through continuous investment and activities that deliver consistent, reinforcing mes-
sages. Differentiation based on quality requires vigilant management of activities
for quality assurance throughout the value chain. While the basis for differentiation
(e.g., status, design, innovation, customer service, reliability, image) may vary widely
among companies pursuing a differentiation advantage, companies that succeed do so
on the basis of a commitment to coordinated value chain activities aimed purposefully
at this objective. Examples include Cartier (status), Room and Board (craftsmanship),
American Express (customer service), Dropbox (innovation), and FedEx (reliability).

How Value Chain Activities Relate to Resources and Capabilities
There is a close relationship between the value-creating activities that a company per-
forms and its resources and capabilities. An organizational capability or competence
implies a capacity for action; in contrast, a value-creating activity initiates the action.
With respect to resources and capabilities, activities are “where the rubber hits the
road.” When companies engage in a value-creating activity, they do so by drawing on
specific company resources and capabilities that underlie and enable the activity. For
example, brand-building activities depend on human resources, such as experienced
brand managers (including their knowledge and expertise in this arena), as well as
organizational capabilities in advertising and marketing. Cost-cutting activities may
derive from organizational capabilities in inventory management, for example, and
resources such as inventory tracking systems.

Because of this correspondence between activities and supporting resources and capa-
bilities, value chain analysis can complement resource and capability analysis as another
tool for assessing a company’s competitive advantage. Resources and capabilities that are
both valuable and rare provide a company with what it takes for competitive advantage.
For a company with competitive assets of this sort, the potential is there. When these
assets are deployed in the form of a value-creating activity, that potential is realized due
to their competitive superiority. Resource analysis is one tool for identifying competi-
tively superior resources and capabilities. But their value and the competitive superiority
of that value can be assessed objectively only after they are deployed. Value chain analy-
sis and benchmarking provide the type of data needed to make that objective assessment.

There is also a dynamic relationship between a company’s activities and its
resources and capabilities. Value-creating activities are more than just the embodi-
ment of a resource’s or capability’s potential. They also contribute to the formation
and development of capabilities. The road to competitive advantage begins with
management efforts to build organizational expertise in performing certain com-
petitively important value chain activities. With consistent practice and continuous
investment of company resources, these activities rise to the level of a reliable orga-
nizational capability or a competence. To the extent that top management makes
the growing capability a cornerstone of the company’s strategy, this capability
becomes a core competence for the company. Later, with further organizational

Performing value chain
activities with capabilities
that permit the company
to either outmatch rivals
on differentiation or beat
them on costs will give the
company a competitive
advantage.

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learning and gains in proficiency, the core competence may evolve into a distinctive
competence, giving the company superiority over rivals in performing an important
value chain activity. Such superiority, if it gives the company significant competi-
tive clout in the marketplace, can produce an attractive competitive edge over rivals.
Whether the resulting competitive advantage is on the cost side or on the differentia-
tion side (or both) will depend on the company’s choice of which types of competence-
building activities to engage in over this time period.

LO 5

How a comprehensive
evaluation of
a company’s
competitive situation
can assist managers
in making critical
decisions about their
next strategic moves.

Using resource analysis, value chain analysis, and benchmarking to determine a
company’s competitiveness on value and cost is necessary but not sufficient. A more
comprehensive assessment needs to be made of the company’s overall competitive
strength. The answers to two questions are of particular interest: First, how does the
company rank relative to competitors on each of the important factors that determine
market success? Second, all things considered, does the company have a net competi-
tive advantage or disadvantage versus major competitors?

An easy-to-use method for answering these two questions involves developing
quantitative strength ratings for the company and its key competitors on each industry
key success factor and each competitively pivotal resource, capability, and value chain
activity. Much of the information needed for doing a competitive strength assessment
comes from previous analyses. Industry and competitive analyses reveal the key suc-
cess factors and competitive forces that separate industry winners from losers. Bench-
marking data and scouting key competitors provide a basis for judging the competitive
strength of rivals on such factors as cost, key product attributes, customer service,
image and reputation, financial strength, technological skills, distribution capability,
and other factors. Resource and capability analysis reveals which of these are com-
petitively important, given the external situation, and whether the company’s competi-
tive advantages are sustainable. SWOT analysis provides a more comprehensive and
forward-looking picture of the company’s overall situation.

Step 1 in doing a competitive strength assessment is to make a list of the industry’s
key success factors and other telling measures of competitive strength or weakness
(6 to 10 measures usually suffice). Step 2 is to assign weights to each of the measures of
competitive strength based on their perceived importance. (The sum of the weights for
each measure must add up to 1.) Step 3 is to calculate weighted strength ratings by scoring
each competitor on each strength measure (using a 1-to-10 rating scale, where 1 is very
weak and 10 is very strong) and multiplying the assigned rating by the assigned weight.
Step 4 is to sum the weighted strength ratings on each factor to get an overall measure of
competitive strength for each company being rated. Step 5 is to use the overall strength
ratings to draw conclusions about the size and extent of the company’s net competitive
advantage or disadvantage and to take specific note of areas of strength and weakness.

Table 4.4 provides an example of competitive strength assessment in which a hypo-
thetical company (ABC Company) competes against two rivals. In the example, rela-
tive cost is the most telling measure of competitive strength, and the other strength
measures are of lesser importance. The company with the highest rating on a given
measure has an implied competitive edge on that measure, with the size of its edge
reflected in the difference between its weighted rating and rivals’ weighted ratings.

QUESTION 5: IS THE COMPANY COMPETITIVELY
STRONGER OR WEAKER THAN KEY RIVALS?

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For instance, Rival 1’s 3.00 weighted strength rating on relative cost signals a con-
siderable cost advantage over ABC Company (with a 1.50 weighted score on relative
cost) and an even bigger cost advantage over Rival 2 (with a weighted score of 0.30).
The measure-by-measure ratings reveal the competitive areas in which a company is
strongest and weakest, and against whom.

The overall competitive strength scores indicate how all the different strength
measures add up—whether the company is at a net overall competitive advantage or
disadvantage against each rival. The higher a company’s overall weighted strength
rating, the stronger its overall competitiveness versus rivals. The bigger the difference

Competitive Strength Assessment

(rating scale: 1 = very weak, 10 = very strong)

ABC Co. Rival 1 Rival 2

Key Success
Factor/Strength
Measure

Importance
Weight

Strength
Rating

Weighted
Score

Strength
Rating

Weighted
Score

Strength
Rating

Weighted
Score

Quality/product
performance

0.10 8 0.80 5 0.50 1 0.10

Reputation/image 0.10 8 0.80 7 0.70 1 0.10

Manufacturing
capability

0.10 2 0.20 10 1.00 5 0.50

Technological
skills

0.05 10 0.50 1 0.05 3 0.15

Dealer network/
distribution
capability

0.05 9 0.45 4 0.20 5 0.25

New product
innovation
capability

0.05 9 0.45 4 0.20 5 0.25

Financial
resources

0.10 5 0.50 10 1.00 3 0.30

Relative cost
position

0.30 5 1.50 10 3.00 1 0.30

Customer service
capabilities

0.15 5 0.75 7 1.05 1 0.15

Sum of
importance
weights

1.00

Overall weighted
competitive
strength rating

5.95 7.70 2.10

TABLE 4.4 A Representative Weighted Competitive Strength Assessment

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A company’s competitive
strength scores pinpoint its
strengths and weaknesses
against rivals and point
directly to the kinds of
offensive and defensive
actions it can use to exploit
its competitive strengths
and reduce its competitive
vulnerabilities.

High-weighted competitive
strength ratings signal
a strong competitive
position and possession
of competitive advantage;
low ratings signal a weak
position and competitive
disadvantage.

between a company’s overall weighted rating and the scores of lower-rated rivals,
the greater is its implied net competitive advantage. Thus, Rival 1’s overall
weighted score of 7.70 indicates a greater net competitive advantage over Rival 2
(with a score of 2.10) than over ABC Company (with a score of 5.95). Conversely,
the bigger the difference between a company’s overall rating and the scores of
higher-rated rivals, the greater its implied net competitive disadvantage. Rival 2’s
score of 2.10 gives it a smaller net competitive disadvantage against ABC Company
(with an overall score of 5.95) than against Rival 1 (with an overall score of 7.70).

Strategic Implications of Competitive Strength
Assessments
In addition to showing how competitively strong or weak a company is relative
to rivals, the strength ratings provide guidelines for designing wise offensive and
defensive strategies. For example, if ABC Company wants to go on the offensive
to win additional sales and market share, such an offensive probably needs to be
aimed directly at winning customers away from Rival 2 (which has a lower over-
all strength score) rather than Rival 1 (which has a higher overall strength score).
Moreover, while ABC has high ratings for technological skills (a 10 rating), dealer
network/distribution capability (a 9 rating), new product innovation capability
(a 9 rating), quality/product performance (an 8 rating), and reputation/image (an
8 rating), these strength measures have low importance weights—meaning that
ABC has strengths in areas that don’t translate into much competitive clout in
the marketplace. Even so, it outclasses Rival 2 in all five areas, plus it enjoys
substantially lower costs than Rival 2 (ABC has a 5 rating on relative cost posi-
tion versus a 1 rating for Rival 2)—and relative cost position carries the highest
importance weight of all the strength measures. ABC also has greater competi-
tive strength than Rival 3 regarding customer service capabilities (which carries
the second-highest importance weight). Hence, because ABC’s strengths are in
the very areas where Rival 2 is weak, ABC is in a good position to attack Rival 2.
Indeed, ABC may well be able to persuade a number of Rival 2’s customers to
switch their purchases over to its product.

But ABC should be cautious about cutting price aggressively to win custom-
ers away from Rival 2, because Rival 1 could interpret that as an attack by ABC
to win away Rival 1’s customers as well. And Rival 1 is in far and away the best
position to compete on the basis of low price, given its high rating on relative cost
in an industry where low costs are competitively important (relative cost carries
an importance weight of 0.30). Rival 1’s strong relative cost position vis-à-vis both
ABC and Rival 2 arms it with the ability to use its lower-cost advantage to thwart
any price cutting on ABC’s part. Clearly ABC is vulnerable to any retaliatory price
cuts by Rival 1—Rival 1 can easily defeat both ABC and Rival 2 in a price-based
battle for sales and market share. If ABC wants to defend against its vulnerability
to potential price cutting by Rival 1, then it needs to aim a portion of its strategy at
lowering its costs.

The point here is that a competitively astute company should utilize the strength
scores in deciding what strategic moves to make. When a company has important
competitive strengths in areas where one or more rivals are weak, it makes sense to
consider offensive moves to exploit rivals’ competitive weaknesses. When a company
has important competitive weaknesses in areas where one or more rivals are strong, it
makes sense to consider defensive moves to curtail its vulnerability.

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KEY POINTS

There are six key questions to consider in evaluating a company’s ability to compete
successfully against market rivals:

1. How well is the present strategy working? This involves evaluating the strategy
in terms of the company’s financial performance and market standing. The stron-
ger a company’s current overall performance, the less likely the need for radi-
cal strategy changes. The weaker a company’s performance and/or the faster the

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The final and most important analytic step is to zero in on exactly what strategic issues
company managers need to address—and resolve—for the company to be more finan-
cially and competitively successful in the years ahead. This step involves drawing on the
results of both industry analysis and the evaluations of the company’s internal situation.
The task here is to get a clear fix on exactly what strategic and competitive challenges
confront the company, which of the company’s competitive shortcomings need fixing,
and what specific problems merit company managers’ front-burner attention. Pinpoint-
ing the specific issues that management needs to address sets the agenda for deciding
what actions to take next to improve the company’s performance and business outlook.

The “priority list” of issues and problems that have to be wrestled with can
include such things as how to stave off market challenges from new foreign com-
petitors, how to combat the price discounting of rivals, how to reduce the com-
pany’s high costs, how to sustain the company’s present rate of growth in light of
slowing buyer demand, whether to correct the company’s competitive deficiencies
by acquiring a rival company with the missing strengths, whether to expand into
foreign markets, whether to reposition the company and move to a different stra-
tegic group, what to do about growing buyer interest in substitute products, and
what to do to combat the aging demographics of the company’s customer base.
The priority list thus always centers on such concerns as “how to . . . ,” “what to
do about . . . ,” and “whether to . . .” The purpose of the priority list is to identify
the specific issues and problems that management needs to address, not to figure
out what specific actions to take. Deciding what to do—which strategic actions to
take and which strategic moves to make—comes later (when it is time to craft the
strategy and choose among the various strategic alternatives).

If the items on the priority list are relatively minor—which suggests that the
company’s strategy is mostly on track and reasonably well matched to the com-

pany’s overall situation—company managers seldom need to go much beyond fine-
tuning the present strategy. If, however, the problems confronting the company are
serious and indicate the present strategy is not well suited for the road ahead, the task
of crafting a better strategy needs to be at the top of management’s action agenda.

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS
MERIT FRONT-BURNER MANAGERIAL ATTENTION?

Compiling a “priority
list” of problems creates
an agenda of strategic
issues that merit prompt
managerial attention.

A good strategy must
contain ways to deal with
all the strategic issues and
obstacles that stand in
the way of the company’s
financial and competitive
success in the years ahead.

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changes in its external situation (which can be gleaned from PESTEL and industry
analysis), the more its current strategy must be questioned.

2. What are the company’s most important resources and capabilities and can
they give the company a sustainable advantage over competitors? A company’s
resources can be identified using the tangible/intangible typology presented in
this chapter. Its capabilities can be identified either by starting with its resources
to look for related capabilities or looking for them within the company’s different
functional domains.

The answer to the second part of the question comes from conducting the four tests
of a resource’s competitive power—the VRIN tests. If a company has resources
and capabilities that are competitively valuable and rare, the firm will have a
competitive advantage over market rivals. If its resources and capabilities are also
hard to copy (inimitable), with no good substitutes (nonsubstitutable), then the
firm may be able to sustain this advantage even in the face of active efforts by
rivals to overcome it.

3. Is the company able to seize market opportunities and overcome external threats
to its future well-being? The answer to this question comes from performing a
SWOT analysis. The two most important parts of SWOT analysis are (1) draw-
ing conclusions about what strengths, weaknesses, opportunities, and threats tell
about the company’s overall situation; and (2) acting on the conclusions to bet-
ter match the company’s strategy to its internal strengths and market opportuni-
ties, to correct the important internal weaknesses, and to defend against external
threats. A company’s strengths and competitive assets are strategically relevant
because they are the most logical and appealing building blocks for strategy; inter-
nal weaknesses are important because they may represent vulnerabilities that need
correction. External opportunities and threats come into play because a good strat-
egy necessarily aims at capturing a company’s most attractive opportunities and at
defending against threats to its well-being.

4. Are the company’s cost structure and value proposition competitive? One telling
sign of whether a company’s situation is strong or precarious is whether its costs
are competitive with those of industry rivals. Another sign is how the company
compares with rivals in terms of differentiation—how effectively it delivers on its
customer value proposition. Value chain analysis and benchmarking are essential
tools in determining whether the company is performing particular functions and
activities well, whether its costs are in line with those of competitors, whether it
is differentiating in ways that really enhance customer value, and whether particu-
lar internal activities and business processes need improvement. They comple-
ment resource and capability analysis by providing data at the level of individual
activities that provide more objective evidence of whether individual resources
and capabilities, or bundles of resources and linked activity sets, are competitively
superior.

5. On an overall basis, is the company competitively stronger or weaker than key
rivals? The key appraisals here involve how the company matches up against key
rivals on industry key success factors and other chief determinants of competi-
tive success and whether and why the company has a net competitive advantage
or disadvantage. Quantitative competitive strength assessments, using the method

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ASSURANCE OF LEARNING EXERCISES

1. Using the financial ratios provided in Table 4.1 and the financial statement infor-
mation presented below for Costco Wholesale Corporation, calculate the follow-
ing ratios for Costco for both 2013 and 2014:

a. Gross profit margin
b. Operating profit margin
c. Net profit margin
d. Times-interest-earned (or coverage) ratio
e. Return on stockholders’ equity
f. Return on assets
g. Debt-to-equity ratio
h. Days of inventory
i. Inventory turnover ratio
j. Average collection period

Based on these ratios, did Costco’s financial performance improve, weaken, or
remain about the same from 2013 to 2014?

LO 1

presented in Table 4.4, indicate where a company is competitively strong and
weak and provide insight into the company’s ability to defend or enhance its mar-
ket position. As a rule, a company’s competitive strategy should be built around
its competitive strengths and should aim at shoring up areas where it is competi-
tively vulnerable. When a company has important competitive strengths in areas
where one or more rivals are weak, it makes sense to consider offensive moves to
exploit rivals’ competitive weaknesses. When a company has important competi-
tive weaknesses in areas where one or more rivals are strong, it makes sense to
consider defensive moves to curtail its vulnerability.

6. What strategic issues and problems merit front-burner managerial attention? This
analytic step zeros in on the strategic issues and problems that stand in the way of
the company’s success. It involves using the results of industry analysis as well as
resource and value chain analysis of the company’s competitive situation to iden-
tify a “priority list” of issues to be resolved for the company to be financially and
competitively successful in the years ahead. Actually deciding on a strategy and
what specific actions to take is what comes after developing the list of strategic
issues and problems that merit front-burner management attention.

Like good industry analysis, solid analysis of the company’s competitive situation vis-
à-vis its key rivals is a valuable precondition for good strategy making.

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Consolidated Income Statements for Costco Wholesale
Corporation, 2013–2014 (in millions, except per share data)

2014 2013

Net sales ………………………………………………………………………………… $110,212 $102,870

Membership fees …………………………………………………………………… 2,428 2,286

Total revenue …………………………………………………………………………. 112,640 105,156

Merchandise costs ………………………………………………………………… 98,458 $ 91,948

Selling, general, and administrative …………………………………….. 10,899 10,155

Operating income …………………………………………………………………. 3,220 3,053

Other income (expense) ………………………………………………………..

    Interest expense ………………………………………………………………… (113) (99)

    Interest income and other, net …………………………………………. 90 97

Income before income taxes ………………………………………………… 3,197 3,051

Provision for income taxes ……………………………………………………. 1,109 990

Net income including noncontrolling interests ……………………. 2,088 2,061

Net income attributable to noncontrolling interests …………… (30) (22)

Net income …………………………………………………………………………….. $ 2,058 $ 2,039

    Basic earnings per share ………………………………………………….. $ 4.69 $ 4.68

    Diluted earnings per share ……………………………………………….. $ 4.65 $ 4.63

Source: Costco Wholesale Corporation 2014 10-K.

Consolidated Balance Sheets for Costco Wholesale Corporation,
2013–2014 (in millions, except per share data)

August 31,
2014

September 1,
2013

Assets

Current Assets

Cash and cash equivalents ………………………………………… $ 5,738 $ 4,644

Short-term investments ……………………………………………… 1,577 1,480

Receivables, net …………………………………………………………. 1,148 1,026

Merchandise inventories ……………………………………………. 8,456 7,894

(continued)

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August 31,
2014

September 1,
2013

Deferred income taxes and other current assets …….. 669 621

Total current assets …………………………………………………….. 17,588 $15,840

Property and Equipment

Land …………………………………………………………………………….. $ 4,716 $ 4,409

Buildings and improvements ……………………………………… 12,522 11,556

Equipment and fixtures ………………………………………………. 4,845 4,472

Construction in progress ……………………………………………. 592 585

22,675 21,022

Less accumulated depreciation and amortization ……. (7,845) (7,141)

Net property and equipment ……………………………………… 14,830 13,881

Other assets ……………………………………………………………….. 606 562

Total assets …………………………………………………………………. $33,024 $30,283

Liabilities and Equity

Current Liabilities

Accounts payable ……………………………………………………….. $ 8,491 $ 7,872

Accrued salaries and benefits …………………………………… 2,231 2,037

Accrued member rewards …………………………………………. 773 710

Accrued sales and other taxes ………………………………….. 442 382

Deferred membership fees ………………………………………… 1,254 1,167

Other current liabilities ……………………………………………….. 1,221 1,089

Total current liabilities ………………………………………………… 14,412 13,257

Long-term debt, excluding current portion ……………….. 5,093 4,998

Deferred income taxes and other liabilities ………………. 1,004 1,016

Total liabilities ……………………………………………………………… 20,509 $19,271

Commitments and Contingencies

Equity

Preferred stock $0.005 par value; 100,000,000 shares
authorized; no shares issued and outstanding

0 0

Common stock $0.005 par value; 900,000,000 shares
authorized; 436,839,000 and 432,350,000 shares
issued and outstanding

2 2

Additional paid-in capital ……………………………………………. $ 4,919 $ 4,670

Accumulated other comprehensive (loss) income …… (76) (122)

(continued)

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August 31,
2014

September 1,
2013

Retained earnings ………………………………………………………. 7,458 6,283

Total Costco stockholders’ equity ……………………………… 12,303 10,833

Noncontrolling interests …………………………………………….. 212 179

Total equity ………………………………………………………………….. 12,515 11,012

Total Liabilities and Equity ……………………………………….. $33,024 $30,283

Source: Costco Wholesale Corporation 2014 10-K.

2. Panera Bread operates more than 1,900 bakery-cafés in more than 45 states and
Canada. How many of the four tests of the competitive power of a resource does
the store network pass? Using your general knowledge of this industry, perform a
SWOT analysis. Explain your answers.

3. Review the information in Illustration Capsule 4.1 concerning Boll & Branch’s
average costs of producing and selling a king-size sheet set, and compare this with
the representative value chain depicted in Figure 4.3. Then answer the following
questions:

a. Which of the company’s costs correspond to the primary value chain activities
depicted in Figure 4.3?

b. Which of the company’s costs correspond to the support activities described in
Figure 4.3?

c. What value chain activities might be important in securing or maintaining Boll
& Branch’s competitive advantage? Explain your answer.

4. Using the methodology illustrated in Table 4.3 and your knowledge as an auto-
mobile owner, prepare a competitive strength assessment for General Motors and
its rivals Ford, Chrysler, Toyota, and Honda. Each of the five automobile manu-
facturers should be evaluated on the key success factors and strength measures of
cost-competitiveness, product-line breadth, product quality and reliability, finan-
cial resources and profitability, and customer service. What does your competitive
strength assessment disclose about the overall competitiveness of each automobile
manufacturer? What factors account most for Toyota’s competitive success? Does
Toyota have competitive weaknesses that were disclosed by your analysis? Explain.

LO 2, LO 3

LO 4

LO 5

EXERCISE FOR SIMULATION PARTICIPANTS

1. Using the formulas in Table 4.1 and the data in your company’s latest financial
statements, calculate the following measures of financial performance for your
company:

a. Operating profit margin
b. Total return on total assets

LO 1

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c. Current ratio
d. Working capital
e. Long-term debt-to-capital ratio
f. Price-to-earnings ratio

2. On the basis of your company’s latest financial statements and all the other avail-
able data regarding your company’s performance that appear in the industry
report, list the three measures of financial performance on which your company
did best and the three measures on which your company’s financial performance
was worst.

3. What hard evidence can you cite that indicates your company’s strategy is work-
ing fairly well (or perhaps not working so well, if your company’s performance is
lagging that of rival companies)?

4. What internal strengths and weaknesses does your company have? What external
market opportunities for growth and increased profitability exist for your com-
pany? What external threats to your company’s future well-being and profitability
do you and your co-managers see? What does the preceding SWOT analysis indi-
cate about your company’s present situation and future prospects—where on the
scale from “exceptionally strong” to “alarmingly weak” does the attractiveness of
your company’s situation rank?

5. Does your company have any core competencies? If so, what are they?
6. What are the key elements of your company’s value chain? Refer to Figure 4.3 in

developing your answer.
7. Using the methodology presented in Table 4.4, do a weighted competitive strength

assessment for your company and two other companies that you and your co-
managers consider to be very close competitors.

LO 1

LO 1

LO 2, LO 3

LO 2, LO 3
LO 4

LO 5

ENDNOTES
Organizations,” California Management
Review 44, no. 3 (Spring 2002), pp. 37–54.
4 M. Peteraf and J. Barney, “Unraveling the
Resource-Based Tangle,” Managerial and
Decision Economics 24, no. 4 (June–July
2003), pp. 309–323.
5 Margaret A. Peteraf and Mark E. Bergen,
“Scanning Dynamic Competitive Landscapes:
A Market-Based and Resource-Based Frame-
work,” Strategic Management Journal 24
(2003), pp. 1027–1042.
6 C. Montgomery, “Of Diamonds and Rust:
A New Look at Resources,” in C. Montgom-
ery (ed.), Resource-Based and Evolution-
ary Theories of the Firm (Boston: Kluwer
Academic, 1995), pp. 251–268.
7 Constance E. Helfat and Margaret A.
Peteraf, “The Dynamic Resource-Based View:

1 Birger Wernerfelt, “A Resource-Based View
of the Firm,” Strategic Management Journal 5,
no. 5 (September–October 1984), pp. 171–180;
Jay Barney, “Firm Resources and Sustained
Competitive Advantage,” Journal of Manage-
ment 17, no. 1 (1991), pp. 99–120.
2 R. Amit and P. Schoemaker, “Strategic Assets
and Organizational Rent,” Strategic Manage-
ment Journal 14 (1993).
3 Jay B. Barney, “Looking Inside for Competi-
tive Advantage,” Academy of Management
Executive 9, no. 4 (November 1995), pp. 49–61;
Christopher A. Bartlett and Sumantra Ghoshal,
“Building Competitive Advantage through Peo-
ple,” MIT Sloan Management Review 43, no. 2
(Winter 2002), pp. 34–41; Danny Miller, Russell
Eisenstat, and Nathaniel Foote, “Strategy from
the Inside Out: Building Capability-Creating

Capability Lifecycles,” Strategic Management
Journal 24, no. 10 (2003).
8 D. Teece, G. Pisano, and A. Shuen, “Dynamic
Capabilities and Strategic Management,” Stra-
tegic Management Journal 18, no. 7 (1997),
pp. 509–533; K. Eisenhardt and J. Martin,
“Dynamic Capabilities: What Are They?” Strate-
gic Management Journal 21, no. 10–11 (2000),
pp. 1105–1121; M. Zollo and S. Winter, “Deliber-
ate Learning and the Evolution of Dynamic
Capabilities,” Organization Science 13 (2002),
pp. 339–351; C. Helfat et al., Dynamic Capabili-
ties: Understanding Strategic Change in Orga-
nizations (Malden, MA: Blackwell, 2007).
9 Donald Sull, “Strategy as Active Waiting,” Har-
vard Business Review 83, no. 9 (September
2005), pp. 121–126.

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(September–October, 1988), pp. 96–103;
Joseph A. Ness and Thomas G. Cucuzza,
“Tapping the Full Potential of ABC,” Harvard
Business Review 73, no. 4 (July–August 1995),
pp. 130–138.
13 Porter, Competitive Advantage, p. 34.
14 Hau L. Lee, “The Triple-A Supply Chain,”
Harvard Business Review 82, no. 10 (October
2004), pp. 102–112.
15 Gregory H. Watson, Strategic Benchmarking:
How to Rate Your Company’s Performance
against the World’s Best (New York: Wiley,

10 M. Peteraf, “The Cornerstones of Competi-
tive Advantage: A Resource-Based View,” Stra-
tegic Management Journal, March 1993, pp.
179–191.
11 Michael Porter in his 1985 best seller Com-
petitive Advantage (New York: Free Press).
12 John K. Shank and Vijay Govindarajan,
Strategic Cost Management (New York:
Free Press, 1993), especially chaps. 2–6, 10,
and 11; Robin Cooper and Robert S. Kaplan,
“Measure Costs Right: Make the Right Deci-
sions,” Harvard Business Review 66, no. 5

1993); Robert C. Camp, Benchmarking: The
Search for Industry Best Practices That Lead
to Superior Performance (Milwaukee: ASQC
Quality Press, 1989); Dawn Iacobucci and
Christie Nordhielm, “Creative Benchmarking,”
Harvard Business Review 78 no. 6
(November–December 2000), pp. 24–25.
16 www.businessdictionary.com/definition/best-
practice.html (accessed December 2, 2009).
17 Reuben E. Stone, “Leading a Supply Chain
Turnaround,” Harvard Business Review 82, no.
10 (October 2004), pp. 114–121.

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Case # 13 – Panera Bread Company: Is the Company’s Strategy to Rejuvenate the Company’s Growth Working?? (CASE is on the PDF) need 2.5-3page answer (use case information on the PDF only, no internet resource)

The template provided must be used with each number showing and an answer for each provided in an informal manner or not requiring full sentences except in the “brief summary” section. An outline format may be used for your answers for each numbered item.

Please check next page for the example case study answer.

Describe the Following for this Case Study-

1. Industry & Market:

2. External Environment:

3. Internal Environment:

4. Financial Analyses:

5. Economic Condition for Industry:

6. Key Trending Factors:

7. SWOT Analysis:

8. Key issues of the case:

9. Critical issue of the case that needs attention first:

10. Assumptions in the recognition of this critical issue:

11. 2 to 3 alternatives to address this critical issue:

12. Choose 1 of the alternatives to implement:

13. Describe the overarching strategy you propose and within which this alternative fits:

14. Explain your plan to implement this alternative:

15. Identify the critical organizational functions of the organization needed for implementation:

16. Identify the processes needed from each of these critical functions for implementation:

17. Describe the Balance Scorecard metrics to measure the success of this implementation:

18. Describe any ethical concerns with this critical issue and plan implementation:

19. Describe any environmental concerns with this critical issue and plan implementation:

20. Describe any social concerns with this critical issue and plan implementation:

21.Write a brief summary of your recommendation and the value you propose this organization may gain from this implementation. (one paragraph – keep this to approximately100 words)

EXAMPLE

Case Analysis Study Approach (CASA)

Vodka

1. Industry & Market – the Alcoholic Beverage Industry enjoys a Global Market

1. External Environment – the industry is highly regulated and taxed on the state level in the United States, meaning, each state regulates how the industry may operate within its boundaries.

1. Internal Environment – The industry classification breaks down the distilled-spirit group into three categories, (1) brown goods, (2) white goods, which includes the case study subject, Absolut Vodka, and (3) specialties.

1. Financial Analyses – the Imported Vodka industry sales were on an upward trend, opposite the distilled-spirits and domestic vodka sales history in that period.

1. Economic Condition for Industry – by 1986, the distilled-spirits industry was on a downward slide for about five years.

1. Key Trending Factors –

5. Demographic – Those having attended college, single with household incomes of $50K or more in the Middle Atlantic region.

5. Social – promoting the brand to specific consumer groups and looking at market trends.

5. Economic – sales growth was on the upswing for imported vodka

5. Environmental – Another consideration is the industry’s effects on society. The influence on alcohol abuse and drunk driving.

1. SWOT Analysis –

6. Strength: in 1979, the U.S. was an open market for Absolut. They were looking for a distributor in a field where they did not currently have one. Strong leader in Mr. Roux.

6. Weakness: Costly advertising methodology, and distributor’s concentration on another brand than Absolut. Also odd-shaped bottle.

6. Opportunity: Niche marketing to expand market share, and flavored Vodka market

6. Threat: International political and industry regulatory impacts. Also odd-shaped bottle

1. Key Issues of the case – Marketing and advertising efforts to increase market share.

1. Critical Issue of the case that needs attention first – mismatch between traditional market-research techniques and the Absolut marketing strategy

1. Assumptions in the recognition of this critical issue –

9. The Swedish government was looking for a U.S. importer for Absolut

9. Stoli’s enjoyed an 80%share of the imported vodka sales

9. U.S. Vodka sales were rising. Foreign vodkas’ 22 percent growth attracted a rush of new importers

1. Two to three alternatives to address this critical issue –

10. Capturing the “Youth” markets

10. Capturing specific ethnic markets

10. Focusing on “Super Premium” products

1. Choose one of the alternatives to implement – focusing on its being a “Super Premium” product

1. Describe the overshadowing strategy you propose and within which this alternative fits – Target market for Absolut would be anyone over the age of 21 with the ability

1. Explain your plan to implement this alternative –

13. Advertise stressing Absolut’s Swedish origins

13. Target upper income trend-setting, artsy crowd

13. Market Absolut as a luxury item

13. Market to the “ferociously hip” crowd

1. Identify the critical organizational functions of the organization needed for implementation –

14. Copy and Media: punning on “absolute” using the superlative. Expanding media outlets beyond the standard weekly news, emphasizing the medium but focusing on the bottle.

14. Special Events and Promotion: Themes of music, art and fashion

14. Budget: increasing budget for advertising to reverse declining sales.

14. Production: ads were costly though generating huge media coverage, especially the much anticipated Christmas special ads.

1. Identify the processes needed from each of these critical functions for implementation –

1. Describe the Balanced Scorecard metrics to measure the success of this implementation –

(Must be these Four goals and a quantitative goal by which to measure strategic proposal success)

16. Financial: Set goals to increase gross sales by 20% and market share by 5%

16. Customer: Absolut enjoyed between 51 and 56 percent of the imported vodka market in the U.S. Survey the customer base to measure current satisfaction and then aim to increase this by 20% over the upcoming year.

16. Internal business processes: Measure initial social media hits and challenge the team to increase this by 30% within the first quarter of the new ad campaign. Set a goal to enter 2 new social media avenues in the upcoming year

16. Learning: Train employees in the new social media tools and require passage of a subsequent test by 75% with a maximum of 2 attempts to pass.

1. Describe any actual or hypothetical ethical concerns with this critical issue and plan implementation – the causal link between advertising and alcohol abuse and drunk driving. Alcohol should not be marketed towards those under the legal drinking age in any country. In the case of a country where no minimum age for consumption or purchase exists, beverage alcohol should not be marketed to those under the age of majority, as defined in that country.

1. Describe any actual or hypothetical environmental concerns with this critical issue and plan implementation – increase in excise taxes, governmental restrictions placed on advertising adult beverages and political fallout from the Russia boycott. U.S. Surgeon General Taskforce recommendation to raise excise taxes, reduce tax deductions for advertising allowances, placement of warnings and restricting advertising.

1. Describe any actual or hypothetical social concerns with this critical issue and plan implementation – effects of alcohol on society and the role of advertising in consumption, its influence in general, and on “abuse” versus “use”.

1. I recommend continuing marketing Absolut as a “Super Premium” product, a luxury item. This focus has proven to have provided positive results growing its market share to the current respectable levels that it enjoys. Absolut is now recognized as leader in creative yet unconventional advertising. The partnership with its advertising firm has been quite a successful venture resulting in the Absolut seasonal campaigns as a yardstick of great advertising, as well as being one of the most anticipated advertising campaigns in the industry. Including messages of consumer responsibility and assimilating a similar emphasis as Anheuser-Busch’s “Know When to Say When” campaign would be very advisable as well.

tho32789_case13_C142-C163.indd 142 12/05/16 04:11 PM

and franchised units in 2010, 88 new units in 2011,
111 new units in 2012, 125 units in 2013, 114 units
in 2014, and 112 units in 2015. Going into 2016,
Panera had 1,972 company-owned and franchised
bakery-cafés in operation in 46 states, the District
of Columbia, and Ontario, Canada. Plans called for
opening 90 to 100 new company-operated and fran-
chised units in 2016.

But despite the ongoing series of store openings,
the company was struggling to grow revenues and
earnings nearly as fast as top executives wanted. Rev-
enue growth of 6.0 percent in 2014 and 6.1 percent in
2015 was well short of the robust 19.9 percent com-
pound average growth achieved during 2009–2013.
Moreover, sales at bakery-cafés open at least one year
rose only 1.1 percent in 2014 and 1.9 percent in 2015,
compared to 2.3 percent in 2013 and 6.5 percent in
2012. The slower-than-desired revenue growth, cou-
pled with higher operating expenses, squeezed Pane-
ra’s profitability, resulting in declines in net income
from $196.2 million in 2013 to $179.3 million in
2014 and to $149.3 million in 2015 and drops in earn-
ings per share from $6.85 in 2013 to $6.67 in 2014 to
$5.81 in 2015.

Nonetheless, in February 2016, top manage-
ment confidently expressed the belief that Panera
had turned the corner and forecast that recently
undertaken strategy initiatives would deliver positive

In spring 2016, Panera Bread was widely regarded as the clear leader of the “fast-casual” segment of the restaurant industry—fast-casual restaurants
were viewed as being a cut above traditional quick-
service restaurants like McDonald’s because of bet-
ter food quality, limited table service, and, in many
instances, often wider and more upscale menu selec-
tions. On average, 7.8 million customers patronized
Panera Bread’s 1,972 company-owned and fran-
chised bakery-cafés each week, and Panera baked
more specialty breads daily than any other bakery-
café enterprise in North America. In 2015, Panera
had corporate revenues of $2.7 billion, systemwide
store revenues of $4.5 billion, and average sales of
$2.5 million per store location.

In 2006, Panera Bread executives announced
their strategic intent to grow the company from 1,027
locations to 2,000 locations by the end of 2010. But
the advent of the Great Recession of 2008–2009
forced the company to drastically downscale the
number of planned store openings; Panera ended
2009 with only 1,380 bakery-café locations. Then,
in 2010 with a modest economic recovery seemingly
underway, Panera’s top executives decided that mar-
ket conditions were favorable enough to permit the
company, given customer enthusiasm for eating at
Panera’s bakery-cafés, to accelerate the number of
new store openings and reinstitute their strategy to
grow the company, albeit at a pace slower than what
was envisioned back in 2006. The company pro-
ceeded to open a net of 76 new company-operated

Arthur A. Thompson
The University of Alabama

Panera Bread Company in 2016—
Is the Company’s Strategy to
Rejuvenate Its Growth Working?

CASE 13

Copyright © 2016 by Arthur A. Thompson. All rights reserved.

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By 1998, it was clear the re-concepted Panera
Bread units had connected with consumers. Au Bon
Pain management concluded the Panera Bread for-
mat had broad market appeal and could be rolled
out nationwide. Ron Shaich believed Panera Bread
had the potential to become one of the leading “fast-
casual” restaurant chains in the nation. Shaich also
believed that growing Panera Bread into a national
chain required significantly more management atten-
tion and financial resources than the company could
marshal if it continued to pursue expansion of both
the Au Bon Pain and Panera Bread chains. He con-
vinced the Au Bon Pain board of directors that the
best course of action was for the company to go
exclusively with the Panera Bread concept and divest
the Au Bon Pain cafés. In August 1998, the company
announced the sale of its Au Bon Pain bakery-café
division for $73 million in cash to ABP Corp.; the
transaction was completed in May 1999. With the sale
of the Au Bon Pain division, the company changed
its name to Panera Bread Company. The restructured
company had 180 Saint Louis and Panera Bread
bakery-cafés and a debt-free balance sheet.

Between January 1999 and December 2006,
close to 850 additional Panera Bread bakery-cafés
were opened, some company-owned and some fran-
chised. In February 2007, Panera purchased a 51 per-
cent interest in Arizona-based Paradise Bakery &
Café, which operated 70 company-owned and fran-
chised units in 10 states (primarily in the west and
southwest) and had sales close to $100 million. At
the time, Paradise Bakery units had average weekly
sales of about $40,000 and an average check size of
$8 to $9. Panera purchased the remaining 49 percent
ownership of Paradise Bakery in June 2009. In 2008,
Panera expanded into Canada, opening 2 locations
in Ontario; since then, 10 additional units in Canada
had been opened.

In May 2010, William W. Moreton, Panera’s
executive vice president and co-chief operating
officer, was appointed president and chief execu-
tive officer and a member of the company’s board.
Ron Shaich, who had served as Panera’s president
and CEO since 1994 and as board chair or co-chair
since 1988, transitioned to the role of executive
board chair. In addition to the normal duties of board
chair, Shaich maintained an active strategic role,
with a particular focus on how Panera Bread could
continue to be the best competitive alternative in the

earnings growth in 2016, accelerating further in
2017. In announcing the company’s financial results
for Q4 and full-year 2015 on February 9, 2016, Ron
Shaich, Panera’s chair and CEO, said:

Our strategic plan is working. Our comps [company-
owned store sales growth] of 3.6% in Q4 2015 and 6.4%
in the first 41 days of Q1 2016 are leading indicators of
the impact our initiatives are having. Further, we are
confident that our results will continue to strengthen
as the startup and transition costs associated with our
initiatives begin to crest and our sales continue to grow.
We now expect the EPS growth we saw in Q4 2015 will
improve in 2016 and further accelerate in 2017. Today,
we are confident we are on a path to return to sustained
double-digit earnings growth.1

Panera indicated it was expecting EPS growth
of 2–5 percent in 2016.

COMPaNY BaCKGROUND
In 1981, Louis Kane and Ron Shaich founded a
bakery-café enterprise named Au Bon Pain Co., Inc.
Units were opened in malls, shopping centers, and
airports along the east coast of the United States and
internationally throughout the 1980s and 1990s; the
company prospered and became the dominant opera-
tor within the bakery-café category. In 1993, Au Bon
Pain Co. purchased Saint Louis Bread Company,
a chain of 20 bakery-cafés located in the St. Louis
area. Ron Shaich and a team of Au Bon Pain man-
agers then spent considerable time in 1994 and 1995
traveling the country and studying the market for fast
food and quick-service meals. They concluded that
many patrons of fast-food chains like McDonald’s,
Wendy’s, Burger King, Subway, Taco Bell, Pizza
Hut, and KFC could be attracted to a higher-quality
quick dining experience. Top management at Au Bon
Pain then instituted a comprehensive overhaul of the
newly acquired Saint Louis Bread locations, altering
the menu and the dining atmosphere. The vision was
to create a specialty café anchored by an authentic,
fresh dough, artisan bakery and upscale, quick- service
menu selections. Between 1993 and 1997, average
unit volumes at the revamped Saint Louis Bread units
increased by 75 percent, and over 100 additional
Saint Louis Bread units were opened. In 1997, the
Saint Louis Bread bakery-cafés were renamed Panera
Bread in all markets outside St. Louis.

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signature soups and salads, and café beverages. Rec-
ognizing that diners chose a dining establishment
based on individual food preferences and mood,
Panera strived to be the first choice for diners crav-
ing fresh-baked goods, a sandwich, soup, a salad, or a
beverage served in a warm, friendly, comfortable din-
ing environment. Its target market was urban work-
ers and suburban dwellers looking for a quick-service
meal or light snack and an aesthetically pleasing
dining experience. Management’s long-term objec-
tive and strategic intent was to make Panera Bread a
nationally recognized brand name and to be the domi-
nant restaurant operator in upscale, quick-service din-
ing. Top management believed that success depended
on “being better than the guys across the street” and
making the experience of dining at Panera so attrac-
tive that customers would be willing to pass by the
outlets of other fast-casual restaurant competitors to
dine at a nearby Panera Bread bakery-café.5

Panera management’s blueprint for attracting
and retaining customers was called Concept Essence.
Concept Essence underpinned Panera’s strategy and
embraced several themes that, taken together, acted
to differentiate Panera from its competitors:

∙ Offering an appealing selection of artisan breads,
bagels, and pastry products that are handcrafted
and baked daily at each café location.

∙ Serving high-quality food at prices that represent
a good value.

∙ Developing a menu with sufficiently diverse offer-
ings to enable Panera to draw customers from
breakfast through the dinner hours each day.

∙ Providing courteous, capable, and efficient cus-
tomer service.

∙ Designing bakery cafés that are aesthetically
pleasing and inviting.

∙ Offering patrons such a sufficiently satisfying
dining experience that they are induced to return
again and again.

Panera Bread’s menu, store design and ambi-
ence, and unit location strategies enabled it to
compete successfully in multiple segments of the
restaurant business: breakfast, AM “chill” (when
customers visited to take a break from morning-hour
activities), lunch, PM “chill” (when customers vis-
ited to take a break from afternoon activities), din-
ner, and take-home, through both on-premise sales
and off-premise catering. It competed with a wide

market segments the company served. However, on
March 15, 2012, the company announced that Ron
Shaich and Bill Moreton would become co-CEOs,
effective immediately; Shaich’s formal title was
changed to board chair and co-CEO and Moreton’s
title became president and co-CEO. In August 2013,
Shaich and Moreton took on new titles because of
family-related issues that required more of More-
ton’s time—Shaich became board chair and CEO
and Moreton was named executive vice chair, with
a role of helping oversee Panera’s business opera-
tions. In February 2015, Moreton also held the title
of interim chief financial officer.

Over the years, Panera Bread had received a
number of honors and awards. In 2015, Fast Com-
pany named Panera Bread as the Most Innovative
Company in Food. In 2011, 2012, and 2013, Har-
ris Poll EquiTrend® Rankings named Panera Bread
as Casual Dining Restaurant Brand of the Year.2
Zagat’s 2012 Fast Food Survey of 10,500 diners
ranked Panera as fourth for Top Food, second for
Top Décor, and fifth for Top Service among national
chains with fewer than 5,000 locations.3 For nine of
the past 12 years (2002–2013), customers had rated
Panera Bread tops on overall satisfaction among
large chain restaurants in Sandelman & Associates’s
Quick-Track study “Awards of Excellence” surveys;
in Sandelman’s 2012 Quick-Track study of more
than 110,000 customers of quick-service restaurants,
Panera ranked number one in the Attractive/Inviting
restaurant category.4

A summary of Panera Bread’s recent finan-
cial performance is shown in Exhibit 1. Exhibit 2
provides selected operating statistics for Panera’s
company-owned and franchised bakery-cafés.

PaNeRa BReaD’s CONCePT
aND sTRaTeGY
Panera Bread’s identity was rooted in its fresh-baked
artisan breads handcrafted with attention to quality
and detail. The company’s breads and baked products
were a major basis for differentiating Panera from
its competitors. According to Panera management,
“bread is our passion, soul, and expertise, and serves
as the platform that makes all of our other food spe-
cial.” The featured menu offerings at Panera locations
included breads and pastries baked in-house, break-
fast items and smoothies, made-to-order sandwiches,

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EXHIBIT 1 selected Consolidated Financial Data for Panera Bread, 2011–2015
(in thousands, except for per-share amounts)

2015 2014 2013 2012 2011

Income Statement Data

Revenues:
Bakery-café sales $ 2,358,794 $2,230,370 $2,108,908 $1,879,280 $1,592,951
Franchise royalties and fees 138,563 123,686 112,641 102,076 92,793
Fresh dough and other product sales
to franchisees 184,223 175,139 163,453 148,701 136,288
Total revenues 2,681,580 2,529,195 2,385,002 2,130,057 1,822,032
Bakery-café expenses:
Food and paper products 715,502 669,860 625,622 552,580 470,398
Labor 754,646 685,576 625,457 559,446 484,014
Occupancy 169,998 159,794 148,816 130,793 115,290
Other operating expenses 334,635 314,879 295,539 256,029 216,237
Total bakery-café expenses 1,974,781 1,830,109 1,695,434 1,498,848 1,285,939
Fresh dough and other product cost of sales
to franchisees 160,706 152,267 142,160 131,006 116,267
Depreciation and amortization 135,398 124,109 106,523 90,939 79,899
General and administrative expenses 142,904 138,060 123,335 117,932 113,083
Pre-opening expenses 9,089 8,707 7,794 8,462 6,585
Total costs and expenses 2,439,986 2,253,252 2,075,246 1,847,187 1,601,773
Operating profit 241,594 275,943 309,756 282,870 220,259
Interest expense 3,830 1,824 1,053 1,082 822
Other (income) expense, net 1,192 (3,175) (4,017) (1,208) (466)
Income taxes 87,247 98,001 116,551 109,548 83,951
Less net income (loss) attributable to
non-controlling interest (17) — — — —
Net income to shareholders $ 149,325 $ 179,293 $ 196,169 $ 173,448 $ 135,952
Earnings per share
Basic $5.81 $6.67 $6.85 $5.94 $4.59

Diluted 5.79 6.64 6.81 5.89 4.55
Weighted average shares outstanding
Basic 25,685 26,881 28,629 29,217 29,601
Diluted 25,788 26,999 28,794 29,455 29,903

Balance Sheet Data

Cash and cash equivalents $ 241,886 $ 196,493 $ 125,245 $ 297,141 $ 222,640
Current assets 502,789 406,166 302,716 478,842 353,119
Total assets 1,475,318 1,390,686 1,180,862 1,268,163 1,027,322
Current liabilities 399,443 352,712 303,325 277,540 238,334
Total liabilities 654,718 654,718 177,645 168,704 372,246
Stockholders’ equity 497,300 736,184 699,892 821,919 655,076

Cash Flow Data

Net cash provided by operating activities $ 318,045 $ 335,079 $ 348,417 $ 289,456 $ 236,889
Net cash used in investing activities (165,415) (211,317) (188,307) (195,741) (152,194)
Net cash (used in) provided by financing activities (107,237) (52,514) (332,006) (19,214) (91,354)
Net (decrease) increase in cash and cash equivalents 45,393 71,248 (171,896) 74,501 (6,659)

Sources: 2015 10-K report, pp. 43–46; 2014 10-K report, pp. 41–43; 2013 10-K report, pp. 41–43; 2011 10-K report, pp. 41–43.

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(much like fast-food enterprises) but is distinguished
by enticing menus, higher food quality, and more
inviting dining environments; typical meal costs
per guest are in the $7–$12 range. Some fast-casual
restaurants have full table service, some have par-
tial table service (with orders being delivered to the
table after ordering and paying at the counter), and
some are self-service (like fast-food establishments,
with orders being taken and delivered at the coun-
ter). Exhibit 3 provides information on prominent
national and regional dining chains that competed
against Panera Bread in some or many geographic
locations.

Panera Bread’s growth strategy was to capital-
ize on Panera’s market potential by opening both
company-owned and franchised Panera Bread loca-
tions as fast as was prudent. So far, working closely
with franchisees to open new locations had been a
key component of the company’s efforts to broaden
its market penetration. Panera Bread had organized its

assortment of specialty food, casual dining, and
quick-service establishments operating nationally,
regionally, and locally. Its close competitors var-
ied according to the menu item, meal, and time of
day. For example, breakfast and AM “chill” com-
petitors included Starbucks and McDonald’s; close
lunch and dinner competitors included such chains
as Chili’s, Applebee’s, California Pizza Kitchen,
Jason’s Deli, Cracker Barrel, Ruby Tuesday, T.G.I.
Friday’s, Chipotle Mexican Grill, and Five Guys
Burgers and Fries. In the bread and pastry segment,
Panera competed with Corner Bakery Café, Atlanta
Bread Company, Au Bon Pain, local bakeries, and
supermarket bakeries.

Except for bread and pastry products, Panera’s
strongest competitors were dining establishments in
the so-called fast-casual restaurant category. Fast-
casual restaurants fill the gap between fast-food
outlets and casual, full table service restaurants. A
fast-casual restaurant provides quick-service dining

EXHIBIT 2 selected Operating statistics, Panera Bread Company, 2010–2015

2015 2014 2013 2012 2011 2010

Revenues at company-operated stores
(in millions) $ 2,358.8 $ 2,230.4 $ 2,108.9 $ 1,879.3 $ 1,593.0 $ 1,321.2

Revenues at franchised stores (in millions) $ 2,478.0 $ 2,282.0 $ 2,175.2 $ 1,981.7 $ 1,828.2 $ 1,802.1

Systemwide store revenues (in millions) $ 4,836.8 $ 4,512.4 $ 4,284.1 $ 3,861.0 $ 3,421.2 $ 3,123.3

Average annualized revenues per company-
operated bakery-café (in millions) $ 2.552 $ 12.502 $ 2.483 $ 2.435 $ 2.292 $ 2.179

Average annualized revenues per franchised
bakery-café (in millions) $ 2.479 $ 2.455 $ 2.448 $ 2.419 $ 2.315 $ 2,266

Average weekly sales, company-owned cafés $ 49,090 $ 48,114 $ 47,741 $ 46,836 $ 44,071 $ 41,899

Average weekly sales, franchised cafés $ 47,680 $ 47,215 $ 47,079 $ 46,526 $ 44,527 $ 43,578

Comparable bakery-café sales percentage
increases*

Company-owned outlets 3.0% 1.4% 2.6% 6.5% 4.9% 7.5%

Franchised outlets 1.0% 0.9% 2.0% 5.0% 3.4% 8.2%

System-wide 1.9% 1.1% 2.3% 5.7% 4.0% 7.9%

Company-owned bakery-cafés open at
year-end 901 925 867 809 740 662

Franchised bakery-cafés open at year-end 1,071 955 910 843 801 791

Total bakery-cafés open 1,972 1,880 1,777 1,652 1,541 1,453

*The percentages for comparable store sales are based on annual changes at stores with an open date prior to the first day of the prior
fiscal year (meaning that a store had to be open for all 12 months of the year to be included in this statistic).

Sources: Company 10-K reports for 2015, 2014, 2013, 2011, and 2010.

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EXHIBIT 3 Representative Fast-Casual Restaurant Chains and selected
Full-service Restaurant Chains in the United states, 2014–2015

Company
Number of Locations,
2013

Select 2014–2015
Financial Data Key Menu Categories

Atlanta Bread
Company

~100 company-owned
and franchised bakery-
cafés in 21 states

Not available (privately
held company)

Fresh-baked breads, salads,
sandwiches, soups, wood-fired
pizza and pasta (select locations
only), baked goods, desserts

Applebee’s
Neighborhood
Grill and Bar* (a
subsidiary
of DineEquity)

2,000+ franchised
locations in 49 states, two
U.S. territories, and 16
countries outside the U.S.

2015 average annual
sales of about
$2.5 million per
U.S. location

Beef, chicken, pork, seafood, and
pasta entrees, plus appetizers,
salads, sandwiches, a selection
of under-500-calorie Weight
Watchers–branded menu
alternatives, desserts, and alcoholic
beverages (about 12 percent of
total sales)

Au Bon Pain 300+ company-owned
and franchised bakery-
cafés in 26 states and
5+ foreign countries

Not available (privately
held company)

A focus on healthful, nutritious
selections with superfood
ingredients, including hot cereals,
bagels, soups, salads, sandwiches
and wraps, and coffee drinks

Buffalo Wild Wings* 1,170 locations in the
U.S., Mexico, Canada,
and Philippines

2015 revenues of
$1.8 billion; average
sales of $3.25 million
per location

Chicken wings, chicken tenders,
specialty hamburgers, sandwiches,
flatbreads, salads, full bar

California Pizza
Kitchen*(a subsidiary
of Golden Gate
Capital)

~300 locations in ~32
states, 16 countries,
and 218 cities

Average annual sales
of about $3.2 million
per location

Signature California-style hearth-
baked pizzas, plus salads, pastas,
soups, sandwiches, appetizers,
desserts, beer, wine, coffees, teas,
and assorted beverages

Chili’s Grill and Bar*
(a subsidiary of
Brinker International)

1,580 locations in
50 states and 307
locations in 30 foreign
countries and territories

2015 average revenues
of ~$2.9 million per
location; 2015 average
check size per customer
of $14.52

Chicken, beef, and seafood
entrees, steaks, appetizers, salads,
sandwiches, desserts, and alcoholic
beverages (14.1 percent of sales)

Chipotle Mexican
Grill

2,000+ units 2015 revenues of
$4.5 billion; average unit
sales of ~$2.5 million;
average check size
$10.17

Gourmet burritos and tacos, salads,
beverages (including margaritas
and beers)

Corner Bakery Café 202 locations in
22 states and District
of Columbia

2014 sales per location
of $2.33 million; menu
price range: $0.99 to
$8.99

Specialty breads, hot breakfasts,
signature sandwiches, grilled
panini, pastas, seasonal soups and
chili, made-to-order salads, sweets,
coffees, and teas

Cracker Barrel* 637 combination retail
stores and restaurants
in 42 states

Restaurant-only sales
of $2.27 billion in 2015;
average sales per
restaurant of $3.6 million;
average guest check
of $10.23; serves an
average of ~1,000
customers per day per
location

Two menus (all-day breakfast
and lunch/dinner); named by
Technomics in both 2013 and
2015 as the full restaurant
category winner of its “Chain
Restaurant Consumers’ Choice
Award”

(Continued)

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Company
Number of Locations,
2013

Select 2014–2015
Financial Data Key Menu Categories

Culver’s 540+ locations in
22 states

2014 revenues of
$1+ billion; average
sales per location of
$2.0 million

Signature hamburgers served
on buttered buns, fried battered
cheese curds, value dinners
(chicken, shrimp, cod with potato
and slaw), salads, frozen custard,
milkshakes, sundaes, and fountain
drinks

Einstein Noah
Restaurant Group
(Einstein Bros. Bagels,
Noah’s New York
Bagels, Manhattan
Bagel)

~850 company-owned,
franchised, and licensed
locations in 40 states

Annual revenue per
company-owned unit
of ~$850,000

Fresh-baked bagels, hot breakfast
sandwiches, made-to-order lunch
sandwiches, creamed cheeses and
other spreads, salads, soups, and
gourmet coffees and teas

Fazoli’s (a subsidiary
of Sun Capital
Partners)

220+ locations in
26 states

2014 sales of ~$260
million

Spaghetti and meatballs,
fettuccine alfredo, lasagna, ravioli,
submarinos and panini sandwiches,
pizza, entrée salads, garlic
breadsticks, and desserts

Firehouse Subs 970+ locations in
42+ states (plans for
2,000 locations by 2020

Average unit sales of
~$800,000

Hot and cold subs, salads, sides,
drinks, catering

Five Guys Burgers
and Fries

1,500+ locations in
47 states and 6 Canadian
provinces

2014 revenues of
$1.2 billion

Hamburgers (with choice of
15 toppings), hot dogs, fries,
and beverages

Jason’s Deli 268+ locations in
29 states

2014 sales per unit of
$2.66 million

Sandwiches, extensive salad bar,
soups, loaded potatoes, desserts,
catering services, party trays, and
box lunches

Moe’s Southwest
Grill (a subsidiary of
Focus Brands)

600+ locations in
37 states and the
District of Columbia

Average annual sales
per restaurant of
~$1.1 million

Burritos, quesadillas, fajitas, tacos,
nachos, rice bowls (chicken, pork,
or tofu), salads, a kid’s menu, five
side items, two desserts, soft
drinks, iced tea, bottled water, and
catering

McAlister’s Deli (a
subsidiary of Focus
Brands)

350 locations in
26 states

Annual sales of
$505 million; sales of
$1.4 per location

Deli sandwiches, loaded baked
potatoes, soups, salads, and
desserts, plus sandwich trays,
lunch boxes, and catering

Noodles & Company ~500 urban and
suburban locations in
32 states and District
of Columbia

2014 sales of
$465 million; comparable
store sales growth of
0.2% in 2014; average
check size $8.00

Customizable Asian,
Mediterranean, and American
noodle/pasta entrees, soups,
salads, sandwiches, alcoholic
beverages

Olive Garden* 846 locations 2015 revenues of
$3.8 billion; average
sales per location of
$4.5 million

Full Italian menu of appetizers (15),
flatbreads (3), soups and salads
(6), pastas (11), beef, chicken, and
seafood entrees (20), desserts
(8), kid’s menu, wide beverage
assortment

Panda Express ~1,500 locations across
the U.S.

2014 revenues of
$2.2 billion

A variety of Chinese entrées,
including orange chicken, Kung
Pao chicken, broccoli beef,
eggplant tofu, angus steak (and
9 others), rice, steamed
vegetables, beverages

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Company
Number of Locations,
2013

Select 2014–2015
Financial Data Key Menu Categories

Qdoba Mexican
Grill (a subsidiary of
Jack-in-the-Box, Inc.)

661 company-owned
and franchised locations
in 47 states, District of
Columbia, and Canada

2015 average unit
sales per location of
$1.2 million; 2015
comparable store sales
growth of 9.3%; 2015
average check size of
$11.82

Signature burritos, tacos, taco
salads, quesadillas, three-cheese
nachos, Mexican gumbo, tortilla
soup, five signature salsas, and
breakfast selections at some
locations

Ruby Tuesday* 692 company-owned
and franchised locations
in 44 states, plus
44 international locations
in 13 foreign countries
and Guam

Fiscal 2015 sales of
$1.13 billion; average
restaurant sales of
$1.7 million; typical
entrée price ranges of
$8.99 to $20.99

Appetizers, handcrafted burgers,
35-item salad bar, steaks, chicken,
crab cakes, lobster, salmon, tilapia,
ribs, desserts, nonalcoholic and
alcoholic beverages, and catering

Starbucks ~12,600 company-operated
and licensed locations
in the U.S. and 10,500+
international locations

2015 global revenues
of $19.2 billion; sales
of $1.38 million per
company-operated
location in the Americas

Italian-style espresso beverages,
teas, sodas, juices, assorted
pastries and confections; some
locations offer sandwiches and
salads

T.G.I. Friday’s* 967 locations in 48 states
and District of Columbia;
22 locations in 6 foreign
countries

2014 annual revenues
of ~$1.8 billion

Appetizers, salads, soups, burgers
and other sandwiches, chicken,
seafood, steaks, pasta, desserts,
nonalcoholic and alcoholic
beverages, party platters

*Denotes a full-service restaurant.

Sources: Company websites, accessed February 16, 2016; Nation’s Restaurant News, “Top 100 Restaurant Chains and Companies,”
June 15, 2015, www.nrn.com (accessed February 16, 2016).

business around company-owned bakery-café opera-
tions, franchise operations, and fresh dough operations;
the fresh bread unit supplied dough and other products
to all Panera Bread stores, both company-owned and
franchised.

Panera Bread’s Product
Offerings and Menu
Panera Bread’s artisan signature breads were made
from four ingredients—water, natural yeast, flour,
and salt; no preservatives or chemicals were used.
Carefully trained bakers shaped every step of the
process, from mixing the ingredients, to kneading
the dough, to placing the loaves on hot stone slabs to
bake in a traditional European-style stone deck bak-
ery oven. Breads, as well as bagels, muffins, cook-
ies, and other pastries, were baked fresh throughout
the day at each café location. Exhibit 4 shows Pane-
ra’s lineup of breads.

The Panera Bread menu was designed to pro-
vide target customers with products built on the
company’s bakery expertise, particularly its variet-
ies of breads and bagels baked fresh throughout the
day at each café location. The key menu groups were
fresh-baked goods, hot breakfast selections, bagels
and cream cheese spreads, hot Panini, made-to-order
sandwiches and salads, soups, fruit smoothies, fro-
zen drinks, beverages, and Espresso bar selections.
Exhibit 5 summarizes the menu offerings at Panera
Bread locations as of March 2015.

Menu offerings were regularly reviewed and
revised to sustain the interest of regular custom-
ers, satisfy changing consumer preferences, and be
responsive to various seasons of the year. Special
soup offerings, for example, appeared seasonally.
Product development was focused on providing food
that customers would crave and trust to be tasty. New
menu items were developed in test kitchens and then
introduced in a limited number of the bakery-cafés to

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lettuces and tomatoes), and revising ingredients and
preparation methods to yield 0 grams of artificial
trans fat per serving. All of the menu boards and
printed menus at company-owned Panera bakery-
cafés included the calories for each food item. Also,
Panera’s website had a nutritional calculator showing
detailed nutritional information for each individual
menu item or combination of menu selections.

Off-Premises Catering In 2004–2005, Panera
Bread introduced a catering program to extend its
market reach into the workplace, schools, and par-
ties and gatherings held in homes, and grow its
breakfast-, lunch-, and dinner-hour sales without
making capital investments in additional physical
facilities. The first menu consisted of items appear-
ing on the regular menu and was posted for view-
ing at the company’s website. A catering coordinator
was available to help customers make menu selec-
tions, choose between assortments or boxed meals,
determine appropriate order quantities, and arrange

determine customer response and verify that prepa-
ration and operating procedures result in product
consistency and high quality standards. If successful,
they were then rolled out systemwide. New product
introductions were integrated into periodic or sea-
sonal menu rotations, referred to as “Celebrations.”
From 2013 through 2015, between 20 and 25 new and
reintroduced menu items appeared on Panera’s menu
each year during the course of five Celebrations.

Over the past 10 years, Panera had responded to
growing consumer interest in healthier, more nutri-
tious menu offerings. In 2004, whole grain breads
were introduced, and in 2005 Panera switched to
the use of natural antibiotic chicken in all of Pane-
ra’s chicken-related sandwiches and salads. Other
recent health-related changes included using organic
and all-natural ingredients in selected items, using
unbleached flours in its breads, adding a yogurt-
granola-fruit parfait and reduced-fat spreads for bagels
to the menu, introducing fruit smoothies, increasing
the use of fresh ingredients (like fresh-from-the-farm

EXHIBIT 4 Panera’s Line of Fresh-Baked Breads, February 2016
Artisan Breads Specialty Breads

Country
A crisp crust and nutty flavor. Available in loaf.

Whole Grain
Moist and hearty, sweetened with honey. Available
in loaf.

Rye
With chopped rye kernels and caraway
seeds. Available in loaf.

French
Slightly blistered crust, wine-like aroma. Available in
baguette; also served in portions as a side with many
food selections.

Ciabatta
A moist, chewy crumb with a thin crust and light olive
oil flavor. Available in loaf.

Focaccia
Italian flatbread baked with olive oil and topped with
either Asiago cheese or sea salt. Available in loaf.

Sprouted Whole Grain Roll
Available as single or pack of 6.

Soft Dinner Roll
Available as single or pack of 6.

Sourdough
Panera’s signature sourdough bread with no fat, oil, sugar,
or cholesterol. Available in loaf.

Asiago Cheese
Standard sourdough recipe with Asiago cheese baked in
and sprinkled on top. Available in loaf.

Honey Wheat
Sweet and hearty with honey and molasses. Available in
loaf.

All-Natural White Bread
Soft and tender white sandwich bread. Available in loaf.

Tomato Basil
Sourdough bread made with tomatoes and basil, and
sweet streusel topping. Available in XL loaf.

Cinnamon Raisin Swirl
Fresh dough made with flour, whole butter, and eggs,
swirled with Vietnamese and Indonesian cinnamons,
raisins, and brown sugar, topped with Panera’s cinnamon
crunch topping. Available in loaf.

Source: www.panerabread.com (accessed February 12, 2016).

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EXHIBIT 5 Panera Bread’s Menu selections, March 2015

Bakery and Sweets Soups (5 selections varying daily, plus seasonal specialties)

Artisan and Specialty Breads (14 varieties) Options include:

Bagels (11 varieties) Broccoli Cheddar

Scones (5 varieties) Bistro French Onion

Sweet Rolls (3 varieties) Baked Potato

Muffins and Muffies (6 varieties) Low Fat All-Natural Chicken Noodle

Artisan Pastries (7 varieties) Cream of Chicken and Wild Rice

Brownie New England Clam Chowder

Cookies (8 varieties) Low Fat Vegetarian Garden Vegetable with Pesto

Cinnamon Crumb Coffee Cake Low Fat Vegetarian Black Bean

Carrot Cake Vegetarian Creamy Tomato

All-Natural Turkey Chili

Bagels & Cream Cheese Spreads

11 varieties of bagels, 7 varieties of spreads Café Salads

Caesar: Classic, Greek

Hot Breakfast

Breakfast Sandwiches (9 varieties) Signature Salads

Baked Egg Soufflés (3 varieties) Chicken Cobb

Spinach Mushroom and Sofrito Chicken Cobb with Avocado

Chicken Caesar

Strawberry Granola Parfait Asian Sesame Chicken

Fuji Apple Chicken

Honey Almond Greek Yogurt Parfait Thai Chicken

BBQ Chicken

Steel Cut Oatmeal Mediterranean Quinoa with Almonds

Greek with Shrimp

Power Almond Quinoa Oatmeal Classic with Chicken

Greek with Chicken

Fruit Smoothies (6 varieties) Power Kale Caesar with Chicken

Chicken Soba Noodle

Fresh Fruit Cup

Broth Bowls

Signature Hot Paninis Thai Garden Chicken Wonton

Frontega Chicken Ricotta Sacchettini with Chicken

Roast Turkey and Caramelized Kale Lentil Quinoa with Chicken

Steak and White Cheddar Lentil Quinoa with Cage-Free Egg

Signature Sandwiches Café Sandwiches

Napa Almond Chicken Salad Smoked Ham and Swiss

Steak and Arugula Roasted Turkey and Avocado BLT

Italian Combo Tuna Salad

Bacon Turkey Bravo Mediterranean Veggie

(Continued)

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salads, soups, pasta dishes, pastries and sweets, and
a selection of beverages. In large geographic loca-
tions with multiple bakery-cafés, Panera operated
catering-only “delivery hubs” to expedite deliveries
of customer orders. Going forward, top executives
at Panera believed that off-premise catering was
an important revenue growth opportunity for both
company-operated and franchised locations.

The MyPanera Loyalty Program
In 2010, Panera initiated a loyalty program to reward
customers who dined frequently at Panera Bread
locations. The introduction of the MyPanera program

pickup or delivery times. Orders came complete with
plates, napkins, and utensils, all packaged and pre-
sented in convenient, ready-to-serve-from packaging.

In 2010, Panera boosted the size of its cater-
ing sales staff and introduced sales training pro-
grams and other tools—factors that helped drive
a 26 percent increase in catering sales in 2010. In
2011, Panera introduced an online catering sys-
tem that catering customers could use to view the
catering menu, place orders, specify whether the
order was to be picked up or delivered to a specified
location, and pay for purchases. The 65-item cater-
ing menu in 2015 included breakfast assortments,
bagels and spreads, sandwiches and boxed lunches,

Café Sandwiches Continued Beverages

Italian Combo Coffee (hot or iced)
Fontina Grilled Cheese Hot Teas
Classic Grilled Cheese Iced Tea
Sierra Turkey Iced Green Tea
Smoked Turkey Pepsi beverages

Dr Pepper
Flatbread Sandwiches Bottled Water
Turkey Cranberry San Pellegrino

Mediterranean Chicken Organic Milk or Chocolate Milk
Thai Chicken Orange Juice
Tomato Mozzarella Organic Apple Juice

Chicken Ham and Swiss Lemonade
Fruit Punch

Signature Pastas Sierra Mist fountain soda

Chicken Sorrentina Assorted other bottled beverages (5)
Chicken Tortellini Alfredo
Mac & Cheese Frozen Drinks
Pesto Sacchettini Frozen Caramel
Tortellini Alfredo Frozen Mocha
Pasta Primavera

Espresso Bar

Panera Kids Espresso
Grilled Cheese Sandwich Cappuccino
Peanut Butter and Jelly Sandwich Caffe Latte

Smoked Ham Sandwich Caffe Mocha
Smoked Turkey Sandwich Vanilla Latte

Mac & Cheese Caramel Latte

10 varieties of regular and seasonal soups Skinny Caffe Mocha
3 salads Chai Tea Latte (hot or iced)
2 squeezable varieties of yogurt Signature Hot Chocolate

Source: Menu posted at www.panerabread.com (accessed February 12, 2016).

EXHIBIT 5 Continued

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complete in 2017. The company had converted 106
of its company-owned bakery-cafés to Panera 2.0 by
year-end 2014 and another 304 were fully converted
to Panera 2.0 by year-end 2015.

CEO Ron Shaich was pleased with the results in
the bakery-cafés that had converted to Panera 2.0—
sales growth was higher in the converted store loca-
tions than in the nonconverted locations and metrics
relating to labor costs, operating improvements, and
guest friction/complaints were also noticeably better
in the converted locations. The data further indicated
that it took three to four quarters for the effects of
sales growth and operating efficiencies to gain full
momentum in the converted Panera 2.0 cafés. Intro-
duction of the “Rapid Pickup” component of Panera
2.0, which featured mobile ordering and payment for
customers picking up orders at a particular bakery-
café, was completed systemwide in early 2015. By
year-end 2015, sales that were digitally placed and
paid for were averaging 16 percent of total sales
companywide but were averaging 22 percent of total
sales at cafés that had converted to Panera 2.0 and
approaching 25 percent of total sales at growing
numbers of Panera bakery-cafés.

While Panera’s rollout of Panera 2.0 was intended
to speed service and checkout, as well as enable
other operating efficiencies, some of Panera’s big-
gest shareholders had expressed their concern to Ron
Shaich that Panera 2.0 was being implemented too
slowly and were also skeptical whether the new soft-
ware would actually improve internal operating effi-
ciency and boost customer traffic outside the lunch
hour by as much as Panera executives hoped.

The “Panera at Home”
Strategic Initiative
In 2013 Panera began selling Panera-branded soups
(15 varieties), mac and cheese, salad dressings,
packaged meats (roast pork, roast turkey, and roast
beef), Panera coffee (7 varieties), and frozen breads
through other retailers, primarily grocery chains. In
2015, Panera food products were available at select
grocery locations in 48 states and its coffees could
be purchased at Amazon.com. In 2015, sales of
these products (roughly 49 items) totaled about $150
million and were growing about 50 percent annually.
Panera’s goal was to build Panera at Home into a
business generating $1 billion in retail sales and over
$300 million in wholesale revenues over time. In

was completed systemwide in November and, by
the end of December, some 4.5 million customers
had signed up and become registered card mem-
bers. Members presented their MyPanera card when
ordering. When the card was swiped, the specific
items being purchased were automatically recorded
to learn what items a member liked. As Panera got
an idea of a member’s preferences over the course
of several visits, a member’s card was “loaded” with
such “surprises” as complimentary bakery-café
items, exclusive previews and tastings, cooking and
baking tips, invitations to special events, ideas for
entertaining, or recipe books. On a member’s next
visit, when an order was placed and the card swiped,
order-taking personnel informed the member of the
surprise award. Members could also go online at
www.MyPanera.com and see if a reward was waiting
on their next visit. At year-end 2015, the company’s
MyPanera program had over 22 million members,
and in 2013, 2014, and 2015 approximately 50 per-
cent of the transactions at Panera Bread bakery-cafés
were attached to a MyPanera loyalty card.

Management believed that the loyalty program
had two primary benefits. One was to entice members
to dine at Panera more frequently and thereby deepen
the bond between Panera Bread and its most loyal
customers. The second was to provide Panera man-
agement with better marketing research data on the
purchasing behavior of customers and enable Panera
to refine its menu selections and market messages.

The Panera 2.0 Strategic Initiative
In 2012, Panera began testing a newly developed
Panera 2.0 app that enabled digital ordering and
payment by customers and that included capabili-
ties store employees and managers could use to per-
form an assortment of internal operating activities.
The app was adaptable to the differentiated needs of
dine-in, to-go, and large-order delivery customers.
The objectives of the Panera 2.0 technology were to
enhance the guest experience, aid the introduction
of marketing innovations, permit cost-efficient han-
dling of a growing number of customer transactions
volumes, and pave the way for greater operating effi-
ciencies in its bakery-cafés. The tests in 14 bakery-
cafés were such a huge success that Panera began
rolling out the full Panera 2.0 experience to its entire
network of company-operated and franchised bakery
cafés in 2013, a process that management planned to

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production systems, integrated as they are, are already
in place to enable [Panera] 2.0 and rapid pickup, and
can be uniquely leveraged to support our Delivery
business. Given our existing technology, Delivery
appears to our cafe managers as just another to-go
order. Orders come in over the same app, go through
our existing kitchen display systems and are produced
by the same staff for our drivers to bring to our cus-
tomers. Thus, there’s little material incremental capital
investment beyond routing software required to sup-
port our Delivery business.

Panera had studied using third-party delivery
services instead of building its own driver network.
But management was not convinced outsourcing
delivery drivers was the best way for Panera to go.
Ron Shaich gave several reasons:7

First, we don’t want to be confined by the limited
mass coverage presently offered by external delivery
resources.

And, second, we found that using our own drivers
ensures a faster delivery time with more consistent
quality of delivery for a better customer experience. We
know this matters to our customer and we believe we
can build a formidable competitive advantage on this.

No third-party delivery operator offers the cover-
age to unlock the market potential we see out there and
want to attack now. We’ve talked with every meaning-
ful third-party provider out there and tested with many,
and at best no single third-party delivery organization
can support more than 15 percent of our markets.

Further, in the markets they do operate within, their
average coverage is below 50% of our cafés’  delivery
zones. That is to say, if you take an individual store, they
only offer delivery to about 50% of the real estate we’re
trying to deliver to. So, as of today, using third-party
drivers would allow us to serve less than 7% of what we
perceive to be our potential delivery customers.

We also are committed to offering a better deliv-
ery experience, one of consistent quality. Our goal is
a 30- to 35-minute order-to-door time, which we have
found possible, at least at this point—which we have
not found possible, at least at this point, through third-
party drivers.

. . .  given the size of the opportunity and our desire
to move quickly, we cannot wait for third-party provid-
ers to expand their capabilities, nor are we willing to
put up with present limitation of third-party services.
Simply put, we will initially move forward with in-
house drivers, believing this will lead to a more rapid
rollout of delivery, making for a competitively more
attractive experience for our customers, and lead to
significantly more incremental profitability.

2016 Panera expected to begin transitioning catego-
ries within its Panera at Home food portfolio from a
licensed model to what it termed a “co-pack model”
in which Panera managed the customer.

Panera’s Latest Strategic Initiative:
Delivering Orders to Customers
Panera management began working on prototyping
and testing delivering orders to customers in 2012–
2013. By year-end 2015, Panera had come up with a
go-forward delivery model which it was testing at 25
cafés in two geographic markets. While the test was
still in the early stages, Panera was generating deliv-
ery orders in the 25 test cafés averaging $5,000 per
week, against a breakeven volume of $3,000 (exclu-
sive of startup, training, and initial awareness costs).

In February 2016, Shaich explained why he was
excited about the potential for order delivery to be a
powerful new channel for sales and profit growth at
Panera:6

First, we believe we have the perfect product for Deliv-
ery. Salads and sandwiches are generally not heated
and, therefore, travel well, especially at lunch. We
also have brand credibility. Our foods are the preferred
choice for many office meetings and gatherings. Deliv-
ery also uses our production capabilities without tax-
ing lunchtime seats which are at or nearly at capacity.

Second, our testing to date indicates delivery sales
are highly incremental, which means we are reach-
ing Panera users not already served through other
channels. Third, our testing indicates delivery has the
potential to [boost sales growth at existing stores] for
multiple years at rates significantly higher than the rate
of [growth without delivery]. Simply put, the trajec-
tory of delivery sales growth is different than the tra-
jectory of sales growth [without delivery].

Fourth, steady state Delivery margins are particu-
larly attractive since there’s no order input cost asso-
ciated with Delivery—all orders are indeed placed
digitally—and no cost for heating and lighting the space
in which the customer consumes the product. Indeed,
customers consume the delivered product in their own
space. The only relevant costs when we do delivery are
production and the net cost of delivery, which in turn
is very much a function of the level of sales per hour
offset by the modest delivery fee we charge.

Fifth, startup and transition costs are modest, very
modest. We simply have to hire and train drivers and
build awareness to reach our initial sales goals.

And sixth, delivery leverages the tech capabilities
we’ve already built. The digital ordering, payment, and

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and one in Boston. Panera expected to serve over
1 million people at the five pay-what-you-want loca-
tions in 2013.8 Statistics showed that in 2013 about
60 percent of store patrons left the suggested
amount, 20 percent left more, and 20 percent less,
often significantly less.9

In March 2013, Panera introduced a special
“Meal of Shared Responsibility”—turkey chili in a
bread bowl—at a suggested retail price of $5.89 (tax
included) at 48 locations in the St. Louis area. The
idea was that those in need could get a nutritious
850-calorie meal for whatever they could afford to
pay, while those who pay above the company’s cost
make up the difference.10 The program was sup-
ported by heavy media coverage at launch, exten-
sive in-store signage, and employees explaining how
the meal worked. In July 2013, after serving about
15,000 of the turkey chili meals, Panera canceled
the program, chiefly because few people in need
were participating—an outcome attributed largely
to most Panera locations in the St. Louis area being
located in middle-class and affluent neighborhoods.
Management indicated it would rethink its approach
to social responsibility and possibly retool the pro-
gram. Later in 2014, the Chicago location of Panera
Cares was closed.

In 2016, the four locations in St. Louis, Dear-
born, Boston, and Portland were still open, operat-
ing under the name Panera Cares Community Cafés.
Since 2010, some 4 million guests had been served
meals. In order to achieve the goal of feeding peo-
ple with dignity and also sustain their operation,
the Panera Bread Foundation had established four
guidelines that guests at these Community Cafés
were asked to observe:11

1. The suggested donation listed on the menu panel
is the retail value of the meal and reflects the
amount we need to cover our operating costs
while also covering the cost of the meals for those
who come in and are unable to contribute for their
meal. We ask that those who are able contribute
that amount do so.

2. For guests who cannot meet our suggested dona-
tion amount or donate your fair share, we ask that
you limit yourself to one entreé and a beverage
per week.

3. If you are unable to contribute for your meal,
you may earn a meal voucher by volunteering for
1 hour per week in our community cafés. We are

All that said, let me state that we respect the third-
party model and we’ll continue to talk with any and all
third-party providers relative to our markets. We are
rigid in our commitment to build a real delivery busi-
ness at Panera but flexible in execution, as we know
the capabilities of independent delivery firms will con-
tinue to evolve rapidly.

But, today, [using] in-house drivers allows us to
move quickly to offer delivery at scale across the coun-
try with a better experience that serves as a competi-
tive advantage for our guests.

Panera franchisees were as excited about deliv-
ering orders as was Panera management, chiefly
because of the incremental sales and profit potential
and the relatively small costs associated with add-
ing delivery capability. As a consequence, the strat-
egy was to roll out delivery simultaneously at both
company-owned and franchised locations. In 2016,
Panera expected to introduce order delivery at 200
to 300 company and franchised locations.

Panera’s Nonprofit Pay-What-You-
Want Bakery-Café Locations
In May 2010, Panera Bread converted one of its res-
taurants in a wealthy St. Louis suburb into a non-
profit “pay-what-you-want” Saint Louis Bread Cares
bakery-café with the idea of helping to feed people in
need and raising money for charitable work. A sign in
the bakery-café said, “We encourage those with the
means to leave the requested amount or more if you’re
able. And we encourage those with a real need to take
a discount.” The menu board listed “suggested fund-
ing levels,” not prices. Payments went into a dona-
tion box, with the cashiers providing change and
handling credit card payments. The hope was that
enough generous customers would donate money
above and beyond the menu’s suggested funding lev-
els to subsidize discounted meals for those who were
experiencing economic hardship and needed help.
The restaurant was operated by Panera’s charitable
Panera Bread Foundation; all profits from the store
were donated to community programs.

After several months of operation, the Saint
Louis Bread Cares store was judged to be success-
ful enough that Ron Shaich, who headed the Panera
Bread Foundation, opted to open two similar Panera
Cares cafés—one in the Detroit suburb of Dearborn,
Michigan, and one in Portland, Oregon. Two more
locations were opened in 2012—one in Chicago

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systemwide bakery-café sales), $44.5 million in 2012
(1.15 percent of systemwide bakery-café sales), $55.6
million in 2013 (1.30 percent of system-ide bakery-
café sales), $65.5 million in 2014 (1.45 percent of
systemwide bakery-café sales), and $68.5 million in
2015 (1.41 percent of systemwide bakery-café sales).
The increased advertising expenses in 2014 were to
support Panera’s first-ever national television adver-
tising campaign, an initiative that was financed by
both Panera and its franchisees and that was contin-
ued in 2015.

Panera’s franchise agreements required fran-
chisees to contribute a specified percentage of their
net sales to advertising. In 2014 and 2015, Panera’s
franchise-operated bakery-cafés were required to con-
tribute 1.8 percent of their sales to a national advertis-
ing fund and to pay Panera a marketing administration
fee equal to 0.4 percent of their sales—Panera contrib-
uted the same net sales percentages from company-
owned bakery-cafés toward the national advertising
fund and the marketing administration fee. Franchisees
were also required in 2014 and 2015 to spend amounts
equal to 0.8 percent of their net sales on advertising in
their respective local markets.

FRaNCHIse OPeRaTIONs
Opening additional franchised bakery-cafés was a
core element of Panera Bread’s strategy and manage-
ment’s initiatives to achieve the company’s revenue
growth and earnings targets. Panera Bread did not
grant single-unit franchises, so a prospective fran-
chisee could not open just one bakery-café. Rather,
Panera Bread’s franchising strategy was to enter
into franchise agreements that required the franchise
developer to open a number of units, typically 15
bakery-cafés in a period of six years. Franchisee can-
didates had to be well-capitalized, have a proven track
record as excellent multiunit restaurant operators, and
agree to meet an aggressive development schedule.
Applicants had to meet eight stringent criteria to gain
consideration for a Panera Bread franchise:

∙ Experience as a multiunit restaurant operator
∙ Recognition as a top restaurant operator
∙ Net worth of $7.5 million
∙ Liquid assets of $3 million
∙ Infrastructure and resources to meet Panera’s

development schedule for the market area the
franchisee was applying to develop

not designed to be a permanent solution for those
facing food insecurity, so if you are in need of
additional services, please visit our resource area
for more information.

4. We also ask that, as a general matter, meals provided
to those who cannot contribute the full suggested
donation amount are consumed in our community
cafes as a means of building community.

Panera’s Marketing Strategy
Panera management was committed to growing sales
at existing and new unit locations, continuously
improving the customer experience at its restau-
rants, and stimulating more frequent customer visits
to its bakery-cafés. The core strategic initiatives to
achieve these outcomes included periodically intro-
ducing new menu items during the Celebrations,
increasing the enrollment of patrons in the MyPanera
loyalty programs, and efforts to strengthen relation-
ships with customers who, management believed,
would then recommend dining at Panera to their
friends and acquaintances. Panera hired a new chief
marketing officer and a new vice president of mar-
keting in 2010; both had considerable consumer
marketing experience and were playing an important
role in crafting the company’s marketing strategy
to increase awareness of the Panera brand, develop
and promote appealing new menu selections, expand
customer participation in the MyPanera loyalty pro-
gram, and otherwise make dining at Panera bakery-
cafés a pleasant and satisfying experience.

To promote the Panera brand and menu offer-
ings to target customer groups, Panera employed a
mix of radio, billboards, social networking, the Inter-
net, and periodic cable television advertising cam-
paigns. In recent years, Panera had put considerable
effort into (a) improving its advertising messages to
better capture the points of difference and the soul
of the Panera concept and (b) doing a better job of
optimizing the media mix in each geographic market.

Whereas it was the practice at many national res-
taurant chains to spend 3 to 5 percent of revenues on
media advertising, Panera’s advertising expenses had
typically been substantially lower, running as low as
0.6 percent of systemwide sales at company-owned
and franchised bakery-cafés in 2008. But in the past
five years, Panera had started upping its advertising
effort to help spur sales growth. Advertising expenses
totaled $33.2 million in 2011 (1.00 percent of

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all of their dough products from sources approved
by Panera Bread. Panera’s fresh dough facility sys-
tem supplied fresh dough products to substantially
all franchise-operated bakery-cafés. Panera did not
finance franchisee construction or area development
agreement payments or hold an equity interest in
any of the franchise-operated bakery-cafés. All area
development agreements executed after March 2003
included a clause allowing Panera Bread the right to
purchase all bakery-cafés opened by the franchisee at
a defined purchase price, at any time five years after
the execution of the franchise agreement. During the
2010–2014 period, Panera purchased 84 bakery-cafés
from the franchisees and had sold 5 company-owned
stores to franchisees.

But in mid-April 2015, following a February
announcement that Panera’s expected earnings per
share in 2015 would, at best, be flat in compari-
son to the $6.64 the company earned in 2014 and

∙ Real estate experience in the market to be developed
∙ Total commitment to the development of the

Panera Bread brand
∙ Cultural fit and a passion for fresh bread

Exhibit 6 shows estimated costs of opening a
new franchised Panera Bread bakery-café. The fran-
chise agreement typically required the payment of a
$5,000 development fee for each bakery-café con-
tracted for in a franchisee’s “area development agree-
ment,” a franchise fee of $30,000 per bakery-café
(payable in a lump sum at least 30 days prior to the
scheduled opening of a new bakery-café), and con-
tinuing royalties of 5 percent on gross sales at each
franchised bakery-café. Franchise-operated bakery-
cafés followed the same standards for in-store oper-
ating standards, product quality, menu, site selection,
and bakery-café construction as did company-owned
bakery-cafés. Franchisees were required to purchase

EXHIBIT 6 estimated Initial Investment for a Franchised Panera Bread
Bakery-Café, 2012

Investment Category Actual or Estimated Amount To Whom Paid

Development fee $5,000 per bakery-café contracted
for in the franchisee’s Area

Development Agreement

Panera

Franchise fee $35,000 ($5,000 of the development
fee was applied to the $35,000

franchise fee when a new bakery-
café was opened)

Panera

Real property Varies according to site and local
real estate market conditions

Leasehold improvements $334,000 to $ 938,500 Contractors

Equipment $198,000 to $ 310,000 Equipment vendors, Panera

Fixtures $ 32,000 to $ 54,000 Vendors

Furniture $ 28,500 to $ 62,000 Vendors

Consultant fees and municipal
impact fees (if any)

$ 51,500 to $ 200,250 Architect, engineer, expeditor, others

Supplies and inventory $ 19,150 to $ 24,350 Panera, other suppliers

Smallwares $ 24,000 to $ 29,000 Suppliers

Signage $ 15,000 to $ 84,000 Suppliers

Additional funds (for working
capital and general operating

expenses for 3 months)

$175,000 to $ 245,000 Vendors, suppliers, employees,
utilities, landlord, others

Total $917,150 to $1,984,100, plus
real estate andrelated costs

Source: www.panerabread.com (accessed April 5, 2012).

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area, and information on nearby competitors. Based
on analysis of this information, including utiliza-
tion of predictive modeling using proprietary soft-
ware, Panera developed projections of sales and
return on investment for candidate sites. Cafés had
proven successful as freestanding units and as both
in-line and end-cap locations in strip malls and large
regional malls. A number of the Panera Bread cafca-
fés that were free-standing or had suitable end-cap
locations had installed drive-thru windows, a feature
that tended to boost sales by about 20 percent.

The average Panera bakery-café size was approx-
imately 4,500 square feet. Most all company-operated
locations were leased. Lease terms were typically
for 10 years, with one, two, or three 5-year renewal
option periods. Leases typically entailed charges for
minimum base occupancy, a proportionate share of
building and common area operating expenses and
real estate taxes, and a contingent percentage rent
based on sales above a stipulated amount. Some lease
agreements provided for scheduled rent increases
during the lease term. The average construction,
equipment, furniture and fixture, and signage cost for
the 65 company-owned bakery-cafés opened in 2014
and the 57 bakery-cafés was $1,400,000 (excluding
capitalized development overhead expenses), com-
pared to average costs of $750,000 for 42 company-
owned bakery-cafés opened in 2010 and $920,000
for 66 company-owned bakery-cafés opened in 2005.

Each bakery-café sought to provide a distinc-
tive and engaging environment (what management
referred to as “Panera Warmth”), in many cases using
fixtures and materials complementary to the neighbor-
hood location of the bakery-café. All Panera cafés used
real china and stainless silverware, instead of paper
plates and plastic utensils. Periodically, the company
introduced new café designs aimed at further refining
and enhancing the appeal of Panera bakery-cafés as
a warm and appealing neighborhood gathering place.
These designs tended to feature newly available fur-
niture, cozier seating, and modernized décor. Some
locations had fireplaces to further create an alluring
and hospitable atmosphere. Many locations had out-
door seating, and all company-operated and most
franchised locations had free wireless Internet to help
make the bakery-cafés community gathering places
where people could catch up on some work, hang out
with friends, read the paper, or just relax (a strategy
that Starbucks had used with great success).

shortly after Panera’s executives had a “constructive
dialogue” with activist shareholder Luxor Capital
Group, Panera Bread announced that it would (a)
expand its share-repurchase plan from $600 mil-
lion to $750 million, (b) sell 73 of its 925 company-
owned bakery-cafés to franchisees to raise money to
help fund the added expenditures on repurchasing
outstanding shares of the company’s common stock,
and (c) borrow $500 million to help fund the share-
buyback plan. As things turned out, Panera ended
up selling 75 company-owned bakery-cafés to fran-
chisees by year-end 2015 and expected to sell about
35 additional company-owned stores to franchisees
in 2016.

As of January 2016, Panera Bread had agree-
ments with 33 franchise groups that operated 1,071
bakery-cafés. Panera’s largest franchisee operated
nearly 200 bakery-cafés in Ohio, Pennsylvania, West
Virginia, Kentucky, and Florida. The company’s fran-
chise groups had committed to open an additional 128
bakery-cafés. If a franchisee failed to develop bakery-
cafés on schedule, Panera had the right to terminate
the franchise agreement and develop its own company-
operated locations or develop locations through new
franchisees in that market. However, Panera from time
to time agreed to modify the commitments of franchi-
sees to open new locations when unfavorable market
conditions or other circumstances warranted the post-
ponement or cancellation of new unit openings.

Panera provided its franchisees with support in a
number of areas: market analysis and site selection
assistance, lease review, design services and new store
opening assistance, a comprehensive 10-week initial
training program, a training program for hourly employ-
ees, manager and baker certification, bakery-café certi-
fication, continuing education classes, benchmarking
data regarding costs and profit margins, access to
company-developed marketing and advertising pro-
grams, neighborhood marketing assistance, and cal-
endar planning assistance.

PaNeRa BReaD OPeRaTIONs
Site Selection and Café Environment
Bakery-cafés were typically located in suburban,
strip mall, and regional mall locations. In evaluating
a potential location, Panera studied the surround-
ing trade area, demographic information within that

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and approximately 1,300 were employed in general or
administrative functions, principally in the company’s
support centers. Roughly 23,800 employees worked,
on average, at least 25 hours per week. Panera had no
collective bargaining agreements with its associates
and considered its employee relations to be good.

Panera’s Bakery-Café Supply Chain
Panera operated a network of 24 facilities (22
company-owned and 2 franchise-operated) to sup-
ply fresh dough for breads and bagels on a daily basis
to almost all of its company-owned and franchised
bakery-cafés—one of the company’s 22 facilities
was a limited production operation co-located at a
company-owned bakery-café in Ontario, Canada,
that supplied dough to 17 Panera bakery-cafés in that
market. All of the company’s facilities were leased.
Most of the 1,500 employees at these facilities were
engaged in preparing dough for breads and bagels, a
process that took about 48 hours. The dough- making
process began with the preparation and mixing of
starter dough, which then was given time to rise;
other all-natural ingredients were then added to create
the dough for each of the different bread and bagel
varieties (no chemicals or preservatives were used).
Another period of rising then took place. Next, the
dough was cut into pieces, shaped into loaves or
bagels, and readied for shipment in fresh dough form.
There was no freezing of the dough, and no partial
baking was done at the fresh dough facilities. Trained
bakers at each bakery-café performed all of the bak-
ing activities, using the fresh doughs delivered daily.

Distribution of the fresh bread and bagel doughs
(along with tuna, cream cheese spreads, and cer-
tain fresh fruits and vegetables) was accomplished
through a leased fleet of about 225 temperature-
controlled trucks operated by Panera personnel. The
optimal maximum distribution route was approxi-
mately 300 miles; however, routes as long as 500
miles were sometimes necessary to supply cafés in
outlying locations. In 2013–2014, the various distri-
bution routes for regional facilities entailed making
daily deliveries to 8–9 bakery-cafés.

Panera obtained ingredients for its doughs and
other products manufactured at its regional facilities.
While a few ingredients used at these facilities were
sourced from a single supplier, there were numerous
suppliers of each ingredient needed for fresh dough
and cheese spreads. Panera contracted externally for

Bakery-Café Operations
Panera’s top executives believed that operating
excellence was the most important element of Panera
Warmth and that without strong execution and oper-
ational skills and energized café personnel who were
motivated to provide pleasing service, it would be
difficult to build and maintain a strong relationship
with the customers patronizing its bakery-cafés.
Additionally, top management believed high-quality
restaurant management was critical to the company’s
long-term success. Bakery-café managers were pro-
vided with detailed operations manuals and all café
personnel received hands-on training, both in small
group and individual settings. The company had cre-
ated systems to educate and prepare café personnel
to respond to a customer’s questions and do their
part to create a better dining experience. Manage-
ment strived to maintain adequate staffing at each
café and had instituted competitive compensation
for café managers and both full-time and part-time
café personnel (who were called associates). Man-
agers at cafés that had converted to Panera 2.0 were
aggressively using the tool to improve a variety of
operating metrics—and with demonstrated results.

Panera executives had established a “Joint Ven-
ture Program,” whereby selected general managers
and multiunit managers of company-operated bak-
ery cafés could participate in a bonus program based
upon a percentage of the store profit of the bakery-
cafés they operated. The bonuses were based on
store profit percentages generally covering a period
of five years, and the percentages were subject to
annual minimums and maximums. Panera manage-
ment believed the program’s multiyear approach
(a) improved operator quality and management
retention, (b) created team stability that generally
resulted in a higher level of operating consistency
and customer service for a particular bakery-café,
(c) fostered a low rate of management turnover, and
(d) helped drive operating improvements at the com-
pany’s bakery-cafés. In 2013–2014, approximately
45 percent of the bakery-café operators Panera’s
company-owned locations participated in the Joint
Venture Program.

Going into 2016, Panera Bread had approxi-
mately 47,200 employees. Approximately 44,400
were employed in Panera’s bakery-cafe operations as
bakers, managers, and associates, approximately 1,400
were employed in the fresh dough facility operations,

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suppliers to improve ingredient quality and cost and
that its various supply-chain arrangements entailed
little risk that its bakery-cafés would experience sig-
nificant delivery interruptions from weather condi-
tions or other factors that would adversely affect café
operations.

The fresh dough made at the regional facilities
was sold to both company-owned and franchised
bakery-cafés at a delivered cost not to exceed 27 percent
of the retail value of the product. Exhibit 7 provides
financial data relating to each of Panera’s three busi-
ness segments: company-operated bakery-cafés, fran-
chise operations, and the operations of the regional
facilities that supplied fresh dough and other products.
The sales and operating profits of the fresh dough
and other products segment shown in Exhibit 7
represent only those transactions with franchised
bakery-cafés. The company classified any operat-
ing profit of the regional facilities stemming from
supplying fresh dough and other products to com-
pany-owned bakery-cafés as a reduction in the cost
of food and paper products. The costs of food and
paper products for company-operated bakery-cafés
are shown in Exhibit 1.

Panera Bread’s Management
Information Systems
Each company-owned bakery-café had programmed
point-of-sale registers that collected transaction data
used to generate transaction counts, product mix,
average check size, and other pertinent statistics.
The prices of menu selections at all company-owned
bakery-cafés were programmed into the point-of-
sale registers from the company’s data support
centers. Franchisees were allowed access to certain
parts of Panera’s proprietary bakery-café systems
and systems support; they were responsible for pro-
viding the appropriate menu prices, discount rates,
and tax rates for system programming.

The company used in-store enterprise appli-
cation tools and the capabilities of the Panera 2.0
app to (1) assist café managers in scheduling work
hours for café personnel and controlling food costs,
in order to provide corporate and retail opera-
tions management with quick access to retail data;
(2)  enable café managers to place online orders
with distributors; and (3) to reduce the time café
managers spent on administrative activities. The
information collected electronically at café registers

the manufacture and distribution of sweet goods to
its bakery-cafés. After delivery, sweet good products
were finished with fresh toppings and other ingredi-
ents (based on Panera’s own recipes) and baked to
Panera’s artisan standards by professionally trained
bakers at each café location.

Panera had arrangements with several indepen-
dent distributors to handle the delivery of sweet goods
products and other items to its bakery-cafés, but the
company had contracted with a single supplier to
deliver the majority of ingredients and other products
to its bakery-cafés two or three times weekly. Virtually
all other food products and supplies for their bakery-
cafés, including paper goods, coffee, and smallwares,
were contracted for by Panera and delivered by the
vendors to designated independent distributors for
delivery to the bakery-cafés. Individual bakery-cafés
placed orders for the needed supplies directly with
a distributor; distributors made deliveries to bakery-
cafés two or three times per week. Panera maintained
a list of approved suppliers and distributors that all
company-owned and franchised cafés could select
from in obtaining food products and other supplies
not sourced from the company’s regional facilities or
delivered directly by contract suppliers.

Although many of the ingredients and menu
items sourced from outside vendors were prepared
to Panera’s specifications, the ingredients for a big
majority of menu selections were generally avail-
able and could be obtained from alternative sources
when necessary. In a number of instances, Panera
had entered into annual and multiyear contracts for
certain ingredients in order to decrease the risks of
supply interruptions and cost fluctuation. However,
Panera had only a limited number of suppliers of
antibiotic-free chicken; because there were rela-
tively few producers of meat products raised with-
out antibiotics—as well as certain other organically
grown items—it was difficult or more costly for
Panera to find alternative suppliers.

Management believed the company’s fresh
dough-making capability provided a competitive
advantage by ensuring consistent quality and dough-
making efficiency (it was more economical to concen-
trate the dough-making operations in a few facilities
dedicated to that function than it was to have each
bakery-café equipped and staffed to do all of its bak-
ing from scratch). Management also believed that
the company’s growing size and scale of operations
gave it increased bargaining power and leverage with

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EXHIBIT 7 Business segment Information, Panera Bread Company,
2011–2015 (in thousands of dollars)

2015 2014 2013 2012 2011

Segment revenues:

Company bakery-café operations $ 2,358,794 $ 2,230,370 $ 2,108,908 $ 1,879,280 $ 1,592,951

Franchise operations 138,563 123,686 112,641 102,076 92,793

Fresh dough and other product
operations at regional facilities 382,110 370,004 347,922 312,308 275,096

Intercompany sales eliminations (197,887) (194,865) (184,469) (163,607) (138,808)

Total revenues $ 2,681,580 $ 2,529,195 $ 2,385,002 $ 2,130,057 $ 1,822,032

Segment operating profit:

Company bakery-café operations $ 366,905 $ 400,261 $ 413,474 $ 380,432 $ 307,012

Franchise operations 133,449 117,770 106,395 95,420 86,148

Fresh dough and other product
operations at regional facilities 23,517 22,872 21,293 17,695 20,021

Total segment operating profit $ 523,871 $ 540,903 $ 541,162 $ 493,547 $ 413,181

Depreciation and amortization:

Company bakery-café operations $ 105,535 $ 103,239 $ 90,872 $ 78,198 $ 68,651

Fresh dough and other product
operations at regional facilities 9,367 8,613 8,239 6,793 6,777

Corporate administration 20,496 12,257 7,412 5,948 4,471

Total $ 135,398 $ 124,109 $ 106,523 $ 90,939 $ 79,899

Capital expenditures:

Company bakery-café operations $ 174,633 $ 167,856 $ 153,584 $ 122,868 $ 94,873

Fresh dough and other product
operations at regional facilities 12,175 12,178 11,461 13,434 6,483

Corporate administration 37,124 44,183 26,965 16,026 6,576

Total capital expenditures $ 223,932 $ 224,217 $ 192,010 $ 152,328 $ 107,932

Segment assets

Company bakery-café operations $ 953,717 $ 953,896 $ 867,093 $ 807,681 $ 682,246

Franchise operations 13,049 13,145 10,156 10,285 7,502

Fresh dough and other product
operations at regional facilities _75,634 _65,219 62,854 60,069 47,710

Total segment assets $ 1,475,318 $ 1,390,902 $ 940,103 $ 878,035 $ 737,458

Sources: Panera Bread’s 2015 10-K report, p. 73; 2014 10-K report, p. 66; 2013 10-K report, p. 67; 2011 10-K report, p. 69.

was used to generate daily and weekly consolidated
reports regarding sales, transaction counts, aver-
age check size, product mix, sales trends, and other
operating metrics, as well as detailed profit-and-
loss statements for company-owned bakery-cafés.

These data were incorporated into the company’s
“exception-based reporting” tools.

Panera’s regional facilities had software that
accepted electronic orders from bakery-cafés and
monitored delivery of the ordered products back to

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another, seeking to set themselves apart from rivals
via pricing, food quality, menu theme, signature menu
selections, dining ambiance and atmosphere, service,
convenience, and location. To further enhance their
appeal, some restaurants tried to promote greater cus-
tomer traffic via happy hours, lunch and dinner spe-
cials, children’s menus, innovative or trendy dishes,
diet-conscious menu selections, and beverage/appe-
tizer specials during televised sporting events (impor-
tant at restaurants/bars with big-screen TVs). Most
restaurants were quick to adapt their menu offer-
ings to changing consumer tastes and eating prefer-
ences, frequently featuring heart-healthy, vegetarian,
organic, low-calorie, and/or low-carb items on their
menus. Research conducted by the National Restau-
rant Association indicated in 2015 that:14

∙ 68 percent of consumers were more likely to visit
a restaurant that offered locally produced food
items.

∙ 70 percent of consumers were more likely to visit
a restaurant that offered healthy menu options.

∙ 72 percent of consumers believe restaurant tech-
nology increases convenience, while 42 percent
said technology makes restaurant visits and
ordering more complicated.

It was the norm at many restaurants to rotate
some menu selections seasonally and to periodically
introduce creative dishes in an effort to keep regu-
lar patrons coming back, attract more patrons, and
remain competitive.

The profitability of a restaurant location ranged
from exceptional to good to average to marginal to
money-losing. Consumers (especially those that ate
out often) were prone to give newly opened eating
establishments a trial, and if they were pleased with
their experience might return, sometimes frequently—
loyalty to existing restaurants was low when consum-
ers perceived there were better dining alternatives. It
was also common for a once-hot restaurant to lose
favor and confront the stark realities of a dwindling
clientele, forcing it to either re-concept its menu and
dining environment or go out of business. Many res-
taurants had fairly short lives. There were multiple
causes for a restaurant’s failure—a lack of enthusiasm
for the menu or dining experience, inconsistent food
quality, poor service, a poor location, meal prices that
patrons deemed too high, and being outcompeted by
rivals with more appealing menu offerings.

the bakery-cafés. Panera also had developed pro-
prietary digital software to provide online training
to employees at bakery-cafés, and online baking
instructions for the baking personnel at each café.

THe ResTaURaNT INDUsTRY
IN THe UNITeD sTaTes
IN 2016
According to the National Restaurant Association,
total food-and-drink sales at some 1.1 million food-
service locations of all types in the United States
were projected to reach a record $783 billion in
2016, up from $587 billion in 2010.12 Of the pro-
jected $783 billion in food-and-drink sales industry-
wide in 2015, about $536 billion were expected to
occur in commercial restaurants, with the remainder
divided among bars and taverns, lodging place res-
taurants, managed food service locations, military
restaurants, and other types of retail, vending, rec-
reational, and mobile operations with foodservice
capability. In 2013, unit sales averaged $966,000
at full-service restaurants and $834,000 at quick-
service restaurants; however, very popular restau-
rant locations achieved annual sales volumes in the
$2.5 million to $5 million range.

Restaurants were the nation’s second-largest pri-
vate employer in 2015 with about 14 million employ-
ees; employment in 2016 was expected to rise to
14.4  million people. Nearly half of all adults in the
United States had worked in the restaurant industry at
some point in their lives, and one out of three adults
got their first job experience in a restaurant. More
than 90 percent of all eating-and-drinking-place busi-
nesses had fewer than 50 employees, and more than
70 percent of these places were single-unit operations.

Even though the average U.S. consumer ate
76 percent of their meals at home, on a typical day,
about 130 million U.S. consumers were foodservice
patrons at an eating establishment—sales at com-
mercial eating places were projected to average
about $1.9 billion on a typical day in 2015. Average
household expenditures for food away from home in
2014 were $2,787, equal to about 40 percent of total
household expenditures for food.13

The restaurant business was labor-intensive,
extremely competitive, and risky. Industry members
pursued differentiation strategies of one variety of

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eNDNOTes
6 Transcript of Panera Bread’s conference
call to discuss its 4th Quarter and full-year
2015 earning and performance, February 10,
2016, www.seekingalpha.com (accessed
February 13, 2016).
7 Ibid.
8 Annie Gasparro, “A New Test for Panera’s
Pay-What-You-Can,” The Wall Street Journal,
June 4, 2013, www.wsj.com (accessed
March 7, 2014).
9 Ibid.
10 Jim Salter, “Panera Suspends Latest
Pay-What-You-Can Experiment in Stores,”
July 10, 2013, www.huffingtonpost.
com (accessed March 7, 2014).

1 Company press release, February 9, 2016.
2 Harris Interactive press releases, March 16,
2011, and May 10, 2012, and information,
www.harrisinteractive.com (accessed
March 7, 2014).
3 “Zagat Announces 2012 Fast-Food Survey
Results,” September 27, 2012, www.prnews
wire.com (accessed March 7, 2014).
4 Sandelman and Associates Quick-Track
Surveys and Fast-Food Awards of Excellence
Winners, and information included in
“Press Kit,” www.panerabread.com (accessed
March 7, 2014).
5 As stated in a presentation to securities
analysts, May 5, 2006.

11 Information posted at www.paneracares.
org (accessed February 15, 2016).
12 The statistical data in this section is based
on information posted at www.restaurant.
org (accessed February 21, 2016).
13 Bureau of Labor Statistics, news release,
September 3, 2015, www.bls.gov (accessed
February 15, 2016).
14 National Restaurant Industry, “2016
Restaurant Industry Pocket Factbook,”
www.restaurant.org, (accessed February 21,
2016).

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