The dependency problem: Never put all eggs in one basket!

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The dependency problem:

Never put all eggs in one basket!

How can company X solve its dependency problem?

Nadine Gussinklo

Groningen, 26 augustus 2009

Rijksuniversiteit Groningen

MScBA Small Bussiness & Entrepreneurship

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Executive summary

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Introduction

Small and medium sized businesses are the engine of the Dutch economy (Ebbers, 2005) and driving forces of economic growth. Considerable contributions to the economy are made by small businesses at different levels. Small businesses account for a large share of employment and they disproportionally create new jobs (OECD, 1997). They also are sources of constant innovation (Acs, 1999). The economic impact of small businesses is enormous and “the emerging conventional wisdom seems to suggest that small businesses and entrepreneurship are both necessary for macroeconomic prosperity” (Acs, 1999, p.7).

Despite the important role that small businesses fulfil, they are fragile and “most sensitive to changes in the business environment” (European Council, 2000, p. 1). Small businesses are very dependent on the overall economy, have problems in attracting and retaining a high quality workforce and face intense global competition (Moutray, 2008). Also in the relational context, small businesses need to cope with uncertainties. Often, transactions are only done with a small number of key relationships, focusing on a few customers (Atherton, 2003; Berg van den, 2009). This dependency on only one or a few customers is seen as one of the major problems of small businesses (Huang & Brown, 1999).

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environment therefore more challenging for small businesses such as company X (Nooteboom & Vianen, 1987).

The vulnerability of company X caused by the small size of its customer base is the focus of this research. This vulnerability is described and possible solutions to this problem are reviewed by doing research on how company X can lower its dependency on one or a few customers in order to be less vulnerable to changes in its customer base.

To find out how company X can lower the dependency on its customers, a few sub-questions need to be answered:

1. Which growth strategies can be applied in order to attract new customers? 2. Which new product markets can be addressed in order to attract new

customers?

3. How attractive and feasible are these new product markets for company X?

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1. Theoretical background

This chapter gives an overview of the relevant theoretical insights concerning the dependency problem of company X and possible solutions. The first section explains the importance of a customer base and the consequences of the dependency problem of company X. Section two concentrates on the process of attracting new customers and how business-to-business marketing fits in this process. Section three continues with an explanation on customer retention. In section four attention is given to customer portfolio theory and how a customer portfolio can help to decide what new customers must be attracted. How to attract these new customers is explained in section five which gives an overview of the different growth strategies. More in-depth information about the diversification strategy is given in section six. Section seven explains the importance of an external analysis to be able to choose an attractive market in which new customers need to be attracted. Section eight shows how the fit between the potential growth strategy and the internal situation of company X can be analysed. The chapter is completed with section nine which summarises the chapter and explains what the focus of the continuing chapters in this research is.

1.1 Small businesses dependency

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By having more customers in different market segments, a firm can protect itself to variations in the overall economic situation due to the fact that the different market segments will differ in their sensitivity to the economic situation. Firms therefore should set up a so called customer portfolio, “consisting of a number of segments which differ not only by socio-demographic-, attitudinal characteristics and customer needs, but also by profitability and risk” (Ryals, 2001, p. 219). Setting up a customer portfolio is only possible by attracting and retaining different customers. How small businesses should do this will be discussed in the next sections.

1.2 Attracting customers

To lower the dependency on the existing customer(s), new and different customers need to be attracted by the company. Knowledge on the stages in which buyer-seller relationships develop, can help businesses in attracting and maintaining new customers. Stages in the development of the buyer-seller relationships are:

1. Awareness, refers to the recognition from consumers that a business is a feasible exchange partner. Consumers will be more aware of local businesses or businesses that advertise frequently. It is very important for the business to create brand/company awareness with potential customers. In the awareness phase no interaction between the consumer and the business takes place.

2. Exploration, refers to the search and trial phase. Consumers consider the costs, benefits and possibilities of exchange with the business. Trial purchases can take place. In this phase the business needs to show the costumer the excellence of its products, that it is able to fulfil consumers wishes and that the business is trustworthy. The integrity and performance of the business is tested in this phase. By fulfilling the exchange obligations, the company’s attractiveness is strengthened. Consumer’s motivation to enhance the relationship will then increase, as the number of alternatives of other businesses is reduced by the good performance of the current business.

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4. Commitment, refers to an implicit or explicit continuity in the exchange relationship between the customer and business. Customer loyalty is achieved because in this phase customers will not constantly assess alternatives.

5. Dissolution, refers to the possibility that the customer will withdraw from the relationship it has with the company. This possibility is present during the whole development of the buyer-seller relationship (Dwyer et al., 1987).

Since company X sells its products to other businesses instead of end use consumers, it is important to know how business-to-business marketing practices can help the company in attracting new customers. The importance of understanding and implementing these practices is underlined by the fact that transactions in business markets generally concern large lot sizes.

Business-to-business marketing

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Establishing a long-term relationship reduces transaction costs since these relationships reduce search costs and risks in transactions (Blythe & Zimmerman, 2005).

To be effective in attracting business buyers it is helpful to keep in mind that business buyers always buy to increase their profits by boosting sales or lowering costs. Business buyers are more rational, less emotional and more risk averse than end consumers. Business-to-business marketing programs should therefore focus on the aspects of increasing sales and reducing costs (Blythe & Zimmerman, 2005). In approaching potential business buyers it is important to focus on how the business can help the business buyer to save time or control costs. Therefore emphasis should be on how the business buyer can be helped in stead of selling the features of a product or service (Lawin, 2004).

1.3 Customer retention

Beside attracting new customers, an increase in customer retention can also help lowering the dependency on one or a few customers (Ryals & Knox, 2005). Customer retention “aims at repeat-purchase behaviour” (Hennig-Thurau & Klee, 1997, p.741). Research has shown that a five percentage point shift in customer retention results on average in 25-100% profit swings. The effects of customer retention on the profitability of a firm run through repeat sales, a shrink in costs for acquiring new customers to replace the old ones and a higher employee retention due to job pride and satisfaction (Reichheld et al., 2000). Apart from that, “relative customer retention explains profits better than market share, scale, cost position or any of the variables usually associated with competitive advantage” (Reichheld et al., 2000, p. 135).

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commitment and calculative commitment (Gustafsson., 2005). Affective commitment is the “positive regard for and attachment to the other party” which results is a loyalty among customers (Gounaris, 2005, p. 128). Contrary, calculative commitment results from the anticipation of switching costs if the relationship is terminated and is therefore based on cost-benefit analysis (Gounaris, 2005). In explaining customer retention it is not sufficient to study satisfaction only since this is a backward looking dimension. Commitment dimensions are forward looking and therefore affect customer retention (Gustafsson et al., 2005). By stimulating a business-customer relationship that entails trust and reciprocity and by taking care of customers, businesses can contribute to affective commitment of customers. Calculative commitment can be built by tying economic consequences to ending the relationship. These economic consequences can be realized if it pays off economically to be a customer of the company, when the company has location advantages or when customers have costs when the relationship ends (Gustafsson et al., 2005). By a combination of attracting new customers and creating customer commitment, the dependency of the company on its customers will decrease.

1.4 Customer portfolio

Irrespective of the method, by attracting and retaining customers, small businesses can build up a customer portfolio. Setting up a customer portfolio helps businesses to target the right potential customers. Diversity in the customer base will benefit the business by reduced uncertainty, managed dependence and more exchange efficiency (Dwyer et al., 1987). Building a customer portfolio not only enables the business to spread risk, it helps to increase returns on the firm’s customer relationships because the number of customers has influence on aspects like cost structures and economies of scale. A diverse set of customers may, for example, contribute to absorbing excess capacity or overhead costs (Mark et al., 2007).

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management of diversity and heterogeneity” (Terho, 2008, p. 43). By establishing a customer portfolio, businesses can differentiate between customers on “the basis of how value is created. Businesses can then link value creation within individual relationships to overall value creation for the business” (Johnson & Selnes, 2004, p.1). By differentiating among customers, businesses can get a clear overview of the profitability of customers and their different roles to the business.

The ability to differentiate among customers enables the business to develop and terminate the right customer relationships and to create additional customer value. This customer value is seen from the perspective of the focal business and is based on the economic, strategic and behavioural value that stems from the relationship between the focal firm and the customer (Terho, 2008). The use of a customer portfolio is especially suitable for business-to-business markets where firms are highly dependent on a small number of customers (Rajagopal & Sanchez, 2004). For these vulnerable businesses, low-value customers may be of strategic importance for growth, continuity and spreading risk. Therefore it might be essential to include low value customers into the portfolio, for purposes of business growth and lowering dependency on other customers (Johnson & Selnes, 2004). Using a customer portfolio is thus not aimed at maximizing the profits from individual customers but it focuses on “the role of different customers in providing long-term value to the business” (Terho, 2008, p. 49) Using the customer portfolio approach helps the business in targeting the right customer group.

Customer dimensions

Targeting suitable new customer groups with the use of a customer portfolio is done by differentiating potential customers along several dimensions (Terho, 2008):

The customer’s direct and indirect value potential for the business.

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market function that allows the firm to gain access to new markets and new customers, the scout function that gives the firm the possibility to gain critical information through customers and finally the access function that allows access to third parties. These direct and indirect value creating functions explain a large part of customer value to the business (Walter et al., 2001).

Customer relationship variables.

Relationship variables do not directly reflect customer value but show the state and nature of the relationship. Indirectly these relational aspects do influence customer value since these variables are connected to the risk and continuity of relationships and therefore affect the future value of the customer. Example variables by which customer relationships can be differentiated are the length of the relationship, co-operation in the relationship, goal similarity of parties, trust and commitment (Terho, 2008).

Power related variables.

Power in customer relations influences the dependency of the business. If the relative share of a customer in the customer portfolio of the business is large, than this customer has high buyer power and the business is in a vulnerable position (Terho, 2008). Therefore it is important for businesses to include other customer relationships into their customer portfolios (Johnson & Selnes, 2004).

Buying behaviour variables.

Also buyer-behaviour variables are important for segmenting customers. Examples of these variables are customer requirements, price sensitivity, payment problems, predictability and volatility (Terho, 2008).

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12 1.5 Strategies for attracting new customers

For company X to be able to set up a customer portfolio, first new customers need to be attracted. In order to do so, different growth strategies can be applied. These different strategies are showed in the generic model of figure one. The growth strategies are formed around two dimensions; markets and products (Aaker & McLoughlin, 2007).

Fig 1: Alternative growth strategies (from Aaker & McLoughlin, 2007, p. 258)

Growth in existing product markets

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13 Product development

By using the product development strategy, new customers are attracted with new products in the existing market. Product development entails a continuum that varies from the addition of new features to existing products to the development of complete new products (Alsem, 2001). Development of new products occurs only over a long time span since this process is formed by several stages, ranging from idea generation to market introduction. Therefore, the product development strategy is a costly and long-term possibility for attracting new customers. The production of new products might also need other capabilities and resources from the business than currently present (Biemans, 2004). For this option to be effective, companies need to consider whether they have the needed competencies and resources for adding the new product to the product line of the company (Aaker & McLoughlin, 2007). An advantage of the product development strategy is that market and customer characteristics are known and that extensive market research is less needed in the process of product development (Biemans, 2004).

Market development

The market development strategy can be used to attract new customers in new markets by offering existing products. This strategy is applied by offering products to new target groups, other geographical markets or institutional markets. To get the products of the business under attention of potential customers in the new market, an effective promotion campaign is needed (Yspeert, 2009). The possibility to attract new customers is only suited if the company sees opportunities in other markets and if the company is able to introduce its products in these new markets. Market expansion however requires the same expertise and knowledge of the product and is therefore easy to apply. On the other hand, the market development strategy can only be applied if the business is already operating successfully since “there is no point in exporting failure or mediocrity” (Aaker & McLoughlin, 2007, p. 267). Before applying the market development strategy, companies need to evaluate the attractiveness of the new potential market and the needed and existing resources for entering this market.

Diversification

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changes in its administrative structure, production systems and management processes (Ramanujan & Varadarajan, 1989, p. 525). With diversification as a growth strategy, the company will meet more needs of different consumers, thereby attracting new consumer segments (Ansoff, 1957). By choosing to diversify, firms are actually modifying their business definitions to better satisfy the performance objectives of the firm. Since satisfying customer groups is a core objective of firms, the new product lines that will be introduced by diversifying will involve modifications in the customer groups the companies will target (Ramanujan & Varadarajan, 1989). Diversification is a high risk growth strategy since operating unfamiliar business in new contexts involves a higher risk compared to the other growth strategies (Aaker & McLoughlin, 2007). Not only new customers are attracted by diversifying, but the company also needs to deal with new competitors, suppliers and regulations. Despite these facts, this research will continue with a focus on the diversification strategy since company X has no possibilities to expand in the Dutch and/or foreign bicycle industry. The present market and product offer no opportunities to expand, which makes the diversification the only strategy suitable to apply by company X.

1.6 Diversification as a growth strategy

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15 Mode of diversification

Differentiation can be accomplished in several ways, which range on a continuum from internal business development to acquisitions and mergers. Other ways in which firms can enter new lines of activity fall in between these extremes and are for example licensing, joint ventures and strategic alliances (Ramanujan & Varadarajan, 1989). Research of Song (1982) shows that only seldom a company follows a single strategy to diversify. Often internal- and external diversification are combined.

Internal diversification: Business development

If there is great relatedness between the business that wishes to diversify and the new activity or product it wants to introduce, than internal development is preferred over external diversification (Yip, 1982). With internal development the business makes use of its internal strengths and it avoids transaction costs (Vandendriessche, 2006). Internal diversification is “the branching out from existing dominant areas of knowledge and key competences, and the application of these to the marketing of new and improved products or services” (Camelo-Ordaz et al., 2004, p.77). It is the internal “development of the resources needed to penetrate the new field” (Pitts, 1977, p.127). Internal diversification can be seen as an organizational learning process (Kazanjian & Drazin, 1987). The capability to diversify builds on the construction and accumulation of new knowledge and alternative use of existing resources (Camelo-Ordaz et al., 2004, p.77). Internal development activities are for example product line extension, -refinement, -repositioning and the introduction of new products that can be related or unrelated to the firm’s core business. Internal diversification can result in a more efficient use of internal resources, but achieving this long-term advantage is only possible over a long time span (Vandendriessche, 2006).

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a higher level of diversification more strain is placed on management, and control- and coordination costs rise. The marginal costs of diversification are therefore high at high levels of diversification. This results in the notion that there is an optimal level of diversification which is shown in an inverted-U relationship between the level of diversification and firm performance. Diversification has a positive effect on performance when the business diversifies across low to moderate ranges of diversification and a negative effect across the moderate to high range of diversification. Besides, unrelated diversification or very high levels of diversification are most of the times realized by acquisition and not by internal development (Kazanjian & Drazin, 1987).

External diversification: Alliances and acquisitions

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The different forms of external diversification do not automatically succeed in delivering positive performance benefits. Both with alliances and acquisitions, resources of different businesses are bundled in a portfolio which determines the upper bound of the firm’s value creating potential. This potential increases if the bundled resources are complementary to each other. By bringing in non-redundant distinctive resources, either by forming alliances or by acquisitions, the business can benefit from resources it otherwise would not have (Das, 2000). Complementary resources are however not enough to create synergies since there is a difference in the potential value and the realized value of a resource portfolio. It is the development, accumulation and usage of resources that determines the actual value of the resources. These so called resource combination capabilities are needed to combine resources to set up novel ways to create value. Experience in resource combination activities is important here since it is the “predominant explanatory variable for capability development” (Heimeriks & Duysters, 2006, p. 28). The impact of experience in resource combining activities is however mediated by the presence of learning mechanisms. These mechanisms accelerate the development of routines within the alliance or new integrated business and disseminate knowledge and experiences. The developed routines bring in and integrate the resources (Wiklund & Shepherd, 2009) and help management to cope with problems by forming standardized solutions. Learning mechanisms are represented by functions such as alliance managers, tools such as training and a partner selection program, control and management processes such as rewards/bonuses and external parties such as advisors and lawyers. Both the presence of experience and learning mechanisms enables the alliance or newly integrated firm to better understand critical issues in alliance or acquisition management. With more experience, more appropriate partners or targets will be selected and the alliance or newly integrated business will be managed more effectively (Heimeriks & Duysters, 2006).

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interpersonal issues must be developed to avoid the substantial costs that will arise if intensive coordination and monitoring is needed to make sure the alliance works properly.

An effective integration of the partner’s or the target’s resources, social- and human capital into the alliance or newly integrated business is achieved by the construction of contracts and the presence of mutual understanding and trust. It is not only the bundling of resources which is needed to succeed, but also the coordination of activities and the integration of social and human capital of the partner or target firms are needed for external diversification to work successfully (Wiklund & Shepherd, 2009). The development of an alliance or an acquisition is more easy in case of domestic alliances or take-overs, where the cultural difference among partner or target businesses is likely to be smaller. This can further be explained by the fact that more cultural distance will decrease the ability to absorb new knowledge (Wiklund & Shepherd, 2009). External diversification thus has a high potential if the resources which are bundled are complementary, if learning mechanisms are present and if social and human capital is integrated.

So far, different strategies for attracting new customers are discussed. However, to be sure that the diversification strategy with its accompanying new market is suitable to company X, an external market analysis and internal company analysis are needed. These are discussed in the next section.

1.7 External analysis

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company X can estimate how much of this economic value is retained by the different players in the market and thereby how much economic value company X can approximately retain if it enters the new market (Porter, 2008).

Fig. 2: Porter’s five competitive forces (from Porter, 2008, p. 80)

The attractiveness of the market is analysed by using Porter’s five competitive forces that shape the market:

Rivalry among established competitors.

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Bargaining power of customers.

Customers with high bargaining power are able to force down prices at the expense of the profitability of the businesses from which they buy. Prices can be forced down by costumers by playing businesses off against each other or by demanding more quality and service which drives up costs. The customers’ bargaining power is higher if there are only a few consumers in the market who demand large volume purchases. If the products offered are standardized and expensive relative to the incomes of the constumers, high price sensitivity will lead to higher bargaining power of the consumers. The sources of buyer power are present for both customers and business-to-business customers (Porter, 2008). In both cases prices can be driven down since customers can easily switch to other businesses which offer the same products. This results in reduced profitability for the businesses in this market. The higher the bargaining power of customers, the less attractive the market is for company X to enter.

Bargaining power of suppliers.

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Threat of new entrants.

Potential entrants are seen as a threat since they will put pressure on prices and costs of the established rivals. The higher the threat of entry is, the lower the established rivals must keep their prices. By setting prices too high, an opportunity is created for the potential entrant to enter the market with lower prices, thereby capturing consumers from the established rivals. Therefore it is actually the threat of entry which holds down profitability for the established rivals and not so much the entry itself. The extent of the threat of entry depends particularly on the entry barriers that are present. These entry barriers are the “advantages that incumbents have relative to new entrants” (Porter, 2008, p. 81). Examples of these entry barriers are the presence of scale economies, access to distribution channels and capital (Porter, 2008). The more the established rivals can take advantage of these entry barriers, the more difficult and less attractive it is for company X to enter these markets.

Threat of substitute products.

The higher the presence of products that perform the same function as the products offered in the market, the higher the threat is of these so called substitutes. The presence of substitute products has a negative impact on the profitability in the market, since the substitutes place a ceiling price on the products. If prices are above the ceiling price, consumers will switch to substitute markets, thereby negatively influencing the profitability of the focal market. The threat of substitutes is higher if the substitute products offer a more attractive price-performance ratio than the product offered in the original market. This threat is also stronger if switching costs are low (Porter, 2008). Therefore a product market, for which a lot of substitutes are present, is less attractive for company X to enter.

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22 1.8 Internal analysis

Beside the external analysis, an internal analysis is needed to determine whether the new market and new product accompanying the diversification strategy fit with the internal situation of the firm. By applying an internal analysis, it can be concluded whether applying the diversification strategy and its accompanying production of new products strengthens the competitive advantage of the firm. For the internal analysis, insights from the following three theories are relevant: the resource based view (Wernerfelt, 1984; Barney, 2001), the theory on strategy analysis by Rangone (1999) and the theory on dynamic capabilities of Teece et al. (2000).

Resource-based view

The resource-based view explains differences among company performance by studying the resources that are possessed by businesses. Contrary to traditional economics, the resource-based view focuses on a broad set of resources which are possessed by a business. Not only labour, land and capital are important resources, but “a resource is anything which could be thought of as a strength or weakness of a given firm” (Wernerfelt, 1984, p. 172).

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Since not all resources in a business are strategic resources, it is important to know how to recognize the strategic resources on which the firm relies for its sustainable competitive advantage. To recognize strategic resources in a business, all resources present in the company can be screened with the help of five tests (Zack, 1999; Rangone, 1999):

Competitive superiority.

→ Does the resource contribute to differentiating the business from its

competitors?

→ Is it a distinctive resource? Imitability.

→ How difficult is it for competitors to imitate the resource? Duration.

→ Are the resource’s benefits also generated in the long term? → How quickly does the resource depreciate?

Appropriability.

→ Is the business able to exploit the generated benefits? → Who captures the value created by the resource? Sustainability.

→ How difficult is it to replace the resource with an alternative one that

generates the same benefits?

Resources that are tested to be superior, difficult to imitate, durable, sustainable and able to appropriate value are strategic resources which can deliver a sustainable competitive advantage to the owning company. If the diversification strategy of the company is based on its strategic resources, the strategy has the highest chance of being successful, because strategic resources may contribute to the sustainable competitive advantage of the firm (Clulow et al., 2003).

Strategy analysis: resource-based approach

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intent and its endowment of strategic resources” (Rangone, 1999, p. 240). In his article, Rangone (1999) develops an approach based on the resource-based view, by which small businesses can analyse the strategies they wish to implement. The first three steps of Rangone’s strategy are described here. These steps can be used to see whether the strategy chosen by a firm fits or is consistent with the strategic intent and the resource endowments of the firm.

Applying steps one to three of Rangone’s strategy analysis is helpful in deciding whether the diversification strategy and the accompanying product is suitable to company X. The steps in Rangone’s strategy analysis are:

1. Define the strategic intent, basic capabilities and key performances.

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2. Identify resources influencing key performances.

In the second step of Rangone’s strategy analysis, “resources that can influence key performances have to be identified. This needs to be done analysing all major activities acting on each key performance, so that the resources necessary to carry out these activities can be determined” (Rangone, 1999, p. 238). The identification of the resources currently present in the company, helps to define whether the new products can easily be produced by company X or whether new resources need to be acquired. 3. Assess the strategic value of resources.

By assessing the strategic value of the resources of the company which are used in the production of the new product, the ability of the resources to create and sustain long term competitive advantage is tested. This test is done by using the strategic value tests on the competitive superiority, imitability, duration, appropriability and sustainability as described previously (Rangone, 1999). This analysis is needed, because possible diversifying products for company X have higher potential if based on the strategic resources of company X (Palich et al., 2000). The value creating potential of the new product is higher if based on strategic resources, since competition will than not erode the competitive advantage that can be achieved by producing the new product (Clulow et al., 2003).

Figure three represents the model as developed by Rangone, which shows how all concepts used in the strategy analysis are related to each other. According to Rangone, the competitive advantage of the company is depending on the resources the company possesses and their fit with the strategic intent of the company.

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Unfortunately, due to a lack of clarity in Rangone’s theory, the model and the accompanying strategy analysis can not easily be applied for analysing the suitability of the diversification strategy to company X. Rangone is not clear about the way in which the used concepts are related to each other and how they can be defined. In step one of his strategy analysis, Rangone uses the concepts of basic capabilities and key performances to define the strategic intent of the firm. He states that defining the strategic intent of the company “implies two levels of choices; a definition of the basic capabilities on which the firm will rely and a definition of the key performances to achieve” (Rangone, 1999, p. 238). In this step Rangone only partly explains how to derive the key performances and he does not explain how the basic capabilities of the company can be derived. Both concepts are used in his model, but it does not show where these concepts stem from, how they are developed and by what factors they are influenced. By discussing that “key performances to achieve” can be derived by studying the industry’s key success factors, Rangone gives the impression that the key performances are externally determined by the market (Rangone, 1999, p. 238). Contrary, Rangone also discusses the “company’s key performances” as if they are internal to the firm (Rangone, 1999, p. 236). Apart from this, the model shows a relation between the company’s strategic resources, basic capabilities and sustainable competitive advantage which is mediated by key performances. Rangone does not explain this link nor its direction, he only states that “it is necessary to consider the company’s key performances to make the links between basic capabilities and critical resources operational” (Rangone, 1999, p. 236). Why the key performances need to be considered here is not explained. The lack of explanation about the concepts and the links between these concepts in Rangone’s model makes it necessary to use some logical reasoning to make the model more clear and better applicable to test potential strategies for company X.

By logically reasoning the following explanation of Rangone’s model can be given:

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Contrary, basic capabilities of the company can internally be derived by studying the strategic intent of the company. Here it is established how the company wants to realize its vision and how it exploits and develops its resources. The basic capabilities of the company can therefore be derived by studying whether the company’s resources are especially used for innovation, production and/or market management.

The next step involves the assessment of a fit between the basic capabilities and the key performances of the potential market. This concerns the identification of those capabilities required to produce the key performances. These capabilities are called the key capabilities.

Only if key capabilities of the company result from the deployment of strategic resources, a sustainable competitive advantage can be created by the company

Even by interpreting Rangone’s model, as described at the previous page, Rangone’s strategy analysis can not be used for assessing the diversification strategy of company X and its accompanying product. Authors such as Teece et al. (2000) and Eisenhardt & Martin (2000), argue that performing the steps of Rangone’s strategy analysis is not enough to conclude whether a strategy can successfully be implemented. These authors argue that the strategy analysis should not only be based on the resource-based view and its focus on strategic resources. They criticise the resource-based view as it “misidentifies the locus of sustainable competitive advantage in dynamic markets” (Eisenhardt & Martin, 2000). The criticism is that the resource-based view is a static theory which can not explain how firms achieve a sustainable competitive advantage in dynamic markets that show rapid and unpredictable changes (Menon, 2008). They argue that competitive advantage is not created by the presence of single strategic resources, but that it is the bundling of these resources which is most important for achieving competitive advantage (Wu, 2005).

Dynamic capabilities

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the company which form the sources of a sustainable competitive advantage by utilising the resources effectively and in congruence with the dynamic business environment (Menon, 2008).

Dynamic capabilities are the “organizational and strategic routines by which firms achieve new resource combinations” needed to match or even create market change (Eisenhardt & Martin, 2000). The core processes, which shape the dynamic capabilities present in a company, are learning and reconfiguration and coordination/integration of resources (Menon, 2008). Organisational learning involves knowledge brokering and the abilities to brainstorm, experiment and come up with solutions to company problems. Reconfiguration is the innovatively redeployment of resources into new combinations, thereby enhancing innovation. Coordination and integration take care of knowledge sharing in the company and capturing synergies among tasks and resources. The more the dynamic capabilities, shaped by these processes, are unique, tacit and difficult to imitate, the higher their contribution to the competitive advantage of the business which possesses these capabilities. It is therefore the presence of the unique dynamic capabilities that are developed internally, which explains the distinctiveness of businesses. The higher the strategic value of the capabilities present in the business, the more they contribute to the sustainability of the competitive advantage of the business. Here, the strategic value of the capabilities can, just as the resources, be tested by applying the five tests on strategic value of Rangone (1999).

Strategy analysis: dynamic capabilities approach

The dynamic capabilities approach can be used as a complement to Rangone’s strategy analysis in the process of analysing whether the new chosen diversification strategy of company X is suitable. Adding the theoretical insights of the dynamic capabilities approach is important here, since company X operates in a dynamic and innovative market. The fit between the newly chosen strategy and the current internal company situation could therefore be analysed by applying a strategy analysis which integrates the theoretical insights of the resource-based view and the dynamic capabilities approach. Besides considering the strategic intent and resource endowments of the firm also the dynamic capabilities of the firm must be analysed. This results in the following strategy analysis:

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3. Assess whether there is a fit between the key performances of the potential market and basic capabilities of the company.

4. Assess which resources and capabilities are needed for the key capabilities that fit the key performances of the potential market.

5. Assess the strategic value of these resources and capabilities.

If the newly chosen strategy fits within the strategic intent of the company and is based on its strategic resources and/or strategic capabilities, the company should continue and apply it.

1.9 Chapter summary

This chapter has underlined the importance of customer relationships to businesses such as company X. Not only do these customer relationships provide work and income for the business, they also influence the position of the business relative to its competitors and suppliers. Currently, company X has positioned itself in a very vulnerable situation, by relying too much on one customer. This customer provides almost 50% of the total turnover and with this high share it would be disastrous if this customer aborts the relationship with company X. The dependency problem where company X currently is confronted with, is a typical phenomenon in the small business sector where four out of ten businesses are too dependent on one or a few customers (van den Berg, 2009). In this research is studied how this dependency problem can be solved, by using company X as a case firm.

To solve its dependency problem, company X must attract new customers thereby lowering its dependency on the existing large customer. Attracting new customers is, however, easy said but not easily done. Before new customers are actually attracted, the company first needs to determine which growth strategy to apply. Depending on the market in which the company operates and on the products it offers, one of the four alternative growth strategies, as discussed in section 1.5, should be applied to attract new customers (Aaker & McLoughlin, 2007). Since there are no possibilities for company X to expand in the existing market or to offer its existing product in new markets, the company must focus on new markets and new products, thereby applying the diversification strategy.

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new products it would like to operate. This decision can only be made after an external and internal analysis are applied. In the external analysis the attractiveness of potential markets is assessed (Porter, 2008). A market is more attractive if company X can retain a relatively high share of the created profits in that market. Besides analysing the attractiveness of the market, it is also important to apply an internal analysis. Here the fit between the strategic intent of the company, its endowment of resources and capabilities, and the diversification strategy it wants to apply, is estimated. Conducting the internal analysis results in concluding whether applying the diversification strategy strengthens the competitive advantage of the firm. The better the fit between the strategic intent and the chosen diversification strategy, the more potential this strategy has. If the resources and capabilities, already present in the company, match with the needed ones for applying the new strategy, than it will be less difficult for the company to successfully apply it. If based on strategic capabilities and resources, the strategy contributes to the sustainable competitive advantage of the company.

Only after the growth strategy and its accompanying markets and products are analysed, new customers can be attracted. The clear distinction between the phases, in which a growth strategy and its accompanying products and markets, is analysed and chosen and the phase of actually attracting new customer is shown in figure four.

Figure 4: The process of solving the ‘dependency problem’ of company X

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After establishing that the company is too dependent on its customers (phase 1) and applying the external and internal analysis (phase 2) on company X’s diversification strategy, new customers can actually be attracted (phase 3).

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2. Methodology

This chapter explains the phases of the conceptual model, developed in chapter one and showed in figure four. An overview of the phases which need to be run through, to solve the dependency problem of company X is given here. Execution of these phases are necessary to form a sound business advice for company X, which shows in what markets and with what products the company should attract new customers.

Phase 1: Measuring dependency

To start, it is important that the small business owner of company X is aware of how dependent the company is on its existing customers. There are several dimensions along which dependency on customers can be measured, but the most applicable one is the share of total turnover that a customer brings in (Berg van den, 2009). The larger this share is, the more dependent the company is and the more disastrous it is to loose this customer. For an accurate measure of dependency on customers, not only current transactions must be considered but also possible future transactions (Rust et al., 2001). This will result in a dependency measure, which shows the current volatility of the company. Depending on the relative size of this measure, the small business owner needs to decide whether it is necessary to attract more customers or that retaining the current customer base is sufficient. Applying phase one of the conceptual model in figure four to company X, shows as previously told, a high dependency on one customer. This customer provides approximately 50% of total turnover. This percentage makes the dependency problem of company X quite evident. This research will therefore especially focus on phase two, in which a solution to the dependency problem needs to be chosen.

Phase 2: External and internal analysis

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Growth in existing product markets.

For company X, this growth strategy is not applicable since the possibilities for attracting new customers in the Dutch bicycle market are limited. There are only a few businesses in the Dutch bicycle industry and already a large part, including one of the main players in this industry, is already customer of company X.

Product development.

This growth strategy is not suitable for company X, since this strategy also focuses on the existing market. As previously mentioned, the possibilities for attracting new customers in this market are limited.

Market development.

Applying the market development strategy is also not effective for company X since its existing product (applications on bicycles) is too specific to offer in other markets. Beside the bicycle market this product can not be offered in other markets. Apart from that, the product is already offered in foreign markets by company X, but here are also not much possibilities to attract new customers. The company experiences that in foreign markets, companies prefer to do business with other domestic companies instead of foreign company X.

Diversification.

Attracting new customers by diversification is the best growth strategy to apply for company X since focusing on existing markets or offering existing products in new markets will probably not result in new customers. This is due to the specific market in which the company currently operates and the specialist product it offers. Therefore, this research will continue by focusing on diversification as a solution to the dependency problem of company X.

For applying the diversification strategy, company X needs to think about what new products to develop and what new markets to target. By pursuing an external analysis, potential new product markets are analysed on their attractiveness and their suitability for company X to attract new customers in.

External analysis

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printing industry are appointed by the owner-manager of company X and by a database of members of the Dutch organisation for screen and sign printers (Branchevereniging van zeefdruk en signondernemingen, 2009). This results in 131 Dutch screen printing companies being analyzed by the products they offer. The analysis is done by studying the companies’ websites and results in an overview on what products are offered by these companies. Products which are currently not offered by company X might offer the company a possibility by which it can diversify.

Focus is on related products since, as mentioned earlier, related diversification has more chance of being successful (Palich et al., 2000). Related diversification has more chance of being successful since it involves some kind of strategic fit. The strategic fit which underlies the success of related diversification can be found in shared technology, common labour skills, similar operating methods, common suppliers and/or similar kinds of management know-how (Irwin, 1995). Relatedness of products will in this case be measured by analysing the technology, operating methods and knowledge needed to produce the products. If they are similar to the present screening techniques of company X with regard to the machines and knowledge they require, there is a high degree of relatedness.

Since the business owner of company X is most familiar with the company’s technologies, operating methods and embedded knowledge, he will judge which of the listed products are most related. The more similar the technologies, operating methods and knowledge are, the more related the product is and the more suitable the product might be for company X to diversify with. The similarity degree will also be determined by the business owner of company X.

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The external analysis will continue with a brief market analysis of the markets in which the chosen products are offered. This analysis focuses on the established rivals in the market, which is one of Porters competitive forces, used to analyse the market (Porter, 2000). Focus is on this competitive factor, because there is a lack of information about the presence of buyers, suppliers, substitute products and entry barriers in these markets. Unfortunately, no official records about the screen printing industry are present, which results in a very limited amount of information about the industry and the companies competing in it. Despite the lack of information a small overview of the Dutch competitors in the potential markets is given and these companies are analysed by their size, location and substitutability. Data on these subjects is found on the websites of the companies, is collected from the Dutch organization for screen and sign printers and gathered from the Dutch Chamber of Commerce (Kamer van Koophandel, 2009). This external analysis contributes in making the decision whether it is possible for company X to enter the new selected markets. If this possibility is too low because the potential for capturing economic value in this industry is low, the products chosen are not, or to a lesser extent, suitable for applying the diversification strategy.

After the choice of related products and the analysis of these product markets, an internal analysis of company X follows. This analysis makes clear, whether the production of the chosen products strengthens the competitive advantage of company X. By applying the internal analysis it becomes clear whether the new products fit within the strategic intent of the company and whether the needed resources and capabilities to produce the new product are present. Further, it will be analysed if the production of the new product is based on strategic resources and capabilities and is thus contributing to a sustainable competitive advantage of the company.

Internal analysis

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1. Define the strategic intent and basic capabilities of the company.

→ What are the current basic capabilities of the company?

2. Identify the key performances for the potential market.

→ What are the key performances of the potential market in which company X might

enter?

3. Assess whether there is a fit between the key performances of the potential market and basic capabilities of the company.

→ Do the basic capabilities of company X match with the key performances of the potential market?

4. Assess which resources and capabilities are needed for the key capabilities that fit the key performances of the potential market.

→ What resources and capabilities are needed for the key capabilities that fit the key

performances of the potential market?

5. Assess the strategic value of these resources and capabilities.

→ Do the key capabilities of the company result from the deployment of strategic

resources and capabilities?

If there is a fit between the new strategy and the strategic intent of company X and if operating in the new market is based on its strategic resources and/or capabilities, the product is suitable for the company to produce and strengthens the sustainable competitive advantage of the company.

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Fig. 5 External and internal analysis for a diversification strategy (phase 2)

1. External Analysis

Analysis of products offered in the screen printing industry.

Owner manager chooses potential products based on: - Relatedness.

- Possibilities to innovate with.

Analysis of the new markets.

Attractive market: Not attractive:

2. Internal Analysis

Define strategic intent of the company.

- What are the company’s key capabilities?

Identify the key performances of the potential market.

Analysis of fit between the key performances of the potential market and the basic capabilities of the company.

Fit: No fit:

Assess which resources and capabilities are needed for the key capabilities that fit the key performances of the potential market.

Assess the strategic value of these resources and capabilities. Strategic value present: No strategic value:

Apply strategy:

- Target new market

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3. External analysis

This chapter analyses potential products by which company X can diversify. First, the potential products need to be selected by the owner manager of the company. This is done by analysing the products that are offered in the Dutch screen printing industry. From this list of products, the owner manager selects the products in which he finds opportunities to develop and innovate. Only the products that are related to the technology, operating methods and knowledge currently present in company X will be selected. The resulting product markets will be analysed to conclude whether these markets are suitable to enter for company X.

3.1 Products offered in the Dutch screen printing industry

By screening the websites of 131 Dutch screen printing companies, appointed in previous chapter, it is possible to give a short overview of the product groups that are produced in this industry. In table one, an overview is given of these product groups and the amount of screen printing companies that produce these products.

Product # of

companies

Product # of companies

Air valve caps 2 Hubcaps 4

Bags 20 Inflatable products 4

Banners 18 Key cords 8

Beer mats 6 Mailboxes 1

Bicycle transfers 5 Memo blocks 2

Boards 63 Mirrors 7

Bottles 3 Mouse pads 10

Bracelets 2 Mug holders 1

Brochure holders 19 Number plates 5

Buttons 2 Paperclips 2

Candles 1 Parasols 4

Canopies 7 Posters 28

Credit cards 14 Safety clothes 11

City maps 8 Scratch lottery tickets 2

Clock faces 7 Shop decorations 31

Crates 2 Detectiongate sleeves 2

Crockery 6 Stickers 53

Cycling clothes 5 Table-mats 8

Displays 31 Tarpaulins 12

Door handles 3 Textile 43

DVD/CD’s 9 Tiles 9

Flags 23 Toys 3

Flagpoles 7 Transfer tattoos 3

Floor decorations 12 Umbrellas 14

Folders 15 Vehicle decorations 40

House front advertisements 28 Window decorations 32

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As can be derived from table one, the most dominant product groups that are offered in the market of screen printing companies are all kinds of screen printed boards, stickers, textile and vehicle decorations.

3.2 Diversification possibilities for company X

When looking for products by which company X can diversify it is important to search for products that are related to the techniques, operating methods and knowledge that are currently present within company X (Palich et al., 2000). By doing so, the selected products will be easy to produce without the company having to buy much new machines or the gain a lot of new knowledge. Relatedness will here be measured by comparing the technology, operating methods and knowledge currently present in the company and the ones needed to produce the potential new product. Besides relatedness, the market for the products also needs to be considered. Product markets which are crowded by strong competitors will offer less possibilities since intense competition will make it harder for company X to enter these markets profitably (Shy, 1996; Porter, 2008).

For an analysis of the relatedness of potential diversifying products, the owner manager is asked to identify the products in table one which can be produced by company X, considering the current present technologies, machines and knowledge together with the possibilities for the firm to innovate with these products. The owner manager of company X concludes that posters, stickers and transfer tattoos are the only products that are related to the current technology, production methods and knowledge of company X. Only these products can be produced in a short time span, because all needed machines, production methods and knowledge are already present in the company. The next market analysis will only focus on stickers and transfer tattoos as opportunities to diversify with, since posters have been produced by the company in the past without much positive influence on the company’s performance. This was due to the fact that the production of poster involved a profit margin which was too small.

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owner of company X is however convinced of the potential of developing these products to higher standards and new user applications, attracting more customers and enlarging the share of total turnover of these products. In the next section the Dutch sticker- and transfer tattoo markets are analysed to conclude whether it is possible for company X to expand the production of these products and to develop the products to higher standards in order to attract new customers. Focus in this market analysis is on the established industry rivals. Due to a lack of information, the other four competitive forces as described by Porter (2008) that also have influence on the attractiveness of the market, are not considered.

3.3 Analysis of the new markets

The analysis of the Dutch markets for transfer tattoos and stickers is done by studying the established rivals or the potential competitors of company X in these markets. By doing so, an overview is given of what kind of transfer tattoos and stickers these established rivals produce. This shows on what specific markets the established rivals focus. The competitors or established rivals themselves are analysed by studying their size by the dimensions of number of employees and other products they produce. These data are extracted from the companies’ websites and data from the Dutch Chamber of Commerce (Kamer van Koophandel, 2009). Unfortunately, there is only a limited amount of information about the screen printing industry and the companies operating in it. Even the Dutch screen printing organisation recognizes this lack of information. Yearly turnover, profits and even the exact amount of companies operating in the screen printing industry are unknown (Zeefdruk Instituut, 2009).

Transfer tattoos

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As can be concluded from table two, the amount of established rivals in the transfer tattoo market is limited. Besides company X, only three other companies are offering the product. Only one of these competitors has more or less the same company size if estimated by the amount of employees. This competitor focuses on the same markets as company X and is situated not far from company X. This results in company A being the most important competitor for company X in the transfer tattoo market.

Company A Company B Company C Company X

Categories of transfer tattoos

Body decoration Body decoration Body decoration Body decoration

Other products Bicycle transfers,

DP-sheets, stickers, glow in the dark decoration.

Stickers, posters, boards, textile, vehicle, window and shop decoration, banners. Stickers, boards, textile, vehicle decoration, flags, banners, folders, posters. Bicycle transfers, stickers. Number of employees 17 5 7 18

Techniques/Machinery Screen printing. Screen-, sign- and digital printing.

Screen printing. Screen printing.

Location Overijssel Gelderland Noord-Brabant Friesland

Other ISO 9001 certificate

Table 2: Competitors and their characteristics in the transfer tattoo market

All competitors focus on producing fake tattoos or nice images for body decoration. Studying internet sites of online shops shows that transfer tattoos can also be produced for other purposes. Other applications might be the production of transfer jewellery (Tongeren, 2009), medical indication tattoos (Bellotte, 2009) or transfer tattoos as entrance tickets for parties.

Producing transfer tattoos can be a good diversification opportunity for company X because: - The production of transfer tattoos is related to the current technologies, production

processes and knowledge of company X. The fact that the production of transfer tattoos is achieved by the use of related resources and capabilities, makes producing the transfer tattoos more easy for company X.

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- Since there are a lot of new application opportunities for transfer tattoos which are not developed yet by the Dutch established rivals, there are market opportunities for company X, without having troubles of a competition which is too intensive by competing along the same dimensions. Developing new applications, such as transfer jewellery, medical indication tattoos and transfer entrance tickets can be developed by company X. In the USA more applications of transfer tattoos are already produced. Examples are glow-in-the dark tattoos, tattoos which colours change if the body temperature changes or perfume tattoos. These application are currently not produced by the established rivals in the Dutch transfer tattoo market, but can be a major opportunity for company X to develop and produce (Eurologo, 2009).

By analysing the transfer tattoo market it can be concluded that the production of transfer tattoos offers a diversifying opportunity to company X, especially if it develops new applications for the transfer tattoos. The internal analysis in the next chapter makes clear if the product is suitable for company X to produce from an internal point of view.

Stickers

From the 53 listed companies in table one who produce stickers, only twelve companies describe the production of stickers as one of their main activities (Branchevereniging van Zeefdruk en Sign Ondernemingen, 2009). These companies are considered to be the direct potential competitors of company X. Since three of the twelve companies do not have a company website where data can be collected and neither have information registered at the Dutch Chamber of Commerce, these companies will not be analysed here. Table three gives an overview of the nine resulting potential competitors of company X and is listed on the next page.

The dependency problem: Never put all eggs in one basket!