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What is strategy?
Strategies are those plans that specifically focus on the actions and responses of competitors. As its core, strategic thinking is about creating, protecting and exploiting competitive advantage.
What can affect the competitive environment? Porter's view
Substitutes, suppliers, potential entrants, buyers and competitors within the industry. However, those forces does not have equal importance. The dominant one is Barriers to Entry (potential entrants). If demand conditions enable any single firm to earn unusually high returns, other companies will notice the same opportunity and flood in.
Barriers to Entry and Competitive Advantages
Being able to do what rivals cannot is the definition of a competitive advantage. Competitive advantages that lead market dominance, either by a single company or by a small number of essentially equivalent firms, are much more likely to be found when the arena is local (bounded either geographically or in product space) than when it is large and scattered. That is because the sources of competitive advantage tend to be local and specific, not general or diffuse.
Which Competitive Advantages
Strategic analysis should begin with two key questions: In the market in which the firm currently competes or plans to enter, do any competitive advantages actually exist? And if they do, what kind of advantages are they?
Supply: These are strictly cost advantages that allow a company to produce and deliver its products or services more cheaply than its competitors. Sometimes the lower costs stem from privileged access to crucial inputs. More frequently, cost advantages are due to proprietary technology that is protected by patents or know-how. Demand: These demand advantages arise because of customer captivity that is based on habit, on the costs of switching, or on the difficulties and expenses of searching for a substitute provider.
Economies of Scale: If costs per unit decline as volume increases, because fixed costs make up a large share of total costs, then even with the same basic technology, an incumbent firm operating at large scale will enjoy lower costs than its competitors.
The competitive advantage of economies of scale depend not on the absolute size of the dominant firm but on the size difference between it and its rivals, that is, on market-share. If average costs per unit decline as a firm produces more, then smaller competitors will not be able to match the costs of the large firm even though they have equal access to technology and resources so long as they cannot reach the same scale of operation. Economies of scale must be coupled with some customer captivity to serve as a competitive advantage.
The Process of Strategic Analysis
To develop an effective strategy, a company not only needs to know what its competitors are doing, but also be able to anticipate these competitors' reactions to any move the company makes. This is true essence of strategic planning. It embraces all of the things a company does in which a competitor's direct reactions are critical to its performance (princing policies, new product lines, geographical expansions, capacity additions.)
How to confirm the existence of competitive advantages and barriers to entry: Market-Share stability and high return on capital (ROIC)!
The differentiation myth: If no forces interfere with the process of entry by competitors, profitabiliy will be driven to levels at which efficient firms earn no more than a "normal" return on their invested capital. Its barriers to entry, not differentiation by itself, that creates strategic opportunities.
More about Economies of Scale: The best strategy for an incumbent with economies of scale is to match the moves of an agressive competitor, price cut for price cut, new product for new product, niche by niche. Then, customer captivity will secure the incumbent's greater market share.
The company has to understand that pure size is not the same thing as economies of scale, which arise when the dominant firm in a market can spread the fixed costs of being in that market across a greater number of units than its rivals. It's the share of the relevant market, rather than size per se, that creates economies of scale.
The strenght of this advantage is directly related to the importance of fixed costs. As a market grows, fixed costs, by definition, remain constant. Variable costs, on the other hand, increase at least as fast as the market itself. The inevitable result is that fixed costs decline as a proportion of total cost.
Although it may seem counterintuitive, most competitive advantages based on economies of scale are found in local and niche market markets, where either geographical or product spaces are limited and fixed costs remain proportionately substantial. An attractive niche must be characterized by customer captivity, small size relative to the level of fixed costs, and the absence of vigilant, dominant competitors. Ideally, it will also be readily extendable at the edges. The key is to "think local".
Three basic steps for testing competitive advantages:
1- Identify the competitive advantage landscape in which the firm operates. Which markets is it really in? Who are its competitors in each one?
2- Test for the existence of competitive advantages in each market. Do incumbent firms mantain stable market share? Are they exceptionally profitable over a substantial period?
3- Identify the likely nature of any competitive advantage that may exist.
To sum up:
As a first rule of thumb, if you can't count the top firms in an industry on the fingers of one hand, the chances are good that there are no barriers to entry. As a second rule of thumb, if over a five to eight year period, the average absolute share change exceeds 5 percentage points, there are no barriers to entry; if the share change is 2 percentage points or less, the barriers are formidable.
Within a given industry, there are two primary approaches to gauge profitability. One uses income as a percentage of revenue, the other income as a percentage of the resources employed in the business.
Important: Operating margins (EBIT/Net Sales) are most revealing when comparing firms within the same industry, because they are likely to have similar requirements for capital. Return on invested capital (how much the company earns on the debt and equity it needs to run its business) is useful to measure of performance between industries as well as within them.
That was a huge simplification on what Greenwald has written, however here we have important insights! I strongly recommend the reading of his book, mainly if you are a beginner!