Strategies are based on context. One of the most common contexts that one runs into in most parts of the world is that of a ‘fragmented industry’.
A fragmented industry is one in which there are very many firms competing and, as a consequence, no ‘one’ player is big enough to influence the direction or growth of the industry. Restaurants, cab services, home-care services, auto dealership and the furniture business are some examples. Such fragmentation can happen due to many reasons.
— Diseconomies of scale in critical parts of the value chain, such as manufacturing, procurement/sourcing, markets, etc. This can result if manufacturing happens to be the most important part of the value created and it suffers from diseconomies of scale (an economic disadvantage such as an increase in cost arising from an increase in the size of an organisation). The same can happen to other aspects of the value chain.
— The other reason could be costs unrelated to scale. For instance, if the output is bulkier than raw material, the entire value chain shifts closer to the market, as in the case of blow-moulded container Industry.
— When the demand is local or with a strong local flavour, the industry tends to become fragmented.
— Some of the other reasons for fragmentation could be low entry barriers, particularly combined with high exit barriers, government regulations and diversity of demand.
Making it work
While the origins of fragmentation could be many, the firms competing in such an industry have to formulate appropriate strategies to respond to this. There can be several approaches to do this:
Chaining is one of the strategies that companies often adopt to overcome the limitations that fragmentation imposes. In this strategy, companies come together to form ‘co-operatives’. They loosely organise themselves into ‘blocs’ to derive advantage of size in activities, such as procurement, logistics and branding.
Franchising is another frequently used strategy to deal with the outcome of fragmentation. Here, companies allow agents/representatives to use their name, logo and brand, but for a fee. While the parent company determines the business model, products/value propositions and processes, the day-to-day operations are left to the agent and they also make the investments. McDonald’s, and KFC are classic examples.
Horizontal mergers are another strategy used to battle fragmentation. Here, firms merge to form bigger entities.
Apart from these, specialising in geography, product and customer type are some of the strategies adopted.
Technology can help overcome fragmentation and some of the recent examples are online grocers/vegetable sellers, or aggregators of taxis like Uber and Ola. Here, the main levers used are cost reduction and convenience.
While fragmentation will continue to be a feature world-wide, strategies such as franchising and chaining need to be carefully adopted and managed. The biggest risks are loss of control and agency issues with franchisees. Emerging economies are likely to have more industries that are fragmented compared to developed economies. Hence, learning to deal with fragmentation becomes more important for them. India should pay heed.
To read more from the Simply Strategy section, click here .