Industry Analysis: The Fundamentals
Industry Analysis: the Fundamentals
OUTLINE
The objectives of industry analysis
From environmental analysis to industry analysis
Porters Five Forces Framework Applying industry analysis Industry & market boundaries Identifying Key Success Factors
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The Objectives of Industry Analysis
To understand how industry structure drives competition, which determines the level of industry profitability. To assess industry attractiveness To use evidence on changes in industry structure to forecast future profitability To formulate strategies to change industry structure to improve industry profitability To identify Key Success Factors
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From Environmental Analysis to Industry Analysis
The national/ international economy The natural environment
THE INDUSTRY ENVIRONMENT Suppliers Competitors Customers
Demographic structure
Technology
Government & Politics
Social structure Social structure
The Industry Environment lies at the core of the Macro Environment. The Macro Environment impacts the firm through its effect on the Industry Environment.
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Profitability of US Industries
(selected industries only)
Median return on equity (%), 1999-2007
HIGH PROFITABILITY
Household & Personal Products 26.0
LOW PROFITABILITY
Motor Vehicles & Parts 9.3
Pharmaceuticals
Petroleum
21.0
20.1
Insurance Life & Health
Forest & Paper Products
9.1
7.3
Tobacco
Food Consumer Products Securities and Investment Banking Beverages Medical Products & Equipment Scientific & Photographic Equip. Commercial Banks
21.6
19.5 18.4 17.2 17.2 15.6 14.8
Food Production
Semiconductors & Electronic Components Network & Communications Equipment Telecommunications Entertainment Airlines
6.5
6.2 5.9 5.8 2.7 (12.6 )
Computer Software
Aerospace & Defense
14.0
13.9
The Determinants of Industry Profitability
3 key influences:
1. The value of the product to customers
2.
The intensity of competition
3.
Relative bargaining power at different levels within the value chain.
The Spectrum of Industry Structures
Perfect Competition Concentration Many firms No barriers Oligopoly Duopoly Monopoly
A few firms
Two firms
One firm
Entry and Exit Barriers
Product Differentiation
Significant barriers
High barriers
Homogeneous Product Perfect Information flow
Potential for product differentiation
Information
Imperfect availability of information
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Porters Five Forces of Competition Framework
SUPPLIERS
Bargaining power of suppliers
INDUSTRY COMPETITORS
POTENTIAL ENTRANTS
Threat of
Threat of
SUBSTITUTES
new entrants
Rivalry among existing firms
substitutes
Bargaining power of buyers
BUYERS
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The Structural Determinants of Competition
Suppliers POWER
Suppliers price sensitivity Relative bargaining power
THREAT OF ENTRY
Capital requirements Economies of scale Absolute cost advantage Product differentiation Access to distribution channels Legal/ regulatory barriers Retaliation
Concentration Diversity of competitors Product differentiation Excess capacity & exit barriers Cost conditions
INDUSTRY RIVALRY
SUBSTITUTE COMPETITION
Buyers propensity to substitute Relative prices & performance of substitutes
BUYER POWER
Buyers price sensitivity Relative bargaining power
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Threat of Substitutes
Extent of competitive pressure from producers of substitutes depends upon:
Buyers propensity to substitute The price-performance characteristics of substitutes.
Threat of New Entrants
Entrants threat to industry profitability depends upon the height of barriers to entry. The principal sources of barriers to entry are: Capital requirements Economies of scale
Absolute cost advantage
Product differentiation Access to channels of distribution Legal and regulatory barriers Retaliation by the competitors
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Bargaining Power of Buyers
Buyers price sensitivity
Cost of purchases as % of buyers total costs. How differentiated is the purchased item? How intense is competition between buyers? How important is the item to quality of the buyers own output?
Relative bargaining power
Size and concentration of
buyers relative to sellers. Buyers information . Ability to backward integrate.
Note: analysis of supplier power is symmetric
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Rivalry Between Established Competitors
The extent to which industry profitability is depressed by aggressive price competition depends upon: Concentration (number and size distribution of firms) Diversity of competitors (differences in goals, cost structure, etc.)
Product differentiation
Excess capacity and exit barriers Cost conditions Extent of scale economies Ratio of fixed to variable costs
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Applying Five-Forces Analysis
Forecasting Industry Profitability
If we can forecast changes in industry structure we can predict likely impact on competition and profitability. Strategic Positioning Once we know which structural features of the industry support profitability and which depress profitability, we can choose a favorable positioning within the industry. Strategies to Improve Industry Profitability
Which of the structural variables that are depressing profitability can we change by individual or collective strategies?
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Drawing Industry Boundaries: What is the Relevant Market?
What industry is Jaguar Ltd. in:
The Motor Vehicle industry (SIC 371) The Automobile industry (SIC 3712) The luxury car industry? Is its industry global, regional (Europe) or national (UK)?
Key criterion: SUBSTITUTABILITY
On the demand side : are buyers willing to substitute between types of cars and across countries On the supply side : are manufacturers able to switch production between types of cars and across countries
We may need to draw industry boundaries differently for different types of decision
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Identifying Key Success Factors
Pre-requisites for success
What do customers want?
How does the firm survive competition
Analysis of competition
Analysis of demand Who are our customers? What do they want?
What drives competition? What drives main What are the competition? What are the competition? dimensions of main dimensions of competition? How intense is competition? How intense is competition? How can we obtain a How can we obtain a superior superior competitive competitive position? position? KEY SUCCESS FACTORS
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Identifying Key Success Factors: Steel, Fashion Clothing, and Supermarkets
WHAT DO CUSTOMERS WANT? (Analysis of demand) Steel Low price Product consistency Reliability of supply Specific technical specifications for special steels. HOW DO FIRMS SURVIVE COMPETITION? (Analysis of competition) Strong price competition and cyclical profitability necessitates cost efficiency and strong financial resources KEY SUCCESS FACTORS Main sources of cost efficiency include: large-scale plants, lowcost location, rapid adjustment of capacity to output. Alternatively, hi-tech minimills can achieve low costs through flexibility and high productivity. Differentiation through product and service quality possible. Combine effective differentiation with low-costs Key differentiation variables are speed of response to changing fashion, style, reputation and quality. Cost efficiency requires manufacture in low wage countries. Low-cost operation requires operational efficiency, scaleefficient stores, strong buying power, low wage costs. Differentiation requires wide product range (hence, large stores), convenient location, easy parking. 18
Fashion clothing
Fragmented demand (segmented by garment type, style, quality, color). Customers willing to pay price premium for brand, style, exclusivity, and quality. Mass market highly price sensitive. Low prices. Convenient location. Wide range of products adapted to local preferences. Fresh/quality produce, good service, ease of parking, pleasant ambience.
Intensely competitive due to low entry barriers, low seller concentration, and strong retail buying power Differentiation can yield substantial price premium, but imitation rapid.
Supermarkets
Markets localized Intensity of price competition depends on number and proximity of competitors. Bargaining power a critical determinant of cost of bought-in goods.
SUMMARY: What Have We Learned?
Forecasting Industry Profitability
Past profitability a poor indicator of future profitability. If we can forecast changes in industry structure we can predict likely impact on competition and profitability.
Strategies to Improve Industry Profitability
What structural variables are depressing profitability? Which can be changed by individual or collective strategies?
Defining Industry Boundaries
Key criterion: substitution The need to analyze market competition at different levels of aggregation (depending on the issues being considered)
Key Success Factors
Starting point for the analysis of competitive advantage
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