Analyzing the Industry Environment

1
Analyzing the Industry Environment
OUTLINE

• The objectives of industry analysis
• From environmental analysis to industry analysis
• Porters Five Forces Framework
• Applying industry analysis
• Industry market boundaries
• Extending the Five Forces Framework
• --Complements, Dynamics, The New Economy
• Identifying Key Success Factors

2
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 identify opportunities to change industry
  structure to impose industry profitability
• To identify Key Success Factors

3
From Environmental Analysis to Industry Analysis
The natural environment
The national/ international economy

• 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.

4
Profitability of US Industries, 1985-97
5
US Industrial Profitability, 1986-97 EVA, Market
Value Added, and ROA
6
The Determinants of Industry Profitability
3 key influences

• The value of the product to customers
• The intensity of competition
• Relative bargaining power at different levels
  within the value chain.

7
The Spectrum of Industry Structures
Perfect Competition
Oligopoly
Duopoly
Monopoly
Concentration
Many firms
A few firms
Two firms
One firm
Entry and Exit Barriers
No barriers
Significant barriers
High barriers
Product Differentiation
Homogeneous Product
Potential for product differentiation
Information
Perfect Information flow
Imperfect availability of information
8
Porters Five Forces of Competition Framework
SUPPLIERS
Bargaining power of suppliers
INDUSTRY COMPETITORS
Threat of substitutes
Threat of new entrants
POTENTIAL ENTRANTS
SUBSTITUTES
Rivalry among existing firms
Bargaining power of buyers
BUYERS
9
Threat of Substitutes

• Extent of competitive pressure from producers of
• substitutes depends upon
• Buyers propensity to substitute
• The price-performance characteristics of
  substitutes.

10
The Threat of Entry

• 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

11
Bargaining Power of Buyers
Buyers price sensitivity
Relative bargaining power

• 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?

• Size and concentration of
• buyers relative to
• sellers.
• Buyers information .
• Ability to backward
• integrate.
  

Note analysis of supplier power is symmetric
12
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

13
Figure 3.5. The Impact of Growth on Profitability
Market Growth Less than -5 -5 to 0
0 to 5 5 to 10 Over 10
14
Profitability and Market Growth
Return on sales
Cash flow/ Investment
Return on investment
Less than -5 -5 to 0 0 to 5
5 to 10 Over 10
15
The Impact of Unionization on Profitability
Percentage of employees unionized None 1-35
35-60 60-75 gt75 ROI () 25
24 23 18 19 ROS () 10.8 9.0
9.0 7.9 7.9 ROI Return on
Investment ROS Return on sales
16
Applying Five - Forces Analysis

• 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?

17
Drawing Industry Boundaries Identifying the
Relevant Market

• What industry is BMW in
• World Auto industry
• European Auto industry
• World luxury car industry?
• 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
• May need to analyze industry at different levels
  for different types of decision

18
The Value Net
CUSTOMERS
COMPANY
COMPLEMENTORS
COMPETITORS
SUPPLIERS
19
Five Forces or Six? Introducing Complements
The suppliers of complements create value for
the industry and can exercise bargaining power
SUPPLIERS
Bargaining power of suppliers
INDUSTRY COMPETITORS
COMPLEMENTS
Threat of new entrants
POTENTIAL ENTRANTS
Threat of substitutes
SUBSTITUTES
Rivalry among existing firms
Bargaining power of buyers
BUYERS
20
Dynamic Competition

• Porter framework assumes
• industry structure drives competitive behavior
• Industry structure is stable.
• But---competition also changes industry structure
• Schumpeterian Competition A perennial
• gale of creative destruction where innovation
  overthrows established market leaders
• Hypercompetition intense and rapid
  competitive moves.creating disequilibrium
  through continuously creating new competitive
  advantages and destroying, obsoleting or
  neutralizing opponents competitive advantages

21
Applying Five Forces to Emerging E-commerce
Markets

• The more unstable is industry structurethe less
  
• helpful is analysis based upon industry
  structure.
• Taking account of timewillingness to endure
  losses
• today in order to reap profit tomorrow
• General structural features of digital,
  networked
• industries
• Low entry barriers Extreme scale economies
• Network externalities Winner-take-all markets
• Intense competition

22
Identifying Key Success Factors

• Pre-requisites for
  success

Pre-requisites for success
What do customers want?
How does the firm survive competition

• Analysis of competition
• What drives competition?
• What are the main dimensions of
  competition?
• How intense is competition?
• How can we obtain a superior competitive position?

• Analysis of demand
• Who are our
• customers?
• What do they want?

• What drives competition?
• What are the main
• dimensions of competition?
• How intense is competition?
• How can we obtain a
• superior competitive position?

KEY SUCCESS FACTORS
23
Identifying Key Success Factors Through Modeling
Profitability The Airline Industry
Profitability Yield x Load
factor - Unit Cost Income
Revenue RPMs
Expenses ASMs RPMs
ASMs ASMs


x
-

• Strength of competition on
  routes.
• Responsiveness to cha- anging market
  conditions
• business travelers.
• Achieving differentia- tion advantage

• Price
• competitiveness.
• Efficiency of route
• planning.
• Flexibility and
• responsiveness.
• Customer loyalty.
• Meeting customer
• requirements.

• Wage rates.
• Fuel
• efficiency of
• planes.
• Employee
• productivity.
• Load factors.
• Administrative
• overhead.

ASM Available Seat Miles RPM Revenue
Passenger Miles
24
Identifying Key Success Factors by Analyzing
Profit Drivers Retailing
Sales mix of products
Return on Sales
Avoiding markdowns through tight inventory control
Max. buying power to minimize cost of goods
purchased
ROCE
Max. sales/sq. foot through location
product mix customer service quality control
Sales/Capital Employed
Max. inventory turnover through electronic data
interchange, close vendor relationships, fast
delivery
Minimize capital deployment through outsourcing
leasing
25
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
• Working at different levels of aggregation

26
SUMMARY (continued)

• Game Theory
• Valuable in analyzing competitive rivalry between
  small number of players
• Analysis of cooperation competition
• Offers insights into the structure of the game
  competitive interaction use of specific
  strategic plays.

• Key Success Factors
• Starting point for the analysis of competitive
  advantage

• Industry Analysis The New Economy
• Porter 5 forces analysis less useful when
  industry structure unstable
• Key to understanding digital, networked markets
  is to understand their underlying structure (esp.
  scale economies and network externalities)