Modern Competitive Strategy
3rd Edition
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved
Chapter 4
Industry Analysis
4-2
What is an Industry?

An industry is composed of:




Firms whose products provide value in functionally equivalent
ways (e.g., air conditioners – but not fans)
Firms that compete directly through changes in product value
and price
Firms that face common economic (e.g., common suppliers
and buyers)
Producers of substitutes (outside the industry) are:

Firms whose products are functionally different from the
industry’s products but compete to provide value to the
industry’s buyers (e.g., snowboards are substitutes for skis)
4-3
How Do Industries Emerge?



Firms create industries, not the reverse
Competing firms influence each other with shifts
in product value and price
Increasing strategic interaction establishes mutual
dependence between firms

Behavior and performance subject to emerging industry
forces
4-4
Market Segmentation

Many industries have more than one market segment


Segments are defined by the distribution of customer
preferences
Firms align their product lines with one or more
segments, which could overlap

Specialist firms


Tailor their product to one segment
Generalist firms

Design their product for many segments
4-5
What Determines Firm Profitability?

Macroeconomic factors


Industry factors


Forces in the overall economy: e.g., regulation, interest rates,
tax policy
Conditions specific to an industry, e.g., the level of
competition, the presence of powerful buyers
The firm’s market position as determined by its
resources and capabilities

The firm’s value and cost compared to competitors and its
ability to defend this position
4-6
Relative Contributions of Industry and
Business Unit to Economic Performance
Manufacturing Sector
Transportation Sector
Services Sector
Percentage Contribution of
Business Segment, Industry
and Other Factors to Business
Return on Assets 1980–1994
(U.S. data).
4-7
Industry Forces Influencing
Firm Performance

Porter’s five industry forces:

Strength of competition

Potential for entry into the industry

The power of buyers

The power of suppliers

The strength of substitutes for the industry’s products

When forces are strong, profitability is low and when
forces are weak, profitability is high

Add complements – e.g., cars and gas stations

Strong complements raise the product’s value
4-8
Porter’s Five Forces Framework
Source: Michael Porter, Competitive Strategy
(New York: Free Press, 1980), p. 4.
Figure 3.1
4-9
Competition

Competition



May reduce prices, while holding value and cost constant,
resulting in customers receiving higher buyer surplus
May increase value without increasing the price of the product
May increase cost if higher value is required to compete
4-10
Effect of Competition on
Transaction with Customers
Can Increase the Value
Required to Compete
Strong
Competition
Value to the
Customer
Reduces Price
Can Increase the Cost
Required to Compete as
Investment in Value Rises
Price
Cost
4-11
Types of Competition

Perfect competition



Monopoly




Strong rivalry among many very similar firms
No firm makes a profit above its cost of capital, since rivalry
has driven the market price down
Absence of rivalry
Monopolists produce less and charge more
Not illegal, but illegal to exploit
Oligopolistic competition

Competition occurs among a few similar firms
4-12
Characteristics of Perfect
Competition






Many competitors
A common set of buyers for all firms
The same value offered by all firms
The same cost structure in all firms
Relatively costless entry
Relatively costless exit
4-13
Oligopoly and Industry Concentration


Oligopolies are found in concentrated industries
Concentration is determined by:


Low ratio of market size to the minimum setup costs necessary
to compete
High level of sunk costs investment made by incumbent
companies

Entrants are at a cost disadvantage to compete with the
incumbents
4-14
Concentration-Profitability
Relationship


More concentrated industries tend to be a little more
profitable
Causes of the concentration-profitability relationship:



Higher efficiency of large firms
Non-cooperative strategic interaction to increase profits
Collusion to increase profits
4-15
Efficiency Differences among Firms


Higher profits are achieved from investing in scale-based
innovations that reduce costs
So interaction with competitors and knowledge of their
practices is necessary for profitability
4-16
Noncooperative Strategic Interaction


Firms act by observing and analyzing competitors’
moves – i.e. they play a game with each other
Profits are possible in a noncooperative game

Focus on a duopoly (two firms competing against each other –
e.g., Coke and Pepsi)

Price takers


Value and price are the same across firms (e.g., oil companies)
 So compete on volume (see the cattle ranches on the next slide)
Price makers

Value, prices and costs differ across firms (e.g., GM, Ford, Toyota and
Honda)
 So compete on value and price
4-17
Quantity Competition
Between Two Cattle Ranches
(best response for each combination is shown in bold)
Number of Steers Delivered by the Ponderosa
10
Number of
Steers
Delivered
by
Reata
20
30
40
50
60
70
80
90
100
10
19,19
18,36
17,51
16,64
15,75
14,84
13,91
12,96
11,99
10,100
20
36,18
34,34
32,48
30,60
28,70
26,78
24,84
22,88
20,90
18,90
30
51,17
48,32
45,45
42,56
39,65
36,72
33,77
30,80
27,81
24,80
40
64,16
60,30
56,42
52,52
48,60
44,66
40,70
36,72
32,72
28,70
50
75,15
70,28
65,39
60,48
55,55
50,60
45,63
40,64
35,63
30,60
60
84,14
78,26
72,36
66,44
60,50
54,54
48,56
42,56
36,54
30,50
70
91,13
84,24
77,33
70,40
63,45
56,48
49,49
42,48
35,45
38,40
80
96,12
88,22
80,30
72,36
64,40
56,42
48,42
40,40
32,36
24,30
90
99,11
90,20
81,27
72,32
63,35
54,36
45,35
36,32
27,27
18,20
100
100,10
90,18
80,24
70,28
60,30
50,30
40,38
30,24
20,18
10,10
4-18
Tacit Collusion


Tacit collusion may occur to make profits above the
competitive outcome
Required conditions among firms





Mutual familiarity
Repeated interaction
Consistent roles
Strategic complementarity
Information signaling

A mechanism for coordinating decisions
4-19
Explicit Collusion

Explicit collusion is the coordination of firms’ major
decisions through direct communication



Generally illegal
Hard to integrate and sustain
Extreme case of collusion leads to cartels



Cartels are illegal in most of the developed world
Cartels are often found in commodity industries
Firms decide on cartel administration and policies
4-20
Forces Influencing Cartelization

Reasons for cartel establishment





Homogenous market positions
Mutual familiarity through long-standing competition
High industry concentration
Lack of viable substitutes for the industry’s product
Reasons for cartel failure




Inability to prevent entry into the industry
Uncontrolled cheating or defection
Fluctuating demand
Bargaining problems within the cartel
4-21
What Factors Raise Entry Barriers?

Lower prices by firms in the industry


High barriers to imitation





Limit pricing
Property rights
Dedicated assets
Causal ambiguity
Learning curve and development costs
High customer switching costs
4-22
Entry Barriers Affecting Transaction
with Customers
Value to the
Customer
Low Barriers
to Entry
Force the Firm
to Lower Price
Price
Cost
Figure 3.3
4-23
Buyer Power

Buyer power is increased by:








Availability of competing products with the same value and
price
Buyer concentration (few buyers)
Low market growth
Percentage of product sold to the buyer
Low importance of the product to the buyer
High importance of selling product to buyer
The firm’s need to fill capacity by selling to buyer
Buyer’s credible threat of vertical (backward) integration
4-24
The Effect of Buyer Power
Force the Firm to
Increase Value
Strong Buyers
Value
Price
Force the Firm
to Lower Price
Cost
Figure 3.4
4-25
Supplier Power

Supplier power is increased by:

Supplier concentration (few suppliers)

Growth in demand for the firm’s product

Low percentage of supplier volume bought by customer (size
of buyer relative to supplier)

High strategic importance of supplier to buyer

Low strategic importance of buyer to supplier
4-26
The Effect of Supplier Power
Decrease the Value of
Their Inputs
Strong Suppliers
Increase the Firm’s Cost by
Raising Their Prices
Value to the
Customer
Price
Cost
Figure 3.5
4-27
Substitutes

The threat of substitutes increases when:



A firm has a low buyer surplus (value minus price) relative to
the substitute
A firm’s customers have low switching costs
Defenses against substitutes:


Increase the buyer surplus
Raise switching costs
4-28
The Effect of Substitutes on Transaction
with Customers
Increase the Value
Required to Compete
Strong
Substitutes
Value to the
Customer
Price
Force Lower
Prices
Cost
Figure 3.6
4-29
Forces Increasing Firm Performance




The strength of complements of the industry’s products
(Legal) cooperation between buyers and suppliers
Coordination among competitors
Strategic groups
4-30
Industry Forces
that Increase Profitability:
The Value Net
Competitors
Customers
The Firm
Suppliers
Complementors
Figure 3.7
4-31
Coordination Among Competitors

Cooperative pricing (not price-fixing) to avoid price
competition



Readily available pricing information
Comparable value-cost profiles for competitors
Interfirm partnerships

For example, R & D consortia
4-32
Cooperative Pricing


Often depends on the presence of a price leader
Price leadership requires:

Observable prices

Common buyers

Strategic discipline

A small number of firms

Common history of competition

Comparable market positions

Adherence to antitrust law

Cooperative output levels
4-33
Cooperation Between Buyers and
Suppliers

Sharing information



Operating decisions (e.g., logistics)
Strategic decisions (e.g., technology development)
Sharing resources and capabilities

Quality management techniques
4-34
Complements

Products in different industries whose patterns of
demand are systematically positively correlated



Skis and ski boots
Sails and sailboats
Tires and automobiles
4-35
Strategic Groups


Strategic groups are a level of analysis between the firm
and the industry.
Characteristics of strategic groups:

Firms within an industry that have similar cost and value
drivers compared to firms in other groups

Firms which compete in the same market segment

Firms that take a similar approach to competing in an industry
4-36
Mobility Barriers

Similar to barriers to entry to the industry – but between strategic
groups

Entry-deterring behavior of firms in a group


Isolating mechanisms specific to the group

Group limit pricing

Actions taken by stronger and more profitable competitors to protect their
groups from entry by rival firms in the industry
Prevent the movement of firms from one strategic group to
another
4-37
Strategic Groups in the U.S. Domestic Airline
Industry
Figure 3.8
4-38
The Effect of Industry Forces
on Value, Cost and Price
Five Industry Forces
Effect on Value
Effect on Cost
Effect onPrice
Stronger
Rivalry
May be based on
higher customer
value
May increase cost
associated with
higher value
Lowers the price
required to
compete in
industry
Stronger
Buyers
Raise the value
required to compete
in industry
Stronger
Suppliers
Lower the value
provided to firms
in the industry
Lower Entry
Costs
More Powerful
Substitutes
Lower the price
required to
compete in industry
Raise the costs of
firms in industry
Lower the price to
keep entrants out
of industry
Raise the value
required to compete
in industry
Lower the price
required to
compete in industry
4-39
The Effect of Industry Force on Value, Cost
and Price (cont’d)
Value Net
Effect on Value
Effect on Cost
Cooperation Between Firm
and Buyers
Raises the value to
buyers without
comparable rise in
firm costs
Lowers firm costs
without
comparable drop
in buyer value
Cooperation Between Firm
and Suppliers
Raises the value to
firm without a
comparable rise in
supplier costs
Lowers supplier
costs without
comparable drop
in firm value
Cooperation Between Firm
And Competitors
Raises the value to
industry buyers
without a comparable
rise in industry costs
(shared innovation)
Lowers the costs in
industry without a
comparable drop
in value to industry
buyers (shared
innovation)
Effective
Complements
Raise the value to
industry buyers
without a comparable
rise in industry costs
Effect onPrice
Raises the
potential price
necessary to
compete
(cooperative
Pricing)
4-40