Rationale for Industry Analysis
First step in the process of strategy formulation for a firm is an
understanding of the industry in which it operates
The competitive environment in which firms offer products
or services in an effort to compete for resources, customers,
sales, and profits
Underlying economics of the industries in which a firm
competes plays an instrumental role in its performance
External positioning
Understanding threats and opportunities
Key drivers of the industry
Key success factors
Salient Issues Regarding Industry
All
companies face uncertain industry
environments.
Managers
must position the organizations
strategically in order to compete successfully.
•This is what we call business definition.
•Requires that managers understand the
dynamics of their firms’ markets before
formulating strategies.
Industry Life Cycles
Rapidly
growing markets (emerging
industries) tend to be less competitive
and often attract new entrants.
Usually
provide sufficient room in competitive space
for making some mistakes.
Mature,
concentrated markets provide
firms with very little breathing room.
Mistakes
by one firm can significantly impact entire
industry.
•One firm’s price reductions can set off industry-wide
price war.
Firm Performance & Industry
performance
of all firms in
an industry will explain about
20% of the variation in the
performance of any single
firm in that industry.
How Much Does Industry Matter?
One cannot generalize that the “industry
is all that matters.”
Average Return on Assets of
Different Industries
Pharmaceuticals
Semiconductors
Temporary Help
Beverages
Airlines
Metals
5%
8%
8%
6%
10%
13%
Average Return on Assets in the
Automobile Industry: 1993 - 1997
1997
5%
-2% 1996
1%
1995
1994
1993
4%
5%
High- and Low-Performing Firms
in the Steel Industry
-1% Wierton Steel
1% LTV
3%
Inland Steel
Bethlehem
6%
Nucor
10%
High- and Low-Performing Firms in
the Pharmaceuticals Industry
-3%
Eli Lilly
3%
Pharmacia Upjohn
Allergan
9%
Merck
Bristol-Myers
18%
21%
The Five Forces Model
Industry structure will impact the
competitive behavior
Firms’ conduct will influence the
average performance of firms in that
industry
As intensity of forces increases, the
industry environment becomes more
hostile and overall industry profitability
will decline.
Analyzing Industry Structure
• Opportunities and threats are competitive
challenges arising from changes in industry
conditions.
• Analytic tools such as the
five forces model help
managers formulate
appropriate strategic
responses.
Five Forces Model
Barriers to Entry
Economies of Scale
Experience effects
Brand Identification
Switching Costs
Technology
Capital
Bargaining
Power of
Suppliers
Number of Important
Suppliers
Importance of components
supplies
Threat of
New
Entrants
Industry
Competitors
Threat of
Substitutes
Number of Firms
Industry Growth Rate
Excess Capacity
Number of Important
Buyers
Importance to Buyers
Bargaining
Power of
Buyers
Availability of close
Substitutes
Value price ratio
Potential Competitors
•New entrants into an industry
threaten incumbent companies.
•Barriers to entry:
– Brand loyalty
– Absolute cost advantages
– Economies of scale
– Switching costs
– Government regulation
•Entry barriers reduce the threat
of new and additional competition.
Rivalry Among Established Companies
• The intensity of competitive rivalry
in an industry arises from:
–Industry’s competitive structure.
–Demand (growth or decline)
conditions in industry.
–Height of industry exit barriers.
Competitive Structure
Continuum of
Industry Structures
Fragmented
Many firms,
no dominant
firm
Few firms,
shared dominance
(oligopoly)
Consolidated
One firm or one
dominant firm
(monopoly)
The Bargaining Power of Buyers
• Buyers are most powerful when:
– There are many small sellers and few
large buyers.
– Buyers purchase in large quantities.
– A single buyer is a large customer to
a firm.
– Buyers can switch suppliers at low
cost.
– Buyers purchase from multiple sellers
at once.
– Buyers can easily vertically integrate
to compete with suppliers.
The Bargaining Power of Suppliers
•Suppliers have bargaining power
when:
– Their products have few substitutes
and are important to buyers.
– The buyer’s industry is not an
important customer to the supplier.
– Differentiation makes it costly for
buyers to switch suppliers.
– Suppliers can vertically integrate
forward to compete with buyers
and buyers can’t integrate
backward to supply their own
needs.
Substitute Products
• The competitive threat of substitute
products increases as they come closer
to serving similar customer needs.
Far
Close
A Sixth Force: Complementors
• Complementors:
–Companies whose products are
sold in tandem with another
company’s products.
–Increased supply of a
complementary product
collaterally increases demand for
the primary product.
• Example:
–Faster CPU chips fuel sales
of personal computers.
Steel: A Five Force Conspiracy
Consistent
All
low industry performance average.
but one of the five forces are intense.
•Remember that as the intensity of any of the
forces becomes higher, the industry becomes
less attractive and industry performance
tends to decline.
Threat
of Entry
Threat
is very real. Initial investment
required is very large, but several Minimills
have entered industry in last 25 years.
Threat
of Substitutes
Significant
factor in this industry.
•Aluminum
•Plastics
•Composite materials
Power
of Steel Buyers
Also
significant.
•Small number of companies account for very
large proportion of steel purchases. Normal
threat is to take their business elsewhere.
Rivalry
Very
intense.
•Key reason is the significant overcapacity
which still exists today despite the closing of
many mills over the last 20 years.
–Mills try to keep running at full capacity in
order to spread their fixed costs over a large
volume.
–Price of steel today is about the same as 20
years ago
Pharmaceuticals: Best of all
Possible Industry Worlds?
Marked contrast to steel industry.
Suppliers
exercise little power because most of raw
materials are commodities that can be obtained from a
large number of suppliers.
Significant
barriers to entry reduce the
threat of new entrants.
R&D
costs and personnel.
Operating finances for many years while new drugs
are developed and approved by FDA.
Must build large professional sales force.
Few
true substitutes exist.
Very
small market (in relative terms) of natural
medicines.
Healthy
living styles have not been adopted by majority
of U.S. population.
Buyers
exercise very little control.
Sick
patients typically do not argue with drug company
over price of product.
•Normally, insurance company pays the bill.
Rivalry.
Industry
enjoys an almost “friendly”
competition.
•Patent protection for 17 years.
Summary
Low
intensity of all five forces helps to
explain the high performance of firms in this
industry.
•New HMO realities may change that
situation. Many patents due to expire
soon.
Two options if firms are in unattractive industries:
•Diversify their firms away from or exit
completely the industry.
–Firms often lack sufficient resources to do this.
–Diversification can be risky for firms with little diversification
experience.
•Attempt to minimize the impact of any of
the forces that are acting to make the
industry unattractive.
–Shield or protect their companies from the power of the
forces. Certain action may lead to allegations of collusion or
other unfair practices (Microsoft vs. Justice Department).
Evolution of Computer Industry was
inconsistent with Porter’s Five Force
Model.
Barriers
existent
to new entrants non-
Entrenched
incumbents
experienced declines in profitability.
New
frameworks and models
needed.
Dynamic Nature of Industry Environments
Personal
Computers
Xerox
Beetle
Daimler-Chrysler
Competing In An Era of Dynamism
Managers must actively
anticipate the future.
Innovation
is more important
than imitation.
The
advantages of thinking like
an outsider.
Beware
of success -- might
lead to complacency