Analysing the Industry Environment

Prof.univ.dr. Ion ANGHEL

Prof.dr.Ion ANGHEL

Topics

Objectives of the lesson Environmental analysis Analyzing industry attractiveness Applying industry analysis Case study

Prof.dr.Ion ANGHEL

1. Objectives

Identify the main structural features of an industry that influence profitability

Explain why some industries are more profitable than others

Use evidence on structural trends within industry to forecast changes in profitability

Identify opportunities to influence industry structure and improve profitability

Analyze competition and customer requirements for competitive advantage

Prof.dr.Ion ANGHEL

2. Environmental analysis

Major Principles1. For the firm, to make profit it must create

value for customers. The firm must understand its customers

2. In creating value the firm acquires goods and services from suppliers. The firm must understand the suppliers

3. The ability to generate profitability from value creating depends on the intensity of competition among the firms

Prof.dr.Ion ANGHEL

THE INDUSTRY ENVIRONMENT

•Suppliers

•Competitors

•Customers

The National/ International Economy

Technology

Government

The Natural Environment

Demographic structure

Social Structure

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Environmental analysis

The purpose of strategy: to help firms to survive and make money

What determine the level of profit in an industry ? Business is about the creation of value

PRODUCTION: Transforming inputs into outputs ARBITRAGE: Transferring products across time and space

The surplus of value over cost is distributed between customers and producers by the force of competition

Ex: house cost = 500 E/mp, market value = 1.000 E/mp, price = 750 E/mp

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Environmental analysis

The profit earned by companies depends on: The value of the products/ service to

customers (ex I pod, LCD, a Ski winter holiday in Austria )

The intensity of competition

The relative bargaining power at different level in the production chain

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3. Analyzing industry attractiveness

Some industries (tobacco, pharmaceuticals) consistently earn high rates of profit but others (iron, steel, airlines, basic buildings materials) have failed to cover their cost of capital

This is the result of systematic influence of the industry structure

Monolopolistic (US market for smokeless tobacco) vs Perfect competition (Chicago grain market)

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Structural features

Perfect Competion

Oligopoly Duopoly Monopoly

Concentration

Many firms A few firms Two firms One Firm

Entry/ Exit Barriers

No bariers Significant barriers

Significant barriers

High barriers

Product differentioation

Homogenous products

Product differentiation

Information Perfect information flow

Imperfect information flow

Industry types

Prof.dr.Ion ANGHEL

Analyzing industry attractiveness

Porter Model 5 forces/ sources of competitive pressure “Horizontal” competition: competition from

substitutes, competition from entrants, competition from established rivals

“Vertical” competition: bargaining power of suppliers and buyers

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The five forces for industry structure and profitability

1. Rivalry amongexisting Firms-industry growth;-concentration;-differentiation;-switching cost;-scale economies;-fixed-variable cost;-excess capacity;-exit barriers;

2. Threat of newEntrants-scale economies;-first mover advantage;-distribution access;-relationships;-legal barriers;

3. Threat of SubstituteProducts-relative price andperformances;-buyers’ willingness toswitch;

INDUSTRY PROFITABILITY

4. Bargaining Power ofBuyers-switching cost;-differentiation;-importance of product -for costs and quality ;-number of buyers;-volume per buyer

5. Bargaining Power ofSuppliers-switching cost;-differentiation;-importance of product -for costs and quality ;-number of suppliers;-volume per suppliers.

Prof.dr.Ion ANGHEL

1.Rivalry among existing Firms

industry growth: growing rapidly: firms need not to grab market share from

other to grow; stagnant industries generates price wars among the firms

in the industry

concentration and balance of competitors a dominant company : only one enforce the rules of

competition; a couple of competitors: they can implicitly cooperate with

each other to avoid destructive price competition; fragmented industry: price competition is likely to be very

severe.

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Rivalry among existing Firms

Degree of differentiation and switching cost If the products in an industry are very similar,

customers are ready to switch to another purely on the basis of price

The scale economies and the ratio fixed to variable expenses;

If the ratio of fixed to variable expense is high, firms has incentive to reduce prices to utilize the installed capacity (air line industry is a quite common example)

Excess capacity and exit barriers; The capacity larger than the demand there is a strong

incentive for companies to cut prices to fill capacities. This is exacerbated when fixed assets are very specialized.

Prof.dr.Ion ANGHEL

2.Threats of New Entrants

Economies of scale. Might arise from large investments in physical plant

and equipment (telecommunication); investments in R & D (pharmaceutical, jet engine

industry); large expenses / investments in advertising (soft –

drink industry); first mover advantage.

to set industry standards to use switching cost advantage in learning

economies (Microsoft operating system)

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Threats of New Entrants

access to channels of distribution and relationships.

Supermarket shelf space for new consumer goods manufactures

Dealer network access for a new car producer Can be very important barrier in industries like as

auditing, investment banking, net advertising Legal barriers

Licensing regulations limit the entry into broadcasting, telecommunications industry, taxi services, medical services.

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Product differentiation: Customers loyal to a single brand: 30%

batteries, garbage bags and 71% cigarettes (US market)

Late entrants into consumer goods market = additional marketing cost 2,1% in revenues

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3. Threat of substitution products

The threat of substitution depends on The relative price performance of the competing

products/ services Customers’ willingness to substitute

Washington – New York by air 2 hours quicker (city center to city center). Average traveler value 25 $/h = train will be competitive with air at fares 50$ bellow.

What about Bucharest- Constanta

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4. Bargaining power of Buyers

Price sensitivity The importance of the product in the total expenses

(ex: the importance of the salt in total cost of a family) The importance of the product in the buyers’ own

products/ services quality

Relative bargaining power The cost to each party of not doing business with the

other party Important factors are: number of buyers relative to the

number of suppliers, volume of purchases by a single buyer, number of alternative products available

Prof.dr.Ion ANGHEL

Bargaining power of suppliers

This is a mirror image of the analysis of the buyer’s powers in an industry.

Suppliers are powerful when there are few companies and few substitutes available.

Soft – drink industry versus can producers; The pilots versus airline company;

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4. Applying industry analysis

Once we understand how industry structure drives competition which determines profitability, we can apply this analysis To forecasting industry profitability Devising strategy to change industry structure

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Applying industry analysis

Forecasting industry profitability First stage: understand how past changes in

industry have influenced competition and profitability

Decreasing in profitability of the world automobile industry Increasing rivalry among existing car makers

(industry concentration): Peugeot and Cittroen merger, VW acquired Skoda and Seat, BMW acquired Rover

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Example US market share top 3 dropped from 85% to 64% In Germany Mercedes + VW decliend from 50 to 28%

Increasing standardization of design, products becoming similar

Capacity utilization remained low Major barriers to exit (political pressure, union

agreements) The power of suppliers had increased (size and

multinationality) Technology development was led by component

manufacturers not the auto companies (automobile supermarket)

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Applying industry analysis

Strategy to alter Industry Structure, 2 steps To identify the key structural features of an

industry that are responsible for depressing profitability

To consider which of these structural factors are amenable to change

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Examples

In consumer electronics, suppliers of leading brands (Sony, Pioneer) have sought to limit the buying power of discount chain: by refusing to supply those chains that advertise cut prices or that do not display their products “an appropriate retailing environment”

Oil refining industry: returns bellow the cost of capital due to competition, excess capacity, commodity products: solution merger between BP and Mobil in Europe, Shell and

Texaco in US Differentiation through performance enhancing

additives to gasoline

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5. Applying industry analysis: the PC Industry

Personal Computer Industry is an young sector, starting in 1981 when IBM announced its PC with Intel’s microprocessor and Microsoft’s DOS operating System

There is a spectacular growth in this industry However in this industry the profitability is

very low: IBM, Compaq, Dell and Apple reported poor performances.

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Competition in PC industry

Is a very intense competition because The industry is very fragmented, with many

companies producing virtually the same products. The most important five vendors controlling 50-60% in the market but there is routine price cut on a monthly base;

Component costs accounted around 60% in total hardware cost;

Products realized by different companies are virtually identical and there are few opportunities to differentiate products. Brand name and service became less important because PC buyers are now more informed about technology;

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Switching cost across different brands were relatively low because almost all used Intel microprocessors and Microsoft Windows operating system;

Access to distribution is a small barrier (Internet based sales starting from 1990);

All components needed to produce a personal computer were available for purchase, there are few limits to entering in the industry (Michael Dell started Dell Computer Company in 1980 by assembling PCs in his University of Texas dormitory room);

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The power of suppliers and buyers Key hardware and software components for PC

were controlled by firms with virtually monopoly (Intel and Microsoft)

Today, because of the clients are knowledgeable about PC technology, customers are not influenced by the brand and the price is the most important consideration in their buying decision;

Prof.dr.Ion ANGHEL

Conclusions

Performances are poor in PC industry because: Intense rivalry Low barriers to entry The important power of suppliers Important pressure on firms to invest money to

introduce new products rapidly, maintain quality, provide excellent customer support

This is a technologically dynamic industry but with poor potential profit. As a result the profitability of the PC industry may not improve significantly any time in the future.

Prof.dr.Ion ANGHEL

Multumesc !

Ion ANGHEL, Ph.dProfessor Academy of Economic Studies

IVSC Professional Board MemberEmail: ion.anghel@ase.ro