Feedbackreinforces or

suggests changes

in managers'

mental models

Managers' Mental Models

Industry environments + How to compete + Appropriate size/diversity, how businesses are related, how diversification should be managed + How to organize

Decisions about

Business Definition

Decisions about

Organizational

Structure

Decisions about

Business Strategy

Decisions about

Corporate Strategy

and Diversification

Market Position,Resources, and

Capabilities

Performanceand

CompetitiveAdvantage

Industry Analysis

All companies face competition.

For resources, customers, sales revenues, and profits.

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.

Salient Issues Regarding Industry

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.

Industry Life Cycles

performance of all firms in an industry will explain about 20% of the variation in the performance of any single firm in that industry.

Firm Performance & Industry

How Much Does Industry Matter? How Much Does Industry Matter?

One cannot generalize that the “industry is all that matters.”

Metals

Pharmaceuticals

Semiconductors

Temporary Help

Beverages

Airlines

13%

10%

5%

6%

8%

8%

Average Return on Assets of Average Return on Assets of Different IndustriesDifferent Industries

Average Return on Assets in the Average Return on Assets in the Automobile Industry: 1993 - 1997Automobile Industry: 1993 - 1997

High- and Low-Performing High- and Low-Performing Firms in the Steel IndustryFirms in the Steel Industry

High- and Low-Performing Firms High- and Low-Performing Firms in the Pharmaceuticals Industryin the Pharmaceuticals Industry

The Five Forces ModelThe 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.

BargainingPower ofSuppliers

Threat ofSubstitutes

Threat ofNew

Entrants

BargainingPower ofBuyers

IndustryCompetitors

Intensity of

Rivalry

Five Forces ModelBarriers to EntryEconomies of ScaleExperience effectsBrand IdentificationSwitching CostsTechnologyCapital

Number of Important SuppliersImportance of componentssupplies

Availability of close SubstitutesValue price ratio

Number of ImportantBuyersImportance to Buyers

Number of Firms Industry Growth RateExcess Capacity

Steel:Steel: A Five Force ConspiracyA Five Force ConspiracyConsistent low industry performance average.

All 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:Pharmaceuticals: Best of all Best of all Possible Industry Worlds? 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.

Incumbent firms not only did not erect sufficient barriers to new entrants, but the entrenched incumbents experienced declines in profitability.

New frameworks and models needed to explain the evolution of industries and better understanding of industry environments.

Personal Computers

Xerox

Beetle

Daimler-Chrysler

Dynamic Nature of Industry Environments

Any industry may be analyzed along three dimensions, but analyst must identify relevant labels.

Customers

(the “who” dimension)

•Age

•Disposal income

•Value

•Lifestyle

Dynamic Model of Industry Analysis

Products and Services

(the “what” dimension)•Size•Availability•Accessories•Cost

Technologies

(the “how” dimension)•State-of-the-Art?•Effectiveness

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

Competing In An Era of Dynamism