Rationale for Industry AnalysisFirst 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 opportunitiesKey drivers of the industry Key success factors

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.

Analyzing Industry StructureAnalyzing 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.

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

Potential CompetitorsPotential 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 Rivalry Among Established CompaniesCompanies

• 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 Competitive StructureStructureContinuum ofContinuum of

Industry Structures Industry Structures

FragmentedFragmentedMany firms,Many firms,no dominantno dominant

firmfirm

Few firms,Few firms,shared dominanceshared dominance

(oligopoly)(oligopoly)

Consolidated Consolidated One firm or oneOne firm or onedominant firmdominant firm(monopoly)(monopoly)

The Bargaining Power The Bargaining Power of Buyersof 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 The Bargaining Power of SuppliersSuppliers

•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 ProductsSubstitute Products

• The competitive threat of substitute products increases as they come closer to serving similar customer needs.

CloseCloseFarFar

A Sixth Force: A Sixth Force: ComplementorsComplementors

• 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: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.

Barriers to new entrants non-existent

Entrenched incumbents experienced declines in profitability.

New frameworks and models needed.

Personal Computers

Xerox

Beetle

Daimler-Chrysler

Dynamic Nature of Industry Environments

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