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ANALYSIS OF INDUSTRY ENVIRONMENTS

Successful positioning or business definition requires that managersthoroughly understand the dynamics of their industries, the trends intheir firms’ external environments, and the basic economics of theirfirms’ markets. They must in short know how to analyse theirindustries. They can then effectively define and position their firms to

compete with sustained advantage. The most noteworthycharacteristic of industry environments is the variability. Someindustries are highly competitive and therefore not very profitable onthe average. Less competitive industry environments on the otherhand permit firms to enjoy high profitability on the average. Whilemature industries would most likely experience low, negligible or evennegative growth rates, emerging industries would enjoy high growthrates.

What is needed then are models or tools for assessing the relativeattractiveness of industries. These will then enable managers to

strategise both in terms of choosing which industries to enter or avoidin case their firms are considering significant investment. Managerscan also decide preemptive or corrective action in industries that theirfirms are already in. Here presented are two widely used frame worksfor analysing industries. The SWOT Analysis and the Five Forces Modelare both well known and have enjoyed widespread application in thebusiness world.

SWOT ANALYSISSWOT Analysis is derived from Strengths Weaknesses Opportunitiesand Threats. Strengths and weaknesses reflect the internal positives

and negatives respectively of a firm. Opportunities and Threats are thepositives and negatives reflected in the firm’s external environment.SWOT Analysis is done in two stages. First managers thoroughlyevaluate their firm’s positives and negatives in their internal andexternal environments. In the next stage use the evaluation to positiontheir firm appropriately in the competive space. This is accomplishedby placing the firm in one of the four quadrants of the SWOT matrix



shown in the exhibit titled The Strengths, Weaknesses, Opportunities,and Threats Matrix.If SWOT Analysis reveals that a firm has several internal strengths andfew internal weaknesses, many environmental opportunities and fewthreats, the firm would be placed in the upper right quadrant of the

SWOT matrix. Likewise a firm with many intenal weaknesses and manyenvironmental threats would be placed in the lower left hand quadrantof the matrix.If the firms managers determine that it has both considerable internalstrengths as well as many external opportunities then SWOT suggeststhat the firm should grow through merger and acquisitions or internaldevelopment of new business opportunities. Firms that have internalweaknesses but see significant opportunities can integrate vertically,enter into joint ventures or unrelated diversification.

The advantages of SWOT lies in its simplicity and straight forwardness.It helps managements to think in a constructive way about theirbusiness environments both internal and external. However it also has

some drawbacks. Firstly it is subjective depending totally on theperceptions of insiders. Personal biases are likely to play a significantpart in the assessment. Consequently there is likely to be a greaterchance of disagreement and lack of consensus between the firmsdecision makers. For instance a firm’s R& D head might view thisfunction as a strength whereas his colleague in the manufacturinghaving experienced numerous problems with products coming out of that function could very legitimately see it as an area of weakness.Another drawback of SWOT is that its use is likely to yield few clear cutrecommendations. One can envisage hardly any firm which ischaracterised by only positives. Therefore most firms cannot be easily

slotted in one of the four quadrants of the matrix but would probablyfall around the centre. There is then a serious risk of suggestion of contradictory strategies.

THE FIVE FORCES MODELThis model by the renowned Michael Porter in his book CompetitiveStrategy offered a new framework for Industry analysis which soughtto overcome the prescriptive inadequacies of the SWOT model. Porters



model examines five forces that influence and determine the structureof industries and consequently the profitability and the attractivenessof those industries. These are The threat of new entry, the availabilityof Substitutes, the Power of Suppliers, the Power of Buyers, and therivalry among competitors within the industry. The model postulates

that depending on the structure, incumbent firms can conductthemselves to charge higher prices to innovate or to act in concert tokeep outsiders out. This in turn would affect the general performancelevel in that industry. Obviously if all or most firms within an industrycould charge higher prices, the average profitability of the industrywould be high. Consequently Porter’s model has been identified as aStructure- Conduct-Performance frame work. Let us examine thismodel in more detail. Refer to the diagram titled The Five ForcesModel.The Threat of New Entry.Cost Barriers. When incumbent firms enjoy scale economies, the

benefits of experience ,and learning effects, or privileged access to keyraw materials or technologies, then potential entrants will be at aserious cost disadvantage. For many years the cost of entry into thecomputer industry was very high thus it was highly profitable forincumbent firms like IBM,Burroughs and CDC. With the advent of PCs, the barriers to entryswiftly crumbled and the hardware industry has become a dangerouslycompetitive arena where even spectacularly successful firms like Dellare now finding the going tough. The concept of Minimum efficientScale is relevant in some industries like the commercial aircraftbusiness where no

incumbent firm or new entrant can hope to succeed unless it hascapacity to meet a minimum of the world demand for commercialaircraft.Structural and Marketing Advantages of Incumbent FirmsIncumbent firms command brand loyalty and have well developeddistribution channels which have been built over a significant period of time and at substantial cost. New entrants therefore are at aconsiderable competitive disadvantage till they are able to match the



industry incumbents in both these areas. Titan and HMT in the IndianWatch industry both have well established distribution and aconsiderable number of loyal customers which new entrants to thismarket will find daunting.Government Restrictions

Where Government regulations operate such has been the case tillvery recently in India barriers to entry are extremely high. In ourcountry there has been a huge amount of regulation and this hasresulted in a very uncompetitive industry and the Indian customer hasbeen short changed. Even in the U.S. air lines and rail roads have forlong been regulated as also for a time the trucking industry. In everysuch case new entrants have found it impossible or at the very leastextremely difficult to make their way into these industry arenas.Behavioural BarriersIncumbent firms might maintain low prices or lower prices to intimidatenew entrants. Sometime they just might threaten to lower prices and

that might serve to discourage potential entrants. Firms like Intelannounce in advance that they are about to obsolete current productthereby signalling to the new rivals that they might be entering withproducts that are dated and therefore stand little chance of success.Such signalling is perfectly legitimate. However collusion byincumbents and collective activity such as forming price cartels isillegal and if resorted to is liable for stricture and severe punishment.

THE THREAT OF SUBSTITUTE PRODUCTSThis is the second of the five forces. Examples of substitute productsinclude Margarine for Butter Pcs for typewriters, and VCRs for movie

theatres. Personal Computers allied with advances in software fromtask specific programmes to data base management systems hasproved the ultimate substitute severely restricting the future of themainframe industry. It is to be noted that the extent of success of substitute products depend on the perceived value that they presentto the customer. Initially VCRs were only affordable by the veryaffluent thus offsetting their tremendous advantage as a home viewingsubstitute. As prices came down they became acceptable to a hugemass of people. The original attractiveness of margarine was its lowprice and unrestricted availability in War torn U.S.A. and Europe. Itspopularity waned after the second world war but it enjoyed a

resurgence in demand when in



these countries health and specially low cholesterol maintenance as a

means of preventing heart disease became major concerns.THE POWER OF SUPPLIERSIf suppliers have excessive power they can charge higher pricesthereby causing a decline in profitably for the buyer industry. Twofactors contribute to the potential for this. Firstly if the number of suppliers is small or in the worst case if there are only one or twosuppliers the potential for price gouging is high. Secondly if criticalcomponents incorporate proprietary technology, buyers will be at themercy of the supplier/suppliers who have this technology. Intel andMotorola have for long employed proprietary technologies in microchips thus giving them the power to charge high prices to their buyers

in the computer hardware industry. Bosch the German auto componentgiant has always been the only company in the world that supplies fuelinjection pumps to the automobile industry thus wielding enormouspower over its buyers.

THE POWER OF BUYERSSometimes buyers exert overwhelming influence over their suppliers.As with the case of suppliers two factors contribute most to thispotential. Firstly if there are a few buyers of products which aresupplied by a large number of suppliers the bargaining power of thebuyers will be enormous. The best example of this in the automobile

industry world wide. In every country with an indigenous auto industrybe it the U.S. Japan, Germany or India the automobile producers arevery few and the suppliers of most components are numerous. Theresult is that the buyers demand outrageous price reductions and thecomponent industry has probably the highest rate of bankruptcy of any industry in the world.

RIVALRY WITHIN THE INDUSTRYGreater rivalry within an industry usually reduces the profitability of the industry by driving down the prices of products and services andby increasing the cost of doing business. Slow growth rates in an

industry will increase the rivalry as firms struggle to maintain orincrease market share and spend more on marketing and sellingactivities. The U.S. cigarette industry grew increasingly unprofitable assale of its products declined. This predictably led to fiercer competitionand even lower profits for firms within the industry. The only way outwas for the cigarette majors like Phillip Morris and Reynolds to go in forunrelated diversification. Most went into foods where their knowledgeof consumer marketing and national distribution came in handy.



Excess capacity in an industry also tends to increase rivalry andusually results in lower prices and reduced profitability. In India theauto industry is already beset by over capacity both for

commercial and passenger vehicles. The result is poor profitability allround. Even the two wheeler segment has excess capacity and is

feeling the pinch of eroding profit margins.APPLICATION OF THE FIVE FORCES MODELWe will apply the model to actual industry situations There are threeexamples that we will look at. Two of these are taken from the U.S. andthe third from our own country.

The United States Steel IndustryIn this industry all but one of the five forces are intense Only supplierpower is not strong and that should be fairly obvious because coal, ironore and oxygen are basic commodities and there are a host of suppliers of each raw material.

The threat of new entry is very real. This is due to the fact that entryinto the steel industry is via the mini mill or mini steel plant routewhere investment is much less as compared to the investmentrequired for an integrated conventional steel producer. Furthermoresizing of these mini steel plants is highly variable. Whereas for atraditional plant the minimum size would be 10 million tonnes per year,a mini plant can be sized as low as a half million tonnes per year.Substitute products pose a major threat to steel. They includeAluminium, plastic and composite materials which have as major pluspoints lightness or greater strength for a given weight. Also thesematerials yield finished sizes and shapes which require little or no

processing before being fitted into their final locations on the endproduct like the automobile.The power of buyers is a major adverse factor for the steel industry.Both the auto industry and the appliance industry( White goods, airconditioners) who are the principal buyers of steel are very aggressivein their purchasing and continuously press for discounts andsubstantial reduction in base prices. This has eroded the steelindustry’s profitability.



Finally the steel industry is the scene of intense internal rivalry. Thereis significant over capacity and this has led to the closure of manysteel mills of the traditional variety. A further adverse factor is theincreasing competition to U.S. steel companies from East European,Brazilian, and Korean producers who are aggressive exporters offering

attractive prices that the Americans cannot or will not match. The overall assessment then, is that the industry prospects are increasinglybleak calling for exit or mega mergers within the industry.

THE U.S. PHARMACEUTICAL INDUSTRY



This industry offers a marked contrast to the steel industry. Suppliersas in the case of the steel industry have little power for the samereason that the inputs for pharmaceuticals are all commodities with alarge supplier base.

Entry barriers are significant in this industry because investmentrequired is high and the gestation period of projects is long. Attracting

the right talent is difficult and time consuming as well.The threat from substitutes is minimal in this industry and only existsin the small number of herbal or natural products which appeal only toa miniscule part of the population.Finally there is very little rivalry between the incumbent firms. Eachfirm ensures that the outcome of its Research and Development effortsis well protected by patents which have a 17 year validity.The low intensity of each of the five forces results in the U.S.pharmaceutical industry being highly profitable and characterised byhealthy growth rates. However that position may not last long becausemost of the existing patents are due to expire soon and the new

patents will not replace the volumes and earnings of the ones that areexpiring. Further the Health Maintenance Organisations (HMOs) aretaking over the health care business and these organisations aredisplaying increasing buying clout and this will tend to reduce theprofitability of the Pharmaceutical Industry.

THE INDIAN PASSENGER CAR INDUSTRY

From Independence up until the early 90s the passenger car industrywas regulated with only three players vis. Hindustan Motors whomarketed and sold Ambassadors, PAL with theiu Fiats and Maruti withits Maruti 800. There were impenetrable entry barriers, no strong

buyers or sellers no substitutes and only mild rivalry within theindustry. Therefore the industry was extremely attractive to theindustry who routinely charged higher prices to cover their increase incosts. When the industry was opened up all this changed. Today theindustry has no entry barriers. While the position on sellers and buyershas not radically changed, every firm in the industry is facing morediscerning buyers with an unprecedented choice in terms of the brandsand models they can choose from. While the threat from substitutes



remains negligible as before, the rivalry within the industry hasbecome intense. Prices have not risen at the rates that they did before.Suppliers are not as vulnerable to bullying by the auto producers asbefore. As a result the Indian car Industry has become unattractive andthe incumbents have only to hope that the market will show srrong

demand growth to permit them to achieve better economies of scale.Maruti the industry leader is expected to show a loss for the first timein its history. Other companies in the industry too are not doing wellfinancially. Telco too is expected to make losses this year mainly onaccount of its car business which has been doing badly.Charts and Exhibits:1) The Strengths Weaknesses Opportunities and Threats Matrix2) The Five Forces Model

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