© Ram Mudambi, Temple University, 2007.
Lecture 2Lecture 2
External Analysis: The Identification of External Analysis: The Identification of Industry Opportunities and ThreatsIndustry Opportunities and Threats
BA 951BA 951Policy Formulation and Policy Formulation and
AdministrationAdministration
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Learning OutcomesLearning Outcomes
Methodologies for analyzing the external Methodologies for analyzing the external environment of the firmenvironment of the firmTheoriesTheoriesApplicationsApplications
European groceriesEuropean groceries Competition in a digital ageCompetition in a digital age
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Lecture OutlineLecture OutlineComponents of External AnalysisComponents of External AnalysisStatic models for examining external environmentStatic models for examining external environment
The Industry - The Five Forces ModelThe Industry - The Five Forces Model Wide Focus – PEST AnalysisWide Focus – PEST Analysis Narrow Focus – Strategic GroupsNarrow Focus – Strategic Groups
Dynamic models – industry evolutionDynamic models – industry evolution Punctuated equilibriumPunctuated equilibrium The life cycle modelThe life cycle model
The external environment and -The external environment and - Network economiesNetwork economies GlobalizationGlobalization The competitive advantage of the Nation StateThe competitive advantage of the Nation State
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Two Components of External Two Components of External AnalysisAnalysis
Supplying a viable,saleable product
Ability to surviveits environment
ANALYSIS OF PRODUCT ANALYSIS OF ENVIRONMENT
KEYSUCCESS FACTORS
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Analysis of Product: What are the Analysis of Product: What are the industry’s dominant economic industry’s dominant economic traits?traits?
Market size andMarket size and growth rategrowth rate Scope of competitive rivalryScope of competitive rivalry Number of competitorsNumber of competitors and their relative sizesand their relative sizes Prevalence of backward/forward integrationPrevalence of backward/forward integration Entry/exit barriersEntry/exit barriers Nature and pace of technological changeNature and pace of technological change Product and customer characteristicsProduct and customer characteristics Scale economies and experience curve effectsScale economies and experience curve effects Capacity utilization and resource requirementsCapacity utilization and resource requirements Industry profitabilityIndustry profitability
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Defining an IndustryDefining an Industry
IndustryIndustry A group of companies offering products or services that are close A group of companies offering products or services that are close
substitutes for each other and that satisfy the same basic customer substitutes for each other and that satisfy the same basic customer needsneeds
Industry boundaries may change as customer needs evolve and Industry boundaries may change as customer needs evolve and technology changestechnology changes
SectorSector A group of closely related industriesA group of closely related industries
Market SegmentsMarket Segments Distinct groups of customers within an industryDistinct groups of customers within an industry Can be differentiated from each other with distinct attributes and Can be differentiated from each other with distinct attributes and
specific demandsspecific demands
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The Computer Sector: Industries The Computer Sector: Industries and Market Segmentsand Market Segments
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Analyzing Industry StructureAnalyzing Industry Structure
Opportunities and threats are competitive Opportunities and threats are competitive challenges arising for changes in industry challenges arising for changes in industry conditions.conditions.
The The five forces model five forces model isis an analytic tool that helps an analytic tool that helps
managers formulate managers formulate appropriate strategic appropriate strategic
responses.responses.
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Porter’s Five Forces ModelPorter’s Five Forces Model
Industry competitorsRivalry amongst existing firms
Potential entrants
Threat of new entrants
Substitutes
Threat of new substitute productor service
Suppliers
Bargaining power of suppliers
Buyers
Bargaining powerof buyers
Source: Adapted and reprinted by permission of Harvard Business Review. An exhibit from “How Competitive Forces Shape Strategy” by Michael E.. Porter (March-April 1979), Copyright © 1979 by the President and Fellows of Harvard College: all rights reserved.
1
2 34
5
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Competitive StrategyCompetitive Strategy
Industry environmentFive forces model
The firmDistinctive competencies
vis-à-vis competitors
Strategic ChoiceMaximize
competitive advantage
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Potential EntrantsPotential Entrants
• Joe Bain’s key insightJoe Bain’s key insight – firm profitability is – firm profitability is affected by extant competition as well as affected by extant competition as well as potential competition.potential competition.• Firms limit their current Firms limit their current profits for fear of attractingprofits for fear of attractingentrants.entrants.
•Entry barriers reduce the threat Entry barriers reduce the threat of new and additional competition.of new and additional competition.
FORCE 1
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Barriers to entry - Bain vs. Barriers to entry - Bain vs. StiglerStigler‘‘Barriers to entry’ is a loaded termBarriers to entry’ is a loaded termJoe Bain (U.C.-Berkeley)Joe Bain (U.C.-Berkeley) - barriers to - barriers to entry exist when entrant firms face entry exist when entrant firms face obstaclesobstaclesGeorge StiglerGeorge Stigler ( (U.ChicagoU.Chicago) - barriers ) - barriers to entry exist when entrant firms face to entry exist when entrant firms face obstacles obstacles not faced by incumbent firmsnot faced by incumbent firms
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““Barriers to entry” - BainBarriers to entry” - Bain• Economies of scaleEconomies of scale• Existence of learning/experience curve effectsExistence of learning/experience curve effects• Strong brand preferences and customer loyalty Strong brand preferences and customer loyalty • Capital requirements and/or other specialized resource Capital requirements and/or other specialized resource requirementsrequirements• Cost disadvantages independent of sizeCost disadvantages independent of size• Access to distribution channelsAccess to distribution channels
All these are barriers according to Bain, but not All these are barriers according to Bain, but not according to Stigler. Entrant firms just have to follow the according to Stigler. Entrant firms just have to follow the same path of incumbentssame path of incumbents
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Barriers to entry - StiglerBarriers to entry - Stigler
All of the above “barriers” would be called All of the above “barriers” would be called first-mover advantages by Stigler. However, first-mover advantages by Stigler. However, Stigler does agree that there are barriers to Stigler does agree that there are barriers to entry. Some examples:entry. Some examples:• Inability to gain access to specialized Inability to gain access to specialized technology - patents are barrierstechnology - patents are barriers• Regulatory policies, tariffs, trade restrictions Regulatory policies, tariffs, trade restrictions - legal restrictions are barriers- legal restrictions are barriers
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Rivalry Among Established Rivalry Among Established CompaniesCompaniesThe intensity of competitive rivalry in an The intensity of competitive rivalry in an industry arises from:industry arises from:
Industry’s competitive structure.Industry’s competitive structure. Demand (growth or decline) conditions in industry.Demand (growth or decline) conditions in industry. Height of industry exit barriers.Height of industry exit barriers.
FORCE 2
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Competitive StructureCompetitive Structure
Continuum 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)
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The Market SpectrumThe Market Spectrum
Real World Market StructuresPerfect Monopolistic Oligopoly Monopoly
Competition Competition Homogeneous Heterogeneous Regulated PureFirms Infinite Many Few Few One
Product Identical Differentiated Homogeneous Heterogeneous No close substituteMkt Pwr None Little Strong Very strong Regulated Perfect
Entry barriers
None LowSubstantial Substantial &
reinforcedLegal Block-
aded
E.g.sStock
marketGas stations, restaurants
Commodities – oil, coffee,
teaAutos, FMCGs Utilities -
Increasing deadweight loss
Inter-dependenceirrelevant
Inter-dependenceabsent
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The Bargaining Power of BuyersThe Bargaining Power of Buyers
Buyers are most powerful when:Buyers are most powerful when: There are many small sellers and few large buyers.There are many small sellers and few large buyers. Buyers purchase in large quantities.Buyers purchase in large quantities. A single buyer is a large customer to a firm.A single buyer is a large customer to a firm. Buyers can switch suppliers at low cost.Buyers can switch suppliers at low cost. Buyers purchase from multiple sellers at once.Buyers purchase from multiple sellers at once. Buyers can easily vertically integrate to compete with Buyers can easily vertically integrate to compete with
suppliers.suppliers.
FORCE 3
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The Bargaining Power of The Bargaining Power of SuppliersSuppliersSuppliers have bargaining power when:Suppliers have bargaining power when:
Their products have few substitutes and are important Their products have few substitutes and are important to buyers.to buyers.
The buyer’s industry is not an important customer to The buyer’s industry is not an important customer to the supplier.the supplier.
Differentiation makes it costly for buyers to switch Differentiation makes it costly for buyers to switch suppliers.suppliers.
Suppliers can vertically integrate forward to compete Suppliers can vertically integrate forward to compete with buyers and buyers can’t integrate backward to with buyers and buyers can’t integrate backward to supply their own needs.supply their own needs.
FORCE 4
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Substitute ProductsSubstitute Products
The competitive threat of substitute products The competitive threat of substitute products increases as they come closer to serving increases as they come closer to serving similar customer needs.similar customer needs.
CloseCloseFarFar
FORCE 5
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A Sixth Force: ComplementorsA Sixth Force: Complementors
Complementors:Complementors: Companies whose products are sold in tandem with Companies whose products are sold in tandem with
another company’s products.another company’s products. Increased supply of a complementary product Increased supply of a complementary product
collaterally increases demand for the primary product.collaterally increases demand for the primary product.
Example:Example: Faster CPU chips fuel salesFaster CPU chips fuel sales
of personal computers.of personal computers.
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Who profits from falling Who profits from falling transaction costs?transaction costs?
Complementary AssetsFreely available Tightly held
or unimportant and important
Imitability High 1. Difficult to make 2. Money made on
Primary money complementary assets
Assets Low 3. Money made on 4. Bargaining power
primary assets determines outcome
MarketFirm 1 Firm 2
Inno
vato
r
Complementor
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ExampleExample
Nokia makes cell phone bodiesNokia makes cell phone bodies
Texas Instruments makes Digital Signal Processing Texas Instruments makes Digital Signal Processing chips (DSPs) that make it possible for cell phones chips (DSPs) that make it possible for cell phones to become web devicesto become web devices Primary assets – Nokia’s cell phone technologyPrimary assets – Nokia’s cell phone technology Complementary assets – TI’s DSP technologyComplementary assets – TI’s DSP technology
Which cell does this fall into?Which cell does this fall into?
This is a generic example as more and more devices This is a generic example as more and more devices become web-enabled, e.g., TVs, fridges, etc. become web-enabled, e.g., TVs, fridges, etc.
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Generic StrategiesGeneric Strategies
Complementary AssetsFreely available Tightly held
or unimportant and important
Imitability High 1. RUN 2. Joint venture (JV),
Primary alliance, acquisition
Assets Low 3. BLOCK 4. BLOCK: JV,
alliance, acquisition
RunRun: continuously changing key elements of the businessmodel - continuous innovationBlockBlock: Erect barriers to entry around existing businessmodel - making imitation costly (patents, brands, etc.)
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Collaborative Advantage – Burton’s 5 sourcesCollaborative Advantage – Burton’s 5 sources
Industry collaboratorsHorizontal strategic alliances
Suppliers Buyers
Previously unrelated industries
Substitutes and complements
Prospective diversificationalliances
Related diversification alliances
Relational contracting,quasi-integration
Partnering w/channels., buyers
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Collaborative StrategyCollaborative Strategy
Industry environmentFive sources model
The firmDistinctive competencies vis-à-vis collaborators
Strategic ChoiceMaximize
collaborative advantage
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Five forces of competition Five sources of collaboration
Firm’s distinctive competencies
Sustainable competitive advantage
Sustainable collaborative advantage
Composite strategyMaximize overall sustainable advantage
PORTER BURTON
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The Role of the Macro-environmentThe Role of the Macro-environment
Polity Economy
Society Technology
Demography
Regulation
BuyersSuppliers
Rivals
Substitutes
INTERNALOperations
FinanceHRM
MarketingEntrants
Complements
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Wide-focus: PEST ANALYSISWide-focus: PEST ANALYSISPOLITY
Nature of govt; Govt stability; Freedom of Markets:
Monopolies; Environment protection laws; Taxation
policy; Foreign trade regulations; Employment law
ECONOMY Business Cycles; GNP trends; Interest rates; Money supply;
Inflation; Unemployment; Disposable income; Energy
availability and cost
SOCIETY Population Demographics; Income
distribution; Social mobility; Lifestyle changes; Attitudes to
work, leisure and risk; Attitudes towards women, minorities, immigration; Consumerism;
Levels of education
TECHNOLOGY Govt spending on research;
Industry focus on technology; New discoveries/development; Speed of technology transfer;
Rates of obsolescence
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Strategic Groups Within Strategic Groups Within IndustriesIndustriesThe concept of strategic groupsThe concept of strategic groups
Within an industry, a competitor grouping using Within an industry, a competitor grouping using similar strategies that differ from other industry similar strategies that differ from other industry groups.groups.
Implications of strategic groupsImplications of strategic groups The closest industry competitors are those in the The closest industry competitors are those in the
group.group. The various industry groups are differentially and The various industry groups are differentially and
competitively advantaged and positioned.competitively advantaged and positioned. Mobility barriers inhibit the movement of competitors Mobility barriers inhibit the movement of competitors
from one strategic group to another.from one strategic group to another.
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Strategic Groups in the Strategic Groups in the Pharmaceutical IndustryPharmaceutical Industry
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Criticisms of the Five Forces and Criticisms of the Five Forces and Strategic Group ModelsStrategic Group Models
•Both models are static and ignore innovation.Both models are static and ignore innovation.•Their focus is on industry and group Their focus is on industry and group structures rather than individual companies.structures rather than individual companies.
Innovation creates change in Innovation creates change in industry structures, altering theindustry structures, altering thecompetitive environment.competitive environment.
Industry structure cannot Industry structure cannot fully explain the performance fully explain the performance differences between industry differences between industry competitors.competitors.
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PunctuatePunctuatedd
EquilibriuEquilibriumm
andandCompetitiCompetiti
veveStructureStructure
Major Innovation
Development & Diffusion
Stasis
Stasis
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The Industry Life Cycle ModelThe Industry Life Cycle Model
Stages in the industry life cycle:Stages in the industry life cycle:
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Technology and the life cycleTechnology and the life cycle
DevelopmentCompeting standards
Leaders – first movers
Diffusion•Emergence of an industry
standard•Network externalities
Fast followers – second movers
ImitationParallel
development
AdoptionLicensing &
royalties
Late followers – thirdmovers
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Industry life cycle and industry Industry life cycle and industry structurestructure
TIME
• Many firms • Competing techs/ standards• Product is:
• Expensive• User unfriendly
• Slow growth
• Mergers/Acquisitions/ Exits• Development of singlestandard• Product is:
• Much cheaper• User friendly
• Product R&D• Rapid growth
• Mature Oligopoly• Intense rivalry• Process R&D• Slow growth, decline
Nascent Phase Consolidation Maturity
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Network Economics As a Network Economics As a Determinant of Industry ConditionsDeterminant of Industry Conditions
The demand for primary industry products The demand for primary industry products depends on the size of the total market for depends on the size of the total market for complementary products.complementary products. Network economics result inNetwork economics result in
positive feedback loops that positive feedback loops that foster rapid demand increases.foster rapid demand increases.
Market competitors are Market competitors are protected by switching protected by switching cost entry barriers.cost entry barriers.
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Positive Feedback in the Computer Positive Feedback in the Computer IndustryIndustry
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Globalization and Industry Globalization and Industry StructureStructureGlobalizationGlobalization
Globally dispersed production lowers Globally dispersed production lowers costs and increases quality.costs and increases quality.
Global markets are replacing Global markets are replacing national markets.national markets.
Trend implicationsTrend implications No isolated national marketsNo isolated national markets More competitors, more intense competitionMore competitors, more intense competition More rapid innovation and shorter product life cyclesMore rapid innovation and shorter product life cycles
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The Internet – a powerful external The Internet – a powerful external stimulusstimulus
Greater incentives for collaborative strategies
Larger fixed costs
Shorter product life-cycles
More uncertainty
INTERNET
Globalizing customers
Dispersed, changing technology
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The Nation-State and The Nation-State and Competitive Advantage – Competitive Advantage – Porter’s Diamond modelPorter’s Diamond modelThe determinants of competitive advantage:The determinants of competitive advantage:
Factorendowments
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SummarySummary
Static models for analyzing the firm’s Static models for analyzing the firm’s external environmentexternal environment
The industry – 5 forcesThe industry – 5 forces Beyond the industry – PESTBeyond the industry – PEST Within the industry – strategic groupsWithin the industry – strategic groups
Dynamic modelsDynamic models Punctuated equilibria and the industry life cyclePunctuated equilibria and the industry life cycle
Drivers of the external environmentDrivers of the external environment Networks, globalization, location advantagesNetworks, globalization, location advantages