Analyzing the Industry Environment

The main objective:to analyze how competition determines industry profitability Primary tasks: Identification the main structural features of an industry that influence competition and profitability Structural analysis to explain why in some industries competition is more intense and profitability lower than in other industries Structural trends within industries to forecast changes in competition and profitability in the future Analysis of competition and customer requirements in order to identify opportunities for competitive advantage within an industry

From Environmental Analysis to Industry Analysis The business environment of the firm consist of all the external influences that affect its decisions and performance. The core of the firms business environment is formed by its relationship with industry environment: customers, suppliers and competitors. This is not to say that macro-level factors such as general economic trends, changes in demographic structure,or social and political trends are unimportant to strategy analysis.

From Environmental Analysis to Industry Analysis The key issue is how these more general environmental factors affect the firms industry environment / figure: From environmental analysis to industry analysis/ By focusing on the industry environment, we can determine which macro-level influencers are important for the firm and how they likely to affect the firms relations with customers,suppliers, and competitors.

The Determinants of Industry Profit: Demand and Competition Business is about the creation of value for customers ! Firms create value by Production /transforming inputs into outputs/ or by Arbitrage/transferring products across time and space/.Value creation requires that the price the customer is willing to pay the firm exceed the cost incurred by the firm.

The Determinants of Industry Profit: Demand and Competition Value creation does not translate directly into profit. The stronger the competition among producers, the lower the price actually paid by customers compared with the maximum price they have been willing to pay.

The Determinants of Industry Profit: Demand and Competition A single supplier of bottled water at an all-night dance party can charge a price that fully exploits the dancers thirst.If there are many suppliers of bottled water, then, in the absence of collusion, competition causes the price of bottled water to fall toward the cost of supplying it.

The Determinants of Industry Profit: Demand and Competition The profits earned by the firms in an industry are determined by three factors: The value of product or service to customers The intensity of competition The relative bargaining power at different levels in the production chain

Industry Attractiveness Some industries/ such as tobacco and pharmaceuticals/ consistently earn high rates of profit; others/ such as iron and steel, nonferrous metals, airlines,and basic building materials/ have failed to cover their cost of capital [table: the profitability of US Industries]

Industry Attractiveness A single firm protected by barriers to the entry of new firms forms a monopoly in which it can appropriate in profit the full amount of the value it creates. By contrast, many firms supplying an identical product with no restrictions on entry or exit constitutes perfect competition : the rate of profit falls to a level that just covers firms cost of capital. In the real world, industries fall between these two extremes../Table: The spectrum of Industry Structures/.

Industry Attractiveness The US market for chewing tobacco is close to being a monopoly; the Chicago grain markets are close to being perfectly competitive. Most manufacturing industries and many service industries tend to be oligopolies: they are dominated by small number of major companies.

Porters Five Forces of Competition Framework Michael Porter /Harvard Business School/ views the profitability of an industry as determined by five forces of competitive pressure: 1.Competition from substitutes 2.Competition from entrants 3.Competition from established rivals 4. Bargaining power of suppliers 5. Bargaining power of buyers /Figures: Porters Five Forces of Competition Framework and The Structural Determinants of the Five Forces of Competition/

Competition from Substitutes The price customers are willing to pay for a product depend, in part,on the availability of substitute products. The absence of close substitutes for a product means that consumers are comparatively insensitive to price: demand is inelastic with respect to price. The existence of close substitutes means that customers will switch to substitutes in response to price increases for the product: demand is elastic with respect to price.

Threat of Entry If an industry earns a return on capital in excess of its cost of capital, that industry acts as a magnet to firms outside the industry. Unless the entry of new firms is barred,the rate profit will fall toward its competitive level. The principal sources of barriers to entry are capital requirements, economies of scale, cost advantages, product differentiation, access to channels of distribution, governmental and legal barriers, and retaliation.

Threat of Entry : Capital Requirements The capital costs of getting established in an industry can be so large as to discourage all but the largest companies. The duopoly of Boeing and Airbus in large passenger jets is protected by the prohibitive costs of establishing such a venture. In satellite television broadcasting in Britain, Rupert Murdochs Sky TV incurred almost $1 billion in capital costs. Startup costs for fast-food restaurants are around $350,000 for a Wendys and close to $1 million for a burger King.

Threat of Entry :Economies of Scale Efficiency requires large-scale operation In automobiles, it is generally reckoned that to be low-cost producer, sales of over four million vehicles a year are necessary. These economies of scale have deterred entry into the industry so that the only recent entrants have either been state-supported companies or companies that have gambled that low labor and material costs would offset their scale inefficiency. Airbuss proposed A380 superjet will cost an estimated $12-16 billion, requiring sales over 800 planes.

Threat of Entry :Absolute Cost Advantage Apart from economies of scale, established firms may have a cost advantage over entrants simply because they entered earlier. Absolute cost advantages tend to be associated with the acquisition of low-cost sources of raw materials or economies of learning

Threat of Entry :Product Differentiation In an industry where products are differentiated, established firms possess the advantages of brand recognition and customer loyalty New entrants to such markets must spend disproportionately heavily on advertising and promotion to gain levels of brand awareness and brand goodwill similar to that of established companies.Alternatively, the new entrant can accept a niche position in the market or can seek to compete by cutting price.

Threat of Entry: Access to Channels of Distribution Whereas lack of brand awareness among of consumers acts as a barrier to entry to new suppliers of consumer goods, a more immediate barrier for the new company is likely to be gaining distribution

Threat of Entry:Governmental and Legal Barriers In taxicabs, banking, telecommunications, and broadcasting, entry usually requires the granting of a license by a public authority. In knowledge –intensive industries, patents, copyrights, and trade secrets are major barriers to entry.Xerox Corporations near-monopoly position in the world plain-paper copier business until the mid –1970s was protected by a wall of over 2,000 patents relating to its xerography process.

Threat of Entry: Retaliation The effectiveness of barriers to entry also depends on the entrants expectations as to possible retaliation by established firms. Retaliation against a new entrant may take the form of aggressive price cutting, increased advertising, sales promotion.The airline industry has a long history of retaliation against low –cost entrants. Laker Air, one of the first cut-price transatlantic airlines, was ultimately driven out of business by established airlines aggressive price cutting.

Threat of Entry: Retaliation When Japanese firms first entered the US car and consumer electronics markets, they sought to avoid retaliation by introducing small products in segments that were deemed unprofitable by US producers. A successful retaliatory strategy is one that deters entry by using a threat that is credible enough to intimidate would-be entrants.

Rivalry between Established Competitors For most industries, the major determinant of the overall state of competition and the general level of profitability is competition among the firms within the industry. Six factors play an important role in determining the nature and intensity of competition between established firms: concentration, the diversity of competitors, product differentiation, excess capacity, exit barriers, and cost conditions

Concentration Seller concentration refers to the number and size distribution of firms competing within a market

Diversity of Competitors The ability of firms in an industry to avoid price competition also depend on their similarities in terms of origins, objectives, costs and strategies. The difficulties of OPEC in agreeing and enforcing oil prices and output quotas are increased by differences among member countries in objectives, costs, politics, and religion.

Product Differentiation The more similar the offerings among rival firms, the more willing customers are to substitute and the greater the incentive for firms to cut prices to increase sales. Commodity industries such as agriculture, mining, and petrochemicals tend to be plagued by price wars and low profits. By contrast, in industries where products are highly differentiated / perfumes, pharmaceuticals, restaurants,etc/ price competition tend to be weak, even though there may be many firms competing.

Excess Capacity and Exit Barriers Unused capacity encourages firms to offer price cuts to attract new business in order to spread fixed costs over a greater sales volume. The key issue is whether excess capacity will leave the industry. Barriers to exit are costs associated with capacity leaving an industry. Where resources are durable and specialized, and where employees are entitled to job protection, barriers to exit may be substantial

Bargaining Power of Buyers The strength of buying power that firms face from their customers depends on two sets of factors: Buyers price sensitivity Relative bargaining power

Buyers Price Sensitivity: four main factors 1.The greater the importance of an item as a proportion of total cost, the more sensitive buyers will be about the price they pay.Beverage manufactures are highly sensitive to the costs of metal cans because this is one of their largest single cost items. 2.The less differentiated the products of the supplying industry, the more willing the buyer is to switch suppliers on the basis of price

Buyers Price Sensitivity: four main factors 3.The more intense the competition among buyers, the greater their eagerness for price reductions from their sellers. As competition in the world automobile industry has intensified, so component suppliers are subject to greater pressures for lower prices, higher quality, and faster delivery

Buyers Price Sensitivity: four main factors 4.The greater the importance of the industrys product to the quality of the buyers product or service, the less sensitive are buyers to the prices they are charged. The buying power of personal computer manufactures relative to the manufacturers of microprocessors /Intel, Motorola, etc/ is limited by the critical importance of these components to the functionality of their product

Relative Bargaining Power Bargaining power rests,ultimately, on refusal to deal with the other party. Several factors influence the bargaining power of buyers relative to that of sellers: Size and concentration of buyers relative to suppliers. The smaller the number of buyers and the bigger their purchases, the greater the cost of losing one.

Relative Bargaining Power Buyers information. The better informed buyers are about suppliers and their prices and costs, the better they are able to bargain Ability to integrate vertically.In refusing to deal with the other party, the alternative to finding another supplier or buyer is to do it yourself.

Bargaining Power of Suppliers Analysis of the determinants of relative power between the producers in an industry and their suppliers is precisely analogous to analysis of the relationship between producers and their buyers

Bargaining Power of Suppliers The suppliers of complex, technically sophisticated components may me able to exert considerable bargaining power.The supplier power of Intel in microprocessors, Microsoft in operating systems has been a powerful.A common source of supplier power is labor unions. Where is an industry has a high percentage of its employees unionized, its profitability is reduced

Key Success factors To survive and prosper in an industry, a firm must meet two criteria: It must supply what customers want to buy It must survive competition Hence, we may start by asking two questions: What do our customers want? What does firm need to do to survive competition?

Key Success factors To answer the first question we need to look more closely at customers of the industry and to view them not so much as a source of bargaining power and hence as a threat to profitability, but more as the basic rationale for the existence of the industry and as the underlying source of profit. The second question requires that the firm examine the basis of competition in the industry.