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Analysing the Industry Environment

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1 Analysing the Industry Environment
Prof.univ.dr. Ion ANGHEL

2 Topics Objectives of the lesson Environmental analysis
Analyzing industry attractiveness Applying industry analysis Case study Prof.dr.Ion ANGHEL

3 1. Objectives Identify the main structural features of an industry that influence profitability Explain why some industries are more profitable than others Use evidence on structural trends within industry to forecast changes in profitability Identify opportunities to influence industry structure and improve profitability Analyze competition and customer requirements for competitive advantage Prof.dr.Ion ANGHEL

4 2. Environmental analysis
Major Principles For the firm, to make profit it must create value for customers. The firm must understand its customers In creating value the firm acquires goods and services from suppliers. The firm must understand the suppliers The ability to generate profitability from value creating depends on the intensity of competition among the firms Prof.dr.Ion ANGHEL

5 The National/ International Economy The Natural Environment
Technology THE INDUSTRY ENVIRONMENT Suppliers Competitors Customers Demographic structure Government Social Structure Prof.dr.Ion ANGHEL

6 Environmental analysis
The purpose of strategy: to help firms to survive and make money What determine the level of profit in an industry ? Business is about the creation of value PRODUCTION: Transforming inputs into outputs ARBITRAGE: Transferring products across time and space The surplus of value over cost is distributed between customers and producers by the force of competition Ex: house cost = 500 E/mp, market value = E/mp, price = 750 E/mp Prof.dr.Ion ANGHEL

7 Environmental analysis
The profit earned by companies depends on: The value of the products/ service to customers (ex I pod, LCD, a Ski winter holiday in Austria ) The intensity of competition The relative bargaining power at different level in the production chain Prof.dr.Ion ANGHEL

8 3. Analyzing industry attractiveness
Some industries (tobacco, pharmaceuticals) consistently earn high rates of profit but others (iron, steel, airlines, basic buildings materials) have failed to cover their cost of capital This is the result of systematic influence of the industry structure Monolopolistic (US market for smokeless tobacco) vs Perfect competition (Chicago grain market) Prof.dr.Ion ANGHEL

9 Structural features Industry types Perfect Competion Oligopoly Duopoly
Monopoly Concentration Many firms A few firms Two firms One Firm Entry/ Exit Barriers No bariers Significant barriers High barriers Product differentioation Homogenous products Product differentiation Information Perfect information flow Imperfect information flow Prof.dr.Ion ANGHEL

10 Analyzing industry attractiveness
Porter Model 5 forces/ sources of competitive pressure “Horizontal” competition: competition from substitutes, competition from entrants, competition from established rivals “Vertical” competition: bargaining power of suppliers and buyers Prof.dr.Ion ANGHEL

11 Prof.dr.Ion ANGHEL

12 1.Rivalry among existing Firms
industry growth: growing rapidly: firms need not to grab market share from other to grow; stagnant industries generates price wars among the firms in the industry concentration and balance of competitors a dominant company : only one enforce the rules of competition; a couple of competitors: they can implicitly cooperate with each other to avoid destructive price competition; fragmented industry: price competition is likely to be very severe. Prof.dr.Ion ANGHEL

13 Rivalry among existing Firms
Degree of differentiation and switching cost If the products in an industry are very similar, customers are ready to switch to another purely on the basis of price The scale economies and the ratio fixed to variable expenses; If the ratio of fixed to variable expense is high, firms has incentive to reduce prices to utilize the installed capacity (air line industry is a quite common example) Excess capacity and exit barriers; The capacity larger than the demand there is a strong incentive for companies to cut prices to fill capacities. This is exacerbated when fixed assets are very specialized. Prof.dr.Ion ANGHEL

14 2.Threats of New Entrants
Economies of scale. Might arise from large investments in physical plant and equipment (telecommunication); investments in R & D (pharmaceutical, jet engine industry); large expenses / investments in advertising (soft – drink industry); first mover advantage. to set industry standards to use switching cost advantage in learning economies (Microsoft operating system) Prof.dr.Ion ANGHEL

15 Threats of New Entrants
access to channels of distribution and relationships. Supermarket shelf space for new consumer goods manufactures Dealer network access for a new car producer Can be very important barrier in industries like as auditing, investment banking, net advertising Legal barriers Licensing regulations limit the entry into broadcasting, telecommunications industry, taxi services, medical services. Prof.dr.Ion ANGHEL

16 Product differentiation:
Customers loyal to a single brand: 30% batteries, garbage bags and 71% cigarettes (US market) Late entrants into consumer goods market = additional marketing cost 2,1% in revenues Prof.dr.Ion ANGHEL

17 3. Threat of substitution products
The threat of substitution depends on The relative price performance of the competing products/ services Customers’ willingness to substitute Washington – New York by air 2 hours quicker (city center to city center). Average traveler value 25 $/h = train will be competitive with air at fares 50$ bellow. What about Bucharest- Constanta Prof.dr.Ion ANGHEL

18 4. Bargaining power of Buyers
Price sensitivity The importance of the product in the total expenses (ex: the importance of the salt in total cost of a family) The importance of the product in the buyers’ own products/ services quality Relative bargaining power The cost to each party of not doing business with the other party Important factors are: number of buyers relative to the number of suppliers, volume of purchases by a single buyer, number of alternative products available Prof.dr.Ion ANGHEL

19 Bargaining power of suppliers
This is a mirror image of the analysis of the buyer’s powers in an industry. Suppliers are powerful when there are few companies and few substitutes available. Soft – drink industry versus can producers; The pilots versus airline company; Prof.dr.Ion ANGHEL

20 4. Applying industry analysis
Once we understand how industry structure drives competition which determines profitability, we can apply this analysis To forecasting industry profitability Devising strategy to change industry structure Prof.dr.Ion ANGHEL

21 Applying industry analysis
Forecasting industry profitability First stage: understand how past changes in industry have influenced competition and profitability Decreasing in profitability of the world automobile industry Increasing rivalry among existing car makers (industry concentration): Peugeot and Cittroen merger, VW acquired Skoda and Seat, BMW acquired Rover Prof.dr.Ion ANGHEL

22 Example US market share top 3 dropped from 85% to 64% In Germany Mercedes + VW decliend from 50 to 28% Increasing standardization of design, products becoming similar Capacity utilization remained low Major barriers to exit (political pressure, union agreements) The power of suppliers had increased (size and multinationality) Technology development was led by component manufacturers not the auto companies (automobile supermarket) Prof.dr.Ion ANGHEL

23 Applying industry analysis
Strategy to alter Industry Structure, 2 steps To identify the key structural features of an industry that are responsible for depressing profitability To consider which of these structural factors are amenable to change Prof.dr.Ion ANGHEL

24 Examples In consumer electronics, suppliers of leading brands (Sony, Pioneer) have sought to limit the buying power of discount chain: by refusing to supply those chains that advertise cut prices or that do not display their products “an appropriate retailing environment” Oil refining industry: returns bellow the cost of capital due to competition, excess capacity, commodity products: solution merger between BP and Mobil in Europe, Shell and Texaco in US Differentiation through performance enhancing additives to gasoline Prof.dr.Ion ANGHEL

25 5. Applying industry analysis: the PC Industry
Personal Computer Industry is an young sector, starting in 1981 when IBM announced its PC with Intel’s microprocessor and Microsoft’s DOS operating System There is a spectacular growth in this industry However in this industry the profitability is very low: IBM, Compaq, Dell and Apple reported poor performances. Prof.dr.Ion ANGHEL

26 Competition in PC industry
Is a very intense competition because The industry is very fragmented, with many companies producing virtually the same products. The most important five vendors controlling 50-60% in the market but there is routine price cut on a monthly base; Component costs accounted around 60% in total hardware cost; Products realized by different companies are virtually identical and there are few opportunities to differentiate products. Brand name and service became less important because PC buyers are now more informed about technology; Prof.dr.Ion ANGHEL

27 Switching cost across different brands were relatively low because almost all used Intel microprocessors and Microsoft Windows operating system; Access to distribution is a small barrier (Internet based sales starting from 1990); All components needed to produce a personal computer were available for purchase, there are few limits to entering in the industry (Michael Dell started Dell Computer Company in 1980 by assembling PCs in his University of Texas dormitory room); Prof.dr.Ion ANGHEL

28 The power of suppliers and buyers
Key hardware and software components for PC were controlled by firms with virtually monopoly (Intel and Microsoft) Today, because of the clients are knowledgeable about PC technology, customers are not influenced by the brand and the price is the most important consideration in their buying decision; Prof.dr.Ion ANGHEL

29 Conclusions Performances are poor in PC industry because:
Intense rivalry Low barriers to entry The important power of suppliers Important pressure on firms to invest money to introduce new products rapidly, maintain quality, provide excellent customer support This is a technologically dynamic industry but with poor potential profit. As a result the profitability of the PC industry may not improve significantly any time in the future. Prof.dr.Ion ANGHEL

30 Professor Academy of Economic Studies IVSC Professional Board Member
Multumesc ! Ion ANGHEL, Ph.d Professor Academy of Economic Studies IVSC Professional Board Member Prof.dr.Ion ANGHEL


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