1. Darral G. Clarke for BM 4991 BM 499 Ghemawat, Chapter 2 Darral G. Clarke Professor of Management

2. Darral G. Clarke for BM 4992 Source: Compustat, Value Line, Marakon Associates Analysis Average Economic Profits of U.S. Industry Groups, 1978-1996 Value Line Industry Groups

3. Number of Industries First Quartile Average 22.2% Fourth Quartile Average 9.3% Note:Return on Equity = Net Income / Year End Shareholders’ Equity; Analysis based on sample of 593 industries Average = 14.7% Median = 13.8% 11.7% 13.8% 16.5% Return on Equity (Percent) Average Return on Equity in US Industries, 1982-1993 Distribution of Industry Returns Source: Jan W. Rivkin’s Analysis Based on Dun and Bradstreet Data

4. Source: Jan W. Rivkin based on Compustat Computer system design Operating Income / Assets, 1988-95 (%) 0510152025 Scheduled airlines Motor vehicles Cable TV service Engineering services Trucking except local Race track operations Petroleum / natural gas Drug stores Eating places Dental equipment Women's clothing stores Semiconductors Prepackaged software Pharmaceuticals Profitability Differences Across Selected Industries

5. A Three-Dimensional Business Landscape

6. Supply Demand Physical Units Equilibrium Quantity Equilibrium Price Monetary Units Supply-Demand Analysis

7. Beds (% of total market 8,270 beds) Case mix adjusted expense per adjusted day ($) Source: Partners HealthCare System, Inc. (A), Case #696-062 LaheyLawrenceNorwood 0 100 200 300 400 500 600 700 800 900 Winchester Atlanticare Beverly Lowell St. JohnsSouth ShoreGoddard Faulkner 0% 10%20%30%40%50%60%70%80%90% 100% WalthamNNE Memorial Malden Leonard MorseSalemSt. Elizabeth'sMount AuburnNewton-WellesleyNE Medical CenterFraminghamHMCUniversity Supply Curve for Boston Hospitals

8. Darral G. Clarke for BM 4998 u Supply / demand analyses say little about what determines the position and shape of the two curves From Supply / Demand to the Five Forces What determines the long-run supply / demand balance? Entry barriers and intensity of rivalry affect whether firms will add capacity in response to excess demand Exit barriers affect whether firms will retire capacity in response to excess supply What determines the effect of a supply / demand imbalance on profitability? In industries with intense rivalry or powerful buyers, small amounts of excess capacity tend to lead to big price wars In industries with powerful suppliers, the benefits of excess demand may accrue to the suppliers

9. Darral G. Clarke for BM 4999 Threat of New Entry Rivalry Among Existing Competitors Bargaining Power of Customers Threat of Substitutes Bargaining Power of Suppliers Industry Analysis: The Five Forces

10. Darral G. Clarke for BM 49910 Theory of the Firm: The link to the Five Forces Five forces identifies the factors that determine differences in firm profitability Five forces tells us how profitability responds to changes in a large variety of factors P Profit Q

11. Darral G. Clarke for BM 49911 Theory of the Firm:The link between the Five Forces and profitability Consider a sequence of market entry and decreasing differentiation P Profit Q P Q D D

12. Darral G. Clarke for BM 49912 Rivalry among Current Competitors Concentration and balance Industry growth Fixed (or storage costs)/Value added Product differences Brand identity Switching costs Intermittent over-capacity Diverse stakes Exit barriers

13. Darral G. Clarke for BM 49913 Entry Barriers Economies of scale Product differences Brand identity Switching costs Capital requirements Access to distribution Absolute cost advantages Learning curve Access to necessary inputs Low cost product design Government policy Expected retaliation

14. Darral G. Clarke for BM 49914 Power of Buyers Intrinsic Strength Buyer concentration Buyer volume Switching costs Buyer information Ability to backward integrate Substitute products Pull through Price Sensitivity Price/Total purchase Product differences Brand identity Impact on quality/performance Buyer profits Decision maker’s incentives

15. Darral G. Clarke for BM 49915 Power of Suppliers Supplier concentration Substitute suppliers Supplier volume Product differences Brand identity Switching costs Low buyer information Threat of forward integration Pull through

16. Darral G. Clarke for BM 49916 Threat of Substitution Product function not form Entire value added chain Thread depends on Relative price/performance Switching costs Often an S-curve process

17. Customers Firm Suppliers Competitors Complementors A player is your complementor with respect to customers if customers value your product more when they have the other player’s product as well A player is your competitor with respect to customers if customers value your product less when they have the other player’s product as well A player is your complementor with respect to suppliers if it is more attractive for a supplier to provide resources to you when it is also supplying the other player A player is your competitor with respect to suppliers if it is less attractive for a supplier to provide resources to you when it is also supplying the other player The Value Net Source: Adam Brandenburger and Barry Nalebuff, Co-opetition (New York: Currency Doubleday, 1996)

18. Darral G. Clarke for BM 49918 Threat of New Entry Rivalry Among Existing Competitors Bargaining Power of Customers Threat of Substitutes Bargaining Power of Suppliers Availability of Complements Expanded Industry Analysis

19. The Power of Complementors Relative concentration Relative buyer or supplier switching costs Ease of unbundling Differences in pull-through Asymmetric integration threats Rate of growth of the pie

20. Landscapes Landscape is broader than industry Landscape includes firms, institutions, and other players which often are not viewed as part of an industry Landscape includes networks of firms (from different industries) whose profits may be interdependent (e.g. Microsoft-Intel)

21. Commitment Opportunities and Structure Production scale economies set a lower bound on concentration Many settings are more concentrated than production scale economies would imply Opportunities to commit resources to advertising and R & D in ways that enhance willingness-to-pay to some minimal degree are what lead to “excess” concentration

22. Steps in Landscape Analysis Define the landscape: what is in, what is out Identify the players e.g., who are the customers, really? Who are the competitors? Assess the relationships among players See Porter (1979, 1980) for some factors to consider Sniff-test Is assessment in line with actual profitability? Are more profitable players better positioned vis-a-vis competitive forces? Assess recent and future changes

23. Identify forces that must be countered in order to achieve superior profitability Test decision to enter Test decision to exit Assess effects of a major change Identify ways to alter structure Pinpoint most threatening force and seek ways to counter (e.g., build switching costs, find new sources of supply) Consider effect of entry on structure; choose relative position; select entry vehicle; compare costs of entry to benefits Identify options for improving structure or relative position; select exit vehicle; compare costs of exit to benefits Consider how change will affect each force Assess consolidation, backward integration, forward integration, investments that raise entry costs, entry into substitute market, etc. PurposeCommon steps Steps in Landscape Analysis (cont.)

24. Darral G. Clarke for BM 49924 Common Pitfalls in Landscape Analysis Failing to define the landscape clearly A clear definition is more important that the “right” definition Confusing transient effects with structural forces Ignoring changes in structural forces Assuming that competitive forces cannot be altered Confusing evidence of a force with its underlying cause e.g., blaming customer power on customer price sensitivity rather than exploring root causes of price sensitivity Ignoring the full range of substitutes Paying equal attention to all the forces

25. Lessons Industries or landscapes are neither created equal nor stay equal The concept of “extended competition” provides a comprehensive framework for assessing structural attractiveness A firm’s strategy can increase or decrease its exposure to competitive forces Other things being equal, a firm should seek to trigger actions that improve structural attractiveness But it isn’t enough to look at just structural attractiveness: competitive position must also be considered

26. Conclusion Envisioning the business landscape Adapting to the business landscape Shaping the business landscape