Presentation on theme: "Economics of Strategy Industry Analysis"— Presentation transcript:
1 Economics of Strategy Industry Analysis Focus here is on the INDUSTRY
2 Five-Forces AnalysisA systematic analysis of major economic forces affecting the industryInternal RivalryEntryBuyer PowerSeller PowerSubstitute ProductsAssess each force by asking“Is it sufficiently strong to reduce or eliminate industry profits?”Widely used tool for strategic decision-making. It has some weaknesses which we will cover later. It also has tremendous strengths.If you want to enter into an industry then you need to make a systematic survey of that industry from a host of perspectives.Five-Force analysis does this.
4 Internal RivalryWhat is the intensity of competition within the market?Types of CompetitionPrice CompetitionNon-price CompetitionInternal Rivalry sets in the middle of the model due to its pivotal role in the industry. Price and non-price competition both take a toll on industry profit margins. Price reductions directly erode TR in markets with elastic demand and non-price competition erodes the TC side.
5 Price CompetitionFirms within the industry competing for consumers with pricePrice competition is more fierce withnumerous sellershomogeneous productsswitching costs that are low for consumerstransaction conditions that are not transparent to other firmssales orders that are large, received infrequently, and at irregular intervalsexcess capacity exists in the industryUse the Profit Mountain Story with S&D AnalysisEntry in the form of (1) Expansion of output levels by extant firms (2) actual entry into the market by new firms. Both have the same effect on the supply curve over time - S shifts out.
6 Non-Price Competition firms within the industry are competing for consumers on non-price factorsproduct delivery conditions and schedulingconditions of contractwarranties, return policies, customer service provisionsterms of payment/financingtie-in salesrelationship selling (“Best BBQ Clause”)
7 Levels of Rivalry Depend upon relative size and success of peer firms large numbers of firms tend to reduce rivalrywide ranges of success tend to increase rivalryindustry growth ratesrapid growth rates tend to increase rivalry
8 Levels of Rivalry Tend to increase with high fixed costs high storage costsperishabilitylow switching costsegosdiversity among firm paths to profitabilitytechnological changelumpy capacity investmentHigh fixed costs, high storage costs, and product perishability all tend to increase the downward pressure on price and competition among peer firms in general.When consumers can easily switch to your competitor rivalry increases.When management egos become involved rivalry can increase (Michael Eisner and Jeffrey Katzenberg)When a host of different strategies have produced good results rivalry increasesTechnological change speeds up the competitive processWhen additional capacity has to be added in large chunks/unit plants (”lumpy”) rivalry increases
9 Entry Entry erodes profit margins Entry from existing firms with existing capacity, change in quantity suppliedwith new capacity, change in supplyEntry from interloper firmsThe “IBM LOVES COMPETITION FALLACY”
10 Barriers to Entry Economies of Scale Economies of Scope Ownership of a required inputintellectual property rights, patents, copyrights, crucial resourceFavorable access to distribution channelsHigh financial capital requirementsProduct differentiation/ strong brand identity
11 Other Potential Incumbent Advantages Learning curves/ accumulated experience in the industryFavorable access or terms with input suppliers’Geographical/Location advantagesRegulatory EnvironmentExperience withInfluence withinCaptured and used to block entrySlow growth in the industry can create time pressures
12 Threat of RetaliationExisting firms may have an established pattern of deterring new entrantsExisting firms may have financial resources to ride out the retaliatory periodExisting firms may have ties to suppliers, distributors, or customers which can be leveraged to deter new entrants
13 Substitutes What are the available substitutes for consumers? Think about all available and potential substitutesChanges in technologyChanges in consumer tastes and preferencesFirm-level price elasticity within the industry or industry-level price elasticity across substitute industries?Look forward… but not too forward!Where are your strategic competitors of the future?Cable TV Companies as an exampleTelephone companies Satellite Dishes Electrical Companies Cellular Service?Could you use a decision tree? Rate each potential competitor on level of short-term, medium-term, and long-term threat.“Beware the ides of futurists” - they make great best-sellers but their predictions often don’t pan out.
14 Identifying Substitutes Identify products which provide the same functional useFocus on substituteswhich are relatively good substitutes but have been historically excluded because of production costswhich are produced by an industry enjoying high profitsElectricity has numerous substitutes in heating (e.g., oil, wood, active solar, passive solar, propane, kerosene, natural gas, geothermal) but few substitutes in lighting.Some potential substitutes that seem very weak, usually due to high relative costs, may become viable substitutes in very short time periods. Could be due to changes in technology (e.g., the development of viable electric cars is highly dependent upon battery technology and advances in battery technology could make electric cars viable substitutes quickly.)Also watch out for firms which have accumulated high levels of retained earnings. They may be laying low for a bushwhackin’ ! If they have a close substitute, but its costs are high, finding ways to reduce those costs provide an entry wedge and may also be a strategic move if their technology is likely to leap-frog yours.
15 Supplier Power input suppliers have market power due to relationship specific assetsexploiting the gap between rents and quasi-rentsdue to monopoly powerallows flexibility in extracting rentswhen buyer is doing well -- raise input priceswhen buyer is doing poorly -- lower input prices
16 Supplier Power increases if Suppliers have market powermonopolyoligopolyyour purchases are unimportant to firm revenuesthey have built in high switching costs for youthey can, or threaten to, integrate upstream
17 Buyer Power buyers may have market power monopsony - single buyer oligopsony - small number of buyerscan be due to relationship specific assetsexploiting the gap between rents and quasi-rentsMonopsony or Oligopsony occur when a firm’s purchases of your product represent a large portion of your sales or their purchases are important to your needs such as a regular cash flow (RAM Photography and TRW.)
18 Buyer Power increases if they are price sensitivebecause the product they are purchasing represents a high proportion of their costsbecause they are acclimated to competitive pricing in the input marketthey earn low profitsthey face low switching coststhey can, or threaten to, integrate downstreamthe input is not critical to the quality of the final product
19 Five-Forces Analysis Inherent Weaknesses Assumes sufficient demand exists in industryFocuses on the industry as a wholeIgnores government (the gorilla in the living room…)Regulatory EnvironmentIndustry-specific regulationHealth, Safety, Environmental regulationProperty Rights policiesTaxation PoliciesSocial Welfare PoliciesQualitative analysis