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Economics of Strategy Industry Analysis. Five-Forces Analysis A systematic analysis of major economic forces affecting the industry –Internal Rivalry.

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Presentation on theme: "Economics of Strategy Industry Analysis. Five-Forces Analysis A systematic analysis of major economic forces affecting the industry –Internal Rivalry."— Presentation transcript:

1 Economics of Strategy Industry Analysis

2 Five-Forces Analysis A systematic analysis of major economic forces affecting the industry –Internal Rivalry –Entry –Buyer Power –Seller Power –Substitute Products Assess each force by asking –“Is it sufficiently strong to reduce or eliminate industry profits?”

3 Entry Supplier Power Substitute Products Buyer Power Internal Rivalry

4 What is the intensity of competition within the market? –Types of Competition Price Competition Non-price Competition

5 Price Competition Firms within the industry competing for consumers with price Price competition is more fierce with –numerous sellers –homogeneous products –switching costs that are low for consumers –transaction conditions that are not transparent to other firms –sales orders that are large, received infrequently, and at irregular intervals –excess capacity exists in the industry

6 Non-Price Competition firms within the industry are competing for consumers on non-price factors –product delivery conditions and scheduling –conditions of contract warranties, return policies, customer service provisions –terms of payment/financing –tie-in sales –relationship selling (“Best BBQ Clause”)

7 Levels of Rivalry Depend upon –relative size and success of peer firms large numbers of firms tend to reduce rivalry wide ranges of success tend to increase rivalry –industry growth rates rapid growth rates tend to increase rivalry

8 Levels of Rivalry Tend to increase with –high fixed costs –high storage costs –perishability –low switching costs –egos –diversity among firm paths to profitability –technological change –lumpy capacity investment

9 Entry Entry erodes profit margins –Entry from existing firms with existing capacity, change in quantity supplied with new capacity, change in supply –Entry from interloper firms

10 Barriers to Entry –Economies of Scale –Economies of Scope –Ownership of a required input intellectual property rights, patents, copyrights, crucial resource –Favorable access to distribution channels –High financial capital requirements –Product differentiation/ strong brand identity

11 Other Potential Incumbent Advantages –Learning curves/ accumulated experience in the industry –Favorable access or terms with input suppliers’ –Geographical/Location advantages –Regulatory Environment Experience with Influence within Captured and used to block entry –Slow growth in the industry can create time pressures

12 Threat of Retaliation Existing firms may have an established pattern of deterring new entrants Existing firms may have financial resources to ride out the retaliatory period Existing 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 substitutes Changes in technology Changes in consumer tastes and preferences Firm-level price elasticity within the industry or industry- level price elasticity across substitute industries? Look forward… but not too forward!

14 Identifying Substitutes Identify products which provide the same functional use Focus on substitutes –which are relatively good substitutes but have been historically excluded because of production costs –which are produced by an industry enjoying high profits

15 Supplier Power input suppliers have market power –due to relationship specific assets exploiting the gap between rents and quasi-rents –due to monopoly power allows flexibility in extracting rents –when buyer is doing well -- raise input prices –when buyer is doing poorly -- lower input prices

16 Supplier Power increases if Suppliers have market power –monopoly –oligopoly your purchases are unimportant to firm revenues they have built in high switching costs for you they can, or threaten to, integrate upstream

17 Buyer Power buyers may have market power –monopsony - single buyer –oligopsony - small number of buyers –can be due to relationship specific assets exploiting the gap between rents and quasi-rents

18 Buyer Power increases if they are price sensitive –because the product they are purchasing represents a high proportion of their costs –because they are acclimated to competitive pricing in the input market they earn low profits they face low switching costs they can, or threaten to, integrate downstream the input is not critical to the quality of the final product

19 Five-Forces Analysis Inherent Weaknesses –Assumes sufficient demand exists in industry –Focuses on the industry as a whole –Ignores government (the gorilla in the living room…) Regulatory Environment –Industry-specific regulation –Health, Safety, Environmental regulation –Property Rights policies Taxation Policies Social Welfare Policies –Qualitative analysis


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