Chapters 3

1
Chapters 3 4 External Analysis Tools

• Industry definition and segmentation
• Porters Five (6?) Forces
• Macro-environmental Forces
• Key Success Factors
• Strategic Groups
• Competitor Analysis
• Game Theory

2
Sowhat is an industry?

• Economists define an industry as a group of
  firms that supplies a market. Hence, the key to
  defining industry boundaries is identifying the
  relevant market. By focusing on the relevant
  market, we do not lose sight of the critical
  relationship among firms within an industry
  competition.
• A markets boundaries are defined by
  substitutability, both on the demand and supply
  side.

3
Segmentation Analysis

• Segmentation is important if the nature and
  intensity of competition varies in an industry
• Identify the key segmentation variables
• Substitutability customer and supply
• Construct a segmentation matrix
• Analyze segment attractiveness
• Identify Key Success Factors
• Analyze broad vs. narrow scope

4
Industry Analysis Objectives

• To understand how industry structure drives
  competition, which determines the level of
  industry profitability
• To assess industry attractiveness
• To use evidence on changes in industry structure
  to forecast future profitability
• To identify opportunities to change industry
  structure to impose industry profitability
• To identify Key Success Factors.

5
Porters 5 (6?) Forces

• Forces that shape competition in an industry
• Used to analyze the external opportunities and
  threats
• As forces grow stronger, the ability of firms to
  raise prices and earn profits becomes limited.

6
Porters 5 Forces
Natural Environment

Political Legal Environment
Technological Environment
Potential Competitors
Supplier Power
Buyer Power
Rivalry
Substitutes
Macroeconomic Environment
Demographic Environment
Social Environment
7
P5 Analyses

• For each factor in the five forces analysis,
  analysts should determine
• The strength of each force
• The effect on industry profitability
• The possibility of change

8
1 - Risk of Entry (Competition)

• Incumbents discourage entry by establishing
  barriers
• Barriers to entry (Bain) include
• Brand loyalty (product differentiation)
• Cost advantages
• Production (knowledge, patents, processes, EOS)
• Resource control (raw materials, labor,
  equipment)
• Access to low-cost capital
• Distribution channel control
• Switching Costs
• Government regulations (policies, taxes, EPA)
• Retaliation

9
2 - Rivalry

• Weak higher prices greater profits
• Strong price wars lower profits
• Function of three factors
• Competitive Structure
• Demand Conditions
• Exit Barriers

10
Competitive Structure

• Fragmented Industries
• Large number of small companies - no domination
• Low barriers to entry
• Commodity-based - difficult to differentiate
• Consolidated Industries
• Small number of large companies
• Very interdependent
• Follow-the-leader strategies prevail

11
Demand Conditions

• Growing demand provides greater room for
  expansion and entry.
• Shrinking demand creates market share wars and no
  entry.
• Excess capacity and the credibility of the threat.

12
Exit Barriers

• Keep companies from leaving an industry
• Investment in specific assets (plant equip)
• High fixed costs of exit (severance)
• Emotional attachment (history)
• Sole source of income (single product)

13
3 - Power of Buyers

• Buyers have power when
• Industry has many small firms (many choices) and
  buyers are few and large.
• Buyers purchase in volume.
• Switching costs are low or buyers can purchase
  from several firms at once.
• High threat of (backward) vertical integration

14
4 - Power of Suppliers

• Suppliers have power when
• Few substitutes
• Industry is not an important customer
• High switching costs (specific or differentiated
  product)
• High threat of (forward) vertical integration

15
5 - Substitute Products

• Close substitutes limits pricing flexibility
• Must consider products both inside and outside
  the industry.
• Beverage
• Auto
• The extent of competitive pressure from
  substitutes depends upon
• Buyers propensity to substitute
• The price/performance characteristics of
  substitutes

16
6 - Complementors

• Companies that sell complements to the
  enterprises own products.
• ie Sony PlayStations Game companies
• Automobile Roads Gas Stations
• Computers Software
• High complementor supply/quality opportunity
• Low complementor supply/quality threat

17
Limitations of Porters 5 (6?)

• Static
• Cross-sectional
• Cannot accommodate innovation
• company viewed in evolutionary terms
• punctuated equilibrium
• Overemphasizes industry, underemphasizes company
• Rumelt - Does industry matter?

18
Key Success Factors

Prereqs for success
What do customers want?
Can we survive competition?
What drives competition? What are the main
factors of competition? How intense is
competiton? How can we obtain SCA?
Who are our customers? What do they want?
KSF's
19
The Macro-environment

• Five factors that can alter the opportunities and
  threats analysis
• Macro-economic environment
• Technological environment
• Social environment
• Demographic environment
• Political Legal environment

20
Macro-environment

• Macro-economic
• Health and well-being of the economy
• growth rate
• interest rates
• inflation
• currency exchange rates
• Technological
• Perennial gale of creative destruction
  (Schumpeter)
• Technological change can change entry and exit
  barriers

21
Macro-environment

• Social environment
• Social consciousness (iehealth)
• Socio-political events (ie Sierra Club)
• Demographic environment
• Change in pop. mix (baby-boom, immigration)
• Political Legal environment
• Deregulation, EPA, etc.
• The Natural Environment
• Global warming, rainforest, etc.

22
Strategic Groups

• Groups of firms within an industry that follow
  the same basic strategy
• Distribution channels Pricing
• Product quality Advertising
• Technology Customer service
• Pharmaceutical Industry
• A firms closest competition is within the
  strategic group.
• Mobility barriers - movement between groups

23
Strategic Groups
Proprietary Group
Merck Pfizer Eli Lilly
Prices Charged
Generic Group
Marion Labs Carter Wallace ICN Pharma
RD Spending
24
Competitor Analysis

• Thus, the result of the analyses above, more than
  anything else, is to understand ones rival.
• To forecast competitors future strategies and
  decisions
• To predict competitors likely reactions to a
  firms strategic initiatives
• To determine how competitors behavior can be
  influenced to make it more favorable.

25
Competitor Analysis Framework
STRATEGY How is the firm competing?

OBJECTIVES Competitions goals? Meeting
goals? Goals likely to change?
PREDICTIONS - What strategy changes will
competition initiate? - How will
competition respond to new strategic initiatives?
ASSUMPTIONS What assumptions does competion hold?
RESOURCES CAPABILITIES What are competitions
key strengths and weaknesses?
26
Game Theory

• One last thoughtP5 offers little insight into
  firms choices of whether to compete or cooperate
  sequential competitive moves and the role of
  threats, promises and commitments.
• Game theory helps us understand factors that
  affect the moves between competitors, but
  generally cant accommodate the complexity of
  real competition.

27
Game Theory Factors

• Cooperation
• In many cases, competition results in an inferior
  outcome for the players than would cooperation
  (prisoners dilemma).
• Deterrence
• The key to effectiveness is credibility
• Signaling
• Selective communication of information to
  competitors to provoke or avoid certain types of
  reactions
• Reputation
• The future casts a shadow on the present.