Question: Explain the purpose of industry analysis.

Answer of the question:

Industry analysis: An industry analysis is a business assessment tool designed to provide a

business with an idea of the complexity and current business environment of a particular
industry. Industry analysis involves reviewing the economic, political and market factors that
influence the way the industry develops. This analysis helps businesses understand various
economic pieces of the marketplace and marketspace and the way to use these pieces to
gain a competitive advantage. Major factors can include the power welded by suppliers and
buyers, the condition of competitors, and the likelihood of new market entrants.

Purpose of industry analysis:

An entrepreneur answers three questions before even having the idea to commence a
business firm:

 Is the industry accessible?

 Is there any scope for innovation and are the industry markets underserved?
 Are there positions in the industry that will avoid some of the negative attributes of
the industry as a whole?

An entrepreneur needs to know inside out of the industry that he is trying to enter
regardless of whether it is a service business, manufacturing, retailing, or some other type
of business. Also everything in that industry that happens outside the business will affect
entrepreneurs company. So knowing about the industry ensures more advantage and
protection. An industry analysis describes:

 Industry participants
 Distribution patterns
 Competition and buying patterns

Industry analysis also allows an entrepreneur to estimate how much he can generate from
business operations. Rarely they enter industries at the plateau stage or those which have
begun an economic decline. Industries under these conditions do not usually generate
enough profits for new business ventures. Moreover, industry analysis leads an
entrepreneur to assess the number of competitors currently selling consumer goods or
services in their industry. High levels of competitors often create lower than desired profits.

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Industry analysis may also help an entrepreneur to discover a market niche not currently
being met by other companies.
From the above discussion one can points out the purpose of industry analysis:

 Analysing industry and competition completes the process of marketing

environment analysis.
 Supports strategy formulation; serves as a prelude to strategy formulation.
 Helps an entrepreneur know the two key factors in forging strategy: industry
attractiveness and its competitive position within the industry.
 Helps the industry identify and build its competitive advantage.

Question: Evaluate the five competitive forces that determine industry profitability.

Answer of the question:

The Five Forces Model: The five forces model was developed by Michael Porter and is a
framework for understanding the structure of an industry. The framework is comprised of
the forces that determine industry profitability. These forces are:

 The threats of substitutes

 The entry of new competitors
 Rivalry among existing firms
 The bargaining power of suppliers
 The bargaining power of buyers

Threat of substitutes: A substitute product is a product from another industry that offers
benefits to the consumer similar to those of the product produced by the firms within the
industry. Threat of substitutes means the availability of such products that the consumer
can purchase instead of the industry's products. The threat of substitution affects the
competitive environment for the organizations in that industry and influences their ability to
achieve profitability because consumers can choose to purchase the substitute instead of
the industry's product. This can be a significant issue as it constrains the ability of suppliers
to raise prices, even though this may be in all of their interests. For example, the price of
newspapers is constrained by the existence of online news and TV news channels. The
availability of these free services has meant that the newspaper industry has been unable to
increase its prices in line with rising costs even though almost all newspaper publishers
would like to do so.

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 Market Products Substitutes
Online News

Newspapers Live TV

Information

Journalists User Blogs

Social Media

Thus the availability of close substitute products can make an industry more competitive
and decrease profit potential for the firms in the industry.
The threat of substitutes is high when:
Consumer switching costs are low.
Substitute product is cheaper than industry product.
Substitute product quality is equal or superior to industry product quality.
Substitute performance is equal or superior to industry product performance.

The threat of substitutes is low when:

Consumer switching costs are high.
Substitute product is more expensive than industry product.
Substitute product quality is inferior to industry product quality.
Substitute performance is inferior to industry product performance.
No substitute product is available.

Threat of new entrants: The number of potential new entrants into a market varies
considerably and is a key factor one need to quantify. Sectors that require high levels of
investment and expertise are much harder for new organizations to break into and
challenge the existing providers, which protects the profit levels of the existing players. If
the market is one that has a common technology base, little brand awareness or loyalty, and
is one in which the distribution channels are accessible to all sizes of organization, then one
will usually find it is easy for new rivals to enter the market.
On the other hand, if the market requires the acquisition of patents or proprietary know
how, many potential new entrants will be deterred because of the large upfront investment
required. It is also more difficult for new rivals to enter a market if brand loyalty is high, as
customers are far less likely to switch to another brand. New rivals may also be prevented
from entering market sector if the distribution channels are restricted.

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There are a number of ways that firms in an industry can keep the number of new entrant
low. These techniques are referred to as barriers to entry. A barrier to entry is a condition
that creates a disincentive way for a new firm to enter an industry. Six major sources of
barriers to entry are:

 Economies of scale
 Product differentiation
 Capital requirements
 Cost advantages independent of size
 Access to distribution channels
 Government and legal barriers

Rivalry among existing firms: One of the keys to success for organizations is their ability to
understand their competitors’ actions and marketing strategies. The degree to which rivalry
exists among competitors varies between industries and the market sectors within them.
Regardless of the number of key competitors’ organization faces it is vital for its longevity
that one understand the differences between rivals. This knowledge is essential when
developing strategy and it cannot be achieved by simply using two indices, e.g. size of
organization and market share, or sales revenue and market value.
There are two indices that are commonly used when judging competitive edge and those of
rivals:
• CRx - Concentration Ratio
• HHI - Herfindahl-Hirschman Index
The Concentration Ratio (CRx)
This ratio measures the total output produced in an industry by a given number of
corporations. It will be expressed by using its initials followed by a number. For example,
CR4 gives the market share of the four largest companies
CR5 gives the market share of the five largest companies, and so on.
Concentration ratios are usually used to show the extent of market control of the largest
firms in the industry.
Concentration ratios range from 0 to 100 percent. The levels reach from No, Low, or
Medium, to High and Total concentration.
If for example CR4=0%, the four largest firms in the industry would not have any significant
market share. If CR4=100% then the four largest firms would account for the total market
share.

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The Herfindahl-Hirschman Index (HHI)
This is also referred to as the Herfindahl Index, and it is more complex than the CRx. It is
important to understand that it measures the size of organizations in relation to the
industry and indicates the amount of competition amongst these organizations. The HHI
also gives a greater weighting to larger organizations.
This index ranges from a value of zero, which indicates a very large number of small
organizations, to one, which represents a monopoly. Therefore, the closer the HHI Index is
to zero the greater the level of competition within the sector.

Factors Affecting Competitive Rivalry

There are several factors that increase the intensity of rivalry that an entrepreneur is likely
to experience:
• A larger number of firms
• Slow market growth
• High fixed costs
• High storage costs
• Low switching costs
• Low levels of product differentiation
• High exit barriers

Bargaining power of suppliers: Organization needs raw materials and this creates buyer-
seller relationships between the market and the suppliers. The distribution of power within
such relationships varies, but if it lies with the supplier then they can use this influence to
dictate prices and availability. One needs to assess the balance of power within own market
as part of using Porter's model. Suppliers may work together to increase bargaining power,
although this is usually against the law in developed countries where legal redress is
available if such actions are discovered.
There are several characteristics that indicate the extent of a supplier's power and one is
that they are able to increase their prices without this having a detrimental effect on the
volume of sales. Another is the ability to create informal or even formal agreements that
control pricing and supply. Most developed countries have extensive anti-trust laws and
regulations in place to deter and penalize suppliers caught in this type of activity.

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Rather than raise prices, suppliers in a strong bargaining position can choose to reduce the
quantity of the product available, something that is most effective if there are few
substitutes buyers can switch to. Suppliers are also in a strong position if the product or
service they supply is an essential component of the end product.
Other ways in which suppliers can dominate include imposing costs or penalties on their
customers if they decide to change to another supplier. In addition, a supplier may decide
that their best strategy for growth and profitability is to purchase or create agreements with
other organizations further down the supply chain in order to increase control of
distribution channels.
While some industries do have dominant suppliers this is not the case for all. In industries
where the product is standardized one is likely to find a large number of competitive
suppliers. The food processing industry is a good example of this because agricultural
product can be bought from a variety of suppliers, both large and small. This is the same for
any market involving commodity products.
A high concentration of purchasers is an indication that suppliers in that market have a
weaker bargaining position. This is one of the characteristics of the music industry, where
there are a limited number of powerful record companies (buyers) and an almost unlimited
number of hopeful musicians (suppliers). The mismatch between these groups means that
supply far outstrips demand, and consequently most musicians are prepared to work for a
pittance, or for free, in the hope of getting their product into the market.
Suppliers are also in a weak position if a purchaser could relatively easily adopt a policy of
backward integration. This factor, combined with global access to numerous suppliers, is a
key characteristic of the automotive components market, where there is only a handful of
customers. To be excluded from supplying a particular car manufacturer could be disastrous
for the supplier who often has to work on very low profit margins.

Bargaining power of buyers: Organization should assess the extent to which its customers
or buyers have bargaining power. In a situation where customers have a strong position,
they can bring considerable pressure to the market and demand improved quality and/or
lower prices. There are several key factors that increase the bargaining power of customers:
• Customers are more concentrated than sellers
• Switching costs for customers are low
• Customer is well educated regarding the product
• Customer is price sensitive
• A large portion of a seller's sales is made up of customer purchases
• The customer's own product or service is affected
• There is little differentiation between products
• The threat of backward integration is high.

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The extent to which customers can influence the market depends on their level of
concentration or how well organized they are. Many small farmers produce fruit and
vegetables, which they are contracted to sell to their customers, the supermarkets. The
smallholder has to meet the strict quality control imposed on them by the supermarkets or
risk losing the contract. This enables the supermarkets, as the customers, to exert pressure
on these small suppliers.
The degree to which customers are able to manipulate market forces is swayed by how
significant their purchases are in terms of the supplier's revenue.
Customers also have significant bargaining power in markets where it is easy for them to
transfer between different products without suffering any transfer costs. A good example of
this is the washing powder market, which without brand loyalty has no financial impact if
you swap between products. This power decreases if the customer has to spend more time
or effort in switching between products or services.
In situations where the customer's purchase represents a substantial proportion of their
total costs they will be more price sensitive and the buying process will be more protracted.
This results in the bargaining power being greater for the customer, and the seller will have
to be more persuasive during the sales process.
Also, the more knowledge the customer has about the product the greater their bargaining
power will be, as they will be aware of the product's benefits and features. They may also be
aware of how your product compares to that of your competitors, and in many instances
may be familiar with your costing structure and prepared to use this intelligence to bargain.
In markets where the products have little to differentiate them, brand loyalty is low or non-
existent, and the product is available from multiple suppliers, customers are usually
motivated to purchase based on price rather than any concept of loyalty. This gives the
customers greater bargaining powers than suppliers, who may only win new customers
temporarily because their offer is better at that particular point in time.

Question: What is the role of “barriers to entry“ in creating disincentives for firms to enter
an industry?

Answer of the question:

Barrier to entry: There are a number of ways that firms in an industry can keep the number
of new entrant low. These techniques are referred to as barriers to entry. A barrier to entry
is a condition that creates a disincentive way for a new firm to enter an industry.

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Six major sources of barriers to entry are:

 Economies of scale
 Product differentiation
 Capital requirements
 Cost advantages independent of size
 Access to distribution channels
 Government and legal barriers

Economies of scale:
Industries that are characterized by large economies of scale are difficult for new firms to
enter, unless they are willing to accept a cost disadvantage. Economies of scale occurs when
mass-producing a product results in lower average costs.
Product differentiation:
Industries that are characterized by firms with strong brands are difficult to break into
without spending heavily on advertising. Product innovation is another way of achieving
differentiation.
Capital requirements:
The need to invest large amounts of money to gain entrance to an industry is another
barrier to entry.
Cost advantages independent of size:
Entrenched competitors may have cost advantages not related to size that are not available
to new entrants. Commonly these advantages are grounded in the firm’s history.
Access to distribution channels:
Distribution channels are often hard to crack. This is particularly true in crowded markets.
Government and legal barriers:
For some certain industries patents, trademarks and copyright form are major barriers to
entry. Other industries also require the granting of a license by a public authority.