519H3 Strategic Management

Session 2: Macroenvironment
and Industry Analysis
Dr Josh Siepel
 Industry Analysis: The Fundamentals

OUTLINE

• The objectives of industry analysis

• From environmental analysis to industry
analysis
• Porter’s Five Forces Framework
• Applying industry analysis
• Industry and market boundaries
• Identifying Key Success Factors
© 2013 Robert M. Grant
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www.contemporarystrategyanalysis.com
 Formulating Strategy:
Linking the External and the Internal Environment

THE FIRM THE

INDUSTRY
Goals and
ENVIRONMENT
Values
Resources and STRATEGY
•Competitors
Capabilities
•Customers
Structure and
•Suppliers
Systems

Lecture 3 Lecture 2
The
The
Environment-
Firm-Strategy
Strategy
Interface
Interface
 Strategic Management Steps

Strategic
Strategic
development
analysis
• Options Strategy
• Environment • Rational selection
• Resources • Finding strategic implementation
• Vision, mission route forward
and objectives • Considering strategy
structure and style
An Economic Perspective on
Strategic Success
Competitive strategy Corporate Strategy
Where to compete
Industry
Attractiveness

Rate of profit Competitive

above the competitive Scope
level

Range of products
Competitive and market segments
Advantage
How to compete
Source: Grant (2005)
 The Objectives of Industry Analysis

• 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 formulate strategies to change industry structure to

improve industry profitability

• To identify Key Success Factors

© 2013 Robert M. Grant
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 From Industry Analysis to
Environmental Analysis
The national/ The natural
international environment
economy

THE INDUSTRY
ENVIRONMENT
• Suppliers Demographic
Technology
• Competitors structure
• Customers
Government Social
& politics structure

• The Industry Environment lies at the core of the Macro

environment
• The Macro Environment impacts the firm through its effect on
the Industry Environment
© 2013 Robert M. Grant
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Analysing the Macroenvironment

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 The PESTEL framework
The PESTEL framework categorises
environmental influences into six main types:
Political, Economic,
Social, Technological,
Environmental Legal

Thus PESTEL provides a comprehensive list of

influences on the possible success or failure of
particular strategies.

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 The PESTEL framework (2)
• Political Factors: For example, Government
policies, taxation changes, foreign trade
regulations, political risk in foreign markets,
changes in trade blocks (EU).

• Economic Factors: For example, business cycles,

interest rates, personal disposable income,
exchange rates, unemployment rates, GDP trends.

• Socio-cultural Factors: For example, population

changes, income distribution, lifestyle changes,
consumerism, changes in culture and fashion.
 The PESTEL framework (3)
• Technological Factors: For example, new discoveries
and technology developments, ICT innovations, rates of
obsolescence, increased spending on R&D.

• Environmental (‘Green’) Factors: For example,

environmental protection regulations, energy
consumption, global warming, waste disposal and re-
cycling.

• Legal Factors: For example, competition laws, health

and safety laws, employment laws, licensing laws, IPR
laws.
 Key drivers of change
• The environmental factors likely to have a
high impact on the success or failure of
strategy.
• For example, the birth rate is a key driver
for those planning nursery education
provision in the public sector.
• Typically key drivers vary by industry or
sector.
 LoNGPEST
• Introducing locational aspects may provide
more detail:
• Local
• National
• Global
• These, when linked with PEST/PESTEL
factors, may provide more granularity for
analysis
 Using the PESTEL framework
• Apply selectively –identify specific factors which
impact on the industry, market and organisation
in question.
• Identify factors which are important currently
but also consider which will become more
important in the next few years.
• Use data to support the points and analyse
trends using up to date information
• Identify opportunities and threats – the main
point of the exercise!
Industry Analysis and The Determinants
of Industry Profitability

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 Profitability of US Industries
(selected industries only)
Median return on equity (%), 2005-2015
High profitability Low Profitability
Tobacco 33.3 Packaging and containers 10.2
Household and personal products 26.8 Automotive retailing and services 9.8
Pharmaceuticals 20.5 Food and drugs stores 9.6
Food consumer products 20.0 Insurance 9.1
Food services 16.8 Hotels, casinos, resorts 8.5
Medical products and equipment 18.5 Metals 8.2
Mining, crude oil production 16.3 Semiconductors and electronic 7.6
components
Securities 15.9 Forest and paper products 7.3
Chemicals 15.7 Food production 5.2
Aerospace and defence 15.7 Telecommunications 5.8
Construction and farm equipment 14.5 Motor vehicles and parts 4.4
IT services 14.1 Airlines -9.3

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“The worst sort of business is one that grows rapidly,
requires significant capital to engender the growth, and
then earns little or no money. Think airlines. Here a
durable competitive advantage has proven elusive ever
since the days of the Wright Brothers. Indeed, if a
farsighted capitalist had been present at Kitty Hawk, he
would have done his successors a huge favor by shooting
Orville down.”

-- Warren Buffet, annual letter to Berkshire Hathaway shareholders, Feb 2008

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The Determinants of Industry Profitability

Three key influences:

1. The value of the product to customers

2. The intensity of competition

3. Relative bargaining power at different stages of the

value chain

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 The Spectrum of Industry Structures

Perfect Oligopoly Duopoly Monopoly

Competition
Concentration Many firms A few firms Two firms One firm
Entry and Exit No barriers Significant barriers High barriers
Barriers
Product Homogeneous Potential for product differentiation
Differentiation product
Information Perfect Imperfect availability of information
information
flow

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 Porter’s Five Forces
Competition Framework

SUPPLIERS
Bargaining power
of suppliers
INDUSTRY
COMPETITORS
Threat of Threat of
ENTRY SUBSTITUTES
new entrants substitutes
Rivalry among
existing firms
Bargaining power
of buyers
BUYERS

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 The Structural Determinants of Competition

SUPPLIER POWER
•Supplier’s price sensitivity
•Relative bargaining power

THREAT OF ENTRY
• Capital requirements INDUSTRY RIVALRY SUBSTITUTE
• Economies of scale • Concentration COMPETITION
• Absolute cost advantage • Diversity of competitors •Buyer’s propensity to
• Product differentiation • Product differentiation substitute
• Access to distribution • Excess capacity and exit •Relative prices and
channels barriers performances of
• Legal/regulatory barriers • Cost conditions substitutes
• retaliation

BUYER POWER
•Buyer’s price sensitivity
•Relative bargaining power
© 2013 Robert M. Grant
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 Threat of Substitutes

Extent of competitive pressure from producers of

substitutes depends on:

•Buyer’s propensity to substitute

•The price-performance characteristics of substitutes

© 2013 Robert M. Grant

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 Threat of New Entrants

• Entrants’ threat to industry profitability depends

upon the height of barriers to entry

• The principle sources of barriers to entry is:

o Capital requirements
o Economies of scale
o Absolute cost advantage
o Product differentiation
o Access to channels of distribution
o Legal and regulatory barriers
o retaliation

© 2013 Robert M. Grant

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 Bargaining Power of Buyers
• The extent to which buyers are able to depress
profitability depends on:
o Buyer’s price sensitivity
 Does the item comprise a big percentage of the
buyer’s total costs?
 Whether purchased item is a commodity or
differentiated?
 How intense is competition between buyers?
 Is the item critical to the quality of the buyer’s own
output
o Relative bargaining power
 Size and concentration of buyers relative to sellers
 Buyer’s information
 Ability to backward integrate
• Note: Analysis of supplier power is symmetric
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 Supplier Power: The Impact of
Unionization on Profitability

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PROFITABILITY (%)

20

15
ROI (%)
10 ROS (%)

0
0% 1%-35% 36%-60% 61%-75% over 75%

PERCENTAGE OF EMPLOYEES UNIONIZED

https://www.youtube.com/watch?v=fbzVy9igKI0

© 2013 Robert M. Grant

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www.contemporarystrategyanalysis.com
Rivalry Between Established Competitors

• The extent to which industry profitability is

depressed by aggressive price competition depends
upon:
o Concentration (number and size distribution of firms)
o Diversity of competitors (difference in goal, cost
strategies, etc.)
o Product differentiation
o Excess capacity and exit barriers
o Cost conditions
 Extent of sale economies
 Ratio of fixed to variable costs

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 Applying Five-Forces Analysis
• Forecasting Industry Profitability
o If we can forecast changes in industry structure we
can predict likely impact on competition and
profitability

• Strategic Planning
o Once we know which structural features of the
industry support profitability and which depress
profitability, we can choose a favorable positioning
within the industry

• Strategies to Improve Industry Profitability

o Which of the structural variables that are depressing
profitability can we change by individual or collective
strategies?
© 2013 Robert M. Grant
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www.contemporarystrategyanalysis.com
 Five Forces or Six?
Introducing Complements
The suppliers of
complements create
SUPPLIERS value for the industry and
can exercise bargaining
Bargaining power power
of suppliers
INDUSTRY COMPLEMENTS
COMPETITORS
Threat of Threat of
ENTRY SUBSTITUTES
new entrants substitutes
Rivalry among
existing firms
Bargaining power
of buyers
BUYERS

5F Application: NETFLIX
© 2013 Robert M. Grant
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 Does Industry Matter?

Percentage of variance in firms’ return on

assets explained by:
Industry Firm effects Unexplained
effects (%) (%) variance (%)
Schmalensee (1985) 19.6 0.6 79.9
Rumelt (1991) 4.0 44.2 44.8
McGahan & Porter (1997) 18.7 31.7 48.4
Hawawini et al. (2003) 8.1 35.8 52.0
Roquebert et al. (1996) 10.2 55.0 32.0
Misangyi et al. (2006) 7.6 43.8 n/a

© 2013 Robert M. Grant

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www.contemporarystrategyanalysis.com
 The Objectives of Industry Analysis

• Porter framework assumes:

a) Industry structure drives competitive behaviour
b) Industry structure is (fairly) stable
• But, competition also changes industry structure
o Schumpeterian Competition – A “perennial gale of creative
destruction” – market leaders over thrown by innovation
o Hypercompetition – “Intense and rapid competition
moves… continuously creating new competitive advantages
and destroying existing competitive advantages
• Implication:
o Within 5 forces framework
INDUSTRY STRUCTURE COMPETITIVE STRATEGY
o Under dynamic competition
COMPETITIVE STRATEGY INDUSTRY STRUCTURE

© 2013 Robert M. Grant

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 Drawing Industry Boundaries
What is the Relevant Market?
• What industry is Jaguar in:
o The motor vehicle industry (SIC 371)
o The automobile industry (SIC 3712)
o The luxury car industry?
o Is its industry global, regional (Europe) or national
(UK)?
• Key criterion: SUBSTITUTABILITY
o On the demand side: Are buyers willing to substitute
between types of cars and across countries
o On the supply side: Are manufacturers able to switch
production between types of cars and across countries

• We may need to draw industry boundaries

differently for different types of decision
© 2013 Robert M. Grant
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 Identifying Key Success Factors
Pre-requisites for success

What do customers want? How does the firm survive

competition?

Analysis of demand Analysis of competition

• Who are our customers? • What drives competition?

• What do they want? • What are the main
dimensions of competition?
• How intense is competition?
• How can we obtain a
superior competitive
position?

Key success factors

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 Identifying Key Success Factors:
Steel, Fashion Clothing & Supermarkets
What do customers want? How do firms survive competition? Key success factors
Steel Low price Strong price competition and Cost efficiency through: large-
Product consistency cyclical profitability necessitates scale plants, low-cost location,
Reliability of supply cost efficiency and strong financial speedy capacity adjustment
Specific technical resources Or hi-tech mini-mills can achieve
specifications for special low costs through flexibility and
steels high productivity
Quality and service differentiation
Fashion Demand segmented by Intensely competitive due to low Combining differentiation with
clothing garment type, style, quality, entry barriers, low seller low-costs
color concentration and strong retail Key differentiation variables:
Customers pay price buying power design, speedy to fashion trends,
premium for brand, style, Differentiation can yield brand reputation, quality
exclusivity and quality substantial price premium but Cost efficiency requires
imitation rapid manufacture in low wage
countries
Super- Low prices Market localized Low-cost operation requires
markets Convenient location Intensity of price competition operational efficiency, scale-
Wide range of products depends on number and proximity efficient stores, strong buying
adapted to local preferences of competitors power, low wage costs
Freshness of produce, good Bargaining power a critical Differentiation requires wide
service, pleasant ambience, determinant of cost of bought-in- product range (hence, large
easy parking goods stores), convenient location, easy
© 2013 Robert M. Grant
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Identifying Key Success Factors by
Analyzing Profit Drivers: Retailing
Sales mix of products

Avoiding markdowns through tight

Return on Sales
inventory control

Max. buying power to minimize

cost of goods purchased

ROCE Max. sales/sq. foot through

location, customer service,
product mix & quality control

Max. inventory turnover through

Sales/Capital
electronic data interchange, close
Employed
vendor relationships, fast delivery

Minimize capital deployment

through outsourcing and leasing
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 Summary
What Have We Learnt?
• Forecasting Industry Profitability
o Past profitability a poor indicator of future profitability
o If we can forecast changes in industry structure we can
predict likely impact on competition and profitability
• Strategies to Improve Industry Profitability
o What structural variables are depressing profitability?
o Which can be changed by individual or collective
strategies?
• Defining Industry Boundaries
o Key criterion: substitution
o The need to analyze market competition at different levels of
aggregation (depending on the issues being considered)
• Key Success Factors
o Starting point for the analysis of competitive advantage

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