Strategic management

Industry Analysis
 Introduction
• An industry is a group of firms that produces a similar product or service, such as
soft drinks or financial services.
• Michael Porter, an authority on competitive strategy, contends that a corporation is
most concerned with the intensity of competition within its industry.
• The level of this intensity is determined by basic competitive forces.
• The collective strength of these forces determines the ultimate profit potential in
the industry, where profit potential is measured in terms of long-run return on
invested capital.
 Five Forces
• The ability of an industry to make profit depends on the intensity of five
forces:
1) Threat of new entrants
2) Threat of substitute products
3) Bargaining power of buyers
4) Bargaining power of suppliers
5) Rivalry among existing firms
Five Forces
 Threat of New Entrants
• New entrants to an industry typically bring to it new capacity, a desire to
gain market share, and substantial resources.
• They are, therefore, threats to an established corporation.
• The threat of entry depends on the presence of entry barriers and the
reaction that can be expected from existing competitors.
 Barriers to Entry
• An entry barrier is an obstruction that makes it difficult for a company to enter an industry.
Some of the possible barriers to entry are:
• Economies of scale
• Product differentiation
• Capital requirements
• Switching costs
• Access to distribution channels
• Government policy
 Threat of Substitute Products
• A substitute product is a product that appears to be different but can satisfy
the same need as another product.
• Substitutes limit the potential returns of an industry by placing a ceiling on
the prices firms in the industry can profitably charge.
• Tea can be considered a substitute for coffee.
• If the price of coffee goes up high enough, coffee drinkers will slowly begin
switching to tea.
• The price of tea thus puts a price ceiling on the price of coffee.
 Bargaining Power of Buyers
• Buyers affect an industry through their ability to force down prices,
bargain for higher quality or more services, and play competitors against
each other.
A buyer or a group of buyers is powerful if some of the following factors
hold true:
• A buyer purchases a large proportion of the seller’s product or service.
• A buyer has the potential to integrate backward by producing the product
itself.
 Bargaining Power of Buyers cont.
• Alternative suppliers are plentiful because the product is standard or undifferentiated.
• Changing suppliers costs very little.
• The purchased product represents a high percentage of a buyer’s costs, thus providing
an incentive to shop around for a lower price.
• A buyer earns low profits and is thus very sensitive to costs and service differences.
• The purchased product is unimportant to the final quality or price of a buyer’s products
or services and thus can be easily substituted without affecting the final product
adversely.
 Bargaining Power of Suppliers
• Suppliers can affect an industry through their ability to raise prices or reduce
the quality of purchased goods and services.
A supplier or supplier group is powerful if some of the following factors apply:
• The supplier industry is dominated by a few companies, but it sells to many (for
example, the petroleum industry).
• Its product or service is unique and/or it has built up switching costs (for
example, word processing software).
• Substitutes are not readily available (for example, electricity).
 Bargaining Power of Suppliers cont.
• Suppliers are able to integrate forward and compete directly with their
present customers (for example, a microprocessor producer such as Intel
can make PCs).
• A purchasing industry buys only a small portion of the supplier group’s
goods and services and is thus unimportant to the supplier (for example,
sales of lawn mower tires are less important to the tire industry than are
sales of auto tires).
 Rivalry among existing firms
• In most industries, corporations are mutually dependent.
• A competitive move by one firm can be expected to have a noticeable effect on its
competitors and thus may cause retaliation.
• According to Porter, intense rivalry is related to the presence of several factors,
including:
• Number of competitors - When competitors are few and roughly equal in size,
such as in the auto and major home appliance industries, they watch each other
carefully to make sure that they match any move by another firm with an equal
countermove.
 Rivalry among existing firms cont.
• Rate of industry growth - Any slowing in passenger traffic tends to set
off price wars in the airline industry because the only path to growth is to
take sales away from a competitor.
• Product or service characteristics - A product can be very unique, with
many qualities differentiating it from others of its kind or it may be a
commodity, a product whose characteristics are the same, regardless of
who sells it. For example, most people choose a gas station based on
location and pricing because they view gasoline as a commodity.
 Rivalry among existing firms cont.
• Amount of fixed costs - Because airlines must fly their planes on a
schedule, regardless of the number of paying passengers for any one
flight, they offer cheap standby fares whenever a plane has empty seats.
• Capacity - If the only way a manufacturer can increase capacity is in a
large increment by building a new plant (as in the paper industry), it will
run that new plant at full capacity to keep its unit costs as low as possible
—thus producing so much that the selling price falls throughout the
industry.
 Rivalry among existing firms cont.
• Height of exit barriers - Exit barriers keep a company from leaving an industry. The
brewing industry, for example, has a low percentage of companies that voluntarily leave
the industry because breweries are specialized assets with few uses except for making beer.
• Diversity of rivals - Rivals that have very different ideas of how to compete are likely to
cross paths often and unknowingly challenge each other’s position.
• This happens often in the retail clothing industry when a number of retailers open outlets in
the same location—thus taking sales away from each other.
• This is also likely to happen in some countries or regions when multinational corporations
compete in an increasingly global economy.