Industry Analysis: The Fundamentals

OUTLIN E
‡ The objectives of industry analysis ‡ From environmental analysis to industry analysis ‡ Porter¶s Five Forces Framework ‡ Applying industry analysis ‡ Industry & market boundaries ‡ Identifying Key Success Factors

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

From Environmental Analysis to Industry Analysis The national/ international economy The natural environment THE INDUSTRY ENVIRONMENT ‡ Suppliers ‡ Competitors ‡ Customers Demographic structure Technology Government & Politics Social 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. .

Glass 7.5 16.3 14.8 11.6 Building Materials.3 Telecommunications 3.3 18.5 Communications Equipment (4.0) Airlines (34.3 13.0 Semiconductors & Electronic Components 5.3 14.Profitability of US Industries Median return on equity (%).5 Forest and Paper Products 3.8 Home Equipment 9.8 16.0 Metals 6.8 22.3 Food Production 5. 1999-2002 Pharmaceuticals Tobacco Household & Personal Products Food Consumer Products Medical Products & Equipment Beverages Scientific & Photographic Equipt. 3 13.0 Hotels.3 Motor Vehicles & Parts 9.5 20. Commercial Banks Publishing.8 18. Casinos.3 12.5 13.8 Insurance: Property & Casualty 5.5 Food and Drug Stores 10.0 14. Electrical Equipment Furniture Chemicals Computers.5 Railroads 9.8 11.0 Insurance: Life and Health 7.0 20. Resorts 8. Office Equipment Health Care 26.8) . Printing Petroleum Refining Apparel Computer Software Electronics.5 Gas & Electric Utilities 10.

2) (1.3) 3. hand tools Printing & Appliances and home advertising (2.6 services Beverages 0.Long-term Profitability of US Industries: EVA and ROA.5) (1.0 5.3) (3.4 7.3 Electrical products Building materials (0.9) (2.6 4.4) (7.4 14.5) (1.5 8.7) (1.6) 3.6 .2 3.6 Aerospace & defense Metals (1.2) (9.5) (1.3) 6.2 6.4) 9.8 8.6) 5.4 Computers & peripherals (3.1) 7.3 (3.0 3.0 Healthcare services Medical products 2.7 7.0) Railroads Telecom services (1.9 10.8 3.2 5.1) Fashion retailing (0.1) (6. 1986-97 Industry EVA/CE ROA Industry Tobacco 9. Strategic Management Journal (January 2003) EVA/CE (1.3) (3.0 Electronics Average Source: Hawawini et al.5 Telephone equipment & Drugs & research 0.8 1.2) 6.3 6.3 4.6 Plastics & products Textiles (0.4 Steel Semiconductors Cable television & components (1.3 furnishings Food processing 2.1) (2.4 publishing Personal care Cars & trucks products 2.4 Paper and products Computer software Broadcasting and & services 5.0 2.5 Machine tools.4) (4.7) (1.0 2.1) ROA 5.1 (3.5 5.2) 4.7 9.6 Airlines Discount retailing (1.0) 2.

The Determinants of Industry Profitability 3 key influences: ‡ The value of the product to customers ‡ The intensity of competition ‡ Relative bargaining power at different levels within the value chain. .

The Spectrum of Industry Structures Perfect Competition Concentration Entry and Exit Barriers Product Differentiation Information Many firms No barriers Homogeneous Product Perfect Information flow Oligopoly Duopoly Monopoly A few firms Two firms One firm High barriers Significant barriers Potential for product differentiation Imperfect availability of information .

Porter¶s Five Forces of Competition Framework SUPPLIERS Bargaining power of suppliers INDUSTRY COMPETITORS POTENTIAL Threat of ENTRANTS new entrants Threat of Rivalry among existing firms SUBSTITUTES substitutes Bargaining power of buyers BUYERS .

The Structural Determinants of Competition BUYER POWER ‡ Buyers¶ price sensitivity ‡ Relative bargaining power THREAT OF ENTRY ‡Capital requirements ‡Economies of scale ‡Absolute cost advantage ‡Product differentiation ‡Access to distribution channels ‡Legal/ regulatory barriers ‡Retaliation INDUSTRY RIVALRY ‡Concentration ‡Diversity of competitors ‡Product differentiation ‡Excess capacity & exit barriers ‡Cost conditions SUBSTITUTE COMPETITION ‡ Buyers¶ propensity to substitute ‡ Relative prices & performance of substitutes BUYER POWER ‡ Buyers¶ price sensitivity ‡ Relative bargaining power .

Threat of Substitutes Extent of competitive pressure from producers of substitutes depends upon: ‡ Buyers¶ propensity to substitute ‡ The price-performance characteristics of substitutes. .

The principal sources of barriers to entry are: ‡ Capital requirements ‡ Economies of scale ‡ Absolute cost advantage ‡ Product differentiation ‡ Access to channels of distribution ‡ Legal and regulatory barriers ‡ Retaliation .The Threat of Entry Entrants¶ threat to industry profitability depends upon the height of barriers to entry.

‡ Buyer¶s information .Bargaining Power of Buyers Buyer¶s price sensitivity ‡ Cost of purchases as % of buyer¶s total costs. ‡ How differentiated is the purchased item? ‡ How intense is competition between buyers? ‡ How important is the item to quality of the buyers¶ own output? Relative bargaining power ‡ Size and concentration of buyers relative to sellers. ‡ Ability to backward integrate. Note: analysis of supplier power is symmetric .

cost structure.Rivalry Between Established Competitors The extent to which industry profitability is depressed by aggressive price competition depends upon: ‡ Concentration (number and size distribution of firms) ‡ Diversity of competitors (differences in goals. etc.) ‡ Product differentiation ‡ Excess capacity and exit barriers ‡ Cost conditions ± Extent of scale economies ± Ratio of fixed to variable costs .

Profitability and Market Growth ROI (%) R tu o on sales eReturn sa s rn n le R Returnn ininvestment e rn o on ve e t tu stm n C sh flo flow/Investment a Cashw In stm n / ve e t -5% 0 0% 5% to 1 Le th n -5 ss a % < -5% %to 0 to 0 to 5 to 5% 5 to 10% %10% Ove 1 % -5 % 0 > r 0 ANNUAL RATE OF GROWTH OF MARKET DEMAND .

0 23 9.9 19 7.The Impact of Unionization on Profitability None ROI (%) ROS (%) 25 10.8 Percentage of employees unionized 1%-35% 35%-60% 60-75% >75% 24 9.9 ROI = Return on Investment ROS = Return on Sales .0 18 7.

Applying Five . ‡ If we can forecast changes in industry structure we can predict likely impact on competition and profitability. Strategies to Improve Industry Profitability ‡ What structural variables are depressing profitability ‡ Which can be changed by individual or collective strategies? .Forces Analysis Forecasting Industry Profitability ‡ Past profitability a poor indicator of future profitability.

Drawing Industry Boundaries : Identifying the Relevant Market ‡ What industry is BMW in: ± World Auto industry ± European Auto industry ± World luxury car industry? ‡ Key criterion: SUBSTITUTABILITY ± On the demand side : are buyers willing to substitute between types of cars and across countries ± On the supply side : are manufacturers able to switch production between types of cars and across countries ‡ May need to analyze industry at different levels for different types of decision .

Identifying Key Success Factors Pre-requisites for success Pre-requisites for success What do customers want? How does the firm survive competition Analysis of competition Analysis of demand ‡ Who are our customers? ‡ What do they want? ‡ What drives competition? ‡ What drives main ‡ What are the competition? ‡ What are the competition? dimensions of main dimensions of competition? ‡How intense is competition? ‡ How intense is competition? ‡ How can we obtain a ‡How can we obtain a superior superior competitive competitive position? position? KEY SUCCESS FACTORS .

‡ Responsiveness to chaanging market conditions ‡ % business travelers. ASM = Available Seat Miles RPM = Revenue Passenger Miles . ‡ Administrative overhead. ‡ Employee productivity. ‡ Customer loyalty. ‡ Fuel efficiency of planes. ‡ Meeting customer requirements. ‡ Strength of competition on routes. ‡ Load factors. ‡ Efficiency of route planning.Unit Cost = x RPMs ASMs - Expenses ASMs ‡ Wage rates. ‡ Achieving differentiation advantage ‡ Price competitiveness.Identifying Key Success Factors Through Modeling Profitability: The Airline Industry Profitability Income ASMs = Yield Revenue RPMs x Load factor . ‡ Flexibility and responsiveness.

fast delivery Minimize capital deployment through outsourcing & leasing . buying power to minimize cost of goods purchased Return on Sales ROCE Max. foot through: *location *product mix *customer service *quality control Sales/Capital Employed Max.Identifying Key Success Factors by Analyzing Profit Drivers: Retailing Sales mix of products Avoiding markdowns through tight inventory control Max. inventory turnover through electronic data interchange. sales/sq. close vendor relationships.

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

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