The Managerial Problem

To craft an effective strategy, you must take account of the

external environment
To decide whether to put your firm in an environment (entry)
Analyzing Business Environment To decide whether to extricate your firm from an environment
(exit)
To p
position your
y firm to succeed in a given
g environment
To assess the effect of a major change (e.g., deregulation)
To shape the environment
Prof. Sougata Ray But the environment is enormously complex
Indian Institute of Management Calcutta
(sougata@iimcal.ac.in) You need structured ways of thinking about the environment
that capture the richness of the real business world
but separate signal from noise

Factors Influencing Firm (SBU)

From Environment Analysis to Industry Analysis Performance

The national/ The natural

international environment
economy THE INDUSTRY
ENVIRONMENT Industry Characteristics
Demographic Domain of
Technology Suppliers structure Competitive
Competitors Strategy
Customers
Complementors Position within Industry
Government Social structure
Social structure
& Politics

The Industry Environment lies at the core of the Macro Environment.

The Macro Environment generally impacts the firm through its effect on the SBU Characteristics
Industry Environment.

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 India: Return on Invested Capital (ROIC) (%) across Selected
Industries (2002-2013)

R&D

When an industry with a reputation for Retail trade

Manufacture of computer

difficult economics meets a manager Motion picture

Textiles

with a reputation for excellence, it is Civil engineering

usually the industry that keeps its

Leather and related products
Chemicals and chemical products

reputation
t ti iintact.
t t (W
(Warren BBuffet)
ff t)
Pharmaceuticals
Warehousing and support activities for

Food and beverage service activities

Banking & Holding Companies

Computer programming (IT)

Manufacture of beverages

Manufacture of food products

Construction of buildings

Manufacture of tobacco products

Information service activities (ITES)

Real estate activities

Broadcasting and programming activities

-20.00% -10.00% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00%
Sougata Ray, IIMC

The Profitability of Global Industries: Return on

Invested Capital, 1963-2003
Profitability of US Industries
(selected industries only)
Median return on equity (%), 2000-2010
Utilities 6.2

Telecom services 6.5

Transporation 6.9 High profitability Low Profitability

Tobacco 33.5 Packaging and containers 10.2
Energy 7.7

Materials 8.4

OVERALL AVERAGE 9 Household and personal 27.8 Automotive retailing and 9.8
Retailing 9 products services
Consumer durables and apparel 9.5 Pharmaceuticals 20.5 Food and drugs stores 9.6
Food retailing 9.6

Capital goods 9.9

Food consumer products 20.0 Insurance 9.1
Automobiles and components 99
9.9 Food services 19 9
19.9 Hotels casinos
Hotels, casinos, resorts 85
8.5
Technology hardware and equipment 10.3

Hotels, restaurants, leisure 10.3

Medical products and 18.5 Metals 8.2
equipment
Food, beverages, tobacco 11

Healthcare equipmernt and services 11.3 Mining, crude oil production 16.3 Semiconductors and 7.7
Semiconductors 11.9 electronic components
Commercial services 12.8 Securities 15.9 Forest and paper products 7.3
Media 14.7

Computer software and services 15

Chemicals 15.7 Food production 5.2
Household and personal products 15.2 Aerospace and defence 15.7 Telecommunications 5.8
Pharmaceuticals 18.4
Construction and farm 14.5 Motor vehicles and parts 4.4
0 5 10 15 20 equipment
Average ROIC 1963-2003 (%) IT services 14.1 Airlines -11.3

2
 Why Industry Analysis?
Understand how industry structure drives
competition and level of industry profitability
Evaluate industry attractiveness
Explain the differences in profitability across
industries
Identify the drivers of industry-level
profitability
Who in the industry value chain captures the value
generated by the industry?
Industry Analysis: Basics
Understand the fundamentals of the
Industry (Industry drivers, economic
traits, structural attributes, industry
value chain, etc.)
Understand how the macro factors (PESTL
local and global) influence the industry
structure
Identify the macro trends for the future
and assess the impacts on the future of
the industry
Why Industry Analysis?
Identify opportunities to change industry
structure to improve profitability
Establish a foundation for making a
strategic choice
e.g.,
e g decisions about entry,
entry exit,
exit or expansion
Highlight important relationships that need
to be managed
Rivals, buyers, suppliers, complementors,
potential entrants
To identify Key Success Factors
Drawing Industry Boundaries : Identifying
the Relevant Market
What industry is BMW in:
World Auto industry
European Auto industry
World luxury car industry?
Qualitative approach: Two products are in the same market if they are
close substitutes
Same or similar product performance characteristics
Same or similar occasions for use
Sold in the same geographic markets
SIC (Standard Industrial Classification) / NIC (in India)
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 strategic decisions
3
Seven Questions for Industry What are the industry dominant
Analysis economic traits?
1. What are the industry dominant economic traits? Market size (Small markets dont attract big fish)
2. What are the forces of change in the industry and Scope of competitive rivalry
what impact will they have? Market/industry growth rate (life cycle)
3. What competitive forces are at work in the industry Fast ggrowth breeds new entry;
y; slowdowns lead
and
d how
h strong are they?
h to increased competition.
4. Which companies are in the strongest/weakest
Number of rivals and their size
competitive position?
5. Whos likely to make what competitive moves next?
Number of buyers and their size
6. What key factors will determine success or failure? Form of Distribution channels
7. How attractive is the industry in terms of its
prospects for above average profitability?

What are the industry dominant What are the forces of change in the industry
economic traits? and what impact will they have?
Level of backward and forward integration
The most dominant Common Driving Forces
Technological change (rate and scope)
forces the cause the Changes in long term industry
Product characteristics e.g., commodity vs industry to change are
growth rate
Changes in who buy the products
differentiability called driving forces and for what reason
Level
L l of
f diff
differentiation
ti ti bbetween
t fi
firms products
d t Task 1 - identify the P d t innovation
Product i ti
Technological change
Opportunities for economies of scale driving forces Disruptive innovation
Ease of entry and exit Task 2 - assessing Increasing globalization
Regulatory changes
Capital requirements their impact on the Changing societal concerns,
industry (few are attitudes and lifestyles
important, generally)

4
 Five Forces or Six? Introducing
Porters Five Forces Complements
Threat of New The suppliers of
complements create
Entry
Economies of scale Capital requirements value for the industry
Proprietary product Access to distribution
differences Absolute cost advantages SUPPLIERS and can exercise
Brand identity Government policy bargaining power
Switching costs Expected retaliation Bargaining power of suppliers
Bargaining Power Bargaining Power
of Suppliers of Customers
Differentiation of inputs
p y concentration
Buyer INDUSTRY
Rivalry Among Existing
Switching costs Buyer volume COMPETITORS COMPLEMENTS
Presence of substitute Competitors Buyer switching costs
inputs Industry growth Switching costs Buyer information
Supplier concentration Fixed costs / value Concentration and Ability to integrate
POTENTIAL Threat of
Importance of volume to added balance backward
supplier Substitute products ENTRANTS Threat of
Overcapacity Informational new entrants
Cost relative to total Product differencescomplexity Price / total purchases Rivalry among SUBSTITUTES
purchases Brand identity Diversity of Product differences substitutes
Impact of inputs on cost competitors Brand identity existing firms
or differentiation Corporate stakes Impact of quality /
Threat of forward Exit barriers performance
integration Buyer profits
Threat of Substitutes Bargaining power of buyers
Relative price performance of substitutes
Source: Michael E. Porter, Switching costs BUYERS
Competitive Advantage Buyer propensity to substitute
(New York: Free Press, 1985)

A Sixth Force - Complementors Applying Six Forces Analysis

Complementors Forecasting Industry Profitability

Industry Participants whose businesses enhance the Past profitability a poor indicator of future profitability.
value of yours
If we can forecast changes in industry structure we can
Opposite of Substitutes predict likely impact on competition and profitability.
Examples
Computer Manufacturers & Software Companies
Consumer Electronics & Entertainment Companies
The Central Issue Strategies to Improve Industry Profitability
How to get complementors to make strategic
What structural variables are depressing profitability
investments which mutually benefit both companies
Which of these variables can be changed by individual or
collective strategies?

5
 Neutralizing The Five Competitive Forces Industry Analysis: Going Beyond 5 Forces Framework

Porter framework assumes:

Force Method for Neutralizing Force a) Industry structure drives competitive behaviour
Erecting barriers (isolating mechanisms) b) Industry structure is (fairly) stable
Entry
create & exploit economies of scale, aggressive But, competition also changes industry structure
Schumpeterian Competition A perennial gale of creative
deterrence, design in switching costs, etc.
o
destruction market leaders over thrown by innovation
Rivalry
y Compete
p on various dimensions: cost leadership
p o Hypercompetition Intense
Intense and rapid competition moves
differentiation, cooperation, etc. continuously creating new competitive advantages and
Substitutes Improve attractiveness compared to destroying existing competitive advantages
substitutes: better service, more features, etc..
Implication:
Reduce buyer uniqueness: forward integrate, o Within 5 forces framework
Buyers
differentiate product, new customers, etc.. INDUSTRY STRUCTURE COMPETITIVE STRATEGY
o Under dynamic competition
Suppliers Reduce supplier uniqueness: backward integrate, COMPETITIVE STRATEGY INDUSTRY STRUCTURE
obtain minority position, second source, etc..

The Contribution of Game Theory to

What key factors will
Competitive Analysis
determine success or failure?
Main Usefulness:
Framing strategic decisions as interactions between Key success factors (KSF) are crucial
competitors elements that lead to success
Predicting outcomes of competitive situations involving a few,
evenly-matched players What are they now? What will they be?
In retail apparel
pp KSF can be low cost,
S
Some k
key concepts:
t
Competition and Cooperation Game theory can show
superior service, superior design
conditions where cooperation is more advantageous than In beer production KSF can be brewing skills
competition
Deterrence Changing the payoffs in the game in order to In Automobiles, Food & Beverages, Discount
deter a competitor from certain actions Retailing, Airlines, PCs, IT Services,
Commitment Irrevocable deployments of resources that KSF=????
give credibility to threats
Signalling Communication to influence a competitors
decision Sougata Ray, IIMC

6
 Identifying Key Success Factors Identifying Key Success Factors
What do customers How do firms survive Key success factors
want? competition?
Steel Low price Strong price competition and Cost efficiency through: large-
Product consistency cyclical profitability necessitates scale plants, low-cost location,
Pre-requisites for success Reliability of supply cost efficiency and strong speedy capacity adjustment
Specific technical financial resources Or hi-tech mini-mills can
specifications for special achieve low costs through
What do How does the firm steels flexibility and high productivity
customers want? survive competition Quality and service
differentiation
Fashion Demand segmented by Intensely competitive due to low Combining differentiation with
clothing garment type, style, entry barriers, low seller low-costs
low costs
Analysis of demand Analysis of competition quality, color concentration and strong retail Key differentiation variables:
Customers pay price buying power design, speedy to fashion
What drives competition? premium for brand, Differentiation can yield trends, brand reputation,
Who are our style, exclusivity and substantial price premium but quality
customers? What are the main quality imitation rapid Cost efficiency requires
dimensions of competition? manufacture in low wage
countries
What do they want? How can we obtain a Super- Low prices Market localized Low-cost operation requires
superior competitive position? 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 of competitors power, low wage costs
preferences Bargaining power a critical Differentiation requires wide
KEY SUCCESS FACTORS Freshness of produce, determinant of cost of bought- product range (hence, large
good service, pleasant in-goods stores), convenient location,
Sougata Ray, IIMC 2013 Robert M. Grant
ambience, easy parking
www.contemporarystrategyanalysis. easy parking
26

Identifying Key Success Factors Through Identifying Key Success Factors

Modeling Profitability: The Airline Industry by Analyzing Profit Drivers: Retailing
Profitability = Yield x Load factor - Unit Cost Sales mix of products
Income Revenue RPMs Expenses
ASMs = RPMs x ASMs - ASMs Avoiding markdowns through
Return on Sales
tight inventory control

Strength of competition on Price competitiveness. Wage rates. Max. buying power to minimize
routes. Efficiency of route Fuel efficiency of cost of goods purchased
planning. planes. ROCE
Responsiveness to changing Max. sales/sq. foot through:
Flexibility and Employee
market conditions *location *product mix
responsiveness. productivity.
*customer service *quality control
% business travelers. Customer loyalty. Load factors.
Meeting customer Administrative Sales/Capital Max. inventory turnover through
Achieving differentiation
requirements. overhead. Employed electronic data interchange, close
advantage
vendor relationships, fast delivery

ASM = Available Seat Miles RPM = Revenue Passenger Miles Minimize capital deployment
through outsourcing & leasing

7
 Strategic Segmentation Analysis: The The Basis for Industry Segmentation:
Customer and Product Characteristics Size
Principal Stages Technical
Industrial buyers sophistication
OEM/replacement
Identify segmentation variables
Identify key variables Reduce to 2 or 3 variables Demographics
Identify discrete categories for Characteristics
and categories. Household buyers Lifestyle
of the Buyers
each variable Purchase occasion
Construct a segmentation matrix Size
Dist ibuti n ch
Distribution channel
nn l Distributor/brokerr
Distributor/broker
Analyze segment attractiveness Exclusive/
Opportunities for nonexclusive
Differentiation Geographical General/special
Identify KSFs in each segment Potential for economies location list
of scope across segments Physical size
Analyze benefits of Similarity of KSFs Price level
broad vs. narrow scope. Product differentiation Product features
benefits of segment focus Characteristics Technology design
of the Product Inputs used (e.g. raw materials)
Performance characteristics
Pre-sales & p
post-sales services

Vertical Segmentation & Industry Profit Pools

Segmenting the World Automobile Market The US Auto Industry

25
PRODUCT REGION %
US& Canada W.Europe E.Europe Asia Lat America Australia Africa
Luxury Cars
20
Full-size sedans
Leasing Service & repair
Mid-size sedans
S ll sedans
Small d 15
Warranty Aftermarke
Station wagons
Auto t
Passenger minivans 10
manufacturing parts Auto
Sports cars Auto Auto rental
New car insurance
Sport-utility dealers loans
5 Used car dealers
Pick-up trucks

0 Gasoline
100%
0 Share of industry revenue

8
Segmentation & Strategic Group Analysis: Which companies Competitor Analysis
are in strongest/weakest competitive position?

The follow
follow--up to
A strategic group is a group of firms in an industry
following the same or similar strategy. Strategic Group
Analysis is effective
Strategic group mapping: two dimensional representation
according to the competitive characteristics (principal strategic analysis of a firms
variables) of the competitors in the industry key Competitors
Position each firm in relation to these variables -Identify
Identify clusters.
Size of circles proportional to combined sales, the closer the
circles, the stronger the rivalry

Product line/merchandise mix

Whos likely to make what

On Competition competitive moves next?
Know your enemy, know yourself and you can fight
a hundred battles with no danger of defeat.
In order to Identify competitors
When you are ignorant of the enemy but know
outmaneuver your strategies
yourself, your chances of winning and losing are
competition you have Evaluate who are the
equal. If you dont know your enemy and yourself,
you are bound
b d to perish h in all
ll battles.
b l to evaluate the major players now
competitors future Who will be the major
It is pardonable to be defeated, but never be
moves. players in the future
surprises.
Those who win every battle are not really skillful.. Evaluate what the
Those who render others armies helpless without major players are
fighting are the best of all. going to do
Sun Tse (Sun Zu) Art of War

9
 Competitor Analysis Industry Dynamics
Assumptions
What assumptions do our Industry analysis provides a snapshot of
competitors hold about the future
of industry and themselves? Response current conditions in an industry
What will our
competitors do in the
The industry landscape is subject to
Current Strategy future? tectonic shifts over time.
Does our current strategy support
changes in
n the competitive
compet t ve
Wh
Where do
d we have
h a Some of these shifts are under the
environment?
competitive advantage? control of the players in the industry
Future Objectives Intel shaped the micro processor industry
How do our goals compare to our How will this change structure in its favour
competitors goals? our relationship with
our competition? Air Deccan altered the aviation industry
structure in India
Capabilities
How do our capabilities compare to
our competitors?

The Driving Forces of Industry

Evolution Final words on industry analysis
BASIC CONDITIONS INDUSTRY STRUCTURE COMPETITION
A starting point for many types of strategic
Customers become
Customers become
decisions
more knowledgeable
& experienced more price conscious
Quest for new
Strategy should fit the external business
sources of environment
Products become differentiation
more standardized n the long run, the business
In bus ness environment
en ronment iss
Diffusion of
Price competition
not fixed
Production
technology becomes less Production shifts intensifies It can be shaped by the strategic choices taken
R&D & skill- to low-wage
intensive countries
by a firm and its rivals
Excess capacity
It also changes based on factors over which the
increases firm has little control
Demand growth Bargaining power
slows as market of distributors The role of the strategist is to identify these
saturation approaches Distribution channels
consolidate
increases changes and adapt the firms strategy to them

10