Economics of Strategy

Fifth Edition
Besanko, Dranove, Shanley, and Schaefer

Chapter 12

Industry Analysis
Slides by: Richard Ponarul, California State University, Chico
Copyright  2010 John Wiley  Sons, Inc.
 Industry Analysis

Industry analysis facilitates

 assessment of industry and firm performance
 identification of factors that affect performance

 determination of the effect of changes in the

business environment on performance and
 identification of opportunities and threats
(SWOT analysis)
 Industry Analysis

 Industry analysis helps with assessing generic

business strategies
 Porter’s five forces framework is rooted in
microeconomics
 Value net (Brandenburger and Nalebuff)
supplements the five forces framework to analyze
strategy
 The Five-Forces Framework

 Michael Porter’s Five-Forces framework

identifies the economic forces that affect
industry profits
 The five forces are
 Internal rivalry
 Entry
 Substitutesand complements
 Supplier power
 Buyer power
The Five-Forces Framework
 Internal Rivalry

 Internal rivalry is the competition for

market share among the firms in the
industry
 Competition could be on price or some non-
price dimension
 Price Competition erodes the price cost
margin and profitability
 Internal Rivalry

 Competition on non-price dimension can

drive up costs.
 Non-price competition does not erode
profits as severely as price competition if
customers are willing to pay a higher price
for the improvements.
 Internal Rivalry

Price competition heats up when

 There are many sellers
 Some firms have cost advantage over others

 There is excess capacity in the industry

 Products are undifferentiated and switching costs

are low
 Prices and sale terms are easily observable
 Internal Rivalry

Other conditions that facilitate intense price

competition
 Large and infrequent sales orders
 Absence of “facilitating practices”

 Absence of a history of cooperative pricing

 Strong exit barriers

 Industry demand is elastic

 Entry

 Entry hurts the incumbents by

 by cutting into the incumbents’ market share and
 by intensifying internal rivalry and leads to a
decline in price cost margin
 Barriers to entry can be
 exogenous (nature of the industry) or
 endogenous (incumbents’ strategic choices)
 Factors that Affect the Threat of Entry

 Minimum efficient scale relative to the size of the

market
 Government policies that favor the incumbents
 Brand loyalty of consumers and value placed by
consumers on reputation
 Entrants’ access to critical resources such as raw
material, technical know how and distribution
network
 Factors that Affect the Threat of Entry

 Steepness of the learning curve

 Network externalities that give the
incumbents the benefit of a large installed
base
 Incumbents’ reputation regarding post-entry
competitive behavior
 Substitutes and Complements

 Availability of substitutes erode the demand

for the industry’s output
 Complements boost industry demand
 When the price elasticity of demand is large,
pressure from substitutes will be significant
 Changes in demand can in turn affect
internal rivalry and entry/exit
 Supplier Power

 Supplier has indirect power if upstream

market is competitive. It sells to the highest
bidder.
 Supplier has direct power if
 the upstream industry is concentrated or
 the customers are locked into the relationship
with suppliers due to relationship specific assets
 Buyer Power

 Buyer power is analogous to supplier power

 Buyers have indirect power in competitive
markets
 Buyer concentration or relationship specific
assets can lead to direct power
 Buyer power relative to upstream is
analogous to supplier power relative to
downstream
 Supplier Power

The factors that determine supplier power are

 Competitiveness of the input market
 Relative concentration the industry
 Relative concentration of upstream and
downstream firms
 Purchase volume by downstream firms
 Availability of substitute inputs
 Extent of relationship specific investments
 Threat of forward integration by suppliers
 Suppliers’ ability to price discriminate
Some Strategies to Cope with the Five Forces

 To outperform its rivals firms can

 develop a cost advantage or
 a differentiation advantage

 Firms can seek an industry segment where

the five forces are less severe
 Firms can try to change the forces
Some Strategies to Cope with the Five Forces

 Facilitating strategies to reduce internal

rivalries
 Moves that increase switching costs for the
customers
 Pursuing entry deterring strategies
 Tapered integration to reduce
buyer/supplier power
 Five Forces and Value Net

 The Five-Forces Framework tends to view

other firms - competitors, suppliers or
buyers - as threats to profitability
 In the value net model (Coopetition)
interactions between firms can be positive or
negative
 Cooperative Interactions Among Firms

 Setting industry standards that facilitate industry

growth
 Lobbying for regulation or legislation that favors
the industry
 Cooperation with buyers/suppliers
 to improve product quality
 to improve productive efficiency

 to improve inventory management

 The Value Net Concept

 The value net consists of

 Suppliers

 Customers

 Competitors and

 Complementors (producers of complementary goods and

services)
 The value net complements the five forces
approach by considering opportunities posed by
each force.
 The DVD Hardware Market:
A Five-Forces Analysis

 Internal rivalry was intense. Brand name was the

main source of differentiation
 It was easy for consumer electronics firms to enter.
 Satellite TV could be a substitute. Streaming over
the internet was another possibility.
 The DVD Hardware Market:
A Five-Forces Analysis

 Movie studios (upstream) and big retailers

(downstream) had power.
 DVD hardware makers, according to this
analysis, had reason to be pessimistic.
 DVD format’s success can be attributed to
firms working together (value net).
The DVD Hardware Market: The Value Net

 In the beginning DIVX was a major threat.

 DVD manufacturers cut prices on some
models and advertised heavily.
 Other members of the value net chipped in
to increase the size of the DVD “pie.”
 Movie studios released popular titles in DVD format and
priced them moderately
 Retailers promoted the DVD hardware and software
 Five Forces Analysis of Chicago Hospitals

 Product market is the market for acute

medical services
 Competition among hospitals is local
 The geographic market for a hospital is the
entire metropolitan area or a particular
submarket.
 Competitive dynamics could vary across
submarkets
 Chicago Hospitals: Internal Rivalry

 In 1980 most hospitals were independent.

Today many of them belong to systems.
 Herfindahl index has gone up from 0.05 to
0.20 over this period.
 Herfindahl index is slightly higher in
submarkets.
 Chicago Hospitals: Internal Rivalry

 With the arrival of managed care

organizations (MCOs), price elasticity of
demand increased
 Insurers were less brand loyal than patients
 Price negotiations were secret
 Contracting was lumpy and price rivalry
intensified
 Chicago Hospitals: Internal Rivalry

 Considerable variation in cost structures.

 Excess capacity with stagnant demand (until
recently) for admissions.
 Managed care organizations (MCOs)
increased the price elasticity of demand by
seeking hospitals that offered the best value.
 Chicago Hospitals: Internal Rivalry

 MCOs intensified internal rivalry by

 treatingall hospitals as identical,
 negotiating with hospitals in secret and

 negotiating large contracts for multiple years

 Hospitals were unable to develop facilitating

practices
Chicago Hospitals: Internal Rivalry

Recent trends towards softening of

competition
 Branding by hospitals with strong reputation
 Patients demand to go outside the MCO
networks
 Consolidation in submarkets
 Chicago Hospitals: Entry

Structural barrier to entry

 State regulatory restrictions on new hospital
construction
 Capital intensive nature of hospitals

 Difficulties is making brand loyal customers

switch
 Difficulties in establishing a base of medical staff
that admit patients
 Chicago Hospitals: Entry

 As the market grows suburbs could attract

entrants
 Technological changes could lower entry
barriers
 Small specialized hospitals may become
feasible reducing the capital requirement
and the size of medical staff needed
Chicago Hospitals: Substitutes/Complements

 Due to technological changes, substitutes for

hospital services have emerged.
 Surgeries performed outside hospitals
 Home healthcare for recuperating patients and the
chronically ill
 Economies of scope have allowed hospitals to
expand into outpatient services.
 Chicago Hospitals: Supplier Power

 The suppliers to an hospital are

 specializedmedical personnel (nurses,
technicians and doctors)
 Firms that supply equipment and supplies and
drugs
 Relationship specific investments are rare
 Suppliers protected by patents can have
direct power
 Chicago Hospitals: Buyer Power

 The buyers are

 patients
 admitting physicians and
 insurance companies.

 Patients and doctors did not wield buyer

power in the 80s.
 Insurers including Medicaid and Medicare
were largely passive in the 80s.
 Buyer power was low in the 80s.
 Chicago Hospitals: Buyer Power

Current trends point to rising buyer power

 Selective contracting has increased insurers’
buyer power
 Government providers have lowered their rates

 Employers are asking employees to bear a

greater share of costs which increases price
elasticity of demand
 Chicago Hospitals: Buyer Power

 In wealthy communities, specialty hospitals could

compete for the most profitable patients.
 Buyers as well as regulators are demanding access
to information about hospital quality
 Anti trust ruling requires hospitals to negotiate
individually (rather than as a group) with insurers.
Five-Forces Analysis of the Chicago Hospital Market
 Commercial Airframe Manufacturing

 Boeing and Airbus compete globally.

 Fringe players in aircraft with capacity less
than 125 seats are excluded from the
analysis.
 The market share (by revenue) of the fringe
players is small.
 There are no meaningful submarkets.
 Commercial Airframe Manufacturing:
Internal Rivalry

 Boeing delivered its first commercial aircraft in

1958.
 Airbus is younger.
 Boeing enjoys economies of scope due to its
defense business.
 Airbus gets government subsidies.
 Stable market shares and reduced incentive for
price wars
 Historically there has been little product
differentiation
 Commercial Airframe Manufacturing:
Internal Rivalry

 Airbus developed the double-decker mega

plane.
 Boeing abandoned competing with its Sonic
Cruiser.
 Airliners exhibit loyalty to suppliers
 Economic slowdown has reduced the
demand for aircraft.
Commercial Airframe Manufacturing: Entry

Major barriers to entry are:

 Huge development costs
 Experience-based advantages

 Buyer reluctance to buy from startups

 Customer loyalty to current suppliers

Commercial Airframe Manufacturing: Substitutes

 Small plane manufacturers cut into demand

for Boeing and Airbus planes in regional
routes.
 As demand for air travel increases airlines
switching back to larger planes in regional
routes.
 Other forms of transportation could be
substitutes (High speed rail) for “regional
jets.”
 Commercial Airframe Manufacturing:
Supplier Power

 Parts market is competitive

 Part suppliers deal directly with airlines.
But Boeing’s Global Airlines Inventory
Network (GAIN) gains leverage over
suppliers.
 Jet engine suppliers are not numerous and
enjoy direct power.
 Unionized labor has significant supplier
power.
 Commercial Airframe Manufacturing:
Buyer Power

 Buyers for aircraft are either airlines or

leasing companies. Neither have buyer
power.
 Each order could be of the order of 15% of
annual sales revenue for the manufacturer.
 Buyers may cancel orders during economic
downturns.
Five-Forces Analysis of the Commercial Aviation
Industry
 Professional Sports: Market Definition

 Major sports leagues in the U. S.

 MLB

 NBA

 NFL

 NHL

 Five force analysis is also applicable to

major sports leagues elsewhere
 Professional Sports: Internal Rivalry

 Sports leagues require competitive balance

to keep the contests interesting
 Athletic competition does not imply
business competition
 Internal rivalry is low within leagues as
teams follow rules and share revenue
 Teams do not compete in the labor market
 Professional Sports: Entry

 Each league has rules for admitting new

teams.
 Current owners need to be compensated
when new teams are added.
 Incumbent owners can veto new franchises
in their geographic market.
 Starting an entire new league is risky.
 Professional Sports:
Substitutes and Complements

 Teams compete in the local markets with

other forms of entertainment
 Elasticity of substitution is quite low
 Important complements
 Television

 Sports betting
 Professional Sports: Supplier Power

 Unionized players
 For new players NCAA has been a benign
supplier
 Cities spend tax dollars to build facilities to
attract sports teams.
 As municipal finances get tighter,
subsidizing teams becomes more difficult.
 Professional Sports: Buyer Power

 Television networks and sports cable

systems compete with each other for
broadcasting rights
 In negotiations regarding broadcast rights
leagues have the upper hand against
 television networks
 local television and

 radio.
Five-Forces Analysis of Professional
Sports Leagues
 Copyright © 2010 John Wiley & Sons, Inc.

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