Industry Structure and Firm

Performance
Industry & Industry Analysis

• Industry:
• Group of incumbent companies
• Relatively the same set of suppliers and buyers
• Tend to offer similar products and services
• Industry Analysis, a method to:
• Identify an industry’s profit potential
• Derive implications for a firm’s strategic position
Average Economic Profits of U.S. Industry
Groups (1987–2002)
Avg. Spread
(1984-2002)
Toiletry & Cosmetic
40%

Tobacco

30%
Soft Drinks
Pharmaceutical
Med Supplies
20% Computer Software
Publishing Petro-Integergrated Railroad
Financial Services Computers & Peripherals
Aerospace/ Auto Parts
Bank For El/Ent.
10% Defense Building Materials
Retail Store Insurance Property & Casualty
For Telecom
Auto & Truck

0%
Tele Service
Semiconduct
(10%) Air Transport
Textile
Steel Power
Paper & For. Entertain
(20%)
0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000

Avg. Equity ($B) (1984-2002)

Source: Ghemawat (2006)e

Profitability Index

Jaiswal and Nath (2012), CCS, IIMB

The Porter Five Forces Model

The following five forces determine the profit potential of an industry and
shape a firm’s competitive strategy:

SOURCE: Michael E. Porter, “The five

competitive forces that shape
strategy,” Harvard Business Review,
January 2008.
Threat of Entry

• The risk that potential competitors will enter an

industry
• Lowers industry profit potential:
• Incumbents lower prices
• Incumbents spend more to satisfy existing
customers.
• Entry barriers:
• Obstacles blocking others from entering
• A significant predictor of industry profit potential
Types of Entry Barriers

• Economies of scale (e.g. Automobile industry)

• Capital requirements (e.g. Passenger jet industry)
• Customer switching costs (e.g. Core Banking
Services)
• Network effects (e.g. Social media)
• Advantages independent of size (e.g. Oil and gas
industry)
• Government policy (e.g. Banking)
• Credible threat of retaliation (e.g. Airlines industry)
Power of Suppliers

• Pressures that industry suppliers can exert on an

industry’s profit potential
• Lowers industry profit potential if:
• Suppliers demand higher prices for their inputs
• Suppliers reduce quality
Bargaining Power of Suppliers
• Concentrated (or limited) supplier industry (e.g. Airlines
industry)
• Incumbent firms face supplier switching costs (e.g.
Automobile industry)
• Suppliers offer differentiated products (e.g. Fashion
retailing)
• Suppliers not dependent on industry for majority of
revenue (e.g. chip manufacturers and automobile
industry)
• There are few or no supplier substitutes (e.g. API
suppliers)
• Suppliers can forward-integrate into the industry (e.g.
bottling industry for carbonated drinks)
Power of Buyers (Customers)

• Pressure customers put on an industry by

demanding:
• A lower price or
• Higher product quality
Bargaining Power of Buyers
• There are a few buyers & each buyer purchases
large quantities (e.g. Air bags)
• The industry’s products are standardized or
undifferentiated commodities (e.g. generic
medicines)
• Buyers face low or no switching costs (e.g. Pen
drive)
• Buyers can backward integrate into the industry
(e.g. Iron ore)
Threat of Substitutes

• Products or services outside an industry meeting

the needs of current customers
• Examples:
• Tea vs. coffee
• Videoconferencing vs. business travel
Threat of Substitutes

• Many close substitutes are available (e.g. soft

drink)
• The substitute offers an attractive
price-performance trade-off (e.g. Metro and bus
services)
• The buyer’s cost of switching to the substitute is
low (e.g. CD and pen drive)
Rivalry Among Competitors

• The intensity with which companies in the same

industry jockey for market share and profitability
• Intensity determined by :
1. Industry concentration and balance (e.g. Passenger
aircrafts industry)
2. Industry growth (e.g. Newspaper)
3. Strategic commitments (e.g. Telecom industry)
4. Exit barriers (e.g. Pharmaceutical industry )
A Sixth Force: Complements

• A product, service, or competency

• Adds value when used with the original product
(e.g. Mobile Apps)
• Complementor:
• A company that provides a good or service that leads
customers to value your firm’s offering more when the
two are combined
How to Apply the Five Forces
Model
• Define the relevant industry.
• Identify the key forces – group them.
• Identify the drivers of each force.
• Are they strong or weak?
• Assess overall industry structure.
• Profit potential
Shortcomings of Models
Discussed
• They are static
• Just a snapshot
• But black swan events happen suddenly
• Information can become obsolete
• Models don’t explain why performance differences
occur in an industry.
• Internal analysis is required