https://www.coursera.

org/learn/strategy-business/lecture/JiaOA/2-3-1-dynamic-
industry-analysis

2-3.1 Dynamic Industry Analysis

Transcript

Help Us Translate

Interactive Transcript - Enable basic transcript mode by pressing the escape key
You may navigate through the transcript using tab. To save a note for a section of text press CTRL +
S. To expand your selection you may use CTRL + arrow key. You may contract your selection using
shift + CTRL + arrow key. For screen readers that are incompatible with using arrow keys for
shortcuts, you can replace them with the H J K L keys. Some screen readers may require using
CTRL in conjunction with the alt key
Play video starting at ::3 and follow transcript0:03

We will now address some key issues in actually applying 

the five forces framework for 

industry analysis and practice. 

So how do you do it? 

You should begin by clearly 

identifying the boundaries of the industry. 

One approach that I find particularly 

useful is to be very clear 

about the who for each of the five forces. 

So for example, you should be really clear about 

which sets of firms are competitors 

and which ones make substitutes. 

Similarly, think about who you would consider as 

potential entrance and about 

all the entities to include in buyers. 

For example, intermediaries 

like wholesalers and retailers, 

as well as the end-consumers. 

Then you should examine 

the structural attributes of each force with 

the goal of course of developing 

an assessment of the strength of that force. 

You can then rate each force according to whether 

it's favorable for industry profitability or not, 

say along the scale of strong to moderate to weak. 

Having completed these three steps, 

which we have already covered earlier in the module, 

you would now turn to how the five forces are 

combined to assess the industry's profitability. 

Finally, you might explore some dynamics. 

How might the industry analysis change as 

the industry itself and its 

structural attributes change over time. 

So once we have evaluated each of the individual forces, 

how should we combine them? 

Should we simply average out 

the degree of competition from each of the forces 

and get an overall rating for 

the industry? Or do it some other way? 

Let me make this a bit more concrete with an example. 

Imagine we have two industries with 

the same average rating over all five forces. 

But one industry, let's call it industry 1, 

has a moderate level of competition in all five forces. 

So the level of competition 

all the forces are essentially equal, 

and the other industry, industry 2, 

has only one but very competitive force. 

Let's say it has very low entry barriers. 

But all the other forces in 

industry 2 are less competitive, 

that is that they are better for profits than industry 1. 

So then overall, 

which industry would be the more profitable of the two? 

Industry 1 or industry 2? 

Would they be the same in profitability? 

Keep in mind that these are two industries that have 

the same average favorability across the five forces. 

So what would your answer be? 

What is the logic for that answer? 

I like to use a metaphor to 

answer this question of how one 

evaluates industry profitability by 

combining the five forces. 

Imagine I'm hiking high up on 

a mountain and come across a lake. 

The water in this lake is being 

held in place by five dams. 

So what determines the amount 

of water being held in this lake? 

In this example, I want you to 

think of these five dams as 

the five forces and of 

the water in the lake, as industry profits. 

Just as gravity is acting on 

the water to try and make it go downhill, 

the forces of competition are constantly acting 

on industries to drain away their profits. 

What is keeping the water and profits in 

place are the barriers to these forces. 

So if any one of the dams is weak and broke down, 

of course all the water from the lake 

would drain away through that bridge. 

It wouldn't matter that the remaining four dams 

are strong and still standing tall. 

In the same way, profits in an industry are 

susceptible to the weakest of the five forces. 

An industry with five moderately strong forces, 

will be more profitable than one with 

four very strong ones and one very weak force. 

We can also take these ideas a step further. 

Because it drives ultimate industry profitability, 

the weakest of the five forces can be thought 

of as the pivotal force for industry profitability. 

Just as building up 

the weakest dam can help 

increase the water level of the lake, 

strengthening the weakest force 

can improve profitability of the industry. 

Therefore, as a manager, 

you should generally prioritize doing 

something about or at the 

very least closely monitoring 

the weakest of the five forces. 

Let's take this idea of a pivotal force 

a bit further and motivate it with an example. 

As we've just noted, 

a pivotal force represents the greatest threat to 

industry profitability from competition 

or bargaining by their entrance, 

rivals, substitutes, or suppliers. 

You've also seen from the analogy of the dams, 

why mitigating an industry's pivotal force can 

directly improve industry profitability. 

A nice example of this can be 

seen in the US airline industry. 

As discussed earlier, rivalry is perhaps 

the most important force in the airline industry. 

It's pivotal force. 

But in recent years, the airline industry 

has gone through a few major mergers, 

which has increased industry concentration, 

and airline companies have also gotten 

better at airline seat utilization, 

so-called yield management, reducing the need 

to slash prices to fill 

all those empty seats at the last moment. 

As a result, airline price rivalry has 

not been nearly as bad as in previous time periods. 

The industry is even making a little bit of money. 

Once you identify the pivotal force in an industry, 

it pays to keep an eye on it and especially on 

the structural attributes of 

the force that make it so competitive. 

After all, changes in this force are most 

likely to directly impact the industry's profitability. 

Managers might also strategically intervene to 

reshape the pivotal force 

and thus improve industry profitability, 

as we've seen in the case of airlines. 

I will now make a brief segue into 

a topic that often comes up with five forces analysis. 

One of the major criticisms of 

the original five forces model 

is that it ignores complements, 

which can be important for the success 

of many products and services. 

For example, the success of 

many electronic hardware products depends on 

the available software and vice versa. 

When compliments are important for an industry, 

it can be included as a sixth force. 

However, the effect of compliments can actually be 

seen as the conceptual opposite of substitutes. 

Rather than decreasing industry profits, 

value adding compliments can actually increase them. 

But an industry's overall relationship with 

its compliments is a bit more tenuous than that. 

While there are benefits from 

cooperation with compliment producers, 

there's also the potential for competition over 

the joint value created by 

the two complimentary industries. 

In this respect, compliment producers 

are also akin to suppliers. 

Ultimately, industry players must learn how 

to operate in so-called co-opetition. 

That is to simultaneously cooperate 

and compete with compliment producers. 

We now turn our attention to understanding how to 

analyze industries as they evolve and change. 

Industry evolution and change can take many forms, 

and I highlight here two ways, 

but not necessarily the only ways to make sense of them. 

One approach draws on an understanding 

of changes in the macro environment, 

say from utilizing 

the PESTEL framework in pharmaceuticals, 

for example an important 

legal and technological trend is that 

many important drugs are coming off patent 

and not being replaced by 

equivalently valuable new drugs. 

Another approach is to rely on 

known patterns of industry evolution over time, 

such as the industry life cycle depicted here. 

We know for example, 

a structural attributes like 

demand growth, scale economies, 

product innovation, and differentiation are likely to 

vary over the industry life cycle in systematic ways. 

Once we know the anticipated pattern of change, 

we can work out what it 

means for the industry by applying 

five forces analysis under the anticipated new structure. 

Thus for example, we can work out the generic substitutes 

might become an important factor 

in the pharmaceutical industry 

because of patent expiration and because threat 

from substitutes is probably 

the pivotal force in this industry today, 

it might actually be valuable to 

focus on changes of this force 

going forward as they are likely to 

have a direct impact on profitability. 

Over the years, I have seen many students make 

the same errors in applying industrial analysis. 

I think it would be valuable for 

you to know what these errors are, 

so that you can avoid them. 

One common error is not being really 

clear about the industry you're analyzing. 

As I noted earlier, 

identifying which actors fall into each of 

the five forces is 

a good way to overcome this potential error. 

Another error is being either too 

broad or too narrow in defining the industry, 

which is something you can overcome over 

time by developing better judgment. 

The third one, which goes hand 

in hand with good industry definition, 

is keeping track of 

the various actors in each of the five forces. 

So we might recognize that the outset that generic should 

be considered as a substitute 

for the pharmaceutical industry. 

But did we actually include generics 

when we analyze the threat from substitutes? 

A fourth important error is that many people 

think of the five forces model as 

simply an opportunity to describe 

the different actors in each of 

the five forces and just stop there. 

What you have then is a nice description of 

the industry but no analysis. 

Another error is to focus too much on 

hard structural attributes like 

scale economies or industry concentration, 

and not enough on software behavioral attributes 

like risk perception or brand loyalty, 

which can often be much more important. 

An important conceptual mistake is to use 

one force in the five forces model to explain another. 

For example, the threat of 

substitutes in this industry is 

low because rivalry is low. 

This is just wrong-headed analysis. 

Now it is possible for some structural attribute 

affect more than one force. 

So differentiation can affect 

both entry barriers and rivalry, 

but industry entry barriers are conceptually 

distinct from rivalry among 

existing firms in the industry, 

and they should be treated as such. 

Another error is to stop after evaluating each of 

the five forces and not 

evaluate overall industry profitability. 

In fact, that is 

the ultimate purpose of industry analysis, 

to evaluate how profitable or attractive 

an industry is and you should get there. 

You may recall from earlier in 

this lesson that you should not 

simply average across 

the five forces to evaluate profitability. 

Focus on the pivotal force instead, 

the one that is most competitive. 

Some students, particularly those 

who peek at industrial financials, 

will draw conclusions based on 

some short-term indicators of industry profits. 

Even the notoriously unprofitable 

industries like airlines can 

have short-term spikes and profitability and vice versa. 

Do not be misled by them. 

Last but not least, 

and this one is more of a recommendation. 

You should look at the dynamics of 

how industry structure is changing 

and also ask yourself what managers 

should do based on your industry analysis. 

If you manage to avoid most of these errors, 

I think you're well on your way to becoming 

an expert in the five forces framework. 

Despite the enduring appeal of the five forces framework, 

it does have a few limitations. 

It is mostly a static framework, 

even though we have learned how to 

extend it to dynamic situations. 

It is also a framework that is based on the idea of 

competition over some surplus or value. 

All of the implications are drawn 

from the extent of this competition, 

but very little attention is paid to actually 

how the value is created or to innovation. 

Also because there are many details about 

different structural attributes and how they 

might affect behavior and then in turn performance, 

the five forces framework require 

some learning and sophistication. 

But once you master it, it 

provides very deep insights that go 

well beyond loose frameworks like SWOT or even PESTEL. 

So in conclusion, I would like to 

highlight the following things 

you learned in this module. 

First, I hope you now 

recognize that firms are embedded in their environment, 

which can consist of many nested layers. 

The outermost layer is its macro-environment, 

and the PESTEL framework provides 

a good checklist for analyzing the macro environment. 

You were also introduced to industry analysis using 

the five forces framework to understand how 

attractive or profitable an industry is. 

Industry analysis is based 

on the Structure-Conduct-Performance paradigm, 

which says that structure 

drives the conduct of industry players, 

which then drives profit performance. 

You also learned how to combine 

the five forces to predict 

industry performance and how to extend 

the five forces model to industry dynamics change. 

Finally, you were introduced to some common errors and 

limitations when applying five forces analysis.