Session 4:

Industry Analysis

MGCR 423 Strategic Management

Mitali Banerjee
Sept. 13, 2023
Does Industry Matter?

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Economists’ View

• Reallocate resources across the economy, based on consumer and

investor preferences.
• If price levels in one business make it more profitable than other
businesses, this business should attract additional investment which, in
turn, will increase supply and, holding demand constant, will result in
lower prices, and therefore lower average industry profitability.
• In the long term, economic profits would tend to zero in all businesses
and no one industry would create –nor destroy –any value.

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Returns Across Industries 1995-2015

ROCE – WACC (%)

Cosmetics 36.1
Tobacco 26.7
Soft drinks 19.1
Pharmaceuticals 18.1
Medical supplies 14.5
Computer software 12.7
Printing and publishing 8.5
Financial services 7.6
Petroleum products 4.8
Retailing 4.1
Aerospace / defense 3.7
Computers & peripherals 3.2
Auto parts 3.1
Building materials 3.1
Automobiles & trucks 1.6
Telecom services 0.5
Airlines - 2.4
Textiles - 2.9
Iron and steel - 3.7
Paper products - 4.2
Telecom equipment - 6.1

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Invisible Hand Predictions Hold True? No!

ROCE – WACC (%)

Cosmetics 36.1
Tobacco 26.7
Soft drinks 19.1
Pharmaceuticals 18.1 Some industries are
Medical supplies 14.5 much more profitable
Computer software 12.7
Printing and publishing
Financial services
8.5
7.6
than others.
Petroleum products 4.8
Retailing 4.1
Aerospace / defense 3.7
Computers & peripherals 3.2
Auto parts 3.1
Building materials 3.1
Automobiles & trucks 1.6
Telecom services 0.5
Airlines - 2.4
Textiles - 2.9
Iron and steel - 3.7
Paper products - 4.2
Telecom equipment - 6.1

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How does industry affect performance?

• Porter’s Five Forces Model

– Intensity of Competition among incumbents
– Threat of new entrants when industry is profitable
– Availability of substitutes:
– Level of differentiation in features other than price
– Bargaining power of suppliers & buyers

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Intensity of Competition Among Incumbents

• Number of competitors & concentration

Industry A Market Share Industry B Market Share
in A in B
A1 10% B1 60%
A2 10% B2 30%
A3 10% B3 10%
A4 10%
A5 10%

A6 10%

A7 10%
A8 10%
A9 10%
A10 10%
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Intensity of Competition Among Incumbents

• Industry growth
– Slower growth means gaining market share requires advertise more, cut
prices, etc.. Over time this would erode profits.
– Faster growth decreases incentives to undercut competition.

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Intensity of Competition Among
Incumbents

• Fixed costs

– High fixed cost require

greater capacity
utilization.

– Greater capacity
utilization requires
more sales, which can
spur price competition
and decrease
profitability.

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Intensity of Competition Among Incumbents

• Level of differentiation
• Low level of differentiation increases customers price sensitivity (e.g.
cement, paper products)

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Intensity of Competition Among Incumbents

• Switching costs
– Costs incurred by buyer when switching suppliers
– e.g.
• razor and blades
• airline miles
• music streaming platforms (Spotify)
– Costs can be material or psychological (e.g. banks or real estate
brokerage)
– Low switching costs make consumers more price sensitive

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Intensity of Competition Among Incumbents

• Competitors with high strategic stakes

P&G (>$40 billion in revenues) Colgate (Approx $10billion in)

revenues

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Intensity of Competition Among Incumbents

• High exit barriers

– If assets are hard to redeploy, then incumbents are forced to remain in
business even as they cut prices.

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Intensity of Competition Among Incumbents

• Capacity increased in large increments

– Can creates excess capacity requiring price cuts and hence, low profits.

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Intensity of Competition Among Incumbents

• Level of Differentiation

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Factors that Affect Intensity of Competition Among
Incumbents

• Number of competitors & concentration

• Industry growth
• Fixed costs
• Switching costs
• Competitors with high strategic stakes
• High exit barriers
• Capacity increased in large increments
• Level of Differentiation

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Factors that Increase Threat of new entrants:

• Low Economies of Scale

– Economies of scale: Larger production capacity diminishes costs
– Low economies of scale reduce entrants’ disadvantage
– Hence more entrants

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Factors that Increase Threat of new entrants:

• Lack of Differentiation
– Consumers more price sensitive and less loyal
– Easy for entrants to steal market share from incumbents

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Factors that Increase Threat of new entrants:

• Low Fixed Costs

– Lower capital requirements to become operational

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Factors that Increase Threat of new entrants:

• Low Switching Costs:

– Consumer not locked into incumbent’s products.

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Factors that Increase Threat of new entrants:

• Ease of Access to Distribution Channels

– Internet has improved access to distribution in many industries (music, film,
creative content), and increased competition.

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Factors that Increase Threat of new entrants:

• Low Economies of Scale

• Lack of Differentiation
• Low Fixed Costs
• Low Switching Costs
• Ease of Access to Distribution Channels
• Limited Value of Experience: Flatter Learning Curve

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Substitutes

• Availability of substitutes puts a ceiling on WTP

– Low cost airlines
– Telephone
– Spotify

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Buyer/Supplier Bargaining Power

• Concentration among buyers

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Buyer/Supplier Bargaining Power

• Buyer’s total product costs as a fraction of supplier’s industry product

costs
• Automobile /steel/rearview mirrors

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Buyer/Supplier Bargaining Power

• Importance of industry’s product to quality of buyer’s product

• Standardization within the industry

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 Buyer/Supplier Bargaining Power

• Importance of industry’s product to quality of buyer’s product

• Standardization within the industry

“Customers will wait 18

months to buy an Nvidia
system rather than buy an
available, off-the-shelf chip
from either a start-up or
another competitor,”

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Buyer/Supplier Bargaining Power

• Buyer’s profit level

• Buyer’s ability of integrate backward
• Buyer’s knowledge of industry profits

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Buyer/Supplier Bargaining Power

• Concentration among buyers

• Buyer’s total product costs as a fraction of industry product costs
• Importance of industry’s product to quality of buyer’s product
• Standardization within the industry
• Buyer’s profit level
• Buyer’s ability of integrate backward
• Buyer’s knowledge of industry profits

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Next Class: Cola Wars Continue

1. What is the industry structure in carbonated beverage?

2. How does industry structure shape Coke and Pepsi’s
profitability?

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