Industry Analysis: The Fundamentals

OUTLIN
E
• The objectives of industry analysis
• From environmental analysis to industry analysis
• Porter’s Five Forces Framework
• Applying industry analysis
• Industry & market boundaries
• Identifying Key Success Factors
 The Objectives of Industry
Analysis

• To understand how industry structure drives competition,

which determines the level of industry profitability.

• To assess industry attractiveness

• To use evidence on changes in industry structure to

forecast future profitability

• To formulate strategies to change industry structure to

improve industry profitability

• To identify Key Success Factors

 From Environmental Analysis
to Industry Analysis

The national/ The natural

international environment
economy THE INDUSTRY
ENVIRONMENT
Demographic
Technology • Suppliers structure
• Competitors
• Customers

Government Social structure

& Politics

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

•The Macro Environment impacts the firm through its effect on the Industry
Environment.
 Profitability of US Industries

Median return on equity (%), 1999-2002

Pharmaceuticals 26.8 Gas & Electric Utilities 10.5

Tobacco 22.0 Food and Drug Stores 10.3
Household & Personal Products 20.5 Motor Vehicles & Parts 9.8
Food Consumer Products 20.3 Home Equipment 9.5
Medical Products & Equipment 18.8 Railroads 9.0
Beverages 18.8 Hotels, Casinos, Resorts 8.0
Scientific & Photographic Equipt. 16.5 Insurance: Life and Health 7.6
Commercial Banks 16.0 Building Materials, Glass 7.0
Publishing, Printing 14.3 Metals 6.0
Petroleum Refining 14.3 Semiconductors &
Apparel 14. 3 Electronic Components 5.8
Computer Software 13.5 Insurance: Property & Casualty 5.3
Electronics, Electrical Equipment 13.3 Food Production 5.3
Furniture 13.3 Telecommunications 3.5
Chemicals 12.8 Forest and Paper Products 3.5
Computers, Office Equipment 11.8 Communications Equipment (4.0)
Health Care 11.5 Airlines (34.8)
Long-term Profitability of US Industries: EVA and ROA, 1986-97

Industry EVA/CE ROA Industry EVA/CE ROA

Tobacco 9.4 14.4 Paper and products (1.5) 5.2
Computer software Broadcasting and
& services 5.9 10.4 publishing (1.5) 6.0
Personal care Cars & trucks (1.5) 2.2
products 2.8 8.0 Healthcare services (1.7) 3.3
Medical products 2.7 9.5 Machine tools, hand tools (1.7) 6.0
Printing & Appliances and home
advertising (2.0) 2.3 furnishings (1.9) 3.4
Food processing 2.5 8.5 Telephone equipment &
Drugs & research 0.7 7.6 services (2.1) 7.0
Beverages 0.2 5.6 Plastics & products (2.6) 5.3
Textiles (0.1) 7.4 Computers & peripherals (3.1) 3.1
Fashion retailing (0.4) 9.3 Electrical products (3.3) 4.6
Building materials (0.6) 5.6 Aerospace & defense (3.3) 4.8
Metals (1.0) - Railroads (3.4) 3.8
Telecom services (1.2) 4.6 Airlines (4.1) 1.0
Discount retailing (1.2) 6.4 Steel (6.4) 2.3
Semiconductors Cable television (7.2) (3.3)
& components (1.3) 6.0 Electronics (9.2) 3.5
Average (1.1) 5.6

Source: Hawawini et al, Strategic Management Journal (January 2003)

 The Determinants of Industry
Profitability

3 key influences:
• The value of the product to customers

• The intensity of competition

• Relative bargaining power at different levels

within the value chain.
 The Spectrum of Industry Structures

Perfect
Oligopoly Duopoly Monopoly
Competition

Concentration Many firms A few firms Two firms One firm

Entry and Exit No barriers Significant barriers High barriers

Barriers

Product Homogeneous
Differentiation Potential for product differentiation
Product

Perfect
Information Imperfect availability of information
Information flow
 Porter’s Five Forces of
Competition Framework

SUPPLIERS
Bargaining power of suppliers

INDUSTRY
COMPETITORS

POTENTIAL Threat of Threat of

SUBSTITUTES
ENTRANTS
new Rivalry among substitutes
entrants existing firms

Bargaining power of buyers

BUYERS
The Structural Determinants of Competition

BUYER POWER
• Buyers’ price sensitivity
• Relative bargaining
power

THREAT OF ENTRY INDUSTRY RIVALRY SUBSTITUTE

•Capital requirements •Concentration COMPETITION
•Economies of scale •Diversity of
•Absolute cost advantage competitors • Buyers’ propensity
•Product differentiation to substitute
•Product differentiation
• Relative prices &
•Access to distribution •Excess capacity &
channels exit barriers performance of
•Cost conditions substitutes
•Legal/ regulatory barriers
•Retaliation

BUYER POWER
• Buyers’ price sensitivity
• Relative bargaining
power
 Threat of Substitutes

Extent of competitive pressure from producers of

substitutes depends upon:

• Buyers’ propensity to substitute

• The price-performance characteristics of

substitutes.
 The Threat of Entry

Entrants’ threat to industry profitability depends

upon the height of barriers to entry. The principal
sources of barriers to entry are:

• Capital requirements
• Economies of scale
• Absolute cost advantage
• Product differentiation
• Access to channels of distribution
• Legal and regulatory barriers
• Retaliation
 Bargaining Power of Buyers

Buyer’s price sensitivity Relative bargaining power

• Cost of purchases as % • Size and concentration of

of buyer’s total costs. buyers relative to
• How differentiated is the sellers.
purchased item? • Buyer’s information .
• How intense is • Ability to backward
competition between integrate.
buyers?
• How important is the
item to quality of the Note: analysis of supplier
buyers’ own output? power is symmetric
 Rivalry Between Established
Competitors

The extent to which industry profitability is depressed by

aggressive price competition depends upon:

• Concentration (number and size distribution of

firms)
• Diversity of competitors (differences in goals, cost
structure, etc.)
• Product differentiation
• Excess capacity and exit barriers
• Cost conditions
– Extent of scale economies
– Ratio of fixed to variable costs
 Profitability and Market Growth
ROI (%)
30

25

20

15

10

0
Return
Return onon sales
sales Return
Return onon investment
investment Cash
Cash flow/Investment
flow/ Investment
-5
Less than -5% < -5%-5% to 0-5% to 00 to 5%
0 to 5% 5%
5% toto 10%
10% > 10% Over 10%

ANNUAL RATE OF GROWTH OF MARKET DEMAND

 The Impact of Unionization on Profitability

Percentage of employees unionized

None 1%-35% 35%-60% 60-75% >75%

ROI (%) 25 24 23 18 19

ROS (%) 10.8 9.0 9.0 7.9 7.9

ROI = Return on Investment

ROS = Return on Sales
 Applying Five - Forces Analysis

Forecasting Industry Profitability

• Past profitability a poor indicator of future
profitability.
• If we can forecast changes in industry structure
we can predict likely impact on competition and
profitability.

Strategies to Improve Industry Profitability

• What structural variables are depressing
profitability
• Which can be changed by individual or
collective strategies?
Drawing Industry Boundaries : Identifying
the Relevant Market
• What industry is BMW in:
– World Auto industry
– European Auto industry
– World luxury car industry?

• 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 decision
 Identifying Key Success Factors

Pre-requisites forsuccess
Pre-requisites for success

What do How does the firm

customers want? survive competition

Analysis of competition
Analysis of demand
• What drives competition?
• Who are our •• What drives
What are the competition?
main
customers? •dimensions
What are theof main
competition?
dimensions of competition?
• What do they want? ••How
Howintense
intenseis iscompetition?
competition?
••How
Howcan
canweweobtain
obtainaasuperior
superior competitive
competitive position? position?

KEY SUCCESS FACTORS

 Identifying Key Success Factors
Through Modeling Profitability: The
Airline Industry
Profitability = Yield x Load factor - Unit Cost
Income
ASMs
= Revenue
RPMs
x RPMs
ASMs -
Expenses
ASMs

• Strength of • Price • Wage rates.

competition on competitiveness. • Fuel
routes. • Efficiency of route efficiency of
• Responsiveness to cha- planning. planes.
anging market • Flexibility and • Employee
conditions responsiveness. productivity.
• Customer loyalty. • Load factors.
• % business travelers. • Meeting customer • Administrative
• Achieving differentia- requirements. overhead.
tion advantage ASM = Available Seat Miles RPM = Revenue Passenger Miles
 Identifying Key Success Factors
by Analyzing Profit Drivers: Retailing

Sales mix of products

Avoiding markdowns through

Return on Sales
tight inventory control

Max. buying power to minimize

cost of goods purchased
ROCE
Max. sales/sq. foot through:
*location *product mix
*customer service *quality control

Sales/Capital Max. inventory turnover through

Employed electronic data interchange, close
vendor relationships, fast delivery

Minimize capital deployment

through outsourcing & leasing
 SUMMARY: What Have We Learned?
Forecasting Industry Profitability
• Past profitability a poor indicator of future profitability.
• If we can forecast changes in industry structure we can predict
likely impact on competition and profitability.

Strategies to Improve Industry Profitability

• What structural variables are depressing profitability?
• Which can be changed by individual or collective strategies?

Defining Industry Boundaries

• Key criterion: substitution
• The need to analyze market competition at different levels of
aggregation (depending on the issues being considered)

Key Success Factors

• Starting point for the analysis of competitive advantage