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ANALYSIS OF INDUSTRIAL AND OPERATING ENVIRONMENT Dr. Sasmita Palo TISS, Mumbai

“Strategy is a choice on how to

- Michael Porter

External analysis • General Environment (macro factors) • Industry and Competitive Environment (micro factors)

Industry Competition and the IO Model

• Industry:

– A group of firms producing products (goods and/or services) that are similar to each other.

• Structure-Conduct-Performance (SCP) model – The primary contribution of the Industrial Organization (IO) economics model • Structure: Structural attributes industry • Conduct: The firm’s actions

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The Structure-Conduct-Performance Paradigm: Basic Conditions: factors which shape the market of the industry, e.g. demand, supply, political factors Structure: attributes which give definition to the supplyside of the market, e.g. economies of scale, barriers to entry, industry concentration, product differentiation, vertical integration. Conduct: the behavior of firms in the market, e.g. pricing behavior advertising, innovation. Performance: a judgment about the results of market behaviour, e.g. efficiency, profitability, fairness/income distribution, economic growth. How can the government improve the performance in an

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Basic Conditions Structure :

no of firms

and concentration, entry conditions, level of vertical integration and diversification

Conduct:

Governm ent Policy

goals of the firm,, price and

outpu t decision, , degree of co-operation and interdependence, anti

Performance:

output, growth,

profitability, employment and efficiency

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Five Forces Framework – “Translated” and extended from the SCP model in 1980 by Michael Porter. – A key proposition: • The focal firm’s performance critically depends on the degree of competitiveness of the five forces within an industry. • The stronger and more competitive these forces are, the less likely the focal firm is able to earn aboveaverage return, and vice versa.

Defining Industry Competition • Business strategists have turned the SCP model from IO economics upside down, by drawing on its insights to help firms perform better. • This transformation is the heart of this.

What is a 5 Forces Analysis? •

Based on premise that: competition in an industry is rooted in the underlying economics, competitive forces or structures that collectively determine the profit potentialof the industry.

Two Key Questions 1. How structurally attractive is the industry? 2. What is the company’s relative position within the industry?

Determinants of Industry Profitability Rivalry Determinants

Entry Barriers Economies of scale Proprietary product differences Brand identity Capital requirements Access to distribution Government policy Expected retaliation

Bargaining Power of Suppliers Determinants of Supplier Power Dominated by few companies Differentiation of product (inputs) causes high switching costs Few substitute inputs Supplier concentration Importance of volume to supplier Cost relative to total purchases in the industry Threat of forward integration relative to threat of backward integration by firms in the industry

Threat of New Entrants

Rivalry Among Existing Competitors Threat of Substitutes Determinants of Substitution Threat Relative price performance of substitutes Switching costs Buyer propensity to substitute

Industry growth Demand conditions (overcapacity) Exit barriers (corporate stakes, high fixed costs) Product differences Brand identity Concentration and balance

Bargaining Power of Buyers Determinants of Buyer Power Bargaining leverage Buyer concentration vs. industry Buyer volume Buyer switching costs Price/total purchases Product differences Brand identity

Source: Michael Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review, March-April 1979, and “Viewer’s Guide,” Michael Porter on Competitive Strategy, Nathan/Tyler, 1988.

Risk of Entry by Potential Competitors Potential Competitors are companies that are not currently competing in an industry but have the capability to do so if they choose. Barriers to new entrants include:

Barriers to Entry – Scale-based low cost advantages (economies of scale)- as firms expand output unit costs fall via: Cost reductions – through mass production Discounts on bulk purchases – of raw material and standard parts Cost advantages – of spreading fixed and marketing costs over large volume Non-scale-based low cost advantages (proprietary technology / know-how / access to raw materials and channels / good locations).

– – – – – –

Product Differentiation Capital Requirements Switching Costs Access to Distribution Channels Government Policy Expected retaliation

Rivalry Among Established Companies Competitive Rivalry refers to the competitive struggle between companies in the same industry to gain market share from each other. Intensity of Industry Competitive Structure vNumber

and size distribution of companies vConsolidated versus fragmented industries

Demand Conditions vGrowing

demand – tends to moderate competition and reduce rivalry vDeclining demand – encourages rivalry for market share and revenue

Cost Conditions vHigh

fixed costs – profitability leveraged by sales volume

Lack of Differentiation ot low switching cost High strategic stakes Height of Exit Barriers – prevents companies from leaving industry vHigh fixed costs of exit vWrite-off of investment in assets vLow scrap value

Emotional attachment to industry Govt. regulations –

Five Forces Framework: Intensity of Rivalry among Competitors (cont’d)

• Conditions leading to a high degree of rivalry: – The more concentrated an industry is, the fewer the competitors are, and the more likely that competitors will recognize their mutual interdependence and so restrain their rivalry. – Competitors of similar size, market influence, and product offerings vigorously compete with each other. – In “big ticket” industries where products are purchased infrequently, it is difficult to

• Blue Ocean

• Red Ocean

Bargaining Power of Buyers Industry Buyers may be the consumers or end-users who ultimately use the product or intermediaries that distribute or retail the products. These buyers 1. 2.

3.

4.

5. 6.

Buyers concentration ratio is high Buyers purchase in large quantities. v Buyers have purchasing power as leverage for price reductions. The industry is dependant on the buyers. v Buyers purchase a large percentage of a company’s total orders. Switching costs for buyers are low. v Buyers can play off the supplying companies against each other. Buyers can purchase from several supplying companies at once. Buyers can threaten to enter the industry themselves.

Bargaining Power of Suppliers are organizations that provide inputs such as material and labor into the industry. These Suppliers suppliers are most powerful when: The product supplied is vital to the industry and has few substitutes. The industry is not an important customer to suppliers.

1. 2. v

Switching costs for companies in the industry are significant.

3. v

4.

Suppliers are not significantly affected by the industry.

Companies in the industry cannot play suppliers against each other.

Suppliers poses a credible threat to integrate forward into the buyers’ industry

Substitute Products Substitute Products are the products from different businesses or industries that can satisfy similar customer needs. 1.

The existence of close substitutes is a strong competitive threat. v Substitutes limit the price that companies can charge for their product. Substitutes are a weak competitive force if an industry’s products have few close substitutes. v Other things being equal, companies in the industry have the opportunity to raise prices and earn additional profits.

n

Substitutes are particularly threatening: ¡

If substitutes are superior to existing products in quality and function.

¡

If switching costs are low.

Interpreting Industry Analysis – The collective strength of these forces determines the ultimate profit potential of an industry. – The stronger each of these forces the more limited industries are in their ability to raise prices and increase profits

In general, a firm is likely to be more profitable if: • •

•

•

•

the less intense is the rivalry in its industry; the less danger of potential entrants & the higher the barriers to entry; the less numerous and less aggressive the firms that sell substitute products, and the more numerous and more aggressive the firms that sell complementary products; the weaker the bargaining power of clients/customers; and the weaker the bargaining power of suppliers. In industry and competitive analysis, firms examine their positions along these lines and seek ways to change conditions to be more favorable to the firm.

High entry barriers Suppliers and buyers have strong positions Strong threats from substitute products Intense rivalry among competitors

Unattractive Industry

Low profit potential

Five Forces Framework: Lessons from the Five Forces Framework • Not all industries are equal in terms of their potential profitability. • The task for strategists is to assess the opportunities (O) and threats (T) underlying each competitive force affecting an industry, and then estimate the likely profit potential of the industry.

Summary • Industry Analysis is a powerful tool for analyzing industry structures – Identify profit opportunity – Identify suitable position strategy

• BUT – less emphasis on choice & innovation – Static model

Concept of sixth force Role of a complementor

STRATEGIC GROUP

Three Strategic Groups in the Global Automobile Industry

Figure 2.2

Critical Evaluation of Comp. Forces and Strategic Group

• Innovation and industry structure • Company differences • Competitive changes during an industry’s evolution

Implications of Strategic Groups 1.Intensity of competition among the companies within the group. 2.Each Strategic Group can have different competitive forces and may face a different set of opportunities and threats. 3.Competition between the groups Mobility Barriers

Competitive Advantage – Performing activities better than competitors – Activities that create value in eyes of consumers

Competitive Analysis • The process of identifying key competitors; assessing their objective, strategies, strengths and weaknesses & reaction patterns; and selecting which competitors to attack or avoid.

(Source: Principles of Marketing by: Philip Kotler and Gary Armstrong 10th Edition )

Steps in the Process: • Identifying Competitors • Assessing Competitors • Selecting Competitors to Attack or Avoid

Firms face a wide range of competition Be careful to avoid “competitor myopia” Methods of identifying competitors: Industry point-of-view Market point-of-view

(Source: Principles of Marketing by: Philip Kotler and Gary Armstrong 10th Edition )

Sources of Competitive Advantage

COMPETITIV E ADVANTAGE

lar i cetr Sim du rtolow t p a os c

P fropre rice mm pr uniium od qu uc e t

COST ADVANTAGE

DIFFERENTIATI ON ADVANTAGE

Porter’s Generic Strategies

SOURCE OF COMPETITIVE ADVANTAGE Low cost Differentiation Industry-wide DIFFERENTIATION

COST

COMPETITIVE

LEADERSHIP

SCOPE Single Segment

FOCUS

Sou r ces of C ompet iti ve Advanta ge Competitive Advantages (Sources of Rates of Profit in Excess of the Competitive Level)

Avoid Competito rs Attractiv e Industry

Attractiv e Strategic Group

Attractiv e Niche

Entry Barriers

Mobility Barriers

Mechanism s

Be Better Than Competition Cost Advantag e

Differentiati on Advantage

Competi tiv e Advant ages as the Sour ce of Super ior • Competitive advantages work in two basic ways • avoiding competitors • outperforming competitors (ie. productivity and efficiency/distinctive competencies)

Sour ces of Superior Pr ofita bilit y • A business can achieve a higher rate of profit (or potential profit) over a rival in one of two ways: • supplying an identical product/service at a lower cost (cost-based advantage) • supplying a differentiated product/service in such a way that the customer is willing to pay a price premium that exceeds the cost of the differentiation (differentiation-based advantage) • These two sources of competitive superiority define fundamentally different approaches to business strategy

Ma r ket Share-P rofi tabili ty Relatio nship : High

Profitabilit y

Differentiatio n-based Strategies

Low Cost Leadershi p Strategies

Stuck-in-the-Middle

Low Low

High

Market Share (Quantity)

Porter’s Generic Strategies

ANALYSIS OF COMPETITOR ENVIRONMENT

Competitor Analysis FUTURE AGENDA •CURRENT STRATEGY •ASSUMPTIONS •CAPABILITIES •

Competitor Analysis Components

The Competitive Profile Matrix

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