Tutorial 4

TUTORIAL 4: INDUSTRY ANALYSIS [Tutorial week beginning 17 Nov 2008] 1a) Is it possible for a perfectly competitive firm to make abnormal profits in the long-run? Explain and illustrate how the firm and industry adjust to its long-run equilibrium. It is not possible, because in a perfectly competitive situation, there are no barriers to entry or exit. So when the market is facing losses, firms can leave the market easily and thus those firms that remain will only be able to breakeven. Answer: - If perfectly competitive firm enjoys abnormal profits (i.e. product pricing & profit margins abnormally high). - will attract new entrants into the industry (due to lack of barriers to entry)…leading to… o increase in overall industry supply of industry’s products o lower pricing as all firms want to clear their inventories - All firms (new and existing) will have to cut their selling prices as the products are homogenous and consumers are indifferent to which firm they buy from - Profit margins and therefore profits will return to a normal lower level 1b) Which market structures does the following statements reflect? Statements

Market Structures (more than one may apply)

i) There is only one seller in the industry.

Monopoly

ii) There are many firms producing differentiated products.

Monopolistic Competition

iii) Firms are free to enter and exit the industry in the long run.

Perfect Competition; Monopolistic Competition

iv) The price charged by one firm is likely to affect the price charged by the other firms.

Perfect Competition; Oligopoly

2a) Assume that all the firms in a particular industry have consistently experienced rates of return that were similar to the results for the industry. Discuss what this implies regarding the importance of industry and company analysis for this industry.

With industry, we are able to identify industries that will prosper and those that will underperform the economy. This is because every company in the same industry will affect the industry growth and in return, affect the different companies. So therefore with the help of industry analysis, we are able to determine whether certain industry are likely to do well or otherwise. Ans: Greater emphasis must be placed upon industry analysis (if performance of individual firms clusters about industry average) Once the industry performance is estimated, the need for individual firm analysis is reduced since all the firms will behave similarly to the industry. 2b) Some observers say that differences in the performance of various firms within an industry limit the usefulness of industry analysis. Do you agree? Why? No, I disagree. This is because industry analysis takes into account the performance of different companies in the industry. A good company will buck the trend, however, if it is mixed with several under-performing companies, the industry will still be unable to prosper. Therefore, industry analysis comes into the picture by telling us how is the industry performing by taking into account the different numbers of companies in the industry. Yes. If the difference between the performances is too great, it will give a false impression on how the industry is performing. Because if the major company in the industry perform exceptionally well, while the rest did not perform, it will affect. There is instability in the industry. However, if the difference is small, it could possibly due to customer references, resulting in a slight difference. The industry is therefore deem as “stable”. Answer: Studies  industry performance can partially explain individual firm performance. - (BF King observation) – 13% of stock price changes explained by industry influences) Industry performance (in difference economic environment) varies  industry analysis still important step before company analysis. - Implication is that individual company analysis is more important for industries where individual company returns are widely dispersed. o If wide dispersion in performance among companies within industries [Industry analysis gives you the idea of how the industry is doing; it is affected by the different companies’ performance. It helps to pick out the positive growing industry among the various. However, when you’re thinking of investing in a company within the industry, without doing the company analysis, you are unable to know which company is the one prospering the economy and which is the one causing under-growth in the industry. Thus, it is highly possible that you may be end up investing in a company that is not as ideal as what you expect. With the company analysis, you’ll be able to identify which company is creating the best result for the industry] 3a) Briefly explain Michael Porter’s 5 Competitive Forces. -

Rivalry among firms o Degree of competition (existing competitors in industry)  affects profitability of the industry.

-

Bargaining Power of Customers o Ability of customers to bid down prices and dictate quality  affect prices & profits

-

Bargaining Power of Suppliers o Ability of suppliers to increase prices and limit quality of products  affect cost & profits

-

Threats of New Entrants o Ease of entry into industry for new entrants to compete with existing firms  affects costs, prices & profits

-

Threats of Substitutes o Extent to which businesses in other (i.e. not the same) industries offer substitute products or services  affects demand, prices & profits

3b. You have been tasked to conduct an analysis on the local mobile telecommunication industry’s competitive structure. Analyse the competitive structure of the industry using any 2 of the 5 forces. Any of the 5 forces are fine. • Rivalry among firms o Uses price promotions and advertizing to compete with one another  new telephone set at attractive prices  rewards (reduction in monthly bill) to promote loyalty from existing subscribers o Competitive but not cut throat  Industry is similar to an oligopoly •

Bargaining power of suppliers o Labour/employee is mobile o Suppliers of telephone handsets e.g. Nokia, Samsung.  has bargaining power as their handsets are popular but there are only 3 service providers, probably equal power between industry and suppliers

•

Bargaining power of customers o Many customers to only 3 service providers.  have to accept the service plans offered  free to choose telco but a necessity ‘must have product’? o Bargaining power probably tilted towards industry

•

Threats of substitutes o Currently no close substitutes to make telephones  Industry keeps up with new technology (3G, phones can take pictures, listen to music, surf internet, email)  Development of interest to compete with use of telephone for interpersonal communications.

•

Threats of new entrants o Most Singaporeans already own at least one mobile phone (i.e. with one of the 3 service providers)  Not many untapped market left for new entrant  Existing subscribers are tied to service plans o New entrant needs to invest huge capital for infrastructure

- End of Tutorial 4 -