Chapter 3 Industry Analysis Copyright © 2004 McGraw Hill Companies, Inc. All rights reserved.

How Are Industries Defined? Products in the industry are functionally similar. Example: Air conditioners cool the air in a building in a functionally similar way that is different from a fan, which is a substitute. Products in the industry compete directly by influencing demand. Changes in the value or price of a firm’s product affect demand for competing firms’ products.

Industry Analysis Identifying industry competitors Firms whose products provide value in functionally equivalent ways. Firms that compete directly through changes in product value and price. Firms that face the same common factors of economic interdependence in an industry. Identifying substitute producers Firms whose products are functionally different from an industry’s products but compete to provide value to the same industry buyers.

What Determines Firm Profitability? Macroeconomic factors The overall state of the economy Industry factors Business environment and competitive conditions specific to an industry The firm’s market position The degree to which a firm is strategically benefited by the position it holds within an industry

Transportation Sector Relative Contributions of Industry and Business Unit to Economic Performance Manufacturing Sector Transportation Sector Services Sector Percentage Contribution of Business Segment, Industry and Other Factors to Business Return on Assets 1980–1994 (U.S. data). Figure 3.3

Economies of Scope Economies of Scope Reduce costs Enhance value Generalist Strategy Specialist Strategy

Industry Development over Time More Product Price Product Value Market Segmentation Less Early Industry Development Late

Forces Influencing Firm Performance The potential for entry into the industry by new firms The strength of competition The power of buyers The power of suppliers The strength of substitutes for the industry’s products The strength of complements of the industry’s products

Porter’s Five Forces Framework Competition for dominance in the industry Source: Michael Porter, Competitive Strategy (New York: Free Press, 1980), p. 4. Figure 3.1

The Effect of Industry Forces on Value, Cost, and Price Table 3.1a

The Effect of Industry Forces on Value, Cost, and Price (cont’d) Table 3.1b

Rivalry’s Effects on Competition Perfect competition No firm makes a profit above its capital cost, since rivalry has driven the market price down to marginal cost. Oligopolistic competition Localized competition occurs among a few similar firms within and across market segments.

Rivalry and Economic Performance Characteristics of increased rivalry that lead to low economic performance: Many competitors A common set of buyers for all firms The same value offered by all firms The same cost structure in all firms Relatively costless entry Relatively costless exit The combination of these conditions produces a state of perfect competition.

Buyer Power Buyer power is increased by: The availability of competing products with the same value and price Buyer concentration (few buyers) Low market growth Low importance of the product to the buyer High importance of selling product to buyer Supplier need to fill capacity by selling to buyer Credible threat of vertical (backward) integration by the buyer

Supplier Power Supplier power is increased by: Supplier concentration (few suppliers) Growth in supplied industry (buyer demand) Low percentage of supplier volume bought by customer (size of buyer relative to supplier) The strategic importance of supplier to buyer The strategic importance of buyer to supplier Low threat of backward integration by buyer

What Factors Raise Entry Barriers? High barriers to imitation Property rights Dedicated assets Causal ambiguity Learning curve and development costs High customer switching costs Lower prices by firms in the industry Limit pricing

Substitutes The threat of substitutes increases when: A firm has a low buyer surplus (value minus price) relative to the substitute. A firm’s customers have low switching costs. Defenses against substitutes: Increase the buyer’s surplus Raise buyer’s switching costs

Cooperation for mutual gain The Value Net Cooperation for mutual gain Adapted from: Adam Brandenburger and Barry Balebuff, Co-opetition (New York: Doubleday, 1996), p. 17. Figure 3.2

Industry Forces Increasing Profits Coordination among competitors Cooperative pricing (not price-fixing) to avoid price competition Readily available pricing information Comparable value-cost profiles for competitors Establishing interfirm partnerships

Industry Forces Increasing Profits Cooperation between buyers and suppliers Sharing information Operating (e.g., logistics) Strategic (e.g., technology development Sharing resources and capabilities Quality management techniques

Cooperative Pricing Example Price leadership requires: Observable prices Common buyers Strategic discipline A small number of firms Common history of competition Comparable market positions Adherence to antitrust law Cooperative output levels Interfirm partnerships

What Are Complements? Complementary products Are products, not in the same industry, whose patterns of demand are systematically positively correlated and move in tandem. Create a reciprocal expansion of demand. Example: Skis and ski boots, sails and sailboats, tires and automobiles.

Strategic Groups Strategic groups are a level of analysis between the firm and the industry. Characteristics of strategic groups: Firms within an industry that have similar cost and value drivers compared to firms in other groups. Firms which compete in the same segment or across segments for the same customers. Firms that take a similar approach to competing in an industry.

Mobility Barriers and Strategic Groups Mobility barriers for strategic groups Are actions taken by stronger and more profitable competitors to protect their segments from entry by rival firms in the industry. Prevent the movement of firms from one strategic group to another. Are created by entry-deterring behavior of firms in a group (e.g., isolating mechanisms specific to the group or limit pricing). Are similar to barriers to entry to the industry.

Value (quality, technology) Strategic groups in the Chain Saw Industry in 1978 (Classic Example of a Products Industry) High Stihl Husqvarna Jonsereds Partner Solo Homelite McCullough Value (quality, technology) Beaird-Poulan Remington Echo Roper Low High Cost (higher price in professional market and lower price in mass market) Low

The Internet Brokerage Industry: Selected Firms (Fall 2000) Table 2.1a

The Internet Brokerage Industry: Selected Firms (Fall 2000) Table 2.1b