Market Structure II: Entry barriers, life cycles, profit pools Paul C. Godfrey Mark H. Hansen Marriott School of Management

Why do these topics matter to strategists Barriers to entry can help a firm earn attractive margins and foreclose competition The industry life cycle helps managers understand how competitive imperatives change over time. Profit pools help managers identify “close in” opportunities for profitable growth.

Barriers to entry

Barriers to entry: The Economics Monopolistic competition allows increased profitability Barriers are the only way to forestall competition Limit pricing perfectly precludes entry High barriers to entry help create an attractive industry $ QQ*Q** P* P** S D

Barriers to entry: Sources Economies of Scale Proprietary Product Differences Brand Identity Information and credibility Switching Costs Capital Requirements Access to Distribution Absolute Cost Advantages –Learning Curves –Input Lock-up –Product Design Government Policy Expected Retaliation

Managing barriers to entry Create and exploit barriers wherever possible Barriers may be intrinsic to product –Capital intensive production –Low overall demand Barriers may be engineered by managers –Brand equity and identity –Switching costs Barriers are not absolute, but a queue of potential competitors

Industry life cycles

Life cycle basics Like products, and individuals, industries go through definitive phases of development Stage of development predicts –Demand –Level of Competition –Type and nature of innovation –Entry, exit, and competitive interactions (e.g., alliances, mergers) Strategies that succeed at one stage may be deadly at another

The Industry Life Cycle Sales Volume Time FragmentationShakeoutMaturityUncertainty Renewal Stagnation Decline

Competition and the Life Cycle Industry Characteristic Fragmentation (Renewal) ShakeoutMaturity (Stagnation)Decline DemandHigh Income BuyersReadily Increasing Penetration Mass Market, Replacement purchases Knowledgeable customers TechnologyNot StandardEmergence of competing paradigms Standardized and well known, quest for improvement ProductsWide VariationProduct “camps” develop Little Innovation, Product extensions Little change Manufacturing & Distribution Batch Production, Specialty Channels Trend toward mass production, channel competition Overcapacity, process innovation, channel stability Heavy overcapacity, new specialty channels reemerge CompetitionFew CompaniesCompeting business models Price-based competition Price wars, exit Key Success Factors First Mover Product Innovation Build Brand Build Scale Cost Control Customer Loyalty Retrench or exit

Managing the industry life cycle Be sensitive to changes in overall demand, the best predictor of life cycle shift Have the courage to do what needs to be done –Shoot the founder (fragmentation to shakeout) –Cull the product line (maturity to decline/ renewal) Decline may be a very profitable strategy –Exploit economies of scale/ scope –Unattractive for competitive entry

Profit pools

Profit pools: Looking at the value chain It’s not just how you compete, but where The Value Chain distributes value unevenly The Personal Computer Industry

Early 1980’s Late 1980’s Mid 1990’s

Mapping profit pools: 4 steps Step 1: Define the boundaries Step 3: Determine the distribution of profits in the pool Step 4: Reconcile estimates & plan strategy Step 2: Determine the size of the pool Conceptual Empirical

Defining the pool Task: Determine which value chain activities influence your ability to generate current and future profits Take a BROAD view—look beyond tradition, go upstream, downstream, and consider substitutes 3 perspectives: your company, your competitors, your customers Look for new business models and innovations Don’t get too detailed at this stage

Sizing the pool Task: develop a baseline estimate of cumulative volumes over the entire industry, by segment The goal is the comparative size of the segments, not the actual accurate volume of each segment Go where you can get data: Government data (Census of Manufacturers) Annual reports, WSJ, Industry analyst reports Try for two levels: company level, product level Focus on largest companies and segments, fill in details through extrapolation and interviews TIP: Government data is pretty good for comparative volumes

Distribution of profits Task: Develop estimates of the profits generated by each segment Look at “pure players” in each segment to determine profitability It’s comparative profitability that matters Are there barriers that keep segment profit high and entrants out? Think creatively TIP: Profit is far more important than volume when deciding whether to enter

Planning strategy Attempt to reconcile estimates in 2 and 3 through interviews and triangulation of data sources The goal is to look for new segments to explore and/or exploit Develop strategic migration path and possibilities Check for consistency with current strategies to avoid conflict

Managing profit pools Profit pools exploits existing customers by offering them new products/ services Firms can leverage existing assets and production expertise Be careful about losing focus –Dilute brand or other reputation-based capital –Divert management attention from core business