Stanford GSB Sloan Program Stramgt 258 Strategic Management 7: Introduction to Industry Analysis Airborne Express

January 28, 2003John Roberts2 Accounting for Performance Overall Performance = Industry Effect + Business Unit Effect + Corporate Effect

January 28, 2003John Roberts3 Industry Analysis Objectives Understand industry’s role in (potential and actual) performance. –Hard to do really well in a bad industry Identify environmental factors to be addressed in setting strategy, building competitive advantage –Leverage and overcome

January 28, 2003John Roberts4 Four Questions If a firm were a monopolist, how profitable would it be? (How big is PIE?) If potential profits are high, can they be retained? (Are buyers or suppliers powerful?) If potential profits are realized, can they be sustained? (Are there entry barriers?) Now what if the firm is not a monopolist? (Does competition erode profits?)

January 28, 2003John Roberts5 Potential Industry Earnings Increase in price of substitutes (complements): –Shifts demand curve out (in) Substitutes also constrain firms’ ability to set price: –With close substitutes even a monopolist in the industry will not enjoy high margins Growth in demand increases P.I.E.: –Income growth –Changes in consumer preferences

January 28, 2003John Roberts6 Buyer Power Buyer Impact On Industry Profitability Buyer Impact On Industry ProfitabilityBuyerNegotiatingAdvantageBuyerNegotiatingAdvantage Focal Industry Stake in Transaction Focal Industry Stake in Transaction Buyer Stake in Transaction Buyer = = * * * * How easily can buyer vs. individual firm in focal industry be replaced? What percentage of buyer’s costs are comprised of purchases from focal industry? What percentage of focal industry’s sales are to buyer segment? Concentration ratios Ability to coordinate Backward integration. Determines buyer’s incentive to use power Given buyer has power and incentive to use it, determines impact on industry Issues/Hints Questions      

January 28, 2003John Roberts7 Example: Impact of Passenger Airlines as Buyer Varies Airline Buyer’s Impact On Industry Profitability ProfitabilityBuyerNegotiatingAdvantageBuyerNegotiatingAdvantage Focal Industry Stake in Transaction Focal Industry Stake in TransactionBuyer Stake in Transaction Buyer = = * * * * High MedHigh Med/HighLow/MedHigh Low/MedHighLowHigh LowHighMedLow Caterers Aircraft Ticket Jackets Uniforms Focal Industry        

January 28, 2003John Roberts8 Supplier Power Supplier Impact On Industry Profitability Supplier Impact On Industry ProfitabilitySupplierNegotiatingAdvantageSupplierNegotiatingAdvantage Focal Industry Stake in Transaction Focal Industry Stake in Transaction Supplier Stake in Transaction Supplier = = * * * * How easily can supplier vs. indiv. firm in focal industry be replaced? What percentage of suppliers’s sales are to focal industry? What percentage of focal industry’s costs are purchases from supplier? Concentration ratios Ability to coordinate Forward integr. Determines supplier’s incentive to use power Given supplier has power and incentive to use it, determines impact on industry Issues/Hints Questions      

January 28, 2003John Roberts9 Switching Costs & Power Switching costs for focal industry firm magnify the effect of buyer/supplier power: –Location specificity –Relationship-specific investments –Linkages between systems (formal or informal) –Reputation

January 28, 2003John Roberts10 Potential Entrants Barrier: Anything that makes an industry less attractive to an entrant than an existing firm. Examples: –Reputation/brand –Learning curve (steepness matters) –Switching costs –Access to distribution channels Judge height of barrier relative to most likely entrant

January 28, 2003John Roberts11 Potential Entrants Capital investment barrier to entry only if both: –MES is large relative to demand –Investment is sunk (exit costs)

January 28, 2003John Roberts12 Example Scale Effects Industry MES Plant Share per Market Paints 7 Petroleum Refining 10 Integrated Steel Works 10 Storage Batteries 11 Glass Bottles 14 Cement 41

January 28, 2003John Roberts13 Rivalry Even with high barriers to entry and no buyer/supplier power firms might compete away profits: –Structure (composition of firms) –Conduct (firm behavior) Structure: –Higher concentration makes (tacit or explicit) coordination easier –But not sufficient

January 28, 2003John Roberts14 Rivalry Conduct: –Even two firms can compete away profits –Highly differentiated products diminish rivalry –Coordinated pricing (helped by visibility of prices) –Effect of excess capacity (scale penalty)