1. Economics of Strategy Fifth Edition Slides by: Richard Ponarul, California State University, Chico Copyright  2010 John Wiley  Sons, Inc. Chapter 12 Industry Analysis Besanko, Dranove, Shanley, and Schaefer

2. Industry Analysis Industry analysis facilitates  assessment of industry and firm performance  identification of factors that affect performance  determination of the effect of changes in the business environment on performance and  identification of opportunities and threats (SWOT analysis)

3. Industry Analysis Industry analysis helps with assessing generic business strategies Porter’s five forces framework is rooted in microeconomics Value net (Brandenburger and Nalebuff) supplements the five forces framework to analyze strategy

4. The Five-Forces Framework Michael Porter’s Five-Forces framework identifies the economic forces that affect industry profits The five forces are  Internal rivalry  Entry  Substitutes and complements  Supplier power  Buyer power

5. The Five-Forces Framework

6. Internal Rivalry Internal rivalry is the competition for market share among the firms in the industry Competition could be on price or some non- price dimension Price Competition erodes the price cost margin and profitability

7. Internal Rivalry Competition on non-price dimension can drive up costs. Non-price competition does not erode profits as severely as price competition if customers are willing to pay a higher price for the improvements.

8. Internal Rivalry Price competition heats up when  There are many sellers  Some firms have cost advantage over others  There is excess capacity in the industry  Products are undifferentiated and switching costs are low  Prices and sale terms are easily observable

9. Internal Rivalry Other conditions that facilitate intense price competition  Large and infrequent sales orders  Absence of “facilitating practices”  Absence of a history of cooperative pricing  Strong exit barriers  Industry demand is elastic

10. Entry Entry hurts the incumbents by  by cutting into the incumbents’ market share and  by intensifying internal rivalry and leads to a decline in price cost margin Barriers to entry can be  exogenous (nature of the industry) or  endogenous (incumbents’ strategic choices)

11. Factors that Affect the Threat of Entry Minimum efficient scale relative to the size of the market Government policies that favor the incumbents Brand loyalty of consumers and value placed by consumers on reputation Entrants’ access to critical resources such as raw material, technical know how and distribution network

12. Factors that Affect the Threat of Entry Steepness of the learning curve Network externalities that give the incumbents the benefit of a large installed base Incumbents’ reputation regarding post-entry competitive behavior

13. Substitutes and Complements Availability of substitutes erode the demand for the industry’s output Complements boost industry demand When the price elasticity of demand is large, pressure from substitutes will be significant Changes in demand can in turn affect internal rivalry and entry/exit

14. Supplier Power Supplier has indirect power if upstream market is competitive. It sells to the highest bidder. Supplier has direct power if  the upstream industry is concentrated or  the customers are locked into the relationship with suppliers due to relationship specific assets

15. Buyer Power Buyer power is analogous to supplier power Buyers have indirect power in competitive markets Buyer concentration or relationship specific assets can lead to direct power Buyer power relative to upstream is analogous to supplier power relative to downstream

16. Supplier Power The factors that determine supplier power are  Competitiveness of the input market  Relative concentration the industry  Relative concentration of upstream and downstream firms  Purchase volume by downstream firms  Availability of substitute inputs  Extent of relationship specific investments  Threat of forward integration by suppliers  Suppliers’ ability to price discriminate

17. Some Strategies to Cope with the Five Forces To outperform its rivals firms can  develop a cost advantage or  a differentiation advantage Firms can seek an industry segment where the five forces are less severe Firms can try to change the forces

18. Some Strategies to Cope with the Five Forces Facilitating strategies to reduce internal rivalries Moves that increase switching costs for the customers Pursuing entry deterring strategies Tapered integration to reduce buyer/supplier power

19. Five Forces and Value Net The Five-Forces Framework tends to view other firms - competitors, suppliers or buyers - as threats to profitability In the value net model (Coopetition) interactions between firms can be positive or negative

20. Cooperative Interactions Among Firms Setting industry standards that facilitate industry growth Lobbying for regulation or legislation that favors the industry Cooperation with buyers/suppliers  to improve product quality  to improve productive efficiency  to improve inventory management

21. The Value Net Concept The value net consists of  Suppliers  Customers  Competitors and  Complementors (producers of complementary goods and services) The value net complements the five forces approach by considering opportunities posed by each force.

22. The DVD Hardware Market: A Five-Forces Analysis Internal rivalry was intense. Brand name was the main source of differentiation It was easy for consumer electronics firms to enter. Satellite TV could be a substitute. Streaming over the internet was another possibility.

23. Movie studios (upstream) and big retailers (downstream) had power. DVD hardware makers, according to this analysis, had reason to be pessimistic. DVD format’s success can be attributed to firms working together (value net). The DVD Hardware Market: A Five-Forces Analysis

24. The DVD Hardware Market: The Value Net In the beginning DIVX was a major threat. DVD manufacturers cut prices on some models and advertised heavily. Other members of the value net chipped in to increase the size of the DVD “pie.”  Movie studios released popular titles in DVD format and priced them moderately  Retailers promoted the DVD hardware and software

25. Commercial Airframe Manufacturing Boeing and Airbus compete globally. Fringe players in aircraft with capacity less than 125 seats are excluded from the analysis. The market share (by revenue) of the fringe players is small. There are no meaningful submarkets.

26. Commercial Airframe Manufacturing: Internal Rivalry Boeing delivered its first commercial aircraft in 1958. Airbus is younger. Boeing enjoys economies of scope due to its defense business. Airbus gets government subsidies. Stable market shares and reduced incentive for price wars Historically there has been little product differentiation

27. Commercial Airframe Manufacturing: Internal Rivalry Airbus developed the double-decker mega plane. Boeing abandoned competing with its Sonic Cruiser. Airliners exhibit loyalty to suppliers Economic slowdown has reduced the demand for aircraft.

28. Commercial Airframe Manufacturing: Entry Major barriers to entry are:  Huge development costs  Experience-based advantages  Buyer reluctance to buy from startups  Customer loyalty to current suppliers

29. Commercial Airframe Manufacturing: Substitutes Small plane manufacturers cut into demand for Boeing and Airbus planes in regional routes. As demand for air travel increases airlines switching back to larger planes in regional routes. Other forms of transportation could be substitutes (High speed rail) for “regional jets.”

30. Commercial Airframe Manufacturing: Supplier Power Parts market is competitive Part suppliers deal directly with airlines. But Boeing’s Global Airlines Inventory Network (GAIN) gains leverage over suppliers. Jet engine suppliers are not numerous and enjoy direct power. Unionized labor has significant supplier power.

31. Commercial Airframe Manufacturing: Buyer Power Buyers for aircraft are either airlines or leasing companies. Neither have buyer power. Each order could be of the order of 15% of annual sales revenue for the manufacturer. Buyers may cancel orders during economic downturns.

32. Five-Forces Analysis of the Commercial Aviation Industry

33. Professional Sports: Market Definition Major sports leagues in the U. S.  MLB  NBA  NFL  NHL Five force analysis is also applicable to major sports leagues elsewhere

34. Professional Sports: Internal Rivalry Sports leagues require competitive balance to keep the contests interesting Athletic competition does not imply business competition Internal rivalry is low within leagues as teams follow rules and share revenue Teams do not compete in the labor market

35. Professional Sports: Entry Each league has rules for admitting new teams. Current owners need to be compensated when new teams are added. Incumbent owners can veto new franchises in their geographic market. Starting an entire new league is risky.

36. Professional Sports: Substitutes and Complements Teams compete in the local markets with other forms of entertainment Elasticity of substitution is quite low Important complements  Television  Sports betting

37. Professional Sports: Supplier Power Unionized players For new players NCAA has been a benign supplier Cities spend tax dollars to build facilities to attract sports teams. As municipal finances get tighter, subsidizing teams becomes more difficult.

38. Professional Sports: Buyer Power Television networks and sports cable systems compete with each other for broadcasting rights In negotiations regarding broadcast rights leagues have the upper hand against  television networks  local television and  radio.

39. Five-Forces Analysis of Professional Sports Leagues