Unit 2 - Industry Analysis PDF

Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth compet...

Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 1 Understanding the competitive environment is critical for identifying profit sources and formulating successful strategies Introduction A profound understanding of the competitive environment is a critical ingredient of a successful strategy. Primary task à identify the sources of profit in the external environment. Proximate environment is its industry environment à the focus of our environmental analysis will be industry analysis 2 PEST analysis helps managers classify and analyze external environmental influences affecting the firm Introduction The business environment of the firm consists of all the external influences that affect its decisions and performance. How can managers hope to monitor, let alone analyze, environmental conditions? à PEST analysis Environmental influences can be classified into political, economic, social, and technological factors à PEST analysis 3 Here are highlighted the main components of the PEST analysis PEST analysis 4 We now dive deeper into how PEST analysis guides strategic decision- making in dynamic environments PEST analysis 5 Effective environmental analysis requires distinguishing between vital and important factors in the business environment Introduction The prerequisite for effective environmental analysis: distinguish the vital from the merely important. Go back to first principles: o For the firm to make profit it must create value for customers. o Understand its suppliers and manage relationships with them. o The firm must understand competition. o The core of the firm’s business environment is formed by its industry environment. 6 Macro-level factors influence a firm’s strategic opportunities and threats Introduction Macro-level factors, such as general economic trends, changes in demographic structure, or social and political trends, may be critical to strategy analysis. o These are critical determinants of the threats and opportunities a company will face in the future. o The key issue is how these more general environmental factors affect the firm’s industry environment. o It is essential to analyze the implications for their industry environment. 7 What influences the industry environment? Introduction 8 The profitability of firms in an industry depends on product value, competition intensity, and bargaining power Introduction The profits earned by the firms in an industry are thus determined by three factors: o The value of the product to customers. o The intensity of competition. o The bargaining power of producers relative to their suppliers and buyers. 9 There are four structural variables influencing competition and profitability Introduction 10 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 11 Porter’s five forces is used to analyze the competitive pressures within an industry Porter’s five forces of competition Porter’s five forces of competition framework views the profitability of an industry as determined by five sources of competitive pressure: o Competition from substitutes o Competition from entrants o Competition from established rivals o The power of buyers o The power of suppliers 12 Here is the framework of Porter’s five forces of competition Porter’s five forces of competition 13 Here are the determinants of Porter’s five forces of competition Porter’s five forces of competition: determinants 14 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 15 What is rivalry? Rivalry How intense the current competition is in the marketplace, which is determined by the number of existing competitors and what each competitor is capable of doing. Rivalry is high when: o there are a lot of competitors equal in size and power. o the industry is growing slowly o consumers can easily switch to a competitors offering for little cost. 16 High rivalry leads to aggressive tactics such as price wars and increased advertising Rivalry When Rivalry is high: o competitors are likely to engage in advertising and price wars. o barriers to exit are high. o consumers can switch to a competitors offering for little cost. A good indicator of competitive rivalry is the concentration ratio of an industry. 17 Multiple factors shape the intensity of rivalry Rivalry The intensity of competition between established firms is the result of interactions between the following factors: Concentration. Diversity of competitors. Excess Capacity and Exit Barriers. Cost Conditions: Scale Economies and the Ratio of Fixed to Variable Costs 18 Let’s delve into the factors that determine the intensity of the rivalry Rivalry Concentration Number and size distribution of firms competing within a market. Commonly measured by the concentration ratio. Role of oligopolies. Diversity of competitors Avoid price competition in favor of collusive pricing practices depends on how similar they are in their origins, objectives, costs and strategies. Excess Capacity and Exit Barriers Balance between demand and capacity is key. Unused capacity encourages firms to offer price cuts to attract new business. More capacity à supply higher than demand à war of producers to sell. 19 Let’s delve into the factors that determine the intensity of the rivalry Rivalry Cost Conditions: Scale Economies and the Ratio of Fixed to Variable Costs Scale economies may also encourage companies to compete aggressively on price in order to gain the cost benefits of greater volume. In industry with high fixed costs, companies want to sell a lot to distribute these fixed costs à price war. But companies whose variable cost is higher than their fixed cost will not want to produce as many units as if they had high fixed costs. 20 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 21 What are substitute products? How do substitute products affect pricing and demand? Substitutes The price that customers are willing to pay depends, in part, on the availability of substitute products. Absence of close substitutes à Inelastic demand with respect to price. Existence of close substitutes à Elastic demand with respect to price. 22 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 23 New entrants and barriers impact industry competition Threat of Entry New entrants bring new capacity and the desire to gain market share. The seriousness of the threat depends on the barriers to entry à higher barriers reduce the threat for existing players An industry where no barriers to entry or exit exist is contestable o A sector with entry or exit barriers is not contestable o Contestability depends on the absence of sunk costs Threat of entry rather than actual entry may be sufficient to ensure that established firms constrain their prices to the competitive level. 24 What are the main sources of barriers to entry? Threat of Entry Main sources of barriers to entry: o Capital Requirements o Economies of Scale o Absolute Cost Advantages o Product Differentiation o Access to Channels of Distribution o Governmental and Legal Barriers o Retaliation o Effectiveness of Barriers to Entry 25 Let’s explain the main sources of barriers to entry Threat of Entry Main sources of barriers to entry: o Capital Requirements: capital costs of becoming established in an industry can be so large as to discourage all but the largest companies. o Economies of Scale: in industries that are capital, research or advertising intensive, efficiency requires large-scale operation. o Absolute Cost Advantages: often result from acquiring of low-cost sources of raw materials. These advantages may also result from economies of learning. o Product Differentiation: advantages of brand recognition and customer loyalty. New entrants spend heavily on advertising and promotion to gain levels of brand awareness. 26 Let’s explain the main sources of barriers to entry Threat of Entry o Access to Channels of Distribution: Limited capacity within distribution channels or risk aversion by retailers result in retailers being reluctant to carry a new manufacturer’s product. o Governmental and Legal Barriers: § Economists from the Chicago School claim that the only effective barriers to entry are those created by government. § Some industries require a license. 27 Let’s explain the main sources of barriers to entry Threat of Entry o Retaliation: o Retaliation against a new entrant may involve aggressive price cutting, increased advertising, sales promotion, or litigation. § Avoid retaliation: new entrants into less visible market segments. o Effectiveness of Barriers to Entry: § Protected industries à above average rates of profit. § Capital requirements and advertising à effective barriers to preventing further entry. 28 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 29 What is the bargaining power of suppliers? Bargaining power of suppliers Capability of these economic agents when it comes to materials, goods or services to companies. o Multitude of suppliers à better position for companies. o Suppliers of complex components à high bargaining power. o Standardized product suppliers à low bargaining power. o Labor unions are an important source of supplier power. 30 Supplier advantages drive their negotiating power Bargaining power of suppliers Supplier advantages may be due to: o Operate in a monopoly market. o Existence of excess demand in relation to supply. o Better quality input than the other competitors. o Attractiveness of the company for the supplier. o Possibility that the supplier can become a competitor. 31 What is the bargaining power of buyers? Bargaining power of buyers Faculty that clients have when entering into agreements to acquire goods and services with companies, always for their own benefit. Factors determine the bargaining power of clients: o Size and concentration with respect to suppliers. o Buyers information. o Threat of substitutes. o Customer buys in large volumes. o Possibility of vertical integration. 32 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 33 Here, a summary of the Porter’s five forces driving industry competition Summary of Porter’s Five Forces Factors 34 What are the limitations of Porter’s five forces of competition? Limitations of the Porter Model Pays limited attention to factors that can affect demand. Ignores changes in income, tastes, and firm strategies of consumers to drive demand. It focuses on an entire industry rather than individual companies. Does not take into account the role of the government. Analysis of the five forces is qualitative. 35 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 36 Industries evolve through distinct phases, each influencing competition and growth opportunities Industry life cycle Most industries tend to go through similar phases over time, and such evolution resembles that of products. - Steven Klepper - “Industry life cycles” (1997 - Industrial and Corporate Change) 37 Here are the main characteristics of the four phases of the industry life cycle Industry life cycle Phases in the industry life cycle: Birth / introduction: Development and early marketing of a new product or service – High uncertainty – Low revenues. Growth: Demand grows rapidly – High investments – Fight for market share – Market leaders arise – New entrants. Maturity / stabilization: Growth slows down – Focus on cost reduction – Economies of scale – Barriers to entry – Price competition. Decline: Obsolescence – Declining revenues and demand – Weaker competitors exit – Disinvestment. 38 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 39 Companies cooperate and compete simultaneously, leading to shared profits and market benefits Coopetition Brandenberger and Nalebuff à Coopetition (Cooperation + Competition) Coopetition: Combine business strategy and game theory, suggesting that it may be better for competitors to work together rather than face each other. Porter à all other companies threats to profitability. Interactions between companies can improve profits and emphasize positive interactions that Porter ignores. Examples: o Efforts to establish technology standards. o Competitors’ efforts to promote favorable laws. o Cooperation with companies and suppliers to improve product quality. 40 Unit 2: Industry analysis Agenda 2.1. Introduction 2.2. Porter’s five forces of competition 2.3. Rivalry 2.4. Substitutes 2.5. Threat of entry 2.6. Bargaining power of buyers and suppliers 2.7. Limitations of Porter’s five forces of competition 2.8. Industry life cycle 2.9. A sixth competitive force? Coopetition 2.10. Porter analysis vs. net value analysis Dr. Juan Carlos Rivera-Prieto, MBA 41 Building on Porter’s five forces of competition, the Value Net Model shifts focus to opportunities Value Net Model The concept of Value Net emerges as a counterpart to Porter’s five forces of competition. Net Value: suppliers, customers, competitors and complements. Evaluates opportunities, unlike Porter’s framework, which only focuses on threats. Complements the analysis of the Porter’s Five Forces of Competition. 42 You will work in groups and present the results of the following activity at the end of the session Group Activity: Business Analysis You need to choose a company and analyze the following: 1. Mission, Vision, Values, and Objectives. 2. Porter’s Five Forces of Competition. 3. SWOT and PESTEL Analysis. Instructions: Complete the work in class. Present your findings in class during the last hour of class (Presentation format: Free choice). Important: Act as reviewers during the presentations of other groups by asking thoughtful questions and providing constructive comments. PARTICIPATE! 43