Industry Analysis PDF

# Topic IV - Industry Analysis ## 4.1 Environmental Analysis ### Structure-conduct-Performance (SCP Model) - The SCP paradigm is a causal theoretical explanation for firm performance through economic conduct. - This model has had direct influence on subsequent in models such as Porters five forces...

# Topic IV - Industry Analysis ## 4.1 Environmental Analysis ### Structure-conduct-Performance (SCP Model) - The SCP paradigm is a causal theoretical explanation for firm performance through economic conduct. - This model has had direct influence on subsequent in models such as Porters five forces analysis - The market environment (PEST) has a direct, short-term impact on the market structure. - The market structure then has a direct influence on the firm's economic conduct, which in turn affects its market performance. - Also, Feedback effects occur such that market performance may impact conduct and structure. - Also, conduct may affect the market structure - Additionally, external factors such as legal or political interventions affect the market framework and, by extension, the structure, conduct and Performance of the market | **S** Market Structure | **ENVIRONMENT** External & Industrial | **C** Conduct & Structure of competitors | **P** Market Performance | Firm's Economic Conduct | |---|---|---|---|---| ### Pest Analysis - Pest Analysis considers the political, economic, social, and technological factors that impact a firm. ### Porter's Diamond - Explains why particular industries become competitive in particular locations or countries - **Factor Conditions:** - Access to specialized factors that are rare and difficult to imitate by foreign competitors - Human resources, physical resources, infrastructure, and capital resources - Ex: Software engineers in silicon valley - **Strategy, Structure, Rivalry companies:** - Strategy and culture of firms - The national competition is a source of competitive stimulus - Ex: selling a car in Germany or wine in Spain is hard → too many competitors - **Demand Condition (specialized clients):** - The nations achieve competitive advantage in sectors where domestic demand requires its companies to innovate quickly and gain competitive advantage over their foreign rivals. It is important the volume of demand, but more important the specialized nature of this demand by clients - Spanish customers are demanding on wines quality - **Related & Supporting Industries:** - Presence of support sectors that provide key elements: economic, effective and preferred - Ex: Car Sector Industry ## 4.2 Objectives of Industrial Analysis ### The Spectrum of Industry Structures | | Perfect Competition | Oligopoly | Duopoly | Monopoly | |---|---|---|---|---| | Concentration | Many firms | A few firms | Two firms | One firm | | Entry and Exit Barriers | No barriers | Significant barriers | High barriers | High barriers | | Product Differentiation | Homogeneous Product | Potential for product differentiation | | | | Product Information availability | Perfect Information | Imperfect availability of information | | | ## 4.3 Key Success Factors - Key success factors → Are those important elements required for a company to compete in its target markets. - Key Success Factors - What does my customer Value? - Demand Analysis - How do I survive to competition - Dimensions of Competition ### Examples: | Industry | What do customers want? | How Firms Survive Competition? | Key Success Factors | |---|---|---|---| | Steel | - Low price - Product consistency - Reliability of supply - Specific technical specifications for special steels | Strong price competition and cyclical demand require low costs and financial strength | Cost efficiency requires either large plants in low-cost locations, or hi-tech, flexible, mini-mills close to customers Quality and service differentiation | | Fashion clothing | - Demand segmented by garment type, style, quality, color - Price premium for brand, style, exclusivity, and quality - Mass market highly price sensitive | Intensely competitive due to low entry barriers, low seller concentration, and strong retail buying power Differentiation can yield substantial price premium, but imitation rapid Markets localized | Combining differentiation with low-costs Key differentiation variables: design, speedy to fashion trends, brand reputation, quality | | Supermarkets | - Low prices - Convenient location - Wide product range adapted to local tastes - Fresh produce, good service, pleasant ambience, easy parking | Intensity of price competition depends on number and proximity of competitors Bargaining power essential to low input costs | Cost efficiency requires low labor costs Low-costs require operational efficiency, efficient supply chain, buying power, low wage costs. Differentiation requires wide product range (hence, large stores), convenient location, easy parking | ## 4.4 Porter's Five Force ### The Determinants of Industry Profitability - 3 key influences: - The value proposition of the product to customers. - Ex. Pharma - The intensity of competition - Ex. Commercial Banks - Relative bargaining power at different stages of the value chain (supplier & customers) - Ex. BME (Spanish Stock Exchange)  ### Bargaining Power of Suppliers | SUPPLIER POWER | | |---|---| | Buyers' price sensitivity | 2 | | Relative bargaining power | | ### Threat of New Entry | THREAT OF ENTRY | | |---|---| | Capital requirements | | | Economies of scale | | | Absolute cost advantage | | | Product differentiation | | | Access to distribution channels | | | Legal/regulatory barriers | | | Retaliation | | ### Threat of Substitutes | SUBSTITUTE COMPETITION | | |---|---| | Buyers' propensity to substitute | 4 | | Relative prices & performance of substitutes | | ### Bargaining Power of Buyers | BUYER POWER | | |---|---| | Buyers' price sensitivity | 3 | | Relative bargaining power | | ## Rivalry Between Established Competitors 1. **Concentration**: How many companies dominate the sector? 2. **Diversity of competitors**: Origin, costs structure, strategies, markets, etc. - Existence of business groups or alliances 3. **Product Differentiation** 4. **Cost Conditions** - High fixed costs vs. variable costs - Scale Economies 5. **Demand growth and Overcapacity** 6. **Barriers to exit**: - The costs for a company to exit the market: - Reduced liquidation value. - High cost industrial conversion. - Emotional or personal barriers. - Legal / concessional restrictions - Forms of Exit: - Firm go bankruptcy (e.g., Air Berlin) - Firm discontinues a product (e.g., Sega left the video game hardware) - Firm leaves a particular geographic market segment (e.g., Peugeot left the U.S. market) ### Concentration - **Unit Market Share (%)** = Unit Sales of the company (#) / Total Market Unit Sales (#) - **Revenue Market Share (%)** = Sales Revenue of the company ($) / Total Market Revenue ($) ## Measure of Concentration of competitors 1. **Market/industry concentration** = number of firms competing in a market/industry 2. **Concentration rate**: - **CR** = Sum of market share of the 'x' largest firms - e.g., C4 = market share of the 4 largest firms 3. **Herfindahl index**: - **HHI** = Sum of squares of all market shares (in decimals form) - An H below 0.01 (or 100) indicates a highly competitive industry. - An H below 0.15 (or 1,500) indicates a non highly concentrated industry. - An H between 0.15 to 0.25 (or 1,500 to 2,500) indicates moderate concentration. - An H above 0.25 (above 2,500) indicates high concentration 4. **Normalized Herfindahl index**: - spans 0-1 (the higher the index, the lower competition) - It considers the Number of Firms in the market ## Bargaining Power of Suppliers - How is the bargaining power of the suppliers? Who sets the rules for the price negotiations? - Some factors to analyze: - Market conditions. - Strategic importance of the product / service provided. - Cost of switching suppliers. - Conditions of other suppliers. - Concentration of suppliers. - Vendor differentiations. ## Bargaining Power of Customers - How is the bargaining power of the Customer? Who sets the rules for the negotiation? - (analyze customer as a group & as an individual) - Some factors to analyze: - Price sensitivity of customers. - Concentration / dispersion of customers. - Purchase volume per customer. - Customer switching costs. - Backward integration. Possibility to work from the supplier or integrate it. - Example: white trade marks. - Perfect / imperfect market. Level of customer information. - Product differentiation, Trademarks & Branding. - Existence of substitute products. ## Threat of Substitutes - Substitutes goods or services that perform the same functions at a lower price and / or premium quality - How do you know if they are really a threat? - Relative Price and Price sensibility (Replacing customer propensity) - Switching costs to the substitute product or service. - Some questions you may ask yourself? - Easy access to substitute products - Is the price competitive? - Is performance superior? - Does it better satisfy the needs of customers? - Is it expensive to change for the customer? - Others... ## Threat of New Entry - Forms of Entry - Entrant is a new firm. - Entrant is an established firm that is diversifying in a new market. - Entrant is an established firm that is entering a new geographical market. ## Entry barriers are factors that - allow the incumbents to earn economic profit while - making it unprofitable for new firms to enter the industry. - Economics of scale: Cost advantages that enterprises obtain due to size. - Experience curve: Relationship between experience and efficiency. - Minimum capital requirements. - Costs of switching suppliers / captive customers - Access to critical inputs and distribution channels - Branding and Trademarks - Product Differentiation - Legal & Governmental barriers - Others.... Anything that makes it difficult to new entrants ### Classification of entry barriers | ENTRY BARRIERS | | |---|---| | EX-ANTE | | | ENDOGENOUS | | | EXOGENOUS | | | EX-POST | | | | **Endogenous or strategic barriers**: *Incumbents' actions to entry* | | E.g.: Product differentiation, R&D and marketing expenses, access to distribution channels, tacit knowledge | | | **Exogenous or structural barriers**: *Natural advantages* | | | E.g.: High set-up costs, economies of scale, network effects, legal barriers | ## 1. Static perspective - Industries that are more dynamic and continuously changing are not well represented ## 2. No interaction among competitors - Actions and success of one industry player may depend on the actions of other players in the industry - Session 13 & 14: Game theory ## 3. Industry influence competition, but competition influence industry - Industry structure influences competition - But: Competition also influences industry structure ## 4. Difficulty of defining industry boundaries - Assumption that industry boundaries are given and well defined - Industry boundaries vary depending on our objectives - Session 6: Segmentation ## 5. Excessive emphasis on industry structure - Assumes that industry structure is the main determinant of firms' profits - Firms' success also depends on firm-level factors (e.g. resources and capabilities) - Session 7 & 8: Resource-based view ## Summary of Topic: - **From Environmental Analysis to Industry Analysis** - The industry is the core of a firm's external environment. Political, economic, social, and technological forces impact the firm through its industry - Forecasting Industry Profitability - Past profitability is a poor indicator of future profitability. - If we can forecast changes in industry structure we can predict likely impact on competition and profitability. - **Strategies to Improve Industry Profitability** - Influencing industry structure by individual or collective strategies - Positioning the firm to shelter from the forces of competition - Defining Industry Boundaries - Key criterion: substitution - Industry definition depends upon the strategic issues being considered - **Key Success Factors** - Gateway to the analysis of competitive advantage