Session 4 - Industry Analysis PDF

Strategies for Competing in Industries and Markets Session 4 - Industry Analysis Structure-Conduct-Performance approach David Millán Planelles  Agenda Defining Industry Analysis Anal...

Strategies for Competing in Industries and Markets Session 4 - Industry Analysis Structure-Conduct-Performance approach David Millán Planelles  Agenda Defining Industry Analysis Analyzing attractiveness: The 5 Forces Framework Applying Industry Analysis The limits of Industry Analysis Assigned material: Grant Book: Chp. 3 Grant Book: Chp. 4, only section “Does Industry Really matter?” Besanko Book: Chp. 5, pages 155-162 Besanko Book: Chp 8, pages 247-254 David Millán Planelles Before we start, remember that… What Makes a Successful Strategy? Robert M. Grant CHAPTER 1 5  The Basic Strategy Framework Strategy as a Link Between the Firm and its Environment Robert M. Grant CHAPTER 1 6  Agenda Defining Industry Analysis Grant Book: Chp. 3 Analyzing attractiveness: The 5 Forces Framework Applying Industry Analysis The limits of Industry Analysis Assigned material: Grant Book: Chp. 3 Grant Book: Chp. 4, only section “Does Industry Really matter?” Besanko Book: Chp. 5, pages 155-162 Besanko Book: Chp 8, pages 247-254 David Millán Planelles Defining Industry Analysis. What is Industry Analysis? INDUSTRY vs. ENVIRONMENT INDUSTRY ANALYSIS The Industry Environment lies at the core of the Macro environment. The Macro Environment impacts the firm through its effect on the Industry Environment. Oftentimes referred as Market (Industry) and Non-Market (Environment) forces. Macro Environment: political, economic, social, technological, legal Industry Environment: competitors, suppliers, customers Firm: resources, capabilities Defining Industry Analysis. What is Industry Analysis? INDUSTRY vs. ENVIRONMENT INDUSTRY ANALYSIS The Industry Environment lies at the core of the Macro environment. The Macro Environment impacts the firm through its effect on the Industry Environment. Oftentimes referred as Market (Industry) and Non-Market (Environment) forces. Macro Environment: political, economic, social, technological, legal Examples ? Industry Environment: competitors, suppliers, customers Firm: resources, capabilities Defining Industry Analysis. What is Industry Analysis? INDUSTRY vs. ENVIRONMENT INDUSTRY ANALYSIS The Industry Environment lies at the core of the Macro environment. The Macro Environment impacts the firm through its effect on the Industry Environment. Oftentimes referred as Market (Industry) and Non-Market (Environment) forces. Macro Environment: political, economic, social, technological, legal Industry Environment: competitors, suppliers, customers Firm: resources, capabilities Defining Industry Analysis. What is Industry Analysis? INDUSTRY vs. ENVIRONMENT INDUSTRY ANALYSIS The Industry Environment lies at the core of the Macro environment. The Macro Environment impacts the firm through its effect on the Industry Environment. Oftentimes referred as Market (Industry) and Non-Market (Environment) forces. Firms’ strategies and performance are influenced by external Macro Environment: political, economic, social, environments. technological, legal Strategy researchers have developed several frameworks in Industry Environment: order to analyze the impact of external environments on firms’ competitors, suppliers, customers strategies and performance. Firm: Framework for environmental analysis: PESTLE. resources, capabilities PESTLE limitations. PESTLE analysis is important but it focuses on very broad and generic aspects, and it does not explain clearly their link to firms’ performance and strategies Defining Industry Analysis. Roots and Assumptions. STRUCTURE Antecedents. The roots of Sector and Industry Analysis are in Industrial Organization studies Knowing the sector characteristics (i.e. origins in Economics) Underlying Paradigm: Structure – Conduct – Performance (S-C-P) The industry structure is assumed to be fairly stable CONDUCT Key idea behind industry analysis is that the structure of the industry competitors, suppliers, buyers determines the conduct Help determining the firm’s position and behavior of the firms within the industry and, as a consequence, the industry performance in terms of profitability Main purpose: Understanding how industry structure drives PERFORMANCE competition, which (in turn) determines the level of industry profitability (profits). Which ultimately explains the firm’s performance  Agenda Defining Industry Analysis Analyzing attractiveness: The 5 Forces Framework Grant Book: Chp. 3 Besanko Book: Chp. 5, pages 155-162 Besanko Book: Chp 8, pages 247-254 Applying Industry Analysis The limits of Industry Analysis Assigned material: Grant Book: Chp. 3 Grant Book: Chp. 4, only section “Does Industry Really matter?” Besanko Book: Chp. 5, pages 155-162 Besanko Book: Chp 8, pages 247-254 David Millán Planelles Analyzing Industry Attractiveness. Can we explain profitability in terms of industry structure? Analyzing Industry Attractiveness. Can we explain profitability in terms of industry structure? Analyzing Industry Attractiveness. The 5 Forces Framework. INDUSTRY and PROFITABILITY The profits earned by a firm in an industry can be determined by 3 main factors : 1. The VALUE of the product to customers 2. The intensity of COMPETITION 3. Relative bargaining POWER at different stages of the value chain Analyzing Industry Attractiveness. The 5 Forces Framework. The 5 Forces Framework - Rivalry The Intensity of Competition can explain industry’s attractiveness How to identify its impact ? Effect on Rivalry Effect on Profit Profit Determinant Price Competition Attractiveness Concentration: If Competitors are many (Low Concentration) Low price coordination Diversity of Competitors Competitors are diverse difficult to coordinate on prices Product Differentiation Prod. Differentiation attainable Low substitutability demand Excess Capacity & Exit Barriers When Excess Capacity relevante (for different reasons, such as: (over-investment, slow demand, asset specificity or job protect) Cost conditions: Ec. of Scale and Fixed/Variable Cost. Economies of Scale can induce aggressive price competition. High Ratio Fixed Cost to Variable Cost pressures price competition. Note: Non-Price Comp, pressures Fixed-cost, but not Price Competition (review Besanko) The 5 Forces Framework - Rivalry How concentrated is the Industry ? Measuring industry structure (Besanko Book, Chp. 5, pages 155-162) Market Concentration refers to the number and distribution of firms in a market. N Firm Concentration ration. Combined market share of the N first firms For instance, CR4 (see Besanko book, Table 5.1) Herfindahl Index. The sum of the squared market share of the firms in the market. Herfindahl Index tend to represent better the market concentration that CR”N”. Note: Remember a highly concentrated industry is an industry with few players  The 5 Forces Framework - Threat of Entry How Barriers to Enter can affect Profitability ? Entry Barriers Threat of Effect on Profit Profit Determinant Entry Attractiveness Capital Requirements When high, entering becomes a challenge for new players. Economies of Scale: When low, no need of market share (or minimum scale) to split fixed costs. Absolute Cost Advantages When existent, Cost Adv. can exist beyond scale (e.g. access raw mat.) Product Differentiation When low, easy to capture customers through price cuts. Access to distribution channels When easy to access distribution networks Legal barriers (e.g. patents): When low, new players can enter more easily Retaliation risk (e.g. ex-post-entry price wars of incumbents) When possible (In Game Theory we will deep dive here) The 5 Forces Framework - Threat of Entry How Barriers to Enter can affect Profitability ? Note 1: Mind the difference between Threat of Entry and Barriers to Enter to avoid mistakes. High Barriers to Enter explains a Low Threat of Entry Note 2: Mind the difference between Exogenous vs Endogenous Entry Barriers (review Besanko book, but we will come back to this with the Entry Strategy Session) - Exogenous: Result from (successful) competition requirements. - Endogenous: Result from incumbent’s strategic choices.  The 5 Forces Framework - Power (Supply and Buyer side) How does the Power (Supply/Buyer) affects Profitability ? PRICE SENSITIVITY BARGAIN POWER Price sensitivity increase with: Bargain Power increases with: Cost of product relative to total cost Size and Concentration of buyers relative to Does the item comprise a big percentage of the producers buyer’s total costs? Product Differentiation Buyer’s switching cost Is the product a commodity or differentiated? Competition Between Buyers Buyer’s information How intense is competition between buyers? Is the item critical to the quality of the buyer’s own output Buyer’s ability to backward integrate Note: Consumer choice does not necessarily imply Power The 5 Forces Framework - Power (Supply and Buyer side) Power Examples A reflection on POWER The 5 Forces Framework - Power (Supply and Buyer side) Power Examples A reflection on POWER The 5 Forces Framework - Power (Supply and Buyer side) Power Examples  Agenda Defining Industry Analysis Analyzing attractiveness: The 5 Forces Framework Applying Industry Analysis Grant Book: Chp. 3 Besanko Book: Chp. 5, pages 155-162 The limits of Industry Analysis Assigned material: Grant Book: Chp. 3 Grant Book: Chp. 4, only section “Does Industry Really matter?” Besanko Book: Chp. 5, pages 155-162 Besanko Book: Chp 8, pages 247-254 David Millán Planelles  Applying Industry Analysis. Objectives Industry Analysis main objectives are: Identify Industry Structure - Identifying who are the main players (producers, customers, suppliers, producers of substitute goods) - Then examining some of the key structural characteristics of each of these groups that will determine competition and bargaining power. - Mapping the industry is sometimes not straightforward. In some industries, particularly in service industries, mapping the industry can be more difficult. Assess Industry Attractiveness: To predict the future profitability of an industry, our analysis proceeds in three stages: - Examine present structure. - Identify the trends that are changing the industry’s structure. - Identify how these structural changes will affect the five forces of competition and resulting profitability of the industry.  Applying Industry Analysis. Objectives PRESENT STRUCTURE Industry Analysis main objectives are: Examine how the industry’s current and recent levels of Identify Industry Structure competition and profit- ability are a consequence of its present - Identifying who are the main players (producers, structure. customers, suppliers, producers of substitute goods) - Then examining some of the key structural characteristics of each of these groups that will TRENDS determine competition and bargaining power. - Mapping the industry is sometimes not Identify the trends that are changing the industry’s structure. Is straightforward. In some industries, particularly in the industry consolidating? Are new players seeking to enter? service industries, mapping the industry can be more Are the industry’s products becoming more differentiated or difficult. more commoditized? Will additions to industry capacity outstrip growth of demand? Is technological innovation causing new Assess Industry Attractiveness: substitutes to appear? To predict the future profitability of an industry, our analysis proceeds in three stages: IMPACT - Examine present structure. - Identify the trends that are changing the industry’s Identify how these structural changes will affect the five forces structure. of competition and resulting profitability of the industry. Will the - Identify how these structural changes will affect the changes in industry structure cause competition to intensify or five forces of competition and resulting profitability of to weaken? Rarely do all the structural changes move the industry. competition in a consistent direction, typically some will exacerbate competitive intensity; others will cause it to abate. Hence, determining the overall impact on profitability tends to be a matter of judgment.  Applying Industry Analysis. Objectives Industry Analysis main objectives are: Identify Industry Structure - Identifying who are the main players (producers, customers, suppliers, producers of substitute goods) - Then examining some of the key structural characteristics of each of these groups that will determine competition and bargaining power. - Mapping the industry is sometimes not straightforward. In some industries, particularly in service industries, mapping the industry can be more difficult. Assess Industry Attractiveness: To predict the future profitability of an industry, our analysis proceeds in three stages: - Examine present structure. - Identify the trends that are changing the industry’s structure. - Identify how these structural changes will affect the five forces of competition and resulting profitability of the industry.  Applying Industry Analysis. Using Industry Analysis to develop the Strategy Which is the rationale behind Once we understand how industry structure influences competition (which in turn determines industry so many cereal products? profitability) we can use this knowledge to develop firm strategies. Alter (improve) industry Structure - Identify the key structural features of an industry that are responsible for depressing profitability. - Consider which of these structural features are amenable to change through appropriate strategic initiatives. Positioning the Company - Effective positioning requires the firm to anticipate changes in the competitive forces likely to affect the industry. Applying Industry Analysis. Using Industry Analysis to develop the Strategy Once we understand how industry structure influences competition (which in turn determines industry profitability) we can use this knowledge to develop firm strategies. Alter (improve) industry Structure - Identify the key structural features of an industry that are responsible for depressing profitability. - Consider which of these structural features are amenable to change through appropriate strategic initiatives. Positioning the Company - Effective positioning requires the firm to anticipate changes in the competitive forces likely to affect the industry.  Applying Industry Analysis. Using Industry Analysis to develop the Strategy Once we understand how industry structure influences competition (which in turn determines industry profitability) we can use this knowledge to develop firm strategies. Alter (improve) industry Structure - Identify the key structural features of an industry that are responsible for depressing profitability. - Consider which of these structural features are amenable to change through appropriate strategic initiatives. Positioning the Company - Effective positioning requires the firm to anticipate changes in the competitive forces likely to affect the industry. Applying Industry Analysis. Defining the Boundaries. Which is my “relevant” market? Different organizations and indicators (e.g. Standard Industrial Classification-SIC) Based on likely price increase in case of merger: Small but significant non-transitory price increase, (SSNIP). (Review Besanko Chp 5 pages 155-162) Key criterion: SUBSTITUTABILITY Demand side: Are buyers willing to substitute between types of cars and across countries Supply side: Are manufacturers able to switch production between types of cars and across countries Industry analysis results might vary based on the “definition” of the Industry. Applying Industry Analysis. Key Success Factors Applying Industry Analysis. Key Success Factors  Agenda Defining Industry Analysis Analyzing attractiveness: The 5 Forces Framework Applying Industry Analysis The limits of Industry Analysis Grant Book: Chp. 4, section “Does Industry Really matter?” Besanko Book: Chp 8, pages 247-254 Assigned material: Grant Book: Chp. 3 Grant Book: Chp. 4, only section “Does Industry Really matter?” Besanko Book: Chp. 5, pages 155-162 Besanko Book: Chp 8, pages 247-254 David Millán Planelles The limits of Industry Analysis. Does Industry Analysis matter? Excessive emphasis on Industry structure - Does really industry structure explains a firm’s returns? - Some research suggest than no more than 20% The limits of Industry Analysis. Extending the 5 Forces. THE VALUE NET MODEL - The 5 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. - The value net complements the five forces approach by considering opportunities posed by each force. (Besanko Chp 8, 247-255)  The limits of Industry Analysis. Other limitations Other limitations are: (will be reviewed later in the course) No integrations among Competitors: - Industry analysis might explain average or total profit, but it does not explain how this profit is shared among players. Static View - Industry analysis asumes a fairly stable industry environment. - Are the lessons valuable for very dynamics industries or assess properly change? - Concept of Hypercompetition. Intense and rapid competition moves continuously creating new competitive advantages and destroying the existing ones. Complementors  The limits of Industry Analysis. Other limitations Other limitations are: (will be reviewed later in the course) No integrations among Competitors: - Industry analysis might explain average or total profit, but it does not explain how this profit is shared among players. Static View - Industry analysis asumes a fairly stable industry environment. - Are the lessons valuable for very dynamics industries Within 5 forces framework or assess properly change? INDUSTRY STRUCTURE COMP. STRATEGY - Concept of Hypercompetition. Intense and rapid competition moves continuously creating new competitive Under dynamic competition advantages and destroying the existing ones. COMP. STRATEGY INDUSTRY STRUCTURE Complementors  The limits of Industry Analysis. Other limitations Other limitations are: (will be reviewed later in the course) No integrations among Competitors: - Industry analysis might explain average or total profit, but it does not explain how this profit is shared among players. Static View - Industry analysis asumes a fairly stable industry environment. - Are the lessons valuable for very dynamics industries or assess properly change? - Concept of Hypercompetition. Intense and rapid competition moves continuously creating new competitive advantages and destroying the existing ones. Complementors  Getting ready for the Exam Q1.- What is difference between the Key Success Factors and the 5 Forces? Q2.- Can you explain the theoretical assumption behind the 5 Forces also know as the Structure Conduct Performance? Q3.- Does the Value Net complement the 5 Forces approach?, in which way? Q4.- Based on the lessons of the 5 forces, what would you expect on a concentrated industry?, How can be concentration be measured? Q5.- Identify example of industries where the the Bargain Power (supply and buyer sides) are fundamental in the industry analysis  US Airline Case Q1.- How did the industry perform in recent years? Q2.- To what extent can the industry’s low average profitability during this period be attributed to the structure of the industry? Which of Porter’s five forces has had the biggest impact in depressing industry profitability? Q3.- What is the outlook for industry profitability during the next five years (2013-2017)? Remember that the slides do not substitute or summarize the readings of the book/cases. Specially when preparing exams. Slides are just a visual aid for class discussion.