Objectives of Industry Analysis
- How industry structure drives competition which determines level of industry profitability
- Assess industry attractiveness; potential long term profitability
- Anticipate how changes in industry structure may impact future profitability; forecast and predict future profitability levels
- Formulate strategies that can change structure of industry; improve industry profitability
Key Influencers of Industry Profitability
- Value of product to customer (customer willingness to pay)
- Intensity of industry rivalry
- Bargaining power of different players at different stages of industry value chain
Porter’s Five Forces
Suppliers: anyone who provides goods to any player in the industry (raw materials, labor, capital). We need to assess how easy it is for suppliers to raise prices and capture greater margins from players in the industry. Things that impact supplier power:
- Number of suppliers of each key input
- Uniqueness of suppliers’ products or services
- Strength and control over firms in industry
- Cost of players in the industry to switch between suppliers
- Threat that suppliers might migrate forward (to become a player)
- Cost of suppliers products or services to total cost of firms in industry
Suppliers are powerful when:
- They are concentrated (only a few suppliers exist)
- When the cost to switch between suppliers is high
- When the suppliers could easily enter the industry themselves (forward integration)
Suppliers are weak when:
- There are many competitive suppliers offering standardized commodity like products (i.e. tiers)
Buyers: the bargaining power of firms and players operating in the industry (how easy it is for buyers to drive DOWN prices and capture more margin for themselves) driven by:
- The number of buyers
- The importance of thebuyer in the industry
- The easy or difficulty of customers to switch between firms
Buyers are powerful when:
- They are concentrated (there are only a few buyers with a significant share)
- When they buy a significant share of your output
- When the buyers could just as easily produce the products themselves
Buyers are weak when:
- They cannot easily switch between firms
- When firms in the industry can threaten to forwoard integrate and sell directly to customers
- When firms in the industry supply critical components to customers
Industry competitive rivalry: the competitiveness of players in the industry. If there are a lot of players in the industry and they offer the same services/products – non of them will be able to charge premium prices. THAT MEANS THAT THE INDUSTRY IS NOT AS ATTRACTIVE AS PROFITS FALL
Disciplined rivalry (if the players have been competing with each other for a long time PEPSI AND COLA):
- Rivalry of firms is low
- Firms compete in disciplined, predictable ways
- Profits tend to be higher
Intensity of competitiveness is set by:
- The number of firms
- Industry growth rate
- Level of fixed investment made by firm
- Low switching costs
- Level of product differentiation
- Exit barriers
Diversity among rivals will cause the competitiveness to increase as the different rivals won’t know how to anticipate a reaction from other competitors
Threat of substitution: increases when customers can find different ways of doing what we do for them.
Threat of entry: how protected is an industry from new firms entering it. if there are high entry barriers – profits tend to be higher.
Example of entry barriers:
- Patents and proprietary knowledge
- Legal and regulatory barriers
- Economies of scale and scope
- Producer learning
- Brand and reputation
- Advertising and channel crowding
- Switching costs
- Retaliation
Porter’s Five Forces – Summing up:
- When the five forces have low intensities – there tend to be higher level of profits
- When the five forces have high intensity – profits tended to be lower on for the long term
- One strong force is enough to destroy industry profits
The framework is helpful in:
- Forecasting industry profitability
- Strategic planning
- Improving the industry
The challenge: how can I neutralize the five competitive forces in the industry?
- Raise entry barriers (crowd shelf space, advertise aggressively, fill distribution channels)
The step that we need to take is understand how to get to a point where competitors are competing NOT on price, but on innovation, product differentiation and unique service offering.
- Decrease buyer power by increase stickiness
To reduce supplier power:
- Create alternative sources
- Integrate backwards to become your own supplier
- Negotiate long term contracts at favorable rates
Cross parrying: attack a competitors’ alternative product line rather than attack a direct rivals’ product