© Ram Mudambi, Temple University, 2007. Lecture 2 External Analysis: The Identification of Industry...

© Ram Mudambi, Temple University, 2007.

Lecture 2Lecture 2

External Analysis: The Identification of External Analysis: The Identification of Industry Opportunities and ThreatsIndustry Opportunities and Threats

BA 951BA 951Policy Formulation and Policy Formulation and

AdministrationAdministration

© Ram Mudambi, Temple University, 2007. 2-2

Learning OutcomesLearning Outcomes

Methodologies for analyzing the external Methodologies for analyzing the external environment of the firmenvironment of the firmTheoriesTheoriesApplicationsApplications

European groceriesEuropean groceries Competition in a digital ageCompetition in a digital age


Lecture OutlineLecture OutlineComponents of External AnalysisComponents of External AnalysisStatic models for examining external environmentStatic models for examining external environment

The Industry - The Five Forces ModelThe Industry - The Five Forces Model Wide Focus – PEST AnalysisWide Focus – PEST Analysis Narrow Focus – Strategic GroupsNarrow Focus – Strategic Groups

Dynamic models – industry evolutionDynamic models – industry evolution Punctuated equilibriumPunctuated equilibrium The life cycle modelThe life cycle model

The external environment and -The external environment and - Network economiesNetwork economies GlobalizationGlobalization The competitive advantage of the Nation StateThe competitive advantage of the Nation State


Two Components of External Two Components of External AnalysisAnalysis

Supplying a viable,saleable product

Ability to surviveits environment

ANALYSIS OF PRODUCT ANALYSIS OF ENVIRONMENT

KEYSUCCESS FACTORS


Analysis of Product: What are the Analysis of Product: What are the industry’s dominant economic industry’s dominant economic traits?traits?

Market size andMarket size and growth rategrowth rate Scope of competitive rivalryScope of competitive rivalry Number of competitorsNumber of competitors and their relative sizesand their relative sizes Prevalence of backward/forward integrationPrevalence of backward/forward integration Entry/exit barriersEntry/exit barriers Nature and pace of technological changeNature and pace of technological change Product and customer characteristicsProduct and customer characteristics Scale economies and experience curve effectsScale economies and experience curve effects Capacity utilization and resource requirementsCapacity utilization and resource requirements Industry profitabilityIndustry profitability


Defining an IndustryDefining an Industry

IndustryIndustry A group of companies offering products or services that are close A group of companies offering products or services that are close

substitutes for each other and that satisfy the same basic customer substitutes for each other and that satisfy the same basic customer needsneeds

Industry boundaries may change as customer needs evolve and Industry boundaries may change as customer needs evolve and technology changestechnology changes

SectorSector A group of closely related industriesA group of closely related industries

Market SegmentsMarket Segments Distinct groups of customers within an industryDistinct groups of customers within an industry Can be differentiated from each other with distinct attributes and Can be differentiated from each other with distinct attributes and

specific demandsspecific demands


The Computer Sector: Industries The Computer Sector: Industries and Market Segmentsand Market Segments


Analyzing Industry StructureAnalyzing Industry Structure

Opportunities and threats are competitive Opportunities and threats are competitive challenges arising for changes in industry challenges arising for changes in industry conditions.conditions.

The The five forces model five forces model isis an analytic tool that helps an analytic tool that helps

managers formulate managers formulate appropriate strategic appropriate strategic

responses.responses.


Porter’s Five Forces ModelPorter’s Five Forces Model

Industry competitorsRivalry amongst existing firms

Potential entrants

Threat of new entrants

Substitutes

Threat of new substitute productor service

Suppliers

Bargaining power of suppliers

Buyers

Bargaining powerof buyers

Source: Adapted and reprinted by permission of Harvard Business Review. An exhibit from “How Competitive Forces Shape Strategy” by Michael E.. Porter (March-April 1979), Copyright © 1979 by the President and Fellows of Harvard College: all rights reserved.

1

2 34

5


Competitive StrategyCompetitive Strategy

Industry environmentFive forces model

The firmDistinctive competencies

vis-à-vis competitors

Strategic ChoiceMaximize

competitive advantage


Potential EntrantsPotential Entrants

• Joe Bain’s key insightJoe Bain’s key insight – firm profitability is – firm profitability is affected by extant competition as well as affected by extant competition as well as potential competition.potential competition.• Firms limit their current Firms limit their current profits for fear of attractingprofits for fear of attractingentrants.entrants.

•Entry barriers reduce the threat Entry barriers reduce the threat of new and additional competition.of new and additional competition.

FORCE 1


Barriers to entry - Bain vs. Barriers to entry - Bain vs. StiglerStigler‘‘Barriers to entry’ is a loaded termBarriers to entry’ is a loaded termJoe Bain (U.C.-Berkeley)Joe Bain (U.C.-Berkeley) - barriers to - barriers to entry exist when entrant firms face entry exist when entrant firms face obstaclesobstaclesGeorge StiglerGeorge Stigler ( (U.ChicagoU.Chicago) - barriers ) - barriers to entry exist when entrant firms face to entry exist when entrant firms face obstacles obstacles not faced by incumbent firmsnot faced by incumbent firms


““Barriers to entry” - BainBarriers to entry” - Bain• Economies of scaleEconomies of scale• Existence of learning/experience curve effectsExistence of learning/experience curve effects• Strong brand preferences and customer loyalty Strong brand preferences and customer loyalty • Capital requirements and/or other specialized resource Capital requirements and/or other specialized resource requirementsrequirements• Cost disadvantages independent of sizeCost disadvantages independent of size• Access to distribution channelsAccess to distribution channels

All these are barriers according to Bain, but not All these are barriers according to Bain, but not according to Stigler. Entrant firms just have to follow the according to Stigler. Entrant firms just have to follow the same path of incumbentssame path of incumbents


Barriers to entry - StiglerBarriers to entry - Stigler

All of the above “barriers” would be called All of the above “barriers” would be called first-mover advantages by Stigler. However, first-mover advantages by Stigler. However, Stigler does agree that there are barriers to Stigler does agree that there are barriers to entry. Some examples:entry. Some examples:• Inability to gain access to specialized Inability to gain access to specialized technology - patents are barrierstechnology - patents are barriers• Regulatory policies, tariffs, trade restrictions Regulatory policies, tariffs, trade restrictions - legal restrictions are barriers- legal restrictions are barriers


Rivalry Among Established Rivalry Among Established CompaniesCompaniesThe intensity of competitive rivalry in an The intensity of competitive rivalry in an industry arises from:industry arises from:

Industry’s competitive structure.Industry’s competitive structure. Demand (growth or decline) conditions in industry.Demand (growth or decline) conditions in industry. Height of industry exit barriers.Height of industry exit barriers.

FORCE 2


Competitive StructureCompetitive Structure

Continuum ofContinuum of Industry Structures Industry Structures

FragmentedFragmentedMany firms,Many firms,no dominantno dominant

firmfirm

Few firms,Few firms,shared dominanceshared dominance

(oligopoly)(oligopoly)

Consolidated Consolidated One firm or oneOne firm or onedominant firmdominant firm(monopoly)(monopoly)


The Market SpectrumThe Market Spectrum

Real World Market StructuresPerfect Monopolistic Oligopoly Monopoly

Competition Competition Homogeneous Heterogeneous Regulated PureFirms Infinite Many Few Few One

Product Identical Differentiated Homogeneous Heterogeneous No close substituteMkt Pwr None Little Strong Very strong Regulated Perfect

Entry barriers

None LowSubstantial Substantial &

reinforcedLegal Block-

aded

E.g.sStock

marketGas stations, restaurants

Commodities – oil, coffee,

teaAutos, FMCGs Utilities -

Increasing deadweight loss

Inter-dependenceirrelevant

Inter-dependenceabsent


The Bargaining Power of BuyersThe Bargaining Power of Buyers

Buyers are most powerful when:Buyers are most powerful when: There are many small sellers and few large buyers.There are many small sellers and few large buyers. Buyers purchase in large quantities.Buyers purchase in large quantities. A single buyer is a large customer to a firm.A single buyer is a large customer to a firm. Buyers can switch suppliers at low cost.Buyers can switch suppliers at low cost. Buyers purchase from multiple sellers at once.Buyers purchase from multiple sellers at once. Buyers can easily vertically integrate to compete with Buyers can easily vertically integrate to compete with

suppliers.suppliers.

FORCE 3


The Bargaining Power of The Bargaining Power of SuppliersSuppliersSuppliers have bargaining power when:Suppliers have bargaining power when:

Their products have few substitutes and are important Their products have few substitutes and are important to buyers.to buyers.

The buyer’s industry is not an important customer to The buyer’s industry is not an important customer to the supplier.the supplier.

Differentiation makes it costly for buyers to switch Differentiation makes it costly for buyers to switch suppliers.suppliers.

Suppliers can vertically integrate forward to compete Suppliers can vertically integrate forward to compete with buyers and buyers can’t integrate backward to with buyers and buyers can’t integrate backward to supply their own needs.supply their own needs.

FORCE 4


Substitute ProductsSubstitute Products

The competitive threat of substitute products The competitive threat of substitute products increases as they come closer to serving increases as they come closer to serving similar customer needs.similar customer needs.

CloseCloseFarFar

FORCE 5


A Sixth Force: ComplementorsA Sixth Force: Complementors

Complementors:Complementors: Companies whose products are sold in tandem with Companies whose products are sold in tandem with

another company’s products.another company’s products. Increased supply of a complementary product Increased supply of a complementary product

collaterally increases demand for the primary product.collaterally increases demand for the primary product.

Example:Example: Faster CPU chips fuel salesFaster CPU chips fuel sales

of personal computers.of personal computers.


Who profits from falling Who profits from falling transaction costs?transaction costs?

Complementary AssetsFreely available Tightly held

or unimportant and important

Imitability High 1. Difficult to make 2. Money made on

Primary money complementary assets

Assets Low 3. Money made on 4. Bargaining power

primary assets determines outcome

MarketFirm 1 Firm 2

Inno

vato

r

Complementor


ExampleExample

Nokia makes cell phone bodiesNokia makes cell phone bodies

Texas Instruments makes Digital Signal Processing Texas Instruments makes Digital Signal Processing chips (DSPs) that make it possible for cell phones chips (DSPs) that make it possible for cell phones to become web devicesto become web devices Primary assets – Nokia’s cell phone technologyPrimary assets – Nokia’s cell phone technology Complementary assets – TI’s DSP technologyComplementary assets – TI’s DSP technology

Which cell does this fall into?Which cell does this fall into?

This is a generic example as more and more devices This is a generic example as more and more devices become web-enabled, e.g., TVs, fridges, etc. become web-enabled, e.g., TVs, fridges, etc.


Generic StrategiesGeneric Strategies

Complementary AssetsFreely available Tightly held

or unimportant and important

Imitability High 1. RUN 2. Joint venture (JV),

Primary alliance, acquisition

Assets Low 3. BLOCK 4. BLOCK: JV,

alliance, acquisition

RunRun: continuously changing key elements of the businessmodel - continuous innovationBlockBlock: Erect barriers to entry around existing businessmodel - making imitation costly (patents, brands, etc.)


Collaborative Advantage – Burton’s 5 sourcesCollaborative Advantage – Burton’s 5 sources

Industry collaboratorsHorizontal strategic alliances

Suppliers Buyers

Previously unrelated industries

Substitutes and complements

Prospective diversificationalliances

Related diversification alliances

Relational contracting,quasi-integration

Partnering w/channels., buyers


Collaborative StrategyCollaborative Strategy

Industry environmentFive sources model

The firmDistinctive competencies vis-à-vis collaborators

Strategic ChoiceMaximize

collaborative advantage


Five forces of competition Five sources of collaboration

Firm’s distinctive competencies

Sustainable competitive advantage

Sustainable collaborative advantage

Composite strategyMaximize overall sustainable advantage

PORTER BURTON


The Role of the Macro-environmentThe Role of the Macro-environment

Polity Economy

Society Technology

Demography

Regulation

BuyersSuppliers

Rivals

Substitutes

INTERNALOperations

FinanceHRM

MarketingEntrants

Complements


Wide-focus: PEST ANALYSISWide-focus: PEST ANALYSISPOLITY

Nature of govt; Govt stability; Freedom of Markets:

Monopolies; Environment protection laws; Taxation

policy; Foreign trade regulations; Employment law

ECONOMY Business Cycles; GNP trends; Interest rates; Money supply;

Inflation; Unemployment; Disposable income; Energy

availability and cost

SOCIETY Population Demographics; Income

distribution; Social mobility; Lifestyle changes; Attitudes to

work, leisure and risk; Attitudes towards women, minorities, immigration; Consumerism;

Levels of education

TECHNOLOGY Govt spending on research;

Industry focus on technology; New discoveries/development; Speed of technology transfer;

Rates of obsolescence


Strategic Groups Within Strategic Groups Within IndustriesIndustriesThe concept of strategic groupsThe concept of strategic groups

Within an industry, a competitor grouping using Within an industry, a competitor grouping using similar strategies that differ from other industry similar strategies that differ from other industry groups.groups.

Implications of strategic groupsImplications of strategic groups The closest industry competitors are those in the The closest industry competitors are those in the

group.group. The various industry groups are differentially and The various industry groups are differentially and

competitively advantaged and positioned.competitively advantaged and positioned. Mobility barriers inhibit the movement of competitors Mobility barriers inhibit the movement of competitors

from one strategic group to another.from one strategic group to another.


Strategic Groups in the Strategic Groups in the Pharmaceutical IndustryPharmaceutical Industry


Criticisms of the Five Forces and Criticisms of the Five Forces and Strategic Group ModelsStrategic Group Models

•Both models are static and ignore innovation.Both models are static and ignore innovation.•Their focus is on industry and group Their focus is on industry and group structures rather than individual companies.structures rather than individual companies.

Innovation creates change in Innovation creates change in industry structures, altering theindustry structures, altering thecompetitive environment.competitive environment.

Industry structure cannot Industry structure cannot fully explain the performance fully explain the performance differences between industry differences between industry competitors.competitors.


PunctuatePunctuatedd

EquilibriuEquilibriumm

andandCompetitiCompetiti

veveStructureStructure

Major Innovation

Development & Diffusion

Stasis

Stasis


The Industry Life Cycle ModelThe Industry Life Cycle Model

Stages in the industry life cycle:Stages in the industry life cycle:


Technology and the life cycleTechnology and the life cycle

DevelopmentCompeting standards

Leaders – first movers

Diffusion•Emergence of an industry

standard•Network externalities

Fast followers – second movers

ImitationParallel

development

AdoptionLicensing &

royalties

Late followers – thirdmovers


Industry life cycle and industry Industry life cycle and industry structurestructure

TIME

• Many firms • Competing techs/ standards• Product is:

• Expensive• User unfriendly

• Slow growth

• Mergers/Acquisitions/ Exits• Development of singlestandard• Product is:

• Much cheaper• User friendly

• Product R&D• Rapid growth

• Mature Oligopoly• Intense rivalry• Process R&D• Slow growth, decline

Nascent Phase Consolidation Maturity


Network Economics As a Network Economics As a Determinant of Industry ConditionsDeterminant of Industry Conditions

The demand for primary industry products The demand for primary industry products depends on the size of the total market for depends on the size of the total market for complementary products.complementary products. Network economics result inNetwork economics result in

positive feedback loops that positive feedback loops that foster rapid demand increases.foster rapid demand increases.

Market competitors are Market competitors are protected by switching protected by switching cost entry barriers.cost entry barriers.


Positive Feedback in the Computer Positive Feedback in the Computer IndustryIndustry


Globalization and Industry Globalization and Industry StructureStructureGlobalizationGlobalization

Globally dispersed production lowers Globally dispersed production lowers costs and increases quality.costs and increases quality.

Global markets are replacing Global markets are replacing national markets.national markets.

Trend implicationsTrend implications No isolated national marketsNo isolated national markets More competitors, more intense competitionMore competitors, more intense competition More rapid innovation and shorter product life cyclesMore rapid innovation and shorter product life cycles


The Internet – a powerful external The Internet – a powerful external stimulusstimulus

Greater incentives for collaborative strategies

Larger fixed costs

Shorter product life-cycles

More uncertainty

INTERNET

Globalizing customers

Dispersed, changing technology


The Nation-State and The Nation-State and Competitive Advantage – Competitive Advantage – Porter’s Diamond modelPorter’s Diamond modelThe determinants of competitive advantage:The determinants of competitive advantage:

Factorendowments


SummarySummary

Static models for analyzing the firm’s Static models for analyzing the firm’s external environmentexternal environment

The industry – 5 forcesThe industry – 5 forces Beyond the industry – PESTBeyond the industry – PEST Within the industry – strategic groupsWithin the industry – strategic groups

Dynamic modelsDynamic models Punctuated equilibria and the industry life cyclePunctuated equilibria and the industry life cycle

Drivers of the external environmentDrivers of the external environment Networks, globalization, location advantagesNetworks, globalization, location advantages

© Ram Mudambi, Temple University, 2007. Lecture 2 External Analysis: The Identification of Industry...

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