Chapter 8 - Industry Analysis

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Economics of Strategy

Fifth Edition

Slides by: Richard Ponarul, California State University, Chico

Copyright2010 John WileySons, Inc.

Chapter 12

Industry Analysis

Besanko, Dranove, Shanley, and Schaefer


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Industry Analysis

Industry analysis facilitates

assessment of industry and firm performance

identification of factors that affect performance

determination of the effect of changes in thebusiness environment on performance and

identification of opportunities and threats

(SWOT analysis)


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Industry Analysis

Industry analysis helps with assessing genericbusiness strategies

Portersfive forces frameworkis rooted in

microeconomics Value net(Brandenburger and Nalebuff)

supplements the five forces framework to analyzestrategy


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The Five-Forces Framework

Michael Porters Five-Forces frameworkidentifies the economic forces that affectindustry profits

The five forces are Internal rivalry

Entry

Substitutes and complementsSupplier power

Buyer power


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Internal Rivalry

Internal rivalry is the competition formarket share among the firms in theindustry

Competition could be on price or some non-price dimension

Price Competition erodes the price cost

margin and profitability


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Internal Rivalry

Competition on non-price dimension candrive up costs.

Non-price competition does not erodeprofits as severely as price competition ifcustomers are willing to pay a higher pricefor the improvements.


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Internal Rivalry

Price competition heats up when

There are many sellers

Some firms have cost advantage over others

There is excess capacity in the industry

Products are undifferentiated and switching costsare low

Prices and sale terms are easily observable


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Internal Rivalry

Other conditions that facilitate intense pricecompetition

Large and infrequent sales orders

Absence of facilitating practices

Absence of a history of cooperative pricing

Strong exit barriers

Industry demand is elastic


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Entry

Entry hurts the incumbents byby cutting into the incumbents market share and

by intensifying internal rivalry and leads to a

decline in price cost margin Barriers to entry can beexogenous (nature of the industry) or

endogenous (incumbents strategic choices)


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Factors that Affect the Threat of Entry

Minimum efficient scale relative to the size of themarket

Government policies that favor the incumbents

Brand loyalty of consumers and value placed byconsumers on reputation

Entrants access to critical resources such as rawmaterial, technical know how and distributionnetwork


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Factors that Affect the Threat of Entry

Steepness of the learning curve

Network externalities that give theincumbents the benefit of a large installed

base

Incumbents reputation regarding post-entrycompetitive behavior


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Substitutes and Complements

Availability of substitutes erode the demandfor the industrys output

Complements boost industry demand

When the price elasticity of demand is large,pressure from substitutes will be significant

Changes in demand can in turn affectinternal rivalry and entry/exit


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Supplier Power

Supplier has indirect powerif upstreammarket is competitive. It sells to the highestbidder.

Supplier has direct powerif

the upstream industry is concentrated or

the customers are locked into the relationship

with suppliers due to relationship specific assets


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Buyer Power

Buyer power is analogous to supplier power

Buyers have indirect powerin competitivemarkets

Buyer concentration or relationship specificassets can lead to direct power

Buyer power relative to upstream isanalogous to supplier power relative todownstream


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Supplier Power

The factors that determine supplier power areCompetitiveness of the input market

Relative concentration the industry

Relative concentration of upstream anddownstream firms

Purchase volume by downstream firmsAvailability of substitute inputsExtent of relationship specific investmentsThreat of forward integration by suppliersSuppliers ability to price discriminate


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Some Strategies to Cope with the Five Forces

To outperform its rivals firms can

develop a cost advantage or

a differentiation advantage

Firms can seek an industry segment wherethe five forces are less severe

Firms can try to change the forces


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Some Strategies to Cope with the Five Forces

Facilitating strategies to reduce internalrivalries

Moves that increase switching costs for the

customers

Pursuing entry deterring strategies

Tapered integration to reducebuyer/supplier power


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The Value Net Concept

The value netconsists of

Suppliers

Customers

Competitors and Complementors (producers of complementary goods and

services)

The value net complements the five forces

approach by considering opportunities posed byeach force.


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The DVD Hardware Market:A Five-Forces Analysis

Internal rivalry was intense. Brand name was themain source of differentiation

It was easy for consumer electronics firms to enter.

Satellite TV could be a substitute. Streaming overthe internet was another possibility.


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Movie studios (upstream) and big retailers(downstream) had power.

DVD hardware makers, according to this

analysis, had reason to be pessimistic.

DVD formats success can be attributed tofirms working together (value net).

The DVD Hardware Market:A Five-Forces Analysis


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The DVD Hardware Market: The Value Net

In the beginning DIVX was a major threat.

DVD manufacturers cut prices on somemodels and advertised heavily.

Other members of the value net chipped into increase the size of the DVD pie. Movie studios released popular titles in DVD format and

priced them moderately Retailers promoted the DVD hardware and software


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Five Forces Analysis of Chicago Hospitals

Product market is the market for acutemedical services

Competition among hospitals is local

The geographic market for a hospital is theentire metropolitan area or a particularsubmarket.

Competitive dynamics could vary acrosssubmarkets


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Chicago Hospitals: Internal Rivalry

In 1980 most hospitals were independent.Today many of them belong to systems.

Herfindahl index has gone up from 0.05 to

0.20 over this period.

Herfindahl index is slightly higher insubmarkets.


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With the arrival of managed careorganizations (MCOs), price elasticity ofdemand increased

Insurers were less brand loyal than patients

Price negotiations were secret

Contracting was lumpy and price rivalryintensified


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Considerable variation in cost structures. Excess capacity with stagnant demand (until

recently) for admissions.

Managed care organizations (MCOs)increased the price elasticity of demand byseeking hospitals that offered the best value.


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MCOs intensified internal rivalry by

treating all hospitals as identical,

negotiating with hospitals in secret and

negotiating large contracts for multiple years

Hospitals were unable to develop facilitatingpractices


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Recent trends towards softening ofcompetition

Branding by hospitals with strong reputation

Patients demand to go outside the MCOnetworks

Consolidation in submarkets


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Chicago Hospitals: Entry

Structural barrier to entry

State regulatory restrictions on new hospitalconstruction

Capital intensive nature of hospitalsDifficulties is making brand loyal customers

switch

Difficulties in establishing a base of medical staffthat admit patients


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Chicago Hospitals: Entry

As the market grows suburbs could attractentrants

Technological changes could lower entry

barriers

Small specialized hospitals may becomefeasible reducing the capital requirement

and the size of medical staff needed


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Chicago Hospitals: Substitutes/Complements

Due to technological changes, substitutes forhospital services have emerged.

Surgeries performed outside hospitals

Home healthcare for recuperating patients and thechronically ill

Economies of scope have allowed hospitals toexpand into outpatient services.


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Chicago Hospitals: Supplier Power

The suppliers to an hospital are

specialized medical personnel (nurses,technicians and doctors)

Firms that supply equipment and supplies anddrugs

Relationship specific investments are rare

Suppliers protected by patents can havedirect power


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Chicago Hospitals: Buyer Power

The buyers are patients

admitting physicians and

insurance companies.

Patients and doctors did not wield buyerpower in the 80s.

Insurers including Medicaid and Medicare

were largely passive in the 80s. Buyer power was low in the 80s.


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Current trends point to rising buyer power

Selective contracting has increased insurersbuyer power

Government providers have lowered their rates

Employers are asking employees to bear agreater share of costs which increases price

elasticity of demand


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In wealthy communities, specialty hospitals couldcompete for the most profitable patients.

Buyers as well as regulators are demanding access

to information about hospital qualityAnti trust ruling requires hospitals to negotiate

individually (rather than as a group) with insurers.


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Five-Forces Analysis of the Chicago Hospital Market


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Commercial Airframe Manufacturing

Boeing and Airbus compete globally.

Fringe players in aircraft with capacity lessthan 125 seats are excluded from the

analysis.

The market share (by revenue) of the fringeplayers is small.

There are no meaningful submarkets.

C i l Ai f M f t i


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Commercial Airframe Manufacturing:Internal Rivalry

Boeing delivered its first commercial aircraft in1958.

Airbus is younger.

Boeing enjoys economies of scope due to itsdefense business.

Airbus gets government subsidies.

Stable market shares and reduced incentive for

price wars Historically there has been little product

differentiation

Commercial Airframe Manufacturing:


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Commercial Airframe Manufacturing:Internal Rivalry

Airbus developed the double-decker megaplane.

Boeing abandoned competing with its Sonic

Cruiser.

Airliners exhibit loyalty to suppliers

Economic slowdown has reduced the

demand for aircraft.


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Commercial Airframe Manufacturing: Entry

Major barriers to entry are:

Huge development costs

Experience-based advantages

Buyer reluctance to buy from startups

Customer loyalty to current suppliers


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Commercial Airframe Manufacturing: Substitutes

Small plane manufacturers cut into demandfor Boeing and Airbus planes in regionalroutes.

As demand for air travel increases airlinesswitching back to larger planes in regionalroutes.

Other forms of transportation could besubstitutes (High speed rail) for regionaljets.



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Commercial Airframe Manufacturing:Supplier Power

Parts market is competitive Part suppliers deal directly with airlines.

But Boeings Global Airlines Inventory

Network (GAIN) gains leverage oversuppliers.

Jet engine suppliers are not numerous andenjoy direct power.

Unionized labor has significant supplierpower.



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Commercial Airframe Manufacturing:Buyer Power

Buyers for aircraft are either airlines orleasing companies. Neither have buyerpower.

Each order could be of the order of 15% ofannual sales revenue for the manufacturer.

Buyers may cancel orders during economic

downturns.

Five Forces Analysis of the Commercial Aviation


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Five-Forces Analysis of the Commercial AviationIndustry


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Professional Sports: Market Definition

Major sports leagues in the U. S.MLB

NBA

NFL

NHL

Five force analysis is also applicable to

major sports leagues elsewhere


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Professional Sports: Internal Rivalry

Sports leagues require competitive balanceto keep the contests interesting

Athletic competition does not imply

business competition

Internal rivalry is low within leagues asteams follow rules and share revenue

Teams do not compete in the labor market


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Professional Sports:


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Professional Sports:Substitutes and Complements

Teams compete in the local markets withother forms of entertainment

Elasticity of substitution is quite low

Important complements

Television

Sports betting


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Professional Sports: Supplier Power

Unionized players

For new players NCAA has been a benignsupplier

Cities spend tax dollars to build facilities toattract sports teams.

As municipal finances get tighter,subsidizing teams becomes more difficult.


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Professional Sports: Buyer Power

Television networks and sports cablesystems compete with each other forbroadcasting rights

In negotiations regarding broadcast rightsleagues have the upper hand against television networks

local television and radio.

Five-Forces Analysis of Professional


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Five-Forces Analysis of ProfessionalSports Leagues


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Documents

Chapter 8 - Industry Analysis