Industry Analysis: The Fundamentals

The objectives of industry analysis

From environmental analysis to industry analysis
Porters Five Forces Framework
Applying industry analysis
Industry & market boundaries
Identifying Key Success Factors
OUTLIN
E
The Objectives of Industry
Analysis

To understand how industry structure drives competition,
which determines the level of industry profitability.

To assess industry attractiveness

To use evidence on changes in industry structure to
forecast future profitability

To formulate strategies to change industry structure to
improve industry profitability

To identify Key Success Factors
THE INDUSTRY
ENVIRONMENT

Suppliers
Competitors
Customers
Social structure
The national/
international
economy
Technology
Government
& Politics
The natural
environment
Demographic
structure
Social structure
From Environmental Analysis
to 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.
Profitability of US Industries
Pharmaceuticals 26.8 Gas & Electric Utilities 10.5
Tobacco 22.0 Food and Drug Stores 10.3
Household & Personal Products 20.5 Motor Vehicles & Parts 9.8
Food Consumer Products 20.3 Home Equipment 9.5
Medical Products & Equipment 18.8 Railroads 9.0
Beverages 18.8 Hotels, Casinos, Resorts 8.0
Scientific & Photographic Equipt. 16.5 Insurance: Life and Health 7.6
Commercial Banks 16.0 Building Materials, Glass 7.0
Publishing, Printing 14.3 Metals 6.0
Petroleum Refining 14.3 Semiconductors &
Apparel 14. 3 Electronic Components 5.8
Computer Software 13.5 Insurance: Property & Casualty 5.3
Electronics, Electrical Equipment 13.3 Food Production 5.3
Furniture 13.3 Telecommunications 3.5
Chemicals 12.8 Forest and Paper Products 3.5
Computers, Office Equipment 11.8 Communications Equipment (4.0)
Health Care 11.5 Airlines (34.8)
Median return on equity (%), 1999-2002
Long-term Profitability of US Industries: EVA and ROA, 1986-97
Industry EVA/CE ROA Industry EVA/CE ROA
Tobacco 9.4 14.4 Paper and products (1.5) 5.2
Computer software Broadcasting and
& services 5.9 10.4 publishing (1.5) 6.0
Personal care Cars & trucks (1.5) 2.2
products 2.8 8.0 Healthcare services (1.7) 3.3
Medical products 2.7 9.5 Machine tools, hand tools (1.7) 6.0
Printing & Appliances and home
advertising (2.0) 2.3 furnishings (1.9) 3.4
Food processing 2.5 8.5 Telephone equipment &
Drugs & research 0.7 7.6 services (2.1) 7.0
Beverages 0.2 5.6 Plastics & products (2.6) 5.3
Textiles (0.1) 7.4 Computers & peripherals (3.1) 3.1
Fashion retailing (0.4) 9.3 Electrical products (3.3) 4.6
Building materials (0.6) 5.6 Aerospace & defense (3.3) 4.8
Metals (1.0) - Railroads (3.4) 3.8
Telecom services (1.2) 4.6 Airlines (4.1) 1.0
Discount retailing (1.2) 6.4 Steel (6.4) 2.3
Semiconductors Cable television (7.2) (3.3)
& components (1.3) 6.0 Electronics (9.2) 3.5
Average (1.1) 5.6
Source: Hawawini et al, Strategic Management J ournal (J anuary 2003)
The Determinants of Industry
Profitability
3 key influences:
The value of the product to customers
The intensity of competition
Relative bargaining power at different levels
within the value chain.
The Spectrum of Industry Structures
Concentration
Entry and Exit
Barriers
Product
Differentiation
Information
Perfect
Competition
Oligopoly Duopoly Monopoly
Many firms
A few firms Two firms One firm
No barriers Significant barriers High barriers
Homogeneous
Product
Potential for product differentiation
Perfect
Information flow
Imperfect availability of information
Porters Five Forces of
Competition Framework
SUPPLIERS
POTENTIAL
ENTRANTS
SUBSTITUTES
BUYERS
INDUSTRY
COMPETITORS
Rivalry among
existing firms
Bargaining power of suppliers
Bargaining power of buyers
Threat of

new
entrants

Threat of

substitutes
THREAT OF ENTRY
Capital requirements
Economies of scale
Absolute cost advantage
Product differentiation
Access to distribution
channels
Legal/ regulatory barriers
Retaliation
SUBSTITUTE
COMPETITION
Buyers propensity
to substitute
Relative prices &
performance of
substitutes
BUYER POWER
Buyers price sensitivity
Relative bargaining
power
INDUSTRY RIVALRY
Concentration
Diversity of
competitors
Product differentiation
Excess capacity &
exit barriers
Cost conditions
BUYER POWER
Buyers price sensitivity
Relative bargaining
power
The Structural Determinants of Competition
Threat of Substitutes
Extent of competitive pressure from producers of
substitutes depends upon:

Buyers propensity to substitute

The price-performance characteristics of
substitutes.
The Threat of Entry
Entrants threat to industry profitability depends
upon the height of barriers to entry. The principal
sources of barriers to entry are:

Capital requirements
Economies of scale
Absolute cost advantage
Product differentiation
Access to channels of distribution
Legal and regulatory barriers
Retaliation
Bargaining Power of Buyers
Buyers price sensitivity Relative bargaining power
Cost of purchases as %
of buyers total costs.
How differentiated is the
purchased item?
How intense is
competition between
buyers?
How important is the
item to quality of the
buyers own output?
Size and concentration of
buyers relative to
sellers.
Buyers information .
Ability to backward
integrate.
Note: analysis of supplier
power is symmetric
Rivalry Between Established
Competitors
The extent to which industry profitability is depressed by
aggressive price competition depends upon:

Concentration (number and size distribution of firms)
Diversity of competitors (differences in goals, cost
structure, etc.)
Product differentiation
Excess capacity and exit barriers
Cost conditions
Extent of scale economies
Ratio of fixed to variable costs
Profitability and Market Growth
-5
0
5
10
15
20
25
30
Return on sales Return on investment Cash flow/Investment
< -5% -5% to 0 0 to 5% 5% to 10% > 10%
Less than -5% -5% to 0 0 to 5% 5% to 10% Over 10%
Return on sales Cash flow/ Investment Return on investment
ANNUAL RATE OF GROWTH OF MARKET DEMAND
ROI (%)
The Impact of Unionization on Profitability
Percentage of employees unionized
None 1%-35% 35%-60% 60-75% >75%

ROI (%) 25 24 23 18 19

ROS (%) 10.8 9.0 9.0 7.9 7.9
ROI = Return on Investment
ROS = Return on Sales
Applying Five - Forces Analysis
Forecasting Industry Profitability
Past profitability 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
What structural variables are depressing
profitability
Which can be changed by individual or
collective strategies?
Drawing Industry Boundaries : Identifying
the Relevant Market
What industry is BMW in:
World Auto industry
European Auto industry
World luxury car industry?

Key criterion: SUBSTITUTABILITY
On the demand side : are buyers willing to substitute between
types of cars and across countries
On the supply side : are manufacturers able to switch
production between types of cars and across countries

May need to analyze industry at different levels for different
types of decision
Pre-requisites for success

What drives competition?
What are the main
dimensions of competition?
How intense is competition?
How can we obtain a
superior competitive position?
Analysis of demand

Who are our
customers?

What do they want?
KEY SUCCESS FACTORS
Analysis of competition
What drives competition?
What are the main
dimensions of competition?
How intense is competition?
How can we obtain a superior
competitive position?
What do
customers want?
How does the firm
survive competition
Pre-requisites for success
Identifying Key Success Factors
Identifying Key Success Factors
Through Modeling Profitability: The
Airline Industry
Profitability = Yield x Load factor - Unit Cost
Income Revenue RPMs Expenses
ASMs RPMs ASMs ASMs

= x
-
Price
competitiveness.
Efficiency of route
planning.
Flexibility and
responsiveness.
Customer loyalty.
Meeting customer
requirements.
Wage rates.
Fuel
efficiency of
planes.
Employee
productivity.
Load factors.
Administrative
overhead.
Strength of
competition on routes.
Responsiveness to cha-
anging market conditions
% business travelers.
Achieving differentia-
tion advantage
ASM = Available Seat Miles RPM = Revenue Passenger Miles
ROCE
Return on Sales
Sales/Capital
Employed
Sales mix of products
Avoiding markdowns through
tight inventory control
Max. buying power to minimize
cost of goods purchased
Max. sales/sq. foot through:
*location *product mix
*customer service *quality control
Max. inventory turnover through
electronic data interchange, close
vendor relationships, fast delivery
Minimize capital deployment
through outsourcing & leasing
Identifying Key Success Factors
by Analyzing Profit Drivers: Retailing
SUMMARY: What Have We Learned?
Forecasting Industry Profitability
Past profitability 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
What structural variables are depressing profitability?
Which can be changed by individual or collective strategies?
Defining Industry Boundaries
Key criterion: substitution
The need to analyze market competition at different levels of
aggregation (depending on the issues being considered)
Key Success Factors
Starting point for the analysis of competitive advantage