Industry Analysis
Exploring the external environment of the firm to identify the
sources of profit in the external environment (especially the firm’s
proximate environment which is its industry environment).
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
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Learning Objectives
By the time you have completed this topic you will:
•be familiar with a number of frameworks used to analyse an organization’s external environment and understand how
the structural features of an industry influence competition and profitability;
•be able to use evidence on structural trends within industries to forecast changes in competition and profitability and
to develop appropriate strategies for the future;
•be able to define the boundaries of the industry within which a firm is located;
•be able to recognize the limits of Porter’s five forces of competition framework and extend the framework to include
the role of complements ;
•be able to segment an industry into its constituent markets and appraise the relative attractiveness of different
segments;
•be able to analyse competition and customer requirements in order to identify opportunities for competitive advantage
within an industry (key success factors).
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
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The profitability of US industries,
2000-2010
Industry
Median
ROE
2000-10(%)
Leading
companies
Tobacco
33.5
Philip Morris Int.,
Altria, Reynolds
American
Household and
personal
products
27.8
Procter & Gamble,
Kimberly-Clark,
Colgate-Palmolive
Motor vehicles
and parts
4.4
GM, Ford, Johnson
Controls
Entertainment
3.9
Time Warner, Walt
Disney, News
Corporation
Airlines
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
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Some industries (such as tobacco..)
consistently earn high rates of profit;
others (motor vehicles and parts,
entertainment) earn much lower
rates of profit or fail to cover their
cost of capital (airlines).
AMR, UAL, Delta
Airlines
Source: Data from Fortune 1000 by industry.
See Grant & Jordan 2e Table 2.1 for a more detailed list of US industries.
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How can we account for these
differences in industry profitability?
• It is all down to luck?
• Some industries are in decline, others are growing fast?
• The basic premise that underlies industry analysis is that
the level of industry profitability is neither random nor
entirely the result of industry-specific influences, it is
determined by the industry’s underlying economic
characteristics
INDUSTRY STRUCTURE
©2015 Robert M. Grant & Judith Jordan
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EXAMPLE
The pharmaceutical industry and the personal-computer have very different
structures, which make one highly profitable and the other a nightmare of
price competition and weak margins.
• The pharmaceutical :
– highly differentiated
– price sensitive consumers and
– new products receive monopoly privileges in the form of patents.
• The personal-computer industry
– many firms,
– commoditized products and
– is squeezed by powerful suppliers (e.g. Intel and Microsoft).
– Small markets can often support much higher profitability (small markets can more
easily be dominated by a single firm: niche markets )
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• The profits earned by the firms in an industry
are thus determined by three factors:
• the value of the product to customers;
• the intensity of competition;
• the bargaining power of the producers
relative to their suppliers.
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Analysing the business environment
• The business environment of the firm consists of the external
influences that affect its decisions and performance
• How can managers monitor the vast array of possible
influences?
– Need to distinguish the ‘vital’ from the ‘merely important
– Classification schemes like PEST can help
©2015 Robert M. Grant & Judith Jordan
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PEST Analysis
How macro-environmental factors might impact a business
organization:
Political
Economic
Changes in government economic policy, e.g.
taxation, government spending, monetary policy
Changes in legal requirements e.g. employment
law, health and safety legislation, licensing
practices, environmental regulations, competition
policy
Changes in the government ownership
e.g. nationalization, privatization, de-regulation
Changes in the level of economic activity, e.g.
growth rates, rates of unemployment, inflation
Changes in wage rates and income distribution
Changes in exchange rates
Social
Technological
Changes in demographics e.g. the size of the
population, the age distribution with the
population
Changing attitudes e.g. work/life balance, concern
for the environment, ethical standards
Changes in social structure e.g. socio-economic
groupings, social mobility
Development of new products and processes
Automation
Developments in information and communication
technologies
Developments in the natural sciences
Some are clearly more important than others. Changes in legislation will have a more
direct and immediate impact than changes in the level of economic activity
©2015 Robert M. Grant & Judith Jordan
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From environmental analysis to
industry analysis
for a firm to make a profit :
-it must create value for customers.
-it must acquire goods and services from suppliers.
- depends on the intensity of competition among firms
Thus, the core of the firm’s business environment is formed
by its relationships with three sets of players
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Porter’s Five Forces of Competition Framework
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Structural determinants
of the competitive forces
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Competition from substitutes
• The price customers are willing to pay for a product depends,
in part, on the availability of substitute products.
• petrol or cigarettes: ……consumers are comparatively
insensitive to price (i.e. demand is inelastic with respect to
price).
• The existence of close substitutes : customers will switch to
substitutes in response to price increases for the product (i.e.
demand is elastic with respect to price):The Internet has
provided a new source of substitute competition :Travel
agencies, newspapers and telecommunication providers
• Rare earth example
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The threat of entry
• If an industry earns a return on capital in
excess of its cost of capital, it will act as a
magnet to firms outside the industry.
• If the entry of new firms is unrestricted, the
rate of profit will fall towards its competitive
level.
• Contestability depends on the absence of sunk
costs – investments whose value cannot be
recovered on exit.
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• Examples:
• Increased health awareness in the US has encouraged increasing demand
for fruit juice and smoothies. Low barriers to entry have resulted in about
4000 new juice and smoothie bars being established since 2000, resulting
in market saturation and a high rate of business failures.
• entry restrictions in many professions: orthodontists
• Eurostar is currently the only company offering a high-speed, passenger
rail service through the Channel Tunnel that links Britain and France. Yet,
Eurostar may be unwilling to exploit its monopoly power to the full given
that European liberalization legislation means that other rail operators will
soon be able to extend their operations to this route.
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• A barrier to entry is any advantage that
established firms have over entrants.
• See previous figure
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Rivalry between established
competitors
• In some industries, firms compete aggressively
– sometimes to the extent that prices are
pushed below the level of costs and industrywide losses are incurred.
• In other industries, rivalry focuses on
advertising, innovation and other non-price
dimensions.
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• The intensity of competition between established firms is the
result of interactions between five factors:
1- CONCENTRATION: the number and size distribution of
firms competing within a market, commonly measured by
the concentration ratio (the combined market share of the
leading firms).
• For example, the fourfirm concentration ratio (CR4) is the market
share of the four largest producers. In markets dominated by a
single firm (e.g. P&G’s Gillette in razor blades, Altria in the US
smokeless tobacco market), the dominant firm can exercise
considerable discretion over the prices it charges.
– As the number of firms supplying a market increases,
coordination of prices becomes more difficult and the
likelihood that one firm will initiate price-cutting increases.
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• 2- DIVERSITY OF COMPETITORS
• avoiding price competition in favour of collusive pricing
practices depends on how similar or different they are in their
origins, objectives, costs and strategies.
• Exp.
• The intense competition that affects the car markets of Europe and North
America today is partly due to the different national origins, costs,
strategies and management styles of the competing firms.
• The key challenge faced by OPEC is agreeing and enforcing output quotas
among member countries that are sharply different in terms of objectives,
production costs, politics and religion.
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3- PRODUCT DIFFERENTIATION
• The more similar the offerings among rival firms, the more
willing customers are to switch between them and the greater
the inducement for firms to cut prices to boost sales.
• When the products of rival firms are virtually indistinguishable
(agriculture, mining and petrochemicals), the product is a
commodity and price is the sole basis for competition.
• in industries where products are highly differentiated
(perfumes, pharmaceuticals, restaurants, management
consulting services), price competition tends to be weak, even
though there may be many firms competing.
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4- EXCESS CAPACITY AND EXIT BARRIERS
- Unused capacity encourages firms to offer price cuts
to attract new business. Excess capacity may be
cyclical
- it may also be part of a structural problem resulting
from overinvestment and declining demand
- Barriers to exit are costs associated with capacity
leaving an industry. Where resources are durable and
specialized and where employees are entitled to job
protection, barriers to exit may be
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5 - COST CONDITIONS: SCALE ECONOMIES AND THE
RATIO OF FIXED TO VARIABLE COSTS
When excess capacity causes price competition, how
low will prices go?
The key factor is cost structure. Where fixed costs are
high relative to variable costs, firms will take on
marginal business at any price that covers variable
costs
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Bargaining power of buyers
• The firms in an industry compete in two types of
markets:
– input markets firms purchase raw materials, components
and financial and labour services.
– In the markets for outputs firms sell their goods and
services to customers (who may be distributors,
consumers or other manufacturers).
– In both markets the transactions create value for both
buyers and sellers. How this value is shared between them
in terms of profitability depends on their relative economic
power.
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• The strength of buying power that firms face
from their customers depends on two sets of
factors:
– buyers’ price sensitivity and
– relative bargaining power.
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Bargaining power of suppliers
• The key issues are the ease with which the firms in the industry can switch
between different input suppliers and the relative bargaining power of
each party.
• Because raw materials, semi-finished products and components are often
commodities supplied by small companies to large manufacturing
companies, their suppliers usually lack bargaining power.
• Hence, commodity suppliers often seek to boost their bargaining power
through cartelization (e.g. OPEC, the International Coffee Organization and
farmers’ marketing cooperatives).
• Conversely, the suppliers of complex, technically sophisticated
components may be able to exert considerable bargaining power.
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Applying industry analysis
Industry analysis can be used to:
• Explain differences in profitability between industries and
changes in the profitability of a given industry over time
• Assist managers in positioning the firm advantageously
• Predict possible changes in competition and profitability in the
near future
• Identify opportunities for changing industry structures and
alleviating competitive pressures.
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
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The challenges of applying the
five forces framework
• Defining the industry
• Dealing with missing factors
• Choosing the appropriate level of analysis
• Dealing with uncertainty and rapid structural change
©2015 Robert M. Grant & Judith Jordan
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Defining the industry
• Industries versus markets.
• Substitutability on the supply side versus
substitutability on the demand side.
• Boundaries are seldom clear-cut.
• In practice the way boundaries are drawn
depends on the purpose and context of
the analysis.
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
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Dealing with missing factors
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Choosing the appropriate level
of analysis
The difficulty in drawing industry boundaries
and the need to define industries more
broadly or more narrowly depending on the
kinds of questions we are seeking to answer
means that it is sometimes helpful to
undertake more detailed, disaggregated
analysis.
Segmentation Analysis
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Segmentation analysis
Identify possible
segmentation variables
Construct a
segmentation matrix
Analyze segment
attractiveness
Identify key success
factors in each segment
Select segment scope
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
32
Illustrative segmentation
variables
Demographic
Gender
Age
Ethnicity
Socio-economic
Income
Education
Occupation
Psychographic
Personality
Lifestyle
Geographic
Region
Urban/suburban/rural
Behavioural
Purchase occasion
Loyalty
Use rate
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
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Dealing with uncertainty and
rapid structural change
• At what rate is structural change occurring?
• Some argue that the pace of change is
accelerating
– Intensifying international competition
– Rapid technological change
– Industries becoming hypercompetitive
But
• Systematic evidence of this trend is elusive.
©2015 Robert M. Grant & Judith Jordan
www.foundationsofstrategy.com
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Identifying key success factors
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to gain market share and improve the
competitive advantage on the new market
1- Prepare well :
good definition of target market;
study of consumers' behaviors, needs and desires;
study of the competition & environment
.
2- Define well the objectives
3- Choose the effective strategy
4- Elaborate a communication strategy to attract and keep clients
Develop the steps for entering this new market
Identify the target market
Perform market research
• Define marketing strategy
• Establish a plan
• Risk mitigation strategy
• Ramping up
Exit strategy
strategies to a successful entry in the new market.
•
• Exporting (spot sales; foreign agent; long-term contract...)
Licensing (franchising; licensing patents...)
• Joint venture (marketing and distribution only)
• Fully integrated
• Wholly owned subsidiary
ē
key challenges faceed when internationalizing the
business?
.
.
Adapt the product and price to the new market;
Understand the consumers' needs and desire on new markets
Understand the consumer behavior on new market
Study of competition on new market: number of competitors; their
positions; products; concentration...
Study of social, political, technological environment...
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