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Porter five forces analysis

An industry is a group of firms that market products which are close


substitutes for each other (e.g. the car industry, the travel industry).
Some industries are more profitable than others. Why? The answer lies in
understanding the dynamics of competitive structure in an industry.
The most influential analytical model for assessing the nature of
competition in an industry is Michael Porter's Five Forces Model, which is
described below:

Porter explains that there are five forces that determine industry
attractiveness and long-run industry profitability. These five "competitive
forces" are
- The threat of entry of new competitors (new entrants)
- The threat of substitutes
- The bargaining power of buyers
- The bargaining power of suppliers
- The degree of rivalry between existing competitors
Threat of New Entrants
New entrants to an industry can raise the level of competition, thereby
reducing its attractiveness. The threat of new entrants largely depends on
the barriers to entry. High entry barriers exist in some industries (e.g.
shipbuilding) whereas other industries are very easy to enter (e.g. estate
agency, restaurants). Key barriers to entry include
- Economies of scale
- Capital / investment requirements
- Customer switching costs
- Access to industry distribution channels
- The likelihood of retaliation from existing industry players.
Threat of Substitutes
The presence of substitute products can lower industry attractiveness and
profitability because they limit price levels. The threat of substitute
products depends on:
- Buyers' willingness to substitute
- The relative price and performance of substitutes
- The costs of switching to substitutes
Bargaining Power of Suppliers
Suppliers are the businesses that supply materials & other products into
the industry.
The cost of items bought from suppliers (e.g. raw materials, components)
can have a significant impact on a company's profitability. If suppliers have
high bargaining power over a company, then in theory the company's
industry is less attractive. The bargaining power of suppliers will be high
when:
- There are many buyers and few dominant suppliers
- There are undifferentiated, highly valued products
- Suppliers threaten to integrate forward into the industry (e.g. brand
manufacturers threatening to set up their own retail outlets)
- Buyers do not threaten to integrate backwards into supply
- The industry is not a key customer group to the suppliers
Bargaining Power of Buyers
Buyers are the people / organisations who create demand in an industry
The bargaining power of buyers is greater when
- There are few dominant buyers and many sellers in the industry
- Products are standardised
- Buyers threaten to integrate backward into the industry
- Suppliers do not threaten to integrate forward into the buyer's industry
- The industry is not a key supplying group for buyers
Intensity of Rivalry
The intensity of rivalry between competitors in an industry will depend on:
- The structure of competition - for example, rivalry is more intense where
there are many small or equally sized competitors; rivalry is less when an
industry has a clear market leader
- The structure of industry costs - for example, industries with high fixed
costs encourage competitors to fill unused capacity by price cutting
- Degree of differentiation - industries where products are commodities
(e.g. steel, coal) have greater rivalry; industries where competitors can
differentiate their products have less rivalry
- Switching costs - rivalry is reduced where buyers have high switching
costs - i.e. there is a significant cost associated with the decision to buy a
product from an alternative supplier
- Strategic objectives - when competitors are pursuing aggressive growth
strategies, rivalry is more intense. Where competitors are "milking" profits
in a mature industry, the degree of rivalry is less
- Exit barriers - when barriers to leaving an industry are high (e.g. the cost
of closing down factories) - then competitors tend to exhibit greater rivalry.











STEEL INDUSTRY

Barriers to entry: We believe that the barriers to entry are medium.
Following are the factors that vindicate our view.
1. Capital Requirement: Steel industry is a capital intensive business. It
is estimated that to set up 1 mtpa capacity of integrated steel plant, it
requires between Rs 25 bn to Rs 30 bn depending upon the location
of the plant and technology used.
2. Economies of scale: As far as the sector forces go, scale of operation
does matter. Benefits of economies of scale are derived in the form of
lower costs, R& D expenses and better bargaining power while
sourcing raw materials. It may be noted that those steel companies,
which are integrated, have their own mines for key raw materials
such as iron ore and coal and this protects them for the potential
threat for new entrants to a significant extent.
3. Government Policy: The government has a favorable policy for steel
manufacturers. However, there are certain discrepancies involved in
allocation of iron ore mines and land acquisitions. Furthermore, the
regulatory clearances and other issues are some of the major
problems for the new entrants.
4. Product differentiation: Steel has very low barriers in terms of
product differentiation as it doesn't fall into the luxury or specialty
goods and thus does not have any substantial price difference.
However, certain companies like Tata Steel still enjoy a premium for
their products because of its quality and its brand value created more
than 100 years back. Bargaining power of buyers: Unlike the FMCG
or retail sectors, the buyers have a low bargaining power. However,
the government may curb or put a ceiling on prices if it feels the
need to do so. The steel companies either sell the steel directly to the
user industries or through their own distribution networks. Some
companies also do exports.
Entry barriers: High
Capital Requirement:
Steel industry is a capital-intensive business. It is estimated that to set
up 1mtpa capacity of integrated steel plant, it requires between Rs 25 bn to Rs
30 bn depending upon the location of the plant and technology used.

Economies of scale:
As far as the sector forces go,scale of operation does matter. Benefits of
economies of scale are derived in the form of lower costs, R& D expenses
and better bargaining power while sourcing raw materials. It may be noted
that those steel companies, which are integrated, have their own mines
for key raw materials such as iron ore and coal and this protects them for
the potential threat for new entrants to a significant extent.

Government Policy:
The government has a favorable policy for steel manufacturers.
However, there are certain discrepancies involved in allocation of iron ore mines
and land acquisitions. Further more, the regulatory clearances and other issues are
some of the major problems for the new entrants.

Product differentiation:
Steel has very low barriers in terms of product differentiation as it doesnt fall into
the luxury or specialty goods and thus does not have any substantial price
difference. However, certain companies like Tata Steel still enjoy a premium for their
products because of its quality and its brand value created more than 100 years
back. Bargaining power of buyers: Unlike the FMCG or retail sectors, the buyers have a
low bargaining power. However, the government may curb or put a ceiling on prices
if it feels the need to do so. The Steel companies either sell the steel
directly to the user industries or through their own distribution networks. Some
companies also do exports.


Bargaining power of suppliers: The bargaining power of suppliers is low for
the fully integrated steel plants as they have their own mines of key raw
material like iron ore coal for example Tata Steel. However, those who are
non-integrated or semi integrated has to depend on suppliers. An example
could be SAIL, which imports coking coal.
Bargaining power of suppliers: High

The bargaining power of suppliers is low for the fully integrated steel
plants as they have their own mines of key raw material like iron ore coal for
example Tata Steel. However, those who are non-integrated or semi integrated has
to depend on suppliers. An example could be SAIL, which imports coking
coal.

Globally, the Top three mining giants BHP Billiton, CVRD and Rio Tinto supply nearly
two-thirds of the processed iron ore to steel mills and command very high bargaining
power. In India too, NMDC is a major


supplier to standalone and nonintegrated steel mills.



Competition: It is medium in the domestic steel industry as demand still
exceeds the supply. India is a net importer of steel. However, a threat from
dumping of cheaper products does exist.
Competition: High

The steel industry is truly global in terms of competition with large producing
countries like China significantly influencing global prices through aggressive
exports.
Steel, being a commodity it is, branding is not common and there is little
differentiation between competing products.

It is medium in the domestic steel industry as demand still exceeds the supply. India is a
net importer of steel. However, a threat from dumping of cheaper products does
exist.

Threat of substitutes: It is medium to low. Although usage of aluminum
has been rising continuously in the automobile and consumer durables
sectors, it still does not pose any significant threat to steel as the latter
cannot be replaced completely and the cost differential is also very high.
Threat of substitutes: Low

Plastics and composites pose a threat to Indian steel in one of its biggest
markets automotive manufacture. F o r t h e a u t o mo b i l e
i n d u s t r y , t h e o t h e r ma t e r i a l a t p r e s e n t w i t h t h e
p o t e n t i a l t o u p s t a g e s t e e l i s a l u mi n i u m.
H o w e v e r , a t p r e s e n t t h e h i g h c o s t o f electricity for
extraction and purification of aluminiumin India weighs against viable use
of aluminium for the automobile industry. Steel has already been replaced in some
large volume applications: railway sleepers (RCC s l eeper s ), l ar ge
di amet er wat er pi pes ( RCC pi pes ) , small diameter pipes (PVC
pipes), and domestic water tanks (PVC tanks). The substitution is more
prevalent int h e m a n u f a c t u r e o f a u t o m o b i l e s a n d
c o n s u m e r durables.




Bargaining power of Consumers: Mixed
S o m e o f t h e m a j o r s t e e l c o n s u m p t i o n s e c t o r s
l i k e automobiles, oil & gas, shipping, consumer durables and
power generat i on enj oy hi gh bar gai ni ng power and get
favorable deals. However, small and retail consumers who are scattered and
consume a significant part do not enjoy these benefits.


Conclusion: After understanding all the above view points and the current
global scenario, we believe that the domestic steel industry will likely to
maintain its momentum in the long term. However, the growth may get
affected in short run. Investors need to focus on companies that are
integrated, have economies of scale and sell premium quality products