Analysis Of The Industry

he word industry is used to refer to a group of firms whose products are sufficiently
close substitutes for each other that the member firms are drawn into competitive rivalry
to serve the same needs of some or all the same types of buyers.

In analyzing an industry, it is also useful to determine if the industry is a global

industry, that is, an industry that requires global operations to compete effectively

Industries differ widely in their economic characteristics, competitive situations, and

future outlooks. Understanding industry structure is the logical starting point for strategic
analysis at the business level.

The key concerns in the industry environment are as follows:

1. The elements of the industry structure

2. The stage in the life cycle of products in the industry.
3. The direction the industry is headed (for example, overcapacity, requiring
rationalization).
4. The forces (for example, political, social, economic, technological) driving the
industry in a particular direction.
5. The underlying economics and performance of the business (for example, cost
structures, profit levels).
6. The key success factors (for example, cost, delivery).
7. Demand segments and strategic groups

The second environment to consider is the competitive environment. The key concerns
in the competitive environment are as follows:

1. The forces driving competition in the industry (which is a function of industry

structure.
2. The differences in the competitive approaches of rival firms (for example, price
competition, advertising battles, increased customer service).
3. Strategies, positions, and competitive strength of market leaders and close rivals.
4. Why some rivals are doing better than others.

The value chain is an important tool for analyzing how a company is faring relative to its
competitors. The issues of competitive environment and the value chain are described in
Chapter 9.

The Elements Of Industries Structure

ndustry structure can be analyzed by using Porter's framework competition in an industry.
Professor Michael E. Porter of Harvard University is the nation's leading authority on
industry analysis.

Porter identifies five basic competitive forces, which determine the state of competition
an its underlying economic structure:

1. The threat of new competitors entering the industry

2. The intensity of rivalry among existing competitors
3. The threat of substitute products or services
4. The bargaining power of buyers
5. The bargaining power of suppliers

These five forces of competition determine the rate of return on invested capital (ROI) in
industry, relative to the industry's cost of capital. The strength of each of the competitive
forces is determined by a number of key structural variables.

Threat Of New Entrants

A major force shaping competition within an industry is the threat of new entrants. The
threat of new entrants is a function of both barriers to entry and the reaction from existing
competitors. There are several types of entry barriers:

Economies of scale. Economies of scale act as barrier to entry by requiring the entrant to
come on large scale, risking strong reaction from existing competitors, or alternatively to
come in on a small scale accepting a cost disadvantage. Economies of scale refer to the
decline in unit costs of a product or service (or an operation, or a function that goes into
producing a product or service).

Product differentiation. Product differentiation creates a barrier to entry by forcing

entrants to incur expenditure to overcome existing customer loyalties. New entrants must
spend a great deal of money and time to overcome this barrier.

Capital requirements. The capital costs of getting established in an industry can be so

large as to discourage all but the largest companies.

Cost advantages independent of scale. Existing firms may have cost advantages not
available to potential entrants regardless of the entrant's size. These advantages can
include access to the best and cheapest raw materials, possession of patents and
proprietary technological know-how, the benefits of learning and experience curve
effects, having built and equipped plants years earlier at lower costs, favourable
locations, and lower borrowing costs.

Switching costs. Switching costs refer to the one-time costs that buyers of the industry's
outputs incur if they switch from one company's products to another's. To overcome the
switching cost barrier, new entrants may have to offer buyers a bigger price cut or extra
quality or service. All this can mean lower profit margins for new entrants.

Access to distribution channels. Access to distribution channels can be a barrier to entry

because of the new entrants's need to obtain distribution for its product. A new entrant
may have to persuade the distribution channels to accept its product by providing extra
incentives which reduce profits.

Governmental and legal barriers. Government agencies can limit or even bar entry by
requiring licenses and permits. National governments commonly use tariffs and trade
restrictions (antidumping rules, local content requirements, and quotas) to raise entry
barriers for foreign firms.

The effectiveness of all these barriers to entry in excluding potential entrants depends
upon the entrants' expectation as to possible retaliation by established firms. Retaliation
against a new entrant may take the form of aggressive price-cutting, increased
advertising, or a variety of legal manoeuvres.

Threat Of Substitutes
All firms in and industry compete with other industries offering substitute products or
services. Steel producers are in competition with aluminum producers. Sugar producers
are in competition with the firms which are introducing sugar-free products. The
competitive force of closely-related substitute products impact sellers in several ways.

First, the presence of readily available and competitively priced substitutes places a
ceiling on the prices companies in and industry can afford to charge without giving
customers an incentive to switch to substitutes and thus eroding their own market
position.

Another determinant of whether substitutes are a strong or weak competitive force is

whether it is difficult or costly for customers to switch to substitutes to substitutes.
Typical switching costs include, the cost of purchasing additional equipment, employees
retraining costs, the time and costs to test the quality for technical help needed to make
the changeover.

As a rule, the lower the price of substitutes and the higher the quality and performance of
substitutes, the more intense are the competitive pressures posed by substitute products.

Bargaining Power Of Buyers

Buyer power refers to the ability of customers of the industry to influence the price and
terms of purchase.
The competitive strength of buyers can range from strong to weak. The buyers are
powerful when:

• They are concentrated and buy in large volume.

• The buyer's purchases are a sizable percentage of the selling industry's total sales.
• The supplying industry is comprised of large numbers of relatively small sellers.
• The item being purchased is sufficiently standardized among sellers that not only
can buyers find alternative sellers but also they can switch suppliers at virtually
zero cost.
• The buyers pose a threat of integrating backward to make the industry's product.
• The sellers pose little threat of forward integration into the product market of
buyers.
• The products are unimportant to the quality of the customer's product or service.
• It is economically feasible for buyers to follow the practice of purchasing the
input from several suppliers rather that one.

These factors change with time and firm's choice of buyers-groups should be regarded as
an important element in strategic decision-making.

Bargaining Power Of Suppliers

Supplier power refers to the ability of providers of inputs to determine the price and
terms of supply. Suppliers can exert power over firms an industry by raising prices or
reducing the quality of purchased goods and services, so reducing profitability.

The extent to which this potential impact is realized depends upon a number of factors; in
general, a group of suppliers is more powerful if the following apply:

• It is dominated by a few firms and is more concentrated than the industry its sells
to.
• When suppliers' products are differentiated to such an extent that it is difficult or
costly for buyers to switch from one suppliers to another.
• When the buying firms are not important customers of the suppliers group.
• When the suppliers of an input do not have to compete with the substitute inputs
of suppliers in other industries.
• When one or more suppliers pose a credible threat of forward integration into the
business of the buyer industry.
• When the buying firms display no inclination toward backward integration into
the suppliers' business.

It is important to recognise that labour is a supplier, and may exert a considerable degree
of power in some situation. The power of suppliers can be an important economic factor
in the marketplace because of the impact they can have on customer profits.
Rivalry Among Existing Firms
ivalry refers to the degree to which firms respond to competitive moves of the other firms
in the industry. Rivalry among existing firms may manifest itself in a number of ways-
price competition, new products, increased levels of customer service, warranties and
guarantees, advertising, better networks of wholesale distributors, and so on.

The degree of rivalry in and industry is a function of a number of interacting structural

features:

• Rivalry tends to intensify as the number of competitors increases and as they

firms become more equal in size and capability.
• Market rivalry is usually stronger when demand for the product is growing
slowly.
• Competition is more intense when rival firms are tempted to use price cuts or
other marketing tactics to boost unit volume.
• Rivalry is stronger when the costs incurred by customers to switch their purchases
from one brand to another are low.
• Market rivalry increases in proportion to the size of the payoff from a successful
strategic move.
• Market rivalry tends to be more vigorous when it costs more to get out of a
business than to stay in and compete.
• Rivalry becomes more volatile and unpredictable the more diverse competitors
are in terms of their strategies, their personalities, their corporate priorities, their
resources, and their countries of origin.
• Rivalry increases when strong companies outside the industry acquire weak firms
in the industry and lunch aggressive, well-funded moves to transform their newly-
acquired firms into major market contenders.

Two principles of competitive rivalry are particularly important: (1) a powerful

competitive strategy used by one company intensifies competitive pressures on the other
companies, and (2) the manner in which rivals employ various competitive weapons to
try to outmanoeuvre one another shapes "the rules of competition" in the industry and
determines the requirements for competitive success.