INDUSTRY PAPER

I. Introduction

This part of the paper is the only concession I make to an English paper – which
every student begins writing.

A. Description This is to be a general introduction to the particular nature

of the industry. A brief history, key players, and general information are required
to set the stage.

B. Segments Identify the segments of the industry, and specifically state

the focus of the paper. Almost every industry has segments – some have too
many, such as the computer industry. Students can not be expected to do all
segments within one semester.

C. Caveats State limitations encountered in the study that prevent a

complete analysis. No caveats are allowed without prior conversation with the
instructor. Work-around are possible. Caveats that I agree exist are written
because I can’t remember all the conversations.

II. Socio-Economic

Learning objective: Determine the power of various stakeholder groups likely to

have an impact on future competitive moves of firms within this industry.

Most texts cover in detail the many factors that can be relevant to any
industry. Here the students must research their industry to find specific factors
likely to impact firms within their industry. The orientation is toward the future. It
is assumed that firms in the industry have adapted to past events. This material is
available in magazine articles, and industry surveys, among other sources.
Obviously this section will be very short for, say, the PC computer industry, and
very large for the forestry products industry.

A. Relevant governmental or environmental factors An example would be

the periodic efforts of the government to regulate auto gas mileage and
emissions.

B. Economic indicators relevant for this industry An example would be

disposable income for firms in industries selling discretionary goods or services.

III. Porter’s Five Forces

Learning objective: Determine the relative strengths of each of the five forces.
 A. Threat of New Entrants

Those industries with high entry barriers will have fewer firms entering.
With fewer firms, there is less environmental complexity, and it is easier for one
firm to begin to dominate the industry. Economic rents are usually higher in such
an environment. This makes the industry attractive. For industries with low
barriers to entry, such as the restaurant industry, new firms come and go with
great rapidity. This prevents dominance by any one, or a few, firms. Economic
rents are usually low. This makes the industry unattractive. The following
elements will help determine the level of threat from new entrants.

1. Economies of scale

If economies of scale exist, it represents a high barrier to entry. Firms

within the industry will have achieved these economies, and if we enter, we will
have to match their scale size, but without the benefits of the associated learning
curve. Since economies of scale do not exist in any tangible way, you must prove
their existence or non-existence. Provide two measures related to the basic
premise that increases in capital investment should lead to lower unit costs.
Reach a conclusion: based on your analysis, do economies exist? What does this
do to the threat of new entrants? Does this make the industry attractive or
unattractive? Provide similar conclusions for each of the following sub-sections.

2. Working capital requirements

How much money will we have to tie up to keep the doors open? This is
money that can not be invested in any other way. It will never earn an income.
This is also a barrier to entry in that if firms must tie up large amounts of capital
for daily operations, this will deter smaller firms from entering. Working capital
requirements are usually provided in the cash flow financial statements.

3. Proprietary product differences

Do you see that some firms have a secret process or secret formula? An
example would be Coca-Cola. They have a secret formula for their cola soft drink
that acts as a high barrier to entry. Very few firms try and compete head-to-head
with Coke in the cola segment of the industry.

4. Absolute cost advantages

Do you see the presence of patents or copyrights? These are legal

constraints to entry created by the government. By definition, they constitute a
high barrier to entry. Examples include patents on pharmaceuticals and
copyrights on software.

5. Brand identity
 Is brand identity important in this industry? Do buyers make conscious
choices based on brand identity? If so, this would be a high barrier to entry.
Examples include Viagra, Coke, and Intel Pentium processors. You must prove
that brand identity is or is not important. One way is through an interview with a
buyer. Another is to examine marketing expenses for the industry as a percentage
of sales across five years. If the trend is upward, then brand identity could be
important.

6. Access to distribution

How do firms get their product or service to market? Would we need to

duplicate the distribution channels, or could we tap into existing channels? This
is not an obvious question, and it requires first determining who the buyers are.
Kia auto discovered that lack of a distribution system in the form of dealerships
limited its access to markets in this country. This was a very high barrier to entry
for them.

7. Expected retaliation

Do you see indications of retaliation against prior newcomers? This will

require research through many historical articles about the industry. An example
would be the airline industry. Midway Airlines, a small regional carrier, competed
head-to-head with American and USAir, and went bankrupt. Southwest has
survived nicely by avoiding the markets dominated by larger airlines such as
American and United. This is one of the high barriers to entry for the major
segment of the airline industry.

From your analysis, you will find that some of these points are not
relevant to your industry. You should also appreciate that some points are more
important than others. Lastly, you should find that some elements will say that
the industry is attractive, while other elements say that the industry is
unattractive. Provide a decision matrix to justify your final answer as to the
barriers to entrants, the threat of new entrants, and the attractiveness of the
industry.

B. Suppliers

While we were concerned about threats in the "entrants" section, here we

are concerned with power. Do suppliers have power over firms in this industry? If
so, this would make the industry unattractive. The first step is to determine what
this industry purchases. Not in detail, but as a generalization. Then, identify items
that are recognized as being commodities. These can be dismissed from further
consideration. Focus on suppliers of key items that firms in this industry must
have. For example, in the micro brewing industry, all inputs are commodity items
except hops. Since hops are the key ingredient for specialty beer production,
supplier analysis would focus only on hops suppliers. Another example would be
the PC industry. While this industry changes regularly, at the time of writing, only
the central processing unit (CPU) is a key input. All other items are commodity in
nature and would not be discussed. Evaluate the following elements only for the
key item or items in the industry.

1. Suppler concentration

Are there more or fewer suppliers than firms in this industry? If suppliers
are concentrated (fewer of them) this could give them power over buyers in this
industry. For example, Intel is one of only a few providers of CPUs for the PC
industry. This gives them power over the PC industry.

2. Presence of substitute inputs

The presence of substitute inputs lowers the power of suppliers. For

example, in the auto industry, aluminum can substitute for steel. This lowers the
power of the steel industry. A lack of substitutes, such as no substitute for the
CPU gives the suppliers power.

3. Differentiation of inputs

Are suppliers able to differentiate their products/services in some way?

Whether legitimate or not, Intel has differentiated its CPU such that many
consumers (not buyers) prefer computers with Intel inside. This ability to
differentiate gives suppliers power.

4. Importance of volume to supplier

Do we, as an industry, buy a significant percentage of the total production

of the suppliers output? For example, the PC industry buys virtually all of the
CPUs that Intel produces. This gives the PC industry power over the suppliers.
Without the PC industry there would be no CPU manufacturers.

5. Impact of inputs on our cost or ability to differentiate

If suppliers have a significant impact on an industry’s cost structure, or

value chain, this gives them power. The same is true if they impact firms’ ability to
differentiate their product or service. Again, the PC industry is a good example.
Intel’s ability to impact PC manufacturers’ final product gives them power.

6. Threat of forward or backward integration

Is there any indication that vertical integration is occurring? If suppliers

are coming forward to gain access to distribution channels, this gives them
power. If there are indications of firms backward integrating to capture margins,
this gives firms in the industry power over suppliers.
 7. Access to capital

Assuming that we enter this industry, at some point in the future we will
want access to capital for expansion or other business reasons. You need to
determine whether we would likely have access to capital on acceptable terms.
Since we can’t know the future, we have to use the past as an indication.
Determine the average profitability for the industry over the last five years. Net
income as a percentage of sales works. Plot a graph comparing industry
profitability against inflation. In your opinion, does the return on investment
represent a reasonable income? If so, we can expect that we would have access
to debt financing on reasonable terms. If not, access to debt financing is likely to
be expensive.

8. Access to labor

If we enter, would we have access to labor on favorable terms? Does this

industry have unions? If so, they limit access to labor and usually increase costs.
Do firms in this industry require highly skilled knowledge workers? How is the
present labor market for this industry?

As with the threat of new entrants section, provide conclusions for each
subsection as to the power of suppliers. Then provide an overall conclusion for
this section using a decision matrix. Do suppliers have power and is the industry
attractive?

C. Buyers

First, determine who the buyers are. This is not a marketing paper, so
don’t think ultimate consumer. What are the channels of distribution for the
industry? Your analysis should focus on the primary buyer, not on the consumer
unless there are no intermediaries. Here again, we are concerned with power. Do
buyers have power over firms in this industry? If so, the industry is unattractive.
The easiest way to get answers is through an interview with a buyer. Most firms
are willing to assist students. While it is not correct to generalize from one
interview or observation, the experience and knowledge gained from the
interview offset the methodological limitations.

1. Buyer concentration

Are there more or fewer buyers than firms in the industry? If buyers are
concentrated, this gives them power. An example would be the airframe industry.
There is only one U.S. based buyer for commercial aircraft parts – Boeing.
Therefore, the buyers for the commercial aircraft parts industry are concentrated,
giving the buyers power, making the commercial aircraft parts industry
unattractive.
 2. Buyer switching costs

Do buyers have switching costs that would limit their willingness to switch
suppliers? If the industry has been able to create switching costs, that gives the
industry power over the buyer and makes the industry attractive. An example
would be the software industry. The switching costs are the time required to learn
a new program. This makes it less likely that a buyer would switch readily from,
say, Excel to Lotus. This buyer switching costs gives power to the software
industry.

3. Buyer Information

Do buyers understand what is happening in this industry? If so, it is less

likely that the industry can make competitive moves to increase profit margins.
An example would be the auto tire industry. Buyers (auto manufacturers) know
what it takes to make a tire. Therefore, they have power over the tire industry.
This is demonstrated by the relatively low margins in the tire industry.

4. Threat of backward integration

Backward integration is the process of firms acquiring their suppliers, or

beginning the process of providing for themselves the means to produce the
input. This can occur for several reasons, among them: to guarantee a
dependable source of the input or to capture the margins normally paid to the
suppliers. Are there indications that buyers are backward integrating? If so, this
gives them power, making the industry unattractive.

5. Pull through

Have firms in this industry been able to create pull through? This requires
that intermediaries exist. If brand identity is important in this industry then pull
through most likely exists. Quantitative analysis of advertising expense as a
percentage of sales over time for the industry is one way of demonstrating that
pull through could exist. The easiest way to answer the question is through an
interview. If pull through exists, this gives the industry power over the buyer. An
example would be the cereal industry, which has established pull through such
that major grocery chains have to carry major brands. This pull through gives the
cereal industry power over the buyers, making the industry attractive.

6. Brand identity of buyers

Does the industry impact the brand identity of its buyers? If so, this would
give the industry power over the buyer. For example, while high performance tires
with a brand name seen on racing cars would favorably impact the brand identity
of a very expensive sports car, a brand of tire that automobile assembly plants
put on compact cars would negatively impact the brand identity of this car.
 7. Price sensitivity

Are buyers price sensitive? This deals with elasticity of demand. Is the
industry able to pass cost increases on to the buyer, or must they absorb them?
If buyers are not price sensitive, this gives the industry power and makes it
attractive.

8. Price to total purchases

Do the buyers’ purchases of this industry’s product/service represent a

significant percentage of their total purchases? If so, this would give the industry
power over the buyers. They would be dependent on a constant supply of goods
or services for their survival.

As with the supplier section, provide conclusions for each subsection as

to the power of buyers. Then provide an overall conclusion for this section using
a decision matrix.

D. Substitute Products

An industry will be attractive if there is no threat from substitute products.

A substitute is any product or service that will fulfill the same need while using a
different technology. An example would be substituting plastic for paper for food
carry out. The electric car is a substitute for the internal combustion engine;
therefore the auto as we know it, even though the auto industry is the primary
developer. The relevance is that substitutes can render obsolete the present
capital investment of the industry.

1. Relative price/performance relationship of substitutes

The electric car has not caught on, in part, because it does not have the
same performance characteristics as the traditional auto. Another example: few
business people put cheap pens in their shirt pockets. They prefer a very
expensive pen. The prestige factor is much higher for the higher-priced pen. The
need being satisfied is not the ability to write, but the image being portrayed.

2. Buyer propensity to substitute

Despite the benefits offered by the substitute product or service, do people

really want it? The ultra-sonic clothes washer was a flop. It got clothes as clean
as the conventional washer, using cold water and no soap. But people preferred
the hot water and soap despite the additional costs. Another example: special
interest groups forced McDonald’s to switch from styrofoam containers to paper
containers for carry out food.

END
 This section does not require a decision matrix. Based on your study of the
industry, what do you conclude about the attractiveness of the industry?

E. Rivalry

An industry characterized by high rivalry is unattractive because it limits

the ability to achieve above normal economic rents. At the other extreme,
industries with no rivalry are usually dominated by a few major firms which could
limit strategic flexibility.

1. Degree of concentration and balance among competitors

Here I cover lecture material on industry structure and the life cycle. Using
a continuum, I show that some industries are fragmented, such as drug stores,
while others are in near-monopoly conditions, such as main frame computers.
The questions for the student are where is their industry on this continuum, and
what are the economic forces acting on firms?

As the business cycle, or life cycle, progresses, there is a tendency for

consolidation to occur within industries. At the beginning of the 20 th century, the
US had around 300 firms in the auto industry. We now have two. As a rule of
thumb, an industry is concentrated if five or fewer firms control 60% or more of
market share. Concentration tends to increase rivalry, but must be considered
along with balance.

If concentration does not exist, then balance is not an issue. The industry
is, by definition, fragmented. This reduces rivalry and makes the industry
attractive. Assuming that the industry is concentrated, then look for balance. If
the two largest firms have market shares within 10% of each other, then the
industry is balanced. This increases rivalry, making the industry unattractive. If
one firm is dominant in market share, this means that the larger firm is setting the
competitive rules for the industry. This reduces rivalry and makes the industry
attractive. A four cell matrix can be constructed to demonstrate these points.

2. Diversity among competitors

Are firms following different strategies? If so, they have found market
niches and this reduces rivalry. If they are all following the same strategy, they
are fighting for the same markets and this increases rivalry, making the industry
unattractive. Students have been exposed to Porter’s generic strategies by this
point.

3. Industry growth rate (past and projected)

If there is a positive trend to industry growth rate, and it is greater than the
inflation rate, then firms are able to grow without taking market share from other
firms in the industry. This reduces rivalry and makes the industry attractive.
Quantitative analysis is required with a graph of the five year growth rate trend.

4. Fixed costs to value added

It is necessary to demonstrate whether fixed costs and value added are

high or low. If fixed costs are high, this usually means that economies of scale
are possible in the industry. If fixed costs are high, and value added is low, the
industry is at or near maturity, and the product/service is most likely a
commodity. This increases rivalry and makes the industry unattractive.

Here I re-introduce break even analysis to show why fixed costs are
important in an industry. What constitutes ‘high or low’ is left to the student to
determine, and to support. This section is a good place to see if the students are
working together in as much as the "entrants" section had to demonstrate
economies of scale. The next element is value added. There are a number of
ways to determine if the firms are able to create a reasonable profit margin, and
the student can pick any supportable argument.

This is one of the sections that allows real evaluation of the students’
analytical ability, and the ability to work with team members. As is obvious, fixed
costs to value added is a very rich topic providing the instructor an opportunity
to take a variety of approaches. More importantly, the student has an opportunity
to integrate a number of significant concepts.

5. Intermittent overcapacity

If the industry is running between 80% and 85% capacity utilization, this is
a normal range. Lower utilization means that the industry is susceptible to
intermittent overcapacity. This increases rivalry as firms attempt to maintain
revenues. If the industry is over the normal range, this indicates that they may
lack the capital investments necessary to meet unexpected demand. This reduces
rivalry and makes the industry attractive.

The Department of Commerce provides figures for capacity utilization.

These numbers are provided for the student, along with the web site for further
data mining. While it is not applicable to all industries, most industries do have
some measure of capacity utilization.

6. Product differentiation

Are firms able to differentiate their product or service? If so, this reduces
rivalry as each firm is able to find a market niche. If not, it increases rivalry and
makes the industry unattractive. For example, BIC and Mont Blanc differentiate
their pens on the basis of quality, image and cost, which reduces rivalry between
these firms. In the airline industry each firm offers basically the same service. The
lack of differentiation makes the industry unattractive.

7. Growth of foreign competition

To what extend are foreign firms able to penetrate the US market? If there
is a growth in foreign firms penetration, this increases rivalry making the industry
unattractive. It also shows that US firms are not being globally competitive. While
this is not an international management course, I do want students to be aware of
the extent to which foreign firms are able to penetrate US markets. We also go
over the reasons during lectures on the global economy.

8. Corporate stakes

While most firms have revenue from a variety of industries, the question
here deals with the degree of dependence on one industry segment. To what
extent are firms dependent on this one industry segment for revenue? If the
percentage of revenue is high, then the stakes are high, and this would increase
rivalry, making the industry unattractive. This requires judgment on the part of
the student, and quantitative support for the argument.

9. Exit barriers

If we enter this industry, will we be able to get out again? A firm can exit
by converting operations to another product/service, or by selling out – merger. If
exit barriers are low, this reduces rivalry and makes the industry attractive.

As with the other sections, in this one provide conclusions for each
subsection as to the degree of rivalry. Then provide an overall conclusion for this
section using a decision matrix.

IV. Conclusion

You have, by now, discovered a number of factors: Firms do not provide

their annual reports in any standardized manner. Reporting services will have
conflicting data. Missing industry numbers can not be computed from firm data.
But the biggest awakenings should be that a lot of the theory you have learned
from other classes does not apply, and there are no correct answers! However,
you are now in a position to look beyond the obvious and to see – and write
about – the opportunities and threats facing firms in an industry.

State what you consider to be the opportunities and threats for firms that
would enter this industry. Use a decision matrix to support a final argument as to
whether we should or should not enter this industry.

A. Critical Success Factors

 You need three. Two are quantitative, and one can be qualitative. A factor
is critical if it defines the difference between a firm that will succeed and one that
will fail. These should come from your analysis of the industry – they are not
separate! For example, if you noticed that the industry is in the mature phase of
the life cycle, and that fixed costs are high and value added is low, then
efficiencies would be a critical factor to survival. Market share is not a critical
factor – it is an obvious point that firms must grow. It is how they grow that
matters.

Most texts give material on key success factors. This is a laundry list.
The point here is to narrow the list down to items that are really important within
an industry. For the auto industry, being a low-cost provider is important, as is
quality of products. These can be measured by the student from industry data.
Another factor is reputation, as Ford found out with the Explorer problem.

B. Prognosis

What is your assessment of this industry as an investment prospect? Is

future growth possible? Will competitive forces contribute to consolidation?
These are just suggestions. Your analysis should lead you to reasonable
conclusion.

V. Bibliography

I would prefer to see not only the references that you cite, but also a listing
of the material that contributed to your body of knowledge. Where did you look
for answers? If it helped you, please include a reference.

VI. Appendices

Here you can put anything that you think is important to an understanding
of this industry. At a minimum you need a set of industry ratios covering the most
recent five year period.

I prefer electronic submissions. You can submit earlier than the required
submission date.

Final Notes: It could be said that there is too much structure in this outline, and
that the student is being driven toward a single conclusion. From experience, I
don’t believe that this is the case. The analysis required is focused. This means
the student must learn certain techniques that will be useful in their future
endeavors. However, as students discover that all theory does not apply in all
cases, this is where they have the chance to see beyond the obvious and
discover new solutions.
 One example of this process: We all know that the auto industry is
unattractive. It is mature, with saturated markets, excess capacity, and strong
labor unions. Despite this, firms still enter and find ways to survive. Witness
Honda and Kia. Others fail, for example, Jugo. When the analysis is finished, the
student is able to discern the opportunities and threats of the industry, and I
believe that the structure of the industry analysis contributes to achieving this
objective.
 INDUSTRY PAPER OUTLINE

I. Introduction

A. Description

B. Segments

C. Caveats

II. Socio-Economic

A. Relevant governmental or environmental factors, etc.

B. Economic indicators relevant for this industry

III. Porters Five Forces

A. Threat of New Entrants

1. Economies of scale

2. Working capital requirements

3. Proprietary product differences

secret formulae or processes

4. Absolute cost advantages:

patents or copyrights

5. Brand identity

6. Access to distribution

7. Expected retaliation

B. Suppliers
 1. Supplier concentration

2. Presence of substitute inputs

3. Differentiation of inputs

4. Importance of volume to supplier

5. Impact of inputs on cost or differentiation

6. Threat of forward or backward integration

7. Access to capital

8. Access to labor

C. Buyers

1. Buyer concentration versus industry concentration

2. Buyer switching costs

3. Buyer information

4. Threat of backward integration

5. Pull through

6. Brand identity of Buyers

7. Price sensitivity

8. Price to total purchases

D. Substitute Products

1. Relative price/performance relationship of substitutes

2. Buyer propensity to substitute

E. Rivalry

1. Degree of concentration and balance among competitors

2. Diversity among competitors

 3. Industry growth rate (past & projected)

4. Fixed costs/value added

5. Intermittent overcapacity

6. Product differentiation

7. Growth of foreign competition

8. Corporate stakes

9. Exit barriers

IV. Conclusion

A. Critical Success Factors. At least three, two of which must be

quantitative.

B. Prognosis - your assessment of the future of this industry.

Summarize the five forces discussion. Threat, power, attractiveness.
Should we enter this industry?

V. Bibliography

VI. Appendices

Industry Ratios

Other relevant indices