Post on 28-May-2020
Lecture 8Industry Analysis: Porter’s
Five Forces Model
Overview
Performing a Five-Forces Analysis– Internal rivalry– Entry– Substitutes and complements– Supplier power – Buyer power
Applying the Five Forces– Wine industry– Airline manufacturing
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Industry Analysis
Industry analysis facilitates– assessment of industry and firm performance– identification of factors that affect
performance– determination of the effect of changes in the
business environment on performance– identification of opportunities and threats –
SWOT Analysis
Porter’s Five-Forces Model
Michael Porter developed a model for industry analysis that incorporates many of the concepts we have studied so far. http://www.youtube.com/watch?v=mYF2_FBCvXw
If we want to understand the nature and intensity of competition among firms in a market, we must understand the outside forces acting on firms in that industry. These forces include supplier power, buyer power, the threat of substitutes, and the threat of entry. We must also understand the market structure of the industry that inherently affects internal rivalry.
When there are only a few firms in an industry, and those firms are somewhat insulated from the other four forces, then the internal rivalry aspect of a market gets interesting.
Internal Rivalry
Internal rivalry is the competition for market share among the firms in the industryCompetition could be on price or some
non-price dimensionPrice competition erodes the price cost
margin and profitability
Internal Rivalry
Competition on non-price dimension can drive up costsTo the extent customers are willing to pay
a higher price for improvements in the non-price dimensions, non-price competition does not erode profits as severely as price competition
Internal Rivalry: Conditions that Increase Price Competition
Presence of many sellers – prices are lower when there are many firms in the marketStagnant or declining industrySome firms’ cost advantage over othersExcess capacity Undifferentiated products/ low switching
costs
Internal Rivalry: Conditions that Increase Price Competition
Hard to observe prices and sale termsInability to adjust prices quicklyLarge and infrequent sales ordersAbsence of “facilitating practices” Absence of a history of cooperative pricingStrong exit barriers – firm would prefer to
operate at a loss than shut down in the short term
Internal Rivalry: Conditions that Increase Price Competition
Market demand for product is highly elastic
Entry
Entry hurts the incumbents in two different ways – Entry cuts into the incumbents’ market share– Entry intensifies internal rivalry and leads to a
decline in price cost margin
Factors that Affect the Threat of Entry
Minimum efficient scale is large relative to the size of the market—economies of scale or scopeBrand loyalty of consumers and value
placed by consumers on reputationEntrants’ access to critical resources such
as raw materials, technical know how, and distribution networkGovernment policies that favor the
incumbents
Factors that Affect the Threat of Entry
Steepness of the learning curveNetwork externalities that give the
incumbents the benefit of a large installed baseIncumbents’ reputation regarding post-
entry competitive behavior
Substitutes and Complements
Availability of substitutes erode the demand for the industry’s outputComplements boost industry demandWhen the price elasticity of demand is
large, pressure from substitutes will be significantChange in demand can in turn affect
internal rivalry and entry/exit
Supplier Power
Suppliers can erode the profitability of downstream firms – If the upstream industry is concentrated,
suppliers can increase prices, to extract profits from the downstream firm
– If the customers are locked into the relationship through relationship-specific assets, there are costs associated with switching suppliers. Supplier can raise prices without firm switching to a competing supplier.
Assessing Supplier Power
The factors that determine supplier power– Competitiveness of the input market– Relative concentration of upstream and
downstream firms– Purchase volume by downstream firms– Extent of relationship-specific investments—
threat of hold-up– Availability of substitute inputs– Threat of forward integration by suppliers– Suppliers’ ability to price discriminate
Assessing Buyer Power
Factors that determine buyer power are analogous to those that determine supplier powerEven when there is no buyer power,
willingness to shop for the best price can create internal rivalry among sellers and make the market price competitive
Some Strategies Regarding the Five Forces
Firms can position themselves to outperform their rivals by developing a cost advantage or a differentiation advantageFirms can seek an industry segment
where the five forces are less severe
Some Strategies Regarding the Five Forces
Firms can try to change the five forces– By reducing internal rivalry by increasing the
switching costs,– By adopting entry deterring strategies, or– By reducing supplier/buyer power through
vertical integration
“Five Forces” and “Value Net”
The five forces framework tends to view other firms – competitors, suppliers or buyers – as threats to profitabilityIn the Value Net model (Brandenberger
and Nalebuff) interactions between firms can be positive or negative
Examples of Cooperative Interactions Among Firms
Firms cooperate in setting industry standards that facilitate industry growth Firms cooperate in lobbying for favorable
regulation or legislationFirms cooperate with their suppliers to
improve product quality and thus boost demand
More Examples of Cooperative Interactions Among Firms
Firms cooperate with their suppliers to improve productive efficiencyFirms cooperate with buyers/suppliers to
improve inventory management
The Value Net Concept
The value net consists of – Suppliers– Customers– Competitors and– Complementors (producers of complementary goods
and services) Considers both threats and opportunities posed by the
five forces Complete five forces analysis should aslo consider
opportunities
Value Net Illustration: DVD
When DVD was introduced, sales were lack luster and DIVX was a major threatThen manufacturers cut prices on some
models and advertised heavilyOther members of the value net chipped in
– Movie studios released popular titles in DVD format and priced them moderately
– Retailers promoted the DVD hardware and software
Limitations to Five-Forces Analysis
Ignores other factors that can affect demand such as preferences and incomeDoes not consider advertisingIgnores the government
– Can be purchaser or supplier– Regulatory role
Purely qualitative
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Five Forces Example for Wineries: Internal Rivalry
Rivalry = head-to-head competitionOften in each region, there are a small
number of large producers with the majority of market share, and a larger number of smaller producersGlobally, the wine industry is very
competitive– Wineries compete for shelf space
Five Forces Example for Wineries: Internal Rivalry
Within regions, competition at local levels is important to industry’s successWineries compete for customers through
tasting room as well as on retailer’s shelf– Wineries compete with other tourist
attractions
Five Forces Example for Wineries: Internal Rivalry
However, competitors can also be complementary for wineries:– When several wineries exist in close proximity
to each other, it is beneficial for all the wineries:
• They can establish the region as one known for quality wines
• Several wineries located in the same area create a greater tourist draw than a single winery
http://www.wavwines.com/
Five Forces Analysis of Wineries: Entry
Threat of new entrants is unique in the wine business– A winery is capital intensive. Market entry can
take multiple years due to initial production time to grow the vines and produce the wine.
• Buy juice initially
Five Forces Analysis of Wineries: Entry
May be a steep learning curveA strong knowledge of winemaking is
required to produce high-quality wines– Hire this labor?
Some barriers to entry
Five Forces / Wineries: Substitutes/Complements
Substitutes for wine include more than just beerWine is served with meals—complement
with fine foodA winery is also a holiday destination and
entertainment, and it competes against other holiday destinations
Five Forces / Wineries: Supplier Power
Several options for wineries: own vineyard (grow grapes), purchase grapes, purchase juiceRaw materials are commodity items and
vary cyclically in price– Over supply of grapes results in low price– Adverse growing conditions result in low yield
and high prices
Five Forces / Wineries: Supplier Power
Bargaining power of supplier may be increased if:– Winery needs specific type of grape– Small winery is not able to purchase large
quantities to receive volume discountSmall winery can offset second concern by
cooperating with other small wineries to purchase grapes/juice collectively
Five Forces / Wineries: Supplier Power
Labor is also an important componentQuality wine maker is important for
producing quality wines– Wine makers can work for multiple wineries– High quality wine maker commands a
premium price—more bargaining power
Five Forces Analysis of Wineries: Buyer Power
Wineries usually have three types of buyers:– Direct consumers– Wholesalers– Retailers
Wholesalers have a significant amount of bargaining power because they are few in number and have considerable influence over which wines are sold by retailers
Legislation in the U.S. restricts the ability of wineries to sell directly to retailers in some states
Five Forces Analysis of Wineries: Summary
Force Threat to ProfitsEntry Medium
Internal rivalry Medium to HighSupplier Power MediumBuyer Power MediumSubstitutes/
ComplementsMedium
Five Forces Analysis of Wineries: SummaryWine production appears to be a fairly
competitive industry with most wineries earning very little economic profit.
Commercial Airframe Manufacturing: Market Definition
Analysis limited to commercial aviationBoeing and Airbus compete globallyOther fringe players in aircraft with fewer
than 100 seats
Commercial Airframe Manufacturing: Internal RivalryAirbus is younger, established by an
European consortium (Great Britain, France, and Germany)Little product differentiationSome airlines have developed loyalties,
most have not– Some advantages to flying only planes from
one producer
Commercial Airframe Manufacturing: Internal RivalryStable market shares and reduced
incentive for price warsConditions in the industry make it difficult
to collude on priceCompete on both price and qulatiy
Commercial Airframe Manufacturing: Barriers to EntryHuge development costs
– Learning-by-doingBuyer reluctance to buy from startupsLeasing economiesCustomer loyalty to current suppliers
Commercial Airframe Manufacturing: Substitutes and ComplementsSmall plane manufacturers cut into demand for
Boeing and Airbus planes Increase in point to point flights As demand for air travel increases, airlines
switching back to larger planesOther forms of transportation could be
substitutes (High speed rail, driving your car)Fall in communication costs may reduce
business travel
Commercial Airframe Manufacturing: Supplier PowerBoeing and Airbus do not have the upper
hand in dealing with jet engine manufacturersOther part suppliers also deal directly with
airlinesUnionized labor has significant power
Commercial Airframe Manufacturing: Buyer PowerTwo kinds of buyers
– Airlines– Leasing companies
Each order could be of the order of 15% of annual sales revenueBuyers may cancel orders during
economic downturns
Commercial Airframe Manufacturing: Summary
Force Threat to ProfitsEntry Low
Internal rivalry Low to MediumSupplier Power MediumBuyer Power MediumSubstitutes/
ComplementsMedium