Chapter 4 Frameworks for the Analysis of Industry Environments Copyright © 1999 by Harcourt Brace &...

Chapter 4Chapter 4Frameworks for the Frameworks for the Analysis of Industry Analysis of Industry

EnvironmentsEnvironments

Chapter 4Chapter 4Frameworks for the Frameworks for the Analysis of Industry Analysis of Industry

EnvironmentsEnvironmentsCopyright © 1999 by Harcourt Brace & Company

All rights reserved. Requests for permission to make copies of any part of the work should be mailed to the following address: Permissions Department, Harcourt Brace & Company, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

Bourgeois, Duhaime,

& Stimpert

Copyright © 1999 by Harcourt Brace & CompanyAll rights reserved

Chapter ObjectivesChapter ObjectivesChapter ObjectivesChapter Objectives

Develop an understanding of industries, the competitive environments in which firms offer products/services in an effort to compete for resources, customers, sales revenues, and profits. See Exhibit 4.1 on following slides.

Introduction to SWOT Analysis and the Five Forces Model. Two frameworks which are commonly used by

managers to analyze industries.


Chapter Objectives Chapter Objectives (cont.)(cont.)Chapter Objectives Chapter Objectives (cont.)(cont.)

Provide specific illustrations of using the Five Forces Model for industry analysis.

Assess the strengths and limitations of SWOT Analysis and the Five Forces Model as tools for analyzing industry environments.


Exhibit 4.1:Exhibit 4.1: Model of Model of Strategic ManagementStrategic ManagementExhibit 4.1:Exhibit 4.1: Model of Model of Strategic ManagementStrategic Management

Feedbackreinforces or

suggests changes

in managers'

mental models

Managers' Mental Models

+ How to compete + Appropriate size/diversity, how businesses are related, how diversification should be managed + How to organize

Decisions about

Business Definition

Decisions about

Organizational

Structure

Decisions about

Business Strategy

Decisions about

Corporate Strategy

and Diversification

Market Position,Resources, and

Capabilities

Performanceand

CompetitiveAdvantage

Industry environments+


IntroductionIntroductionIntroductionIntroduction

All companies face competition. For resources, customers, sales revenues, and

profits. All companies face uncertain industry environments.

Managers must position the organizations strategically in order to compete successfully.

• This is what we call business definition.• Requires that managers understand the dynamics of

their firms’ markets before formulating strategies.


Introduction Introduction (cont.)(cont.)Introduction Introduction (cont.)(cont.)

Rapidly growing markets (emerging industries) tend to be less competitive and often attract new entrants. Usually provide sufficient room in competitive space

for making some mistakes. Mature, concentrated markets provide firms with very

little breathing room. Mistakes by one firm can significantly impact entire

industry.• One firm’s price reductions can set off industry-wide

price war.


How Much Does How Much Does Industry Matter?Industry Matter?How Much Does How Much Does Industry Matter?Industry Matter?

Firm performance depends a great deal on the attractiveness of the industries in which the firms compete. See Exhibit 4.2 on next slide. Regression analysis on almost any industry shows

that the variation in the average performance of all firms in an industry will explain about 20% of the variation in the performance of any single firm in that industry.


Exhibit 4.2:Exhibit 4.2: Average Return Average Return on Assets of Different on Assets of Different IndustriesIndustries

Exhibit 4.2:Exhibit 4.2: Average Return Average Return on Assets of Different on Assets of Different IndustriesIndustries

Metals

Pharmaceuticals

Semiconductors

Temporary Help

Beverages

Airlines

13%

10%

5%

6%

8%

8%


How Much Does How Much Does Industry Matter? Industry Matter? (cont.)(cont.)

How Much Does How Much Does Industry Matter? Industry Matter? (cont.)(cont.)

One cannot generalize that the “industry is all that matters.”

• Returns vary in any industry from year to year (see Exhibit 4.3 on next slide).

• Some industries are more cyclical than others.

• Evidence indicates that the difference between the performance of the highest- and lowest-performing firms in any industry will be 6 times greater than the difference between the performance of the highest- and lowest-performing industry (see Exhibits 4.4 [A] and [B]).


Exhibit 4.3:Exhibit 4.3: Average Return Average Return on Assets in the Automobile on Assets in the Automobile Industry: 1993 - 1997Industry: 1993 - 1997

Exhibit 4.3:Exhibit 4.3: Average Return Average Return on Assets in the Automobile on Assets in the Automobile Industry: 1993 - 1997Industry: 1993 - 1997


Exhibit 4.4 [A]:Exhibit 4.4 [A]: High- and High- and Low-Performing Firms in Low-Performing Firms in the Steel Industrythe Steel Industry

Exhibit 4.4 [A]:Exhibit 4.4 [A]: High- and High- and Low-Performing Firms in Low-Performing Firms in the Steel Industrythe Steel Industry


Exhibit 4.4 [B]:Exhibit 4.4 [B]: High- and High- and Low-Performing Firms in Low-Performing Firms in the Pharmaceuticals the Pharmaceuticals IndustryIndustry

Exhibit 4.4 [B]:Exhibit 4.4 [B]: High- and High- and Low-Performing Firms in Low-Performing Firms in the Pharmaceuticals the Pharmaceuticals IndustryIndustry


SWOT AnalysisSWOT AnalysisSWOT AnalysisSWOT Analysis Acronym derived from Strengths, Weaknesses,

Opportunities, and Threats. Used for analyzing industry environments and firms’

internal strengths and weaknesses. Performed in a 2-step process:

Managers thoroughly evaluate their firm’s internal strengths and weaknesses and its environmental (external) opportunities and threats.

Managers use the evaluation developed in the first step to place the firm in one of the quadrants of the SWOT matrix shown in Exhibit 4.5.


Exhibit 4.5:Exhibit 4.5: SWOT SWOT AnalysisAnalysisExhibit 4.5:Exhibit 4.5: SWOT SWOT AnalysisAnalysis

OvercomeWeakness Grow

DiversifyRestructure

Numerous EnvironmentalOpportunities

Major EnvironmentalThreats

SubstantialInternal

Strengths

CriticalInternal

Weaknesses


SWOT Analysis SWOT Analysis (cont.)(cont.)SWOT Analysis SWOT Analysis (cont.)(cont.)

Advantages of SWOT Analysis: Easy to use. Can be helpful framework for getting managers to

think constructively about their firms’ external environments and internal strengths and weaknesses.

Drawbacks of SWOT Analysis: Subjective. Biased by managers’ perceptions of their firms’

strengths and weaknesses.


SWOT Analysis SWOT Analysis (cont.)(cont.)SWOT Analysis SWOT Analysis (cont.)(cont.)

• For example, managers of strong firms will likely view environmental phenomena as opportunities, while his counterpart in a weak company will likely view them as threats.

The use of SWOT Analysis is likely to yield few clear-cut recommendations.


The Five Forces The Five Forces ModelModelThe Five Forces The Five Forces ModelModel

Devised by Michael Porter of Harvard. Examines the 5 forces which influence the

structure of industries• Framework suggests that industry structure will

impact the competitive behavior of firms in that industry.

• Also suggests that firms’ conduct will influence the average performance of firms in that industry.

• As intensity of forces increases, the industry environment becomes more hostile and overall industry profitability will decline.


Exhibit 4.6:Exhibit 4.6: Five Forces Five Forces ModelModelExhibit 4.6:Exhibit 4.6: Five Forces Five Forces ModelModel

BargainingPower ofSuppliers

Threat ofSubstitutes

Threat ofNew

Entrants

BargainingPower ofBuyers

IndustryCompetitors

Intensity ofRivalry


Threat of New EntryThreat of New EntryThreat of New EntryThreat of New Entry

Incumbent firms erect barriers to prevent entry by potential rivals. Cost barriers

• Incumbent firms might enjoy economies of scale, benefits of learning effects, or privileged access to key raw materials or technologies.

– High level of minimum efficient scale (MES) might prevent new entrants from being profitable.

See Exhibits4.7, 4.8, & 4.9


Threat of New EntryThreat of New Entry (cost.)(cost.)Threat of New EntryThreat of New Entry (cost.)(cost.)

Marketing advantages enjoyed by incumbents.• Incumbents might have brand loyalty or access to

certain distribution channels.

• If customers of incumbent firms might incur “switching costs” by buying products from another firm, then they will be more hesitant to shift allegiance to new entrant.


Threat of New EntryThreat of New Entry (cost.)(cost.)Threat of New EntryThreat of New Entry (cost.)(cost.)

Government restrictions might minimize entry.• Industry regulation causes potential entrants to gain

government approval before they could begin offering products or service.

Fourth set of barriers referred to as “behavioral” entry barriers can be very effective in limiting entry.

• Incumbents might signal that they would lower prices considerably if another firm were to enter the industry.


Threat of SubstitutesThreat of SubstitutesThreat of SubstitutesThreat of Substitutes

If substitute products or services are readily available, then firms in the industry are likely to enjoy lower average profitability. Margarine is a substitute for butter. Substitutability depends on value-price ratios of

the two products.• When VCRs were first introduced, their prices were

much higher than they are today -- only a few consumers chose to buy (as opposed to going to a movie).


Power of SuppliersPower of SuppliersPower of SuppliersPower of Suppliers If suppliers to an industry have enough power, they may

be able to extract higher prices for critical components, thereby reducing average industry profitability. Two factors are generally the most critical in

determining supplier power:• If only a few suppliers of a particular component exist

relative to the number of buyers, then those suppliers will tend to have more bargaining power.

• If the component is a critical component, then the suppliers generally will have greater power.


Power of BuyersPower of BuyersPower of BuyersPower of Buyers

Powerful buyers of an industry’s products/services extract price concessions, thus reducing industry profitability. Critical factors:

• If only a few buyers exist relative to number of firms, then those buyers will have greater bargaining power.

• If the product/service is not particularly important to buyers or does not incorporate proprietary technologies, then buyers will have greater power.


RivalryRivalryRivalryRivalry

Rivalry will either drive down prices or increase the costs of doing business (as firms seek to add more features without raising prices for those features).

Several factors tend to increase rivalry: Generally, the more firms in an industry, the

greater will be the rivalry.• The trucking industry.

Mergers and acquisitions are often pursued in an effort to reduce rivalry.


Rivalry Rivalry (cont.)(cont.)Rivalry Rivalry (cont.)(cont.)

Growth rate of an industry will affect rivalry.• Slower growth or declines in overall industry sales

tend to increase rivalry.– Cigarette industry.

Excess capacity tends to increase rivalry and usually results in lower prices, lower profit margins, and a less attractive industry.

See Exhibits4.10 & 4.11


Five Forces Model - Five Forces Model - SummarySummaryFive Forces Model - Five Forces Model - SummarySummary

Nearly all of the forces are present in most industries, but it is the intensity of the forces that will determine their impact on any industry. As intensity of the forces increases, the industry

environment becomes more hostile and overall industry profitability will decline.


Application of the Five Application of the Five Forces ModelForces ModelApplication of the Five Application of the Five Forces ModelForces Model

Use Exhibit 4.12 as a Guide to Using the Five Forces Model for Industry Analysis.

Two industries will be examined: Steel Pharmaceutical


Steel:Steel: A Five Force A Five Force ConspiracyConspiracySteel:Steel: A Five Force A Five Force ConspiracyConspiracy

Consistent low industry performance average. All but one of the five forces are intense.

• Remember that as the intensity of any of the forces becomes higher, the industry becomes less attractive and industry performance tends to decline.

Threat of Entry Threat is very real.

• Initial investment required is very large, but several Minimills have entered industry in last 25 years.


Steel:Steel: A Five Force A Five Force Conspiracy Conspiracy (cont.)(cont.)


Threat of Substitutes Significant factor in this industry.

• Aluminum• Plastics• Composite materials

Power of Steel Buyers Also significant.

• Small number of companies account for very large proportion of steel purchases.

– Normal threat is to take their business elsewhere.




Rivalry Very intense.

• Key reason is the significant overcapacity which still exists today despite the closing of many mills over the last 20 years.

– Mills try to keep running at full capacity in order to spread their fixed costs over a large volume.

– Price of steel today is about the same as 20 years ago.

SeeExhibit

4.13


Pharmaceuticals:Pharmaceuticals: Best of Best of all Possible Industry all Possible Industry Worlds?Worlds? (cont.)(cont.)


Marked contrast to steel industry. Suppliers exercise little power because most of raw

materials are commodities that can be obtained from a large number of suppliers.

Significant barriers to entry reduce the threat of new entrants. R&D costs and personnel. Operating finances for many years while new drugs are

developed and approved by FDA. Must build large professional sales force.




Few true substitutes exist. Very small market (in relative terms) of natural

medicines. Healthy living styles have not been adopted by

majority of U.S. population. Buyers exercise very little control.

Sick patients typically do not argue with drug company over price of product.

• Normally, insurance company pays the bill.




Rivalry. Industry enjoys an almost “friendly” competition.

• Patent protection for 17 years. Summary

Low intensity of all five forces helps to explain the high performance of firms in this industry.

• New HMO realities may change that situation.

• Many patents due to expire soon.SeeExhibit

4.14


Limitations of the Five Limitations of the Five Forces ModelForces ModelLimitations of the Five Limitations of the Five Forces ModelForces Model

Inability to suggest strategies for managers. Porter states that managers have two options if

they find their firms in unattractive industries:• Diversify their firms away from or exit completely

the industry.– Firms often lack sufficient resources to do this.

– Diversification can be risky for firms with little diversification experience.


Limitations of the Five Limitations of the Five Forces Model Forces Model (cont.)(cont.)


• Attempt to minimize the impact of any of the forces that are acting to make the industry unattractive.

– Make their industries more attractive by reducing the power of the five forces; or

– Shield or protect their companies from the power of the forces.

• Certain action may lead to allegations of collusion or other unfair practices (Microsoft vs. Justice Department).




Another key limitation is suggested by changes occurring in pharmaceutical industry: Model provides “snapshot” of industry at that

time, but fails to show how industry is changing.• Most managers assume that conditions will remain

relatively stable.


Key Points Key Points Introduced in Introduced in Chapter 4Chapter 4

Key Points Key Points Introduced in Introduced in Chapter 4Chapter 4

Industry environments vary considerably. Some industries are relatively young, emerging

industries, while others are more mature. Some industries are characterized by fierce

competition, while others are characterized by very little rivalry.

Some industries are, on average, more profitable than others in any one year.


Key Points Introduced Key Points Introduced in Chapter 4 in Chapter 4 (cont.)(cont.)


SWOT analysis can be used to analyze industry environments and organizational capabilities. It specifically examines organizational Strengths

and Weaknesses and environmental Opportunities and Threats.

• The major limitation of SWOT analysis is that it lacks objective dimensions -- any conclusions tend to reflect managers’ subjective evaluations of their industry environments.




The Five Forces Model analyzes five aspects of industry structure in order to assess the relative attractiveness of different industries. Use of the Five Forces Model I straightforward:

• As the intensity of forces increases, the industry environment becomes more hostile and overall industry profitability will decline.




Both SWOT analysis and the Five Forces Model are static frameworks. Users must recognize that most industry

environments can be quite dynamic. Any conclusions based on these models may not be

appropriate in the future (due to changes in a firm’s industry environment).

Chapter 4 Frameworks for the Analysis of Industry Environments Copyright © 1999 by Harcourt Brace &...

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