Applying the Five Forcesby Wesley Shu, text by D. Besanko et al.
Hospital Market in Chicago Area Thriving in 80s, then declined, recently
on the rise
Internal Rivalry – Background
about 70 hospitals, mostly independent, i.e., low Herfindahl index (HHI)
Fierce internal rivalry, because Many competitors Production costs vary Substantial excess capacity –
occupancy rate < 70% at many hospitals
Stagnant or declining demand
Internal Rivalry – MCO Took Advantage Managed care organizations (MCO,
insurance companies) took advantage: Contract with hospitals offering the
most favorable rates Lower the co-pay to encourage
patients to choose those hospitals Due to high price elasticity, demand
increase – hospitals are more homogenous
Internal Rivalry – MCO Took Advantage Negotiations between MCO and
hospitals were secret, hospitals in disadvantageous position
Contracts are infrequent – hospitals assumed pressure
Internal Rivalry – Hospital Fought Back Established brand identity, e.g.,
Northwestern Medical Center Diversified into related products, e.g.,
skilled nursing services Differentiated their services, e.g.,
establishing cancer center, etc. Patients required hospital in
neighborhood – increase loyalty Merger
Entry - Barriers
Government regulation on new hospital construction
Hospitals are capital intensive Brand identity not easy for new
hospitals
Entry – The Other Side
Chicago area grew Innovations allowed smaller niche
hospitals
Substitutes and Complements Few inpatient services could be
performed outside the hospitals But improvement in surgical
techniques made it possible Outpatient diagnostic facilities (ODF) –
substitutes But ODF can also be complement –
hospitals already had technology and experience to do it – economies of scope
Suppliers
Demand for nurses high, supply low Price rising for drugs and other
medical supplies
Buyers
Insurers wield substantial power Insurers are large size – high
negotiation power, e.g., Blue Cross and Medicare
Highly skilled physicians became strong buyers who brought patients
Overview
Force Threat to Profit, 1980s
Threat to Profit, today
Internal rivalry
Low High but falling
Entry Low Medium but growing
Substitutes and complements
Medium High
Supplier power
Medium Medium
Buyer power Low Medium
Pentagonal Analysis
Internal Rivalry
Buyer
SupplierSub & Comp
Entry
Internal Rivalry
Buyer
Supplier Sub & Comp
Entry
Use of Pentagonal Analysis
Compared the intensity of competition of two industries (or the same one, different time)
Entry strategy and decision for entrant, ex. Better enter in 80s in Chicago hospitals
than now Now, form an alliance with suppliers or
buyers to bargain or compete with sub/comp and other hospitals
In 80s, differentiate to avoid sub/comp
Template – Internal Rivalry
Current
Future
Degree of seller concentration?
Rate of industry growth?
Significant cost differences among firms?
Excess capacity?
Cost structure of firms: sensitivity of costs to capacity utilization?
Degree of product differentiation among sellers? Brand loyalty to existing sellers? Cross-price elasticities of demand among competitors in industry?
Buyers’ switching costs?
Template – Internal Rivalry
Current
Future
Are prices and terms of sales transactions observable?
Can firms adjust prices quickly?
Large and/or infrequent sales orders?
Use of ”facilitating practices”?
History of “cooperative” pricing?
Strength of exit barriers?
Template – Threat of Entry
Current
Future
Significant economies of scale
Importance of reputation or established brand loyalties in purchase decision
Entrants’ access to distribution channels
Entrants’ access to raw materials
Entrants’ access to technology/know-how
Entrants’ access to favorable locations
Experience-based advantages of incumbents
Template – Threat of Entry
Current
Future
Network externalities
Government protection of incumbents
Perception of entrants about expected retaliation of incumbents/reputations of incumbents for ‘toughness’
Template – Substitutes & Complements
Current
Future
Availability of close substitutes
Price-value characteristics of substitutes
Price elasticity of industry demand
Availability of close complements
Price-value characteristics of complements
Template – SuppliersCurrent
Future
Is supplier industry more concentrated than industry it sells to?
Do firms in industry purchase small volumes relative to other customers of suppliers? Is typical firm’s purchase volume small relative to sales of typical suppliers?
Few substitutes for suppliers’ input
Do firms in industry make relationship-specific investments to support transactions with specific suppliers?
Do suppliers pose credible threat of forward integration into the product market?
Are suppliers able to price-discriminate among prospective customers according to ability/willingness to pay for input?
Template – BuyersCurrent
Future
Is buyers’ industry more concentrated than industry it purchases from?
Do buyers purchase in large volumes? Does a buyer’s purchase volume represent large fraction of typical seller’s sales revenue?
Can buyers find substitutes for industry’s product?
Do firms in industry make relationship-specific investments to support transactions with specific buyers?
Is price elasticity of demand of buyer’s product high?
Template – BuyersCurrent
Future
Do buyers pose credible threat of backward integration?
Does product represent significant fraction of cost in buyer’s business?
Are prices in the market negotiated between buyers’ and sellers on each individual transaction or do sellers post a ‘take it or leave it’ price that applies to all transaction?