Transcript Chapter 2

Economics of Strategy
Fifth Edition
Besanko, Dranove, Shanley, and Schaefer
Chapter 12
Industry Analysis
Slides by: Richard Ponarul, California State University, Chico
Copyright  2010 John Wiley  Sons, Inc.
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 and
 identification of opportunities and threats
(SWOT analysis)
Industry Analysis
 Industry analysis helps with assessing generic
business strategies
 Porter’s five forces framework is rooted in
microeconomics
 Value net (Brandenburger and Nalebuff)
supplements the five forces framework to analyze
strategy
The Five-Forces Framework
 Michael Porter’s Five-Forces framework
identifies the economic forces that affect
industry profits
 The five forces are
 Internal
rivalry
 Entry
 Substitutes
and complements
 Supplier power
 Buyer power
The Five-Forces Framework
Internal Rivalry
 Internal rivalry is the competition for
market share among the firms in the
industry
 Competition could be on price or some nonprice dimension
 Price Competition erodes the price cost
margin and profitability
Internal Rivalry
 Competition on non-price dimension can
drive up costs.
 Non-price competition does not erode
profits as severely as price competition if
customers are willing to pay a higher price
for the improvements.
Internal Rivalry
Price competition heats up when
 There
are many sellers
 Some firms have cost advantage over others
 There is excess capacity in the industry
 Products are undifferentiated and switching
costs are low
 Prices and sale terms are easily observable
Internal Rivalry
Other conditions that facilitate intense price
competition
 Large
and infrequent sales orders
 Absence of “facilitating practices”
 Absence of a history of cooperative pricing
 Strong exit barriers
 Industry demand is elastic
Entry
 Entry hurts the incumbents by
 by cutting into the incumbents’ market share and
 by intensifying internal rivalry and leads to a
decline in price cost margin
 Barriers to entry can be
 exogenous (nature of the industry) or
 endogenous (incumbents’ strategic choices)
Factors that Affect the Threat of Entry
 Minimum efficient scale relative to the size of the
market
 Government policies that favor the incumbents
 Brand loyalty of consumers and value placed by
consumers on reputation
 Entrants’ access to critical resources such as raw
material, technical know how and distribution
network
Factors that Affect the Threat of Entry
 Steepness of the learning curve
 Network externalities that give the
incumbents the benefit of a large installed
base
 Incumbents’ reputation regarding post-entry
competitive behavior
Substitutes and Complements
 Availability of substitutes erode the demand
for the industry’s output
 Complements boost industry demand
 When the price elasticity of demand is large,
pressure from substitutes will be significant
 Changes in demand can in turn affect
internal rivalry and entry/exit
Supplier Power
 Supplier has indirect power if upstream
market is competitive. It sells to the highest
bidder.
 Supplier has direct power if
 the
upstream industry is concentrated or
 the customers are locked into the relationship
with suppliers due to relationship specific assets
Buyer Power
 Buyer power is analogous to supplier power
 Buyers have indirect power in competitive
markets
 Buyer concentration or relationship specific
assets can lead to direct power
 Buyer power relative to upstream is
analogous to supplier power relative to
downstream
Supplier Power
The factors that determine supplier power are
 Competitiveness
of the input market
 Relative concentration the industry
 Relative concentration of upstream and
downstream firms
 Purchase volume by downstream firms
 Availability of substitute inputs
 Extent of relationship specific investments
 Threat of forward integration by suppliers
 Suppliers’ ability to price discriminate
Some Strategies to Cope with the Five Forces
 To outperform its rivals firms can
 develop
a cost advantage or
 a differentiation advantage
 Firms can seek an industry segment where
the five forces are less severe
 Firms can try to change the forces
Some Strategies to Cope with the Five Forces
 Facilitating strategies to reduce internal
rivalries
 Moves that increase switching costs for the
customers
 Pursuing entry deterring strategies
 Tapered integration to reduce
buyer/supplier power
Five Forces and Value Net
 The Five-Forces Framework tends to view
other firms - competitors, suppliers or
buyers - as threats to profitability
 In the value net model (Coopetition)
interactions between firms can be positive or
negative
Cooperative Interactions Among Firms
 Setting industry standards that facilitate industry
growth
 Lobbying for regulation or legislation that favors
the industry
 Cooperation with buyers/suppliers
to improve product quality
 to improve productive efficiency
 to improve inventory management

The Value Net Concept
 The value net consists of
 Suppliers
 Customers
 Competitors and
 Complementors (producers of complementary goods and
services)
 The value net complements the five forces
approach by considering opportunities posed by
each force.
The DVD Hardware Market:
A Five-Forces Analysis
 Internal rivalry was intense. Brand name was the
main source of differentiation
 It was easy for consumer electronics firms to enter.
 Satellite TV could be a substitute. Streaming over
the internet was another possibility.
The DVD Hardware Market:
A Five-Forces Analysis
 Movie studios (upstream) and big retailers
(downstream) had power.
 DVD hardware makers, according to this
analysis, had reason to be pessimistic.
 DVD format’s success can be attributed to
firms working together (value net).
The DVD Hardware Market: The Value Net
 In the beginning DIVX was a major threat.
 DVD manufacturers cut prices on some
models and advertised heavily.
 Other members of the value net chipped in
to increase the size of the DVD “pie.”
Movie studios released popular titles in DVD format and
priced them moderately
 Retailers promoted the DVD hardware and software

Commercial Airframe Manufacturing
 Boeing and Airbus compete globally.
 Fringe players in aircraft with capacity less
than 125 seats are excluded from the
analysis.
 The market share (by revenue) of the fringe
players is small.
 There are no meaningful submarkets.
Commercial Airframe Manufacturing:
Internal Rivalry
 Boeing delivered its first commercial aircraft in
1958.
 Airbus is younger.
 Boeing enjoys economies of scope due to its
defense business.
 Airbus gets government subsidies.
 Stable market shares and reduced incentive for
price wars
 Historically there has been little product
differentiation
Commercial Airframe Manufacturing:
Internal Rivalry
 Airbus developed the double-decker mega
plane.
 Boeing abandoned competing with its Sonic
Cruiser.
 Airliners exhibit loyalty to suppliers
 Economic slowdown has reduced the
demand for aircraft.
Commercial Airframe Manufacturing: Entry
Major barriers to entry are:
 Huge
development costs
 Experience-based advantages
 Buyer reluctance to buy from startups
 Customer loyalty to current suppliers
Commercial Airframe Manufacturing: Substitutes
 Small plane manufacturers cut into demand
for Boeing and Airbus planes in regional
routes.
 As demand for air travel increases airlines
switching back to larger planes in regional
routes.
 Other forms of transportation could be
substitutes (High speed rail) for “regional
jets.”
Commercial Airframe Manufacturing:
Supplier Power
 Parts market is competitive
 Part suppliers deal directly with airlines.
But Boeing’s Global Airlines Inventory
Network (GAIN) gains leverage over
suppliers.
 Jet engine suppliers are not numerous and
enjoy direct power.
 Unionized labor has significant supplier
power.
Commercial Airframe Manufacturing:
Buyer Power
 Buyers for aircraft are either airlines or
leasing companies. Neither have buyer
power.
 Each order could be of the order of 15% of
annual sales revenue for the manufacturer.
 Buyers may cancel orders during economic
downturns.
Five-Forces Analysis of the Commercial Aviation
Industry
Professional Sports: Market Definition
 Major sports leagues in the U. S.
 MLB
 NBA
 NFL
 NHL
 Five force analysis is also applicable to
major sports leagues elsewhere
Professional Sports: Internal Rivalry
 Sports leagues require competitive balance
to keep the contests interesting
 Athletic competition does not imply
business competition
 Internal rivalry is low within leagues as
teams follow rules and share revenue
 Teams do not compete in the labor market
Professional Sports: Entry
 Each league has rules for admitting new
teams.
 Current owners need to be compensated
when new teams are added.
 Incumbent owners can veto new franchises
in their geographic market.
 Starting an entire new league is risky.
Professional Sports:
Substitutes and Complements
 Teams compete in the local markets with
other forms of entertainment
 Elasticity of substitution is quite low
 Important complements
 Television
 Sports
betting
Professional Sports: Supplier Power
 Unionized players
 For new players NCAA has been a benign
supplier
 Cities spend tax dollars to build facilities to
attract sports teams.
 As municipal finances get tighter,
subsidizing teams becomes more difficult.
Professional Sports: Buyer Power
 Television networks and sports cable
systems compete with each other for
broadcasting rights
 In negotiations regarding broadcast rights
leagues have the upper hand against
television networks
 local television and
 radio.

Five-Forces Analysis of Professional
Sports Leagues