Transcript of 1 Strategic Management/ Business Policy Power Point Set #3: Industry Analysis.
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- 1 Strategic Management/ Business Policy Power Point Set #3:
Industry Analysis
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- 2 Efficient Markets The efficient market hypothesis, which
Professor Eugene Fama of the University of Chicago has supported
(e.g., in financial markets), is one in which prices reflect
information instantaneously and one in which extra- ordinary profit
opportunities are thus rapidly dissipated by the action of
profit-seeking individuals in the market. How well does the
efficient market hypothesis for capital markets apply to product
markets? If the efficient market hypothesis applied fully to
product markets then we should see over time equalization in risk-
adjusted rates of return across industries. What do the data
support?
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- 4 Some Industries Are More Profitable Than Others ROE & ROA
- Selected Industries, 1989 0% 5% 10% 15% 20% 25% 30%
PharmaceuticalsTires / RubberHome Appliances ROE ROA
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- 5 Within Industries, Some Competitors Perform Better than
Others. ROE - Pharmaceutical Industry 1989 0% 10% 20% 30% 40% 50%
60% AmgenAMPEli LillyMerckMylanPfizer
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- 9 Three Factors Determining Company Performance Industry
Context e.g., during the last two decades, companies in the
airlines industry have been less profitable than those in the
pharmaceutical industry National Context e.g., worlds most
successful consumer electronics firms are in Japan Company
Capabilities and Strategies E.g., Wal-mart and Southwest
Airlines
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- 10 Industry Analysis Supports The Identification of Threats and
Opportunities Strengths, Weaknesses, Opportunities, and Threats -
SWOT Analysis Strengths & Weaknesses Opportunities &
Threats Values Of Management Values Of Stakeholders Strategy
Internal Factors External Factors Objectives Drivers Industry
Analysis
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- 13 Structure-Conduct-Performance Market Structure: Number of
buyers and sellers (e.g., CR4) Barriers to entry Substitutes Cost
Structures Regulation
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- 14 Structure-Conduct-Performance Industry concentration is
measured by the four-firm sales concentration ration (CR4).
Problem: CR4 =.6 (.15,.15,.15,.15) or CR4 =.6 (.57..01,.01,.01)
Which is more likely to exhibit monopoly power? Alternative
Measure: HHI index 7 firms (15, 15, 15, 15, 15, 15, 10) = 1450 44
firms (57, 1, 1, 1 ) = 3292 (3249 + 43) Correlation between CR4 and
HHI in 1982 was 0.954
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- 15 Structure-Conduct-Performance Defining the relevant market:
Even more important than choosing the proper index of concentration
is ensuring that the market for which concentration is being
measured is properly defined. In the United States, the basic
system is called the Standard Industrial Classification (SIC). Onto
it, the Census Bureau has grafted an even more intricately
subdivided system organized around a series of seven digit numbers,
each successive digit reflecting a finer degree of
classification.
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- 16 Structure-Conduct-Performance In 1982, the manufacturing
sector was divided into 450 such four-digit industries. SIC CodeCR4
# of firmsHHI 3632 household refrigerators.94 39 2745 3511
turbines.84 71 2602 2082 beer.77 67 2089 3011 tires.66 108 1591
2834 pharmaceuticals.26 584 1306 3237 ready-mix concrete.06 4161
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- 18 Barriers To Entry The free entry and free exit assumption
that works reasonably well for describing financial markets seems
to be a premise that strays so far from our world of experience
that the assumption impedes our understanding of real-world product
competition. Thus, empirical evidence suggests that(risk-adjusted)
ROE does NOT equalize in the long run.
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- 19 A Taxonomy of Barriers to Entry (1) Economies of Scale
Product-specific economies of scale Lower setup costs as a
percentage of total costs More specialized machinery and tooling
(e.g., Honda) Plant-specific economies of scale Engineers 2/3 rule:
Since the area of a sphere or cylinder varies as two-thirds power
of volume, the cost of constructing process industry plants can be
expected to rise as two thirds power of their output capacity.
(This rule applies to petroleum refining, cement making, iron ore
reduction and steel conversion). Also economies of massed
reserves
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- 22 A Taxonomy of Barriers to Entry Economies of Scale
Multi-product economies of scale (economies of scope) Example: Cost
(Iron, Steel) < Cost (Iron) + Cost (Steel) Key idea: Shareable
input (In this case, thermal economies in the production of iron
and steel) Modern examples: Aircraft, Automobiles, Consumer
electronics, Household Appliances; Personal Computers, Software,
Power Tools Multi-plant economies of scale Economies of multi-plant
production, investment, and physical distribution.
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- 23 Examples of Economies of Scope Aircraft: Common wing, nose,
and tail components allow several models to be leveraged using
different numbers of fuselage modules to create aircraft of
different lengths and passenger freight capacities by Boeing and
Airbus Industries. Automobiles: The Taurus platform is leveraged to
provide the basis for Taurus and Mercury Sable sedans and wagons
and the Ford Windstar.
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- 24 Examples of Economies of Scope Consumer Electronics: Over
160 variations of the Sony Walkman were leveraged by mixing and
matching modular components in a few basic system designs. (Legos)
Personal Computers: Personal computers typically consist largely of
modular components like hard drives, flat screen displays, and
memory chips, coupled with some distinctive components like a
micro- processor chip and enclosure.
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- 25 Examples of Economies of Scope Software Software designers
are creating modules of routines which can be combined to create
customized applications programs. (The term modularity gained wide
currency by software designers in the 1960s.)
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- 26 A Taxonomy of Barriers To Entry (2) Experience Curve
Advantages Marvin Lieberman, a management professor at UCLA, found
that in the chemical industry, on average, each doubling of plant
scale over time was accomplished by an 11% reduction in unit costs.
Thus, there is an 89% learning curve. (Note: The mere presence of
an experience curve does not insure an entry barrier. Another
critical prerequisite is that the experience be kept proprietary,
and not be made available to competitors and potential
entrants.)
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- 27 Hours per unit, T N Cumulative units, N 90 % curve 80% curve
T N = (100)(N log.90/log2 )
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- 28 Aircraft Assembly (1925-57): 80% Calculator (1975-78): 74%
Heart Transplants (1985-88): 79% 1995 Corel Corp.
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- 30 A Taxonomy of Barriers To Entry Limits of Learning Curve
Advantages: Copying and reverse engineering of products; Hiring a
competitors employees; Purchasing the know-how from consultants;
Obtaining the know-how from customers; and Experience advantages
are often nullified by innovations.
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- 31 A Taxonomy of Barriers To Entry (3) Intended Excess Capacity
Building extra capacity for the intended purpose of deterring
entrants from entering the industry. (Note: potential free-rider
problems) Excess capacity deters entry by increasing the
credibility of price cutting as an entry response by incumbents.
Innocent excess capacity: Demand is cyclical; Demand falls short of
expectations; Demand is expected to grow.
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- 32 A Taxonomy of Barriers To Entry (4) Reputation A history of
incumbent firms reacting aggressively to entrants may play a role
in current market interactions. (5) Product Differentiation Brand
identification and customer loyalty to incumbent products may be a
barrier to potential entrants (e.g. Coca-Cola). Product
differentiation appears to be an important entry barrier in the
market for over-the counter drugs and in the brewing industry
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- 33 A Taxonomy of Barriers To Entry ( 6) Capital Requirements
(7) High Switching Costs of Buyers E.g., changing may require
employee retraining (e.g., IV solutions, and computer
software).
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- 34 A Taxonomy of Barriers To Entry (8) Access to Distribution
Channels The manufacturer of a new food product, for example, must
persuade the retailer to give it space on the fiercely competitive
supermarket shelf via promises of promotion, and intense selling
efforts to retailers. (9) Favorable Access to Raw Materials and to
Markets Alcoa --> bauxite Exclusive dealing arrangements
Favorable geographic locations
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- 35 A Taxonomy of Barriers To Entry (10) Proprietary Technology
Product know how Low cost product design Patents (and other
government restrictions) (11) Exit barriers (of incumbents) can be
entry barriers (to potential entrants)
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- 36 A Taxonomy of Barriers To Entry High exit costs: High
exogenous and endogenous sunk costs (not just high fixed costs!)
High asset specificity Highly illiquid assets Low salvage value if
exit occurs High switching costs Low mobility of assets Credible
commitments Irreversible investment e.g., Alaskan pipeline built in
1977 at a cost of $10 billion
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- 37 Bargaining Power of Buyers Buyers compete within the
industry by forcing down prices, bargaining for higher quality or
more services, and playing competitors against each other. A buyer
group is powerful when: The buyer group is concentrated (potential
collusion); The buyer group purchases large volumes relative to
seller sales (e.g., HMO power buying drugs); The product is
standard and undifferentiated; Few switching costs on the part of
the buyer; High switching costs on the part of the seller; and
Buyers pose a credible threat of backward integration
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- 38 Threat From Substitutes Substitute products increase the
industrys overall elasticity of demand and limit the potential
returns of the industry by placing a ceiling on the prices that
firms in the industry can profitably charge. Companies in the
coffee industry compete indirectly in the tea and soft-drink
industries (all three industries serve consumer needs for
drinks).
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- 39 Bargaining Power of Suppliers Suppliers can be broadly
defined as the supplier of any input: Labor, Management,
Technology, Physical Materials The bargaining power of suppliers is
high when: It is dominated by a few companies and is more
concentrated than the industry it sells to; It does not contend
with substitute products; The suppliers product is an important
input to the buyers business; and Suppliers products are
differentiated (high switching costs for the buyer).
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- 40 Degree Of Rivalry Increases When: Industry Concentration is
lower; Industry Growth is slower; Product Differentiation is lower;
Over-capacity is higher; and Exit Barriers are higher Price
competition is highly unstable. Price cuts are quickly and easily
matched by rivals, and once matched, they lower revenues for all
firms (unless price elasticity of demand is high enough).
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- 41 Degree Of Rivalry Advertising battles, on the other hand,
may well expand or enhance the level of product differentiation in
the industry for the benefit for all firms. In other words,
advertising is not necessarily a zero-sum game.
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- 42 The Uses of Industry Analysis Static Analysis - How Do We
Explain Current Rivalry and Profitability? Dynamic Analysis - Where
Is The Industry Headed In The Future?
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- 43 Industries Evolve Over Time As The Relationships Between The
Five Forces Change Dynamic 5-Forces Analysis time demand
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- 45 A Sixth Force - The Presence of Complementors Complementors
Industry participants whose businesses enhance the value of yours
The opposite of Substitutes The emergence of Networks of
organizations Examples Computer manufacturers and software makers
Consumer electronics and entertainment companies The Central Issue
How to get complementors to make strategic investments, which
mutually benefit both companies?
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- 46 A Sixth Force -The Presence of Complementors The biggest
benefit of considering complementors is that they add a cooperative
dimension to Porters (1980) competitive forces model. Thinking
[about] complements is a different way of thinking about business.
Its about finding ways to make the pie bigger rather than fighting
with competitors over a fixed pie. To benefit from this insight,
think about how to expand the pie by developing new complements or
making existing complements more affordable. Brandenburger &
Nalebuff Co-opetition
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- 47 Empirical Testing of Structure-Conduct (Strategy)-
Performance ROE(j) = 14.7 +.050 CR4(j) +.119 [CAP/S](j) + (2.08)
(1.98) 1.30 [A/S](j) +1.40 [R&D/S](j) +0.26 [GROW](j) (7.20)
(2.95) (2.90) t-statistics in parenthesesR-squared =.43 CR4 =
4-firm concentrationROE = return on equity R&D/S =
R&D/SalesA/S = advertising/sales CAP/S = capital
expenditures/SalesGROW = demand growth
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- 48 Empirical Testing of Structure-Conduct (Strategy)-
Performance Model Specification In practice, researchers estimate a
statistical model of the following form where data are aggregated
to the industry level: Industry Profit Rates = f (Concentration,
Barriers to Entry, Demand )
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- 49 Empirical Testing of Structure-Conduct (Strategy)-
Performance Model Specification Multiple regression analysis seeks
to evaluate the degrees to which deviations of the dependent
variable (and in this course our focus has been on profit rates as
the dependent variable) from its mean are explained by or
associated with variations in each of a set of independent or
explanatory variables (e.g., concentration, barriers to entry,
demand, etc.)
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- 50 Empirical Testing of Structure-Conduct (Strategy)-
Performance Model Specification The nature of this association is
captured by regression coefficients relating the profit rates in
the industry of each independent variable, allowing us to determine
the effect, for example, of a 10% increase in seller concentration
on profit rates, holding all other explanatory variables constant
(i.e., ceteris paribus)
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- 51 Empirical Testing of Structure-Conduct (Strategy)-
Performance Model Specification Predicted SignReason CR4+Higher
concentration enables higher prices CAP/S+Capital-cost barrier to
entry A/S+Advertising intensity as a product differentiation
barrier to entry R&D/S+Technological know-how GROW+Demand
growth leads to less likely price wars
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- 52 Empirical Testing of Structure-Conduct (Strategy)-
Performance Model Specification Note that the multiple regression
results are consistent with (but do not prove!) the
structure-conduct-performance model. As you probably are aware from
your statistics classes, there are many potential problems that can
interfere with the reliable estimation of regression models,
leading to incorrect inference about the statistical significance
and economic importance of explanatory variables.
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- 53 Empirical Testing of Structure-Conduct (Strategy)-
Performance Three Potential Problems: (1)Mis-specification
problems; (2)Measurement problems; and (3)Identification
problems
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- 54 Empirical Testing of Structure-Conduct (Strategy)-
Performance (1) Mis-specification Problems: Important Variables
Omitted. In our regression, the impact of substitute products, and
the power of buyers and suppliers have not been included in the
model specification. Irrelevant Variables Included. If you believe
fervently in perfect capital markets then you may question the idea
of capital cost entry barriers and therefore you would question the
inclusion of the independent variable [CAP/S] in the model.
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- 55 Empirical Testing of Structure-Conduct (Strategy)-
Performance (1) Mis-specification Problems: Model assumes a linear
relationship. Since the regression assumes a linear relationship,
this may turn out to be a poor approximation if some of the
explanatory variables (e.g., ADV/S) influence the dependent
variable (i.e., ROE) in a non-linear way. Independent variable may
not be truly independent. For example, not only can increased
concentration affect profit rates but profit rates may affect
industry concentration. Multicollinearity. If independent variables
such as (ADV/S) and {R&D/S) are highly correlated, then the
validity of the t-statistics come into question.
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- 56 Empirical Testing of Structure-Conduct (Strategy)-
Performance (2) Measurement Problems: For example, CR4 may not be
the best measure of industry concentration, where the HHI is a
better measure. Perhaps some performance measure other than ROE
would also be better for testing the theory. Note: If the evidence
is not consistent with the theory it is not necessarily the case
that we abandon the theory. One of the many possibilities is that
we do not have good measures of the theoretical concepts.
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- 57 Empirical Testing of Structure-Conduct (Strategy)-
Performance (3) Identification Problems: - These problems are
related to the idea that correlation does not imply causality. For
example, you might maintain that high advertising/sales is a
barrier to entry (product differentiation) strategy that causes
high profit rates. The regression is consistent with Porters (1980)
theory.
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- 58 Empirical Testing of Structure-Conduct (Strategy)-
Performance (3) Identification Problems However, you might argue
instead that high profit rates allow more discretionary spending in
marketing and thus, high profit rates cause high advertising/sales.
The empirical evidence is also consistent with this theory. Thus,
we have an identification problem. The data are consistent with
multiple theories and we must find more refined tests and better
econometric methods in order to advance our scientific knowledge in
strategic management.