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CONTEMPORARY STRATEGY

ANALYSIS (7th edition, John Wiley & Sons Ltd., 2010)

Robert M. Grant

Chapter 3Industry Analysis:The Fundamentals

Chapter 3Industry Analysis:The Fundamentals

1© 2010 Robert M. Grantwww.contemporarystrategyanalysis.com

• The objectives of industry analysis

• From environmental analysis to industry analysis

• Porter’s Five Forces Framework

• Applying industry analysis

• Industry & market boundaries

• Identifying Key Success Factors

OUTLINE

Industry Analysis: the FundamentalsIndustry Analysis: the Fundamentals


• To understand how industry structure drives competition, which determines the level of industry profitability.

• To assess industry attractiveness

• To use evidence on changes in industry structure to forecast future profitability

• To formulate strategies to change industry structure to improve industry profitability

• To identify Key Success Factors

The Objectives of Industry AnalysisThe Objectives of Industry Analysis


THE INDUSTRYENVIRONMENT

• Suppliers• Competitors• Customers

Social structure

The national/ The national/ international international

economyeconomy

TechnologyTechnology

GovernmentGovernment& Politics& Politics

The natural The natural environmentenvironment

Demographic Demographic structurestructure

Social structureSocial structure

•The Industry Environment lies at the core of the Macro Environment.

•The Macro Environment impacts the firm through its effect on the Industry Environment.

From Environmental Analysis to Industry Analysis

From Environmental Analysis to Industry Analysis


Median return on equity (%), 1999-2007

Profitability of US Industries(selected industries only)

Profitability of US Industries(selected industries only)

HIGH PROFITABILITY LOW PROFITABILITY

Household & Personal Products 26.0 Motor Vehicles & Parts 9.3

Pharmaceuticals 21.0 Insurance Life & Health 9.1

Petroleum 20.1 Forest & Paper Products 7.3

Tobacco 21.6 Food Production 6.5

Food Consumer Products 19.5 Semiconductors & Electronic Components

6.2

Securities and Investment Banking 18.4 Network & Communications Equipment

5.9

Beverages 17.2 Telecommunications 5.8

Medical Products & Equipment 17.2 Entertainment 2.7

Scientific & Photographic Equip. 15.6 Airlines (12.6)

Commercial Banks 14.8

Computer Software 14.0

Aerospace & Defense 13.9

3 key influences:

1. The value of the product to customers

2. The intensity of competition

3. Relative bargaining power at different levels within the value chain.

The Determinants of Industry Profitability

The Determinants of Industry Profitability


Concentration

Entry and ExitBarriers

ProductDifferentiation

Information

Perfect Competition

Oligopoly Duopoly Monopoly

Many firms A few firms Two firms One firm

No barriers Significant barriers High barriers

HomogeneousProduct

Potential for product differentiation

PerfectInformation flow

Imperfect availability of information

The Spectrum of Industry StructuresThe Spectrum of Industry Structures


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Porter’s Five Forces of Competition Framework

Porter’s Five Forces of Competition Framework

SUPPLIERS

POTENTIALENTRANTS

SUBSTITUTES

BUYERS

INDUSTRYCOMPETITORS

Rivalry amongexisting firms

Bargaining power of suppliers

Bargaining power of buyers

Threat of

new entrants

Threat of

substitutes

© 2010 Robert M. Grantwww.contemporarystrategyanalysis.com

THREAT OF ENTRY•Capital requirements•Economies of scale•Absolute cost advantage•Product differentiation•Access to distribution channels•Legal/ regulatory barriers•Retaliation

SUBSTITUTECOMPETITION

• Buyers’ propensity to substitute• Relative prices & performance of substitutes

BUYER POWER• Buyers’ price sensitivity • Relative bargaining power

INDUSTRY RIVALRY•Concentration•Diversity of competitors•Product differentiation•Excess capacity & exit barriers•Cost conditions

BUYER POWER• Buyers’ price sensitivity • Relative bargaining power

The Structural Determinants of Competition

The Structural Determinants of Competition


Extent of competitive pressure from producers of

substitutes depends upon:

• Buyers’ propensity to substitute

• The price-performance characteristics of substitutes.

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Threat of SubstitutesThreat of Substitutes


Entrants’ threat to industry profitability depends upon the height of barriers to entry. The principal

sources of barriers to entry are:

• Capital requirements

• Economies of scale

• Absolute cost advantage

• Product differentiation

• Access to channels of distribution

• Legal and regulatory barriers

• Retaliation

Threat of New EntrantsThreat of New Entrants


Buyer’s price sensitivity Relative bargaining power

• Cost of purchases as % of buyer’s total costs. • How differentiated is the purchased item? • How intense is competition between buyers? • How important is the item to quality of the buyers’ own output?

• Size and concentration of buyers relative to sellers. • Buyer’s information . • Ability to backward integrate.

Note: analysis of supplierpower is symmetric

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Bargaining Power of BuyersBargaining Power of Buyers


The extent to which industry profitability is depressed by aggressive price competition depends upon:

• Concentration (number and size distribution of firms)

• Diversity of competitors (differences in goals, cost structure, etc.)

• Product differentiation

• Excess capacity and exit barriers

• Cost conditions– Extent of scale economies– Ratio of fixed to variable costs

Rivalry Between Established Competitors

Rivalry Between Established Competitors


-5

0

5

10

15

20

25

30

Return on sales Return on investment Cash flow/Investment

< -5% -5% to 0 0 to 5% 5% to 10% > 10% Less than -5% -5% to 0 0 to 5% 5% to 10% Over 10%

Return on sales Cash flow/ InvestmentReturn on investment

ANNUAL RATE OF GROWTH OF MARKET DEMAND

ROI (%)

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Profitability and Market GrowthProfitability and Market Growth


0

5

10

15

20

25

0% 1%-35% 36%-60% 61%-75% over 75%

ROI (%)

ROS (%)

Percentage of employees unionized

Pro

fita

bil

ity

(%

)

Supplier Power: The Impact of Unionization on Profitability

Supplier Power: The Impact of Unionization on Profitability


Forecasting Industry Profitability

• If we can forecast changes in industry structure we can predict likely impact on competition and profitability.

Strategies to Improve Industry Profitability

• Which of the structural variables that are depressing profitability can we change by individual or collective strategies?

Strategic Positioning

• Once we know which structural features of the industry support profitability and which depress profitability, we can choose a favorable positioning within the industry.

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Applying Five-Forces AnalysisApplying Five-Forces Analysis


• What industry is Jaguar Ltd. in:– The Motor Vehicle industry (SIC 371)– The Automobile industry (SIC 3712)– The luxury car industry?– Is its industry global, regional (Europe) or national (UK)?

• Key criterion: SUBSTITUTABILITY– On the demand side : are buyers willing to substitute between

types of cars and across countries

– On the supply side : are manufacturers able to switch production between types of cars and across countries

• We may need to draw industry boundaries differently for different types of decision

Drawing Industry Boundaries: What is the Relevant Market?

Drawing Industry Boundaries: What is the Relevant Market?


• What drives competition? • What are the main dimensions of competition? • How intense is competition? • How can we obtain a superior competitive position?

Analysis of demand

• Who are our customers?

• What do they want?

KEY SUCCESS FACTORS

Analysis of competitionAnalysis of competition

• What drives competition?What drives competition?

• What are the main What are the main dimensions of competition?dimensions of competition?

•How intense is competition?How intense is competition?

•How can we obtain a superior How can we obtain a superior competitive position?competitive position?

What do What do customers want?customers want?

How does the firm How does the firm survive competitionsurvive competition

Pre-requisites for success

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Identifying Key Success FactorsIdentifying Key Success Factors


WHAT DO CUSTOMERS WANT?(Analysis of demand)

HOW DO FIRMS SURVIVE COMPETITION?(Analysis of competition)

KEY SUCCESS FACTORS

Steel Low price Product consistency Reliability of supply Specific technical

specifications for special steels.

Strong price competition and cyclical profitability necessitates cost efficiency and strong financial resources

Main sources of cost efficiency include: large-scale plants, low-cost location, rapid adjustment of capacity to output.

Alternatively, hi-tech minimills can achieve low costs through flexibility and high productivity.

Differentiation through product and service quality possible.

Fashion clothing

Fragmented demand (segmented by garment type, style, quality, color).

Customers’ willing to pay price premium for brand, style, exclusivity, and quality.

Mass market highly price sensitive.

Intensely competitive due to low entry barriers, low seller concentration, and strong retail buying power

Differentiation can yield substantial price premium, but imitation rapid.

Combine effective differentiation with low-costs

Key differentiation variables are speed of response to changing fashion, style, reputation and quality.

Cost efficiency requires manufacture in low wage countries.

Supermarkets Low prices. Convenient location. Wide range of products

adapted to local preferences.

Fresh/quality produce, good service, ease of parking, pleasant ambience.

Markets localized Intensity of price

competition depends on number and proximity of competitors.

Bargaining power a critical determinant of cost of bought-in goods.

Low-cost operation requires operational efficiency, scale-efficient stores, strong buying power, low wage costs.

Differentiation requires wide product range (hence, large stores), convenient location, easy parking.

Identifying Key Success Factors: Steel, Fashion Clothing, and Supermarkets

Identifying Key Success Factors: Steel, Fashion Clothing, and Supermarkets

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Profitability = Yield x Load factor - Unit Cost Income Revenue RPMs Expenses ASMs RPMs ASMs ASMs

= x -

• Price competitiveness.

• Efficiency of route planning.• Flexibility and responsiveness.• Customer loyalty.• Meeting customer requirements.

• Wage rates.

• Fuel efficiency of planes.

• Employee productivity.

• Load factors.

• Administrative overhead.

• Strength of competition on routes.

• Responsiveness to cha- anging market conditions

• % business travelers.

• Achieving differentiation advantage

ASM = Available Seat Miles RPM = Revenue Passenger Miles

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Identifying Key Success Factors Through Modeling Profitability: The Airline IndustryIdentifying Key Success Factors Through Modeling Profitability: The Airline Industry


ROCE

Return on Sales

Sales/Capital Employed

Sales mix of products

Avoiding markdowns throughtight inventory control

Max. buying power to minimizecost of goods purchased

Max. sales/sq. foot through:*location *product mix*customer service *quality control

Max. inventory turnover through electronic data interchange, closevendor relationships, fast delivery

Minimize capital deploymentthrough outsourcing & leasing

Identifying Key Success Factors by Analyzing Profit Drivers: Retailing

Identifying Key Success Factors by Analyzing Profit Drivers: Retailing


Forecasting Industry Profitability• Past profitability a poor indicator of future profitability.• If we can forecast changes in industry structure we can predict

likely impact on competition and profitability.

Strategies to Improve Industry Profitability• What structural variables are depressing profitability?• Which can be changed by individual or collective strategies?

Defining Industry Boundaries• Key criterion: substitution

• The need to analyze market competition at different levels of aggregation (depending on the issues being considered)

Key Success Factors• Starting point for the analysis of competitive advantage

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SUMMARY: What Have We Learned? SUMMARY: What Have We Learned?


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