Chapter 4

Industry and competitor analysis

Industry analysis

Competitor analysis

Industry analysis

When studying an industry, an entrepreneur must answer three

questions before pursuing the idea of starting a firm:

Is the industry accessible (is it a realistic place for a new venture to enter)?

Does the industry contain markets that are ripe for innovation or are underserved?

Are there positions in the industry that will avoid some of the negative aspects of the industry as a whole?

A new venture can use the five competitive forces model to assess the overall attractiveness of the industry it plans to enter and to determine if a favorable position exists in that industry.

The five competitive forces that determine industry profitability (the model of Michael Porter)

These forces determine industry profitability and the average rate of return for the firms in the industry. Threat of substitutesThe price that consumers are willing to pay for a product depends in part on the availability of substitute products.

Example:There are few substitutes for prescription medicines, which is one of the reasons the pharmaceutical industry is so profitable. When a person is sick, he does not make any comment about the price of a medicine.

When close substitutes for a product exist, industry profitability is

suppressed because consumers will choose not to buy when the price is

too high.

Example:

If the price of the movie tickets gets too high, consumers can easily

switch to rent videos.

The firms in an industry often offer their customers amenities to reduce

the likelihood of their switching to a substitute product.

Example:

The coffee sold at Starbucks is expensive. A consumer could easily find

a less expensive cup of coffee at a donut shop or brew a coffee at

home. To decrease the likelihood that consumers will choose one of

these alternatives, Starbucks offers high-quality fresh coffee, a pleasant

atmosphere and good service. Some Starbucks restaurants offer their

customers access to computers and the Internet as ways of motivating

them to remain loyal to Starbucks.

Threats of new entrants

If the firms in an industry are highly profitable, the industry becomes a

magnet to new entrants.

There are barriers to entry that creates a disincentive for a new firm to

enter an industry and keep the number of new entrants low.

The barriers to entry are the followings: Economies of scale: industries that are characterized by large

economies of scale are difficult for new firms to enter, unless they

accept a cost disadvantage.

Economies of scale occur when producing a product in large quantities

it results in lower average costs.

Example:

Intel has huge microchip factories that produce large quantities of chips,

reducing the average cost of a chip. It would be difficult for a new

entrant to match Intel’ s advantage in this area.

Product differentiation

Example:

Industries such as the soft drink industry that are characterized by firms

with strong brand are difficult to enter without spending a lot on

advertising. It is very costly to compete against Pepsi or Coca-Cola.

Capital requirements

The need to invest large amounts of money to enter an industry is

another barrier to entry.

Many new firms do not have the capital to compete at this level.

Cost advantages independent of size

These advantages are grounded in the firm’ s history.

The existing competitors in an industry may have purchased land and

equipment in the past when the cost was less than new entrants would

have to pay for the same assets today.

Access to distribution channels: is difficult in crowded markets, such as the convenience store market.

Example:

A new sports drink to be placed on a convenience store shelf it has to

display a product that is already there.

Government and legal barriers:

In knowledge-intensive industries, such as biotechnology and software,

patents, trademarks and copyrights form major barriers to entry.

Other industries, such as banking and broadcasting require the granting

of a license by a public authority.

When a new firm tries to enter an industry with powerful barriers to

entry, it must have a plan to overcome these barriers.

Example:

Firma Sun Microsystems was able to overcome the barriers to entry in

many industries through a program of partnering with other forms (by

forming strategic alliances).

Rivalry among existing firms

In most industries, the profitability is dependent on the level of

competition among the firms already competing in these industries.

In industries with high competition the prices are pushed below the

level of costs and firms have losses or the profit margins are small (for

example in the personal computer industry).

Other industries are less competitive (such as specialized medical

equipment industry) and the profit margins are higher.

Bargaining power of suppliers

In some cases suppliers influence the profitability of industries to which

they sell by raising prices or reducing the quality of the components.

If a supplier reduces the quality of the components it supplies, the

quality of the finished product will decrease and the manufacturer will

have to lower its price.

Example:

Intel is a powerful supplier of Pentium chips to the PC industry. Intel can

command a premium price from the PC manufacturers, thus affecting

the overall profitability of the PC industry.

The factors that have an impact on the ability of suppliers to influence

the profitability of the industries they serve are the following: Supplier concentration: when there are only a few suppliers that

supply a critical product to a large number of buyers, the supplier has an advantage.

Example:

In the pharmaceutical industry, few drug manufacturers sell to

thousands of doctors and patients.

Switching costs: if switching costs are high, a buyer will be less likely to switch suppliers.

Example:

Suppliers often provide their largest buyers with specialized software

that makes it easy to buy their products. After the buyer spends time

and effort learning the supplier’ s ordering and inventory management

systems, it will be less likely to want to spend time and effort learning

another supplier’ s system.

Attractiveness of substitutes: supplier’ s power increases if there are no attractive substitutes for the products/services it offers.

Example:

There is little the computer industry can do when Microsoft and Intel

raise their prices because there are no substitutes for their firms’

products.

Threat of forward integration: the power of a supplier increases if there is a possibility that the supplier might enter the buyer’ s industry.

Example:

Microsoft’ s power as a supplier of computer operating systems is

enhanced by the threat that it might enter the PC industry.

Bargaining power of buyers

Buyers can influence the profitability of the industries from which they

purchase by demanding price decreases or increases in quality.

Example:

The automobile industry is dominated by few large companies that buy

products from thousands of suppliers in different industries. If the car

manufacturers demand price reductions or better quality for the same

price, the profitability of suppliers would suffer.

The factors that affect buyers` ability to exert pressure on suppliers and

influence the profitability of the industries from which they buy are the

following: Buyer group concentration: if the buyers are concentrated, meaning

that there are only a few large buyers and they buy from a large number of suppliers they can pressure the suppliers to lower costs and thus affect the profitability of the industry from which they buy.

Buyer` costs: the greater the importance of an item is to a buyer, the more sensitive the buyer will be to the price it pays.

Degree of standardization of supplier` s products: the degree to which a supplier` s product differs from its competitors affects the buyer` s bargaining power. A buyer who purchases a standard or undifferentiated product will look for a supplier who offers the best combination of price and service.

Threat of backward integration: the power of a buyer increases if there is a threat that the buyer might enter the supplier` s industry.

Example:

The PC industry can keep the price down by threatening to make its

own monitors if the price gets too high.

The value of the five forces model

This model helps a firm understand the dynamics of the industry it plans

to enter and determine whether it should enter a particular industry.

The ways this model can be used are the following:

The model can be used to assess the attractiveness of an industry or a specific position in an industry by determining the level of threat to industry profitability for each of the forces.

If several of the threats to industry profitability are high, the firm should

reconsider entering the industry or think carefully about the position it

will occupy in the industry.

Threat to industry profitability

Competitive forces

Low Medium High

Threat of substitutes

Threat of new entrants

Rivalry among existing firms

Bargaining power of suppliers

Bargaining powers of buyers

Example:

In the restaurant industry the threat of substitute products, the threat of

new entrants and the rivalry among existing firms are high. For certain

restaurants, such as fresh-seafood restaurants, the bargaining power of

suppliers may also be high (the number of seafood suppliers is relatively

small compared to the number of beef and chicken suppliers).

A firm that enters the restaurant industry has several forces working

against it and it must establish a favorable position.

The model can be used to answer several questions:

Question 1: Is the industry a realistic place for a new firm to enter?

This question can be answered by looking at the overall attractiveness

of an industry and by assessing whether the window of opportunity is

open or closed.

Question 2: If we enter the industry, can our firm do a better job than the

industry as a whole in avoiding or diminishing the impact of the forces

that suppress industry profitability?

A new firm can enter an industry with a fresh brand, innovative ideas

and a world-class management team and perform better than the

firms already in that industry.

Example:

Having innovative ideas Google entered the Internet search engine

Industry and displaced Yahoo! as the market leader.

Question 3: Is there a unique position in the industry that avoids or

diminishes the forces that suppress industry profitability?

Question 4: is there a superior business model that can be put in place

that would be hard for competitors to duplicate?

Sometimes the largest firms in an industry prefer to maintain their

strategies providing an opening for a start-up to try something new.

Example:

When Dell started selling computers directly to consumers, its largest

rivals (Hewlett-Packard, Compaq, IBM) were not able to respond. They

were locked into a strategy of selling through retailers.

Industry types and the opportunities they offer

Emerging industries

An emerging industry is a new industry in which standard operating

procedures have to be developed.

The firm that enter such an industry can capture a first-mover

advantage.

Because a high level of uncertainty characterizes emerging industries,

any opportunity that is captured may be short lived.

Many new firms enter emerging industries because the barriers to entry

are low and there is not established a pattern of rivalry.

Fragmented industries

A fragmented industry is characterized by a large number of firms of

equal size.

The opportunity existing for new firms is to consolidate the industry and

establish a leader position.

In industry consolidation, the smaller firms are acquired or leave the

industry and few larger companies take over the majority of the

business.

Example:

In the video rental industry in the USA there were many small video

stores. After Blockbuster entered the industry, through internal growth

and acquisitions, this firm grew quickly and consolidated a previously

fragmented industry.

Mature industries

They are experiencing slow or no increase in demand, have numerous

repeat (rather than new) customers and have limited product innovation.

There is an opportunity for a new firm to innovate processes and

products/services.

Example:

In 1996 White Wave a company that makes vegetarian food products

introduced Silk Soymilk, which has quickly become the best-selling soy

milk in the country. This product is not really milk at all, it is a soybean-

based beverage that looks like milk and it is a healthy substitute for milk.

Declining industries

They are industries that are experiencing a reduction in demand.

Entrepreneurial firms can use the following strategies:

a). The leadership strategy in which the firm tries to become the leader in the industry. This is a rare strategy for a start-up in a declining industry.

b). The niche strategy which focuses on a narrow segment of the industry that might grow through product or process innovation.

c). The cost reduction strategy is accomplished through achieving lower costs than the other competitors through process improvements.

Global industries

They are industries that are experiencing significant international sales.

Many start-ups enter global industries and they try to address

international rather domestic markets.

The most common strategies followed by firms in global industries are

the multidomestic strategy and the global strategy.

Firms that pursue a multidomestic strategy compete for market share on

a country-by-country basis and vary their products or services to meet

the demands of the local market.

Firms pursuing a global strategy use the same basic approach in all

foreign markets.

The choice between these two strategies depends on how similar

consumers` tastes are from market to market.

Example:

Food companies pursue a multidomestic strategy because food

preferences vary significantly from country to country. Firms that sell

more universal products, such as athletic shoes pursue a global

strategy.

Competitor analysis

It helps a firm understand the positions of its major competitors and the

opportunities that are available to obtain a competitive advantage.

Identifying competitors is the first step in a competitor analysis and it

is more difficult because most companies run several businesses and

they have a set of competitors.

The different types of competitors a business face are: Direct competitors are firms that offer products identical or similar to

the products of the firm completing the analysis.

These competitors are the most important because they address the same customers as the local firm.

It is very difficult for a start-up to attract customers even when it has a better product.

Indirect competitors offer substitutes to the products the firm completing the analysis sells.

Future competitors are firms that are not yet direct or indirect competitors but could become at any time.

It is impossible for a company to identify all its direct and indirect

competitors. It is easier for a firm to complete its competitive analysisif it

identifies its top 5 to 10 direct competitors and its top 5 to 10 indirect

and future competitors.

There are a number of ways that a firm can ethically obtain information

about its competitors: attend conferences and trade shows; read

industry related books, magazines, Web sites; talk to customers about

what motivated them to buy your product; purchase competitors`

products to understand their features, advantages and disadvantages.

Completing a competitive analysis grid is a tool for organizing the

information a firm collects about its competitors.

It can help a firm understands its position against the competitors,

provides ideas for markets to pursue and identifies its primary

sources of competitive advantage.

Information about its competitors can refer to: product features, brand-

name recognition, access to distribution channels, quality of products,

ease of use, price, marketing support, quality of customer service.