Chapter TwoExternal Analysis The Identification of Opportunities and Threats

Strategy is a choice on how to compete. - Michael Porter

We assess -

1Industry environment in which company operates

Competitive structure of industry- The no. and size distribution of co's - Fragmented, Consolidated (Oligopoly), Monopoly What are the implications ?

Competitive position of the companyCompetitiveness and position of major rivals

2The national environments in which company competes.

3The wider socioeconomic or macro environment that may affect the company and its industry

SocialLegal TechnologicalGovernmentInternationalEXTERNAL ANALYSISThe purpose of external analysis is to identify the strategic opportunities and threats in the organizations operating environment that will affect how it pursues its mission.

COMPETITIVE STRUCTURE : IMPLICATIONSCharacteristics of Fragmented Ind.

Typically Commodity type products/ servicesEntry barriers low

As industry profits rise

New companies rush in

Excess capacityDepressed prices

Undercutting prices to surviveMore commodity like, more vicious price war

Booms are short-livedBoom-n-Bust cyclesas industry profits rise and fall.

Bankruptcies and exits brings capacity in line with demand slowly and cycle starts once again.

Therefore it is more a threat than an opportunity.Characteristics of Consolidated Ind.

Companies are interdependent as ones actions(price, quality, responsiveness etc) impacts the rest

Market share & profitability of rivals directly impacted

Hence it generally forces a move from its rivals

Leading to a dangerous spiral,Undercutting prices, offer customers more value

Profits down(Airlines, Telecom, Cereals etc)

The SolutionAcceptance of dominant company as the leaderand set prices by watching, interpreting, anticipating..

Tacit price agreements existand break down under adverse conditions

Case Study : Price Wars in Breakfast Cereal industry.

INDUSTRY ANALYSIS : DEFINING AN INDUSTRY Industry A group of companies offering products or services that are close substitutes for each other and that satisfy the same basic customer needs.

Industry boundaries The basic customer needs that are served by a market define industry boundary. May change as customer needs evolve and technology changes. Coca-Cola Mid-90s : Soda market (carbonated soft drinks) or Soft Drinks (incl. Non-Carbonated drinks) Sector A group of closely related industries.

Market Segments Distinct groups of customers within an industry. Can be differentiated from each other with distinct attributes and specific demands.The Computer Sector, Industries and Market Segments

PORTERS FIVE FORCES MODEL HOW THEY SHAPE COMPETITION WITHIN AN INDUSTRY ?The stronger that each of these five forces is, the more limited is the ability of established companies to raise prices and earn greater profits within their industry i.e. a Threat.

The weaker that each of these five forces is, the more pronounced is the ability of established companies to raise prices and earn greater profits within their industry i.e. an Opportunity.Through its choice of strategies a company may alter the strength of one or more of the five forces to its advantage. The systematic analysis of forces is a powerful tool that helps managers think strategically.

It is important to recognize that one competitive force often affects the others, so all forces need to be considered and thought about when doing industry analysis.

It leads managers to think systematically about how their strategic choices will be affected by 5 forces and also how their choices will in turn affect 5 forces and change conditions in industry.

Potential Competitors are companies that are not currently competing in an industry but have the capability to do so if they choose.

Barriers to new entrants include: RISK OF ENTRY BY POTENTIAL COMPETITORSEconomies of Scale as firms expand output unit costs fall via:

Cost reductions through mass production.Bulk purchases of raw material and standard parts.Cost advantages of spreading fixed and marketing costs over large volume.

Brand Loyalty

By creating well-established customer preferences.Difficult for new entrants to take market share from established brands.

Absolute Cost Advantages relative to new entrants

Accumulated experience in production and key business processes (Learning/ Experience Curve).Control of particular inputs required for production.Lower financial risks access to cheaper funds.

Customer Switching Costs for Buyers where significant.

Government Regulation may be a barrier to enter certain industries.

Industry Competitive Structure

Number and size distribution of companies.Consolidated vs. fragmented.

Demand Conditions

Growing demand - tends to moderate competition and reduce rivalry.Declining demand - encourages rivalry for market share and revenue.

Cost Conditions

High fixed costs profitability leveraged by sales volume (Shipping, Airlines, Telecom, Air Express etc). Slow demand and growth can result in intense rivalry and lower profits.

Height of Exit Barriers prevents companies from leaving industry even when unprofitable, demand declining..

Write-off of investment in assetsEconomic dependence on industry if in single industryMaintain assets - to participate effectively in an industry UPS, FedEx to maintain nationwide n/w RIVALRY AMONGST ESTABLISHED COMPANIESCompetitive Rivalry refers to the competitive struggle between companies in the same industry to gain market share from each other. Intensity of rivalry is a function of: 4.High fixed costs of exit - severance pay, health benefits, pensions etc5.Emotional attachment - sentiments/ pride6.Bankruptcy regulations - allowing unprofitable assets to remain (Chapter 11 in US)

Industry Buyers may be the consumers or end-users who ultimately use the product or intermediaries that distribute or retail the products. These buyers are most powerful when: BARGAINING POWER OF THE BUYERSBuyers are dominant.

Buyers are large and few in number. Large Auto, Aircraft ManuThe industry supplying the product is composed of many small companies Component Manu

Buyers purchase in large quantities.

Buyers have purchasing power as leverage for price reductions Wal-Mart, Reliance

The industry is dependant on the buyers.

Buyers purchase a large percentage of a industrys produce. _ _ _ _ _ _ _ _ _

Switching costs for buyers are low.

Buyers can play off the supplying companies against each other. _ _ _ _ _ _ _ _ _

Buyers can purchase from several supplying companies at once. _ _ _ _ _ _ _ _

Buyers can threaten to enter the industry themselves.

Buyers produce themselves and supply their own product.Buyers can use threat of entry as a tactic to drive prices down.

Suppliers are organizations that provide inputs such as material and labor into the industry. These suppliers are most powerful when: BARGAINING POWER OF THE SUPPLIERSThe product supplied is vital to the industry and has few substitutes.e.g. Intel Microprocessors

The industry is not an important customer to suppliers._ _ _ _ _ _ _ _

Suppliers are not significantly affected by the industry.

Switching costs for companies in the industry are significant.IBM, HP .. Datacenters

Companies in the industry cannot play suppliers against each other.

Suppliers can threaten to enter their customers industry.Backward Integration

Suppliers can use their inputs to produce and compete with companies already in the industry.

Companies in the industry cannot threaten to enter suppliers industry.

Substitute Products are the products from different businesses or industries that can satisfy similar customer needs. SUBSTITUTE PRODUCTSThe existence of close substitutes is a strong competitive threat.

Substitutes limit the price that companies can charge for their product. e.g. Intel, AMD etc. Soft Drinks, Tea, Coffee

Substitutes are a weak competitive force if an industrys products have few close substitutes.

Other things being equal, companies in the industry have the opportunity to raise prices and earn additional profits.

STRATEGIC GROUPS WITHIN INDUSTRIESStrategic Groups are groups of companies that follow a business model similar to other companies within their strategic group but are different from that of other companies in other strategic groups.Implications of Strategic Groups The closest competitors are within the same Strategic Group and may be viewed by customers as substitutes for each other.

Each Strategic Group can have different competitive forces and may face adifferent set of opportunities and threats.

2.Mobility Barriers Factors within an industry that inhibit the movement of companies between strategic groups

Include barriers to enter another group orexit existing group.The basic differences between business models in different strategic groups can be captured by a relatively small number of strategic factors.High Risk High Return

Focus on developing new proprietary drugs

Heavy R&D spendingLow Risk Low ReturnFocus on low-cost copies of drugs with expired patents.

Production efficiency

Strategic Barriers in the Pharmaceutical IndustryStrategic Barrier

Lack of R&D Skills to develop new proprietary drugs

The Model analyzes the affects of industry evolution on competitive forces over time and is characterized by five distinct life cycle stages:Industry Life Cycle AnalysisEmbryonic industry just beginning to developRivalry based on perfecting products, educating customers, and opening up distribution channels.

Growth first-time demand takes-off with new customersLow rivalry as focus is on keeping up with high industry growth.

Shakeout demand approaches saturation, replacementsRivalry intensifies with emergence of excess productive capacity.

Mature market totally saturated with low to no growthIndustry consolidation based on market share, driving down price.

Decline industry growth becomes negativeRivalry further intensifies based on rate of decline and exit barriers.

Growth in Demand and CapacityIndustry Shakeout: Rivalry Intensifies with growth in excess capacityAnticipate how forces will change and formulate appropriate strategy Life Cycle IssuesIndustry cycles do not always follow the life cycle generalization.In rapid growth situations embryonic stage is sometimes skipped. Industry growth revitalized through innovation or social change.The time span of the stages can vary from industry to industry.

Innovation and ChangePunctuated Equilibrium occurs when an industrys long term stable structure is punctuated with periods of rapid change by innovation.Hypercompetitive industries are characterized by permanent and ongoing innovation and competitive change.

Company DifferencesThere can be significant variances in the profit rates of individual companies within an industry.

In addition to industry attractiveness, company resources and capabilities are also important determinants of its profitability.Limitations of Models for Industry AnalysisModels provide useful ways of thinking about competition within an industry but be aware of their limitations.

Punctuated Equilibrium and Competitive StructureIndustry Structure revolutionized by innovation

The Role of the Macro environmentChanges in the forces in the macro-environment can directly impact:

The Five Forces Relative Strengths Industry AttractivenessAndrew Grove, forcer CEO of Intel arguesthat Porters Model ignores a sixth force -

The power, vigor and competence of Complementors.

These are companies that sell products that add value to (complement) the products of the industry because when used together, the products best satisfy customer needs.

e.g. software applications