Industry analysis and Porter\'s five forces model

1. Industry Analysis:Porter’s Five Forces Model Michael McDermott mcdermottm1@nku.edu http://www.linkedin.com/in/michaelcmcdermott www.facebook.com/strategycapstone www.strategycapstone.ning.com www.Mcdermottstrategy.wikispaces.com www.globalbusinessstrategy.wikispaces.com 1 www.facebook.com/strategycapstone

2. 2 Exhibit 1.2 The vocabulary of strategy www.facebook.com/strategycapstone

3. 3 Exhibit 2.1 Layers of the business environment www.facebook.com/strategycapstone

4. PEST Analysis is Complete(see previous slides) Remember the PEST focuses upon the remote external environment These are the factors that NO company can control But the company MUST heed the conclusions from its PEST analysis Aligning with such trends is very wise Ignoring them is very risky if not foolish 4 www.facebook.com/strategycapstone

5. Scenario Planning

6. Scenario Planning This demands consideration of a range of scenarios To be meaningful, if should include the most optimistic and most pessimistic scenarios This is intended to compel executives to ask the “what if” questions 6 www.facebook.com/strategycapstone

7. Scenario Planning Organizations sometimes undertake this exercise The aim is to construct scenarios and then consider the strategic implications of these 7 www.facebook.com/strategycapstone

8. Scenario Planning in the Auto industry Price of oil is $200 per barrel; Price of oil is $100 pb Price of oil is $50 pb Price of oil is $30 pb 8 www.facebook.com/strategycapstone

9. Scenario Planning and the Auto Industry 9 www.facebook.com/strategycapstone

10. Scenario Planning in the Auto industry Now that is very simplistic and considers only one variable – an economic factor Clearly proper scenario planning would be much more sophisticated, and factor in multiple variables to identify many scenarios 10 www.facebook.com/strategycapstone

11. Industry Analysis

12. “The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability” Michael Porter, “The Five Competitive Forces that Shape Strategy”, Harvard Business Review, January 2008. 12 www.facebook.com/strategycapstone

13. Defining the Relevant Industry Quality of industry analysis is compromised if it is not well defined Avoid defining it too broadly – obscures differences among products, customers or geographic regions Avoid defining it too narrowly – overlook s commonalities 13 www.facebook.com/strategycapstone

14. Defining an Industry: Employ two key dimensions Scope of Products or Services The one product may be sold to very different buyers and thus despite product similarities, we have two or more industries: Motor oil is sold for lawn mowers, cars, trucks and thus we have three industries as the industry structure is very different Geographic scope Most industries exist in many countries. Is competition local, national, regional or global? 14 www.facebook.com/strategycapstone

15. Steps in Industry Analysis Define the relevant industry Identify participants – who are: The buyers and buyer groups The suppliers and supplier groups The competitors The substitutes The potential entrants 15 www.facebook.com/strategycapstone

16. Steps in Industry Analysis Assess the underlying drivers of each competitive force to determine which forces are strong and which are weak and why; Determine overall industry structure Why is the level of profitability what it is? Which are the controlling forces for profitability Are more profitable players better positioned in relation to the five forces 16 www.facebook.com/strategycapstone

17. Steps in Industry Analysis Analyze recent and likely future changes in each force – positive and negative Identify aspects of industry structure that might be influenced by competitors, by new entrants, or by ‘your’ company 17 www.facebook.com/strategycapstone

18. 18 Exhibit 2.1 Layers of the business environment www.facebook.com/strategycapstone

19. Why Undertake Industry Analysis The purpose is to determine the attractiveness or unattractiveness of the industry And in particular the sources of the above by consideration of five key forces (Porter’s five forces model, developed in 1979) Unlike factors considered in PEST analysis, a company CAN influence industry attractiveness 19 www.facebook.com/strategycapstone

20. Industry Analysis 20 www.facebook.com/strategycapstone

21. Porter 2008: Updated Version of “The Five Forces” “In essence, the job of the strategist is to understand and cope with competition” Remember this is the dominant view of strategy; Remember in week 1 we posed the question is this view still as applicable today 21 www.facebook.com/strategycapstone

22. Common Mistake Competition is defined too narrowly Competition includes direct rivals But competition for profits demands considerations of four other competitive forces: These five forces combined define an industry’s structure 22 www.facebook.com/strategycapstone

23. 23 Exhibit 2.2 The five forces framework Source: Adapted with the permission of The Free Press, a Division of Simon & Schuster Adult Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved www.facebook.com/strategycapstone

24. Porter’s Five Forces and Industry Analysis: His examples Industries with intense forces Airlines Hotels Textiles Industries with benign forces Software Soft drinks Toiletries 24 www.facebook.com/strategycapstone

25. Industry Analysis 25 www.facebook.com/strategycapstone

26. Porter’s Key Point is this: Industry structure determines profitability Not the nature of the product or service whether the industry is emerging or mature whether high-tech or low-tech whether regulated or unregulated 26 www.facebook.com/strategycapstone

27. Industry Profitability Determined by… In Short term A myriad of factors The weather (severe cold weather deters trips to shops) The business cycle (products at end of PLC vs new products – think of Video Game Consoles) In Medium/Long Term Industry structure as manifested in the competitive forces 27 www.facebook.com/strategycapstone

28. Why is it essential to understand the forces? These reveal the roots of an industry’s current profitability They also provide a framework for anticipating and influencing competition (and profitability) over time Essential for strategic positioning Need to defend against the competitive forces And to shape the forces to the company’s advantage 28 www.facebook.com/strategycapstone

29. Industry Analysis: Example 1: Commercial Aircraft 29 www.facebook.com/strategycapstone

30. Key Point “The strongest competitive force or forces determine the profitability of an industry and become the most important force for consideration in strategy formulation” Porter, 2008, Harvard Business Review 30 www.facebook.com/strategycapstone

31. Photographic Film Industry Low returns are due not so much to rivalry (i.e. between Kodak and Fuji) But due to the advent of a superior substitute product (i.e. digital photography) Hence coping with this substitute product emerges as the top or number one strategic priority 31 www.facebook.com/strategycapstone

32. The Five Forces in-depth

33. First Force: Threat of new entrants 33 www.facebook.com/strategycapstone

34. Threat of Entry New entrants increase industry capacity and want to win market share This leads to pressure on prices, costs and the rate of investment required to compete New entrants that emerge from other markets can have a major impact as they can leverage existing capabilities and cash flows to shake up competition: 34 www.facebook.com/strategycapstone

35. Threat of Entry: Recent Examples Google with Android in smart phones; Apple with iPad in eReader; Pepsico entering bottled water and other beverage segments; Amazon with Online entertainment 35 www.facebook.com/strategycapstone

36. Threat of entry 36 www.facebook.com/strategycapstone

37. What determines level of Threat of Entry? The height of entry barriers (i.e. the advantages that incumbents have relative to new entrants) The reaction new entrants provoke from incumbents 37 www.facebook.com/strategycapstone

38. Barriers to Entry: Seven Major sources 38 www.facebook.com/strategycapstone

39. Barriers to Entry: Seven Major sources 39 www.facebook.com/strategycapstone

40. Barriers to Entry: Seven Major sources 40 www.facebook.com/strategycapstone

41. Barriers to Entry: Seven Major sources 41 www.facebook.com/strategycapstone

42. Barriers to Entry: Seven Major sources and a practical perspective 42 Now consider the extent of these barriers to companies such as Apple, Dell, Google, RIM (ie Blackberry in China) www.facebook.com/strategycapstone

43. Barriers to Entry: Seven Major sources and Google in China 43 Could Google possibly ever succeed in China? www.facebook.com/strategycapstone

44. Big Challenge in Emerging Markets You may be seduced by the opportunities, but often the barriers to entry are very high. Should a company enter a market where the barriers are so high that it is either peripheral or confined to being a niche player? 44 www.facebook.com/strategycapstone

45. What determines level of Threat of Entry? The height of entry barriers (i.e. the advantages that incumbents have relative to new entrants) The reaction new entrants provoke from incumbents 45 www.facebook.com/strategycapstone

46. Expected Retaliation by Incumbents 46 www.facebook.com/strategycapstone

47. Reasons to Fear Retaliation Incumbents have a history of mounting strong defence against new entrants Incumbents have the resources to fight back: Cash Production capacity Clout with distribution channels and customers Incumbents will cut prices to protect market share and/or have high fixed costs Industry growth is slow so the only way for new entrants to gain volume is at the expense of an incumbent 47 www.facebook.com/strategycapstone

48. 1. Threat of New Entrants Vital to stress that it’s the mere threat, not actual entry that holds down profitability When threat is high, incumbents need to hold down prices or boost investment to deter entrants Threat of entry is high and profits are moderated when entry barriers are low and newcomers expect little retaliation from incumbents 48 www.facebook.com/strategycapstone

49. Second force: The power of suppliers 49 www.facebook.com/strategycapstone

50. 2. Bargaining Power of Suppliers Supplier are more powerful when: They sell to an industry less concentrated than their own The supplier is not heavily dependent on the industry for its revenues Switching costs for industry participants are high Suppliers offer differentiated products No substitutes are available Suppliers could undertake forward integration 50 www.facebook.com/strategycapstone

51. third force: The power of buyers 51 www.facebook.com/strategycapstone

52. 3. Bargaining Power of Buyers Powerful buyers can: force down prices; Demand better quality or more service (thus driving up costs); and can play industry participants off against each other These all result in a reduction of profitability for those catering to these buyers 52 www.facebook.com/strategycapstone

53. Bargaining Power of Buyers is Strong when….… There are few buyers; Or when each buyer purchases in volumes that are large relative to the size of a single vendor; Buyers perceive vendors products as standardized or lacking in differentiation, so they perceive no advantage in buying from a particular vendor; Buyers have low switching costs in changing vendors; Buyers can credibly threaten backward integration and produce the vendor’s product themselves 53 www.facebook.com/strategycapstone

54. Bargaining Power of Buyers is Weak when….… There are many buyers; Or when each buyer purchases in volumes that are small relative to the size of a single vendor; Buyers perceive vendors products as differentiated, so they perceive no advantage in buying from a particular vendor; Buyers have high switching costs in changing vendors; Buyers cannot credibly threaten backward integration and produce the vendor’s product themselves 54 www.facebook.com/strategycapstone

55. Let’s Sum Up the Previous Two Slides 55 www.facebook.com/strategycapstone

56. Spotting Price Sensitive Buyers A buyer group is price sensitive when: It buys a product from the industry that represents a high percentage of its cost structure E.g. imagine a company buys just one particular component that accounts for 30 per cent of its total cost structure – the company will be very price sensitive and seek to lower cost of that component as much as possible 56 www.facebook.com/strategycapstone

57. Spotting Price Sensitive Buyers A buyer group is price sensitive when: It earns low profits, is strapped for cash, or is under pressure to reduce purchasing costs; Its own products/services are not greatly affected by the quality of the vendors’ products/services E.g. let’s assume that the ducting used in a Dyson hose is not critical to the quality of Dyson would be a very price-sensitive buyer of such ducting; However, the motor may be very important, so for that product Dyson would be much less price sensitive 57 www.facebook.com/strategycapstone

58. Spotting Price Sensitive Buyers A buyer group is price sensitive when: The industry’s product has little effect on the buyer’s other costs E.g. an automobile producer may be very price sensitive when it comes to purchase of lights in vehicles, but not at all price-sensitive in choice of CNC machinery 58 www.facebook.com/strategycapstone

59. Just Think of Yourself as a Consumer! When are you a price sensitive buyer? When you are buying products that lack differentiation; When you are buying products that are relatively expensive to you; When product performance is not a major concern 59 www.facebook.com/strategycapstone

60. Fourth force: the threat of substitutes 60 www.facebook.com/strategycapstone

61. Substitute Products When the threat is high, industry profitability suffers The existence of substitute products/services limits an industry’s profit potential by placing a ceiling on prices Therefore an industry needs to reduce the appeal of substitutes through product performance, marketing etc E.g. golf club companies seek to reduce appeal of previous generations of product by regular new product launches and claims of improved performance 61 www.facebook.com/strategycapstone

62. Substitute Products In Emerging Markets, industries that may have expected to reap the benefits of economic development miss out due to substitute products Rather than subscribe to a wired telephone line, they rely exclusively upon wireless telecommunications 62 www.facebook.com/strategycapstone

63. The threat from substitute products is high if…. it offers an attractive price-performance trade-off to the industry’s product Imagine paying $200 for a set of rarely used golf clubs that retailed for $1,200 only 12 months earlier; People use Skype and Vonage rather than conventional service providers for long-distance calls; TV cable companies in 2010 have seen largest drop in subscriber numbers as people rely on Online services such as Hulu, Netflix and YouTube. 63 www.facebook.com/strategycapstone

64. The threat from substitute products is high if…. The buyer’s cost of switching to the substitute is low Consumers may switch at minimal cost from branded products (e.g cereals, drugs) to generics 64 www.facebook.com/strategycapstone

65. Substitute Products Changes in other industries may render them attractive substitutes when they were not before Consider some examples: Steel may be replaced by plastics as the latter innovates; Nuclear power may be replaced by renewable energy sources as the latter innovates 65 www.facebook.com/strategycapstone

66. Threat of Substitute Products A substitute performs the same or similar function as an industry’s product by a different means video conferencing is a substitute for travel; Plastic for aluminum Email for fax/letters Facebook for email 66 www.facebook.com/strategycapstone

67. Threat of Substitute Products Substitutes are always present…though they can often easily be overlooked; Valentine’s Day is approaching so think of the range of substitute products Think of what you may choose to buy for your partner – that ‘list’ of potential purchases are in fact all substitute products Consider your gift purchases at Christmas time – the options that you faced in each purchase again highlights the nature of substitutes 67 www.facebook.com/strategycapstone

68. It is a substitute to… do without – you may decide not to make a purchase (e.g. buy a car; book a vacation) buy used (so this can be a strong substitute for cars, sports equipment, books etc – internet and ecommerce has perhaps increased the strength of this force) do it yourself (e.g. remodel yourself rather than employ a contractor; wash your own car rather than go to commercial carwash) 68 www.facebook.com/strategycapstone

69. Fifth force: intensity of rivalry 69 www.facebook.com/strategycapstone

70. Think of How Rivals Compete What do auto companies do in order to win sales? What do mobile phone service carriers do in order to win subscribers? What do retailers to in order to attract customers? 70 www.facebook.com/strategycapstone

71. Rival’s Means of Competing 71 www.facebook.com/strategycapstone

72. High Rivalry Limits The Profitability of the Industry 72 www.facebook.com/strategycapstone

73. Intensity of Rivalry 73 www.facebook.com/strategycapstone

74. Price Competition is most likely if… 74 www.facebook.com/strategycapstone

75. Common Errors in Industry Analysis:Factors Not Forces 75 www.facebook.com/strategycapstone

76. Intensity of Rivalry In addition to the dimensions of rivalry, intensity increases when firms compete on the same dimensions Firms aim to meet the same needs Or compete on the same attributes 76 www.facebook.com/strategycapstone

77. The Five forces In an ideal world what would the analysis conclude for an organization competing in a particular industry? What would be the worst case scenario? Does the ideal scenario ever exist in a free market economy? 77 www.facebook.com/strategycapstone

78. The Five Forces in Operation Let’s identify an industry/industries and examine it using the five forces model Often students are confused by this tool They talk of ‘substitutes’ when they mean ‘rivals’ They are not clear on who the suppliers are Or do not distinguish between different types of buyers 78 www.facebook.com/strategycapstone

79. Porter’s Five Forces Model It is vital that you grasp this concept and can apply it any context It needs to be applied at the SBU level of the organization It reveals the nature of competition in the present, but also needs to be employed to consider the nature of each force in the future This future orientation allows the organization to develop strategies to deal with each force in the future Changes in the remote environment can exert enormous impact upon the nature of a particular force 79 www.facebook.com/strategycapstone