Chapter 3 - Industry and Sector analysis PDF

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3 – Industry and Sector Analysis 3.1 Introduction Industry: A group of firms producing products and services that are essentially the same, mentioned as industries or sectors. Example: Automobile industry, airline industry, health sector or education sector. Market: A group of customers for specific products or services that are essentially the same. Example: The automobile industry has markets in America, Europe and Asia.

3.2 The Competitive Forces Industry attractiveness measured by how easy it is for participating firms to earn high profits. Porter’s five forces framework: Helps identify the attractiveness of an industry in terms of five competitive forces: the threat of entry, the threat of substitutes, the power of buyers, the power of suppliers and the extent of rivalry between competitors. Where the five forces are high, industries are not attractive to compete in. The framework can provide a useful starting point for strategic analysis, even when profit criteria may not apply.

3.2.1 Competitive rivalry Incumbents = existing players; the more competitive rivalry, the worse for incumbents. Competitive rivals: Organisations with similar products and services aimed at the same customer group (i.e. not substitutes). Example: Air France and British Airways; high-speed trains are a ‘substitute’ Factors defining the extent of rivalry:  Competitor balance - Where competitors are equal size there is the danger of intensely rivalrous behaviour, as one competitor attempts to gain dominance over others (example: through price cuts).

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Industry growth rate - With strong growth, organisation can grow with the market. With low growth, any growth is likely to be at the expense of a rival and meet with fierce resistance (price competition). The industry life cycle influences growth rates and hence competitive conditions. High fixed costs - Industries with high fixed costs tend to be highly rivalrous. Companies will seek to spread their costs by increasing their volumes (to do so, they cut prices; triggering price wars). High exit barriers - The high barriers to exit (closure) tends to increase rivalry, especially in declining industries. They fight to maintain market share. Exit barriers might be high for a few reasons: high redundancy cost or high investment in specific assets. Low differentiation - In a commodity market, where products or services are poorly differentiated, rivalry is increased; there is a little to stop customers switching between competitors. The only way to compete is price.

3.2.2 The threat of entry How easy it is to enter the industry. The greater the threat of entry, the worse it is for the incumbents in an industry. An attractive industry has high barriers to entry in order to reduce the threat of new competitors. Barriers to entry: The factors that need to be overcome by new entrants if they are to compete in an industry. Typical barriers are:  Scale and experience - In some industries, economies of scale are extremely important (production). Once incumbents have reached large-scale production, it will be very expensive for new entrants to match them and until they reach a similar volume they will have higher unit costs. This scale effect is increased where there are high investment requirements for entry. Barriers also come from experience curve effects (incumbents: cost advantage as do things more efficiently than an inexperienced new entrant).  Access to supply or distribution channels- In many industries manufacturers have had control over supply and/or distribution channels (ownership or supplier loyalty). In some industries this barrier has been overcome by entrants who bypassed retail distributors (sold directly to consumers through e-commerce).  Expected retaliation- They believe that the retaliation of an existing firm will be too great to prevent entry or that entry would be too costly. The knowledge that incumbents are prepared to retaliate is often sufficiently discouraging to act as a barrier.  Legislation or government action - Legal restraints on new entry vary from patent protection (pharmaceuticals) to regulation of markets (pension selling), through to direct government action (tariffs). If governments remove such protection, vulnerability to new entrants increased.  Incumbency advantages – may have cost or quality advantages not available to entrants e.g. brand or customer loyalty

3.2.3 The threat of substitutes Substitutes: Products or services that offer a similar benefit to an industry’s products or services, but have a different nature. Example: Tablets for laptops; aluminium for steel; charities for public services ‘The threat of substitutes’ Substitutes can reduce demand for a particular type of product as customers switch to alternatives even to the extent that this type of product or service becomes obsolete. Actual switching not necessary for the threat to have an effect. The risk may put a cap on prices that can be charged in an industry. There are two important points to bear in mind about substitutes:  The price/performance ratio: critical to substitution threats. It is the ratio of price to performance that matters, rather than simple price (even if the product is more expensive, consumers can see performance advantages).  Extra-industry effects: the core of the substitution concept. The value is to force managers to look outside their own industry to consider more distant threats and constraints. The higher the threat of substitution, the less attractive the industry.

3.2.4 The power of buyers Buyers: The organisation’s immediate customers, not necessarily the ultimate consumers. Powerful buyers can demand low prices or costly product or service improvements. Buyer power is likely to be high when some of the following conditions prevail:  Concentrated buyers - Where a few large customers account for the majority of sales, the power is increased; a few retailers dominate the market.  Low switching costs - Where buyers can easily switch between one supplier and another, they have a strong negotiating position and can squeeze suppliers who are desperate.  Buyer competition threat - If the buyer can supply itself, or if it has the possibility to acquiring such a capability, it tends to be powerful. It is doing the suppliers’ job themselves (also called: backward vertical integration).  Low buyer profit and impact on quality - For industrial or organisational buyers there are two additional factors that can make them price sensitive and thus increase their threat: first, if the buyer group is unprofitable and pressured to reduce purchasing costs and, second, if the quality of the buyer’s product or services is little affected by the purchased product.

3.2.5 The power of suppliers Suppliers: Those who supply the organisation with what it needs to produce the product or service. The supplier power is likely to be high where there are: • Concentrated suppliers - Where there are just a few producers who dominate supply, suppliers have more power over buyers e.g. Iron ore

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High switching cost- When it is expensive or disruptive to move from one supplier to another, the buyer becomes dependent and weak. Supplier competition threat- Where they are able to cut out buyers who are acting as intermediaries; they are moving closer to the ultimate customer (also called: forward vertical integration). Differentiated products – when the products or services are highly differentiated, suppliers will be more powerful.

3.2.6 Complementors and network effects The ‘sixth force’: organisations that are complementors rather than simple competitors. Complementor: an organisation that enhances your business attractiveness to customers or suppliers. • Demand side: if customers value a product or service more when they also have the other organisation’s product there is a complementarity with respect to customers. For example, app providers • Supply side: if it is more attractive for a supplier to deliver to you when it also supplies the other organisation. For example, Boeing aircraft improvements Value net: a map of organisations in a business environment demonstrating opportunities for value-creating cooperation as well as competition. Network effects: when one customer of a product or service has a positive effect on the value of that product for other customers. For example: Ebay or Facebook. Industry is structurally attractive with high barriers to entry, low intensity of rivalry and power over buyers as entrants and rivals can’t compete with other companies’ larger networks and buyers become locked into them. In some industries complementors and network effects work in tandem. For example, App providers are complementors to Apple as customers

attracted by many apps. When more customers are attracted the network of users grows, which increases user value even further. Strategic lock-in is where users become dependent on a supplier and are unable to use another supplier without substantial switching costs. Complementors and network effects can create this. With customers securely locked in, it becomes possible to keep prices well above costs.

3.2.7 Defining the industry Several issues to consider: 1) Industry must not be defined to broadly or narrowly 2) The broader industry value chain needs to be considered. Different industries often operate in different parts of a value chain or value system and should be analysed separately. For example Iron ore industry deliver to the steel manufacturing industry that in turn deliver to a wide variety of industries such as automobiles and construction. 3) Most industries can be analysed at different levels, for example different geographies, markets and even different product or service segments within them. For example, the airline industry spans different geographical markets and also has different service segments within each market (e.g. leisure, business and freight)

3.2.8 Implications of the Competitive Five Forces It is important to use the framework for more than simply listing the forces; the bottom line is an assessment of the attractiveness of the industry and any possibilities to manage strategies in relation to the forces to promote long-term survival and competitive advantage. The analysis should do investigation of the implications of these forces, for example: • Which industries to enter (or leave) • How can the five forces be managed? • How are competitors affected differently? Although originating in the private sector, five forces analysis can have important implications in the public sector too.

3.3 Industry types and dynamics 3.3.1 Industry types There are four main types of industry structure: 1. Monopolistic industries Monopoly: Formally an industry with just one firm and therefore no competitive rivalry. There is a lack of choice between rivals, there is potentially very great power over buyers and suppliers; which can be very profitable. Mostly pure monopolies are rare because government regulators typically prohibit them.

Example: Google in early 2010 (65% of the search market). 2. Oligopolistic industries Oligopoly: Where just a few firms dominate an industry, with the potential for limited rivalry and threat of entrants and great power over buyers and suppliers. Oligopolistic firms have a strong interest in minimising rivalry between each other so as to maintain a common front against buyers and suppliers; therefore it can be very profitable. 3. Perfectly competitive industries Perfect competition: Where barriers to entry are low, there are many equal rivals each with very similar products, and information about competitors is freely available. 3. Hypercompetitive industries Hyper competition: Where the frequency, boldness and aggression of competitor interactions accelerate to create a condition of constant disequilibrium and change. Rivals tend to invest heavily in destabilising innovation, expensive marketing initiatives and aggressive price cuts, with negative impacts on profits (often occurs in oligopoly).

3.3.2 Industry structure dynamics Convergence is where previously separate industries begin to overlap or merge in terms of activities, technologies, products and customers.

The industry life cycle The industry life cycle concept: Proposes that industries start small in their development stage, then go through period of rapid growth (‘adolescence’), culminating in a period of ‘shake-out’. The final stages are first a period of slow/zero growth (‘maturity’) and then the final stage of decline (‘old age’). Each stage has implications for the five forces. One stage does not follow predictably after another: industries vary widely in the length of their growth stages. Some industries can rapidly ‘de-mature’ through radical innovation.

The development stage is an experimental one, typically with a few players, little direct rivalry and highly differentiated products. The five forces are likely to be weak, therefore, though profits may actually be scarce because of high investment requirements. The rapid growth phase is with low rivalry due to the plenty of market opportunity for everybody. Low rivalry and keen buyers of the new product favour profits at this stage, but these are not certain. Barriers to entry may still be low, as existing competitors have not build up much scale, experience or loyalty. Suppliers can be powerful too if there is a shortage of components or materials that fastgrowing businesses need for expansion. The shake-out stage begins as the market becomes increasingly saturated and cluttered with competitors. Profits are variable, as increased rivalry forces the weakest competitors out of the business. The maturity stage; barriers to entry tend to increase, control over distribution is established and economies of scale and experience curve benefits come into play. Products or service tend to standardise. Buyers may become more powerful as they become less avid for the industry’s products and more confident in switching between suppliers. Profitability at the maturity stage relies on high market share, providing leverage against buyers and competitive advantage in terms of cost. The decline stage can be a period of extreme rivalry, especially where there are high exit barriers. Survivors in the decline stage may still be profitable if competitor exit leaves them in a monopolistic position.

Comparative industry structure analyses You can compare the five forces over time in a simple ‘radar plot’. The five forces can be displayed on five axes. Comparing the five forces over time on a radar plot thus helps to give industry structure, where possible new industries to enter can be compared in terms of attractiveness.

3.4 Competitors and markets 3.4.1 Strategic groups Strategic group: Organisations within an industry or sector with similar strategic characteristics, following similar strategies or competing on similar bases. Example: in the grocery retailing industry, supermarkets, convenience stores and corner shops each form different strategic groups. There are many characteristics that distinguish between strategic groups but these can be grouped into two major categories: Which characteristics are relevant differs from industry to industry, but typically important are those that separate high performers from low performers. Characteristics that are shared by top performers, but not by low performers, are likely to be particularly relevant for mapping strategic groups. This can be visualized with two axes, as example; one axis might be the extent of the product range and the other axis the size of marketing spend.

The strategic group concept is useful in at least three ways: • Understanding competition- Managers can focus on their competitors with their strategic group instead of the whole industry. They can also establish the dimensions that distinguish them from other groups. • Analysis of strategic opportunities - It shows where the ‘strategic spaces’ are within an industry; the white spaces in the map. • Analysis of mobility barriers - Moving across the map to take advantage of opportunities is not costless. Therefore, strategic groups are characterised by mobility barriers, obstacles to movement from one strategic group to another.

3.4.2 Market segments Market segment: A group of customers who have similar needs that are different from customer needs that are different from customer needs in other parts of the market. These are often called ‘niches’ when they are small. These issues are particularly important in market segment analysis: • Variation in customer needs - Focusing on customer needs that are highly distinctive from those typical in the market is one means of building a secure segment strategy. Think about buyer behaviour as an indicator. • Specialisation- This is also called a ‘niche strategy’. Organisations that have experience in servicing a particular market segment should not only have lower cost, but also have built relationship which may be difficult for other to break down.

3.4.3 Critical success factors and ‘Blue Oceans’ Strategy canvas: Compares competitors according to their performance on key success factors in order to establish the extent of differentiation. There are three features which are important in this canvas: • Critical success factors (CSFs) are those factors that either are particularly valued by customers (i.e. strategic customers) or provide a significant advantage in terms of cost. An important source of competitive advantage or disadvantage. • Value curves: A graphic depiction of how customers perceive competitors’ relative performance across the critical success factors. What is the value of the CFS per company? • Value innovation: The creation of new market space by excelling on established critical success factors on which competitors are performing badly and/or by creating new critical success factors representing previously unrecognised customer wants; the blue ocean.

Blue Oceans: New market spaces where competition is minimised. Finding or crating market spaces that are not currently being served; finding strategic gaps. A value innovator is a company that competes in ‘Blue Oceans’. Red Oceans: Where industries are already well defined and rivalry is intense. Company C exemplifies two critical principles in Blue Ocean thinking: focus and divergence.

3.5 Opportunities and Threats The Strengths, Weaknesses, Opportunities and Threats (SWOT) analyses shape many companies’ strategy formulation. The techniques and concepts in this chapter should help in identifying environmental threats and opportunities, for instance: • PESTEL analysis of the macro-environment might reveal threats and opportunities presented by technological change, or shifts in market demographics or such like factors. • Identification of key drivers for change can help generate different scenarios for managerial discussion, some more threatening and others more favourable. • Porter’s five forces analysis might, for example, identify a rise or fall in barriers to entry, or opportunities to reduce industry rivalry, perhaps by acquisition of competitors. • Blue Ocean thinking might reveal where companies can create new market spaces; alternatively, it could help identify success factors which new entrants might attack in order to turn ‘Blue Oceans’ into ‘Red Oceans’....