PS2 Solution - Lecturer: Dr. Rachel Male PDF

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Lecturer: Dr. Rachel Male...

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ECN302 Corporate Strategy Problem Set 2 – Solutions Industry Analysis: The Five-Forces Framework True or False? Q1.

Concentration in an industry is frequently measured by the concentration ratio, which is represents the combined market share of the industry’s leading firms.

True (Grant, 2016 p.72 or 2018 p.69) Q2.

Excess capacity motivates firms to increase prices to cover their fixed costs.

False (Grant, 2016 p.73 or 2018 p.70) Q3.

Retaliation against a new entrant may take the form of aggressive price cutting, increased advertising, sales promotion, or litigation.

True (Grant, 2016 p.71 or 2018 p.68) Q4.

If an industry earns a return on capital in excess of its cost of capital, in the absence of entry barriers, incumbent firms will earn abnormal profit and build a sustainable competitive advantage.

False. It will attract firms from outside the industry, and the rate of profit will fall towards its competitive level. (Grant, 2016 p.70 or 2018 p.66)

Analysis Questions: Q5.

How do Porter’s five forces of competition explain the attractiveness of the industry?

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Porter’s model decomposes the overall competitive tension in the industry into five forces (or five tensions) between different existing / potential players or products / services within the industry. The bargaining power of suppliers and customers, the threat of new entrants, and internal rivalry describe tensions between players whereas the threat of products of substitution focuses on a potential tension related to the choice of a product or service originating in a different industry.



The fundamental assumptions are that the overall competitive intensity is the sum of these five forces (or sub-tensions) and that these five forces are themselves driven by a set of dimensions within the industry, such as the existence of barriers to entry and exit, the ability to create differentiated products, the relative importance of the product for the players, the structure of the industry in terms of the continuum monopoly – perfect competition, etc.



The intensity of competition and the detail of the industry characteristics will determine if that industry is worth the entry and what would be the cost, the difficulties, and the return a potential entrant may expect.

Q6.

Table 3.1 (Grant, 2018) shows the profitability of US industries between 2010 and 2016. Comparing the most profitable industries (e.g. Tobacco, Computer Software, and Household and Personal Products) and the least profitable (e.g. Motor Vehicles and Airlines), use Porter’s (1979) Five-Forces Framework to briefly explain the observed differences in profitability.

ECN302 Corporate Strategy Problem Set 2 – Solutions (Hint: you do not need to perform a detailed five forces analysis for each industry, just identify the main factors affecting the industry and hence profitability) High profit industries: Tobacco. The high profitability of the industry is primarily a result of limited competitor rivalry within the industry. This reflects high concentration (US industry dominated by Altria and R.J. Reynolds) and high product differentiation (most consumers strongly brand loyal). Other forces also weak: entry barriers high (government restrictions of advertising handicaps potential entrants), no close substitutes, supplier power weak (tobacco growers are fragmented), so is buyer power (cigarettes distributed through very wide range of retail outlets, none with significant clout). Computer software. A highly segmented market, but many of these segments (e.g. operating systems, office productivity software, database management software, and document formatting software) are either monopolies or duopolies protected by high barriers to entry and high user switching costs. Household & personal products. Industry rivalry weak due to few competitors (many product areas dominated by P&G and Unilever) and high levels of product differentiation (supported by heavy advertising) resulting in brand-loyal, price insensitive customers and limited incentives for the main companies to compete on price. Barriers to entry high due to control over distribution (newcomers have difficulty getting shelf space). Pharmaceuticals. Patent legislation means that the industry is fragmented by drug type and each firm has a statutory monopoly over its patented drug. For each medical condition there are typically several alternative drugs, however, price competition between them is limited since consumers have limited choice—it’s their doctors who select which drug to prescribe. Buyer power is primarily exercised by medical groups (e.g. HMOs in the US) or by public authorities in countries where there is socialized medicine. For drugs where patents have expired, the competitive situation is very different due to the presence of multiple producers of “generic” drugs. Profit margins are much lower on these drugs.

Low profit industries: Motor vehicles. The key force here is internal industry rivalry. There are about 20 major global producers of automobiles supplying the US market or which only two are US-based (GM and Ford). Most of these have excess capacity. The importance of scale economies mean that they all wish to expand market share. Among mass-market vehicles, product differentiation and brand loyalty are weak. The suppliers of sophisticated, technology-intensive components (e.g. antilock braking systems, fuel injection systems, etc.) exert significant supplier power. Ride-share services are increasingly important substitutes for car ownership in urban areas. Airlines. In terms of rivalry: although on most routes there are 4 or fewer competitors, price competition tends to be strong because of low product differentiation, excess capacity, high exit barriers, and the preponderance of fixed costs in their cost structures. Hence, when excess capacity triggers price competition, prices can fall far below the break-even point. Suppliers (plane manufacturers, airport owners, and labor unions—especially pilots) exercise substantial bargaining power. Buyers have limited bargaining power but are price sensitive and have low switching costs. Substitutes (especially for journeys >300 miles) are few, but video conferencing growing and offers cost effective and efficient alternative (especially during the pandemic).

ECN302 Corporate Strategy Problem Set 2 – Solutions Q7.

Perform a five forces analysis for the UK food retail industry (e.g. supermarkets).

Competitors: (Strong)  Despite being a highly concentrated market1, it is highly competitive due to low switching costs, buyer price sensitivity and lack of differentiation of many products.  Concentration has declined in last few years reflecting increasing market share of discount retailers, this has intensified price competition. (CR4 ratio has declined from 73.5% in 2013 to 68% in 2020)  Zero-sum game – gains by one supermarket, come at the expense of the other players in the market. (All four market leaders have lost market share over the last 5 years, as the discount retailers have made gains).  High concentration can make it easier to cooperate with supermarkets tending to compete on selected items for limited time periods rather than entering destructive price wars.  Tesco’s launched discount store “Jacks”, which could trigger a price war with other discount retailers (Aldi, Lidl), but growth of this chain has been very slow.  There is also significant non-price competition – branding, advertising, loyalty schemes, ownbrand products, exclusive products (all of which aim to increase switching costs and hence increase customer loyalty).  Diversification for most supermarkets (e.g. non-food products, pharmaceuticals, banking and finance services), help to offset some of the dependence on UK food sales.  War on online delivery capacity and time slots, as pressure to offer same day deliveries increases; driven by introduction of Amazon Fresh. Suppliers: (Weak to moderate)  Individual suppliers tend to be small component of Supermarket’s total costs – low bargaining power.  Limited differentiation of many products – low bargaining power.  Supermarkets dictate price (if supplier does not accept, left with very small market for their product).  Some larger suppliers (e.g. Proctor and Gamble, Unilever) or suppliers of branded products have stronger bargaining power.  Supplier power has been reduced by backwards integration of supermarkets (own brand) Buyers: (Moderate)  Low switching costs.  Price sensitive.  Little individual power, but strong collectively.  Brand loyalty and consumer tastes determine diversity of products in store.  Loyalty schemes (e.g. Tesco Clubcard, Nectar Card, My Waitrose) try to minimise switching; if can successfully reduce buyer mobility then bargaining power of buyers will be reduced.  Consumer preference determines demand: significant increase in market share for Aldi and Lidl, as consumers switch to discount stores; pressure to introduce same day delivery slots may cause this segment of consumers to switch to the most efficient store. Potential Entrants: (Moderate)  High capital costs.  Need to establish economies of scale and distribution channels. 1

Grocery market share (12 weeks ending 24/01/2021): Tesco 27.3%, Sainsbury’s 15.7%, Asda 14.6%, Morrisons 10.4%, Aldi 7.4%, Co-Op 6.0%, Lidl 5.9%, Waitrose 5.0%, Iceland 2.5%, Ocado 1.7%, independent and other retailers 3.4%.

ECN302 Corporate Strategy Problem Set 2 – Solutions      

Risk of retaliation by established supermarkets. Branding – strong branding of UK supermarkets makes it extremely difficult for new entrants to establish themselves. Moderate sales growth may attract new entrants. {Has been some entrance during the last 30 years, including Wal-Mart (by acquiring Asda in 1999) and by larger European brands, e.g. ALDI (1989) and LIDL (1994)} Entry possible by smaller, niche retailers (e.g. organic wholefoods) Threat of larger scale entry by online retailers, e.g. Amazon.

Substitutes: (Weak)  Food service industry (Restaurants / Take-away food)  Meal-Kit industry (e.g. HelloFresh)  On-line retailers (e.g. Amazon) (especially for branded non-food products).  Subsistence farming...