4.1. Market structure

Question 1

What is an industry?

Answer 1

a group of companies that are engaged in a similar type of economic activity
Can be further refined as within “creative industries”, we have advertising, web design, 3D animation

Question 2

Define Porter’s 5forces analysis

Answer 2

a framework for the industry analysis and business strategy development developed by Michael E. Porter. It derives five forces which determine the competitive intensity and therefore attractiveness of a market.
- provides a theory of how
industry structure affects firm
profitability

Question 3

What are the 5 forces?

Answer 3

3 horizontal forces:
- threat of substitute products
- the threat of established rivals
- threat of new entrants
2 vertical forces:
- the bargaining power of suppliers
- the bargaining power of customers

Question 4

Define rivalry

Answer 4

rivalry among existing competitors takes forms usually of price war, aggressive products launches, advertisements

Question 5

When does profitability shrink/ rivalry increase?

Answer 5

1. when competitors are numerous (low industry concentration)
2. when competitors are roughly equal in size and power
3. industry growth is slow (slow market growth that forces firms to take a share from rivals if they wish to increase sales)
4. exit barriers are high (fixed costs vs. variable costs, industry with high fixed costs => fixed assets => difficult to exit the market because it cannot be sold off easily)
5. when products lack differentiation
6. when capacity must be expanded in large increments (e.g. buying a whole power plant, not just a few rooms)
7. when products are perishable
8. when there exist low customer switching costs (The negative costs that a consumer incurs as a result of changing suppliers, brands or products. e.g. Apple uses iTunes system that cannot be used on other devices, not differentiation)

Question 6

Why and when would companies run when there is low profitability growth?

Answer 6

When there exist high fixed costs which force firms to try to obtain economies of scale

Question 7

New entrants

Answer 7

want to gain a share in the market
likelihood of success depends on the entry barriers
entry barriers are high -> profitability are reserved

Question 8

When are entry barriers high?

Answer 8

1. when there exists high economies of scale
2. when there are high capital requirements
3. when there is high customer switching costs
4. when there are legal restrictions
5. unequal access to distribution channels
6. history of incumbent responses (high responsiveness -> high barrier)

Question 9

Suppliers

Answer 9

have higher bargaining power => profitability is threatened

Question 10

When do suppliers have high bargaining power?

Answer 10

1. Supplier’s industry is more concentrated/high concentration (few firms dominate the market) than the industry it sells to
2. Industry participants face switching costs (use airbus instead of boeing)
3. Suppliers offer differentiated products
4. Suppliers serve many industries

Question 11

Customers

Answer 11

exert their bargaining power

customers have higher bargaining power => profitability is threatened

Question 12

When do customers have high bargaining power?

Answer 12

1. Customers are concentrated and purchase in high volumes
2. Industry products are undifferentiated
3. There are no switching costs (for the firm)
4. There is a credible threat of backward integration

Question 13

Threat of substitutes

Answer 13

perform the same or similar function as an industry’s product, but by a different means
substitutes come from different industries, and are rarely perceived timely as a threat
substitutes become more attractive => profit is threatened

Question 14

When does threat of substitute magnify?

Answer 14

1. The price performance trade off is rapidly improving (car vs. oyster public transportation card)
2. Substitutes are produced by growing industries, generating high profits, and can invest to reduce prices