Chapter 2 / Week 2 (Economies of Scale, INV, Learning Curves, HHI index) Flashcards
Contemporary Strategy Analysis - Robert M. Grant
All slides beyond this until slide 13
Economic definition of industry
A group of firms that supplies a market
What is the difference between analyzing industry structure and analyzing market structure
Principle difference is that industry analysis, notably five forces analysis, looks at industry profitability being determined by competition in two markets:
1) Product markets
2) input market
Industries
Identified with relatively broad sectors
Markets
Related to specific products
Two sides of sustainability
1) Substitutability on the demand side
2) Substitutability on the supply side
1) Substitutability on the demand side
Are customers willing to substitute between Jaguars and mass-market brands on the basis of price difference?
2) Substitutability on the supply side
If manufacturers were able to switch their production from family sedans to luxury cars, and if jaguar could could enter other parts of the automobile market
The key test of geographical boundaries of a market is PRICE:
If price differences for the same product between different locations tend to be eroded by demand-side and supply-side substitution, then these locations llie within a single market
Substitutability is ____ in the long run then in the ____ run
Long
Short
The boundaries of a market or industry are seldom clear-cut: the market in which an offering competes is a ______ rather than a bounded space
Continuum
Example: If we define Disneyland as competing within the broad entertainment industry, then beach and ski resorts are _______, if we define Disneyland as competing in the theme park industry, then bean and ski resorts are _____
Rivals
Substitutes
END OF Contemporary Strategy Analysis - Robert M. Grant
END OF Contemporary Strategy Analysis - Robert M. Grant
The Herfindahl-Hirschman Index
All slides beyond this
The Herfindahl-Hirschman Index (AKA Herfindahl index)
HHI
Is a statistical measure of concentration
Can be used to measure concentration in a number of context
(become so popular by its use by the Department of Justice and the Federal Reserve in the analysis of the competitive effects of mergers)
Score less than 1800 or a change less than 50 = no concentrated
Above 1800 is concentrated or a merger increase of larger than 50 = concentrated
Market concentration
The degree of concentration of the output of firms in banking or industrial markets
Horizontal mergers
Firms operating in the same product and geographic markets
1992 Revised Guidelines
The guidelines, as applied to banking, specify that if a bank merger would result:
1) in a post-merger HHI in a market of less than 1,800
2) in a change in the HHI of less than 200 (less than 50 in other industries),
it is likely that the market structure would not reach a concentration level, or concentration would not increase enough, such that firms in the market would have the market power to maintain prices above competitive level for a significant period
If the post-merger HHI does not exceed the numerical guidelines:
It is generally presumed that the merger would not be seriously anticompetitive, and no further analysis is conducted
If the post-merger HHI exceeds the numerical:guidelines:
A detailed economic analysis of competition is undertaken to determine whether other factors, such as potential competition, indicate that the market would be more (or less) competitive then the HHI alone suggests
The HHI accounts for:
the number of firms in a market, as well as concentration, by incorporating the relative size (that is, market share) of all firms in a market
HHI = n>E, i=1 (MSi)>2
It is on paper for easier sake
Examples: Bank A holds 40 percent of bank deposits, Bank B holds 30 percent, Bank C holds 20 percent, Bank D holds 10 percent
Assume that Bank C with 20 percent of the market acquired Bank D, which has 10 percent of the market, calculate the HHI
(40)>2+(30)>2+(20)>2+10>2
1600 + 900+ 400+ 100 = 3000
(40)>2 + (30)<2 + (20+10)<2 =
1600 + 900 + 900 = 3400
Increases HHI by 400 from 3000 to 3400
The HHI reaches a maximum at
10000 when a monopoly exists
The HHI reaches zero, in theory
In purely competitive markets with many firms with small market share
Common HHI
1000: 10 firms, 10% per firm
2000: 5 firms, 20% per firm
3300: 3 firms, 33.3% per firm
5000: 2 firms, 50% per firm
END OF The Herfindahl-Hirschman Index
END OF The Herfindahl-Hirschman Index
Highly Concentrated: Companies That Dominate Their Industries IBIS World
Highly Concentrated: Companies That Dominate Their Industries STARTS HERE
IBISWorld has
identified the 10 most concentrated
industries in the United States,
with the
four largest companies in each industry
generating at least 90 percent of revenue.
Search Engines stats
Top four market share: 98.5%
Major companies:
Google: 64.1%
Yahoo: 18.0%
Microsoft: 13.6%
Search Engines explanation
This industry’s concentration has increased steadily during the past five years, primarily driven by Google’s growth while smaller search engines like Ask.com and AOL decline in prevalence.
Difficult entry due to skilled software programmers, IT professionals, and system engineers being needed
Unless an entrant chooses to license a competitor’s
technology, companies in this industry would need to develop their own algorithms
Arcade, Food & Entertainment Complexes
Top four market share: 96.2%
Major companies: CEC Entertainment Inc.: 52.2% Dave & Buster’s: 35.0% Sega Entertainment USA Inc. Namco Cybertainment Inc.
*CEC is commonly known as Chuck E. Cheese’s
Sanitary Paper Product Manufacturing
Top four market share: 92.7% Major companies:
Kimberly-Clark Corporation: 35.5%
Proctor & Gamble: 30.0%
Georgia-Pacific: 27.2%
Wireless Telecommunications Carriers
Top four market share: 94.7%
Major companies: Verizon Wireless: 36.5% AT&T Inc.: 32.1% Sprint Nextel Corporation: 15.4% T-Mobile USA: 10.7%
Wireless Telecommunications Carriers explanation
There were two waves of mergers and acquisitions (M&As) in this industry over the past decade.
First, there was a high level of M&A activity among the “baby bells” (the spin-offs of the former AT&T
monopoly) which led to the creation of new number-one and number-two players.
This event was then followed by a second wave of M&A activity that yielded a significant increase in concentration across the various telecommunications industries.
A large subscriber base is critical to competitiveness
because it delivers considerable scale economies, enabling a carrier to offer cheaper prices and realize higher margins.
Satellite TV Providers
Top four market share: 94.5%
Major companies:
DirecTV: 57.6%
Dish Network: 36.9%
Satellite TV Providers explanation
It is difficult for smaller players to compete
in terms of quality and the level of services they can offer to consumers at a reasonable price
In addition to the intense competition, high start-up costs and regulation have prohibited small producers from developing niche markets.
Soda Production
Top four market share: 93.7%
Major companies:
The Coca-Cola Company: 41.2%
PepsiCo: 33.6%
Dr Pepper Snapple Group: 15.4%
Expected to decline 4.5% first company with decline
Food Service Contractors
Top four market share: 93.2%
Major companies: Compass Group: 32.8% Aramark: 28.3% Sodexo: 25.6% Delaware North: 6.5%
Food Service Contractors explanation
Major industry clients are increasingly looking for
food-service contractors that can handle catering, property maintenance, security and other services.
This trend favors larger operators because smaller ones may not have the capital and infrastructure that is required to fill all of these roles for clients.
Additionally, new entrants are discouraged from entering the market because the large operators have higher marketing budgets, bargaining power in contract negotiations, better brand recognition and existing contacts.
Lighting & Bulb Manufacturing
Top four market share: 91.9%
Major companies:
General Electric Company: 32.9%
Koninklijke Philips Electronics NV: 31.7%
Siemens AG: 27.3%
Lighting & Bulb Manufacturing explanation
In addition to the dominance of existing players, many other factors make it difficult for any new companies to enter the industry, including:
1) significant government regulation,
2) resource constraints,
3) technological changes
4) the industry’s declining life cycle
New entrants must have the resources to stock high inventories and have a strong knowledge of niche markets to survive the high levels of internal competition.
Tire Manufacturing
Top four market share: 91.3%
Major companies: The Goodyear Tire & Rubber Company: 39% Michelin North America: 28.2% Copper Tire & Rubber Company: 12.5% Bridgestone: 11.6%
Tire Manufacturing Explanation
Experienced a wave of mergers and acquisitions since the 1980s, largely driven by an increase in cross-border production and trade by automobile manufacturers. As a result, most tire manufacturers were taken over and control transferred to foreign owners
Major Household Appliance Manufacturing
Top four market share: 90.0%
Major companies: Whirlpool Corporation: 43.8% AB Electrolux: 20.7% General Electric Company: 17.1% LG Electronics: 9.2%
END OF Highly Concentrated: Companies That Dominate Their Industries IBIS World
END OF Highly Concentrated: Companies That Dominate Their Industries IBIS World
EBOOK pg 148-158 Focus on Economies of Scale/Scope, learning curve and experience curve
EBOOK pg 148-158 Focus on Economies of Scale/Scope, learning curve and experience curve
ECONOMIES OF SCALE
Decreases in cost per unit as output increases.
(Example: You already own the radio tower and pay for it, the more people who use it, up to a certain degree, will keep owning the tower be cheaper over time
Economies of
scale allow firms to
1) Spread their fixed costs over a larger output.
2) Employ specialized systems and equipment.
3) Take advantage of certain physical properties
SPREADING FIXED COSTS OVER LARGER OUTPUT
Larger output allows firms to spread their fixed costs over more units. That is why gains in market share are often critical to drive down per-unit cost.
Spending 20 million on R&D looks bad at first, but when selling over 100 million copies of window 10, the price is significantly cheaper, and the more they sell the more the price per unit lowers
cube-square rule:
The volume of a body such as a pipe or a tank increases disproportionately more than its surface.
minimum efficient scale (MES)
Output range needed to bring down the cost per unit as much as possible, allowing a firm to stake out the lowest-cost position that is achievable through economies of scale.
diseconomies of scale
Increases in cost per unit when output increases.
As firms get too big, the complexity of managing and coordinating the production process raises the cost, negating any benefits to scale.
Dampens motivation, shortages of inputs, time pressures
Scale economies
are critical to driving down a firm’s cost and strengthening a cost-leadership position.
LEARNING CURVE History
first documented in aircraft manufacturing as the United States ramped up production in the 1930s, before its entry into World War II. Every time production was doubled, the per-unit cost dropped by a predictable and constant rate (approximately 20 percent)
The steeper the learning curve
the more learning has occurred.
As cumulative output increases, firms move down the learning curve, reaching lower per-unit costs.
In a 90 percent learning curve, per-unit cost drops
10 percent every time output is doubled.
It is important to note that the learning-curve effect is driven by
increasing cumulative output within the existing technology over time.
That implies that the only difference between two points on the same learning curve is the size of the cumulative output
Differences in timing
Learning effects occur over time as output accumulates, while economies of scale are captured at one point in time when output increases.
There are no diseconomies to learning
there are no diseconomies to learning
Differences in complexity
In some production processes (e.g., the manufacture of steel rods), effects from economies of scale can be quite significant, while learning effects are minimal. In contrast, in some professions (brain surgery or the practice of estate law), learning effects can be substantial, while economies of scale are minimal.
EXPERIENCE CURVE
Holds cumulative output constand (whereas learning curve held price constant and changed cumulative)
Process
innovation
a new method or technology to produce an existing product
Learning vs experience curve
Learning by doing allows a firm to lower its per-unit costs by moving down a given learning curve, while experience-curve effects based on process innovation allow a firm to leap-frog to a steeper learning curve, thereby driving down its per-unit costs
END OF 148-158
END OF 148-158
Start of Vertical integration along the industry value chain; Pages 191-197.
Start of Vertical integration along the industry value chain; Pages 191-197.
The first key question when formulating corporate strategy is:
In what stages of the industry value chain should the firm participate?
Vertical integration
the firm’s ownership of its production of needed inputs or of the channels by which it distributes its outputs.
Shirt manufacturer going to clothing store
Industry value chain (vertical value chain)
Depiction of the transformation of raw materials into finished goods and services along distinct vertical stages, each of which typically represents a distinct industry in which a number of different firms are competing.
Examples of a backward and forward vertical integration along the industry value chain
Stage 1: raw materials Stage 2: Components, intermediate goods Stage 3: FInal assembly, manufacturing Stage 4: Marketing, Sales Stage 5: After-sales service and support
Stage 1: raw materials
The raw materials to make your cell phone, such as chemicals, ceramics, metals, oil for plastic, and so on, are commodities.
Stage 2: Components, intermediate goods
Elements such as integrated circuits, dis-plays, touchscreens, cameras, and batteries are provided by firms
Stage 3: FInal assembly, manufacturing
Original equipment manufacturing firms (OEMs) such as Flextronics (Singapore) or Foxconn (Taiwan) typically assemble cell phones under contract for consumer electronics and telecommunications companies such as Apple
Stage 4: Marketing, Sales
Stage 5: After-sales service and support
Finally, to get wireless data and voice service, you pick a service provider such as AT&T,
How many people use this full 5-step model?
In general, fewer firms are fully vertically integrated.
Most firms concentrate on only a few stages in the industry value chain, and some firms just focus on one
backward vertical integration
Changes in an industry value chain that involve moving ownership of activities upstream to the originating (inputs) point of the value chain.
forward vertical integration
Changes in an industry value chain that involve moving ownership of activities closer to the end (customer) point of the value chain.
BENEFITS OF VERTICAL INTEGRATION
Vertical integration, either backward or forward, can have a number of benefits, including:
1) Lowering costs. Improving quality.
2) Facilitating scheduling and planning.
3) Facilitating investments in specialized assets.
4) Securing critical supplies and distribution channels.
specialized assets
Unique assets with high opportunity cost: They have significantly more value in their in-tended use than in their next-best use. They come in three types: site specificity, physical-asset specificity, and human-asset specificity
Site specificity
assets required to be co-located, such as the equipment necessary for mining bauxite and aluminum smelting.
Physical-asset specificity
assets whose physical and engineering properties are designed to satisfy a particular customer. Examples include the bottling machinery for E&J Gallo.
Human-asset specificity
investments made in human capital to acquire unique knowl-edge and skills, such as mastering the routines and procedures of a specific organization, which are not transferable to a different employer.
Opportunism
defined as self-interest seeking with guile
RISKS OF VERTICAL INTEGRATION
It is important to note that the risks of vertical integration can outweigh the benefits. Depending on the situation, vertical integration has several risks, some of which directly counter the potential benefits, including:
1) Increasing costs.
2) Reducing quality.
3) Reducing flexibility.
4) Increasing the potential for legal repercussions.
vertical market failure
When the markets along the industry value chain are too risky, and alternatives too costly in time or money.
END OF Start of Vertical integration along the industry value chain; Pages 191-197.
END OF Start of Vertical integration along the industry value chain; Pages 191-197.
Strategic Management Frank T. Rothaermel
Strategic Management Frank T. Rothaermel
M&A
Mergers and acquisitions
Merger defintion
Joining of two independent companies to form a combined entity
Aspects of a merger
Tend to be friendly
Example: Disney’s acquisition of Pixar was a friendly one, in which both management teams believed the joining was a good idea
Acquisition definition
The purchase or takeover of one company by another
Can be friendly or unfriendly
____ can also be a defining factor for mergers and acquisitions
Size!
The combining of two firms of comparable size is often described as a merger when it may be an acquisition
Hostile takeover
Acquisition in which the target company does not wish to be acquired
Horizontal integration
The process of merging with competitors, leading to industry consolidation
Clothing store buying another clothing store
3 benefits to horizontal integration:
1) Reduction in competitive intensity
2) Lower costs
3) Increased differentiation
4) Gain access to new capability or competency
5) Gain access to new market
Horizontal integration can favourably affect several of Porter’s five forces for the surviving firms:
1) Strengthening bargaining power vis-a-vis supplies and buyers
2) Reducing the threat of entry
3) Reducing rivalry among existing firms
The FTC and or the European commision usually must do what?
Approve any large horizonal integration activity
Horizontal integration for lower costs
Through economies of scale, enhance their economic value creation, and in turn their performance
Firms with high fixed costs must reach economies of scale to make money
Horizontal integration through M&A can help firms strengthen their competitive positions by increasing the differentiation of their products and service offerings
This is done by filling in gaps in a firm’s product offerings
END OF Strategic Management Frank T. Rothaermel
END OF Strategic Management Frank T. Rothaermel
START OF Concepts in strategic management and business policy
START OF Concepts in strategic management and business policy
Value chain (Industry value chain IVC)
Linked set of value-creating activities that begin with basic raw materials coming from suppliers, moving on to a series of value-added activities involved in producing and marketing a product or service, and ending with distributors getting the final goods into the hands of the ultimate consumer
Value-chain analysis works for every type of business
Regardless if it is a service or manufacture a product
Typical value-chain for a manufactured prouct
Raw materials > Primary manufacturing > Fabrication > Distributor > Retailer
The value chains of most industries can be split into two segments
1) Upstream
2) Downstream
Center of gravity
Part of the chain where the company’s greatest expertise and capabilities lie – its core competencies
Porter proposes that a manufacturing firm’s primary activities usually begin with _____
Inbound logistics (raw materials handling and warehousing)
Primary activities
Inbound logistics > Operations > Outbound logistics > Marketing and Sales > Sales
Corporate value-chain analysis involves 3 steps
1) Examine each product line’s value chain in terms of the various activities involved in producing that product or service
2) Examine the “linkages” within each product line’s value chain
3) Examine the potential synergies among the value chains or different product lines or business units
Linkages
The connections between the way one value activity (IE marketing) is performed and the cost of performance of another activity (IE quality control)
Economies of scope
Results when the value chains of two sperate products or services share activities, such as the same marketing channels or manufacturing facilities
Video From Norine
Company’s portion of the total scales in relation to the market or industry in which it operates
Questions to ask for market share
What market is most relevant to you?
What time period is required?
What specific sales info can be used?
CHanges in market share are monitored by investors and industry analsysts
- Signals the relative competitiveness of a company
- Increases in MS should allow a company to achieve a greater scale in operations (lower costs, increase profitability)
Market share reflects state of industry
- If industry is growing, the company wants to grow at the same pace or faster
- Mature companies and major players “fight” to increase market share
Why may a market share differ over time?
- New competitor enter or competitor exits
- Competitor has undertaken some M&A activity
- MS calculated during a competitor promotion / sale
Industry Structure
Largely determined by number and size of competitors (Aka degree of concentration)
Reasons for merger and acquisitions
- improve cost and quality
- Acquire new capabilities / technologies
- Gain market share
- Stop intense competition
- Enter new markets
HHI in theory
A^2+B^2+C^2+N^2
1
For this course we ONLY USE THE FIRST 4 INDUSTRIES
If HHI is less than 1800 or change in HHI is less than 50, than the industry is _______________________
not concentrated
(Therefore, HHI>1800 =
Lecture and beyond
Lecture and beyond
“Diamond E Framework”
1) Want to do
2) Need to do
3) Can do
How does a company attain Economies of scale?
- Spread fixed costs over greater volume
- Perform operations differently and more efficiently at larger volume
- “Redesign” products for volume production, including specialized systems and equipment
- Use purchasing power to reduce material costs
- Take advantage of physical properties (ie bigger stores)
- Improve capacity utilization (some plants only operate 1-2 8 hour shifts)
First mover advantage (FMA)
Generally accepted belief that an early entry into a new industry or product category yields an insuperable head start
- Better access to resources / channels / customers
- Steps ahead on experince and learning curve
Research shows this doesn’t always hold true
Depends on dynamic of industry
- Market growth
- Tech changes
Hyper-competition
Everyone is fighting to be the best and be the first, no one can get ahead of the game
Frequency, boldness, and aggressiveness of dynamic movement by players accelerates to create a condition of constant disequilibrium and change
Short product life cycles
New technologies
Frequent entry by outsidersRepositioning by incumbents
Tactical redefinition of industry boundaries
Companies are willing to cannibalize their own products to gain any competitive advantage
Hard to maintain competitive advantage as the competitors imitate successful strategies (Samsung releasing a product, apple soon having that too)
Cannibalization from a business POV
Competing against your own products
Example: New iPhone coming out each year
Upstream players
Your suppliers and your suppliers suppliers
Costs, performance features, and quality of inputs provided by suppliers
Upstream providers influence your costs and product performance
Upstream providers influence your costs and product performance
Down stream players
All whole sale /retail channel intermediaries between you and the buyer/user
Costs and margins are part of price paid by ultimate end-user
Activities performed by downstream partners affect the satisfaction of your end-users
Activities performed by downstream partners affect the satisfaction of your end user, and the price
Steps to identify a IVC
1) Identify the major activities / stages
2) Determine the required elements at each stage (equipment, supplies, resources, knowledge, labor)
3) Determine the unique value/quality contributed at each stage
4) Identify which stage(s) are core to industry and undertaken by industry players (center of gravity)
Revised generic industry value chain for a manufactured product
Sage 0: Product design Stage 1: raw materials Stage 2: Components, intermediate goods Stage 3: FInal assembly, manufacturing Stage 4: Marketing, Sales Stage 5: After-sales service and support STage 6: Recycling
DO NOT USE INTERNAL OR ORGANIZATIONAL VALUE CHAIN
DO NOT USE MICHAEL PORTER’S CHAIN
Market share definition
A company’s portion of the total sales in relation to the market or industry in which it operates
Changes in MS are monitored by investors and industry analysts
Signals the relative competitiveness of a company
Increases in MS should allow a company to achieve greater scale in operations
Lower costs
Increase profitability
Why might your market share differ over time
Assuming a company has not done anything different, and there are no major breakthroughs or product launches
A new competitor enters market/competitor exits market
A competitor has undertaken some M&A activity
MS Calculated during competitor promotion / sale
Industry grows
it depends on how much business you gain from
growth and if your company grows faster or slower
than industry
Reasons for M&A (merger and acquisition)
Improve cost and quality Acquire new capabilities/technologies Gain market share Stop intense competition Enter new markets
How does a company attain EOS (Economies of scale)
Spread fixed costs over greater volume
Perform operations differently and more efficiently at larger volume
“Redesign” products for volume production, including specialized systems and equipment
Use purchasing power to reduce material costs
Take advantage of physical properties (ie big box stores)
Improve capacity utilization
