Chapter 4: Industry & sector analysis Flashcards
Describe Porters Five Forces: Competitive rivalry
Competitive rivals are organisations aiming at the same customer groups with similar products and services (so not substitutes). Ex rivalry between airline industries, not trains.
Five factors define the extent of rivalry in an industry or market:
1.Competitor concentration and balance
The similar competitors are in terms of size and market share, the more rivalry. Incumbents want to gain dominance and this can be done through aggressive price cuts → price wars.
Vice verse, industries with little rivalry might have only two dominant organisations. They usually won’t seek to dominate the other through the same strategies. Instead, they try to, for example, focus inwards on their niches and not get attention from the other company.
2. Degree of differentiation
For very similar products, meaning there is no differentiation, like the commodity market (wheat), rivalry is increased. This is because there is little to sop the customers to switch between competitors. So the only way for companies competing while being little differentiated is on price.
3. Industry growth rate
The industry growth rate affects competitive rivalry because it influences how much opportunity there is for companies within the industry to expand.
In a fast-growing industry (high growth rate; introduction or growth), companies have plenty of opportunities to capture new customers and expand their market share. Because there’s enough “room” for everyone to grow, competition tends to be less intense. Rivalry is lower because businesses don’t need to aggressively fight for the same customers.
On the contrary, in a slow-growing or stagnant industry (low growth rate; maturity or decline stage), the market is not expanding as much, so companies must compete more fiercely to gain or maintain their share. When there’s little to no growth, the only way to grow is to take customers away from competitors, which increases competitive rivalry. Usually there is price competition and low profitability.
The industry life cycle (introduction, growth, maturity, decline) influences the growth rates, and hence competitive conditions. So really this section is about where the industry is in the industry life cycle, and depending on where it is, it affects the competitive conditions.
4. High fixed costs
Companies can have high fixed costs because of high investments in capital equipment or research (ex airline industry). They need to spread their costs by selling more to cover these costs (meaning that they will reduce their unit costs) and this can lead to more aggressive competition.
In simple terms, high fixed costs force companies to compete harder to make enough money, leading to higher competitive rivalry. In the end this can create price wards in which all competitors in the industry suffer.
Think of airlines as an example. Airlines have high fixed costs like buying planes and paying for airport gates. Even if the flight is half-empty, the airline still has to pay for the plane and the staff. So, airlines compete fiercely to fill their seats by offering discounts, special deals, or better services, leading to intense rivalry in the industry.
5. High exit barriers
High exit barriers (such as high sunk costs, contractural obligations, emotional or strategic reasons) increase competitive rivalry because they make it difficult for companies to leave the industry, even if they’re not profitable. When companies can’t easily exit, they are forced to stay and keep competing, which drives up rivalry since they are not leaving the industry.
Two examples:
Steel industry: Steel manufacturers invest in expensive, specialized equipment and plants. If demand falls, these companies can’t easily exit because they’ve invested so much in their factories. As a result, they stay and compete, even at a loss, which can lead to price wars.
Retail industry: Large retail stores with long-term leases might stay open even when they’re unprofitable because it’s cheaper than breaking the lease. They keep competing for customers to minimize losses, which heightens rivalry.
What is the threat of entry?
Barriers to entry are the factors that need to be overcome by new entrants if they are to compete in an industry. The threat of entry refers to the possibility that new companies might enter an industry and compete with existing businesses. This affects industry attractiveness (how appealing it is for companies to operate in) because when the threat of new entrants is high, (meaning that the entry barriers are low) it can reduce profitability for the existing players. They might have to lower their prices to stay competitive or spend more money on R&D which is driving up internal costs. Low entry barriers might also make a company lose market share, increasing rivalry. There can be low entry barriers when the access to resources is easy or when regulations are few.
There can, on the contrary, be high entry barriers (low threat of entry) when incumbents have strong brand loyalty, high start-up costs or government regulations. All of these factors protects existing companies from new competitors. This makes the industry much more attractive.
In simple terms, the easier it is for new companies to enter an industry, the less attractive that industry becomes for existing players, as they have to work harder and make less profit.
What are the five factors of barriers to entry?
Five important entry barriers are:
1.2.2.1 Economies of scale (supplier side and demand/buyer side)
Ex in Pharma companies there is very high fixed costs for R&D that must be spread over a high level of output. Once they have reached a large-scale production it will be very hard and expensive for new entrants to match them. (supply side)
Another scale barrier comes from the experience curve effects. Existing incumbents have a cost advantage because they have learned how to do things more efficiently than a new and unexperienced player. (supply side)
There are also demand or buyer side economies of scale, aka network effects, as buyers value being in a network of a larger number of other customers. Network effects occur when the value of a product or service increases as more people use it. This makes it harder for new companies to enter the market because they can’t easily match the customer base of established companies.
More Users = More Value: For certain products or services, the more people that use it, the more valuable it becomes to each individual user. For example:
Social Media: Facebook is valuable because millions of people use it. If only a few people were on it, the platform wouldn’t be as useful.
Online Marketplaces: On platforms like eBay or Amazon, buyers benefit from having many sellers, and sellers benefit from having many buyers.
A new company trying to enter the market has a tough time competing because it doesn’t have that large user base yet. Customers may prefer the existing product because it already has many users, making it more valuable (thanks to the network effect).
1.2.2.2 Customer switching costs
Customer switching costs refer to the costs (financial, time, or effort) that a customer has to bear when switching from one product or service to another. These costs can create a barrier for new companies trying to enter an industry, making it harder for them to attract customers.
High Switching Costs = Less Likely to Switch: If existing customers face high switching costs, they are less likely to change to a new company. This reduces the likelihood that customers will leave an established business for a new entrant. Because customers are “locked in” with their current providers due to high switching costs, new companies will struggle to attract enough customers to be profitable. This makes the industry less attractive for new entrants, lowering the threat of entry. So, when switching costs are high, the threat of entry is lower because it creates a barrier for new entrants.
Example: Your business uses Teams. Switching to a Slack means re-training employees, transferring data, and possibly losing compatibility with existing tools. These costs make it difficult for new software companies to convince customers to switch.
1.2.2.3 Capital requirements
If you need high levels of financial resources to enter an industry, new companies are less likely to try to enter → lower threat of entry. Again, like the Pharma industry.
1.2.2.4 Access to supply or distribution channels and other incumbency advantages
When existing incumbents have ex control over supply and/or distribution channels. Ex through direct ownership (vertical integration) or through customer and supply loyalty. Or having access to technology (patents) or brand identify (Coca Cola).
Supply Channels: Established companies often have long-term relationships with suppliers, giving them favorable terms, better prices, or reliable access to essential resources. New entrants may find it hard to negotiate similar deals, increasing their costs. Large brands like Coca-Cola or Pepsi have strong relationships with grocery stores and vending machine companies. It’s difficult for a new beverage company to get the same prominent shelf space or vending machine spots, making it harder for them to compete.
Distribution Channels: Incumbents may already have established distribution networks—like shelf space in retail stores or partnerships with delivery companies. New entrants will have a harder time getting their products to customers, either because distributors already have agreements with incumbents or because new entrants lack the scale or trust to get priority. Major pharmaceutical companies have established relationships with hospitals and pharmacies. New drug manufacturers might struggle to get their products distributed as widely.
1.2.2.5 Expected retaliation (response)
Expected retaliation affects the threat of entry because if new companies believe that existing players (incumbents) will aggressively defend their market position, they may be discouraged from entering the industry. Aggressive defense can be such as price cuts, increased marketing, or legal challenges, and this raises the costs and risks of entering the market. This makes the industry less attractive to enter.
Example: Tech Industry: A new software company entering the market might expect a tech giant like Microsoft or Google to respond by bundling similar services into their existing products, making it harder for the new entrant to gain customers.
In simple terms, if new companies believe established players will fight hard to keep their position, they’ll think twice about entering the market, which reduces the chance of new competition.
What is the threat of substitutes and which are the two important factors of it?
Substitutes = products or services that offer the same or a similar function and benefit to an industry own products or services but have a different nature. Ex: aluminum is a substitute for steel. Or using a tablet computer instead of a laptop.
There are two important points here:
1.2.3.1 Extra-industry effects
Substitutes come from outside the incumbents industry and should not be confused with competitors threats from within the industry. Therefore its important to look outside your industry. If the buyers switching costs for the substitute is low, then the threat of substitutes increases. The higher the threat, the less attractive the industry is. The term“extra-industry effects”is used to indicate influences or impacts that originateoutsidea specific industry but still affect that industry’s dynamics, particularly concerning the threat of substitutes.
1.2.3.2 The price/performance ratio
Not only price matters, performance and value as well.
Ex aluminium is more expensive than steel, but its lightness and resistance to corrosion give it an advantage in some automobile manufacturing applications.
What is the power of buyers? And what three conditions apply when buyer power is likely to be high?
Buyer = the organisations immediate customers, does not always mean end consumer. If buyers are powerful, they can demand low prices.
Buyer can be = Walmart
Supplier = Unilever
Buyer power is likely to be high when some the four following conditions applies:
1.2.4.1 Concentrated buyers
Buyer power is high when there are concentrated buyers (a few large buyers) because these buyers have more leverage over suppliers. So when a small number of buyers account for a large portion of a supplier’s sales, they can exert pressure on the supplier in several ways, leading to stronger bargaining (negotiation) power.
Fewer Buyers = More Influence: If a supplier relies on a small number of large buyers for most of its sales, losing even one buyer can significantly hurt the supplier’s business. This gives the buyer the upper hand in negotiations because the supplier can’t afford to lose them.
Concentrated buyers can demand for lower prices: because they know that the supplier depends on their business. Suppliers might have to accept lower profit margins to keep these large buyers.
Example: In the retail industry, large supermarket chains like Walmart or Tesco have large buying power because they represent a significant portion of sales for many suppliers. These chains can use their influence to demand lower prices or better terms from suppliers, who depend on them for business.
1.2.4.2 Low switching costs
If the buyer (Walmart) can easily switch between one supplier and another (from Unilever to Procter & Gambler) then Walmart have a strong negotiating position and can squeeze suppliers who are desperate for their business to run.
Switching costs are typically low for standardized products and undifferentiated commodities such as steel because these products are largely the same, regardless of which supplier you buy them from. Switching costs are also more likely to be low when the buyers are fully informed about prices and product performance because buyers can easily compare options and make decisions that benefit them. Standardized market price like oil.
1.2.4.3 Buyer competition threat (backwards vertical integration)
If the buyer (Walmart) has the capability to supply itself (maybe by creating Walmarts own deodorant brand), or if it has the ability to acquire such an capability, then its very powerful in negotiation with suppliers; it raises the threat of doing the suppliers job themselves! (backwards vertical integration).
What is the power of suppliers?
Suppliers are those who supply the organization with what it needs in order to produce the product or service.
Supplier: chip manufacturer like Intel
Buyer: computer manufacturer like Dell
Supplier power is likely to be high where there are:
1.2.5.1 Concentrated suppliers
Where just a few producers dominate supply, suppliers have more power over buyers.
1.2.5.2 High switching costs
If it is expensive to move from one supplier to another then the buyer becomes dependent on the supplier. And this increased the power of the supplier. Buyers are prepared to pay a premium to avoid the problem.
1.2.5.3 Supplier competition threat (forwards vertical integration)
Suppliers have increased power where they are able to enter the industry themselves or cut out buyers who are acting as intermediaries.
1.2.5.4 Differentiated products
When the products or services are highly differentiated, suppliers will be more powerful. For example, although Walmart is powerful, suppliers like P&G still have high negotiating power.
What is the purpose of the five forces?
The purpose of the five forces is to: conclude whether there are advantageous strategic positions where the organisation can
- defend itself from strong competitive forces
- exploit weak ones
- or influence the forces in its favor
What is three different industry types?
Monopoly, oligopoly, perfect competition.
Describe monopoly
One firm. Unique products or services. Very high entry barriers. Forces are low.
Firms can still have monopoly power where they are simply the dominant competitor based on network effects; Google has over 60% of market share for the US search engine market which gives it price setting powers.
Often industries are monopolistic because of economies of scale: water utility companies. Its uneconomic for small players to try to compete. So the government sometimes gives one firm the right to be the only supplier.
Describe oligopoly.
A few firms. Differentiation varies. High entry barriers. Forces varies.
Duopoly = just two oligopolistic rivals; like Airbus and Boeing.
Describe perfect competition
Many firms. Similar products or services. Low entry barriers. Forces are high.
Information about prices, products and competitors are perfectly available.
Competition focuses on price because products are standardized and undifferentiated.
Firms are unable to earn more profit than the bare minimum required to survive. Ex agriculture.
More common with slightly imperfect so that products can be differentiated to a certain degree: restaurants, hairdressers..
What are ways to understand change in industry structure?
Industry life cycle and comparative industry structure analysis
What is the industry life cycle?
The industry life cycle underlines the importance of making industry structure analysis more dynamic and not only understand the five forces as they are working RIGHT NOW.
What is business ecosystems?
Like a biological systems where your competitiveness is not just about the five forces but also attracting complements because that gives you competitive advantage.
A business ecosystem = an arrangement through which a group of mutually dependent and collaborative partners interact and combine their individual offerings into a coherent customer solution to create value for all.
In contrast to traditional market-based bilateral collaborations and vertical supply chain relations, business ecosystems emphasize multilateral communities of connected partners. What sets them apart from regular customer-supplier relations is that customers can choose among products or the offering elements supplied by the ecosystem participants without the need of a single supplier integrating these for the customer. The participants are interdependent and bound together based on some standard in a core ecosystem.
Ecosystem example: Nespresso with its single-use coffee capsules that allows some coffee machine producers like DeLonghi to manufacture machines specifically designed to work with the capsule and hence does not buy the full package from Nespresso. Ecosystem involves both competition and cooperation = co-opetition.
What is complementors?
A complementor enhances another organisations business attractiveness such that customers value the organisations products more. This suggests that not only suppliers, distributors, substitutes, etc needs to be analyzed, but companies that independently provide complementary products or services directly to mutual customers.
