F: Discuss the principles of strategic analysis of an industry

Question 1

Strategic analysis of an industry involves analyzing the competitive forces that determine the possibility of economic profits.

Answer 1

Porter’s five forces that determine industry competition are:

Rivalry among existing competitors.
Threat of new entrants.
Threat of substitute products.
Bargaining power of buyers.
Bargaining power of suppliers.

Higher barriers to entry reduce competition
• Unused capacity in an industry, especially if prolonged, results in
intense price competition
• Stability in market share reduces competition
• More price sensitivity in customer buying decisions results in greater
competition

Question 2

Industries profitability differences due to

Answer 2

Economic fundamentals
– Industry structure
– Degree of competition

Question 3

Economic profits – return on invested capital minus its cost

Answer 3

Economic profits – return on invested capital minus its cost

Question 4

Factors that increase competition in an industry most likely include: low barriers to entry, low concentration, and high unused capacity.

Answer 4

Low barriers to entry increase competition as more firms can enter the business. Industries that are fragmented and have unused capacity tend to be highly competitive as they fight for market share and attempt to utilize excess manufacturing resources.

Question 5

Economic profits are most likely to be earned by firms in an industry that is characterized by:

Answer 5

high barriers to entry and low bargaining power of buyers.

High barriers to entry (low threat of new entrants) and low bargaining power of suppliers both increase the potential for economic profits within an industry. The five forces that shape industry competition are rivalry among existing competitors, threat of new entrants, threat of substitute products, bargaining power of buyers, and bargaining power of suppliers. The stronger any of these forces are within an industry, the less potential that industry has to generate (or continue to earn) economic profits.

Question 6

Industries with undifferentiated products and high exit costs most likely have:

Answer 6

high rivalry among competitors and low profit margins.

Industries with undifferentiated products have high rivalry with their competitors. Companies with high exit costs try to operate at full capacity to cover fixed costs and typically have low profit margins.