Industry Analysis

Question 1

How is Industry Analysis a new approach to answering the ultimate question?

Answer 1

• Moving from corporate strategy to business strategy
• So far, we were concerned with corporate level strategy
• Now the perspective is that of a given business, not the corporation

Question 2

What are the components of industry analysis?

Answer 2

• Market defintion
  
  • Crucial to identifying who your competitors are: part of the market definition
• Relevant features of industry structures
  
  • e.g. insensitivity of competition, Concentration ratio; entry barriers etc
• Market Classification
  
  • Structure, conduct, and performance of firms under competition, monopoly, monopolistic, and oligopical market structure
• Porters’ Five Forces

Question 3

What are the components of market definition??

Answer 3

• Demand side: group of customers who have strong commonality in their demand
• Supply side: boundary within which firms compete with each other
• Statistics to define markets

Question 4

How is the market defined with a supply side approach?

Answer 4

• “Competitors are firms who’s strategic choices directly affect one another”: Product substitutability
• Competition implies high cross-product elasticity

Question 5

What are the practical statistics to define markets?

Answer 5

• Industry classifications
• SSNIP
• Time Elasticity of Demand
• Flow analysis

Question 6

What are some common industry classifications used to define markets?

Answer 6

• Standard industry classifications (SIC); North American Industry Classification (NAIC) etc
  
  • Sometimes competition within SICs is obvious; other times it is not
    
    • Magazine and chewing gum (point of sale) sales suffer from smart-phones becoming more common etc.
    • Competition could extend outside traditional classifications
• Common use of raw materials (e.g. based on input-output tables for the economy)
• Common use of production techniques (handicraft, machine-based, service sector, etc)

Question 7

What is SSNIP used to define markets?

Answer 7

• Used by regulators
• Competitor identification
• Check if a market defined in a particular way is ‘worth monopolising’. That is, can a hypothetical monopoly of all firms in the market raise profits by increasing the price
• This would imply that consumer had no other choice but to buy from there entities and this therefore defines the market
• Premise: a market is well defined, and competitors identified if a merger among all the competitors within would lead to a small, but significant non transitory increase in price

Question 8

How is SSNIP used specifically?

Answer 8

• Small: >5%
• Nontransitory: > 1 year
• e.g. BMW & Audi merger: BMW’s view: in the ‘global luxury car’ market, this couldn’t reduce conception much; FTC view: it would if you consider the ‘German luxury car’ market
• If FTC’s view is correct: should be possible for them to increase profits by raising prices for at least one year by 5%
• If BMW’s view is correct: a price rise leads to losing money

Question 9

What is the consensus about SSNIP?

Answer 9

• Intuitive conceptually, but:
  
  • Requires computing the effects of a hypothetical scenario
  • Requires unusually detailed data on prices and profits

Question 10

How is the time elasticity of demand used to define the market?

Answer 10

• Rather than rely on geography, use the notion of ‘cost of travel’ to buy goods to identify competitors
• Increase travel times and see where people go for alternatives
• Same principle as SSNIP: uniformly making all options more unattractive and seeing if people have alternatives: if not, you have defined the entire market

Question 11

How is Flow analysis used to define the market?

Answer 11

• Little in from outside (LIFO)
  
  • = 1 - patients in flows / patients treated in the area
• Little out from inside (LOFI)
  
  • = 1 - patient out flows/ patients treated in the area
• LIFO and LOFI greater than 75% could identify markets correctly

Question 12

What is market structure in industry analysis?

Answer 12

• Once we have identified the boundaries of the market or industry, what features should we look at?
• How do we quantify the extent of competition?
• Simple measure: number of firms

Question 13

What are the market concentration measures?

Answer 13

• Try to summarise information on firm sizes and numbers; their focus is on depicting the distribution of firm sizes
• Aim is to provide a convenient numerical measure reflect the implications of the number and size of distribution of firms for the nature of conception in the industry
• N-firm concentration ratio
• Hefindahl - Hirchman Index
• Lorenz Curve

Question 14

What is N-Firm Concentration?

Answer 14

• Combined market share of the N largest firms in the market
• CRN = ∑Si
  
  • Si = the market share of the ith firm
• Alternatively this can be seen as the size of the biggest firms in the industry as a proportion of the total industry size

Question 15

What are the n-Firm concentration ratios pros and cons?

Answer 15

• Pros
  
  • Requires size data on the top n firms only, together with the aggregate industry measures
• Cons
  
  • It is based only on the biggest firm: not representative
  • It is invariant to changes in the sizes of the largest firms. C3 can be the same over two periods despite the market shares held by the three changing dramatically
    
    • i.e. a merger between the top two firms in the industry will have no impact

Question 16

What is the HHI?

Answer 16

• Uses every point in the firm size distribution
• Employs a weighting system to account for the relative importance of individual firms. Market share of each firm is squared so larger firms receive a higher weighting in the index
• The higher the index, the less likely the industry is competitive. Basically, market share is concentrated in the hands of few firms
• HHI = ∑ (Si)2

Question 17

Pros/cons of HHI?

Answer 17

• Pros

- Accounts for skewed size distributions better than concentration ratios

Question 18

How is the HHI regulated?

Answer 18

• Deal scrutiny: HHI∆ > 100
• Unconcentrated markets: HHI < 1500
• Moderately concentrated: 1500 < HHI < 2500
• Highly concentrated: HHI > 2500

Question 19

How are markets classified by HHI?

Answer 19

• Perfect comp
  
  • HHI < .2
• Mon Comp
  
  • HHI < .2
• Oligolopy
  
  • .2 < HHI < .6
• Monopoly
  
  • HHI > .6

Question 20

How is the Lorenz curve used?

Answer 20

• Shows variation in the cumulative size of the n largest firms in an industry, as n varies from 1 to N
• Horizontal axis: firms from the largest to smallest
• Vertical axis: cumulative size
• If all firms are equal sized: 45 degree line
• If distribution is skewed: concave curve

Question 21

What are porter’s forces and what is the consensus on this system?

Answer 21

• Existing Internal Rivalry
• Threat of new entrants
• Bargaining power of suppliers
• Bargaining power of buyers
• Threat of substitutes/complements
• Critique
  
  • All threats, no opportunities

Question 22

What can multipoint competition be?

Answer 22

• Tit-for-tat (intense) rivalry

* Forbearance (Tacit Collusion)

Question 23

What is tit-for-tat rivalry?

Answer 23

• Understood to arise in single-point rivalry
• BIC & Gillette
  
  • BIC revolutionised the ball-point pen industry
  • Gillette enters disposable pen market
  • BIC responds by entering the disposable razor market
• Masters & Bunnings
  
  • Wesfarmers buys Bunnings, then Coles, bringing it into competition with Woolworths
  • Woolworths announces it is getting into the home home improvement: codename ‘project oxygen’: suck oxygen out of Bunnings

Question 24

What is forbearance?

Answer 24

• Understood to arise in multi-point rivalry (or at least softer competition)
  
  • Punishments from a single market undercut/price war etc. can lead to widespread retaliation in all the other markets; not possible in single-point rivalry.
• Airline Price Collusions
  
  • Overlapping markets lead players to be highly susceptible to price wars etc
• Need for intra-firm coordination
  
  • Coordination across divisions within a firm can be hard
  • Especially when the competition is across multiple product markets
• If firms are able to co-ordinate properly and collude effectively with multi-point contact, increased firms in the market can lessen rivalry