Structural Analysis of Industries

Question 1

What is the Purpose of Industrial Structural Analysis (ISA)?

Answer 1

To understand the forces influencing a Firm’s ability to compete and profit in an Industry.

Porter, Competitive Strategy — P. 31.

Question 2

What is an Industry?

Answer 2

A group of Firms producing products that are close substitutes for each other.

Porter, Competitive Strategy — P. 34.

Question 3

How does Industrial Structural Analysis inform Competitive Strategy?

Answer 3

It allows a Firm to:

• See the underlying competitive pressures in its industry;
• Understand its strengths and weaknesses; and
• Plan strategies across various time horizons that leverage and fortify its position.

Porter, Competitive Strategy — P. 32.

Question 4

What are the Five Basic Competitive Forces?

Otherwise known as Porter’s Five Forces.

Answer 4

• Threat of Entry.
• Intra-Incumbent Competition.
• Buyers’ Bargaining Power.
• Suppliers’ Bargaining Power.
• Threat of Substitute Products.

Porter, Competitive Strategy — P. 32.

Each Force is influenced by several Underlying Factors, but the Forces themselves are distinct and exist above them.

Question 5

What is the Threat of Entry?

Answer 5

The prospect of Entrants who can bring new capacity and gain market share.

Porter, Competitive Strategy — P. 35.

Question 6

Which Factors influence the Threat of Entry?

Answer 6

• Barriers to Entry.
• Expected Retaliation.

Sometimes called ‘Entry Barriers’.

Porter, Competitive Strategy — P. 36.

Question 7

Which Factors influence Barriers to Entry?

Answer 7

• Switching Costs.
• Government Policy.
• Economies of Scale.
• Capital Requirements.
• Product Differentiation.
• Access to Distribution Channels.
• Cost Disadvantages Independent of Scale (CDISs).

Porter, Competitive Strategy — P. 36.

Question 8

What are Switching Costs?

Answer 8

The costs a Buyer incurs for switching Suppliers.

Porter, Competitive Strategy — P. 38-39.

These may include employee retraining, new support staff, new equipment, product redesign, etc.

Question 9

How do Switching Costs deter Entry?

Answer 9

They force Entrants to majorly improve on cost or performance in order to draw Buyers away from Incumbents.

Porter, Competitive Strategy — P. 39.

Question 10

How does Government Policy deter Entry?

Answer 10

If strict and complex, it forces Entrants to incur significant compliance costs and decreases their operational flexibility.

Porter, Competitive Strategy — P. 42.

Such things include licensing requirements, limits on access to raw materials, regulatory codes and standards, and the like.

Question 11

What are Economies of Scale?

Sometimes called ‘Scale Economies’.

Answer 11

The declines in unit costs as absolute volume increases.

The more you make of something, the cheaper it is to make.

Porter, Competitive Strategy — P. 36.

Common sources of Scale Economies include bulk purchasing, administrative cost sharing, learning effects, and technological investment.

Question 12

How do Economies of Scale deter Entry?

Answer 12

It forces an Entrant to either:

• Enter at large scale and risk strong retaliation; or
• Enter at small scale and accept a cost disadvantage to maintain discretion.

Both are suboptimal.

Porter, Competitive Strategy — P. 36.

Question 13

What are Capital Requirements?

Answer 13

The minimum financial resources an Entrant needs to reasonably compete.

Porter, Competitive Strategy — P. 38.

Question 14

How do Capital Requirements deter Entry?

Answer 14

• If large, they disallow entry to most Firms.
• If necessary for high-risk activities, like R&D, they decrease the risk-adjusted profitability of entry.

Porter, Competitive Strategy — P. 38.

Question 15

What is Product Differentiation?

Answer 15

The degree to which brands and products are distinct and customer loyalties are entrenched.

Porter, Competitive Strategy — P. 38.

Question 16

How does Product Differentiation deter Entry?

Answer 16

It forces Entrants to spend heavily, usually over an extended period, to overcome existing customer loyalties.

Porter, Competitive Strategy — P. 38.

This is particularly risky since an Entrant would have nothing to salvage if their entry failed.

Question 17

How does Access to Distribution deter Entry?

Answer 17

If limited or monopolized, it forces Entrants to negotiate on relatively weaker terms with Distributors to win their business.

Porter, Competitive Strategy — P. 39.

Such things include price breaks, cooperative advertising allowances, and the like.

Question 18

What are Cost Disadvantages Independent of Scale?

Answer 18

Cost advantages that are irreplicable by Entrants through Economies of Scale.

Porter, Competitive Strategy — P. 40-41.

Such things include intellectual property, rights to essential inputs, prime real estate, government contracts and subsidies, and efficiencies of proprietary experience.

Question 19

How do Cost Disadvantages Independent deter Entry?

Answer 19

It forces Entrants to operate at a relative disadvantage, and therefore to compete more fiercly, often to their short-to-medium term detriment.

Porter, Competitive Strategy — P. 40.

Question 20

What causes Barriers of Entry to change?

Answer 20

• Incumbents’ actions; and
• Environmental changes.

Porter, Competitive Strategy — P. 44.

Strengthening one Barrier may weaken another. For instance, increased volume (Economies of Scale) may decrease exclusivity (Product Differentiation) or leave fewer resources for R&D (CDISs).

Question 21

What is Expected Retaliation?

Answer 21

The likelihood that Incumbents will respond forcefully to an Entrant’s arrival.

Porter, Competitive Strategy — P. 42.

Question 22

Which Factors influence Expected Retaliation?

Answer 22

• The Industry’s maturity.
• Incumbents’ degree of reliance on the Industry.
• Incumbents’ quantity of disposable resources.
• The Industry’s historical disposition toward retaliation.

Porter, Competitive Strategy — P. 42.

Question 23

What is the Entry Deterring Price?

Answer 23

The structure of prices and terms beyond which entry is economically unviable and consequently deterred.

Porter, Competitive Strategy — P. 43.

Question 24

Which Factors influence Intra-Incumbent Competition (IIC)?

Answer 24

• High Stakes.
• High Fixed Costs.
• High Exit Barriers.
• Slow Industry Growth.
• Low Strategic Diversity.
• High Quantity of Incumbents.
• Low Product Differentiation or Switching Costs.

Porter, Competitive Strategy — P. 46-49.

Question 25

How does the Quantity of Incumbents influence IIC?

Answer 25

If numerous, the likelihood of mavericks increases and Firms can move unnoticed more easily.

Porter, Competitive Strategy — P. 46.

Question 26

How does the Rate of Industry Growth influence IIC?

Answer 26

If low, competition goes to turn on market share, consequently becoming fiercer and more volatile.

Porter, Competitive Strategy — P. 47.

Question 27

How do High Fixed Costs influence IIC?

Answer 27

They strongly pressure Firms to fill capacity, often leading to price cutting spirals when there is excess capacity.

Porter, Competitive Strategy — P. 47.

What you should pay attention to is fixed costs relative to value added, and not fixed costs as a proportion of total costs.

Question 28

How does the Lack of Product Differentiation or Switching Costs influence IIC?

Answer 28

It intensifies pressure for price and service competition, both of which are particularly fierce and volatile.

Porter, Competitive Strategy — P. 47.

Question 29

How does Strategic Diversity influence IIC?

Answer 29

Multiple Firms with distinct differences will compete differently, and resultantly, may conflict often.

Porter, Competitive Strategy — P. 48.

Core differences include commercial objectives, tactics, strategies, origins, personalities, relationships to parent companies, etc.

Question 30

How do High Stakes influence IIC?

Answer 30

The more Firms need to succeed in an Industry, the fiercer and more volatile the competition will be.

Porter, Competitive Strategy — P. 49.

Question 31

How do High Exit Barriers influence IIC?

Answer 31

They inflate competition by keeping uncompetitive Firms active for longer than is optimal.

Porter, Competitive Strategy — P. 49.

Question 32

Which Factors influence Exit Barriers?

Answer 32

• Fixed costs of exit.
• Socio-political restrictions.
• Strategic interrelationships.
• Management’s emotional disposition.
• Specialized assets with low liquidation values or high costs of transfer.

Porter, Competitive Strategy — P. 49.

Question 33

What is the Threat of Substitute Products?

Answer 33

The risk that a more attractive price-performance alternative will displace demand for a Product at a certain price, effectively capping profits.

Porter, Competitive Strategy — P. 52.

Question 34

What is a Substitute Product?

Answer 34

A Product that performs the same function as another Product, minor differences and native Industries notwithstanding.

Porter, Competitive Strategy — P. 53.

Particularly problematic Substitutes are those that: (1) are improving in price-performance metrics; or (2) are produced by high-growth Industries expecting slower growth.

Question 35

How does Buyers’ Bargaining Power influence Industry Profitability?

Answer 35

If high, it decreases profitability by increasing competition over prices and service quality.

Porter, Competitive Strategy — P. 53.

Question 36

When does a Buyer Group have high Bargaining Power?

Answer 36

• It has full information.
• It faces few Switching Costs.
• It is purchasing an Undifferentiated Product.
• It does not particularly need the Seller’s Product.
• It represents a majority of the Seller’s trading volume.
• It can influence downstream purchasing decisions.
• It poses a credible threat of backward integration.
• It must spend frugally, whether due to low profits or the Product’s necessity and expensiveness.

Porter, Competitive Strategy — P. 53-55.

Question 37

How does Suppliers’ Bargaining Power influence Industry Profitability?

Answer 37

If high, it decreases profitability by increasing prices or decreasing service quality, usually to cover Suppliers’ own cost increases.

Porter, Competitive Strategy — P. 56.

Labor must also be recognized as a Supplier, and one that exerts great power. Scarce, highly skilled employees or tightly unionized labor can bargain away a significant fraction of Industry profits.

Question 38

When does a Supplier Group have high Bargaining Power?

Answer 38

• It has full information.
• It poses a credible threat of forward integration.
• Its Product is Differentiated.
• Its Product cannot be Substituted.
• Its Buyers need its Product.
• Its Buyers face high Switching Costs.
• Its Buyers represents a minority of its trading volume.

Porter, Competitive Strategy — P. 56-57.

Question 39

What distinguishes an Effective Competitive Strategy?

Answer 39

It fortifies the Firm against the Five Forces by:

• Defensively positioning it; while
• Influencing the Forces; and
• Anticipating and exploiting changes therein to maximise its welfare.

Porter, Competitive Strategy — P. 59.

Question 40

How does a Firm Defensively Position itself?

Answer 40

It finds and occupies the position in an Industry where the Forces are weakest, from which it can most effectively confront and avoid competition.

Porter, Competitive Strategy — P. 59.

Question 41

How does a Firm influence the Forces?

Answer 41

By understanding the degree of influence it can exert over which Underlying Factors and developing tactics accordingly.

Porter, Competitive Strategy — P. 60.

Question 42

How does a Firm anticipate and exploit changes in the Forces?

Answer 42

By understanding which trends, budding and prevailing, are most likely to affect which Underlying Factors and developing tactics accordingly.

Porter, Competitive Strategy — P. 60.