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Analisi - Cap03

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  • 8/3/2019 Analisi - Cap03


    I ndustry Analysis: The FundamentalsChapter 3


    From Environmental Analysis to Industry Analysis

    Value Creation and Profitability

    Determinants of Industry Profit Porters Five Forces of Competition

    - Unit Costs and Economies(volume, scale, scope, learning)

    Applying Industry Analysis

    Boundaries of the Industry

    Identifying Key Success Factors

  • 8/3/2019 Analisi - Cap03


  • 8/3/2019 Analisi - Cap03


    From Environmental Analysis toI ndustry Analysis

    Natural Environment

    Demographic Structure

    National and International



    Government and Politics

    Social Structure

    Potential Entrants

    Industry Competitors Substitutes


    Buyers (Customers)

    Customers Suppliers Competitors

    The industry environment isrooted in the macro-environment

    The macro-environment affectsthe firm through its influence onthe industry environment

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    Value creation and profitability:transaction betw een producers and end-users

    Value is created throughtransformation:

    - Production(physical transformation)

    - Trade(transformation in space/time)

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    Value creation and profitability:more transformation phases before final sale

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    1. Value of the product to customers

    2. Intensity of competition

    3. Relative bargaining power at different

    levels within the value chain

    Determinants of Industry P rofitability

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    PerfectCompetition Oligopoly Duopoly Monopoly

    Concentration Many firms A few firms Two firms One firm

    Entry and exitbarriers

    No barriers Significant barriers High barriers



    product(commodity) Potential for product differentiation


    Perfectavailability Imperfect availability of information

    Determinants of I ndustry Profitability:I ndustry Structure

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    Rivalry among

    existing firms




    Bargaining powerof buyers

    Threat ofsubstitutes

    Threat ofnew


    Bargaining powerof suppliers

    3 horizontal forces:

    Potential Entrants Industry competitors

    Substitutes2 vertical forces: Suppliers Buyers

    Determinants of Industry Profitability:P orter Five Forces of Competition

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    INDUSTRY RIVALRY Concentration

    Diversity of competitors Product differentiation Excess capacity &

    exit barriers Cost conditions

    THREAT OF ENTRY Capital requirements

    Economies of scale Absolute cost advantage Product differentiation Access to distribution

    channels Legal/regulatory barriers


    BUYER POWER Buyers price sensitivity Relative bargaining power

    Determinants of Industry Profitability:P orter Five Forces of Competition

    SUPPLIER POWER Buyers price sensitivity

    Relative bargaining power

    SUBSTITUTECOMPETITION Buyers propensity to


    Relative prices & performanceof substitutes

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    Competitive pressure from producers of substitutes depends on

    Buyers propensity to substitute, which in turn depends onThe price-performance characteristics of substitutes

    In so far that propensity is high, and the price-performance characteristics of thesubstitutes are similar to the industry product- The greater decrease of demand may be caused by a lower price of the substitutes

    - The less freedom the industry producers enjoy in setting their own market prices

    If the product is complex and assessing its performance difficult, it is lesslikely that customers consider substitution on the basis of price differences

    P orter Five Forces of Competition:Threat of Substitutes

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    The fact that an industry shows a good rate of return on employedcapital attracts new investments from the outside.

    These entries cause an increase of supply and competition, and thispushes prices and profits toward the competitive level.

    The possibility for an industry to maintain high average profitabilitydepends on the existence of entry barriers that make new entriesdifficult and costly

    Barriers to entry are obstacles to the entry of other firms in theindustry. They may be also regarded as advantages enjoyed by theexisting firms in the industry(e.g.: specific resources owned only by the firms that already operate in the industry,

    and not easily available to new entrants).

    P orter Five Forces of Competition:Threat of New Entrants

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    Capital requirements

    Economies of scale

    Absolute cost advantages

    P roduct differentiation Access to channels of distribution

    Governmental and legal barriers

    RetaliationHowever the effectiveness of these barriers depends on theendowment of resources of new potential entrants (size, liquidity,

    brand, product range etc.)

    P orter Five Forces of Competition:Threat of New Entrants and Barriers to Entry

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    U n i t s o

    f p r o

    d u c t

    F i x e

    d ( t o t a l ) c o s t s

    V a r i a

    b l e c o

    s t s

    U n i t c o s t s

    F i x e

    d ( u n i t

    ) c o s t s

    1 10 1 11.00 10.002 10 2 6.00 5.003 10 3 4.33 3.334 10 4 3.50 2.505 10 5 3.00 2.006 10 6 2.67 1.677 10 7 2.43 1.43

    8 10 8 2.25 1.259 10 9 2.11 1.11

    10 10 10 2.00 1.00

    Fixed costsVariable (unit) cost








    1 2 3 4 5 6 7 8 9 10

    Fixed Costs

    Given a production capacity , when actual production fully exploits that capacity unit costs are lower,because the fixed costs of production facilities are distributed over a greater production volume (seethe red curve below).

    Unit Costs and Economies:Economies of Volume

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    Lower unit costs are caused by larger production capacity (for constant rate of exploitation of thatcapacity) , as a consequence of the higher efficiency of large production facilities.

    In economies of volume the production capacity is given and fixed , the variable is the rate of exploitation of the capacity, the higher it is the lower is the incidence of fixed costs for product unit.

    In economies of scale the production capacity itself is the variable and lower unit costs follow from:i. increase in the cost of a larger plant is less than proportional to the increase of capacityii. variable unit costs are lower; for instance, less electrical power for product unit.

    The difference between economies of volumeand economies of scale is parallel to thedistinction between (unit) cost functions

    - Short term ( x axis is the rate of exploitation of a given capacity)

    - Long term ( x axis is the productioncapacity itself).

    Unit Costs and Economies:Economies of Scale

    Short term unit cost for somealternative installed capacities(increasing from left to right)

    Long term unit cost

    Units of output perperiod

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    Lower unit costs caused by the increase of cumulated production. This is the total productionobtained since the first product was obtained, while production capacity is the production obtainableper time unit (e.g. year). The decrease of unit costs is consequence of:i. improvement of individual abilities of the workers (individual learning-by-doing)ii. improvement of organization of production (organizational learning).

    In this case the production volume on the x axis- is NOT the quantity produced in a given period (a

    rate, e.g. the production per year)

    - but the entire production obtained across all thetime elapsed since the production of the first unit

    of product (cumulated production).If we fix the rate of production (e.g. given quantityper year) we can consider the x axis as the timedimension.

    2000 2001 2002 2003 200410.000 20.000 30,000 40.000 50.000

    TimeCumulated production

    Unit Costs and Economies:Economies of Experience or Learning

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    Lower unit costs are caused by the widening of the products range . This is the effectof the increased exploitation of resources that may be employed for further productswithout additional costs. For instance:- different types of products can be sold across the same distribution facilities

    (suppose they are not entirely exploited for a narrower range of products, and thatthey are not reducible)

    - an already established brand can be extended over further products without

    additional costs- the technical know-how developed in connection with a certain product might be

    valuable also for products of different type.

    Note that there may be ambiguity in labeling the types of economies. While the

    distinction between volume , scale and experience is clear-cut, the distinction of economies of scope from the economies of scale or volume is sometime not sostraightforward.

    It helps to consider that the economies of scope are caused by the increased variety

    of the products range , while other economies are caused by the increased productionof a given product . What is common to all cases is that it is always implied a higherlevel of activity inside the firm.

    Unit Costs and Economies:Economies of Scope

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    Concentrationnumber of firms, size of the firms (relative to the aggregated market demand)

    Diversity of competitorsfor their cost conditions, objectives, interpretation of the competitive situation

    P roduct differentiationextent to which the offerings of different firms cannot be compared only on the basis of price

    Excess capacity and exit barriers

    Cost conditions:

    economies of scale and ratio fixed costs/ variable costs

    Within the industry, among the existing firmsthe nature of competition

    (on price or other dimensions, such as product innovation, advertising )and its intensity, depend on

    P orter Five Forces of Competition:Rivalry Betw een Established Competitors

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    P orter Five Forces of Competition:Rivalry Betw een Established Competitors(role of balance betw een capacity and demand)








    Return on sales Return on investment Cash flow/Investment

    < -5% -5% to 0 0 to 5% 5% to 10% > 10%


    Annual rate of growth of market demand

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    1. Buyers price sensit ivity

    o Cost of purchases as % of buyers total costo Differentiation of the purchased itemo Intensity of competition between buyerso

    Importance of the purchased item for the quality of the buyersown output

    2. Relative bargaining pow ero Size and concentration of buyers relative to sellerso Buyers informationo Potential of backward vertical integration of buyers

    P orter Five Forces of Competition:Bargaining P ow er of Buyers

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    P orter Five Forces of Competition:Bargaining Pow er of Suppliers

    Here the industry firms find themselves in the reversed role of buyers, but the same factors apply again. With some remarks

    Raw materials, semi-finished goods and components are oftencommodities supplied by small companies to large manufacturers.

    Because of this commodity suppliers often seek to enhance theirbargaining power through:

    Cartelization(OPEC, International Coffee Organization ; similar is the unionization of workers)

    Product differentiation

    Forward vertical integration into the buyers industry

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  • 8/3/2019 Analisi - Cap03


    Applying I ndustry Analysis

    Describing industry structure

    Forecasting industry profitability Changing industry structure

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    Identify the main playersProducers, customers, suppliers, producers of substitute goods, potential entrants not always these are allimportant, at the same time it might be the case that other types of actors are important (i.e. complementors)

    Examine their characteristics that determine competition andbargaining power it may be difficult !

    Television programming in the USA : there are a number of different types of player and it is not simple toestablish (i) the industry boundaries and (ii) which actors are buyers and which are sellers.

    i. Industry boundaries: do we consider all forms of TV distribution or indentify separate industries for broadcast TV,cable TV and satellite TV?

    ii. Buyers and sellers: the industry has quite a complex value chain with the producers of the individual shows,networks that put together program schedules, and local broadcasting and cable companies that undertake finaldistribution. For the distribution companies there are two buyers: viewers and advertisers. Some comapnies arevertically integrated across several stages of the value chain thus networks such as FOX and NBC not only createand distribute program schedules, they are also backward integrated into producing some TV shows and forwardintegrated into local distribution through ownership of local TV stations.

    Vertical boundaries :Which activities of the value chain to include in the industry?

    Horizontal boundaries :Which products and geographical areas to include in the industry?

    Applying I ndustry Analysis:Describing Industry Structure

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    Industry analysis may explain the profitability of the industry in the past,however what is really important is predicting future profitability.

    Strategic decisions are essentially investment decisions that commit resources toan industry for a long time. Forecasting is of critical importance.

    Current or past profitability may not be a reliable index of future profitability.

    1. Examine how current and recent levels of competition and profitabilityare a consequence of its present structure

    2. Identify the trends that are changing the industrys structure

    3. Identify how these structural changes will affect the five forces of competition and resulting profitability of the industry

    Different structural changes may have different direction, some willincrease competition, some will moderate it. Establishing their net effect isa matter of judgment.

    Applying I ndustry Analysis:Forecasting Industry Profitability

    l d l

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    Industry structure may be changed through appropriate strategicinitiatives.

    1. Which are the important structural features of the industry?

    2. On which is it possible to intervene, and how?Individually? Collectively through inter-firm agreements?

    Steel industry :good profitability between 2002 and 2008 was result of growing demand, but also supportedby the rapid consolidation of the industry, led by Mittal Steel.

    European petrochemicals :

    excess capacity was a major problem. Through a series of bilateral plant exchanges, eachcompany built a leading position within a particular product area.

    U.S. airline industry :frequent flyer schemes built customer loyalty in the absence of product differentiation;through hub-and-spoke route systems companies have achieved dominance of particular

    airports. Mergers and alliances have reduced the number of competitors on many routes.P rofessional associations :impose barriers to entry by controlling training, and especially accreditation, of professionals.

    Applying I ndustry Analysis:Changing Industry Structure

    B d i f h I d

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    Suppose Jaguar is assessing its future prospects. In forecasting industry profitability

    Which product scope should be considered?

    Segment of luxury cars (SIC 3712) automobile industry (SIC 371) motor vehicles and equipment

    Which geographic scope?

    National (UK) Regional (Europe) Global

    Definition: Economists define an industry as a group of firms that supply a market.Is there a one-to-one correspondence between industry and market?What if the same firms supply different and heterogeneous markets? it happens!What if heterogeneous firms serve the same market? it happens!

    Current usage: industry is broad definition (i.e. packaging), and may be subdividedin several markets (glass containers, metal cans, paper boxes ).

    Confusing! lets try to make order

    Industry : group of firmsSupply side ; based on which similarities among firms is the group identified?

    Market : group of productsDemand side ; based on which similarities among products? Are these similarities in production or consumption?

    Industry structure, industry analysis: referred to producers, supply side.Market structure, market analysis: types of customers, demand side.

    Boundaries of the I ndustryI ndustries and Markets

    B d i f h I d

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    Boundaries of the I ndustryI nterdependencies betw een different products (and producers)Substitution in Demand and Supply

    Interdependencies : Which actors in Jaguars economic environment may influence itsprofitability? Whose behaviors may make a difference for the attainment of its goals?

    Demand-side substitution:Do Jaguar customers consider as a potential alternative the purchase of a truck, based on thecomparison of price and performance? No, producers of trucks may be excluded, even if they

    produced fast and cheap trucks they would not take customers from Jaguar in the same fashionthe producers of economy cars may be excluded too.

    Supply-side substitution:Are economy cars or truck producers able to convert their production to luxury cars? If yes theirbehaviors are relevant, and must be included in the analysis if conversion takes time, inclusion

    or not in the industry depends on the temporal scope of the analysis, which in turn depends on theduration of the investments that are considered. The longer term are the decision that a firm isconsidering, the more broadly it will wish to consider its markets.

    Suppose Jaguar is assessing its future prospects. In forecasting industry profitability

    Which product scope should be considered?

    Segment of luxury cars (SIC 3712) automobile industry (SIC 371) motor vehicles and equipment

    Which geographic scope?

    National (UK) Regional (Europe) Global

    B d i f th I d t

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    Interdependencies : If price differences for the same product between differentlocations tend to be eroded by demand-side and supply-side substitution, then theselocations lie within a single market.

    Demand-side substitution:May Jaguars customers consider as an alternative the purchase of a German or Italian car

    (Europe)? What about an US or Japanese car (global)? Supply-side substitution:

    Are German or Italian producers able to supply the UK market? What about the US or Japanese? IsJaguar able to supply German, Italian, US or Japanese markets?

    If Japanese produced luxury cars perceived by customers as an alternative to Jaguar cars, and soldthem at lower prices in the same geographical markets, then Jaguar would experience a loss of customers that would put pressure toward either (i) effectively distinguish its cars from the Japanese(differentiation); (ii) lower its cars prices (likely also by cutting costs)

    Suppose Jaguar is assessing its future prospects. In forecasting industry profitability

    Which product scope should be considered?

    Segment of luxury cars (SIC 3712) automobile industry (SIC 371) motor vehicles and equipment

    Which geographic scope?

    National (UK) Regional (Europe) Global

    Boundaries of the I ndustryI nterdependencies betw een different geographical locationsSubstitution in Demand and Supply

    K S F t

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    Key Success Factors

    What do customers want? How to deal with competiton?


    o Who are our customers?o What do they want ?


    o What factors drive competition?o What are the main dimensions of

    competition?o How intense is competition?o How can we obtain a superior

    competitive position?


    How to create value How to appropriate the rent

    Ke S ccess Factors

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    Key Success FactorsExamples of Steel, Fashion Clothing and Supermarkets(Table 3.3)

    W HAT DO CUSTOMERS W ANT?(Analysis of demand)

    HOW DO FIRM S SURVIVECOMPETITION?(Analysis of competition)


    Steel Low price Product consistency Reliability of supply Specific technical specifications

    for special steels.

    Strong price competition andcyclical profitability necessitatescost efficiency and strongfinancial resources

    Main sources of cost efficiency include:large-scale plants, low-cost location,rapid adjustment of capacity to output.

    Alternatively, hi-tech minimills canachieve low costs through flexibility andhigh productivity.

    Differentiation through product andservice quality possible.


    Fragmented demand(segmented by garment type,style, quality, color).

    Customers willing to pay pricepremium for brand, style,exclusivity, and quality.

    Mass market highly pricesensitive.

    Intensely competitive due tolow entry barriers, low sellerconcentration, and strong retailbuying power

    Differentiation can yieldsubstantial price premium, butimitation rapid.

    Combine effective differentiation withlow-costs

    Key differentiation variables are speedof response to changing fashion, style,reputation and quality.

    Cost efficiency requires manufacture inlow wage countries.

    Supermarkets Low prices. Convenient location. Wide range of products adapted

    to local preferences. Fresh/quality produce, good

    service, ease of parking,pleasant ambience.

    Markets localized Intensity of price competition

    depends on number andproximity of competitors.

    Bargaining power a criticaldeterminant of cost of bought-in goods.

    Low-cost operation requires operationalefficiency, scale-efficient stores, strongbuying power, low wage costs.

    Differentiation requires wide product

    range (hence, large stores), convenientlocation, easy parking.

    Key Success Factors

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    Key Success FactorsI dentifying key success factors by analyzing profit driversExample of Retailing (Figure 3.7)


    Return on Sales


    Sales mix of products

    Avoiding markdowns throughtight inventory control

    Maximize buying power to minimize

    cost of goods purchased

    Maximize sales/square foot through:*location *product mix*customer service *quality control

    Maximize inventory turnover throughelectronic data interchange, closevendor relationships, fast delivery

    Minimize capital deploymentthrough outsourcing & leasing

    Key Success Factors

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    Key Success FactorsI dentifying key success factors by modeling profitabilityThe Airline I ndustry (Box 3.6)








    ASMs= x -

    Yield Load factorProfitability Unit cost

    Strength of competition on routes.

    Responsiveness to changingmarket conditions

    % business travelers

    Achieving differentiationadvantage

    Price competitiveness. Efficiency of route planning. Flexibility and

    responsiveness. Customer loyalty. Meeting customer


    Wage rates. Fuel efficiency of planes. Employee productivity. Load factors. Administrative overhead.

    ASM = Available Seat Miles ( number of seats available for sale x distance traveled in miles )RPM = Revenue Passenger Miles ( number of paying passengers x distance traveled in miles )