Market Structure II:Entry barriers, life cycles, profit pools

Paul C. Godfrey

Mark H. Hansen

Marriott School of Management

Why do these topics matter to strategists

• Barriers to entry can help a firm earn attractive margins and foreclose competition

• The industry life cycle helps managers understand how competitive imperatives change over time.

• Profit pools help managers identify “close in” opportunities for profitable growth.

Barriers to entry

Barriers to entry: The Economics

• Monopolistic competition allows increased profitability

• Barriers are the only way to forestall competition

• Limit pricing perfectly precludes entry

• High barriers to entry help create an attractive industry

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Barriers to entry: Sources

• Economies of Scale

• Proprietary Product Differences

• Brand Identity

• Information and credibility

• Switching Costs

• Capital Requirements

• Access to Distribution

• Absolute Cost Advantages– Learning Curves– Input Lock-up– Product Design

• Government Policy

• Expected Retaliation

Managing barriers to entry

• Create and exploit barriers wherever possible

• Barriers may be intrinsic to product– Capital intensive production

– Low overall demand

• Barriers may be engineered by managers– Brand equity and identity

– Switching costs

• Barriers are not absolute, but a queue of potential competitors

Industry life cycles

Life cycle basics

• Like products, and individuals, industries go through definitive phases of development

• Stage of development predicts– Demand

– Level of Competition

– Type and nature of innovation

– Entry, exit, and competitive interactions (e.g., alliances, mergers)

• Strategies that succeed at one stage may be deadly at another

The Industry Life Cycle

Sales Volume

Time

Fragmentation Shakeout Maturity Uncertainty

Renewal

Stagnation

Decline

Competition and the Life Cycle

Industry Characteristic

Fragmentation (Renewal)

Shakeout Maturity (Stagnation) Decline

Demand High Income Buyers Readily Increasing Penetration

Mass Market, Replacement purchases

Knowledgeable customers

Technology Not Standard Emergence of competing paradigms

Standardized and well known, quest for improvement

Products Wide Variation Product “camps” develop

Little Innovation, Product extensions

Little change

Manufacturing & Distribution

Batch Production, Specialty Channels

Trend toward mass production, channel competition

Overcapacity, process innovation, channel stability

Heavy overcapacity, new specialty channels reemerge

Competition Few Companies Competing business models

Price-based competition

Price wars, exit

Key Success Factors

First Mover

Product Innovation

Build Brand

Build Scale

Cost Control

Customer Loyalty

Retrench or exit

Managing the industry life cycle

• Be sensitive to changes in overall demand, the best predictor of life cycle shift

• Have the courage to do what needs to be done– Shoot the founder (fragmentation to shakeout)

– Cull the product line (maturity to decline/ renewal)

• Decline may be a very profitable strategy– Exploit economies of scale/ scope

– Unattractive for competitive entry

Profit pools

Profit pools: Looking at the value chain

• It’s not just how you compete, but where

• The Value Chain distributes value unevenly

• The Personal Computer Industry

Early 1980’s

Late 1980’s

Mid 1990’s

Mapping profit pools: 4 steps

Step 1: Define the boundaries

Step 3:Determine the distribution

of profits in the pool

Step 4: Reconcileestimates & plan

strategy

Step 2: Determine the size of the pool

Conceptual

Empirical

Defining the pool

• Task: Determine which value chain activities influence your ability to generate current and future profits

• Take a BROAD view—look beyond tradition, go upstream, downstream, and consider substitutes

• 3 perspectives: your company, your competitors, your customers

• Look for new business models and innovations

• Don’t get too detailed at this stage

Sizing the pool

• Task: develop a baseline estimate of cumulative volumes over the entire industry, by segment

• The goal is the comparative size of the segments, not the actual accurate volume of each segment

• Go where you can get data: Government data (Census of Manufacturers) Annual reports, WSJ, Industry analyst reports

• Try for two levels: company level, product level

• Focus on largest companies and segments, fill in details through extrapolation and interviews

• TIP: Government data is pretty good for comparative volumes

• http://www.census.gov/econ/census02/

Distribution of profits

• Task: Develop estimates of the profits generated by each segment

• Look at “pure players” in each segment to determine profitability

• It’s comparative profitability that matters

• Are there barriers that keep segment profit high and entrants out?

• Think creatively

• TIP: Profit is far more important than volume when deciding whether to enter

Planning strategy

• Attempt to reconcile estimates in 2 and 3 through interviews and triangulation of data sources

• The goal is to look for new segments to explore and/or exploit

• Develop strategic migration path and possibilities

• Check for consistency with current strategies to avoid conflict

Managing profit pools

• Profit pools exploits existing customers by offering them new products/ services

• Firms can leverage existing assets and production expertise

• Be careful about losing focus– Dilute brand or other reputation-based capital

– Divert management attention from core business