I N D U S T R Y  A N A L Y S I S  A N D  T H E  F I V E  F O R C E S  M O D E L
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I N D U S T R Y A N A L Y S I S A N D T H E F I V E F O R C E S M O D E L

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Industry analysis and Porter\'s five forces model

Industry analysis and Porter\'s five forces model

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I N D U S T R Y  A N A L Y S I S  A N D  T H E  F I V E  F O R C E S  M O D E L I N D U S T R Y A N A L Y S I S A N D T H E F I V E F O R C E S M O D E L Presentation Transcript

  • Industry Analysis:Porter’s Five Forces Model
    Michael McDermott
    mcdermottm1@nku.edu
    http://www.linkedin.com/in/michaelcmcdermott
    www.facebook.com/strategycapstone
    www.strategycapstone.ning.com
    www.Mcdermottstrategy.wikispaces.com
    www.globalbusinessstrategy.wikispaces.com
    1
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  • 2
    Exhibit 1.2 The vocabulary of strategy
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  • 3
    Exhibit 2.1 Layers of the business environment
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  • PEST Analysis is Complete(see previous slides)
    Remember the PEST focuses upon the remote external environment
    These are the factors that NO company can control
    But the company MUST heed the conclusions from its PEST analysis
    Aligning with such trends is very wise
    Ignoring them is very risky if not foolish
    4
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  • Scenario Planning
  • Scenario Planning
    This demands consideration of a range of scenarios
    To be meaningful, if should include the most optimistic and most pessimistic scenarios
    This is intended to compel executives to ask the “what if” questions
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  • Scenario Planning
    Organizations sometimes undertake this exercise
    The aim is to construct scenarios and then consider the strategic implications of these
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  • Scenario Planning in the Auto industry
    Price of oil is $200 per barrel;
    Price of oil is $100 pb
    Price of oil is $50 pb
    Price of oil is $30 pb
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  • Scenario Planning and the Auto Industry
    9
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  • Scenario Planning in the Auto industry
    Now that is very simplistic and considers only one variable – an economic factor
    Clearly proper scenario planning would be much more sophisticated, and factor in multiple variables to identify many scenarios
    10
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  • Industry Analysis
  • “The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability”
    Michael Porter, “The Five Competitive Forces
    that Shape Strategy”, Harvard Business Review, January 2008.
    12
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  • Defining the Relevant Industry
    Quality of industry analysis is compromised if it is not well defined
    Avoid defining it too broadly – obscures differences among products, customers or geographic regions
    Avoid defining it too narrowly – overlook s commonalities
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  • Defining an Industry: Employ two key dimensions
    Scope of Products or Services
    The one product may be sold to very different buyers and thus despite product similarities, we have two or more industries:
    Motor oil is sold for lawn mowers, cars, trucks and thus we have three industries as the industry structure is very different
    Geographic scope
    Most industries exist in many countries.
    Is competition local, national, regional or global?
    14
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  • Steps in Industry Analysis
    Define the relevant industry
    Identify participants – who are:
    The buyers and buyer groups
    The suppliers and supplier groups
    The competitors
    The substitutes
    The potential entrants
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  • Steps in Industry Analysis
    Assess the underlying drivers of each competitive force to determine which forces are strong and which are weak and why;
    Determine overall industry structure
    Why is the level of profitability what it is?
    Which are the controlling forces for profitability
    Are more profitable players better positioned in relation to the five forces
    16
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  • Steps in Industry Analysis
    Analyze recent and likely future changes in each force – positive and negative
    Identify aspects of industry structure that might be influenced by competitors, by new entrants, or by ‘your’ company
    17
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  • 18
    Exhibit 2.1 Layers of the business environment
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  • Why Undertake Industry Analysis
    The purpose is to determine the attractiveness or unattractiveness of the industry
    And in particular the sources of the above by consideration of five key forces (Porter’s five forces model, developed in 1979)
    Unlike factors considered in PEST analysis, a company CAN influence industry attractiveness
    19
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  • Industry Analysis
    20
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  • Porter 2008: Updated Version of “The Five Forces”
    “In essence, the job of the strategist is to understand and cope with competition”
    Remember this is the dominant view of strategy;
    Remember in week 1 we posed the question is this view still as applicable today
    21
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  • Common Mistake
    Competition is defined too narrowly
    Competition includes direct rivals
    But competition for profits demands considerations of four other competitive forces:
    These five forces combined define an industry’s structure
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  • 23
    Exhibit 2.2 The five forces framework
    Source: Adapted with the permission of The Free Press, a Division of Simon & Schuster Adult Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved
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  • Porter’s Five Forces and Industry Analysis: His examples
    Industries with intense forces
    Airlines
    Hotels
    Textiles
    Industries with benign forces
    Software
    Soft drinks
    Toiletries
    24
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  • Industry Analysis
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  • Porter’s Key Point is this:
    Industry structure determines profitability
    Not
    the nature of the product or service
    whether the industry is emerging or mature
    whether high-tech or low-tech
    whether regulated or unregulated
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  • Industry Profitability Determined by…
    In Short term
    A myriad of factors
    The weather (severe cold weather deters trips to shops)
    The business cycle (products at end of PLC vs new products – think of Video Game Consoles)
    In Medium/Long Term
    Industry structure as manifested in the competitive forces
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  • Why is it essential to understand the forces?
    These reveal the roots of an industry’s current profitability
    They also provide a framework for anticipating and influencing competition (and profitability) over time
    Essential for strategic positioning
    Need to defend against the competitive forces
    And to shape the forces to the company’s advantage
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  • Industry Analysis: Example 1: Commercial Aircraft
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  • Key Point
    “The strongest competitive force or forces determine the profitability of an industry and become the most important force for consideration in strategy formulation”
    Porter, 2008, Harvard Business Review
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  • Photographic Film Industry
    Low returns are due not so much to rivalry (i.e. between Kodak and Fuji)
    But due to the advent of a superior substitute product (i.e. digital photography)
    Hence coping with this substitute product emerges as the top or number one strategic priority
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  • The Five Forces in-depth
  • First Force: Threat of new entrants
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  • Threat of Entry
    New entrants increase industry capacity and want to win market share
    This leads to pressure on prices, costs and the rate of investment required to compete
    New entrants that emerge from other markets can have a major impact as they can leverage existing capabilities and cash flows to shake up competition:
    34
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  • Threat of Entry: Recent Examples
    Google with Android in smart phones;
    Apple with iPad in eReader;
    Pepsico entering bottled water and other beverage segments;
    Amazon with Online entertainment
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  • Threat of entry
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  • What determines level of Threat of Entry?
    The height of entry barriers (i.e. the advantages that incumbents have relative to new entrants)
    The reaction new entrants provoke from incumbents
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  • Barriers to Entry: Seven Major sources
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  • Barriers to Entry: Seven Major sources
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  • Barriers to Entry: Seven Major sources
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  • Barriers to Entry: Seven Major sources
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  • Barriers to Entry: Seven Major sources and a practical perspective
    42
    Now consider the extent of these barriers to companies such as Apple,
    Dell, Google, RIM (ie Blackberry in China)
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  • Barriers to Entry: Seven Major sources and Google in China
    43
    Could Google possibly ever succeed in China?
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  • Big Challenge in Emerging Markets
    You may be seduced by the opportunities, but often the barriers to entry are very high.
    Should a company enter a market where the barriers are so high that it is either peripheral or confined to being a niche player?
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  • What determines level of Threat of Entry?
    The height of entry barriers (i.e. the advantages that incumbents have relative to new entrants)
    The reaction new entrants provoke from incumbents
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  • Expected Retaliation by Incumbents
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  • Reasons to Fear Retaliation
    Incumbents have a history of mounting strong defence against new entrants
    Incumbents have the resources to fight back:
    Cash
    Production capacity
    Clout with distribution channels and customers
    Incumbents will cut prices to protect market share and/or have high fixed costs
    Industry growth is slow so the only way for new entrants to gain volume is at the expense of an incumbent
    47
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  • 1. Threat of New Entrants
    Vital to stress that it’s the mere threat, not actual entry that holds down profitability
    When threat is high, incumbents need to hold down prices or boost investment to deter entrants
    Threat of entry is high and profits are moderated when entry barriers are low and newcomers expect little retaliation from incumbents
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  • Second force: The power of suppliers
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  • 2. Bargaining Power of Suppliers
    Supplier are more powerful when:
    They sell to an industry less concentrated than their own
    The supplier is not heavily dependent on the industry for its revenues
    Switching costs for industry participants are high
    Suppliers offer differentiated products
    No substitutes are available
    Suppliers could undertake forward integration
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  • third force: The power of buyers
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  • 3. Bargaining Power of Buyers
    Powerful buyers can:
    force down prices;
    Demand better quality or more service (thus driving up costs);
    and can play industry participants off against each other
    These all result in a reduction of profitability for those catering to these buyers
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  • Bargaining Power of Buyers is Strong when….…
    There are few buyers;
    Or when each buyer purchases in volumes that are large relative to the size of a single vendor;
    Buyers perceive vendors products as standardized or lacking in differentiation, so they perceive no advantage in buying from a particular vendor;
    Buyers have low switching costs in changing vendors;
    Buyers can credibly threaten backward integration and produce the vendor’s product themselves
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  • Bargaining Power of Buyers is Weak when….…
    There are many buyers;
    Or when each buyer purchases in volumes that are small relative to the size of a single vendor;
    Buyers perceive vendors products as differentiated, so they perceive no advantage in buying from a particular vendor;
    Buyers have high switching costs in changing vendors;
    Buyers cannot credibly threaten backward integration and produce the vendor’s product themselves
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  • Let’s Sum Up the Previous Two Slides
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  • Spotting Price Sensitive Buyers
    A buyer group is price sensitive when:
    It buys a product from the industry that represents a high percentage of its cost structure
    E.g. imagine a company buys just one particular component that accounts for 30 per cent of its total cost structure – the company will be very price sensitive and seek to lower cost of that component as much as possible
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  • Spotting Price Sensitive Buyers
    A buyer group is price sensitive when:
    It earns low profits, is strapped for cash, or is under pressure to reduce purchasing costs;
    Its own products/services are not greatly affected by the quality of the vendors’ products/services
    E.g. let’s assume that the ducting used in a Dyson hose is not critical to the quality of Dyson would be a very price-sensitive buyer of such ducting;
    However, the motor may be very important, so for that product Dyson would be much less price sensitive
    57
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  • Spotting Price Sensitive Buyers
    A buyer group is price sensitive when:
    The industry’s product has little effect on the buyer’s other costs
    E.g. an automobile producer may be very price sensitive when it comes to purchase of lights in vehicles, but not at all price-sensitive in choice of CNC machinery
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  • Just Think of Yourself as a Consumer!
    When are you a price sensitive buyer?
    When you are buying products that lack differentiation;
    When you are buying products that are relatively expensive to you;
    When product performance is not a major concern
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  • Fourth force: the threat of substitutes
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  • Substitute Products
    When the threat is high, industry profitability suffers
    The existence of substitute products/services limits an industry’s profit potential by placing a ceiling on prices
    Therefore an industry needs to reduce the appeal of substitutes through product performance, marketing etc
    E.g. golf club companies seek to reduce appeal of previous generations of product by regular new product launches and claims of improved performance
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  • Substitute Products
    In Emerging Markets, industries that may have expected to reap the benefits of economic development miss out due to substitute products
    Rather than subscribe to a wired telephone line, they rely exclusively upon wireless telecommunications
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  • The threat from substitute products is high if….
    it offers an attractive price-performance trade-off to the industry’s product
    Imagine paying $200 for a set of rarely used golf clubs that retailed for $1,200 only 12 months earlier;
    People use Skype and Vonage rather than conventional service providers for long-distance calls;
    TV cable companies in 2010 have seen largest drop in subscriber numbers as people rely on Online services such as Hulu, Netflix and YouTube.
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  • The threat from substitute products is high if….
    The buyer’s cost of switching to the substitute is low
    Consumers may switch at minimal cost from branded products (e.g cereals, drugs) to generics
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  • Substitute Products
    Changes in other industries may render them attractive substitutes when they were not before
    Consider some examples:
    Steel may be replaced by plastics as the latter innovates;
    Nuclear power may be replaced by renewable energy sources as the latter innovates
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  • Threat of Substitute Products
    A substitute performs the same or similar function as an industry’s product by a different means
    video conferencing is a substitute for travel;
    Plastic for aluminum
    Email for fax/letters
    Facebook for email
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  • Threat of Substitute Products
    Substitutes are always present…though they can often easily be overlooked;
    Valentine’s Day is approaching so think of the range of substitute products
    Think of what you may choose to buy for your partner – that ‘list’ of potential purchases are in fact all substitute products
    Consider your gift purchases at Christmas time – the options that you faced in each purchase again highlights the nature of substitutes
    67
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  • It is a substitute to…
    do without – you may decide not to make a purchase (e.g. buy a car; book a vacation)
    buy used (so this can be a strong substitute for cars, sports equipment, books etc – internet and ecommerce has perhaps increased the strength of this force)
    do it yourself (e.g. remodel yourself rather than employ a contractor; wash your own car rather than go to commercial carwash)
    68
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  • Fifth force: intensity of rivalry
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  • Think of How Rivals Compete
    What do auto companies do in order to win sales?
    What do mobile phone service carriers do in order to win subscribers?
    What do retailers to in order to attract customers?
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  • Rival’s Means of Competing
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  • High Rivalry Limits The Profitability of the Industry
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  • Intensity of Rivalry
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  • Price Competition is most likely if…
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  • Common Errors in Industry Analysis:Factors Not Forces
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  • Intensity of Rivalry
    In addition to the dimensions of rivalry, intensity increases when firms compete on the same dimensions
    Firms aim to meet the same needs
    Or compete on the same attributes
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  • The Five forces
    In an ideal world what would the analysis conclude for an organization competing in a particular industry?
    What would be the worst case scenario?
    Does the ideal scenario ever exist in a free market economy?
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  • The Five Forces in Operation
    Let’s identify an industry/industries and examine it using the five forces model
    Often students are confused by this tool
    They talk of ‘substitutes’ when they mean ‘rivals’
    They are not clear on who the suppliers are
    Or do not distinguish between different types of buyers
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  • Porter’s Five Forces Model
    It is vital that you grasp this concept and can apply it any context
    It needs to be applied at the SBU level of the organization
    It reveals the nature of competition in the present, but also needs to be employed to consider the nature of each force in the future
    This future orientation allows the organization to develop strategies to deal with each force in the future
    Changes in the remote environment can exert enormous impact upon the nature of a particular force
    79
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