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Industry analysis and Porter\'s five forces model

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  1. 1. Industry Analysis:Porter’s Five Forces Model<br />Michael McDermott<br />mcdermottm1@nku.edu<br />http://www.linkedin.com/in/michaelcmcdermott<br />www.facebook.com/strategycapstone<br />www.strategycapstone.ning.com<br />www.Mcdermottstrategy.wikispaces.com<br />www.globalbusinessstrategy.wikispaces.com<br />1<br />www.facebook.com/strategycapstone<br />
  2. 2. 2<br />Exhibit 1.2 The vocabulary of strategy<br />www.facebook.com/strategycapstone<br />
  3. 3. 3<br />Exhibit 2.1 Layers of the business environment<br />www.facebook.com/strategycapstone<br />
  4. 4. PEST Analysis is Complete(see previous slides)<br />Remember the PEST focuses upon the remote external environment<br />These are the factors that NO company can control<br />But the company MUST heed the conclusions from its PEST analysis<br />Aligning with such trends is very wise<br />Ignoring them is very risky if not foolish<br />4<br />www.facebook.com/strategycapstone<br />
  5. 5. Scenario Planning<br />
  6. 6. Scenario Planning<br />This demands consideration of a range of scenarios<br />To be meaningful, if should include the most optimistic and most pessimistic scenarios<br />This is intended to compel executives to ask the “what if” questions<br />6<br />www.facebook.com/strategycapstone<br />
  7. 7. Scenario Planning<br />Organizations sometimes undertake this exercise<br />The aim is to construct scenarios and then consider the strategic implications of these<br />7<br />www.facebook.com/strategycapstone<br />
  8. 8. Scenario Planning in the Auto industry<br />Price of oil is $200 per barrel; <br />Price of oil is $100 pb<br />Price of oil is $50 pb<br />Price of oil is $30 pb<br />8<br />www.facebook.com/strategycapstone<br />
  9. 9. Scenario Planning and the Auto Industry<br />9<br />www.facebook.com/strategycapstone<br />
  10. 10. Scenario Planning in the Auto industry<br />Now that is very simplistic and considers only one variable – an economic factor<br />Clearly proper scenario planning would be much more sophisticated, and factor in multiple variables to identify many scenarios<br />10<br />www.facebook.com/strategycapstone<br />
  11. 11. Industry Analysis<br />
  12. 12. “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”<br />Michael Porter, “The Five Competitive Forces <br />that Shape Strategy”, Harvard Business Review, January 2008.<br />12<br />www.facebook.com/strategycapstone<br />
  13. 13. Defining the Relevant Industry<br />Quality of industry analysis is compromised if it is not well defined<br />Avoid defining it too broadly – obscures differences among products, customers or geographic regions<br />Avoid defining it too narrowly – overlook s commonalities<br />13<br />www.facebook.com/strategycapstone<br />
  14. 14. Defining an Industry: Employ two key dimensions<br />Scope of Products or Services<br />The one product may be sold to very different buyers and thus despite product similarities, we have two or more industries:<br />Motor oil is sold for lawn mowers, cars, trucks and thus we have three industries as the industry structure is very different<br />Geographic scope<br />Most industries exist in many countries.<br />Is competition local, national, regional or global?<br />14<br />www.facebook.com/strategycapstone<br />
  15. 15. Steps in Industry Analysis<br />Define the relevant industry<br />Identify participants – who are:<br />The buyers and buyer groups<br />The suppliers and supplier groups<br />The competitors<br />The substitutes<br />The potential entrants<br />15<br />www.facebook.com/strategycapstone<br />
  16. 16. Steps in Industry Analysis<br />Assess the underlying drivers of each competitive force to determine which forces are strong and which are weak and why;<br />Determine overall industry structure<br />Why is the level of profitability what it is?<br />Which are the controlling forces for profitability<br />Are more profitable players better positioned in relation to the five forces<br />16<br />www.facebook.com/strategycapstone<br />
  17. 17. Steps in Industry Analysis<br />Analyze recent and likely future changes in each force – positive and negative<br />Identify aspects of industry structure that might be influenced by competitors, by new entrants, or by ‘your’ company<br />17<br />www.facebook.com/strategycapstone<br />
  18. 18. 18<br />Exhibit 2.1 Layers of the business environment<br />www.facebook.com/strategycapstone<br />
  19. 19. Why Undertake Industry Analysis<br />The purpose is to determine the attractiveness or unattractiveness of the industry<br />And in particular the sources of the above by consideration of five key forces (Porter’s five forces model, developed in 1979)<br />Unlike factors considered in PEST analysis, a company CAN influence industry attractiveness<br />19<br />www.facebook.com/strategycapstone<br />
  20. 20. Industry Analysis<br />20<br />www.facebook.com/strategycapstone<br />
  21. 21. Porter 2008: Updated Version of “The Five Forces”<br />“In essence, the job of the strategist is to understand and cope with competition”<br />Remember this is the dominant view of strategy;<br />Remember in week 1 we posed the question is this view still as applicable today<br />21<br />www.facebook.com/strategycapstone<br />
  22. 22. Common Mistake<br />Competition is defined too narrowly<br />Competition includes direct rivals<br />But competition for profits demands considerations of four other competitive forces:<br />These five forces combined define an industry’s structure<br />22<br />www.facebook.com/strategycapstone<br />
  23. 23. 23<br />Exhibit 2.2 The five forces framework<br />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<br />www.facebook.com/strategycapstone<br />
  24. 24. Porter’s Five Forces and Industry Analysis: His examples<br />Industries with intense forces<br />Airlines<br />Hotels<br />Textiles<br />Industries with benign forces<br />Software<br />Soft drinks<br />Toiletries<br />24<br />www.facebook.com/strategycapstone<br />
  25. 25. Industry Analysis<br />25<br />www.facebook.com/strategycapstone<br />
  26. 26. Porter’s Key Point is this:<br />Industry structure determines profitability<br />Not<br />the nature of the product or service<br />whether the industry is emerging or mature<br />whether high-tech or low-tech<br />whether regulated or unregulated<br />26<br />www.facebook.com/strategycapstone<br />
  27. 27. Industry Profitability Determined by…<br />In Short term<br />A myriad of factors<br />The weather (severe cold weather deters trips to shops)<br />The business cycle (products at end of PLC vs new products – think of Video Game Consoles)<br />In Medium/Long Term<br />Industry structure as manifested in the competitive forces<br />27<br />www.facebook.com/strategycapstone<br />
  28. 28. Why is it essential to understand the forces?<br />These reveal the roots of an industry’s current profitability<br />They also provide a framework for anticipating and influencing competition (and profitability) over time<br />Essential for strategic positioning <br />Need to defend against the competitive forces<br />And to shape the forces to the company’s advantage<br />28<br />www.facebook.com/strategycapstone<br />
  29. 29. Industry Analysis: Example 1: Commercial Aircraft<br />29<br />www.facebook.com/strategycapstone<br />
  30. 30. Key Point<br />“The strongest competitive force or forces determine the profitability of an industry and become the most important force for consideration in strategy formulation”<br />Porter, 2008, Harvard Business Review<br />30<br />www.facebook.com/strategycapstone<br />
  31. 31. Photographic Film Industry<br />Low returns are due not so much to rivalry (i.e. between Kodak and Fuji)<br />But due to the advent of a superior substitute product (i.e. digital photography)<br />Hence coping with this substitute product emerges as the top or number one strategic priority<br />31<br />www.facebook.com/strategycapstone<br />
  32. 32. The Five Forces in-depth<br />
  33. 33. First Force: Threat of new entrants<br />33<br />www.facebook.com/strategycapstone<br />
  34. 34. Threat of Entry<br />New entrants increase industry capacity and want to win market share<br />This leads to pressure on prices, costs and the rate of investment required to compete<br />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:<br />34<br />www.facebook.com/strategycapstone<br />
  35. 35. Threat of Entry: Recent Examples<br />Google with Android in smart phones;<br />Apple with iPad in eReader;<br />Pepsico entering bottled water and other beverage segments;<br />Amazon with Online entertainment<br />35<br />www.facebook.com/strategycapstone<br />
  36. 36. Threat of entry<br />36<br />www.facebook.com/strategycapstone<br />
  37. 37. What determines level of Threat of Entry?<br />The height of entry barriers (i.e. the advantages that incumbents have relative to new entrants)<br />The reaction new entrants provoke from incumbents<br />37<br />www.facebook.com/strategycapstone<br />
  38. 38. Barriers to Entry: Seven Major sources<br />38<br />www.facebook.com/strategycapstone<br />
  39. 39. Barriers to Entry: Seven Major sources<br />39<br />www.facebook.com/strategycapstone<br />
  40. 40. Barriers to Entry: Seven Major sources<br />40<br />www.facebook.com/strategycapstone<br />
  41. 41. Barriers to Entry: Seven Major sources<br />41<br />www.facebook.com/strategycapstone<br />
  42. 42. Barriers to Entry: Seven Major sources and a practical perspective<br />42<br />Now consider the extent of these barriers to companies such as Apple, <br />Dell, Google, RIM (ie Blackberry in China)<br />www.facebook.com/strategycapstone<br />
  43. 43. Barriers to Entry: Seven Major sources and Google in China<br />43<br />Could Google possibly ever succeed in China?<br />www.facebook.com/strategycapstone<br />
  44. 44. Big Challenge in Emerging Markets<br />You may be seduced by the opportunities, but often the barriers to entry are very high.<br />Should a company enter a market where the barriers are so high that it is either peripheral or confined to being a niche player?<br />44<br />www.facebook.com/strategycapstone<br />
  45. 45. What determines level of Threat of Entry?<br />The height of entry barriers (i.e. the advantages that incumbents have relative to new entrants)<br />The reaction new entrants provoke from incumbents<br />45<br />www.facebook.com/strategycapstone<br />
  46. 46. Expected Retaliation by Incumbents<br />46<br />www.facebook.com/strategycapstone<br />
  47. 47. Reasons to Fear Retaliation<br />Incumbents have a history of mounting strong defence against new entrants<br />Incumbents have the resources to fight back: <br />Cash<br />Production capacity<br />Clout with distribution channels and customers<br />Incumbents will cut prices to protect market share and/or have high fixed costs<br />Industry growth is slow so the only way for new entrants to gain volume is at the expense of an incumbent<br />47<br />www.facebook.com/strategycapstone<br />
  48. 48. 1. Threat of New Entrants<br />Vital to stress that it’s the mere threat, not actual entry that holds down profitability<br />When threat is high, incumbents need to hold down prices or boost investment to deter entrants<br />Threat of entry is high and profits are moderated when entry barriers are low and newcomers expect little retaliation from incumbents<br />48<br />www.facebook.com/strategycapstone<br />
  49. 49. Second force: The power of suppliers<br />49<br />www.facebook.com/strategycapstone<br />
  50. 50. 2. Bargaining Power of Suppliers<br />Supplier are more powerful when:<br />They sell to an industry less concentrated than their own<br />The supplier is not heavily dependent on the industry for its revenues<br />Switching costs for industry participants are high<br />Suppliers offer differentiated products<br />No substitutes are available<br />Suppliers could undertake forward integration<br />50<br />www.facebook.com/strategycapstone<br />
  51. 51. third force: The power of buyers<br />51<br />www.facebook.com/strategycapstone<br />
  52. 52. 3. Bargaining Power of Buyers<br />Powerful buyers can:<br />force down prices;<br />Demand better quality or more service (thus driving up costs);<br />and can play industry participants off against each other<br />These all result in a reduction of profitability for those catering to these buyers<br />52<br />www.facebook.com/strategycapstone<br />
  53. 53. Bargaining Power of Buyers is Strong when….…<br />There are few buyers;<br />Or when each buyer purchases in volumes that are large relative to the size of a single vendor;<br />Buyers perceive vendors products as standardized or lacking in differentiation, so they perceive no advantage in buying from a particular vendor;<br />Buyers have low switching costs in changing vendors;<br />Buyers can credibly threaten backward integration and produce the vendor’s product themselves<br />53<br />www.facebook.com/strategycapstone<br />
  54. 54. Bargaining Power of Buyers is Weak when….…<br />There are many buyers;<br />Or when each buyer purchases in volumes that are small relative to the size of a single vendor;<br />Buyers perceive vendors products as differentiated, so they perceive no advantage in buying from a particular vendor;<br />Buyers have high switching costs in changing vendors;<br />Buyers cannot credibly threaten backward integration and produce the vendor’s product themselves<br />54<br />www.facebook.com/strategycapstone<br />
  55. 55. Let’s Sum Up the Previous Two Slides<br />55<br />www.facebook.com/strategycapstone<br />
  56. 56. Spotting Price Sensitive Buyers<br />A buyer group is price sensitive when:<br />It buys a product from the industry that represents a high percentage of its cost structure<br />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<br />56<br />www.facebook.com/strategycapstone<br />
  57. 57. Spotting Price Sensitive Buyers<br />A buyer group is price sensitive when:<br />It earns low profits, is strapped for cash, or is under pressure to reduce purchasing costs;<br />Its own products/services are not greatly affected by the quality of the vendors’ products/services<br />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;<br />However, the motor may be very important, so for that product Dyson would be much less price sensitive<br />57<br />www.facebook.com/strategycapstone<br />
  58. 58. Spotting Price Sensitive Buyers<br />A buyer group is price sensitive when:<br />The industry’s product has little effect on the buyer’s other costs<br />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<br />58<br />www.facebook.com/strategycapstone<br />
  59. 59. Just Think of Yourself as a Consumer!<br />When are you a price sensitive buyer?<br />When you are buying products that lack differentiation;<br />When you are buying products that are relatively expensive to you;<br />When product performance is not a major concern<br />59<br />www.facebook.com/strategycapstone<br />
  60. 60. Fourth force: the threat of substitutes<br />60<br />www.facebook.com/strategycapstone<br />
  61. 61. Substitute Products<br />When the threat is high, industry profitability suffers<br />The existence of substitute products/services limits an industry’s profit potential by placing a ceiling on prices<br />Therefore an industry needs to reduce the appeal of substitutes through product performance, marketing etc<br />E.g. golf club companies seek to reduce appeal of previous generations of product by regular new product launches and claims of improved performance<br />61<br />www.facebook.com/strategycapstone<br />
  62. 62. Substitute Products<br />In Emerging Markets, industries that may have expected to reap the benefits of economic development miss out due to substitute products<br />Rather than subscribe to a wired telephone line, they rely exclusively upon wireless telecommunications<br />62<br />www.facebook.com/strategycapstone<br />
  63. 63. The threat from substitute products is high if….<br />it offers an attractive price-performance trade-off to the industry’s product<br />Imagine paying $200 for a set of rarely used golf clubs that retailed for $1,200 only 12 months earlier;<br />People use Skype and Vonage rather than conventional service providers for long-distance calls;<br />TV cable companies in 2010 have seen largest drop in subscriber numbers as people rely on Online services such as Hulu, Netflix and YouTube.<br />63<br />www.facebook.com/strategycapstone<br />
  64. 64. The threat from substitute products is high if….<br />The buyer’s cost of switching to the substitute is low<br />Consumers may switch at minimal cost from branded products (e.g cereals, drugs) to generics<br />64<br />www.facebook.com/strategycapstone<br />
  65. 65. Substitute Products<br />Changes in other industries may render them attractive substitutes when they were not before<br />Consider some examples:<br />Steel may be replaced by plastics as the latter innovates;<br />Nuclear power may be replaced by renewable energy sources as the latter innovates<br />65<br />www.facebook.com/strategycapstone<br />
  66. 66. Threat of Substitute Products<br />A substitute performs the same or similar function as an industry’s product by a different means<br />video conferencing is a substitute for travel;<br />Plastic for aluminum<br />Email for fax/letters<br />Facebook for email<br />66<br />www.facebook.com/strategycapstone<br />
  67. 67. Threat of Substitute Products<br />Substitutes are always present…though they can often easily be overlooked;<br />Valentine’s Day is approaching so think of the range of substitute products<br />Think of what you may choose to buy for your partner – that ‘list’ of potential purchases are in fact all substitute products<br />Consider your gift purchases at Christmas time – the options that you faced in each purchase again highlights the nature of substitutes<br />67<br />www.facebook.com/strategycapstone<br />
  68. 68. It is a substitute to…<br />do without – you may decide not to make a purchase (e.g. buy a car; book a vacation)<br />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)<br />do it yourself (e.g. remodel yourself rather than employ a contractor; wash your own car rather than go to commercial carwash)<br />68<br />www.facebook.com/strategycapstone<br />
  69. 69. Fifth force: intensity of rivalry<br />69<br />www.facebook.com/strategycapstone<br />
  70. 70. Think of How Rivals Compete<br />What do auto companies do in order to win sales?<br />What do mobile phone service carriers do in order to win subscribers?<br />What do retailers to in order to attract customers?<br />70<br />www.facebook.com/strategycapstone<br />
  71. 71. Rival’s Means of Competing<br />71<br />www.facebook.com/strategycapstone<br />
  72. 72. High Rivalry Limits The Profitability of the Industry<br />72<br />www.facebook.com/strategycapstone<br />
  73. 73. Intensity of Rivalry<br />73<br />www.facebook.com/strategycapstone<br />
  74. 74. Price Competition is most likely if…<br />74<br />www.facebook.com/strategycapstone<br />
  75. 75. Common Errors in Industry Analysis:Factors Not Forces<br />75<br />www.facebook.com/strategycapstone<br />
  76. 76. Intensity of Rivalry<br />In addition to the dimensions of rivalry, intensity increases when firms compete on the same dimensions<br />Firms aim to meet the same needs<br />Or compete on the same attributes<br />76<br />www.facebook.com/strategycapstone<br />
  77. 77. The Five forces<br />In an ideal world what would the analysis conclude for an organization competing in a particular industry?<br />What would be the worst case scenario?<br />Does the ideal scenario ever exist in a free market economy?<br />77<br />www.facebook.com/strategycapstone<br />
  78. 78. The Five Forces in Operation<br />Let’s identify an industry/industries and examine it using the five forces model<br />Often students are confused by this tool<br />They talk of ‘substitutes’ when they mean ‘rivals’<br />They are not clear on who the suppliers are<br />Or do not distinguish between different types of buyers<br />78<br />www.facebook.com/strategycapstone<br />
  79. 79. Porter’s Five Forces Model<br />It is vital that you grasp this concept and can apply it any context<br />It needs to be applied at the SBU level of the organization<br />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<br />This future orientation allows the organization to develop strategies to deal with each force in the future<br />Changes in the remote environment can exert enormous impact upon the nature of a particular force<br />79<br />www.facebook.com/strategycapstone<br />