Applying Michael Porter's Five Forces

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Applying Michael Porter's Five Forces

  1. 1. Applying the Five Forces by Wesley Shu, text by D. Besanko et al.
  2. 2. Hospital Market in Chicago Area <ul><li>Thriving in 80s, then declined, recently on the rise </li></ul>
  3. 3. Internal Rivalry – Background <ul><li>about 70 hospitals, mostly independent, i.e., low Herfindahl index (HHI) </li></ul><ul><li>Fierce internal rivalry, because </li></ul><ul><li>Many competitors </li></ul><ul><li>Production costs vary </li></ul><ul><li>Substantial excess capacity – occupancy rate < 70% at many hospitals </li></ul><ul><li>Stagnant or declining demand </li></ul>
  4. 4. Internal Rivalry – MCO Took Advantage <ul><li>Managed care organizations (MCO, insurance companies) took advantage: </li></ul><ul><li>Contract with hospitals offering the most favorable rates </li></ul><ul><li>Lower the co-pay to encourage patients to choose those hospitals </li></ul><ul><li>Due to high price elasticity, demand increase – hospitals are more homogenous </li></ul>
  5. 5. Internal Rivalry – MCO Took Advantage <ul><li>Negotiations between MCO and hospitals were secret, hospitals in disadvantageous position </li></ul><ul><li>Contracts are infrequent – hospitals assumed pressure </li></ul>
  6. 6. Internal Rivalry – Hospital Fought Back <ul><li>Established brand identity, e.g., Northwestern Medical Center </li></ul><ul><li>Diversified into related products, e.g., skilled nursing services </li></ul><ul><li>Differentiated their services, e.g., establishing cancer center, etc. </li></ul><ul><li>Patients required hospital in neighborhood – increase loyalty </li></ul><ul><li>Merger </li></ul>
  7. 7. Entry - Barriers <ul><li>Government regulation on new hospital construction </li></ul><ul><li>Hospitals are capital intensive </li></ul><ul><li>Brand identity not easy for new hospitals </li></ul>
  8. 8. Entry – The Other Side <ul><li>Chicago area grew </li></ul><ul><li>Innovations allowed smaller niche hospitals </li></ul>
  9. 9. Substitutes and Complements <ul><li>Few inpatient services could be performed outside the hospitals </li></ul><ul><li>But improvement in surgical techniques made it possible </li></ul><ul><li>Outpatient diagnostic facilities (ODF) – substitutes </li></ul><ul><li>But ODF can also be complement – hospitals already had technology and experience to do it – economies of scope </li></ul>
  10. 10. Suppliers <ul><li>Demand for nurses high, supply low </li></ul><ul><li>Price rising for drugs and other medical supplies </li></ul>
  11. 11. Buyers <ul><li>Insurers wield substantial power </li></ul><ul><li>Insurers are large size – high negotiation power, e.g., Blue Cross and Medicare </li></ul><ul><li>Highly skilled physicians became strong buyers who brought patients </li></ul>
  12. 12. Overview Medium Low Buyer power Medium Medium Supplier power High Medium Substitutes and complements Medium but growing Low Entry High but falling Low Internal rivalry Threat to Profit, today Threat to Profit, 1980s Force
  13. 13. Pentagonal Analysis
  14. 14. Use of Pentagonal Analysis <ul><li>Compared the intensity of competition of two industries (or the same one, different time) </li></ul><ul><li>E ntry strategy and decision for entrant, ex. </li></ul><ul><ul><li>Better enter in 80s in Chicago hospitals than now </li></ul></ul><ul><ul><li>N ow, form an alliance with suppliers or buyers to bargain or compete with sub/comp and other hospitals </li></ul></ul><ul><ul><li>I n 80s, differentiate to avoid sub/comp </li></ul></ul>
  15. 15. Template – Internal Rivalry Buyers’ switching costs? Degree of product differentiation among sellers? Brand loyalty to existing sellers? Cross-price elasticities of demand among competitors in industry? Cost structure of firms: sensitivity of costs to capacity utilization? Excess capacity? Significant cost differences among firms? Rate of industry growth? Degree of seller concentration? Future Current
  16. 16. Template – Internal Rivalry Strength of exit barriers? History of “cooperative” pricing? Use of ”facilitating practices”? Large and/or infrequent sales orders? Can firms adjust prices quickly? Are prices and terms of sales transactions observable? Future Current
  17. 17. Template – Threat of Entry Experience-based advantages of incumbents Entrants’ access to favorable locations Entrants’ access to technology/know-how Entrants’ access to raw materials Entrants’ access to distribution channels Importance of reputation or established brand loyalties in purchase decision Significant economies of scale Future Current
  18. 18. Template – Threat of Entry Perception of entrants about expected retaliation of incumbents/reputations of incumbents for ‘toughness’ Government protection of incumbents Network externalities Future Current
  19. 19. Template – Substitutes & Complements Price elasticity of industry demand Availability of close complements Price-value characteristics of complements Price-value characteristics of substitutes Availability of close substitutes Future Current
  20. 20. Template – Suppliers Do suppliers pose credible threat of forward integration into the product market? Few substitutes for suppliers’ input Do firms in industry make relationship-specific investments to support transactions with specific suppliers? Are suppliers able to price-discriminate among prospective customers according to ability/willingness to pay for input? Do firms in industry purchase small volumes relative to other customers of suppliers? Is typical firm’s purchase volume small relative to sales of typical suppliers? Is supplier industry more concentrated than industry it sells to? Future Current
  21. 21. Template – Buyers Is price elasticity of demand of buyer’s product high? Can buyers find substitutes for industry’s product? Do firms in industry make relationship-specific investments to support transactions with specific buyers? Do buyers purchase in large volumes? Does a buyer’s purchase volume represent large fraction of typical seller’s sales revenue? Is buyers’ industry more concentrated than industry it purchases from? Future Current
  22. 22. Template – Buyers Are prices in the market negotiated between buyers’ and sellers on each individual transaction or do sellers post a ‘take it or leave it’ price that applies to all transaction? Does product represent significant fraction of cost in buyer’s business? Do buyers pose credible threat of backward integration? Future Current

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