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1. Business strategy part 2
Mcenroe ng

2. Analyzing Industry Structure
• An important aspect of business strategy is the ability to understand the
dynamics and the structure of an industry or market segment, and
specifically, how that make up of an industry can impact the future
profitability potential of firms who operate in that industry.
- example. US airline industry. It's a fascinating case study because
historically, US airlines were highly regulated, but then in the late 1970s,
that was an industry that was deregulated and all of a sudden, that freed
up things so that a lot of these market dynamics could play out.
- So the question is, what's happened over the last 30 years in this industry?
We've had literally hundreds of carriers enter the industry. We've had
literally hundreds of carriers exit the industry. Many of the firms have been
in and out of bankruptcy. And generally speaking, a lot of the airlines have
really struggled. So the question is, why?

3. Analyzing Industry Structure
• Why has competition been so difficult in the airline industry?
• fundamental idea from strategy that if everybody can do it, it's
difficult to create and capture value from it. So the question is, was
that it?

4. Analyzing Industry Structure

5. Analyzing Industry Structure
• characterized by huge capital budgets, it's a highly technical business to be
in, I don't think it's necessarily the case that just anybody can run an
airline. So remember, theoretically, in a perfectly competitive market, no
firm realizes economic profits, or what economists would describe as rents.
• where do profits come from in a particular industry market segment or in a
particular firm?
• So on one hand, we have this idea from industrial organization economics
about monopoly profits or monopoly rents.
• And this is an idea that focuses largely on barriers to entry and it really
focuses on the structure of the industry and how that can impact the
prospects of firms operating in that industry.

6. Analyzing Industry Structure
• On the other hand, there is a view,
• the Ricardian view, that comes more from the resource based
tradition.
• Remember that the industrial organization perspective kind of takes it
as a given that the industry structure matters a lot. In fact, from this
perspective, this is the most important thing.
• And, you know, it's very difficult, given the sort of barriers to
competition, it's very difficult to move the supply curve outward and
lower prices. And so, essentially, that difficulty gives rise to the
possibility of monopolistic profits.

7. Analyzing Industry Structure

8. Analyzing Industry Structure
• Those arise largely from barriers to competition. And as a result of all of
this, it turns out that some industries are simply, on average, more
profitable than others.
• looks at industry average profitability. And you can see that some types of
industries are very profitable. Aerospace and medical devices, and Farma.
• These are industries where the average profitability, measured here in this
chart by just looking at return on assets, it's a simple simple measure of
profits, but in those industry segments, profitability potential is quite high.
And then you can see down at the bottom, we've got, you know, industries
like real estate and airlines, like we were talking about a moment ago. And
these are industries where the average profitability in the industry is quite
low.

9. Analyzing Industry Structure
• So the question is, why is that? Why do firms differ? It can't possible
just be a difference in demand for these products and services. Last
time we checked, I think there's lots of demand for airline tickets,
right? So there's got to be something else going on.
• the Five Forces. This was something that was pioneered by Professor
Michael Porter at Harvard back in the 80s.
• there are five key competitive forces that serve to minimize or
dampen the prospects for profitability in a particular industry

10. Analyzing
Industry
Structure

11. Threat of Entry, Part 1
• And the question is, do we want the threat of entry to be high, or
low?
• Well, the Five Forces Tool tells us that we want the threat of entry to
be low. Because remember, we're already in the industry. We're trying
to analyze what's the profitability potential of this industry as it exists.
• So, while potential new entrants might want the entry barriers to be
low, and therefore the threat of entry to be high, we're already in this
industry and we want that threat of entry to be low.

12. Threat of Entry, Part 1
• So the question is, what sorts of things might make the threat of
entry low?
• be lower if all these potential new entrants face high sunk costs. Now,
• Remember, if we've got a good idea and a good business plan, we
should be able to go to the capital markets and raise money so that
we can enter an industry.
• But, if there are highs sunk costs, that is gonna give these potential
new entrants a little more pause.

13. Threat of Entry, Part 1
• One way of thinking about sunk costs is these are things that are
highly asset specific. In other words, they represent risks to these
potential new entrants that if things don't work out in their attempt
to enter the industry,
• difficulty recovering those costs or investments
• So it's a capital expenditure, but it might not necessarily be a sunk
cost. It's not highly asset specific.

14. Threat of Entry, Part 1
• incumbents might have a competitive advantage.
• arise from intellectual property
• it might even be explicitly protected by patents or licenses or copyrights,
• to really succeed in an industry, we need this intellectual property,
and somebody already owns that intellectual property.
• very hard for new entrants to compete.

16. Threat of Entry, Part 1
• pre-commitment contracts can be a source of competitive advantage.
• large economies of scale, relative to demand.
• If you look here on the y-axis, we've got price or cost. On the x-axis,
we've got output. And the idea here is that the more our output
increases, the average cost per unit is gonna come down.
• to the minimum efficient scale or MES point. And the idea here is that
minimum efficient scale is really the point that you need to achieve to
be cost competitive in an industry.

17. Threat of Entry, Part 1

18. Threat of Entry, Part 1
• Now, different industries will have different sort of levels of minimum
efficient scale.
• Some industries, just because of the technology or the structure of
the industry, might have a minimum efficient scale that's very high.
• We've got unit cost on the y-axis, we've got output on the x-axis, but
there's a key difference.
• The output here is cumulative. So it's not just average output or unit
output this year, but it's cumulative output. In other words, are we
getting better at this? And is that lowering our manufacturing cost
because we're just doing more and more of it?

19. Threat of Entry, Part 1
• The cost of doing something comes down if we get better at it. And we see this in
industries.
• Take the semi conductor industry. There's an industry where people talk about Moore's
law, which essentially says that every 18 months, the capacity doubles, just because of
the march of technology, all right?
• And so what we see over time, here's something from the semiconductor industry. What
we see is that the sort of cost per bit, we think of that as kind of the unit cost.
• What does it cost these firms to produce semiconductors? It just keeps coming down,
the more and more of this that the firms do. And so, again, the point here is that this can
be a source of competitive advantage. Because it makes it very difficult for a new entrant
to catch up with the incumbents that have a competitive advantage, arising from
learning curves or any of these other factors.
• So that's the key thing to think about in terms of threat of entry, is are there structural
things about competitive advantage that will make threat of entry lower or higher,
depending on the dynamics of the industry?

20. Threat of Entry, Part 2

21. Reference
• University of Virginia