Defining the Industry
Two firms are likely in the same industry if:
1. Production view: Same input, output, and technology (process of input → output)
2. Demand view: Same customer group and customer needs addressed
E.g.,
DVD vs. streaming?
Streaming TV shows vs. films?
Cars vs. bikes?
*One company can compete in multiple industries.
Layers of a firm’s business/external environment
The organization (very inner) → Markets & Competitors → Industry (or sector) → The macro-environment
Firm’s External Environment
Outside of 0. Company (which’s considered internal), there’s:
1. Suppliers, 2. Produces of Substitute Products 3. Buyers 4. New Entrants and 5. Rival Firms
Above all is within the Immediate Industry and Competitive Environment (i.e. you can control)^^
Outside of that, there’s:
1. Economic Conditions 2. Sociocultural Forces 3. Technological Factors 4. Environmental Forces 5. Legal/Regulatory Factors 5. Political Factors
Above all is part of the Macro-environment (i.e. you can not control)^^
PESTEL Analysis
The organization is affected by:
1. Political
- Government stability
- Taxation trade
- Foreign trade regulations
- Social welfare policies
2. Economical
- The Economic Growth Rate
- Interest rates
- Money supply
- Inflation
- Unemployment
- Tax Rate
- Foreign exchange rates
3. Social
- Population demographics
- Income distribution
- Lifestyle changes
- Attitudes to work and leisure
- Levels of education
4. Technological
- Government spending on research
- Government and industry focus on technological effort
- Speed of technology
5. Environmental
- Environmental protection laws
- Waste disposal
- Energy consumption
Porter’s Five Forces
Key insight:
The value created by an industry can be lost to rivals, bargained away by customers or suppliers, limited by substitutes or constrained by entrants.
Steps to a 5 Forces Analysis:
1. Define the industry
2. Identify the players (especially for case studies)
3. Assess the strength of each force
4. State the overall attractiveness for the industry
5. Assess recent & future changes in each force
Porter’s Five Forces: 1. Rivalry among existing competitors
“Threat of price wars” is high if:
1. Demand:
- Undifferentiated products - elastic products.
- Low buyer switching cost
- Stagnant/slow-growing demand
2. Production
- Low marginal cost/High fixed costs
- High exit barriers
- Excess capacity/inventory and high holding cost (e.g. perishables)
3. Market structure
- Fragmented market (many similar-sized competitors)
Porter’s Five Forces: 2. Threat of New Entry
High entry barrier (EB) lowers threat of new entry:
1. Production-driven entry barrier:
- Economies of scale/high fixed costs
- Experience, or learning
- Capital requirements
- Relationship/long-term contracts with suppliers
- Demand-driven entry barrier:
- Network effects
- Switching cost/inertia
- Consumer Information
- Brand recognition - Government policies:
- Loose anti-trust policies
- Strong patents protection
Porter’s Five Forces: 3. Supplier (Bargaining) Power
Suppliers has low bargaining power if:
1. Demand (for supplier products)
- Undifferentiated supplier products / many substitutes
- Low switching costs for supplier products
- Market structure (of supplier industry)
- Large number of small suppliers (unconcentrated industry)
- Credible threat of backward integration
- Suppliers depend heavily on the industry
Porter’s Five Forces: 4. Buyer/Consumer (Bargaining) Power
Buyer/Customers have low bargaining power/price sensitivity if:
For all types of customers:
1. Differentiated products
2. High switching costs
3. Low price/budget ratio; how price-elasticity
For enterprise customers:
1. Large number of small buyers
2. No credible threat of backward integration
3. Buyers depend heavily on the industry
Threat of Substitutes
- Substitutes compete for industry profits from outside the industry.
- Two industries offer substitutable products if the cross-price elasticity between the two products is positive.
- The smaller the magnitude of this elasticity (in absolute value), the smaller the threat is
- A close substitute with higher performance/price ratio is bad.
- If X and Y are substitutes, a decrease (increase) in the price of X leads to a decrease (increase) in the consumption of Y.
Threat of Complements
- Complementary industries offer cooperation opportunities.
- Two industries offer complementary products if the cross-price elasticity between the two products is negative.
- If X and Y are complements, a decrease (increase) in the price of X leads to an increase (decrease) in the consumption of Y. (e.g., web bowser and internet search engine; gaming console and game software)
- Similar to supplier power - if a complement industry is too powerful (concentrated market, high switching cost, etc.), then it diminishes industry profit.
Key Take Aways
- Micro-environment analysis (Porter’s Five Forces analysis) helps to understand the industry structure and industry profitability. This can enable a firm to decide on whether to compete in the industry and then how to compete (Internal).
- Macro-environment analysis (PESTLE) is another crucial analytical tool to help a firm understand factors that may impact its business which may not necessarily be under its control (Circle of Influence v.s. Circle of Concern).
