List three specific parts of the Industry Section of the Case Guide (see below) that you had the most difficulty understanding. Describe your current understanding of these parts.
INDUSTRY ANALYSIS SECTION A. Definition of Industry The industry definition for our purposes is a tool that frames the analysis of the case. The definition should make clear what product or service markets define your industry. Definitions should clearly distinguish rivals from substitutes. (Substitutes will be defined in the five competitive forces analysis in Section 3C below). Be very precise. If your definition can include products or services that you do not consider to be part of your industry definition, then your definition is not precise enough. Define industries narrowly rather than broadly, but not so narrowly that you cannot identify three to six industry segments in the industry. (Segments will be explained in Section 4, Industry Segment Analysis, below and in the reading notes for Week One.) The three to six segments minimum is a guideline, but there are a few rare exceptions. Your industry definition does not need to (and often should not) cover all of the businesses of your company if more than one division exists. It should include the main business of your company on which you focus. Your industry definition will very rarely match the industry definitions of published sources, such as Value Line, Fortune, or U.S. SIC codes, so researching these will do more harm than good, most likely. Make sure that the industry’s geographic boundaries (separately for sales and manufacturing) are identified, in order to make the definition clear. For example consider the beer industry in the United States. Your case only addresses the United States, but when you walk into a beer distributor you find Heineken and Tsingtao that are direct competitors with Boston Brewing, although the former are foreign beers. To resolve this dilemma in your industry definition, you could state: The industry consists of beer manufacturers who brew anywhere in the world, but sell at least some of their product in the United States. 24 The industry definition not only provides a context for your strategy, but sets the parameters for Industry Analyses, particularly Five Competitive Forces Analysis (Section 3C below). Additionally, a precise and accurate industry definition is important for Segment Analysis in Section 4 below, particularly the creation of the strategic group map. B. Industry Characteristics (Minimize research; Identify estimates; Make estimates single points, not ranges.) The first slide of this analysis should include the four industry characteristics (from the following list) that are most important in explaining or supporting your objectives and strategy. A sentence or two for each of the four characteristics should explain its importance. The following slides should include each and all of the other industry characteristics. Although many of these industry characteristics have detailed descriptions below, you only need to state the characteristic and briefly (a couple of words) describe it. During the class review of your case you might be asked to defend selected items. Keep any notes (but do not submit them) that support your detailed assessments. 1. Market size (Present it as annual revenue or units sold.) 2. Market growth rate (State it as a percent. It should match Section 1A.) 3. Stage in industry life cycle (Stages are emerging, growth, maturity, and decline.) Unlike what you might have learned in other courses, we are talking about industries, and not products or companies. Some industries take decades to go through an industry stage (the Automobile Industry), while others move much more quickly (the Personal Computer Industry). Some generalizations include: A. During the growth stage of the industry, companies have negative cash flow because they are investing in capacity. Once the industry reaches maturity (aggregate demand flattens out), companies in the industry have positive cash flows and some (market share leaders) are called “cash cows.” B. During the growth stage of the industry, competition is not intense because aggregate demand exceeds supply. Companies, with even a minimally acceptable level of quality can sell more than they make. Because of this, inefficient companies can be successful. During late growth, when aggregate 25 demand slows, there is often a “shake out” in the industry. Inefficient companies or companies that have not achieved competitive economies of scale will either go out of business or be acquired by other companies. C. Although individual companies may become profitable very quickly, the industry as a whole does not become profitable until the late growth stage. D. Being the market share leader in a declining industry can be quite profitable and stable. For purposes of this course, we will arbitrarily consider an industry to be in the mature stage if the industry growth rate is between 0% and 5% plus inflation. Be able to justify your choice. 4. Number of companies in industry (Include both the number and concentration.) Students often have no idea of the number of small companies in an industry. Pick a specific number, not a range, and identify it as an estimate (e. g., 100,000 estimated.) In a similar situation, if these are ten major companies identified in the case/your research, then describe it as such. The industry contains ten major companies and an estimated 100,000 much smaller companies. For this course, we will define concentration level as the total market share of the four largest companies in the industry. Other commonly used definitions include the sum of the eight or twenty largest companies’ market share. Although there is no commonly accepted cut-off point, for this course we will consider concentration percentages over 80% as reflecting a highly concentrated industry. We will also consider an industry with a concentration level of less than 15% as being highly fragmented. Industries in between these two parameters are “neither concentrated nor fragmented.” Industries characterized as having high concentration levels generally have large economies of scale. It is difficult for smaller companies in the industry to effectively compete head-on with the larger companies, although the small companies may find niche markets within the industry. The entry of competitive new companies into the industry is very difficult. An example of this would be the mainframe computer industry in the 1970s. This was a highly-concentrated industry with a level over 90%. IBM alone had over 80% market share, largely due to superb marketing skills, superior products, and a reputation developed over more than a decade. At the other extreme are fragmented industries. In these industries there are generally no significant economies of scale and no clear path for companies to achieve advantages for gaining large market shares. Entry into the industry tends to be relatively easy. An example of a fragmented industry would be the dance instruction industry. Many towns and cities have small dance studios where children learn ballet or tap 26 dancing. Capital requirement are low, there are no economies of scale (one teacher cannot instruct a class of 1,000 students), and anyone with dance experience can open a studio (i.e., enter the industry). 5. Customers (List categories, number, and characteristics.) An example would be the Automobile Manufacturers Industry (worldwide) whose sales occur at least partially in the U.S. The major customer groups/categories would be dealers, rental car companies, and fleet purchasers, including governments (but, not you and me. Remember that this is industry level). We might estimate that there are 100 car rental companies. Refer to companies not locations. A major characteristic of automobile rental companies is that they are very price sensitive and may switch from one manufacturer to another each year. Dealers are more committed to a specific manufacturer. This gives us some idea of the relative power of different customers. Note that we are addressing immediate customers (buyers), not end-users (company level). 6. Ease of industry entry (Is it easy or difficult?) We are not assessing whether or not a company can have a significant competitive effect on the industry, merely whether it is easy or difficult to enter it. The same holds true for ease of exit below. This contrasts with potential new entry power in Section 3C (Five Competitive Forces), where we are examining not only the ease of entry, but the ability of it to affect industry profitability. 7. Ease of industry exit (Is it easy or difficult?) 8. Technology/innovation trends (If applicable, list speed, size, & consistency/timing, otherwise list “None”) Speed refers to how quickly innovations spread throughout the industry (i.e., how easily they can be copied by competitors). Identifying speed as fast or slow is sufficient. Size refers to whether or not these are big or small industry innovations. Consistency and timing refers to how often and how consistently innovations occur. For example, consider the worldwide automotive tire industry in the 1960’s. Michelin developed the radial tire which was far superior to other existing tires. This innovation spread very slowly throughout the industry. The introduction of radial tires required automakers to redesign their suspension systems. U.S. automobile manufacturers were not willing to do this. As a result this innovation did not spread to U.S. based tire manufacturers for nearly a decade. In terms of size, this was a large innovation. In terms of consistency it was a one-time innovation. 27 Interestingly Michelin had a competitive advantage and was able to sell its radial tires at premium prices generating significant additional profits. However, once the innovation spread through the industry, competition drove prices down. Unfortunately for the tire industry, radials lasted much longer than the old biased tires and aggregate demand dropped significantly. People did not need to buy new tires as often. This resulted in large layoffs throughout the industry. 9. Product/service characteristics (Defend the degree of standardization as: commodity-like, highly differentiated, or somewhat differentiated) Although the industry will most likely have a lot of different products or services, on average will they be more standardized (commodity-like) or differentiated. In a highly differentiated industry, competition is less based upon price than it is in a commoditylike industry. The farming industry’s products are, in general, commodities. In general, the college industry is highly differentiated. Differentiation characteristics might include the atmosphere of the campus, the reputation of the school, or the ability to get a job upon graduation. Pick a few aspect of differentiation that you feel are most important (unless you select commodity-like). Other industries are more difficult to assess. For example, in the beer brewing industry, companies try to convince you that their beer is special using heavy advertising. Is this effective or do “most” people decide based upon price? This would be for you to decide, but whatever you decide should be consistent with your strategy. You should also be prepared to defend your selection, if asked. 10. Scale economies (Are they large or small?) Economies of scale are factors that cause a producer’s average cost per unit to fall as production (scale) is increased. 11. Capacity utilization (Show this as a percentage. It is usually estimated by your team.) Capacity utilization is the amount of products/services that all companies in the industry are currently producing, divided by the maximum amount that they could produce, in total, with current resources. About the highest that the U.S. economy, as a whole, can operate is around 85%. Industries can operate at higher levels, but few industries can approach 100% capacity utilization. Remember we are discussing industries, not companies. This percentage often has a significant effect on your strategic “story.” 28 12. Current industry profitability (Quantify the ROA, ROS, and state your source.) It would be highly unlikely that your source’s definition of the industry would be the same as yours. Briefly describe the source’s definition. 13. Stability of demand (Identify if it is cyclical, countercyclical, or noncyclical. Also identify if it is seasonal or nonseasonal.) If your industry’s products or services are cyclical, then industry revenues would increase or decrease with the economy. An example would be the house construction industry. If an industry is countercyclical, then the industry revenues would move in the opposite direction of the general economy. Fast food would be an example of a counter-cyclical service. If trends in industry revenues are independent of the larger economy, then that industry is non-cyclical. An example of this might be the coffee bean industry. In many cases, like Psychiatry Services (if we can define this branch of medicine as an industry) may be difficult to determine without the framework of the industry definition and we’ll find the same with many of these characteristics. Another aspect of stability of demand which must be examined is seasonality. Does industry demand vary with the seasons? An obvious example would be the U.S. skiing resort industry. The prescription drug industry is non-seasonal. You should assess and present each of these two types of stability of demand. 14. Special industry problems (List any, if applicable.) An example would be noise regulations in the lawn mower industry. C. Five Competitive Forces This analysis, like many other analyses in the strategic management field, was conceptualized by Michael Porter at Harvard University. Drawing on the field of industrial economics, this analysis is intended to explain “industry” profitability. Each of the five following forces is strong if it will lower industry profitability. Conversely, no or little effect on industry profitability will indicate that the force is weak. You’ll read Porter’s article on the topic in the early weeks of the course. Under each force is a list of factors that should be used to support your assessment of whether a force is 1) very strong, 2) strong, 3) weak, or 4) very weak. For this course, 29 these are the only choices. You should make your judgment about the relative strength or weakness before you defend your selection using the underlying factors. For example, if there is severe price competition in the industry you might rate the rivalry force as being very strong. Once you have done this, you might use the factor “product demand is growing slowly” to support your assessment. You’ll note that the list of measures does not include medium, average, or moderate and you should not use these. Use two to four factors, in decreasing order of importance, to support each rating. For example, if you rate a force as being strong it would be inconsistent for your first supporting factor to indicate a weak force. Assess the effect of each factor independently. Do not attempt to combine factors in your justification or you will complicate your support unnecessarily. The first slide of this analysis should only include each of the five competitive forces and its rating. Once you have done this, include on subsequent slides the detailed analysis for each force. More often than not, rivalry is the strongest force. Make sure that the measures on the summary slide match the choices you list on the detailed slides in support of the summary. The following definitions will be helpful in assessing and understanding both the forces and the factors to support your ratings: 1. Switching costs – costs outside of price and related distribution costs which buyers of the industry incur when switching from one product/service to another. For example, you might incur additional transportation costs when switching purchases from a supplier within five miles of your plant to another located thirty miles away. At the consumer level in the past, when switching from cassette tapes to CDs you must buy a CD player. 2. Substitutes (Strategic Management Definition) – A product/service that the buyers of your industry might buy from another industry rather than products from you industry. The precision of your industry definition becomes important in determining substitutes. An example, for the carbonated drink industry, bottled water is a substitute. Consider the immediate buyer and not the end-user when assessing substitutes. List the actual substitutes, buyers, and suppliers that have the greatest affects upon your rating. This is shown below. Rivalry (Provide one overall rating: Very Weak, Weak, Strong, or Very Strong.) Factors that make rivalry stronger are: 30 – Number of competitors is increasing – Size of competitors is becoming equal – Product demand is growing slowly – Volume is important (Price-cutting is tempting.) – Some competitors are dissatisfied with market share – There is a high potential payoff for strategic moves – High exit costs (barriers) exist, such as: - Specialized assets - Interrelationships between businesses - Fixed costs of exit - Emotional barriers - Government restrictions Particularly as an industry enters the mature phase, competition will be weaker if companies can easily exit the industry. – Great diversity in competitors exists This makes rivalry stronger because competitors can misunderstand each others’ strategic moves and over-react. – Increased threat of buyouts of competitors from large corporations exists – The industry has high fixed costs The airline industry has had this problem and has gone through periods in the past where they – the industry – have lost billions of dollars. If there are limited customers, then competitors, at the extreme, will price down to just above variable cost. If fixed costs are high then variable costs are low, indicating a very low price where competitors lose a great deal of money. If you charge just above variable cost in order to gain customers, at least you have contributed a little toward fixed cost. This is better than having no customers at all. When pricing below variable cost it is better just to shut down. Although pricing rarely becomes this extreme, many industries have periods of “price wars” where most companies lose money. – There are low switching costs – Capacity can only be augmented in large increments 31 Consider an industry with only two competitors. Assume that they each have one plant and the plants’ production together exactly equal aggregate demand. Existing plants cannot be expanded. To increase production, a whole new plant needs to be built (large increments). Both companies realize that aggregate demand will grow steadily. Not wanting to concede the market to the other competitor, each company will build a new plant. Because the plants are so big, the industry will have overcapacity. Each company will lower price in an attempt to gain customers. Lower prices will lower industry profitability. This condition will remain until aggregate demand matches the production capacity of the industry’s four plants (each company built a second plant), but then the expansion dilemma occurs again. Potential Entry (Provide one overall rating: Very Weak, Weak, Strong, or Very Strong.) Unlike ease of entry in industry characteristics, these low entry barriers can affect industry profitability. Factors that make potential entry stronger are: – Economies of scale are small – There is easy access to technology/specialized know-how – There are low or non-existent learning curve effects – Brand preferences and customer loyalty are low – There are low capital requirements – No non-scale cost advantages exist (An example would be oil reserves discovered on land owned by a company that is not in the oil industry.) – There is open access to distribution channels – There are no restrictive regulatory policies – Low tariffs/trade restrictions exist – Incumbents have low dedication to the industry General Mills might be an example of this. Although it is the second largest competitor in the breakfast cereal industry, cereal only accounts for 5% of its corporate sales. It would certainly be more concerned about other industries in which it participates, such as coffee, which represents over 30% of company revenue. Notice that this force is “Potential” Entry. Actual entrants become rivals. Existing 32 companies in the industry take strategic moves, such as lowering prices, to keep potential entrants out of the industry. These actions lower industry profitability. Substitutes (List the major specific substitutes by priority.) (Then provide one overall rating: Very Weak, Weak, Strong, or Very Strong.) Factors that make substitutes stronger are: – There is a low cost/price structure for substitutes – Substitutes rank high on quality and performance – Low switching costs for current product exist – Substitutes are coming from high profit industries These factors are rather general and there are only four. Prepare a detailed explanation (two sentences or so per factor) of how each factor specifically supports your rating. Buyers (List the major buyer groups by priority.) (Then provide one overall rating: Very Weak, Weak, Strong, or Very Strong.) Factors that make buyers stronger are: – Buyers are concentrated and purchase large volumes relative to seller (This is often a key selection.) – Product/service represents a significant fraction of buyer costs (The buyer will negotiate more intensely for big cost items than for small cost items.) – Products are standard or undifferentiated – There are few switching costs – Buyers earn low profits (If buyers earn low profits, they will be limited in how low they can price during negotiations.) – Buyers pose a credible threat of backward integration – The product/service is unimportant to quality of buyers' products/services – Buyer has full information Suppliers (List the major supplier groups by priority.) (Then provide one overall rating: Very Weak, Weak, Strong, or Very Strong.) 33 Factors that make suppliers stronger are: – Suppliers are dominated by a few (concentrated) companies – Few substitutes exist for suppliers' products – Supplier does not consider your industry an important customer – Suppliers' product is an important input to your business – Supplier products are differentiated or have switching costs – Suppliers pose credible threat of forward integration D. Driving Forces (Classify each one as Favorable or Unfavorable.) Driving Forces exist inside and outside the industry (the task and general environments) and either inhibit or contribute to industry revenues or profits (for all players). Generally no more than three driving forces will apply. You need to present evidence that these forces are present in the industry already. Do not list driving forces that “might” occur. Use one item from the list below for each driving force and then describe it in more detail (a couple of sentences). How does it apply to your strategy? In addition, you should categorize each force as favorable or unfavorable by including in your discussion one of the following specific criteria for your assessment. The criteria for a “favorable” classification are that the force must increase industry revenues and/or industry profits. The opposite holds for an “unfavorable” classification. If the force affects industry profit differently from industry revenue, select the stronger force. Remember that you are analyzing at the industry rather than company level. For example, consider two companies in a mature industry where aggregate demand is growing very slowly. One company has demonstrated a series of outstanding marketing innovations and has increased sales significantly. The increased sales have increased dollar profits, as well. In conducting this analysis, are these innovations favorable or unfavorable? The answer is unfavorable. Although one company is benefiting, the industry as a whole is not. Industry revenues are not growing, although one company is taking market share from the other. The marketing innovations cost money and might even result in lower pricing. In any event industry profits are dropping. Do not confuse company analysis with industry analysis. 34 Some possible driving forces include: – Changes in long-term industry growth rate – Changes in buyer groups/product use – Product innovation – Technological change – Marketing innovation – Entry/exit of major firms – Diffusion of technical know-how – Globalization of industry – Changes in cost/efficiency – Increasing differentiation – Regulatory influences/government policy changes – Changing societal concerns, attitudes, and lifestyles – Reduction in uncertainty and business risk – Emerging new internet capabilities and applications