Learning MBA Master Degree

STUDENT: Hi, Teacher. I’m going to start our conversation by making a rather negative statement on the subject of "Visions" and "Missions" we covered in previous Modules. And I am going to do it by quoting the man who turned around IBM when Big Blue was courting with bankruptcy: Louis V. Gerstner Jr.

When he took over as CEO, everyone expected him to craft a new vision for IBM. Many investors and analysts where disappointed when Gerstner said: "The last thing IBM needs now is a vision". And this "non-visionary" approach did not prevent this man from leading IBM back into profitability.

TEACHER: Your quotation is very accurate. And it is true that IBM did not publish formal "vision" and "mission" statements while Gerstner was CEO and Chairman of the Board. But this does not mean that IBM did not have a clear strategy; basically to improve customer service and to grow in the area of services. And I am sure that the IBM team did a lot of industry and competitive analysis. And as you know, industry and competitive analysis is the subject matter we'll discuss in this Module.

Crafting strategy is an analysis-driven exercise, not an activity where managers can succeed through good intentions and creativity. Judgments about what strategy to pursue have to be based on a realistic assessment of a company's external environment and internal situation.

STUDENT: I agree with that, of course. A firm can not succeed if its management lives in a limbo.

TEACHER: I am glad you agree with me. Unless a company's strategy is well-matched to both external and internal circumstances, there is no way it can compete effectively. In short, it must consider:

1. External environment: industry and competitive conditions and
2. Internal situation and competitive position.

This Module will deal with point 1 above.

The Methods Of Industry And Competitive Analysis

Industries differ widely in their economic characteristics, competitive situations, and future out1ooks. The pace of technological change can range from fast to slow. Capital requirements can vary from big to small. The market can extend from local to worldwide. Sellers' products can be standardized or highly differentiated. Competitive forces can be strong or weak and can reflect varying degrees of emphasis on price, product performance, service, promotion, and so on. Buyer demand can be rising briskly or declining. Industry conditions differ so much that leading companies in unattractive industries can find it hard to earn respectable profits, while even weak companies in attractive industries can turn in good performances.

Moreover, industry conditions change continuously as one or more aspects grow or diminish in influence.

Industry and competitive analysis utilizes a toolkit of concepts and techniques to get a clear fix on changing industry conditions and on the nature and strength of competitive forces. This tool kit provides a way of thinking strategically about any industry's overall situation and drawing conclusions about whether the industry represents an attractive investment for company funds. Industry and competitive analysis aims at developing probing answers to the following...

Seven questions:

1. What are the industry's dominant economic traits?
2. What competitive forces are at work in the industry and how strong are they?
3. What are the drivers of change in the industry and what impact will they have?
4. Which companies are in the strongest/weakest competitive positions?
5. Who's likely to make what competitive moves next?
6. What key factors will determine competitive success or failure?
7. How attractive is the industry in terms of its prospects for above-average profitability?

The answers to these questions build understanding of a firm's surrounding environment and, collectively, form the basis for matching its strategy to changing industry conditions and competitive realities.

Question 1: What Are The Industry’s Dominant Economic Traits?

Because industries differ significantly in their basic character and structure, industry and competitive analysis begins with an overview of the industry's dominant economic traits.

STUDENT: In exactly what sense is the word "industry" used here?

TEACHER: As a working definition, we use the word industry to mean a group of firms whose products have so many of the same attributes that they compete for the same buyers. The factors to consider in profiling an industry's economic features are fairly standard:



* Market size.
* Scope of competitive rivalry (local, regional, national, international, or global).
* Market growth rate and where the industry is in the growth cycle (early development, rapid growth and takeoff, early maturity, late maturity and saturation, stagnant and aging, decline and decay).
* Number of rivals and their relative sizes -is the industry fragmented with many small companies or concentrated and dominated by a few large companies?
* The number of buyers and their relative sizes.
* The prevalence of backward and forward integration.
* Ease of entry and exit.
* The pace of technological change in both production process innovation and new product introductions.




* Whether the product(s) and/or service(s) of rival firms are high1y differentiated, weakly differentiated, or essentially identical.
* Whether companies can realize scale economies in purchasing, manufacturing, transportation, marketing, or advertising.
* Whether high rates of capacity utilization are crucial to achieving low-cost production efficiency.
* Whether the industry has a strong learning and experience curve such that average unit cost declines as cumulative output (and thus the experience of "learning by doing") builds up.
* Capital requirements.
* Whether industry profitability is above/below par.


STUDENT: That’s a long list. Maybe we can use some illustrations, can’t we?

TEACHER: Good idea, but you go ahead, please. Can you think of an industry with very high Capital Requirements?

STUDENT: From the top of my mind, the airline industry.

TEACHER: Good example. In truth, this industry has not delivered a cent in actual profits or dividends in decades; capital costs consume most of the revenue, the rest going to cover other costs such as labor, fuel and maintenance. And what about an industry where the pace of technological change in both production process innovation and new product introductions is very fast?

STUDENT: I would say that the "chip" –semiconductor- industry is a good example of that.

TEACHER: Very good. Let’s go on now.

An industry's economic characteristics are important because of the implications they have for strategy. For example, in capital-intensive industries where investment

in a single plant can run several hundred million dollars, a firm can spread the burden of high fixed costs by pursuing a strategy that promotes high utilization of fixed assets and generates more revenue per dollar of fixed-asset investment. Thus commercial airlines employ strategies to boost the revenue productivity of their multimillion dollar jets by cutting ground time at airport gates (to get in more flights per day with the same plane) and by using multi-tiered price discounts to fill up otherwise empty seats on each flight.

In industries characterized by one product advance after another, companies must spend enough time and money on R&D to keep their technical prowess and innovative capability abreast of competitors -a strategy of continuous product innovation becomes a condition of survival.

In industries like semiconductors, the presence of a learning/experience curve effect in manufacturing causes unit costs to decline about 20 percent each time cumulative production volume doubles. With a 20 percent experience curve effect, if the first 1 million chips cost $ 100 each, by a production volume of 2 million the unit cost would be $80 (80 percent of $ 100), by a production volume of 4 million the unit cost would be $64 (80 percent of $80), and so on. When an industry is characterized by a strong experience curve effect in its manufacturing operations, a company that moves first to initiate production of a new-style product and develops a strategy to capture the largest market share can win the competitive advantage of being the low-cost producer. The bigger the experience curve effect, the bigger the cost advantage of the company with the largest cumulative production volume.

Question 2: What Is Competition Like And How Strong Are Each Of The Competitive Forces?

One important component of industry and competitive analysis involves looking at the industry's competitive process to discover the main sources of competitive pressure and how strong each competitive force is. This analytical step is essential because managers cannot devise a successful strategy without in-depth understanding of the industry's competitive character.

The Five-Forces Model of Competition

Even though competitive pressures in various industries are never precisely the same, the competitive process works similarly enough to use a common analytical framework in gauging the nature and intensity of competitive forces. As Professor Michael Porter of the Harvard Business School has convincingly demonstrated, the state of competition in an industry is a composite of five competitive forces:

1. The rivalry among competing sellers in the industry.

2. The market attempts of companies in other industries to win customers over to their own substitute products.

3. The potential entry of new competitors.

4. The bargaining power and leverage exercisable by suppliers of inputs.

5. The bargaining power and leverage exercisable by buyers of the product.

Porter's five-forces model is a powerful tool for systematically diagnosing the principal competitive pressures in a market and assessing how strong and important each one is. Not only is it the most widely used technique of competition analysis, but it is also relatively easy to use.

1 - The Rivalry among Competing Sellers

The strongest of the five competitive forces is usually the jockeying for position and buyer favor that goes on among rival firms. Rivalry emerges because one or more competitors sees an opportunity to better meet customer needs or is under pressure to improve its performance. The intensity of rivalry among competing seller is reflected in how vigorously they employ such competitive tactics as lower prices, snazzier features, increased customer services, longer warranties, special promotions, and new product introductions. Rivalry can range from friendly to cutthroat, depending on how frequently and how aggressively companies undertake fresh moves that threaten rivals’ profitability.

2 - Competitive Pressures from Substitute Products

Firms in one industry are, quite often, in close competition with firms in another industry because their respective products are good substitutes. The producers of eyeglasses compete with the makers of contact lenses. The producers of wood stoves compete with such substitutes as kerosene heaters and portable electric heaters. The sugar industry competes with companies that produce artificial sweeteners or corn syrup. The producers of plastic containers confront strong competition from manufacturers of glass bottles and jars, paperboard cartons, and tin cans and aluminum cans. Aspirin manufacturers must consider how their product compares with other pain relievers and headache remedies.

3 - The Competitive Force of Potential Entry

New entrants to a market bring new production capacity, the desire to establish a secure place in the market, and sometimes substantial resources with which to compete. Just how serious the competitive threat of entry is in a particular market depends on two classes of factors: barriers to entry and the expected reaction of incumbent firms to new entry. A barrier to entry exists when ever it is hard for a newcomer to break into the market and/or economic factors put a potential entrant at a disadvantage relative to its competitors. There are several types of entry barriers:

Economies of scale: Scale economies deter entry because they force potential competitors either to enter on a large-scale basis (a cost1y and perhaps risky move) or to accept a cost disadvantage (and consequently lower profitability). Large-scale entry is a difficult barrier to hurdle because it can create chronic overcapacity problems in the industry and it can so threaten the market shares of existing firms that they retaliate aggressively (with price cuts, increased advertising and sales promotion, and similar blocking actions) to maintain their positions. Either way, a potential entrant is discouraged by the prospect of lower profits. Entrants may encounter scale-related barriers not just in production, but in advertising, marketing and distribution, financing, after-sale customer service, raw materials purchasing, and R&D as well.
Inability to gain access to technology and specialized know-how: Many industries require technological capability and skills not readily available to a new entrant. Key patents can effectively bar entry as can lack of technically skilled personnel and an inability to execute complicated manufacturing techniques.

We can also mention long learning and experience curve effects, brand preferences and customer loyalty, Capital requirements, Access to distribution channels, Tariffs and international trade restrictions.

4 - The Power of Suppliers

Whether the suppliers to an industry are a weak or strong competitive force depends on market conditions in the supplier industry -and the significance of the item they supply. The competitive force of suppliers is greatly diminished whenever the item they provide is a standard commodity available on the open market from a large number of suppliers with ample capability to fill orders. Then it is relatively simple to obtain whatever is needed from a list of capable suppliers, dividing purchases among several to promote lively competition for orders. In such cases, suppliers have market power only when supplies become tight and users are so anxious to secure what they need that they agree to terms more favorable to suppliers. Suppliers are likewise in a weak bargaining position whenever there are good substitute inputs and switching is neither costly nor difficult. For example, soft drink bottlers can effectively check the power of aluminum can suppliers by using more plastic containers and glass bottles.

5 - The Power of Buyers

Just as with suppliers, the competitive strength of buyers can range from strong to weak. Buyers have substantial bargaining leverage in a number of situations. The most obvious is when buyers are large and purchase a sizable percentage of the industry's output. The bigger buyers are and the larger the quantities they purchase, the more clout they have in negotiating with sellers. Often, purchasing in large quantities gives a buyer enough leverage to obtain price concessions and other favorable terms. Buyers also gain power when the costs of switching to competing brands or substitutes are relatively low. Any time buyers have the flexibility to fill their needs by sourcing from several sellers rather than having to use just one brand, they have added room to negotiate with sellers.

When sellers' products are virtually identical, it is relatively easy for buyers to switch from seller to seller at little or no cost. However, if sellers' products are strongly differentiated, buyers are less able to switch without incurring sizable changeover costs.

One last point: all buyers are not likely to possess equal degrees of bargaining power with sellers, and some may be less sensitive than others to price, quality, or service. For example, in the apparel industry, major manufacturers confront significant customer power when selling to retail chains like Wal-Mart or Sears. But they can get much better prices selling to the small owner-managed apparel boutiques.

Strategic Implications of the Five Competitive Forces

The value of the five-forces model is the assist it provides in exposing the makeup of competitive forces. To analyze the competitive environment, managers must assess the strength of each one of the five competitive forces. The collective impact of these forces determines what competition is like in a given market. As a rule, the stronger competitive forces are, the lower is the collective profitability of participant firms. The most brutally competitive situation occurs when the five forces create market conditions tough enough to impose prolonged subpar profitability or even losses on most or all firms.

Student, can you tell me when the competitive structure of an industry is clearly "unattractive" from a profit-making standpoint?

STUDENT: I imagine that if rivalry among sellers is very strong, entry barriers are low, competition from substitutes is strong, and both suppliers and customers are able to exercise considerable bargaining leverage, the competitive structure must be rather unattractive. On the other hand, when competitive forces are not collectively strong, the competitive structure of the industry is certainly "favorable" or "attractive" from the standpoint of earning superior profits.

TEACHER: And what do you think would be the "ideal" competitive environment from a profit-making perspective?

STUDENT: Must be when both suppliers and customers are in weak bargaining positions, there are no good substitutes, entry barriers are relatively high, and rivalry among present sellers is on1y moderate.

TEACHER: Good answer. However, even when some of the five competitive forces are strong, an industry can be competitively attractive to those firms whose market position and strategy provide a good enough defense against competitive pressures to preserve their ability to earn above-average profits.

To deal successfully with competitive forces, managers must craft strategies that (1) insulate the firm as much as possible from the five competitive forces, (2) influence the industry's competitive rules in the company's favor, and (3) provide a strong, secure position of advantage from which to "play the game" of competition as it unfo1ds in the industry. Managers cannot do this task well without a perceptive understanding of the industry's whole competitive picture. The five-forces model is a tool for gaining this understanding.

Question 3: What Is Causing The Industry's Competitive Structure And Business Environment To Change?

An industry's economic features and competitive structure say a lot about the basic nature of the industry environment but very little about the ways in which the environment may be changing. All industries are characterized by trends and new developments that either gradually or speedily produce changes important enough to require a strategy response form participating firms. The popular hypothesis about industries going through evolutionary phases or life-cycle stages are strongly keyed to the overall industry growth rate (which is why such terms as rapid growth, early maturity, saturation, and decline are used to describe the stages). Yet there are more causes of industry change than an industry’s position on the growth curve.

Question 4: Which Companies Are In The Strongest/Weakest Positions?

The next step in examining the industry’s competitive structure is to study the market positions of rival companies. One technique for revealing the competitive positions of industry participants is "Strategic group making". This analytical tool is a bridge between looking at the industry as a whole and considering standing of each firm separately. It is the most useful when an industry has so many competitors that it is not practical to examine each one in depth.

Question 5: What Strategic Moves Are Rivals Likely To Make Next?

Studying the actions and behavior of one's closest competitors is essential. Unless a company pays attention to what competitors are doing, it ends up flying blind into competitive battle. A company can't expect to outmaneuver its rivals without monitoring their actions and anticipating what moves they are likely to make next. As in sports, a good scouting report is invaluable. The strategies rivals are using and the actions they are likely to take next have direct bearing on a company's own best strategic moves -whether it needs to defend against specific actions taken by rivals or whether rivals' moves provide an opening for a new offensive thrust.

Identifying Competitors' Strategies: A quick profile of key competitors can be obtained by studying where they are in the industry, their strategic objectives as revealed by actions recently taken, and their basic competitive approaches. Such a summary, along with a strategic group map, usually suffices to diagnose the competitive intent of rivals.

Evaluating Who the industry’s Major Players Are Going to Be: It’s usually obvious who the current major contenders are, but these same firms are not necessarily positioned strongly for the future. Some may be losing ground or be ill-equipped to compete on the industry's future battleground. Smaller companies may be moving into contention and poised for an offensive against larger but vulnerable rivals. Long-standing market leaders sometimes slide quickly down the industry's ranks; others end up being acquired. Today's industry leaders don't automatically become tomorrow's.

Question 6: What Are The Key Factors For Competitive Success?

An industry's key success factors (KSFs) are the strategy-related action approaches, competitive capabilities, and business outcomes that every firm must be competent at doing or must concentrate on achieving in order to be competitively and financially successful. KSFs are business aspects all firms in the industry must pay close attention to -the specific outcomes crucial to market success (or failure) and the competencies and competitive capabilities with the most direct bearing on company profitability. In the beer industry, the KSFs are full utilization of brewing capacity (to keep manufacturing costs low), a strong network of wholesale distributors (to gain access to as many retail outlets as possible), and clever advertising (to induce beer drinkers to buy a particular brand and thereby pull beer sales through the established wholesale/retail channels).

In apparel manufacturing, the KSFs are appealing designs and color combinations (to create buyer interest) and low-cost manufacturing efficiency (to permit attractive retail pricing and ample profit margins). In tin and aluminum cans, where the cost of shipping empty cans is substantial, one of the keys is having plants located close to end-use customers so that the plant's output can be marketed within economical shipping distances (regional market share is far more crucial than national share).

Determining the industry's key success factors, in light of prevailing and anticipated industry and competitive conditions, is a top-priority analytical consideration. At the very least, managers need to know the industry well enough to conclude what is more important to competitive success and what is less important. Company managers who misdiagnose what factors are truly crucial to long-term competitive success are prone to employ ill-conceived strategies or to pursue less important competitive targets.

Frequently, a company with perceptive understanding of industry KSFs can gain sustainable competitive advantage by training its strategy on industry KSFs and devoting its energies to being distinctively better than rivals at succeeding on these factors. Indeed, using one or more of the industry's KSFs as cornerstones for the company's strategy is often a wise approach to crafting a winning managerial game plan.

Key success factors vary from industry to industry and even from time to time within the same industry as driving forces and competitive conditions change. Only rarely does an industry have more than three or four key success factors at any one time. And even among these three or four, one or two usually outrank the others in importance. Managers, therefore, have to resist the temptation to include factors that have only minor importance on their list of key success factors -the purpose of identifying KSF`s is to make judgments about what things are more important to competitive success and what things are less important.

To compile a list of every factor that matters even a little bit defeats the purpose of concentrating management attention on the factors truly crucial to long-term competitive success.

STUDENT: What you mean is that in addition to KSFs, managers must adhere to the famous KISS principle: "Keep It Simple, Stupid".

TEACHER: Certainly. Now, to the last of the seven questions:

Question 7: Is The Industry Attractive And What Are Its Prospects For Above-Average Profitability?

The final step of industry and competitive analysis is to review the overall industry situation and develop reasoned conclusions about the relative attractiveness or unattractiveness of the industry, both near-term and long-term. An assessment that the industry is fundamentally attractive typically suggests using an aggressive grow-and build strategy, expanding sales efforts and investing in additional facilities and equipment as needed to strengthen the firm's long-term competitive position in the

business. If the industry and competitive situation is judged relatively unattractive, more successful industry participants may choose to invest cautiously, look for ways to protect their long-term competitiveness and profitability, and perhaps acquire smaller firms if the price is right. Weaker companies may consider leaving the industry or merging with a rival. Stronger companies may consider diversification into more attractive businesses.

Outsiders considering entry may decide against investing in the business and look elsewhere for opportunities.

Important factors for company managers to consider in drawing conclusions about whether the industry is a good business to be in include:



* The industry's growth potential.
* Whether the industry will be favorably or unfavorably impacted by the prevailing driving forces.
* The potential for the entry/exit of major firms (probable entry reduces attractiveness to existing firms; the exit of a major firm or several weak firms opens up market share growth opportunities for the remaining firms).
* The stability/dependability of demand (as affected by seasonality, the business cycle, the volatility of consumer preferences, inroads from substitutes, and the like).
* Whether competitive forces will become stronger or weaker.
* The severity of problems/issues confronting the industry as a whole.
* The degrees of risk and uncertainty in the industry's future.
* Whether competitive conditions and driving forces are conducive to rising or falling industry profitability.


As a general proposition, if an industry's overall profit prospects are above average, the industry can be considered attractive. If its profit prospects are below average, it is unattractive. However, it is a mistake to think of industries as being attractive or unattractive in an absolute sense. Attractiveness is relative, not absolute, and conclusions one way or the other are in the eye of the beholder. Companies on the outside may look at an industry ', s environment and conclude that it is an unattractive business for them to get into; they may see more profitable opportunities elsewhere. But a favorably positioned company already in the industry may survey the very same business environment and conclude that the industry is attractive because it has the resources and competitive capabilities to exploit the vulnerabilities of its weaker rivals, gain market share, build a strong leadership position, and grow its revenues and profits at a rapid clip.
• The company's competitive position in the industry and whether its position is likely to grow stronger or weaker. Hence industry attractiveness a1ways has to be appraised from the standpoint of a particular company. Industries unattractive to outsiders may be attractive to insiders. Industry environments unattractive to weak competitors may be attractive to strong competitors.

While companies contemplating entry into an industry can rely on the above list of factors, along with the answers to the first six questions, to draw conclusions about industry attractiveness, companies already in the industry need to consider the following additional aspects: being a well-entrenched leader in an otherwise lack1uster industry can still produce good profitability).

• The company's potential to capitalize on the vulnerabilities of weaker rivals (thereby converting an unattractive industry situation into a potentially rewarding company opportunity).