Economics of Strategy

Seventh Edition
Besanko, Dranove, Shanley, and Schaefer

Chapter 8

Industry Analysis

Copyright  2016 John Wiley  Sons, Inc.

 Industry Analysis

Industry analysis facilitates

 assessment of industry and firm performance
 identification of factors that affect performance

 determination of the effect of changes in the business

environment on performance and
 identification of opportunities and threats (SWOT
analysis)
 Industry Analysis

Industry analysis helps with assessing generic business

strategies
Porter’s five forces framework is rooted in
microeconomics
Value net (Brandenburger and Nalebuff) supplements
the five forces framework to analyze strategy
 The Five-Forces Framework
Michael Porter’s Five-Forces framework
identifies the economic forces that affect
industry profits
The five forces are
 Internal rivalry
 Entry
 Substitutesand complements
 Supplier power
 Buyer power
The Five-Forces Framework
 Internal Rivalry

Internal rivalry is the competition for market

share among the firms in the industry
Competition could be on price or some non-
price dimension
Price Competition erodes the price cost margin
and profitability
 Internal Rivalry

Price competition heats up when

 There are many sellers
 Some firms have cost advantage over others

 There is excess capacity in the industry

 Products are undifferentiated and switching costs are

low
 Prices and sale terms are easily observable
 Entry
Entry hurts the incumbents by
 by cutting into the incumbents’ market share and
 by intensifying internal rivalry and leads to a decline
in price cost margin
Barriers to entry can be
 exogenous(nature of the industry) or
 endogenous (incumbents’ strategic choices)
 Factors that Affect the Threat of Entry

Minimum efficient scale relative to the size of the

market
Government policies that favor the incumbents
Brand loyalty of consumers and value placed by
consumers on reputation
Entrants’ access to critical resources such as raw
material, technical know how and distribution network
 Factors that Affect the Threat of Entry

Steepness of the learning curve

Network externalities that give the incumbents
the benefit of a large installed base
Incumbents’ reputation regarding post-entry
competitive behavior
 Substitutes and Complements

Availability of substitutes erode the demand for

the industry’s output
Complements boost industry demand
When the price elasticity of demand is large,
pressure from substitutes will be significant
Changes in demand can in turn affect internal
rivalry and entry/exit
 Supplier Power

The factors that determine supplier power are

 Competitiveness of the input market
 Relative concentration the industry
 Relative concentration of upstream and downstream
firms
 Purchase volume by downstream firms
 Availability of substitute inputs
 Extent of relationship specific investments
 Threat of forward integration by suppliers
 Suppliers’ ability to price discriminate
 Buyer Power

Buyer power is analogous to supplier power

Buyers have indirect power in competitive
markets
Buyer concentration or relationship specific
assets can lead to direct power
Buyer power relative to upstream is analogous
to supplier power relative to downstream
 Some Strategies to Cope with the Five Forces

To outperform its rivals firms can

 develop a cost advantage or
 a differentiation advantage

Firms can seek an industry segment where the

five forces are less severe
Firms can try to change the forces
 Some Strategies to Cope with the Five Forces

Facilitating strategies to reduce internal rivalries

Moves that increase switching costs for the
customers
Pursuing entry deterring strategies
Tapered integration to reduce buyer/supplier
power
 Five Forces and Value Net

The Five-Forces Framework tends to view other

firms - competitors, suppliers or buyers - as
threats to profitability
In the value net model (Coopetition) interactions
between firms can be positive or negative
 The Value Net Concept

The value net consists of

 Suppliers
 Customers

 Competitors and

 Complementors (producers of complementary goods and

services)
The value net complements the five forces approach by
considering opportunities posed by each force.
 Five Forces Analysis of Chicago Hospitals

Product market is the market for acute medical

services
Competition among hospitals is local
The geographic market for a hospital is the
entire metropolitan area or a particular
submarket.
Competitive dynamics could vary across
submarkets
 Chicago Hospitals: Internal Rivalry

In 1980 most hospitals were independent. Today

many of them belong to systems.
Herfindahl index has gone up from 0.05 to 0.20
over this period.
Herfindahl index is slightly higher in
submarkets.
 Chicago Hospitals: Internal Rivalry

With the arrival of managed care organizations

(MCOs), price elasticity of demand increased
Insurers were less brand loyal than patients
Price negotiations were secret
Contracting was lumpy and price rivalry
intensified
 Chicago Hospitals: Entry

Structural barrier to entry

 State regulatory restrictions on new hospital
construction
 Capital intensive nature of hospitals

 Difficulties is making brand loyal customers switch

 Difficulties in establishing a base of medical staff that

admit patients
 Chicago Hospitals: Entry

As the market grows suburbs could attract

entrants
Technological changes could lower entry
barriers
Small specialized hospitals may become feasible
reducing the capital requirement and the size of
medical staff needed
 Chicago Hospitals: Substitutes/Complements

Due to technological changes, substitutes for hospital

services have emerged.
Surgeries performed outside hospitals
 Home healthcare for recuperating patients and the chronically
ill
Economies of scope have allowed hospitals to expand
into outpatient services.
 Chicago Hospitals: Supplier Power

The suppliers to an hospital are

 specialized medical personnel (nurses, technicians and
doctors)
 Firms that supply equipment and supplies and drugs

Relationship specific investments are rare

Suppliers protected by patents can have direct
power
 Chicago Hospitals: Buyer Power
The buyers are
 patients
 admitting physicians and
 insurance companies.

Patients and doctors did not wield buyer power

in the 80s.
Insurers including Medicaid and Medicare were
largely passive in the 80s.
Buyer power was low in the 80s.
 Chicago Hospitals: Buyer Power

Current trends point to rising buyer power

 Selective contracting has increased insurers’ buyer
power
 Government providers have lowered their rates

 Employers are asking employees to bear a greater

share of costs which increases price elasticity of
demand
Five-Forces Analysis of the Chicago Hospital Market
 Commercial Airframe Manufacturing

Boeing and Airbus compete globally.

Fringe players in aircraft with capacity less than
125 seats are excluded from the analysis.
The market share (by revenue) of the fringe
players is small.
There are no meaningful submarkets.
 Commercial Airframe Manufacturing:
Internal Rivalry

Boeing delivered its first commercial aircraft in 1958.

Airbus is younger.
Boeing enjoys economies of scope due to its defense
business.
Airbus gets government subsidies.
Stable market shares and reduced incentive for price
wars
Historically there has been little product differentiation
 Commercial Airframe Manufacturing:
Internal Rivalry

Airbus developed the double-decker mega

plane.
Boeing abandoned competing with its Sonic
Cruiser.
 Airliners exhibit loyalty to suppliers
Economic slowdown has reduced the demand
for aircraft.
 Commercial Airframe Manufacturing: Entry

Major barriers to entry are:

 Huge development costs
 Experience-based advantages

 Buyer reluctance to buy from startups

 Customer loyalty to current suppliers

Commercial Airframe Manufacturing: Substitutes

Small plane manufacturers cut into demand for

Boeing and Airbus planes in regional routes.
As demand for air travel increases airlines
switching back to larger planes in regional
routes.
Other forms of transportation could be
substitutes (High speed rail) for “regional jets.”
 Commercial Airframe Manufacturing:
Supplier Power

Parts market is competitive

Part suppliers deal directly with airlines. But
Boeing’s Global Airlines Inventory Network
(GAIN) gains leverage over suppliers.
Jet engine suppliers are not numerous and enjoy
direct power.
Unionized labor has significant supplier power.
 Commercial Airframe Manufacturing:
Buyer Power

Buyers for aircraft are either airlines or leasing

companies. Neither have buyer power.
Each order could be of the order of 15% of
annual sales revenue for the manufacturer.
Buyers may cancel orders during economic
downturns.
Five-Forces Analysis of the Commercial Aviation
Industry
 Professional Sports: Market Definition

Major sports leagues in the U. S.

 MLB

 NBA

 NFL

 NHL

Five force analysis is also applicable to major

sports leagues elsewhere
 Professional Sports: Internal Rivalry

Sports leagues require competitive balance to

keep the contests interesting
Athletic competition does not imply business
competition
Internal rivalry is low within leagues as teams
follow rules and share revenue
 Teams do not compete in the labor market
 Professional Sports: Entry

Each league has rules for admitting new teams.

Current owners need to be compensated when
new teams are added.
Incumbent owners can veto new franchises in
their geographic market.
Starting an entire new league is risky.
 Professional Sports:
Substitutes and Complements

Teams compete in the local markets with other

forms of entertainment
Elasticity of substitution is quite low
Important complements
 Television

 Sports betting
 Professional Sports: Supplier Power

Unionized players
For new players NCAA has been a benign
supplier
Cities spend tax dollars to build facilities to
attract sports teams.
As municipal finances get tighter, subsidizing
teams becomes more difficult.
 Professional Sports: Buyer Power

Television networks and sports cable systems

compete with each other for broadcasting rights
In negotiations regarding broadcast rights
leagues have the upper hand against
 television networks
 local television and

 radio.
Five-Forces Analysis of Professional
Sports Leagues
 Professional Search Firms: Market Definition

Most production of search firms is done by

search consultants
Knowledge based business:
 Who is working where?
 What are the industry compensation standards?

 What will it take to encourage employer switching by

candidates?
Strong sales ability required of consultants
 Professional Search Firms: Internal Rivalry

Top ten firms have 11% of search market out of

4,000 firms.
Firms are diferentiated by:
 Geography

 Industry

Price is linked to quality, little competition on

price
 Professional Search Firms: Entry

Low barriers to entry: A cell phone and a list of

contacts
Success requires demonstrated ability to to
match managers to employers
Typical time from start-up to establishment is 18
months
 Professional Search Firms:
Substitutes and Complements

Internal HR departments could perform searches

External firms can provide:
 Discretion from internal discovery
 Insulation from internal challenges
 Professional Search Firms: Supplier Power

Ease of entry and exit

Star search consultants take clients to competing
firms
Specialized industry knowledge is transportable
between firms
Non-compete clauses exist, but are
unenforceable in many jurisdictions
 Professional Search Firms: Buyer Power

Large firms fill 85% of executive positions

through search firms
In negotiations regarding search fees, firms have
the upper hand
 Demand incentives for quality
 Demand timeliness

 Lowers fees with bonuses for successful hires

Five-Forces Analysis of Professional
Search Firms Leagues

Moderate
Moderate
Low
Low
Medium to High
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