Economics of Strategy

Fifth Edition
Slides by: Richard Ponarul, California State University, Chico
Copyright 2010 John Wiley Sons, Inc.
Chapter 12

Industry Analysis
Besanko, Dranove, Shanley, and Schaefer
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
Porters 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 Porters Five-Forces framework
identifies the economic forces that affect
industry profits
The five forces are
Internal rivalry
Entry
Substitutes and 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
Competition on non-price dimension can
drive up costs.
Non-price competition does not erode
profits as severely as price competition if
customers are willing to pay a higher price
for the improvements.
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

Internal Rivalry
Other conditions that facilitate intense price
competition
Large and infrequent sales orders
Absence of facilitating practices
Absence of a history of cooperative pricing
Strong exit barriers
Industry demand is elastic
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 industrys 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
Supplier has indirect power if upstream
market is competitive. It sells to the highest
bidder.
Supplier has direct power if
the upstream industry is concentrated or
the customers are locked into the relationship
with suppliers due to relationship specific assets

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
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

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
Cooperative Interactions Among Firms
Setting industry standards that facilitate industry
growth
Lobbying for regulation or legislation that favors
the industry
Cooperation with buyers/suppliers
to improve product quality
to improve productive efficiency
to improve inventory management
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.
The DVD Hardware Market:
A Five-Forces Analysis
Internal rivalry was intense. Brand name was the
main source of differentiation
It was easy for consumer electronics firms to enter.
Satellite TV could be a substitute. Streaming over
the internet was another possibility.

Movie studios (upstream) and big retailers
(downstream) had power.
DVD hardware makers, according to this
analysis, had reason to be pessimistic.
DVD formats success can be attributed to
firms working together (value net).
The DVD Hardware Market:
A Five-Forces Analysis
The DVD Hardware Market: The Value Net
In the beginning DIVX was a major threat.
DVD manufacturers cut prices on some
models and advertised heavily.
Other members of the value net chipped in
to increase the size of the DVD pie.
Movie studios released popular titles in DVD format and
priced them moderately
Retailers promoted the DVD hardware and software
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: Internal Rivalry
Considerable variation in cost structures.
Excess capacity with stagnant demand (until
recently) for admissions.
Managed care organizations (MCOs)
increased the price elasticity of demand by
seeking hospitals that offered the best value.
Chicago Hospitals: Internal Rivalry
MCOs intensified internal rivalry by
treating all hospitals as identical,
negotiating with hospitals in secret and
negotiating large contracts for multiple years
Hospitals were unable to develop facilitating
practices
Chicago Hospitals: Internal Rivalry
Recent trends towards softening of
competition
Branding by hospitals with strong reputation
Patients demand to go outside the MCO
networks
Consolidation in submarkets
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
Chicago Hospitals: Buyer Power
In wealthy communities, specialty hospitals could
compete for the most profitable patients.
Buyers as well as regulators are demanding access
to information about hospital quality
Anti trust ruling requires hospitals to negotiate
individually (rather than as a group) with insurers.
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 Boeings 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
Copyright 2010 John Wiley & Sons, Inc.

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