Strategy Analysis SMM880

MSc Management
Session 2: External Analysis
Dr. Sam Kamuriwo

Agenda
Recap from last session
Readings for this session
Sources of profit at industry level
Macro level influences on industry structure
Segmentation
Strategy group analysis
Limitations of Porters five forces framework
Competitive interaction
Case Discussion
Conclusion
2

Recap

ANALYTICAL TOOLS
Strategy Formulation

Tough choices

Strategy Analysis

Profound understanding of
Objective Appraisal of
the external environment:the internal environment:

(Intended) Strategy

Goals & Resource

Allocation

Value creation and

capture

Scope and competitive

advantage

Strategy Execution

Realized
Strategy

Two main purposes of strategy..

Unique value
creation

Internal
Alignment

Internal alignment

Are measures aligned with strategy?

Measures reliable and controllable?
Is scorecard embedded in a broader
system of goal setting, accountability and
rewards
Is a formalized monitoring system in place,
with set regular reviews

Readings for this

session
Required Readings:
1. Contemporary Strategy Analysis Chapter 3:
Industry analysis: The Fundamentals
2. Contemporary Strategy Analysis Chapter 4:
Further topics in Industry and competitive
analysis
3. Ready to Eat Case

Sources of profit at industry level

The goal of external analysis.

analyse sources of profit

Each Industry has a

different Underlying
SUPPLIER POWER
structure
Suppliers
price

sensitivity
Relative bargaining
power

THREAT OF ENTRY
Capital requirements
Economies of scale
Absolute cost advantage
Product differentiation
Access to distribution
channels
Legal/ regulatory barriers
Retaliation

INDUSTRY
RIVALRY

Concentration
Product
differentiation
Diversity of
competitors
Excess capacity &
exit barriers
Cost conditions

SUBSTITUTE
COMPETITION

Buyers propensity
to substitute
Relative prices &
performance of
substitutes

BUYER POWER

Buyers price
sensitivity
Relative bargaining
power

10

E.g. Industry profit

potential/attractiveness
e.g. Airlines
SUPPLIER POWER
Airline
manufacturers
Labour unions
Airports

INDUSTRY
RIVALRY

Multiple
competitors
Low product
differentiation
Excess capacity
High exit barriers
High ratio of
fixed to variable
costs

HREAT OF ENTRY

Cost of entry modest

Industry attracts entrepreneurs

SUBSTITUTE
COMPETITION

car/rail journeys <250miles

Video conferencing

BUYER POWER

Limited bargaining
power, but price
sensitive and easy
switching
11

Macro level influences on industry

structure

12

But what drives industry

structure change?
Porters 5 forces
1. Buyer power
2. Supplier
power
3. Rivalry
4. Entry barriers
5. Substitutes

The Industry Environment lies at the core of the Macro Environment.

The Macro Environment impacts the firm through its effect on the Industry
Environment.
13

Example: The Elevator and

Escalator Industry
Political/Economic changes:
global shift to emerging world economies : GDP
Short term, medium and long term outlook in west and
emerging economies (fiscal austerity, banking,
construction)
New market Installations?
Maintenance?

14

Example: The Elevator and

Escalator Industry
Social Changes
Massive urbanisation trends in China etc.
Ageing global population (increasing % of over 65 in most
countries)
Implications?

15

Example: The Elevator and

Escalator Industry
Technology:
Mature industry, incremental innovations to energy and
cost efficiencies
Low and high end requirements mean that a range of
products across a cost spectrum required
Implications?

16

Example: The Elevator and

Escalator Industry
Legal
Safety norms in Europe due to ageing lifts

Implications?

17

Structure changes
1. Increasingly
open source
design
2. R&D increase
in energy
efficiency

e.g. Elevator & Escalator

industry

SUPPLIER POWER
1. Safety
legislation in
europe

Largely outsourced
Suppliers
fragmented
High supplier
competition

INDUSTRY
RIVALRY

CR4 ratio >60%

2007 price fixing
HREAT OF ENTRY
fines in Europe
Scale advantages of incumbents
Differentiation on
Deep relations with service network
energy efficiency
Good and cheap manufacturers
and reputation
China
and track record

BUYER POWER
majority of
customers
fragmented but
some may be large
Conversion ratio of
new equipment
installment contract

1. Europe
depressed
2. Emerging
markets boom

THREAT OF SUBSTITUTES
Low

1. Demographics
trend in europe
2. Urbanization in
emerging
markets
18

Application exercise
8.5b thin gauge plastic bags were used by
shoppers in the UK last year. As part of a
new government policy to reduce waste,
the government will on 5 October 2015
introduce a 5p charge for each single use
plastic carrier bag for all retailers with 250
or more employees. What will be the most
impactful change in competitive forces for
producers of thin bag plastics?

19

Segmentation

20

How important is the industry to

A number of studiesprofitability?
seem to show that industry environment
is a relatively minor determinant of a firms profitability

Schmalensee (1985)
Rumelt (1991)
McGahan & Porter

% of variance in firms ROA explained

by:
Industry
effects
19.6%
4.0%
18.7%

Firm
effects
0.6%
44.2%
31.7%

Unexplaine
d variance
79.9%
44.8%
48.4%

(1997)
Hawawini et al.

8.1%

35.8%

52.0%

(2003)
Roquebert et al.

10.2%

55.0%

32.0%

(1996)
Misangyi et al.

43.8%
n.a.
This points to the need to7.6%
dig deeper, for example, by
(2006)

analysing competition between firms within particular

market segments, strategy groups or by looking more
closely at the competitive behaviour of individual firms.
21

E&E industry: market segment reveals

differences in opportunities
New Installation Market
Modernisation

600k 50% in
china
Low margins
Europe
depressed
Increasingly
open source
design rather
proprietary

Europe
5m units
70% >10yrs
Safety
Energy
Cost drivers

Maintenance

Profitability = density
Most lucrative margins
High conversion rate
But variable in emerging

22

Strategy Groups

23

Competitor matrix: strategy

groups
Easy of
ordering

new venture platform

Online platforms
Casual dining chains
Traditional caterers
Local restaurants

Customer
service

6
9
5
3
2

food
food quality food variety presentation
7
7
5
5
5
5
9
3
3
3
2
6
6
7
5
9
3
5
4
3

24

Limitations of Porters five forces

25

Complements the missing

force?
SUPPLIER POWER

Compleme
nts

Suppliers price

sensitivity
Relative bargaining
power

THREAT OF ENTRY
Capital requirements
Economies of scale
Absolute cost advantage
Product differentiation
Access to distribution
channels
Legal/ regulatory barriers
Retaliation

INDUSTRY
RIVALRY

Concentration
Product
differentiation
Diversity of
competitors
Excess capacity &
exit barriers
Cost conditions

SUBSTITUTE
COMPETITION

Buyers propensity
to substitute
Relative prices &
performance of
substitutes

BUYER POWER

Buyers price
sensitivity
Relative bargaining
power

26

Limiting assumptions of 5
forces
An industry consists
of a set of unrelated
buyers, sellers, substitutes and
competitors that interact at arms length
The wealth accrue to players that are able
to erect barriers against competitors and
potential entrants i.e. the source of
advantage is structural advantage
Uncertainty is sufficiently low that you
can accurately predict participants
behaviour and choose a strategy
27
accordingly

Competitive Interaction

28

Competitive Interactions
At the micro level
analysis : to hone
your ability to
analyse individual
competitors
Competitor analysis
involves
understanding what
actions are in the
best, rational
29 a
interests of

Competitive Reaction
retaliation vs. accommodation
retaliation

How to react
to an
aggressive
move by a
competitor?accommodate

30

Economics of retaliation and

accommodation
BA currently flies
a route with 700
passengers and
1000 seats per
day (70%
capacity
utilisation)
Current fare =
$100 per
passenger;
marginal cost per
passenger $8
Easyjet plans to
enter route with a

accommodate

retaliation

let easyjet fill its

passengers: drop
in profit = (100-8)
* 100 = $9200
drop prices to
$70: reduction in
profitability =
700*(100-70) =
$21000
31

ramework for competitor analysis: predisposit

OBJECTIVES
What are competitors current goals?
Is performance meeting these goals?
How are its goals likely to change?

PREDICTIONS

STRATEGY
How is the firm competing?

ASSUMPTIONS
What assumptions does the competitor
hold about the industry and itself?

What strategy changes

will the competitor
initiate?

How will the competitor

respond to our strategic
initiatives?

RESOURCES & CAPABILITIES

What are the competitors key
strengths and weaknesses?

32

Case Discussion

33

RTE Industry Case

Ready to Eat Cereal Industry
Why has the industry been so successful?
What are the industrys significant
segments?
What has changed?
What should Kellogg's do?

34

Conclusion
Industry Structure is useful for explaining
profitability differences ACROSS industries
But falls short at explaining profit
differences WITHIN industries which are
more dominant
But external analysis still important
because it allows us to understand:

How macro level influences change industry

structure to present emerging opportunities and
threats
How firm strategies are changing industry
structure as they position themselves35for unique
value creation

Readings next
session
1. Contemporary Strategy
Analysis: Chapter 5
2. Looking inside for competitive advantage;
Barney, J. 1995
3. Creating Competitive Advantage; P.Ghemawat
and J. Rivkin. HBS Note # 9-798-062

36

Appendix

37

Threat of entry

New entrants bring new capacity and

desire to gain market share
The threat of entry puts on a cap on
the profit potential of the industry
The threat of entry depends on
barriers to entry and on the reaction
from existing competitors that
entrants can expect

38

Threat of entry
Barriers to entry:
Supply side economies of scale forces
aspirants either to come in at a large
scale or to accept a cost disadvantage
Demand side benefits of scale network
effects increases willingness to pay for
the incumbents and discourages entry
Customer switching costs
Capital requirements huge upfront
investments
Incumbency advantages independent of
size e.g. proprietary technology
(patents)
39
Unequal access to distribution channels

Threat of entry
Expectations about the reaction of
existing competitors:
Incumbents track record of past
responses against new entrants
Incumbents possess substantial
resources to fight back
Incumbents seem likely to cut prices
(fear of market share loss or excess
capacity available)
Slowing industry growth means that
newcomers must gain volume from
incumbents
40

The power of suppliers

Supplier groups (e.g. raw materials,
labour) more powerful if:
More concentrated than the industry it
sells to
Incumbents face switching costs in
changing suppliers
Supplier products differentiated
No substitutes to what the supplier group
provides
Supplier group can credible (threaten) to
forward integrate
Supplier serves other industries 41

The power of customers

Customers (or customer groups) are
powerful if:
Concentrated or buys in volume relative to the size of
a single vendor
Products are undifferentiated
They face few switching costs in changing vendors
They can credibly (threaten) to integrate backwards

They are price sensitive:

Products purchased are a significant fraction of its
expenditure
Earns low profits
Quality of little effect
product of little effect to overall buyers costs
42

The threat of substitutes

A Substitute performs the same or a
similar function as an industrys
product but by a different means
Substitutes place a ceiling on the prices
that companies in an industry can charge
Substitutes more powerful if priceperformance trade-off attractive

43

Rivalry among existing

competitors

Degree of rivalry depends on the basis

and intensity of competition
Product lacks differentiation
Fixed costs are high and marginal costs low
Large increments in supply - overcapacity and price
cutting
Product is perishable

Price competition likely if:

Competitors are numerous and roughly equal in size and
power
Industry growth is slow
Exit barriers are high
Rivals committed to the business but have diverse
approaches
44

Branded versus Private label cost

Branded Cereals
structure
Raw material
suppliers

Cereal company
.42+.19=$0.61Overhead .4
Manufacturing .52
Distribution .14
Marketing .75
Margin .4

$2.82

Grocer
.38
(12% of $3.20

$3.20

Private label cereals

Raw material
suppliers

Cereal company
Overhead .38
.38+.15=$0.53Manufacturing .47
Distribution .00
Marketing .00
Margin .07

Food wholesaler
$1.45 .16
(10% of $1.61)

Grocer
$1.61 .29
$1.91
(15% of $1.90)