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Stanford GSB

Sloan Program
Stramgt 258
Strategic Management

7: Introduction to Industry Analysis


Airborne Express
Accounting for Performance

Overall Performance = Industry Effect


+
Business Unit Effect
+
Corporate Effect

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Industry Analysis Objectives
Understand industrys role in (potential and
actual) performance.
Hard to do really well in a bad industry
Identify environmental factors to be
addressed in setting strategy, building
competitive advantage
Leverage and overcome

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Four Questions
If a firm were a monopolist, how profitable would
it be? (How big is PIE?)
If potential profits are high, can they be retained?
(Are buyers or suppliers powerful?)
If potential profits are realized, can they be
sustained? (Are there entry barriers?)
Now what if the firm is not a monopolist? (Does
competition erode profits?)

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Potential Industry Earnings

Increase in price of substitutes (complements):


Shifts demand curve out (in)
Substitutes also constrain firms ability to set price:
With close substitutes even a monopolist in the industry
will not enjoy high margins
Growth in demand increases P.I.E.:
Income growth
Changes in consumer preferences

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Buyer Power

Buyer Impact Buyer Buyer Focal Industry


On Industry = Negotiating * Stake in * Stake in
Profitability Advantage Transaction Transaction

How easily can What percentage of What percentage of
buyer vs. individual buyers costs are focal industrys sales
Questions firm in focal industry comprised of are to buyer
be replaced? purchases from focal segment?
industry?
Concentration ratios Determines buyers Given buyer has
Issues/Hints Ability to coordinate incentive to use power and incentive
Backward power to use it, determines
integration. impact on industry
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Example: Impact of Passenger
Airlines as Buyer Varies
Airline Buyers Buyer Buyer Focal Industry
Impact On Industry = Negotiating * Stake in * Stake in
Profitability Advantage Transaction Transaction

Focal Industry
Caterers High High Med High
Aircraft Med/High Low/Med High High
Ticket Jackets Low/Med High Low High
Uniforms Low High Med Low

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Supplier Power

Supplier Impact Supplier Supplier Focal Industry


On Industry = Negotiating * Stake in * Stake in
Profitability Advantage Transaction Transaction

How easily can What percentage of What percentage of
supplier vs. indiv. supplierss sales are focal industrys costs
Questions firm in focal industry to focal industry? are purchases from
be replaced? supplier?

Concentration ratios Determines Given supplier has


Issues/Hints Ability to coordinate suppliers incentive power and incentive
Forward integr. to use power to use it, determines
impact on industry
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Switching Costs & Power
Switching costs for focal industry firm
magnify the effect of buyer/supplier power:
Location specificity
Relationship-specific investments
Linkages between systems (formal or informal)
Reputation

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Potential Entrants
Barrier: Anything that makes an industry less
attractive to an entrant than an existing firm.
Examples:
Reputation/brand
Learning curve (steepness matters)
Switching costs
Access to distribution channels
Judge height of barrier relative to most likely
entrant

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Potential Entrants
Capital investment barrier to entry only if
both:
MES is large relative to demand
Investment is sunk (exit costs)

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Example Scale Effects
MES Plant Share
Industry per Market

7
Paints

10
Petroleum Refining
Integrated Steel
10
Works

11
Storage Batteries

14
Glass Bottles

41
Cement
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Rivalry
Even with high barriers to entry and no
buyer/supplier power firms might compete away
profits:
Structure (composition of firms)
Conduct (firm behavior)
Structure:
Higher concentration makes (tacit or explicit)
coordination easier
But not sufficient
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Rivalry
Conduct:
Even two firms can compete away profits
Highly differentiated products diminish rivalry
Coordinated pricing (helped by visibility of
prices)
Effect of excess capacity (scale penalty)

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