2002 IBA

Semester 1

Lecture 2: Industry Analysis The Five Forces Model

In this lecture, we will study about industry analysis, focusing on M. Porters Five
Forces Model. The industry analysis is useful to explore some of the reasons for
industry-wide high profitability and the factors that contribute to a more
forgiving environment. Namely it provides an analytical framework to answer
why, in some markets, over some periods of time, most of the firms in the
industry seem to do better than the market as a whole.
Goal:
To understand what factors to be considered to analyse industry profitability,
focusing on the Porters Five Forces Model
References: Besanko et al. (Economics of Strategy, John Wiley, 4 th ed. Ch.10).
Pindyck&Rubinfeld: Chap.8. Ripczynski et al. Ch.1
Reading:
http://www.leadingcompany.com.au/big-ideas/revolutionarythinkers-michael-porters-strategy-game-changer/201302283812

2002 IBA

Semester 1

Factors Affecting Industry Profitability

(1) The Macro-environment: factors affecting the growth of the industry in
the future
Economic trends
-

Globalisation

income growth

Political trend
-

Sep. 11 incidents and terrorism

Technology
-

ICT boom

Legal/regulation
-

environmental issues

water conservation

(2) Assessing the industry environment and profitability: Five-Forces Model

A scheme for organising facts about a particular industry that bear
on how profitable firms in the industry will be. Porter suggests
organising the data into the categories of rivalry, supplier power,
customer power, substitute products and barriers to entry.

2002 IBA

Semester 1

The firm and strategy: How to increase profits?

Strategic Plan
For
New Direction
Industry Analysis
Existing
and
potential
rivals

Process

Macro-environment
External
Environment
(Socio-economic,
political)

The Firm
Internal
Characteristics of
the Organisation
(goals, structure)

This figure shows that the firms strategy to increase its profitability is a process,
which includes industry analysis and reviewing macro biz environment.

Factors affecting the profitability of the industry: M. Porters Five Forces Model
Key message of the model: Profitability will rise if
(1) entry to the industry is difficult (potential competition)
(2) many suppliers exists (buyers bargaining power)
(3) many small buyers (sellers bargaining power)
(4) few substitute (threat of substitute)
(5) rivalry among existing firms/few competitor (actual competition)

2002 IBA

Semester 1

Strategic Groups
Strategic
groups:
Groups
of firms
producing
___________
products/services and forming clusters in terms of similar characteristics
(eg size, history, assets, product positioning). They often take ____________
strategies.
cross price elasticity of demand ( P ) is useful to evaluate the relationship: if
two firms have strong substitute relationship, then the calculated P should be
_____ and __________.
Demand for Big Mac meal and KFC combo.
We can similarly think about the relationship b/ margarine and
butter
retail supermarket: Coles vs Woolworth
domestic airline: Qantas vs Virgin Blue

Industry
Industry could merely be seen as an aggregation of firms, but it is also an entity
with observable characteristics. The concept of industry often includes strategic
groups.
eg. Banking industry, Retail Industry, Airline Industry, etc.
Strategic groups vs. industry
Case 1(retail industry): _________ ________ _________
Case 2(financial industry): _________ ______ _________
Case 3(airline industry): _______ __________

2002 IBA

Semester 1

Porters Five Forces are:

Rivalry among existing firms (actual competition)

Threat of entry (potential competition)
Bargaining power of buyers
Bargaining power of suppliers
Threat of substitute products/services.

Threat of
entry

Buyers

Internal
rivalry

Suppliers

Substitute

1) Factors affecting Internal rivalry

No. and size distribution of firms
a. CRn: N-firm concentration ratio
b. HI: Herfindahl index
Stability of demand: inelastic mkt demand little rivalry
Speed of industry growth: fast growing drop rivalry
High FC (sunk cost) or storage costs rising rivalry
Lack of differentiation rising rivalry
High exit barriers rising rivalry

2002 IBA

Semester 1

If rivalry ___ (profitability)

2)Barriers to entry/Potential Competition
Key threat to a stable mkt
Factors affecting Entry barriers:
(a) Cost adv. due to EOS incumbents can cut price

(b) First-mover advantages

a. ______contracts
b. _______ effects
c. ______ image
(c) Policies: legal restrictions on entry
(d) Psychological barriers: signalling effect
- keeping excess capacity on hand, for either production or distribution, often
deters entry
- holding patents and products on the shelf, ready for use when and if needed
3)Substitutes
If there are large # of subst/close subst drop profitability
<Case 1> Britannica Encyclopaedia Web infor.
<Case 2> disposable diaper (Huggies Pampers) cloth nappy
4)Buyer power
If there is a strong buyer power drop profitability
<Case 1(fast food-soft drink)> KFC vs. Pepsi cola
<Case 2(car-material/parts)> Car producer vs. steel producer
6

2002 IBA

Semester 1

5)Supplier power
If suppliers have power _______ industry profitability
<Case> Labor union power rising wage
The suppliers power rises if
-

# of suppliers drops
Differentiated products market
The products have complicated information

Summary: Record material industry

1. rivalry: 6 major CD co, competing for the best artist
-

not price competition

once contract exclusiveness [cf. George Michaels conflict with Sony in late 90s]
2. Entry barriers

EOS(setting up costs for initial capital equipment)

Reputation
Established network
3. substitute

DVD, TV, Radio, books, megazine [home consumed entertainment]

How consumers collectively feel about these subst?
4. Buyer power

the individual who purchase the output

reputation is important
5. Supplier power

low (many artist in the mkt)

rather, they rely on record co (recording, distribution, promotion) industry
profitability is high

2002 IBA

Semester 1

Evaluations of the five force model

<Contribution>
It provides comprehensive analytical scheme/tools, combining
industry economics with market competition

<Limitations>
Qualitative information: it shows direction of profitability, not the
size
Role of government/cultural aspects are not directly included
Ignoring managerial economics aspects: ie it ignored possible +ve
sum game/ coopetition
Relationship between history, institutions, govt. regulation and industry
profitability more complex.