Analysis of the Competitive Environment

Chapter 7

Learning Objectives
Quick review of analysis of the external macroenvironment Key definitions Understand the significance of industry and market analysis Understand and be able to apply Porters 5 Forces model, and understand its limitations Define competitive vs. collaborative behavior in industries Understand and be able to apply the resource-based framework of analysis of the competitive environment Define strategic groups

Quick Review

Analysis of the external environment includes:

Analysis of the macroenvironment (far environment) Analysis of the microenvironment (near environment, or competitive environment)

External Environment
External macro or far environment External micro Internal Environment or near environment

Quick Review: Analysis of the Macroenvironment

Tool for analysis: SPENT Analysis Socio-demographic Political Economic Natural Environmental Technological

Quick Review: Conducting Macroenvironmental Analysis

Scanning Monitoring Forecasting Assessing

NOTE: The ability to predict trends and changes in the macroenvironment that impact a business, and the ability to make changes based on the prediction, can be a source of competitive advantage

Analysis of the Competitive Environment: Key Definitions

Macroenvironment Microenvironment Industry Market Switching costs Substitute products

Identify opportunities for competence leveraging Understand customers and their needs Identify current and potential threats Understand resource markets

Purpose of Analysis of Microenvironment (Industry and Markets)

Industry Analysis: Classification

Porter: Industry is a group of businesses whose products are close substitutes Other definitions: by production process

Examples: SIC (Standard Industrial Classification) and NACE (Nomenclature Generale des Activites Economiques dans les Communautes Europeenes)

SIC Examples
Link: UK SIC(92) Examples: D Manufacturing

DA Manufacture of food products, beverages and tobacco DB Manufacture of textiles DC Manufacture of leather and leather products

Example: Industry Classification

Philip Morris Headquarters: New York City. Chairman, chief executive: Geoffrey Bible. Major tobacco brands: Marlboro, Merit, Basic, Virginia Slims, Cambridge. U.S. cigarette market share: 47.5 percent in 1997, up from 46.3 percent in 1996. Cigarette division: Philip Morris USA. Financial highlights: Net income of $6.3 billion, or $7.68 a share, on sales of $68.9 billion. Other businesses: Kraft Foods, Inc., the largest U.S. food company (Oscar Mayer, Jell-O, Post cereals, Maxwell House); Miller Brewing Co., the No. 2 U.S. brewer (Miller, Red Dog, and Lowenbrau); financial services and real estate. Number of employees: 154,000.

Industry Analysis Checklist

Location Location of support and resource markets Extent of concentration or fragmentation Product types produced Levels of output, growth and lifecycle position Ownership issues Other activities of industry members

Porters 5 Forces Model of Industry Analysis

Developed in 1980 to analyze the nature and extent of competition within an industry Porter identified 5 competitive forces that determine the nature of competition within an industry

Bio on Michael Porter

Born 1947 Degree in aeronautical engineering (Princeton); doctorate in economics (Harvard) Member of the faculty at Harvard Seminal work: Competitive Strategy (1980) Other works: The Competitive Advantage of Nations (1990)

Porters 5 Forces Model

Threat of new entrants Threat of substitute products Power of buyers or customers Power of suppliers Rivalry among businesses

Advantage of the Model

According to Porter, businesses can use the model to identify how to position itself to take advantage of opportunities and overcome threats

Force 1: Threat of New Entrants

Force 1 depends on the height of barriers to entry Barriers to entry include:

Costs of capital investment needed to enter Regulatory and legal barriers Brand loyalty and customer switching costs Economies of scale utilized by existing competitors Access to suppliers and distributors Resistance from existing competitors

Force 2: Threat of Substitute Products

Substitute products: products that meet the same needs The threat existing from substitute products depends upon:

Extent to which price and performance of a substitute can match the industrys product Willingness of buyers to switch to the substitute

Example: Threat of substitute products

The threat of substitutes makes it difficult to increase prices and improve margins Example: The price of aluminum cans is restricted by the threat of substitutes like glass bottles, steel cans and plastic containers

Force 3: Bargaining Power of Buyers or Customers

The threat is related to how much power buyers or customers have over the industry (the higher the power, the lower the price) Bargaining power of buyers or customers depends upon:

Number of customers and volume of their purchases Number and size of businesses supplying the product Switching costs

Bargaining Power of Buyers

Monopsony a market where there are many suppliers and one buyer Thus, buyer has a great deal of power over price In order to decrease the power of buyers, sellers need to find buyers with lower power to negotiate, switch suppliers or develop offers strong buyers cant refuse

Force 4: Bargaining Power of Suppliers

The threat is related to how much power suppliers have over the industry Bargaining power of suppliers depends upon:

Uniqueness and scarcity of the supplied resource Switching costs How many industries require the resource Number and size of resource suppliers

Example: Bargaining Power of Suppliers

DeBeers worldwide diamond supplier DeBeers controls most of the productive diamond mines in the world Thus, they have extremely high power in the industry In this situation, its better to build winwin relationships with the supplier

Force 5: Intensity of Rivalry

Intensity of rivalry of competitors in the industry is related to competition on both price and non-price bases Force 5 is directly related to the other 4 forces, and depends upon:

Height of entry barriers and number and size of competitors Maturity of the industry Degree of brand loyalty Power of buyers and availability of substitutes

Intensity of Rivalry
Concentrated vs. Fragmented industries SIC classification is useful to assess this portion High concentration ratio means the majority of market share is held by a few firms Low concentration ratio means the industry has many rivals, none with significant market share Competitive strategies include:

Changing prices Improving product differentiation Creatively using channels of distribution Exploiting relationships with suppliers

Porters 5 Forces and Profit

Force
Bargaining power of suppliers

Profitability will be higher if:

Weak suppliers

Profitability will be lower if:

Strong suppliers

Bargaining power of buyers Threat of new entrants Threat of substitutes Competitive rivalry

Weak buyers

Strong buyers

High entry barriers Low entry barriers Few possible substitutes Little rivalry Many possible substitutes Intense rivalry

Criticisms of Porters 5 Forces Model

Porters 5 Forces is designed to assess industry profitability. Other argue that company-specific factors (for example, competences) are more important Implies the five forces apply equally to all competitors in the industry No consideration of product and resource markets It cannot be applied without consideration of the macroenvironment Assumes relationships with competitors, buyers and suppliers is not cooperative, but competitive

Co-operative Environment
One of the criticisms of Porters 5 Forces Model is that it views all relationships as competitive, not cooperative BUT: Most organizations have formal and informal co-operative relationships with suppliers and distributors

Co-operative Environment (Cont.)

Co-operative environment is important because it may:

Help achieve sustainable competitive advantage Produce lower costs Provide sustainable relationships with those outside the organization

Analysis of the Co-operative Environment

Government Links

Informal Co-operative Links

Organization

Complementors

Formal Co-operative Links

Co-operative Links
Informal co-operative links organizations link together for mutual or common purpose without legally binding contracts Formal co-operative links links bound by some sort of contract Complementors companies whose products add value to the organizations basic product Government links relationships with governments

Informal Co-operative Links

Examples: Chambers of Commerce, Industry Associations, Keiretsu (Japan), Chaebol (Korea) These networks provide strong support for the organizations which belong to them Strong support links may provide competitive advantage

Formal Co-operative Links

Examples: Joint Ventures, Strategic Alliances Links can be with suppliers, distributors and even competitors Real world examples: Benetton, Toyota, Marks & Spencer Strong links may deliver lower prices and higher quality service to the organization

Complementors
Examples: Software is a complementor of hardware Usually, complementors work with the organization to provide a joint offering Real world example: Microsoft

Government Links
Examples: negotiations with government on tax, investment and legal issues; organization lobbies Real world examples: For companies in the defense and pharmaceutical industries (Boeing, Smith Kline Beecham), strong government links are essential

Co-operative Links: Summary

Co-operative links can be opportunities, and cooperative links of competitors may be threats Porters 5 Forces analysis focuses on the competitiveness of relationships, BUT, competitive advantage may be gained through cooperation Establishing cooperative links is an emergent approach to strategy development

Alternative to 5 Forces Analysis: Resource-based Framework

Resource-based framework is designed to compensate for disadvantages in traditional models (like Porters 5 Forces) Emphasizes the importance of core competence in achieving competitive advantage

Resource-based Framework
Complicated and comprehensive analysis Analysis of 5 inter-related areas:

Organization Industry Product markets Resource markets Other industries

Resource-based Framework
Competitive Rivalry Company Industry Buyer Power Resource Markets Product Markets New Markets Organizations Products

Supplier Power

Organization

Competence Related Industry

Threat of Substitutes

Substitutes

Resource-based Framework: Organization

Focuses on competences, core competences, resources and value chain (as we discussed in detail in Chapter 2) This part of the analysis includes an analysis of:

Resources Organizational competences, core competences and activities Value chain

Resource-based Framework: Industry

Focuses on analysis of competitors:

Skills and competences Configuration of value-adding activities Technology Number and size Performance (focus on financial performance) Ease of entry and exit (barriers) Strategic groupings

A Note on Strategic Groupings

Strategic groups the group of competitors representing an organizations closest competitors Example: a group of branded clothes including Polo (Ralph Lauren), Tommy Hilfiger, and Izod (Lacoste), among others, may be a strategic group, even though there are other lower quality brands that are technically competitors Example 2: Rolex, Tag Heuer, Tissot may be part of a strategic group that does not include Swatch, Timex, Seiko, even though they are all watchmakers

Resource-based Framework: Product Markets

Analysis is focused on:

Customer needs and satisfaction Unmet customer needs Market segments and profitability Number of competitors to the market and relative market share Number of customers and their purchasing power Access to distribution channels Ease of entry Potential for competence leveraging Need for new competence building

Product-based Framework: Resource Markets

Resource markets: where organizations obtain finance, human resources, human resources, physical resources, technological resources Analysis focuses on:

Resource requirements Number of actual and potential suppliers Size of suppliers Potential collaboration with suppliers (cooperation) Access by competitors to suppliers Nature of the resource and availability of substitutes

Resource-based Framework: Competence-related Industries

Focuses on analysis of other industries with similar competences and which may produce products that can be substitutes of the organizations products Analysis is useful to identify:

Potential threats Other industries in which the organization may be able to leverage their competences New markets

Next Class: Tutorial

UK Outbound tour operations industry, pp.370 390 Consider analysis of the industry by Porters 5 Forces Analysis, Resource-based Framework Identify any parts of the value chain Identify an strategic groups Discuss the intensity of rivalry in the industry Identify SPENT influences Identify any cooperative links