Introduction to industry analysis
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Introduction to Industry Analysis. Industry Structure. How can we explain why some industries are more profitable than others? Industry analysis is a technique that can help to explain differences in average performance levels. Step 1: Identify the “industry” to be analyzed.

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Introduction to industry analysis

Introduction to Industry Analysis


Industry structure

Industry Structure

  • How can we explain why some industries are more profitable than others?

  • Industry analysis is a technique that can help to explain differences in average performance levels.

  • Step 1: Identify the “industry” to be analyzed.

  • Step 2: Ask “is this industry attractive to an incumbent?”

  • Note: Do not answer this question by looking at profitability. Performance is the consequence; we are looking for the cause.


Four questions

Four questions:

1. If a firm were a monopolist, how profitable would it be? (What are the PIE?)

2. If potential profits are high, can they be retained? (Are buyers or suppliers powerful?)

3. If potential profits are realized, can they be sustained? (Are there entry barriers?)

4. Now what if the firm is not a monopolist? (Is there competition?)


Sizing up the pie

Sizing up the PIE

  • How profitable would a monopolist be?

    • How elastic is demand?

    • How are costs relative to demand?

    • Are there substitutes or complements?

    • How are these variables changing?

    • How is the market changing over time?

  • Distinguish both technical and normative causes.


Supplier power

Supplier power

  • If potential profits are high, can they be retained?

    • Technical: For any given factor, we want to know the structure of exchange between suppliers and producers:

      • Can suppliers coordinate pricing? (e.g., concentration)

      • Are you a major customer for the good or can you coordinate your purchases with others? (bargaining power)

      • Can you free ride on the bargaining power of others? (only if not differentiated/no possibility of price discrimination or arbitrage is unlikely)

      • Are there close substitutes?

    • Normative: Relative status of buyer and supplier

    • Across all factors, we want to know what proportion of a producer’s costs a particular factor represents.


Buyer power

Buyer power

  • Technical: What is the structure of exchange between producers and buyers?

    • How concentrated are buyers?

    • Can small buyers free ride on the bargaining power of others? (only if not differentiated/no possibility of price discrimination or arbitrage is unlikely)

  • Technical: How price-sensitive are customers?

    • What proportion of a buyer’s purchases is your product?

    • Does the buyer care mostly about non-price characteristics? (e.g., quality, service)

  • Normative: Relative status of buyer and supplier

    • Who has the brand? (leverage regarding end user)


  • Entry barriers

    Entry barriers

    • Anything that makes an industry less attractive to an entrant than to an existing firm

      • Technical: Are there economies of scale?

        • What is MES relative to the size of the market?

        • Are there firm-level economies of scale?

        • Are scope economies available?

      • Technical: Are there experience economies?

        • What does the shape of the experience curve look like?

        • Was experience driven by prior competition?

        • Is prior learning outdated? Can the experience be imitated?

      • Normative: Entrant vs. incumbent status and identity


    Entry barriers cont

    Entry barriers (cont.)

    • We want to know about the switching costs of suppliers and customers:

      • Are relevant resources controlled by incumbents?

      • Can an entrant gain access to distribution channels?

      • How strong are consumer loyalties? (relationships, brands)

  • We want to know about the likelihood of fierce resistance:

    • How significant are barriers to exit?

    • What reputations for rivalry have incumbents cultivated?


  • Competition

    Competition

    • Does industry structure allows price coordination (on technical and normative grounds)?

      • How many players are there?

      • What are the size and status distributions of the players? (possibilities for price leadership)

      • How diverse are the players in their competitive styles? (parent organizations, age of industry)

    • Are incumbents insulated from price competition?

      • What is the extent of product/market differentiation or customer loyalties? (switching costs)


    Introduction to industry analysis

    The Basic Situation:

    Exchange Partners with Alternatives

    ?

    ?

    Sellers

    Buyers


    Introduction to industry analysis

    The Value Chain

    Supply Industry 1

    Industry

    Buyers

    Supply Industry 2


    Introduction to industry analysis

    Entrants and Substitutes: ‘Five Forces’

    Producers of Substitutes

    Supply Industry 1

    Industry

    Buyers

    Supply Industry 2

    Potential Entrants


    Introduction to industry analysis

    Other Users

    The Essence of Industry Analysis

    Producers of Substitutes

    Other Products/

    Potential Complements

    Supply

    Industry 1

    Supply

    Industry 2

    Industry

    Buyers

    End-User

    Potential Entrants

    Other Users


    Introduction to industry analysis

    Other Users

    The Essence of Competitive Advantage

    Producers of Substitutes

    Other Products/

    Potential Complements

    Supply

    Industry 1

    Supply

    Industry 2

    Firm

    Buyers

    End-User

    Competitors

    Other Users


    Framework for strategic analysis

    Framework for Strategic Analysis

    Industry

    Evolution

    Industry

    Structure

    Organizational

    Performance

    Organizational

    Evolution

    Organizational

    Strategy


    Strategy definition and identification

    Strategy Definition and Identification


    What is strategy

    What is Strategy?

    • Traditional view: Business strategy is the logic that gives direction to the activities of the organization.

      • Represents the firm to external constituencies.

      • Guides the actions of organizational members.

    • Corporate strategy is the rationale for grouping together various businesses in the same corporation.

      • Helps manage investor relations.

      • Encourages “synergy” across business units.

    • Strategy is articulated by top management in plans that are implemented at lower levels and updated over time.


    What really comes first

    What really comes first?

    • The emergent-strategy view: “I'll know what I am when I see what I do.”

      • Honda motor company in the U.S.

      • Generally, where markets and technologies are uncertain.

    • From this view, the strategic manager is a sense-maker.

      • Retrospective rationalization of the organization’s actions.

    • Strategy exists de facto, whether or not recognized.

      • “Learning from samples of 1 or fewer.”

    • Market success is decided by natural selection, causing (not caused by) the fact that some strategies are better.


    Strategy as managed evolution

    Strategy as Managed Evolution

    • Strategy guides the organization’s evolution.

      • Opportunities and threats emerge from experience.

      • Strategic managers discover these and shape the response.

    • Three stages of the strategy process:

      • 1. Strategy Identification

      • 2. Strategy Evaluation

      • 3. Strategic Adaptation

    • Strategic management is involved throughout.


    Strategy identification

    Strategy Identification

    • The strategic manager has a broad view.

      • Not confined to any one functional area.

    • Identify business strategy by discovering:

      • The long-term objectives of the firm.

      • The the scope of business activities.

      • The sources of competitive advantage.

      • The organizational logic that fits the firm's functional tactics to its scope and advantage.

    • Strategy includes tactics, but is not just a list of tactics.


    Strategy evaluation

    Strategy Evaluation

    • Evaluate strategy based on current consistency:

    • 1. Internal consistency of organization.

      • Is the whole more than the sum of its parts?

    • 2. Consistency with capabilities.

      • Does it match the firm’s capabilities?

    • 3. Environmental consistency.

      • Does it fit the competitive environment?

    • Explicit current-time evaluation allows:

      • Coordination and incentive alignment

      • Increased efficiencies


    Strategy adaptation

    Strategy Adaptation

    • Evaluate strategy based on future trajectory:

    • 1. Internal direction of organization.

      • Are changes adding value?

    • 2. Change in capabilities.

      • Is strategy developing the right capabilities?

    • 3. External direction of organization.

      • Are changes improving fit with the competitive environment?

    • Explicit adaptive evaluation allows:

      • Benchmarking to guide organizational learning.

      • Drive, rather than react to, technology and market change.


    Framework for strategic analysis1

    Framework for Strategic Analysis

    Industry

    Evolution

    Industry

    Structure

    Organizational

    Performance

    Organizational

    Evolution

    Organizational

    Strategy


    Competitive advantage

    Competitive Advantage


    Strategic capabilities

    Strategic Capabilities

    • How can we explain why some firms are more profitable than others in the same industry?

    • “Capabilities”: what an organization can do.

    • They may or may not be good for the firm.

      • They are valuable to a firm if they bring value to its customers.

      • Generally, they are valuable to a firm if they help it overcome today’s strategic challenges.

    • Embodied in organization

      • Products or technologies are consequences, not causes.


    The problem of uniqueness

    The Problem of Uniqueness

    • The most valuable capabilities are unique.

    • Such capabilities are inherently less understandable.

      • Tacit

      • Ambiguous to rivals, analysts, and managers

    • Unique capabilities emerge over time.

      • “Know what you are when you see what you do”

    • The result of organizational evolution.

    • How to manage?

      • Manage the development process, not its consequence.


    How capabilities evolve

    How Capabilities Evolve

    • Competitors cause you problems.

    • Your organization’s solution is another organization’s new problem to be solved

    • …And their solution is your new problem…

    • Over time, this process accounts for the evolution of capable firms.


    When capabilities are harmful

    When Capabilities are Harmful

    • Fact: Managers apply known solutions when problems arise.

      • Consequence: The “competency trap.”

    • New rivals may offer challenges that your organization did not coevolve to deal with.

      • Consequence: “Blindspots” among established firms.


    Strategic position

    Strategic Position

    • Positional advantage results from who you are, not what you do.

    • There are many forms of valuable strategic position, but all stem from a company’s location in the economic or social structure.

      • Social status, reputation, and legitimacy

      • Social network position

      • Legal and political advantages

      • Market incumbency: costs, standardization, or legitimacy

    • Robust versus fragile strategic positions.


    How strategic position evolves

    How Strategic Position Evolves

    • Strategic position is difficult to develop.

      • Market position is costly

      • Social position is elusive

      • Others resist you at all costs

    • Capability may generate strategic position.

      • Position typically is gained by adding value

      • Use today’s capabilities as leverage

    • Affiliation may generate social position.

      • Deference is the flow, status is the stock


    When position is harmful

    When Position is Harmful

    • Compensatory fitness.

      • Position as a shield against capability-creating competition

    • The leverage curse.

      • An advantaged position may open doors too readily

    • Through these mechanisms, position can damage capability generation over time.

      • Through organizational design, strategic management can affect these harmful processes


    Framework for strategic analysis2

    Framework for Strategic Analysis

    Industry

    Evolution

    Industry

    Structure

    Organizational

    Performance

    Organizational

    Evolution

    Organizational

    Strategy


    Role of organization in competitive advantage exploration

    Role of Organization in Competitive Advantage: Exploration


    Organizational evolution vsr framework

    Organizational Evolution: VSR Framework

    Variation

    Selection

    Retention

    Generate diversity of solutions looking for problems

    Membrane between two processes that determines which solutions / capabilities to retain and scale-up

    Efficiently apply known solutions to existing & new problems

    Premises:

    • Development of capabilities through trial & error learning

    • Variation / retention processes - independent & somewhat incompatible


    Both explorer and exploiter engage in vsr

    Both Explorer and Exploiter Engage in VSR

    Variation

    Selection

    Retention

    Explorer

    Exploiter

    R&D

    Driven by external & internal

    Driven by external

    Control System for Resource Allocation

    Filter conserves on scarce retention resources

    Filter conserves on scarce variation resources

    Operations

    (Mfg / Mktg / Sales)

    Time to market

    Feed relevant variation

    Efficiency

    Feed relevant variation

    Explorer

    Exploiter


    How to recognize an exploiter explorer

    How to Recognize an Exploiter / Explorer

    • R&D % of Sales

      • BP 1992 – less than 1% of sales

      • 3M 1991 – 6.8% of sales

      • All US manufacturing 1990 – 3.1%

      • Chemicals – 5.3%

      • Rubber products – 2.1 %

      • Stone, clay and glass - 1.7%

      • Primary metals - .8%

      • Professional / scientific instruments – 7.1%


    Organization and the key to exploitation

    Organization and the Key to Exploitation

    • Know what you have to exploit and transfer

      • May exist is disparate parts of the organization

      • Match knowledge of problem with knowledge of solution

      • Imprint know-how on to acquisition

  • Emphasize efficiency over experimentation through PARC

    • High short-term accountability

    • Clear lines of responsibility / quick decision-making

    • Established procedures / policies

    • Centralized directed change

    • Investment in the “D” of R&D

    • Strong socialization that emphasizes conformity

  • Exploitation suggests hierarchical orientation, but not always


  • Organization and the key to exploration

    PARC objectives

    Tolerance for some sort-term failure

    Tolerance for some ambiguity / slower decision-making

    Loosely coupled, organic change

    Some tolerance for radicals

    Encourage boundary spanners / spanning activities

    Connect parts of the technology tree

    Bring in new market problems looking for solutions

    Develop tools for reinvention – Learning how to learn

    Organization and the Key to Exploration

    • Goal: Keep variation within an “acceptable” window

      • Too little: The creative engine stops

      • Too much:

        • Cumulative learning no longer possible

        • No longer a firm, but an “adhocracy”


    Which is optimal exploit vs explore

    Performance

    (Profit)

    t

    Time

    Which is Optimal? Exploit vs. Explore

    Explore

    Exploit

    • Scenarios

      • A. Incremental environmental change

        • A1. Time < tExploit wins

        • A2. Time > tExplore starts to win

      • Radical environmental change

        • Exploiter has bankroll from earlier successes to fuel retooling

        • Explorer has diverse portfolio of capabilities, some of which still viable


    Additional opportunity for explorer

    Additional Opportunity for Explorer

    Performance

    (Profit)

    Explore

    Exploit

    t

    Time

    Obtain temporal advantage from creation of new market


    Why exploration is hard for firms

    Why Exploration is Hard for Firms

    • Given with exploration:

      • Slack – i.e. suboptimal, short-term performance

      • Greater variance in performance

    • Runs counter to preference for short-term reliability

      • Financial markets

      • Manager’s tools and cognition oriented towards short-term

    • Second-order learning is difficult


    Big verses small firms as explorers

    Big verses Small Firms as Explorers

    • Big Firms

      • Potential upsides

        • Variation aided by “stew” of capabilities

        • Can be better at selection than market if has special knowledge

      • Potential downsides

        • Past successes lead to competency trap

        • Bureaucracy smothers the innovator

    • Small Firms

      • Upside – not have downsides of bigness

      • Downside – Your small firm may not benefit

        • Variation occurs across population of firms

        • Selection on organizations


    Options for hybrid exploiters explorers

    Options for Hybrid Exploiters / Explorers

    • Create separate business units with variation in practices

      • Represent a set of simultaneous experiments

      • Each unit exploits

      • Across the portfolio of units we would have corporate exploration

    • Outsource approach

      • Exploiter outsources exploration

      • Explorer outsources exploitation

      • Positional advantage enhances the viability of this approach


    Summary of tensions in organizational design

    Summary of Tensions in Organizational Design

    • Hierarchy vs. Market orientation

    • Coordination vs. Initiative

    • Exploit vs. Explore

    • Optimize for Today vs. Tomorrow

    • Knowledge generation vs. knowledge capture

    • Consistency in PARC vs. Need for tailoring / change

      • Over time

      • Over different parts of the organization

    • Cost of suboptimal design vs. cost of change


    Framework for strategic analysis3

    Framework for Strategic Analysis

    Industry

    Evolution

    Industry

    Structure

    Organizational

    Performance

    Organizational

    Evolution

    Organizational

    Strategy


    Introduction to industry analysis

    Organizational Evolution: VSR Framework

    Variation

    Selection

    Retention

    Generate diversity of solutions looking for problems

    Membrane between two processes that determines which solutions / capabilities to retain and scale-up

    Efficiently apply known solutions to existing & new problems


    Resource partitioning and niche strategies

    Resource Partitioning and “Niche” Strategies


    Industrial heterogeneity

    Industrial Heterogeneity

    • Tremendous differences exist within industries among parts of the market

      • Geography

      • Taste characteristics

    • Differences also exist among organizations

      • Degree of integration (vertical and horizontal)

      • Forms of organization

        • Capability and position differences result


    Why these differences matter

    Why these differences matter

    • Different “niches” emerge, where market and organizational differences correspond

    • Competitive threats appear within a given niche, and between them “in the middle”

    • Growth, performance, and failure rates are strongly affected by your position on this landscape

      • “Good” strategies often face the strongest rivalry

      • The consequences of strategic change often hinges on this distinction


    Analyzing niches

    Analyzing niches

    • Step one: Dimensionalizing the landscape

      • The more dimensions, the greater the opportunities for successful differentiation

      • Some dimensions can be shaped by the firm

    • Step two: Identify mobility barriers

      • Is it possible to straddle multiple niches?

      • Is it possible to leverage capabilities in one niche to invade another?

      • Important: Note both technical and normative barriers!


    Resource partitioning i early generalist competition

    Resource Partitioning I:Early generalist competition

    • Fact: As they develop, industries often are populated by various, somewhat differentiated generalists.

      • Examples: Beer brewers, banks, newspapers.

    • These generalists do best by enjoying the “center” of the market, but differentiate in order to avoid head-on-head competition:


    Resource partitioning ii increasing concentration

    Resource Partitioning II:Increasing concentration

    • As generalists compete, size advantages mean that selection favors certain firms.

    • These (fewer) victorious firms now can enjoy the middle of the market, where size advantages are favored.

    • Consequence, increasing concentration leaves open more space in the market’s peripheral areas:


    Resource partitioning iii specialist proliferation

    Resource Partitioning III:Specialist proliferation

    • With the periphery now open, specialist firms proliferate into the market.

      • More examples: Wine, telephone companies.

    • Note: the “periphery” need not be literally at the “edge” of market dimensions.

      • Sphere packing as a better metaphor


    Resource partitioning iv niche development

    Resource Partitioning IV:Niche development

    • Once populated by specialists, niches take on growth dynamics of their own.

      • Increasing numbers of specialists legitimate the niche.

      • “Oppositional” strategies often mark the specialists, helping to erect social barriers and reinforce the niche

        • Example: “Sustainable ecotourism”


    Concentration increases specialization

    Concentration increases specialization

    • In sum, increases in industry concentration often are accompanied by increases in the numbers and variety of specialists.

    • Far from being hostile to niche strategists, concentrated industries are an ideal breeding ground for these specialists.


    Concentrated markets and strategic interactions

    Concentrated Markets and Strategic Interactions


    Strategic markets defined

    Strategic Markets Defined

    • Monopoly

      • “We control our own destiny.”

    • Perfectly competitive

      • “We are price takers in world where only price matters.”

    • Strategic markets

      • “What we gain is based on what you do, which is based on what we did.”


    Conditions that give rise to strategic markets

    Conditions that Give Rise to Strategic Markets

    • Concentrated industries with a few key players

      • I can see them.

      • I can see the impact of their actions on me.

      • Opportunity to cooperate / retaliate


    Select manufacturing concentration ratios

    Select Manufacturing Concentration Ratios


    Conditions that give rise to strategic markets1

    Conditions that Give Rise to Strategic Markets

    • Concentrated industries with a few key players

      • I can see them.

      • I can see the impact of their actions on me.

      • Opportunity to cooperate / retaliate

    • Less differentiated goods / services

    • Buyers / suppliers not dictate rules of the game

    • Repeat interaction with same players likely

      • Rate of entry low

      • Rate of exit low


    Two categories of strategic behavior

    Force others to exit

    ++

    Strategic Behavior

    Incumbents split PIE

    +

    Erode Margins

    _

    Two Categories of Strategic Behavior

    Non-cooperative

    Cooperative

    • Easy to supply market demand

    • Price follows capacity decision (apples example)

    • Benefits of stealing share >> cost

    • Win war of attrition through cost advantage

    • Hard to supply market demand

    • Price / quantity simultaneously determined (fish example)

    • Win through truce

      • Differentiated products

      • Price coordination


    Aides to cooperation

    Aides to Cooperation

    • Dimensions for non-price based competition

    • Tie your own hands by making cheating costly

      • Most favorite customer clause

      • Establish reputation for cooperation

    • Signal willingness to retaliate - “Meet or beat price guarantee”

    • Borrow enforcement power from adjacent periods / regions

      • Repeat interaction with no foreseen end period

      • Multi-market contact

        • Firms 1 & 2 compete in Markets A & B

        • Firm 1 is dominant in A and 2 is dominant in B

        • Each has ability to discipline defection due to asymmetric losses

    • Fold-in non market costs of defection

      • Shared social structures in which firms are embedded

      • Example: Garment industry


    Enemies of cooperation

    Enemies of Cooperation

    • Inability to monitor “cheating”

      Are they secretly discounting?

      • Opaque pricing schemes

      • Changes in market share are not good indicators

    • Incentive to steal share vs. cost is high

      • Relatively large fixed costs and overcapacity

    • Cooperation today not a good indicator of what I’ll do tomorrow

      • Short time lines for capacity additions

    • Asymmetry in price war costs

      • Market shares

      • Endowments (Your ability to survive until tomorrow.)

    • US government


    Strategic interaction vs monopoly can be good

    Strategic Interaction vs. Monopoly Can Be Good

    • Provides incentive to develop capability advantage

    • May erect barrier to competition from 2nd tier firms and new entrants

    • Invest in growth of industry as hedge against competition from competing industries

    • Net societal impact?

      • Drives short-term efficient allocation of resources

      • Firms deprived of rents necessary to invest in future innovation


    Framework for strategic analysis4

    Industry

    Structure

    Organizational

    Performance

    Organizational

    Evolution

    Organizational

    Strategy

    Framework for Strategic Analysis

    Industry

    Evolution


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