Industry Analysis & Competition in Strategic Management: Understanding Necessity & Factors, Schemes and Mind Maps of Strategic Management

Download Industry Analysis & Competition in Strategic Management: Understanding Necessity & Factors and more Schemes and Mind Maps Strategic Management in PDF only on Docsity! INDUSTRY ANALYSIS Industry analysis is a part of strategic analysis of organizations. Industry analysis basically consists of analyzing the industry environment in which organizations operate their activities. The strategy managers need to analyze the industry along with an analysis of the general environment. In the previous unit we have discussed about the general environmental analysis. This unit will address the issue of industry analysis, to be followed by SWOT analysis in the next unit. 3 School of Business Unit-3 Page-44 Blank Page Bangladesh Open University Strategic Management Page-47 9. Providing invaluable insights into the industry and competition, which help managers identify appropriate strategy and implement strategy successfully. Analysis of Competition in the Industry The most widely used model for an industry’s competition analysis is Michael Porter’s Five Forces Model. Managers can use this model to analyze the competitive environment in the industry in which their company is operating its business. This model provides a framework to identify industry-related opportunities and threats. We discuss this model here in details. Michael Porter’s Five Forces Model Managers need to analyze competitive forces in the industry’s environment in order to identify the industry-related opportunities and threats confronting their company. Porter has developed a framework that helps managers in this analysis. His framework is known as Five Forces Model, which is shown in Figure 3.1 Figure 3.1: Michael E. Porter’s Five Forces Model (Source: Michael Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review, (March-April, 1979). Explanation of the Forces in the Porter’s Model 1. Threat of new entrants In the marketplace some competitors are already operating their businesses. They are called existing competitors. Some other competitors are not now competing in the industry but they can enter into the industry if they have the capability and desire to compete. They are potential competitors. Bangladesh Telephone and Telegraph Board (BTTB) was once considered a potential competitor in the cellular telephone industry. In fact, BTTB entered into the industry with its cheaper mobile phones in April 2005, although it could not manage the market-situation well. Potential competitors create a threat to existing companies (or incumbent companies) because if they enter they can make competition tougher through taking away market share from the existing companies. Thus, existing companies discourage potential competitors from entering into the industry by creating barriers to entry. ‘Barriers to entry’ are created Threat of new entrants Rivalry among the existing firms Threat of substitute products or services Bargaining power of buyers Bargaining power of suppliers Managers need to analyze competitive forces in the industry’s environ- ment in order to identify the industry- related opportunities and threats confron- ting their company. Existing companies discourage potential competitors from entering into the industry by creating barriers to entry. School of Business Unit-3 Page-48 by undertaking some measures that are very costly for the competitors to adopt. Such barriers may be brand loyalty, absolute cost advantage, economies of scale, and government regulations. 2 On the other hand, if the risk of entry by potential competitors is low, the existing companies can raise prices and earn higher profits. 2. Bargaining power of suppliers A company has to procure various types of supplies from the suppliers such as raw materials, components, parts and other materials necessary for producing a product. If the suppliers are powerful they can raise prices of materials. As a result, powerful suppliers are a threat to the companies who have to buy at that price. If suppliers are weak, company may be in an advantageous position and can demand high quality at a lower price from the suppliers. In Bangladesh, in the paper industry the number of suppliers is very few and they are very strong in bargaining prices. This has created a threat for the publishing industry. However, this threat has been to some extent diluted due to imported paper. Suppliers have very little or no bargaining power if the materials they sell are available from different parties. Their power increases if the supply of the materials is limited or if the materials are such that they are inevitable for the company (buyer). For example, in the PC market Intel is the most powerful because of its unique position in producing microprocessor (Pentium). 3. Bargaining power of buyers Buyers of products may be ultimate consumers or even the intermediaries such as dealers, wholesalers and retailers. Buyer’s bargaining power becomes high when suppliers have to depend on them for some reasons such as uniqueness of the product or nonavailability of similar products. On the other hand, their bargaining power is weak when suppliers are capable to raise prices. Whether buyer-seller relationships represent a weak or strong competitive force depends whether buyers have sufficient bargaining power to influence the terms and conditions of sale in their favor, and the extent of seller-buyer strategic partnerships in the industry. 3 According to Porter, buyer’s bargaining power is highest when: (i) The supply industry is composed of many small companies and the buyers are few in number as well as they are large. (ii) Buyers purchase in large quantities. (iii) The supply industry depends on the buyers for a large percentage of its total orders. (iv) Buyers can switch orders between supply companies at a low cost. (v) It is economically feasible for the buyers to purchase the input from several companies at once. (vi) Buyers can use the threat to supply their own needs through vertical integration (backward linkage) as a device for forcing down prices. Bangladesh Open University Strategic Management Page-49 4. Threat of substitute products A company needs to consider the competitive pressures from substitute products. The substitute products may come from either the same industry of the company or from other industries. For example, cotton producers are in direct competition with the producers of polyester fabrics. Newspapers compete against television in providing latest news. E-mail is a substitute for the overnight delivery of documents by the courier service companies. Coffee is a substitute of tea. Bottled water is a substitute of juice and soft drinks. The major factors that determine the strength of the competition from substitutes are (i) attractiveness of the prices of substitutes; (ii) buyers’ satisfaction with the substitutes in terms of quality and other features; and (iii) the easiness to switch to substitutes. When the substitutes are available at cheaper prices, the producers of the normal product are in a high competitive pressure to reduce prices. When substitute products are available, customers begin to compare prices, quality etc with the normal products. Similarly, when switching costs from the normal product to substitute products are low (and also not inconvenient), buyers become more prone to the substitutes. Existence of substitute products in the industry poses a threat to a company. Thus, the company’s profit is likely to depress due to cutting down prices. If a company has few substitutes, it has the opportunity to raise prices and thereby increase profits. 5. Rivalry among the existing firms A very important force in the Porter’s Model is the extent of rivalry among the established companies in the industry. In an environment of weak rivalry (competition), company can raise prices and make higher profits. When competition is strong, the industry may face severe price- war in which companies compete against each other on the basis of price cuts. If there is a severe competition among the firms in the industry, profitability decreases substantially. Thompson and Strickland regard this force of rivalry as the ‘strongest of the five forces.’ Inter-company rivalry or competition stems from several factors, as identified by Porter in his famous book Competitive Strategy. These are as follows: 4 a) Competition increases as the number of competitors increases. b) Competition is usually stronger when demand for the product is growing slowly. c) Competition is more intense when industry conditions encourage competitors to cut prices. d) Competition is stronger when customers’ costs to switch brands are low. e) Competition is stronger when one or more competitors are dissatisfied with their market position and undertake other measures to win the battle for market share. f) Competition tends to be more intense when it costs more to get out of a business than to stay in the industry. School of Business Unit-3 Page-52 Lesson-2: Methods of Industry Analysis Learning Objectives After studying this lesson, you should be able to: • Discuss the methods for the analysis of an industry. • Identify dominant economic characteristics of an industry. • Assess the main sources of competitive pressures. • Define driving force and identify the major driving forces in the industries. • Evaluate the market position of competitors. • Define strategic group and use the procedure for constructing a strategic group map. • Predict the strategic moves of the competitors in the industry. • Find out the key success factors in the industry. • Evaluate the attractiveness of an industry. • Prepare an industry analysis plan. Introduction Thompson and Strickland have used a model for the analysis of industry. This model is based on seven forces. Let’s call this Thompson and Strickland’s seven factors model for industry analysis. This model provides a comprehensive treatment for the analysis of the issues in an industry. It focuses on dominant economic characteristics of an industry, sources of competitive pressures, strengths of the competitive forces in the industry, driving forces, market position of the competitors, strategic actions undertaken by competitors, the key success factors in the industry and the overall attractiveness of the industry. Thompson and Strickland’s Seven Factors Model The model for industry and competitive analysis proposed by Thompson and Strickland has been able to overcome the drawbacks of Porter’s Model. It seems to be comprehensive. It touches on all the relevant issues in an industry that need to be analyzed for assessing the overall industry situations, including the degree of competition in the industry. The seven factors of the Thompson and Strickland are as follows: 1 (i) Industry’s dominant economic features. (ii) Main sources of competitive pressure and the strengths of the competitive forces. (iii) Driving forces. (iv) Market position of the rival companies. (v) Competitor’s strategic moves. (vi) Industry’s key success factors. (vii) Industry’s overall attractiveness and profitability prospects. An analysis of these factors reveals competitive structure of the industry. Let’s discuss the factors one by one. The information generated through An analysis of Strickland seven factors reveals competitive structure of the industry. Thompson and Strickland model provides on compre- hensive treatment for the analysis of the issues in an industry. Bangladesh Open University Strategic Management Page-53 the analysis of these factors would build understanding of a firm’s surrounding environment and form the basis for matching strategy to changing industry conditions and competitive forces Factor-1: Dominant Economic Features of the Industry An industry’s economic features are important because their implications for strategy making are great. Economic features of an industry generally include: Market size; scope of competitive rivalry (local, regional etc); market growth rate and position; stage in life cycle (early development, rapid growth and takeoff, decline and decay etc); number of companies in industry; number of customers; extent of backward linkage or forward linkage (i.e., degree of vertical integration in the industry); ease of entry into the industry; ease of exit from the industry; types of distribution channels; level of differentiation of competitors’ products; technology/innovation; opportunities to realize economies of scale by the companies; capacity utilization; and industry profitability. An industry’s economic features are relevant to managerial strategy making in various ways. Here are some examples. The strategic importance of ‘market size’ is that small markets do not usually attract big competitors but big markets do it. The strategic importance of ‘entry barriers’ is that high barriers protect market position and profits of existing firms and low barriers invite more and more potential competitors to enter into the industry. Similarly, big capital requirements create barriers to entry of potential competitors. Factor-2: Main Sources of Competitive pressures An important component of industry analysis is sources of competitive pressures and the strengths of each competitive force. An understanding of the competitive character of the industry helps managers develop successful strategy. Thompson and his colleague suggested the use of Michael Porter’s Five Forces Model for the analysis of competitive pressures and the strength of each force of competition. They are of the view that the state of competition in an industry is a composite of five competitive forces identified by Porter. Factor-3: Driving Forces Economic characteristics say a very little about the ways in which the environment may be changing because of new developments in the industry. New developments take place in the industry because important forces are always driving the competitors, customers and suppliers to alter their actions. These forces in the industry are the major underlying causes of changing competitive conditions in the industry. These are called driving forces. The most common driving forces are changes in the long-term industry growth rate, changes in buyer demographics, product innovation, technological change, marketing innovation, entry or exit of major firms, diffusion of technical know-how, increasing globalization of the industry, changes in cost and efficiency, emerging buyer preferences, government policy changes, changing attitudes and life-styles etc. Early detection of driving forces is possible through systematically and regularly scanning the industry environment as well School of Business Unit-3 Page-54 as other external factors. Known as Environmental Scanning, this qualitative technique of investigating into external factors involves itself in monitoring and studying current events, constructing scenarios and identifies the driving forces. Many large companies employ environmental scanning on a continuous basis such as Coca-Cola, Motorola, Shell Oil, etc. There may be many forces of change in an industry but in reality all do not qualify as ‘driving forces’. Managers need to carefully evaluate the forces so that they can intelligently separate the major changes from the minor changes. This would help mangers formulate sound strategy. Factor-4: Market Position of Competitors Market position of competitors in the industry has a bearing on the overall competition in the industry. Therefore, the strengths of competitive forces need to be analyzed. Such analysis is important to discover the main sources of competitive pressures and how strong they are. Attempt is made to study the market position of rival companies. One technique for revealing the competitive (market) positions of industry participants is strategic group mapping. It is most useful when an industry has so many competitors that it is not practical to examine each one in depth. Strategic group mapping endeavors to determine the strategic group for a product of a company. So, naturally, the question arises: What is a strategic group? Strategic Group: Companies in an industry often differ with respect to several factors: distribution channels, market segments, quality of products, technological leadership, customer service, pricing policy, advertisement policy and promotion policy, etc. As a result, some companies follow the same basic strategy and follow a different strategy than that of companies in other groups. These groups are known as strategic groups. The competitors that pursue similar strategic approaches and have similar positions in the market constitute a strategic group. For instance, although Maruti car is in the automobile industry, it is not a competitor of Civic Honda. Subaru is not competing with Mercedes-Benz. Figure 3.2 shows two main strategic groups - Proprietary Group, and Generic Group - in the pharmaceutical industry. Figure 4.2: Two strategic groups in the pharmaceutical industry. High Prices Charged Low PROPRIETARY GROUP • Company- A • Company-B • Company-C GENERIC GROUP • Company-X • Company- Y Low R & D Spending High Bangladesh Open University Strategic Management Page-57 Factor-7: Industry Attractiveness Strategy-makers in a company must be able to give answer to the question: “Is the industry attractive and what are its prospects for above- average profitability?” In order to answer to this question, strategists review the overall industry situation and develop reasoned conclusions about the relative attractiveness or unattractiveness of the industry. The factors that they usually analyze for assessing industry attractiveness include: a. industry’s growth potential b. favorable or unfavorable impact by the prevailing driving forces c. competitive position of the company in the industry d. potential entry or exit of major firms e. stability and/ or dependability of demand f. possibility of competitive forces becoming stronger or weaker g. severity of problems/issues confronting the industry as a whole h. degrees of risk and uncertainty in the industry’s future. Preparing an Industry Analysis Plan Industry analysis provides information about the industry situations that help strategy-makers concentrate on strategic thinking and predicting the future of the industry. An insight about the overall industry situations facilitates effective and pragmatic strategy-making. On the basis of the above analyses, managers can prepare a document containing all the information related to the competitive forces in the industry. Below is given a sample format for jotting down the information in a document form. INFORMATION ABOUT ECONOMIC FEATURES Market size, growth potential, technology, vertical integration, number and sizes of buyers and sellers, and so on SOURCES OF COMPETITION Status of competition among competitors, power of buyers and suppliers, competition from substitutes, threat of potential entry and so on. DRIVING FORCES Changes in long-term industry growth, globalization of competition in the industry, product innovation, changing buyer preferences, etc. MARKET POSITION Market leaders, runner-ups, weak companies, strategic group members. STRATEGIC MOVES OF RIVALS Competitors’ strategic moves and intents, whom to be watched and so on. KSF Product attributes, competencies, capabilities and so on. INDUSTRY’S OVERALL ATTRACTIVENESS Factors making industry attractive. Factors making industry unattractive, special industry problems, favorable or unfavorable profit outlook. Industry analysis provides information about the industry situations that help strategy-makers concentrate on strategic thinking and predicting the future of the industry. School of Business Unit-3 Page-58 After making an analysis of the industry environment, managers have no reason to suffer from complacency. They cannot really make winning strategy unless they gather information regarding the company’s internal situations and the general macroenvironmental factors. In the industry analysis, managers look at the industry-specific macroenvironmental factors only. This analysis provides only industry-related external opportunities and threats. But they cannot know about the general opportunities and threats that arise from the general economic environment, political and legal environment, social and cultural environment, natural environment and demographic environment. Against this backdrop, we devote the next Unit to making SWOT analysis that helps in identifying internal strengths and weaknesses and external opportunities and threats of an organization. Industry Analysis provides only indus- try-related external opportunities. Bangladesh Open University Strategic Management Page-59 Review Questions 1. Discuss the methods for the analysis of an industry. 2. What are the dominant economic characteristics of an industry? 3. State the main sources of competitive pressures. 4. Define driving force and discuss the major driving forces in the industries. 5. What is the importance of evaluating the market position of competitors? 6. Define strategic group and explain the procedure for constructing a strategic group map. 7. Why should a company assess the strategic moves of the competitors in the industry? 8. What are the key success factors in an industry? Explain your answer with examples from the jute industry in Bangladesh. 9. How can you evaluate the attractiveness of an industry? 10. Prepare an industry analysis plan. Application Discussion Questions 1. Suppose your company is operating its business in the pharmaceutical industry. What are the key success factors in this industry? 2. Prepare the strategic group for your firm, which is doing business in the textile industry. What factors would you consider for strategic group mapping? NOTES 1. This section draws on Thompson and Strickland, op.cit. pp. 74-113.