New Venture Strategies

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New Venture Strategies
Session 4 - 7
Industry structure and strategy

• PIRNAY Fabrice
• 2002 - 2003

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Le  menu du jour 

• 1. What is an industry ?
• 2. Drawing the structure of a given industry

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1. What is an industry ?

• 1.1. Industry Boundaries
• 1.2. Industry Life Cycle

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1.1. Industry Boundaries
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1.1. Industry Boundaries

• What is an industry?
• Collection of firms whose products (or services)
  are perfect or near perfect substitutes
• Similarity of products/services is key
• Importance of industry boundaries
• Helps managers understand arena of competition
• Enables identification of competitors
• Helps managers identify key success factors
• Provides basis to evaluate firm goals

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1.1. Industry Boundaries

• Problems with industry definition
• Industries evolve
• Structure and firms change over time
• At what level of aggregation?
• For example, beer vs. craft beer segment
• Industries emerge from industries
• For example, electronics industry of 60s is now
  multiple industries -- TV, VCR, computers
• Domestic versus global in scope

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1.1. Industry Boundaries

• Question What industry is BMW in ?
• world auto industry ?
• European auto industry ?
• world luxury car industry ?
• world sports car industry ?

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1.1. Industry Boundaries

• An industry is a group of companies offering
  products or services that are close substitutes
  for each other
• Key criterion SUBSTITUTABILITY
• On the demand side are buyers willing to
  substitute between types of cars (across
  countries) ?
• On the supply side are manufacturers able to
  switch production between types of cars (across
  countries) ?
• Drawing Industry Boundaries Identifying the
  Relevant Market

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The Spectrum of Industry Structures
Perfect Competition
Oligopoly
Duopoly
Monopoly
Concentration
Many firms
A few firms
Two firms
One firm
Entry and Exit Barriers
No barriers
Significant barriers
High barriers
Product Differentiation
Homogeneous Product
Potential for product differentiation
Information
Perfect Information flow
Imperfect availability of information
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The Spectrum of Industry Structures
Fragmented Many firms, no dominant firm
Few firms, shared dominance(oligopoly)
Consolidated One firm or one dominant
firm (monopoly)
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1.2. Industry Life Cycle
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1.2. Industry Life Cycle

• Four Major Stages
• Emergence
• Growth
• Maturity
• Decline

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1.2. Stages of the Industry Life Cycle
Maturity
Shakeout
Decline

• Demand takes off
• prices fall
• barriers to entry low
• rivalry low

• No new demand
• barriers to entry high
• rivalry increases
• prices down
• cost cutting
• industry consolidation
• usually oligopolies

Demand

• Growth slows
• rivalry increases
• excess capacity
• price drops
• firms exit

• Growth slow
• buyers unsure
• high prices
• barriers about
• knowledge,
• standard setting

Growth

• Demand falls
• rivalry increases
• price cuts
• exit barriers are key

Embryonic
Time
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1.2. Industry Life Cycle

• I. Emergence
• New product or concept
• How to enter and refrain subsequent entry?
• Consequence
• Fixing the price level
• Convince or educate prospective customers
• Determine the segment to enter
• Generate barriers to entry (price, segment,
  preemption actions and investments,)

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1.2. Industry Life Cycle

• II. Growth
• The rate of growth is increasing
• The analysis of diffusion is critical
• Entry starts to occur
• Consequence
• Build capacity
• Innovate entry option
• Create new segment
• Develop partnerships and strategic alliances
•  Take the money and run 

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1.2. Industry Life Cycle

• III. Maturity
• Rate of growth is declining
• Development of a replacement market
• Increasing market segmentation
• Consequences
• Effort for differentiation
• Develop market niches
• Reduce costs
• Manage exit

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1.2. Industry Life Cycle

• IV. Decline
• Big variations across segments possible
• Consequence
• Manage the withdraw

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1.2. Industry Life Cycle

• Limitations of Life Cycle
• it is just a generalization
• tends to focus on sales, market share, and
  investment in the industry
• Life cycle model can help to anticipate industry
  change, but it is dangerous to assume any
  pre-determined pattern of industry development

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2. The structure of a given industry
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2. The structure of a given industry

• How to describe industry structure?
• Industry size / growth
• Industry life cycle
• Industry concentration (Is the industry dominated
  by a few players?)
• The industry structure is a product of and
  defines the rules of competition
• Industry structures constantly change
• Transformation can just as easily undermine
  industry attractiveness as enhance it
• Opportunities and threats arise from changes in
  industry structure

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2. The structure of a given industry

• 2.1. The B.C.G. Matrix 2
• 2.2. The Five Forces Model (M. PORTER)
• 2.3. The Strategic Groups

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2.1. The B.C.G. Matrix 2
Many
Fragmented
Specialization
Number of Approaches to Achieve Advantage
Volume
Stalemate
Few
Small
Large
Size of the Advantage
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2.1. The B.C.G. Matrix 2
Many
Number of Approaches to Achieve Advantage
Few
Small
Large
Size of the Advantage
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2.2. The Five Forces Model (PORTER)

• The Five Forces
• I. Threat of New Entrants
• II. Intensity of Competitive Rivalry
• III. Bargaining Power of Suppliers
• IV. Bargaining Power of Buyers
• V. Availability of Substitute Products

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2.2. The Five Forces Model (PORTER)
The Model
AVAILABILITY OF SUBSTITUTE PRODUCTS
RIVALRY AMONG COMPETING SELLERS Competitive
forces arising from the jockeying for better
market position and a competitive advantage.
BARGAINING POWER OF BUYERS
BARGAINING POWER OF SUPPLIERS
THREAT OF NEW ENTRANTS
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I. Threat of New Entrants
AVAILABILITY OF SUBSTITUTE PRODUCTS
RIVALRY AMONG COMPETING SELLERS Competitive
forces arising from the jockeying for better
market position and a competitive advantage.
BARGAINING POWER OF BUYERS
BARGAINING POWER OF SUPPLIERS
THREAT OF NEW ENTRANTS
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I. Threat of New Entrants

• New Entrants...
• Bring more capacity to industry
• Can 'shake up' industry

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I. Threat of Entrants Depends Upon

• Entry Barriers
• Entry barriers stem from...
• Economies of scale
• Product differentiation
• Capital requirements
• Switching costs
• Access to distribution channels
• Cost advantages not related to scale
• Proprietary technology
• Access to raw materials
• Favorable locations
• Government subsidies

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I. Threat of Entrants Depends Upon

• Entry Barriers (Cont.)
• Government policy
• Regulation restricting capacity, players
• Standards safety, anti-pollution
• Testing delays
• Expected Retaliation of Industry Incumbents

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II. Intensity of Competitive Rivalry
AVAILABILITY OF SUBSTITUTE PRODUCTS
RIVALRY AMONG COMPETING SELLERS Competitive
forces arising from the jockeying for better
market position and a competitive advantage.
BARGAINING POWER OF BUYERS
BARGAINING POWER OF SUPPLIERS
THREAT OF NEW ENTRANTS
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II. Intensity of Competitive Rivalry

• The Intensity of Competitive Rivalry Is Greatest
  When...
• There are numerous, or equally balanced
  competitors
• Industry growth is slow
• Incumbents have high fixed costs
• Buyers have minimal switching costs
• Capacity is augmented in large increments

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II. Intensity of Competitive Rivalry

• The Intensity of Competitive Rivalry Is Greatest
  When... (Cont.)
• Competitors are diverse
• Family owned businesses
• Foreign owned competitors
• Competitors have high strategic stake in industry
• Industry has high exit barriers
• Specialized assets---low liquidation value
• Fixed costs of exit---unions, suppliers,
  warranties
• Emotional barriers
• Government restrictions

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II. Intensity of Competitive Rivalry
Effects of Entry Barriers and Exit Barriers on
Industry Profits
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II. Intensity of Competitive Rivalry

• Four firm Concentration ratio (CR4)
• - Add the market shares held by the 4 largest
  companies in the industry ( of total industry
  sales accounted by the 4 largest firms)
• - Minimum theoretically near 0
• - Maximum 100 (or 1.00)
• Logging 18
• Cigarettes 85

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II. Intensity of Competitive Rivalry

• Herfindahl Index (HI) - a measure of the balance
  in an industry
• HI 10,000 (The Sum of (the square of each
  firms market share))
• Example 3 firms with market shares of 0.50,
  0.25, 0.25
• HI 10,000 ((0.50)2(0.25)2(0.25)2)
  3750
• 0 Perfectly Competitive
• 10,000 Monopoly
• gt 1,800 Industries with reduced rivalry

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III. Bargaining Power of Suppliers
AVAILABILITY OF SUBSTITUTE PRODUCTS
RIVALRY AMONG COMPETING SELLERS Competitive
forces arising from the jockeying for better
market position and a competitive advantage.
BARGAINING POWER OF BUYERS
BARGAINING POWER OF SUPPLIERS
THREAT OF NEW ENTRANTS
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III. Bargaining Power of Suppliers

• Suppliers Affect Industry By...
• Raising prices
• Reducing quality

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III. Bargaining Power of Suppliers

• Suppliers Are Most Powerful When...
• Supplier industry is concentrated, or dominated
  by a few large firms
• Buying industry is fragmented
• Substitutes are not available
• The industry is not an important customer of
  suppliers
• The suppliers' product is an important input to
  the buyer's business

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III. Bargaining Power of Suppliers

• Suppliers Are Most Powerful When... (Cont.)
• The supplier can vertically integrate forward
• Suppliers are unified
• Trade associations
• Cartels
• Trade unions

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IV. Bargaining Power of Buyers
AVAILABILITY OF SUBSTITUTE PRODUCTS
RIVALRY AMONG COMPETING SELLERS Competitive
forces arising from the jockeying for better
market position and a competitive advantage.
BARGAINING POWER OF BUYERS
BARGAINING POWER OF SUPPLIERS
THREAT OF NEW ENTRANTS
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IV. Bargaining Power of Buyers

• Buyers Affect Industry By...
• Forcing prices down
• Bargaining for higher quality
• Bargaining for more favorable terms
• Playing competitors off against each other

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IV. Bargaining Power of Buyers

• Buying Groups Are Most Powerful Under the
  Following Circumstances...
• Buyers are concentrated and/or large compared to
  industry
• Industry is fragmented
• The product purchased from industry is
  undifferentiated
• Buyers face few switching costs
• Buyers earn low profits
• Buyers can integrate backwards
• Buyers have full information

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V. Availability of Substitute Products
AVAILABILITY OF SUBSTITUTE PRODUCTS
RIVALRY AMONG COMPETING SELLERS Competitive
forces arising from the jockeying for better
market position and a competitive advantage.
BARGAINING POWER OF BUYERS
BARGAINING POWER OF SUPPLIERS
THREAT OF NEW ENTRANTS
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V. Availability of Substitute Products

• Firms Are Not Only Competing Against Firms in
  Their Own Industry, but Also Firms in Industries
  Producing Substitute Products.
• Substitutes limit profits in normal times
• Substitutes reduce bonanza in boom times
• May be countered by industry collectives

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V. Availability of Substitute Products

• Forms of substitution
• Product-for-product
• Substitution of need
• Generic substitution
• Doing without

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The Case of Business - Research Industry
Potential Entrants (Future Business
Professors) 1. High entry barriers 2. Low return
on investment
Low threat of entry
Rivalry (Business Professors)
Low rivalry due to 1. Strong growth of
demand 2. Relatively few rivals 3. Significant
differentiation 4. Low exit barriers
Buyers (Students and
Executives) 1. High demand 2. Relatively many
buyers 3. Limited substitutes at present 4. Some
backward integration
Suppliers (Students and
Executives) 1. Suppliers are the buyers 2. Low
differentiation
Low bargaining power of suppliers
Low bargaining power of buyers
Moderate threat from substitutes
Substitutes (Experience
and non-university education) 1. Excess demand
for professors services 2. Price-performance
ratio difficult to measure
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The implications of the five forces model

• It makes it possible to diagnose the competitive
  forces and characterize the position of a
  company.
• To a large extent, the forces influences the
  rules of the game of the competitors and the
  strategies which are potentially available.
• To an extent, it determines the profit potential
  of the industry.

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The limitations of the five forces model

• Does not foretell the future, nor does it
  eliminate uncertainty for any organization.
• Does not guarantee organizational effectiveness.
• Is static and ignore innovation
• Is dynamic only to a limited extent, e.g. the
  industry conditions take on punctuated
  equilibrium.
• Can it be applied to complex business landscape
  and/or hypercompetitive business environment?

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The limitations of the five forces model

• The focus is on industry rather than individual
  companies
• Innovation creates change in industry structures,
  altering the competitive environment.
• Industry structure cannot fully explain the
  performance differences between industry
  competitors.
• Academic studies suggest that there can be
  enormous variance in the profit rates of
  individual companies within an industry, with
  industry effects accounting for only 10 to 20
  percent of the variance in company profit rates.
• Although this does not mean that the five forces
  are irrelevant, it does indicate that their
  usefulness is limited. A company will not be
  profitable just because it is based in an
  attractive industry much more is required.

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2.3. The Strategic Groups

1. The concept of Strategic Groups
2. Strategic Groups Mapping Guidelines
3. Some Examples
4. Usefulness of Strategic Groups
5. Implications of Strategic Groups

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a. The concept of Strategic Groups

• Within an industry, a competitor grouping using
  similar strategies that differ from other
  industry groups.
• gt a strategic group is a set of firms within an
  industry pursuing similar strategies
• Requires answering two questions
• What industry (or business) are we in?
• What are the dimensions which are relevant to
  the firms performance within the industry?
  (what is important to the customer?)

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b. Strategic Groups Mapping Guidelines

• STEP 1 Identify the competitive characteristics
  that differentiate firms in the industry
• price/quality (high, medium, low)
• geographic coverage (local, regional, national,
  global)
• degree of vertical integration (none, partial,
  full)
• product line breath (wide, narrow)
• degree of service offered (limited, full
  service)
• STEP 2 Plot firms on a two-variable map using
  pairs of these differentiating characteristics

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b. Strategic Groups Mapping Guidelines
STEP 3 Assign firms that fall in about the same
strategy space to same strategic group STEP 4
(if possible) Draw circles around each group,
making circles proportional to size of groups
respective share of total industry sales
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b. Strategic Groups Mapping Guidelines
- Variables selected as axes should not be highly
correlated - Variables chosen as axes should
expose big differences in how rivals compete -
Variables do not have to be either quantitative
or continuous - Drawing sizes of circles
proportional to combined sales of firms in each
strategic group allows map to reflect relative
sizes of each strategic group - If more than two
good competitive variables can be used, several
maps can be drawn
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c. Some Examples
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Strategic Groups in the U.S. Pharmaceutical
Industry
High
Prices Charged
Low
High
Low
RD Spending
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Strategic Groups in the U.S. Airline Industry
(1996)
High
American United Delta
Quality
USAir
Northwest TWA
Am. West Continental
Low
High
Low
Cost
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Strategic Groups in the Video Game Industry
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d. Usefulness of Strategic Groups
- Preserve info characterizing individual
competitors that may be lost in studies using
averaged and aggregated data - Allow for the
investigation of multiple competitors
concurrently - Allow assessment of the
effectiveness of competitors strategies over a
wider range of variation than a single
organizations experience affords - Provide a
means of summarizing info to bring key dimensions
of strategy in high relief and - Capture the
intuitive notion that within-group rivalry and
between-group rivalry differ.
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e. Implications of strategic groups

• - Mobility barriers inhibit the movement of
  competitors from one strategic group to another
• gt the closest industry competitors are those in
  the group
• - The various industry groups are differentially
  and competitively advantaged and positioned
• gt competitive analysis varies across strategic
  groups
• - Can encounter a semantic problem in defining
  an industry versus a group