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.
 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:
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
 How profitable would a monopolist be?
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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
 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:
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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
 Technical: What is the structure of exchange
between producers and buyers?
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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?
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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
 Anything that makes an industry less attractive to
an entrant than to an existing firm
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Technical: Are there economies of scale?
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Technical: Are there experience economies?
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What is MES relative to the size of the market?
Are there firm-level economies of scale?
Are scope economies available?
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.)
 We want to know about the switching costs of
suppliers and customers:
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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:
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How significant are barriers to exit?
What reputations for rivalry have incumbents cultivated?
Competition
 Does industry structure allows price coordination
(on technical and normative grounds)?
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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)
The Basic Situation:
Exchange Partners with Alternatives
?
Sellers
?
Buyers
Supply
Industry 1
The Value Chain
Industry
Supply
Industry 2
Buyers
Entrants and Substitutes: ‘Five Forces’
Supply
Industry 1
Producers of
Substitutes
Industry
Supply
Industry 2
Potential Entrants
Buyers
Other Users
The Essence of Industry Analysis
Other Products/
Potential Complements
Producers of
Substitutes
Supply
Industry 1
Supply
Industry 2
Industry
Other Users
Potential Entrants
Buyers
End-User
Other Users
The Essence of Competitive Advantage
Other Products/
Potential Complements
Producers of
Substitutes
Supply
Industry 1
Supply
Industry 2
Firm
Buyers
Competitors
Other Users
End-User
Framework for Strategic
Analysis
Industry
Evolution
Industry
Structure
Organizational
Performance
Organizational
Evolution
Organizational
Strategy
Strategy Definition and
Identification
What is Strategy?
 Traditional view: Business strategy is the logic that gives
direction to the activities of the organization.
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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.
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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?
 The emergent-strategy view: “I'll know what I am when
I see what I do.”
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Honda motor company in the U.S.
Generally, where markets and technologies are uncertain.
 From this view, the strategic manager is a sense-maker.
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Retrospective rationalization of the organization’s actions.
 Strategy exists de facto, whether or not recognized.
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“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 guides the organization’s evolution.
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Opportunities and threats emerge from experience.
Strategic managers discover these and shape the response.
 Three stages of the strategy process:
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1. Strategy Identification
2. Strategy Evaluation
3. Strategic Adaptation
 Strategic management is involved throughout.
Strategy Identification
 The strategic manager has a broad view.
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Not confined to any one functional area.
 Identify business strategy by discovering:
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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
 Evaluate strategy based on current consistency:
 1. Internal consistency of organization.
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Is the whole more than the sum of its parts?
 2. Consistency with capabilities.
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Does it match the firm’s capabilities?
 3. Environmental consistency.
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Does it fit the competitive environment?
 Explicit current-time evaluation allows:
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Coordination and incentive alignment
Increased efficiencies
Strategy Adaptation
 Evaluate strategy based on future trajectory:
 1. Internal direction of organization.
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Are changes adding value?
 2. Change in capabilities.
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Is strategy developing the right capabilities?
 3. External direction of organization.
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Are changes improving fit with the competitive environment?
 Explicit adaptive evaluation allows:
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Benchmarking to guide organizational learning.
Drive, rather than react to, technology and market change.
Framework for Strategic
Analysis
Industry
Evolution
Industry
Structure
Organizational
Performance
Organizational
Evolution
Organizational
Strategy
Competitive Advantage
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.
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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
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Products or technologies are consequences, not causes.
The Problem of Uniqueness
 The most valuable capabilities are unique.
 Such capabilities are inherently less understandable.
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Tacit
Ambiguous to rivals, analysts, and managers
 Unique capabilities emerge over time.
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“Know what you are when you see what you do”
 The result of organizational evolution.
 How to manage?
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Manage the development process, not its consequence.
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
 Fact: Managers apply known solutions when
problems arise.
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Consequence: The “competency trap.”
 New rivals may offer challenges that your
organization did not coevolve to deal with.
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Consequence: “Blindspots” among established
firms.
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.
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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
 Strategic position is difficult to develop.
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Market position is costly
Social position is elusive
Others resist you at all costs
 Capability may generate strategic position.
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Position typically is gained by adding value
Use today’s capabilities as leverage
 Affiliation may generate social position.
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Deference is the flow, status is the stock
When Position is Harmful
 Compensatory fitness.
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Position as a shield against capability-creating
competition
 The leverage curse.
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An advantaged position may open doors too readily
 Through these mechanisms, position can damage
capability generation over time.
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Through organizational design, strategic management
can affect these harmful processes
Framework for Strategic
Analysis
Industry
Evolution
Industry
Structure
Organizational
Performance
Organizational
Evolution
Organizational
Strategy
Role of Organization in
Competitive Advantage:
Exploration
Organizational Evolution: VSR
Framework
Variation
Generate diversity
of solutions looking
for problems
Selection
Membrane between two
processes that determines
which solutions / capabilities
to retain and scale-up
Retention
Efficiently apply known
solutions to existing &
new problems
Premises:
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Development of capabilities through trial & error learning
Variation / retention processes - independent & somewhat
incompatible
Both Explorer and Exploiter Engage in VSR
Variation
Selection
Retention
Explorer
Exploiter
R&D
Control System for
Resource Allocation
Operations
(Mfg / Mktg / Sales)
Explorer
Driven by external
& internal
Filter conserves on
scarce retention
resources
Time to market
Feed relevant variation
Exploiter
Driven by external
Filter conserves on
scarce variation
resources
Efficiency
Feed relevant variation
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
 Know what you have to exploit and transfer
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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
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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
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”
 PARC objectives
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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
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Connect parts of the technology tree
Bring in new market problems looking for solutions
Develop tools for reinvention – Learning how to learn
Which is Optimal?
Exploit vs. Explore
Performance
(Profit)
Explore
Exploit
t
Time
Scenarios
A. Incremental environmental change
B.
A1. Time < t
Exploit wins
A2. Time > t
Explore 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
Performance
(Profit)
Explore
Exploit
t
Obtain temporal advantage from creation of
new market
Time
Why Exploration is Hard for Firms
 Given with exploration:
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Slack – i.e. suboptimal, short-term performance
Greater variance in performance
 Runs counter to preference for short-term
reliability
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Financial markets
Manager’s tools and cognition oriented towards shortterm
 Second-order learning is difficult
Big verses Small Firms as Explorers
 Big Firms
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Potential upsides
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Variation aided by “stew” of capabilities
Can be better at selection than market if has special
knowledge
Potential downsides
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Past successes lead to competency trap
Bureaucracy smothers the innovator
 Small Firms
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Upside – not have downsides of bigness
Downside – Your small firm may not benefit
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Variation occurs across population of firms
Selection on organizations
Options for Hybrid Exploiters / Explorers
 Create separate business units with variation in
practices
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Represent a set of simultaneous experiments
Each unit exploits
Across the portfolio of units we would have
corporate exploration
 Outsource approach
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Exploiter outsources exploration
Explorer outsources exploitation
Positional advantage enhances the viability of this
approach
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
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Over time
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Over different parts of the organization
 Cost of suboptimal design vs. cost of change
Framework for Strategic Analysis
Industry
Evolution
Organizational
Evolution
Industry
Structure
Organizational
Performance
Organizational
Strategy
Organizational Evolution: VSR Framework
Variation
Generate diversity
of solutions looking
for problems
Selection
Membrane between two
processes that determines
which solutions / capabilities
to retain and scale-up
Retention
Efficiently apply known
solutions to existing &
new problems
Resource Partitioning and “Niche”
Strategies
Industrial Heterogeneity
 Tremendous differences exist within
industries among parts of the market
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Geography
Taste characteristics
 Differences also exist among organizations
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Degree of integration (vertical and horizontal)
Forms of organization
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Capability and position differences result
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
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“Good” strategies often face the strongest rivalry
The consequences of strategic change often hinges on
this distinction
Analyzing niches
 Step one: Dimensionalizing the landscape
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The more dimensions, the greater the opportunities for
successful differentiation
Some dimensions can be shaped by the firm
 Step two: Identify mobility barriers
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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
 Fact: As they develop, industries often are
populated by various, somewhat
differentiated generalists.
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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
 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
 With the periphery now open, specialist firms
proliferate into the market.
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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
 Once populated by specialists, niches take on
growth dynamics of their own.
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Increasing numbers of specialists legitimate the
niche.
“Oppositional” strategies often mark the
specialists, helping to erect social barriers and
reinforce the niche
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Example: “Sustainable ecotourism”
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
Strategic Markets Defined
 Monopoly
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“We control our own destiny.”
 Perfectly competitive
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“We are price takers in world where
only price matters.”
 Strategic markets
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“What we gain is based on what you do,
which is based on what we did.”
Conditions that Give Rise to
Strategic Markets
 Concentrated industries with a few key
players
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I can see them.
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I can see the impact of their actions on me.
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Opportunity to cooperate / retaliate
Select Manufacturing Concentration Ratios
Market share held
by Top 4 Firms
(1987)
Motor vehicles
Breakfast cereals
Household refrigerators
Steel
Audio / Video equipment
Publishing
Kitchen cabinets
90%
87%
85%
44%
39%
24%
16%
Conditions that Give Rise to
Strategic
Markets
 Concentrated industries with a few key
players
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I can see them.
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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
Force others
Behavior
to exit
++
Erode
Margins
Strategic
Behavior
+
Incumbents
split PIE
_
Non-cooperative
Cooperative
Easy to supply market demand
Hard to supply market demand
Price follows capacity decision
(apples example)
Price / quantity simultaneously
determined (fish example)
Benefits of stealing share >>
cost
Win through truce
Win war of attrition through cost
advantage
Differentiated products
Price coordination

Aides to Cooperation
 Dimensions for non-price based competition
 Tie your own hands by making cheating costly
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Most favorite customer clause
Establish reputation for cooperation
 Signal willingness to retaliate - “Meet or beat price
guarantee”
 Borrow enforcement power from adjacent periods / regio
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Repeat interaction with no foreseen end period
Multi-market contact
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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
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
 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
Framework for Strategic Analysis
Industry
Evolution
Organizational
Evolution
Industry
Structure
Organizational
Performance
Organizational
Strategy