Stanford GSB
Sloan Program
Stramgt 258
Strategic Management
7: Introduction to Industry Analysis
Airborne Express
Accounting for Performance
Overall Performance = Industry Effect
+
Business Unit Effect
+
Corporate Effect
January 28, 2003
John Roberts
2
Industry Analysis Objectives
• Understand industry’s role in (potential and
actual) performance.
– Hard to do really well in a bad industry
• Identify environmental factors to be
addressed in setting strategy, building
competitive advantage
– Leverage and overcome
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Four Questions
• If a firm were a monopolist, how profitable would
it be? (How big is PIE?)
• If potential profits are high, can they be retained?
(Are buyers or suppliers powerful?)
• If potential profits are realized, can they be
sustained? (Are there entry barriers?)
• Now what if the firm is not a monopolist? (Does
competition erode profits?)
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Potential Industry Earnings
• Increase in price of substitutes (complements):
– Shifts demand curve out (in)
• Substitutes also constrain firms’ ability to set price:
– With close substitutes even a monopolist in the industry
will not enjoy high margins
• Growth in demand increases P.I.E.:
– Income growth
– Changes in consumer preferences
January 28, 2003
John Roberts
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Buyer Power
Buyer Impact
On Industry =
Profitability
Questions
Issues/Hints
January 28, 2003
Buyer
Negotiating *
Advantage

How easily can
buyer vs. individual
firm in focal industry
be replaced?
Buyer
Stake in
Transaction
*

What percentage of
buyer’s costs are
comprised of
purchases from focal
industry?
Concentration ratios Determines buyer’s
Ability to coordinate incentive to use
Backward
power
integration.
John Roberts
Focal Industry
Stake in
Transaction

What percentage of
focal industry’s sales
are to buyer
segment?
Given buyer has
power and incentive
to use it, determines
impact on industry
6
Example: Impact of Passenger
Airlines as Buyer Varies
Airline Buyer’s
Buyer
Buyer
Impact On Industry = Negotiating * Stake in
*
Profitability
Advantage
Transaction
Focal Industry

Focal Industry
Stake in
Transaction



Caterers
High
High
Med
High
Aircraft
Med/High
Low/Med
High
High
Ticket Jackets
Low/Med
High
Low
High
Low
High
Med
Low
Uniforms
January 28, 2003
John Roberts
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Supplier Power
Supplier Impact
On Industry
=
Profitability
Questions
Issues/Hints
January 28, 2003
Supplier
Negotiating *
Advantage
Supplier
Stake in
Transaction
*
Focal Industry
Stake in
Transaction


How easily can
What percentage of
supplier vs. indiv.
suppliers’s sales are
firm in focal industry to focal industry?
be replaced?

What percentage of
focal industry’s costs
are purchases from
supplier?
Concentration ratios Determines
Ability to coordinate supplier’s incentive
Forward integr.
to use power
Given supplier has
power and incentive
to use it, determines
impact on industry
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Switching Costs & Power
• Switching costs for focal industry firm
magnify the effect of buyer/supplier power:
–
–
–
–
Location specificity
Relationship-specific investments
Linkages between systems (formal or informal)
Reputation
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Potential Entrants
• Barrier: Anything that makes an industry less
attractive to an entrant than an existing firm.
• Examples:
–
–
–
–
Reputation/brand
Learning curve (steepness matters)
Switching costs
Access to distribution channels
• Judge height of barrier relative to most likely
entrant
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Potential Entrants
• Capital investment barrier to entry only if
both:
– MES is large relative to demand
– Investment is sunk (exit costs)
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Example Scale Effects
Industry
7
Paints
Petroleum Refining
Integrated Steel
Works
Storage Batteries
10
10
11
14
Glass Bottles
41
Cement
January 28, 2003
MES Plant Share
per Market
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Rivalry
• Even with high barriers to entry and no
buyer/supplier power firms might compete away
profits:
– Structure (composition of firms)
– Conduct (firm behavior)
• Structure:
– Higher concentration makes (tacit or explicit)
coordination easier
– But not sufficient
January 28, 2003
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Rivalry
• Conduct:
– Even two firms can compete away profits
– Highly differentiated products diminish rivalry
– Coordinated pricing (helped by visibility of
prices)
– Effect of excess capacity (scale penalty)
January 28, 2003
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