Industry Analysis: Understanding the External Forces and Opportunities

1. Chapter 4 External Analysis Objective: analyzing the external factors (industry and environment) to make strategic judgments

2. Why to conduct industry analysis? • In external analysis, the next factor (after customer and competitors) to analyze is the industry/market in which the company operates. For effective strategic planning, it is a must to understand the industry forces affecting the company, and the company’s capabilities to deal with those forces. • Understanding the industry + anticipating its future trends and directions give the company the knowledge it needs to react and control its portion of that industry.

3. The industry analysis helps the company; • to identify threats and opportunities that may influence the company’s abilities to reach its goals. • to focus in on any competitive advantages available. Since both the company and its competitors are in the same industry, the key to success is in finding the different abilities between the company and the competitors in dealing with the industry forces. If the company can identify abilities it has that are superior to competitors, it can use those abilities to establish a competitive advantage.

4. Dimensions of an Industry Analysis Industry analysis often include the following dimensions; • Industry size and growth • Industry forces (profitability) • Industry attractiveness • Industry success factors

5. Industry Size and Growth A basic starting point for the analysis of an industry is the total sales level (size). • What are the important and potentially important submarkets? • What are their size and growth characteristics? • What submarkets are or will soon decline? How fast? • It is also useful to consider the potential market; a new use, new user group, or more frequent usage could change the size of the market.

6. After the size of the market and its important submarkets has been estimated, the focus turns to growth rate. • What will be the market size in the future? Growth often means more sales and profits even without increasing market share. • Identifying the driving forces, forecasting the rate (predicting the market sales), detecting maturity and declines (turning points in market sales and profit) are important considerations about market growth. • Company can detect maturity or decline by checking if; there is price pressure caused by overcapacity, lack of product differentiation, increase in buyer sophistication and knowledge, and substitute products or technology, decline in first-time buyers, no further growth opportunities for users or new users, and reduction in customer interest.

7. Industry Forces • As identified by Michael Porter, a Harvard economist, there are five basic forces at work within any industry which influence profitability. The problem is to estimate how profitable the average firm will be (measured by the long-term return on investment of the average firm). • (1) Ease of entry, (2) Supplier power, (3) Buyer power, (4) Product substitutes, (5) Industry competitors.

8. 1 - Ease of Entry • Ease of entry refers to the relative degree of difficulty for a new firm to enter the industry. This force affects the company because each new entrant means a new competitor. • If it is easy to enter the industry, competitive advantages that the company have today may quickly disappear with each new competitor.

9. However, if ease of entry is difficult, the company benefits because; • The competitive advantages the company may have greater longevity • The company’s set of competitors will remain fairly constant. • Two factors influence ease of entry into an industry. Those are; • Barriers to entry that currently exist • Reaction of existing competitors to each new entrant

10. Barriers to entry What barriers to entry may exist? • Product differentiation: Does a new firm need to offer distinct product advantages in order to capture business? • Capital requirements and existence of high fixed costs: Are large amounts of capital required to set up a business within the industry? • Switching costs for the customer: Will customers incur high expenses in order to switch to a competitor? • Access to distribution channels: Can new competitors access distribution channels easily?

11. Reaction of competition How will the existing companies react to a new layer in the market? There are several factors to look at; • History: How have they reacted in the past? • Strength of existing firms: Do existing firms have substantial resources or large commitments to the industry? • Industry growth rate: Is the industry limited in its ability to accept new firms because of a slow growth rate?

12. 2 - Supplier Power Supplier power (suppliers may influence the relationship that company has with its customers, e.g. dictate the quality company offers, control the price, conditions) exists; • when the industry sells products manufactured by just a few suppliers • when the product they supply is unique or do not have substitutes • when the company is not a significant part of the supplier’s business • When the supplier has intention to move forward on the distribution chain and displace the company.

13. 3 - Buyer Power Buyer power exists when the purchasers (intermediaries) of the company’s product can exert influence on the company e.g. through customers demanding lower prices, demanding higher quality or more services or playing competitors each other. Factors that give purchasers buying power; • Single buyer purchases high volumes of the company’s product • The company’s products are undifferentiated or subject to substitution

14. It is relatively easy and inexpensive for a buyer to switch from the company to a competitor • The company’s product is unimportant to the quality of the buyer’s product. The key in the buyer-power scenario is the needs of the customer. Buyers of the company’s products or the company can gain power in the relationship by influencing the customer’s decision.

15. 4 - Product Substitution • A substitute product is one that can perform the same function as the company’s product. • It becomes a substitute when, in the mind of the customer, it performs the same function at an equal or better price-performance ratio. • The solution is; differentiating the product by understanding the customer.

16. 5 - Industry Competitors • The battle between the company and its competitors is about getting a superior position in the mind of the customer. • The intensity and form (e.g. price war, ad campaigns, expanded service offerings, new or improved product introductions) of this battle affects the company’s ability to win that position and sustain it. • Several industry factors dictate the intensity and form of the battle; (1) the number of competitors, (2) the rate of industry growth, (3) the rate of differentiation.

17. Industry Attractiveness • Industry attractiveness is the presence or absence of threats displayed by each of the industry forces. • The greater a threat posed by an industry force, the less attractive the industry becomes (the industry forces should be rated). • Industry attractiveness should be evaluated at each SBU base. This is important in order to rank each SBU’s importance for the company.

18. Industry Success FactorsBases of Competition • Success factors are indicators of why a company succeeds or fails within an industry. • Identifying success factors is a subjective process since qualified judgments are made based on the collected information. • Some examples for industry success factors; ability to quickly respond to marketplace, good credit arrangements, excellent product quality/performance/reliability, excellent support after sale, knowledgeable personnel, strong financial foundation etc.

19. Risks in High-Growth Markets The conventional wisdom that the growing markets are better, neglects the risks involved in those markets. The following risks are important to consider before the company decides to enter a growing market; • Competitive overcrowding; too many competitors with unrealistic expectations would get attracted. But in reality there may not be sufficient sales volume to support all those firms. • A superior competitive entry; a competitor would enter with a superior product or low-cost advantage.

20. Changing key success factors; key success factors would change and the company cannot adapt. • Changing technology; technology would change. A safe strategy is to wait until it becomes clear which technology will dominate and then attempt to improve it with a compatible entry. • Disappointing market growth; the market growth would fail to meet expectations. • Resource constraints; resources may be inadequate to maintain a high growth rate. • Distribution constraints; adequate distribution may not be available.

21. Environmental Analysis • After the market/industry is analyzed, the focus shifts to the environment surrounding the market. • Why to conduct environmental analysis? The environmental analysis is used to locate current and future trends or events that represent potential opportunities or threats to the business.

22. Opportunities and Threats • The goal of the environmental analysis is to allow the company to locate the opportunities (represent a chance for the company to increase its sales, growth, or competitive position – anything that would have a positive impact on the business) that the company should attempt to take advantage of, and the threats (anything that can cause a decrease in sales, represent an obstacle to success or endanger the company’s survival) that have greatest potential to negatively affect the future of the business and therefore the company should decide to develop strategy to defend against it.

23. Which data to collect? • Since there are millions of changes taking place in the environment, each company must decide which data will have the greatest impact on its success and survival and therefore have significant impact on strategy. • Ideally, the data should represent both current and future (anticipating + forecasting) critical environmental factors; those that will likely impact the company, its customers, and its competitors • The environmental analysis is not complied on an annual basis, it is an ongoing process.

24. Dimensions of Environmental Analysis Environmental analysis is usually divided into the following four areas: • Political • Economic • Social • Technological

25. Political Regulation and Actions • The introduction or removal of legislative or regulatory constraints can represent major strategic threats and opportunities. E.g. the ban of some ingredients in food products or cosmetics. • One research indicated that governmental issues tend to follow an eight-year cycle. For the first five years, the issues carry less importance but can be detected in the press and in some polls. In the fifth or six year, the national press becomes interested and finally, government action results. Of course, the earlier a company becomes involved, the better.

26. Economic Conditions • Some strategies will be affected by judgments made about the economy, particularly inflation and general economic health as measured by unemployment and economic growth. E.g. heavy investment in a capital-intensive industry needs to be matched with a strong economy to avoid a possibly damaging period of losses. • Usually it is better to look beyond the general economy and consider the health of the specific industry. • Multinational companies must forecast the relative valuation of currencies. Thus, an analysis of balance of payments and other factors affecting currency valuations might be needed.

27. Social Trends • Shifts in the makeup of the population have great effect on the companies. • Social, cultural and demographic (age, income, education, geographic location) trends can represent both threats and opportunities for a wide variety of companies. E.g. the change in women’s life styles influences dress designer’s product lines and pricing strategies. E.g. the rise in the ageing population influences the type of food offered in the restaurants.

28. Technology • Technological trends or technological events occurring outside the market/industry have potential to impact strategies. • Impact of new technologies; introduction of a new technology does not always mean that businesses with prior technology will suddenly become unhealthy. Generally, the sales of the old technology continues for some time, since (1) companies continue to improve it and (2) it is difficult to predict the outcome of the new technology.

29. The technology life cycle; many technologies have life-cycles. E.g. computer printer industry. The key to manage the transition from one technology to another is to detect when the original technology is in the decline phase (indicators; (1) if performance levels are approaching physical barriers, (2) R&D efforts are becoming less effective, (3) small competitors are experiencing with alternative technologies). • Forecasting new technologies; studies indicate that reviewing articles, magazines etc help in forecasting technological trends and events.

30. Forecasting Environmental Trends and Events • Expert opinions often are helpful in environmental forecasting. • Another method of forecasting is trend extrapolation. However, departures from an extrapolated trend carry more interest. • It is important to consider the cross-impact of one environmental development on others. In cross-impact analysis, the impact of one event on the probability of another is determined.

31. Scenario Analysis • Forecasting the individual events and trends would be too simplistic in a complex environment where some key area of uncertainty and complexity may not be resolved. • Scenario analysis is one way to deal with both complexity and uncertainty in the environment.

32. How to conduct scenario analysis? Scenario analysis involves; • the development (identification) of a set of total scenarios of what the future environment will contain (based on optimistic, pessimistic, and most likely scenarios). • relating those identified scenarios to strategies (strategy development). Major purpose here is to create new strategic options. • evaluating alternative scenarios by determining the scenario probabilities (asking experts). • comparing the expected outcomes of each strategy if the wrong scenario emerges (regret analysis)

33. Impact Analysis • Throughout the entire external analysis, the problem of information overload occurs. • So, it is crucial to determine not only which information is needed, but also which information has priority. • For this purpose, the creation of an “impact matrix” which identify and evaluate the various information need areas and also quantify their impact on each SBU, can be useful.

34. “Impact Matrix”Impact of an information-need area • On the matrix, the vertical axis lists potential information needs areas, areas in which information could be gathered and organized. They can be drawn not only from an environmental analysis, but also from analyses of the customer, competitor and market. • The horizontal axis represents the present SBUs, may also include proposed and potential SBUs. • The entries in the matrix represent the relative impact that trends or events associated with information-need areas will have on the SBUs. The impact can be positive or negative (as the scale on the bottom of the example show).

35. The listing and assessing the impact of information need areas on SBUs can help (1) identify and (2) prioritize the information need areas for each SBU. The areas with greatest impact are those with the highest scale values. • The column at the right (which adds the positive and negative entries for each row) provides a summary measure of the impact associated with an information-need area. • On the other hand, the vertical column totals at the lower section indicate the SBUs sensitivity to trends and events in the environment. The relative importance of each SBU is also shown.

36. “Immediacy/Impact Matrix”Immediacy of an information-need area • When the information-need areas have high impact but such a low probability of occurrence, then it is not worth gathering and analyzing that information. • Similarly, when occurrence is far in the future, then it may also be of little concern. • The following matrix is helpful in identifying “how much” information will be sufficient, after an information need is crystallized.

37. Monitor and In-depth analysis; analysis, strategy contingent development strategies considered Monitor Monitor and analysis High “Impact” Low Low High “Immediacy”

38. If both the immediacy and impact are low, then a low level of monitoring may be sufficient. • If the impact is thought to be low but the immediacy is high, the area deserves monitoring and analysis. • If the immediacy is low and the impact is high, then the area may require monitoring and analysis in more depth, and contingent strategies may be considered but not necessarily developed and implemented. • If both the immediacy and potential impact of the underlying trends and events are high, then an in-depth analysis will be appropriate, as will be the development of reaction plans or strategies.