Ch2: External Environmental Analysis

1. Ch2: External Environmental Analysis Junichi Yamanoi Special Lecture (Strategy, Policy, and Planning) 4/26/12

2. Which companies are more profitable? • Let’s check Fortune 500. (Go to Google, enter “Fortune 500” and click the second link from the top, “Fortune 500 2010.”). • Which companies earn higher profits? • Are there any commonalities among profitable companies?

3. What is an “Industry”? • A group of firms producing products/services that are close substitutes. • Eg. Automobile industry. -What companies are in? • Eg. -In which industry? Pharmaceuticals. -Other companies in the same industry?

4. Why do Industries Matter to Firm Performance? • The S-C-P model. -Industry structure (e.g., # of firms, sales concentration…) -Firm conduct (e.g., Price cut, product development, advertising…). -Firm performance (e.g., ROIC, ROE, ROA, ROS…). • Five (competitive) forces in an industry represent its industry structure, determining then profitability of the industry -Industry attractiveness.

5. Five Forces surrounding Industries 4. New entrants’ threat • Introduced by Michael Porter (1980). 1. Rivalry among existing firms Industry where a focal firm operates. 2. Buyers’ bargaining power 3. Suppliers’ bargaining power 5. Substitute product/service threat

6. 1.Rivalry among existing competitors • Rivalry is determined based on intensity and basis. • Intensity is high when… -many similar competitors in size and power exist, -industry growth is slow, -exit barriers are high, -competitors are committed to the industry, or -competitors cannot understand others’ signals in competition. • If firms compete on the same dimension (such as price, product quality etc.), rivalry is strong.

7. 2.Buyers’ Bargaining Power • When buyers’ have higher bargaining power, they can request lower prices of their goods and services from the companies in an industry. • Buyers’ bargaining power is high when… -buyers purchase a large portion of the industry’s total output, -few buyers exist, -products/services are standardized, or -buyers are highly motivated to integrate backward in the industry.

8. 3.Suppliers’ Bargaining Power • When suppliers’ have higher bargaining power, they can set higher prices of their goods and services. • Suppliers’ bargaining power is high when… -the sales of the suppliers’ industry are concentrated, -the suppliers do not heavily depend on the industry, -the firms in the industry bear switching costs, -suppliers’ products are differentiated, -no substitution exists, or -suppliers are highly motivated to integrate forward in the industry.

9. 4.New entrants’ threat • New entrants bring additional production capacity into an industry. • New entrants’ threat is high when… - the entry barrier to the industry is low, or - the expected retaliation for the market entry is not intense. • Entry barriers are high when there are… -Supply-side economies of scale. -Demand-side benefits of scale. -Customer switching costs. -Capital requirements for operation. -Incumbency advantages independent of size. -Unequal access to distribution channels. -Restrictive government policy.

10. 5.Substitution threat • If a substitute similar to a product exists, customers of the product can switch to the substitute. The companies producing the product have to lower its prices to compete with the substitute. • The threat of a substitute is high when… -the substitute has higher relative value to the product/service (in terms of price and/or quality). -buyers’ switching costs are low.

11. Group work • Let’s draw a five forces model of the Japanese commercial airline industry! 1.Please analyze ONE force in detail. 2.Is the force of the Japanesecommercial airline industry high/low? Why? 3.Name different industries facing the high/low level of the same force.

12. General Environment Political-legal trends Threat of New Entrants Economic trends Industry Firm Supplier Power Competitive Rivalry Buyer Power Firm Firm Global trends Threat of Substitution Technological trends Demographic trends Physical environment trends Socio-cultural trends

13. What is a general (or macro) environment? • An environment composed of dimensions in the broader society that influence the industry and the firms within it. • 7 segments of macro-environment: -Demographic: Population size, age, geographic distribution…. -Economic: Nature and direction of economy. -Socio-cultural: Society’s attitudes and cultural values. -Physical environment: Concerns about environment and related restrictions. -Technological: Knowledge related to new outputs, products, processes, and materials. -Political/legal: Laws, regulations, and governments. -Global: Global political events, the growth of newly industrialized countries, different cultural and institutional attributes ….

14. Why is a general environment important for companies? • Once the macro-environment changes, the influences of five forces of an industry would change, too. e.g., The Development of the Internet. -Entry barriers got lower for the retail business. Physical stores are not necessary to run the retail business. • Firms have to meet the challenge of environmental changes. -How? e.g., by changing a competitive position. by exiting from the industry and entering a profitable industry.

15. Example: Fujifilm • A Japanese company of photographic films and cameras. • After the spread of digital cameras, the photographic film business became less lucrative in the 2000s. • The company shrank the photographic film business and shifted to films for liquid crystal display and medical equipment markets. • Also, the company increased its equity of Fuji Xerox and initiated the cosmetic business. Reference: http://fujifilm.jp

16. Example: Toyota • The market share of the Japanese automakers was small in the U.S. before 1973 (lower than 9%; 41.2% in 2005). -Japanese cars were much smaller than American cars. • However, after the oil shocks in the 1970s, the gasoline price in the US boosted up ($1.32 per gallon in 1978$1.79 in 1982). • Customers preferred Japanese cars that were more fuel-efficient than American cars (The market share of Japanese cars was 22.8% in 1982). • When Toyota launched the project of developing “the car for the 21st century” in 1993, the keywords are “resources” and “environment.” Toyota introduced the hybrid car in 1997, Prius. Reference: Reinhardt, R. L. et al., 2005. Toyota motor corporation; Launching prius. Harvard Business School.

17. Example: Fidec • Fidec is a Japanese financial institution starting a new financial service. -The company buys trade accounts receivable from small firms and then receives cash trade from large established firms that have trade accounts payable to the small firms. -Fidec also engages in managing trades of large firms by forming outsourcing contracts. • However, the company went almost bankrupt. • Why? -because of financial crisis, large established firms went bankrupt!

18. Group work • Let’s analyze the general environmental trends surrounding Japanese commercial airline industry. • Choose ONE segment of a general environment and consider its trend. • Does the trend of the segment have a major/minor impact on the industry and its five forces? Why?

19. Demographic segment • Population size. • Age structure. • Geographic distribution. • Ethnic mix. • Income distribution.

20. Economic segment • Inflation rates. • Interest rates. • Trade deficits or surpluses. • Budget deficits or surpluses. • Personal savings rates. • Business savings rates. • Gross domestic product.

21. Socio-cultural segment • Workforce diversity. • Attitudes about quality of work and life. • Shifts in work and career preferences. • Shifts in product and service preferences.

22. Physical environment segment • Concerns about environment. -Customer demands for eco-friendly production and products. -Environmental organizations’ protests. • Access to resources on a global basis. • Global warming.

23. Technological segment • Product innovations. • New applications of knowledge. • Focus of private and government-supported R&D expenditures. • New communication technologies.

24. Political/legal segment • Antitrust laws. • Taxation laws. • Deregulation philosophies. • Labor training laws. • Educational philosophies and policies.

25. Global segment • Important political events. • Critical moves in the global markets. • Growth of newly industrialized countries. • Different cultural and institutional attributes.

26. Conclusion • Industry profitability is (somewhat) determined by five competitive forces of the industry. • General environment trends are closely related to the five forces of an industry. • Changing a strategic position is a means of meeting the trends.

27. Sample questions for writing assignments • Choose a firm and define its industry. Then, analyze the five forces of the industry. Is the industry attractive? Is each force strong/weak? Why or why not? • Choose two industries and compare their profitability. Which industry is more attractive for firms? Why is the industry more attractive? Please explain based on the five forces model. • Choose an industry. What are the most/least influential environmental trends? How did the firms in the industry deal with the influential environmental treads?