The Industry Environment

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Understand the significance of the global industry environment for the strategies of multinational firms;

Apply market segmentation analysis; strategic group analysis; and the five force model;

Understand the importance of industry evolution and the international product life cycle

Appreciate differences between forecasting techniques for understanding the future of an industry

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Industry environment plays a critical role in firm’s development.

The key elements of industry environments are: customer, competition and suppliers

It is vital for organizations to identify their own industry precisely, in order to have a perfect understanding of the market and the nature of competition.

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Key Questions Thinking strategically about a company’s industry and

competitive environment requires answering the following questions:

1. What are the industry’s dominant economic features?2. What kinds of competitive forces are industry members facing

and how strong is each force?- Five Forces Model3. What forces are driving industry changes and what impacts

they will have on competitive intensity and industry profitability?

4. What industry position do industry rivals occupy?5. What strategic moves are rivals likely to make next?6. What are the key factors for future competitive success?7. Does the outlook for the industry present the company with

sufficiently attractive prospects for profitability?

“The essence of formulating competitive strategy is relating a company to its environment. Although the relevant environment is very broad, encompassing social as well as economic forces, the key aspect of the firm’s environment is the industry or industries in which it competes” (Porter, 1980: 3).

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An industry is “the group of firms producing products that are close substitutes for each other” (Porter, 1980: 5).

E.g.: Mercedes and Toyota are both in the car industry, but an increase in the price of Mercedes Benz does not necessary mean more sales of the Toyota Corolla.

* Customer * Nature of advertising* Product Development * Pricing policies

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Market size and growth rate Number of rivals Scope of competitive rivalry Buyer needs and requirements Degree of product differentiation Product innovation Supply/demand conditions Pace of technological change Vertical integration Economies of scale Learning and experience curve effects

What are the Industry’sDominant Economic Traits?

“the subdividing of a market into distinct subsets of customers” (Kotler, 1976: 144).

“a group of customers who have similar needs that are different from customer needs in other parts of the market” (Johnson et al., 2008: 77)

E.g.: personal care products could be divided according to customer needs: oral care, grooming, infant hygiene, feminine hygiene- all of these would present separate markets for companies

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“A strategic group is the group of firms in an industry following the same or a similar strategy along the strategic dimensions” (Porter, 1980: 129)

This analysis helps to identify: Key competitors Nature of competition Profitability within an industry Future strategic plan

Mobility barrier: barriers which prevent other firms entering the strategic group and threatening the existing members.

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Strategic Group Map The procedures for constructing a strategic group

map:◦ Identify the competitive characteristics that differentiate

firms in the industry. Typical variables are price/quality range (high/medium/low); geographic coverage (local, regional, national, global); degree of vertical integration (none, ptial, full); product line breadth ( wide, narrow); use of distribution channels (one, some, all); and degree of service offered ( no-frills, limited, full).

◦ Plot the firms on a two variable map using pair of these differentiating characteristics

Fundamental determinants of firms profitability is industry attractiveness.

Michael Porter provided a framework that models an industry as being influenced by five forces.

The strategic business manager seeking to develop an edge over rival firms can use this model to better understand the industry context in which the firm operates.

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Five Forces Analysis

The five force are analysis for a specific market segment or similar market segment not for an entire industry.

the strength of the five forces varies from industry to industry and can change as the industry evolves.

Five forces enable managers to understand the rules of competition in their industry so that they become aware both of industry attractiveness and of their firm's own competitive position within the industry

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The nature of competition in an industry is the combined out-come of competitive pressures generated by:

the moves of rivals battling for market sharethe entry of new rivals seeking market sharethe efforts of firms outside the industry to convince buyers to switch to their substitute productsthe push by suppliers to charge more for their inputsthe push by buyers to pay less for products

Markets are not perfectly competitive; some firms consistently outperform industry averages.

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The way one uses the five forces model to determine the nature and strength of competitive pressures in a given industry is to build the picture of competition in three steps:◦ Step 1: Identify the specific competitive pressures

associated with each of the five forces ◦ Step 2: Evaluate how strong the pressures comprising each

of the five forces are ( fierce, strong, medium, weak) ◦ Step 3: Determine whether the collective strength of the

five competitive forces is conductive to earning attractive profits.

The five-forces model defines the structure and competition in an industry in a way that reveals:what forces are driving changes within an industrythe relative strength of each fundamental forcewhich fundamental forces shape strategic conductthe strategic moves rivals are likely to make

Common to each issue is the question of whether the current or future outlook suggests that firms in the industry

have no, some, or great potential to realize profits.

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Barriers to entry: Obstacles which potential newcomers would

encounter when entering the market. Capital requirements Economies of scale Product differentiation Access to distribution channel Government policy Expected retaliation

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Bargaining power of Buyers and Suppliers: Buyer / Supplier concentration Buyer switching costs Product differentiation Price/total purchases Threat of vertical integration Buyer information Impact of quality/performance International expansion

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Threat of Substitutes A substitute product is a good or service which is

regarded by buyers as interchangeable

The extent to which substitutes can reduce profitability in an industry depends on three factors

Relative price performance of a substitute Switching cost for the buyer Propensity to substitute

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Competitive Rivalry: Rivalry between firms encourages innovation but

it also has the effect of depressing firm profitability.

Concentration Product differentiation & switching cost Industry growth Exit barriers Excess capacity

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The model cannot be used for analyzing the position of charitable organizations or government bodies.

Static vs. dynamic competition: era of hyper competition.Hyper competitive behavior-the process of continuously generating

new competitive advantages and destroying, obsolete and neutralizing the opponent’s competitive advantage, so firms need to go for continuous renovation and improvement.

Industry profitability: small proportions of firms profitability could be ascribed to the industry in which the firm operated

The model disregards the importance of HRM

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When industry structure changes slowly, the industry’s influence on the firm’s profitability only changes very slowly.

Brian(1996)has argued that firms usually have the ability to influence industrial structure in the early stages. But once are specific products, process or technology wins over the alternatives, the development of the industry becomes locked into a specific path of development and firms can do a little to change the five forces. E.g.-Microsoft

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Class Assignment As the owner of a fast-food company seeking a loan

from a bank to finance the construction and operation of a new store locations, you have been asked to provide the loan officer with a brief analysis of the competitive environment in fast food. Draw a five-forces diagram for the fast-food industry, and briefly discuss the nature and strength of each of the five competitive forces in fast food.

the concept of the ‘Product Life Cycle’ is useful in understanding the course of industry evolution

Raymond Vernon (1966) suggested the(1966) suggested the concept of the ‘Product Life Cycle’ that every basic product evolves through a cycle of roughly four stages-introduction, growth, maturity and decline-which correspond to the rate of growth of industry sales.

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His IPLC described an internationalization process wherein a local manufacturer in an advanced country (Vernon regarded the United States of America as the principle source of inventions) begins selling a new, technologically advanced product to high-income consumers in its home market.

Production capabilities build locally to stay in close contact with its clientele and to minimize risk and uncertainty.

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As demand from consumers in other markets rises, production increasingly shifts abroad enabling the firm to maximize economies of scale and to bypass trade barriers.

As the product matures and becomes more of a commodity, the number of competitors increases. In the end, the innovator from the advanced nation becomes challenged in its own home market making the advanced nation a net importer of the product. This product is produced either by competitors in lesser developed countries or, if the innovator has developed into a multinational manufacturer, by its foreign based production facilities.

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The concept of ‘The International Product Life Cycle’ suggests that many products go through an international life cycle, during which a developed country is initially an exporter(when innovation is central to product success),then loses its export markets, and finally could become an importer of the product from developing countries (when production costs become central to product success).

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Stage 1InnovationInnovative firms create new products andprocesses in their country of origin

Stage 2ProductionSecond-tear country subsidiaries receive products/processesfrom innovators and produce for local markets

Stage 3TransferDeveloping countrysubsidiaries receive products/processes from innovators andproduce for local marketsand global markets at low costs

Innovative countryProduct life cycle

Second tier Country Product life cycle

Developing countryProduct life cycle

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Phase 1: Introduction in the Home Market: The IPLC begins when a company in a developed country

wants to exploit a technological breakthrough by launching a new, innovative product on its home market.

Such a market is more likely to start in a developed nation because more high-income consumers are able to buy and are willing to experiment with new, expensive products.

Furthermore, easier access to capital markets exists to fund new product development. Production is also more likely to start locally in order to minimize risk and uncertainty

Characteristics: slow sales growth and nonexistent profit

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Phase 1: Introduction in the Home Market:The market for the product widens and demand develops in other high income countries.Other advanced nations have consumers with similar desires and incomes making exporting the easiest first step in an internationalization effort.Export allows the innovator to increase revenue and to increase the downward descent of the product’s experience curve.

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Phase 2: Export to Developed Country:The production of the product becomes fairly standard , and the widening of the market makes economies of scale possibleCompetition comes from a few local or domestic players that produce their own unique product variations. Exports to markets in advanced countries further increase through time making it economically possible and sometimes politically necessary to start local production.

Characteristics: price decrease

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Phase 3: Export by Developed Countries to Developing Countries:

The low price attract more customers from developing nations.

Export orders will begin to come from countries with lower incomes

As the demand for product increase in developing countries developed countries will start to export and even produce the product in developing countries.

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Phase 4: Export by Developed Countries to Home Country:

The increasing international distribution of product, standardized product and its relatively lower cost of production, will result in developed countries exporting back to the countries where the product was originally introduced.

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Phase 5: Export by Developing Countries to Developed Countries:

During this phase, the principal markets become saturated. To counter price competition and trade barriers or simply to

meet local demand, production facilities will relocate to countries with lower incomes. As previously in advanced nations, local competitors will get access to first hand information and they will start to copy and sell the product.

Finally the country in which the product was first introduced and produce becomes the importer of the product.

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In spite of its simplicity and appeal, theory failed to explain the globalisation of innovation that took place after 1960s. Income differences between advanced nations had dropped significantly, competitors were able to imitate product at much higher speeds than previously envisioned and MNCs had built up an existing global network of production facilities that enabled them to launch products in multiple markets simultaneously.

Today a large variety of products are developed globally for world markets and launched at almost the same time in the key countries of America, Asia and Europe.

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The model stated that the stages are separate and sequential in order.

The model assumed integrated firms that begin producing in one nation, followed by exporting and then building facilities abroad. The trade-off between export or foreign direct investments was too simplistic: more entry modes exist.

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Shifts in production site do not change for many types of products

products with very short life cycles luxury products for which cost is not a concern

for the consumer products used to promote differentiation strategy products requiring specialized technical labor to

evolve

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Thus industry environment plays a crucial role in developing firms strategy.

The steps to analyze industry environment: identify firm’s industry and precise market to identify precise market firms can conduct a market

segmentation and strategic group analysis More comprehensive understanding can be gained

through performing five force analysis. The five forces and market condition changes over time as

a result of industry evolution and IPLC model helps to understand the process.

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