Everything you need to know about Industry Analysis! Also learn about:- 1. Introduction to Industry Analysis 2. Components of Industry Environment 3. Competitive Forces Model 4. Strategic Group Analysis 5. Competitive Intelligence 6. Hyper Competition 7. Formulation of Strategy 8. Limitations of Five Forces and Strategic Group Analysis.
Further this article will help you to learn about:-
- What is Industry Analysis and Why is it Important?
- Industry Analysis Example
- Components of Industry Analysis
- External Environment Analysis
What is Industry Analysis and Why is it Important: Introduction, Importance, Components, Forces, Purpose and Example
Industry Analysis – What is Industry Analysis and Why is it Important? (Introduction)
Some companies do well partly because their relevant external environment is extremely favorable; others do poorly because their environment is hostile. The relevant environment refers to the industry environment to which a firm belongs. An industry is a group of firms producing a similar product or service, such as soft drink or pharmaceuticals. The industry environment in which a company operates also determines its performance.
The attractiveness of the industry in which a firm chooses to do business and its relative competitive position within that industry affects the strategies and objectives of that firm. Glueck conceived of an industry “as a set of firms which are in competition with one another for customers of their goods and services and which rely upon others that supply critical inputs.
In order to be successful a company must either match its strategy to the industry environment in which it operates, or be able to reshape the industry environment to its advantage through its chosen strategy? Companies typically fail when their strategy no longer fits the environment in which they operate. If the companies are to avoid the mistakes, they must understand the forces that drive competition in the industry. Otherwise they have little hope of either pursuing strategies that fit the existing industry environment or identifying strategies that might reshape the industry environment to their advantage.
Industry Analysis – Components of Industry Analysis and Factors
Impact of the Company’s Industry Environment on Its Competitive Advantage
The industry environment comprises mainly of three components:
Component # i. Customers:
Effective strategists are concerned with their customers, their needs and desires, their potential customers and their location as well as the trends in the future that may lead to changes in customer buying patterns. In fact, opportunities come through identifying and providing for customer needs and desires, and threats come from failures to meet changing customer needs.
The various issues concerning to customers and potential customers relate to three factors as follows:
(a) Customer identification,
(b) Demographic factors and
(c) Geographic location of markets.
Customers show their interest in a product or service for a variety of reasons. They purchase a product or service because it satisfies their needs, desires or requirements. Marketers generally describe three distinct classes of customers – consumers, retailers and/or wholesalers and industrial and/or institutional buyers.
Each of these groups has somewhat different factors that affect their purchase decisions. Factors as availability of a product or service, its price, variety, convenience, quality, warranty, easiness of credit and reputation generally influence consumers.
Retailers and/or wholesalers decide in favor of a product or service because of competitiveness of a product or service, product availability, product turnover, product line breadth, consumer recognition, profit potential, promotional and merchandising support and supply dependability.
Cost vs. profitability, price, product performance, product line, product information, source availability, legal conformity, and financing, technical assistance influence the industrial and/or institutional buyers.
These factors vary in importance. For example, industrial buyers of durable goods may be more concerned with setup or maintenance costs of equipment as a factor in their own profitability and less concerned with price. These same purchasers may be very price-sensitive to commodities as pens or paper. Therefore, consumer products firms adapt their strategies as consumer needs shift and as demographic changes take place.
Corporate strategists identify the nature of the customers, their needs and desire in order to avoid threats of loss of customers and create opportunities for them to find new customers or sell more to existing ones. Again, these customers and their needs are constantly changing.
Several important conditions associated with the general population affect the market for goods and services for different industries. Marketers refer to these as “primary demand factors”. Changes in population, age shifts in the population and income distribution of the population are the most important of the factors that create threats and opportunities, and affect strategies of different types of firms in different industries.
An effective strategist also examines the geographic environment to identify opportunities and threats as part of analyzing the customer sector. The strategist has essentially to determine if conditions are better elsewhere for achieving corporate objectives. He seeks new locations to add to current location or search for areas to relocate.
Sometimes a change involves moving corporate headquarters to a new region. It could also mean moving the plant or operations location from the city to a suburb or from one city to another.
Thus in the customer sector of the industry environment, the firm’s strategy must be related with its customers and their needs and desires, changes in their purchase patterns and their location.
Component # ii. Suppliers:
Suppliers of a firm provide capital, labor, materials, and so on to a firm. Effective strategists are concerned with supplier changes in the environment, cost and availability of all the factors of production, raw materials, subassemblies, money, energy and employees. The power relationships between the firm and the suppliers affect them. The power of buyer also affects the cost of supplies.
Component # iii. Competitors:
The strategists must also assess the state of competition in the industry environment. For this determines whether a firm will remain in its current business and what strategies it will follow in pursuing its business.
Three factors must be examined regarding competition:
(1) Entry and exit of major competitors
(2) Substitutes and complements for current products and services
(3) Major strategic changes by current competitors
Industry Analysis – Competitive Forces Model
Managers face the task of analyzing competitive forces in an industry environment in order to identify the opportunities and threats confronting a company. Michael Porter argues that a corporation is most concerned with the intensity of competition within its industry. Basic competitive forces in the industry determine the level of this intensity.
“The collective strength of these forces determines the ultimate profit potential in the industry, where profit potential is measured in terms of long-run return on invested capital.” At the time of scanning its industry environment, a company must assess the importance to its success of each of the basic forces.
Porter has mentioned five of these forces, to which Wheelen and Hunger have added six one: The model is designed to help the analysis of the basic posture of competition in any industry, by taking a broader look at the forces of competition and bringing together a number of different factors in a convenient model.
The model focuses on six forces that shape competition within an industry:
1. The threat of potential entry from outside the industry
2. The degree of rivalry among companies within an industry.
3. The bargaining power of buyers,
4. The bargaining power of suppliers, and
5. The threat posed by industries producing substitute goods or services.
6. Other stakeholders
The sixth force reflects the power that governments, local communities, and other groups from the task environment wield over industry activities. The stronger each of these forces, the more limited companies are in their ability to raise prices and earn greater profits.
The development of a viable strategy, therefore, should first involve the identification and evaluation of all six forces. The nature and importance of these forces vary from industry to industry and from company to company. The strategy, should, then aim to protect the firm from the resultant dangers.
The strength of these forces limits the ability of established companies to raise prices and earn higher profits. A strong competitive force can be regarded as a threat since it reduces profit. A weak competitive force can be considered as an opportunity, for it permits a company to earn greater profits. In the short run, these forces act as constraints on a company’s activities.
In the long run, however, it may be possible for a company, through its choice of strategy, to change the strength of one or more of the forces to the company’s advantage. The task of a strategic manager is to recognize opportunities and threats as they arise and to formulate appropriate strategic responses.
A strategist can evaluate any industry by rating each competitive force as high, medium or low in strength. For example, the rivalry in the athletic shoe industry could be rated as high where Nike, Reebok, Adidas, and Converse are strong competitors worldwide; threat of potential entrants is low where industry has reached maturity and sales growth rate has slowed; threat of substitutes is low because other does do not provide support for sports activities; bargaining power of suppliers is medium but rising as suppliers in Asian countries are increasing in size and ability; bargaining power of buyers is medium but increasing as the popularity of athletic shoes is dropping; threat of other stakeholders is medium to high because of growing government regulations and concern for human rights.
On the basis of current trends in each of these competitive forces, it can be inferred that the industry appears to be increasing in its level of competitive intensity leading to falling profit margins for the industry as a whole.
When this risk is low, companies can charge higher prices and earn greater profits. Companies more likely pursue strategies consistent with these aims. The height of barriers to entry is the most important determinant of profit rates in an industry.
Pharmaceuticals, house- hold detergents, and commercial jet aircraft are the examples of industries where entry barrier are considerable/high. Pharmaceuticals and household detergents industries have achieved product differentiation through substantial expenditures for research and development and advertising and have built brand loyalty, making it difficult for new companies to enter these industries on a significant scale.
The differential strategies of Procter and Gamble and Unilever have been so successful in house- hold detergents that these two companies dominate the global industry. In case of commercial jet aircraft industry, the barriers to entry are primarily due to scale economies. In some industries, scale economies are extremely important, for example, in the car or airline industry.
Competitive Force # 1. Entry of Potential Competitors:
Potential competitors are companies that currently are not competing in an industry but have the capability to do so if they choose. These new entrants to an industry typically bring to it new capacity, a desire to gain market share, and substantial resources. They are, therefore, threats to an established company.
Established companies in an industry try to discourage potential competitors from entering, since the more companies enter an industry, the more difficult it becomes for established companies to keep their share of the market and generate profits.
New entrants to an industry typically bring to it new capacity, a desire to gain market share, and substantial resources. They are, therefore, threats to established companies. On the other hand, if the risk of new entry is low, established companies could take advantage of this opportunity to raise prices and earn greater returns.
The threat of entry depends on the presence of entry barriers and the reaction that can be expected from existing competitors. An entry barrier is an obstruction that makes it difficult for a company to enter an industry.
The barriers to entry imply that there are significant costs to joining an industry. The higher the costs the potential entrants must bear, the greater are the barriers to entry. High entry barriers keep potential competitors out of an industry even when industry returns are high.
Joe Bain identified three main sources of entry barriers:
i. Economies of scale
ii. Brand Loyalty
iii. Absolute Cost Advantages
Some more entry barriers are added:
iv. Switching Costs
v. Capital Requirements
vi. Access to Distribution Channels, and
vii. Product Differentiation
viii. Government Policy
The scale economies result in saving. They are the cost advantages associated with large company size and determine the returns to scale. The cost reductions gained through mass- production of a standard output, discounts on purchases of raw material inputs and component parts in large quantities, the spreading of fixed costs over a large volume and scale economies in advertising are the sources of scale economies.
If these cost advantages are significant, then new entrants face the problem of either entering on a small scale or bear a significant cost disadvantage or take a very large risk by entering on a large scale and bearing significant capital costs.
The large- scale entry of new entrants, increasing the supply of products, will bring down prices and result in vigorous retaliation by established companies. If established companies have economies of scale, the threat of new entrants is reduced.
The companies that have created brand loyalty for their products, have an absolute cost advantage with respect to potential competitors. Brand loyalty is defined as ‘buyers’ preference for the products of incumbent companies’. Continuous advertising of brand and company names, patent protection of production, product innovation through company research and development programs, an emphasis on high product quality, and good after-sales service can create brand loyalty for a company.
New entrants cannot take market share away from established companies if they have created brand loyalty. Thus brand loyalty reduces the threat of entry by new competitors since they may find the task of breaking down well- established consumer preference as too costly.
When established companies enjoy lower absolute costs it becomes difficult for potential competitors to match. Superior production techniques can give rise to absolute cost advantages. Past experience, patents, or secret processes, control of particular inputs required for production, such as labor, materials, equipment, or management skills or access to cheaper funds can be the techniques to achieve cost advantages. If established companies have an absolute cost advantages, the threat of entry decreases.
To a large extent cost advantages have to do with entries in to market and the experience so gained. It is difficult for a competitor to break into a market if there is an established operator who knows that market well, has good relationships with the key buyers and suppliers and knows how to overcome market and operating problems.
Once software program like Excel or Word becomes established in an office, office managers are very reluctant to switch to a new program because of the high training costs.
The need to invest huge financial resources in manufacturing facilities in order to produce large commercial airplanes creates a significant barrier to entry to any competitor for Boeing and Airbus.
Small entrepreneurs often find it difficult to get supermarket shelf space for their goods because large retailers charge for space on their shelves and give priority to the established firms who pay for advertising required to generate high customer demand.
Differentiation means the provision of a product or service regarded by the user as meaningfully different from the competitors. The organizations that are able to achieve differentiation provide for themselves real barriers to competitive entry.
For example, customers of Marks and Spencer perceived it as a unique retailer with an image for reliability and quality that it seeks to ensure through a coordinated mix of staff training, product and quality specification and control at supplier level and strong corporate values supportive of the quality image.
Corporations like Proctor and Gamble and General Mills, which manufacture products like Tide and Cheerios, create high entry barriers through their high levels of advertising and promotion.
Governments can restrict entry into an industry through licensing requirements by restricting access to raw materials, such as oil-drilling sites in protected areas.
Competitive Force # 2. Rivalry among Existing Firms in an Industry:
Companies will also be related with the extent of rivalry among competing firms in an industry. In most industries, companies are mutually dependent and a competitive move by one firm can be expected to have a noticeable effect on its competitors and thus may cause counter moves.
For example, the entry of Dell and Gate into PC industry previously dominated by IBM, Apple, and Compaq enhanced the intensity of competition to such an extent that any price reduction or new product introduction is now soon followed by similar moves from other PC makers.
The rivalry among the competing sellers in an industry will be most intense where entry is likely, substitutes threaten, or buyers or suppliers exercise control.
Companies have to face each other’s competitive initiatives using the tools of product introduction and innovation, pricing, quality, features, services, marketing campaigns, the use of distribution, and the like.
The intensity of rivalry among competing sellers is related to a number of factors:
i. There exist a large number of competitors that are comparable in size and power, making it more difficult for a competitor to gain dominance over another and for stability to be reached.
ii. There is a lack of product differentiation or high switching costs, forcing all companies to fight for exactly the same market. There is little to stop customers switching between sellers.
iii. When there are high fixed costs, creating a strong temptation to cut prices to increase capacity utilization.
iv. If there exist capacity indivisibilities, high exit barriers and excess capacity it will result in increased competition
v. The pace with which competitors can respond to any given initiative, as the faster they can do so, the smaller the reward is from any such initiative.
vi. Competitors dissatisfied with their current position and eager to improve it by launching destabilizing offensive attacks.
vii. Competitors diverse in terms of resources, styles, strategies, priorities and personalities, with different ideas of how to compete.
viii. An industry experiencing slow growth may increase rivalry if it is entering maturity and competitors are eager to establish themselves as market leaders.
The extent of rivalry also determines the organizational performance. The weak competitive force among companies within an industry encourages companies to charge higher price and earn greater profits.
But the strong competitive force implying significant price competition may enrage price war among companies within an industry. Price competition by lowering down the profit margins reduces the profitability of the companies.
According to Hill and Jones, the intensity of rivalry within an industry is mainly a function of three factors:
(a) Demand conditions,
(b) The height of exit barriers in the industry, and
(c) Industry competitive structure
The demand conditions within an industry also determine the intensity of rivalry among companies operating within an industry. Growing demand tends to moderate competition by providing greater space for expansion and reduces rivalry because all companies can sell more without taking market share away from other companies and result in high profits. Demand grows when the market as a whole is growing.
This may be when the new consumer starts consuming or the existing consumers increase usage of an industry’s product. If demand is growing, companies can have increased revenues without taking market share away from the competitors. Thus growing demand provides a company a major opportunity to expand operations.
On the other hand, falling demand increases competition among the companies to maintain their market share and revenues. Demand reduces when consumers are leaving the market or when the existing consumers are buying less.
When demand is declining, a company can achieve growth only by snatching market share away from other companies. Thus declining demand presents a major threat, for it increases the extent of rivalry between established companies.
Exit barriers pose a major competitive threat when industry demand is falling. ‘Exit barriers are economic, strategic, and emotional factors that keep companies competing in an industry even when returns are low.’
If exit barriers are high, companies find it difficult to leave an unprofitable industry. Excess productive capacity can occur and lead to intensified price competition. Companies can engage in cutting prices in order to obtain the orders necessary to utilize their idle capacity.
The following are the common exit barriers:
1. Investments in plant and equipment that have no alternative uses.
2. High fixed costs of exit, such as severance of pay redundant employees.
3. Company management’s emotional attachment to an industry.
4. When a company is not diversified and relies economically on the industry.
5. There is strategic relationship between business units.
For example the steel industry has experienced the negative competitive effects of high exit barriers. Declining demand conditions combined with new low-cost sources of supply resulted in overcapacity in the steel industry during the late 1980s. Thus high exit barriers prevented the companies to leave the industry, which threatened the profitability of all companies within the steel industry.
The competitive structure of an industry means the number and size distribution of companies operating in an industry. Different competitive structures have different implications for rivalry among companies within an industry. Industry structures range from fragmented to consolidated. “A fragmented industry contains a large number of small or medium-sized companies, none of which is in a position to dominate the industry.”
Agriculture, video rental, and health clubs, real state brokers are examples of fragmented industry. “A consolidated industry is dominated by a small number of large companies” Aerospace, automobiles and pharmaceuticals are examples of consolidated industry.
Fragmented industries enjoy low entry barriers and are characterized by commodity- type products that are difficult to differentiate. This results in boom- and -bust cycles. Whenever the demand is strong, profits rise. The entry barriers being low, new firms enter into the industry hoping to cash in on the boom. The flood of new entrants creates excess capacity leading to price cuts in order to utilize excess- capacity.
The price war wipes out industry profits and compels some companies to leave the industry, and prevents potential entrants. A fragmented industry structure, thus, constitutes a threat rather than an opportunity.
Most booms will be relatively short-lived because of the ease of new entry followed by price wars and bankruptcies. Since product differentiation is often difficult in these industries, the best strategy to pursue may be cost minimization that allows a company to take advantage of high profits in a boom and survive in recession.
The nature and intensity of competition in consolidated industries are not easy to predict. The companies in the consolidated industries are interdependent. The competitive actions of one company directly affect the market share and profitability of other companies in the industry.
For instance, in 1986, the cut-rate financing by General Motors immediately affected adversely the sales and profits of Chrysler Corp. and Ford Motor Co. In order to protect their own market share, these companies had to introduce similar packages.
Obviously, in consolidated industries the interdependence of companies and the possibility of a price war constitute a major threat. In order to encounter this threat, companies often follow the price determined by a dominant company in the industry.
More often, when price wars are a threat, companies resort to non-price competition such as quality of the product and design features. This is a step towards building brand loyalty and reduces the possibility of a price war.
However, the effect of this strategy depends upon the differentiation of the industry’s product. Although some products (such as automobiles) are relatively easy to differentiate, others (such as airline travel) are very difficult to differentiate.
Competitive Force # 3. The Bargaining Power of Buyers:
Buyers affect an industry through their ability to force down prices, bargain for higher quality or more services, and play competitors against each other. To do this, they may refuse to buy from any single producer.
Alternatively, weak buyers give a company the opportunity to raise prices and earn greater returns. Whether buyers are able to make demands on a company depends on their power relative to that of the company.
A buyer or a group of buyers is powerful if some of the following factors hold true:
i. The buyers are concentrated (i.e. they are few in number and large in size). This allows the buyers to dominate suppliers.
ii. When the buyers purchase in bulk, they can bargain for price reductions.
iii. When the buyers buy a large percentage of the total order of the supply industry.
iv. When the buyers can switch orders between supply companies at a low cost.
v. Alternative suppliers are plentiful because the product is standard or undifferentiated for example, motorists can choose among many gas stations.
vi. When the buyers use the threat to supply their own needs through backward integration as a device for forcing down prices.
vii. If the quality of the product is not particularly important
viii.If there are readily available substitutes
ix. A buyer has the potential to integrate backward by producing the product itself.
Buyers exercise their bargaining power if they earn low profits, as they will earn low profits. This will create an incentive to lower purchasing costs or otherwise squeeze the industry, or to attempt to share its profit; for example, by backward integration.
The firm can limit the power of buyers by targeting and selling to buyers who possess the least power to influence it adversely. In general, companies can only sell profitably in the long run to powerful buyers when it produces at a low cost and its product is adequately differentiated. If the company lacks both these characteristics, each sale to a power buyer makes the company more vulnerable. In such circumstances, targeting and selling to the weaker buyers becomes very important
Competitive Force # 4. The Bargaining Power of Suppliers:
Suppliers can exercise their bargaining power and affect an industry through their ability to raise prices or by reducing the quality of the product or service supplied, including delivery schedules etc. Alternatively, weak suppliers provide a company the opportunity to force down prices and demand higher quality. As with buyers, the ability of suppliers to make demands on a company depends on their power relative to that of the company.
Supplier power is likely to be high if:
i. There is concentration of suppliers than a fragmented source of supply.
ii. If its product is not a standard commodity but is unique, or at least differentiated;
iii. If the supplier’s product makes up a sizeable fraction of the cost of an industry’s product;
iv. When the product that suppliers sell has few substitutes and is crucial to the industry’s production process
v. When the company’s industry is not an important customer to the suppliers. In such instances, the supplier’s health does not depend on the company’s industry, and suppliers have little incentive to reduce prices or improve quality.
vi. When supplier’s respective products are differentiated to such an extent that it is costly for a company to switch from one supplier to another. In such cases, the company depends on its suppliers and cannot play them off against each other.
vii. If there is credible threat of the supplier integrating forward into the industry’s business.
viii.When buying companies cannot use the threat of vertically integrating backward and supplying their own needs as a means to reduce input prices.
ix. If the supplier can supply the industry more cheaply than the industry can make the input itself.
x. When the supplier’s product significantly affects the quality of the industry’s product.
xi. The brand of the supplier is powerful.
In general, suppliers are more likely to exercise their leverage when the competition in their own industry is weak. Some organizations may rely on suppliers other than tangible goods. For example, the provision of finance may be crucial to an organization and therefore, the power of the supplier of finance may be vital.
Human resources also can be a critical area of supply. Professional services such as management consultancy, corporate tax advice, and medicine or teaching, the availability of skilled staff is crucial. If they are not organized, it cannot provide them power. If trade union power is strong, labor supply may exercise power.
In addition to controlling the above factors, the firm can limit the power of the supplier by:
(a) Buying from several sources to insure competition
(b) Dividing orders between suppliers that are themselves in competition;
(c) Occasionally seeking proposals from other suppliers, to collect information and test the market;
(d) Raising the quantities demanded by means of aggregating purchases with sister business units or companies or by making longer term agreements with phased deliveries; or
(e) Attempting to understand the supplier’s costs.
Competitive Force # 5. The Threat of Substitute Products:
Substitute products are those products that appear to be different but can satisfy the same need as another product. For example, bottled water is a substitute for a cola. The availability of substitute products influences the actions of the firm’s customers.
The fewer are the substitutes, the greater the difficulty of switching to them, the more secure is the firm’s revenue. According to Porter,” Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge”.
The existence of close substitutes presents a strong competitive threat, limiting the price a company can charge and thus its profitability. For example, tea can be considered a substitute for coffee.
If the price of coffee goes up high enough, coffee drinkers will slowly begin switching to tea. The price of tea thus puts a price cap on the price of coffee. However, if a company’s products have few close substitutes, other thing being equal, the company has the opportunity to raise price and earn additional profits.
The threat of substitutes may be actual or potential substitution of one product for another. A new product may render a product superfluous. Substitutes may also be thought of as those competing for discretionary expenditure.
For example, refrigerator manufacturers or retailers should know that they compete for other household expenditure with manufacturers or retailers of television, furniture, video, cookers, gas range, scooter, car etc. ‘Doing without’ can also be considered as a substitute, as in the case of a tobacco industry.
The strategists also need careful consideration of the strategic impact of actual or potential substitutes.
The availability of substitutes may have the strategic impact on the product or service in the ways:
i. Put a limit on prices of a company’s products.
ii. Make dent into the market and so reduce its attractiveness.
iii. Turn a firm’s product or service obsolete or provide a higher perceived benefit or value.
However, companies can reduce the risk of substitution by building in switching costs, perhaps through added product or service benefits meeting buyer needs.
Competitive Force # 6. Relative Power of Other Stakeholders:
A sixth force is added to Porter’s five forces to include the effect of a variety of stakeholder groups from the task environment. Some of these groups are governments, local communities, creditors, trade associations, special-interest groups, unions, and shareholders. The importance of these stakeholders differs by industry.
Industry Analysis – Strategic Group Analysis
The companies in an industry might differ with respect to factors, such as use of distribution channels used, serving of market segments, product quality, technological leadership, customer service, pricing policy, advertising policy, and promotions. These differences imply for the opportunities and threats that companies face.
Despite these differences and their implications within most industries, it is possible to observe groups of companies in which each member pursues the same basic strategy as other companies in the group but a strategy different from the one followed by companies in other groups.
These groups of companies are known as strategic groups. A strategic group is a set of business units or firms that “pursue similar strategies with similar resources”. The identification of strategic groups within an industry enables the competitive structure of the industry to be redefined to compare strategies of various competitors for similarities and differences and is very useful as a way of better understanding the competitive environment.
Thus some firms may have comparable product lines, be similarly vertically integrated, focus on similar customer segments, use the same distribution channels, sell with the same product positioning, and the like. If all competitors within an industry have similar strategic characteristics, then there will be only one strategic group. However, in most industries with a significant number of competitors it is common for more than one cluster of competitors to emerge.
Strategic group analysis can help build on competitor analysis so as to gain an understanding of the positioning of an organization in relation to the strategies of other organizations.
In a given industry there may be many companies, each of which has different interests and competes on a different basis. In analyzing the relative positions of organizations there is a need for some intermediate level of understanding between that of the individual firm and that of the industry -one such level is the market segment, another is the strategic group.
The purpose of strategic group analysis is to identify clearly defined groupings so that each represents organizations with similar strategic characteristics, following similar strategies or competing on similar bases. Porter argues that such groups can usually be identified using two, or perhaps three, sets of key characteristics.
The strategic group analysis assists better understanding of the degree and nature of competitive rivalry. As a generalization, the closer the strategic groups are to one another, the greater is the likelihood of competitive rivalry between the firms within the group.
Firms that are strategically distant from the main groups may be subject to much less competitive pressure. As a result, the profit potentials of different competitors may be radically different and not necessarily correlated with size. Thus, a large competitor, despite enjoying the advantage of a high market share, may operate within a group in which competitive rivalry is intense, thus leading to profit erosion.
By contrast, a number of competitors operating in a smaller market or strategic space may enjoy superior margins due to the lack of other competitors. Thus competitive pressures will tend to significantly favor some groups over others.
The strategic group analysis is useful in three ways:
1. Helps to gain a better understanding of the bases of rivalry within strategic groups; and also how this is different from that within other groups.
2. Raises the question as to how likely it is for an organization to move from one strategic group to another. Mobility between groups is a matter of considering the extent to which there are barriers to entry between one group and another. Mobility barriers may be substantial, particularly for the multinational groups, but probably also for the own- label producers; the minor national branders are, perhaps, less secure in their position, being susceptible to both major- brand and low- price competition.
3. Strategic groups mapping might also be used to predict market changes or identify strategic opportunities.
Strategic group analysis has a number of implications for industry analysis and the identification of opportunities and threats.
1. A company’s immediate competitors are those in its strategic group. Since all the companies in a strategic group are pursuing similar strategies, buyers tend to view the products of such companies as being direct substitutes for each other. Thus a major threat to a company’s profitability can come from within its own strategic group.
2. Different strategic groups can have a different standing with respect to the risk of new entry by potential competitors, the degree of rivalry among companies within a group, the bargaining power of buyers and suppliers, and the competitive force of substitute products and can vary in intensity among different strategic groups within the same industry.
3. Some strategic groups are more desirable than others, for they have a lower level of threats and greater opportunities. Managers must evaluate whether their company would be better off competing in a different strategic group. If the environment of another strategic group is more comfortable, then moving into that group can be regarded as an opportunity.
But the mobility barriers restrict the movement of companies between groups in an industry including both the entry and exit barriers. Thus a company contemplating entry into another strategic group must evaluate the height of mobility barriers before deciding whether the move is worthwhile.
Industry Analysis – Competitive Intelligence
Strategists do a large part of external environment analysis on an informal and individual basis. Various sources such as suppliers, customers, industry publications, employees, industry experts, industry conferences, and the Internet provide the information for such analysis.
Scientists, engineers and managers working in a firm related to research and development of a firm learn about new products and competitors’ ideas at professional meetings; and people from the purchasing department, conversing with supplier-representatives’ personnel, may also get important bits of information about a competitor.
A study found that the customer, in the form of inquiries and complaints, initiated 77% of all product innovations in the scientific instruments and 67% in semiconductors and printed circuit boards. In these industries, the sales force and service departments must keep especial vigilance.
Competitive intelligence is a formal program of gathering information on a company’s competitors. Until recently, few U.S. corporations had fully developed competitive intelligence programs. In contrast, all Japanese corporations involved in international business and most large European companies have active intelligence programs.
However, the situation is changing now. Competitive intelligence is increasingly getting recognized as one of the fastest growing fields within strategic management. For example, General Mills has trained all its employees to recognize and tap sources of competitive information.
Most companies depend on outside organizations to provide with environmental data.
Industry Analysis – Hyper Competition
Most industries today are becoming more complex and more dynamic and are facing an ever-increasing level of environmental uncertainty. Industries that remained multi-domestic are going global. New flexible, aggressive, innovative competitors are entering into established markets to erode rapidly the advantages of large previously dominant firms. Distribution channels differ from country to country.
Traditional distribution channels are increasingly giving way to sophisticated information systems. Close relationships with suppliers are proving helpful to reduce costs, increase quality, and gain access to new technology.
It is becoming more difficult to sustain any competitive advantage for a longer period as the companies learn to quickly imitate the successful strategies of market leaders and raising the level of competitive intensity in most industries.
Richard D’Aveni argues that as this type of environmental turbulence reaches more industries, competition becomes hyper-competition. According to D’Aveni-
In hyper-competition the frequency, boldness, and aggressiveness of dynamic movement by the players accelerates to create a condition of constant disequilibrium and change. Market stability is threatened by short product life cycles, short product design cycles, new technologies, frequent entry by unexpected outsiders, repositioning by incumbent, and tactical redefinitions of market boundaries as diverse industries merge. In other words, environments escalate toward higher and higher levels of uncertainty, dynamism, heterogeneity of the players and hostility.
In hyper-competitive industries such as computers, competitive advantage flows from an up-to-date knowledge of environmental trends and competitive activity combined with a willingness to risk a short- term advantage for a long term one. Companies must be willing to cannibalize their own products in order to sustain their competitive advantage.
As a result, industry or competitive intelligence has never been more important as they are today. For example, Microsoft, a hyper- competitive firm operating in a hyper-competitive industry has used its dominance in DOS and Windows operating systems to walk into a very strong position in word processing and spreadsheets application programs like Word and Excel.
Even though MS held 90% of the market for PC operating systems in 1992, it still invested hugely in the development of next generation. Instead of trying to protect its advantage in the profitable systems, MS actively sought to replace DOS with various versions of Windows. MS realized that if it did not replace its own product line with a better product, someone else would do.
Industry Analysis – Formulation of Strategy
Having assessed the forces influencing competition in an industry and their underlying causes, the corporate strategist can identify his company’s strengths and weaknesses.
Then the corporate strategist can chalk out a plan of action that may include:
(a) Positioning the company so that its capabilities provide the best defense against the competitive force;
(b) Influencing the balance of forces through strategic moves, thereby improving the company’s position; and
(c) Anticipating changes in the factors underlying the forces and responding to them for the purpose of exploiting change by selecting a strategy appropriate for the new competitive balance before competitors recognize it.
In the following paragraphs we discuss these approaches:
Approach # 1. Positioning the Company:
The corporate strategist attempts to match the strengths and weaknesses of the company to its given industry structure. Here, ‘strategy can be viewed as building defenses against the competitive forces or as finding positions in the industry where the forces are weakest’. Knowledge of the company’s capabilities and the causes of the competitive forces will indicate the areas where the company should face the competition and where to avoid it.
If the company is an efficient one and a low- cost producer, it may decide to face power buyers while taking care to sell them only products not vulnerable to competition from substitutes.
Approach # 2. Influencing the Balance:
When dealing with the forces that drive industry competition, a company can devise a strategy that takes the offensive. This posture is designed to do more than merely cope with the forces themselves; it is meant to alter their causes.
Innovations in marketing can raise brand identification or otherwise differentiate the product. Capital investments in large-scale facilities or vertical integration affect entry barriers. The balance of forces is partly a result of external factors and partly in the company’s control.
Approach # 3. Exploiting Industry Change:
From the strategic point of view industry evolution is important because it brings with it changes in the sources of competition. The product life cycle indicates that as a business become more mature the growth rate changes, product differentiation begins to decline and the companies tend to integrate vertically.
These trends are important for the fact that they affect the sources of competition. For example, extensive vertical integration both in manufacturing and in software development in the maturing minicomputer industry is greatly raising economies of scale as well as the amount of capital investment necessary to compete in the industry.
This in turn is raising barriers to entry and may drive some smaller competitors out of the industry once growth levels off. From the strategic point of view, the trends that affect the important sources of competition in the industry and those that bring new causes to the forefront hold the highest priority.
The framework for analyzing competition can also be used to predict the eventual profitability of an industry. For the purpose of long range planning, the strategists have to examine each competitive force, predict the magnitude of each underlying cause, and then construct a composite picture of the likely profit potential of the industry.
The outcome of such an exercise may differ a great deal from the existing industry structure. The framework for analyzing industry competition has direct benefits in setting diversification strategy.
It provides a road map for answering the extremely difficult question relating to potential of a business inherent in diversification decisions. Combining the framework with judgment in its application, a company may be able to spot an industry with a good future before this good future is reflected in the prices of acquisition candidates.
Industry Analysis – Limitations of Five Forces and Strategic Group Analysis
The five forces and strategic group analysis models provide an understanding of the competitive environment of an industry. However, these models are criticized and mainly two arguments are put forward.
In many industries competition can be seen as a process driven by innovation. Companies that innovate products, processes or strategies can earn huge profits. This outlook provides companies a strong motivation to look for innovative products, processes and strategies. The outstanding growth of Apple Computers, Dell Computers, Microsoft or Wal-Mart exemplifies that they all have been innovators.
Successful innovation can revolutionize industry structure. In recent times, it has been experienced that fixed costs of production have reduced because of innovation. This has lowered barriers to entry and allowed new and smaller companies to compete with large established companies.
Michael Porter has also recognized the role of innovation in revolutionizing industry structure. Porter talks of innovation as “unfreezing” and reshaping industry structure. He seems to believe that after a period of turmoil started by innovation the structure of an industry once more settles down into fairly stable pattern.
Once the industry gains stability in its new configuration, the concepts of five forces and strategic groups can once more be applied. This viewpoint of the evolution of industry structure is known as “punctuated equilibrium”.
The concept of “punctuated equilibrium” states that long periods of equilibrium characterized by stable industry structure are punctuated by periods of rapid change when innovation revolutionizes industry structure. Thus there is an unfreezing and refreezing process.
However, the industry might gain a new state of equilibrium with a more fragmented or consolidated competitive structure. But the consolidated structure is not common. In general, innovation lowers down barriers to entry resulting entry of more companies into the industry and consequently leads to fragmentation.
Thus five forces and strategic group models apply while the industry is in a stable state but not while it is undergoing radical restructuring due to innovation. They, being static in nature do not take into consideration the factors that change during turbulence, but they are certainly useful for analyzing industry structure during periods of stability.
Richard D’Avani has questioned the validity of punctuated equilibrium and argued that many industries are hyper- competitive. Hyper- competitive industries, such as computer, are characterized by permanent and ongoing innovation. Industry- structure in such industries is constantly being revolutionized by innovation. There are no periods of equilibrium.
Argument # 2. Individual Company Differences:
The five forces and strategic group models over-emphasize the importance of industry- structure as a determinant of company performance and be-little the significance of differences between companies within an industry or a strategic group. There can be wide differences in the profit rates of individual companies within an industry.
Rumelt’s research suggests that industry structure explains only about 10 percent of the differences in profit rates across companies, while individual company differences explain much of the remainder.
Several other studies suggest that the individual resources and capabilities of a company are far more important determinants of its profitability than is the industry or strategic group of which a company is a member. A company will not be profitable just because it is based in an attractive industry or strategic group.