BUAD 497 Strategic Management Session 4 Five Forces Agenda Flash Review Industry Analysis Kahoot it Lecture discussion The Five Competitive Forces that Shape Strategy Application Exercise Five Forces Flash Review We will do a flash review using Kahoot 12 questions from the reading not graded Go to Kahoot it on your computer or phone Enter the game pin which I will share on my screen Scores for the top several students will be shown leaderboard Use your USC ID No nicknames Industry Analysis Five Forces Framework Strategy Big Picture Map Environment Industry Analysis Firm Internal Analysis Core problem s Recommendations Industry Analysis Company economic performance is a function of two causes Industry Structure Strategic Positioning withing the Industry Industry Attractiveness Profitability Sustainable Competitive Advantage Michael Porter How much do industry and firm matter Porter McGahan 1997 There are large differences in mean profitability across different industries McKinsey Industry Analysis Porter s Five Forces Threat of New Entrants Industry structure determines the industry s long term profit potential Bargaining Power of Suppliers Bargaining Power of Buyers Rivalry Among Existing Competitors Threat of Substitute Products or Services Some preliminaries on the Five Forces Porter s Five Forces PFF helps you identify the competitive forces that influence average profitability in your industry so that you can develop a strategy PFF encapsulates the insights from consumer theory and industrial organization economics that help explain the systematic factors that influence industry profitability A first pass five forces analysis identifies forces that are high and low it puts structure on the problem Goals is to understand key drivers of industry profitability What explains most of the variance And what can you do about it Then you need to do more Dig into the key forces and drivers that shape the industry Find ways to give quantitative interpretations to the data What steps can you take to make the industry more attractive for you Defining industry scope of rivals The value of the framework depends on defining the appropriate industry boundaries too wide a boundary or two narrow means insights will be less useful but this usually becomes apparent The five forces model is sensitive to defining the industry and its boundaries You should include Ford when analyzing the automobile industry You may not include Ford when analyzing the sedan sub industry Defining industry scope of rivals Quick answer rivalry among existing competitors refers to those firms for whom you regularly compete for customers and whom you obviously benchmark against in terms of cost product quality etc McDonalds vs Burger King Northface vs Patagonia Honda vs Toyota USC vs UCLA A more detailed answer is that competitors Have the same similar product performance characteristics Have the same or similar occasion for use Are sold in the same geographic markets Limited differences and larger overlap in suppliers and or buyers Why do we care about rivalry competition As competition goes up potential for industry profitability goes down First need to define the industry then analyze factors influencing competition Defining industry NAICS codes classify establishments based on similar processes or means of production Codes use a two to six digit level of detail from broad sectors like manufacturing and retail 2 digit codes to individual industries 6 digit codes Revenue or value of shipments data is used to determine an establishment s primary business activity NAICS codes are used by government agencies for example when collecting Economic Census data and by business databases to classify companies by their lines of business Defining industry GICS the Global Industry Classification Standard was developed by Standard Poor s and Morgan Stanley Capital International MSCI for use by financial analysts investors and portfolio managers It classifies public companies listed worldwide using a market based approach based on how they earn their revenues Many stock exchanges use GICS to develop industry sector indexes The GICS structure consists of 11 sectors 24 industry groups 69 industries and 158 sub industries Industry Value Chain Upstream Suppliers Suppliers Firm Buyers Downstream Buyers Industry Analysis Porter Five Forces Bargaining Power of Suppliers Bargaining Power of Buyers Threat of New Entrants Rivalry Among Existing Competitors Threat of Substitute Products or Services Rivalry Among Existing Competitors Refers to competition within an industry First need to define the industry then analyze factors influencing competition Potential for industry profitability goes down as competition goes up How do we estimate the threat of competition Intensity and basis of competition Number of firms Exit barriers Similarity in Goals Operations efficiency Products or services Note the importance of defining industry boundaries Rivalry an Econ 101 recap Perfect Competition Oligopoly Monopoly Numerous firms No market power Price takers Identical products Free entry exit long run cost efficiency Long run Economic profits driven to zero Good for consumers bad for firms A few firms Depends on how firms react to each other Bertrand Firms compete on price Cournot Firms compete on quantity Duopoly Two firms Collusion Firms choose price cooperatively One firm Market power Chose price to maximize profit subject to market demand No entry or exit Long run Positive economic profits Good for firm sometimes bad for consumers FFFFFFFF FFFFFFFF FFFFFFFF FFFFFFFF Industry Concentration Defined by the number and relative size of competitors Herfindahl Hirschman Index HHI a measure of the balance in an industry Example 3 firms with market shares of 0 50 0 25 0 25 HHI 0 50 2 0 25 2 0 25 2 0 25 0 0625 0 0625 0 375 HHI of 0 Perfectly Competitive HHI of 1 Monopoly HHI 0 18 Relatively high concentration i e industries with reduced rivalry Industry Concentration Concentration ratio of total industry sales accounted by the 4 largest firms Some examples of concentration ratios Agriculture 5 Hotels 18 Soap Detergent 63 Malt Beverages 86 Concentration ratios can be calculated for any number of firms within an industry or all firms 4 firm and 8 firm concentration ratios are common Industries with a higher degree of concentration have a smaller number of firms that control a higher portion of industry sales while less concentrated or fragmented industries have