What is Industry Analysis ?
A number of environmental factors influence the organizations. It is up to managers to ensure that this influence is harnessed in a positive way, leading to organizational success. For the firm to make profit, it must create value for customers or buyers. Hence, the firm needs to understand its customers. While creating value, the firm has to obtain goods and services from suppliers.
So, it must value its suppliers and form enduring business relationships with them. While creating value for its buyers, the firm must closely look at the rivals who are there in the arena competing for the same space. Hence, the firm must understand the competition. Thus, buyers, suppliers and competitors form the substance of a firm's industry environment.
Forces from the industry environment directly affect the firm, and the amount of influence the firm has over its industry is dependent on the dominance of its competitive position. Most strategic management books utilize Michael Porter's Five Forces Model as a framework for analyzing the competitive forces within the industry.
As so many other models used to make strategic decisions today, the implicit assumption of this model is that the industry is operating within an economy closed to the greater society and ecosystem. From the view of the Five Forces Model, industry analysis is traditionally portrayed in strategic management books from the rather static perspective of "what is" within the industry. This model suggests that strategic managers scan the product market segments in which they compete for opportunities and threats without much regard for context.
Their primary focus is on increasing market share within defined industry boundaries, and the competition is defined as those competitors who directly compete with them in individual product or service categories. Cooperative relationships are typically limited to those with direct suppliers and buyers. Capabilities to create value are viewed as residing in a single firm, and organizational performance is measured primarily in terms of how well the individual firm is managed with respect to its economic sustainability. Thus, within this traditional paradigm of industry analysis, strategic managers engage in adaptive learning within well-defined industry segments.
Factors Analyzed in Industry Analysis
Some of the major factors that are needed to be analyzed in the industry analysis. Factors for the analysis of an industry are as follows :
1) Basic Features and Conditions of the Industry :
The most basic task is to analyze the general features and condition of the industry. The basic feature of an industry involves the size of industry, the products and services offered by the companies, variants of the products and services, past performances of the industry. current industry position, future expectation, etc.
2) Industry Environment :
Another factor that must be studied in the industry analysis is the environment of the industry. Environment of industry can be classified according to Michel Porter as fragmented, emerging, matured, declining and global industries.
3) Industry Structure :
In order to analyze the industry in a better way, the structure of that particular industry should be understood. Every industry has a specific market size, certain number of companies and each company has its own market share. The firms in an industry compete with each other to capture the market. These characteristics determine the severity of competition in the industry, the extent of profitability and attractiveness of the industry.
4) Industry Attractiveness :
Industry attractiveness is determined by factors like industry potential, industry growth, the profitability, future trends for the industry, the entry and exit barriers in the industry. etc. All these play a vital role in developing the attractiveness of an industry.
5) Industry Performance :
The determinants of an industry's performance are its annual production, profitability per year. technological advancements, etc.
6) Industry Practices :
The practices of an industry can be defined as the products or services in which the companies deal in, the type of markets they share, the business practices they carry-out, such as pricing, promotion, selling, research and development, etc. All these factors affect the overall industry in significant ways.
7) Emerging Trends :
The trends that are going to define the industry in future also impact the business practices indirectly. Some of the important factors like product life cycle, industry life cycle, changes in needs and preferences of the consumers, changes in laws, possibilities of new entrants, innovation, changes in technology, etc., are some variables that have a significant impact on the industry.
Importance of Industry Analysis
Industry analysis is carried-out to identify the strengths and weaknesses of an organisation in relation to the possible opportunities and threats existing in the industry. It highlights the level of competition and the attractiveness in the industry. Along with analyzing a particular industry, it also outlines the competitor's and their strategies that may have an influence on a company. Industry analysis is used widely by the marketers for making strategic decisions. Industry analysis is helpful to the firms in the following ways :
1) Analysis of Industry Attractiveness :
Industry analysis studies the level of attractiveness of a particular industry. It determines whether it is profitable to invest in certain market or not. It highlights the attractiveness by analyzing the potentials of the industry, scrutinizing its profitability, and by identifying the strengths and weaknesses of competitor firms in the industry.
2) Studies the Competitive Position of a Firm :
Industry analysis strives to understand the competitive position of a firm in relation to other firms in the market. Analyzing competitive position specifies the strengths and weaknesses of a firm along with the values it can provide to its customers as compared to the competitors. The firm can use the knowledge to enhance the products and services and improve its market position.
3) Analyses the Environmental Variables :
Analyzing industry allows the marketers to understand the structure of the industry and identifies the immediate environmental factors as well as the factors that indirectly affect the business and its operations. It also allows the firms to know about the rival firms which in turn help in formulating competitive strategies.
4) Helps in Strategy Formulation :
Industry analysis acts as a framework under which the strategists formulate various strategies to compete with the rival firms in the market. It facilitates a deep understanding about the environmental forces that are working for and against the organisation. These characteristics help the firms in identifying their own strengths and weaknesses which ultimately leads to better strategy formulation and implementation.
Dominant Economic Features
Industries differ from one another in terms of their structure and composition. An industry analysis of a firm thus starts with an analysis of the dominant economic features of the industry. The knowledge of dominant economic features of the industry plays a significant role in evaluating the competitive environment of a company. This analysis also provides a bird's eye view of the industry. Some of these Industry dominant economic features are :
1) Market Size and Growth Rate :
It is essential for a company to have an overview of the industry market size. Market size of an industry is equal to the number of companies in a particular industry. Knowledge of industry growth rate helps in identifying the industry's position in its life cycle, i.e., early development stage, rapid growth stage, early maturity stage, maturity stage, stagnation stage, decline stage.
2) Number of Rivals :
Before making an entry, a company should identify the rivals in a particular industry. There may be numerous small rivaling companies or a small number of big business houses. For example, the petrochemicals industry is dominated by Reliance and a few other larger players. On the other hand, an industry like FMCG industry has many players - both big and small. It is also important to be aware about the current developments in the industry like mergers and acquisitions, strategic alliances, etc.
3) Scope of Competitive Rivalry :
It is important for the firm to know about the extent or scope of competition in its industry. For example, if product diversification is identified as a future industry trend then a new company in the industry should also a plan for future diversification.
4) Buyer Requirements and Needs :
It is very important for a company to know about the needs and requirements of its customers. It also requires to keep a track of the changing patterns of buyer's needs so that it is able acquire new customers and retain the existing ones. It can do this by doing systematic research on buyer behavior and other market trends.
5) Degree of Product Differentiation :
The degree of differentiation in the industry will define the kind of pricing premium that a firm can charge its customers. In case the level of differentiation in low then the prices charged by the firms will also be low. This will in turn raise the level of competition in the industry. It becomes very difficult for new players to compete on the basis of price due to low profit levels.
6) Product Innovation :
Product innovation is also an important dominant feature. There are industries where companies are characterized by short span of product life cycles and high product innovation levels. Research and Development is a very important function in these industries and industry participants should always try to create new and innovative products for maintaining their market position. For example, there is a very high rate of innovation in the smartphone industry. The typical life cycle of a smartphone phone is very short as the buyers are on the lookout for new features all the time.
7) Rate of Technological Change :
Industries that are dependent on the rapid diffusion of new technologies are characterized by a high investment in R&D on new technologies. When. a company enters an industry where the rate of change of technology is high it must direct its efforts in staying at par with the latest technological changes in the industry. Companies which don't adjust to the rapid change of technology lose their market share, e.g., Nokia.
8) Vertical Integration :
It is necessary to analyze the level of integration of the companies. Analysis of an industry is largely affected by the horizontal and vertical in integration levels as both the level have their respective advantages and disadvantages. Apart from the integration activities competitive advantages and competencies of the rivals firms should also be analyzed.
9) Economics of Scale :
Companies also need to analyze and keep abreast of economies of scale in the industry may bring the cost down. They need to analyze of operations of their competitors and see if larger scale of economies brings about reduction in their cost structures. High economy scales lead to low production costs and high profit returns.
Porter's Five Forces Model
For analyzing an industry efficiently, it is essential to consider various competitive forces and how they interact with each other to create pressure on one another. These factors decide the nature of competition in the industry. The study of these competitive forces is necessary because without scrutinizing them, an industry cannot be analyzed thoroughly.
Michael Porter developed a model which explains that the industry of a firm is affected by five forces. The strategic business manager can use Porter's model to analyze an industry on these five forces and then judge the strengths and weaknesses of his firm based on his industry analysis. The industry analysis will basically enable the manager to review how strong each force is in a particular industry. This model thus helps the firm to gain an edge over its rivals in the industry.
An industry can be very loosely defined as a group of firms that produce similar products and services - so that the customer can substitute one for the other. This five forces model is a widely used technique for analyzing the industry. It also illustrates the nature and level of competition existing in the industry along with the forces that shape a business and its functions. An industry consists of number of firms that produce and sell similar products or services to the consumers. Therefore the five force model is quite significant in understanding the complex and diverse characteristics of the competition in different industry areas.
The competition faced by a firm is actually much broader as it includes both current and potential competitors. A company can face negative consequences by emergence of new technologies and new competitors as well as the existing competitors. Before analyzing the nature and scope of competition in an industry, it makes sense to define its boundaries. This helps in the following ways :
1) Define Arena :
It helps in defining the arena (or playing field) of the firm.
2) Focus on the Competitors :
Setting the industry boundaries helps the firm to get an idea of its competitors and firms that are manufacturing substitute products.
3) Identify Key Factors for Success :
This helps in allocating and deploying the key success factors in the industry.
Components of Porter's Five Forces Model
The five forces of the Michael Porter Model are as follows :
1) Rivalry inside Industry :
According to perfect competition model, no firm can enjoy super normal profits, and in the long run the competition drives the excess profits to zero. In the real market, the competition is not perfect and the firms are not just the entities interested in charging money from the consumers, they actually attempt to seek a competitive advantage over their rivals. The level of rivalry in an industry is of great importance to economists and strategic analysts. One such ratio which gives an idea of the prevalent state of competition in an industry is the concentration ration (CR). A high industry concentration ratio means that a very few firms command a very high market share in that industry.
For example, the petrochemical industry in India is dominated by Reliance Industries and has a very high concentration ratio. If the concentration ratio is low, then the industry is considered to be a disciplined one. This discipline might be a result of a code of conduct or mutual amenability among the firms. This discipline results from the history of competition in the industry, the presence of a great leading firm, an informal or tactical understanding between the players to avoid breaking the rules. However even in a disciplined industry a rebel firm can cause havoc with its business activities.
Following features of the industry can influence the intensity of rivalry :
i) Number of Players :
As the number of players increase in an industry, the intensity of competition also rises. The reason behind this competitive landscape is that greater numbers of firms compete for the same customers and resources. The situation gets more intense. when the firms with similar market share try to become the market leader.
ii) Slow Market Growth :
When the market growth is slow then the companies have to increase the intensity of the competition to garner market share. In such cases company grows only at the expense of some other company. On the other hand, when the growth rate is more e.g., the initial days of the telecom industry in India, companies can grow by simply being a part of the growing market.
iii) High Fixed Costs :
The competition intensity also increases with the increase in fixed cost. When the maximum portion of total cost fixed costs, then firms try to produce more in quantity to achieve the low unit cost. This leads for the firms to compete with other firms in the market, which in turn increases. competition. A good example of this is the automobile industry in India
iv) High Storage Costs or Highly Perishable Products:
If the products manufactured by the industry are perishable or difficult to store then firms will be under pressure to sell their stock rapidly so that the wastage is low. This increases rivalry in the industry.
v) Low Switching Cost :
When the cost for switching the products is low, then customers feel free to switch from one to the other. This increases the competition as every company tries to grab maximum number of customers. For example, in the telecom industry, with the introduction of number portability the customers can switch from one mobile operator to another without having to change their numbers. This has increased the competition levels in the telecom sector.
vi) Low Levels of Product Differentiation :
If the products in the industry are not differentiated then there is very high rivalry because all products seem alike to the customers and companies have to try harder to gain high market share.
vii) Market Share :
When a company is losing its market share or trying to gain a market share, then the competition is high as the companies struggle with each other to survive and expand their share of the market.
viii) High Exit Barriers :
Exit barriers prevent a company from leaving an industry even if it is suffering from losses. These barriers impose a high cost on the companies if they want to exit from the industry.
ix) Diverse Competitors :
If the competitor firms are different from each other in various aspects such as business orientation, culture, background, etc., then it becomes difficult to anticipate the competitor strategies. The rivalry in this condition can be intense and unstable.
x) Market Saturation :
When the market is growing, then it attracts many firms to enter in the industry and produce the products. This leads to increase in the production. The market reaches a point where it is crowded with the competing firms and the supply is more than the demand. Therefore, the market gets saturated and large number of rival firms trying to target few customers increase the level of competition in the market.
2) Threat of Substitutes :
The substitutes can be defined as the products of other industries that have the ability to satisfy similar needs. For example, coffee can be a substitute for tea, as it can also be used as a caffeine drink in the morning.
When the price of a substitute product changes the demand of a related product also gets affected. When the number of substitute products increases, the competition also increases as the customers have more alternatives to select from. This forces the companies to raise or lower down the prices. Therefore, it can be concluded that the competition created by the substitute firms is price competition. The presence of a number of substitutes impacts the ability of the company to increase the price of its products as increasing the price will make the substitutes more attractive for the target market.
Since, the substitute products serve the same or similar purposes; therefore a close substitute may act as a negative competitive force in the market. Hence, the industries which have no close substitutes are more attractive for various firms as they can charge higher prices when required.
For example, when Coca-Cola came out with a pricing of Rs.5 for its 200 ml bottles it was able to acquire customers from substitute products like coconut water, mango and fresh juice etc.
Some of the conditions in which the power of substitutes is high are as follows :
i) Low Switching Cost :
When there is slight or no switching cost paid by the customers, they become free to select another similar product substitute. If all the factors remain constant, such as differentiation, brand loyalty, brand image, etc., then it becomes relatively easy for the customers to go for a similar product. The firms must try to design their product in a way that the switching cost is high.
ii) Low Substitute Price :
If a similar product is relatively cheaper, then it increases the risk of the consumers to go for the attractive substitute. It also puts a limit on the level of price charged by the companies. If the companies charge prices more than this limit, they may lose their customers.
iii) High Quality of Substitute :
If the substitute product has high quality than the company's product, then the customers will prefer to select the substitute product.
iv) Better Performance of Substitute Products :
If the performance of substitute products is better than any other product, then it is more likely that the customers will select the substitute one.
v) Availability of Substitutes :
The availability of substitutes also affects the market share of an organisation. If there are few substitutes, then it will hardly affect the business, while high number of substitutes can have major impact on the market share. Potential substitute firms can be recognized by creative thinking and considering other non traditional rival firms.
3) Buyer Power :
The bargaining power of buyers also has a very important effect on the manufacturing industry. When there are many producers and there is a single customer in a market, then that situation is termed as a "monopsony". In these markets, the position of buyer is very strong and he sets the price. In reality, only a few monopsony markets exist.
The buyer's power or bargaining power of buyers compels the firms to reduce the prices. They may also demand a product or service of higher quality at low price or may demand added value in exchange of their money.
The buyers have more power in following conditions :
- When the number of buyers is relatively less.
- When buyers purchase in bulk.
- Availability of alternate suppliers who can provide the same product or service at a competitive price.
- When the cost of switching from one producer to the other is quite low.
- When the buyers, i.e., wholesaler, retailer, etc., charge low prices from the consumers and are unlikely to pay high prices.
- When the buyers pay the maximum share in the total cost of product. This may lead the organizations to search for cheaper alternatives.
- If the buyer is capable of starting new alliance by integrating backwards with other firms making itself a powerful supplier.
4) Supplier Power :
Since the company needs raw material for producing, therefore the producers have to build relationship with its suppliers. When suppliers have the power in their hands, they can exert influence on the producing firms by selling them raw materials at higher prices.
For example, Walmart as an organisation thrives on the basis of its relationship with its suppliers.
Bargaining power of the suppliers is their ability to influence the industry either through individual or group interaction with the company. The suppliers have a bargaining power with which they can raise the prices of products or services or force the customers to purchase a low quality product or service. This empowers the position of suppliers in the industry.
The suppliers can exercise their bargaining power in the following cases :
i) Few Numbers of Suppliers :
The suppliers have higher bargaining power when they are few in numbers and are more dominant than the producing firms.
ii) Few or No Alternatives :
If the buyers and producers have few or no alternatives, then suppliers get an added advantage over the buyers. The buyers would have to purchase the supplies in the price set by the suppliers.
iii) Less Important Buyers :
When buyers are not much important for the suppliers then they do not consider them. For example, for cement industry, major companies, construction houses have much more value than an ordinary man trying to build his house.
iv) Suppliers Selling Critical Products :
When the suppliers provide critical or crucial products, which are rare to find somewhere. else, then they have high bargaining power.
v) Differentiated Supplier Product :
If the suppliers supply differentiated products as compared other suppliers, then they may have a bargaining power in their hands. This increases the switching costs of the buyer. For example, loyalty programs.
vi) Supplier's Ability to Enter the Buying Industry :
When the suppliers have the ability to enter in the industry by collaborating with other firms through forward integration, then the suppliers have a high bargaining power.
5) Threat of New Entrants :
The market is full of competition. Not only the existing firms pose threat to the business, but the arrival of new entrants is also a challenge. As per the ideal scenario, the market is always open for entry and exits, resulting in comparable profits to all the firms. But, this is not applicable in the real picture market. In reality, all industries have some traits that protect their high profits and help them in warding off potential new entrants by erecting barriers.
Various factors that hinder the entry of new firms in the industry are called as "barriers to entry". These barriers prevent the new firms from entering into the industry. This helps in maintaining profit levels for the existing firms These barriers can either be developed or fully utilized to improve the performance of organisation. These entry barriers can be a source of competitive advantage for the firms.
These barriers to entry can be developed from following sources :
i) Government Laws and Regulations :
Government laws and regulations are one of the biggest entry barriers. Although the government tries to keep competition alive in the market, it also supports the existing firms by formulating regulations that encourage market monopolies.
ii) Patents as Barriers :
Patents and copyrights also give the owner the right to prevent other players from using a technology or a product. This stops other firms. from copying and using those ideas, knowledge, technologies, etc., that give the existing firms a competitive edge.
iii) Asset Specificity Inhibits Entry into an Industry :
May times an industry requires an investment in a particular asset category. More specific the asset, the less is its resale value or it is less deploy-able. This investment can be in technology or plant and equipment. Hence, asset specificity may act an entry barrier because the new entrant may not want to invest in the exclusive technology at the risk of failure.
Entry and Exit Barriers
The profitability of a business is affected by many factors among which the entry and exit barriers play an important role. These factors maintain the profitability of an industry by prohibiting new entrants from entering and existing firms from exiting the industry.
Entry barriers are those factors that are faced by the new firms when they try to enter in an industry, market, or trade group. These barriers control the competition within the industry by imposing restrictions on the new entrants. By stopping new firms, the existing firms gain the power to set and raise the prices of their products and services. Companies which operate in industries with strong entry barriers can charge a higher price from their customers and have greater profitability than companies which don't have the shelter of entry barriers.
Exit barriers are those factors that prohibit a firm from leaving the industry, market, or trade group. These barriers may arise from various sources such as the exit costs to be paid by the firms, difficulty in exiting the market, etc. The strength of exit barriers intensifies the competition compared to the industry where the exit barriers are not so intense. Both of these barriers maintain the level of competition by restricting the number of players in an industry.
Exit Barriers
Exit barriers are the factors that prohibit a firm from exiting an industry or market. These factors force the firms to stay in the industry by compelling it economically, emotionally, or strategically. Even if the profitability is not high, these factors restrict the firm from exiting the industry. The intensity of competition is directly proportion to the strength of exit barriers of an industry. The price competition and aggressive promotions are the some of the resultants of strong exit barriers. Some of the factors that act as the exit barriers are as follows :
1) Employee Lay-off :
Even when a company is suffering from losses, it may decide against downsizing as cost of employee pay-off might be higher than its annual losses. An organisation having shortage of funds may prefer to continue the business at loss in the hope that other firms in the industries will wind up first.
2) Disengagement Costs :
At times when organizations decide to discontinue the business, they need to pay some costs other than paying. off the employees. These costs may be in the form of restoring the plant site after exiting. paying leases for the building even when the business has been closed-off, etc. All these costs cause a considerable loss to the firm.
3) Customer Loyalty :
Customers often value a bundle of products and services from the same supplier. Hence, if the organisation chooses to continue with only profitable products in the product mix and discontinue the unprofitable ones, it could lose its existing customers.
4) Non-Economic Barriers :
Some of the non economic exit barriers which prohibit an organisation from exiting are emotional attachments, fear of losses, government laws, etc. The company could also have an unreasonable fear that its image could get tarnished by exiting the business.
5) Shared Costs :
Sometimes resources are shared between various businesses in a company. Hence, when a loss making business unit is closed, it also impacts the profitable business unit as the resources and costs are shared between the two. For example, a company maybe using the same raw material for manufacturing two different products.
Entry Barriers
The factors that hinder the entrance of new firms in an industry are called entry barriers. These factors are imposed by the industry itself restrict the competition. The entry barriers in the industrialized countries (such as North America, Western Europe, etc.,) are well-known in comparison to the countries that have developing markets (such as China).
These barriers are studied by various organizations to analyze their competitive position. Analyzing the entry barriers also enables the firms to determine the degree of competition imposed by the new firms against the existing firms. These barriers are not only analyzed by the existing firms but also by the companies which are planning to enter a particular industry. Some of the entry barriers that prohibit the entry of new firms and maintain a degree of competition the market are as follows :
1) Economies of Scale :
Economies of scale can be defined as a condition when the firm has the capacity and ability to produce large quantities of products in minimum possible unit cost. Creating demand for the products is easier for the existing firms in contrast to the new firms. New firms are not able to increase production level to the scale required to beat the competition and also the demand for their products is likely to be low This prevents the new entrants from developing economies of scale.
Economies of scale can be developed in any of the business functions such as marketing, distribution, manufacturing, research and development, etc. In order to gain competitive advantage and generate economies of scale, firms collaborate with other organizations. Existing firms that have achieved the economies of scale rarely worry about the flexible customer demand, which is a major factor to be considered by the new entrants as they need to be more dynamic and adaptive to the shifts in demand. Thus, economies of scale can act as an entry barrier for the aspiring firms.
2) Brand Image :
The existing firms of an industry make a favorable impact on the consumers and create an image of uniqueness in their minds This perception is created due to the effective promotion techniques, first mover advantages. prompt service to the customers, etc. This results in brand loyalty, repeat purchases, and customer satisfaction. In order to compete with the brand image of the large firms, the new entrants offer products and services at cheaper rates. Due to this at times, they suffer with low profits or significant losses.
A very good example of this is the market position of PepsiCo and Coca Cola. These companies strive for market share in all countries across the globe with their aggressive advertising, visibility and distribution, and have been able to build strong customer loyalty. Any new entrant in the soft drink market will have to spend a large amount of money just to register their brand in the minds of the customer.
3) Capital Requirements :
For a firm to enter and establish itself in an industry, a considerable amount of capital is required. This capital is required for various activities ranging from day-to-day operations to critical business investments. Even if the market is attractive and opportunities are extensive, the lack of capital may prohibit a new entrant from exploiting them. A firm that is already established in the industry has the advantage of capital and fund availability over the new entrants.
For example, Indian railway has the monopoly in India. Indian government spends a huge amount of capital on the trains, railway tracks, land, labour, etc. If a new entrant tries to enter in the market, then it would have to spend a significant amount in all these factors to compete with this monopoly and achieve profit.
4) Other Barriers :
Some other entry barriers are as follows :
i) Reaction of Established Firms :
The firms which are already established in the industry may react strongly against the new entrants. These reactions may be in the form of aggressive promotions, lowering prices, etc., and may also act as the entry barriers.
ii) Lack of Cost Advantages :
Since the firms that are already established have large production capacity, they are able to produce at lower unit cost which leads to significant reduction in total cost. New entrants lack this advantage, as they lack the production capacity.
iii) Limited Access to Channels of Distribution :
Access to profitable distribution channel is also a challenging task for the new entrants. Existing firms strengthen their position with the help of efficient distribution channel. This can be an entry barrier as the new firms would have to lure the intermediaries for superior distribution services with the help of rebates, allowances, etc.
iv) Government Intervention :
Government can restrict the entry of a new firm in the industry by putting a limit on giving license and permits or by making new regulatory policies against the new entrants.
v) Brand Identity :
Building a suitable brand identity and strong positioning in the consumer's mind is also a huge entry barrier for new entrants.