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Unformatted text preview: CHAPTER VE Industry and Com.petitor Analysis OPENING PROFILE BUSINESSESATOZ Occupying a Unique Position in a Difficult Industry-and Thriving In high school, Amy Shukla and Bhavdip Bhayani earned extra income by developing Web sites for clients. They did "project" work, meaning that once a Web site was completed, they referred the client to a Web hosting company that charged a monthly fee to host its Web site. While the arrangement worked well, it was obvious to Shukla and Bhayani that they were leaving money on the table. If they could offer their own Web hosting service, they could keep the clients they built Web sites for and create a source of recurring income. Shukla and Bhayani recall meeting at Denny's near their homes in Orange County, California, to hammer out how they could create a company to meet their objectives. Bhayani outlined the business on a napkin-a keepsake the two have to this day. What they designed is akin to what's referred to as a Web development firm. They would (1) d esign Web sites and (2) o ffer a Web hosting service. They picked a name for the company, but the Internet domain name was already taken. Shukla's dad owned the domain name, and agreed to let them use it. As a result, the business, which was launched in July 2007, was named BusinessesAtoZ. By this time, Shukla was a math and computer science student at Chapman University and Bhayani was preparing to enter Fullerton College as an electrical engineering and computer science major. The two universities are only a few miles apart. Shukla and Bhayani made a good team, partly because they have complementary skills. Shukla's expertise is in graphic design and customer service, and Bhayani is an expert coder. The two knew that Web hosting is a tough industry, so they positioned BusinessesAtoZ carefully. The Web hosting industry is characterized by firms that represent two extremes. One extreme is small companies that own their own servers. While these companies offer customer service, the risk is if a server goes down a client's Web site could go dark. The other extreme is large companies like Yahoo! While a clients' Web site will never go down if it's hosted by Yahoo! (Yahoo! has ample redundancy in its operations), it's harder to get good customer service. To capture the benefits of both extremes, Shukla and Bhayani positioned BusinessesAtoZ right in the middle. The company offers high levels of customer service. In fact, an innovation that Shukla and Bhayani came up with to bolster customer service is a "ticket" or work order system, where a client can "open a ticket" or submit a request for service and rate the urgency of the request on a scale of 1 to 1 0. That way Shukla and Bhayani can prioritize their work and deal with the most critical customer service issues first. In terms of the risks associated with small companies and servers going down, rather than owing their own equipment, Shukla and Bhayani lease servers from various compa­ nies. This gives them the same level of guaranteed uptime service as their larger competi­ tors. As a result, BusinessesAtoZ captures the strengths of both extremes of the Web hosting industry-it offers high customer service (like the other little guys) and very little chance that a client's Web site will go down (like the big guys). This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. 145 146 PART 2 • DEVELOPING SUCCESSFUL BUSINESS IDEAS Lea ..ning Objectives After studying this chapter you should be ready to: The other benefit that Shukla and Bhayani offer, which is something that large firms have trouble matching, is hustle. They're passionate about their business, which is evident in the work they do, how quickly they respond to client requests, and in the extras they offer. For example, many Web hosting firms outsource much of what they offer their clients, like the shopping cart functionality that e-commerce sites have. BusinessesAtoZ builds every Explain the purpose of an component from scratch, which saves money and avoids incompatibility industry analysis. issues. Similarly, through a job with a technology company, Bhayani has developed an expertise in backup solutions for Web sites. It's now possible Identify the five competitive for a company to have the data on its computers backed up in real time, so forces that determine there is no possibility of data being lost. BusinessesAtoZ plans to offer this industry profitability. service to its Web hosting clients for free. If a competitor tries to match Explain the role of "barriers to entry" in creating disincentives for firms to enter an industry. Identify the nontraditional BusinessesAtoZ in this area, it will likely incur additional costs because it will have to outsource the service absent Bhayani's expertise. Shukla and Bhayani plan to graduate from their respective universities in fall 2010. They credit academic mentors who have contributed to their success. Amy Shukla's father, Pradip Shukla, has been particularly helpful. barriers to entry that are He's an entrepreneurship professor at Chapman University. A challenge especially associated with that Shukla and Bhayani will face moving forward is offering the same levels entrepreneurial firms. of customer service and amenities as their business grows. List the four industry-related questions to ask before pursuing the idea for a firm. Identify the five primary B usinessesAtoZ is a success in part because of Amy Shukla and Bhavdip Bhayani's ability to analyze the Web hosting industry and precisely position BusinessesAtoZ within it. In this chapter, we'll look at industry analysis and competitor analysis. The first section of the chapter considers industry analysis, which is business research industry types and the that focuses on the potential of an industry. An industry is a group of opportunities they offer. firms producing a similar product or service, such as music, fitness Explain the purpose of a is feasible in regard to the industry and the target market in which it drinks, or electronic games. Once it is determined that a new venture competitor analysis. Identify the three groups of competitors a new firm will face. will compete, a more in-depth analysis is needed to learn the ins and outs of the industry the firm plans to enter. This analysis helps a firm determine if the niche or target markets it identified during its feasibility analysis are accessible and which ones represent the best point of entry for the new firm. We focus on competitor analysis in the second section of the Describe ways a firm can ethically obtain information about its competitors. Describe the reasons for chapter. A competitor analysis is a detailed evaluation of a firm's competitors. Once a firm decides to enter an industry and chooses a market in which to compete, it must gain an understanding of its com­ petitive environment. We'll look at how a firm identifies its competition and the importance of completing a competitive analysis grid. completing a competitive analysis grid. I INDUSTRY ANALYSIS Learning Objective Explain the purpose of an industry analysis. When studying an industry, an entrepreneur must answer three ques­ tions before pursuing the idea of starting a firm. First, is the industry accessible-in other words, is it a realistic place for a new venture to enter? Second, does the industry contain markets that are ripe for innovation or are underserved? Third, are there positions in the indus­ try that will avoid some of the negative attributes of the industry as a whole? It is useful for a new venture to think about its position at both This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. CHAPTER 5 • INDUSTRY AND COMPETITOR ANALYSIS the company level and the product or service level. At the company level, a firm's position determines how the company is situated relative to its competitors, as discussed in Chapter 4. For example, Blue Maze Entertainment has positioned itself as a company that produces branded music products and manages branded music campaigns. This is a much different position than Warner Music or EMI, which are all-purpose music companies. Sometimes, through savvy posi­ tioning, a firm can enter an unattractive industry and do well. Because it found an attractive niche market and has nicely positioned itself in that market, Blue Maze is profitable even though it competes in a moderately unattractive industry. The importance of knowing the competitive landscape, which is what an industry is, may have been first recognized in the fourth century B.c. by Sun-tzu, a Chinese philosopher. Reputedly he wrote The Art of War to help generals prepare for battle. However, the ideas in the book are still used today to help managers prepare their firms for the competitive wars of the marketplace. The fol­ lowing quote from Sun-tzu's work points out the importance of industry analysis: We are not fit to lead an army on the march unless we are familiar with the face of the country-its pitfalls and precipices, its marshes and swamps.1 These words serve as a reminder to entrepreneurs that regardless of how eager they are to start their businesses, they are not adequately prepared until they are "familiar with the face of the country"-that is, until they understand the industry or industries they plan to enter. To illustrate the importance of the industry a firm chooses to enter, research evidence shows that both firm- and industry-specific factors contribute to a firm's profitability.2 Firm-level factors include a firm's assets, products, culture, reputation, and other resources. Industry-specific factors include the threat of new entrants, rivalry among existing firms, the bargaining power of suppliers, and other factors discussed in this chapter. In various studies, researchers have found that from 8 to 30 percent of the variation in firm profitability is directly attributable to the industry in which a firm competes. 3 Two researchers (including Harvard University professor Michael Porter, the author of the five competitive forces model we discuss in this chapter) who are known for their studies of industry effects found that 19 percent of the variation in firm prof­ itability is attributable to stable industry effects. Commenting on the 19 percent figure, Porter concluded, "This result provides strong support for the idea that industry membership has an important influence on [firm] profitabi lit y. " 4 Because both firm- and industry-level factors are important in determining a firm's profitability, there are firms that do well in unattractive or moderately attractive industries if they are well positioned and well managed. Still, the overall attractiveness of an industry should be part of the equation when an entrepreneur decides whether to pursue a particular opportunity. Two techniques that entrepreneurs have available for assessing industry attractive­ ness are studying industry trends and the five forces framework. Studying Industry Trends The first technique that an entrepreneur has available to discern the attractive­ ness of an industry is to study industry trends. The two trends that are the most important to focus on are environmental trends and business trends. Environmental Trends As discussed in Chapter 2, environmental trends are very important. The strength of an industry often surges or wanes not so much because of the management skills of the firms in the industry, but because environmental trends shift in favor or against the products or services sold by firms in the industry. This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. 147 148 PART 2 • DEVELOPING SUCCESSFUL BUSINESS IDEAS Economic trends, social trends, technological advances, and political and regulatory changes are the most important environmental trends for entrepre­ neurs to study. For example, any industry that sells products to seniors, such as the eyeglasses industry and the hearing aid industry, are benefiting from the aging of the population, a social trend. In contrast, industries that sell food products that are high in sugar, such as the candy industry and the sugared soft-drink industry, are suffering as the result of a renewed emphasis on health and fitness. Sometimes there are multiple environmental changes at work that set the stage for an industry's future. This point is illustrated in the following statement from Standard & Poor's NetAdvantage's assessment of the future of the motorcycle industry: Over time, we think factors that are likely to affect motorcycle sales are personal income and spending levels, consumer confidence, levels of unemployment, demographics, the amount of free time that people have available, and the extent to which brand recognition and appeal are created. We expect that an aging population, and the impact that this has on consumer demand, will limit opportu­ nities for industry sales growth. In the U.S., we expect that efforts will increase to 5 encourage the number of female motorcycle riders. This short statement illustrates the degree to which environmental change can affect one industry, and may cause an entrepreneur who was considering entering the motorcycle industry to pause. Similar forces are at work in all industries. Some industries experience slow or no growth for years and then experience sudden upswings in growth and popularity as the result of savvy industry incumbents and/ or entrepreneurs who realized that environmental change has turned in favor of the industry. A current example is the mattress industry. In Business Week's 2007 list of"The Best (100) Small Companies to Watch," two of the companies, Select Comfort and Tempur -Pedic International, were mattress companies. Surprising, isn't it. Who would have thought that with all the high-tech and other interesting companies in the United States that two mattress companies would make the list? But a number of significant environ­ mental trends are working in favor of the industry.6 • Rising incomes have led to increased mattress sales at the high end of the market. • High shipping costs have limited imports (imports represent only of U.S. mattress industry sales). 2.9 percent • A recent upswing in hotel and motel construction has resulted in a spike in mattress demand from that sector. • There are approximately 2 .7 million hospital and nursing home beds in the United States. These facilities typically purchase high-end mattresses with enhancements that allow them to be electronically adjusted. As the popula­ tion ages, the health care market for mattresses will continue to expand. • An increased emphasis on wellness has created new markets for mattresses that will improve sleep quality and provide better neck and back support. • Technological improvements in spring design, foam usage, and overall construction of mattresses have stimulated additional demand for high­ quality mattresses. If you spend a few minutes browsing Select Comfort and Tempur-Pedic's Web sites, you'll see that they are tapping into these exact trends. An awareness of environmental trends can help start-ups better understand the industries they plan to enter and help them develop more successful businesses. This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. CHAPTER 5 • INDUSTRY AND COMPETITOR ANALYSIS Business Trends 149 Other trends impact industries that aren't environmental trends per se but are important to mention. For example, the firms in some industries benefit from an increasing ability to outsource manufacturing or service functions to lower-cost foreign labor markets, while firms in other industries don't share this advantage. In a similar fashion, the firms in some industries are able to move customer procurement and service functions online, at considerable cost savings, while the firms in other industries aren't able to capture this advantage. Trends like these favor some industries over others. One company that suffered as a result of not staying on top of environmental and business trends is Bath & Body Works, as illustrated in the "What Went Wrong?" feature. From 1993 to 2000 Bath & Body Works had a strong position in its industry. The company lost its way in the early 2000s largely because it took its success for granted and its competitors beat it to the punch in terms of reading changing environment and business trends. What Went WRONG? Bath & Body Works: How One Company Lost a Favorable Position m an Industry Once a company establishes a favorable position in Works' turf-and started offering fresh new products, an industry, it must remain vigilant or its position can like all-natural and organic compounds. Their stores be lost. This is what happened to Bath & Body Works were well organized and pleasant, with signature in the early 2000s. For over 10 years, the company music always playing. More importantly, they offered a had been selling, with great success, midprice body different approach to beauty than the homey approach and personal care products, primarily through stores offered by Bath & Body Works. Their product lines in malls. From 1993 to 2000, the company grew at an wove together elements of science, design, fitness, incredible rate of 51 percent per year, soaring to relaxation, and psychology, which resonated with con­ nearly $2 billion in annual sales. But then the bottom sumers. People were willing to spend a little more for fell out. The company's revenues dropped 19 percent their fresher and more sophisticated offerings, particu­ from 2000 to 2002, and it lost nearly 40 percent of its larly in the area of facial creams and makeup. At the pretax income. What went wrong? same time this was happening, Target, Wai-Mart, and The company simply missed a number of chang­ the other big-box retailers were nipping at Bath & Body ing industry trends and lost its favorable position in Works from the low end, particularly in the area of the marketplace as a result. Here's how it happened. Bath & Body Works was launched in 1990 by Leslie Wexner, founder of The Limited. The hunch was body lotions, soaps, and accessories. The big-box retailers started carrying products that looked just like those sold at Bath & Body Works, but were cheaper. that there was a favorable position in the health and As the result of these factors, Bath & Body Works beauty products market just waiting to be filled-a lost its edge and was no longer in a favorable position. position just above the drug store and just below the The company was outflanked by Aveda, Sephora, and department store in terms of pricing. Bath & Body others at the top end of the market and by Target, Works moved into this position and opened a chain of Wai-Mart, and others at the bottom end. To counter cheerful and wholesome stores, brimming over with its slipping sales, Bath & Body Works started to rely fruit- and flower-scented soaps, creams, oils, scented more and more on discounts, promotions, and sales. candles, and other accessories. For millions of shop­ According to Neil Fiske, the company's newly hired pers, Bath & Body Works' positioning was just right. It CEO, "In 2002, during our critical holiday time period, offered attractive and fun products at a price that was there were twenty-two in-store deals at Bath & Body high enough to be enticing but low enough to be Works. It was like a garage sale with deal signs all affordable. The company grew from 15 stores in 1990 over." Stated plainly, Bath & B ody Works lost the to more than 1,300 in 2000. favorable position it had occupied in the bath and By the year 2000, however, things had turned sour. beauty products industry for over 10 years. It was Competing retailers, such as Aveda, Sephora, and essentially stuck in the middle, with no discernible Origins began opening stores in malls-Bath & Body competitive advantage. (continued) This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. 150 PART 2 • DEVELOPING SUCCESSFUL BUSINESS IDEAS Fortunately, Bath & B ody Works' leaders recog­ nized its rapidly deteriorating plight and hired Neil Fiske, a Boston Consulting Group veteran, to revive the company and reestablish its position in the Body Works have taken to prevent the loss of its favorable position in the bath and beauty products marketplace in the early 2000s? 2. Look at the Web sites of Bath & Body Works and marketplace. Fiske started by reconnecting the com­ Sephora, one of the other firms mentioned in the pany with its customers and refashioning its product feature. How would you describe the positioning line based on more contemporary customer prefer­ differences between Bath & Body Works and ences and tastes. As a result, over time, a bevy of new Sephora today? Which firm do you think has the partners have been brought on board, enabling the most distinct positioning strategy? What industry company to enhance its product offerings and update trends do you think Sephora is relying on to its stores. Shoppers may now purchase many continue its positive momentum? non-Bath & Body Works brands in the stores, which 3. Why do you think Bath & Body Works seemed to has created a marketplace that brings together all get caught off-guard by emerging competition at kinds of offerings at many price points, to appeal to a the top end from Sephora and others and the broad cross section of mall shoppers. This new strategy seems to be working. The company is growing again and has returned to profitability. bottom end from Target and Wai-Mart? 4. Use Table 5.2 to complete an industry analysis on the bath and beauty products industry today. Is it an attractive industry? Would it be a good or poor industry for a start-up firm to enter? Questions for Critical Thinking 1. What specific industry trends did Bath & Body Works miss? What steps, if any, could Bath & Sources: Bath & Body Works homepage, www.bathandbody (accessed November 6, 2008); M. J. Silverstein and J. Butman, Treasure Hunt (New York: Portfolio, 2006). The Five Competitive Forces Model Learning The five competitive forces model is a framework for understanding the structure of an industry and was developed by Harvard professor Michael Porter. Shown in Objective Figure Identify the five 5.1, the framework is comprised of the forces that determine industry profitability ? These forces-the threat of substitutes, the entry of new competi­ competitive forces tors, rivalry among existing firms, the bargaining power of suppliers, and the that determine bargaining power of buyers-determine the average rate of return for the firms in industry profitability. an industry. Each of Porter's five forces impacts the average rate of return for the firms in an industry by applying pressure on industry profitability. Well-managed companies try to position their firms in a way that avoids or diminishes these forces-in an attempt to beat the average rate of return for the industry. For example, the rivalry among existing firms in the music industry is high. Blue Maze diminished the impact of this threat to its profitability by avoiding head­ to-head competition with the maj or record labels. FIGURE 5.1 - New entrants Forces That Determine j Industry Profitability Source: Reprinted with permission of The Free Press, Adult Publishing Group, from Techniques for Analyzing Industries and Competitors by Threat of new entrants Rivalry among existing firms a Division of Simon & Schuster Competitive Strategy: j Bargai ning power of suppliers Threat of substitutes Bargaining power of buyers Michael E. Porter. Copyright© 1980, 1998 by The Free Press. All rights reserved. This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. CHAPTER 5. INDUSTRY AND COMPETITOR ANALYSIS I n his book Competitive Advantage, Porter 151 points out that industry profitability is not a function of only a product's features. Although it was written in 1985 and the dynamics of the industries mentioned have changed, Porter's essential point continues to offer important insights for entrepreneurs: Industry profitability is not a function of what the product looks like or whether it embodies high or low technology but of industry structure. Some very mundane industries such as postage meters and grain trading are extremely profitable, while some more glamorous, high-technology industries such as personal computers and cable television are not profitable for many participants.8 The five competitive forces that determine industry profitability are described next. As mentioned in previous chapters, industry reports, produced by com­ panies like Mintel, IBISWorld, and Standard & Poor's NetAdvantage, provide substantive information for analyzing the impact of the five forces on specific industries. All three of these resources are available free through many univer­ sity library Web sites and are highlighted in the Internet Resources Table in Appendix 3.2. Threat of Substitutes In general, industries are more attractive when the threat of substitutes is low. This means that products or services from other industries can't easily serve as substitutes for the products or services being made and sold in the focal firm's industry. For example, there are few if any substitutes for prescription medicines, which is one of the reasons the pharmaceutical industry is so profitable. When people are sick, they typically don't quibble with the pharmacist about the price of a medicine. In contrast, when close substitutes for a product do exist, industry profitability is suppressed because consumers will opt not to buy when the price is too high. Consider the price of airplane tickets. If the price gets too high, businesspeople will increasingly utilize videoconferencing as a substitute for travel. This problem is particularly acute if the substitutes are free or nearly free. For example, if the price of express mail gets too high, people will increasingly attach documents to e-mail messages rather than sending them via UPS or FedEx. Actions such as these were becoming more common in late 2008, a time when there was a worldwide recession taking place. The extent to which substitutes suppress the profitability of an industry depends on the propensity for buyers to substitute alternatives. This is why the firms in an industry often offer their customers amenities to reduce the likeli­ hood of their switching to a substitute product, even in light of a price increase. Let's look at the coffee restaurant industry as an example of this. The coffee sold at Starbucks is relatively expensive. A consumer could easily find a less expen­ sive cup of coffee at a convenience store or brew coffee at home rather than pay more at Starbucks. To decrease the likelihood that customers will choose either of these alternatives, Starbucks offers high-quality fresh coffee, a pleasant atmosphere, and good service. Starbucks doesn't do this just so its customers don't go to a different coffee restaurant. It offers the service so its customers won't switch to substitute products as well. Although this strategy is still working for Starbucks, it isn't as effective as it once was, given Starbucks' slow­ down in growth in 2008 and 2009. Because of this slowdown, Starbucks was experimenting with offering less expensive coffees while maintaining its com­ mitment to quality and providing customers with a unique experience. Learning Objective Threat of New Entrants In general, industries are more attractive when the threat of entry is low. This means that competitors cannot easily enter the industry to copy what the industry incumbents are doing. There are a number Explain the role of "barriers to entry" in creating disincentives of ways that firms in an industry can keep the number of new entrants low. for firms to enter an These techniques are referred to as barriers to entry. A barrier to entry is a industry. This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. 152 PART 2 • DEVELOPING SUCCESSFUL BUSINESS IDEAS Starbucks doesn't just sell coffee. It also offers its patrons a convenient and pleasant place to meet, socialize, and study. Starbucks offers these amenities in part to decrease the likelihood that its customers will "substitute" their Starbucks coffee for a less expensive alternative. condition that creates a disincentive way for a new firm to enter an industry. 9 Let's look at the six major sources of barriers to entry: • Economies of scale: Industries that are characterized by large economies of scale are difficult for new firms to enter, unless they are willing to accept a cost disadvantage. Economies of scale occur when mass-producing a product results in lower average costs. For example, Intel has huge microchip factories that produce vast quantities of chips, thereby reducing the average cost of a chip. It would be difficult for a new entrant to match Intel's advantage in this area. There are instances in which the advantages of economics of scale can be overcome. For example, many microbreweries have successfully entered the beer industry by brewing their beer locally and relying on a local niche market clientele. This strategy counters the enormous economies of scale that national brewers like Anheuser-Busch and Miller have. • Product differentiation: Industries such as the soft-drink industry that are characterized by firms with strong brands are difficult to break into without spending heavily on advertising. For example, imagine how costly it would be to compete head-to-head against Pepsi or Coca-Cola. Another way of achieving differentiation is through exclusive licensing agreements. For example, in 2004, Electronic Arts inked a five-year exclusive deal with the National Football League, making it the only company that can produce electronic games involving NFL players, teams, or stadiums.10 • Capital requirements: The need to invest large amounts of money to gain entrance to an industry is another barrier to entry. The airline industry is characterized by large capital requirements, although JetBlue, which launched in 1999, was able to overcome this barrier and raise substantial funds by winning the confidence of investors through the strength of its business model and its management team. • Cost advantages independent of size: Entrenched competitors may have cost advantages not related to size that are not available to new entrants. Commonly, these advantages are grounded in the firm's history. For example, the existing competitors in an industry may have purchased land and equipment in the past when the cost was far less than new entrants would have to pay for the same assets at the time of their entry. This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. CHAPTER 5 • INDUSTRY AND COMPETITOR ANALYSIS • Access to distribution channels: Distribution channels are often hard to crack. This is particularly true in crowded markets, such as the conve­ nience store market. For a new sports drink to be placed on a convenience store shelf, it typically has to displace a product that is already there. • Government and legal barriers: In knowledge-intensive industries, such as biotechnology and software, patents, trademarks, and copyrights form major barriers to entry. Other industries, such as banking and broadcasting, require the granting of a license by a public authority. When a new firm tries to enter an industry with powerful barriers to entry, it must have a plan to overcome those barriers. Scott McNealy, the cofounder of Sun Microsystems, says that Sun was able to overcome the barriers to entry in many of its industries primarily through a program of partnering with other firms: Initially, Sun's business model was no different from that of its rivals. We wanted to beat our competitors, grow internally, build manufacturing plants, create new distribution channels, acquire promising new start-ups, and so on. What happened was that we realized we couldn't do it alone. The markets were vast, our competitors were huge, barriers to entry to some segments were overwhelming, we didn't have enough cash, and the pace of change in the industry was too fast. What we did was purely instinctive. We reached out to other companies that could help us. We lever­ aged their expertise and specialty products by forming strategic alliances. 11 When start-ups create their own industries or create new niche markets within existing industries, they must create barriers to entry of their own to reduce the threat of new entrants. It is difficult for start-ups to create barriers to entry that are expensive, such as economies of scale, because money is usually tight. The biggest threat to a new firm's viability, particularly if it is creating a new market, is that larger, better-funded firms will step in and copy what it is doing. The ideal barrier to entry is a patent, trademark, or copyright, which prevents another firm from duplicating what the start-up is doing. Apart from these options, however, start-ups have to rely on nontraditional barriers to entry to dis­ courage new entrants, such as assembling a world-class management team that would be difficult for another company to replicate. A list of nontraditional barriers to entry, which are particularly suited to start-up firms, is provided in Table 5.1. Rivalry Among Existing Firms In most industries, the major determinant of industry profitability is the level of competition among the firms already com­ peting in the industry. Some industries are fiercely competitive to the point where prices are pushed below the level of costs. When this happens, industry­ wide losses occur. In other industries, competition is much less intense and price competition is subdued. For example, the personal computer industry is so competitive that profit margins are extremely thin. ASUSTeK Computer, for example, was selling its Eee PC laptop for $300 toward the end of 2008.12 In contrast, the market for specialized medical equipment is less competitive, and profit margins are higher. There are four primary factors that determine the nature and intensity of the rivalry among existing firms in an industry: • Number and balance of competitors: The more competitors there are, the more likely it is that one or more will try to gain customers by cutting prices. Price-cutting causes problems throughout the industry and occurs more often when all the competitors in an industry are about the same size and when there is no clear market leader. • Degree of difference between products: The degree to which products differ from one producer to another affects industry rivalry. For example, This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. 153 154 PART 2 • DEVELOPING SUCCESSFUL BUSINESS IDEAS Table 5.1 NONTRADITIONAL BARRIERS TO ENTRY Explanation Barrier to Entry Strength of management team Example If a start-up puts together a world-class management team, it JetBiue may give potential rivals pause in taking on the start-up in its chosen industry. If a start-up pioneers an industry or a new concept within an First-mover advantage Facebook existing industry, the name recognition the start-up establishes may create a formidable barrier to entry. Passion of management team If the key employees of a start-up are highly motivated by its and employees unique culture, are willing to work long hours because of their Amgen belief in what they are doing, and anticipate large financial gains through stock options, this is a combination that cannot be replicated by a larger firm. Think of the employees of a biotech firm trying to find a cure for a disease. Unique business model If a start-up is able to construct a unique business model and Dell establish a network of relationships that make the business model work, this set of advantages creates a barrier to entry. Some Internet domain names are so "spot-on" in regard to Internet domain name a specific product or service that they give a start-up a meaningful leg up in terms of e-commerce opportunities. Think of,, and Inventing a new approach to If a start-up invents a new approach to an industry and an industry and executing the idea in an exemplary fashion Wikipedia executes it in an exemplary fashion, these factors create a barrier to entry for potential imitators. commodity industries such as paper products producers tend to compete Learning on price because there is no meaningful difference between one manufac­ Objective turer's products and another's. Identify the nontradi­ tional barriers to entry that are especially • Growth rate of an industry: The competition among firms in a slow­ growth industry is stronger than among those in fast-growth industries. associated with Slow-growth industry firms, such as insurance, must fight for market entrepreneurial firms. share, which may tempt them to lower prices or increase quality to get customers. In fast-growth industries, such as pharmaceutical products, there are enough customers to go around to fill the capacity of most firms, making price-cutting less likely. • Level of ilXed costs: Firms that have high fixed costs must sell a higher volume of their product to reach the break-even point than firms with low fixed costs. Once the break-even point is met, each additional unit sold contributes directly to a firm's bottom line. Firms with high fixed costs are anxious to fill their capacity, and this anxiety may lead to price-cutting. Bargaining Power of Suppliers I n general, industries are more attractive when the bargaining power of suppliers is low. In some cases, suppliers can suppress the profitability of the industries to which they sell by raising prices or reducing the quality of the components they provide. If a supplier reduces the quality of the components it supplies, the quality of the finished product will suffer, and the manufacturer will eventually have to lower its price. If the suppliers are powerful relative to the firms in the industry to which they sell, industry profitability can suffer.13 For example, Intel, with its Pentium chip, is a powerful supplier to the PC industry. Because most PCs feature Pentium chips, Intel can command a premium price from the PC manufacturers, thus This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. CHAPTER 5 • INDUSTRY AND COMPETITOR ANALYSIS directly affecting the overall profitability of the PC industry. Several factors have an impact on the ability of suppliers to exert pressure on buyers and sup­ press the profitability of the industries they serve. These include the following: • Supplier concentration: When there are only a few suppliers to provide a critical product to a large number of buyers, the supplier has an advan­ tage. This is the case in the pharmaceutical industry, where relatively few drug manufacturers are selling to thousands of doctors and their patients. • Switching costs: Switching costs are the fixed costs that buyers encounter when switching or changing from one supplier to another. If switching costs are high, a buyer will be less likely to switch suppliers. For example, suppliers often provide their largest buyers with specialized software that makes it easy to buy their products. After the buyer spends time and effort learning the supplier's ordering and inventory manage­ ment systems, it will be less likely to want to spend time and effort learning another supplier's system. • Attractiveness of substitutes: Supplier power is enhanced if there are no attractive substitutes for the products or services the supplier offers. For example, there is little the computer industry can do when Microsoft and Intel raise their prices, as there are relatively few if any practical substitutes for these firms' products. • Threat of forward integration: The power of a supplier is enhanced if there is a credible possibility that the supplier might enter the buyer's industry. For example, Microsoft's power as a supplier of computer operating systems is enhanced by the threat that it might enter the PC industry if PC makers balk too much at the cost of its software or threaten to use an operating system from a different software provider. Bargaining Power of Buyers In general, industries are more attractive when the bargaining power of buyers (a start-up's customers) is low. Buyers can suppress the profitability of the industries from which they purchase by demanding price concessions or increases in quality. For example, even in light of the problems it encountered in 2008 and 2009, the automobile industry remains dominated by a handful of large automakers that buy products from thousands of suppliers in different industries. This enables the automakers to suppress the profitability of the industries from which they buy by demanding price reductions. Similarly, if the automakers insisted that their suppliers pro­ vide better-quality parts for the same price, the profitability of the suppliers would suffer. Several factors affect buyers' ability to exert pressure on suppliers and suppress the profitability of the industries from which they buy. These include the following: • Buyer group concentration: If the buyers are concentrated, meaning that there are only a few large buyers, and they buy from a large number of suppliers, they can pressure the suppliers to lower costs and thus affect the profitability of the industries from which they buy. • Buyer's costs: The greater the importance of an item is to a buyer, the more sensitive the buyer will be to the price it pays. For example, if the component sold by the supplier represents 50 percent of the cost of the buyer's product, the buyer will bargain hard to get the best price for that component. • Degree of standardization of supplier's products: The degree to which a supplier's product differs from its competitors' affects the buyer's bargaining power. For example, a buyer who is purchasing a standard or undifferentiated product from a supplier, such as the corn syrup that goes This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. 155 156 PART 2• DEVELOPING SUCCESSFUL BUSINESS IDEAS into a soft drink, can play one supplier against another until it gets the best combination of features such as price and service. • Threat of backward integration: The power of a buyer is enhanced if there is a credible threat that the buyer might enter the supplier's industry. For example, the PC industry can keep the price of computer monitors down by threatening to make its own monitors if the price gets too high. The bargaining power of buyers is such a pervasive threat that some new ventures opt out of particular industries when the extent of the bargaining power of buyers becomes clear. This scenario changed the course of history for the Sony Corporation, as explained in the boxed feature titled "Savvy Entrepreneurial Firm." Savvy Entrepreneurial F I R M How the Bargaining Power of Buyers Changed the Fate of Sony in Its Start-Up Years There are many variables that shape a company in its decided that Sony would go after the consumer market. start-up years, but perhaps none are as powerful as "In other words, we decided to do business with Porter's five forces. Many companies, for example, unspecified millions of individuals instead of with a spe­ establish strong brands or differentiate themselves in cific few. On this basis we started to produce the first creative ways, primarily to establish barriers to entry and tape recorders and tapes in Japan," Morita later recalled. stem the tide of new entrants. Other companies, such This remarkable story illustrates the compelling as Starbucks and Barnes & Noble, offer amenities in nature of the real bargaining power of buyers. This clout their places of business to discourage customers from is most formidable when there are only a few buyers switching to less expensive substitute products. The and many sellers. Morita redirected Sony's entire future story of Sony, however, tops them all. When Sony was a to avoid this threat. Today, as it has throughout the start-up, it changed its entire approach to doing majority of its history, Sony's future lies in the hands of business as the result of the bargaining power of the millions of people who buy its products rather than buyers. In fact, if Sony hadn't responded to this threat in in the hands of just a few powerful buyers. the way it did, it wouldn't be a household name today. Sony was established in 1946 by Masaru lbuka and Akio Morita, two Japanese businessmen, to make com­ munication equipment for the reconstruction of Japan after World War II. One thing lbuka and Morita learned quickly was that to make a sale, they had to win the confidence of the purchasing officers in the government agencies with whom they were dealing. This task often proved difficult, but their hard work typically paid off in orders from these purchasing officers. One day, how­ ever, early in the life of Sony, a purchasing agent who Morita had worked particularly hard to win over was transferred to a new position. This was frustrating to Morita because he had to start from square one to win the confidence of the purchasing officer's replacement. After this scenario repeated itself several times, Morita considered the problem. While he liked the fact that large orders could be granted by the purchasing agents of government agencies and large firms, he was leery of the fact that Sony's sales hinged on the decisions of such a small number of people. After dis­ cussing this concern with lbuka, Morita decided to take Sony in a different direction. Instead of placing the future of Sony in the hands of a few purchasing agents, Morita Questions for Critical Thinking 1. Analyze the electronics industry using Porter's five forces model. What do you think are the biggest threats to the electronics industry today? What is Sony doing to try to deter these threats? 2. Think of examples of at least two other companies that are in industries that are subject to the strong bargaining power of buyers. Do you think the profitability of these firms is being suppressed by the strong bargaining power of their buyers? What, if anything, can these firms do to neutralize this threat? 3. How would you describe Sony's positioning strategy in the electronics industry? 4. What single industry do you think suffers the most from the bargaining power of buyers? How about the bargaining power of suppliers? Are entrepreneurial start-ups able to enter these industries? If so, how? Source: A. Morita, "Moving Up in Marketing by Getting Down to Basics," in The Book of Entrepreneurs' Wisdom, ed. Peter Krass (New York: John Wiley & Sons, 1999), 315-23. Reproduced with the permission of John Wiley & Sons, Inc. This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. CHAPTER 5 8 INDUSTRY AND COMPETITOR ANALYSIS The Value of the Five Forces Model Along with helping a firm understand the dynamics of the industry it plans to enter, the five forces model can be used in two ways: (1) to help a firm deter­ mine whether it should enter a particular industry and (2) whether it can carve out an attractive position in that industry. Let's examine these two positive outcomes. First, the five forces model can be used to assess the attractiveness of an industry or a specific position within an industry by determining the level of threat to industry profitability for each of the forces, as shown in Table 5.2. This analysis of industry attractiveness should be more in-depth than the less rigorous analysis conducted during feasibility analysis. For example, if a firm filled out the form shown in Table 5.2 and several of the threats to industry profitability were high, the firm may want to reconsider entering the industry or think carefully about the position it will occupy in the industry. In the restaurant industry, for example, the threat of substitute products, the threat of new entrants, and the rivalry among existing firms are high. For certain restaurants, such as fresh-seafood restaurants, the bargaining power of sup­ pliers may also be high (the number of seafood suppliers is relatively small compared to the number of beef and chicken suppliers). Thus, a firm that enters the restaurant industry has several forces working against it simply because of the nature of the industry. To help sidestep or diminish these threats, it must establish a favorable position. One firm that has accomplished this is Panera Bread, as discussed in Case 5.1 in this chapter. By studying the restaurant industry, Panera found that some consumers have tired of fast food but don't always have the time to patronize a sit-down restaurant. To fill the gap, Panera helped to pioneer a new category called "fast casual," which combines relatively fast service with high-quality food. Panera has been very successful in occupying this unique position in the restaurant industry. You'll learn more about Panera Bread's success while reading Case 5.1. The second way a new firm can apply the five forces model to help determine whether it should enter an industry is by using the model Table 5.2 DETERMINING THE ATTRACTIVENESS OF AN INDUSTRY USING THE FIVE FORCES MODEL Threat to Industry Profitability Competitive Force Low Medium High Threat of substitutes Threat of new entrants Rivalry among existing firms Bargaining power of suppliers Bargaining power of buyers Instructions: Step 1 Step 2 Select an industry. Determine the level of threat to industry profitability for each of the forces (low, medium, or high}. Step 3 U se the table to get an overall feel for the attractiveness of the industry. Step 4 Use the table to identify the threats that are most often relevant to industry profitability. This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. 157 158 PART 2 • DEVELOPING SUCCESSFUL BUSINESS IDEAS Panera Bread offers a variety of alternatives to the typical burger and fries offered at many fast-food restaurants. In addition to a selection of fresh baked bread, Panera is also known for bagels, pastries, soups, sandwiches, salads, and coffee. p ictured in Figure 5.2 to answer several key questions. By doing so, a new Learning venture can assess the thresholds it may have to meet to be successful Objective in a particular industry: List the four industry­ Question 1: I s the industry a realistic place for our new venture to related questions to ask enter? before pursuing the idea tiveness of an industry, as depicted in Table 5.2, and by assessing for a firm. T his question can be answered by looking at the overall attrac­ whether the window of opportunity is open. It is up to the entrepreneur to determine if the window of opportunity for the industry is open or closed. FIGURE 5.2 - Question 2: If we do enter the industry, can our firm do a better job Using the Five Forces Model to Pose Questions to Determine the Potential Success of a New Venture the forces that suppress industry profitability? Is the industJy a realistic place for a new venture? No than the industry as a whole in avoiding or diminishing the impact of A new venture can enter an industry with a fresh brand, innovative ideas, and a world-class manage­ ment team and perform better than the industry incumbents. This was the Yes Are there areas in which we can avoid or diminish the factors that suppress industry profitability? Yes Is there a unique position in the industry that avoids or diminishes the factors that suppress industry profitability? No Reconsider new venture. Is there a superior business model that industry incumbents would find hard to duplicate? This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. CHAPTER 5 • INDUSTRY AND COMPETITOR ANALYSIS 159 case when Google entered the Internet search engine industry and displaced Yahoo! as the market leader. Outperformance of industry incumbents can also be achieved if a new venture brings an attractive new product to market that is patented, preventing others from duplicating it for a period of time. Q uestion 3: I s there a unique position in the industry that avoids or diminishes the forces that suppress industry profitability? As we've described, this is the advantage that both BusinessesAtoZ and Panera Bread have captured. Question 4: Is there a superior business model that can be put in place that would be hard for industry incumbents to duplicate? Keep in mind that the five forces model provides a picture of an industry "as is," which isn't necessarily the way a new venture has to approach it. Sometimes the largest firms in an industry are trapped by their own strategies and contrac­ tual obligations, providing an opening for a start-up to try something new. For example, when Dell started selling computers directly to consumers, its largest rivals-Hewlett-Packard, Compaq, and IBM-were not able to respond. They were locked into a strategy of selling through retailers. If they had tried to mimic Dell and sell directly to end users or customers, they would have alienated their most valuable partners-retailers such as Sears, and Best Buy. However, with the passage of time, Dell's competitors have learned how to effectively and efficiently sell directly to consumers, largely erasing Dell's historic advantage in the process of doing so. The steps involved in answering these questions are pictured in Figure 5.2. If the founders of a new firm believe that a particular industry is a realistic place for their new venture, a positive response to one or more of the questions posed in Figure 5.2 i ncreases the likelihood that the new venture will be successful. Industry Types and the Opportunities T hey Offer Along with studying the factors discussed previously, it is helpful for a new venture to study industry types to determine the opportunities they offer.14 The five most prevalent industry types, depicted in Table 5.3, are emerging indus­ tries, fragmented industries, mature industries, declining industries, and global industries.15 There are unique opportunities offered by each type of industry. Emerging Industries I An emerging industry is a new industry in which standard operating procedures have yet to be developed. The firm that pioneers or takes the leadership of an emerging industry often captures a first-mover advantage. A first-mover advantage is a sometimes insurmountable advan­ tage gained by the first significant company to move into a new market. Because a high level of uncertainty characterizes emerging industries, any opportunity that is captured may be short-lived. Still, many new ventures enter emerging industries because barriers to entry are usually low and there is no established pattern of rivalry. Fragmented Industries A fragmented industry is one that is characterized by a large number of firms of approximately equal size. The primary opportu­ nity for start-ups in fragmented industries is to consolidate the industry and establish industry leadership as a result of doing so. The most common way to do this is through a geographic roll-up strategy, in which one firm starts acquiring similar firms that are located in different geographic areas.16 This is what Blockbuster did in the video rental industry. Prior to Blockbuster's arrival, thousands of small video stores were scattered throughout the United This document is authorized for use by Chetna mehra, from 12/19/2011 to 5/19/2012, in the course: MGMT 472: Entrepreneurship and Small Business - Turner (Spring 2012), University of South Carolina. Any unauthorized use or reproduction of this document is strictly prohibited. Learning Objective Identify the five primary industry types and the opportunities they offer. ...
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This note was uploaded on 01/11/2012 for the course MGMT 472 taught by Professor Turner during the Spring '11 term at South Carolina.

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