Industry Analysis

Introduction to Industry Analysis

In this video, we are introduced to the industry analysis framework developed by Michel Porter. The purpose of the framework is to analyze the competitive forces that shape an industry and evaluate the extent to which they threaten profitability.

What is an Industry?

• An industry represents a set of companies that do the same jobs for customers in essentially the same ways.

• Different industries have different players, and companies that do different jobs for customers or that do similar jobs in different ways belong outside of the circle.

Identifying Direct Exchange Partners

• When focusing on one specific industry, we can identify direct exchange partners: buyers and suppliers.

• Companies purchase products and services from their suppliers, then transform those products and services into new products and services that they sell to buyers.

• The majority of value flows into an industry through its buyers.

Traditional Industry Analysis Tools

• Traditional industry analysis tools help assess the average profitability of an industry rather than individual companies within it.

• Five forces shape industries: rivalry, buyer power, supplier power, threat of entrants, and threat of substitutes.

• Recently scholars have suggested a sixth force: complements.

Rivalry

• Rivalry captures the extent to which competition between competitors enhances or destroys industry profitability.

• Industries typically have higher rivalry when there are many competitors, high product standardization, low growth rate, production overcapacity or high exit barriers.

Conclusion

This video has introduced us to Michel Porter's industry analysis framework. We learned what constitutes an industry and how direct exchange partners operate within it. We also learned about traditional industry analysis tools such as five forces shaping industries with a recent addition being complements. Finally we discussed how rivalry affects industry profitability.

Porter's Five Forces

In this section, the speaker discusses Porter's Five Forces framework and how it affects industry profitability.

Price-Based Competition vs. Differentiated Food Offerings

• McDonald's competes on price for bargain shopping customers.

• Fast casual dining companies like Chipotle and Five Guys compete on differentiated food offerings.

• Price-based competition is rare in the fast casual dining segment.

Threat of Entrance

• The threat of entrance captures the extent to which new companies entering the industry enhances or destroys industry profitability.

• Industries have higher threats to average profits when they have low scale economies, low capital costs of entry, less brand awareness, low buyer switching costs, or few regulations.

• New entrants come in and fight to gain market share when it is very low cost for companies to enter the industry.

Buyer Power

• Buyer power captures the extent to which customers have power to negotiate for more value and/or lower prices.

• Buyers tend to have more power when there are fewer buyers than companies in the industry, low switching costs, easy backward integration, or high price sensitivity.

• Buyers can use their power to demand better products and services and/or lower prices.

Supplier Power

• Supplier power captures the extent to which suppliers have power to negotiate for higher prices from companies in our industry.

• Suppliers tend to have more power when there are fewer suppliers than competitors in the industry, costly switching away from supplier products/services, or easy forward integration.

• Suppliers can force companies in an industry to pay whatever they want if they hold significant supplier power relative to that industry.

Threat of Substitutes

• The threat of substitutes captures the extent to which other companies do the same job as your company but in different ways.

• The threat of substitutes is higher when customers are highly aware of the substitutes, they are low priced, their performance is high, and customer switching costs are low.

• Substitutes represent a threat to the industry because they do the same core job but in different ways.

Existence of Complements

• The existence of complements captures the extent to which other products and services increase demand for the job customers hire your industry to do.

• Complements enhance industry profits when customers perceive higher value in consuming your products in a bundle, when compliments are available at attractive prices, and when the performance of compliments is high.

• Complements can change demand for an industry's products/services based on how much consumers value them.

How Forces Affect Industry Profits

• All revenues enter an industry from customers.

• How much money each customer pays for each product depends on the relative bargaining power of buyers and competitors in the industry.

• Powerful buyers can negotiate for lower prices.

Industry Analysis Framework

In this section, the speaker explains how to use the industry analysis framework to examine the overall profitability of an industry and make company-level decisions to increase performance.

Forces Affecting Industry Profits

• Buyer power and supplier power affect the flow of cash into and out of the industry through bargaining for lower or higher prices respectively.

• Complements and substitutes affect industry profits by impacting the total number of buyers feeding cash into our industry. Substitutes peel some buyers away while complements attract more customers.

• Rivalry and threat of entrants determine how aggressively each company needs to fight for its share of the cash. If entry barriers are low, new companies enter our industry and claim some available revenues.

Pair of Forces

• Buyer power & supplier power are a pair of forces because they both affect the flow of cash into and out of the industry.

• Complements & substitutes are a pair of forces because they both impact the total number of buyers who come to our industry.

• Rivalry & threat of entrance are a pair of forces because both affect how aggressively existing competitors fight with each other for market share.

Impact on Company-Level Decisions

• Industry analysis gives you a framework to examine overall profitability in order to help you understand what company-level decisions to make in order to increase your performance within your industry.

Conclusion

The speaker concludes by stating that using this framework can generate useful insights for your company.