Analyzing an Industry
INTRODUCTION
that compete directly with each other
We tend to think of an industry as a group of companies or orga-
nizations
in the market-
place. Although intuitive,
the simplicity of this definition masks a
complex issue. ln maTIr instances, an industry caTIbe reasonably
defined in more than one way. Do makers of facsimile machines
compete with each other, with manufacturers
of personal comput-
ers and PDAs, with telephone
companies, with the us. Postal
Service and overnight delivery companies, or with aIl of them? Is
competition primarily between products, companies, or networks
of alliance partners? Should we analyze rivalry at the business
level? Should we distinguish
unit
between regional competition and global rivalry? As these ques-
tions suggest, deciding on industry
ln
addition, misspecification of ~n industry caTIbe extremely costly.
The use of tao narrow a definition caTIlead to strategie myopia
or
and cause executives
threats, such as would occur
to be
competing with other railroads. The use of tao broad a definition,
such as identifying a firm's industry simply as "high technology,"
could prevent
of the competitive
environment.
if railroads were judged
to overlook important
the corporate
a meaningful
opportunities
level or at
is diffieult.
assessment
boundaries
77
WHAT Is AN INDUSTRV?
in terms
(2) customers,
is best defined
of four dimensions:
(3) geography, and (4) stages in the
An industry
(1) products,
production-distribution pipeline.! The first dimension-products-
function and
caTIbe further broken clown into two components:
technology. Function refers to what
the product or service does.
Saille cooking appliances bake. Others bake and roast. Still others
fry or bail. Functionality caTIbe actual or perceived. Saille over-
the-counter
for example, are posi-
tioned as cold relievers, whereas others with similar chemieal
are promoted as aIlergy medicines. The difference
formulations
as of actual
is as mu ch a matter of positioning
and perception
factor: Saille
functionality. Technology is a second distinguishing
use gag, whereas others are electrie; Saille
cooking appliances
cold remedies
are available in liquid form, whereas others are
sold in.gel capsules.
remedies for nasal congestion,
compete
ln addition,
to distinguish
of aIl of these dimensions.
Defining an industry's boundaries
and the market(s) it serves. For example,
requires the simultaneous
it is impor-
consideration
between the industry in whieh a company
tant
a company
competes
might
industry but
in the large kit chen appliance
choose refrigerators as its served market. This caTIbe depicted as a
collection of (adjacent) three-dimensional
by a partieular
materials,
industry,
cells that are most relevant
cells, each characterized
technologies/
an
the group of market
therefore, consists of identifying
to the firm' s strategie analysis.
and types of customers.
The task of defining
of functions/uses,
combination
it is often
ln the process of generating strategie alternatives,
industry
definitions. Assessing a com-
for example, might require the use of a
definition than assessing its current
helpful
to use multiple
pany' s growth potential,
different
relative cost position.
industry /market
Industry Structure and Porter's Five Forces Model
Miehael Porter's five forcesmodel is a useful tool for industry and
competitive analysis.2 It holds that an industry's profit potential
78
Strategy: A View from the Top
Figure
4-1
Porter's Five Forces Madel
Threat01
new entrants
Industry
Bargaining power
01 suppliers
1 Suppliers 1
.
power
competitorsu Bargaining
Il
01 buyers
Rivalryamong
existing lirms
1 Buyers 1
Threat 01
substitute products
or services
Source:Reprinted with the permission of TheFreePress,an imprint of Simon & Schuster Adult
Publishing Group, from Competitive Strategy: Techniquesfor Analyzing Industries and Competitors by
Michael E. Porter. Copyright @ 1980, 1998 by The Free Press.
is largely determined
by the intensity of the competitive rivalry
in
industry,
within that
in turn,
and that
terms of five forces: (1) the threat of new entrants, (2) the bargaining
power of customers, (3) the bargaining power of suppliers, (4) the
threat of substitute products or services, and (5) the jockeying among
current rivaIs (Figure 4-1).
is explained
rivalry,
The Threat of Entry
When it is relatively easy to enter a market, an industry caTIbe
expected
new entrants
competitive.
to be highly
threaten to increase the industry's
capacity, to intensif y the fight
the balance between demand and
for market share, and to upset
on (1) what
supply. The likelihood
barriers
are
likely to react.
to entry exist and (2) how entrenched
of new entrants
competitors
Potential
depends
Charter 4 Analyzing an Industry
79
III
III
(1) economies
(3) capital
of
There are six major barriers
to market entry:
channels,
for example,
the difficulty
differentiation
(brand equity),
that are independent
(4) cost disadvantages
(5) access to distribution
of scale, (2) product
requirements,
and (6) government
size,
of entering
regulations. Consider,
Publicité
the soft drink industry and competing with advertising
giants
such as Coca-Cola and Pepsi Cola or the plight of microbrew-
for their brands of beer against
ers trying to gain distribution
major companies
industries,
serve
however, and cause strategie windows
up. A prime
ex ample
deregulated
industries.
ln high-technology
experience
caTI change,
to open
is deregulation. When airlines were
the
in the 1980s, new carriers were able to enter
su ch as Anheuser-Busch.
as major barriers.
and accumulated
of opportunity
requirements
conditions
Industry
capital
influence
competition
Powerful Suppliers and Buyers
Buyers and suppliers
exerting pressure over priees, quality, or the quantity demanded
or sold. Soft drink bottIers, for example, suffered a damaging ero-
sion of their profit margins when concentrate producers dramat-
ieally raised priees in the late 1980s and bottIers could not pass
the increases on to consumers because of tierce competition at the
retaillevel.
in an industry by
Generally, suppliers
and they are more concentrated
are more powerful when (1) there are a
th an
few dominant
companies
supplied is differen-
the industry they serve; (2) the component
(3) there
tiated, making switching
are few substitutes;
and
(5) the industry generates but a small portion of the suppliers'
revenue base.
among suppliers
caTI integrate
(4) suppliers
diffieult;
forward;
Buyers have substantial
them and/ or they buy in large volume;
relatively
suppliers;
of the sellers'
backward.
undifferentiated,
(3) the buyers' purchases
revenues;
power when (1) there are few of
is
making it easy to switch to other
a sizable portion
caTI integrate
represent
and (4) buyers
(2) the product
total
80
Strategy: A View from the Top
and services
are substitutes
products
and,
Substitute Products and Services
continu aIly threaten most
Substitute
in effect, place a lid on prices and profitability.
industries
reniai
to the movie
HBO. and pay-per-view
the industry can charge for ifs
business and effectively limit what
services. Moreover, when cost structures
for
example, by employing new technology, substitutes can take sub-
share frOID existing businesses. The increased
stantial market
over cable networks,
availability of pay-per-view entertainment
of movie reniai
for example,
substitute
companies. From a strategic perspective,
products or services that deserve the closest scrutiny are those
that (1) show improvements
relative to the
industry average and (2) are produced by companies with deep
rackets.
in price performance
can be changed,
the competitive
therefore,
position
erodes
prowess
the industry's
relative size, and competitive
Riva/rv Among Participants
The intensity of competition in an industry also depends on the
number,
of its partici-
growth rate; and related characteristics.
pants;
are numer-
Intense rivalry can be expected when (1) competitors
OtiSand relatively equal in size and power; (2) industry growth is
slow and the competitive battle is more about existing customers
than about creating new customers;
(3) fixed costs are high or the
(4) capacity increases are secured
product or service is perishable;
in large increments;
are high, making it
prohibitively expensive to discontinue operations.
and (5) exit barriers
need software,
Andrew Grove, founder of Intel, has suggested adding a sixth
the influence of complementary products.
force to Porter's model:
Computers
and software needs ha..rdware; cars
need gasoline, and gasoline needs cars. When the interests of the
the status quo
industry are aligned with those of complementors,
can
is preserved. However,
to
upset
diverge.3 An example
which renders
incompatible.
the existing order and cause complementors'
paths
standards,
and services
is a change in technological
new technologies
or approaches
compatible
previously
products
Charter 4 Analyzing an Industry
81
-
components,
to streamline
this enhances
about products
access to information
and ancillary services. To
The influence of these forces continues
to shift as industry
structures and business models change. For example, companies
are increasingly using the Internet
their procure-
ment of raw materials,
the extent
and services and facilitates the valuation of alternate sources of
supply,
over
it increases the bargaining power of manufacturers
the saille technology might reduce barriers
suppliers. However,
to entry for new suppliers and provide them with a direct chan-
l\~\ \\) ~l\\\. \\~~l~, \\wx~\)~ l~d.\\,-\.\\~ \\\~ \~'l~\.à.~e. ai mtex.me.di-
of
aries. The effect of
substitute products
and services is equally ambiguous. On the
one hand, by increasing efficiency, it can expand markets. On the
the threat
other hand, as new uses of the Internet are pioneered,
rapid
of substitutes
spread
rivalry
among
This has
business models generally are
occurred because Internet-based
hard to protect
they often are
Publicité
and, because
frOID imitation
focused on reducing
they create an unwanted
focus on price. Thus, although the Internet does not fundamen-
tally alter the nature of the forces affecting industry
changes
attractiveness. 4
to entry and increased
in many
increases. At the saille time,
has reduced
existing
barriers
competitors
relative influence
on the possible
the Internet's
the Internet
on industry
profitability
industries.
it
and
variable
rivalry,
threat
costs,
their
INDUSTRY
EVOLUTION
-.. --
change over time. Entry barriers can faU, as
of industries where brand
competitive weapon. Sometimes
Industry structures
in the case of deregulation, or rise considerably, as has happened
an
in a number
important
become
IDOIe collcentrated as real or perceived benefits of scale and
to consoIidate. Models of indusfry evofu-
score cause businesses
change
lion cafl help us understand
over time. Perhaps the ward evolution is somewhat deceptive;
it
suggests
change
change. Structural
rapidity, as in the case when a major
can occur with remarkable
a process of slow, graduaI
how and why industries
industries
identity
became
82
Strategy: A View from the Top
technological
companies at the expense 'of others.
breakthrough
enhances
the prospects
of some
Four Trajectories of Changes
industries
that
trajectories of change:
evolve according to one
A recent study suggests
of four distinct
cre-
radical, progressive,
ative, and intermediating. Two types of obsolescence define these
paths of change: (1) a threat to an industry's coreactivities,which
account for a significant portion of an industry's profits: and (2) a
core assets, which are valued as differen-
threat
tiators. The steady decrease in importance
tradi-
tional sales activities as online shopping has increased is a good
example of the first
type of obsolescence. The eroding brand
value of many prescription drugs in the face of generic competi-
tion illustrates the second.
to the industry's
of a dealer's
Figure 4-2 shows the relationship between these two types of
obsolescence and the four trajectories of industry change. Radical
change occurs when an industry is threatened with obsolescence
Figure
4-2
Trajectories of Industry Change
Core Activities
Threatened
Not Threatened
Radical
Change
Creative
Change
(Travel agencies)
(Movie studios)
Intermediating
Change
(Museums)
Progressive
Change
(Trucking)
.!!!
Q)
en
en
<t:
Q)
0
()
"0
Q)
c:
Q)
ai
L:
1-
"0
Q)
c:
Q)
ai
Q)
.c
1-
ë
z
Source:Reprinted by Permission of Harvard BusinessReview.From "How Industries Change" by
A. M. McGahan, 10/04. Copyright @ 2004 by the Harvard Business School Publishing Corporation;
aIl rights reserved.
Charter 4 Analyzing an Industry
83
and core a~sets at
the saille time.
of both its core activities
in the travel business
as an
McGahan cites the major changes
example. As airlines modernized
and began to compete more
directly with enhanced reserveition systems, and corporate travel
providers
clients
such as
service
Expedia and Travelocity, many traditional
travel agents had to
themselves as a matter of survival.
reinvent
to lnternet-based
turned
Progressive changé
form of
caI1 be expected wh en neither
is imminent. This is the most common form of
has seen
has remained
and
strategies
through
change. The long-haul
its fundamental
ln such environments,
often are targeted at increased efficiencies
value proposition
competitive
obsolescence
industry
changes, but
the saille.
innovation
scale and cost reduction.
truc king industry
Creative and intermediating change paths are defined by the
dominance of one of the two forfis of obsolescence. Under cre-
the core assets are threatened, but the core activities
ative change,
this scenario calls for the renewal
retain their value. StrategicaIly,
to produce
of asset values;
another
the core
blockbuster. Under
are threatened.
as sets remain valuable, but
Museums are highly valuable as repositories of art, for example,
but modern communication methods have reduced their power
as educators.
intermediating
the core activities
think of a movie
studio having
change,
Publicité
Industry Structure, Concentration,
and Product Differentiation
It is often useful to analyze changes in industry structure in terms of
the movement
froID a primarily vertical to a more horizontal struc-
ture, or vice versa; changes in the degree of industry concentration;
and increases or decreases in the degree of product differentiation.
convergence
apart-
dimensions
These
industries
of three
and television. This conver-
telecommunications,
industry in which
gence has spawned an integrated multimedia
traditional
lnstead
industry boundaries have aIl but disappeared.
of consisting of three distinct businesses in which being vertically
that originated
computers,
some 50 years
illustrated
by the
are
84
Strategy: A View from the Top
functionality),
integrated was key to success, the industry has evolved into five
primarily horizontal segmènts in which businesses can successfully
compete: content (products and services), packaging (bundling of
the network (physical infra-
content and additional
structure),
transmission (distribution), and display devices. ln this
new structure, strategie advantage for many companies is primar-
by their relative positions within one of the five
ily determined
segments. However, vertical
is likely to become an
important business strategy once again when economics of scale
and score become more critical to competitive success and a princi-
pal driver behind another round of industry consolidation.
integration
the size distribution
When economies of scale are important and market share and
industry structures often are
total unit costs are inversely related,
of business
concentrated. ln such industries,
firms is often highly skewed and the so-called "Rule of Three and
Four" might apply. This rule states that many stable markets will
the market
have only three significant
shares of these competitors will roughly be proportioned
as four-
to-two-to-one,
reflecting a concentration
70 percent of total industry sales for the three companies.
Studies have also shown that, as markets mature,
level of approximately
competitors
and that
companies
suggesting that
often loge market
times become legs concentrated,
between relative share and cost position is legs pronounced
for
mature markets than it is for immature markets. This explains why
larger
as the industry
matures: Their cost advantage diminishes over time. ln contrast,
in fragmented industries, characterized by a relatively low degree
of concentration, no single p\ayeT bas a majoT maTKet snaTe. Sucn
industries
are found in many areas of the economy. Some are
highly differentiated, such as application software; others tend to
ln the absence of major
commodity status, as in the case of lumber.
forces for change, fragmented industries can remain fragmented
for a long time.
share
they some-
the relationship
Product Life Cycle Analysis
The product life cycle model-based
on the theory of diffusion of
innovations and its logical counterpart, the pattern of acceptance of
Charter 4 Analyzing an Industry
85
The product
to follow an S-shaped curve,
perhaps the best known model of industry evolution.
new ideas-is
It holds that an industry passes through a number of stages: intro-
duction, growth, ma tu rit y, and decline. The different stages are
defined by changes in the rate of growth of industry sales, generally
thought
reflecting the cumulative
result of first and repeat adoptions of a product or service over time.
life cycle can be a useful analytie tool for strategy
development. Research has shawn that the evolution of an indus-
of a number of
try or product class depends on the interaction
factors,
firms,
of rival
strategies
changes in customer behavior, and legal and social influences.
Figure 4-3 shows typical competitive
to the changes
that accompany the transition frOIDa market's
introduction stage
to growth to maturity and, ultimately,
the competitive
to decline.
responses
including
A high level of uncertainty
characterizes
the introductory
or
evolution,
emerging stage of a product or industry life cycle. Competitors
often are unsure whieh segments to target and how. Potential cus-
tomers are unfamiliar with the new product or service, the benefits
it offers, where to buy it, or how much to par. Consequently, a sub-
is a hallmark of emerging
stantial amount of experimentation
are legs uncertain and competi-
industries. Growth environments
tively more intense. At this stage of an industry's
the
number of rivaIs is usually largest. Therefore, competitive shake-
outs are common toward the end of the growth phase. Mature
industries, although the most competitively stable, are relatively
in terms of sales growth. However, product development
stagnant
techno-
can give fige to new spurts of growth in specifie segments,
can alter the course of market development
logieal breakthroughs
and upset
can
order, and global opportunities
open avenues for further growth. Declining industries are typieally
can produce
regarded
substantial profits. We will return to these different scenarios in
Charter
for each life
cycle stage.
Although
7 wh en we consider
useful as a general
specifie strategies
for understanding
the competitive
as unattractive,
strategies
construct
clever
but
how the princip le of diffusion can shape industry sales over time,
value.
the product
growth does not
Empirical
life cycle concept
studies have shawn that
little predictive
industry
has
86
Strategy: A View from the Top
Decline
High; few
remaining
harvesters
Decreasing as
competitors
leave
market
High capital
intensity,
low returns
Decreasing;
endgame
Very elastic;
bargaining
power of
buyers high
Figure
4-3
Strategie Choiees over the Produet Life Cycle
,
Characteristic
Emerging
Growth
Publicité
Concentration
of competitors
High; few
pioneers
Product
differentiation
Low, if any
Declining as
more competi-
tion enters
Imita-
Increasing;
tionsand
variations
Maturity
Increasing
after
shakeout
High; increas-
ing market
segmentation
Barriers to entry
Barriers to exit
Price elasticity
of demand
Ratio of fixed to
variable cost
Economies of
scale
Experience
curve effects
Vertical
integration
of competitors
Risk involved
in business
High,
if
product can
be protected
Low; little
investment
Inelastic, few
customers
Decreasing;
Increasing as
growing tech-
nology transfer
Low, but
mcreasing
Increasingly
elastic
capital
intensity
increases
High for large
company
Inelastic only
in segments
Generally low
Increasing
High
Decreasing
Few, generally
unimportant
Large early
gains
Low
Low
Increasing capital
High
intensity
Very high; large
production
volume
Decreasing
magnitude
Increasing
High
High
Few
High
Increasing
Increasing
Declining
barriers exit
Source:A. J. Rowe, R. O. Mason, K. E. Dickel, and N. A. Snyder, StrategieManagement:A
Methodologieal Approaeh, 3rd edition, Addison-Wesley Longman, Glenview, IL, 1989. Used with
permission of Dr. Alan J. Rowe.
always follow an S-shaped pattern.
very brief. More important,
not explicitly acknowledge
affect the shape of the growth curve through strategie
such as increasing the pace of innovation or repositioning
ln some instances, stages are
life cycle concept does
can
actions
their
the product
the possibility
that companies
Charter 4 Analyzing an Industry
87
offerings. Taking an industry growth curve ~s a given, therefore,
can unnecessarily become a self-fulfilling prophecy.
New Patterns
Many new industries, such as cellular telephone or high-definition
television, evolve through some convergence in technologicalstan-
dards. Competition for standards or formats is frequently waged
within a group of comparues between the developer of one stan-
favoring a different stan-
dard and another group of companies
share is important,
dard. Competition
because
for its adopters
substantial
gies and set-top box standards,
market share.
a
share of future profits. Battles for cell phone technolo-
for example, decide the winners in
or format
standard will garner
the winning
for standard
of strategie
success, C. K. Prahalad
For industries in whieh competition for standards
is an impor-
has pro-
tant determinant
posed a model
that describes industry evolution in three phases.6
ln the first phase, competition is mostly focused on ideas, product
concepts, technology choices, and the building of a competency base.
the future
The primary goal at this stage is to learn more about
potential of the industry and about the key factors that will deter-
mine future success or failure.
ln the second phase, competition
is more about building a viable coalition of partners that will support a
standard against competing formats. Companies cooperating at this
stage may compete vigorously in phase three of the process-the
bafflefor market sharefor end products and profits.
suppliers,
industries
competitors,
and partners
As competition becomes more global,
consolidate,
technology becomes more pervasive, and the lines between cus-
tomers,
becoming blurred. With greater frequency, companies
pete in one market collaborate
each other's customers or suppliers. This complex juxtaposition
of foies makes accurately forecasting an industry' s future struc-
ture extremely diffieult and relying on simple, stylized models
of industry evolution very dangerous. As industry boundaries
in adjacent indus-
structural
become more permeable,
changes
serving the same customer base with different
tries (industries
that com-
they can be
in others. At times,
are increasingly
88
Strategy: A View from the Top
influence
technologies
technologies,
using similar
or services, or industries
processes) or rélated industries
products
and production
plying components,
increasingly
Finally, change sometimes
Buyers generally become more discriminating
more familiar with a product and Hs substitutes
quence,
improvements.
sup-
services)
the future.
is simply a function of experience.
as they become
and, as a conse-
for
or complementary
for
outlook
they are likely to be more explicit
in their demands
an industry's
(industries