Porter's Five Forces Model: Analyzing Industry Attractiveness and Competition | Appunti di Economia

EXTERNAL ANALYSIS

We know that corporate strategy is about choosing which businesses to

operate in, right? Right now, we need to decide how diversified we want to be

and how much we want to integrate vertically, which we will talk about later.

But the main question is: are we playing the right game? Are we in a game we

can win? We understand that this depends on looking at both external and

internal factors, including how attractive the market is and our strengths.

Now, let’s take a moment to talk about external analysis.

Analyzing the External Environment: there are 4+1 analysis that you can use:

1) Understanding the «big picture»: Steep Analysis

2) Understanding the «industry»: Porter’s 5 forces model

3) Understanding the «competitors»: Competitor Analysis

4) Understanding the «supply chain»: Profit Pool Mapping

5) (Understanding the customers: Segmentation and Buyer Analysis)

Understanding the <<big picture>>: STEEP ANALYSIS

STEEP Analysis: a method to look at outside factors that affect a

business. It includes five categories: social, technological,

economic, ecological, political.

Goal: To find opportunities and threats in the market.

SWOT Analysis: a tool to evaluate a company's position. It has four

parts: strengths, weaknesses, opportunities, threats.

Connection between STEEP and SWOT: The STEEP analysis gives information about outside factors that help

identify opportunities and threats in the SWOT analysis.

Political/legal: monopolies legislation, taxation policy, foreign trade regulations (ruled for importing and

exporting goods), tariffs, political stability.

Socio-cultural: population demographics, income distribution, social mobility, lifestyle changes, levels of

education, consumer activism, urbanization.

Economic: business cycles, GNP trends, interest rates, exchange rates, money supply and Inflation

Unemployment & av. income Energy availability and cost.

Ecological: environmental protection laws, compliance to env. Protocols, decommissioning costs.

Technological: breakthroughs, connectedness.

Technological disruption: technology is very important in business today. It's crucial to assess whether a

technology is an opportunity. Important examples include artificial intelligence, the Internet of Things, and

cloud technology. These technologies change very quickly. For example, recently, a research team was

updating an educational program for executives. They found that the topic of "big data" was already outdated;

now, everyone is talking about artificial intelligence. This shows how fast technology trends can change.

(Evaluating Factors: a group can list factors and score each one from -10 (negative) to +10 (positive). After

calculating the average score, the group can decide if a factor is an opportunity or a threat).

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EXTERNAL ANALYSIS

We know that corporate strategy is about choosing which businesses to operate in, right? Right now, we need to decide how diversified we want to be and how much we want to integrate vertically, which we will talk about later. But the main question is: are we playing the right game? Are we in a game we can win? We understand that this depends on looking at both external and internal factors, including how attractive the market is and our strengths. Now, let’s take a moment to talk about external analysis. Analyzing the External Environment : there are 4+1 analysis that you can use:

Understanding the «big picture»: Steep Analysis
Understanding the «industry»: Porter’s 5 forces model
Understanding the «competitors»: Competitor Analysis
Understanding the «supply chain»: Profit Pool Mapping
(Understanding the customers: Segmentation and Buyer Analysis ) Understanding the <>: STEEP ANALYSIS STEEP Analysis : a method to look at outside factors that affect a business. It includes five categories: social, technological, economic, ecological, political. Goal: To find opportunities and threats in the market. SWOT Analysis: a tool to evaluate a company's position. It has four parts: strengths, weaknesses, opportunities, threats. Connection between STEEP and SWOT: The STEEP analysis gives information about outside factors that help identify opportunities and threats in the SWOT analysis. Political/legal: monopolies legislation, taxation policy, foreign trade regulations (ruled for importing and exporting goods), tariffs, political stability. Socio-cultural: population demographics, income distribution, social mobility, lifestyle changes, levels of education, consumer activism, urbanization. Economic: business cycles, GNP trends, interest rates, exchange rates, money supply and Inflation Unemployment & av. income Energy availability and cost. Ecological: environmental protection laws, compliance to env. Protocols, decommissioning costs. Technological: breakthroughs, connectedness. Technological disruption : technology is very important in business today. It's crucial to assess whether a technology is an opportunity. Important examples include artificial intelligence, the Internet of Things, and cloud technology. These technologies change very quickly. For example, recently, a research team was updating an educational program for executives. They found that the topic of "big data" was already outdated; now, everyone is talking about artificial intelligence. This shows how fast technology trends can change. (Evaluating Factors: a group can list factors and score each one from - 10 (negative) to +10 (positive). After calculating the average score, the group can decide if a factor is an opportunity or a threat).

A simple way to do this analysis is to: identify each possible factor, give each factor a percentage chance of happening and a score for its impact in the next 3-5 years, where: - 5 = very bad; +5 = very good. (Puoi stabilire l'impatto di un fattore e la probabilità che accada. Ad esempio, se pensi che ci saranno problemi con i fornitori di batterie, puoi dare un punteggio negativo, come - 5, e una probabilità del 50%. Così, il punteggio finale sarà - 2.5) In the end, you will have a score that helps you see the situation. Use the evaluations to create a matrix. The X-axis can represent impact, while the Y-axis represents probability. This helps identify which factors are the biggest opportunities and which are the most relevant threats. It is important to pay attention to events with low probability but high impact. For example, the COVID-19 pandemic was seen as unlikely, but it had huge effects worldwide. We need to be ready to manage uncertainty, not just risk. Understanding the <>: PORTER’S 5 FORCES MODEL The attractiveness of an industry or business area can be measured by looking at the average profitability and growth rate of companies in that area. If the leading companies are making good profits and growing, the area is attractive to new investors. Michael Porter developed a model called "Five Forces" to analyze how attractive an industry is. Difference between monopolies and competition: monopolies are not good for consumers because they can raise prices and limit choices. In contrast, competition is beneficial for customers as it offers more options and better prices. Portes’s 5 forces model is referred to a specific Business Area. Basic assumption:

Competition is driven by industry structure (If there are few strong competitors (like in a monopoly), the industry is less appealing for new businesses. But if many companies compete, the industry becomes more attractive)
Business Area’s attractiveness is inversely proportional to the level of competition of the competitive environment (the more competition there is, the less attractive the area is for companies already in the market, because competition lowers profit margins)
Competition in an industry goes well beyond established players  concept of extended rivalry : Competition can come from outside the usual players. For example, TomTom, which makes GPS devices, faces competition not just from other GPS makers but also from Google Maps. Companies need to consider competitors from other industries. Existing Competition (center): this looks at how much competition there is right now. More competitors make it harder for a business to succeed. Suppliers and Customers : if suppliers and customers are strong, they can control prices, making it harder for a business to make good profits. But if the business can control the prices with them, it’s more attractive.

The Direct Competitors matrix It’s important to know who your competitors are. Direct competitors sell the same product as you, while indirect competitors sell different products that could replace yours. Industry Concentration: this means how many competitors are in the market. If there are a lot of competitors, it is low concentration. If there are only a few, it is high concentration. Market Growth: this tells us if the market is getting bigger or not. If the market isn’t growing, there are fewer chances to sell more. Low Growth and High Concentration: In a market with many competitors and no growth, competition is very high. Everyone is fighting for the same customers. High Growth and High Concentration: In a growing market with few competitors, competition is low. Companies focus on working together to grow the market instead of fighting each other. Example of Renewable Energy: The speaker mentions the renewable energy sector. In this area, the market is growing quickly, and there are not many competitors. This means there is less competition among companies. THREAT OF NEW ENTRANTS Structure determinants:

Entry barriers : o Economies of Scale : established companies can produce at lower costs, making it hard for new entrants to compete. o Capital requirements o Brand identity: well-known brands make it difficult for new companies to attract customers (for example, car sector) o Switching costs o Access to distribution channel : getting shelf space in stores can be expensive and complicated. Established brands often get the best spots (ad esempio, trovo shel space Gillet nei supermercati) o Cost advantages independent of size : some companies have lower costs due to unique technologies, special skills , or better access to raw materials (for example, San Pellegrino), location, learning curve (established companies may have learned efficient practices over time that new entrants still need to figure out), government subsidies (companies receiving government support may have lower costs, making it harder for others to compete) o Legislation or government actions Entry into a business arena is not easy (even in the «digital» era). Every business arena is «protected» by barriers that makes the entry a costly decision for companies. The higher barriers to entry, the more profitable (other else being equal) business arena for those companies that are already in, as the threat of external competitors is limited.

Example of barriers to entry: there are obstacles that make it hard for new companies to enter the market. Aer Lingus is the national airline of Ireland. When they entered the market, they faced significant barriers to entry from established airlines. These companies reacted aggressively by lowering prices and increasing flights to keep Aer Lingus from making profits. As a result, Aer Lingus struggled for many years, even almost going bankrupt multiple times. It wasn't until about 2002 that they began to succeed in the competitive airline industry after fighting for 15 years in a price war. SOBSTITUTES Substitutes are products provided by other industries that perform the same function as the product of the industry. Examples:  Short haul airline routes vs. High-Speed Trains  Airlines vs. Web Conferencing  Aluminum vs. Steel Substitutes limit the potential return of an industry by placing a ceiling on the prices companies in the industry can profitably charge. The competition from substitutes is a function of:

switching costs : this refers to the cost that a customer has to bear when switching from one product to another. If it’s easy and convenient for customers to switch to a substitute, there’s more competition. If switching is difficult or expensive, customers are more likely to stick with the original product.
substitute product’s price vs. industry’s product price : if the price of the substitute product is lower than that of the industry product, customers are more inclined to choose the cheaper option. This puts pressure on companies in the industry to keep their prices low.
substitute product’s quality and performance vs. industry’s product quality and performance : if a substitute product is of higher quality or performs better than the industry product, customers may prefer it. Therefore, companies need to work harder to improve their products and retain their customers. In summary, substitutes can limit how much profit companies can make by influencing customer choices based on costs, prices, and quality. If substitutes are cheaper, easy to choose, or better than the original product, companies in that industry may struggle to raise their prices and maintain their profits.

Buyer’s characteristics : some characteristics of buyers, such as their size or purchase volume, can influence bargaining power. For example, a large company that buys in bulk may negotiate better prices than a smaller company. A fundamental aspect of the analysis is the distinction between the buyers and the ultimate customers. It’s important to distinguish between buyers (those who purchase the product) and ultimate customers (the end users of the product). Sometimes, the buyer and the ultimate customer are different. There is a big difference between B2B (business-to-business) and B2C (business-to-consumer) markets. In B2C, the company often has more power than the consumers. The power of buyers in B2C: It is usually quite low, but it increases if:  product differentiation is low : for example, when we buy everyday things like electricity, gas, or internet services, we don't care who provides it as long as it works. In this case, we can easily switch from one supplier to another, which gives us more power.  information about the product is easily available : also, when we know a lot about the products, we can negotiate better and find the best deal for ourselves. But sometimes, we don't know exactly what the products are like.  switching costs are low : the cost of switching from one supplier to another is another important factor that affects our buying power. The power of buyers in B2B:  Relative concentration  the bargaining power of buyers is higher if their business area is more concentrated than that of suppliers (for example, if there are a few big buyers purchasing from many suppliers, these buyers will have more power to negotiate better prices or terms).  Product’s features  the bargaining power of buyers increases if: product differentiation is low, switching costs are low, product’s impact on the final performance is weak (only for intermediate products) (Cioè, Se il prodotto ha un ruolo secondario nel determinare le prestazioni finali, il potere contrattuale degli acquirenti aumenta. Inoltre, se i costi di cambio sono bassi e la differenziazione del prodotto è limitata, gli acquirenti possono facilmente passare da un fornitore all'altro, aumentando ulteriormente il loro potere. Ad esempio, immagina di voler comprare una lampadina. Se:  La lampadina non influisce molto su quanto è luminosa la stanza (ruolo secondario).  Puoi trovarla facilmente in diversi negozi (bassi costi di cambio).  Le lampadine sono simili e non molto diverse (poca differenziazione). In questo caso, come acquirente, hai più potere perché puoi cambiare negozio se trovi un prezzo migliore e non sei legato a un marchio specifico. Questo costringe i fornitori a offrire prezzi migliori o prodotti più interessanti per attirarti) Examples of Supplier Power: Sports Clothing: Waterproof jackets often use GORE-TEX. Customers are willing to pay more for quality. This makes GORE-TEX suppliers stronger. Laptops: Laptops with "Intel Inside" show customers that they use Intel chips, which builds trust and increases Intel's power in the market. In both cases, customers recognize the importance of quality materials, giving more power to the suppliers.

 Buyer’s characteristics  the bargaining power of buyers increases if: they are able to integrate themselves backward, they have clear information about the product, the component or material cost is a high percentage of the total cost Spiegazione: le caratteristiche degli acquirenti dipendono dalla loro capacità di integrarsi verticalmente. Se l'azienda acquirente è in grado di farlo, il suo potere contrattuale aumenta, poiché rappresenta una minaccia per il fornitore. Ad esempio, l'acquirente può dire: "Mi offri un buon prezzo, altrimenti aprirò la mia fabbrica". Inoltre, se il costo del componente o del materiale è una parte molto alta del costo totale del prodotto finale, l'acquirente avrà un maggiore potere contrattuale. Se il tuo prodotto rappresenta una grande porzione del costo totale del prodotto dell'acquirente, allora il potere contrattuale dell'acquirente aumenta, poiché sei un fornitore molto importante per loro e vorranno negoziare con forza. Al contrario, se il prodotto che vendi rappresenta solo una piccola parte del costo totale, come nel caso di un tappo di penna, l'acquirente non avrà molta motivazione a negoziare. Se il tappo rappresenta solo l'1% del costo totale, anche una riduzione del 50% non porterebbe a un grande risparmio. Invece, se stai fornendo un componente che è una grande spesa, l'acquirente vorrà negoziare duramente per ottenere un prezzo migliore, poiché anche una piccola riduzione del prezzo potrebbe significare un grande aumento dei profitti per loro. BERGAINING POWER OF SUPPLIERS Upstream competition When we talk about suppliers, it's the opposite. It's exactly the same measures, just interpreting the different way  The structural determinants of bargaining power of suppliers are dual to those influencing the bargaining power of buyers. The power of suppliers:  Relative concentration  The bargaining power of suppliers is higher if their business area is more concentrated than that of companies producing the product.  Product/service’s features  The bargaining power of suppliers increases if: product/service differentiation is high, switching costs are high, product’s impact on the final performance is high.  Customer characteristics  the bargaining power of suppliers increases if: their customers are not able to integrate backward, their customers have not clear information about the products, the supplying cost is a low percentage of the total cost (this means that if a component has a low-cost relative to the final product, the client company will not spend much time or resources negotiating that price. For example, for a company that purchases paper or internet services, the cost is so small compared to the total cost that it’s not worth negotiating). (Car manufacturers, like Volkswagen or Fiat, do not produce most of the components themselves. Instead, they focus on design, assembly, distribution, and sales. 85% of the cost of a car comes from external suppliers—companies that manufacture the components. This means that car manufacturers are highly dependent on their suppliers. Car manufacturers generally have very low profit margins, around 3.5% , so they make about $1000 in profit for each car sold. The reason these profits are so low is that they must give a significant portion of their revenue to suppliers)

Different industries make different amounts of money. Some are very profitable, while others are not. To understand how attractive an industry is, you need to look at how much money it earns. For example, technology industries usually make more money and are more attractive. Some industries, like hotels and restaurants, make about 8.5% profit, while infrastructure industries earn only about 5.8% to 6%. The differences in profit levels can be explained by factors like competition, supplier power, and customer choices (substitutes). Understanding the <>: COMPETITOR ANALYSIS Three main purposes:  to forecast competitors’ future strategies and decisions  to predict competitors’ reaction to a firm’s strategic initiatives  to determine how competitors’ behavior can be influenced Three main sections:  to understand how rivals compete at present  to forecast how a competitor might change its strategy  to understand the perception of the industry competitors have There are four main parts: Strategy: How is the competitor competing? What method are they using? Objectives: What are the competitor's goals? Are they reaching their goals? Will anything change? Assumptions: What ideas does the competitor have about the market and themselves? These ideas affect their choices. Resources and Capabilities: What are the competitor's strengths and weaknesses? What do they do well, and where do they struggle? All of this helps us make predictions about: what changes the competitor might make and how the competitor will react to what we do. Competitive Intelligence : competitive Intelligence involves the systematic collection and analysis of public information about rivals for informing decision making. The main sources of data and information to conduct competitive intelligence are: annual reports and company profiles, product brochures, fairs and exhibitions, press releases, articles published in the media, suppliers, customers, business community.

Strategic groups : A strategic group is «the group of firms in an industry following the same or a similar strategy along the strategic dimensions». By selecting the most important strategic dimensions and locating each firm in the industry along them, it is possible to identify groups of companies that have adopted more or less similar approaches to competing within the industry. Industries have strategic groups, meaning there are companies that follow similar strategies within the same sector. For example, in the car industry, it's too big to analyze everything at once. It doesn't make sense to compare Ferrari and Fiat because they operate in very different areas: Ferrari focuses on luxury sports cars, while Fiat makes utility cars. So, it’s necessary to narrow down the analysis to groups of companies that follow similar strategies based on certain factors. This approach helps to get a more useful and relevant understanding of market dynamics within specific segments of the industry. È più facile comprendere i gruppi strategici usando un grafico. Questi gruppi possono essere definiti in base all'ambito geografico e alla gamma di prodotti. Ad esempio, si possono analizzare produttori di auto di lusso come Jaguar e BMW, o produttori più piccoli come Bristol e Morgan. In alternativa, si possono considerare aziende globali come General Motors e Renault. Per analizzare i gruppi strategici in un settore come quello aereo, bisogna scegliere delle dimensioni da considerare, come i prezzi dei biglietti e il numero di rotte. Ci sono compagnie aeree low cost, come JetBlue e Ryanair, e compagnie globali come Delta. Si può anche separare Air France e altre compagnie di lusso. Inoltre, stanno emergendo compagnie che offrono voli a lungo raggio a prezzi molto bassi. Ad esempio, un volo da Londra agli Stati Uniti può costare solo 270 euro, anche se non è molto comodo. Mapping strategic groups Additional insights:  Competitive rivalry is strongest between firms that are within the same strategic group.  The external environment affects strategic groups differently.  The five competitive forces affect strategic groups differently.  Some strategic groups are more profitable than others.

Porter's Five Forces Model: Analyzing Industry Attractiveness and Competition, Appunti di Economia

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EXTERNAL ANALYSIS