ANALYSIS OF INDUSTRY ENVIRONMENTS

Successful positioning or business definition requires that managers

thoroughly understand the dynamics of their industries, the trends in
their firms’ external environments, and the basic economics of their
firms’ markets. They must in short know how to analyse their
industries. They can then effectively define and position their firms to
compete with sustained advantage. The most noteworthy
characteristic of industry environments is the variability. Some
industries are highly competitive and therefore not very profitable on
the average. Less competitive industry environments on the other
hand permit firms to enjoy high profitability on the average. While
mature industries would most likely experience low, negligible or even
negative growth rates, emerging industries would enjoy high growth
rates.

What is needed then are models or tools for assessing the relative
attractiveness of industries. These will then enable managers to
strategise both in terms of choosing which industries to enter or avoid
in case their firms are considering significant investment. Managers
can also decide preemptive or corrective action in industries that their
firms are already in. Here presented are two widely used frame works
for analysing industries. The SWOT Analysis and the Five Forces Model
are both well known and have enjoyed widespread application in the
business world.

SWOT ANALYSIS
SWOT Analysis is derived from Strengths Weaknesses Opportunities
and Threats. Strengths and weaknesses reflect the internal positives
and negatives respectively of a firm. Opportunities and Threats are the
positives and negatives reflected in the firm’s external environment.
SWOT Analysis is done in two stages. First managers thoroughly
evaluate their firm’s positives and negatives in their internal and
external environments. In the next stage use the evaluation to position
their firm appropriately in the competive space. This is accomplished
by placing the firm in one of the four quadrants of the SWOT matrix
shown in the exhibit titled The Strengths, Weaknesses, Opportunities,
and Threats Matrix.
If SWOT Analysis reveals that a firm has several internal strengths and
few internal weaknesses, many environmental opportunities and few
threats, the firm would be placed in the upper right quadrant of the
SWOT matrix. Likewise a firm with many intenal weaknesses and many
environmental threats would be placed in the lower left hand quadrant
of the matrix.
If the firms managers determine that it has both considerable internal
strengths as well as many external opportunities then SWOT suggests
that the firm should grow through merger and acquisitions or internal
development of new business opportunities. Firms that have internal
weaknesses but see significant opportunities can integrate vertically,
enter into joint ventures or unrelated diversification.

The advantages of SWOT lies in its simplicity and straight forwardness.

It helps managements to think in a constructive way about their
business environments both internal and external. However it also has
some drawbacks. Firstly it is subjective depending totally on the
perceptions of insiders. Personal biases are likely to play a significant
part in the assessment. Consequently there is likely to be a greater
chance of disagreement and lack of consensus between the firms
decision makers. For instance a firm’s R& D head might view this
function as a strength whereas his colleague in the manufacturing
having experienced numerous problems with products coming out of
that function could very legitimately see it as an area of weakness.
Another drawback of SWOT is that its use is likely to yield few clear cut
recommendations. One can envisage hardly any firm which is
characterised by only positives. Therefore most firms cannot be easily
slotted in one of the four quadrants of the matrix but would probably
fall around the centre. There is then a serious risk of suggestion of
contradictory strategies.

THE FIVE FORCES MODEL

This model by the renowned Michael Porter in his book Competitive
Strategy offered a new framework for Industry analysis which sought
to overcome the prescriptive inadequacies of the SWOT model. Porters
model examines five forces that influence and determine the structure
of industries and consequently the profitability and the attractiveness
of those industries. These are The threat of new entry, the availability
of Substitutes, the Power of Suppliers, the Power of Buyers, and the
rivalry among competitors within the industry. The model postulates
that depending on the structure, incumbent firms can conduct
themselves to charge higher prices to innovate or to act in concert to
keep outsiders out. This in turn would affect the general performance
level in that industry. Obviously if all or most firms within an industry
could charge higher prices, the average profitability of the industry
would be high. Consequently Porter’s model has been identified as a
Structure- Conduct-Performance frame work. Let us examine this
model in more detail. Refer to the diagram titled The Five Forces
Model.
The Threat of New Entry.
Cost Barriers. When incumbent firms enjoy scale economies, the
benefits of experience ,and learning effects, or privileged access to key
raw materials or technologies, then potential entrants will be at a
serious cost disadvantage. For many years the cost of entry into the
computer industry was very high thus it was highly profitable for
incumbent firms like IBM,
Burroughs and CDC. With the advent of PCs, the barriers to entry
swiftly crumbled and the hardware industry has become a dangerously
competitive arena where even spectacularly successful firms like Dell
are now finding the going tough. The concept of Minimum efficient
Scale is relevant in some industries like the commercial aircraft
business where no

incumbent firm or new entrant can hope to succeed unless it has

capacity to meet a minimum of the world demand for commercial
aircraft.
Structural and Marketing Advantages of Incumbent Firms
Incumbent firms command brand loyalty and have well developed
distribution channels which have been built over a significant period of
time and at substantial cost. New entrants therefore are at a
considerable competitive disadvantage till they are able to match the
industry incumbents in both these areas. Titan and HMT in the Indian
Watch industry both have well established distribution and a
considerable number of loyal customers which new entrants to this
market will find daunting.
Government Restrictions
Where Government regulations operate such has been the case till
very recently in India barriers to entry are extremely high. In our
country there has been a huge amount of regulation and this has
resulted in a very uncompetitive industry and the Indian customer has
been short changed. Even in the U.S. air lines and rail roads have for
long been regulated as also for a time the trucking industry. In every
such case new entrants have found it impossible or at the very least
extremely difficult to make their way into these industry arenas.
Behavioural Barriers
Incumbent firms might maintain low prices or lower prices to intimidate
new entrants. Sometime they just might threaten to lower prices and
that might serve to discourage potential entrants. Firms like Intel
announce in advance that they are about to obsolete current product
thereby signalling to the new rivals that they might be entering with
products that are dated and therefore stand little chance of success.
Such signalling is perfectly legitimate. However collusion by
incumbents and collective activity such as forming price cartels is
illegal and if resorted to is liable for stricture and severe punishment.

THE THREAT OF SUBSTITUTE PRODUCTS

This is the second of the five forces. Examples of substitute products
include Margarine for Butter Pcs for typewriters, and VCRs for movie
theatres. Personal Computers allied with advances in software from
task specific programmes to data base management systems has
proved the ultimate substitute severely restricting the future of the
mainframe industry. It is to be noted that the extent of success of
substitute products depend on the perceived value that they present
to the customer. Initially VCRs were only affordable by the very
affluent thus offsetting their tremendous advantage as a home viewing
substitute. As prices came down they became acceptable to a huge
mass of people. The original attractiveness of margarine was its low
price and unrestricted availability in War torn U.S.A. and Europe. Its
popularity waned after the second world war but it enjoyed a
resurgence in demand when in
these countries health and specially low cholesterol maintenance as a
means of preventing heart disease became major concerns.
THE POWER OF SUPPLIERS
If suppliers have excessive power they can charge higher prices
thereby causing a decline in profitably for the buyer industry. Two
factors contribute to the potential for this. Firstly if the number of
suppliers is small or in the worst case if there are only one or two
suppliers the potential for price gouging is high. Secondly if critical
components incorporate proprietary technology, buyers will be at the
mercy of the supplier/suppliers who have this technology. Intel and
Motorola have for long employed proprietary technologies in micro
chips thus giving them the power to charge high prices to their buyers
in the computer hardware industry. Bosch the German auto component
giant has always been the only company in the world that supplies fuel
injection pumps to the automobile industry thus wielding enormous
power over its buyers.

THE POWER OF BUYERS

Sometimes buyers exert overwhelming influence over their suppliers.
As with the case of suppliers two factors contribute most to this
potential. Firstly if there are a few buyers of products which are
supplied by a large number of suppliers the bargaining power of the
buyers will be enormous. The best example of this in the automobile
industry world wide. In every country with an indigenous auto industry
be it the U.S. Japan, Germany or India the automobile producers are
very few and the suppliers of most components are numerous. The
result is that the buyers demand outrageous price reductions and the
component industry has probably the highest rate of bankruptcy of
any industry in the world.

RIVALRY WITHIN THE INDUSTRY

Greater rivalry within an industry usually reduces the profitability of
the industry by driving down the prices of products and services and
by increasing the cost of doing business. Slow growth rates in an
industry will increase the rivalry as firms struggle to maintain or
increase market share and spend more on marketing and selling
activities. The U.S. cigarette industry grew increasingly unprofitable as
sale of its products declined. This predictably led to fiercer competition
and even lower profits for firms within the industry. The only way out
was for the cigarette majors like Phillip Morris and Reynolds to go in for
unrelated diversification. Most went into foods where their knowledge
of consumer marketing and national distribution came in handy.
Excess capacity in an industry also tends to increase rivalry and
usually results in lower prices and reduced profitability. In India the
auto industry is already beset by over capacity both for

commercial and passenger vehicles. The result is poor profitability all

round. Even the two wheeler segment has excess capacity and is
feeling the pinch of eroding profit margins.
APPLICATION OF THE FIVE FORCES MODEL
We will apply the model to actual industry situations There are three
examples that we will look at. Two of these are taken from the U.S. and
the third from our own country.

The United States Steel Industry

In this industry all but one of the five forces are intense Only supplier
power is not strong and that should be fairly obvious because coal, iron
ore and oxygen are basic commodities and there are a host of
suppliers of each raw material.
The threat of new entry is very real. This is due to the fact that entry
into the steel industry is via the mini mill or mini steel plant route
where investment is much less as compared to the investment
required for an integrated conventional steel producer. Furthermore
sizing of these mini steel plants is highly variable. Whereas for a
traditional plant the minimum size would be 10 million tonnes per year,
a mini plant can be sized as low as a half million tonnes per year.
Substitute products pose a major threat to steel. They include
Aluminium, plastic and composite materials which have as major plus
points lightness or greater strength for a given weight. Also these
materials yield finished sizes and shapes which require little or no
processing before being fitted into their final locations on the end
product like the automobile.
The power of buyers is a major adverse factor for the steel industry.
Both the auto industry and the appliance industry( White goods, air
conditioners) who are the principal buyers of steel are very aggressive
in their purchasing and continuously press for discounts and
substantial reduction in base prices. This has eroded the steel
industry’s profitability.
Finally the steel industry is the scene of intense internal rivalry. There
is significant over capacity and this has led to the closure of many
steel mills of the traditional variety. A further adverse factor is the
increasing competition to U.S. steel companies from East European,
Brazilian, and Korean producers who are aggressive exporters offering
attractive prices that the Americans cannot or will not match. The over
all assessment then, is that the industry prospects are increasingly
bleak calling for exit or mega mergers within the industry.

THE U.S. PHARMACEUTICAL INDUSTRY

This industry offers a marked contrast to the steel industry. Suppliers
as in the case of the steel industry have little power for the same
reason that the inputs for pharmaceuticals are all commodities with a
large supplier base.

Entry barriers are significant in this industry because investment

required is high and the gestation period of projects is long. Attracting
the right talent is difficult and time consuming as well.
The threat from substitutes is minimal in this industry and only exists
in the small number of herbal or natural products which appeal only to
a miniscule part of the population.
Finally there is very little rivalry between the incumbent firms. Each
firm ensures that the outcome of its Research and Development efforts
is well protected by patents which have a 17 year validity.
The low intensity of each of the five forces results in the U.S.
pharmaceutical industry being highly profitable and characterised by
healthy growth rates. However that position may not last long because
most of the existing patents are due to expire soon and the new
patents will not replace the volumes and earnings of the ones that are
expiring. Further the Health Maintenance Organisations (HMOs) are
taking over the health care business and these organisations are
displaying increasing buying clout and this will tend to reduce the
profitability of the Pharmaceutical Industry.

THE INDIAN PASSENGER CAR INDUSTRY

From Independence up until the early 90s the passenger car industry
was regulated with only three players vis. Hindustan Motors who
marketed and sold Ambassadors, PAL with theiu Fiats and Maruti with
its Maruti 800. There were impenetrable entry barriers, no strong
buyers or sellers no substitutes and only mild rivalry within the
industry. Therefore the industry was extremely attractive to the
industry who routinely charged higher prices to cover their increase in
costs. When the industry was opened up all this changed. Today the
industry has no entry barriers. While the position on sellers and buyers
has not radically changed, every firm in the industry is facing more
discerning buyers with an unprecedented choice in terms of the brands
and models they can choose from. While the threat from substitutes
remains negligible as before, the rivalry within the industry has
become intense. Prices have not risen at the rates that they did before.
Suppliers are not as vulnerable to bullying by the auto producers as
before. As a result the Indian car Industry has become unattractive and
the incumbents have only to hope that the market will show srrong
demand growth to permit them to achieve better economies of scale.
Maruti the industry leader is expected to show a loss for the first time
in its history. Other companies in the industry too are not doing well
financially. Telco too is expected to make losses this year mainly on
account of its car business which has been doing badly.
Charts and Exhibits:
1) The Strengths Weaknesses Opportunities and Threats Matrix
2) The Five Forces Model