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3 Industry and Environment Analysis
3 Industry and Environment Analysis
1
Introduction
There are 4 perspectives in the motivation of
businesses to earn a profit:
Economic Analysis
Porter’s Five Forces Analysis
Environmental Scanning
SWOT Analysis
2
Economic Analysis of Profit Maximization
Market Concentration
Refers to the number of sellers and buyers in the market
The more concentrated the market means the lesser
producers are there in the industry
Monopoly: one seller (most concentrated with huge
market power)
Oligopoly: few sellers (lesser degree of market
concentration but with significant market power)
Perfect Competition: many sellers (diluted market
concentration with no market power)
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Economic Analysis of Profit Maximization
Barriers to Entry
Refers to inherent features of the industry and various
means devised in the market to prevent the entry of
potential players and competitors
Scale barriers: requirements for large production plants
for a feasible operation in the industry (huge amounts of
capital and resources)
Legal Barriers: proprietary rights and their
corresponding legal protection extended to existing
market players in the production and distribution of a
product or service
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Economic Analysis of Profit Maximization
Barriers to Entry (cont.)
Monopoly: scale and legal barriers; government barriers
Oligopoly and Monopolistic Competition: some scale
barriers or contestable market
Perfect competition: no barrier to entry
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Economic Analysis of Profit Maximization
Product Differentiation
Refers to the ability of a business firm to create a market
niche through several means of varying its products and
services
Monopoly: highly differentiated product
Oligopoly and Monopolistic Competition: some degree
of product differentiation
Perfect Competition: homogenous good
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Economic Analysis of Profit Maximization
Limited Information
Refers to the unevenness in the distribution of
information among actors in the market
When market actors are not evenly informed, those with
more information can have market power
Monopoly: very limited information
Oligopoly and Monopolistic Competition: limited
information
Perfect Competition: perfect information
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Economic Analysis of Profit Maximization
Market Power
Monopoly: high market power
Oligopoly and Monopolistic Competition: limited
market power
Perfect Competition: no market power
See table 3.1 for a summary of what we discussed
8
Porter’s Five Forces of Competitive Position
Developed by Michael Porter (1979) as an alternative
perspective on profitability analysis and on the
attractiveness of an industry for business ventures
The stronger the forces of competition bearing on the
industry, the lower its profitability and the less
attractive the industry for business enterprises
See figure 3.2
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Porter’s Five Forces of Competitive Position
Competition Among Existing Firms in the Industry
Monopoly: absence of competition (high profit)
Oligopoly: forces of competition depends on the
behavior and interactions of few firms in the industry
Cooperate: forces of competition are mitigated (high profit)
Independent actions: strong competition (low profit)
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Porter’s Five Forces of Competitive Position
Competition Among Existing Firms in the Industry
(cont.)
Monopolistic Competition: ability to differentiate
products can temper the forces of competition; but there
are many sellers, so heightened competition
(moderate/low profit)
Perfect Competition: very intense competition (very low
profit)
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Porter’s Five Forces of Competitive Position
Bargaining Power of Customers
Utility maximizing buyers prefer lower price to enhance
their level of satisfaction
Monopsony: sole buyer has huge bargaining power on
the sellers in the industry
In order to free the dependence of a business enterprise
and the industry on a single or relatively few buyers:
Diversification: diversify the buyers of the product
Differentiated Products: divide its product lines
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Porter’s Five Forces of Competitive Position
Bargaining Power of Suppliers
If an industry sources its raw materials from a single or
few suppliers, these suppliers can have strong forces in
the industry that may lower the industry’s profitability
In order to weaken the bargaining power of suppliers,
the industry can adjust by:
Diversifying its sources of raw materials
Form a subsidiary firm
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Porter’s Five Forces of Competitive Position
Bargaining Power of Suppliers (cont.)
Suppliers of factor inputs can exert bargaining power on
the business enterprise and on the industry (labor
unions)
In order to weaken the bargaining power of labor
unions, the industry can adjust by:
Subcontracting through a number of manpower services firms
In weakening the market power of the suppliers of
capital, many large companies integrate banks in their
conglomerate, thus bargaining power is diminished
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Porter’s Five Forces of Competitive Position
Threats of Potential Entrants
Scale and legal barriers can reduce the competitive
forces, but what if potential entrants have resources to
overcome barriers
How to deal with these potential entrants:
Engage in research and development to improve their
products and to segment the market through product
differentiation
For firms with excess capacity, allow the potential competitors
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Porter’s Five Forces of Competitive Position
Threats of Substitute Goods
Usually industries that exhibit high rate of profitability
are the ones challenged by the emergence of substitute
goods
Cross elasticity of demand: responsiveness of the
demand for a substitute good due to a change in the
price of the product produced in the industry
As the differentiation from the substitute goods widens
and the cross elasticity of demand declines, the
competitive force of substitute goods is mitigated
16
Environmental Scanning in Industry Analysis
There is a need to also consider the indirect impacts of
factors and forces that were not considered in the
previous two analyses
See figure 3.3
17
Environmental Scanning in Industry Analysis
National Economy
A rapidly growing economy will have positive effects
A lethargic economy will have negative effects
Global Economy
Crises in other countries can affect the national
economy in a bad way
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Environmental Scanning in Industry Analysis
Government Policies and Regulation
Can be beneficial to businesses when it promotes
economic growth and employment
But can be unfavorable to businesses when dealing with
regulations and taxes
Technological Developments
Have intensified competition within the industry
Companies that are slow to adapt or fail to adapt to
these rapid developments are bound to exit from the
industry
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Environmental Scanning in Industry Analysis
Demographic Changes
Population is the market base for industries and changes
in the structure of the population has an impact on
businesses
People are also the source of firms’ laborers, professional
and technical expertise, savers, investors and
entrpreneurs
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Environmental Scanning in Industry Analysis
Social Changes
Modifications in family structure and other social
changes have an impact on consumer behavior and
tastes
Changes in the Natural Environment
Extreme fluctuations in the natural environment can
have adverse effects on the production of certain sectors
and may even temporarily impair the purchasing power
of some consumers
21
SWOT Analysis
Strengths, Weaknesses, Opportunities and Threats
Focuses on strengths and opportunities that can
enhance the profitability of an industry as a measure
of benefit
Identifies the weaknesses and threats that may
contribute in increasing the costs of the industry that
make it less attractive for business ventures
See figure 3.4
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SWOT Analysis
Strengths
Internal characteristics of firms or industry that can
contribute directly to the profitability of firms and the
industry
Weaknesses
Internal characteristics of firms or industry that mitigate
the profitability of firms and the industry
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SWOT Analysis
Opportunities
Positive impacts of various external environments on
the profitability of an industry
Unlike strengths, these are only potential, indirect and
prospective (firms have no direct control)
Threats
Undesirable impacts of external factors on the
profitability of the industry
Unlike weaknesses, these are only potential, indirect and
prospective (firms have no direct control)
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SWOT Analysis
SWOT Analysis and the Business Climate
The business climate is shaped by the interactions
between various sets of internal factors and external
factors manifesting as SWOT
Macroeconomic policies are government actions meant
to stabilize and promote economic growth
Government regulations are a set of rules meant to
address market distortions to promote public welfare
Institutional support refers to government assistance
that can make a favorable business climate
25
SWOT Analysis
Business Opportunities in Various Economic Sectors:
Agricultural Sector and Agribusiness
Industrial Sector and Manufacturing Industries
Services Sector and Retail Services
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Synthesis
There are several perspectives that can be used in analyzing
the firm’s profitability and identifying business
opportunities (profit maximization, Porter’s five competitive
forces, environmental scanning and SWOT analysis)
There are limitations in each perspective
There are three major sectors of the Philippine economy:
agriculture, industry and services
There are numerous industries in each economic sector that
potential entrepreneurs can pursue
The perspectives discussed can give insights on what
business opportunities have promise for implementation
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