session 2 - external analysis (joel) Flashcards
(26 cards)
What are the key frameworks used in External Analysis?
- PESTEL Analysis
- Porter’s Five Forces Analysis
What are Industry Effects?
Industry Effects:
- Describes the economic structure of the industry
- Industry effects include external forces like market structure, regulations, and competitive dynamics.
What purpose does the PESTEL framework serve in ascertaining Industry Effects?
It serves as a straightforward way to scan, monitor and evaluate external factors.
What purpose does the Porter’s 5 Forces serve in ascertaining Industry Effects?
Michael Porter’s model identifies five forces that help strategic leaders understand industry competition and profit potential BASED ON EXTERNAL FACTORS.
- Threat of entry
- Power of suppliers
- Power of buyers
- Threat of substitutes
- Rivalry among existing competitors
The weaker the five forces, the greater the industry’s profit potential.
Threat of entry - Types of entry barriers
- Economies of scale
- Network effects
- Customer switching costs
- Capital requirements
- Advantages independent of size
- Government policy
- Credible threat of retaliation
Threat of entry - Types of entry barriers (Economies of Scale)
- Economies of scale are cost advantages that accrue to firms with larger output because they can spread fixed costs over more units, employ technology more efficiently, benefit from a more specialized division of labor, and demand better terms from their suppliers.
- These factors, in turn, drive down the cost per unit, allowing large incumbent firms to enjoy a cost advantage over new entrants that cannot muster such scale.
- If the required scale to reach the lowest possible production cost is high, the threat of entry is decreased.
Threat of entry - Types of entry barriers (Network Effects)
- Network effects refer to the positive impacts that one user of a product or service has on other users of that product or service.
- When network effects are present, the value of the product or service increases with the number of users.
- An increase in the value of a product or service as a function of its users is a positive externality.
- The threat of potential entry is reduced when network effects are present.
Example: Social media platforms, Airbnb, etc.
Threat of entry - Types of entry barriers (Switching Cost)
- Switching costs are the costs that a customer incurs when changing to the products, services, and/or brands offered by a different vendor.
- The higher the switching costs, the lower the threat of entry.
Threat of entry - Types of entry barriers (Threat of Retaliation)
If new entry does occur, incumbents can retaliate quickly by initiating a price war.
In this case, the industry profit potential can easily fall below the cost of capital.
What are Exit Barriers?
- The rivalry among existing competitors is also a function of an industry’s exit barriers, the obstacles that interfere with a firm’s ability to leave an industry.
- Exit barriers are created by both economic factors and social factors.
- They include fixed costs that must be paid regardless of whether the company is operating in the industry or not.
- An industry with low exit barriers is more attractive because it allows underperforming firms to exit more easily.
- Such exits reduce competitive pressure on the remaining firms because excess capacity is removed.
Full Checklist: The threat of entry is high when:
✓ The minimum efficient scale to compete in an industry is low.
✓ Network effects are not present.
✓ Customer switching costs are low.
✓ Capital requirements are low.
✓ Incumbents do not possess:
○ Brand loyalty.
○ Proprietary technology.
○ Preferential access to raw materials.
○ Preferential access to distribution channels.
○ Favorable geographic locations.
○ Cumulative learning and experience effects.
✓ Restrictive government regulations do not exist.
✓ New entrants expect that incumbents will not or cannot retaliate.
Full Checklist: The power of suppliers is high when:
✓ Supplier’s industry is more concentrated than the industry it sells to.
✓ Suppliers do not depend heavily on the industry for their revenues.
✓ Incumbent firms face significant switching costs when changing suppliers.
✓ Suppliers offer products that are differentiated.
✓ There are no readily available substitutes for the products or services that the suppliers offer.
✓ Suppliers can credibly threaten to forward-integrate into the industry.
Full Checklist: The power of buyers is high when:
✓ There are a few buyers and each buyer purchases large quantities relative to the size of a single seller.
✓ The industry’s products are standardized or undifferentiated commodities.
✓ Buyers face low or no switching costs.
✓ Buyers can credibly threaten to backwardly integrate into the industry
Full Checklist: The threat of substitutes is high when:
✓ The substitute offers an attractive price/performance trade-off.
✓ The buyer’s cost of switching to the substitute is low.
Full Checklist: The rivalry among existing competitors is high when:
✓ There are many competitors in the industry.
✓ The competitors are roughly of equal size.
✓ Industry growth is slow, zero, or negative.
✓ Exit barriers are high.
✓ Incumbent firms are highly committed to the business.
✓ Incumbent firms cannot read or understand other firms’ strategies well.
✓ Products and services are direct substitutes.
✓ Fixed costs are high and marginal costs are low.
✓ Excess capacity exists in the industry.
✓ The product or service is perishable.
What is Competive Industry Structure?
The competitive industry structure refers to elements and features common to all industries. These features are:
- The number and size of a firm’s competitors.
- The firm’s degree of pricing power.
- The type of product or service (commodity or differentiated product).
- The height of entry barriers.
(Refer to textbook exhibit 3.4)
What are the features of Perfect Competition? - Competive Industry Structure
- Many small firms
- Firms are price takers (a company that must accept the prevailing prices in the market of its products, its own transactions being unable to affect the market price.)
- Commodity product
- Low entry barriers
What are the features of Monopolistic Competition? - Competive Industry Structure
- Many firms
- Some pricing power
- Differentiated product
- Medium entry barriers
What are the features of Oligopoly? - Competive Industry Structure
- Few (large) firms
- Some pricing power
- Differentiated product
- High entry barriers
What are the features of Monopoly? - Competive Industry Structure
- One firm
- Considerable pricing power
- Unique product
- Very high entry barriers
What are Firm Effects?
Firm Effects:
* Firm effects stem from unique capabilities, resources, and strategic positioning.
* Attribute firm performance to strategic leaders’ actions
* More important than industry effects
What factors determine firm effects?
- Strategic Positioning
- Strategic Commitments
What is Strategic Positioning (affects Firm Effects)?
It refers to a firm’s ability to:
* Create value for customers (V).
* While containing costs (C).
* Goal: To generate a large gap between V - C
* The greater the Value - Cost gap, the stronger a firm’s competitive advantage.
Example:
* Differentiation Strategy → Increase Value (WTP)
* Cost Leadership Strategy → Reduce Cost
What are Strategic Commitments (affects Firm Effects)?
Strategic Commitments are Firm decisions that are:
* Costly, long-term oriented, and difficult to reverse (e.g., spending billions of dollars building a new high-tech factory)
* Affects the intensity of rivalry among competitors.
Can stem from:
* Large, fixed cost requirements.
* Non-economic considerations.
Opposite: Tactical decisions, short-term and can be easily reversed (e.g., a marketing campaign)
