Industry Analysis Learning objective: to determine the opportunities and threats that exist for firms within a competitive

environment. Method: Apply an adapted model of Porters (1980) five forces. Student perspective and instructions: You are a team of analyst hired to answer a corporate-level question: should we enter this industry? You are outsiders looking in. In other words, when analyzing an industry, taking all factors into account, should we, as a corporation, enter this industry? The end result will be an understanding of what it takes to compete successfully. Industry selection: Firm and industry selection are concurrent activities. Start with the firm. It must be publicly traded to give you access to an annual report and 10K, and it must have a definable problem. You are strongly advised to choose a firm with a production function, but exceptions are possible. Discuss this with your instructor first. From your initial reading about the firm, what industries does it compete in? Make a choice of industry to be analyzed based on personal interest, firm problems, or in consultation with your instructor. The firms primary source of revenue will in most cases define your industry choice. Maintain your focus on the questions being asked. Provide a conclusions for each section and subsection. Note carefully the form of the conclusion provided in each section. A decision matrix should be provided at the end of each section, and an overall matrix provided in the conclusion section. Where quantitative analysis is required, provide average industry numbers expressed as ratios. Use five years of data to establish trends. Where qualitative analysis is required, provide citations to support your arguments. Assumptions and common knowledge are not accepted. Continuity: I do read these papers! Be sure that if you make a declarative statement in one section, you do not contradict yourself in another. While it is a team project, I read it as the work of one person. Integrate the paper. Please number pages, and use section headings and sub-headings. Help is just a mouse-click away! I strongly encourage you to show me your work as you progress. I can, and will, save you hours of frustration if you will show me what you are doing. INDUSTRY PAPER I. Introduction This part of the paper is the only concession I make to an English paper which every student begins writing. A. Description This is to be a general introduction to the particular nature of the industry. A brief history, key players, and general information are required to set the stage.

B. Segments Identify the segments of the industry, and specifically state the focus of the paper. Almost every industry has segments some have too many, such as the computer industry. Students can not be expected to do all segments within one semester. C. Caveats State limitations encountered in the study that prevent a complete analysis. No caveats are allowed without prior conversation with the instructor. Work-arounds are possible. Caveats that I agree exist are written because I cant remember all the conversations. II. Socio-Economic Learning objective: Determine the power of various stakeholder groups likely to have an impact on future competitive moves of firms within this industry. Most texts cover in detail the many factors that can be relevant to any industry. Here the students must research their industry to find specific factors likely to impact firms within their industry. The orientation is toward the future. It is assumed that firms in the industry have adapted to past events. This material is available in magazine articles, and industry surveys, among other sources. Obviously this section will be very short for, say, the PC computer industry, and very large for the forestry products industry. A. Relevant governmental or environmental factors An example would be the periodic efforts of the government to regulate auto gas mileage and emissions. B. Economic indicators relevant for this industry An example would be disposable income for firms in industries selling discretionary goods or services. III. Porters Five Forces Learning objective: Determine the relative strengths of each of the five forces. A. Threat of New Entrants Those industries with high entry barriers will have fewer firms entering. With fewer firms, there is less environmental complexity, and it is easier for one firm to begin to dominate the industry. Economic rents are usually higher in such an environment. This makes the industry attractive. For industries with low barriers to entry, such as the restaurant industry, new firms come and go with great rapidity. This prevents dominance by any one, or a few, firms. Economic rents are usually low. This makes the industry unattractive. The following elements will help determine the level of threat from new entrants. 1. Economies of scale If economies of scale exist, it represents a high barrier to entry. Firms within the industry will have achieved these economies, and if we enter, we will have to match their scale size, but without the benefits of the associated learning curve. Since economies of scale do not exist in any tangible way, you must prove their existence or non-existence. Provide two measures related to the basic premise that increases in capital investment should lead to lower unit costs. Reach a conclusion: based on your

analysis, do economies exist? What does this do to the threat of new entrants? Does this make the industry attractive or unattractive? Provide similar conclusions for each of the following sub-sections. 2. Working capital requirements How much money will we have to tie up to keep the doors open? This is money that can not be invested in any other way. It will never earn an income. This is also a barrier to entry in that if firms must tie up large amounts of capital for daily operations, this will deter smaller firms from entering. Working capital requirements are usually provided in the cash flow financial statements. 3. Proprietary product differences Do you see that some firms have a secret process or secret formula? An example would be Coca-Cola. They have a secret formula for their cola soft drink that acts as a high barrier to entry. Very few firms try and compete head-to-head with Coke in the cola segment of the industry. 4. Absolute cost advantages Do you see the presence of patents or copyrights? These are legal constraints to entry created by the government. By definition, they constitute a high barrier to entry. Examples include patents on pharmaceuticals and copyrights on software. 5. Brand identity Is brand identity important in this industry? Do buyers make conscious choices based on brand identity? If so, this would be a high barrier to entry. Examples include Viagra, Coke, and Intel Pentium processors. You must prove that brand identity is or is not important. One way is through an interview with a buyer. Another is to examine marketing expenses for the industry as a percentage of sales across five years. If the trend is upward, then brand identity could be important. 6. Access to distribution How do firms get their product or service to market? Would we need to duplicate the distribution channels, or could we tap into existing channels? This is not an obvious question, and it requires first determining who the buyers are. Kia auto discovered that lack of a distribution system in the form of dealerships limited its access to markets in this country. This was a very high barrier to entry for them. 7. Expected retaliation Do you see indications of retaliation against prior newcomers? This will require research through many historical articles about the industry. An example would be the airline industry. Midway Airlines, a small regional carrier, competed head-to-head with American and USAir, and went bankrupt. Southwest has survived nicely by avoiding the markets dominated by larger airlines such as American and United. This is one of the high barriers to entry for the major segment of the airline industry.

From your analysis, you will find that some of these points are not relevant to your industry. You should also appreciate that some points are more important than others. Lastly, you should find that some elements will say that the industry is attractive, while other elements say that the industry is unattractive. Provide a decision matrix to justify your final answer as to the barriers to entrants, the threat of new entrants, and the attractiveness of the industry. B. Suppliers While we were concerned about threats in the "entrants" section, here we are concerned with power. Do suppliers have power over firms in this industry? If so, this would make the industry unattractive. The first step is to determine what this industry purchases. Not in detail, but as a generalization. Then, identify items that are recognized as being commodities. These can be dismissed from further consideration. Focus on suppliers of key items that firms in this industry must have. For example, in the micro brewing industry, all inputs are commodity items except hops. Since hops are the key ingredient for specialty beer production, supplier analysis would focus only on hops suppliers. Another example would be the PC industry. While this industry changes regularly, at the time of writing, only the central processing unit (CPU) is a key input. All other items are commodity in nature and would not be discussed. Evaluate the following elements only for the key item or items in the industry. 1. Suppler concentration Are there more or fewer suppliers than firms in this industry? If suppliers are concentrated (fewer of them) this could give them power over buyers in this industry. For example, Intel is one of only a few providers of CPUs for the PC industry. This gives them power over the PC industry. 2. Presence of substitute inputs The presence of substitute inputs lowers the power of suppliers. For example, in the auto industry, aluminum can substitute for steel. This lowers the power of the steel industry. A lack of substitutes, such as no substitute for the CPU gives the suppliers power. 3. Differentiation of inputs Are suppliers able to differentiate their products/services in some way? Whether legitimate or not, Intel has differentiated its CPU such that many consumers (not buyers) prefer computers with Intel inside. This ability to differentiate gives suppliers power. 4. Importance of volume to supplier Do we, as an industry, buy a significant percentage of the total production of the suppliers output? For example, the PC industry buys virtually all of the CPUs that Intel produces. This gives the PC industry power over the suppliers. Without the PC industry there would be no CPU manufacturers. 5. Impact of inputs on our cost or ability to differentiate

If suppliers have a significant impact on an industrys cost structure, or value chain, this gives them power. The same is true if they impact firms ability to differentiate their product or service. Again, the PC industry is a good example. Intels ability to impact PC manufacturers final product gives them power. 6. Threat of forward or backward integration Is there any indication that vertical integration is occurring? If suppliers are coming forward to gain access to distribution channels, this gives them power. If there are indications of firms backward integrating to capture margins, this gives firms in the industry power over suppliers. 7. Access to capital Assuming that we enter this industry, at some point in the future we will want access to capital for expansion or other business reasons. You need to determine whether we would likely have access to capital on acceptable terms. Since we cant know the future, we have to use the past as an indication. Determine the average profitability for the industry over the last five years. Net income as a percentage of sales works. Plot a graph comparing industry profitability against inflation. In your opinion, does the return on investment represent a reasonable income? If so, we can expect that we would have access to debt financing on reasonable terms. If not, access to debt financing is likely to be expensive. 8. Access to labor If we enter, would we have access to labor on favorable terms? Does this industry have unions? If so, they limit access to labor and usually increase costs. Do firms in this industry require highly skilled knowledge workers? How is the present labor market for this industry? As with the threat of new entrants section, provide conclusions for each subsection as to the power of suppliers. Then provide an overall conclusion for this section using a decision matrix. Do suppliers have power and is the industry attractive? C. Buyers First, determine who the buyers are. This is not a marketing paper, so dont think ultimate consumer. What are the channels of distribution for the industry? Your analysis should focus on the primary buyer, not on the consumer unless there are no intermediaries. Here again, we are concerned with power. Do buyers have power over firms in this industry? If so, the industry is unattractive. The easiest way to get answers is through an interview with a buyer. Most firms are willing to assist students. While it is not correct to generalize from one interview or observation, the experience and knowledge gained from the interview offset the methodological limitations. 1. Buyer concentration Are there more or fewer buyers than firms in the industry? If buyers are concentrated, this gives them power. An example would be the airframe industry. There is only one U.S. based buyer for commercial

aircraft parts Boeing. Therefore, the buyers for the commercial aircraft parts industry are concentrated, giving the buyers power, making the commercial aircraft parts industry unattractive. 2. Buyer switching costs Do buyers have switching costs that would limit their willingness to switch suppliers? If the industry has been able to create switching costs, that gives the industry power over the buyer and makes the industry attractive. An example would be the software industry. The switching costs are the time required to learn a new program. This makes it less likely that a buyer would switch readily from, say, Excel to Lotus. This buyer switching costs gives power to the software industry. 3. Buyer Information Do buyers understand what is happening in this industry? If so, it is less likely that the industry can make competitive moves to increase profit margins. An example would be the auto tire industry. Buyers (auto manufacturers) know what it takes to make a tire. Therefore, they have power over the tire industry. This is demonstrated by the relatively low margins in the tire industry. 4. Threat of backward integration Backward integration is the process of firms acquiring their suppliers, or beginning the process of providing for themselves the means to produce the input. This can occur for several reasons, among them: to guarantee a dependable source of the input or to capture the margins normally paid to the suppliers. Are there indications that buyers are backward integrating? If so, this gives them power, making the industry unattractive. 5. Pull through Have firms in this industry been able to create pull through? This requires that intermediaries exist. If brand identity is important in this industry then pull through most likely exists. Quantitative analysis of advertising expense as a percentage of sales over time for the industry is one way of demonstrating that pull through could exist. The easiest way to answer the question is through an interview. If pull through exists, this gives the industry power over the buyer. An example would be the cereal industry, which has established pull through such that major grocery chains have to carry major brands. This pull through gives the cereal industry power over the buyers, making the industry attractive. 6. Brand identity of buyers Does the industry impact the brand identity of its buyers? If so, this would give the industry power over the buyer. For example, while high performance tires with a brand name seen on racing cars would favorably impact the brand identity of a very expensive sports car, a brand of tire that automobile assembly plants put on compact cars would negatively impact the brand identity of this car. 7. Price sensitivity

Are buyers price sensitive? This deals with elasticity of demand. Is the industry able to pass cost increases on to the buyer, or must they absorb them? If buyers are not price sensitive, this gives the industry power and makes it attractive. 8. Price to total purchases Do the buyers purchases of this industrys product/service represent a significant percentage of their total purchases? If so, this would give the industry power over the buyers. They would be dependent on a constant supply of goods or services for their survival. As with the supplier section, provide conclusions for each subsection as to the power of buyers. Then provide an overall conclusion for this section using a decision matrix. D. Substitute Products An industry will be attractive if there is no threat from substitute products. A substitute is any product or service that will fulfill the same need while using a different technology. An example would be substituting plastic for paper for food carry out. The electric car is a substitute for the internal combustion engine; therefore the auto as we know it, even though the auto industry is the primary developer. The relevance is that substitutes can render obsolete the present capital investment of the industry. 1. Relative price/performance relationship of substitutes The electric car has not caught on, in part, because it does not have the same performance characteristics as the traditional auto. Another example: few business people put cheap pens in their shirt pockets. They prefer a very expensive pen. The prestige factor is much higher for the higher-priced pen. The need being satisfied is not the ability to write, but the image being portrayed. 2. Buyer propensity to substitute Despite the benefits offered by the substitute product or service, do people really want it? The ultrasonic clothes washer was a flop. It got clothes as clean as the conventional washer, using cold water and no soap. But people preferred the hot water and soap despite the additional costs. Another example: special interest groups forced McDonalds to switch from styrofoam containers to paper containers for carry out food. This section does not require a decision matrix. Based on your study of the industry, what do you conclude about the attractiveness of the industry? E. Rivalry An industry characterized by high rivalry is unattractive because it limits the ability to achieve above normal economic rents. At the other extreme, industries with no rivalry are usually dominated by a few major firms which could limit strategic flexibility.

1. Degree of concentration and balance among competitors Here I cover lecture material on industry structure and the life cycle. Using a continuum, I show that some industries are fragmented, such as drug stores, while others are in near-monopoly conditions, such as main frame computers. The questions for the student are where is their industry on this continuum, and what are the economic forces acting on firms? As the business cycle, or life cycle, progresses, there is a tendency for consolidation to occur within industries. At the beginning of the 20th century, the US had around 300 firms in the auto industry. We now have two. As a rule of thumb, an industry is concentrated if five or fewer firms control 60% or more of market share. Concentration tends to increase rivalry, but must be considered along with balance. If concentration does not exist, then balance is not an issue. The industry is, by definition, fragmented. This reduces rivalry and makes the industry attractive. Assuming that the industry is concentrated, then look for balance. If the two largest firms have market shares within 10% of each other, then the industry is balanced. This increases rivalry, making the industry unattractive. If one firm is dominant in market share, this means that the larger firm is setting the competitive rules for the industry. This reduces rivalry and makes the industry attractive. A four cell matrix can be constructed to demonstrate these points. 2. Diversity among competitors Are firms following different strategies? If so, they have found market niches and this reduces rivalry. If they are all following the same strategy, they are fighting for the same markets and this increases rivalry, making the industry unattractive. Students have been exposed to Porters generic strategies by this point. 3. Industry growth rate (past and projected) If there is a positive trend to industry growth rate, and it is greater than the inflation rate, then firms are able to grow without taking market share from other firms in the industry. This reduces rivalry and makes the industry attractive. Quantitative analysis is required with a graph of the five year growth rate trend. 4. Fixed costs to value added It is necessary to demonstrate whether fixed costs and value added are high or low. If fixed costs are high, this usually means that economies of scale are possible in the industry. If fixed costs are high, and value added is low, the industry is at or near maturity, and the product/service is most likely a commodity. This increases rivalry and makes the industry unattractive. Here I re-introduce break even analysis to show why fixed costs are important in an industry. What constitutes high or low is left to the student to determine, and to support. This section is a good place to see if the students are working together in as much as the "entrants" section had to demonstrate

economies of scale. The next element is value added. There are a number of ways to determine if the firms are able to create a reasonable profit margin, and the student can pick any supportable argument. This is one of the sections that allows real evaluation of the students analytical ability, and the ability to work with team members. As is obvious, fixed costs to value added is a very rich topic providing the instructor an opportunity to take a variety of approaches. More importantly, the student has an opportunity to integrate a number of significant concepts. 5. Intermittent overcapacity If the industry is running between 80% and 85% capacity utilization, this is a normal range. Lower utilization means that the industry is susceptible to intermittent overcapacity. This increases rivalry as firms attempt to maintain revenues. If the industry is over the normal range, this indicates that they may lack the capital investments necessary to meet unexpected demand. This reduces rivalry and makes the industry attractive. The Department of Commerce provides figures for capacity utilization. These numbers are provided for the student, along with the web site for further data mining. While it is not applicable to all industries, most industries do have some measure of capacity utilization. 6. Product differentiation Are firms able to differentiate their product or service? If so, this reduces rivalry as each firm is able to find a market niche. If not, it increases rivalry and makes the industry unattractive. For example, BIC and Mont Blanc differentiate their pens on the basis of quality, image and cost, which reduces rivalry between these firms. In the airline industry each firm offers basically the same service. The lack of differentiation makes the industry unattractive. 7. Growth of foreign competition To what extend are foreign firms able to penetrate the US market? If there is a growth in foreign firms penetration, this increases rivalry making the industry unattractive. It also shows that US firms are not being globally competitive. While this is not an international management course, I do want students to be aware of the extent to which foreign firms are able to penetrate US markets. We also go over the reasons during lectures on the global economy. 8. Corporate stakes While most firms have revenue from a variety of industries, the question here deals with the degree of dependence on one industry segment. To what extent are firms dependent on this one industry segment for revenue? If the percentage of revenue is high, then the stakes are high, and this would increase rivalry, making the industry unattractive. This requires judgment on the part of the student, and quantitative support for the argument. 9. Exit barriers

If we enter this industry, will we be able to get out again? A firm can exit by converting operations to another product/service, or by selling out merger. If exit barriers are low, this reduces rivalry and makes the industry attractive. As with the other sections, in this one provide conclusions for each subsection as to the degree of rivalry. Then provide an overall conclusion for this section using a decision matrix. IV. Conclusion You have, by now, discovered a number of factors: Firms do not provide their annual reports in any standardized manner. Reporting services will have conflicting data. Missing industry numbers can not be computed from firm data. But the biggest awakenings should be that a lot of the theory you have learned from other classes does not apply, and there are no correct answers! However, you are now in a position to look beyond the obvious and to see and write about the opportunities and threats facing firms in an industry. State what you consider to be the opportunities and threats for firms that would enter this industry. Use a decision matrix to support a final argument as to whether we should or should not enter this industry. A. Critical Success Factors You need three. Two are quantitative, and one can be qualitative. A factor is critical if it defines the difference between a firm that will succeed and one that will fail. These should come from your analysis of the industry they are not separate! For example, if you noticed that the industry is in the mature phase of the life cycle, and that fixed costs are high and value added is low, then efficiencies would be a critical factor to survival. Market share is not a critical factor it is an obvious point that firms must grow. It is how they grow that matters. Most texts give material on key success factors. This is a laundry list. The point here is to narrow the list down to items that are really important within an industry. For the auto industry, being a lowcost provider is important, as is quality of products. These can be measured by the student from industry data. Another factor is reputation, as Ford found out with the Explorer problem. B. Prognosis What is your assessment of this industry as an investment prospect? Is future growth possible? Will competitive forces contribute to consolidation? These are just suggestions. Your analysis should lead you to reasonable conclusion. V. Bibliography I would prefer to see not only the references that you cite, but also a listing of the material that contributed to your body of knowledge. Where did you look for answers? If it helped you, please include a reference.

VI. Appendices Here you can put anything that you think is important to an understanding of this industry. At a minimum you need a set of industry ratios covering the most recent five year period. I prefer electronic submissions. You can submit earlier than the required submission date. Final Notes: It could be said that there is too much structure in this outline, and that the student is being driven toward a single conclusion. From experience, I dont believe that this is the case. The analysis required is focused. This means the student must learn certain techniques that will be useful in their future endeavors. However, as students discover that all theory does not apply in all cases, this is where they have the chance to see beyond the obvious and discover new solutions. One example of this process: We all know that the auto industry is unattractive. It is mature, with saturated markets, excess capacity, and strong labor unions. Despite this, firms still enter and find ways to survive. Witness Honda and Kia. Others fail, for example, Jugo. When the analysis is finished, the student is able to discern the opportunities and threats of the industry, and I believe that the structure of the industry analysis contributes to achieving this objective. INDUSTRY PAPER OUTLINE I. Introduction A. Description B. Segments C. Caveats II. Socio-Economic A. Relevant governmental or environmental factors, etc. B. Economic indicators relevant for this industry III. Porters Five Forces A. Threat of New Entrants 1. Economies of scale 2. Working capital requirements 3. Proprietary product differences secret formulae or processes 4. Absolute cost advantages: patents or copyrights

5. Brand identity 6. Access to distribution 7. Expected retaliation B. Suppliers 1. Supplier concentration 2. Presence of substitute inputs 3. Differentiation of inputs 4. Importance of volume to supplier 5. Impact of inputs on cost or differentiation 6. Threat of forward or backward integration 7. Access to capital 8. Access to labor C. Buyers 1. Buyer concentration versus industry concentration 2. Buyer switching costs 3. Buyer information 4. Threat of backward integration 5. Pull through 6. Brand identity of Buyers 7. Price sensitivity 8. Price to total purchases D. Substitute Products 1. Relative price/performance relationship of substitutes 2. Buyer propensity to substitute E. Rivalry

1. Degree of concentration and balance among competitors 2. Diversity among competitors 3. Industry growth rate (past & projected) 4. Fixed costs/value added 5. Intermittent overcapacity 6. Product differentiation 7. Growth of foreign competition 8. Corporate stakes 9. Exit barriers IV. Conclusion A. Critical Success Factors. At least three, two of which must be quantitative. B. Prognosis - your assessment of the future of this industry. Summarize the five forces discussion. Threat, power, attractiveness. Should we enter this industry? V. Bibliography VI. Appendices Industry Ratios Other relevant indices

Refer: http://faculty.philau.edu/lermackh/industry_analysis.htm http://www.wikihow.com/Write-an-Industry-Analysis-Report http://web.ntpu.edu.tw/~jason/120%20MM/reference%201/Porter's%20Five%20Forces.pdf http://www.quickmba.com/strategy/porter.shtml http://www.sba-bc.ca/guide/business-research-basics/industry-analysis-step-step