darral g. clarke for bm 4991 bm 499 ghemawat, chapter 2 darral g. clarke professor of management

Darral G. Clarke for BM 499 1

BM 499Ghemawat, Chapter 2

Darral G. ClarkeProfessor of Management


ROE-Ke Spread

(15%)

(10%)

(5%)

0%

5%

10%

15%

20%

0 100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300

Average Invested Equity ($B)

Toiletries/Cosmetics

Steel

PharmaceuticalsSoft Drink

TobaccoFood Processing

Household ProductsElectrical Equipment

Financial ServicesSpecialty Chemicals

NewspaperBank

Integrated PetroleumTelecom Retail Store

Tire & RubberElectric Utility - Central

Electric Utility - East

Medical ServicesMachinery

Auto & TruckComputer & Peripheral

Paper & ForestAir Transport

Source: Compustat, Value Line, Marakon Associates Analysis

Average Economic Profits of U.S. Industry Groups, 1978-1996

Value Line Industry Groups

Darral G. Clarke for BM 499

0

10

20

30

40

50

60

70

80

90

100

2%

4%

6%

8%

10

%

12

%

14

%

16

%

18

%

20

%

22

%

24

%

26

%

28

%

30

%

32

%

Numberof

Industries

First QuartileAverage

22.2%

Fourth QuartileAverage

9.3%

Note: Return on Equity = Net Income / Year End Shareholders’ Equity; Analysis based on sample of 593 industries

Average = 14.7%Median = 13.8%

11.7%

13.8%

16.5%

Return on Equity (Percent)

Average Return on Equity in US Industries, 1982-1993

Distribution of Industry Returns

Source: Jan W. Rivkin’s Analysis Based on Dun and Bradstreet Data

Darral G. Clarke for BM 499 Source: Jan W. Rivkin based on Compustat

Computer system design

Operating Income / Assets, 1988-95 (%)

0 5 10 15 20 25

Scheduled airlines

Motor vehicles

Cable TV service

Engineering services

Trucking except local

Race track operations

Petroleum / natural gas

Drug stores

Eating places

Dental equipment

Women's clothing stores

Semiconductors

Prepackaged software

Pharmaceuticals

Profitability Differences Across Selected Industries


30

40

50

60

70

80

90

100

Pro

fitab

ility

Choice BChoice A

A Three-Dimensional Business Landscape


Supply

Demand

PhysicalUnits

EquilibriumQuantity

EquilibriumPrice

MonetaryUnits

Supply-Demand Analysis


Beds (% of total market 8,270 beds)

Case mix adjusted expenseper adjusted day ($)

Source: Partners HealthCare System, Inc. (A), Case #696-062

Lah

ey

Law

ren

ce

Nor

woo

d

0

100

200

300

400

500

600

700

800

900

Win

ches

ter

Atl

an

ticare

Bev

erly

Low

ell

St.

Joh

ns

Sou

th S

hor

e

God

dar

d

Faulkner

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Wal

tham

NN

E M

emor

ial

Malden

Leo

nar

d M

orse

Sal

em

St.

Eli

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's

Mou

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Au

bu

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Med

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iver

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Supply Curve for Boston Hospitals


Supply / demand analyses say little about what determines the position and shape of the two curves

From Supply / Demand to the Five Forces

What determines the long-run supply / demand balance? Entry barriers and intensity of rivalry affect whether firms

will add capacity in response to excess demand Exit barriers affect whether firms will retire capacity in

response to excess supply

What determines the effect of a supply / demand imbalance on profitability?

In industries with intense rivalry or powerful buyers, small amounts of excess capacity tend to lead to big price wars

In industries with powerful suppliers, the benefits of excess demand may accrue to the suppliers


Threat of New Entry

Rivalry Among Existing

Competitors

Bargaining Powerof Customers

Threat of Substitutes

Bargaining Powerof Suppliers

Industry Analysis: The Five Forces


Theory of the Firm: The link to the Five Forces

Five forces identifies the factors that determine differences in firm profitabilityFive forces tells us how profitability responds to changes in a large variety of factors

P

Profit

Q


Theory of the Firm:The link between the Five Forces and profitability

Consider a sequence of market entry and decreasing differentiation

P

Profit

Q

P

Q

DD


Rivalry among Current Competitors

Concentration and balanceIndustry growthFixed (or storage costs)/Value addedProduct differencesBrand identitySwitching costsIntermittent over-capacityDiverse stakesExit barriers


Entry BarriersEconomies of scaleProduct differencesBrand identitySwitching costsCapital requirementsAccess to distribution

Absolute cost advantages Learning curve Access to necessary

inputs Low cost product design

Government policyExpected retaliation


Power of BuyersIntrinsic Strength

Buyer concentrationBuyer volumeSwitching costsBuyer informationAbility to backward integrateSubstitute productsPull through

Price SensitivityPrice/Total purchaseProduct differencesBrand identityImpact on quality/performanceBuyer profitsDecision maker’s incentives


Power of SuppliersSupplier concentrationSubstitute suppliersSupplier volumeProduct differencesBrand identitySwitching costsLow buyer informationThreat of forward integrationPull through


Threat of SubstitutionProduct function not formEntire value added chainThread depends on Relative price/performance Switching costs

Often an S-curve process


Customers

Firm

Suppliers

Competitors Complementors

A player is your complementor with respect to customers if customers value your product more when they have the other player’s product as well

A player is your competitor with respect to customers if customers value your product less when they have the other player’s product as well

A player is your complementor with respect to suppliers if it is more attractive for a supplier to provide resources to you when it is also supplying the other player

A player is your competitor with respect to suppliers if it is less attractive for a supplier to provide resources to you when it is also supplying the other player

The Value Net

Source: Adam Brandenburger and Barry Nalebuff, Co-opetition (New York: Currency Doubleday, 1996)


Threat of New Entry

Rivalry Among Existing

Competitors

Bargaining Powerof Customers

Threat of Substitutes

Bargaining Powerof Suppliers

Availability of Complements

Expanded Industry Analysis


The Power of ComplementorsRelative concentrationRelative buyer or supplier switching costsEase of unbundlingDifferences in pull-throughAsymmetric integration threatsRate of growth of the pie


LandscapesLandscape is broader than industry

Landscape includes firms, institutions, and other players which often are not viewed as part of an industry

Landscape includes networks of firms (from different industries) whose profits may be interdependent (e.g. Microsoft-Intel)


Commitment Opportunities and Structure

Production scale economies set a lower bound on concentration

Many settings are more concentrated than production scale economies would imply

Opportunities to commit resources to advertising and R & D in ways that enhance willingness-to-pay to some minimal degree are what lead to “excess” concentration


Steps in Landscape AnalysisDefine the landscape: what is in, what is outIdentify the players

e.g., who are the customers, really? Who are the competitors?

Assess the relationships among players See Porter (1979, 1980) for some factors to consider

Sniff-test Is assessment in line with actual profitability? Are more profitable players better positioned vis-a-vis

competitive forces?

Assess recent and future changes


Identify forces that must be countered in order to achieve superior profitability

Test decision to enter

Test decision to exit

Assess effects of a major change

Identify ways to alter structure

Pinpoint most threatening force and seek ways to counter (e.g., build switching costs, find new sources of supply)

Consider effect of entry on structure; choose relative position; select entry vehicle; compare costs of entry to benefits

Identify options for improving structure or relative position; select exit vehicle; compare costs of exit to benefits

Consider how change will affect each force

Assess consolidation, backward integration, forward integration, investments that raise entry costs, entry into substitute market, etc.

Purpose Common steps

Steps in Landscape Analysis (cont.)


Common Pitfalls in Landscape Analysis

Failing to define the landscape clearly A clear definition is more important that the “right”

definition

Confusing transient effects with structural forcesIgnoring changes in structural forcesAssuming that competitive forces cannot be alteredConfusing evidence of a force with its underlying cause

e.g., blaming customer power on customer price sensitivity rather than exploring root causes of price sensitivity

Ignoring the full range of substitutesPaying equal attention to all the forces


LessonsIndustries or landscapes are neither created equal nor stay equal

The concept of “extended competition” provides a comprehensive framework for assessing structural attractiveness

A firm’s strategy can increase or decrease its exposure to competitive forces

Other things being equal, a firm should seek to trigger actions that improve structural attractiveness

But it isn’t enough to look at just structural attractiveness: competitive position must also be considered


Conclusion

Envisioning the business landscapeAdapting to the business landscapeShaping the business landscape

darral g. clarke for bm 4991 bm 499 ghemawat, chapter 2 darral g. clarke professor of management

Documents

suppliers slide

retaliation slide

bradstreet data slide

supply demand balance

excess supply

players product

supply demand imbalance

industries average