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WHEN AN INDUSTRY WITH A REPUTATION FOR DIFFICULT ECONOMICS MEETS A MANAGER WITH A REPUTATION FOR EXCELLENCE, IT IS USUALLY THE INDUSTRY THAT KEEPS ITS REPUTATION INTACT. (WARREN BUFFET) Industry and Competitive Analysis

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A Three-Dimensional Business Landscape ( Ghemawat, 2001)

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Industry Analysis: Tools and Frameworks 1. Supply and Demand 2. Value Added 3. Driving Forces 4. Porters Five Forces Analysis 5. Value Net and Complementors

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Simple Economic Tools for Strategic Analysis (Corts and Rivkin, 2000) Monetary Units ($) Equil. Price Supply Physical Units (q) Demand Equil. Quantity

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Demand Analysis: Key Concepts 1. Willingness to pay a) Tastes or needs b) Income or wealth c) Substitute goods d) Complementary goods 2. Market Demand a) Arraying individual buyers in order of their willingness to pay 3. Demand Segments and Price Discrimination 4. Price Sensitivity, or Elasticity of Demand

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Supply Analysis: Key Concepts 1. Supply in the short run a. Fixed costs b. Marginal costs 1. Cash costs 2. Opportunity Costs c. Supply (Q) up to p = MC 2. Supply in the long run a. Fixed costs 1. Opportunity costs of capital

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Marginal Cost Average Cost Units Price Shut Down Immediately Stay in but do not reinvest Reinvest and stay in Business

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Value Added - A Simple Game Imagine there are 30 students in this class. A black card is passed out to each student.

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Value Added - A Simple Game Imagine the instructor holds 30 red cards.

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Value Added - A Simple Game The Dean has agreed to pay $100 for each pair (1 black + 1 red) of cards. $100

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Value Added - A Simple Game How much would you be willing to accept for your black card? Imagine the instructor offered you $20. Would you accept this offer?

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Value Added A Slight Modification Imagine the same game except now the instructor only has 27 red cards. There are still 30 black cards for 30 students. How much would you accept for your black card?

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YOUR ADDED VALUE = The size of the pie when you are in the game Minus The size of the pie when you are out of the game (Brandenburger and Nalebuff, Coopetition, 1996)

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Added Value in the card game = When the instructor is in the game, the value of the game is $3,000. When the instructor is not in the game the value of the game is $0. When there are 30 black and 30 red cards, each student has an added value of $100 because without each student a match cannot be made and $100 is lost.

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Added Value in the card game = When there are 30 black and 27 red cards, the instructor has an added value of $2,700 and an individual student has an added value of $0. Since 3 students will end up without a match, no one student is essential to the game. The total value of the game with 30 students is $2,700; the total value of the game with 27 students is $2,700.

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What is your added value? Ask yourself the following question: If I enter this game, what do I add? That is how much you can bargain for.

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Value Added Raw Material Components Assembly Distrib.Retail 0%100% Sales Revenue Material Cost

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Value Added of a UNR Education (U.S. Census data, 2005) Avg. Annual Income H.S. Dropout$18,734 High School$27,915 Bachelors$51,206 Advanced74,602 Of those age 25 or over surveyed, 85% have completed high school and 28% have a bachelors degreeboth record highs.

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Cost of UNR Education Undergraduate = $83 * 128 = $10,624 MBA = $111 * 51 = $5,661 Assume we took UNR out of the game, what would you do?

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Driving Forces What is causing the industry to change? "An Update on Moores Law "An Update on Moores Law

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Moores Law The observation made in 1965 by Gordon Moore, co- founder of Intel, that the number of transistors per square inch on integrated circuits had doubled every year since the integrated circuit was invented. Moore predicted that this trend would continue for the foreseeable future. In subsequent years, the pace slowed down a bit, but data density has doubled approximately every 18 months, and this is the current definition of Moore's Law, which Moore himself has blessed. Most experts, including Moore himself, expect Moore's Law to hold for at least another two decades.

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Rivalry Threat of Substitutes Threat of Entry Buyer Power Supplier Power Five Forces Framework

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Michael Porter Speaks on the Five Forces http://aok.hbsp.harvard.edu/educators/hbsp/educa tors/article/index2.html http://aok.hbsp.harvard.edu/educators/hbsp/educa tors/article/index2.html

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1. Rivalry Intense rivalry among firms in an industry reduces average profitability.

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What causes rivalry to be strong or weak? 1. Number and relative size of competitors Concentration ratio= % of total industry sales accounted by the 4 largest firms Logging = 18% Cigarettes = 85%

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What causes rivalry to be strong or weak? Herfindahl Index - a measure of the balance in an industry HI = 10,000 * (The Sum of (the square of each firms market share)) Example: 3 firms with market shares of 0.50, 0.25, 0.25 HI = 10,000 ((0.50)^2+(0.25)^2+(0.25)^2) = 3750 = 0 Perfectly Competitive = 10,000 Monopoly >1800 Industries with reduced rivalry

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2. Buyer Power Size and concentration of customers

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3. Supplier Power Differentiation Switching Costs Intel Gets Fined May 2009

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4. Threat of Substitutes Price to Performance Ratios Switching Costs

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5. Threat of Entry

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Entry Barriers Brand Identity

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Minimum Efficient Scale Volume Unit Costs MES Entry Point

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Entry Barriers Economies of Scale Minimum Efficient Scale- (MES) is the smallest volume for which the unit costs reach a minimum. Example. MES is the following industries is: Cigarettes 20.0% Tires 3.0% Capital Requirements

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Co-opetition - The Value Net Company Suppliers Customers Complementors Competitors

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Competitive Position of Major Companies / Strategic Groups Price Quality Rolls Royce Jaguar Camry Accord Tauras Yugo Kia

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Other Steps 6. Competitor Analysis 7. Key Success Factors 8. Overall Industry Attractiveness

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Industry Importance: Empirical Evidence 1. Rumelt, R. (1991). How much does industry matter? Strategic Management Journal, 12: 167-185. Rumelt, R. (1991). How much does industry matterStrategic Management Journal "To the extent that accounting returns measure the presence of economic rents, the results obtained here imply that by far the most important sources of rents in US manufacturing businesses are due to resources or market positions that are specific to particular business-units rather than to corporate resources or to membership in an industry. Put simply, business units within industries differ from one another a great deal more than industries differ from one another.

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Rumelt (1991) Approximate Effects on Variance in Return on Capital: Variable% of Variance Explained Corporate Effects0.8% Stable Business Effects8.3% Stable Business-Unit Effects 46.4%

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Porter & McGahan (1997) Approximate Effects on Variance in Return on Capital: Variable% of Variance Explained Year2% Industry19% Corporate Parent4% Business Specific Effects32%

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Industry Importance: Empirical Evidence 2. McGahan, A., Porter, M. (1997). How much does industry matter, really? Strategic Management Journal, v18, pp. 15-30.Strategic Management Journal We also find that the importance of the effects differ substantially across broad economic sectors. Industry effects account for a smaller portion of profit variance in manufacturing but a larger portion in lodging/entertainment, services, wholesale/retail trade, and transportation.