CS - Lecture 1

Finish the sentence: "Substitutes limit the potential of an industry by ..."

placing a ceiling on the prices firms can charge."

Define a substitute product.

A product that can perform the same function as the product of the industry.

How does product differentiation create a barrier to entry?

It forces entrants to spend heavily to overcome existing customer loyalties, not infrequently involving start-up losses and considerable elapsed time.

Define joint costs and give two examples of joint costs.

Joint costs occur when a firm producing product A (or an operation or function that is part of producing A) must inherently produce product B. An example is air passenger services and air cargo. A second exampl is when business units can share intangible assets such as brand names and knowhow.

Name a form of competition that is likely to leave an entire industry worse off from a profitability standpoint, and name another firm likely to leave an industry better off.

Price competition is highly unstable and quite likely to leave the entire industry worse off from a profitability standpoint. Price cuts are quickly and easily matched by rivals. Advertising battles, on the other hand, may well expand demand or raise the level of product differentiation in the industry for the benefit of all firms.

Name some tactics commonly used by rivals in an industry.

Price competition, advertising battles, product introductions, and increased customer service or warranties.

Finish the sentence: "Cost declines with experience seem to be most significant in businesses involving ...

a high labor content and/or complex assembly operations (i.e., aircraft, shipbuilding).

Give two examples of how industry rivalry changes.

1) An industry matures and its growth rate declines, resulting in intensified rivalry, declining profits, and often, a shakeout. 2) An acquisition introduces a very different personality to an industry 3) A technological innovation can boost hte level of fixed costs in the production process and raised the volatility of rivalry.

Name eight structural factors that characterize intense rivalry.

1) Competitors are numerous or are roughly equal in size and power. 2) Industry growth is slow. 3) High fixed or storage costs (High fixed costs create strong pressures for all firms to fill capacity, which often leads to price cutting. Additionally, firms purchasing a high proportion of costs in outside outputs may feel enormous pressures to fill capacity to break even.) 4) The product or service lacks differentiation or switching costs (i.e., one-time costs of switching brands or switching from one competitor's product to another). 5) Capacity is normally augmented in large increments (When economics dictate that capacity must be added in large increments, the industry may face chronic periods of overcapacity and price cutting). 6) Competitors are diverse in strategies, origins, "personalities," and relationships to their parent companies. 7) High strategic stakes (e.g., some firms are expansionary and are potentially willing to sacrifice profitability for market dominance) 8) High exit barriers

How is government a force in industry competition?

1) In many industries, government IS a buyer or supplier and can influence industry competition by the policies it adopts. 2) Government can also affect the position of an industry with substitutes through regulations, subsidies or other means.

Name eight factors that contribute to the power of a buyer group.

1) It is concentrated or purchases large volumes relative to seller sales (e.g., Wal-Mart). 2) The products it purchases from the industry represents a significant fraction of its costs or purchases, thereby incentivizing buyers to expend the resources necessary to shop for a favorable price and purchase selectively. 3) The products the buyer purchases from the industry are standard or undifferentiated. 4) The buyer faces few switching costs. 5) The buyer earns low profits 6) The buyer poses a credible threat of backward integration (i.e., they could self-manufacture the input) 7) The industry's product is unimportant to the "quality" of the buyers' products or services. 8) In the case of retailers or wholesales, when they can influence consumers' purchasing decisions, as retailers do in audio components, jewelry, appliances, etc.

What five traits make a supplier group powerful?

1) It is dominated by a few companies and is more concentrated than the industry it sells to. Suppliers selling to more fragmented buyers will be able to exert considerable influence on prices, quality and terms. 2) It is not obliged to contend with other substitute products for sale to the industry. 3) The industry is not an important customer of the supplier group. 4) The supplier group's products are differentiated or it has built up switching costs. 5) The supplier group poses a credit threat of forward integration

Name the five major sources of exit barriers.

1) Specialized assets 2) Fixed costs of exit (e.g., labor agreements, etc.) 3) Strategic interrelationships (i.e., interrelationships between the business unit and others in the company in terms of image, marketing ability, access to financial markets, shared facilities, etc.) 4) Emotional barriers (i.e., management's unwillingness to make economically justified exit decisions due to loyalty to employees, fear for their own careers, pride, etc.) 5) Government and social restrictions (i.e., government discouragement of exit due to job loss and regional economic benefits. This is particularly common outside the U.S.)

Name the three ways that buyers compete with the industry (i.e., decline industry profitability).

1) force down prices 2) demanding higher quality or more services 3) playing competitors against each other

What three conditions signal strong likely retaliation from competitors and hence deter new entrants from an industry?

1. A history of vigorous retaliation to entrants 2. Established firms with substantial resources to fight back, including excess cash and unused borrowing capacity, adequate excess productive capacity to meet all likely future needs, or great leverage with distribution channels or customers 3. Slow industry growth, which limits the ability of the industry to absorb a new firm without depressing the sales and financial performance of established firms

What are two properties of entry barriers that are crucial from a strategic standpoint?

1. Entry barriers can and do change (e.g., patents expire, product differentation can disappear) 3. While entry barriers sometimes change for reasons largely outside the firm's control, firm strategic decisions can have a major impact on entry barriers. These decisions include changing advertising levels, expanding or decreasing distribution channels, etc.

Name three limits to economies of scale as an entry barrier.

1. Large scale and hence lower costs may involve tradeoffs with other potentially valuable barriers to entry such as product differentiation or the ability to rapidly develop proprietary technology. 2. Technological change may penalize the large scale firm if facilities designed to reap scale economies are also more specialized and less flexible in adapting to new technologies. 3. Commitment to achieving scale economies using existing technology may cloud the perception of new technological possibilities, or of other new ways of competing that are less dependent on scale.

Name three ways that experience may be available to competitors or potential entrants?

1. Outright copying 2. Hiring of the competitors' employees 3. Purchasing the latest machinery from equipment suppliers or purchasing knowhow from consultants or other firms In situations where experience cannot be kept proprietary, new entrants may actually have an advantage if they can buy the latest equipment or adapt to new methods unencumbered by having operated the old way in the past

Name five most critical cost advantages established firms often have, that are independent of economies of scale.

1. Proprietary product technology -- e.g., patents or trade secrets 2. Favorable access to raw materials -- i.e., through contracts or relationships 3. Favorable locations 4. Government subsidies 5. Learning or experience curve -- in some businesses, there is an observed tendency for unit costs to decline as the firm gains more cumulative experience in producing a product. This is because workers improve their methods and get more efficient, layout improves, product deisng changes make manufacturing easier, etc.

Draw the chart of possible outcomes where exit barriers and entry barriers can be high or low.

1. When entry and exit barriers are both low, there are low returns. 2. When entry barriers are high and exit barriers are low, this is the best case. 3. When entry and exit barriers are both high, there is the potential for high returns but there's also risk. 4. When entry barriers are low and exit barriers are high, the result is the worst case.

What traits characterize somewhat formidable substitutes?

1. those that are subject to trends improving their price-performance trade-off (e.g., electronic alarm systems. labor-intensive guard services face inevitable cost esvalation, while electronic systems are highly likely to improve in performance and decline in costs). 2. those that are produced by industries earning high profits

Define access to distribution channels as a barrier to entry.

A barrier to entry can be created by the new entrant's need to secur distribution for its product. To the extent that logical distribution channels for the product have alreayd been served by established firms, the new firm must persuade the channels to accept its product through price breaks, cooperative advertising allowances, and the like, which reduce profits. A new food product, for example, must displace others from the fiercely competitive supermarket shelf via promotions, intense selling efforts, heavy advertising to create consumer pull, or some other means.

Name some industries in which product diferentiation is probably the most important barrier to entry.

Baby care products, OTC drugs, cosmetics, investment banking and public accounting. In the brewing industry, product differentation is coupled with economies of scale in production, marketing and distribution to create high barriers.

What does the phrase "firms are mutually dependent" mean?

Competitive moves by one firm have noticeable effects on its competitors and thus may incite retaliation or efforts to counter the move. This pattern of action and reaction may or may not leave the initiating firm and the industry as a whole better off. If moves and countermoves escalate, then all firms in the industry may suffer and be worse off than before.

Why is it important to determine the strength of the collective five forces?

Doing so allows one to gauge the state of competition in an industry, and thereby, the industry's ultimate profit potential. The analysis may also clarify the areas where strategic changes may yield the greatest payoff, and places where industry trends promise to hodl the greatest significance as either opportunities or threats.

Define economies of scale

Economies of scale refer to declines in unit costs of a product (or operation or function that goes into producing a product) as the absolute volume produced PER PERIOD increases.

Name the six major barriers to entry.

Economies of scale, product differentiation, capital requirements, access to distribution channels, cost disadvantages independent of scale, and government policy.

Describe cost disadvantages independent of scale as a barrier to entry.

Established firms may have cost advantages not replicable by potential entrants nomatter what their sie and attained economies of scale.

Besides the barriers to entry, what else may deter a company from entering an industry?

Expected retaliation from existing competitors.

T/F: Economies of scale and experience have the same properties as entry barriers.

F. While economies of scale or sharing ALWAYS leads to a cost advantage for the large scale or properly diversified firm over small scale or undiversified firms (presupposing that the large scale firms have the most efficient facilities, distribution systems, service organizations and other functional units for their size), experience must be proprietary in order for it to result in a cost advantage.

T/F: All industries have equal potential.

False. Industries differ fundamentality in their ultimate profit potential as the collective strength of these forces differs. The forces range from intense in industries like tires, paper, and stell, where no firm earns spectacular returns, to relatively mild in industries like oil field equipment and services, cosmetics and toiletries, where high returns are quite common.

Describe how the five forces differs from short-run factors (i.e., economic conditions) that can affect competition and profitability.

Fluctuations in economic conditions over the business cycle finfluence the short-run profitability of nearly all firms in many industries, as can material shortages, strikes, spurts in demand, and the like. However, the focus of structural analysis is on identifying the stable, underlying characteristics of an industry. While industry structure can shift over time, firms will each have unique strengths and weaknesses in dealing with structure.

Give the goal of competitive strategy.

For a business unit, to find a position in the industry where the company can best defend itself against the five forces or can influence them in its favor.

Describe the economist's perfectly competitive industry.

Free entry, existing firms have no power against suppliers and customers, and rivalry is unbridled because there are numerous firms and products alike.

Finish the sentence: "If costs decline with experience in an industry AND [fill in the blank], then this leads to an entry barrier."

If the experience can be kept proprietary by established firms

Define product differentiation.

Product differentiation occurs when established firms have brand identification and customer loyalties, which stem from past advertising, customer service, product differences, or simply being the first in the industry.

Name a few examples in which government policy can act as a barrier to entry.

Product safety and efficacy regulations, environmental regulations, subsidies

Give a general definition of profit potential.

Return on invested capital

Name the five basic forces that define the state of competition in an industry.

Rivalry among existing firms, (bargaining power) of suppliers, (threat of) substitutes (products or services), (threat of) potential entrants, and (bargaining power of) buyers/customers

How do suppliers exert bargaining power?

Suppliers exert power by raising prices or reducing the quality of purchased goods and services.

T/F: Scale economies may relate to an entire functional area, as in the case of a sales force, or they may stem from particular operations or activities that are part of a functional area.

T

Define competitive strategy. What possible approaches are taken into account?

Taking action (offensive or defensive) in order to create a DEFENDABLE position against the five competitive forces. The possible approaches: 1) Positioning the firm so that its capabilities provide the best defense against the existing array of competitive forces. 2) Influencing the balance of forces through strategic moves, thereby improving the firm's relative position. 3) Anticipating shifts in the factors underlying the forces and responding to them.

Name a few limits to the experience curve as an entry barrier.

The experience can be nullified by product or process innovations leading to a substantially new technology and thereby createing an entirely new experience curve. New entrants can leapfrog the industry leaders and alight on the new experience curve, to which the leaders may be poorly positioned to jump. 2. Pursuit of low cost through experience may involve tradeoffs with other valuable barriers such as product differentiation through image, or technological progressiveness. 3. If more than one strong company is building its strategy on economies of experience, the benefits can be diminished.

Define "industry."

The group of firms producing products that are close substitutes for each other.

Define capital requirements as a barrier to entry.

The need to invest large financial resources in order to compete. creates a barrier to entry, particularly if the capital is required for risky or uncoverable up-front advertising or R&D.

Define entry deterring price.

The prevailing price structure inthe industry, adjusted for product quality and service, which just balances the potential rewards from entry (forecast by the potential entrant) with the expected costs of overcoming entry barriers and risking retaliation.

Why are the five basic forces important?

They define the state of competition in an industry, and their collective strength determines the ultimate profit potential in the industry.

How can multi-business firms possibly reap economies similar to scale economics?

They may by possibly sharing operations or functions subject to economies of scale with other businesses in the company. For example, the multi-business company may manufacture small electric motors which are then used in producing industrial fans, hairdryers and cooling systems for electronic equipment.

How can a company deal with buyers' power?

Through BUYER SELECTION -- i.e., finding buyers who possess the least power to influence it adversely.

T/F All five competitive forces jointly determine the intensity of industry competition and profitability.

True. The strongest force(s) govern(s) and become(s) crucial from the point of view of strategy formation

Finish this sentence: competition in an industry continually works to ...

drive down the rate of return on invested capital toward the return that would be earned by the economist's "perfectly competitive" industry.