MQM 385 Chapter 3

A framework developed by Michael Porter that identifies five forces that determine the profit potential of an industry and shape a firm's competitive strategy.

Five forces model

A. They reduce the value of the primary product. B. They act as the strategic equivalent of the primary product. *C. They increase the demand for the primary product.* D. They lower the utility of the primary product. (Complements increase the demand for a primary product, thereby enhancing the profit potential for the industry and the firm.)

How do complements affect a primary product or service?

A. economic environment B. sociocultural environment C. ecological environment *D. political environment* (The political environment describes the processes and actions of government bodies that can influence the decisions and behavior of firms. Governments, for example, can affect firm performance by exerting political pressure on companies.)

Restrictions imposed by the government, such as export quotas on certain products, are a part of the _____ of the PESTEL framework.

What increases the intensity of rivalry? • Industry growth • strategic commitments • exit barriers • pricing power • Perfect Competition • Monopolistic Competition • Oligopoly • Monopoly high-->low competition low --> high profit potential high rivalry: commodity products low rivalry: specialty products

Rivalry Among Existing Competitors Porter's Five Forces Model

The set of companies that pursue a similar strategy within a specific industry.

Strategic Group

A framework that explains differences in firm performance within the same industry by clustering different firms into groups based on a few key strategic dimensions.

Strategic Group Model

A firm's strategic profile based on value creation and cost. The goal is to generate as large a gap as possible between the value the firm's product or service creates and the cost required to produce it (V−C).

Strategic Position

product x helps product y (increases value) examples: - Smartphone industry - Airline + Hotel/Resort

The 6th Force: The Role of Complements Porter's Five Forces Model

*A. Aura Software Inc. will have better access to highly skilled human capital at a lower cost.* B. Aura Software Inc. will have to expand its operations to meet the increasing consumer demand. C. Aura Software Inc. will experience lower competition from rival companies. D. Aura Software Inc. will find it easier to secure capital to finance future growth. (Aura Software Inc. will most likely have better access to highly skilled human capital at a lower cost. In economic downturns, unemployment rises. As more people search for employment, skilled human capital is abundant and wages usually fall. A period of high unemployment could be a good time for firms to expand or upgrade their human capital base.)

Aura Software Inc. has been operating in the country of New Fernsland for almost a decade. The nation is currently experiencing an economic downturn. Which of the following is the most likely benefit of this economic condition for Aura Software Inc.?

Cooperation by competitors to achieve a strategic objective.

Co-opetition

Elements and features common to all industries, including the number and size of competitors in an industry, whether the firms possess some degree of pricing power, and the type of product or service the industry offers.

Competitive industry structure

A product, service, or competency that adds value to the original product offering when the two are used in tandem.

Complement

A company that provides a good or service that leads customers to value your firm's offering more when the two are combined.

Complementor

Obstacles that determine how easily a firm can enter an industry. Entry barriers are often one of the most significant predictors of industry profit potential.

Entry barriers

Obstacles that determine how easily a firm can leave an industry.

Exit barriers

A. They cannot employ technology efficiently. B. They can spread fixed costs over lesser units. C. They benefit from a less specialized division of labor. *D. They can demand better terms from their suppliers.* (Economies of scale are cost advantages that accrue for firms with larger output because they can spread fixed costs over more units, can employ technology more efficiently, can benefit from a more specialized division of labor, and can demand better terms from their suppliers)

Incumbent firms can benefit from several important sources of entry barriers. Economies of scale are one such source. Which of the following is an implication of economies of scale for incumbent firms?

A group of (incumbent) companies that face more or less the same set of suppliers and buyers; these firms tend to offer similar products or services to meet specific customer needs.

Industry

A method to (1) identify an industry's profit potential and (2) derive implications for a firm's strategic position within an industry.

Industry Analysis

A process whereby formerly unrelated industries begin to satisfy the same customer need.

Industry Convergence

Industry-specific factors that separate one strategic group from another.

Mobility Barriers

A. monopolistically competitive B. oligopolistic C. monopolistic *D. perfectly competitive* (The coffee bean industry in Zatvia best illustrates a perfectly competitive industry structure. A perfectly competitive industry is characterized as fragmented and has many small firms, a commodity product, ease of entry, and little or no ability for each individual firm to raise its prices.)

Owners of coffee plantations in the country of Zatvia grow their own coffee beans and supply them to various stores and restaurants all over the country. There are many plantation owners supplying to a huge number of companies, and they are typically unable to differentiate their products from each other. They also do not have the power to fix their own prices in the industry. In addition, these suppliers can only achieve competitive parity and not a competitive advantage. Thus, the coffee bean industry in Zatvia best illustrates a(n) _____ structure.

Political Economic Sociocultural Technological Ecological Legal

PESTEL Analysis

A framework that categorizes and analyzes an important set of external forces (political, economic, sociocultural, technological, ecological, and legal) that might impinge upon a firm. These forces are embedded in the global environment and can create both opportunities and threats for the firm.

PESTEL Model

• Threat of new entrants • Bargaining power of buyers • Bargaining power of suppliers • Threat of substitute products or services • Rivalry among existing competitors

Porter's Five Forces Model

easy for suppliers = hard for buyers buyer has negotiating power on product price

Power of Buyers Porter's Five Forces Model

What are the drivers of supplier power? - Concentration of suppliers, Switching cost, Differentiated supply, No substitutes, Threat of Forward Integration Examples of industry with particularly high (low) power of suppliers? - Grocery Retail (Strong Buyer Power + Low Supplier Power)

Power of Suppliers Porter's Five Forces Model

A. the suppliers provide products that are differentiated. *B. incumbent firms face low switching costs when changing suppliers.* C. there are no readily available substitutes for the products and services they offer. D. the suppliers' industry is more concentrated than the industry it sells to. (The relative bargaining power of suppliers is most likely low when incumbent firms face low switching costs when changing suppliers.)

The relative bargaining power of suppliers is most likely low when:

The risk that potential competitors will enter an industry.

Threat of Entry

Impact on incumbents? - Lower price - Higher cost (to deliver greater value) What are the barriers to entry? - Economies of scale, Network effects, Customer switching costs, Capital requirements, Advantages independent of size (brand loyalty, IP, location), Government policy, Credible threat of retaliation -initial capital needed can block entrance -large fixed cost (relative to variable cost) favors incumbents (economies of scale) -network effects

Threat of Entry Porter's Five Forces Model

What increases the threat of substitution? - Price/performance trade-off - Low switching cost - customer highly price sensitive in airline industry: Driving (time+cost) Tradeoff of features *High*: if able to drive *Low*: fly US to Europe (no alternative) willing to pay $, customer not price sensitive

Threat of Substitutes Porter's Five Forces Model

A. An automobile company that can backwardly integrate to produce its own component parts B. A fast food chain that has multiple suppliers for processed meat C. A government agency that buys large quantities of cement from a private supplier *D. A cell phone company that requires highly customized software for its phones* (The firm that most likely has the lowest bargaining power as a buyer is a cell phone company that requires highly customized software for its phones. The power of buyers is high when the industry's products are standardized or undifferentiated commodities. When suppliers offer products that are differentiated, the bargaining power of buyers reduces.)

Which of the following firms most likely has the lowest bargaining power as a buyer?

*A. A consolidated industry has the potential to be highly profitable.* B. A consolidated industry is dominated by a large number of small firms. C. A consolidated industry does not allow firms to set prices. D. A consolidated industry has low entry barriers. (A consolidated industry is dominated by a few firms, or even just one firm, and has the potential to be highly profitable.)

Which of the following is a feature of a consolidated industry?

*A. Airbus was created by a number of European governments through direct subsidies in order to provide a countervailing power to Boeing.* B. Airbus and Boeing are likely to exit the aircraft manufacturing industry when industry profit potential falls to zero. C. The traditional U.S. airlines Delta, United, and American Airlines have large fixed costs to maintain their network of routes that affords global coverage, frequently in conjunction with foreign partner airlines. D. Given their strategic commitments, airlines are unlikely to exit the industry. (In some cases, strategic commitments to a specific industry may be the result of more political than economic considerations. Airbus, for example, was created by a number of European governments through direct subsidies in order to provide a countervailing power to Boeing.)

Which of the following real-world examples best supports the statement that strategic commitments to a specific industry may be the result of more political than economic considerations?

A. Substitutes are not readily available since customers cannot use other means of transport. B. Taken together, the competitive forces are quite favorable for generating a profit potential in the airline industry. *C. The combination of the competitive forces leads to intense rivalry among existing airlines.* D. Entry barriers in the airline industry are relatively high because of the high costs involved. (As discussed in Strategy Highlight 3.2, taken together, the competitive forces are quite unfavorable for generating a profit potential in the airline industry: low entry barriers, high supplier power, high buyer power combined with low customer switching costs, and the availability of low-cost substitutes. This type of hostile environment leads to intense rivalry among existing airlines and low overall industry profit potential.)

Which of the following statements about the five forces in the U.S. airline industry is true?

A perfectly competitive industry has __________ entry barriers and ______ small firms

low; many