A Guide for Industry Study and the Analysis of Firms and Competitive Strategy
This page is a guide to applying the principles of Economics to researching and understanding a market and the industries and firms that make up the market.
An excellent source for the information needed to conduct an industry study or an analysis of a firm's competitive strategy is the Babson College Horn Library at http://www.babson.edu/library/. The Horn Library provides a research guide and sources for researching a company and an industry.
I. Introduction
There are two distinct yet related models for studying markets. One method of analysis is the "Structure-Conduct-Performance" paradigm from the Industrial Organization field of Economics. Another is Porter's Five Forces. As we will see shortly, Porter's Five Forces and the "Structure-Conduct-Performance" paradigm overlap in many ways. This page combines both methods into a unified guide for industry studies and the analysis of firms and competitive strategy.
I. A. Porter's Five Forces
I. A. 1. Introduction
"The Structural Analysis of Industries" is covered quite well in Chapter 1 of Porter, Michael E., Competitive Strategy: Techniques for Analyzing Industries and Competitors, 1980 and new introduction in 1998, The Free Press, New York, NY.
Figure 1 is a graphical representation of Porter's Five Forces.
Figure 1: Porter's Five Forces
Porter details the factors that impact each force and develops an analytical model to study industries. The purpose of this analysis is to assess the profitability potential of industries. The analytical tools of Porter's book will not be reproduced here. However, Porter's framework incorporates the analysis of market structure and vertical supply chains and each of these concepts will be addressed from the perspective of an economist.
I. A. 2. The Microfoundations of Porter's Five Forces
The real genius of Porter's Five Forces is that it builds on and combines two tools from microeconomics, namely the analysis of market structure and vertical boundaries. The analysis of market structure is the first element of the "Structure-Conduct-Performance" paradigm.
I. A. 2. a. Market Structure
The vertical elements of Porter's Five Forces are shown in Figure 2.
Figure 2: The Vertical Elements of Porter's Five Forces
Each of these elements corresponds to a determinant of market structure as detailed in Table 1 below.
Table 1: Porter's Five Forces and Market Structure
Element of Porter's Five Forces / Determinant of Market StructurePotential Entrants / Barriers to Entry
Industry Competitors
(Direct Substitutes) / Number of Sellers
Product Characteristics
Indirect Substitutes / Product Characteristics
I. A. 2. b. Vertical Supply Chain
The horizontal elements of Porter's Five Forces are shown in Figure 3.
Figure 3: The Horizontal Elements of Porter's Five Forces
If one were to show these elements vertically, they would appear as:
Figure 4: The Vertical Supply Chain
This representation now shows the vertical supply chain. The important issue for firms in the industry is how they position themselves in the supply chain. The firms essentially must choose their vertical boundaries.
I. B. The "Structure-Conduct-Performance" Paradigm
The "Structure-Conduct-Performance" paradigm is a road map for identifying the factors that determine the competitiveness of a market, analyzing the behavior of firms, and assessing the success of an industry in producing benefits for consumers.
"Structure" refers to the market structure of an industry which is indicative of the degree of competition in the industry. "Conduct" refers to business practices adopted by firms in the industry to implement their competitive strategies and to create competitive advantage (the ability to outperform competitors in the industry). "Performance" refers to measurements by which the industry or firms in the industry can be judged as to whether they have achieved their stated goals.
I. C. A Unified Guide for Studying Industries and Firms
The methodology of our unified guide for understanding markets begins with an industry study and continues with an examination of the competitive strategies of firms in the industry. The framework we will use for analyzing industries and firms is:
· Evaluate the industry's potential for profitability (with an industry analysis).
· Identify the firm's strategic positioning within the industry and analyze its business practices.
· Assess the firm's potential for competitive advantage (the firm's ability to outperform competitors in the industry).
II. Industry Analysis
The purpose of an industry analysis is to assess the profitability potential of the industry.
The steps in an industry analysis are:
· Identify the industry and describe its market.
· Classify the market structure of the industry.
· Characterize relationships between links in the vertical supply chain.
· Evaluate the future profitability potential of the industry.
II. A. Introduction to the Industry and its Market
II. A. 1. Industry Definition and Description
II. A. 1. a. Definition and Specific Description
The first task is to define the industry. Industry definition is important to determining the competitive set. In economics, defining the competitive set is equivalent to defining a firm's horizontal boundaries. A firm's horizontal boundaries are its competitors who supply direct substitutes.
The U.S. Census Bureau classifies industries with the North American Industrial Classification System (NAICS). NAICS can be accessed at the web page www.census.gov/naics. A researcher can navigate and/or search the site and find a description and definition of most industries in the US. Industry descriptions vary from very broad (two-digit NAICS codes) to very narrow (six-digit NAICS codes). Usually, a researcher will choose the narrowest description of an industry. This allows the researcher to most closely identify the companies that compete with each other in an industry. The narrower the description of an industry, the more likely the competitive set will be based on products that are direct substitutes. The broader the description on an industry, the more likely the competitive set will be based on products that are indirect substitutes.
For each six-digit NAICS code, there is a short description of the industry. Additionally, the U.S. Census Bureau provides a short definition of the industry. The researcher must determine if the description and definition of the industry fit with the intended companies targeted for study.
II. A. 1. b. General Description
An industry analysis often starts with a brief introduction to the industry. Sources for general information on an industry are:
· Company provided information (web pages and information packages)
· Industry reviews (See "Introductory Reviews" under the subheading "INDUSTRY SOURCES" on the checklist provided on the Babson College Horn Library web site "Library Research Guide: United States Company & Industry Checklist" at http://www.babson.edu/library/companyindustrycklist.htm.)
· Investment analyst reports. (See "Investment Analyst Reports" under the subheading "INDUSTRY SOURCES" on the above checklist.)
· Corporate reports of publicly-held corporations. Companies often provide this information on their web sites. Another alternative is the SEC Edgar Database of corporate information available at http://www.sec.gov/edgarhp.htm. (See "Corporate Reports of Publicly-Held Companies" under the subheading "COMPANY SOURCES" on the above checklist.)
· Periodical articles and news. (See "Index to Periodical Articles and Current News" under the subheading "INDUSTRY SOURCES" on the above checklist.)
· Trade associations. A listing of trade associations is available at http://www.associationcentral.com/. (Other sources are provided on the Babson College Horn Library web site "Researching an Industry: Trade Association Material" at http://www.babson.edu/library/indtrade.htm.)
II. A. 2. Market Conditions
General market conditions faced by an industry are often important factors in the choice of conduct by firms and for the ability of firms to generate profits and meet expected performance goals. Identifying relevant general market conditions requires an analysis of:
· Supply and demand conditions that define the market.
· The overall market environment. Environmental factors are often identified with a PEST methodology. The PEST acronym stands for Political/Legal, Economic, Sociocultural, and Technological factors.
II. A. 2. a. Supply and Demand Conditions
The factors driving the supply of and demand for a product of an industry are detailed in Table 2 below. These factors determine the defining characteristics, position and slope, of supply and demand curves in an economist's representation of a market.
Table 2: Basic Market Conditions, Determinants of Supply and Demand
Determinants of Demand / Determinants of SupplyPosition of demand curve:
· Change in number of buyers (market growth)
· Change in buyer tastes and preferences
· Change in income (income elasticity of demand)
· Change in the prices of related goods, substitutes and complements (cross-price elasticity of demand)
· Change in expectations / Position of supply curve:
· Change in number of suppliers (more or less competition in the industry)
· Change in resource prices (raw materials and labor)
· Change in technology
· Changes in taxes and subsidies
· Change in prices of other goods
· Change in expectations
Slope of demand curve:
· Buyer price sensitivity (price elasticity of demand)
- Degree of substitutability
- Proportion of buyer income
- Type of product (inferior versus normal good, normal good further classified as necessity versus luxury)
- Buyer time to purchase product / Slope of supply curve:
· Firm time to respond to a change in the price of the product
The interaction of supply and demand determine production levels and product price in the market. In a perfectly competitive market, equilibrium price and output in a market are determined where quantity supplied equals quantity demanded. Determination of output and price in other market structures is a bit more complex. For additional information, see a standard Principles of Microeconomics textbook such as Economics: Principles, Problems, and Policies, by Campbell R. McConnell and Stanley L. Brue, The McGraw-Hill Companies, Inc.
The analysis of supply and demand conditions are closely related to two aspects of Porter's Five Forces. The determinants of demand parallel Porter's analysis of buyer bargaining power and the determinants of supply are important factors in studying the intensity of rivalry between existing industry competitors.
II. A. 2. b. PEST
In addition to market forces within the industry, it is critical to monitor external forces that may impact the industry on an ongoing basis. A manager may have a very good understanding of what is happening within an industry, and yet be blindsided by external events that change the nature of competition and revenue within an industry. A marketing framework commonly used to examine these factors that impact business decisions is referred to as PEST. PEST is an acronym for the political/legal, economic, sociocultural, and technological factors that shape the environment of an industry or a business.
Political/Legal
An industry must remain abreast of political forces that may influence the viability and profitability of the overall industry, as well as specific firms. Political and legal issues that have impacted businesses and industries over the past decade include: environmental legislation, regulation of the Internet, antitrust rulings, to name a few. For a multinational business, these factors become much more complicated. The business must continually monitor the stability of governments, understand differences in governmental practices, know the rules in terms of importing and exporting goods, and be knowledgeable about the laws that impact the industry and the business in each country. These factors can impact the structure and profitability of the business and industry in each country. Sources of information that can be used to monitor this factor include: government agency web sites and publications, embassies, lawyers and legal journals, and, of course, newspapers.
Economic
The economy can have a serious impact on sales and profitability within an industry and firm. Unemployment rates, the value of the dollar, inflations, growth, and productivity are factors that impact the health of the economy and consumer confidence. These factors provide indicators to potential concerns on recession and inflation. The economy may lead to reduced spending by consumers that have a rebound effect throughout companies and industries. A firm must monitor these factors to forecast sales and profits appropriately and devise appropriate strategies to ride out an unfavorable economic environment. Firms may even be able to take advantage of an economic downturn to gain share and customers from competitors. Potential sources of information to evaluate the current and projected state of the economy include the New York Stock Exchange and NASDAQ (as well as world exchanges), Wall Street Journal, and analyst reports.
Sociocultural
Trends may occur within the social and/or cultural structure of society. Examples in the past decade include the increase in working women, the health and fitness craze, and the growth in discretionary spending by youths. These trends can have a serious impact on entire industries, as well as individual companies. A business must monitor these trends to make sure that its product will continue to meet the needs of the consumers it serves. New attributes may emerge and the importance of existing attributes may change as a result of changes in society. Similarly, as the business enters new markets or countries, expectations may be very different based on the social structure and societal expectations of the specific culture or cultures. Sources of information on these trends include newspapers and magazines, television and other mass communication media, and specific monitoring publications or companies as American Demographics and the Yankelovich Monitor.
Technology
In the past century, the world has seen a technological revolution. Today, we can travel faster, receive communications instantly, and produce more per capita. As a result of this change, many industries have emerged (e.g., cellular phones and dot-coms) and many industries have all but disappeared (e.g., typewriters). Business that have survived have succeeded in staying ahead (or only slightly behind) the technological advances. These businesses have taken advantage of the emerging technology in other industries to improve their product and/or service. These firms are always looking for technology that will help serve customers better and/or cheaper. In that way, technology may provide a competitive advantage. Sources of information on technology include journals in potential areas such as computers or genetics, scientific journals, and other newspapers and magazines.
The critical element in environmental scanning is to continually monitor the media relevant to your customers, your industry, your market(s), and overall technological development. As changes occur for elements within PEST, a company (and industry) must ask: