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2.1 Porter’s Five Forces
2. Industry Industry Analys Analysis is Port er’s er’s F ive Forces provides provides a convenient fra mework for for exploring th e econo economic mic factors factors t ha t affect the profits and prices of an industry. Porter ’s an alysis systemat ically ically and compreh ensively applies economic economic tools tools t o an alyse an indust ry in in depth:
Entry
• How can t he firm ma ke profits? profits? • Opport Opport un ities fo for success success and t hr eat s to
success? • A bas is fo for gener at ing st ra tegic choices. hoices. • Applies Applies to service service sectors sectors a s well as in dus tr ial.
Supplier Power
Internal Industry Rivalry
Limitat ions ions of the fram ework: ework: • it does not not a ddr ess th e size size of of dema nd or its
growth • it focusses on the entire industry, not on a
part icular icular firm • it does not explicitly account for the role of
government • it is qua qua lita lita tive
Substitute Products
Buyer Power
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2.2 The Economics of of the Five Forces 2.2.1 2.2 .1 Intern Internal al Ind Indust ustry ry Rivalr Rivalry y This m ay occ occur via pr ice ice competit competit ion, ion, or via n onprice compet compet ition. (See Lectu Lectu res 3–5.) Six factors favour price competition: • mar ket str ucture: man y selle sellers rs
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2.2.2 Entry Fir ms a tt ra cted by (ec (eco onomic) pr ofits ofits . Remember th at Tota Tota l Cost Cost includes includes a n orm al ret ur n t o capita capita l, so positive positive acc accoun ting pr ofits may not be sufficient incentive to entry. En tr y of of new firm s erodes profits by:
• no pr odu ct diffe differen ren tia tion: homogeneous homogeneous
• reductions reductions in sales and sha res, and
• th e na tu re of th e sa les process: process: secret secret ive, ive, large,
• reductions reductions in ma rket concentr at ion, ion, which which →
and lumpy • capacity ut ilisa ilisa tion: excess excess
great er inter na l (indust (indust ry) rivalry, and often often reducing cost-price margins. (Remember the mark-up formula on page 1-20.)
• consumers (buyers) — motivated, and capable:
low switching costs Even with with out a ppar ent compet compet itors, itors, an incumbent firm m ay set compet compet itive prices. prices. See contestable markets in Lecture 6.
Barr iers to entr y (see (see Lec Lectu tu re 6) ma y be str uctur al or r egulatory: • ec econom onom ies of of scale an d scope scope (see §2.5 below) • limited a ccess ccess to essent ial r esources or or
channels of distribution A history of coexistence with respect to price rivalr y (bec (becau au se of price leadership a n d signalling — see Lecture 5), versus repeated price wars.
• patents • need to establish brand identity, or overcome
incumbents’ incumbents’ brand identities identities • oth er cost cost a dvant ages, such as a n in cum bent’s bent’s
learning economies (see § 2.5.5 below) • pred at ory pricing pricing (selling (selling below min A C ) • high capital costs • licen licen cing cost cost s
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En tr y bar rier ma y also be stra tegic: incum bents ma inta in excess capa city or th reat en to slash prices. Exit bar riers a lso serve as ent ry bar riers, given the costs of exiting for risk-averse entrants who eventually fail. A high ra te of ent ry in th e past ma y be cont inued. Techn ological cha nge ma y redu ce ent ry bar riers → great er competit ion.
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2.2.3 Substitutes Substitutes steal shar e and intensify intern al rivalry. Like entr ant s, but new substitutes ma y reflect new t echn ologies, whose u nit costs AC ma y fall becau se of th e learning curve. New substitut es may pose large th reats to esta blished pr oducts, even if they seem ha rm less now. e.g. Polar oid v. digital ph otogra ph y How to determine whet her a product is in th e same ma rket a s existing products, a n ew entr ant , or a substitute? • Cross-price elasticity, measu res t he per cent age
change in demand for good B that results from a 1% ch an ge in t he p rice of good A; iden t ifies th e substitu tes faced by our product. e.g. Pepsi and t ap wat er? • Residua l deman d curve ana lysis — pricing
decisions in a well-defined m ar ket will not be const ra ined by the possibility th at consu mers will switch to sellers outside the market: if pricing is so const ra ined, enlar ge th e mar ket definition.
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• Pr ice correla tion — if two sellers a re in t he
sam e mar ket, they should face th e same dema nd forces, which will lead t o corr elat ed price movement s. Not a good met hod: ma y be hard t o inter pret — if firm s ar e colluding, t heir prices will move together. • Tra de flows — ident ical pr oduct not sold in th e
same geographical area are not substitutes: must identify the customer catchment area. • Compet ition a mong firm s in a n indus tr y is
captu red by the fi rm -level price elast icity of de mand (see p. 1-18). • Threat ening substitutes measur ed by the
ind ustry-level price elasticity of d em and • Others?
Own-price elast icity of dema nd?
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2.2.4 Supplier Power and Buyer Power Suppliers of input s (labour, ma ter ials, energy, equipment, certification, etc.) may be able to cha rge prices th at extra ct pr ofits (surplus) from their customers: sup plier power . No ma rk et power if th e input su pply indust ry is perfectly competit ive, an d prices are set by th e inter action of supply and d eman d. But suppliers may have market power: • if th ey ar e concentr at ed, or • th eir cust omer s ar e locked int o cont inuing
relat ionsh ips with th em becau se of rela tionsh ip-specific investm ent s (see §2.4 below). Unions ha ve raised wages when its employer indust ry is faring well, an d ma y ma ke concessions when t hin gs ar en’t good. A supplier can th us extra ct mu ch of th e tar get indust ry’s profits with out destr oying th e indust ry firms. “Power” is not t he sa me a s “import an ce.” e.g. jet fuel is importa nt , but from a comp etit ive supply indust ry
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Buyer power is analogous: customers may be able
to negotiate lower prices, and hence capture some of th e profits. Many buyers ha ve some power, but t he ma rket s for out pu t a re pr ice competit ive, with price close to M C (see page 1-20.) The willingn ess of buyer s to shop for best pr ice is a source of int ern al r ivalry in th e indu str y, not buyer power. In ma ny industrial ma rkets, fierce interna l rivalry and buyer power can coexist: each transaction is th e result of a bar gain between a sales agent a nd a pur cha sing agent, a nd t he cont ra ct pr ice for identical products can vary significantly.
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2.2.5 Strategies for Coping with the Five Forces A five-forces ana lysis identifies th e th rea ts t o industry profits tha t a ll firms in the industr y must cope with. Severa l ways: 1.
F ir m s m a y position th emselves t o out perform th eir r ivals, by developing a cost or differentiation advantage that somewhat insulates them from the five forces.
2.
F ir m s m a y identify an ind ustry segment in which th e five forces ar e less severe. e.g. Crown Cork & Sea l served ma nu factu rer s of “ha rd -to-hold” liquids, a less competitive niche market → much higher r ates of retur n.
3.
F ir m s m a y t r y t o change th e fi ve forces :
In t his cont ext, buyers m ay be powerful if: • th ere ar e few of th em, an d • a seller is locked into a relationship with the
buyer becau se of rela tionsh ip-specific investments.
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— ma y reduce inter na l rivalry by crea ting switching costs, such as using its pa rt s lest th e warr an ty be voided, which creat es a cost (th e voided war ra nt y) to th ose who switch an d buy part s from another supplier — ma y reduce th e thr eat of ent ry by pursuing entry-deterring str ategies — ma y try to reduce buyer or supplier power by ta pered integra tion (in which the firm both ma kes — vert ical int egrat ion — an d buys — ma rk et excha nge: see §2.3 below).
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2.3 Make versus Buy: the Vertical Boundaries of the Firm (Besan ko Table 2.1, p.73) Benefits an d Costs of Using th e Mark et: Benefits • Mar ket firm s can a chieve economies of scale
th at in-house depar tm ent s producing only for th eir own needs can not. Specialisation. • Mar ket fir ms a re su bject t o th e discipline of th e
ma rk ets an d must be efficient an d innovat ive to sur vive. Overa ll corporat e success may hide th e inefficiencies a nd lack of inn ovat iveness of in-house department s • Avoids possible post -merger cultu re clash .
Costs • Coordina tion of pr odu ction flows th rough t he
vertical chain may be compromised when an activity is pur cha sed from an independent mar ket firm r ath er tha n performed in-house. • Pr ivat e inform at ion m ay be leaked when an
activity is perform ed by an independent ma rket firm. • There ma y be costs of tra nsa cting (cont ra cting)
with independent mar ket firms tha t can be avoided by perform ing th e activity in-house. • Long-term contracts may reduce flexibility and
inform at ion on altern at ives.
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S ome M ake-or-Bu y Fallacies: • Firms should generally buy, rat her t han mak e,
to avoid paying th e costs n ecessar y to make t he product. • Firms should generally mak e, rat her th an buy,
to avoid paying a pr ofit ma rgin t o independent firms. • Firms should make, rath er th an buy, because a
vertically integrated producer will be able to avoid paying high market prices for the input during periods of peak demand or scarce supply. (Use opport un ity costs.)
2.3.1 Tapered Integration: Make & Buy (Besan ko p.156) A mixtur e of both : • a ma nu factur er might produce some input
itself and buy some; • it might sell some of its product through an in-
house sales force an d sell th e rest t hr ough a n independent rep Severa l benefits: • expands t he firm ’s input an d/or outpu t
cha nn els without mu ch capita l invested: helpful for new an d growing firm s • use inform at ion a bout th e cost a nd pr ofita bility
of its int erna l cha nn els to help negotiat e with the independents
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• use the threat to furt her use the market to
motivate th e perform an ce of its int erna l channels • ma y develop int erna l input supply capa bilities
to protect itself against holdup by independen t input suppliers A clear exam ple of holdup (see Besank o p.116) is the impas se between Apple and t he Mac clone m ak ers over th e price for licensin g th e MacOS 8 — th e CEO of Power Comput ing ha s recent ly quit , an d its fort hcomin g IPO is likely delayed. But t apered integrat ion m ay: • not allow sufficient scale in the internal and
external channels to produce efficiently • lead t o coordina tion pr oblems over
specificat ions an d t iming • lead to much higher monitoring costs
Altern at ives t o Mak e or Bu y?
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2.4 Rents and Quasi-Rents (See Besa nk o pp.114–) ______________________________________________________
$ million/yr ______________________________________________________ (1) (2)
Total Variable Costs (V C ) 3.0 Ex ante opportun ity costs of the in vest m en t in t h e pla n t 2.0 (3) Minimum revenue seller requires t o e n t er t h e r e la t i on s h ip = (1 ) + (2 ) 5 .0 (4) Act u a l r even u e 5.0 (5) Seller ’s r en t = (4) – (3) 0.0 (6 ) E x p os t op por t u n it y cos t of t h e p la n t 0 .5 (7) Minimum revenue seller requires t o pr even t exit = (1) + (6) 3.5 (8) Seller ’s qu asi-r en t = (4) – (7) 1.5 _ _____________________________________________________
Seller will produce a good for a buyer: • Tota l Var iable Cost is $3.0 m/year • Plan t in vestment of $40.0 m u p front. • Minimum accepta ble rat e of ret ur n is 5% p.a. ∴
an nu al ex ant e opport un ity cost is $2.0 m
∴
the minimum r eturn to the seller mu st be $5.0 m/year
Th e seller ’s rent is th e differen ce between wha t it actua lly receives and wh at it mu st r eceive (minimu m) to ma ke it wort hwh ile to ent er th e deal. Before t he deed ( ex ante facto), it m ust receive at least $5.0 m/year. Its rent in this case is zero, which reflects that fact th at competit ion t o supply ha s been fierce.
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Suppose th e plan t is buyer-specific: • Once th e plan t is built, it h as few alter na tive
uses. • It s next best us e is only $0.5 m/year (its ex post
facto opport un ity cost ). ∴
th e minimum th e seller must r eceive not to exit = $3.5 m/year .
• This is the TVC plus the ex post opportunity
cost. • If the seller r eceived only $3.25 m, th en it s
ear nin gs would only be $0.25 m, which is less th an its next best retu rn of $0.5 m/year . Th e seller ’s quasi-rent is th e differen ce between: a.
th e revenue the seller would actua lly receive under th e initial terms, and
b.
th e revenue it mu st receive to be induced not to exit after it ha s ma de its relationshipspecific investments.
Here, its qu asi-rent is $1.5 m/year Competitive bidding ex ante does not drive quasirent s to zero when th ere ar e relationship-specific assets. The buyer h as m ore bar gaining power, ex post, when t here a re r elationsh ip-specific asset s. Th e holdup problem occurs when a seller tries to exploit the relationship-specific investment to obtain a higher price.
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2.5 Economies of Scale and Scope (Besan ko pp. 173–216)
2.5.1 Economies of Scale A produ ction pr ocess for a specific good or ser vice exhibits econom ies of scale over the range of output when Average Cost declines over that range. F or AC to decline as output Q increa ses, th e Margina l Cost M C mu st be less tha n overa ll AC . If AC is const an t, then M C = AC and we say tha t production exhibits constant returns to scale . If AC is increas ing, then M C > AC and we say there are di seconom ies of scale . $/unit M C (Q ) AC (Q )
.. ...... .. .... ..... . . . . . ...... . ... ...... ...... .. . ........ . . . . . .. .......... ......................................... .... .. ... . . . ... ..... ............ Q MES
Out put per period, Q
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2.5.2 Economies of Scope Econ omi es of scope exist if th e firm a chieves
savings as it increases the variety of activities it perform s, such a s t he va riet y of goods or s ervices it produces. Usua lly defined in t erms of the r elative total cost of producing a var iety of goods togeth er in one fir m versus separ at ely in two or m ore firm s. The cost implications are shown in the table: ____________________________
Q x Q y T C (Q x , Q y ) ____________________________
100m 0 $55m 0 600m $220m 100m 600m $245m 200m 0 $60m 0 1200m $340m 200m 1200m $370m _ ___________________________ Q x is the n um ber of adh esive message note pads produced an d Q y is the n um ber of ta pe rolls
produced.
T C (Q x , Q y ) is th e Tota l Cost t o th e single firm of producing Q x pads of adh esive messa ges and Q y
rolls of tape.
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Given th at t he firm has ma de the investment in developing t he k now-how for ma kin g ta pe, mu ch of that knowledge can be applied to producing relat ed products, such as a dhesive message notes. Given t he u p-front investm ent to produce ta pe, the additional investment needed to ramp up production of message notes is less than otherwise, an d th e addit iona l cost s to produce 100 million pa ds, on t op of 600 m illion r olls of t ap e, is only $25 million, in st ead of th e $55 million necessar y from scratch. Exp loit ing economies of scope is oft en k now as “levera ging core comp et en ces”, “com pet ing on capabilities”, or “mobilising invisible assets”.
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2.5.3 Sources of Economies of Scale and Scope • Indivisibilities and the Spreading of Fixed
Costs
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2.5.4 Limits to Economies of Scale Why not a single mega-firm? Well: • Rising Labour Costs.
— At t he pr oduct level (scale).
— Lar ger firm s pay more to th eir work ers.
— At the plant and multi-plant level (scope).
— More likely to be un ionised?
— Capita l-inten sive v. labour-int ensive production (scale).
— Lower work er tur nover at larger firms.
• Increased P roductivity of Var iable Inpu ts.
— Increased specialisation. • Inventories.
— Lar ge firm s car ry smaller invent ories as a percent age of sales th an can sma ll firm s. • The Cube-Squar e Law and th e Physical
Properties of Production. • Mar keting Economies.
— Sprea ding advertising costs over lar ger markets. — Reputa tion effects an d umbr ella bra nding. • R&D • Pu rchasing Economies.
— Cheaper in bulk.
• Incentive and Bureaucracy Effects. • Spr ead ing Specialised Resour ces Too Thin .
e.g. The excellent chef.
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2.5.5 The Learning Curve
2.5.6 The Learning Curve v. Economies of Scale
The imp ort an ce of experience, or lear nin g by doing.
The form er: reductions in un it cost with accum ulat ing experience an d pr oduction. The latt er: reductions in u nit cost with a lar ger scale per per iod.
Economies of scale: th e cost ad van ta ges flowing from pr oducing a lar ger flow of outpu t in a given period. Th e learning curve (or exper ience cur ve): th e cost advantages flowing from accumulating experience and know-how. A progress ratio is th e ra tio of aver age cost s after and before cumulative production increases: AC 2 AC 1 , wher e AC 2 is th e Avera ge Cost at cumulative output Q 2 a n d AC 1 is the Average Cost at cum ulat ive out put Q 1 , wher e Q 2 = 2 Q 1 . The median progress ratio is about 0.80, which mean s th at for th e typical firm doubling cum ulat ive out put redu ces unit costs by about 20%. Such learn ing an d cost r eductions m ay slow an d event ua lly be exhau sted. Learn ing by doing applies to qua lity a s well as t o costs.
Learn ing economies can be substa nt ial even when economies of scale ar e min ima l: Economies of scale can be subst an tia l even when learn ing economies are minima l: e.g. simple capita l-int ensive a ctivities, su ch a s can manufacturing. If a lar ge firm h as lower un it costs becau se of economies of scale, th en a ny cut backs in production will raise unit costs. If lower costs are the result of learning, then cut backs do not necessarily result in h igh u nit costs.
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2.6 The Importance of Scale and Scope Economies: Firm Size, Profitability, and Market Structure Economies of scale a nd scope pr ovide lar ge firm s with an inherent cost advantage. This encour ages sma ll firms t o try to grow, but limits th e num bers of firms t ha t can su ccessfully compete.
2.6.1 Scale, Scope, and Firm Size Scale an d scope economies give large fir ms a n AC advan ta ge over small firm s. In indu str ies wher e buyers a re price sensitive, lar ge firms can pa ss along some of th eir AC advan ta ge to consu mer s, which dr ives sma ll (an d th erefore h igher- AC ) firm s out of busin ess or int o niches. If sma ll firm s ar e to match t he low AC of lar ge firms, th ey mu st grow, th rough: • reta ined earn ings, • increa sed equity, • higher debt • pr oduct port folio ma na gement (Cash Cows v.
Rising St ar s etc.) • new product development • geogra ph ical d iversificat ion • mergers
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Corp ora te m erger s ma y be “syner gistic”: syner gies ar e economies of scale wait ing t o be exploited — should a merger be permitt ed between t wo large firms wh ich m ay crea te some mar ket (or monopoly) power if th e mer ger allows th e new fir m to achieve substantial efficiencies through econom ies of scale?
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2.6.2 Market Share and Profitability
2.6.3 Scale, Scope, and Market Structure
When econom ies of scale or scope exist , but only some firms have been able to exploit them, one would expect to find a positive correla tion bet ween a firm ’s mar ket sha re an d its profita bility.
Market structure refers to th e num ber an d size
Ma rk et Sh ar e ROS _ ______________________ < 10% –0.16% 10%–20% 3.42% 20%–30% 4.84 30%–40% 7.60% >40% 13.16% _______________________
distribut ion of th e firm s in a ma rket . A key determ inan t: size of deman d relat ive to th e m inim um efficient scale (MES) of produ ction. $/unit AC (Q )
AC*
...... ... ... ...... . . . . ...... ... ....... ...... . ........ . . . . ... ............ .................................
Relationsh ip Between Market S hare and Pre-T ax Profit as Percentage of S ale (R OS ).
D
(Besa nk o Table 5.8) For th e 1970s, th ere was a corr elation between mar ket sha re and profitability. But a m istak e to conclude: Post h oc, ergo propter hoc. Correlation is not necessarily causality. Indeed, th e cau sality m ay flow from profitability t o ma rket sha re, not vice versa: wrong to believe th at a char ge for sh ar e would resu lt in higher pr ofits, especially when th e sha re is “bough t”. Imp ossible for a ll kids to be above avera ge: sha re is a zero-sum game.
Q MES
Out put per period, Q A single firm selling to the whole market can set an y price above AC* and ma ke a profit. If another firm en ter ed the m ar ket, it could not drive its costs down as low as th e first firm u nless it stole away some of its cust omer s. The most efficient configuration in this industry is for one firm to sat isfy all ma rket deman d: if two firms split th e mar ket a t a given price, th ey would ha ve higher u nit costs ( AC ) th an if a sin gle firm supplied the entire mar ket at tha t price.
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Such a mar ket is kn own as a natu ral m onopoly . Often governm ent-owned or r egulated so tha t a single firm can ut ilise t he economies of scale of lowest AC but not abuse its market power.
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Three features emerge from Table 5.9: 1.
Concentr ation can vary substan tially by industry.
2.
Concentr at ion levels for a given indust ry appea r compa ra ble across na tions. e.g. highly concentrated: cigarettes, glass bott les, refrigera tors e.g. low concent ra tions: shoes, paint s, fabr ic weaving
A ru le of th um b for t he nu mber of firms t ha t can fit into a ma rket: let AC* be th e avera ge cost of pr odu ction at Q MES ; if D* is th e qua nt ity of goods th at will be bough t when price P = AC* , then th e num ber of firms th e ma rket can accomm odat e is D* / Q MES .
Suggest s th at th e technology of produ ction is a major determinant of market concentr at ion: highest ar e capital-int ensive, lowest generally not.
If th e mar ket grows ( D* increa ses), then more firms can fit int o it. If th e MES (Q MES ) increa ses (becau se of lar ger plan ts ), then fewer efficient fir ms will fit into it, cet. par . This implies: that industries with substantial economies of scale — indu st ries wit h capit alint ensive t echn ologies — may come t o be domina ted by a few lar ge firms. Besank o’s Table 5.9 shows th e ma rket sha res controlled by the three largest firms in 12 different indust ries across six nations. The higher t he ma rket sha res of the largest firms, the more concentrated the industry.
E CL 2-28
3.
Markets in the U.S.A. tend to be less concent rat ed; mar kets in Canada and Sweden are m ore concentr at ed.
A much larger mar ket an d greater aggregate wealth in th e U.S. mea ns th at dem an d is likely to be grea ter , an d so more firms can en ter t he mar ket, so tha t th e largest firms ha ve a sma ller sha re of th e mark et in the U.S. Growing populat ions a nd incomes in J apa n a nd Europe have allowed their manufacturers to achieve scale economies domestically. This ha s allowed t hem to comp ete on t he ba sis of pr ice with established U.S. firms.
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Lower costs of transport and communications and lower t ar iffs a nd non-ta riff bar riers t o tra de ha ve lowered th e costs of inter na tiona l tr ade, ena bling ma nu factur ers access to global ma rk ets, fur th er increas ing t heir economies of scale. The number of firms in a given market in a given country increasingly depend s on h ow m any fi rm s can fit into the global m arket.
In d u stry L argest fou r ________________________________________
Toba cco pr odu ct s 100 P et r oleu m r efin in g 85 Rea dy m ixed con cr et e 69 Refr iger a tor s & a pplia n ces 46 Biscu it s 95 J eweller y & silver wa r e 15 P_______________________________________ r in t in g & bookbin din g 14 _ Four-firm Concentration Ratios in Australian Man ufacturing In du stries 1982–83
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2.6.3.1 Exogenous v. Endogenous Fixed Costs and Market Structure FC ar e not only techn ological (blast fur na ces, jumbo jets, dr ugs t esting pr ogram mes) or exogenous , beyond the firm’s control.
Such things as R&D for product improvement and advert ising for bra nd equity ar e under t he firm ’s control — endogenous — so th e fir m cou ld choose not to incur t hem before ma nu factur ing. The firm will incur th ese expenditu res so long as th e mar gina l benefits exceed the ma rginal costs of doing so. For m an y food pr odu cts (bread , mar gar ine, soft drink s, pet foods, beer) J ohn Sut ton foun d, using t h e D* Q MES ru le of th um b, tha t one might expect to find many more firms in each food category than exist. e.g. frozen foods: expect over 100 firms in the U.S. ma rket , but every cat egory domina ted by a sma ll nu mber of firms . Substantial FC in establishing bran d-nam e recognition (“bra nd equ ity”), so th at sm all to midsize firm s mak e little head way.
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2.6.3.2 The Survivor Principle Th e survivor principle borr ows from evolut ion’s “su rvival of th e fitt est” (Spen cer, not Da rwin ). J ust a s the fittest species survive in t heir nat ura l niches, so th e fitt est fir ms (th e most efficient , with optimu m size) sur vive in t heir ma rket environments. Hence industries with significant economies of scale should be dominated by large firms, but ... To as sess t he imp orta nce of a va riet y of firm characteristics, including size: 1.
Classify th e firms into the char acteristic in question
2.
Measure performa nce (e.g., mar ket share, pr ofits ) of th e firm s over tim e.
3.
Ident ify classes of cha ra cterist ics th at show improving performance.
For U .S. brewing (Besan ko Table 5.10), a sh ift away from smaller breweries (ignoring microbreweries), becau se of increas ing economies of scale: • improvemen ts in refrigera tion → easier
transport → large-scale, centralised brewing • larger cost-effective bottling lines • advertising has created a nationwide premium
brand image
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E CL 2-32
2.7 How Does the Magnitude of Scale Economies Affect the Intensity of Each of the Five Forces? Barriers to Entry: E conom ies of scale (EOS ) det er
ent ry by forcing an ent ra nt t o ma ke a large capita l investment or incur la rge up-front costs a nd r isk st rong rea ction from exiting fir ms or a ccept cost disadvantage. Internal Industry Rivalry: EOS affect market size
an d concentr at ions, which in t ur n affect th e nat ur e of rivalry in th e indust ry. With E OS, only one or ver y few large fir ms will be able to produce at or above MES. Sma ller firm s will be at a cost disadvantage. Competit ion t ends to be fiercer when th ere ar e only a few firms in the indust ry. With t his mar ket str uctur e, th ere can be little mista ke concerning the relative power of individual firms, as well as who the indust ry leaders a re. Supplier Power: EOS a ffect th e nu mber of
competitors that can compete successfully in any mar ket. If EOS are high, then th ere are likely to be fewer player s, increas ing th e power of th e supplying indu str y over buyers. As EOS decline in importance, the supplying indust ry will have m ore compet itors, increasing th e supplier power in downst rea m indust ries, which will have m ore choices an d be less th rea tened by hold-up.
R.E. Ma r ks
ECL 2-33
Buyer Power: Again , EOS will affect t he n um ber
of comp etit ors th at can comp ete su ccessfully in any mar ket. If EOS are high, then th ere are likely to be few players, increa sing th e relat ive power of the buying industry. As EOS decline in imp orta nce, th ere will be more firms bu ying, an d th e selling indust ry will be able to play competing buyers aginst one another for th e best deal. Substitutes: One category of subst itut e pr oducts
th at deserves the most at ten tion in t he five-forces an alysis is those tha t ar e subject to tren ds impr oving th eir pr ice-performa nce tra deoff with th e designat ed indu str y’s product: if th e ma nu factur er of a su bstitu te product has achieved EOS, the substitute product will be offered at a much lower price point that the industry’s product e.g. while advert ising by one firm in an indust ry ma y do little t o bolster th e indu st ry’s position against a substitute, heavy/susta ined advertising by all indu str y players m ay impr ove the indu str y’s collective position against the substitute.
R.E. Mar ks
2.8 Applying the Five Forces 2.8.1 U.S. Hospital Markets Over t he pa st fifteen years, U.S. hospita l bank ru ptcies h ave increased to 1.5% p.a. Internal Rivalry?
Define the mar ket. Other pa rt sellers: substitutes. Geographical markets 1980: Fierce internal rivalry or competition? 1996: Fierce internal rivalry or competition? Entry?
Magnitu de of entr y bar riers? Substitutes? Supplier Power?
Who/What ar e the ma in suppliers to hospitals? Who ar e the buyers? Asset specificity? (Relationship-specific investments?)
E CL 2-34
R.E. Ma r ks
ECL 2-35
R.E. Mar ks
E CL 2-36
Buyer Power?
2.8.2 Tobacco
Who ar e the buyers?
Internal Rivalry?
Hospitals’responses?
Fierce inter na l rivalry?
_________________________________________________
The margin P M C as a meas ur e of rivalry.
F or ce
Th r ea t t o P r ofit s 1980 1996 _________________________________________________ In t er n a l Riva lr y Low H igh Entry Low Mediu m Su bst it u t es Mediu m H igh Su pplier P ower Mediu m Mediu m Bu yer P ower Low H igh _________________________________________________
Reasons? Entry?
Magnitu de of entr y bar riers? Substitutes? S upplier and Bu yer Power? __________________________________
F or ce Th r ea t t o P r ofit s __________________________________ In t er n a l Riva lr y Low Entry Low Su bst it u t es Low Su pplier P ower Low Bu yer P ower Low __________________________________ Recent developm ent s outs ide th e five-force framework?
R.E. Ma r ks
ECL 2-37
R.E. Mar ks
E CL 2-38
2.8.3 Photocopiers
2.8.4 Commercial Banking
Hist ory a nd developm ent of today’s t echn ology.
Hist ory and developmen t of today’s indu st ry.
Rivals?
Internal Rivalry?
Internal Rivalry?
Markets for mortgages, commercial loans.
Consu mer s: price, speed, reliability, service.
Credit car ds.
Mar gins: copiers, su pplies
Deregulation.
Market segments?
Entry?
Entry?
Magnitu de of entr y bar riers?
Magnitude of entry barriers? R&D, service networks.
Substitutes? Supplier Power and Buyer Power?
Substitutes? __________________________________
Buyer Power?
F or ce Th r ea t t o P r ofit s __________________________________
Who ar e the buyers? Dealers and m anu facturers. Supplier Power? ____________________________________
F or ce Th r ea t t o P r ofit s ____________________________________ I n t er n a l R iva l r y Entry Su bst it u t es Su pplier P ower Buyer Power
M ed iu m t o L ow Low Low Low Medium (growing?)
In t er n a l Riva lr y H igh Entry H igh Su bst it u t es H igh S u p plie r P ow er (G ove r n m en t ) Bu yer P ower Low __________________________________
R.E. Ma r ks
ECL 2-39
2.9 Comment on the following: All of Porter’s wisdom regarding the five forces is reflected in the economic identity: Profit = (Price – Average Cost) × Q u a n t i t y
2.10 It has been said that Porter’s five-forces analysis turns antitrust law — law intended to protect consumers from monopolies — on its head. What do you think this means?
R.E. Mar ks
E CL 2-40
CONTENTS 2. Industry Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Porter’s Five Forces . . . . . . . . . . 2.2 The Economics of the Five Forces 2 .2 .1 I n t e r n a l I n d u s t r y R iv a lr y 3 2.2.2 E n tr y 4 2 .2 .3 S u bs t it u t es 6 2.2.4 Supplier Power and Buyer Power 8 2.2.5 Stra tegies for Coping with the Five Forces 10 2.3 Make versus Buy: the Vertical Bounda ries of the . . . . . . . . . . . . . . . . . . . . Firm 2.3.1 Tapered Integra tion: Make & Buy 12 2.4 Rents and Quasi-Rents . . . . . . . . . . . . . . 2.5 Economies of Scale and Scope . . . . . . . . . . . . 2.5.1 Economies of Scale 16 2.5.2 Economies of Scope 17 2.5.3 Sources of Economies of Scale an d Scope 19 2.5.4 Limits to Economies of Scale 20 2.5.5 The Learning Curve 21 2.5.6 The Learning Curve v. Economies of Scale 22 2.6 The Importance of Scale and Scope Economies: Firm Size, Profitability, and Market Structure . . . . . . . . . . 2.6.1 Scale, Scope, and Firm Size 23 2.6.2 Market Share and Profitability 25 2.6.3 Scale, Scope, and Market Stru cture 26 2.6.3.1 Exogenous v. En dogenous Fixed Costs and M a r k et S t r u ct u r e 3 0 2.6.3.2 Th e Survivor Principle 31 2.7 How Does the Magnitu de of Scale Economies Affect the . . . . . . . . . Intensity of Each of the Five Forces? . . . . . . . . . . . . . 2.8 Applying the Five Forces 2.8.1 U.S. Hospital Markets 34 2.8.2 Tobacco 36 2.8.3 Photocopiers 37 2.8.4 Commercial Banking 38 2.9 Commen t on the following: All of Port er’s wisdom regard ing the five forces is reflected in th e economic identit y: . . . . . . 2.10 It ha s been said that Porter’s five-forces analysis turn s ant itrust law — law inten ded to protect consum ers from monopolies — on its h ead. What do you think t his . . . . . . . . . . . . . . . . . . . means?
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1 2 3
11 14 16
23
32 34
39
39
