THE IMPORTANCE OF INDUSTRY ANALYSIS
Industry analysis is a tool that facilitates a company’s understanding of its position relative to other companies that produce similar products or services. Understanding the forces at work in the overall industry is an important component of effective strategic planning. Industry analysis enables business owners to identify the threats and opportunities facing their business, and to focus their resources on developing unique capabilities that could lead to a competitive advantage.
Many business owners and executives consider themselves as worst victims, and at best observers of what goes on in their industry. They sometimes fail to perceive that understanding your industry directly impacts your ability to succeed. Understanding your industry and anticipating its future trends and direction gives you the knowledge you need to react and control your portion of that industry.
However, your analysis of this is significant only in a relative sense. Since both you and your competitors are in the same industry, the key is in finding the differing abilities between you and the competition in dealing with the industry forces that impact you. If you can identify abilities you have that are superior to competitors, you can use that ability to establish a competitive advantage.
An industry analysis consists of three major elements: the underlying forces at work in the industry; the overall attractiveness of the industry; and the critical factors that determine a company’s success within the industry. The premier model for analyzing the structure of industries shows that rivalry among firms in industry depends on five forces: the potential for new competitors to enter the market; the bargaining power of buyers and suppliers; the availability of substitute goods; and the competitors and nature of competition. These factors are outlined below.
The first step in performing an industry analysis is to assess the impact of the five forces. The collective strength of these forces determines the ultimate profit potential in the industry, where profit potential is measured in terms of long term return on invested capital. The goal of competitive strategy for a business unit in an industry is to find a position in the industry where the company can best defend itself against these competitive forces or can influence them in its favor.
Understanding the underlying forces determining the structure of the industry can highlight the strengths and weakness of a business, show where strategic changes can make the greatest difference, and illuminate areas where industry trends may turn into opportunities or threats.
Ease of Entry
Easy of entry refers to how easy or difficult it is for a new firm to begin competing in the industry. The ease of entry into an industry is important because it determines the likelihood that accompany will face new competitors. In industries that are easy to enter, sources of competitive advantage tend to wane quickly. On the other hand, in industries that are difficult to enter, sources of competitive advantage last longer, and firms also tend to benefit from having a constant set of competitors.
The ease of entry into an industry depends upon two factors: the reaction of existing competitors to new entrants; and the barriers to market entry that prevail in the industry. Existing competitors are most likely to react strongly against new entrants when there is a history of such behavior, when competitors have invested substantial resources in the industry, and when the industry is characterized by slow growth. Some of the major barriers to market entry include economies of scale, high capital requirements, switching costs for the customer, a high degree of product differentiation, and restrictive government policies.
Power of Suppliers
Suppliers can gain bargaining power within an industry through a number of different situations. For example, suppliers gain power when an industry relies on just a few suppliers, when there are no substitutes available for suppliers’ products, when there are switching costs associated with changing suppliers, when each purchaser accounts for just a small portion of the suppliers’ business, and when suppliers have the resources to move forward in the chain of distribution and take on the role of their customers.
Supplier power can affect the relationship between a business and its customers by influencing the quality and price of the final product.
All of these factors combined will affect your ability to compete. They will impact your ability to use your supplier relationship to establish competitive advantages with your customers.
Power of Buyers
The reverse situation occurs when bargaining rests in the hands of buyers. Powerful buyers can exert pressure on businesses by demanding lower prices, higher quality, or additional services, or by playing competitors off one another. The power of buyers tend to increase when single customers account for large volumes of the business’s product, when substitutes are available for the product, when the costs associated with switching suppliers are low, and when buyers possess the resources to move backward in the chain of distribution.
Availability of Substitutes
All firms in an industry are competing, in a broad sense, with industries producing substitute products. Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge. Product substitution occurs when a business’s customer comes to believe that a similar product can perform the same function at a better price. Substitution can be subtle – for example, insurance agents have gradually moved into the investment field formerly controlled by financial planners. The main defense available against substitution is product differentiation. By forming a deep understanding of the customer, some companies are able to create demand specifically for their products.
The battle you wage against competitors is one of the strongest industry forces with which you contend. Competitive battle can take the form of price wars, advertising campaigns, new product introductions, or expanded service offerings – all of which can reduce the profitability of firms within an industry. The intensity of competition tends to increase when an industry is characterized by a number of well-balanced competitors, a slow rate of industry growth, high fixed costs, or a lack of differentiation between products.
Another factor increasing the intensity of competition is high exit barriers – including specialized assets, emotional ties, government or social restriction, strategic interrelationships with other business units, labor agreements, or other fixed costs – which make competitors stay and fight even when they find the industry unprofitable.
Industry Attractiveness and Success Factors
Industry attractiveness is the presence or absence of threats exhibited by each of the industry forces. The greater the threat posed by an industry force, the less attractive the industry becomes. Small businesses, in particular, should attempt to seek out markets in which the threats are low and the attractiveness is high. Understanding what industry forces are at work enables small business owners to develop strategies to deal with them. These strategies, in turn, can help businesses to find unique ways to satisfy their customers in order to develop a competitive advantage over industry rivals.
Success factors are those elements that determine whether a company succeeds or fails in a given industry. They vary greatly by industry. Some examples of possible success factors include quick response to market changes, a complete product line, fair prices, excellent product quality or performance, knowledgeable sales support, a good record for deliveries, solid financial standing, or a strong management team.
The reason for identifying success factors is that it will help lead you to areas where you can establish competitive advantages. The first step is to determine whether or not the company possesses each success factor identified. Then the business owner can decide whether the company can and should develop additional success factors.
Importance of Industry Analysis
A comprehensive industry analysis requires a business owner to take an objective view of the underlying forces, attractiveness, and success factors that determine the structure of the industry. Understanding the company’s operating environment in this way can help the business owner to formulate an effective strategy, position the company for success, and make the most efficient use of the limited resources of the business.
Once the forces affecting competition in an industry and their underlying causes have been diagnosed, the firm is in a position to identify its strengths and weaknesses relative to the industry. An effective competitive strategy takes offensive or defensive action in order to create a defendable position against the five competitive forces. Some of the possible strategies include positioning the firm to use its unique capabilities as defense, influencing the balance of outside forces in the firm’s favor, or anticipating shifts in the underlying industry factors and adapting before competitors do in order to gain a competitive advantage.
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