Industry Structure Analysis Porter Model

Industry structure analysis looks at the forces that will shape an industry's profitability. Michael Porter of Harvard is best known for having formalized

industry structure models.1 An approach to industry structure analysis is shown on Exhibit 11.1. In this model, four forces drive an industry's profit potential: substitute products, supplier bargaining power, customer bargaining power, and entry/exit barriers.

The existence of substitute products can place significant limits on an industry. For example, railroads and trucks compete for the movement of freight. Rail movement is relatively cheap for large, long hauls but is not as flexible and inexpensive as truck movement for small, short hauls. For some shipments between the very long and very short, a shipper could use either rail or truck transportation and could try to create bidding competitions between them.

Entry and exit barriers determine the likelihood of competitors entering and leaving the industry. Entry barriers arise when there are skills or assets that only a few competitors can obtain. Access to capital is rarely an entry barrier because it is easy to obtain. On the other hand, access to new technology and patents can shut out new competitors. Exit barriers exist when competitors are better off staying in the industry, even though they are not earning their cost of capital. Exit barriers often arise in capital intensive industries where companies may be earning more than their marginal cost so they do not wish to exit, but the returns on capital are low. Furthermore, management may continue to invest capital in low-return industries for long periods because they do not wish to dismantle their organization or they are hoping other competitors will leave first.

The bargaining power of suppliers determines what share of the total pool of customer revenues can be retained by the industry. If a company can increase its bargaining power, its share of the revenue will increase. Wal-Mart, the discount retailer, has successfully exploited its purchasing power and information technology about customer wants to obtain from vendors

1 M. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980).

lower prices and better service than its competitors. But attempts to extract value from suppliers do not always work. Many department stores have attempted to cut out the manufacturers altogether by developing their own house brands for which they design the products and contract out the manufacturing. Some of these retailers have found that costs for design and manufacturing are not low enough to make up for the lower prices they generally have to charge for their non-name-brand goods.

The bargaining power of customers also affects the industry's share of revenues. In carpet manufacturing, for example, the major competitors have found ways to skip the wholesalers—who traditionally distributed their products to retailers—and deal directly with the retail stores. They have thus been able to take a significant share of the total revenue pool away from the wholesalers.

The Porter model is static. The Structure-Conduct-Performance model, developed by McKinsey consultants in the 1980s, adds a dynamic element to industry structure analysis as illustrated in Exhibit 11.2. The S-C-P model adds external shocks to the system to analyze how they will affect the structure, how competitors are likely to respond, and how the performance of the industry and competitors will be affected.

Customer Segmentation Analysis

The purpose of customer segmentation analysis is to help estimate potential market share by explicitly identifying why customers will choose one company's products over others. It also tells us how difficult it will be for a competitor to differentiate itself and helps to identify how profitable each type of customer is likely to be, based on their needs and cost to serve.

Customer segmentation analysis works from two perspectives: the customer and the producer. From the customer perspective, product attributes have different importance to different groups of customers. After-sale service may be more important to a small manufacturing customer than a large customer with its own in-house maintenance staff. In addition, competitors may include different attributes in their product offering and, in this way, deliver different benefits to customer groups.

Exhibit 11.2 Structure-Conduct-Performance Model

A customer segment is a group of customers to whom similar product attributes provide similar benefits. Segmenting customers forces the analyst to understand why customers prefer one product over another, often despite the fact that the products appear similar. This helps to identify why competitive market share may differ across customer groups and to find opportunities for segment differentiation. In the overnight package delivery business, for example, detailed billing information on each package is important to some customers, while others are content with summary data. Some customers want to know instantaneously where a package is, while other customers can wait for the information. So while all customers receive the same overnight delivery, other less apparent attributes may be important.

From the producer perspective, different customers have different costs to serve. In the salt industry, distance to the customer has a major impact on the costs to serve because of salt's low value-to-weight characteristics. Some customers may be simply too far away to serve if competitors are much closer. It follows that customers close by may be important to lock up because their proximity creates a major competitive advantage.

By segmenting customers according to both the customer and producer attributes, and then comparing a company's ability to satisfy those customers relative to competitors, you can begin to identify current or potential competitive advantages.

Competitive Business System Analysis

The business system is the way that a company provides product attributes to the customer, as illustrated in Exhibit 11.3. The business system extends from product design to after-sales service. Analysis of the business system provides insight into how a company can achieve a competitive advantage through lower costs, better capital use, or superior customer value. To do this, the analyst needs to lay out the business systems of the major competitors and identify:

• What product attributes does each competitor provide with its business system? Exhibit 11.3 Business System Analysis

• What costs and capital are associated with providing these attributes? Ideally, this should be done for each component of the business system. In addition, linkages between the components should be considered.

• What are the reasons for differences in performance among competitors?

A competitor may have a manufacturing cost advantage because its labor force is not unionized. To overcome this labor cost advantage, other competitors must achieve greater labor productivity or cost savings elsewhere in the business system or provide a superior product to their customers.

A variation on this business system analysis focuses on core processes rather than the functional orientation of the traditional business system. A core process for a fast-food chain might be site development (including site selection and construction), which might cut across many traditional functional areas, including marketing, real estate, construction, and finance. The advantage of this perspective is that it highlights the competitive advantages that can be gained from better cross-functional management.

Coyne/Subramaniam Industry Model

Kevin Coyne and Somu Subramaniam have developed a strategy model that adds several important dimensions to the Porter model.2 Exhibit 11.4 summarizes this approach. You can see two of the dimensions: industry structure/conduct and the basis of competition. The Porter model inhabits the large box on the bottom of the exhibit, where companies compete on an arm's-length basis and structural advantage is the basis of competition. Coyne and Subramaniam add additional structures and bases of competition.

2 K. Coyne and S. Subramaniam, ''Bringing Discipline to Strategy," McKinsey Quarterly, no. 4 (1996), pp. 14-25.

Along the industry structure dimension, the traditional arm's-length relationship between players is supplemented by two additional structures, referred to as privileged relationships and co-dependent systems. In the traditional model, each player competes at arm's length with its competitors, customers, and suppliers for a share of the total value. Co-dependent systems refer to industries where alliances, networks, and economic webs are critical elements of competition. Industries based on privileged relationships are characterized by companies providing special ''non-economic" treatment of each other because of common financial interests, friendship, political connections, or ethnic loyalty.

Along the basis-of-competition axis, the traditional model assumes that structural advantages provide the source of extraordinary returns. Coyne and Subramaniam add two other sources of advantage: front-line execution and insight/foresight. Some companies can beat the competition simply by better execution of day-to-day tasks. This can sometimes overwhelm any structural advantage. Other companies can create value by consistently developing insights or knowledge ahead of the competition.

Bringing together the three industry structures and the three sources of advantage provides a more complete picture of how a company can create value.

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