Entrepreneurship: Successfully Launching New Ventures, 2/e Bruce R. Barringer R. Duane Ireland Chapter 5 © 2008 Prentice Hall 5 -1
Chapter Objectives (1 of 2) 1. Explain the purpose of an industry analysis. 2. Identify the five competitive forces that determine industry profitability. 3. Explain the role of “barriers to entry” in creating disincentives for firms to enter an industry. 4. Identify the nontraditional barriers to entry that are especially associated with entrepreneurial firms. 5. List the four industry-related questions to ask before pursuing the idea for a firm. © 2008 Prentice Hall 5 -2
Chapter Objectives (2 of 2) 6. Identify the five primary industry types and the opportunities they offer. 7. Explain the purpose of a competitor analysis. 8. Identify the three groups of competitors a new firm will face. 9. Describe ways a firm can ethically obtain information about its competitors. 10. Describe the reasons for completing a competitive analysis grid. © 2008 Prentice Hall 5 -3
What is Industry Analysis? • Industry – An industry is a group of firms producing a similar product or service, such as airlines, fitness drinks, furniture, or electronic games. • Industry Analysis – Is business research that focuses on the potential of an industry. © 2008 Prentice Hall 5 -4
Why is Industry Analysis Important? • Why is this Topic Important? – Once it is determined that a new venture is feasible in regard to the industry and market in which it will compete, a more in-depth analysis is needed to learn the ins and outs of the industry the firm plans to enter. – This analysis helps a firm determine if the niche markets it identified during feasibility analysis are accessible and which ones represent the best point of entry for a new firm. © 2008 Prentice Hall 5 -5
Three Key Questions When studying an industry, an entrepreneur must answer three questions before pursuing the idea of starting a firm Question 1 Question 2 Question 3 Is the industry accessible—in other words, is it a realistic place for a new venture to enter? Does the industry contain markets that are ripe for innovation or are underserved? Are there positions in the industry that will avoid some of the negative attributes of the industry as a whole? © 2008 Prentice Hall 5 -6
Industry Versus Firm-Specific Factors • Firm-Level Factors – Include a firm’s assets, products, culture, teamwork among its employees, reputation, and other resources. • Industry-Level Factors – Include threat of new entrants, rivalry among existing firms, bargaining power of buyers, and related factors. • Conclusion – In various studies, researchers have found that from 8% to 30% of the variation in firm profitability is directly attributable to the industry in which a firm competes. © 2008 Prentice Hall 5 -7
The Five Competitive Forces That Determine Industry Profitability (1 of 3) • Explanation of the Five Forces Model – The five competitive forces model is a framework for understanding the structure of an industry. – The model is composed of the forces that determine industry profitability. – The forces—the threat of substitutes, the threat of new entrants, rivalry among existing firms, the bargaining power of suppliers, and the bargaining power of buyers— help determine the average rate of return for the firms in an industry. © 2008 Prentice Hall 5 -8
The Five Competitive Forces That Determine Industry Profitability (2 of 3) • Explanation of the Five Forces Model (continued) – Each of the five forces impacts the average rate of return for the firms in an industry by applying pressure on industry profitability. – Well-managed firms try to position their firms in a way that avoids or diminishes these forces—in an attempt to beat the average rate of return of the industry. © 2008 Prentice Hall 5 -9
The Five Competitive Forces That Determine Industry Profitability (3 of 3) Five-Forces Model © 2008 Prentice Hall 5 -10
Threat of Substitutes (1 of 2) • Threat of Substitutes – The price that consumers are willing to pay for a product depends in part on the availability of substitute products. – For example, there are few if any substitutes for prescription medicines, which is one of the reasons the pharmaceutical industry is so profitable. – In contrast, when close substitutes for a product exist, industry profitability is suppressed, because consumers will opt out if the price gets too high. © 2008 Prentice Hall 5 -11
Threat of Substitutes (2 of 2) • Threat of Substitutes (continued) – The extent to which substitutes suppress the profitability of an industry depends on the propensity for buyers to substitute between alternatives. – This is why firms in an industry often offer their customers amenities to reduce the likelihood that they will switch to a substitute product, even in light of a price increase. © 2008 Prentice Hall 5 -12
Threat of New Entrants (1 of 6) • Threat of New Entrants – If the firms in an industry are highly profitable, the industry becomes a magnet to new entrants. – Unless something is done to stop this, the competition in the industry will increase, and average industry profitability will decline. – Firms in an industry to keep the number of new entrants low by erecting barriers to entry. • A barrier to entry is a condition that creates a disincentive for a new firm to enter an industry. © 2008 Prentice Hall 5 -13
Threat of New Entrants (2 of 6) Barriers to Entry Barrier to Entry Economies of scale Product differentiation Capital requirements © 2008 Prentice Hall Explanation Industries that are characterized by large economies of scale are difficult for new firms to enter, unless they are willing to accept a cost disadvantage. Industries such as the soft drink industry that are characterized by firms with strong brands are difficult to break into without spending heavily on advertising. The need to invest large amounts of money to gain entrance to an industry is another barrier to entry. For example, it now takes about two years and $4 million to develop an electronic game. Many new firms do not have the capital to compete at this level. 5 -14
Threat of New Entrants (3 of 6) Barriers to Entry (continued) Barrier to Entry Cost advantages independent of size Explanation Entrenched competitors may have cost advantages not related to size. For example, the existing competitors in an industry may have purchased property when it was much less expensive than a new entrant would have to pay. Access to distribution channels Distribution channels are often hard to crack. This is particularly true in crowded markets, such as the convenience store market. For a new sports drink to be placed on the shelf, it has to displace a product that is already there. Government and legal barriers In knowledge intensive industries, such as biotechnology and software, patents, trademarks, and copyrights form major barriers to entry. Other industries, such as broadcasting, require the granting of a license by a public authority. © 2008 Prentice Hall 5 -15
Threat of New Entrants (4 of 6) • Nontraditional Barriers to Entry – It is difficult for start-ups to execute barriers to entry that are expensive, such as economies of scale, because money is usually tight. – Start-ups have to rely on nontraditional barriers to entry to discourage new entrants, such as assembling a world-class management team that would be difficult for another company to replicate. © 2008 Prentice Hall 5 -16
Threat of New Entrants (5 of 6) Nontraditional Barriers to Entry Barrier to Entry Explanation Strength of management team If a start-up puts together a world-class management team, it may give potential rivals pause in taking on the start-up in its chosen industry. First-mover advantage If a start-up pioneers an industry or a new concept within an existing industry, the name recognition that the start-up establishes may create a formidable barrier to entry. Passion of the management team and employees If the employees of a start-up are highly motivated by the unique culture of a start-up, and anticipate large financial rewards through stock options, this is a combination that cannot be replicated by larger firms. Think of the employees of a biotech firms trying to find a cure for a disease. © 2008 Prentice Hall 5 -17
Threat of New Entrants (6 of 6) Nontraditional Barriers to Entry (continued) Barrier to Entry Explanation Unique business model If a start-up is able to construct a unique business model and establish a network of relationships that makes the business model work, this set of advantages creates a barrier to entry. Internet domain name Some Internet domain names are so “spot-on” in regard to a specific product or service that they give a start-up a meaningful leg up in terms of e-commerce opportunities. Inventing a new approach to an industry and executing the idea in an exemplary fashion If a start-up invents a new approach to an industry and executes it in an exemplary fashion, these factors create a barrier to entry for potential imitators. © 2008 Prentice Hall 5 -18
Rivalry Among Existing Firms (1 of 3) • Rivalry Among Existing Firms – In most industries, the major determinant of industry profitability is the level of competition among existing firms. – Some industries are fiercely competitive, to the point where prices are pushed below the level of costs, and industrywide losses occur. – In other industries, competition is much less intense and price competition is subdued. © 2008 Prentice Hall 5 -19
Rivalry Among Existing Firms (2 of 3) Factors that determine the nature and intensity of the rivalry among existing firms in an industry Number and balance of competitors Degree of difference between products © 2008 Prentice Hall The more competitors there are, the more likely it is that one or more will try to gain customers by cutting its price. Price-cutting occurs more often when all the competitors in an industry are about the same size and when there is no clear market leader. The degree to which products differ from one product to another affects industry rivalry. For example, the firms in commodity industries (such as paper products) tend to compete on price because there is little difference between one manufacturer’s products and another’s. 5 -20
Rivalry Among Existing Firms (3 of 3) Factors that determine the nature and intensity of the rivalry among existing firms in an industry (continued) Growth rate of an industry Level of fixed costs © 2008 Prentice Hall The competition among firms in a slow-growth industry is stronger than among those in fast-growth industries. Slowgrowth industry firms must fight for market share, which may tempt them to lower prices to gain market share. In fast-growth industries, there are enough customers to go around, making price-cutting less likely. Firms that have high fixed costs must sell a higher volume of their product to reach the break-even point than firms with low fixed costs. As a result, firms with high fixed costs are anxious to fill their capacity, and this anxiety may lead to price-cutting. 5 -21
Bargaining Power of Suppliers (1 of 3) • Bargaining Power of Suppliers – Suppliers can suppress the profitability of the industries to which they sell by raising prices or reducing the quality of the components they provide. – If a supplier reduces the quality of the components it supplies, the quality of the finished product will suffer, and the manufacturer will eventually have to lower its price. – If the suppliers are powerful relative to the firms in the industry to which they sell, industry profitability can suffer. © 2008 Prentice Hall 5 -22
Bargaining Power of Suppliers (2 of 3) Factors that have an impact on the ability of suppliers to exert pressure on buyers Supplier concentration When there are only a few suppliers that supply a critical product to a large number of buyers, the supplier has an advantage. Switching costs are the fixed costs that buyers encounter when switching or changing from one supplier to another. If switching costs are high, a buyer will be less likely to switch suppliers. © 2008 Prentice Hall 5 -23
Bargaining Power of Suppliers (3 of 3) Factors that have an impact on the ability of suppliers to exert pressure on buyers (continued) Attractiveness of substitutes Threat of forward integration © 2008 Prentice Hall Supplier power is enhanced if there are no attractive substitutes for the product or services the supplier offers. For example, there is little the computer industry can do when Intel or Microsoft raise their prices, as there are simply no practical substitutes for their products. The power of a supplier is enhanced if there is a credible possibility that the supplier might enter the buyer’s industry. 5 -24
Bargaining Power of Buyers (1 of 3) • Bargaining Power of Buyers – Buyers can suppress the profitability of the industries from which they purchase by demanding price concessions or increases in quality. – For example, the automobile industry is dominated by a handful of large companies that buy products from thousands of suppliers in different industries. This allows the automakers to suppress the profitability of the industries from which they buy by demanding price reductions. © 2008 Prentice Hall 5 -25
Bargaining Power of Buyers (2 of 3) Factors that have an impact on the ability of suppliers to exert pressure on buyers Buyer group concentration Buyer’s costs © 2008 Prentice Hall If the buyers are concentrated, meaning that there are only a few large buyers, and they buy from a large number of suppliers, they can pressure the suppliers to lower costs and thus affect the profitability of the industries from which they buy. The greater the importance of an item is to a buyer, the more sensitive the buyer will be to the price they pay. For example, if the component sold by the supplier represents 50% of the cost of the buyer’s product, the buyer will bargain hard to get the best price for that component. 5 -26
Bargaining Power of Buyers (3 of 3) Factors that have an impact on the ability of suppliers to exert pressure on buyers (continued) Degree of standardization of supplier’s products Threat of backward integration © 2008 Prentice Hall The degree to which a supplier’s product differs from its competitors affects the buyer’s bargaining power. For example, a buyer who is purchasing a standard product, like the corn syrup that goes into soft drinks, can play one supplier against another until it gets the best combination of price and service. The power of buyers is enhanced if there is a credible threat the buyer might enter the supplier’s industry. 5 -27
The Value of the Five Forces Model (1 of 4) • First Application of the Model – The five forces model can be used to assess the attractiveness of an industry by determining the level of threat to industry profitability for each of the forces, as shown on the next slide. – If a firm filled out the form shown on the next slide and several of the threats to industry profitability were high, the firm may want to reconsider entering the industry or think carefully about the position it would occupy. © 2008 Prentice Hall 5 -28
The Value of the Five Forces Model (2 of 4) Determining the Attractiveness of an Industry Using the Five Forces Model © 2008 Prentice Hall 5 -29
The Value of the Five Forces Model (3 of 4) • Second Application of the Model – The second way a new firm can apply the five forces model to help determine whether it should enter an industry is by using the model to answer several key questions. – The questions are shown in the figure on the next slide, and help a firm project the potential success of a new venture in a particular industry. © 2008 Prentice Hall 5 -30
The Value of the Five Forces Model (4 of 4) Using the Five Forces Model to Pose Questions to Determine the Potential Success of a New Venture in a Particular Industry © 2008 Prentice Hall 5 -31
Industry Types and the Opportunities They Offer (1 of 3) • Emerging Industries – Industries in which standard operating procedures have yet to be developed. • Opportunity: First-mover advantage. • Fragmented Industries – Industries that are characterized by a large number of firms of approximately equal size. • Opportunity: Consolidation. © 2008 Prentice Hall 5 -32
Industry Types and the Opportunities They Offer (2 of 3) • Mature Industries – Industries that are experiencing slow or no increase in demand. • Opportunities: Process innovation and after-sale service innovation. • Declining Industries – Industries that are experiencing a reduction in demand. • Opportunities: Leadership, establishing a niche market, and pursuing a cost reduction strategy. © 2008 Prentice Hall 5 -33
Industry Types and the Opportunities They Offer (3 of 3) • Global Industries – Industries that are experiencing significant international sales. • Opportunities: Multidomestic and global strategies. © 2008 Prentice Hall 5 -34
Competitor Analysis • What is a Competitor Analysis? – A competitor analysis is a detailed analysis of a firm’s competition. – It helps a firm understand the positions of its major competitors and the opportunities that are available. – A competitive analysis grid is a tool for organizing the information a firm collects about its competitors. © 2008 Prentice Hall 5 -35
Identifying Competitors Types of Competitors New Ventures Face © 2008 Prentice Hall 5 -36
Sources of Competitive Intelligence (1 of 2) • Collecting Competitive Intelligence – To complete a competitive analysis grid, a firm must first understand the strategies and behaviors of its competitors. – The information that is gathered by a firm to learn about its competitors is referred to as competitive intelligence. – A new venture should take care that it collects competitive intelligence in a professional and ethical manner. © 2008 Prentice Hall 5 -37
Sources of Competitive Intelligence (2 of 2) Ways that a firm can ethically obtain information about its competitors • Attend conference and trade shows. • Read industry-related books, magazines, and Web sites. • Talk to customers about what motivated them to buy your product as opposed to your competitors. • Purchase competitor’s products to understand their features, benefits, and shortcomings. • Study competitor’s Web sites. • Study Web sites that provide information about companies. © 2008 Prentice Hall 5 -38
Completing a Competitive Analysis Grid (1 of 2) • Competitive Analysis Grid – A tool for organizing the information a firm collects about its competitors. – A competitive analysis grid can help a firm see how it stacks up against its competitors, provide ideas for markets to pursue, and identify its primary sources of competitive advantage. © 2008 Prentice Hall 5 -39
Completing a Competitive Analysis Grid (2 of 2) Competitive Analysis Grid for Activision © 2008 Prentice Hall 5 -40
Chapter 5 – Industry and Competitor Analysis Application Questions © 2008 Prentice Hall 5 -41
Application Question 5 - 9 Troy Pearson is starting a medical products business in Albany, New York. He knows he should put together a competitor analysis, but doesn’t know how to go about it. If Troy turned to you for advice, what would you tell him? © 2008 Prentice Hall 5 -42
Application Question 5 – 9 … Troy should be told that there are three steps to putting together a competitor analysis: Step 1: Identify the company’s direct competitors, indirect competitors and future competitors. Step 2: Learn as much as possible about the company’s primary direct competitors via competitive intelligence. Step 3: Complete a competitive analysis grid, using the information collected via competitive intelligence. The competitive analysis grid will help Troy see how his firm stacks up to its competitors, provide ideas for markets to pursue, and identify his primary sources of competitive advantage. © 2008 Prentice Hall 5 -43
Application Question 5 - 10 Susan Willis is planning to launch an advertising agency in Tampa, Florida. She knows that she needs to complete a competitor analysis, but doesn’t know where to obtain information about her competitors. Provide Susan with several suggestions on how to proceed. © 2008 Prentice Hall 5 -44
Application Question 5 – 10 … Susan needs to complete some competitive intelligence. Three of the most common forms of competitive intelligence include (1) attending conferences and trade shows, (2) reading industry-related books, magazines, and Web sites, and (3) purchasing competitors’ products to understand their features, benefits and shortcomings. © 2008 Prentice Hall 5 -45
Application Question 5 - 12 Dana Smith will soon be opening a fitness club in Tucson, Arizona. Having identified his competitors, he wants to display the information he has collected in a way that will help him determine how he’ll stack up against his competitors and pinpoint his sources of competitive advantage. Describe to Dana a technique that he could use to help achieve his objectives. © 2008 Prentice Hall 5 -46
Application Question 5 – 12 … Dana should complete a competitive analysis grid. A competitive analysis grid, which is described in the chapter, is a tool for organizing the information a firm collects about its competitors. © 2008 Prentice Hall 5 -47
You Be the VC Day. Jet © 2008 Prentice Hall 5 -48
Day. Jet Company: – Dayjet – www. dayjet. com • Business Idea: – Offer a new and affordable form of air travel that provides “air-taxi” services to individuals and groups that accommodates their schedules and is able to reach out-of-the way places. © 2008 Prentice Hall 5 -49
Day. Jet Pitch • Pitch: – Busy individuals and business travelers have two choices when it comes to air travel: booking a flight on a commercial airline or owning or chartering a private jet. Neither of these choices is very attractive. Commercial airline travel comes with lots of hassles, like checking bags, standing in line at security, and crowded airplanes. At the same time, only the super rich and large companies can afford to charter or own a private jet. To further complicate matters, it’s hard to get to and from places that have small airports. For example, try to get from Columbia, South Carolina, to Gainesville, Florida, in an efficient manner. – Day. Jet’s mission is to fill this void. The company, made possible largely by the emergence of affordable “very light jets” like the Eclipse 500, is rolling out an air-taxi service unlike any service currently available. The service will be a “per-seat, on-demand” service, which will resemble a taxi cab service, but will take travelers from point to point on very light jets. The service will operate between specific airports called Day. Ports are mostly regional and community airports that have little or no scheduled airline service. And customers will only pay for the seats they require, not the whole plane. © 2008 Prentice Hall 5 -50
Day. Jet – Pitch continued… • The cost of a flight on Day. Jet will range from $1 to $3 per mile. That compares to 50 cents per mile on a commercial airline and $10 per mile on a chartered jet. The big advantage of Day. Jet will be time savings and convenience. A business executive that flies from South Florida to Raleigh, North Carolina, to visit a client could easily make the round-trip in a single day using Day. Jet’s service. The same trip on a commercial airline could take parts of three days, and require two nights in a hotel room, if the executive had to leave the night before the visit and return the morning after. • Day. Jet has announced that its initial service area will cover seven Southeastern states, including Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, and Tennessee. The service is pending FFA approval, which is anticipated towards the end of 2006. © 2008 Prentice Hall 5 -51
Day. Jet … Strength of New Venture Team: Score 5 (on a scale of 1 – 5) • CEO Edward Iacobucci is a prominent high-tech entrepreneur, and is a past winner of the Ernst & Young “International Entrepreneur of the Year” award. Iacobucci started his career at IBM, and was an integral part of the IBM-Microsoft design team that launched the modern era of personal computing. Iacobucci later co-founded Citrix Systems and led efforts at Wingedfoot Services LLC to make Bombardier Learjet aircraft available for charter service. Iacobucci co-founded Day. Jet in 2002. • CFO John Staten is a seasoned financial executive, with extensive experience in start-up companies. • VP of Flight Operations Don Osmundson is a veteran aviator with a distinguished career, and has spent the majority of his career working for major airlines in various capacities. © 2008 Prentice Hall 5 -52
Day. Jet … Strength of the Opportunity: Score 4 (on a scale of 1 – 5) The opportunity is strong. As discussed in the pitch, Dayjet is pioneering the “per-seat, on-demand” business travel concept, which offers customers short-haul flights using small, community airports. The service is designed to avoid the hassles of flying commercially while at the same time offering many of the amenities of private jet service. Recent new stories about airport congestion and people being stuck on airplanes for hours as the result of weather delays should bolster the attractiveness of Day. Jet’s service. © 2008 Prentice Hall 5 -53
Day. Jet … Strength of the Industry: Score 3 (on a scale of 1 – 5) While the airline industry is not strong, Day. Jet is clearly establishing a new position in the industry that avoids many of the negative aspects of the industry in general. The company’s positioning strategy seems to be a savvy one. © 2008 Prentice Hall 5 -54
Day. Jet … Strength of the Business Model: Score 4 (on a scale of 1 – 5) Day. Jet will make money by selling air travel on and a “per-seat, on-demand” basis as described above. The company plans to fly super efficient “mini” jets, like the Eclipse 500 described in the You Be the VC 5. 1 feature. The company will also operate out of small, community airports, which should reduce overhead expenses. The key will be whether the company can keep its planes in the air enough hours a day to cover its overhead and provide for a healthy profit. © 2008 Prentice Hall 5 -55
You Be the VC Day. Jet Overall Score: Continued © 2008 Prentice Hall 5 -56
You Be the VC Day. Jet The Business Decision: • We would fund this firm. We like the position that Day. Jet has established in the air travel industry, which is between commercial flights and more expensive private jet travel. All the elements of the company’s business plan and business model make sense. The key will be whether the company can keep its planes in the air enough hours a day to cover its overhead and provide for a healthy profit. Day. Jet’s management team is first-rate and we think they are up to the challenge. If Day. Jet is successful, it will pioneer a new position in the air travel industry. Decision: FUND. © 2008 Prentice Hall 5 -57
Case 4. 2 Panera Bread: Occupying a Favourable Position in a Highly Competitive Industry © 2008 Prentice Hall 5 -58
Panera Bread • Panera Bread: • www. panera. com © 2008 Prentice Hall 5 -59
Panera Bread Discussion Question 3 • What barriers to entry has Panera Bread created for potential competitors? How significant are these barriers? Panera has created barriers to entry in the following areas: – Product differentiation: Panera’s brand is growing in strength. In addition, its Artisan breads and other bakery products are distinctive in terms of their taste and quality. – Cost advantages independent of size: As a firstmover, Panera has snapped up many of the locations that are ideal for a fast-casual restaurant. © 2008 Prentice Hall 5 -60
Panera Bread Discussion Question 4 • What are Panera Bread’s primary sources of competitive advantage? In your judgment, are these sources of advantage sustainable? Why or why not? – Panera’s primary sources of competitive advantage are: (1) its position in the restaurant industry, (2) its brand strength, (3) the atmosphere of its restaurants, and (4) the distinctive nature of its bakery products. © 2008 Prentice Hall 5 -61
Panera Bread Application Question 1 • What are the ways that Panera Bread can conduct ethical and proper forms of competitive analysis to learn about potential competitors entering the fastcasual category? – reference librarians can often offer invaluable help regarding the types of databases to query to obtain the type of information needed to answer this question. © 2008 Prentice Hall 5 -62
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