Reading 37: The Five Competitive Forces that Shape Strategy- drive, center, industry, 2010

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Session 11: Equity Valuation: Industry and Company Analysis in a Global Context
Reading 37: The Five Competitive Forces that Shape Strategy

LOS b: Illustrate how the competitive forces drive industry profitability.

 

 

 

While Joseph Donovan, CFA, was interviewing Gene Hickman, the CEO of Hickman Supply, Hickman made the following comments on the auto supply industry:

1. Auto manufacturers are relying on Tier 1 suppliers for more and more sub-assembly work and quality control and testing.
2. The additional subassembly work facilitates specialization among suppliers and allows them to resell their expertise to other auto manufacturers.
3. The additional subassembly work requires additional capital investment and risk taking by the suppliers.

Given these statements, Donovan is most likely to conclude that barriers to entry to the auto supply industry have increased due to:

A) Statements 1 and 2 only.

B) Statements 2 and 3 only.

C) Statements 1 and 3 only.

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Based on the Porter model, increased specialization and an increase in capital investment may each act to increase barriers to entry. The fact that auto manufacturers are relying more and more on their suppliers may be interpreted as an industry dynamic that would attract more competition. Finally, the negotiation for lower prices by auto manufacturers suggests that suppliers are losing some bargaining power.

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Mary Moore is preparing a report on the commercial banking industry. As she gleaned information from the competitors annual reports she encountered the following statements in the CEO’s letters to their shareholders and the Management Discussion and Analysis (MD&A) section:

William Spencer, CEO of Western Banks, stated in the MD&A: “Consolidation within the industry will continue at its current pace, or perhaps accelerate, as banking concerns seek to increase their presence and market share.”

Margaret Acosta, CEO of Southwest Banking, stated in her letter to the shareholders: “Competition is becoming increasingly diverse as banks continue to increase in size and offer products ranging from insurance and mutual funds to high tech interaction with customers.”

Maria Bellini, CEO of Atlantic Mercantile Banks, noted in the MD&A that: “Cost advantages in most traditional banking activities seem to be mostly gone now, which will impact the industry future profitability.”

Moore is most likely to report that the commercial banking industry has high rivalry among competitors based on:

A) Margaret and Maria's statements only.

B) William and Maria's statements only.

C) William and Margaret's statements only.

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William and Maria's statements support arguments for rivalry among commercial banks in that they indicate that banks must increase market share through mergers and acquisitions and that traditional banking activities are now commodities. Margaret's statement suggests that banks are offering increasingly diverse products in an attempt to differentiate – the opposite of a commodity-type business.

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Which of the following are likely to result in higher profitability for a firm in a competitive industry?

A) Low supplier concentration, low buyer concentration, and commoditization of the industry’s products.

B) Product differentiation, low switching costs, and high barriers to exit.

C) High barriers to entry, low barriers to exit, and high switching costs.

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All else equal, high barriers to entry, low barriers to exit, and high switching costs will tend to result in higher profitability for a firm in a competitive industry.

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With respect to industry attractiveness, the key concern is whether the:

A) industry is currently profitable.

B) industry is currently experiencing significant sales growth.

C) industry is attractive in terms of long-term profit potential.

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The key concern of industry attractiveness is whether the industry is attractive in terms of long-term profit potential.

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Which of the following is NOT one of Porter’s five factors determining the intensity of competition within an industry?

A) Threat of substitute products.

B) Rivalry among existing competitors.

C) Bargaining power of the firm's creditors.

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The bargaining power of the firm’s customers and suppliers along with the threat of substitute products, the threat of new entrants, and the rivalry among existing competitors comprise Porter’s five factors. The bargaining power of the firm’s creditors is not one of Porter’s five factors.

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An industry that manufactures and sells a commodity-like product will face increased competition primarily because of greater:

A) bargaining power of buyers.

B) threat of substitute products.

C) threat of new entrants.

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Substitute products limit the profit potential of an industry.  Why?  They limit the prices firms can charge.  There will be higher levels of competition and lower profit margins for more commodity-like products.

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If an analyst was assessing a pharmaceutical company’s competitive strategy, the length of the drug patent would be related to which of Porter's Five Forces?

A) Bargaining power of buyers.

B) Rivalry among existing competitors.

C) Entry barriers.

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Long drug patents make entry into the industry difficult; therefore this relates to barriers to entry.