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MGT451_VideoTranscript_Mod02_P3 Industry Analysis and Porters 5 Forces Model

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Before you start analyzing a company it can be valuable to look at the industry and one of the models that we often times use in industry analysis is to look at the product life cycle. And here I have this graph right here: where we have time on the X axis and sales on the Y axis. And you have these four different stages: introduction of the product, growth period, maturity, and then decline. Early in the going, sales are growing but they are not growing that rapidly. You can see here is that it starts to turn up between this dashed line here And this growth phase. It gets steeper. Now early in the going, you know, people are reluctant about the product, they may not know if it's going to be good, some people are buying it. You have early adopters, people who like to adopt the product early. Sometimes a product isn't really valuable until other people have it. Think about a fax machine, a fax machine is only valuable if other people have a fax machine so you can send them a fax. Usually in economics the more people who have something the less valuable it is, but in an item like a fax machine it's a much more valuable for more people to have them. Or think about telephones where you can send texts. When they first came out if you are the only one who can text it's not particularly valuable. Now that everybody can text your phone is a lot more valuable. So you get to the point there's early growth and then often times companies figure out how to make the product cheaper So growth really begins to take off, the product becomes accepted in society, and it grows quite rapidly. At some point growth starts to slow down, see it's still going up but it's flatter. and the reason it slows down is there may be better products that have come out, it may be the case that everybody who wants one already owns one. I mean there are some things that you don't replace very often. You know, early in the PC industry (in the personal computer industry) very few people have them, very expensive, growth was slow. Then they got to the point when they were quite cheap and everybody starts to buy one. You'll find that people you would never expect to have a computer owned a computer. Your grandmother who, you know, probably wasn't that big into computers may have run out and bought one because they were cheap. She was able to e-mail the grandchildren, she was able go on the Internet, and send e-mail or view her favorite TV shows online, all kinds of things, find recipes, search out other information she would be interested in. So it takes off and there's still some growth because people replace computers, but most people who want a computer already have one. I suspect that many of you are watching this video have owned several computers over your lifetime even though you may only be 20 years old. You know, in your home there may be three, or four, or five computers. Then you get to a point where you start to see decline. Okay, even in the personal computer industry. What's replacing personal computers? Tablets. The Apple iPad. Okay, some of these other pads or tablet computers have started to replace the basic personal computers. So you start to see decline. So when do you want to invest? Well it can be quite risky here because you're not sure if this is going to start taking off or if it's going to die. So a good place to invest is here where growth is really beginning to take off. Generally you like get out before the decline although there may be some good businesses to invest in even during decline because during decline of a lot of companies are leaving the industry; and it becomes less competitive. So it becomes more profitable for the few companies that have remained in the industry. Now another model that's really quite valuable for analyzing (sorry...chuckles) for analyzing an industry is a model by Michael Porter. Michael Porter is a professor at the Harvard Business School, and he came up with this Five Forces model. His model looks at - what he did was, he analyzed a lot of industries and he tried to figure out why are some profitable and others aren't? And he figured out that there were these five forces. For example, 'threat of new entrants' the harder it is for someone to get into your line of business, into your industry the more profitable it's going to be. Think about the pharmaceutical industry. It's very difficult to get into the pharmaceutical industry. You need, you need laboratories You need to do testing of these new products that takes a long time to get patents. It takes a long time to get FDA approval. after, even after you've created and have a new medication approved, by the FDA, you have to have a sales force to sell these things. If you've ever been in the doctor's office and you see somebody stroll in who is dressed in a business suit and dragging along a rolling, rolling briefcase kind of thing often times that's a pharmaceutical rep busy pitching to the doctors what they should buy. Okay, you should prescribed this cholesterol drug because ours is better. And you've may be noticed when you sign in at the doctor's office there are pens with the different pharmaceutical companies names or products on them - they give away a lot of the stuff. They buy lunch for the doctors, they do all kinds of things like that. You need a sales force to do that; because that's who is going to prescribe the medication. So the tougher it is to get into a business less profitable it is. I compare often times, I tell my students to compare school teachers, you know public school teachers or private school teachers to college professors. It's harder to become a college professor because you generally need a PhD. It's a barrier to entry. Most universities are not going to hire somebody with only a bachelor's degree, now there are some exceptions, you may be able to teach part-time with a bachelor's degree. You might be able to teach at a community college with a Masters degree. But if you want to teach at a four year university you need a PhD. It makes it tougher to get in. Another factor that matters is threats of substitutes Now keep in mind that this is an industry model, so what I'm talking about substitutes on talking about substitutes for the industry. For example, if this is the auto industry we are not comparing Ford and GM. We're comparing the automobile to other means of transportation; such as mass transit, bicycles, motorcycles, or for that matter, walking. That's what the substitute is. For many of us there is no real substitute for the automobile. If you live in New York City where, particularly Manhattan, where there's a subway system, where there are regular buses, you can get away without driving. But if you live in New Jersey, as I do, it's very difficult to get around without a car. So, what kinds of substitutes makes a big difference. Another factor is the bargaining power of buyers. Are there a lot of small buyers? Then they can't negotiate for price. Or are there a few very, very large buyers in the industry? Think about the defense industry. Who buys missiles? Who buys tanks? Governments. And there aren't that many of them to sell to. So they are able to negotiate a fair price. Over here we have bargaining power of suppliers. What kind of supplies go into making the goods? If you look at the pharmaceutical industry, a lot of the ingredients in your medications are things like water, or things that can be found anywhere. And so the supplies don't cost very much, so there is no one gouging them or grabbing some of their profits But think about the personal computer industry. What you need if you build a personal computer? You need an operating system. so, unless you're Apple, and you have your own operating system, you're probably going to use Microsoft Windows Microsoft attracts much of your profit. You need a processor. So you can go to Intel or you can go to AMD. Again, they're going to charge quite a bit. They're going to grab much of the industry profits. Some of the other components of a personal computer are not, don't have much bargaining power; those businesses don't have a lot of bargaining power. There are quite a few hard drive makers and memory manufacturers so they don't grab a lot of the profits. The last factor that matters is the rivalry among existing competitors. And the biggest thing about rivalry we care about is price competition Is there a lot of cutting of price? Because if there is, if everybody cuts price - if company A cuts price and then you have to cut price to match, and then they cut price to match you, you keep cutting - nobody makes any money. That's very difficult. Again think of the pharmaceutical industry. I'm sure many of you have seen ads on the TV or heard them on the radio for certain medications. When do they ever talk about price? They talk about their product being safer, they talk about it being more effective, they talk about it being a trusted brand, but they never talk about price. They never say use our cholesterol drug because it's cheaper. They tell you that ours is better, faster, safer. So they don't compete on price and that's what makes the pharmaceutical industry, at least in the past, has made it fairly profitable. So when you think about a business - and this is a fairly easy model - even without a lot of analysis you can kind of look at an industry and get an idea as to whether it would be it would be a profitable industry, or whether there would be a lot of competition, and is it easy to get into the industry, are there substitutes, etc. Again think about the PC industry, which is not having a good time right now. What's the substitute? The substitute is a tablet computer. So that's extracting a lot of their profits. How about threats of entrance? Well it's quite easy to get into the personal computer business. I mean there aren't many right now but if you go back to the mid-80s late 80s early 90s, there were a lot of PC companies. They popped up out of everywhere. Michael Dell got started building computers in his dorm room. So you don't need a lot of capital it's pretty easy to start. This is a good model to look at as you decide whether an industry is worth exploring or not.

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Duration: 12 minutes and 20 seconds
Language: English
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Posted by: christineward on Apr 1, 2016

Industry Analysis and Porters 5 Forces Model

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