An important element in strategy development is attempting to anticipate how a competitor might respond to an organization’s changes in strategy(ies). Selec

So let’s walk through each of the five forces. And I want to start with the one that I told you last time that I think is the most important and that is barriers to entry or threat of new entries because if you don’t have barriers to entry, and you have bargaining power over suppliers and buyers, then companies should enter that industry to get at that bargaining power and to make more money. So you tend to see more entries, so there really should be something preventing new entrants from getting in if you want to try and maintain the high profits in an industry. So think of it this way, you’ve got an industry here, you’ve got Firm D who wants to get in and can’t get in. Why can’t it get in? So let’s just sort of walk through different things that serve as barriers of entry to an industry. Let’s start with actually scale economies and capital requirements. So can anybody here define what scale economies means? What’s scale economies?

S: It’s when your company is able to produce at such a high scale that you’re being able to cut down your costs.

P: Okay, so your cost per unit goes down because you’re producing very high volumes. And in fact what you see is that you can spread, you tend to have high fixed costs in a business that you can then spread across lots of units when you produce more. And then there’s this notion of capital requirements so I’m going to talk about the aerospace industry for both of these. In some cases you need a lot of money to enter an industry, in some cases you don’t need a lot of money to enter an industry.

So let’s just talk about the aircraft manufacturing industry for a moment. How many aircraft manufacturers are you aware of? Boeing and Airbus, they’re the two big ones. There are some regional jets and small ones, like Embraer and Canadair, but really it’s Boeing and Airbus that dominate this. About 25 years ago, we actually had McDonald Douglas, we had Lockheed which also made aircraft, Martin Marietta was also a producer of aircrafts or at least large portions of aircrafts and we gradually saw those folks disappear. And here’s partly why. The cost to develop a new aircraft in terms of just figuring out the design of it and then building the manufacturing plant to produce it is about five billion dollars.

Okay, so you need a lot of money. This is why capital requirements can be a barrier of entry. Imagine if I go down and work for Boeing and have an idea for a new jet, I go down to my bank, I say you know I just need five billion dollars to design this new jet, and I won’t have even sold any yet, that’s just to design it, to build the plant, to be ready to produce. You have these huge capital requirements and that creates a barrier to entry. But then in order to make back the five billion dollars, typically you need to sell somewhere around 300 and 400 aircrafts, sort of a rule of thumb, given the amount you tend to make per aircraft. So for a certain sized aircraft, Boeing 737 size, let’s say, there are about 1,200, 1,300 planes that are sold worldwide over the life of a plane. So you’re talking about maybe a 15 year product life cycle. 1,200, 1,300 planes, you need to sell 300 to 400 in order to break even. How many companies are you going to see in that industry? Not too many. It’s hard for there to be four players because for there to be four players, each sell 300 to 400, that means they’d all be breaking even if they all sold 300 to 400. Does that make sense? So what we’ve seen over time is that we’ve had fewer and fewer players in the industry because you need to be able to produce more than 300 to 400 planes if you’re going to make money with any given product. That’s how economies of scale can be a barrier to entry.

So in some industries you have to look at the total volume in the industry, and then you’ve got to look at well how many units are we going to have to be likely to produce in order to be able to produce it, what we call a minimum efficient scale. With a minimum efficient scale, you’ll read more about this in the cost section, it’s basically looking at cost per unit, and as you see it come down, you’ll see that it starts to flatten out and then go up, it’s a scale curve. And at that point that it starts to flatten, that’s the minimum efficient scale. And if that number is, if you have to produce 300 planes and there’s like 1,200, there’s only going to be a small number of players in that industry because you can’t get enough scale in order to survive to build plants to produce your product. And so you tend to have few players in that industry. And it becomes a barrier to entry. You don’t want to enter that particular industry because it’s too risky and you have to make too many planes.

And capital requirements, as I already mentioned, can be a barrier to entry. The more money you need to enter an industry then the less likely you’re to have a new entrance because it’s hard to raise that kind of money. We also talked about scope economies. So economies of scale mean that you lower your cost per unit because you do the same thing over and over and over again. Whether it’s making a Boeing 737 over and over again or a particular motor cycle, but you do the same activity over and over again. That’s what we think of as economies of scale. Economies of scope you sort of do related activities that somehow by doing two activities, it lowers the cost for you because you do two activities that are in some way related. Let me give you an example. In the United States, where do we mostly shop for clothing?

S: Malls.

P: Malls, right? We mostly shop at malls. So now the question is, how do retailers get space in a mall? How’s that?

S: Leasing.

P: Leasing. They’ve got to be able to go and lease the space. Now have you noticed are becoming more and more alike over the years with the same stores in the malls? That’s because big companies, some of them will actually own multiple stores in the malls. So like The Limited, the company The Limited, has over the years they’ve bought and sold some of these stores, but over the years they have owned a number of kinds of stores in the mall. For example, they own The Limited, The Limited II, Express, Structure, Bath and Body Works, Victoria Secret, Learner, Blain Brian, those have all been sort of in their portfolio of stores and brands that they offer. How might that create a barrier to entry for a new company wanting to come into selling clothing or even Bath and Body Works in a mall? Let’s think, how does that help them stop another company from coming in?

S: Because they, all of those are stores that sell generally the same thing, but with some variation. So whichever store in entering, they’re going to have to be willing to lower their prices, or even take the loss because those stores pull up ________.

P: Okay, so one option is we can be aggressive in one particular market or area and we could make it up other places. Okay, so that’s one way.

S: So if let’s say 40 percent of the mall is owned by one company, then just the number of, the space that’s left over for other companies _____. You reduce the supply and the price will go up and it’s going to reduce the number of competitors.

P: Right, think about if The Limited is going in or The Gap or others if they have multiple stores, then they’re going to negotiate with the developer for rent. If I can bring you eight stores, do you think that would give them better rent? Absolutely, right? So now not only do I get in early, do I get better rental prices, but I might even get preferred positions in the malls and what that effects is a barrier of entry for someone new trying to get into the industry because they are going to have to pay higher rent because they don’t have the scope of operations, the number of different store formats, and they’re also unlikely to be unable to afford the higher rents.

The other thing is, think of distribution out of the mall. Now we could have central warehousing and we could sell, send a truck and we could have clothing for multiple different of our stores on the same distribution truck. Or we can give, the other we can do, we can give coupons out, if we go out to the outlet mall or other places, sometimes you’ll buy at one place and they’ll give you coupons for other places that you can buy products because they’re often owned by the same company. So now you get this cross-selling opportunities that occur. All of this scope of operations can now produce a barrier of entry for a new entrant. Does that make sense? Any questions about that? Okay, so that’s the way scope economies works.

Switching costs, some products inherently have switching costs. Software is typically one of those. Compatibility issues with switching costs, you’ve learned how to use a certain kind of software, whereas most of us can change our brand of gum without huge switching costs, right? Or a different candy bar or whatever it might be. Products that have these inherent switching costs where there’s learning involved, where there’s investment involved, those products tend to have barriers to entry that other products don’t have. That’s actually one of the reasons that software tends to be a very attractive industry generally because once you get users, there tend to be switching costs which makes it harder for entrants to come in. Access to scarce resources can be a barrier to entry. De Beers company that sells diamonds and actually now has diamond stores, but basically by trying to own the diamond mines, they’ve owned a lot of the scarce resources that you need in order to be in the diamond business and that creates a barrier of entry to somebody else because there are only so many diamonds and diamond mines out there, and if De Beers already owns it, it’s hard to get into the industry.

The learning or experience curve, so we’ve got here, I’ve got automated motor cycles, we’ll do a case a little bit later on Harley Davidson, but Honda by producing of millions of motorcycles it’s able to bring down their cost per unit, and it’s a fairly steep experience curve, which means with every doubling of volume their costs drop fairly significantly, 20 to 25 percent. Well that means for a new entry to come in, if you’re going to produce motorcycles in the same way, or a similar way, you’re going to have a huge cost disadvantage because you just don’t have the volumes to get in. So learning curve or experience curve can be a barrier to entry.

Product complexity can be a barrier to entry like intel we’ll do a case on Intel on Monday, but microchips are a very complex product and so it’s hard, there are fewer people who can figure out how to run a microchip company than there are who can figure out how to run a grocery store company, let’s say. So in fact you’re going to have more supply of people who can run a certain kind of business than others, so really complex business, a lot of times there will be barriers to entry because you’ve got to have people who have the analytical horsepower to figure out how to run that kind of a business. And then finally you could have entry regulations or tariffs that could prevent entry into a particular business, so tariffs are what the US government puts up in some cases to prevent foreign companies from coming into a particular market. They also have had regulations, for example, tobacco, you can’t run an ad on TV for a tobacco product. So in some ways that’s actually been good for the existing tobacco companies because that means new companies can’t come in and really advertise on TV. I know there are reasons the government has for not wanting ads on TV for any kind of tobacco at all, but in some ways it does protect the companies. Is there a question?

S: What’s the difference between scale economies and the learning curve?

P: Let me save that for our discussion on costs. But the short answer is the learning curve is about cost going down with volume because you learn how to do things better. The scale economies are more around cost coming down because I can build a bigger plant with equipment that can handle more volume, and I can spread those fixed costs across more units. So one is more around spreading fixed costs and investment, the other is more around actually learning how to do something better.

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A

B

C

D

Industry

Direct substitution with similar or the same functionality

Diesel vs gas engines

DirecTV vs cable

Be Your Own Substitute

Starbucks acquiring Seattle’s best coffee (partnerships with both Barnes & Noble and Borders)

MTV (acquiring other music channels (VH1, Country)

Customers

What Alternatives are Available to Customers (Threat of Substitutes)

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