This addition is helpful in assessing the share of profits that the group of incumbent firms retain from the total industry value. Refine the five forces model and introduce the concept of Potential Industry Earning to the analysis to evaluate a firm's ability to enjoy its share of the industry profits.
PIE = Total value added by the industry - Total cost to produce the goods
Some Industries like solar power have a high total value add to the customer, but also, an extremely high opportunity cost to produce goods. The diamond industry and the designer clothing industry have significant PIE since they are able to create more value, as shown in the prices customers are willing to pay, at a low opportunity cost.
1. Potential Entrants: Barriers to entry such as high capital costs, proprietary technology and patents, and scale and branding of existing competitors prevent the erosion of profits by new competitors. Industries with low cost of entry and undifferentiated products such as ocean fisheries that only require a boat and a small crew, mean that existing players are unable to capture a large share of profits unless they can create some type of barrier to new entrants such as scale or branding or some sort.
2. Supplier Power: Suppliers are providers of the inputs to the industry being evaluated. For example, Petroleum Industry in which OPEC is the sole organisation that has the power to manipulate the market for personal benefit. The concentration of suppliers and their power to cut off the supply gives them the ability to take PIE from the industry and this is how they make the industry less attractive for new competitors. Internal competition among them also determines how much leverage suppliers can have over the industry and how much of the PIE they can capture.
3. Buyer Power: The power of the buyers can take away significant PIE from incumbents. Ability to influence others decision referred as power. Power can be classified as Reward, Expert, Reference, Coercion and Legitimate power. For example, Wal-mart, Tesco etc are very large customers of many consumer goods companies. they have a great deal of leverage over small and medium suppliers simply because of their size and scale. Not making it onto Wal-Mart's shelves can mean the difference between a successful and an unsuccessful product launch. Knowing this, Wal-Mart buyers can leverage their strength into lower wholesale prices. As a result, smaller manufacturers are not able to capture a large portion of the PIE because there are substitutes for their products.
4. Substitutes: The availability of acceptable substitutes can cause buyers and end customers to bypass the industry products completely and lower the size of the overall PIE. For example, a couple of decades ago people were using STD's to call that time cellular phones was costly and also we did not use it. Gradually more substitutes came in the market and people started switching towards mobile phones and also considering it as the status symbol. Today, Almost every user have their personal handset and we hardly see any STD booth. This is how the PIE has been shifted from Landline to the cellular phones and considered acceptable substitutes.
5. Internal Competition: Is usually less intense in industries in which a large portion of the market is split among one or a few large players and products are somewhat differentiated. However, this rule of thumb is not always true. For example, the boom in the real estate and construction industry in India saw a sudden and sharp increase in the price of cement up to the extent of 17% a month in 2007. The finding was not supporting that this happened because of demand-supply mismatch or increase in the cost of production. But because of few players trying to leverage in the hike of real estate industry, govt. took a disciplinary step and announced the import of cement. This impacted negatively on the PIE of the domestic player.
By identifying what is most important for an industry and its customers, strategist can make specific recommendations about the directions in which a company should go. Operational excellence, Customer intimacy and product leadership these three value disciplines should be adopted to achieve and maintain market leadership despite being in competitive industries.
Written By:
Khushal Gupta
