Analyiss of Competition Structure for Industry

One of the first steps in analyzing an industry is the determination of the amount of industry concentration. If the industry is fragmented, many firms compete, and the theories of competition and product differentiation are most applicable.

Industry Competition Structure

With more concentration and fewer firms in the industry, oligopolistic competition and game theories become more important. In analyzing industry concentration, two methods are normally used. One method is the N firm ratio: the combined market share of the largest N firms in the industry. A related but more precise measure is the Herfindahl index, the sum of the squared market shares of the firms in the industry. The Herfinclahl index has a value that is always smaller than one. A small index indicates a competitive industry with no dominant players.

The advantage of the N firm concentration ratio is that it provides an intuitive sense of industry competition, If the analyst knows that the seven largest seven firms have a combined share of less than 15 percent, he or she immediately knows that the industry is fragmented and thus more risky because of competitive pressures and the lack of cooperation. The HerfIdahl index (H) has the advantage of greater discrimination because it reflects all firms in the industry and it gives greater weight to the companies with larger market shares. An H below O.l indicates an unconcentrated industry, an H of O.l to 0.18 indicates moderate concentration, and an H above 0.18 indicates high concentration.

Analysis of Competitive Advantages and Strategies

Porter used the notions of economic geography that different locations have different competitive advantages. National factors that can lead to a competitive advantage are: factor conditions such as human capital; demand conditions such as the size and growth of the domestic competitive position. related supplier and support industry; and strategy, structure, and rivalry such as the corporate governance etc.

A competitive strategy is a set of actions that a firm is taking to optimize its future competitive position. Porter distinguishes three generic competitive strategies:

• Cost leadership: The firm seeks to be the low-cost producer in its industry.
• Differentiation:The firm seeks to provide product. benefits that other firms do not provide.
• Focus:The firm targets a niche with either a cost or a benefit (differentiation) focus.

Equity valuation analysis in large part is analysis of the probability of success of company strategies. Analysts will consider the company's commitment to a strategy as well as the likely responses of its competitors. Is the company a tough competitor that is likely to survive a war in the game?

Porter Five Forces and Competition Strategies

Rivalry intensity: This is the degree of competition among companies in the industry. For example, airline competition is more re intense now with more carriers and open skies agreements between countries than in the days of heavier regulation with fewer carrier limited to domestic companies. Coordination can make rivalry much less intense, The analyst must be alert for possible changes in coordination and rivalry intensity that are not yet reflected in equity prices.

Substitutes: this is the threat of products or services that are substitutes for the products or services of the industry. For example, teleconferencing is a substitute for travel. The analyst must be alert for possible changes in substitutes that are not yet reflected in equity prices.

Buyer Power: This is the bargaining power of buyers of the producer's products or services. For example, car rental agencies have more bargaining power with automobile manufacture than have individual consumers. The analyst must be alert for possible changes in buyer that are not yet reflected in equity prices.

Supplier Power: this is the bargaining power of suppliers to the producers. For example, traditional aircraft supplier lost power when niche players entered the market and began producing short-haul jets, The analyst must be alert for possible changes in supplier power that are not yet reflected in equity prices.

New Entrants: this is the threat of new entrants into the industry. For example, a European consortium entered the aircraft manufacturing industry and has become a company now competing globally. The analyst must be alert for possible changes in new entrant threats that are not yet reflected equity prices.