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Chapter 5

Macro-foundations of Strategic Advantage: Industry Analysis

Why console gaming is dying?

Since 2010, console-based video games industry has slumped. The waning consumer interest has hurt the big three consoles: Microsoft's Xbox 360, Sony's PlayStation 3 and Nintendo's Wii. The console game industry has kept alive because of a select few big game franchises like “Call of Duty” and “Madden”. However, the industry’s future is uncertain.

In the past, each next generation of consoles was a step above, and thrived on differentiation. Nintendo NES was a step above Atari and imprecise joysticks. Genesis offered a huge leap in affordable home graphics. PlayStation immersed players into 3-D worlds. Xbox overcame polygons in favor of rounded looks. Current generation of consoles has largely offered better-looking versions of games consumers have already played. Next-generation is no longer “next”. Even wii, after five years of phenomenal growth, is slumping. Console industry has introduced an ever larger number of games, but fewer have gone into new creative territories and are must-have.

In the recent years, gaming consoles have transformed into entertainment hubs for consumers to stream movies or web-based videos from Amazon and Netflix. 40% of all game console activity is non-game. Game consoles account for half of all Netflix users. The shift in the use of game consoles for movies has hurt the console game industry. Over the past 30 years, the business model of the console makers such as Sony and Microsoft was to spend billions in R&D and marketing costs on a new console system on a five year lifecycle, to sell them at loss for the first few years, and to make up the cost from incomes from proprietary and third-party software business - a slew of lucrative $50-$60 games. Now, the console makers are unable to recover their costs, and are incurring losses.

Console makers have tried to reinvigorate interest in living-room and dedicated handheld gaming. Their mainstream consoles are quite old – in 2012, Xbox 360 was 7 years old, and the Wii and the PlaysStation 3 were both 6 years old. New motion-controlled gaming systems like Microsoft’s Kinect and Sony’s Move let players control in-game avatars by moving their arms and legs. They have helped sustain consumer interest, but not helped turnaround the console maker fortunes as anticipated.

Experts wonder if a new hardware cycle is really a solution. Some suggest console makers should act more like nontraditional platforms. In 2013, a new entrant launched a console Ouya with free-to-play games and a $99 launch price, and a focus on TV gaming. Some console game developers are using the “free to play” business model to give away their games for free, and then charge players later $5 to $10 for various status upgrades or gameplay perks. This threat of cut-price rivalry is forcing lot of other console gamers to offer deals, as the customers make fewer full-price game purchases than before.

In the interim, firms in social and mobile sectors have introduced novel gameplay with cheap, 99 cents, bite-size games such as “Angry Birds” and “Plants vs. Zombies” for iphones and ipads. This has exploded social and mobile based gaming, as well as the overall demand for gaming as a whole group of new players have started playing games. This new group is attracted to games for the social aspect, and is not interested in game consoles. To tap the new trends, $5-$20 on sale games have been introduced for PCs as well, breathing new life into PC gaming.

Customers, the console owners, have increasingly taken to playing games on multiple platforms. They are looking for a wider spread of experiences, such as the quick, bite sized gaming sessions in-between breaks or errands. It is faster to tap an icon on the smartphone, than to go to the living room, wait for the console to power on, load the game from the main menu, and wait for it to boot.

The big console makers have strived to capture a share of the social gaming pie, by retreading their older console games as cut-down smaller versions for the web, such as at XBLA (Xbox Live Arcade) and PSN (PlayStation Network). However, consumers have dismissed these as a sign of creative stagnation of the console makers in game design. Critics contend that console games need to deliver more meaningful experiences. Ubisoft's Hutchinson observes, “"We need to offer more experiences that are understandable to people's real lives, either in terms of mechanics or narrative, and attract people who don't read fantasy novels or watch the SyFy channel. Our mechanics are often not the barrier, but our content sometimes is."

As the overall game industry continues to grow in size, the survival of traditional console makers will depend on how they adapt to evolving business models and changing consumer tastes.

Adapted from Snow (2012)

As illustrated by the case of the video-gaming console industry, changes initiated by other participants in the industry have a significant impact on the strategic advantage of the firms. In this chapter we discuss two major approaches for the analysis of industry linkages:

· Structural approach. This approach emphasizes how firms identify and defend spaces over which they have control on.

· Process approach. This approach emphasizes the possibilities of cooperative as well as competitive relationships, and of national and global-level networks and support systems.

Structural Approach - Porter’s Five Forces Framework

Porter’s Five Forces framework helps to analyze the structural attractiveness of an industry, in order to assess the profit potential of the firms within a value system. For instance, the profit potential of mobile network operators is influenced by their position relative to the content and service providers (“the suppliers”), and to the mobile users (“the buyers”). Presence of substitutes such as the desktops, laptops, tablets, and landlines, is also an influencing factor. Possibility of new rival entry for taking away a share of the market also influences the profit potential. Finally, one must consider the intensity of rivalry among different mobile network operators, such as whether the different rivals focus on very different target markets or strive to make inroads on one another’s target market at all costs. Exhibits 5.1 portrays these five forces in the framework – bargaining power of suppliers, bargaining power of buyers, potential threat from substitute providers, potential threat of entry from new firms, and intensity of rivalry among firms in the industry.

Exhibit 5.1: Porter’s Five Forces model

The Five Forces framework pinpoints structural factors that hinder the profit potential for any intermediate stage in the value system. It posits that the firms need to restructure or reconfigure the processes in the value system, so that they are able to move into a structurally more attractive position. For instance,

· They may need to cultivate new suppliers, strengthen the commitment of current suppliers, or find ways to reduce their dependency on major suppliers.

· They may also need to cultivate new buyers, strengthen the loyalty of current buyers, or find ways to reduce their dependency on major buyers.

· They may further need product or service innovations, or develop complements, to offer the benefits more attractive than those offered by the substitutes, and at more competitive costs.

· They may additionally need to make sure that the new entrants are playing fairly, such as not illegally imitating their knowledge, not using deceptive tactics, and not using unfair subsidies from their governments to undercut.

· To preempt new entrants, they also need to continue investing in their dynamic capabilities, to remain sufficiently differentiated and cost-effective in their offerings to the customers.

The thrust of the Five Forces framework is on the industry level analysis, and interventions that enable a firm to restructure its position within an existing industry structure, or by favorably changing this industry structure. It is based on an assumption that the overall profit potential of any industry is constant, as determined by the cost structure across the value system and the final value accrued by the customers. The firms participating in the value system leading up to the final demand must find ways to capture a larger share of this industry’s profit pie. In other words, the objective of the Five Forces analysis is to improve value capture, as opposed to improving value creation.

The five forces analysis assumes that the structure of the industry influences the conduct or behavior of the participants. To improve their performance, firms must create or discover new positions where the behavior of the participants in their value system is more favorable. In other words, the analysis assumes that it is not possible to change participant behavior directly; the firms must strive to reposition themselves or change the industry structure in order to bring about a change in participant behavior. This assumption is core to the industrial organizational (I/O) theory, according to which market structure shapes participant conduct, which in turn shapes participant performance. This is referred to as the Structure-Conduct-Performance paradigm.

The Five forces framework has the following three major limitations:

· Five forces analysis does not consider the independent effects of macro factors such as politics and new technologies, that may enable a firm to drive a fundamental restructuring of the entire value system and of its industry structure

· Five forces analysis does not consider the independent effects of micro behavioral factors such as cognitions, emotions, and social relations, on the profit potential of an industry, irrespective of its structure. Thus, the role of knowledge (a cognitive factor) in the profit potential of an industry is overlooked. Similarly, the framework fails to consider the interactive effects of high trust, collaborative, and relationship-based culture. Information and communication technologies in the new economy require considerable cooperation among participants; a focus exclusively on a firm’s own positions may hurt its ability to participate in network exchanges and to be a resourceful solutions shop.

· Five forces analysis does not consider the interactive effects of macro and micro factors, such as how participant knowledge (cognitions) may improve through interactions with new technologies, thereby allowing a firm to accrue more value.

The Five forces framework does allow firms to also evaluate how macro shifts have or might generate shifts in industry structure, and in the positions of various participants. It is also possible to evaluate the effects of changes in the participant knowledge, capabilities, and core competencies on their respective positions, and on the overall structure of the industry.

Structural Analysis using Five forces framework

Threat of Entry of New Firms. Any industry that is perceived as being highly profitable tends to attract new firms. These new firms desire to capture a share of the industry profits potential and grow by investing in production capacity and gaining market share. If the prospects for their success are good, then the existing firms will face an erosion of their own revenues, market share, and profitability. The prospects for the success of new firms depend on two factors: the entry barriers to an industry and the expected retaliation from existing firms. The concept of entry barriers implies that substantial costs, time and investment are required to enter an industry. The higher the entry barriers, the less likely are the new firms to enter the industry. Entry barriers depend on two sub-factors: ease of building supply, and ease of building demand.

a) Ease of building supply implies how easily new firms can build their primary activities, and depends on three factors:

· Access to difficult-to-trade resources, capabilities, and core competencies. These may include new technology, scarce raw materials (e.g. diamond, crude oil), or assets (e.g. content that could be used to offer mobile services). For example, Gillette faced lower costs of entry into disposal lighters than many other firms, because of its well-developed distribution channels for razors and blades. Sometimes, requisite resources and capabilities may not be accessible at the time of entry, but need learning and experience to be accumulated. If experience can accumulate more rapidly for the later entrants, than for the existing pioneer firms, then the later entrants may have an entry advantage. They may observe the best of the pioneer processes, invest in latest technology, or adopt new methods, without being encumbered by the old ways and inertia that may beset the existing firms.

· Reachable capital requirements. It is easier to build supply if the capital requirements are modest or within the reach of a new firm. Capital may be in form of funds for investment, or in other forms, such as the information technology infrastructure or the distribution channels. Business models may influence capital requirements, for instance, a new firm may be able to lease the IT infrastructure and outsource the distribution channels, instead of building them. Another factor to consider is Minimum Efficient Scale (MES), or the minimum scale of operation for being cost-effective. If the minimum efficient scale is relatively small compared to total market size (e.g. software applications), it is easier for the new firms to enter. But if it is large, then the industry structures tend to be more concentrated and it is more difficult for the new firms to build supply. For instance, Kanoria (2007) estimated that in the US airline industry, using the US Bureau of Transportation data from 1990 to 2005, MES was only eight aircrafts. Airlines achieved little cost savings by operating with greater number of aircrafts, as any savings were balanced by the higher costs of operational coordination. The low capital requirements for cost-effective operations attracted more than 100 airlines to the US skies. A final factor to consider is the economies of scale. Economies of scale exist when average total cost declines as output in a period increases, such as because of the possibility of specialized investments in machinery and human capital at higher volumes. For instance, in ball bearing manufacturing, production of less than 100 rings is done by hand on general purpose lathes at fairly high average costs. For 100 – 1 million rings, investments in a specialized screw machine allow moderate average costs. For more than 1 million rings, an even more specialized high speed, continuous process machine allows even lower average costs. Moreover, the average costs decline as the specialized machinery is operated at a scale close to full capacity.

· Favorable regulatory policies, such as liberal, transparent, and easy licensing, tax breaks, and other support enable new firms to build new supply more effectively.

b) Ease of building demand implies how easily new firms may capture a share of the market, and also depends on three factors:

· Penetrability of the customer relationships of existing firms, which is based on their reputation and brand loyalty, and knowledge of the customers about the firm’s products and their perceived distinctiveness. If the existing firms have strong reputation, brand loyalty, and other forms of product differentiation, and have invested in training their customers about their specialized products, and how they are distinctive, then it will be difficult for the new firms to win over these customers.

· Insufficient switching costs from the existing products or services to ones offered by the new firms. Switching costs tend to be high when the firms operate as network exchanges, where the value accrued by a customer is a function of the size of the network – also referred to as the installed base. For instance, if all the friends of a customer are on facebook, then the customer may not perceive as much value from switching over to an alternative social media application where s/he has no friends currently. Switching costs also tend to be high when the firms operate as solutions shops, where the value accrued by a customer is a function of a set of complementary products and services offered by the firm as a single solution. For instance, if a customer has bought and gained expertise in Macromedia’s Flash suite on a regular desktop, then this customer may not be willing to switch over to Apple’s Macintosh since Apple’s products are not compatible with Flash.

· Rapid market renewal, generating shifts in customer preferences and segments. An important factor influencing the pace of market renewal is product lifecycle. Product lifecycle is the evolution of a product through sequential stages of introduction, growth, maturity, and disruption. In fashion and technology-driven industries, product lifecycles tend to be very fast, resulting in rapid change in customer preferences and segments. New fashions and technologies disrupt the previous ones, opening a window of opportunity for the new firms who offer fresh fashions and disruptive technologies in their products and services. For instance, with rapid growth in downloadable music since mid-2000s, the sales of audiocassettes have disappeared, while that of the pre-recorded CDs has fallen sharply. Older fashions and technologies may still be attractive for alternative market segments, such as those including less affluent groups; thus opening a window of opportunity for the new firms who are better connected with these alternative segments.

Besides the entry barriers, potential threat to entry of new firms is also a function of how vigorously existing firms are expected to retaliate against entry. The retaliation is likely to be strong if the existing firms:

· enjoy substantial resources and historical experience to fight back, including excess cash and unused borrowing capacity, adequate excess productive capacity to meet all likely future needs, or great leverage with distribution channels or customers;

· experience high exit barriers, which may include great commitment to industry, or highly specialized and illiquid assets that have limited alternative use.

· face slow industry growth, which limits the ability of the industry to absorb a new firm without depressing the sales and the financial performance of existing firms.

Despite the formidable barriers of entry and retaliation from existing firms, new firms are still able to enter most industries based on technology, product, or process innovations. The profit potential of the industries where new firms must bring substantial innovations to succeed is higher than of the industries where new firms may enter with limited or no innovations. Learning and experience factor, and resources, capabilities, and core competencies, do offer some protection to the existing firms; however, the same may also trap the existing firms into older paradigms. Instead of expending their resources in just retaliating against new firms, existing firms may also consider collaborating with or possibly acquiring the new firms, especially if they are genuinely innovative.

Threat of substitute providers. Substitutes limit the potential profits of an industry by placing a ceiling on the prices firms in the industry can charge. The more attractive the price-performance alternative offered by substitutes, the firmer the ceiling. Laptop manufacturers confronted with the large scale penetration of other portable devices such as tablets and smartphones are learning this lesson today, as have postal service firms that faced extreme competition from alternative, low-cost mail transmission substitutes such as the email. Substitutes limit profits in normal times, and the bonanza an industry can reap in boom times. High oil costs and extreme weather conditions are generating a huge demand for the solar-based device firms. However, the industry’s ability to raise prices is moderated by several energy substitutes, such as nuclear power, natural gas, energy insulation products, and energy conservation efforts.

To identify substitutes, firms need to search for other products that can perform the same function or fulfill the same need as the products of the industry. For instance, when the equity markets are performing poorly, equity brokers may find substitutes in the offerings of the real estate brokers, insurance brokers, foreign exchange brokers, commodity brokers, and private equity funds. The firms should be particularly attentive to those substitute products that (a) show a trend of improving their price-performance ratio, and/or (b) generate high profits, that may become the basis for the substitute providers to drive cost and price reduction or performance improvement and differentiation. For instance, electronic alarm systems are a strong substitute for the security guard industry. Their price-performance ratio has continuously improved, as labor-intensive guard services face cost escalation and more cost-effective and better performing electronic systems have been launched. The successful security guard firms are those who offered packages of guards and electronic systems, rather than to try to outcompete electronic systems. On the other hand, candles are a poor substitute for lightbulbs, even though both are lighting solutions. Candles offer limited light, and pose a higher risk of starting a fire.

The position of the firms relative to the substitute providers is generally a matter of collective action by the industry participants. Product quality improvement, product availability, and product differentiation and advertising by a single firm may not be sufficient to improve the industry’s position against a substitute. However, heavy and sustained efforts by all participating firms can improve the industry’s collection position. For instance, jute manufacturer association in India invest significant amount to promote jute as an ecologically-friendly packaging material, thereby bolstering jute against the substitutes such as plastic.

The executives must decide the dividing line between the firms who provide a substitute vs. the competitors. For instance, Subway competes with Panera Bread in the sandwich business, but full service restaurants such as at Hilton’s hotel will be a competitor if industry is conceived as the restaurant industry and a substitute otherwise. Of course, takeaway sandwich offered at a grocery store is likely to be considered a substitute, not a competitor.

Bargaining Power of Buyers . Powerful buyers bargain for higher quality or more services, lower prices, and play competitors against each other – thus putting pressure on industry profitability. An industry may serve several buyer groups, whose forcefulness to bargain depends on three factors:

a) Its need for superior terms of purchase, such as because of the low profitability of its industry, or because its purchases from our industry constitute a significant portion of its costs. For instance, auto firms in many nations pressure their suppliers to offer superior terms of purchase, because of the low profitability of the auto industry and high share of auto parts in the automaker costs. Conversely, buyer groups that are more profitable and that expend only a small share of their budget on the industry’s products are less sensitive to cost, are more considerate of the viability of their vendors, and are less likely to pressurize for better terms.

b) Its leverage over our industry, such as because of its knowledge about our industry, or its power to negotiate, and integrate backward into our industry. When a buyer group is knowledgeable about our industry’s demand patterns, cost structure, and price discrimination, then it is in a better position to secure the best terms and counter claims that the existing terms are the best possible ones. It can do so in two ways. First, if a buyer group is concentrated, and its purchases constitute a large share of our industry’s sales, then it will have greater power to negotiate with us. This is particularly so when our industry’s fixed costs are high, so that large volumes are critical to fill the capacity and secure economies of scale. For instance, consolidation of the department stores and retail chains has increased the power of these buyer groups, and put downward pressure on the margins of the ready-to-wear manufacturing industry that has a need to recover the high fixed costs of new fashion designs. Second, buyer group could use its knowledge to integrate backward into our industry, and to be credible, engage in partial self-production, referred to as tapered integration. For instance, General Motors and Ford are known for producing some of their needs for a given specialized component in-house, and purchasing the rest from outside suppliers.

c) Its ease of substitution, such as because the products offered by our industry are undifferentiated and standard, or because they do not involve much switching costs. When an industry’s products are undifferentiated and standard, buyer groups can easily play one firm against the other. Similarly, when an industry’s products do not lock-in the customers, buyer groups are more willing to go for the substitutes that offer marginally superior price-performance ratio. For instance, the older buyer groups who have devoted considerable time in learning about Microsoft operating system are less likely to switch over to Android and other alternatives, as compared to the younger buyer groups who are deciding which operating system to learn. Similarly, the older buyer groups that already have a game console are more likely to use these game consoles for smart applications such as navigating the internet and watching movies, than the newer buyer groups who may consider gaming as well as other functions on their smart televisions or smart tablets, or other devices.

The firms may improve their strategic position through their buyer group selection decisions. All industries typically have multiple buyer segments, each with different forcefulness to negotiate. For instance, replacement or aftermarket parts market is often less price-performance sensitive than the original equipment manufacturer (OEM) market.

Bargaining Power of Suppliers . Powerful suppliers bargain for higher prices or threaten reduced volumes and/or quality of purchased products – thus putting pressure on our industry’s profitability. An industry may deal with several supplier groups, whose forcefulness to bargain on factors that mirror those of buyer groups.

a) Its need for superior terms of sale, such as because of the low profitability of its industry, or because our industry’s purchases are not of great importance to it – such as because they constitute only a small portion of its overall revenues.

b) Its leverage over our industry, such as because of its knowledge about our industry, or its power to negotiate, and integrate forward into our industry. When a supplier group is knowledgeable about our industry’s sourcing patterns, cost structure, and demand conditions, it is in a better position to secure the best terms. It can do so in two ways. First, if a supplier group is concentrated, and its products are critical to our industry’s success, then it will have greater power to negotiate with us. Second, the supplier group could use its knowledge to integrate forward into our industry, and to be credible, engage in R&D for value-added processing.

c) Its difficulty of substitution, such as because the products it offers are proprietary and differentiated, or because they involve significant switching costs.

Note that the concept of suppliers includes not only the other firms providing intermediate inputs, equipment, and services, but also the labor. Scarce, highly skilled employees are difficult to substitute; they may have significant knowledge about our industry, as well as an ability to become potential new entrants. When the economy is in boom, or when the cost of living is increasing, labor may feel particular need for improved employment terms. Its leverage may be high if the firm is unable to find ways to expand its skilled labor pool. In order to improve its leverage, labor may take collective action, such as by forming unions.

Intensity of Rivalry among Competitors . Rivalry among competitors means jockeying for position, using tactics that include price competition (e.g. price wars, discount wars, or free gift wars) and non-price competition (e.g. advertising wars, product line wars, or warranty wars). When one firm takes an action to improve its position, other firms tend to notice effects on their own position and react with a countermove. Price reductions are easily and quickly matched by competitors, and result in a reduction in the revenues of the entire industry, unless the price elasticity of demand is sufficiently high. Non-price differentiators are more likely to help grow the industry demand, and have more asymmetric effect on participating firms, depending on their capabilities such as for advertising, introducing new product lines, and high accuracy to keep the warranty costs low. Intensity of rivalry among firms depends on the following three factors:

a) Presence of numerous, equally balanced, or diverse competitors. Intensity of rivalry is usually inversely correlated with the industry concentration ratio. Four-firm concentration ratio measures the share of the market for the top four firms, and is interpreted low and highly competitive if less than 50%, moderate if between 50 and 80%, and high if more than 80%. In the US, breakfast cereals, circus, and automotive manufacturing are highly concentrated. Flight training, sugar manufacturing, and fiber optic cables are moderately concentrated. Daily newspapers, truck driving schools, full-service restaurants, and legal services are less concentrated.

When there are numerous competitors, some may believe they could reduce prices and gain market share without being noticed by their rivals. This will keep the intensity of rivalry high. Even when there are only a few competitors, but they are equally balanced in their resources, capabilities and core competencies, they are likely to retaliate vigorously to any unilateral moves by their competitors in order to defend their share of the market. However, if these competitors are imbalanced, then the leader firm tends to act in a more disciplined manner and the non-dominant firms are also encouraged not to take any adverse actions.

Finally, if the competitors are very diverse in terms of their goals, historical or cultural origins, strategies, and tactics, they may not play by the same set of rules and perceive rivalry to be overwhelming. An example is the rivalry between Samsung – a Korean firm, and Apple – an American firm. Samsung pursued a strategy of offering a large variety of its smartphones at a range of prices, to be affordable to the emerging market customers, where it has gained a leadership position. In contrast, Apple strategy was to offer a limited variety of its smartphones at only a higher price range, to ensure a sense of pride and exclusivity for its customers. While it has maintained a leadership in the industrial markets, it had to give up leadership in terms of volumes to Samsung.

b) Disruptive growth of the industry. When an industry is growing slowly, or is in a mature or disruptive phase, firms are more likely to fight to keep their share of the market. In such markets, products of an industry tend to become like commodities, with low levels of differentiation. Therefore, they are prone to intense price competition, with little scope for any meaningful non-price differentiation. Pressures on the firms to engage in such competition tend to be higher when their fixed costs are high and they have excess capacity, so that they need to maintain and expand their share of the market to have a competitive cost structure. Pressures are also high when the firms have low value-added (price – cost of intermediate inputs), as then they need large volumes to recover their fixed costs. Finally, pressures are high when the storage costs of the products are high, as in the case of perishable products, so that the firms are motivated to try to dispose their products quickly and at whatever value they may be able to realize.

c) High exit barriers. Exit barriers are the factors that make firms reluctant to exit from the industry, because of their emotional commitments, cognitive stakes, economic costs, or regulatory sanctions. Executives may have emotional pride in an industry associated with their family and community. Or, they may have high cognitive stakes, such as when a diversified firm may not wish to exit a loss-incurring smartphone business because of the potential negative impact on its mobile software business, and a foreign firm like Samsung may not wish to exit the US smartphone market because it may consider it as a loss leader gateway for introducing other product lines in the US in future. Or, they may have to bear the economic costs to lay off labor, and their assets may have limited salvage value if sold. Or, the government may seek to discourage their exit because of the perceived effects on the local region or job losses, and may try to bail them out. All these factors contribute to firms retaining inefficient operations, and competing vigorously with the more efficient firms, thus intensifying the rivalry.

Firms may improve their position in competitive rivalry by focusing their efforts on the fastest growing segments of the industry, or on market areas where they have an asymmetric advantage in terms of resources and capabilities and being able to differentiate. They may also try to avoid confronting competitors with high exit barriers, so that they mitigate the threats of price warfare.

Exhibit 5.2 Facebook through the lens of Porter’s Five Forces

Threat Of New Entrants: Moderate (3/5)

a) Ease of building supply: It is relatively easy to build new social networking sites and applications.

b) Ease of building demand: Significant amount of resources are required for marketing and for gaining brand recognition, and this raises the barriers to entry to an extent. However, Facebook’s usage is increasingly shifting to mobile platform -mobile daily active users comprised for more than 80% of overall Facebook’s daily active users in 2014. The rising popularity of new mobile apps (in areas including social sharing, messaging, micro-blogging) with the advent of smart phones could make it easier for the new entrants to build demand using innovative targeted apps.

c) Retaliation from existing firms: The introduction of innovative and niche social networking sites could potentially be a threat to Facebook. Concerns related to falling teen engagement on FB had led to a drop in its stock price in 2013.

Threat Of Substitute Products: Moderately high (4/5)

a) Availability of quality, cost-effective substitutes: A large number of social networks facilitate sharing of information, as a substitute for Facebook. A number of social networks cater to specific interests such as cooking and gaming, and hence any increase in their popularity could impact engagement levels on FB-owned properties. Moreover, new and innovative mobile applications could potentially impact user growth on Facebook.

Bargaining Power Of Customers: Moderately high (4/5)

a) Need for superior terms of purchase: As the economy is expected to improve, the profitability of the marketers is expected to improve. Therefore, they are likely to be more inclined to persist and expand their ad budget on social networking sites, including on Facebook.

b) Leverage: Given the large-scale competition from alternative platforms, the bargaining power of users is high. Ensuring good user experience is the key to attract and retain customers on social networking platforms. The wide-spread popularity of Facebook, along with its ad-targeting capabilities, makes it an attractive platform for both small and large marketers, raising FB’s bargaining leverage with advertisers.

c) Substitution: The switching costs for users are low, making it easy for them to migrate to other platforms. This also places a higher limit on the ad load (the percentage of posts that are ads) on the FB platform; it is unlikely to be able to go beyond the existing ad load of 5 to 10% without compromising on user experience. Since customers can choose from a wide array of messaging and other apps, this restricts the fees Facebook could charge for Whatsapp – its messaging platform. Similarly, if Facebook starts increasing ad pricing significantly, marketers could migrate towards other social networking platforms. This limits Facebook’s ability to dramatically raise ad pricing on the platform.

Bargaining Power Of Suppliers: Moderately low (2/5)

a) Need for superior terms: Social networking firms are important and major customers for the suppliers including providers of servers, storage, power, software, data center and office equipment, and technology.

b) Leverage: Supplier leverage is moderate, as Facebook is a large scale customer holding significant buying power.

c) Substitution: There are only a few reputed suppliers for a large range of hardware and software supplies, and hence this raises their bargaining power to an extent.

Competitive Rivalry Within The Industry: Moderately high (4/5)

a) Presence of major competitors: Competition from other full featured platforms Google+ and Twitter can cause a reduction in the average time spent by active users on the FB platform, as these platforms offer unique sets of features. A number of social networks are emerging to target a niche user base. For example, Snapchat appeals to a younger audience and is more popular among females. As this trend is expected to persist, Facebook could see competition intensifying within different user demographics.

b) Disruptive growth of the industry: Social networking space is prone to innovation, swift change and the introduction of new technologies. If Facebook fails to keep up, its massive user base could potentially migrate to other social media networks. One of the major changes is replacement of desktop usage with mobile usage. The mobile platform is inherently different, with apps targeted towards a specific functionality rather than a broad range of features. Currently FB provides a range of services including photo-sharing and messaging. Newer innovative apps could emerge and gain widespread popularity providing one of these discrete services. That could lead to lower engagement on FB platforms, and in Facebook buying out upcoming competitors at steep valuations.

c) Exit barriers: Several regional social networks, such as Renren in China, Mixi in Japan, and vKontakte in Russia compete with FB for users in their respective geographies. Increased regulation in certain markets such as China may support regional players.

Overall, the structure of the social networking industry is moderately competitive (total of 17/25, i.e. 3.4/5).

Source: Adapted from Forbes (2014)

Strategizing based on Structural Analysis

Structural analysis of five forces helps to diagnose the causative factors influencing the profitability of an industry. It reveals the threats and the opportunities for improving a firm’s position. It also reveals strengths and weaknesses of a firm relative to other firms in the industry. Based on the structural analysis, a firm is able to craft a competitive strategy to create a defendable position against the five forces, using three possible approaches:

a) Better competitive positioning. A firm may assume the structure of the industry as given, and seek to find and move into positions or segments in the industry where the five competitive forces are the weakest. These may include faster growing segments of the industry, targeting buyer groups and mobilizing supplier groups less prone to bargain, addressing needs not so vulnerable to substitutes, and leveraging experiences for reconfiguring capabilities to avoid being jeopardized by potential new firms.

b) Influencing the balance of forces. A firm may consider what aspects of the five competitive forces are under its control, and strive to actively shift the forces by managing those aspects. It may, for instance, improve its product differentiation, and knowledge of the customer and supplier industries; it may integrate backward or forward to reduce its vulnerability; or it may make new capital investments to preempt the entry of new firms.

c) Exploiting evolution and disruptions in industry structure. Just like product life cycle, industries also experience the familiar S-curve life cycle. The cycle moves the industry from an emerging stage, to growth stage, to maturity, and then to decline and disruption. Industry evolution and disruption motivates changes in the structure of competitive forces as well. For instance, during the emerging and growth phase, firms tend to focus on specialized and narrow set of activities, to maintain their agility and growth. But in the maturity phase, they tend to integrate vertically, backward as well as forward, in order to maintain fuller control over their operations, and to gain new avenues for growth. That raises the capital requirements, and increases the barriers to entry. In the disruption phase, extensive vertical integration may become a liability, and inhibit the ability of the firms to exit from the older paradigms and to reconfigure their assets around new technologies and markets. Predicting the likely shifts in the structure of competitive forces through the different phases of industry evolution can help firms stay ahead.

Competitive Positioning using Strategic Groups Analysis

An important goal of the structural analysis is to improve the competitive positioning of a firm in the larger value system of the industry. In most industries, there exist multiple possibilities of competitive positioning, also referred to strategic posture. Different groups of firms tend to adopt different strategic postures, each characterized by a different cluster of competitive strategies and tactics, targeting different buyer groups, mobilizing different supplier groups, addressing different set of needs relative to substitutes, and investing in different process configurations. A group of firms that exhibit similar strategic behavior, but whose behavior is dissimilar from other firms, is referred to as a Strategic Group. The firms within a strategic group perceive each other as their most direct competitors. Strategic group hypothesis asserts that within an industry, firms with similar process configurations will pursue similar competitive strategies with similar performance results. The Strategic Group concept has been found to explain performance differences within an industry in various studies.