• Session 2

• External drivers of competitive advantage – Industry analysis

• Case: Zoom wars

Photographs: Anand Nandkumar

Successful strategy – external and internal fit

• External fit
• Alignment with external environment
• Strategy consistent with opportunities and threats

• Internal fit
• Alignment within firm activities
• Strategy consistent with strengths and weaknesses
Quiz 1
https://forms.office.com/r/CZuHw74emT
General external environment
Technological
Change
Demographic
Specific Smart Trends
international events phones &
apps
Pandemic Young population

Focal
Firm
Changing Policy toward Oil
Exploration on Public Lands Changing Image of SUVs
Low or
rising
Legal/Political interest Cultural
Conditions rates Trends
Economic
Climate

Source: Strategic Management & Competitive Advantage, Barney & Hesterly, 2012
Making sense of the
local environment
• Constant scanning of general environment is
costly, leads to information overload

• Distinguish between vital and important

• For revenues: need customers
• For creating value: need goods/services
from suppliers
• For profitability: competitors actions

Source: Robert Grant (2010), Contemporary Strategy Analysis

 How weather, disease, and Mexican criminals affect the
price of margaritas on the NYC bar menu

Source: “Is Lime an Endangered Species?”, New York Times, 29 March 2014
Lime…
The market for lime
• A few reasons might turn guacamole, lime pie and margaritas into rare delicacies well at least in
America!
• In 2014, unprecedented shortage of limes sent wholesale prices from around $25 for a 40-pound
carton in early February to more than $100 today
• Reason: Immigration from tropical countries and the growing taste for their foods – consumption
has increased from ½ a pound per person of limes a year to over 2½ pounds (Demand)
• Competition from Mexico, hurricane devastation in 1992 and canker disease in 2002-06 wiped
out the Florida groves.
• Since 2009 huanglongbing disease, has spread across many of Mexico’s lime-growing districts.
• Criminals linked to drug gangs are plundering fruit from groves and hijacking trucks being used
for export
• “Many growers don’t go to their fields because they’re afraid”
• This has further lowered the quality
Lime prices in May, 2014
Lime prices in the United States

https://fortunedotcom.files.wordpress.com/2014/05/sap-lumira-lime-price-predictive-graph.jpeg
How does the recent fall in oil prices impact the green power
industry?

Source: www.nasdaq.com
Fortunes of green energy companies rely on oil
• “Since by and large, producing clean energy is more expensive than oil,
the lower the price of oil, the less economically viable clean energy
becomes as an alternative” (Boris Valentinov, an investment analyst at
FactSet)
• In 2015, through Nov. 30, some in the group were trading 15% to 22%
lower.
What about electric
vehicles?

Source: US Electric Car Market, Gas2.org

Five forces analysis
Threat of substitutes

Bargaining power of Rivalry among Bargaining power of

suppliers existing Buyers
competitors

Threat of New Entrants

Higher Threat /
Bargaining power Lower Average Profits
Do you want to be in the
Indian airline business?
Airline industry
• Bargaining Power of Customers: HIGH
• Many competing airlines → customers can always find an alternative carrier.
• Implies high elasticity of demand and implies p(q) is low (residual demand curve is to the very left)

• Bargaining Power of Suppliers: HIGH

• Airports (with their high landing fees) are monopolies.
• Aircraft providers (Boeing & Airbus) are a duopoly.
• Fuel prices are determined by global oil markets, so airlines are price takers.
• Even employees tend to be unionized,
• c(q) is very high
Airline industry
• Threat of Substitute Products: MEDIUM.
• If you're travelling from London to Hong Kong, you don't have many alternatives to flying.
• But from London to Paris, you can drive or take the train.
• Is skype a substitute product to air travel?
• Either way, air travel is rarely an absolute necessity.
• Moderately high elasticity of demand and implies price competition p(q) is low
• Threat of New Entrants: MEDIUM to LOW.
• Like computer software, college kids can't just start up a new airline in their garage due to the
regulatory and capital requirement barriers to entry.
• But, it's not the hardest thing in the world to lease two aircrafts and start up by operating out of
small, regional airports.
• Moderate F.
 Airline industry (2)
• Competitive Intensity among Incumbents: HIGH.
• Cutthroat price competition
• Services are hard to differentiate (basically, you're just moving people, everything else is
peripheral)
• Multiple carriers service the same routes
• Implies a low p(q) and q
• Put these together in aggregate, and you see why margins are so low.
• High c(q).
• Low p(q) and q as well due to competition
• Moderate F
• These imply that margins are low

http://www.economist.com/blogs/economist-explains/2014/02/economist-explains-5
Airline industry revisited

Threat of substitutes MEDIUM

HIGH
Bargaining power of Rivalry among Bargaining power of
suppliers HIGH existing Buyers HIGH
competitors

Threat of New Entrants MEDIUM

Higher Threat / Lower Average Profits

Bargaining power
Threats and competition

High threats Low threats

Perfect Monopolistic Oligopoly Monopoly

competition competition
# firms Large Large Small One
Products Same Different Same One
Entry & exit Low cost Low cost Costly Costly
Examples Stock market Toothpaste Cereal (US) MRT
Performance Parity Advantage Advantage Advantage

Source: Barney & Hesterly (2011). Strategic Management and Competitive Advantage
Bottled water industry analysis
• What are some of the characteristics of the bottled water industry?

• How attractive is this industry?

Carbonated soft drinks industry
Industry analysis
• Carbonated Soft Drinks (CSDs) – one of the most profitable businesses in
the history of the industrial world
• How can companies that sell sugar water – which some “experts” cannot
even identify accurately – be so profitable for so long?
• Average ROE was close to 50% in the 1990s
• Even in the last decade, in the mid- to high- 30s
Threat of new entrants – LOW

• First mover advantage – brand equity

• Coke and Pepsi as part of American/world “culture”
• Marketing investment high
• On average, Coca-Cola has spent $4 billion in advertising over the last six years.
• In 2018, the company spent $4.11 billion on advertising
• Limited shelf space, vending slots, fountains
• Very expensive to buy shelf space
• Franchise system
• bottling is expensive ($4-10 million each), bottlers have exclusive agreements with
Coke and Pepsi
• Bottler consolidation
• New entrants have to dependent on Coke & Pepsi’s bottling network
• All this implies high F
Threat of substitutes – LOW

• Many (lower cost) substitutes – water, juice, coffee, etc.

• But not always conveniently available

• Coke and Pepsi available within arms reach

• Coke and Pepsi as lifestyle, status choices

• Strong brand loyalty

• Implies p(q) is high dues to inelastic demand (pricing power)

 Bargaining power of suppliers – LOW

• What goes into the concentrate?

• Not sugar (generally added by the bottler)
• Not water (added by bottler)
• Maybe artificial sweeteners
• It’s a secret!
• Caramel coloring, phosphoric/citric acid, natural flavors, caffeine – all
commodities
• How much do you think the ingredients cost? Not much!

• What about can manufacturers and plastic bottles?

• Commodity products, low bargaining power
• Affects bottlers, not CPs
Bargaining power of suppliers is low

• Supplier group is not concentrated

• Most inputs are commodities
• Low switching costs for changing suppliers

• Implies c(q) is low

Bargaining power of buyers – LOW

• High switching costs due to contracts and investment in company-specific

equipment
• Franchise agreements lock into exclusive deals
• Final customer
• Low bargaining power
• Fragmented
• May be price sensitive, but susceptible to advertising
• No switching costs, but substitutes not always available
• Some very loyal consumers
• Implies high p(q) and low elasticity of demand
Rivalry among firms - LOW

• Intensity of rivalry is actually quite weak

• Only 2-3 significant players
• Growing consumption until the mid-2000s
• Firms familiar with each other’s signals

• Basis of competition has not been on price

• Concentrate price been increasing since mid-1980s
• Competition largely focused on shelf space, advertising, selective discounting on
downstream products, etc.
Cola business

• Constrained competition
• High Barriers to Entry
• Locked-in buyers
• Secret ingredients (low cost, hard to imitate)
• Lots of substitutes, but advertising and distribution limit their impact

Overall, a great business, driven by the strategies

of two smart, dominant competitors who know
each other extremely well
Quiz 2
https://forms.office.com/r/C27Sw8agT6
Would you advice Coke and Pepsi
to make the market for bottled
water a top priority?
Are there strategies that companies can adopt to de-commoditize
bottled water? Can such strategies be difficult for rivals to imitate?
Bottled water

Threat of substitutes HIGH

HIGH
Bargaining power of Rivalry among Bargaining power of
suppliers LOW existing Buyers HIGH
competitors

Threat of New Entrants LOW

Higher Threat / Lower Average Profits

Bargaining power
Bottled water industry
Some points to remember
• Analysis is at industry, not firm level

• Analysis is from the point of view of incumbents

• Analysis is sensitive to industry definition

• Forces are not mutually exclusive

• Each ‘force’ is a collection of multiple factors

38
Zoom wars case
Question
• Eric Yuan wants your advice on whether he should cash out now or wait longer. What
would be your advice to him? Give reasons.

• Assume Eric Yuan owns 5% of Zoom.

• Total shares outstanding on 31 Dec 2020 is 234.24M. Price to sales ratio is 51.03 as
on 31st 2020.

• Ten-year payback for a VC is 10 times.

• How did you come to this conclusion? Please be prepared to walk us through the logic
that led you to your conclusions.
Five force analysis – Zoom
Threat of substitutes MEDIUM

HIGH
Bargaining power of Rivalry among Bargaining power of
suppliers LOW existing Buyers MEDIUM
competitors
Potential entrants
• Amazon
• Apple
• Unknown / kid in
Threat of New Entrants MEDIUM garage
First two have substantial
related resources and
capabilities as well as valuable
brands that would allow them
to enter more easily.
Five force analysis – Zoom
Threat of substitutes MEDIUM

HIGH
Bargaining power of Rivalry among Bargaining power of
suppliers LOW existing Buyers MEDIUM
• Internet Providers
competitors
• Operating systems
• Infrastructure as a service (IAAS) such
as Amazon Web Services or Microsoft
Azure
Each category of supplier has limited power
Threat of New Entrants MEDIUM
to charge since there is significant
competition. In addressing short term
spikes, some may have greater power as
capacity may be constrained in the short
term.
Five force analysis – Zoom
Threat of substitutes MEDIUM

HIGH
Bargaining power of Rivalry among Bargaining power of
suppliers LOW existing Buyers LOW
competitors
• Enterprise-user
• Elderly or immuno-compromised
• Personal use
Threat of New Entrants Enterprise users typically have the
most resources and willingness to pay
MEDIUM given the impact on their operations.
Personal users are willing to pay the
least.
Five force analysis – Zoom
• Conference call
• Shared documents Threat of substitutes MEDIUM
• In-person meetings
The pandemic might make WFH
persist. Conf. calls may not have the
benefit of face-to-face collaboration HIGH
Bargaining power of Rivalry among Bargaining power of
suppliers LOW existing Buyers LOW
competitors

Threat of New Entrants

MEDIUM
Thus, rivalry is the only force that requires further consideration
Five force analysis – Zoom
Threat of substitutes MEDIUM

HIGH
Bargaining power of Rivalry among Bargaining power of
suppliers LOW existing Buyers MEDIUM
competitors
• Microsoft Teams
• Cisco Webex
• Google Hangouts
Threat of New Entrants But none are as easy to use as Zoom.
Microsoft Teams and Cisco products
MEDIUM are enterprise specific and Hangouts is
personal use. Most operate with a
freemium model.
Rivalry
• Competitors make
High significant •
Assume Eric Yuan
competition improvements owns 5% of Zoom.
70% • Growth become a tenth•
Total shares
of the past average
growth
outstanding on 31
Dec 2020 is
Zoom 234.24M. Price to
sales ratio is 51.03
30% • Competition does not
Low increase as on 31st 2020.
• Growth remains the • Ten-year payback
competition same for a VC is 10
times.
Financials
Consolidated Statements of Operations Data (in thousands, except share and per share
data)
Last
2020 2019 2018 2017 4Q Avg Max Min

Revenue $622,658 $330,517 $151,478 $60,817

Revenue Growth 88.4% 118.2% 149.1% 125.0% 120.2% 149.1% 88.4%

Cost of revenue(1) 115,396 61,001 30,780 12,472

Gross profit $507,262 $269,516 $120,698 $48,345

Gross Profit % 81.5% 81.5% 79.7% 79.5% 78.4% 80.1% 81.5% 78.4%

Source: Yahoo finance

Rivalry

Low competition High competition

Sales per Terminal value for Sales per Terminal value for
Year Sales share Eric Sales share Eric
2020 622,658 0.003 1,588,712 622,658 0.003 1,588,712
2021 1,400,981 0.006 3,574,602 700,490 0.003 1,787,301
2022 3,152,206 0.013 8,042,854 788,052 0.003 2,010,713
2023 7,092,464 0.030 18,096,421 886,558 0.004 2,262,053
2024 15,958,044 0.068 40,716,948 997,378 0.004 2,544,809
2025 35,905,598 0.153 91,613,133 1,122,050 0.005 2,862,910
2026 80,787,595 0.345 206,129,549 1,262,306 0.005 3,220,774
2027 181,772,089 0.776 463,791,486 1,420,094 0.006 3,623,371
2028 408,987,201 1.746 1,043,530,843 1,597,606 0.007 4,076,292
2029 920,221,202 3.929 2,347,944,398 1,797,307 0.008 4,585,829
2030 2,070,497,705 8.839 5,282,874,894 2,021,970 0.009 5,159,058
Scenarios for Eric
• If Eric invests in a startup today, he will likely make $1,58,87,120
(1,588,712*10)
Expected value High rivalry Low rivalry Expected value Baseline
1 Scenario 1 0.2 0.8 4,227,331,727 15,887,119
2 Scenario 2 0.3 0.7 3,699,560,143 15,887,119
3 Scenario 3 0.4 0.6 3,171,788,560 15,887,119
4 Scenario 4 0.5 0.5 2,644,016,976 15,887,119
5 Scenario 5 0.6 0.4 2,116,245,392 15,887,119
6 Scenario 6 0.7 0.3 1,588,473,809 15,887,119
7 Scenario 7 0.8 0.2 1,060,702,225 15,887,119
8 Scenario 8 0.9 0.1 532,930,641 15,887,119
9 Scenario 9 0.95 0.05 269,044,849 15,887,119
10 Scenario 10 0.99 0.01 57,936,216 15,887,119
11 Scenario 11 1 0 5,159,058 15,887,119
Conclusions
• Clearly the prediction of rivalry matters a lot
• Determines market share among the firms in the industry
• How can Zoom soften rivalry?
• Intense competition can lead to a price war which will erode the price cost
margin and profitability
• If Eric wants to persist, he must explore ways to soften price and non-price
competition
• Price competition heats up when
• Also rivals such as Microsoft could do more with the eco-system
• If rivalry is “high” his net worth will only go up 5-fold!
• May not be worth it because if Eric invests 1.5 M (present value) as a VC he might
make about 10 times!
• Depends on whether Eric believes in “Moon or bust”
What did Eric Yuan do?
Man v. Machine
• Why is Porter's five forces model useful for strategists?

https://chat.openai.com/chat
Summary
• External analysis can help to identify opportunities and threats

• Can be a guide for “where to play” and whether to persist

• Can also help identify the key opportunities or threats in an

industry

• Five forces only tells you the attractiveness of an industry at a

given point in time!
• Static not dynamic
Thank you!