How do we define and analyze our industry?
Discussions of Industry Dynamics and Risk Analysis
Understanding the environment of the industry is most important when planting the seeds of a new business venture. The environment is defined as all elements outside the boundary of an organization including the industry, government, customers, suppliers, the financial community, and other business ventures.
In the late 1970s, Harvard Business School’s Michael Porter introduced his theories on business strategy formulation, and since then he has transformed the theory, practice, and teaching of business strategy throughout the world. The ideas in this section build and extend on his discussions.
Your first step is defining your industry.
The second step is to get a very basic fundamental overview of your industry by looking at key success factors, focusing in particular on the industry’s average profitability. We use three very basic and simple characteristics to describe an industry: dynamic, technologically sophisticated, and hostile:
- A dynamic industry is emerging and growing with no leaders that dictate profits.
- Technologically sophisticated industries have a huge difference in profitability. The products range from highly sophisticated with great profits, to those that are commodities. There are widespread opportunities for growth and innovation for those who plan accordingly.
- Hostile environments provide little room for missteps. There are large, powerful, established firms who control the industry’s profitability.
Other success factors include size and structure of the market, rate of year-over-year growth, profile of key customers, level of innovation, and pace of technological change.
The third step is examining the “product life cycle” of similar products in this industry. Porter states that the dynamics within an industry are often framed by the life cycle stages of its products and services. The industry or segments of an industry in the introductory and “emerging growth stages” can be expected to behave more aggressively in their pursuit of growth, sometimes at the expense of profitability. Industries with “mature” and declining products are predominantly characterized by the pursuit of profitability and the efficiencies required to obtain it.
According to Porter, emerging markets are newly formed or re-formed industries that have been created by technological changes, shifts in relative cost relationships, emergence of new customer needs, or other economic and sociological changes that elevate a new product or service to the level of a potentially viable business opportunity.
Porter found the following to be true for emerging markets:
- the boundaries are not clearly established
- buyers and needs are not well-defined
- there is no base of experience about market behavior
- the range of products are often limited
- distribution systems will have to be developed
- the scope and structure of the market are likely to change during the emerging stage
- forecasting the direction of growth of the market may be difficult
- there is often a tendency to overestimate the speed and magnitude of market growth
Industry Risk Analysis
The only certainty in the uncertain process of new business venturing and developing new products is that the unexpected lies ahead. The simple fact of bringing into existence products and services that currently do not exist implies that much of the information required by potential stakeholders—such as technology, price, quantity, tastes, supplier networks, distributor networks, and business models—are not reliably available.
So uncertainty means that decision-makers do not have sufficient information about environmental factors, which increases the risk of failure. We define risk as the degree of certainty or uncertainty as to the realization of expected future financial returns in a business venture. But because it is important to have an understanding about the risk/reward scenario for each industry. There are certain industry risks uncertainty of the industry and you measure the potential profitability of business activity.
For your industry analysis, start with the apex companies—the ones that are at the top of the food chain in your environment, preferably publicly traded. Your research should include their key success factors, how you can use them for business modeling, and financial analysis.