What is Industry Analysis?

Industry analysis helps businesses assess their competitive landscape, identify key success
factors, and predict changes in the business environment. The goal is to understand what
drives profitability in an industry and how a firm can gain a competitive edge.
Key objectives:
Assess industry and firm performance
Identify factors affecting profitability
Evaluate the impact of market and regulatory changes
Recognize opportunities and threats (SWOT analysis)
1.2 Industry Concentration: Herfindahl-Hirschman Index (HHI)
HHI measures market concentration and competition. It’s calculated as:
HHI=∑(Market Share of Each Firm)2
 Unconcentrated (< 0.15) → Highly competitive (e.g., FMCG sector in India)
 Moderately concentrated (0.15 - 0.25) → Medium competition (e.g., banking)
 Highly concentrated (> 0.25) → Oligopoly/Monopoly (e.g., telecom in some
regions)
Example Calculation:
 Firm A: 40% market share → 0.402=0.160.40^2 = 0.160.402=0.16
 Firm B: 30% → 0.302=0.090.30^2 = 0.090.302=0.09
 Firm C: 20% → 0.202=0.040.20^2 = 0.040.202=0.04
 Firm D: 10% → 0.102=0.010.10^2 = 0.010.102=0.01
HHI=0.16+0.09+0.04+0.01=0.30HHI = 0.16 + 0.09 + 0.04 + 0.01 =
0.30HHI=0.16+0.09+0.04+0.01=0.30
Since HHI = 0.30 (> 0.25), this industry is highly concentrated (oligopoly or monopoly-
like structure).
2. Sustaining Competitive Advantage
Why is sustaining competitive advantage difficult?
Once a firm gains a competitive advantage, it faces imitation, market shifts, and
technological changes that threaten its position. Firms must develop long-term strategies to
maintain their lead.

2.1 Competitive Advantage in Different Market Structures

1) Perfect Competition (No Competitive Advantage)

 In perfect competition, firms are price takers.
  No firm can maintain a competitive edge because products are identical, and entry
is free.
 Example: Agriculture (Wheat, Rice) – One farmer cannot sell at a higher price than
another.

2) Monopolistic Competition (Short-Term Advantage)

 Firms sell differentiated products, creating a temporary advantage.
 Competitors imitate successful features, reducing long-term profit.
 Example: Fast food chains (McDonald's vs. Burger King) – Any product innovation
is quickly copied.

3) Monopoly (Sustained Competitive Advantage Possible)

 Single firm dominates, controlling price and supply.
 Competitive advantage is protected by legal barriers (patents), high capital
requirements, or government regulations.
 Example: Google in Search Engines, IRCTC in Indian Railways.

2.2 Threats to Sustainability

Imitation & Substitution
 Competitors copy business models, technology, or branding strategies.
 Example: Coca-Cola vs. Pepsi – Pepsi imitated Coke’s formula, brand positioning,
and pricing.
Market Power Shifts
 Buyers/Suppliers gain power, reducing the firm’s pricing ability.
 Example: Jio’s telecom entry forced Airtel & Vodafone-Idea to lower prices
drastically.
Regression to the Mean
 High-profit firms face declining returns due to industry competition.
 Example: Tata Nano started strong but faded as market preference shifted to
premium hatchbacks.
Changes in Consumer Preferences & Technology
 Example: Nokia’s failure in the smartphone era – Stuck to Symbian OS while
Android & iOS dominated.

2.3 Resource-Based View (RBV) – A Sustainable Strategy

RBV suggests that long-term competitive advantage comes from unique, inimitable
resources.
Valuable – Contributes to cost efficiency, differentiation, or revenue growth.
Rare – Competitors cannot easily acquire.
Imperfectly Imitable – Difficult to replicate due to historical conditions, patents, or brand
equity.
Non-Substitutable – No alternative resources provide the same benefit.

2.4 Isolating Mechanisms – Protecting Competitive Advantage

Isolating mechanisms are like entry barriers that prevent rivals from eroding an
advantage.
Impediments to Imitation
These factors prevent competitors from copying a firm’s success:
 Legal Barriers – Patents, trademarks (e.g., Pfizer’s patents on medicines)
 Superior Access to Inputs – Securing raw materials (e.g., De Beers in Diamonds)
 Scale Economies – Reducing unit costs via volume (e.g., Tesla’s Gigafactories)
 Causal Ambiguity – Competitors don’t understand what makes a firm successful
(e.g., Google’s Search Algorithm)
 Social Complexity – Strong corporate culture & networks (e.g., Goldman Sachs in
investment banking)
Early-Mover Advantage
First-mover firms gain a head start in market dominance, brand recall, and cost advantages.
Key Early-Mover Advantages:
 Learning Curve – First movers refine processes faster (e.g., Toyota in Lean
Manufacturing).
 Reputation & Buyer Uncertainty – Customers prefer proven brands (e.g., Amazon
in e-commerce).
 Switching Costs – Difficult for users to shift brands (e.g., Microsoft Office vs.
Google Docs).
 Network Effects – More users → Stronger competitive edge (e.g., Facebook,
WhatsApp, LinkedIn).
Counterexample: When First Mover Fails
 Wang Laboratories (Computer Industry) – Created innovative word processors but
failed as Microsoft adapted & dominated PC software
2.5 Can Isolating Mechanisms Protect Firms Long-Term?
No advantage is permanent. The Creative Destruction Theory by Joseph Schumpeter
explains how innovation disrupts firms.
Creative Destruction Process:
Stable Period – Firms with superior products earn profits (e.g., BlackBerry in Business
Phones).
Disruption by New Tech/Entrant – A breakthrough destroys old leaders (e.g., iPhone
killed BlackBerry).
New Period of Stability – The innovator becomes the new leader (e.g., Apple dominating
smartphones).
Disruptive Innovation Examples:
 Digital Cameras → Replaced Film Photography (Kodak’s Decline)
 Netflix’s Streaming → Killed Blockbuster’s DVD Business
 Tesla’s EV Tech → Threatens Traditional Automakers
Takeaway: Even strong brands need to keep innovating to stay ahead.
4. Economies of Scale & Scope
Economies of scale and scope are cost advantages that firms achieve as they expand.
Understanding these concepts helps firms optimize production, lower costs, and gain a
competitive edge.

4.1 Economies of Scale

Definition:
Economies of scale exist when average costs (AC) decrease as production volume
increases.
Key idea:
 As production doubles, cost does not double – it increases at a lower rate, reducing
per-unit costs.
 Example: A cement factory producing 1,000 tons per day has lower costs per ton
than a factory producing only 100 tons per day.
Types of Economies of Scale
Internal Economies of Scale (Happen within the firm)
Technical – Larger firms use better technology and automation (e.g., Tesla’s Gigafactories
reduce EV production costs).
Managerial – Big firms can hire specialists for efficiency (e.g., Reliance Industries has
dedicated teams for different business verticals).
Financial – Large firms get cheaper loans due to lower risk (e.g., Tata Group secures better
interest rates than a startup).
Marketing – Bulk advertising spreads cost (e.g., Coca-Cola’s global marketing reduces per-
unit ad expenses).
Purchasing – Buying raw materials in bulk lowers costs (e.g., Amazon negotiates better
rates with suppliers).
2 External Economies of Scale (Happen outside the firm, within the industry)
Supplier Development – As an industry grows, suppliers lower costs (e.g., IT outsourcing in
India → Cheaper software services).
Infrastructure – Better industry support lowers firm costs (e.g., Pharma hubs like
Hyderabad provide research facilities).
Cluster Effect – Firms benefit from being in the same region (e.g., Silicon Valley for tech
startups).

4.2 Diseconomies of Scale (When bigger is not better)

Coordination Issues – Too many layers of management slow decision-making (e.g.,
Bureaucracy in large government organizations).
Higher Wage Costs – Large firms may face union demands for higher salaries (e.g., Auto
industry strikes affecting Maruti Suzuki).
Supply Chain Complexity – Bigger firms struggle with logistics (e.g., Boeing’s global
supplier issues for aircraft production).
Example:
 Walmart benefits from economies of scale in purchasing, but managing global
inventory creates complexity.
 Kingfisher Airlines grew too fast, faced coordination problems, and collapsed.

4.3 Economies of Scope

Definition:
Economies of scope exist when producing multiple products together is cheaper than
producing them separately.
TC(QX,QY)<TC(QX,0)+TC(0,QY)TC(QX, QY) < TC(QX, 0) + TC(0,
QY)TC(QX,QY)<TC(QX,0)+TC(0,QY)
Key Idea: Sharing resources across products reduces costs.
Example:
 Apple produces iPhones, iPads, MacBooks using shared technology and R&D.
 Tata Group operates steel, automobiles, telecom under the same brand umbrella,
leveraging expertise across industries.
Types of Economies of Scope
Production-Based: Shared facilities reduce costs (e.g., Nestlé produces chocolates & dairy
products in the same plants).
Distribution-Based: Selling multiple products through the same channel saves money (e.g.,
Amazon sells electronics, books, and groceries via the same logistics network).
Brand-Based (Umbrella Branding): A single brand covers multiple products (e.g.,
Samsung makes phones, TVs, refrigerators).
R&D-Based: Research breakthroughs apply to multiple products (e.g., Tesla’s battery tech
benefits both cars & energy storage).
Example:
 Google uses its AI expertise across search engines, YouTube, and Android.
 Unilever markets Dove, Lux, and Lifebuoy using shared supply chains and
advertising.

4.4 Strategic Decisions Based on Scale & Scope

When to focus on Economies of Scale?
If demand is high and stable (e.g., Cement, Steel).
If technology allows mass production (e.g., Cars, Smartphones).
When to focus on Economies of Scope?
If products share resources & distribution (e.g., FMCG brands like ITC).
If brand trust helps launch new products (e.g., Tata launching Tata Neu super app).

5. Make-or-Buy & Vertical Boundaries of the Firm

The vertical boundaries of a firm define which activities it performs in-house (Make) and
which it outsources (Buy). This decision affects cost, control, efficiency, and
competitiveness.

5.1 The Vertical Chain

The vertical chain includes all activities from raw material acquisition to final product
delivery.
Example:
For a smartphone brand like Apple, the vertical chain includes:
 Chip Manufacturing (TSMC & Samsung produce Apple’s processors)
 Assembly (Foxconn assembles iPhones)
 Software Development (Apple does this in-house)
 Retail & Distribution (Apple sells through Apple Stores & partners)
At each stage, Apple must decide whether to integrate or outsource.
5.2 Make-or-Buy Decision
Companies decide whether to perform tasks internally (Make) or outsource (Buy).
Reasons to Make (Vertical Integration)
 Better coordination & control (e.g., Amazon’s own logistics network)
 Protecting proprietary technology (e.g., Apple’s M1 chips instead of Intel)
 Reducing supplier power (e.g., Tesla making its own batteries to reduce reliance on
Panasonic)
Risks of Making:
 High fixed costs (factories, employees)
 Less flexibility in adapting to market changes
 Coordination complexity
Reasons to Buy (Outsourcing)
 Lower costs due to supplier specialization (e.g., Nike outsources shoe production)
 Flexibility in sourcing from multiple suppliers
 Focus on core competencies (e.g., Microsoft focuses on software, not
manufacturing)
Risks of Buying:
 Dependence on external suppliers
 Possible quality & supply chain risks
 Loss of competitive advantage if suppliers gain too much power

5.3 Types of Vertical Integration

Backward Integration – Taking control of suppliers.
Example: Tata Steel acquiring iron ore mines to reduce raw material costs.
Forward Integration – Controlling distribution & retail.
Example: Apple opening Apple Stores instead of relying on third-party retailers.
Full Vertical Integration – Controlling the entire supply chain.
Example: Reliance Industries refining crude oil, producing petrochemicals, and selling
through Reliance Retail.

5.4 Transaction Cost Economics (TCE) – Why Firms Integrate?

Ronald Coase’s Theory (1937): Firms should outsource if the market provides services
cheaper than internal production.
 Oliver Williamson’s TCE Model: Firms integrate when market transactions become
costly due to:
Asset Specificity – Specialized investments that cannot be reused elsewhere.
 Example: Boeing needs customized parts that cannot be used by other companies.
Opportunism – Suppliers may overcharge or reduce quality once a company
becomes dependent.
 Example: Intel vs. Apple – Apple switched to its own M-series chips to avoid
supplier dependence.
Uncertainty & Coordination – Complex tasks may need closer control.
 Example: SpaceX produces rockets in-house due to extreme precision needs.
When should firms integrate?
If suppliers hold too much power
If the firm needs custom, high-quality inputs
If supply chain disruptions impact business
When should firms outsource?
If the supplier is highly efficient
If the firm needs flexibility & lower costs

5.5 Alternatives to Full Integration

Instead of complete Make or Buy, firms use hybrid approaches:
Long-Term Contracts – Firms secure supplies without ownership.
Example: Tata Motors signs long-term contracts with tire manufacturers instead of making
tires.
Joint Ventures – Firms share investments.
Example: Maruti-Suzuki (India-Japan partnership).
Tapered Integration – Partly make, partly buy.
Example: Amazon uses third-party sellers but also sells its own products (Amazon
Basics).
Learning Curve in Detail
What is the Learning Curve?
The learning curve describes how costs decrease as workers and firms gain experience in
production.
Key Idea: As cumulative output doubles, the average cost per unit decreases due to
learning effects.
1. Why Does the Learning Curve Exist?
As firms produce more, they become more efficient, reducing costs due to:
Process Improvement – Workers refine techniques and reduce errors.
Specialization – Labor is divided for efficiency.
Automation – Machines replace manual tasks over time.
Supply Chain Optimization – Bulk purchasing and better logistics reduce input costs.
Example:
Boeing found that each time aircraft production doubled, costs dropped by 20% due to
worker experience and process refinement.

2. Measuring Learning Curve Effects

The learning rate is the percentage cost reduction when production doubles.
Common Learning Curve Rates:
 90% learning curve → Costs fall 10% as output doubles.
 80% learning curve → Costs fall 20% as output doubles.
Example Calculation:
Suppose a company has a 90% learning curve, and the first unit costs ₹100.
 After 2 units: ₹100 × 0.90 = ₹90 per unit
 After 4 units: ₹90 × 0.90 = ₹81 per unit
 After 8 units: ₹81 × 0.90 = ₹72.9 per unit
As production scales, costs continue declining exponentially.

3. Learning Curve vs. Economies of Scale

Feature Learning Curve Economies of Scale

Focus Efficiency from experience Efficiency from higher volume

Applies to Labor, process improvements Fixed cost spreading, bulk purchasing

Cost Improves over time with

Improves with production level
Reduction experience

Tesla improving battery Walmart reducing per-unit cost via bulk

Example
production buying

Example:
 Toyota (Learning Curve): Continuous process improvements (Kaizen) reduce
defects and assembly time.
 Coca-Cola (Economies of Scale): Spreads advertising costs over millions of bottles.
5. Strategic Implications for Businesses
First-Mover Advantage – Early entrants can gain experience first, creating a cost
advantage (e.g., Tesla in EVs).
Pricing Strategy (Penetration Pricing) – Firms charge lower prices initially to scale
faster and benefit from the learning curve.
Cost Forecasting – Helps companies predict future costs and plan investment.
Market Entry Decisions – A firm entering a mature industry faces higher learning costs
than experienced players.

What is Agency Cost?

Agency cost arises when there is a conflict of interest between principals
(owners/shareholders) and agents (managers/executives) who make decisions on their
behalf. The agent may not always act in the best interest of the principal, leading to
inefficiencies, monitoring costs, and loss of firm value.
Implications of Agency Costs
Reduced Firm Value & Shareholder Returns
 Managers may prioritize personal benefits over profitability.
 Example: Excessive executive bonuses and perks at the expense of dividends.
Inefficient Resource Allocation
 Managers might invest in projects that increase their power rather than maximize
shareholder wealth.
 Example: A CEO pursuing empire-building acquisitions that don’t add value.

Higher Cost of Capital

 Investors demand a risk premium if they believe managers act in self-interest.
 Example: Poor governance at Yes Bank led to a decline in investor trust and stock
price collapse.
Moral Hazard & Opportunism
 Agents take excessive risks, knowing they won’t bear the full consequences.
 Example: 2008 Financial Crisis – Bankers took high-risk bets expecting government
bailouts.

Outcomes of Agency Costs

Stronger Governance Improves Performance
  Firms with strict monitoring mechanisms (independent boards, activist investors)
perform better.
 Example: Tata Sons replacing Cyrus Mistry due to disagreements over strategic
direction.
Costly Monitoring & Incentive Alignment Required
 Stock options & performance-based bonuses align managerial interests with
shareholders.
 Example: Infosys links CEO compensation to revenue growth & profit targets.
Short-Termism vs. Long-Term Growth
 High agency costs force managers to focus on short-term stock prices rather than
sustainable long-term strategies.
 Example: Companies engaging in share buybacks to inflate stock prices rather than
reinvesting in growth.

Key Takeaways
Agency costs reduce firm value, increase inefficiencies, and distort investment
decisions.
Effective governance, performance-linked incentives, and shareholder activism help
mitigate agency costs.
Unchecked agency costs can lead to financial scandals, excessive risk-taking, and
corporate failures.

What is Transaction Cost Economics?

Transaction Cost Economics (TCE), developed by Oliver Williamson, explains why firms
make or buy decisions based on the costs associated with market transactions. It argues that
firms exist to minimize transaction costs, which arise when using the market to coordinate
production instead of doing it in-house.

Implications of Transaction Costs

Market vs. Hierarchy Decision (Make or Buy)
 If market transaction costs are high, firms prefer vertical integration (make in-
house).
 If market transaction costs are low, firms prefer outsourcing (buy from suppliers).
 Example: Tesla initially outsourced batteries from Panasonic but later built
Gigafactories due to high transaction costs.
Hold-Up Problem & Opportunism
 Firms relying on a single supplier may face opportunistic behavior (supplier
demands higher prices after investment).
 Example: Boeing faced supplier hold-ups, leading it to bring manufacturing of
critical parts in-house.
Asset Specificity & Relationship Lock-In
 When a firm invests in highly specialized assets, it becomes locked into a supplier
relationship.
 Example: Oil refineries are designed for specific crude types, making switching
costly.
Uncertainty & Contract Incompleteness
 It is impossible to predict all future contingencies, making contracts incomplete.
 Example: Apple and Qualcomm’s legal disputes over chip pricing arose due to
incomplete agreements.

Outcomes of Transaction Cost Considerations

Higher Transaction Costs → More Vertical Integration
 Example: Amazon developed its own logistics network (Amazon Air, last-mile
delivery) instead of relying on UPS.
Long-Term Contracts & Strategic Alliances Reduce Risks
 Example: Automakers sign multi-year contracts with steel suppliers to hedge
against price fluctuations.
Market Efficiency vs. Control Trade-Off
 If transaction costs outweigh economies of scale, firms choose integration.
 If market suppliers are highly efficient, firms outsource.
 Example: Apple designs its chips but outsources production to TSMC.

What Are Strategic Alliances & Joint Ventures?

Strategic Alliances – A cooperative agreement between two or more firms to share resources
while remaining independent.
Joint Ventures (JVs) – A new entity formed by two or more firms with shared ownership,
risks, and profits.
Key Difference:
 Alliances → No new company is formed (e.g., Apple & Mastercard for Apple Pay).
  JVs → A separate company is created (e.g., Sony-Ericsson, Tata Starbucks).

Implications of Strategic Alliances & JVs

Market Expansion & Synergy
 Alliances help firms expand into new markets without full ownership.
 Example: Starbucks partnered with Tata Group to enter the Indian market (Tata
Starbucks JV).
Access to Resources & Technology
 Firms gain capabilities they lack (tech, distribution, branding).
 Example: Google & NASA collaborated to enhance AI for space research.
Risk & Cost Sharing
 Large investments and risks are spread across partners.
 Example: Boeing and Tata Aerospace formed a JV to produce aircraft components in
India, reducing investment risks.
Cultural & Management Conflicts
 Partners may disagree on strategy, profit-sharing, or control.
 Example: Sony-Ericsson JV failed due to differences in innovation priorities.
Opportunism & Knowledge Spillover Risks
 One firm may learn from the other and later compete independently.
 Example: Honda initially collaborated with Hero MotoCorp in India but later exited
to become a direct competitor.

Outcomes of Strategic Alliances & JVs

Successful Alliances Enable Market Leadership
 Example: Renault-Nissan Alliance helped both companies survive economic
downturns.
Weak JVs Often End in Conflict & Exit
 Example: Daimler-Chrysler JV collapsed due to operational clashes.
Knowledge-Sharing Must Be Managed Carefully
 Example: Tesla & Panasonic collaborated on battery production, but Tesla later
developed in-house capabilities.
Oligopoly: Market Power & Strategic Behavior
An oligopoly is a market structure where a few large firms dominate, leading to
interdependence in decision-making.
Implications of Oligopoly
Price Rigidity & Collusion Risks
 Firms avoid price wars to maintain stable profits.
 Example: OPEC nations coordinate oil production to control prices.
High Barriers to Entry Protect Profits
 Economies of scale, brand loyalty, and capital intensity deter new entrants.
 Example: Telecom (Jio, Airtel, Vi) – High infrastructure costs prevent small
firms from competing.
Non-Price Competition (Branding & R&D)
 Since price competition is risky, firms focus on advertising, innovation, and loyalty
programs.
 Example: Apple & Samsung compete via technology upgrades & ecosystem lock-
in, not just price.
Strategic Interdependence & Game Theory
 Firms must anticipate rival reactions before making strategic moves.
 Example: Airline ticket pricing – If one airline lowers fares, others follow to
retain customers.

Entry Strategy: Overcoming Barriers in Oligopoly

New firms must choose strategies to penetrate oligopolistic markets successfully.
Key Entry Strategies & Their Implications
Disruptive Innovation (New Tech or Business Models)
 Entering with superior technology or a cheaper alternative forces incumbents to
react.
 Example: Jio’s free data strategy forced Airtel & Vi to cut rates drastically.
Niche Differentiation (Targeting Unserved Segments)
 Entering a specific market gap avoids direct competition.
 Example: Tesla entered as a premium EV brand, avoiding direct competition with
fuel-powered cars.
Strategic Partnerships & Acquisitions
  Collaborating with an established player helps overcome brand and distribution
challenges.
 Example: Starbucks partnered with Tata to enter India smoothly.
Aggressive Pricing & Loss-Leading Strategy
 Offering deep discounts to capture market share quickly.
 Example: Flipkart & Amazon burned billions in discounts to dominate India’s e-
commerce.

Rivalry & Competitive Dynamics in Oligopoly

Since firms are mutually dependent, rivalry takes unique forms:
Key Rivalry Outcomes

Price Wars Reduce Industry Profits

 Example: IndiGo & SpiceJet frequently engage in price battles, hurting margins.

Brand Loyalty & Differentiation Lead to Premium Pricing

 Example: Apple maintains high prices due to strong brand power.

Collusion & Tacit Coordination Maintain Stability

 Example: Airlines coordinate pricing by adjusting fuel surcharges together.

New Entrants Trigger Retaliatory Responses