THESIS CHAPTER 2 - ANALYZING THE COMPETITIVE FORCES OF THE AUTOMOBILE INDUSTRY IN MAINLAND, CHINA
This chapter will show the different literatures and studies regarding the subject or topic. It will help in order to present in-depth review of background knowledge about the automobile industry in China, which will help in order to inform and educate the reader of the study regarding the subject, which will be helpful in understanding the next chapters.
Analyzing the business environment is difficult and complex due to different reasons. First, the environment is being affected by different forces which cause diversity. Second, complexity happens due to the related separate issues and risks in the business environment (Johnson, Scholes and Whittington, 2010). Figure 3 shows the layers of the business environment.
Figure SEQ Figure \* ARABIC 3 Layers of the Business Environment
Source: (Johnson, Scholes and Whittington, 2010)
The macro-environment pertains on the broad factors within the environment which affect to a greater or lesser degree on most all organizations. Inside the general environment lies the industry or sector, which pertains on the group of organizations that are producing the same products or services towards the customers. Lastly, the competitors and markets pertain on the group of people and businesses which influence the strategic movement of the company (Johnson, Scholes and Whittington, 2010).
It is important to take note that industry analysis is vital for corporate strategy and business strategy. Corporate strategy pertains on the process of deciding regarding which industries the company must considered and how it should be allocated with different resources. These decisions require evaluation of the attractiveness of different industries by focusing potential of profits. On the other hand, business strategy pertains on the establishment and maintenance of competitive advantage. By evaluating the needs of the customers, preferences and demands, together with the competition in the environment, companies will be able to come up on how they will improve their strategies (Grant, 2005).
This is because businesses do not operate in a vacuum, thus, in order to understand and analyze the possible behavior of a competitor, it is important to know the context in which the organization will operate. One of the important element is the external business environment, in a given country in which the industry is operating. Another factor is the balance of the different forces which help to determine the behavior of the competitor within a given industry. This information is vital because it helps to understand and interpret what a competitor will possibly do with a given situation (Jenster & Soilen, 2009).
With these, in general, industry analysis enables businesses, companies and firms in a given industry to take a look or have an overview regarding the different factors found in both macro- and micro-environmental factors, which include all of the important stakeholders in the industry which affect the profitability and sales of individual business or company. Thus, all of the factors or forces found in the environment can affect the process of planning and implementing of a given strategy.
It is important to take note that the overall business environment, in which a company or firm operates is being affected and influenced by different external influences, which affect their decisions, performances and strategies. Because of the vast number and range of different external factors, it is important to focus on framework in organizing the information. For instance, environmental influences can be grouped by different sources such as political, economic, social and technological factors (PEST analysis) or by terms of proximity, such as micro-environment or task-environment which can be analyzed from the broad impacts from the macro-environment. Next, it is important to understand the customers or market, create value and generate profitability from the value-creating activities depending on the competitions among the major players in the industry. Thus, this lead to connection to the 3 important stakeholders in the industry, which are: customers, suppliers and competitors – known as the industry environment. Figure 3 shows the different factors which include the macro-environmental factors such as general economic development, changes in the structure of demographics, social and political changes, which are important in determining the threats and opportunities that the companies will be facing in the future (Grant, 2005). These factors are considered as important and interrelated in the overall business environment, therefore, it is important to consider them, in order to plan and implement strategies that will be suitable and feasible for the company/business and the industry, together with the market.
Figure SEQ Figure \* ARABIC 4 Environmental Analysis to Industry Analysis
Source: (Grant, 2005)
An industry analysis can be done in different forms or types. This is connected with the process of positioning the given industry within its life cycle, which focuses on defining the sector (Hooke, 1998). According to the Association for Investment Management and Research, the industry analysis is broken down into its key components, which include: industry classification (life cycle position, business cycle); external factors (technology, government, social, demographic, foreign); demand analysis (end-users, real and nominal growth, trends and cyclical variation around trends); supply analysis (degree of concentration, ease of entry, industry capacity); profitability (supply/demand analysis, cost factors, pricing); and international competition and markets (cited in Grant, 2005).
According to Porter (2008) good industry analysis has 4 important attributes or characteristics which include:
· A good industry analysis looks rigorouly at the structural underpinnings of profitability. The preliminary step is to know and understand the time horizon;
· The main point or importance of industry analysis is not to declare the attractiveness or unattractiveness of the industry, but to recognize and comprehensive the underpinnings of competition and root causes of profitability;
· The strength of the competitive forces influences prices, costs and the investments that are required in order to compete, therefore, the forces that are directly connected to the income statements and balance sheets of the participants in the industry; and
· A good industry analysis does not just list pluses or advantages and minuses or disadvantages, but sees and overviews the industry as a whole, in systematic terms.
With all these attributes or characteristics, it show that there are vast and different factors that must be considered in analyzing and evaluating a specific industry. It will not just focus on individual or separate factors which influences the entire industry, but it is important to focus on the different factors and forces affecting the entire industry as one, meaning, these factors are interconnected, thus, each factor or force affect other factors – which shows interdependences.
There are different models or tools which are used for industry analysis. However, the most popular are the use of PEST (Political, Economic, Social and Technological) analysis and Porter’s Five Forces. This is because the PEST analysis enables to measure the potential of market by focusing on the areas of growth and decline (Fullen & Podmoroff, 2006). Porter’s Five Forces study the five important competitive forces, which affect the industry (Culpan, 1997).
PEST analysis stands for Political, Economic, Social and Technological analysis, which is considered as a useful strategic tool in understanding the macro-environment, which includes the growth potential of a market, strategic positioning, possible growth and direction for the company (Krach, 2008). PEST is widely used and applied in conducting market analysis in order to support the process of business planning and strategy development. It can help in order to produce a checklist of different important remote factors which to consider in analyzing the potentials of market, as well as the market direction, growth, decline and attractiveness of the market (Smith & Raspin, 2008). Depending on the industry being analyzed, other factors such as Legislative and Ecological Factors can also be considered (PESTLE) (Fullen & Podmoroff, 2006).
PESTLE analysis helps to analyze factors related on the wider environment, which have the power to influence the demands for a given products being offered by a specific firm in an industry; the way in which products and services are being distributed; the process of pricing; and the overall competition in the industry (Haberberg & Rieple, 2008). Figure 1 show the PESTLE model for environmental and industry analysis.
- Political Factors – pertains on factors related to government policies and standards, which include the level of intervention in the economy or the political decisions that have vital impacts on the industry.
- Economic Factors – pertains on changes in the economy, which include interest rates, taxes, economic growth, inflation, exchange rates, etc.
- Social Factors – focuses on the trends and changes in the society which affect the demands or sales of a given products or services, together with the availability and willingness of the individuals to work.
- Technological Factors – technology always affect how business or industry operates. One of the biggest examples is the presence of the Internet which changed how businesses are being managed. With this, new technologies create new products, procedures and services, which affect the final products.
- Legislative/Legal Factors – pertains on the legal environment, where a specific company or business operates. This is important because different countries implement their different laws and regulations which affect the different stakeholders and processes inside the organization, particularly those that are related to consumers, competition, employment and health and safety.
- Ecological/Environmental Factors – environmental factors pertains on the weather and climate changes. Currently, the most common factors considered is the climate change or global warming, which affect all of the industries, particularly turning into green marketing (Oxford University Press, 2007).
Figure SEQ Figure \* ARABIC 5 PESTLE Analysis
Source: (Gill, 2006)
The credit for much of the thinking regarding the industry analysis goes to the industrial economists, and much to Michael Porter, who incorporated and furthermore improved much of the thinking from industrial economics, regarding the impact of profitability of an organization in a competitive situation – which is described by Porter’s Five Forces model (Jenster & Soilen, 2009). Figure 5 shows Porter’s five forces, which include: threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitute and intensity of rivalry. According to Porter, the stronger each of these important forces is, the more restricted is the capability of different established firms to increase prices, thus earn more profits. Thus, it shows that a strong competitive force can be considered as threat or risk because it lessen the chance of gaining profit, while a weak competitive force can be considered as opportunity due to the fact that it enables firms to gain more profits (Hill & Jones, 2009).
Figure SEQ Figure \* ARABIC 6 Porter's Five Forces Model
Source: (Hill & Jones, 2009)
- Bargaining Power of Suppliers – is the degree to which the suppliers to an industry have the power to influence or dictates prices, quality standards, delivery lead times and other terms and conditions towards the companies that they are supplying (Haberberg & Rieple, 2008). According to Krach (2008) factors that are important in determining the degree of supplier power are: supplier switching costs; importance of volume to supplier; degree of specialization; presence of substitutes; supplier concentration; threat of forward integration by supplies relative to the threat of backward integration by firms; and cost of inputs relative to selling price of the product. If the supplier power is strong, then they will be able to charge high prices, and take profit for themselves (Haberberg & Rieple, 2008).
- Bargaining Power of Buyer – is the degree to which the customers of the industry have the power to dictate prices, quality, standards and other terms and conditions to the company that are supplying them (Haberberg & Rieple, 2008). Factors that are important in determining the degree of buyer power are: buyer concentration; bargaining power; buyer volume; buyer switching costs; buyer information; ability to backward integrate; availability of substitutes; buyer price sensitivity; price of total purchase; brand identity; and product differentiation (Krach, 2008). If the power of buyer is high, companies in the industry will be limited in how high they can set their prices, therefore, companies will be forced to incur high costs to meet the demands of the customers (Haberberg & Rieple, 2008).
- Threat of Substitute – pertains on availability of substitute products – not just rival products, but also substitute products, made by another industry, but which customer may choose to spend their money instead (Haberberg & Rieple, 2008). The willingness of the buyers to substitute; relative price performance of substitutes; buyer switching costs and perceived level of product differentiation are important factors in determining this threat (Krach, 2008).
- Risk of Entry – determine the threat that new entrants pose to firms in an industry. If new companies are able to come into the industry, competition will intensify, thus profits will fall (Haberberg & Rieple, 2008). The following are the factors considered as barriers to entry: absolute cost advantages; proprietary learning curve; access to inputs; government policies; economies of scale; patents; brand equity; brand identity; switching costs; capital requirements; access to distribution; expected retaliation; and proprietary products (Haberberg & Rieple, 2008).
- Competitive Rivalry between the Firms in the Industry – affected by the first forces. The stronger the power of buyers, suppliers and the intensity of competition, the more intense competition are likely to be (Haberberg & Rieple, 2008). The intensity of rivalry is affected by: a large number of firms; slow market growth; high fixed costs; low switching costs; high strategic stakes; high exit barriers; diversify of rivals and industry shakeouts (Krach, 2008).