Applied Mergers and Acquisitions. Robert F. Bruner

      1 Barriers to entry. In theory, if an industry offers high returns, new entrants will be attracted into it, thus driving returns to a more normal level. But barriers may exist (or may be constructed) that prevent this from happening and enable current players in an industry to enjoy sustained high returns. Classic examples of entry barriers include regulatory restrictions (e.g., you must have a banking or broadcasting license from the government to compete), brand names (hard to develop and/or imitate), patents (illegal to exploit without ownership or license), high capital requirements (you must build a large greenfield plant to become a viable competitor), and unique know-how (Wal-Mart’s “hot docking” technique of logistics management). Porter highlighted the role of accumulated experience as a potential barrier—this learning curve effect is illustrated in Exhibit 6.6 and consists in reducing one’s cost of production as know-how accumulates. The effect of learning is apparent, for instance, in the substantial decline in the price of semiconductors over time: Unit costs decline by about 20 percent with each doubling of accumulated production. The learning curve gives a competitive advantage to the first or early mover. This benefit can be achieved in either of two ways. First, one can accumulate experience faster than one’s competitors can (e.g., through higher volume production or more rapid product changes) and thus get farther down the common learning curve faster. Second, one can try to steepen the slope of learning through larger leaps in internal development or the acquisition of know-how from outside the firm. Exhibit 6.6 shows the dramatic effects on unit cost of differing rates of cost reduction. Abernathy and Wayne (1974) discuss the impact of experience in various industries.

      2 Customer power. Powerful customers can strongly influence prices and product quality in an industry. Examples are Wal-Mart and Federated Department Stores for consumer goods, and the U.S. government for the U.S. defense industry. Weak customers, on the other hand, are likely to be mere price-takers—examples would be consumers of filmed entertainment, cigarettes, and education. In those industries, the suppliers have been able to sustain prices increases well ahead of the rate of inflation.Slope Base Cost Cumulative Unit Production10% Cost Reduction 0.1 $100.0020% Cost Reduction 0.2 $100.0030% Cost Reduction 0.3 $100.000$100.00$100.00$100.0010$ 90.00$ 80.00$ 70.0020$ 81.00$ 64.00$ 49.0040$ 72.90$ 51.20$ 34.3080$ 65.61$ 40.96$ 24.01160$ 59.05$ 32.77$ 16.81320$ 53.14$ 26.21$ 11.76EXHIBIT 6.6 Illustration of Learning CurveSource: Author’s analysis.

      3 Supplier power. Similarly, powerful suppliers (e.g., monopolists) can extract high prices from firms in an industry. Weak suppliers can be a source of positive value to an industry—through most of the 1990s, the U.S. auto industry extracted material price reductions and quality improvements from its suppliers.

      4 Threat of substitutes. Substitutes limit the pricing power of competitors in an industry. For instance, the price of coal quoted to electric power generators is influenced by the prices of Btu (British thermal unit) substitutes such as oil and natural gas.

      5 Rivalry conduct. This final force captures the effects of dynamic competition among players in an industry. Investment in new product or process innovation, opening new channels of distribution, and entry into new geographic markets can alter the balance of competitive advantage. Cartel agreements (banned under the antitrust regulations in most countries) create industries with few adverse surprises for its players. At the other extreme, predatory pricing aimed at driving peers out of business can produce sharp variations in profitability. Porter noted that rivalry may be sharper where the players are similar in size, the barriers to exit from an industry are high, fixed costs are high, growth is slow, and products or services are not differentiated.