How to understand the structure of [any] industry

When you’re starting/leading a business, or investing in any industry, you ought to know the competition you’ll face. Understanding the competitive forces in that industry helps you identify how profitable the business may be. It doesn’t matter if such a business is new or has existed for a while. By analyzing the industry structure, you’re able to predict and effect changes in the competition and profits of that industry.

Competitive forces of an industry

So, if you know the competition, you can make good decisions about your business to increase its chance of succeeding.

Per Porter's Five Forces, there are 5 competitive forces that influence an industry and identify its strengths and weaknesses; viz:

• Threat of new entrants
• Bargaining power of suppliers
• Bargaining power of customers
• Rivalry among existing competitors
• Threat of substitutes

Know this ?? In every industry, there are competitive forces that affect the profitability of a company. The [competitive] forces that have the?biggest impact on profits?become the?most important factors?to consider when creating a business strategy -?read it again, slowly!

Having worked in Media, Entertainment, Marketing, and now Tech environments, I can tell you every type of business has specific characteristics that make it operate uniquely. So, these competitive forces emanate from the viewpoint of companies already present in the said industry and we can see how these forces might impact new companies that want to join the industry. Therefore, understanding the industry's structure helps you know how the competition works and how to navigate certain tricky waters.

Zooming into the first competitive force:

Threat of New Entrants

When new businesses enter an industry, they bring in new resources and want to get a share of the market - I’ve experienced this with record labels in the music industry time and again.

As more competitors enter the industry, the industry can become less profitable since everyone is competing for the same customers. The threat of new businesses entering an industry?depends on how easy it is to join?and whether they can expect a reaction from existing companies. If it’s easy to join the industry and there won’t be much competition, then more businesses are likely to enter the industry which?can make it less profitable.

In the next?seven?days, I’ll take you through?seven?main reasons why it can be difficult for new businesses to enter certain industries.

1. Supply-side Economies of Scale

Let me first break down what?Economies of Scale?means.

Economies of Scale [Breakdown]

Imagine you like baking cupcakes. You decide to bake?6 cupcakes?for your family and friends. You go to the grocery store to buy ingredients, and you end up spending?$10?for that. This means that each cupcake costs you around?$1.67.

Now imagine you decide to bake?60 cupcakes?to sell them. When you go to the store to buy ingredients, you realize that you'll need to?buy in bulk, to get?a lower price.

Since you are?buying more ingredients, the overall?cost of each cupcake will be less. So, now if you spend?$50?on ingredients for?60?cupcakes, each cupcake will individually cost you?$0.83 (50/60), rather than?$1.67.

This is a basic example of economies of scale - the?more you produce, the?less it costs to produce?each individual item.

And of course, there are different cases of economies of scale such as:

• Supply-side economies of scale
• Technical economies of scale
• Purchasing economies of scale
• Financial economies of scale
• Managerial economies of scale
• Marketing economies of scale?

For this convo, we’ll just keep it with?Supply-side economies of scale?- as a source of barrier to entering an industry.

Supply-side economies of scale [Restaurant context]

Supply-side economies of scale?are the cost savings that occur when a company is able to produce goods or services more efficiently, often due to the size or scale of its operations.

For instance, small restaurants may have to pay higher prices for supplies than large or chain restaurants. This is because the small restaurant doesn’t buy as many supplies in bulk as the large or chain restaurant, so the supplier is likely to charge them a higher price per item. But large or chain restaurants have the advantage of being able to buy supplies in bulk at a lower cost because of their large-scale operations.

This gives large/chain restaurants an advantage in the industry as they’re able to produce their dishes at a lower cost than small restaurants. So, the small restaurant would need to find ways to make up for this cost disadvantage, maybe by offering relatively unique dishes, recipes, and experiences for customers.

Supply-side economies of scale [Explained]

Supply-side economics of scale refers to the economic principle in which the?cost per unit decreases?as the?amount of production increases. This happens because larger companies are often able to spread fixed costs over more units, use more efficient technology, or obtain better deals from suppliers. This creates a barrier to entry for new companies, as it may be difficult for them to produce at a large enough scale to benefit from these cost savings.

Supply-side economies of scale [Automobile industry]

Let’s look at the?automobile?industry for instance.

With big names like?Toyota, and?Volkswagen?- their cost per unit should be lower than a smaller manufacturer who produces fewer cars because big car manufacturers have bargaining power with suppliers due to their volumes of orders, which can result in less expensive parts and materials.

In contrast, new car manufacturers may struggle to keep their prices competitive because they cannot produce at the large scale necessary to benefit from economies of scale.

Supply-side economies of scale [Microprocessor industry]

Let’s look at another example - the?microprocessor industry.

Imagine two companies that are manufacturing microprocessors -?Intel?and a hypothetical start-up called?TJ Processors. Intel has been producing microprocessors for many decades and has made significant investments in research, development, and production capabilities. On the other hand, TJ Processors is a new entrant in the industry.

Due to Intel’s established position, it is able to produce microprocessors at a lower cost compared to TJ Processors, which has to compete at a cost disadvantage. Intel can take advantage of economies of scale to spread its fixed costs over a large number of units manufactured, while TJ Processors may not have the resources/edge to leverage such advantages.

TJ Processors would need to make huge investments to set up a large-scale manufacturing facility to compete with Intel’s established facilities. Without such investments, TJ Processors may not be able to compete on price - making it a significant barrier to entry.

Supply-side economies of scale [Fintech industry]

Let’s examine another example in relation to?Fintech.

Here, supply-side scale economies might refer to the cost advantage that big companies have when providing digital financial services like online banking, digital wallets, mobile payments, etc. Let’s imagine two companies that offer digital payment services -?Flutterwave?and?TJ Fintech.

Having operated for years, Flutterwave has a considerable advantage with its established infrastructure, user base, and ability to manage customer transactions securely. It can also spread its fixed costs over a larger volume of transactions, thereby reducing the cost per transaction.

On the other hand, TJ Fintech is a new start-up that has recently entered the market and does not have the same established infrastructure or customer base as Flutterwave. And because Flutterwave has already scaled its operations, it enjoys lower costs per transaction, which permits it to charge lower fees to customers. This can make it difficult for TJ Fintech to enter the market and compete with Flutterwave on price, as it?[TJ Fintech]?may not have the same economies of scale.

TJ Fintech would need to invest heavily in developing infrastructure, payment processing systems, data security protocols, and customer acquisition to compete well enough. Without these investments, TJ Fintech may struggle to establish itself in the Fintech space.

Supply-side economies of scale [Music industry]

Here, "supply-side scale economies" can refer to the advantages that bigger record companies have when producing and promoting music. Let’s imagine two record labels -?Mavin Records?and a hypothetical independent label?TJ Records???.

Mavin Record is well-established with significant resources for artist development, music production, marketing, and distribution. They have established relationships with global distribution outlets and can negotiate better deals due to their catalog size, market position, brand recognition, etc.

All these factors contribute to making it easier for Mavin Records to access a wider audience and garner more attention for their artists. In contrast, TJ Records may not have the same level of resources or market power as Mavin Records, making it more difficult for them to compete with the bigger label.

Due to economies of scale, Mavin Records could get better access to recording music, producers, professional talent, etc. They [Mavin] may also have better distribution channels and can command more shelf space in music stores (read: Playlists). Also, due to its stronger brand recognition, it can attract better partnership/investment and tastemaker partnerships/affiliation while TJ Records may find it hard to attract professional talent, airplay, and promote their music to a wider audience.

Conclusion

From the above examples, it seems new businesses may have to start at a large scale or accept a higher cost disadvantage compared to existing businesses that have operated in said industry long enough.

Next up!

Let me know if this piece drives home the point enough. Hopefully tomorrow, we’ll examine the?next reason?why it can be difficult for new businesses to enter certain industries.

And after going through seven of these reasons, we’ll circle back to the other forces that shape competition in the industry, and by the end of these exercises, you and I will be able to?assess the underlying structure?of an industry and its?competitive forces.

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