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Sunday, July 17, 2011

About Entrepreneurs: Small Businesses Looking a Bit More Optimistic

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From Mitchell York, your Guide to Entrepreneurs

Small Businesses Looking a Bit More Optimistic
Small business owners are probably optimistic by nature, but if you believe some new data out this week, they're putting their money where their optimism is -- into job creation. The... Read more

Facebook the Big Winner in Amex Small Business Promotion
American Express OPEN has partnered with Facebook to allow its Membership Rewards customers to redeem purchase points for Facebook advertising. Each $6,750 (yes, six thousand seven hundred and fifty American... Read more

Establishing Social Media Street Cred
Dun & Bradstreet Credibility Corp., which provides credit solutions for business, has its social media crew working overtime. The company has developed a list of the Most Influential Small Business... Read more

Becoming an Entrepreneur
Making the choice on becoming an entrepreneur can be a challenge unto itself. Start here for information on the entrepreneurial lifestyle, types of businesses you can start, and other information you'll need to help you decide if the life of an entrepreneur is right for you.

 


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Monday July 18, 2011
Competitive Strategy: Techniques for Analyzing Industries and Competitors
by Michael E. Porter
 

Chapter 1: The Structural Analysis of Industries

The essence of formulating competitive strategy is relating a company to its environment. Although the relevant environment is very broad, encompassing social as well as economic forces, the key aspect of the firm's environment is the industry or industries in which it competes. Industry structure has a strong influence in determining the competitive rules of the game as well as the strategies potentially available to the firm. Forces outside the industry are significant primarily in a relative sense; since outside forces usually affect all firms in the industry, the key is found in the differing abilities of firms to deal with them.

The intensity of competition in an industry is neither a matter of coincidence nor bad luck. Rather, competition in an industry is rooted in its underlying economic structure and goes well beyond the behavior of current competitors. The state of competition in an industry depends on five basic competitive forces. The collective strength of these forces determines the ultimate profit potential in the industry, where profit potential is measured in terms of long run return on invested capital. Not all industries have the same potential. They differ fundamentally in their ultimate profit potential as the collective strength of the forces differs; the forces range from intense in industries like tires, paper, and steel - where no firm earns spectacular returns - to relatively mild in industries like oil-field equipment and services, cosmetics, and toiletries - where high returns are quite common.

This chapter will be concerned with identifying the key structural features of industries that determine the strength of the competitive forces and hence industry profitability. The goal of competitive strategy for a business unit in an industry is to find a position in the industry where the company can best defend itself against these competitive forces or can influence them in its favor. Since the collective strength of the forces may well be painfully apparent to all competitors, the key for developing strategy is to delve below the surface and analyze the sources of each. Knowledge of these underlying sources of competitive pressure highlights the critical strengths and weaknesses of the company, animates its positioning in its industry, clarifies the areas where strategic changes may yield the greatest payoff, and highlights the areas where industry trends promise to hold the greatest significance as either opportunities or threats. Understanding these sources will also prove to be useful in considering areas for diversification, though the primary focus here is on strategy in individual industries. Structural analysis is the fundamental underpinning for formulating competitive strategy and a key building block for most of the concepts in this book.

To avoid needless repetition, the term "product" rather than "product or service" will be used to refer to the output of an industry, even though the principles of structural analysis developed here apply equally to product and service businesses. Structural analysis also applies to diagnosing industry competition in any country or in an international market, though some of the institutional circumstances may differ.

Structural Determinants of the Intensity of Competition

Let us adopt the working definition of an industry as the group of firms producing products that are close substitutes for each other. In practice there is often a great deal of controversy over the appropriate definition, centering around how close substitutability needs to be in terms of product, process, or geographic market boundaries. Because we will be in a better position to treat these issues once the basic concept of structural analysis has been introduced, we will assume initially that industry boundaries have already been drawn.

Competition in an industry continually works to drive down the rate of return on invested capital toward the competitive floor rate of return, or the return that would be earned by the economist's "perfectly competitive" industry. This competitive floor, or "free market" return, is approximated by the yield on long-term government securities adjusted upward by the risk of capital loss. Investors will not tolerate returns below this rate in the long run because of their alternative of investing in other industries, and firms habitually earning less than this return will eventually go out of business. The presence of rates of return higher than the adjusted free market return serves to stimulate the inflow of capital into an industry either through new entry or through additional investment by existing competitors. The strength of the competitive forces in an industry determines the degree to which this inflow of investment occurs and drives the return to the free market level, and thus the ability of firms to sustain above-average returns.

The five competitive forces - entry, threat of substitution, bargaining power of buyers, bargaining power of suppliers, and rivalry among current competitors - reflect the fact that competition in an industry goes well beyond the established players. Customers, suppliers, substitutes, and potential entrants are all "competitors" to firms in the industry and may be more or less prominent depending on the particular circumstances. Competition in this broader sense might be termed extended rivalry.

All five competitive forces jointly determine the intensity of industry competition and profitability, and the strongest force or forces are governing and become crucial from the point of view of strategy formulation. For example, even a company with a very strong market position in an industry where potential entrants are no threat will earn low returns if it faces a superior, lower-cost substitute. Even with no substitutes and blocked entry, intense rivalry among existing competitors will limit potential returns. The extreme case of competitive intensity is the economist's perfectly competitive industry, where entry is free, existing firms have no bargaining power against suppliers and customers, and rivalry is unbridled because the numerous firms and products are all alike.

Different forces take on prominence, of course, in shaping competition in each industry. In the ocean-going tanker industry the key force is probably the buyers (the major oil companies), whereas in tires it is powerful original equipment (OEM) buyers coupled with tough competitors. In the steel industry the key forces are foreign competitors and substitute materials.

The underlying structure of an industry, reflected in the strength of the forces, should be distinguished from the many short-run factors that can affect competition and profitability in a transient way. For example, fluctuations in economic conditions over the business cycle influence the short-run profitability of nearly all firms in many industries, as can material shortages, strikes, spurts in demand, and the like. Although such factors may have tactical significance, the focus of the analysis of industry structure, or "structural analysis," is on identifying the basic, underlying characteristics of an industry rooted in its economics and technology that shape the arena in which competitive strategy must be set. Firms will each have unique strengths and weaknesses in dealing with industry structure, and industry structure can and does shift gradually over time. Yet understanding industry structure must be the starting point for strategic analysis.

A number of important economic and technical characteristics of an industry are critical to the strength of each competitive force. These will be discussed in turn.

THREAT OF ENTRY

New entrants to an industry bring new capacity, the desire to gain market share, and often substantial resources. Prices can be bid down or incumbents' costs inflated as a result, reducing profitability. Companies diversifying through acquisition into the industry from other markets often use their resources to cause a shake-up, as Philip Morris did with Miller beer. Thus acquisition into an industry with intent to build market position should probably be viewed as entry even though no entirely new entity is created.

The threat of entry into an industry depends on the barriers to entry that are present, coupled with the reaction from existing competitors that the entrant can expect. If barriers are high and/or the newcomer can expect sharp retaliation from entrenched competitors, the threat of entry is low.

Barriers To Entry

There are six major sources of barriers to entry:

Economies of Scale. Economies of scale refer to declines in unit costs of a product (or operation or function that goes into producing a product) as the absolute volume per period increases. Economies of scale deter entry by forcing the entrant to come in at large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disadvantage, both undesirable options. Scale economies can be present in nearly every function of a business, including manufacturing, purchasing, research and development, marketing, service network, sales force utilization, and distribution. For example, scale economies in production, research, marketing, and service are probably the key barriers to entry in the mainframe computer industry, as Xerox and General Electric sadly discovered.

Scale economies may relate to an entire functional area, as in the case of a sales force, or they may stem from particular operations or activities that are part of a functional area. For example, in the manufacture of television sets, economies of scale are large in color tube production, and they are less significant in cabinetmaking and set assembly. It is important to examine each component of costs separately for its particular relationship between unit cost and scale.

Units of multibusiness firms may be able to reap economies similar to those of scale if they are able to share operations or functions subject to economies of scale with other businesses in the company. For example, the multibusiness company may manufacture small electric motors, which are then used in producing industrial fans, hairdryers, and cooling systems for electronic equipment. If economies of scale in motor manufacturing extend beyond the number of motors needed in any one market, the multibusiness firm diversified in this way will reap economies in motor manufacturing that exceed those available if it only manufactured motors for use in, say, hairdryers. Thus related diversification around common operations or functions can remove volume constraints imposed by the size of a given industry. The prospective entrant is forced to be diversified or face a cost disadvantage. Potentially shareable activities or functions subject to economies of scale can include sales forces, distribution systems, purchasing, and so on.

The benefits of sharing are particularly potent if there are joint costs. Joint costs occur when a firm producing product A (or an operation or function that is part of producing A) must inherently have the capacity to produce product B. An example is air passenger services and air cargo, where because of technological constraints only so much space in the aircraft can be filled with passengers, leaving available cargo space and payload capacity. Many of the costs must be borne to put the plane into the air and there is capacity for freight regardless of the quantity of passengers the plane is carrying. Thus the firm that competes in both passenger and freight may have a substantial advantage over the firm competing in only one market. This same sort of effect occurs in businesses that involve manufacturing processes involving by-products. The entrant who cannot capture the highest available incremental revenue from the by-products can face a disadvantage if incumbent firms do.

A common situation of joint costs occurs when business units can share intangible assets such as brand names and know-how. The cost of creating an intangible asset need only be borne once; the asset may then be freely applied to other business, subject only to any costs of adapting or modifying it. Thus situations in which intangible assets are shared can lead to substantial economies.

A type of economies of scale entry barrier occurs when there are economies to vertical integration, that is, operating in successive stages of production or distribution. Here the entrant must enter integrated or face a cost disadvantage, as well as possible foreclosure of inputs or markets for its product if most established competitors are integrated. Foreclosure in such situations stems from the fact that most customers purchase from in-house units, or most suppliers "sell" their inputs in-house. The independent firm faces a difficult time in getting comparable prices and may become "squeezed" if integrated competitors offer different terms to it than to their captive units. The requirement to enter integrated may heighten the risks of retaliation and also elevate other entry barriers discussed below.

Product Differentiation. Product differentiation means that established firms have brand identification and customer loyalties, which stem from past advertising, customer service, product differences, or simply being first into the industry. Differentiation creates a barrier to entry by forcing entrants to spend heavily to overcome existing customer loyalties. This effort usually involves start-up losses and often takes an extended period of time. Such investments in building a brand name are particularly risky since they have no salvage value if entry fails.

Product differentiation is perhaps the most important entry barrier in baby care products, over-the-counter drugs, cosmetics, investment banking, and public accounting. In the brewing industry, product differentiation is coupled with economies of scale in production, marketing, and distribution to create high barriers.

Capital Requirements. The need to invest large financial resources in order to compete creates a barrier to entry, praticularly if the capital is required for risky or unrecoverable up-front advertising or research and development (R&D). Capital may be necessary not only for production facilities but also for things like customer credit, inventories, or covering start-up losses. Xerox created a major capital barrier to entry in copiers, for example, when it chose to rent copiers rather than sell them outright which greatly increased the need for working capital. Whereas today's major corporations have the financial resources to enter almost any industry, the huge capital requirements in fields like computers and mineral extraction limit the pool of likely entrants. Even if capital is available on the capital markets, entry represents a risky use of that capital which should be reflected in risk premiums charged the prospective entrant; these constitute advantages for going firms.

Switching Costs.

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About Financial Planning: Get Next Year's Tax Refund Now

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From Jeremy Vohwinkle, your Guide to Financial Planning
The year may only be half over, but that doesn't mean it's not a good time to think about taxes. If you're like most Americans, you're probably going to get a refund come April. The IRS issues millions of taxpayers refunds each year, and the average refund is over $2,000. That's a lot of money for a lot of people. But have you ever wondered why refunds are so common and think about how you might be able to make better use of that money if you didn't have to wait until filing your taxes each year to get it? You're also not alone and luckily you can get your hands on that money early.

Get Next Year's Tax Refund Now
The IRS sends out nearly 100 million income tax refunds each year. That's a lot of money! If you're like most taxpayers, you're probably familiar with the drill. You have taxes withheld from your paycheck all year and then come March you begin to prepare your taxes so that you can get that tax return. Since the average tax return is... Read more

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Credit card reform may have stopped some shady practices, but it isn't all good news. If you're like most people, you probably get a lot of credit card offers in... Read more

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Predatory lenders are everywhere, and in this difficult economy where people are more desperate for money it's easy to fall prey to their loans. As unsavory as the industry may... Read more

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Ratings Agencies Late Again

D.R. U.S. versionThe Daily Reckoning U.S. Edition Home . Archives . Unsubscribe
More Sense In One Issue Than A Month of CNBC
The Daily Reckoning | Sunday, July 17, 2011

Forget QE3 – America's Going Bust, on the Road to Bankrupt Hell

If America had a credit card, it would get mercilessly cut up and thrown back in her face.

The country's basically broke and isn't paying its debts. Harsh, but true.

All of that – and how it could affect your family and your retirement – is revealed in this urgent video report.

Don't wait, watch now.

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This Week's Most Popular Column:

We, "The People" by Addison Wiggin

-------------------------------------------------------

  • Ratings agencies are on the crime scene...but all eyes are on the perp,
  • Readers weigh in on the debt ceiling debate, Germany's rise and the cost of leverage,
  • Plus, all the rest of this week's reckonings, debt-free and ready for your leisurely afternoon reading...

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Ratings Agencies Late Again
Joel Bowman
Joel Bowman
Checking in from Buenos Aires, Argentina...

Among the juicy media tidbits on offer this week, ratings agencies Moody's and S&P, rarely accused of being early on the scene, threatened to sever the United States prized AAA credit rating. The pair cited political gridlock regarding the debt ceiling debate and the nation's uncertain (to put it mildly) financial situation as cause for concern.

Should the agencies – which are licensed, let us not forget, by the US Government – choose to make good on their threat, it would be the first time in history the US was awarded anything less than the highest possible rating.

One might think that, since the AAA rating is supposed to indicate "zero-risk," a platform from which all other risk is priced globally, a downgrade for the United States would have dire consequences, not only for the nation itself, but for all assets priced relative to US Treasurys.

"Ho hum," said investors, who were evidently far more concerned with the mutterings of one Ben S. Bernanke and his on-again, off-again hints at QE3...or QE2.5...or whatever his next round of money conjuring might be called.

As we've observed many times before in these pages, by the time these ratings agencies have arrived at the crime scene, the perpetrator is usually long gone. How curious, then, that today we should find not only that the perp is still on the scene...with green ink staining his hands...but that he has captivated everyone's attention.

To switch metaphors for a moment, the lunatics are truly running the asylum.

Just how far along the road to financial ruin is the temporarily AAA-clad Empire, we wonder? Addison provided some details in this week's feature column, We, "The Public."

"According to the Bipartisan Policy Center," wrote Addison, "tax revenue for the 29 days of August after the 2nd will total roughly $172.4 billion. That compares to $306.7 billion in spending.

"Ordinarily, the Treasury would cover that $134.3 billion gap by issuing new Treasury debt. But after Aug. 2, it won't be able to do so. That means Uncle Sam would have to immediately balance his books.

"What would that look like?

"Well, he'd have to choose his priorities. The Bipartisan Policy Center report breaks down the government's Aug. 3-31 expenses in a way that shows what the $172.4 billion in revenue can cover... and what it can't.

Treasury to Choose Which Bills to Pay

"The Social Security checks would still be cut," observed Addison, "but not income tax refunds. Medicare and Medicaid would be kept going...but not food stamps. Military contractors would still be paid...but not the troops.

"They can move certain items above the $172.4 billion line and others below it...but something has to give. And as we pointed out yesterday, matters are even worse than that list of priorities reveals."

For the rest of Addison's feature column, see here:

We, "The Public" – By Addison Wiggin

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Tiny US Wildcatter Discovers $1.2 Billion Alaskan "Oil Jackpot"

And this explosive exploration company acquired this "Oil Jackpot" for a mere $4.5 million – a monster 99.6% discount! It's one of the best market buys in the history of the oil industry. Early investors could make huge gains off this once-in-a-lifetime oil bargain.

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ALSO THIS WEEK in The Daily Reckoning...
The Euro and You
By Frederick Sheehan


A week does not go by without the ECB reducing its standards of collateral. The cost is not only its credibility as a central bank, but in the composition of its deteriorating balance sheet. To make matters worse, Greece is the smallest economy among the impoverished PIIGS: Portugal, Ireland, Italy, Greece, and Spain. Since others will probably follow Greece, the current impasse is all the more discouraging. The Greek government cannot meet its July interest payment obligations to banks, central and commercial. It can no longer borrow from banks or in the bond markets. (This is also true for Ireland and Portugal, and possibly others.)


Distress is the Mother of Opportunity
By Ray Blanco


Few technologies have had a greater impact than the invention of television. But, it took decades for the basic idea to become commonplace.

In the early 20th century, inventors tinkered with a variety of low- resolution electromechanical displays. The FCC even granted experimental broadcast licenses for early TV broadcasts using these sets. Yet by the mid-1930s, the broadcasts had ceased. It would take a superior technology to make television practical for the masses.


Graphene: The Next Wonder Material?
By Addison Wiggin
Baltimore, Maryland


Cheap solar panels. The most powerful transistors ever. Even the ability to make a fighter jet invisible. One barrier to solar breakthrough – its cost – is going down Each of these breakthroughs has been announced in the last two weeks. Each relies on one of the most basic elements mined from the earth. And each could line your pockets with cash if you move quickly enough. Let's hopscotch through these new developments...


The Greater Depression Is Upon Us
By David Galland


The phrase "Greater Depression" was coined by Doug Casey a decade or so back, as a way of describing the economic crisis he foresaw as inevitable, and which is now materializing. Doug Casey now believes that the unfolding crisis is going to be even worse than he first imagined, and the longer the rest of us at Casey Research study the tea leaves, it is hard to disagree that the Greater Depression is still ahead. Consider...


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Only a Few Researchers Worldwide Know About the Last Stock You'll Ever Need...

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The Weekly Endnote...
And now, a few words from our Fellow Reckoners...

First up, Reckoner J.S.H. has this:

Here are my thoughts on the subject. It does not seem like the majority of folks in our country are taking this situation seriously enough. The news media has done a lousy job of explaining what it means to everyone. Not just the rich or poor, but all people in our country. Congress and the president all seem to be jockeying for position to end the crisis with a big bang. What they should be doing is get down to brass tacks, so to speak, and put everything on the table. Taxes, spending, entitlements including their own salary, including foreign aid and such. Lastly, military spending.

If they cannot get together in say 5 more days – go home because you are not doing your job. They were all elected to do their job, what is best for the citizens of this country. Either get on with it or go back home. We will hold elections and run people who are worth less than say $100,000.00 and see if they can do a better job of running this country.

And this, from Reckoner M.K., in Florida:

I read with interest Bill Bonner's article, "Giving up on the economic recovery." When he states that the middle class has been decimated, he's absolutely correct. He also stated:

Leverage is an amazing thing: When prices go up, the borrower gets all the gains. And when prices go down, the borrower takes all the losses. Some families lost everything when the bubble collapsed, others lost very little. But, on average, American homeowners lost 55% of the wealth in their home.
This is correct as far as it goes. However, entire regions in many states have seen their home values plummet much further than that. By comparing all the regions with each other actually minimizes the problems in the areas that were hardest hit. MUCH more than a loss of 55% was realized in these areas. For instance Southwest Florida from Bradenton, to Fort Myers, even as far south as Naples have seen housing values plummet below year 2000's valuation.

My own home, for which I paid $305,000 in 2007, finally sold in 2010 for $91,000. The buyer? Fannie & Freddie. Good luck with that.

And finally, a thoughtful musing from Reckoner P.A.:

Just had an idea...

While everyone is distracted by China rising, Germany is rising and shining. A First World country, skilled in running the First World.

After the 'Wall' fell, Germany took a breather to collect itself. Two decades later it is Europe's largest economy, the world's fourth largest economy, the world's second largest exporter, etc., etc. It is growing and prospering, while the PIIGs are becoming totally dependent on EU loans. Should that read: dependent on German aid?

Rioting mobs in Greece can see the huge debt trap closing in on them, but supposedly the high-minded, high officials of the IMF and ECB can't do the math! Rot.

The EU is about controlling trade. Germany dominates the EU.

In developing countries we know this game. The EU won't allow free trade. Giving aid or loans that cannot be repaid is preferred. That way local industry and independent growth is discouraged.

First establish economic control then at the first excuse move in the military. Isn't that how it is done? Not sure, I skipped political science.

Here comes the Fourth Reich, bigger and better! It's just an idea. Europe is finished I hear.

---

If you'd like to chime in, feel free to send your thoughts to us at the address below. Other than that...

..enjoy your weekend.

Cheers,

Joel Bowman
Managing Editor
The Daily Reckoning

-------------------------------------------------------

Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com
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The Bonner Diaries The Mogambo Guru The D.R. Extras!

Sticking With the Golden Formula As Empires Crumble
"Sell stocks on rallies; buy gold on dips." That has been our advice for the last 11 years. Don't we have anything to add? Haven't we discovered any new tricks? Isn't it time to try a different strategy? Nope. Stick with the formula. It's a formula that doesn't work very often. But when it does...it's, well, golden.

Makers, Takers and the Transfer of Wealth

Active Volcanoes of Debt

China: Where Money Is Treated Best
I am sure that Mr. Pento is right because every country on the Face Of The Planet (FOTP) is desperately creating more and more money, and the money will eventually find its way to the place where it is treated best and/or has the best prospects, which is, in this case, Bob. Oops! I meant "China."

Buying Gold on the Price Inflation Guarantee

Awaiting the "Zero Hour" of Available Credit

How QE3 Could Bring About $5,000 Gold and $1,000 Silver
With potential for QE3 — a third round of the Federal Reserve's quantitative easing program — on the horizon, governments around the world must consider alternatives to the US dollar and other paper money. These developments are likely to continue impacting precious metal prices.

Bernanke Backtracks Stimulus Talk

Moody's Warns of a Downgrade for US Debt

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The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists.
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