Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

APPENDIX 6C: COMPETITIVE STRATEGY ANALYSIS FRAMEWORK

This appendix summarizes the analytical framework presented in Michael E. Porter’s influential book, Competitive Strategy (New York: The Free Press, 1980).

Forces Determining Industry Competition

I. Threat of new entrants.

A. Barriers to entry.

1. Economies of scale. Unit costs decline as absolute volume per period increases.

2. Product differentiation. Established firms have brand identification and customer loyalties that differentiate their products from those of the rest of the industry. Differentiation creates a barrier to entry by forcing entrants to spend resources to overcome existing consumer loyalties.

3. Capital requirements. Examples include high expense requirements for R&D, production facilities, customer credit, and inventories.

4. Switching costs. The high one-time costs when a buyer switches from one supplier’s product to another are a barrier to entry. Examples of switching costs include employee retraining costs, the cost of new ancillary equipment, and product redesign costs.

5. Access to distribution channels. A new entrant’s need to secure distribution channels for its product can be a barrier to entry.

6. Cost disadvantages independent of scale. Established firms may have cost advantages that cannot be reproduced by potential entrants regardless of their size and realized economies of scale. Examples include proprietary product technology, favorable access to raw materials, and favorable locations. ...