External+Environment+&+Industry+Analysis


 * External Environment / Industry Analysis: **


 * Key Success Factors: **

The core assets/activities of this industry are primarily the facilities (geographic location included), the contracts with suppliers, buyer power, and the barriers to entry.

The factor affecting rivalry among existing competitors is a significant concentration within the industry that has left five or six main competitors capturing major market share. Competing on price at high volumes is the winning strategy within this industry. If significant price differences exist among firms, the lower price strategy will win over any others and that firm will earn above average profits. The firms competing in this industry are very sensitive to costs and capacity utilization. The majority of the facilities in this industry are often around 140,000 square feet, and they are sparsely located based of consumer population within that area. Buyer switching costs increase rivalry because buyers’ switching costs are low. Firms have been known to adopt a price-matching policy to adjust prices quickly in order to aid the final purchase decision. However, many of the firms’ prices vary little so some cooperative pricing exists. There is a high industry price elasticity of demand. Overall, rivalry is determined by the price and cost structure of the firms operating within the industry, thus rivalry is low or high relative to the price per product.

The factor affecting the threat of entry is brand loyalty. Brand loyalty has been created by some firms impacting the purchase decision. Entrant’s access to distribution channels is not easy. Entrant’s access to raw materials and technology/know-how is easy due to the advancements over the years (especially in operations management). It is very hard for new firms to find favorable locations and strong networks. There is an experience-based advantage to the current firms. Overall, threat to entry is relatively low given these circumstances.

The factor affecting or reflecting pressure from substitute products and support from compliments is close substitutes that are readily available. Price determines the willingness to pay for substitutes. The price-value characteristics of substitutes and the price elasticity of demand are high. Complements are also readily available and the price-value characteristics of complements are high. Overall, substitute products are not competitive based on the pricing strategy.

The factor affecting or reflecting power of suppliers is concentration of the suppliers to this industry is minimal at best. Firms in the industry do not purchase relatively small volumes and as such they are able to negotiate volume discounts and strip the power of the supplier. The suppliers’ input substitutes are many; substitutes can come from all over for the supplier inputs. Firms make industry relationship-specific investments to support transactions with specific suppliers; this produces great profit margins for these firms in this industry. The suppliers pose very little forward integration into the product market, but this may continue to change over time. Suppliers are not able to price-discriminate among prospective customers according to ability/willingness to pay for input all too much because the importance of the purchase is too great. Many suppliers can guarantee sales levels by negotiating contracts with these firms. Overall, supplier power is minimal.

The factor affecting or reflecting power of buyers is buyers’ industry is not more concentrated than the industry it purchases from because buyer’s can go anywhere. Typical buyers purchase large volumes, and they purchase individual items in bulk. Buyers can find substitutes for industry substitutes easily at a price premium, but maybe more convenient with respect to location alone. Firms attempt to make relationship-specific investments to support transactions with specific buyers, but high volumes of customers do lessen the opportunity for strong relationships with consumers. All the buyers have one thing in common; they want a low price for a reasonable or large quantity. The price elasticity of demand of buyers’ product is high. Buyers do not pose a credible threat of backward integration. There is some negotiation of prices in this industry between buyers and sellers on each individual transaction, but most transactions are a “take-it-or-leave-it” price application. Overall buyer power is high given buyer options.

This industry has limited rivalry, a few enormous barriers to entry, very little supplier power, strong buyer power, and little threat from substitutes.

Costco belongs to the discount, variety stores industry. Within this industry, competitors range from Wal-Mart, BJ’s Wholesale, Target, and many more. The industry can be somewhat attractive to a company as long as the company is able to acquire the capital and suppliers needed to compete with competitors that have created a strong base over time. Assuming that a company is able to meet these requirements, the discount, variety stores industry is somewhat attractive for several reasons. The industry provides great revenue and great growth potential; however, profitability is not as high compared to other industries. An attractive feature to the discount, variety stores industry, is its ability to generate revenue. In the past 12 months, the discount, variety stores industry has created $325.65 billion in revenue according to MSN’s Money Central. This figure is significantly larger than most industries. The medical instruments and supply industry, biotechnology industry, diversified utilities industry, and electronics store industry generate $7.02 billion, $8.41 billion, $11.77 billion, and $32.71 billion respectively. As shown by Table 1 below, the percentage difference in revenue between the discount, variety stores industry and the four comparison industries is fairly large. The average difference is -95.40%.
 * Primary Industry Attractiveness: **
 * Table 1 **
 * ** Industry  ** || ** Revenue ($billion)   ** || ** % Difference from Discount, Variety Industry   ** ||
 * ** Discount, Variety Stores  ** || 325.65

|| 0.00%

||
 * ** Med. Instruments & Supply  ** || 7.02

|| -97.84%

||
 * ** Biotechnology  ** || 8.41

|| -97.42%

||
 * ** Diversified Utilities  ** || 11.77

|| -96.39%

||
 * ** Electronics Stores  ** || <span style="color: black; mso-bidi-font-family: 'Times New Roman'; mso-themecolor: text1; mso-themeshade: 191;">32.71

|| <span style="color: black; mso-bidi-font-family: 'Times New Roman'; mso-themecolor: text1; mso-themeshade: 191;">-89.96%

|| Another reason the discount, variety stores industry remains somewhat attractive is its growth potential. While the economy has maintained a downward or stagnant trend the past twelve months, the discount, variety stores industry has maintained growth in their revenue. According to MSN’s Money Central, sales growth in the past 12 months for the industry was 6.70%. Reuter’s has predicted sales growth to remain positive over the next five years at 14.42% versus the S&P’s growth rate of 14.29%. Income growth over the past 12 months has also remained positive in the industry at .10%. As shown by these numbers, the industry shows it strength and attractiveness by maintaining growth in stressful economic times. Aside from large revenue and growth potential, the discount, variety stores industry maintains profitability but at a much lower rate than other industries on the S&P 500. The five year average gross margin for the discount, variety stores industry has been predicted by Reuters to be 24.74%, while the S&P 500 has an average margin for the next five years at 40.15%. This is a 15.41% difference. Also, the discount, variety stores industry lags behind the S&P 500 net income margin by a whopping 8.20%. The discount, variety stores industry generates returns but not in excess or above average. Return on investment for the industry was 3.05% for the past 12 months with a five year predicted return of 7.73%. The return on investment compared to the S&P 500 is significantly lower. The S&P 500 had a return on investment of 10.88% over the past 12 months and a five year predicted return of 11.49%. The difference of the five year predicted return between the discount, variety stores industry and the S&P 500 is 3.71%. The discount, variety stores industry is unable to make-up for this difference even with a lower cost of capital. Using the industry’s beta of .71 generated by Reuters and normal economic time benchmarks such as a market premium of 6% and risk-free rate of 5%, the discount, variety stores industry has a weighted average cost of capital (WACC) of 9.26%. Applying this same measure to the S&P 500, the S&P 500 has a WACC of 10.70%. Table 2 below shows the economic spread between WACC and ROI. As shown, discount, variety stores has a positive spread. This means the industry is losing money with cost of capital exceeding return. The S&P 500, however, has created a high enough return to cover the cost of capital.
 * Past and Future Returns: **
 * Table 2 **

(WACC-ROI) ** ||
 * || ** WACC % ** || ** ROI % ** || ** Economic Spread %
 * ** Discount, Variety Stores ** || 9.26 || 7.73 || 1.53 ||
 * ** S&P 500 Average ** || 10.7 || 11.49 || -0.79 ||