Okay, we're talking about the five forces analysis. And remember this is a tool that helps us think carefully about these five competitive forces that all work against or threaten the profitability potential of an industry or a market segment, right? So let's start with the first one, threat of entry. Now, the question is, do we want the threat of entry to be high or low? Well, the five forces tool tells us that we want the threat of entry to be low because remember, we're already in the industry, we're trying to analyze what's the profitability potential of this industry as it exists? So while potential new entrants might want the entry barriers to be low and therefore the threat of entry to be high, we're already in this industry and we want that threat of entry to be low. So the question is, what sorts of things might make the threat of entry low? What would diminish the chances of more and more competitors entering this industry to compete with us? So there's several things to think about here. The threat of entry is going to be lower if all these potential new entrants face high sunk costs. Now, I've chosen those words very carefully because it's not just high costs. If it is going to cost a new entrant a lot to enter the industry if they have to raise a bunch of capital that in and of itself might not be an impediment to them entering. Remember, if we've got a good idea and a good business plan, we should be able to go to the capital markets and raise money so that we can enter an industry. But if they're high sunk costs, that is going to give these potential new entrants a little more pause. One way of thinking about sunk cost is these are things are highly asset-specific. In other words, they represent risks to these potential new entrants, that if things don't work out in their attempt to enter the industry, they're going to have difficulty recovering those costs are investments, right? So, for example, if we think of an industry, let's say we were going to start a new big-box retailer and park it out there on the highway next to all the other big-box retailers, what we need to do is raise a bunch of money to build that building. But if things don't work out, if it turns out, we can't out-compete, Costco or Walmart, we're probably going to be able to sell that big building to somebody else, right? So it's a capital expenditure, but it might not necessarily be a sunk cost, it's not highly asset-specific. Let's say in contrast that we were going to enter the amusement park industry, we were going to build a roller coaster park, well, those are assets that we can't use for much else, right? So, we've got, we think we've got this great idea to build a theme park right next to Disney World and it turns out we can't really compete very well with them and they run us out of business, It's going to be very hard for us to get our money back from those sunk costs, right? So that's the idea here, that might be something that diminishes the likelihood of new entrants entering the industry if those new entrants all face high sunk costs. Let's talk about another one, what if it's just the case that a particular industry has an incumbent or a set of incumbents in that industry that just have a really dominant competitive advantage? That might actually diminish the chances of someone entering a new entrant entering the industry, right? Because if they're going to be at a competitive disadvantage compared to the existing players, it just might not be profitable to enter. So, let's talk about some ways in which incumbents might have a competitive advantage. Their competitive advantage might arise from intellectual property, secret sauce of some type, right? And it might even be explicitly protected by patents or licenses or copyrights, right? If to really succeed in an industry, we need this intellectual property and someone already owns that intellectual property, well, it's going to be very hard for new entrants to compete. So remember, if we're in that industry that's good for us because that would lower the threat of new entrants because they're going to be very hesitant to come compete with us if we've got all the intellectual property tied up, right. Another thought here might be pioneering brands. What I mean by that are these sort of iconic brands that come to sort of define an industry, so when we think of internet search, who do we think of? We think of Google, in fact, my children will say, hey, google that or google this, right? I mean they use it as a verb for internet search. So google has become sort of this dominant brand associated with internet search. We might say the same thing about Kleenex or xerox, we might not make a photocopy, we might make a xerox of something. So, if a particular company has, it just dominates the sort of the psyche of an industry and where customers that are seeking those goods or services just tend to google and xerox them, that might be a structural disadvantage for a new potential new entrant, right. And so again, that might lower the threat of new entrants if there's some household name firms that tend to sort of dominate their kind of, these pioneering brands. Now, the caveat is, I always caution my students to do not think that if that's your source of competitive advantage, it might not be unassailable, right? History is littered with all sorts of stories about pioneering brands that have fallen by the wayside as they've been replaced by newer, better ideas. So, again, these sources of competitive advantage might not be perfect, but under certain circumstances, they might serve to lower the risk of potential new entrants. Let's talk about pre-commitment contracts. So this is an idea about perhaps there are firms in the industry that have already sort of tied up all of, say the distribution channels. So this might be an entry barrier in an industry like mass brewing or soft drinks, right? Pepsi and Coke or Anheuser Busch might have a lot of the distribution channels sort of tied up in contracts already and that might be an impediment to new entrants entering the mass brewing or soft drink industry, right? So these pre-commitment contracts can be a source of competitive advantage. Let's talk about large economies of scale, relative to demand. Here's a concept from economics, it's worth diving into this one a little bit. If you look here on the Y-axis, we've got price or cost on the X-axis, we've got output. And the idea here is that the more our output increases, the average cost per unit is going to come down, and it's going to come down to the point until we hit this point that we call minimum efficient scale or MES. And the idea here is that minimum efficient scale is really the point that you need to achieve to be cost-competitive in an industry. Now, different industries will have different sort of levels of minimum efficient scale. Some industries, just because the technology or the structure of the industry might have a minimum efficient scale that's very high, so in mass brewing, it's going to be quite higher in automobile manufacturing, it's going to be quite high, right? Other industries, the minimum efficient scale might be lower. And to the extent that economies of scale don't matter so much, then the threat of entry is going to go up, right? But if it's really important to have this minimum efficient scale and that's really difficult to achieve, then that's going to lower the threat of entry, right? Well, let's talk about a sort of related idea that involves learning curves or experience curves. So, I'll show you another graph here, this looks a lot like the economies of scale illustration we've got unit cost on the Y-axis, we've got output on the X-axis but there's a key difference, the output here is cumulative, so it's not just average output or unit output this year, but it's cumulative output. In other words, are we getting better at this, and is that lowering our manufacturing costs because we're just doing more and more of it. I mean, think of it as the very intuitive idea from each of our personal lives of practice makes perfect. The cost of doing something comes down if we get better at it, and oftentimes the best way to get better at it is to just do more and more of it, right? And we see this in industries, we see, take the semiconductor industry, there's an industry where people talk about Moore's law which essentially says that the every 18 months the capacity doubles just because of the march of technology, right. And so what we see over time, here's something from the semiconductor industry. What we see is that the sort of cost per bit we think of as kind of the unit cost, what does it cost these firms to produce semiconductors? It just keeps coming down the more and more of this that the firms do. And so again, the point here is that this can be a source of competitive advantage because it makes it very difficult for a new entrant to catch up with the incumbents that have a competitive advantage arising from learning curves or any of these other factors. So that's the key thing to think about in terms of threat of entry. Are there structural things about competitive advantage that will make threat of entry lower or higher depending on the dynamics of the industry?
