Read the article given below on Analysis of I Industry a Attractiveness on US tobacco industry

and answer following questions.

a) Briefly explain the Michael Porter's 5 forces model and why strategists use the model in

strategy formulation process. (10 marks)

b) Explain how you determine the attractiveness of an industry environment for an organization.

(20 marks)

c) Describe the forces and their respective competitiveness for Altria management to determine

whether to make further investment in this company. (50 marks)

d) Express your opinion on what the management of Altria should do? Give reasons for your

answer. (20 marks)

United States Tobacco Industry

The U.S. tobacco industry is rather interesting. At a time when the industry on the whole is

grappling with declining volumes, two big tobacco players, Reynolds (No.2) and Lorillard (No.3)

have joined forces to increase the level of consolidation in the industry, which could

significantly alter the competitive landscape going forward. In this article, we use Porter's

model of industry rivalry to assess the U.S. tobacco industry on the basis of the threat of

potential new entrants, the bargaining power of suppliers, the bargaining power of buyers, and

the threat of substitutes. We use this analysis to assess prospects for the leader, Altria, in this

industry.

Threat of New Entrants: The threat of new entrants is an important factor for judging the

level of competition in an industry, since a proliferation of new entrants could result in share

losses for incumbent firms. In this case, pricing power could be severely hampered as firms may

have to slash prices in order to maintain their market shares.

Now, do we foresee any new players in the U.S. tobacco industry in the short to medium run?

Probably not. Although barriers to entry in the tobacco industry are low, in the sense that it is

easy for smaller players to enter the market, it may not be very viable for them to compete

against conglomerates such as Altria at a national level. This is because these companies enjoy

economies of scale in manufacturing, packaging, branding, distribution, and marketing, the

costs associated with which, could be extremely high for a smaller company to undertake.

Furthermore, a ban on tobacco advertisements could make it difficult for smaller names to

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drive brand recognition among the masses, making it hard for them to broaden their customer

base. Having said this however, Altria could face stiff competition in the future from other big

tobacco names that have established themselves in markets outside of the U.S. For one, with

the Reynolds-Lorillard merger, the industry will see the British tobacco company, Imperial,

competing at the No.3 spot with some of its own brands, and some divested brands from

Reynolds. In this case, Altria continues to face a threat from new entrants, who have already

built the necessary capital needed to compete at a national level from operations in other

markets.

Bargaining Power of Suppliers: Supplier bargaining power is an important parameter to

assess competition since it could translate into higher costs for tobacco producers to reduce

overall industry profitability. The degree of supplier bargaining power depends on factors such

as the number of suppliers in the market, the value of the firm demanding the product to the

supplier, the scarcity of the resource, and the substitutability of the resource.

Companies such as Altria rely on farmers for tobacco supply. Since the 1930s, the U.S.

government regulated the tobacco market under a quota system, where a farmer could grow

only a fixed amount of the crop. This restriction in supply, along with government initiatives

such as the provision of low interest loans, guaranteed minimum price and grower cooperatives

(bought unsold tobacco), and made the crop a rather profitable one for farmers to grow.

However, in 2004, this system ended with the introduction of a $9.6 billion buyout program,

which paid farmers a fixed sum annually to help them transition to free markets. This, coupled

with dwindling tobacco volumes, have led to plummeting profits, against which, farmers have

lost their bargaining power. The loss in the degree of bargaining power for suppliers in the U.S.

is evident from the statement below made by Marvin Eaton, a farmer who currently supplies

tobacco to Altria and Reynolds "The companies, they're in control, and if they don't want

Marvin Eaton raising tobacco and I can't make a living on what they say they're going to pay me

for, then I, Marvin Eaton needs to get him something else he enjoys doing."

Bargaining Power of Buyers: In some cases, powerful buyers could exert a downward

pressure on prices to reduce industry profitability. Bargaining power here depends on factors

such as the number of buyers in the market, availability of substitutes, and the number of firms

producing the product.

In the tobacco industry, at large, bargaining power of buyers may be lower. Part of this is solely

based on the addictive nature of the product involved. In general, tobacco companies tend to

have a greater command on pricing since there will always be a proportion of the population

that will buy cigarettes irrespective of its price. Furthermore, cigarette demand in general is

price inelastic, i.e. demand is less responsive to changes in price. Now, with the ReynoldsPage

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Lorillard merger, and further consolidation in the industry, buyers could lose out further on

bargaining power since they would have fewer substitutes to turn to in the situation that any

one firm resorts to price hikes.

Threat of Substitutes: A substitute product can be anything that is produced in a different

industry but manages to meet the same needs. In the case of tobacco, this would entail overthe-

counter products such as nicotine patches, gum, nasal sprays, lozenges, and other products.

With growing awareness about the ill-effects of smoking and regulatory crackdown on the

industry making the product expensive, many Americans have been opting for tobacco

substitutes. Furthermore, there are hardly any costs associated with switching to an alternate

in this case. For instance, if a smoker smoking a pack of cigarettes costing $5.50 chooses to quit,

he can save up to $1,980 in a year. Even the cost of nicotine replacements is far lower than that

of cigarettes, in that the smoker could save anything between $11-$47 a week depending on his

choice of therapy. (See: Choice of Over-the-Counter Nicotine Replacement Therapy -

Factsheet) Such savings could be a huge incentive for smokers to kick the habit going forward.

However, new on the block are e-cigarettes, which have been seeing unprecedented growth

over the past few years. Big tobacco companies such as Altria have been capitalizing on the

opportunity in this realm, which could go on to benefit them. However, while e-cigarettes could

be an effective tool for "damage control," it is highly unlikely that they will actually go on to

offset the losses coming in from a declining market.

Competitive Rivalry: The U.S. tobacco industry was already highly consolidated and this level

of consolidation is expected to further intensify this year on, with the Reynolds-Lorillard

merger. The post-merger Reynolds is expected to have a stronger presence with 34% of the

market, as opposed to 28%, to form a stronger competitive force against Altria. Apart from this,

the entity is expected to have a clear win in the Menthol market, with America's top brand,

Newport (37% market share), in its portfolio. Clearly, these two powerhouses joining forces is

bound to bring in synergies in production, distribution, and promotions. In order to compete

effectively, Altria may have to incur costs going forward to drive its brand presence among the

masses. This is particularly true for Menthol, where Altria's Marlboro Menthol could lose share

to the likes of Newport and Camel, which have, in general, been seeing rising shares and could

only benefit further from the merger.

In conclusion, while Altria could have little to worry about when it comes to factors such as new

players entering the market, they could be threatened as an increasing number of smokers opt

for substitutes in an attempt to quit smoking. This development, along with an intensifying

competitive landscape, could threaten prospects for the company. However, further

consolidation in the industry could bring with it certain advantages, particularly in the form of

higher pricing power, which could ensure steady profits for Altria going forward.