The analysis of the environmental situation contributes to an understanding of the conditions under which FIH can implement its strategic decisions.
The utilization of Industrial Economics as the approach means that a special focus is put on competition which, means that the positioning for a company is vital for its profit possibilities and according to Porter, “the key to growth – even survival – is to stake out a position that is less vulnerable to attack from head-to-head opponents, whether established or new, and less vulnerable to erosion from the direction of the buyers, suppliers and substitute goods”.
(Porter, 1980, s. 50)
The following sections represent the part of the analysis where the market arena and forces are in focus. The analysis is carried out by utilizing the framework of Industrial Economics.
The analysis will consist of three main components:
Definition of the market arena
Utilization of Porter’s Five Forces in order to analyze the competitive situation
Discussion of FIH’s positioning
The aim of the external analysis is to obtain an insight into what conditions FIH is operating under in the market place and to define FIH’s position is in the market.
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3.2.1 Market Arena
The Financial Sector (MFI17) consists, as stated in section 2.5, of banks, pension funds, insurance companies and mortgage-credit institutes.
The industry has a significant value in the Danish Society because it links together the different monetary parts in the economy. In 2009, the Financial Industry had a total balance of DKK 10,611.74 billions. (Appendix 7)
Figure 12: The Division of the Financial Industry Measured in Terms of Total Balance
Source: Appendix 7
As it can be seen on the chart, the banks sit on 41% of the total industry balance. The mortgage-credit institutes comes next with 29% and then the life insurance companies comes with 11%. The rest of the players are rather small, but ATP, which is only one individual player, actually holds 5.7% which is a lot for only one player to keep.
17The Danish Central Bank utilizes the term “Monetary Financial Sector” in its statistics – in everyday usage it is just called ”the Financial Sector”
37.90 39.37
42.61
44.22
40.75
26.28 26.20 26.05 26.34
29.23
12.00 11.42 10.48 10.45 11.42
0 5 10 15 20 25 30 35 40 45 50
2005 2006 2007 2008 2009
Percentage of the Total Balance
Year
The Division of the Financial Industry
Banks Mortgage-credit institutes Danmarks Skibskreditfond
Investment companies Investment funds Non-life insurance companies Life insurance companies Transverse pension funds Firm pension funds
ATP LD AES
SP DMP
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The composition of market players in the Financial Sector means that the market arena is broad with lots of different financial products and services targeted at different customer types and needs.
Due to the focus of this project, examples will be based on aspects that are closely linked to FIH.
3.2.2 Products
In MFI, there exists a variety of many differentiated products. Loans, derivatives, deposits and advisory are only some of the products offered. In general, the similarity among the products and services in the industry is hard to measure, because many to a great extent are flexible regarding amounts, interest rates and terms.
When seen this way, the products and services are therefore heterogeneous, but if looked upon the individual product categories and product types, it appears that they might not be as different as first assumed.
For example, if a corporate customer wants a special term deposit agreement, these are essentially quite alike – the difference lies between interest rates, costs, loan size, maturity etc.
Furthermore, services like equity trading can be argued to be similar in the way that the purchase of a wished product can be reached from a number of different providers.
In short, there exists a very high number of complex products in MFI, but within the same categories, the products are close to homogenous. The overall perspective upon MFI, however, indicates that products are in fact heterogeneous because they are so different in their setup and in targeting different customer needs.
3.2.3 Evaluating Competition
As explained above, competition is the essential analysis component which is also emphasized by Porter:”the essence of strategy formulation is coping with competition”, who also puts forth the Five Forces model as a way to illustrate the state of an industry’s competition aspects. (Porter, 1980)
Porter’s view upon Industrial economics is strongly represented in the above quotation – the focus is on strategy and competition. The famous framework known as Porter’s Five Forces which will be utilized for identifying and analyzing the competition is shown in the following.
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Figure 13: Porter’s Five Forces – “Forces governing competition in an industry”
Source: (Porter, 1980)
The Five Forces provides a framework for evaluating factors which define the competition in an industry. In this way, the competition in the Financial Industry can be characterized by the utilization of the model and thus, result in an idea of what competitive aspects that are present and how these influences the profit opportunities for FIH.
3.2.4 Competitive Rivalry
The competitive rivalry is “the intensity of competition among a firm’s direct competitors”.
(Barney & Hesterly, 2008)
As it is the whole MFI which is analyzed, all competitors within this are of concern in relation to competitive aspects.
Recent numbers from The Danish FSA and the Danish Bankers Association, states that there were 347 market participants in the beginning of 2010 in MFI; in total, 46 stock broker companies, 100 non-life insurance businesses, 60 life insurance businesses and lateral pension funds, 8 mortgage-credit institutions and 133 Banks were present. (Appendix 7)
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Consequently, the large number of market participants infers that the MFI seen from an overall perspective is highly competitive.
Also, high exit barriers support this view; locking down business operations must be seen as costly because many products and services, especially those related to the banks, pension funds and mortgage-credit-institutes, are based on long-term business relations.
However, if taking a closer look at the market participants it becomes clear that the market is dominated by a group of very big institutions and a large number of smaller competitors; in terms of the 2009 total balance, the 6 largest banks account for 34.6%, ATP for 5.7% and a the 8 mortgage-credit institutes for 29.2% whilst the 2 largest18 pension and insurance related institutions PFA Pension an Danica Pension accounts for 4.9 %. (Appendix 7)
Seen this way, the market has a high concentration because the 17 institutions accounts for approximately 75% of MFI’s total balance.
If looked upon the players from an even wider level, the big ones are spread all over the parts of the industry; e.g. the Nordea Group has both banking, mortgage-credit products and pensions etc, and that is also the case with Nykredit, Danske Bank and more.
Thus, the market seems to be controlled by a little group of dominating players and a large group of smaller competitors.
The division between the different types of market participants which are not all competing within the same product and service categories, and the heterogeneous products offered by the industry in general, questions the aspect of a highly competitive industry.
Instead, it seems that the industry is divided so that a group of leaders controls a large part of the market whilst smaller followers in large numbers fight for the remaining 25 % of the total industry balance.
3.2.5 Threat of New Entrants
Porter states that “the seriousness of the threat of entry depends on the barriers present and on the reaction from existing competitors that the entrant can expect” and further outlines that barriers to entry can exist in a number of ways which will be discussed in the following paragraphs. (1980, s. 36)
18 When excluding the already mentioned institutions
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Economies of scale is “when a firm’s costs fall as a function of its volume of production”
which means that the greater the output the smaller the costs of the individual product or service. (Barney & Hesterly, 2008, p. 41)
The following table shows the income/cost ratio for the parts of the industry where these statistics were available.
Figure 14: Income/cost ratios for bank groups and mortgage-credit institutions
Source: Appendix 7
At first notice, the income/cost ratios are having a decreasing trend, but this can be due to the Financial Crisis.
What is interesting, however, is to realize that for the banks, the ones in group level 1 have a higher income/cost ratio than the ones in group level 2 and 3 – and that is the case for all years.
This implies that the big sized banks have an advantage compared to smaller banks which means that economies of scale exists. This is also supported by the fact that the mortgage-credit institutions have a higher income/cost ratio than the banks in general, but closer to the banks in group level 1.
The future, however, might infer even bigger advantages in terms of scale; in relation to funding, big-sized banks will possibly be better off. Also, new regulations can imply that the administrative costs will increase, thus, providing even greater economies of scale. (Sørensen, 2009c)
“Product differentiation” as a barrier (Porter, 1980) must be considered to be of diminishing importance since the increasing diversification of the business areas makes everyone “the same”.However, branding and reputation is a barrier which can only be built up over time, but due to the standardization within many product and service categories it is difficult to be different.
Income/cost ratio 2005 2006 2007 2008 2009 2010 H1
Mortgage credit institutions, consolidated level 2.84 2.82 2.29 0.94 1.17 1.41 Commercial banks and savings banks, group level 1-4 1.86 1.96 1.73 1.01 0.94 1.04 Commercial banks and savings banks, group level 1 1.89 2.01 1.79 1.10 1.07 1.15 Commercial banks and savings banks, group level 2 1.72 1.93 1.67 0.71 0.75 0.76 Commercial banks and savings banks, group level 3 1.56 1.67 1.48 0.78 0.52
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Also, for new entrants “capital requirements” (Porter, 1980) is a barrier that is very consistent; the business is very dependent on having access to cheap financing and to fulfill the legal regulations to obtain and sustain the needed licenses.
“Cost disadvantages independent of size” (Porter, 1980) is not perceived to be a considerable barrier. The reason is that experience curve is partly diminishing due to the visibility in the market – for example, the Internet allows entrants to collect knowledge from others’
experiences as well as general financial knowledge.
In some areas, like advisory services, the learning curve might provide a barrier, but in general this is not perceived to be the case in the industry.
Last, but not least, “potential rival’s expectations about the reaction of existing competitors”
(Porter, 1980) are not considered to be a high barrier because of the composition of the market. The fact that the market are quite centralized and that there are great economies of scale entails that existing competitors will not be highly threatened by a newcomer and therefore, not pushed to act defensively.
However, if the entrant is, for example, a very large international institution it can put pressure on the market, but the regulative intervention in the industry and political factors can impact barriers.
Within the banking sector, for example, more competition from internationals has come over the years; in 2007 the total number was 25 and it must be expected to be must be expected to raise from the current level of 12 when the economic climate changes. (Appendix 7)
The investment service companies already have a several international competitors.
(Appendix 7)
In brief, the threat of entry is limited by great economies of scale and the high capital requirements.
What makes the threat more extensive is when taking an international perspective on the matter; huge international institutions already have access to economies of scale and to capital and can thus, be a greater threat from the beginning of their entrance on the Danish market.
Also, the diminishing differentiation in the competitors’ business profiles together with the relatively standardized products within the categories means that internationals will also be
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highly competitive on this area if they already operate within the Financial Industry in other countries.
3.2.6 Bargaining Power of Suppliers
It is essential to consider the bargaining power of suppliers as a high level of power means that they can change the prices, (Aaker, 2008) and thus cut down earnings.
The MFI is in many ways different from other industries. It is an industry where capital is the core – in terms of input as well as output.
Liquidity can be obtained in the money market. In Denmark, this is the interbank market and to a less extent the agreement market. (Danmarks Nationalbank, 2009)
The Danish Central Bank intervenes by setting the money supply once every week to the credit institutes. But, during the week, individual market participants trade liquidity with each other. (Danmarks Nationalbank, 2009) As such, they are suppliers for each other despite the fact that they compete in other areas.
However, the Danish Central Bank essentially makes sure that the money market is “well-functioning” (Danmarks Nationalbank, 2009) and the power of suppliers must be assumed not to be a great threat to the individual MFI players; the reason is that they can collect liquidity from a high number of money market participants and that there is a great visibility of changing prices (interest rate movements).
On the other hand, big positions could alter the price level, but regulations make sure that individual positions and risks do not become too big – thus, the bargaining power in the interbank market can be determined to be small.
What must be emphasized it that the bargaining power of the Danish Central Bank is huge, because it has legal powers and rights to intervene the market, but due the fact that its mains tasks are to secure price stability, secure that payments are safe and that the financial system is stable (Danmarks Nationalbank, 2009), it really cannot be perceived as a supplier which poses a threat for the MFI players. Consequently, the Central Bank is rather supporting MFI rather than putting pressure upon the players.
In brief, it can be concluded that the bargaining power of suppliers are very limited.
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3.2.7 Bargaining Power of Customers
Customers “can force down prices, demand higher quality or more service, and play competitors off against each other – all at the expense of industry profits”. (Porter, 1980, s.
40)
In the MFI, there exists many different types of customers; corporations, consumers and professional investors etc.
Several things play a role for whether or not these customers can be perceived to have bargaining power.
The number of buyers in the industry is very high. As already argued, the MFI services everyone’s need for financial solutions in different areas. This indicates that buyers do not have much bargaining power. (Barney & Hesterly, 2008)
The fact that the products are quite homogenous and standardized within the categories means that buyers “can always find alternative suppliers”, (Porter, 1980) meaning that a provider can easily lose its customers to competitors.
This however can incur switching costs which means that the customers’ bargaining power decreases. (Brealy, Myers, & Allen, 2008)
The size of the individual customer is also of concern because a customer will have more power if “its purchase size is a large proportion of the seller’s business”. (Aaker, 2008) For some customer groups like huge institutional investors and big corporations it can be the case that they hold more bargaining power than smaller customers.
This is especially an aspect which is supported by the fact that for example corporate customers, as earlier mentioned, are demanding a wide palette of products and consequently, their demand entails that they will become even more important because their purchase is linked to several products and services.
This aspect assumes that the seller (MFI) is dependent on a particular customer group which cannot be argued to always be the case. But, it must be emphasized that there is a possibility that big customers could have better terms for negotiation.
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In general, the customers cannot be seen as having a great bargaining power based on the fact that the survival of individual market players does not depend on only a few customers. FIH for example, has thousands of corporate customers.
In brief, the bargaining power of the customers depends on their relative size and impact on the seller. The decreasing number of banks players, cf. Appendix 7, however, infers that competition is centralized to a few places, thus limiting the customers’ bargaining power.
3.2.8 Threat of Substitute Products or Services
Porter states that “substitution is the process which one product or service supplants another in performing a particular function or functions for a buyer”. (2004)
Hereby said, the threat stems from the fact that current products or services within the industry either is subject to competition or substitution.
The problem is that substitution can “limit the potential in an industry” due to the fact that it influences the price level. (Porter, 1980)
For example, corporate loans are not only offered by the banks – in 2009, the mortgage-credit institutes collectively had DKK 102.8 billion of loans given to corporate properties which corresponded to 21.59% of the total advances. (Realkreditrådet, 2010)
Also, the development of new combinations of financial products, resulting in new ones, is a threat, but still, one that is essentially stemming from the industry itself – however, new combinations do not have to out-compete existing ones; it can also be complementary.
In general, Porter mentions that basic threats are that a “buyer does not purchase anything at all” or “lower the usage rate of the product required”. (2004) These are, of course, also threats for MFI, but as the industry competitors have licenses to be e.g. stock brokers, this means that the customer will not be able to fully trade on his own.
Developments of technical solutions or superior products which substitute the expertise of the MFI players are considerable threats, because they have the potential to make existing products obsolete.
Threats related to corporate products and services are that firms become self-financing.
However, it seems unlikely that the majority of companies will be 100% equity-financed, as there are advantages of having debt due to tax advantages and the fact that a company can
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leverage its business by lending money which it can invest in for example business improvements.
Other threats could be that the buyers found a solution between themselves; e.g. if firms, instead of lending from MFI, decided to go together in a group and make a pool of funds which could then be lent out to the ones that needed it.
In general, I can outline that prevailing threats are:
Development of new superior products with the result of complementing or substituting existing products
Changes in customers’ needs and preferences
Replacement of products so already existing products can be utilized in other ways
Alternative ways for customers to satisfy their need for products
However, due to the many regulations existing in the area, it must be strongly emphasized that the threat of substitute products or services from the outside of the industry is not very big.
Rather, it is the internal competition and development among products which are the main threat.
3.2.9 Reflections on the Competition in the Financial Industry
As the evaluation above demonstrated, the competition in the financial industry is moderate;
there are many competitors, but industry elements make the biggest most powerful. Suppliers have essentially no bargaining power whilst the customers’ bargaining powers relates to their relative purchase size.
In general, transparency in the market is high, because it is easy to observe what is happening in the market – mainly, due to information technology solutions. Interest rates, economic data and stock prices etc. are all available for the interested party.
However, if the large players in the industry make strategic changes – for example decreases the interest rate margin to its customers thus being able to offer better prices, but earning smaller profits, the visibility in the market implies that competing firms need to follow the new price setting under the assumption that the customer loyalty is low.