Competitive Analysis: Porter’s Five-Forces Model
The collective impact of competitive forces is so brutal in some industries that the market is clearly “unattractive” from a profit-making standpoint. Rivalry among existing firms is severe, new rivals can enter the industry with relative ease, and both suppliers and customers can exercise considerable bargaining leverage. According to Porter, the nature of competitiveness in a given industry can be viewed as a composite of five forces: 1. 2. FIGURE 3-3 The Five-Forces Model of Competition Potential development of substitute products Rivalry among competing firms Potential entry of new competitors
Bargaining power of suppliers Rivalry among competing firms Bargaining power of consumers Potential entry of new competitors CHAPTER 3 • THE EXTERNAL ASSESSMENT 75 TABLE 3-10 Intensity of Competition Among Firms in Different Industries (A through H industries only) Year-End Profit Margin 2006 2008 6 2 5 1 7 5 16 8 18 6 12 4 7 3 2 10 10 2 5 0 4 3 3 5 4 3 4 6 7 8 -13 9 -8 3 5 5 10 32 4 -1 7 7 1 3 -10 12 2 7 1 7 -10 3 2 2 3 1 -47 -5 Year-End Return on Investment 2006 2008 6 2 8 3 4 5 1. 3 7 8 7 1 5 8 3 4 4 6 5 6 1 7 4 5 8 4 9 6 6 3 8 -14 34 -10 2 6 0. 3 12 20 5 0 3 9 2 5 -3 2 4 7 1 11 -8 5 4 3 7 1 -43 0
Competitive Analysis: Porter’s Five-Forces Model Essay Example
Industry Aerospace and Defense Airlines Apparel Automotive Retailing Beverages Chemicals Commercial Banks Computer Peripherals Computer Software Computers, Office Equipment Diversified Financials Diversified Outsourcing Services Electronics, Electrical Equipment Energy Engineering, Construction Entertainment Financial Data Services Food and Drug Stores Food Consumer Products Food Production Food Services Forest and Paper Products General Merchandisers Health Care: Insurance Health Care: Medical Facilities Health Care: Pharmacy Home Equipment/Furnishings Homebuilders Hotels, Casinos, Resorts
Source: Based on John Moore, “Ranked Within Industries,” Fortune (May 4, 2009): F-46–F-60. 3. 4. 5. Potential development of substitute products Bargaining power of suppliers Bargaining power of consumers The following three steps for using Porter’s Five-Forces Model can indicate whether competition in a given industry is such that the firm can make an acceptable profit: 1. 2. 3. Identify key aspects or elements of each competitive force that impact the firm.
Evaluate how strong and important each element is for the firm. Decide whether the collective strength of the elements is worth the firm entering or staying in the industry. Rivalry Among Competing Firms Rivalry among competing firms is usually the most powerful of the five competitive forces. The strategies pursued by one firm can be successful only to the extent that they 76 PART 2 • STRATEGY FORMULATION provide competitive advantage over the strategies pursued by rival firms.
Changes in strategy by one firm may be met with retaliatory countermoves, such as lowering prices, enhancing quality, adding features, providing services, extending warranties, and increasing advertising. Free-flowing information on the Internet is driving down prices and inflation worldwide. The Internet, coupled with the common currency in Europe, enables consumers to make price comparisons easily across countries. Just for a moment, consider the implications for car dealers who used to know everything about a new car’s pricing, while you, the consumer, knew very little.
You could bargain, but being in the dark, you rarely could win. Now you can shop online in a few hours at every dealership within 500 miles to find the best price and terms. So you, the consumer, can win. This is true in many, if not most, business-to-consumer and business-to-business sales transactions today. The intensity of rivalry among competing firms tends to increase as the number of competitors increases, as competitors become more equal in size and capability, as demand for the industry’s products declines, and as price cutting becomes common.
Rivalry also increases when consumers can switch brands easily; when barriers to leaving the market are high; when fixed costs are high; when the product is perishable; when consumer demand is growing slowly or declines such that rivals have excess capacity and/or inventory; when the products being sold are commodities (not easily differentiated such as gasoline); when rival firms are diverse in strategies, origins, and culture; and when mergers and acquisitions are common in the industry.
As rivalry among competing firms intensifies, industry profits decline, in some cases to the point where an industry becomes inherently unattractive. When rival firms sense weakness, typically they will intensify both marketing and production efforts to capitalize on the “opportunity. ” Table 3-11 summarizes conditions that cause high rivalry among competing firms. Potential Entry of New Competitors Whenever new firms can easily enter a particular industry, the intensity of competitiveness among firms increases.
Barriers to entry, however, can include the need to gain economies of scale quickly, the need to gain technology and specialized know-how, the lack of experience, strong customer loyalty, strong brand preferences, large capital requirements, lack of adequate distribution channels, government regulatory policies, tariffs, lack of access to TABLE 3-11 Conditions That Cause High Rivalry Among Competing Firms 1. High number of competing firms 2. Similar size of firms competing 3. Similar capability of firms competing 4.
Falling demand for the industry’s products 5. Falling product/service prices in the industry 6. When consumers can switch brands easily 7. When barriers to leaving the market are high 8. When barriers to entering the market are low 9. When fixed costs are high among firms competing 10. When the product is perishable 11. When rivals have excess capacity 12. When consumer demand is falling 13. When rivals have excess inventory 14. When rivals sell similar products/services 15. When mergers are common in the industry
CHAPTER 3 • THE EXTERNAL ASSESSMENT 77 raw materials, possession of patents, undesirable locations, counterattack by entrenched firms, and potential saturation of the market. Despite numerous barriers to entry, new firms sometimes enter industries with higher-quality products, lower prices, and substantial marketing resources. The strategist’s job, therefore, is to identify potential new firms entering the market, to monitor the new rival firms’ strategies, to counterattack as needed, and to capitalize on existing strengths and opportunities.
When the threat of new firms entering the market is strong, incumbent firms generally fortify their positions and take actions to deter new entrants, such as lowering prices, extending warranties, adding features, or offering financing specials. Potential Development of Substitute Products In many industries, firms are in close competition with producers of substitute products in other industries. Examples are plastic container producers competing with glass, paperboard, and aluminum can producers, and acetaminophen manufacturers competing with other manufacturers of pain and headache remedies.
The presence of substitute products puts a ceiling on the price that can be charged before consumers will switch to the substitute product. Price ceilings equate to profit ceilings and more intense competition among rivals. Producers of eyeglasses and contact lenses, for example, face increasing competitive pressures from laser eye surgery. Producers of sugar face similar pressures from artificial sweeteners. Newspapers and magazines face substitute-product competitive pressures from the Internet and 24-hour cable television.
The magnitude of competitive pressure derived from development of substitute products is generally evidenced by rivals’ plans for expanding production capacity, as well as by their sales and profit growth numbers. Competitive pressures arising from substitute products increase as the relative price of substitute products declines and as consumers’ switching costs decrease. The competitive strength of substitute products is best measured by the inroads into the market share those products obtain, as well as those firms’ plans for increased capacity and market penetration.
Bargaining Power of Suppliers The bargaining power of suppliers affects the intensity of competition in an industry, especially when there is a large number of suppliers, when there are only a few good substitute raw materials, or when the cost of switching raw materials is especially costly. It is often in the best interest of both suppliers and producers to assist each other with reasonable prices, improved quality, development of new services, just-in-time deliveries, and reduced inventory costs, thus enhancing long-term profitability for all concerned.
Firms may pursue a backward integration strategy to gain control or ownership of suppliers. This strategy is especially effective when suppliers are unreliable, too costly, or not capable of meeting a firm’s needs on a consistent basis. Firms generally can negotiate more favorable terms with suppliers when backward integration is a commonly used strategy among rival firms in an industry. However, in many industries it is more economical to use outside suppliers of component parts than to self-manufacture the items.
This is true, for example, in the outdoor power equipment industry where producers of lawn mowers, rotary tillers, leaf blowers, and edgers such as Murray generally obtain their small engines from outside manufacturers such as Briggs & Stratton who specialize in such engines and have huge economies of scale. In more and more industries, sellers are forging strategic partnerships with select suppliers in efforts to (1) reduce inventory and logistics costs (e. g. through just-in-time deliveries); (2) speed the availability of next-generation components; (3) enhance the quality of the parts and components being supplied and reduce defect rates; and (4) squeeze out important cost savings for both themselves and their suppliers. 13 Bargaining Power of Consumers When customers are concentrated or large or buy in volume, their bargaining power represents a major force affecting the intensity of competition in an industry.
Rival firms may 78 PART 2 • STRATEGY FORMULATION offer extended warranties or special services to gain customer loyalty whenever the bargaining power of consumers is substantial. Bargaining power of consumers also is higher when the products being purchased are standard or undifferentiated. When this is the case, consumers often can negotiate selling price, warranty coverage, and accessory packages to a greater extent.
The bargaining power of consumers can be the most important force affecting competitive advantage. Consumers gain increasing bargaining power under the following circumstances: 1. 2. 3. 4. 5. If they can inexpensively switch to competing brands or substitutes If they are particularly important to the seller If sellers are struggling in the face of falling consumer demand If they are informed about sellers’ products, prices, and costs If they have discretion in whether and when they purchase the product14