Competitive Analysis

Michael Porter’s five forces describe the characteristics of an industry that influence how profitable firms

in the industry will be.

The five forces are(1) rivalry among existing firms in the industry

(2) potential entrants and barriers to entry

(3) substitute and complementary products

(4) the bargaining power of clients/customers

(5) the bargaining power of suppliers

In general, a firm is likely to be more profitable

(1) the less intense is the rivalry in its industry; (2) the less danger of potential entrants & the higher the

barriers to entry; (3) the less numerous and less aggressive the firms that

sell substitute products, and the more numerous and more aggressive the firms that sell complementary products;

(4) the weaker the bargaining power of clients/customers; and

(5) the weaker the bargaining power of suppliers.

In industry and competitive analysis, firms examine their positions along these lines and seek ways to change conditions to be more favorable to the firm.

(1) Rivalry

Good rivals, in terms of industry profits, are rivals who are restrained in their competition.

They are willing to following your firm’s lead.

In markets that are segmented into different groups of buyers, good rivals are satisfied with taking care of their groups and letting you take care of yours.

(2) Potential Entrants & Barriers to Entry

Since industry profits encourage new firms to enter, firms in a profitable industry remain profitable to the extent that barriers to entry keep out potential entrants.

Types of Entry Barriers

1. Tangible barriers – anything that would put a potential entrant at a competitive disadvantage after entry.

2. Psychological barriers – beliefs on the part of potential entrants that, if they enter, firms already in the business will react aggressively, and are even willing to incur short-term losses, to force out the new entrant.

Tangible barriers - examples

1. scale-based cost advantages: when fixed costs are high & the efficient scale is large

2. scope-based cost advantages: when fixed costs can be shared among different products (Operation may be cheaper for firms that are already producing other products with connected fixed costs.)

3. knowledge-based cost advantages: when experience is an important factor in knowing how to do things efficiently

Tangible barriers – examples cont’d4. financial resources: when firms are able to

fight off new entrants by cutting prices as a result of having significant financial resources available

5. favored access to particular resources: when existing firms control resources that are useful or essential to efficient operation (For example, airlines may control landing slots at favorable times.)

6. favored access to distribution channels: when existing firms can more easily reach the customers

Tangible barriers – examples cont’d7. customer goodwill and reputation: when a firm

has built up a loyal customer base, but new entrants have to win those loyal customers away or convince new customers who were not buying the product to do so

8. customer lock-in: when customers tend to continue with the original firm because of issues such as compatibility with existing equipment, economies in maintenance & repair, etc.

9. legal & political restrictions: when firms are protected against entry by legal restrictions such as government certification or licenses (Existing firms may also encourage the government to ban foreign competitors from entering the industry.)

Creating Psychological Barriers

1. Fighting off an entrant or two is one way for a firm to gain a reputation for being willing & able to fight off new entrants.

2. Maintaining excess capacity for production or distribution can also deter entry.

3. Keeping patents & products on the shelf ready for use if needed can also send a strong signal.

(3) Substitutes & ComplementsIf there are many good substitutes for a product,

the elasticity of demand for that product will be high.

This will limit the ability of the firm to raise prices and will consequently lower potential profits.

Suppose in addition, that a firm raises its prices. If firms producing substitute goods would take advantage of the opportunity to actively entice away customers, the profitability of the original firm would be limited.

Strong complements can increase the profitability of a good.

For example, disposable diapers (as opposed to cloth diapers) are strongly complementary with travel. So when the travel industry is booming, the disposable diaper industry is better off.

(4) Bargaining power of clients/customers

Factors that tend to make a client/customer more powerful:

1. The client industry is highly concentrated. (The firms buying the product are in an industry in which there are just a few companies and they are large.)

2. One particular client industry buys a very large share of the products of the selling industry.

3. The item is not essential to the clients; there are lots of good substitute inputs in the clients’ production process.

4. The cost of the item is a large fraction of the clients’ costs/budget. The client is then likely to resist attempts to push up prices.

(5) Bargaining power of suppliers

Factors that tend to make a supplier more powerful:

1. The supplier has a franchise or patent on a particular item that is required by firms in the industry.

2. The supplier is not restrained by any close substitutes for its product.

3. The supplier industry is concentrated (there are very few firms) and the firms are not aggressive rivals with each other.

A firm's relative position within its industry determines whether a firm's profitability is above or below the industry average.The fundamental basis of above average profitability in the long run is sustainable competitive advantage.

Competitive Advantage

Strategies are based on a combination of Competitive Advantage and Competitive Scope.

Competitive Advantage

Competitive Scope

There are two types of competitive advantage a firm can possess: lower cost or differentiation.

Competitive Advantage

Lower Cost Differentiation

Competitive Scope

The firm can seek to achieve these advantages for a broadly or narrowly focused scope of activities or customers.

Competitive Advantage

Lower Cost Differentiation

Competitive Scope

Broad Target

Narrow Target

Combining the two types of competitive advantage with the scope of activities or customers leads to four strategies. The two narrowly focused strategies are often considered a single focus strategy with two variants.

Competitive Advantage

Lower Cost Differentiation

Competitive Scope

Broad Target

Overall Cost Leadership

Broadly Targeted Differentiation

Narrow Target

Cost Focus Differentiation Focus

Overall Low-Cost Producer

The sources of cost advantage depend on the structure of the industry. if a firm can maintain overall cost leadership, then it will be an above average performer in its industry, provided it can command prices at or near the industry average.

Some of the major drivers of cost1. Economies of scale,2. Learning and experience curve effects,3. High percentage of capacity utilization,4. Sharing opportunities with other business units

within the enterprise,5. Vertical integration with suppliers or buyers,6. Timing considerations associated with first-

mover advantages and disadvantages, and7. Locational factors such as differences in wage

levels, tax rates, energy costs, and shipping costs.

Characteristics of the overall low-cost leadership strategy

Production emphasis: “Nobody does it cheaper.”Marketing emphasis: “Budget Prices and Good

Value.”Standardized products – only a few models and

limited optional features.No Frills operating culture – lean and mean

reputation.Lower prices leads to higher volume and greater

market share which leads to lower costs due to experience effects.

Higher productivity per employee.Cost-cutting innovations.Accept low profit margins in return for high volume.

Differentiation

The firm selects one or more attributes that many buyers in an industry perceive as important, and uniquely positions itself to meet those needs. It is rewarded for its uniqueness with a premium price.

Areas that tend to lead to longer-lasting competitive advantage

are differentiation based on

• Technical superiority

• Quality

• More support services

• More value for the money

Differentiation strategies work best in situations where

• There are many ways to differentiate the product or service and these differences are perceived by some buyers to have value,

• Buyers needs and uses of the item are diverse, and

• Not many rival firms are following a differentiation strategy.

Characteristics of the broadly focused differentiation strategy

Production emphasis: “Nobody makes it better.”Marketing emphasis: “Ours is better than theirs.”Many frills – different models, options, features,

and services.One or more points of difference.Frequent innovation.Premium pricing to cover cost of differentiation.Intensive advertising and sales efforts.

Focus

The firm selects a segment or group of segments in the industry and tailors its strategy to serving them to the exclusion of others.

The focus strategy uses differences between a target segment and other segments in the industry.

cost focus strategy

The production and delivery system that best serves the targeted customers differs from that of other industry segments.

The cost focus strategy exploits the cost differences.

differentiation focus strategy

The targeted customers must have unusual needs.

The differentiation focus strategy exploits those special needs.

A focused strategy may be appropriate when

• There are distinctly different groups of buyers who either have different needs or else utilize the product in different ways,

• No other rival is attempting to specialize in the target segment,

• The firm’s resources do not permit it to go after a wide segment of the total market, and

• Industry segments differ widely in size, growth rate, profitability, and intensity of the five competitive forces, such that some segments are much more attractive than others.

Characteristics of the narrowly focused strategies

Production emphasis: “Made especially for you.”Marketing emphasis: “Ours meets your needs

better.”Specialization for buyer segments, geographic

areas or end-use applications.Competitive advantage depends on being the

low-cost leader in the target segment, or doing something particularly appealing to the targeted customers.