PORTER�S FIVE FORCES MODEL OF COMPETITION

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PORTER�S FIVE FORCES MODEL OF COMPETITION Powered By Docstoc
					             EXTERNAL ENVIRONMENTS
         (2) THE COMPETITIVE ENVIRONMENT
                (2b) INDUSTRY COMPETITIVE FORCES
      USING A CHOSEN INDUSTRY, WE STUDY THE COMPETITIVE ENVIRONMENT FROM THE
PERSPECTIVE THAT SIX EXTERNAL FORCES ACT TO CREATE OPPORTUNITIES OR THREATS THAT
AFFECT INDUSTRY PROFITS. THESE FORCES OF COMPETITION USUALLY AFFECT AN INDUSTRY
MORE DIRECTLY AND SWIFTLY THAN SEGMENTS OF THE MACROENVIRONMENT, BECAUSE THEIR
IMPACT OCCURS IN THE DAY-TO-DAY INTERACTION BETWEEN FIRMS. UNDERSTANDING THE
INTERACTIONS THAT OCCUR IN THE COMPETITIVE ENVIRONMENT DRAW FROM TERMS AND
CONCEPTS USED IN OUR DISCUSSION OF INDUSTRY CHARACTERISTICS.




          (1) RIVALRY        (2) BARGAINING
             AMONG
             COMPETITORS
                                POWER OF
                                SUPPLIERS             OPPORTUNITIES



                                                                INDUSTRY
          (3) POTENTIAL         (4) BARGAINING                   PROFITS
              ENTRANTS              POWER OF
                                    BUYERS




          (6) SUBSTITUTES   (5) COMPLEMENTORS
                                                      THREATS




     OUR IMMEDIATE GOAL IS TO UNDERSTAND HOW EACH FORCE POTENTIALLY AFFECTS
     INDUSTRY PROFITS. THIS KNOWLEDGE WILL HELP US UNDERSTAND HOW MANAGERS OF
     FIRMS COMPETING IN THE INDUSTRY CAN IMPROVE THEIR COMPETITIVE POSITION WITH
     RESPECT TO EACH OF THE SIX FORCES WHEN WE SHIFT OUR FOCUS TO THE INTERNAL
     ENVIRONMENT AND STRATEGY
(1) INTENSITY OF RIVALRY AMONG COMPETITORS
Intense rivalry (head-to-head competition) occurs when competitors react quickly and
aggressively to each other’s competitive moves. We see this among firms engaged in price-
cutting in firms that try to differentiate products. In most cases, the following industry
characteristics are associated with more intense rivalry. Keep in mind that, as in all other
forces of competition, intensity of rivalry is a dynamic phenomenon.
Industry Growth is Stagnant or Declining: Intense rivalry to keep market share or take it
away from competitors. We often see price wars and/or attempts to differentiate products
(e.g., domestic noncraft beer firms engage in massive advertising campaigns, PC makers
have recently cut prices). Under these industry conditions, firm growth generally occurs
by taking market share from competitors rather than by generating new demand.
Industries with Degree of Consolidation Toward the Extremes:
        In consolidated industries, larger competitors watch each other’s moves carefully
and usually respond vigorously with countermoves. This is especially true when firms are
large and have ample resource bases that make retaliatory actions possible (e.g., vigilance
and quick response of jet engine makers, big pharmaceutical firms heavily advertise
certain classes of drugs, mass merchandise retailers watch prices of competitors, big beer).
        In fragmented industries (many competitors with no firm possessing a dominant
position), firms must work hard to maintain their positions because customers have so
many options (e.g., nonchain restaurants, haircutters). Moreover, the moves made by a
particular competitor are often less visible to most other competitors and firms often
make aggressive competitive moves because they perceive them to be less risky.
Low Product Differentiation: In industries with products that are not highly differentiated,
we often see intense rivalry in the form of price-cutting (e.g., PCs, airlines, steel, grocery
chains). High price elasticity and low switching costs often prevail.
Low Industry Capacity Utilization: Firms' attempts to cover high fixed costs associated with
low industry capacity utilization and the potential accumulation of inventories can lead to
intense rivalry (home builders, RV manufacturers).
                            (2) POWER OF SUPPLIERS
Powerful suppliers to an industry can influence the price, quality, and quantity of goods
or services sold to their buyers such that buyers may incur higher costs. This potentially
affects the buying industry's profits. Conditions that give rise to powerful suppliers are:
Supplier Group is Dominated by a Few Large Companies and is More Consolidated Than the
Industry it Sells to – Limits ability of buyer to negotiate better prices, delivery
arrangements or quality (e.g., PC makers face the almost monopolistic power of operating
system and microprocessor suppliers, Swatch as monopolistic supplier, DVD rental kiosks
to consumers).
The Buying Industry is Not a Major Customer of the Supplying Industry – When one
industry buys a very small proportion of the supplying industry’s output (e.g., titanium
supplied to aerospace industry vs. golf club manufacturers, polysilicon supplied to
microprocessor producers vs. solar power device producers).
Suppliers’ Products Have Created High Switching Costs For Buyers - Suppliers’ products
are differentiated and/or require the buyer to make special investments such that buyers
cannot easily switch to alternate suppliers (e.g., customized software, various outsourced
products that require supplier to develop specialized assets).
Suppliers Can Vertically Integrate Forward into the Buying Firm’s Industry – The supplier
distributes its own output and may even become a competitor of the buying firm (e.g.,
apparel producers forward integrate into retail sales, catfish farming, some Chinese
mobile phone makers that began as component manufacturers).
                               (3) POWER OF BUYERS
Buyers (direct and/or indirect customers of firms in the supplying industry) can force
down price and/or bargain for and receive higher quality/better service, often by playing
competitors against one another. Conditions that can give rise to powerful buyers are:
Relatively Few Buyers, Each Buying a Large Fraction of Suppliers’ Sales or Total Industry
Output – Buyers can dictate terms, force price concessions, or have a strong impact on
what is produced (e.g., mass retail firms as buyers from suppliers that use excessive
packaging; mass retail firms as buyers of housewares)
Products it Purchases are Standard or Undifferentiated to the Extent that Buyers Have Low
Switching Costs – Assuming available alternate suppliers, buyers play one company
against the other. Most often with commodity-like products (e.g., steel, sugar beets, and
standard coffee).
Buyers Can Vertically Integrate Backward Into the Supplying Firm’s Industry – The buyer
produces own input and could become a competitor of the supplier (e.g., small Swiss
watch makers begin to make their own parts, large beer firms formerly backward
integrated into producing their own hops and aluminum cans, steel firms into scrap).
              (4) POTENTIAL ENTRANTS TO AN INDUSTRY
New entrants to an industry can influence industry profitability. BARRIERS TO ENTRY
created by existing competitors limit the ability of potential entrants to enter an industry.
Thus, high barriers substantially reduce threats to incumbent firms. Potential entrants
refer to entrants with same products, NOT different products. We view substitutes
(discussed below) as a uniquely different competitive force, because they enter as a
competitor with a physically different good or different way of providing a service.
- Low barriers for tablet computer makers
- Low barriers for luxury hotels in the Parisian market
SOURCES OF ENTRY BARRIERS:
Significant Capital Requirements - Firms may require substantial resources to invest in
physical facilities, inventories, advertising, distribution (e.g., high barriers in auto making,
airframe manufacturing).
Government Restrictions – Licenses, permits, and quotas can control entry into an industry
(e.g., quotas on the number of entrants into certain marine fisheries, oil and gas drilling
rights, radio broadcasting)
Economies of Scale – New entrants may need to achieve economies of scale to compete
profitably. They achieve economies of scale when lower unit costs result from conducting
an activity in greater volume (e.g., increasing for mutual fund sellers in India, purchasing
in mass retail, manufacturing cars).
Product Differentiation – New entrants must overcome strong brand loyalty, which forces
potential entrants to make high and often risky investments (many branded consumer
products, perhaps toothpaste)
Access to Distribution Channels - Firms in some industries may build strong relationships
with distributors over time. Potential entrants find barriers in transporting and/or getting
sufficient and visible shelf space (e.g., craft beer) Consider the lower barriers that
potential entrants to digital music now enjoy
Access to Scarce Resources – Resources needed to compete in the industry may be hard to
come by (e.g., land for growing grapes to make wine; aluminum in the 1930s, highly
specific and skilled types of labor).
Access to Scarce Technology – Inability to access or develop a technology needed to
compete in an industry (e.g., patent protection, open source software removes a
technological barrier for smartphone and tablet computer producers)
High Switching Costs – Costs are associated with switching to the new entrant’s product
(e.g., switching operating systems, video games and consoles).
Retaliatory Moves by Existing Competitors – Existing competitors, especially in large
profitable firms, may lower prices for a sustained period and/or engage in extensive
advertising to undermine the efforts of a new entrant to the industry
                          (5) SUBSTITUTE PRODUCTS
Goods that differ physically and services that are provided in a different manner yet fulfill
the same end use. Substitutes come from outside the focal industry as a different product
and thus we do not label them as a "potential entrant," although their entry may threaten
incumbent firms in an existing industry. Substitutes create a threat to an industry when
they offer features, quality, and/or prices that approach or exceed what the product for
which they act as a substitute provides. In the very least, they create an upper limit on the
prices sought by the focal industry (e.g: flax for cotton in apparel, aluminum replacing
steel in cars; aluminum, glass, and plastic bottles; paper and plastic bags; wood and
plastic railroad ties; cloud computing and conventional software development; and, digital
teleconferencing technology and airlines).
                               (6) COMPLEMENTORS
Complementary goods or services that come from different industries that complement
each other in what they mutually provide to a customer, thereby increasing the value of
each industry’s offering (e.g. peanut butter and jelly combined increases the value to jelly
makers and peanut butter makers; tourism and air travel industries; and, tires for OEMs
and the auto industry).
CLOSING COMMENTS ON THE
            FORCES OF COMPETITION MODEL:

Note that it is often difficult to know precisely how the forces of competition
act individually and collectively to influence industry profits for at least three
important reasons:
(1) The industry characteristics that we use to define our relationships for a
specific force of competition may interact in complex ways (for example, the
combined influences of concentration, degree of product differentiation,
growth, and capacity utilization)
(2) A given industry usually experiences the effects of multiple forces at any
point in time
(3) Many industries are very dynamic, such that forces of competition change
continuously.
In light of the above, it is not surprising that industry analysts often differ in
their written or stated opinions about the attractiveness of a given industry or
industry segment.
Furthermore, it is important to note that:
- Managers should not necessarily avoid low profit industries/industry
segments. These can still yield high returns for some players that pursue sound
strategies (this point, as we will soon discover, is central to principles of
strategic management).
- The model implicitly assumes a zero-sum game in determining how a firm
can enhance its position relative to the forces. This is shortsighted and
overlooks building long-term and mutually beneficial win-win relationships
between buyers and suppliers (e.g., cooperatively building JIT inventory
systems with suppliers)

				
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