Market Share of Kfc in Fast Food Industry by zpr14796

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									                           Case 25: KFC and the
                        global fast-food industry

(1) Using the five forces model, assess the strength of each
force within the fast-food industry.


The fast-food industry includes group of companies that are offering different products
and services, which satisfy customers’ needs. These products and services might be
considered as close substitutes for each other. Therefore, the critical task of managers is
to analyze the competitive forces in the industry’s environment in order to identify the
threats and opportunities that the firm can protect or get benefit from. Porter’s five forces
model helps manager to identify and analyze the competitive force within the industry.
This model stated that the increase in the strength of a particular force limits and reduces
the ability of established companies to increase their prices and earn more profits. By
using this model, managers would be able to identify new opportunities or threats that
might affect their businesses’ operations. The five forces model includes the following:


1- Risk of entry by Potential competitors.
Potential competitors are companies that are not currently operating and competing in a
certain industry, but they are expected to enter the industry as they have the capability to
compete with other companies if they choose. Potential competitors might face some
difficulties or barriers that are formed by established companies that are already operating
in the industry (incumbent companies) to discourage them from entering the industry.
This is because the entry of potential competitors reduces the ability of established
companies to hold their market share and generate profits. In addition, the barriers to
entry increase the costs of entering potential competitors to the industry.
These barriers include the following:
   Brand loyalty.
It is basically about the buyer’s preference for the products of established companies. The
company can build its brand loyalty through the continuous advertising of the company’s
different products and brands, patent protection of product innovation that can be
achieved through the research and development efforts. In addition, the firm could
maintain its products’ high quality and improve its customer’s services and after-sales
services in order to maintain its brand loyalty.
Brand loyalty plays a key role to make it difficult for new entrants to take the market
share of existed companies. Therefore, it reduces the threat or risk of the entry of
potential competitors as they might found it difficult and costly to break down the well-
established consumer’s brand loyalty.


   Absolute Cost Advantages.
The risk and threat of new entrants can be reduced, if incumbent companies have an
absolute cost advantages. The incumbent companies can acquire absolute cost advantages
by achieving superior production operations of having a good a control of inputs that are
needed for production. In addition, established companies could obtain an absolute cost
advantage by having an access to cheaper funds as they represent lower risks than
entrants, which are not yet established.


   Economies of Scale.
They are the cost advantages that associated with large sized company. The sources of
economies of scale include discount on bulk purchases, cost reduction, spreading of fixed
costs over large outputs and economies of scale in advertising. The established
companies that have high economies of scale would be able to reduce the risks of new
entrants. Since, new entrants would face the risk of entering on a small scale and
suffering of high cost disadvantage or entering on a large scale and hold a huge risk of
high capital costs. In addition, new entrants would be forced to reduce their prices due to
the high supply of products in a large-scale of entry.
   Governmental regulations.
Government’s regulations have played a key role as barriers into different industries.
These regulations restrict the entrance of new companies into the industry. As a result
this would reduce the competition level and help established companies to earn more
profits.


The sales in the fast-food segment of the food industry are growing rapidly. For instance,
the sales increased from $87 million in 1994 to $93 billion in 1995 in the United States.
The rapid growth would encourage lots of potential competitors who are not currently
operating and competing in the industry to enter and establish their businesses. These
potential competitors might be Heublein, Inc and R. J. Reynolds Industries, Inc or other
companies, which have diversification strategy that includes the acquisition of different
companies in several industries. For example, RJR has a diversification strategy into
unrelated areas to its major business. It merged with KFC in 1982, but it sold it to
PepsiCo after 3 years. Therefore, such companies could enter the industry if they have the
capability to compete with other fast-food companies.
Potential companies or new entrants would face some difficulties or barriers that
eliminate their entrance. For example, brand loyalty to goods produced by incumbent
companies is considered as a barrier to new entrants as they would take a long time to
shift customers’ loyalty to their products. In addition, the threat of new entrants can be
reduced because most of the established companies in the industry have economies of
scale advantage. For instance, McDonald’s has cut its building costs and spread this fixed
cost over large outputs. Also, PepsiCo has improved its economies of scale within its
business operation by adopting the dual branding strategy. Therefore, this enables KFC to
improve its customer base by increasing its menu offerings. This would reduce the threat
of new entrants because they will not be able to compete in the market and hold high cost
disadvantages compare to the already established firms. What is more, government
regulations and other bureaucratic procedures make it difficult for new competitors to
enter the market.
2- Rivalry among established companies:
The second competitive force is the extent of competition or rivalry among established
companies in the industry. For instance, if the rivalry is weak, companies have an
opportunity to increase prices and gain more profits. While, if there is a strong
competition, companies would compete in prices, which might result in a price war. This
would reduce or limit profitability due to the reduction in the sales margins.


The extent of rivalry among established companies depends on the following factors:
   Competitive Structure.
The industry’s competitive structure refers to the number and the size of distribution of
company’s in the industry. The structure might be fragmented or consolidated the t have
different rivalry implications. A fragmented industry includes a large member of small or
medium sized companies, where no company dominates the industry. It characterized by
low barriers to entry and its products are hard to differentiate. Therefore, whenever
demand and profit are high, there will be a flood of new entrants who hope to enter the
market.
A consolidated industry is dominated by a small number of large companies (oligopoly)
or in other cases by just one company (monopoly). In this industry, companies are
interdependent, which means the competitive actions of one company directly affect
other competitors’ profitability and market share.


   Demand Conditions:
The growing demand from new customers or additional purchases by existing customers
helps to moderate competition as it provides companies with greater ability for
expansion. In addition, it could reduce rivalry because all companies can sell more
without affecting other competitors’ market share, which increases their profits, While
the reduction in demand increases rivalry in the industry as companies fight to maintain
their market share and revenues. Therefore, companies can grow by taking market share
away from competitors, which represents the decrease in demand to be viewed as a threat
for companies.
   Exit Barriers:
They are strategic, economic and emotional factors that keep companies in the industry
even when returns are low. If exist barriers are high companies would be locked into an
unprofitable industry where the overall demand is unstable or declining. This would
result in an excess production capacity that would lead to a strong price competition, as
companies would tend to reduce their prices to get rid of their idle capacity.
The exit barriers include high fixed costs of exit (severance pay for large number of
employees) and investment in plant and equipment that have no other uses and cannot be
sold off. In addition, if the company is not diversified and highly depends on the industry
as a source of income.


As it was mentioned previously, the fast food industry is growing rapidly, which
increases the competition among its existed companies to increase their sales, profits and
market share. Therefore, each company is doing its best to acquire more of the sales and
market share. For instance, there is a huge competition between KFC and McDonald’s as
each on of them is competing to improve its customer services such as introducing new
items in its menu and home delivery service.
The consolidated competitive structure of fast food industry has a small number of big
companies. These firms have a huge and powerful financial situation, which provides
them with the required funds and resources to help them to outgrow their smaller
competitors and eliminate new entrants. In addition, the fast food industry has a huge
demand for its products (demand condition). It is expected that the demand for fast food
in the US would continue through year 2000. Also, the introduction of microwaves has
increased the demand for fast-food industry products that can be quickly and easily
prepared in microwaves. This would help to moderate the competition as it provides
companies with greater opportunity to sell more and increase their profits and market
share. Moreover, the various demographic and social trends might affect the future
demand for fast food in different ways. From this it’s clear that as the rivalry decreases,
companies have an opportunity to increase their prices and gain more profits. However,
the opposite can happen if the rivalry increases among established competitors.
3- The bargaining power of buyers:
Buyers of a company might be the customers who used its products (end users), and
companies that distribute the products to end users such as retailers and wholesalers.
Buyers can be in positions that view them as a competitive threat for the company. For
instance, when they are able to demand lower prices or better services. But, when buyers
are weak, the company can increase its prices and gain more profits.


Based on Porter’s model, buyers are powerful in the following conditions:
-   When the buyers buy in large quantities as they can bargain for price reduction.
-   When the supply company depends highly on the buyer for large portion of its total
    orders.
-   When the supply industry includes small companies and the buyers are few in number
    and large. This allows the buyers to dominant and control supply companies.
-   When the buyers switch orders between companies as they bargain for higher quality
    or more services or lower prices, which makes companies play off against each other.
-   When buyers can supply their own needs through vertical integration. As a result, the
    supply companies would be threatened and forced to reduce their prices.
-   When it is possible and feasible for buyers to buy the input from different companies
    at once.


The bargaining power of buyers in the fast food industry is very strong. This is because
the buyers such as KFC and McDonald’s are small in number and big in size, which
gives them the ability to bargain for price reduction as they purchase in large quantities
from suppliers. In addition, these firms have large internal cash flow that allow them to
invest in cheap and less risky countries to supply their own input needs (vertical
integration). As a result, the suppliers would be threatened and forced to reduce their
prices. Also, the buyers would be able to reduce their costs and increase the
competitiveness of their goods in the market. Another thing is that individual customers
(end users) can have power over the fast food companies and force them to reduce their
prices. For example, in 1991 families in the US looked for greater value in the food they
purchase and forced fast food chains to reduce their operating costs and prices.
4- The bargaining power of suppliers:
Suppliers can be a competitive threat in an industry because they can increase the prices
of raw materials or reduce products’ quality, which reduces companies’ profitability. This
is because the companies would not be able to pay or cover the price increase that
suppliers have created.
According to Porter, suppliers can be powerful when:
-   The products have few substitutes and are important for the buying companies.
-   The buying companies are not important for suppliers have their businesses and they
    don’t depend on them to operate their businesses. Therefore, suppliers have little
    incentive to improve quality or reduce prices.
-   The industry’s companies have differentiated products, which makes it costly for
    them to change their suppliers. This means companies depend on their suppliers and
    can’t play them off against each other.
-   The suppliers use the threat of vertically integrated forward into the industry and
    compete directly with the industry’s companies. This allows suppliers to increase
    their prices.
-   The buying companies can’t match with the threat of vertically integrating backward
    and supply their own needs to reduce their prices.


The bargaining power of supplier could be very strong, if we assumed that the buying
companies are not important for the supplier as its business profitability doesn’t depend
on them. Therefore, he could set his own terms and offer them to the buying companies
and if they refused to approve on the terms, the suppliers could go to other buying
companies in the industry such as McDonalds if KFC refused the terms. From this it is
clear that the buyer could not force the supplier to reduce prices or improve quality.
On the other hand suppliers could have relatively moderate or weak bargaining power in
the fast food industry. This is because the industry’s products have lots of substitutes that
customers can use to satisfy their needs. Also, the buyer’s products are not highly
differentiated, which makes it easy for them to change their suppliers. This means they
don’t depend on one supplier and can switch to other suppliers. Furthermore, the buying
companies such as PepsiCo are not heavily depended on this industry to generate profits,
but it diversify their business operations into several unrelated industries to diversify its
source of income. This helps to reduce the bargaining power of suppliers. Another thing
is that the buyers who distribute the products to end users are big companies that are
financially strong. This enables them to invest their money on cheaper countries such as
Mexico and supply their own needs. From this we can see that buyers can match with the
threat of vertical integrating backward and reduce the bargaining power of suppliers.


5- The threat of Substitute products:
Substitute products are alternative products that satisfy customer’s needs in a similar way
to those being served and provided by the industry. Therefore, product’s shortage or
increase in prices would shift customers to substitute products. That is why, the existence
of substitute products acts as a strong competitive threat for companies as it restricts its
ability to rise prices and increase profitability. On the other hand, if a firm’s products
have few close substitutes, it would have a good opportunity to raise its prices and gain
more profits.


The companies in the fast food industry are selling products that might be considered as
substitute for each other as they satisfy customer’s needs in the same way. Therefore, the
shortage or increase in price of one of the products would shift customers to the substitute
products. Also, if one of the fast food firms has developed new items in its menu, this
might shift customers to the firm and increase its sales. For instance, KFC has lost its
market share over the last two years to both Boston Market and Kenny Rogers Roasters
because they have offered roasted chicken over the traditional fried chicken offered by
chicken chains. Therefore, the increase in KFC prices would shift customers to other
substitutes.
Another point that I would like to mention is that products in each segment of the fast
food chains is considered as substitute for the products that are being offered in other
segments. For instance, the items that are being offered in the “sandwich segment” by
McDonald’s might be considered as substitute for other items offered in the “chicken
segment” by KFC.
Source: Noora Ibrahim, BAS student Apr 2001

								
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