It is important that a business organization defines clearly its industry, which is an OUTPUT concept and its markets, which is a DEMAND concept. An industry is a group of firms producing the same principal product. A market is a group of customers with similar interest and whose expectation the organization can satisfy profitably. It is imperative that a business organization identifies its competitors within the competitive environment. It is within this context that analysis of competitor becomes a phenomenon of great importance.
Michael Porter and the competitive forces model
The competitive forces model was developed by Michael Porter of Harvard University in 1980. He argues that the intensity of competition in an industry is neither a matter of coincidence or bad luck, but rather the way the industry is structured. He therefore identifies FIVE forces that he says influence the nature of competition in an industry. These include:
1. Threats of entry
2. The supplier power
3. Buyer power
4. Substitute products
The five forces framework
1. The Threat of Entry
New entrants to an industry bring new capacity, a desire to gain market share and position and very often new approaches to serving customers‘ needs. The threat of entry depends on the extent to which there are barriers to entry. Barriers to entry are factors that need to be overcome by new entrants if they are to compete successfully. The typical barriers are:
1. Economies of scale – Firms already enjoying economies of scale may make it difficult for new firms to penetrate the market e.g. Coca-Cola.
2. The capital requirements of entry – The capital cost of entry will vary according to technology and scale. Technology driven industries e.g. mobile phone service provision, often require high capital base.
3. Access to distribution channels – Established companies normally finance distribution outlets making it difficult for new companies to distribute their products e.g. EABL.
4. Experience – Early entrants into the market gain experience sooner than others. This gives them an advantage in terms of cost, customers and suppliers.
5. Expected retaliation – If an organization considering entering a market believes that the retaliation of an existing firm will be so great as to prevent entry, or would be too costly, this becomes a barrier e.g. EABL Vs. Castle Larger.
6. Legislation or government action – Legal restraints on competition vary from patent protection to regulation of markets e.g. pharmaceuticals and sugar industry in Kenya.
7. Differentiation – This means the provision of a product or service regarded by the user as unique from and of higher perceived value than the competition. The lower the degree of differentiation the higher the barrier to market entry.
2. The Threat of Substitutes
The availability of substitute products places limits on the market prices market leaders can charge in an industry. This implies substitution reduces demand for a particular class of products as customers switch to the alternatives especially when they perceive the substitute to be higher value or benefit. Substitution may take the following forms:
- Product for product substitution – Technological advancement may render a product superfluous (obsolete) e.g. e-mail substitution for postal service.
- Indirect substitution – Occurs when a need is substituted for by a new product e.g. instead of hiring home guards, install surveillance camera, use a fax machine instead of a telephone etc.
- Direct substitution – Occurs when one product is substituted for by another product that serves the same purpose e.g. tea substituting coffee, a Dell computer is substituted by a compact computer.
- Generic substitution – occurs where products or services compete for the disposable income e.g. your income being hotly pursued by an electronic seller and a furniture dealer.
3. Buyer Power
The ultimate aim of industrial customers is to pay the lowest possible price for products or services that it uses as inputs. Buyer power is likely to be high when some of the following conditions prevail:
- There is a concentration of buyers and purchase in volumes e.g. wholesalers or distributors.
- The supplying industry comprises a large number of small operators.
- There are alternative sources of supply perhaps because the product required is undifferentiated between suppliers.
- The cost of switching a supplier is low or involves little risk.
- There is a threat of backward integration by the buyers e.g. by acquiring a supplier.
4. Supplier Power
- There is a concentration of suppliers rather than a fragmented source of supply e.g. a group of banks in one street, or industries producing similar products concentrated in industrial area.
- The switching cost from one supplier to another is high. Common with suppliers of chemical products.
- The brand of the supplier is powerful – for example a retailer in Kenya might not be able to do without Coca-Cola, blue band etc.
- There is the possibility of the supplier integrating forwards if it does not obtain a good price and hence the profit margin it seeks.
- The supplier’s customers are highly fragmented.
- Many manufacturers faced with competitive demands for lower prices and hence the need to reduce costs forcing the number of suppliers to reduce.
5. Competitive Rivalry
Competitive rivals are organizations with similar products and services aimed at the same customer group.
Rivalry is greatest in highly competitive markets where:
- Entry is likely
- There are threats of substitute products
- Buyer or supplier power exist.
Michael Porter outlines the interacting structural factors which makes rivalry more intense to include:
1. The extent to which competitors are in balance. Where competitors are of roughly equal size, there is the danger of intense competition as each attempts to gain dominance over another e.g. Standard chartered Bank and Barclays in Kenya.
2. High fixed cost resulting in price wars. High capital intensity may result to price wars and very low margin operations as capacity fill becomes a prerogative e.g. Airtel and Safaricom.
3. Differentiation – Similarity in product or service makes rivalry more intense e.g. Cow Boy, Kasuku, Fry Mate etc.
4. High exit barriers to an industry – Exit barriers might be high where the companies have to incur high investment in non-transferable fixed assets or high redundancy costs, where they have an emotional attachment (pride), high legal or financial costs.
5. Acquisition of weaker companies by large ones hence introducing more funds for competition.