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Five Forces That Shape Industry Competition: Rivalry Among Existing Competitors
Five Forces That Shape Industry Competition: Rivalry Among Existing Competitors
Threat of New
entrants
Rivalry
Bargaining Power among Bargaining power
of suppliers of buyers
existing
competitors
Threat of substitute
products or
services
Threat of Entry
New entrants to an industry bring new capacity and a desire to gain market share
This puts pressure on prices, costs and rate of investment necessary to compete
Especially when new entrants are diversifying they can leverage existing capabilities and
cash flows to shake up competition
Pepsi when it entered bottled water industry
Reliance when it is entering telecom
When “threat of entry” is high, incumbents must hold down their prices or boost
investments
Threat of Entry
Barriers to Entry
Supply-side economies of scale: These economies arise when firms produce at larger volumes enjoy
lower costs per unit
Eg: Intel is protected by scale economics in research, chip design and consumer marketing
Demand-side benefits of scale: Also known as Network Effect.
Buyers willingness to pay for a company’s product increases with the number of other buyers
Eg: IBM when it was a dominant computer maker, Maruti in India
Customer switching costs: Fixed cost the buyers face when they switch customers.
Eg: Enterprise Resource Planning (ERP) Software. Shifting from SAP is not that easy
Capital requirements: The need to invest large financial resources in order to compete can deter new
entrants
Incumbency advantages independent of size: Incumbents have cost or quality advantages.
Eg: Access to best technology, raw material source, Eg: Amul
Unequal access to distribution channels: New entrant must secure distribution of its product or service
A new food item must displace other from the supermarket shelf via price breaks, promotions etc
Eg: Maggi.
Restrictive Government Policy: Policy can hinder new entry
Eg: Regulated industries like liquor retailing, taxi services and airlines
Power of Suppliers
Powerful suppliers capture more of the value for themselves by charging higher prices, limiting
quality or services
Eg: Microsoft has contributed to the erosion of profitability among personal computer makers
by raising prices on OS.
PC makers competing fiercely for customers who can easily switch them, have limited freedom
to raise their prices accordingly
Also, presence of PC assemblers amplify the situation.
Shifting suppliers is difficult if companies have invested heavily in ancillary equipment or in
learning how to operate a suppliers equipment (eg: Bloomberg terminals used by finance
professionals)
Pilot unions exercise considerable supplier power over airlines
Power of Buyers
Powerful customers can capture more value by forcing down prices, demanding
better quality or more service (drives up cost)
Large-volume buyers are particularly powerful in industries with high fixed costs
such as telecommunication equipment, offshore drilling and bulk chemicals.
If Industry’s products are standardized or undifferentiated, buyers believe they can
always find an equivalent product.
Threat of substitutes
A substitute performs the same or similar function as an industry’s product by a
different means.
Videoconferencing is a substitute for travel
Plastic is a substitute for aluminium
Software sold to travel agents is threatened when airline and travel websites substitute for travel agents.
When the threat of substitutes is high, industry profitability suffers.
Substitute products limit an industry’s profit potential by placing a ceiling on prices.
Switching from branded drugs to generic drugs– cost of shifting is low.
Plastic substitute steel in many automobile components.
Rivalry among existing competitors
Rivalry among existing competitors take many forms
Price discounting, new product introductions, advertising campaigns and service improvements
High rivalry limits the profitability of an industry
Eg; Airline industry, e-commerce industry
The intensity of rivalry is greatest if
Competitors are numerous or are roughly equal in size and power
Industry growth is slow. Slow growth precipitates fights for market share
Exit barriers are high. Specialised assets are managements devotion to a particular business. These barriers keep
companies in market even though their earnings are low
Rivals are highly committed to the business and have aspirations for leadership
Rivalry is destructive to profitability if it gravitates solely to price.
Price competition transfers profits directly from an industry to customer
Eg: E-commerce industry- discounts
Price competition is most likely to occur if
Products or services of rivals are nearly identical and few switching costs for buyers
Fixed costs are high and marginal costs are low
The product is perishable
Implications for Strategy
Understanding the forces that shape industry competition is the starting point for
developing strategy
Baseline for sizing up company’s strengths and weaknesses
Where does the company stand versus buyers, suppliers, entrants, rivals and substitutes.
Positioning the company: Strategy can be viewed as building defences against the
competitive forces or finding a position in the industry where forces are weakest
Exploiting Industry Change: Opportunity to spot and claim new strategic positions if
the strategist has an understanding of these five forces.
Steps in Industry Analysis
Define the relevant industry
Asses the drives of each competitive force to determine which forces are strong and
which are weak and why?
Analyse recent and likely future changes in each force, both positive and negative