1. Introduction The model of the Five Competitive Forces was developed by Michael E. Porter in his book ―Competitive Strategy: Techniques for Analyzing Industries and Competitors―in 1980. Since
that time it has become an important tool for analyzing an organizations industry structure in strategic processes. Porters model is based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Especially, competitive strategy should base on and understanding understan ding of industry industr y structures and the way they the y change. Porter has identified five competitive forces that shape every industry and every market. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The objective of corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Porter’s model supports analysis of the driving forces in an industry. Based on the information derived from the Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry. indus try analysis and business busin ess strategy Porter five forces analysis is a framework for industry development. It draws upon industrial upon industrial organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. a market. Attractiveness Attractiveness in this context refers to the overall industry profitability. An "unattractive" industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven driv en to normal to normal profit. Three of Porter's five forces refer to competition from external sources. The remainder are internal threats. Porter referred to these forces as the micro the micro environment, to environment, to contrast it with the more general term macro environment. environment. They consist of those forces close to a company a company that affect its ability to serve its customers and make a profit. a profit. A change in any of the forces normally requires a business unit to re-assess the marketplace the marketplace given the overall change in industry in industry information. The information. The overall industry attractiveness does not imply that every firm every firm in the industry will return the same profitability. Firms are able to apply their core core competencies, business competencies, business model or network to achieve a profit above the industry average. A clear example of this is 1
the airline industry. airline industry. As an industry, profitability is low and yet individual companies, by applying unique business models, have been able to make a return in excess of the industry average. Porter's five forces include - three forces from 'horizontal' competition: the threat of substitute products or services, the threat of established rivals, and the threat of new entrants; and two forces from 'vertical' competition: the bargaining power of suppliers and the bargaining power of customers. This five forces analysis is just one part of the complete Porter strategic models. The other elements are the value the value chain and the generic the generic strategies. Porter developed his Five Forces analysis in reaction to the then-popular SWOT SWOT analysis, which he found unrigorous un rigorous and an d ad hoc. Porter's five fi ve forces are based on the StructureConduct-Performance paradigm in industrial organizational economics. It has been applied to a diverse range of problems, from helping businesses become more profitable to helping governments stabilize industries.
2. The Five Competitive Forces
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the airline industry. airline industry. As an industry, profitability is low and yet individual companies, by applying unique business models, have been able to make a return in excess of the industry average. Porter's five forces include - three forces from 'horizontal' competition: the threat of substitute products or services, the threat of established rivals, and the threat of new entrants; and two forces from 'vertical' competition: the bargaining power of suppliers and the bargaining power of customers. This five forces analysis is just one part of the complete Porter strategic models. The other elements are the value the value chain and the generic the generic strategies. Porter developed his Five Forces analysis in reaction to the then-popular SWOT SWOT analysis, which he found unrigorous un rigorous and an d ad hoc. Porter's five fi ve forces are based on the StructureConduct-Performance paradigm in industrial organizational economics. It has been applied to a diverse range of problems, from helping businesses become more profitable to helping governments stabilize industries.
2. The Five Competitive Forces
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1. Bargaining Power of Suppliers The term 'suppliers' comprises all sources for inputs that are needed in order to provide goods or services. Supplier bargaining power is likely to be high when:-
The market is dominated by a few large suppliers rather than a fragmented source of supply,
There are no substitutes for the particular input,
The suppliers customers are fragmented, so their bargaining power is low,
The switching costs from one supplier to another are high,
There is the possibility of the supplier integrating forwards in order to obtain higher prices and margins. This threat is especially high when
The buying industry has a higher profitability than the supplying industry,
Forward integration provides economies of scale for the supplier,
The buying industry hinders the supplying industry in their development (e.g. reluctance to accept new releases of products),
The buying industry has low barriers to entry.
In such situations, the buying industry often faces a high pressure on margins from their suppliers. The relationship to powerful suppliers can potentially reduce strategic options for the organization.
2. Bargaining Power of Customers Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes. Customers bargaining power is likely to be high when:
They buy large volumes, there is a concentration of buyers,
The supplying industry comprises a large number of small operators
The supplying industry operates with high fixed costs, 3
The product is undifferentiated and can be replaces by substitutes,
Switching to an alternative product is relatively simple and is not related to high costs,
Customers have low margins and are price-sensitive,
Customers could produce the product themselves,
The product is not of strategically importance for the customer,
The customer knows about the production costs of the product
There is the possibility for the customer integrating backwards.
3. Threat of New Entrants The competition in an industry will be the higher, the easier it is for other companies to enter this industry. In such a situation, new entrants could change major determinants of the market environment (e.g. market shares, prices, customer loyalty) at any time. There is always a latent pressure for reaction and adjustment for existing players in this industry. The threat of new entries will depend on the extent to which there are barriers to entry. These are typically
Economies of scale (minimum size requirements for profitable operations),
High initial investments and fixed costs,
Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets,
Brand loyalty of customers
Protected intellectual property like patents, licenses etc,
Scarcity of important resources, e.g. qualified expert staff
Access to raw materials is controlled by existing players,
Distribution channels are controlled by existing players,
Existing players have close customer relations, e.g. from long-term service contracts,
High switching costs for customers
Legislation and government action
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4. Threat of Substitutes A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category categor y also relates to complementary products. pro ducts. Similarly to the threat of new entrants, the treat of substitutes is determined by factors like
Brand loyalty of customers,
Close customer relationships,
Switching costs for customers,
The relative price for performance of substitutes,
Current trends.
5. Competitive Rivalry between Existing Players This force describes the intensity of competition between existing players (companies) in an industry. High competitive pressure results in pressure on prices, margins, and hence, on profitability for every ever y single company in the industry. indu stry. Competition between existing players is likely to be high when
There are many players of about the same size,
Players have similar strategies
There is not much differentiation between players and their products, hence, there is much price competition
Low market growth rates (growth of a particular company is possible only at the expense of a competitor),
Barriers for exit are high (e.g. expensive and highly specialized equipment).
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3. Use of the Information from Five Forces Analysis
Five Forces Analysis can provide valuable information for three aspects of corporate planning:
a. Statical Analysis: The Five Forces Analysis allows determining the attractiveness of an industry. It provides insights on profitability. Thus, it supports decisions about entry to or exit from and industry or a market segment. Moreover, the model can be used to compare the impact of competitive forces on the own organization with their impact on competitors. Competitors may have different options to react to changes in competitive forces from their different resources and competences. This may influence the structure of the whole industry.
b. Dynamical Analysis: In combination with a PEST-Analysis, which reveals drivers for change in an industry, Five Forces Analysis can reveal insights about the potential future attractiveness of the industry. Expected political, economical, socio-demographical and technological changes can influence the five competitive forces and thus have impact on industry structures. Useful tools to determine potential changes of competitive forces are scenarios.
c. Analysis of Options: With the knowledge about intensity and power of competitive forces, organizations can develop options to influence them in a way that improves their own competitive position. The result could be a new strategic direction, e.g. a new positioning, differentiation for competitive products of strategic partnerships.
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Thus, Porters model of Five Competitive Forces allows a systematic and structured analysis of market structure and competitive situation. The model can be applied to particular companies, market segments, industries or regions. Therefore, it is necessary to determine the scope of the market to be analyzed in a first step. Following, all relevant forces for this market are identified and analyzed. Hence, it is not necessary to analyze all elements of all competitive forces with the same depth.
The Five Forces Model is based on microeconomics. It takes into account supply and demand, complementary products and substitutes, the relationship between volume of production and cost of production, and market structures like monopoly, oligopoly or perfect competition.
4. Influencing the Power of Five Forces After the analysis of current and potential future state of the five competitive forces, managers can search for options to influence these forces in their organization’s interest.
Although industry-specific business models will limit options, the own strategy can change the impact of competitive forces on the organization. The objective is to reduce the power of competitive forces.
The following figure provides some examples. They are of general nature. Hence, they have to be adjusted to each organization’s specific situation. The options of an organization are
determined not only by the external market environment, but also by its own internal resources, competences and objectives.
a. Reducing the Bargaining Power of Suppliers
Partnering
Supply chain management
Supply chain training 7
Increase dependency
Build knowledge of supplier costs and methods
Take over a supplier
b. Reducing the Bargaining Power of Customers
Partnering
Supply chain management
Increase loyalty
Increase incentives and value added
Move purchase decision away from price
Cut put powerful intermediaries (go directly to customer)
c. Reducing the Treat of New Entrants Increase minimum efficient scales of operations Create a marketing / brand image (loyalty as a barrier) Patents, protection of intellectual property Alliances with linked products / services Tie up with suppliers Tie up with distributors Retaliation tactics
d. Reducing the Threat of Substitutes Legal actions Increase switching costs Alliances Customer surveys to learn about their preferences Enter substitute market and influence from within
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Accentuate differences (real or perceived)
e. Reducing the Competitive Rivalry between Existing Players Avoid price competition Differentiate your product Buy out competition Reduce industry over-capacity Focus on different segments Communicate with competitors
Assumptions made about the Porter’s Five Forces model
That buyers, competitors, and suppliers are unrelated and do not interact and collude
That the source of value is structural advantage (creating barriers to entry)
That uncertainty is low, allowing participants in a market to plan for and respond to competitive behaviour.
5. A MODEL FOR INDUSTRY ANALYSIS
The model of pure competition implies that risk-adjusted rates of return should be constant across firms and industries. However, numerous economic studies have affirmed that different industries can sustain different levels of profitability; part of this difference is explained by industry structure. Michael Porter provided a framework that models an industry as being influenced by five forces. The strategic business manager seeking to develop an edge over rival firms can use this model to better understand the industry context in which the firm operates.
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Diagram of Porter's 5 Forces
SUPPLIER POWER Supplier concentration Importance of volume to supplier Differentiation of inputs Impact of inputs on cost or differentiation Switching costs of firms in the industry Presence of substitute inputs Threat of forward integration Cost relative to total purchases in industry
BARRIERS TO ENTRY Absolute cost advantages
THREAT OF SUBSTITUTES
Proprietary learning curve Access to inputs Government policy Economies of scale
Switching costs
Capital requirements
Buyer inclination to
Brand identity
substitute
Switching costs
Price-performance
Access to distribution
trade-off of substitutes
Expected retaliation Proprietary products
BUYER POWER
DEGREE OF RIVALRY
Bargaining leverage Buyer volume Buyer information Brand identity Price sensitivity Threat of backward integration
Exit barriers Industry concentration Fixed costs/Value added Industry growth Intermittent overcapacity Product differences
Product differentiation
Switching costs
Buyer concentration vs. industry
Brand identity
Substitutes available Buyers' incentives
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Diversity of rivals Corporate stakes
A. Rivalry In the traditional economic model, competition among rival firms drives profits to zero. But competition is not perfect and firms are not unsophisticated passive price takers. Rather, firms strive for a competitive advantage over their rivals. The intensity of rivalry among firms varies across industries, and strategic analysts are interested in these differences. Economists measure rivalry by indicators of industry concentration. The Concentration Ratio (CR) is one such measure. The Bureau of Census periodically reports the CR for major Standard Industrial Classifications (SIC's). The CR indicates the percent of market share held by the four largest firms (CR's for the largest 8, 25, and 50 firms in an industry also are available). A high concentration ratio indicates that a high concentration of market share is held by the largest firms - the industry is concentrated. With only a few firms holding a large market share, the competitive landscape is less competitive (closer to a monopoly). A low concentration ratio indicates that the industry is characterized by many rivals, none of which has a significant market share. These fragmented markets are said to be competitive. The concentration ratio is not the only available measure; the trend is to define industries in terms that convey more information than distribution of market share. If rivalry among firms in an industry is low, the industry is considered to be disciplined. This discipline may result from the industry's history of competition, the role of a leading firm, or informal compliance with a generally understood code of conduct. Explicit collusion generally is illegal and not an option; in low-rivalry industries competitive moves must be constrained informally. However, a maverick firm seeking a competitive advantage can displace the otherwise disciplined market. When a rival acts in a way that elicits a counter-response by other firms, rivalry intensifies. The intensity of rivalry commonly is referred to as being cutthroat, intense, moderate, or weak, based on the firms' aggressiveness in attempting to gain an advantage. In pursuing an advantage over its rivals, a firm can choose from several competitive moves:
Changing prices - raising or lowering prices to gain a temporary advantage.
Improving product differentiation - improving features, implementing innovations in the manufacturing process and in the product itself.
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Creatively using channels of distribution - using vertical integration or using a distribution channel that is novel to the industry. For example, with high-end jewelry stores reluctant to carry its watches, Timex moved into drugstores and other nontraditional outlets and cornered the low to mid-price watch market.
Exploiting relationships with suppliers - for example, from the 1950's to the 1970's Sears, Roebuck and Co. dominated the retail household appliance market. Sears set high quality standards and required suppliers to meet its demands for product specifications and price.
The intensity of rivalry is influenced by the following industry characteristics: a.
A larger number of firms increase rivalry because more firms must compete
for the same customers and resources. The rivalry intensifies if the firms have similar market share, leading to a struggle for market leadership. b.
Slow market growth causes firms to fight for market share. In a growing
market, firms are able to improve revenues simply because of the expanding market. c.
High fixed costs result in an economy of scale effect that increases rivalry.
When total costs are mostly fixed costs, the firm must produce near capacity to attain the lowest unit costs. Since the firm must sell this large quantity of product, high levels of production lead to a fight for market share and results in increased rivalry. d.
High storage costs or highly perishable products cause a producer to sell
goods as soon as possible. If other producers are attempting to unload at the same time, competition for customers intensifies. e.
Low switching costs increases rivalry. When a customer can freely switch
from one product to another there is a greater struggle to capture customers. f.
Low levels of product differentiation are associated with higher levels of
rivalry. Brand identification, on the other hand, tends to constrain rivalry. g.
Strategic stakes are high when a firm is losing market position or has
potential for great gains. This intensifies rivalry. h.
High exit barriers place a high cost on abandoning the product. The firm
must compete. High exit barriers cause a firm to remain in an industry, even when the venture is not profitable. A common exit barrier is asset specificity. When the plant and equipment required for manufacturing a product is highly specialized, these assets cannot easily be sold to other buyers in another industry. Litton Industries' acquisition 12
of Ingalls Shipbuilding facilities illustrates this concept. Litton was successful in the 1960's with its contracts to build Navy ships. But when the Vietnam war ended, defense spending declined and Litton saw a sudden decline in its earnings. As the firm restructured, divesting from the shipbuilding plant was not feasible since such a large and highly specialized investment could not be sold easily, and Litton was forced to stay in a declining shipbuilding market. A diversity of rivals with different cultures, histories, and philosophies make
i.
an industry unstable. There is greater possibility for mavericks and for misjudging rival's moves. Rivalry is volatile and can be intense. The hospital industry, for example, is populated by hospitals that historically are community or charitable institutions, by hospitals that are associated with religious organizations or universities, and by hospitals that are for-profit enterprises. This mix of philosophies about mission has lead occasionally to fierce local struggles by hospitals over who will get expensive diagnostic and therapeutic services. At other times, local hospitals are highly cooperative with one another on issues such as community disaster planning. Industry Shakeout. A growing market and the potential for high profits
j.
induce new firms to enter a market and incumbent firms to increase production. A point is reached where the industry becomes crowded with competitors, and demand cannot support the new entrants and the resulting increased supply. The industry may become crowded if its growth rate slows and the market becomes saturated, creating a situation of excess capacity with too many goods chasing too few buyers. A shakeout ensues, with intense competition, price wars, and company failures. BCG founder Bruce Henderson generalized this observation as the Rule of Three and Four: a stable market will not have more than three significant competitors, and the largest competitor will have no more than four times the market share of the smallest. If this rule is true, it implies that:
If there is a larger number of competitors, a shakeout is inevitable
Surviving rivals will have to grow faster than the market
Eventual losers will have a negative cash flow if they attempt to grow
All except the two largest rivals will be losers
The definition of what constitutes the "market" is strategically important. 13
Whatever the merits of this rule for stable markets, it is clear that market stability and changes in supply and demand affect rivalry. Cyclical demand tends to create cutthroat competition. This is true in the disposable diaper industry in which demand fluctuates with birth rates, and in the greeting card industry in which there are more predictable business cycles.
B. Threat Of Substitutes In Porter's model, substitute products refer to products in other industries. To the economist, a threat of substitutes exists when a product's demand is affected by the price change of a substitute product. A product's price elasticity is affected by substitute products - as more substitutes become available, the demand becomes more elastic since customers have more alternatives. A close substitute product constrains the ability of firms in an industry to raise prices. The competition engendered by a Threat of Substitute comes from products outside the industry. The price of aluminum beverage cans is constrained by the price of glass bottles, steel cans, and plastic containers. These containers are substitutes, yet they are not rivals in the aluminum can industry. To the manufacturer of automobile tires, tire retreads are a substitute. Today, new tires are not so expensive that car owners give much consideration to retreading old tires. But in the trucking industry new tires are expensive and tires must be replaced often. In the truck tire market, retreading remains a viable substitute industry. In the disposable diaper industry, cloth diapers are a substitute and their prices constrain the price of disposables. While the treat of substitutes typically impacts an industry through price competition, there can be other concerns in assessing the threat of substitutes. Consider the substitutability of different types of TV transmission: local station transmission to home TV antennas via the airways versus transmission via cable, satellite, and telephone lines. The new technologies available and the changing structure of the entertainment media are contributing to competition among these substitute means of connecting the home to entertainment. Except in remote areas it is unlikely that cable TV could compete with free TV from an aerial without the greater diversity of entertainment that it affords the customer. 14
C. Buyer Power The power of buyers is the impact that customers have on a producing industry. In general, when buyer power is strong, the relationship to the producing industry is near to what an economist terms a monophony - a market in which there are many suppliers and one buyer. Under such market conditions, the buyer sets the price. In reality few pure monopolies exist, but frequently there is some asymmetry between a producing industry and buyers. The following tables outline some factors that determine buyer power.
Buyers are Powerful if:
Example
Buyers are concentrated - there are a few buyers with DOD purchases from defense contractors significant market share Buyers purchase a significant proportion of output Circuit City and Sears' large retail market provides distribution of purchases or if the product is power over appliance manufacturers standardized Buyers possess a credible backward integration threat can threaten to buy producing firm or rival
Large auto manufacturers' purchases of tires
Buyers are Weak if:
Example
Producers threaten forward integration - producer can Movie-producing companies have integrated forward take over own distribution/retailing to acquire theaters Significant buyer switching costs - products not standardized and buyer cannot easily switch to another IBM's 360 system strategy in the 1960's product Buyers are fragmented (many, different) - no buyer has Most consumer products any particular influence on product or price Producers supply critical portions of buyers' input Intel's relationship with PC manufacturers distribution of purchases
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D. Supplier Power A producing industry requires raw materials - labor, components, and other supplies. This requirement leads to buyer-supplier relationships between the industry and the firms that provide it the raw materials used to create products. Suppliers, if powerful, can exert an influence on the producing industry, such as selling raw materials at a high price to capture some of the industry's profits. The following tables outline some factors that determine supplier power.
Suppliers are Powerful if:
Credible forward integration threat by suppliers
Example Baxter International, manufacturer of hospital supplies, acquired American Hospital Supply, a distributor
Suppliers concentrated
Drug industry's relationship to hospitals
Significant cost to switch suppliers
Microsoft's relationship with PC manufacturers
Customers Powerful
Boycott of grocery stores selling non-union picked grapes
Suppliers are Weak if:
Example
Many competitive suppliers - product is standardized
Tire industry relationship to automobile manufacturers
Purchase commodity products
Grocery store brand label products
Credible backward integration threat by purchasers
Timber producers relationship to paper companies
Concentrated purchasers
Customers Weak
Garment industry relationship to major department stores
Travel agents' relationship to airlines
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E. Barriers to Entry / Threat of Entry It is not only incumbent rivals that pose a threat to firms in an industry; the possibility that new firms may enter the industry also affects competition. In theory, any firm should be able to enter and exit a market, and if free entry and exit exists, then profits always should be nominal. In reality, however, industries possess characteristics that protect the high profit levels of firms in the market and inhibit additional rivals from entering the market. These are barriers to entry. Barriers to entry are more than the normal equilibrium adjustments that markets typically make. For example, when industry profits increase, we would expect additional firms to enter the market to take advantage of the high profit levels, over time driving down profits for all firms in the industry. When profits decrease, we would expect some firms to exit the market thus restoring a market equilibrium. Falling prices, or the expectation that future prices will fall, deters rivals from entering a market. Firms also may be reluctant to enter markets that are extremely uncertain, especially if entering involves expensive start-up costs. These are normal accommodations to market conditions. But if firms individually (collective action would be illegal collusion) keep prices artificially low as a strategy to prevent potential entrants from entering the market, such entry-deterring pricing establishes a barrier. Barriers to entry are unique industry characteristics that define the industry. Barriers reduce the rate of entry of new firms, thus maintaining a level of profits for those already in the industry. From a strategic perspective, barriers can be created or exploited to enhance a firm's competitive advantage. Barriers to entry arise from several sources: a. Government creates barriers
Although the principal role of the government in a market is to preserve competition through anti-trust actions, government also restricts competition through the granting of monopolies and through regulation. Industries such as utilities are considered natural monopolies because it has been more efficient to have one electric company provide power to a locality than to permit many electric companies to compete in a local market. To restrain utilities from exploiting this advantage, government permits a monopoly, but regulates the industry. Illustrative of this kind of barrier to entry is the local cable company. The franchise to a cable provider may be granted by competitive bidding, but once the franchise is awarded by a 17
community a monopoly is created. Local governments were not effective in monitoring price gouging by cable operators, so the federal government has enacted legislation to review and restrict prices. The regulatory authority of the government in restricting competition is historically evident in the banking industry. Until the 1970's, the markets that banks could enter were limited by state governments. As a result, most banks were local commercial and retail banking facilities. Banks competed through strategies that emphasized simple marketing devices such as awarding toasters to new customers for opening a checking account. When banks were deregulated, banks were permitted to cross state boundaries and expand their markets. Deregulation of banks intensified rivalry and created uncertainty for banks as they attempted to maintain market share. In the late 1970's, the strategy of banks shifted from simple marketing tactics to mergers and geographic expansion as rivals attempted to expand markets.
b. Patents and proprietary knowledge serve to restrict entry into an industry
Ideas and knowledge that provide competitive advantages are treated as private property when patented, preventing others from using the knowledge and thus creating a barrier to entry. Edwin Land introduced the Polaroid camera in 1947 and held a monopoly in the instant photography industry. In 1975, Kodak attempted to enter the instant camera market and sold a comparable camera. Polaroid sued for patent infringement and won, keeping Kodak out of the instant camera industry.
c. Asset specificity inhibits entry into an industry
Asset specificity is the extent to which the firm's assets can be utilized to produce a different product. When an industry requires highly specialized technology or plants and equipment, potential entrants are reluctant to commit to acquiring specialized assets that cannot be sold or converted into other uses if the venture fails. Asset specificity provides a barrier to entry for two reasons: First, when firms already hold specialized assets they fiercely resist efforts by others from taking their market share. New entrants can anticipate aggressive rivalry. For 18
example, Kodak had much capital invested in its photographic equipment business and aggressively resisted efforts by Fuji to intrude in its market. These assets are both large and industry specific. The second reason is that potential entrants are reluctant to make investments in highly specialized assets.
d. Organizational (Internal) Economies of Scale
The most cost efficient level of production is termed Minimum Efficient Scale (MES). This is the point at which unit costs for production are at minimum - i.e., the most cost efficient level of production. If MES for firms in an industry is known, then we can determine the amount of market share necessary for low cost entry or cost parity with rivals. For example, in long distance communications roughly 10% of the market is necessary for MES. If sales for a long distance operator fail to reach 10% of the market, the firm is not competitive. The existence of such an economy of scale creates a barrier to entry. The greater the difference between industry MES and entry unit costs, the greater the barrier to entry. So industries with high MES deter entry of small, start-up businesses. To operate at less than MES there must be a consideration that permits the firm to sell at a premium price - such as product differentiation or local monopoly. Barriers to exit work similarly to barriers to entry. Exit barriers limit the ability of a firm to leave the market and can exacerbate rivalry - unable to leave the industry, a firm must compete. Some of an industry's entry and exit barriers can be summarized as follows:
Easy to Enter if there is:
Difficult to Enter if there is:
Common technology
Patented or proprietary know-how
Little brand franchise
Difficulty in brand switching
Access to distribution channels
Restricted distribution channels
Low scale threshold
High scale threshold
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Easy to Exit if there are:
Difficult to Exit if there are:
Salable assets
Specialized assets
Low exit costs
High exit costs
Independent businesses
Interrelated businesses
6. DYNAMIC NATURE OF INDUSTRY RIVALRY Our descriptive and analytic models of industry tend to examine the industry at a given state. The nature and fascination of business is that it is not static. While we are prone to generalize, for example, list GM, Ford, and Chrysler as the "Big 3" and assume their dominance, we also have seen the automobile industry change. Currently, the entertainment and communications industries are in flux. Phone companies, computer firms, and entertainment are merging and forming strategic alliances that re-map the information terrain. Schumpeter and, more recently, Porter have attempted to move the understanding of industry competition from a static economic or industry organization model to an emphasis on the interdependence of forces as dynamic, or punctuated equilibrium, as Porter terms it. In Schumpeter's and Porter's view the dynamism of markets is driven by innovation.
7. GENERIC STRATEGIES TO COUNTER THE FIVE
FORCES Strategy can be formulated on three levels:
Corporate level
Business unit level
Functional or departmental level.
The business unit level is the primary context of industry rivalry. Michael Porter identified three generic strategies (cost leadership, differentiation, and focus) that can be implemented at the business unit level to create a competitive advantage. The proper generic strategy will
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position the firm to leverage its strengths and defend against the adverse effects of the five forces.
8. Porter’s Five Force’s Analysis on Different Industries A. The Airline Industry Few inventions have changed how people live and experience the world as much as the invention of the airplane. During both World Wars, government subsidies and demands for new airplanes vastly improved techniques for their design and construction. Following the World War II, the first commercial airplane routes were set up in Europe. Over time, air travel has become so commonplace that it would be hard to imagine life without it. The airline industry, therefore, certainly has progressed. It has also altered the way in which people live and conduct business by shortening travel time and altering our concept of distance, making it possible for us to visit and conduct business in places once considered remote. The airline industry exists in an intensely competitive market. In recent years, there has been an industry-wide shakedown, which will have far-reaching effects on the industry's trend towards expanding domestic and international services. In the past, the airline industry was at least partly government owned. This is still true in many countries, but in the U.S. all major airlines have come to be privately held.
Porter's 5 Forces Analysis
1.
Threat of New Entrants
At first glance, you might think that the airline industry is pretty tough to break into, but don't be fooled. You'll need to look at whether there are substantial costs to access bank loans and credit. If borrowing is cheap, then the likelihood of more airliners entering the industry is higher. The more new airlines that enter the market, the more saturated it becomes for everyone. Brand name recognition and frequent fliers point also play a role in the airline industry. An airline with a strong brand name and incentives can often lure a customer even if its prices are higher.
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2.
Power of Suppliers
The airline supply business is mainly dominated by Boeing and Airbus. For this reason, there isn't a lot of cutthroat competition among suppliers. Also, the likelihood of a supplier integrating vertically isn't very likely. In other words, you probably won't see suppliers starting to offer flight service on top of building airlines. 3.
Power of Buyers
The bargaining power of buyers in the airline industry is quite low. Obviously, there are high costs involved with switching airplanes, but also take a look at the ability to compete on service. Is the seat in one airline more comfortable than another? Probably not unless you are analyzing a luxury liner like the Concord Jet. 4.
Availability of Substitutes
What is the likelihood that someone will drive or take a train to his or her destination? For regional airlines, the threat might be a little higher than international carriers. When determining this you should consider time, money, personal preference and convenience in the air travel industry. 5.
Competitive Rivalry
Highly competitive industries generally earn low returns because the cost of competition is high. This can spell disaster when times get tough in the economy.
B. The Oil Services Industry There is no doubt that the oil/energy industry is extremely large. According to the Department of Energy (DOE), fossil fuels (including coal, oil and natural gas) makes up more than 85% of the energy consumed in the U.S. as of 2008. Oil supplies 40% of U.S. energy needs. 22
OPEC: The
Organization of Petroleum Exporting Countries is an intergovernmental
organization dedicated to the stability and prosperity of the petroleum market. OPEC membership is open to any country that is a substantial exporter of oil and that shares the ideals of the organization. OPEC has 11 member countries. Output quotas placed by OPEC can send huge shocks throughout the energy markets.
Porter's 5 Forces Analysis
1. Threat of New Entrants
There are thousands of oil and oil services companies throughout the world, but the barriers to enter this industry are enough to scare away all but the serious companies. Barriers can vary depending on the area of the market in which the company is situated. For example, some types of pumping trucks needed at well sites cost more than $1 million each. Other areas of the oil business require highly specialized workers to operate the equipment and to make key drilling decisions. Companies in industries such as these have higher barriers than ones that are simply offering drilling services or support services. Having ample cash is another barrier - a company had better have deep pockets to take on the existing oil companies. 2. Power of Suppliers
While there are plenty of oil companies in the world, much of the oil and gas business is dominated by a small handful of powerful companies. The large amounts of capital investment tend to weed out a lot of the suppliers of rigs, pipeline, refining, etc. There isn't a lot of cut-throat competition between them, but they do have significant power over smaller drilling and support companies. 3. Power of Buyers
The balance of power is shifting toward buyers. Oil is a commodity and one company's oil or oil drilling services are not that much different from another's. This leads buyers to seek lower prices and better contract terms. 4. Availability of Substitutes
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Substitutes for the oil industry in general include alternative fuels such as coal, gas, solar power, wind power, hydroelectricity and even nuclear energy. Remember, oil is used for more than just running our vehicles, it is also used in plastics and other materials. When analyzing an energy company it is extremely important to take a close look at the specific area in which the company is operating. Also, companies offering more obscure or specialized services such as seismic drilling or directional drilling tools are much more likely to withstand the threat of substitutes. (For more on oil substitutes, see The Biofuels Debate Heats Up.) 5. Competitive Rivalry
Slow industry growth rates and high exit barriers are a particularly troublesome situation facing some firms. Until quite recently, oil refineries were a particularly good example. For a period of almost 20 years, no new refineries were built in the U.S. Refinery capacity exceeded the product demands as a result of conservation efforts following the oil shocks of the 1970s. At the same time, exit barriers in the refinery business are quite high. Besides the scrap value of the equipment, a refinery that does not operate has no adding capability. Almost every refinery can do one thing - produce the refined products they have been designed for.
C. Precious Metals The precious metals industry is very capital intensive. Constructing mines and building production facilities requires huge sums of capital. Long-term survival requires heavy expenditures to finance production and exploration. Technology has played a big role in the computer and internet industry, but it has also greatly changed the mining industry. Gold is the most popular precious metal for investors. As you may know, gold is a commodity, and, as such, the price for gold fluctuates on a daily basis in the commodity markets.
Porter's 5 Forces Analysis 1. Threat of New Entrants
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Financing is a principal barrier to entry in the precious-metals industry, which is heavily capital intensive. Constructing mines, production facilities, exploration and development and mining equipment all require large sums of capital. This capital is required before the mine is in production. Therefore, favourable financing terms are extremely important. In short, longterm survival in the precious-metal market requires significant capital. 2. Power of Suppliers
The only supply-side issues that miners face deal with government regulations and rules. The supply of land is plentiful, but gaining approval and permits to mine the land can be difficult, especially if environmental risks are high. 3. Power of Buyers
Gold is a commodity-based business, so the gold from one company is not that much different from another's. This translates into buyers seeking lower prices and better contract terms. 4. Availability of Substitutes
Substitutes for the precious metals industry include other precious metals such as diamonds, silver, platinum, etc. These are worthy substitutes for gold, but they are not as widely accepted as gold. Gold has the advantage of being standard for a world currency, so a gold bar in the U.S. is worth the same as it is in Ecuador. As oth er forms of precious metals such as diamonds gain popularity, they may also become more threatening as substitutes. 5. Competitive Rivalry
Gold companies don't compete on price, mainly because the prices are determined by market forces. But gold companies do compete for land. The backbone of a precious metals company is its reserves, and the only way to beef up reserves is to explore for good mining areas. Companies go to great lengths to discover gold deposits, and the discovery is on a first-comefirst-serve basis.
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D. Automobiles Similar to the invention of the airplane, the emergence of automobiles has had a profound effect on our everyday lives. The auto manufacturing industry is considered to be highly capital and labour intensive.
Porter's 5 Forces Analysis
1. Threat of New Entrants It's true that the average person can't come along and start manufacturing automobiles. Historically, it was thought that the American automobile industry and the Big Three were safe. But this did not hold true when Honda Motor Co. opened its first plant in Ohio. The emergence of foreign competitors with the capital, required technologies and management skills began to undermine the market share of North American companies. 2. Power of Suppliers The automobile supply business is quite fragmented (there are many firms). Many suppliers rely on one or two automakers to buy a majority of their products. If an automaker decided to switch suppliers, it could be devastating to the previous supplier's business. As a result, suppliers are extremely susceptible to the demands and requirements of the automobile manufacturer and hold very little power. 3. Power of Buyers Historically, the bargaining power of automakers went unchallenged. The American consumer, however, became disenchanted with many of the products being offered by certain automakers and began looking for alternatives, namely foreign cars. On the other hand, while consumers are very price sensitive, they don't have much buying power as they never purchase huge volumes of cars.
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4. Availability of Substitutes Be careful and thorough when analyzing this factor: we are not just talking about the threat of someone buying a different car. You need to also look at the likelihood of people taking the bus, train or airplane to their destination. The higher the cost of operating a vehicle, the more likely people will seek alternative transportation options. The price of gasoline has a large effect on consumers' decisions to buy vehicles. Trucks and sport utility vehicles have higher profit margins, but they also guzzle gas compared to smaller sedans and light trucks. When determining the availability of substitutes you should also consider time, money, personal preference and convenience in the auto travel industry. Then decide if one car maker poses a big threat as a substitute. 5. Competitive Rivalry Highly competitive industries generally earn low returns because the cost of competition is high. The auto industry is considered to be an oligopoly, which helps to minimize the effects of price-based competition. The automakers understand that price-based competition does not necessarily lead to increases in the size of the marketplace; historically they have tried to avoid price-based competition, but more recently the competition has intensified - rebates, preferred financing and long-term warranties have helped to lure in customers, but they also put pressure on the profit margins for vehicle sales.
E. Retail Industry All businesses that sell goods and services to consumers fall under the umbrella of retailing, but there are several directions we can take from here. For starters, there are department stores, discount stores, specialty stores and even seasonal retailers. Each of these might have their own little quirks; however, for the most part the analysis overlaps to all areas of retailing. This section of the industry handbook will try to focus more on general retailers and department stores. In some parts of the world, the retail business is dominated by smaller family-run or regionally-targeted stores, but this market is increasingly being taken over by billiondollar multinational conglomerates like Wal-Mart and Sears. The larger retailers have 27
managed to set up huge supply/distribution chains, inventory management systems, financing pacts and wide scale marketing plans.
Porter's 5 Forces Analysis 1. Threat of New Entrants One trend that started over a decade ago has been a decreasing number of independent retailers. Walk through any mall and you'll notice that a majority of them are chain stores. While the barriers to start up a store are not impossible to overcome, the ability to establish favourable supply contracts, leases and be competitive is becoming virtually impossible. Their vertical structure and centralized buying gives chain stores a competitive advantage over independent retailers. 2. Power of Suppliers Historically, retailers have tried to exploit relationships with suppliers. A great example was in the 1970s, when Sears sought to dominate the household appliance market. Sears set very high standards for quality; suppliers that didn't meet these standards were dropped from the Sears line. You could also like this to the strict control that Wal-Mart places on its suppliers. A contract with a large retailer such as Wal-Mart can make or break a small supplier. In the retail industry, suppliers tend to have very little power. 3. Power of Buyers Individually, customers have very little bargaining power with retail stores. It is very difficult to bargain with the clerk at Safeway for a better price on grapes. But as a whole, if customers demand high-quality products at bargain prices, it helps keep retailers honest. 4. Availability of Substitutes The tendency in retail is not to specialize in one good or service, but to deal in a wide range of products and services. This means that what one store offers you will likely find at another store. Retailers offering products that are unique have a distinct or absolute advantage over their competitors.
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5. Competitive Rivalry Retailers always face stiff competition. The slow market growth for the retail market means that firms must fight each other for market share. More recently, they have tried to reduce the cutthroat pricing competition by offering frequent flier points, memberships and other special services to try and gain the customer's loyalty.
F. The Banking Industry If there is one industry that has the stigma of being old and boring, it would have to be banking; however, a global trend of deregulation has opened up many new businesses to the banks. Coupling that with technological developments like internet banking andATMs, the banking industry is obviously trying its hardest to shed its lackluster image.
There is no question that bank stocks are among the hardest to analyze. Many banks hold billions of dollars in assets and have several subsidiaries in different industries. A perfect example of what makes analyzing a bank stock so difficult is the length of their financials they are typically well over 100 pages.
Porter's 5 Forces Analysis 1. Threat of New Entrants
The average person can't come along and start up a bank, but there are services, such as internet bill payment, on which entrepreneurs can capitalize. Banks are fearful of being squeezed out of the payments business, because it is a good source of fee-based revenue. Another trend that poses a threat is companies offering other financial services. What would it take for an insurance company to start offering mortgage and loan services? Not much. Also, when analyzing a regional bank, remember that the possibility of a mega bank entering into the market poses a real threat.
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2. Power of Suppliers
The suppliers of capital might not pose a big threat, but the threat of suppliers luring away human capital does. If a talented individual is working in a smaller regional bank, there is the chance that person will be enticed away by bigger banks, investment firms, etc. 3. Power of Buyers
The individual doesn't pose much of a threat to the banking industry, but one major factor affecting the power of buyers is relatively high switching costs. If a person has a mortgage, car loan, credit card, checking account and mutual funds with one particular bank, it can be extremely tough for that person to switch to another bank. In an attempt to lure in customers, banks try to lower the price of switching, but many people would still rather stick with their current bank. On the other hand, large corporate clients have banks wrapped around their little fingers. Financial institutions - by offering better exchange rates, more services, and exposure to foreign capital markets - work extremely hard to get high-margin corporate clients. 4. Availability of Substitutes
As you can probably imagine, there are plenty of substitutes in the banking industry. Banks offer a suite of services over and above taking deposits and lending money, but whether it is insurance, mutual funds or fixed income securities, chances are there is a non-banking financial services company that can offer similar services. On the lending side of the business, banks are seeing competition rise from unconventional companies. Sony (NYSE:SNE), General Motors (NYSE:GM) and Microsoft (Nasdaq:MSFT) all offer preferred financing to customers who buy big ticket items. If car companies are offering 0% financing, why would anyone want to get a car loan from the bank and pay 5-10% interest? 5. Competitive Rivalry
The banking industry is highly competitive. The financial services industry has been around for hundreds of years, and just about everyone who needs banking services already has them. Because of this, banks must attempt to lure clients away from competitor banks. They do this by offering lower financing, preferred rates and investment services. The banking sector is in a race to see who can offer both the best and fastest services, but this also causes banks to 30
experience a lower ROA. They then have an incentive to take on high-risk projects. In the long run, we're likely to see more consolidation in the banking industry. Larger banks would prefer to take over or merge with another bank rather than spend the money to market and advertise to people.
G. Biotechnology Biotechnology uses of biological processes in the development or manufacture of a product or in the technological solution to a problem. Since the discovery of DNA in 1953, and the identification of DNA as the genetic material in all life, there have been tremendous advances in the vast area of biotechnology. Biotech has a wide range of uses including food alterations, genetic research and cloning, human and animal health care, pharmaceuticals and the environment.
Porter's 5 Forces Analysis 1. Threat of New Entrants Because the biotech industry is filled with lots of small companies trying to hit the jackpot, the barriers to enter this industry are enough to scare away all but the serious companies. Biotech firms require huge amounts of funding to finance their large R&D budgets. Having ample cash is one of the biggest barriers, so when interest rates are low, or the equity markets are receptive to initial public offerings, the barriers are lower. Specialization also creates barriers. For instance, knowledge about cancer and heart disease is quite high, whereas a company focusing on something more obscure would likely have a low threat of new entrants because there are very few experts in this field. 2. Power of Suppliers Biotech companies are unique because most of their value is driven byintellectual property. The nature of their business does not force them, unlike other industries, to rely on suppliers. Scientific tools, materials, computers and testing equipment is highly specialized, but the 31
likelihood of these companies invading on their line of business is not very high. One snag is that marketing alliances have often proved to be problematic. Small biotech firms don't have the distribution capabilities to promote their new drugs, so they are forced to license their drugs to other suppliers. 3. Power of Buyers The bargaining power of customers has different levels in the biotech arena. For example, a company that sells pharmaceutical drugs has thousands of individual customers and doesn't need to worry too much about a buyer revolt. After all, when is the last time you were able to bargain with the pharmacist for a better deal? On the other side are the biotech firms, which sell highly specialized products to governments and hospitals. These large organizations have a lot more bargaining power with biotech companies. 4. Availability of Substitutes The threat of substitutes in the biotechnology field, again, really depends on the area. While patent protection might stop the threat of alternative drugs and chemicals for a period of time, eventually there will be a company that can produce a similar product at a cheaper price. Generic drugs, for instance, are a problem: a company that spends millions of dollars on the creation of a new drug must sell it at a high price to recoup the R&D costs, but then along comes a generic drug maker, which simply copies the formula and sells it for a fraction of the cost. This is a big problem in foreign countries where there is a lack of government control. Organizations will illegally produce patent protected drugs and sell them at much lower prices. 5. Competitive Rivalry There are more than 1,000 biotech companies operating in North America. With the top 1% of these companies making up a majority of the revenue, it's a tough industry in which to make a mark. The fight to see who can cure a disease or condition has researchers working day and night. Trade secrets are also extremely valuable. In short, the rivalry is extremely intense.
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H. The Semiconductor Industry
The semiconductor industry lives - and dies - by a simple creed: smaller, faster and cheaper. The benefit of being tiny is pretty simple: finer lines mean more transistors can be packed onto the same chip. The more transistors on a chip, the faster it can do its work. Thanks in large part to fierce competition and to new technologies that lower the cost of production per chip, within a matter of months, the price of a new chip can fall 50%.
As a result, there is constant pressure on chip makers to come up with something better and even cheaper than what redefined state-of-the-art only a few months before. Chips makers must constantly go back to the drawing board to come up with superior goods. Even in a down market, weak sales are seen as no excuse for not coming up with better products to whet the appetites of customers who will eventually need to upgrade their computing and electronic devices.
Porter's 5 Forces Analysis 1. Threat of New Entrants In the early days of the semiconductors industry, design engineers with good ideas would often leave one company to start up another. As the industry matures, however, setting up a chip fabrication factory requires billions of dollars in investment. The cost of entry makes it painful or even impossible for all but the biggest players to keep up with state-of-the-art operations. It comes as no surprise, then, that established players have had a big advantage. Regardless, there are signs that things could be changing yet again. Semiconductor companies are forming alliances to spread out the costs of manufacturing. Meanwhile, the appearance and success of "fabless" chip makers suggests that factory ownership may not last as a barrier to entry. 2. Power of Suppliers For the large semiconductor companies, suppliers have little power - many semiconductor companies have hundreds of suppliers. This diffusion of risk over many companies allows the 33
chip giant to keep the bargaining power of any one supplier to a minimum. However, with production getting hugely expensive, many smaller chip makers are becoming increasingly dependent on a handful of large foundries. As the suppliers of cutting-edge equipment and production skills, merchant foundries enjoy considerable industry bargaining power. The largest U.S.-based foundry belongs to none other than IBM – which is also a top chip maker in its own right. 3. Power of Buyers Most of the industry's key segments are dominated by a small number of large players. This means that buyers have little bargaining power. 4. Availability of Substitutes The threat of substitutes in the semiconductors industry really depends on the segment. While intellectual property protection might stop the threat of new substitute chips for a period of time, within a short period of time companies start to produce similar products at lower prices. Copy-cat suppliers are a problem: a company that spends millions, if not billions, of dollars on the creation of a faster, more reliable chip will strive to recoup the R&D costs. But then along comes a player that reverse engineers the system and markets a similar product for a fraction of the price. 5. Competitive Rivalry The industry is marked by intense rivalries between individual companies. There is always pressure on chip makers to come up with something better, faster and cheaper than what redefined the state-of-the-art only a few months before. That pressure extends to chip makers, foundries, design labs and distributors – everyone connected to the business of bringing chips from R&D into high-tech equipment. The result is an industry that continually produces cutting-edge technology while riding volatile business conditions.
I. The Insurance Industry As a result of globalization, deregulation and terrorist attacks, the insurance industry has gone through a tremendous transformation over the past decade. 34
In the simplest terms, insurance of any type is all about managing risk. For example, in life insurance, the insurance company attempts to manage mortality (death) rates among its clients. The insurance company collects premiums from policy holders, invests the money (usually in low risk investments), and then reimburses this money once the person passes away or the policy matures. A person called an actuary constantly crunches demographic data to estimate the life of a person. This is why characteristics such as age/sex/smoker/etc. all affect the premium that a policy holder must pay. The greater the chance that a person will have a shorter life span than the average, the higher the premium that person will have to pay. This process is virtually the same for every other type of insurance, including automobile, health and property.
Porter's 5 Forces Analysis
1. Threat of New Entrants The average entrepreneur can't come along and start a large insurance company. The threat of new entrants lies within the insurance industry itself. Some companies have carved out niche areas in which they underwrite insurance. These insurance companies are fearful of being squeezed out by the big players. Another threat for many insurance companies is other financial services companies entering the market. What would it take for a bank or investment bank to start offering insurance products? In some countries, only regulations that prevent banks and other financial firms from entering the industry. If those barriers were ever broken down, like they were in the U.S. with the Gramm-Leach-Bliley Act of 1999, you can be sure that the floodgates will open. 2. Power of Suppliers The suppliers of capital might not pose a big threat, but the threat of suppliers luring away human capital does. If a talented insurance underwriter is working for a smaller insurance company (or one in a niche industry), there is the chance that person will be enticed away by larger companies looking to move into a particular market. 3. Power of Buyers
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The individual doesn't pose much of a threat to the insurance industry. Large corporate clients have a lot more bargaining power with insurance companies. Large corporate clients like airlines and pharmaceutical companies pay millions of dollars a year in premiums. Insurance companies try extremely hard to get high-margin corporate clients. 4. Availability of Substitutes This one is pretty straight forward, for there are plenty of substitutes in the insurance industry. Most large insurance companies offer similar suites of services. Whether it is auto, home, commercial, health or life insurance, chances are there are competitors that can offer similar services. In some areas of insurance, however, the availability of substitutes are few and far between. Companies focusing on niche areas usually have a competitive advantage, but this advantage depends entirely on the size of the niche and on whether there are any barriers preventing other firms from entering. 5. Competitive Rivalry The insurance industry is becoming highly competitive. The difference between one insurance company and another is usually not that great. As a result, insurance has become more like a commodity - an area in which the insurance company with the low cost structure, greater efficiency and better customer service will beat out competitors. Insurance companies also use higher investment returns and a variety of insurance investment products to try to lure in customers. In the long run, we're likely to see more consolidation in the insurance industry. Larger companies prefer to take over or merge with other companies rather than spend the money to market and advertise to people.
J. Telecommunication Think of telecommunications as the world's biggest machine. Strung together by complex networks, telephones, mobile phones and internet-linked PCs, the global system touches nearly all of us. It allows us to speak, share thoughts and do business with nearly anyone, regardless of where in the world they might be. Telecom operating companies make all this happen.
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Not long ago, the telecommunications industry was comprised of a club of big national and regional operators. Over the past decade, the industry has been swept up in rapid deregulation and
innovation.
In
many
countries
around
the
world,
government monopolies are now privatized and they face a plethora of new competitors. Traditional markets have been turned upside down, as the growth in mobile services out paces the fixed line and the internet starts to replace voice as the staple business.
Porter's 5 Forces Analysis
1. Threat of New Entrants It comes as no surprise that in the capital-intensive telecom industry the biggest barrier to entry is access to finance. To cover high fixed costs, serious contenders typically require a lot of cash. When capital markets are generous, the threat of competitive entrants escalates. When financing opportunities are less readily available, the pace of entry slows. Meanwhile, ownership of a telecom license can represent a huge barrier to entry. In the U.S., for instance, fledgling
telecom
operators
must
still
apply
to
the Federal
Communications
Commission (FCC) to receive regulatory approval and licensing. There is also a finite amount of "good" radio spectrum that lends itself to mobile voice and data applications. In addition, it is important to remember that solid operating skills and management experience is fairly scarce, making entry even more difficult. 2. Power of Suppliers At first glance, it might look like telecom equipment suppliers have considerable bargaining power over telecom operators. Indeed, without high-tech broadband switching equipment, fibre-optic cables, mobile handsets and billing software, telecom operators would not be able to do the job of transmitting voice and data from place to place. But there are actually a number of large equipment makers around. There are enough vendors, arguably, to dilute bargaining power. The limited pool of talented managers and engineers, especially those well versed in the latest technologies, places companies in a weak position in terms of hiring and salaries. 3. Power of Buyers
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With increased choice of telecom products and services, the bargaining power of buyers is rising. Let's face it; telephone and data services do not vary much, regardless of which companies are selling them. For the most part, basic services are treated as a commodity. This translates into customers seeking low prices from companies that offer reliable service. At the same time, buyer power can vary somewhat between market segments. While switching costs are relatively low for residential telecom customers, they can get higher for larger business customers, especially those that rely more on customized products and services. 4. Availability of Substitutes Products
and
services
from
non-traditional
telecom
industries
pose
serious substitution threats. Cable TV and satellite operators now compete for buyers. The cable guys, with their own direct lines into homes, offer broadband internet services, and satellite links can substitute for high-speed business networking needs. Railways and energy utility companies are laying miles of high-capacity telecom network alongside their own track and pipeline assets. Just as worrying for telecom operators is the internet: it is becoming a viable vehicle for cut-rate voice calls. Delivered by ISPs - not telecom operators - "internet telephony" could take a big bite out of telecom companies' core voice revenues. 5. Competitive Rivalry Competition is "cut throat". The wave of industry deregulation together with the receptive capital markets of the late 1990s paved the way for a rush of new entrants. New technology is prompting a raft of substitute services. Nearly everybody already pays for phone services, so all competitors now must lure customers with lower prices and more exciting services. This tends to drive industry profitability down. In addition to low profits, the telecom industry suffers from high exit barriers, mainly due to its specialized equipment. Networks and billing systems cannot really be used for much else, and their swift obsolescence makes liquidation pretty difficult.
K. Utilities Industry The allure of utility and power as investment safe havens has faded as new and riskier business models populate the industry. Utility monopolies once attracted investors with reliable earnings and fat dividends; today the same companies, operating in open
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markets, divert cash into expansion opportunities while they try to keep growth-hungry competitors at bay. As the utility industry evolves, as markets grow more volatile and as regulations change, investors can expect more lucrative opportunities. Simultaneously, they must learn to embrace more risk.
Firms that make the bulk of their money from wholesale trading, arguably carry the highest risk. Their shares react instantaneously to wholesale energy markets' wild price swings, credit ratings, and news headlines. Power trading companies can make a lot of money for investors, but they can also lose them a lot. They demand close investor scrutiny.
Porter's 5 Forces Analysis
1. Threat of New Entrants Incumbent utility players enjoy considerable barriers to entry. Setting up new generation plants carries high fixed costs and new power producers need a lot of upfront capital to enter the market. Gaining regulatory approval to build new plants can be a long and complicated process for merchant generators. Achieving brand-name recognition and the trust required to convince consumers to switch from incumbent utility providers is not just costly but also time consuming. Meanwhile, once a power plant is built and a market established, the cost of serving one more customer or offering one more kilowatt-hour is minimal. This is a barrier because new entrants can only hope to realize similar unit costs by rapidly capturing a large market share. There is also a relative shortage of talented, experienced managers for which new entrants must compete. Nonetheless, the structural unbundling trend does offer entry opportunities, especially at the trading and retailing end of the market where upfront capital requirements are less onerous. 2. Power of Suppliers The power systems supply business is dominated by a small handful of companies. There isn't a lot of cut-throat competition between them; they have significant power over generation companies. Meanwhile, as the industry's vertical structures dissolve into a chain of generation suppliers, network suppliers, traders and retailers expect the leverage of any one of them to be reduced. As profits are spread over more players, each one's share will shrink. 39
3. Power of Buyers The balance of power is shifting toward buyers. Because one company's electricity is no different from another's, service can be treated as a commodity. This translates into buyers seeking lower prices and better contract terms from energy providers. Commercial and industrial customers, in particular, have great leverage. Long-term power purchasing agreements, for instance, are now the norm for commercial buyers; by replacing more traditional short-term contracts, these shift much of the risk associated with wholesale pricing from buyers and onto utilities. Meanwhile, consumers are forming online communities and buying groups and cooperatives in bids to bolster their market power. As the industry becomes more competitive, customers ought to enjoy more power over utilities. 4. Availability of Substitutes Power doesn't have a substitute; it is a necessity in the modern world. Short-term demand for power is inelastic. This means that price hikes do little to diminish consumption, at least in the near term. However, while there are no existing substitutes for electrons or natural gas, there are alternative ways of generating them. Industrial groups have launched programs to develop small generators. Microturbines and fuel cells are on the market horizon. These small generators could allow users to bypass traditional power grids altogether, or to limit the use of the grid when prices rise too much over time. 5. Competitive Rivalry Rivalry among competitors is getting increasingly fierce. Utilities must fight for market share in order to create the economies of scale needed to lower costs and remain competitive. Because nearly everybody already uses a utility, competitors are forced to rely mainly on lower prices and to capture market share. This tends to drive industry profitability down. Competitors try to break out of commoditization by trying to differentiate services, segmenting the market and bundling value-added services. However, the characteristics of the electricity market threaten to neutralize such efforts.
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L. Internet Industry The current climate for internet portal companies is a cold one. In the wake of the internet market crash, portal players are taking a closer look at their business models. The pressure is on to transform users into paying customers - converting them into hard cash. While seeking to reduce churn and reach new markets, they are also searching for new revenue streams ones that actually produce the goods.
The first web portals were online services, such as AOL, that provided access to the web. Others were search engines like Alta Vista and Excite that offered users ways of finding the information they were looking for on the web. But by now most of the traditional search engines have transformed themselves into multipurpose web portals to attract and keep a larger audience. At a consumer internet portal like Yahoo!, a whole host of information and services can be found. Check email, update you investment portfolio, shop for a car or vacation, do research for a term paper or even join a discussion group. Portals users can do it all.
Porter's 5 Forces Analysis
1. Threat of New Entrants You do not need to look far to realize that the cost of entry has fallen fast. It used to costs an arm and a leg to launch a portal. The price of computer software and servers and network bandwidth - of which portals consume a substantial amount - was enormous. Yet costs are falling fast, as off-the shelf systems can now do what only customized technologies could do just a few of years ago and at a fraction of the price. At the same time, brainy web developers, which were scarce at the height of the internet market boom, are now much easier for new entrants to find and have become more affordable keep. However, the apparent success of companies like Amazon, is not based on their low entry cost into book retailing, but the very large sums of money spent on promotion and growing their business. Entering a new market with a new brand still calls for deep pockets.
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2. Power of Suppliers Portals generally have little power over suppliers. Basically, this is because they don't actually own much. Most of the information and services they deliver to users is supplied by outside companies – stock brokerages, new magazines and the like. Expect content suppliers to enjoy growing power, especially considering portals will not able to give content away forever. At the same time, internet portals rely on telecom network operators for a steady diet of internet bandwidth. Granted, the telecom bandwidth business is getting increasingly competitive and prices are falling fast. But once systems are hooked up to telecom operator networks, it can be awfully difficult to switch to a new supplier. 3. Power of Buyers Internet portals have two sets of buyers: visitors and advertisers. Both enjoy considerable power over portals. Competing sites are just a click away; URL book-marking makes the job of switching to other sites even easier for users. In fact, portals are in constant danger of a mass desertion of users to other sites because in most cases, customers make no financial commitment to the service. Portals' heavy reliance on advertising dollars means that ad spenders can squeeze increasingly better terms for banner space. 4. Availability of Substitutes Internet portals must defend themselves from a raft of substitutes. The most obvious are other websites that offer the same, or similar, information and services. Most portals do little more than aggregate information and services that already exists on the internet; original content suppliers represent a readily available set of substitutes. In most cases, they are just a click away. There are more, less obvious substitutes as well, such as television and magazines. Television's clear, moving images never suffer slow connections; magazines can be rolled up and carried on the bus. Don't forget that the good old telephone directories - both white and yellow pages - are still very convenient business search tools. 5. Competitive Rivalry
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Feeble barriers to entry, a slew of substitutes and steadily increasingly buyer power combine to create a disturbing impact: fierce competition and industry rivalry. Portal competitors now must lure customers with lower prices and heavy investment in more exciting content services. All of this tends to drive industry profitability down, threatening the survival of players who can't compete.
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9. Case Study – Apple Inc. - iPhone In first-quarter 2007, Apple launched its "revolutionary" product, the iPhone. iPhone combines three concepts popular with customers: a mobile phone, a widescreen iPod, and a internet communication device. The iPhone brags "an entirely new user interface based on a large multi-touch display and pioneering software." which users can control with just their fingers. The iPhone default Internet browser is Apple's own Safari, but it is open to other software as well. The iPhone allows for 8 hours of talk time. Apple sold more than1 million iPhones in less than three month after this product was available to customers. Apple continued this trend during 2008 and to reach sales of 10 million iPhones, stealing 1 percent of the mobile phone market share. One year following the untimely death of Steve Jobs, the company he co-founded and led for most of his adult life appears to be thriving and lacking any serious obstacles to its breakneck growth in a rapidly changing technology market. That said, Apple Inc. still has plenty of challenges ahead. Some of those stem simply from the nature of the fast-paced, hyper-competitive consumer technology business the company currently competes in — and largely dominates. Other challenges may be more unique to Apple and its singular focus on a relatively narrow line of products. And long-term, the company may still feel the loss of a leader who possessed an uncanny ability to see around corners, and bend other strong personalities to his will. ―The guy who could literally pull rabbits out of his hat no longer exists,‖ said independent
technology analyst Roger Kay. Apple’s had a phenomenally strong year since Jobs’ death from cancer last October, which
left the company permanently in the hands of the senior management team he spent years cultivating, led by CEO Tim Cook. It’s also had some stumbles along the way.
Some missteps with features such as Siri — the infamous personal digital assistant first embedded into last year’s iPhone 4S — and the Apple Maps tool in the latest iPhone 5 have caused some level of embarrassment. The company under Jobs’ direction was not fr ee of slip-
ups either, and some issues have spanned both periods, such as growing concerns about the
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treatment of workers in the massive Chinese factories that produce the company’s popular
products. But if proof is in the numbers, investors may find it hard to argue against the crew running Apple now. The company is conservatively projected to report a 44% revenue gain for its just-ended fiscal year — with earnings expected to post a gain of more than 60% from the previous year. Apple’s stock is up more th an 70% from the day Jobs passed away, despite the stated
concerns at the time of many investors and analysts about how well the company could keep its pace of innovation without its chief visionary at the helm. The key challenge for Apple’s management team will be in keeping the company’s strongest
profit engines humming. And this will involve the right mix of technological innovation and deal making. The iPhone is the most crucial element. First launched in 2007, the smartphone accounted for nearly 55% of Apple’s total revenue in the first nine months of the just -ended fiscal year. While the company does not disclosed profitability data on its product lines, analysts believe the iPhone is the major driver of operating profits, with a gross margin of well over 50% on the devices. Apple can command those high subsidies because of the strong consumer demand for the iPhone. But competitors are pushing hard into the smartphone space. Samsung has already outpaced Apple in global shipments thanks to its use of Google’s Android operating system and its wide line of phones that appeal to a broader array of markets and consumers. Apple’s old nemesis Microsoft is launching an updated Windows Phone platform this fall,
with Nokia and Samsung building devices for the software. Investors will continue to watch closely for signs that Apple’s current team can not only push
forward its existing product line, but add to them with new categories and innovations. Though the iPhone 5 launched a year following his death, a report by Bloomberg BusinessWeek cited unnamed sources as saying that the device received ―detailed input‖
from Jobs prior to his death. Despite Apple’s strong run of success, it’s narrow product line and strong reliance on the
iPhone makes it vulnerable to competitors who may come up with better ideas. 45
Apple’s future success will likely hinge on its ability to maintain that posture — no matter who’s in charge. Apple vision statement :
Apple is committed to bringing the best personal computing experience to students, educators, creative professionals and consumers around the world through its innovative hardware, software and Internet offerings. Smartphone sales will be driven by two main factors,
Replacement of nearly 5 billion "dumbphones" with smartphones (smartphones currently make up only 10% of handsets worldwide)
Price declines - The average price of a smartphone will drop from about $315 last year to $200 over the next several years
Porter’s Five Force Analysis Six years to the month after Steve Jobs unveiled the first iPhone, the smartphone industry’s go-go years are officially over. Cautious comments from Samsung Electronics on Friday underlined the message conveyed by the latest quarterly results from Apple earlier in the week: even as it scales new heights, the smartphone market is entering a phase in which vaulting growth rates – and high profit margins – will be much harder to come by. The developing world, is riding a wave of cut-price devices, many of them closer in nature to feature phones than the high-end smartphones that have put Apple and Samsung at the top. Apple’s shares continued to slip following its announcement of weaker than expected iPhone sales in the final quarter of 2012, with Exxon taking its crown as the world’s most valuable
company. Despite selling 47.8m iPhones – 29 per cent more than in its previous record quarter a year before – Apple failed to live up to Wall Street’s high hopes , leading some analysts to predict the years of super-charged growth that began with the iPod were behind it.
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Threat of new entrants : Powerful companies like Samsung that have a lot to say these days with new products in smartphone market. Android, as a partially free operating system could be a influential competitor.
Bargaining power of suppliers: A dissembled iPhone reveals that the microprocessor chip is supplied by Samsung; Philips and many other companies provide chips that are central to the camera, display, and motion sensor. Marinating good supplier relationships is a balanced that apple will have to find in order to stay ahead of its competitors.
Bargaining power of customers:
Competitive rivalry in smartphone industry
iPhone counts as a luxury device. It is expensive in comparison to other smartphones. Retailers often report customer’s dissatisfaction about iPhone and other Apple products.
Threat of Substitutes: In this concept we do not look for other brands similar products. In face we should find totally different products for this section of analysis. With all the capabilities that a smartphone could have, there will be another revolution or kind of invention for substitute product.
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Conclusion We all know Apple is a big company with worldwide reputation. People willing to line up for new products and mostly they are satisfied with results. Nevertheless Apple has problems too. Technology is a very competitive market. And day by day companies do more R&D to make products better than others. We reviewed Apple strength and weaknesses, all the good things like brand loyalty, unique technology especially in iPhone, matchless interface and applications, strategic agreements with big companies like AT&T and Weaknesses like expensiveness, retailers controlling problems, vigorous competitor like Samsung and RIM. Apple is on top from so many points now, no doubt. Brands devour fame and income and willing to do their best. Apple financial statements say everything is ok and growth is more than satisfactory, but in risks section many items were mentioned to remind investor it is a very hard business. Samsung is catching up but Apple still dominates US and aside recession points, figures show Apple knows the business.
Recommendations
Innovative iPhone Operating System
Mini iPhone and concentration on the Chinese Market
Observation on the Industry and current trends and innovations
Reduce stock price volatility during the year by spreading out product launches
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10. Critique
Porter’s model of Five Competitive Forces has been subject of much critique. Its main
weakness results from the historical context in which it was developed. In the early eighties, cyclical growth characterized the global economy. Thus, primary corporate objectives consisted of profitability and survival. A major prerequisite for achieving these objectives has been optimization of strategy in relation to the external environment. At that time, development in most industries has been fairly stable and predictable, compared with today’s dynamics. In general, the meaningfulness of this model is reduced by the following factors:
In the economic sense, the model assumes a classic perfect market. The more an industry is regulated, the less meaningful insights the model can deliver.
The model is best applicable for analysis of simple market structures. A comprehensive description and analysis of all five forces gets very difficult in complex industries with multiple interrelations, product groups, by-products and segments. A too narrow focus on particular segments of such industries, however, bears the risk of missing important elements.
The model assumes relatively static market structures. This is hardly the case in today’s dynamic markets. Technological breakth roughs and dynamic market
entrants from start-ups or other industries may completely change business models, entry barriers and relationships along the supply chain within short times. The Five Forces model may have some use for later analysis of the new situation; but it will hardly provide much meaningful advice for preventive actions.
The model is based on the idea of competition. It assumes that companies try to achieve competitive advantages over other players in the markets as well as over suppliers or customers. With this focus, it dos not really take into consideration strategies like strategic alliances, electronic linking of information systems of all companies along a value chain, virtual enterprise-networks or others.
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Overall, Porters Five Forces Model has some major limitations in today’s market environment. It is not able to take into account new business models and the dynamics of markets. The value of Porters model is more that it enables managers to think about the current situation of their industry in a structured, easy-to-understand way – as a starting point for further analysis.
11.Conclusion Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a firm's strategic position. However, for most consultants, the framework is only a starting point or "checklist." They might use "Value Chain" afterward. Like all general frameworks, an analysis that uses it to the exclusion of specifics about a particular situation is considered naive. According to Porter, the five forces model should be used at the line-of-business industry level; it is not designed to be used at the industry group or industry sector level. An industry is defined at a lower, more basic level: a market in which similar or closely related products and/or services are sold to buyers. A firm that competes in a single industry should develop, at a minimum, one five forces analysis for its industry. Porter makes clear that for diversified companies, the first fundamental issue in corporate strategy is the selection of industries in which the company should compete; and each line of business should develop its own, industry-specific, five forces analysis. The average Global 1,000 company competes in approximately 52 industries (lines of business).
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