Supplementary Handout- Business Environment. Chapter 01

Transcription

1 Supplementary Handout- Business Environment Chapter 01 Sources of competition- The five forces framework By Himashi De Mel: CIMA Passed Finalist Inherent with the notion of strategy is the issue of competitiveness. In business, this is about gaining advantage over competitors. Typically managers take too parochial view as to the sources of competition, usually focussing their attention on direct competitive rivals (as discussed below). But there are many other factors in the environment which influence this competitiveness. Porter s five forces framework was originally developed as a way of assessing the attractiveness (profit potential) of different industries. As such it can help identifying the sources of competition in the industry or sector. Although initially used with business in mind, it is of value to most organisations. When using this framework to understand competitive forces it is essential to bear the following in mind: It must be used at the level of strategic business units and not at the level of whole organisation. This is because organisations are diverse in their operations and business markets. For example, an airline might compete simultaneously in several different arenas such as domestic and long haul, and target different customer groups such as leisure, business and freight. The impact of competitive forces may be different for each SBU. Understanding the connections between competitive forces and the key drivers in the macro environment is essential. For example, technological changes can destroy many of the competitive advantages and barriers that have protected organisation historically. In the public services the same could be true with political changes (such as new government). The five forces are not independent of each other. Pressures from one direction can trigger off changes in another dynamic process of shifting sources of competition. For example, potential new entrants finding themselves blocked may find new routes to By Himashi De Mel Page 1

2 market by bypassing traditional distribution channels and selling directly to consumers. Competitive behaviour may be concerned with disrupting these forces and not simply accommodating them. Bearing these cavities in mind, the five forces is a useful starting point understanding competitive forces. Potential entrants Threat of entry Suppliers Bargaining power Competitive entry Buyers Bargaining power Substitutes Threat of substitutes By Himashi De Mel Page 2

3 The threat of entry Threat of entry will depend on the extent to which there are barriers to entry. These are factors that need to be overcome by new entrants if they are to compete successfully. These should been seen as providing delays to entry and not as permanent barriers to determined potential entrants. Typical barriers are as follows: Economies of scale. In some industries, economies of scales are extremely important: for example, in the production of automobiles, in distribution (e.g. brewing) or in sales and marketing (e.g. advertising costs for fast moving consumer goods.) The capital requirement of entry. The capital cost of entry will vary according to technology and scale. The cost of setting up a dot.com business with leased premises is minimal when compared with the cost of, for example, entering capital intensive industries such as chemicals, power of mining. Access to supply and distribution channels. In many industries manufactures have had control over supply and/or distribution channels. (For example Dell computers and Amazon). Customer or supplier loyalty. It is difficult for a competitor to break into an industry if there are one or more established operators that know the industry well and have good relationships with the key buyers and suppliers. Legislation or government action. Legal restraints on competition vary from patent protection, to regulation of markets (e.g. pharmaceuticals and insurance), through to direct government action. The threat of substitutes Substitution reduces demand for a particular class of products as customers switch to the alternatives. Substitution may take different forms: Product-for-product substitution. (For example, substituting for postal services) Generic substitution occurs where products or services compete for disposable income. (For example, furniture manufacturers compete for available house hols expenditure with suppliers of televisions, videos, cars and holidays.) By Himashi De Mel Page 3

4 The power of buyers and suppliers The next two forces can be considered together because they can have similar effects in constraining the strategic freedom of an organisation and in influencing the margins (and hence the financial attractiveness) of that organisation. Buyer power is likely to be high when some of the following conditions prevail. Concentration of buyers, particularly if the volumes purchased by buyers are high and/or supply industry comprises a large number of small operators. The cost of switching a supplier is low or involves little risk- for example in e- commerce transactions buyers are more able to shop around quickly with no risk. There is a threat of the supplier being acquired by the buyer and/or the buyer setting up in competition with the supplier. This is known as the backward integration. For example Amazon.com backward vertically integrated when it became not only a bookseller but a book publisher. As a bookseller, Amazon.com buys books from various suppliers, such as publishing companies. By becoming a publisher itself, it has integrated into its business the role of supplier and can sell books that its own publishing company publishes. Supplier power is likely to be high when some of the following conditions prevail. There is a concentration of suppliers rather than fragmented source of supply. The switching costs from one supplier to another are high, perhaps because an organisation s processes are dependent on the specialist product of a supplier. The brand of the supplier may be powerful- for example a retailer might not be able to do without a particular brand in its range. There is a possibility of the suppliers competing directly with their buyers (this is called forward integration). Competitive rivalry These wider competitive forces (above discussed) will impinge on the direct competitive rivalry between an organisation and its most immediate rivals. Competitive rivals are organisations with similar products and services aimed at the same customer group. There By Himashi De Mel Page 4

5 are a number of factors that affect the degree of competitive rivalry in an industry or sector. The extent to which competitors are in balance. Where competitors are of roughly equal size there is the danger of intense competition as the competitor attempts to gain dominance over another. Industry growth rate may affect the rivalry Where there are high exit barriers to an industry, there is again likely to be the persistence of excess capacity and consequently, increased competition. For example high investment in non-transferable fixed assets (very common in manufacturing companies) or high redundancy costs. Reference Johnson, G., Scholes, K., and Whittington, R. (2011), Exploring Corporate Strategy, 7 th Ed, Pearson Education Limited: United Kingdom By Himashi De Mel Page 5