We can now examine the influences from the immediate competitive environment of our organisation so that we can identify where the opportunities for developing a competitive advantage arise.
Porter’s (1980) Five Forces Model as you can see below, is a useful means towards conducting this analysis.
Adapted from M E Porter (1980)
Threat of Entry
The threat of new entrants into an industry depends on the barriers to entry. If it is easy to get into an industry then, assuming profits are attractive, new firms will enter. Subsequently if demand does not rise to match the increased production capacity caused by the new entrants, prices and profits are likely to fall.
Barriers to entry differ by industry and by product/market so it is important to establish:
- Which barriers exist,
- How robust are they in preventing entry,
- Your company’s position in all this (eg. preventing entry or attempting to gain entry).
Bargaining Power of Buyers
When the bargaining power of buyers is high they can reduce potential profits. Firms may undercut each other to get the buyer’s business. They can also use their power to extract other benefits like credit, quality improvements etc. Buyer power is likely to be high when they are few in number and they purchase large quantities. It is increased further when the item being purchased is standardised so that it is easy to switch to another supplier.
Bargaining Power of Suppliers
Suppliers of vital resources (raw materials, components, power, skilled labour etc.) can demand high prices, which raises input cost and squeezes profits.
Suppliers are powerful when there are few of them and they are concentrated (e.g. OPEC). It is further increased when the costs of switching from one supplier to another are high.
A challenge in strategic management is the extent to which mutual interests can be accommodated. For example, if you squeeze your suppliers/buyers so that they reduce their activities, those remaining will gain volume and since there are less of them, enjoy increased bargaining power. Perhaps it might be advantageous to develop strategies, which build mutually beneficial links in the supplier – buyer channel. Some organisations, such as Benetton, have built a formidable strategic architecture to deal with this issue.
Threat of Substitutes
Substitution can take different forms. For our purpose a substitute is something that meets the same needs as your product (ie. product for product substitution). If the substitute is more attractive in terms of price, quality, performance etc. then buyers will be tempted away from your product.
So when thinking of substitutes, you must really understand the wants and needs of the buyers and how these change over time.
A market with low barriers of entry will experience a greater level of competition and may not particularly be an attractive industry due to the number of competitors. However the degree of competitive rivalry will depend on which of these factors prevail; exit barriers are high; buyers or suppliers have high power; Market growth rates; and substitutes are readily available.
Market growth rates also affect rivalry. The life cycle concept suggests that the balance between supply and demand determines the degree of competitive rivalry and that this varies according to the different stages in the life cycle.
An effective competitive strategy takes offensive or defensive action in order to create a defendable position against the five forces. There are a number of possible approaches:
- Positioning the firm so that its capabilities provide the best defence against the existing array of competitive forces.
- Influencing the balance of forces through strategic moves so as to improve the firms relative position
- If factors underlying the forces are going to change, selecting a strategy appropriate to the new circumstances before rivals recognise the situation.