Forces shaping Competition in an Industry

Competition in an industry is determined by its own particular structure. Industry structure refers to the inter relationship among five different forces that drive behavior of firms competing in that industry. According to Porter, an industry’s profit potential (long run return on invested capital) depends on five basic competitive forces within the industry. These forces can be quite strong in industries such as tires or steel where returns are generally low, but may be relatively mild in such industries as toiletries and cosmetics where returns are often high. To compete effectively therefore the firm should find a position in the industry from which it can influence these forces to its advantage or can effectively defend against them. Let’s examine these forces in greater detail:

Forces driving Industry Competition:

Entry barriers: (1) Economics of scale (2) Proprietary product differences (3) Brand identity (4) Switching costs (5) Capital requirements (6) Access to distribution (7) Absolute cost advantages (8) Proprietary curve (9) access to necessary inputs (10) Proprietary low cost product design (11) Government policy (12) Executed retaliation.

Rivalry Determinants:

(1) Industry growth (2) Fixed (or storage) costs/ value added (3) Product differences (4) Brand identity (5) Switching costs ( 6) Concentration and balance (7) informational complexity (8) Diversity of competitors (9) Corporate stakes (9) Exit barriers.

New entrants  Suppliers  buyers  Substitute  Industry competitors

Determinants of Supplier Power

(1) Differentiation of inputs (2) Switching costs of suppliers and firms in the industry (3) presence of substitute inputs (4) Supplier concentration (5) Importance of volume to supplier (6) Cost relative to total purchase in the industry. (7) Impact of inputs on cost or differentiation (8) Threat of forward integration relative to the threat of backward integration by firms in the industry.

Determinants of Buyer Power:

Bargaining Leverage: (1) buyer concentration versus firm concentration (2) Buyer volume (3) buyer switching costs relative to firm switching costs (4) Buyer information (5) Ability to backward integrate Substitute products (6) Pull through.

Price Sensitivity

(1) Price / total purchase (2) Product differences (3) Brand identity (4) Impact on quality/ performance (5) buyer profits (6) decision maker’s incentives.

Threat of Entry: A new entrant in an industry represents a competitive threat to established firms (called as incumbents) The entrant adds new production capacity, brings in expertise and substantial resources (large advertising or R&D budget) which would eventually erode the market shares of incumbent. Availability of attractive returns would entice new players into an industry. But the likelihood of new players invading an industry is a function of two factors: (1) barriers to entry and (2) the expected retaliation from incumbents. Where the entry barriers are high and the retaliation from incumbents is likely to be sharp the potential entrants are obviously discouraged to take the plunge. New entrants in most cases cannot enter on equal teams with those of established players. The size of advantage of an incumbent over an entrant firms (in terms of unit costs) measures the height of barriers or entry. There are six major sources of barriers to entry.

Economics of scale: New entrants are often caught in a dilemma. They have to enter the industry in a big way to reap economies of scale, thereby risking a strong retaliation for existing firms or operate at a small scale with its accompanying cost disadvantages. Scale economies in production, marketing and service are probably the key barriers to entry in paper steel, aluminium, oil etc. Economies of scale also can act as hurdles in distribution (Public sector oil companies) utilization of sales force (large pharma companies such as Dr Reddy Labs, Cipla, Ranbaxy), financing nearly any other part of a business.

To overcome such high entry barriers automobile manufacturers now customize their products, of course not produced in large volumes for large number of small customer groups and deliver the same within a very short time. Such companies try to respond to changes in customers, desires instead of relying on scale economies.

Source: Strategic Management