3.7.7 Analysing the external environment to assess opportunities and threats: the competitive environment


    3.7.7 Analysing the external environment to assess opportunities and threats: the competitive environment

    Porter’s five forces, how and why these might change, and the implications of these forces for strategic and functional decision making and profits

    How markets differ:

    • Size (e.g. sales revenue, volumes, numbers of customers)
    • Structure (e.g. the number of brands and competitors)
    • Distribution channels (how the product gets from producer to final consumer)
    • Customer needs and wants (the basis of marketing segmentation)
    • Growth (the rate of growth and which businesses are growing faster or slower than the market)
    • Product life cycle (the stage of the life cycle for the industry as a whole and for products and brands within it)
    • Alternatives for the consumer (e.g. substitute products)


    Porter’s Five Forces = a framework for analysing the nature of competition within an industry.


    • It helps to develop strategies for specific industries by taking into account variables such as power, relationships, threats, and the intensity of competition

    Porter identified five factors that act together to determine the nature of competition within an industry. These are the:

    • Threat of new entrants to a market
    • Bargaining power of suppliers
    • Bargaining power of customers (buyers)
    • Threat of substitute products
    • Degree of competitive rivalry


    Threat of new entrants:

    • If new entrants move into an industry they will gain market share & rivalry will intensify
    • The position of existing firms is stronger if there are barriers to entering the market
    • If barriers to entry are low then the threat of new entrants will be high, and vice versa
    • Barriers to entry are, therefore, very important in determining the threat of new entrants. An industry can have one or more barriers. The following are common examples of successful barriers:

    Bargaining power of suppliers:

    • If a firm’s suppliers have bargaining power they will:
      • Exercise that power
      • Sell their products at a higher price
      • Squeeze industry profits
    • If the supplier forces up the price paid for inputs, profits will be reduced. It follows that the more powerful the customer (buyer), the lower the price that can be achieved by buying from them.
    • Suppliers find themselves in a powerful position when:
      • There are only a few large suppliers
      • The resource they supply is scarce
      • The cost of switching to an alternative supplier is high
      • The product is easy to distinguish and loyal customers are reluctant to switch
      • The supplier can threaten to integrate vertically
      • The customer is small and unimportant
      • There are no or few substitute resources available
    • Just how much power the supplier has is determined by factors such as:

    Bargaining power of customers:

    • Powerful customers are able to exert pressure to drive down prices, or increase the required quality for the same price, and therefore reduce profits in an industry.
    • Example = the dominant grocery supermarkets which exert great power over supplier firms.
    • Several factors determine the bargaining power of customers, including:

    • Customers tend to enjoy strong bargaining power when:
      • There are only a few of them
      • The customer purchases a significant proportion of output of an industry
      • They possess a credible backward integration threat – that is they threaten to buy the producing firm or its rivals
      • They can choose from a wide range of supply firms
      • They find it easy and inexpensive to switch to alternative suppliers


    Threat of substitute products:

    • A substitute product can be regarded as something that meets the same need
    • Substitute products are produced in a different industry – but crucially satisfy the same customer need. If there are many credible substitutes to a firm’s product, they will limit the price that can be charged and will reduce industry profits.
    • The extent of the threat depends upon:
      • The extent to which the price and performance of the substitute can match the industry’s product
      • The willingness of customers to switch
      • Customer loyalty and switching costs
    • If there is a threat from a rival product the firm will have to improve the performance of their products by reducing costs and therefore prices and by differentiation.


    Intensity of rivalry:

    • If there is intense rivalry in an industry, it will encourage businesses to engage in:
      • Price wars (competitive price reductions)
      • Investment in innovation & new products
      • Intensive promotion (sales promotion and higher spending on advertising)
    • All these activities are likely to increase costs and lower profits
    • Several factors determine the degree of competitive rivalry; the main ones are:




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