8 Competitive and Industry Analysis

1.   Learning Outcome

After completing this module the students will be able to understand:

• General Environment
• External Environment
• Competitive Environment
• Concept of Strategic Groups
• Porter’s Five Forces Framework

2.      Introduction

The environment in which the business operates has a greater influence on its performance. The success or failure of any organisation’s strategies is based on the fundamental understanding of its external environment. The external environment of an organisation consists of both a general environment and competitive environment (Figure 1). The general environment is often referred to as the macro-environment and includes factors such as political, economic, social and technological. It should be noted that any change in the general environment has the potential to influence the organisation’s competitive environment and will also have an effect that transcend beyond the firms or specific industries. For example, Hitkari Potteries, a popular bone-china crockery brand till 2000 slowly lost ground to competitors like La Opala and Corelle. This happened because the firm failed to scan the general environment for signs of change i.e. the social change. The societal change underway was the change in the lifestyle of potential consumers. With more and more numbers of women joining the workforce, the ladies were facing shortage of time for their household chores. Therefore, to strike a balance between their professional, personal and family lives, these modern working women were looking for the crockery that was convenient to use, unbreakable, chip resistant and microwave safe. Hitkari failed to notice this social change in the general business environment and had to face stiff competition from companies likes La Opala and Corelle that introduced ceramic crockery that could meet the emergent needs of the consumers (Exhibit 1). Therefore, it is important that the organisations scan the general environment and identify factors that have the ability to influence or fundamentally change the industry within which they compete.

3.   Competitive Environment

The competitive environment refers to the dynamic system in which an organisation competes and operates. This system is generally referred to as an industry or a strategic group. Where, an industry is defined as a group of firms producing the same product or products that are close substitutes, while, strategic groups are the sub-groups (small group of firms) within an industry that have similar characteristics and compete on similar basis. The competition between firms within a strategic group is greater than the companies that fall outside the said strategic group. For example, all the companies manufacturing the cell phones collectively represent the mobile industry. Whereas, the companies that manufacture smartphones (Android as operating system) are termed as strategic group as they compete on similar technological platform when compared with the rest of the firms that manufacture first generation cell phones (Symbian as operating system). These groups have very little in common and therefore, pay little attention to each other when planning for competitive moves. But the companies that manufacture smartphones (Windows, iOS as operating system), however, have a great deal of commonality with the manufactures of smartphones (Android as operating system). Consequently, the firms within this group are strong rivals. However, there may be many different characteristics on to which the strategic groups can be distinguished from each other, i.e. product quality, geographical coverage, service levels etc. Hence, the concept of strategic groups is helpful for the organisations to know more about their direct rivals and the basis on which the competitive rivalry is likely to take place within the groups. Therefore, it becomes imperative for the organisation to have an in-depth understanding of industry’s competitive character as a part of external analysis and to help them shape their future strategies.

4. Porter’s Five Forces Framework

The five forces framework is developed by Michael Porter (Exhibit 2) and is the most widely used analytical tool for assessing the competitive environment. The five forces analysis is undertaken from the perspective of both an incumbent (already operating in industry) organisation and a new entrant organisation. The intensity of competition within the industry is of utmost concern for any organisation. This framework helps the organisations to determine this intensity of rivalry by examining the interaction of five competitive forces. It is therefore, the combined strength of these five forces that helps the organisation to determine the industry attractiveness and eventually the profit potential within a given industry. The five forces are (1) threat of new entrant, (2) bargaining power of buyers, (3) bargaining power of suppliers, (4) threat of substitute products or services, (5) intensity of rivalry among firms in an industry. Onto the evaluation of the strength of these forces, a high force can be looked upon as a threat as it reduces profitability whereas, a low force would mean an opportunity that allows a firm to earn more profits. Figure 2 depicts Porter’s five forces model of industry rivalry. A description of each of these five forces is discussed in details in the following section.

4.1 Threat of New Entrants

Any industry that has the potential for growth and is perceived to be profitable tends to attract new entrants. These new entrants are the firms that are interested in investment to avail the oppurtunities that lies ahead within the industry. If new firms are able to come into an industry, the existing firms have to either share ceratin portion of the growing sales with a large number of competing firms or have to part off with some of it own market share. Either way, the existing firms have to face declining sales volumes and revenue, ultimately leading to fall in incumbents’ profits.

The possibility that a firm enters from outside into an industry basically dependent on two factors. The first being the barriers to entry and second, being the expected retaliation (strong reaction) from the existing firms. A high entry barrier implies that there would be lesser likelihood for new firms to make an entry into the industry at the first instance or will be abstained from establishing themselves before they may pose competition to the existing firms. Therefore, the higher entry barriers keeps the prospective entrants at a distance from an industry. Some of the possible entry barriers are:

1.      Brand benefits: Buyers are often attached to established brands and to break through these well placed brands becomes a challenge for the new comers. The new entrants have to struggle and redefine their strategies so as to bring in a change in the mindset of the consumers. For example, Johnson & Johnson (J&J) has ruled the market for last 60 years in the babycare segment. Companies like Marico, Dabur, Wipro, Himalaya have tried their hand at babycare, but with little success. This is primarily because as far as baby is concerned, the mothers do not want to risk experimenting with new brands in the market. They want products which are completely trusted and safe. J&J products have thus established itself as a most trusted brand over the generations (Exhibit 3).

2.      Access to Distribution Channel: Most existing companies in FMCG and automobile industry are found to have a strong distribution channel which is very difficult for a new entrant to penetrate.

For example, Lay’s potato chips by Pepsico India have a well established distribution channel that has made its products available to the consumers at an arm’s length. This has not only posed a challenge to product like Bingo by ITC (a conglomerate) but has also refrained the local players from establishing themselves in the industry. In the same way, Suzuki-Maruti in the automobile industry has established a vast network of dealers and services centre across the length and breadth of the country making it the most affordable car in India (Exhibit 4). Such deeply entrenched distribution network act as a barrier to entry for the new entrants.

3.      Government Policy: Government policies may also act as an entry barrier. Exhibit 5, showcase that how the 5/20 rule by the government has restrained the Indian aviation companies from flying in international skies and making the new companies lose to the opportunity before the existing airlines in aviation industry.

4.      Switching Costs: Switching costs are a particularly important consideration. Switching costs are the expenses (financial or psychological) that a customer incurs when he/she switches from one seller’s product to another. In an industry where the switching cost is high, it becomes difficult for a new entrant to establish or survive because the customers are not readily willing to switch. These costs may be because of advance technology adopted by the existing firm and the level of convenience that a customer experiences in owning a particular product, or may be the strong brand association.

5.      Product Differentiation: Corporation like 3M (Exhibit 6) that is known as the global innovation company had differentiated its products in the marketplace and created high entry barriers through its high levels of innovation. The people at 3M capture the spark of new ideas and transform them into thousands of ingenious products and practical applications that help make people’s lives better. 3M’s office business is home to some of the world’s best-known brands like Post-it, Scotch etc.

Exhibit 6: 3M Product Innovation (Source: http://www.3m.com)

6.       Economies of Scale: The firms that operate at a larger scale tend to get benefits of lower production cost because of economies of scale. Over the years, an already established firm in an industry might have attained that scale of production but a new entrant normally would have to start its operation from a smaller scale. This in turn leads to relatively higher cost of production for the new firm and adversely affects its competitive position in the industry.

7.      Capital Requirement: High capital requirements may prevent the new entrants from making investments in an industry. For example, developing telecom infrastructure in rural India requires high capital investment as it involves greater logistical risks and also extend the time taken to roll out telecom services. The lack of trained personnel in the rural area to operate and maintain the cellular infrastructure, especially passive infrastructure such as towers, is also seen as a hurdle for extending telecom services to the under penetrated rural areas.

4.2 Bargaining Power of Suppliers

Sourcing in any industry is amongst one of the most essential activities of a business. Organizations have a large dependence on the suppliers and latter has the ability to influence their profitability. The supplier’s decisions on prices, quality of products & services, payment and delivery terms are the various factors that influences buyer’s profit potential and in turn determines the profit trends of an industry. Therefore, in the following given situations, a supplier or supplier group is said to be powerful:

1.      Importance of the Supplier’s Product to Buyer: When the supplier’s products are an important and integrate part of buyer’s manufacturing process and its product quality, the bargaining power of suppliers will be high. Taking an example of automobile industry in India, Sona Koyo Steering Systems Limited (Exhibit 7) is the largest manufacturer of steering systems for the passenger car and utility vehicle market. Its customers largely include all major vehicle manufacturers in India such as Maruti Suzuki, Toyota, Hyundai, Tata Motors, Mahindra & Mahindra, General Motors and Mahindra-Renault. Steering being a specialist component for the automobile industry and Sona Koyo being the manufacturer of high quality precision steering, enables Sona Koyo to hold a high command as a supplier in the industry.

(Source: http://sonagroup.com/index.php?option=com_content&view=article&id=153&Itemid=342)

2. Greater Concentration among Supplier: A highly concentrated industry is one which is largely dominated by few large firms. Such few firms hold greater control to influence the industry as the larger share of industry’s output vest in their hands. This gives the supplier or supplier group greater power over those who do business with them. Petroleum industry is one such suitable example.

3. Importance of the Buyer to Supplier Group: In case the purchasing industry buys only a small portions of the supplier group’s product than the importance of the buyer to supplier group will be less (for example: the tyre industry, the sales of bicycle tyres is relatively more important as compared to automobile tyres).

4.  Threat of Forward Integration by Suppliers: A situation where the suppliers are capable of moving up the value chain and may think of doing a business that their buyers are already into; puts the buyers in a disadvantageous situation. A recent example may be of Ranbaxy Laboratories which has decided to move from manufacturing of bulk drugs & formulations to retailing of drugs through its own chain of retail stores and Fortis Hospital pharmacies.

5. High Switching Cost for Buyers: In this case the costs to the buyer of switching supplier is high because of suppliers’ advantageous position or by the nature of supplies itself.

4.3 Bargaining Power of Buyers

The buyer in an industry, individually or collectively is supposed to have a stronger bargaining power when they can force a reduction in the prices of the supply or demand a higher quality of product/service or is being able to seek more value for their purchase in any way. On the other hand, a low buyer bargaining power enables the supplier to pass the price increase to the buyer or make the buyer to accept products and services of low quality at a higher price. The bargaining power of buyer is increased in following circumstances.

1. Standard or Undifferentiated Products: When there is no differentiation in the supplies of products & services, the buyers pressurize the suppliers on price rather than the features of the products knowing that they can always find alternative suppliers.
2. Greater Concentration in Buyer’s Industry and Buying Volumes are High: Where the number of buyers is few and the volume of purchase of any buyer is high, the buyer’s business gains more importance to that of suppliers. For example, the cash & carry format retailers that enjoy aggregate demand, exert massive pressure on its suppliers’ margin.
3. Threat of Backward Integration by Buyers: A situation opposite to forward integration which the suppliers attempt to do so as to have command over the buyers. Here, the buyers in order to hold their position stronger in the market may integrate their business backwards i.e. close to the source of raw material. This will mean that the buyers undertake the activities of manufacturing or distribution for which they have been dependent on suppliers till now. For example, a textile company may go in for backward integration by having its own tread production.
4. Accurate Information of Suppliers’ Cost Structure: A customer who is more informed about the suppliers’ cost structure is capable of negotiating with suppliers. Whenever such customers notice a decline in the suppliers cost they too would negotiate a proportionate decrease in the price. For example, in present times when the fuel prices are deregulated or market linked, the customer expects the prices of public transportation too to fall proportionately with any decline in the prices of crude oil in international markets.
5. Customer’s Price Sensitivity: The utilitarian customers are the one who seek value and are generally price sensitive. In an industry where the purchases are largely dominated by such customers, the buyers tend to gain advantage in its bargaining power.

4.4  Threat of Substitute Products

A firm is not only exposed to competition from within but also from outside industry products. These products may be close substitutes of each other that apparently are different but satisfy the same set of customer needs. For example: as per a market research, it is estimated that parents buy baby care products for their babies till the time they are nine and a half months old. After which, they tend to use their personal care products on the children and this cross-usage of non baby brands (substitute product) has restricted the potential growth of products in baby care category.

Quoting another example of recent happening where the bread makers were charged of allegation about the presence of carcinogenic chemicals in their products. The firm offering the substitute product i.e. home appliance for making baked breads at home left no stone unturned to avail this opportunity. It posed a serious threat to the bread manufacturers. The Company, Glen, advertised its product (Exhibit 8) in the local newspaper (HT City, Chandigarh edition, 04 June 2016) to boost its sales. Through this advertisement the company offered the benefits (Fresh, Hygienic & Convenient) of baking the bread at home to the customers making it more attractive over the packed bread sold in the market.

Exhibit 8: Home appliance – an Automatic Bread Maker as substitute for packed bread.

However, the competition from the substitute products depends primarily on the following factors:

1.      How attractively are the substitutes priced in the marketplace;

2.      Whether the substitutes are able to provide the same level of quality and performance;

3.      How straight forwardly the buyers can switch to substitutes.

(Source: https://www.slideshare.net/116iiminternship/how-should-a-company-choose-the-most-attractive-target-markets-49609884)

4.5 Competitive Rivalry

When the firms in the industry exhibit a high level of rivalry, the profitability of the industry may be affected. Such rivalry may take the form of incumbents competing aggressively on the basis of product/service price. In response to which price cuts are commonly assumed by the rivals and ultimately lowering the profits for all the firms in an industry. The following are the factors that affect competitive rivalry in an industry.

1.      Competitive Structure: Competitive Structure refers to the size, number and diversity of the competitors in an industry. The different types of competitive structures have different implications for both incumbent and new firms. Where there are few competitors and all are of similar size, there is likely to be intense competition as each rival fights for dominance. On the other hand, where there are few large companies or just one company, the intensity of competition many range from state of neglect to fierce. Like in telecom, the firms have collaborated with each other to share the burden of huge investment by having a common tower infrastructure. In such cases, firms may also adopt a policy that is mutually beneficial to the firms in the industry. While, in some other industries there might be prevalence of cut throat competition by ways of pricing, delivery, advertising, after-sales service etc.

2.      Industry Growth: When the industry growth is sluggish and shows no symptoms of recovery, in those situations the intensity of rivalry within the industry may increase.

3.      Exit Barrier: Exit barriers refer to economic, strategic and emotional factors that limit the firms to exit from its business or industry even in times of low or negative returns. Economic factors could be high investments committed to plant and machinery that has no alternative usage, deterioration of demand conditions resulting to excess capacity, high fixed exit cost. Strategic factors could be value chain integrations or the linkages of different businesses of a firm, such as, a firm may have been its own buyer or supplier or its different businesses may have been sharing the common pool of resources. While the emotional factors could be the sentiments of the management attached to a business or their commitment towards the employees or other stakeholders like distributor, supplier etc.

5. Summary

It becomes imperative for the managers to understand the immediate competitive environment alongside the general environment as it largely influences the business growth potential of an organization. Moreover, for highly diversified companies, the most fundamental issue in corporate strategy is to identify the industry or line of business in which the company should compete.

Porter’s five force framework helps to identify and analyze the five competitive forces that outlines an industry and explains why different industries are able to sustain different levels of profitability. The overall attractiveness of the industry does not imply that every firm in the industry will enjoy the same profitability. With the help of this model, the firms are able to determine their strengths and on the other side try to overcome their weaknesses to achieve a profit above the industry average.