WPC 480 - CH 3

Threat of Substitutes

Substitutes meet the same basic customer needs as the industry's product but in a different way. The threat of substitutes is the idea that products or services available from outside the given industry will come close to meeting the needs of current customers.

Customer Switching Costs (Entry Barrier)

Switching costs are incurred by moving from one supplier to another and are one time sunk costs. Changing vendors may require the buyer to alter product specifications, retain employees, and/or modify existing processes.

Industry

An industry is a group of incumbent firms facing more or less the same set of suppliers and buyers.

Monopoly

An industry when there is only one, often large firm supplying the market. The firm may offer a unique product, and the challenges to moving into the industry tend to be high.

Oligopoly

An oligopolistic industry is consolidated with few large firms, differentiated products, high entry barriers, and some degree of pricing power. A key feature is that competing firms are interdependent.

Network Effects (Entry Barrier)

Network effects describe the positive effect the one user of a product or service has on the value of that product or service for other users. When the network effects are present, the value of the product or service increases with the number of users. The threat of potential entry is reduced when network effects are present.

The Power of Buyers

The bargaining power of buyers is the opposite of suppliers, the buyers are the customers of the industry. The power of the buyers relates to the pressure an industry's customers can put on the producers margins by demanding a lower price or higher quality product.

Power of Suppliers

The bargaining power of suppliers captures pressures that industry suppliers can exert on an industry's profit potential. The force reduces a firm's ability to obtain superior performance by: 1. Powerful suppliers can raise the cost of production by demanding higher prices for their inputs or by reducing the quality of the input factor or service level delivery. 2. Powerful suppliers are a threat to firms because they can reduce the industry's profit potential by capturing part of the economic value created.

Competitive Industry Structure (Rivalry)

The competitive industry structure refers to elements and features common to all industries. The structure of an industry is largely captured by the number and size of its competitors and the firm's degree of pricing power.

5 Forces Model

The highly influential five forces model helps strategic leaders understand the profit potential of different industries and how their respective firms gain and sustain competitive advantage. The five forces are: 1. Threat of entry. 2. Power of suppliers. 3. Power of buyers. 4. Threat of substitutes. 5. Rivalry among existing competitors.

External Environment

The industry in which the firm operates, and the competitive forces that surround the firm from the outside.

Exit Barriers (Rivalry)

The obstacles that determine how easily a firm can leave that industry. Exit barriers comprise both economic and social factors. They include fixed costs that must be paid regardless of whether the company is operating in the industry or not.

When is the relative bargaining power of the suppliers high?

1. The suppliers industry is more concentrated than the industry it sells to. 2. Suppliers do not depend heavily on the industry for a large portion of their revenues. 3. Incumbent firms face significant switching costs when changing suppliers. 4. Suppliers offer products that are differentiated. 5. There are no readily available substitutes for the products or services that the suppliers offer. 6. Suppliers can credibly threaten to forward integrate into the industry.

The Strategic Role of Complements (A Sixth Force)

A complement is a product, service, or competency that adds value to the original product offering when the two are used in tandem. Complements increase demand for the primary product, thereby enhancing the profit potential for the industry and the firm.

Strategic Group

A firm occupies a place within a strategic group, a set of companies that pursue a similar strategy within a specific industry in their quest for competitive advantage. Strategic groups differ from one another along important dimensions such as expenditures on research and development, technology, product differentiation, product and service offerings, market segments, distributions channels, and customer service.

Strategic Positioning

A firm's strategic position relates to its ability to create value for customers (V) while containing the cost to do so (C). Competitive advantage flows to the firm that is able to create as large a gap as possible between the value the firm's product or service generates and the cost required to produce it (V-C).

PESTEL Framework

A framework that categorizes and analyzes an important set of external factors (political, economical, sociocultural, technological, ecological, and legal) that might impinge upon a firm. The factors can create both opportunities and threats for a firm. The PESTEL model provides a straightforward way to scan, monitor, and evaluate the important external factors and measures trends that might affect the firm.

When is the threat of substitutes high?

A high threat of substitutes reduces industry profit potential by limiting the price the industry's competitors can charge for their products and services. The threat of substitutes is high when: - The substitute offers an attractive price performance trade off. - The buyers cost of switching to the substitute is low.

Monopolistic Competition

A monopolistic competitive industry has many firms, differentiated product, some obstacles to entry, and the ability to raise prices for a relatively unique product while retaining customers.

Perfect Competition

A perfectly competitive industry is fragmented and has many small firms, a commodity product, ease of entry, and little or no ability for each individual firm to raise its prices. The firms typically small in size and resource.

Capital Requirements (Entry Barrier)

Capital Requirements describe the "price of the entry ticket" into a new industry. How much capital is required to compete in this industry, and which companies are willing and able to make such investments.

Economies of Scale (Entry Barriers)

Economies of Scale are cost advantages that come from firms with larger output because they can spread fix costs over more units, employ technology more efficiently, benefit from a more specialized division of labor, and demand better terms from their suppliers. These factors in turn drive down the cost per unit, allowing large incumbent firms to enjoy a cost advantage over new entrants that cannot muster such scale.

Government Policy (Entry Barrier)

Frequently government policies restrict or prevent new entrants. The threat of entry is high when restrictive government policies do not exist or when industries become deregulated.

Advantages Independent of Size (Entry Barrier)

Incumbent firms often posses cost and quality advantages that are independent of size. These advantages can be based on brand loyalty, proprietary technology, preferential access to raw materials and distribution channels, favorable geographic locations, and cumulative learning and experience effects.

Industry Effects

Industry effects describe the underlying economic structure of the industry. They attribute firm performance to the industry in which the firm competes. The structure of an industry is determined by elements common to all industries.

Credible Threat of Retaliation (Entry Barrier)

Potential new entrants must also anticipate how incumbent firms will react. A credible threat of retaliation by incumbent firms often deters entry. If a entry still occurs, incumbents are able to retaliate quickly, though initiating price war.

Rivalry Among Competitors

Rivalry among competitors describes the intensity with which companies within the same industry jockey for market share and profitability. It can range from gentle to cutthroat. The stronger the forces, the stronger the expected competitive intensity, which in turns limits the industry's profit potential. The intensity of rivalry among competitors is determined by competitive industry structure, industry growth, strategic commitments, and exit barriers.

Strategic Commitments (Rivalry)

Strategic Commitments are firm actions that are costly, long term oriented, and difficult to reverse.

What are the factors that increase buyer power?

The power of buyers is high when: - There are a few buyers and each buyer purchases large quantities relative to the size of a single seller. - The industry's products are standardized or undifferentiated commodities. - Buyers face low or no switching costs. - Buyers can credibly threaten to backward integrate into the industry.

How are the 5 forces measured?

The stronger the five forces, the lower the industry's profit potential - making the industry less attractive. The weaker the five forces, the greater the industry profit potential - making the industry more attractive.

Threat of New Entries

The threat of new entries describes the risk of potential competitors entering the industry. Potential new entry depresses industry profit potential in two major ways: 1. Reduces the industries overall profit potential. 2. Increases spending among incumbent firms.