Conceptual framework for industry analysis has been provided by Porter. He developed a five-factor model for industry analysis, as shown as follows. The model identifies five key structural features that determine the strength of the competitive forces within an industry and hence industry profitability.
As shown in this model, the degree of rivalry among different firms is a function of the number of competitors, industry growth, asset intensity, product differentiation, and exit barriers. Among these variables, the number of competitors and industry growth are the most influential. Further, industries with high fixed costs tend to be more competitive because competing firms are forced to cut price to enable them to operate at capacity. Differentiation, both real and perceived, among competing offerings, however, lessens rivalry. Finally, difficulty of exit from an industry intensifies competition.
Threat of entry into the industry by new firms is likely to enhance competition. Several barriers, however, make it difficult to enter an industry. Two cost-related entry barriers are economies of scale and absolute cost advantage. Economies of scale require potential entrants either to establish high levels of production or to accept a cost disadvantage. Absolute cost advantage is enjoyed by firms with proprietary technology or favorable access to raw materials and by firms with production experience.
As shown in this model, the degree of rivalry among different firms is a function of the number of competitors, industry growth, asset intensity, product differentiation, and exit barriers. Among these variables, the number of competitors and industry growth are the most influential. Further, industries with high fixed costs tend to be more competitive because competing firms are forced to cut price to enable them to operate at capacity. Differentiation, both real and perceived, among competing offerings, however, lessens rivalry. Finally, difficulty of exit from an industry intensifies competition.
Threat of entry into the industry by new firms is likely to enhance competition. Several barriers, however, make it difficult to enter an industry. Two cost-related entry barriers are economies of scale and absolute cost advantage. Economies of scale require potential entrants either to establish high levels of production or to accept a cost disadvantage. Absolute cost advantage is enjoyed by firms with proprietary technology or favorable access to raw materials and by firms with production experience.
In addition, high capital requirements, high switching costs (i.e., the cost to a buyer of changing suppliers), product differentiation, limited access to distribution channels, and government policy can act as entry barriers.
A substitute product that serves essentially the same function as an industry product is another source of competition. Since a substitute places a ceiling on the price that firms can charge, it affects industry potential. The threat posed by a substitute also depends on its long-term price/performance trend relative to the industry’s product.
Bargaining power of buyers refers to the ability of the industry’s customers to force the industry to reduce prices or increase features, thus bidding away profits. Buyers gain power when they have choices when their needs can be met by a substitute product or by the same product offered by another supplier. In addition, high buyer concentration, the threat of backward integration, and low switching costs add to buyer power.
Bargaining power of suppliers is the degree to which suppliers of the industry’s raw materials have the ability to force the industry to accept higher prices or reduced service, thus affecting profits. The factors influencing supplier power are the same as those influencing buyer power. In this case, however, industry members act as buyers.
These five forces of competition interact to determine the attractiveness of an industry. The strongest forces become the dominant factors in determining industry profitability and the focal points of strategy formulation, as the following example of the network television industry illustrates. Government regulations, which limited the number of networks to three, have had a great influence on the profile of the industry. This impenetrable entry barrier created weak buyers (advertisers), weak suppliers (writers, actors, etc.), and a very profitable industry. However, several exogenous events are now influencing the power of buyers and suppliers. Suppliers have gained power with the advent of cable television because the number of customers to whom artists can offer their services has increased rapidly. In addition, as cable television firms reduce the size of the network market, advertisers may find substitute advertising media more cost effective. In conclusion, while the industry is still very attractive and profitable, the changes in its structure imply that future profitability may be reduced.
A substitute product that serves essentially the same function as an industry product is another source of competition. Since a substitute places a ceiling on the price that firms can charge, it affects industry potential. The threat posed by a substitute also depends on its long-term price/performance trend relative to the industry’s product.
Bargaining power of buyers refers to the ability of the industry’s customers to force the industry to reduce prices or increase features, thus bidding away profits. Buyers gain power when they have choices when their needs can be met by a substitute product or by the same product offered by another supplier. In addition, high buyer concentration, the threat of backward integration, and low switching costs add to buyer power.
Bargaining power of suppliers is the degree to which suppliers of the industry’s raw materials have the ability to force the industry to accept higher prices or reduced service, thus affecting profits. The factors influencing supplier power are the same as those influencing buyer power. In this case, however, industry members act as buyers.
These five forces of competition interact to determine the attractiveness of an industry. The strongest forces become the dominant factors in determining industry profitability and the focal points of strategy formulation, as the following example of the network television industry illustrates. Government regulations, which limited the number of networks to three, have had a great influence on the profile of the industry. This impenetrable entry barrier created weak buyers (advertisers), weak suppliers (writers, actors, etc.), and a very profitable industry. However, several exogenous events are now influencing the power of buyers and suppliers. Suppliers have gained power with the advent of cable television because the number of customers to whom artists can offer their services has increased rapidly. In addition, as cable television firms reduce the size of the network market, advertisers may find substitute advertising media more cost effective. In conclusion, while the industry is still very attractive and profitable, the changes in its structure imply that future profitability may be reduced.
2 comments:
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