Integrative and Analytical Tools

Four Forces of Porter’s Framework

The following will now examine four of the forces in Porter’s framework
(1980):
Threats of Substitutes: What substitutes exist, and how likely are
customers to switch?
When assessing the competition, it is imperative to look beyond other firms
that provide similar products or services within an industry to also consider
those firms in industries that provide alternative or substitute products that a
customer could opt to purchase. For example, firms in the soft drink industry
face competition outside the industry with substitutes such as juice, coffee,
water, and so forth.
When many substitutes exist for an industry’s product, there are more
options for customers to choose from. Price then plays a major factor in
determining how likely customers are to switch. The substitutes that pose the
greater threat to an industry are those that are more apt to improve their
price-performance tradeoff with the industry’s product. Also, substitutes in
industries that are earning high profits pose a substantial risk.
Technology and the rise of the Internet have actually hurt many industries by
firstly providing substitute products. The Internet also exposes customers to
more potential sources of substitutes.

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Industry Competitors: What rivalry exists?
Within any industry, the degree to which firms compete with each other
differs. This is also referred to as the degree of competitive rivalry. Several
aspects of the industry determine how intense the competitive rivalry is
within an industry.
• Concentration: The concentration ratio measures the percentage of
market share held by the largest four firms within an industry. When
only a few firms hold the majority of the market share in an industry,
this suggests that the competitive rivalry is less intense. On the other
hand, a low concentration ratio is characterized by many rivals, none
of which have a majority hold on the industry. This type of fragmented
industry results in a fierce rivalry among the firms as they jockey for
position.
• Industry growth: When an industry exhibits slow or declining
growth, competition becomes fiercer as firms fight for market share in
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fear of being pushed out.
• Product differentiation: If little product differentiation and switching
costs exist, the end result is customers being raided by other
providers. This is the case within the dry cleaning industry in which
firms commonly advertise that they will accept competitor’s coupons
in an attempt to sway customers that have little customer loyalty.
• Exit barriers: When exit barriers are high, it keeps firms within an
industry and competing with each other. This can happen when
employees are entitled to job protection or there are specialized
resources involved.
Supplier Power: What is the bargaining power of suppliers?
Suppliers play a key role in an industry because of the reliance of industry
firms upon the supplier to be able to produce its goods and services. If
suppliers are powerful, they are able to raise prices and squeeze out the
profitability within an industry. Suppliers can also impact the quality of the
goods and services that they supply for industry firms. What determines the
bargaining power of a supplier, and hence, how powerful it is? The following
factors come into play:
• Size and concentration: If the supplier groups for an industry are
dominated by a few large players, the suppliers have more bargaining
power because there are fewer options for industry firms to choose
from.
• Switching costs: Switching costs are the costs industry firms have to
pay to switch suppliers. These switching costs arise when a supplier
provides a unique or differentiated product that is difficult to find
elsewhere, and/or when an industry firm has invested heavily in
specialized equipment or other capital expenditures (such as computer
software) to utilize the suppliers’ products.
• Forward integration ability: If a supplier has the ability to integrate
forward into a firm’s industry, there is a greater potential threat
posed. In these instances, suppliers have greater bargaining power.
• Importance: When an industry is not an important customer of a
supplier group, there is less bargaining power on behalf of the industry
firms. On the other hand, when industry firms represent vital
customers for a supplier group, there is greater bargaining power and
suppliers will typically try to provide more reasonable pricing and work
with the industry in any way they can.
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Buyer Power: What is the bargaining power of buyers?
The buyer groups are vital to an industry simply because they purchase the
products or services being produced; however, the bargaining power of these
buyer groups varies quite dramatically across industries. The factors that
determine the bargaining power of buyers are fairly similar to the bargaining
power of suppliers, as follows:
• Size and concentration: When an industry has a few large buyer
groups, there is a greater risk to the industry because all of its apples
are in one basket. In these cases, the buyer groups are more powerful
and can make or break firms in an industry.
• Switching costs: If an industry provides a unique or differentiated
product to its buyer groups, it is a much safer situation; however,
when there are many alternates or substitutes for the buyer group to
select from, the buyer groups are more powerful and demand lower
pricing or terms from the industry firms.
• Backward integration ability: Buyers can pose a credible threat to
an industry if they have the ability to integrate backward and produce
the industry’s product themselves.
• Importance: When an industry provides products that are relatively
low in importance to a buyer group, there is typically less price
sensitivity and the buyer holds more bargaining power. A much better
scenario to be in is when an industry provides a critical component to
a buyer group and where price is accordingly not as big of a factor in
the purchasing decision.
Other Industry Analysis Tools
Although Porter’s five forces of competition framework is by far the most
commonly used tool to assess the attractiveness of an industry, other
industry analysis tools do exist. A few identified by Grant (2008) are briefly
summarized in the following:
• Game theory: Game theory attempts to model competitive
interaction by mathematically computing the outcome of competitive
situations and identify the optimal choice. This is best demonstrated
through the classic prisoners’ dilemma game.
• Competitor analysis: Through gaining competitive intelligence,
another alternative is to analyze such information to predict
competitor behavior. This involves first gathering information
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regarding competitors’ current strategy, objectives, assumptions about
the industry, and resources and capabilities. Second, the competitors’
information is analyzed to predict what strategic changes the
competitors will initiate on their own and in response to strategic
initiatives.
• Segmentation analysis: Industries can be disaggregated into
specific markets called segments. A segmentation analysis involves
breaking an industry down into its segments and then working forward
to analyze segment attractiveness and key success factors.
• Strategic groups: Industries can also be disaggregated based on the
strategies of its members firms, or what are called strategic groups.
By identifying and analyzing the differences among strategic groups,
insight can be gained as to performance differentials and strategic
positioning.
References
Grant, R. M. (2008). Contemporary strategy analysis. Oxford: Blackwell.
Porter, M. E. (1980). Competitive strategy: Techniques for analyzing
industries and competitors. New York: Free.

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