Competitive Behavior Model - Case Study Example

"Explain how Michael Porter's model of competitive behavior can help us understand the different strategies that may be adopted by firms attempting to develop policies of competitive advantage and competitive scope." In today’s dog-eat-dog world, competition is fierce in almost every industry. No single organization holds the aces for long, someone is always popping up from behind to surprise even the most seasoned companies. Competitive advantage is when a firm gains profits that exceed the average for its industry (Competitive Advantage, 1999-2007). The aim of most business strategies is to build up and sustain this advantage. According to Michael Porter, there are 2 basic types of competitive advantage: 1) cost advantage, and 2) differentiation advantage. Cost advantage arises when a firm is able to provide customers the same benefits as their rivals but at a lower cost. Likewise, differentiation advantage is when a firm is able to differentiate its products by exceeding the benefits that customers gain from other rivals. Combining this, competitive advantage is at maximum when a firm is able to provide superior value to customers while creating superior profits for itself (Competitive Advantage, 1999-2007). Companies are able to maintain competitive advantage through effective strategies. A strategy is “a realistic process of solving or tapping or nabbing opportunities by identifying the consistency of the alternatives with the corporate goals, policies and available resources” (Kumar & Kaur, n.d., p.2). Competitive strategy aims to master the inner workings of a market environment by understanding and anticipating the actions of other economic agents, such as competitors. It is the path through which resources and knowledge are matched suitably with market opportunities and problems (Kumar & Kaur, n.d.). So how do businesses create sound strategies to ensure competitive advantage? A variety of methods are available addressing this need, but perhaps the most popular is Michael Porter’s model of five forces. Developed in 1979, the model serves as a framework for industry analysis and business strategy development. Porter identified 5 forces in a firm’s microenvironment that affect its ability to serve its customers and gain profit. Any change in these forces would require a company to re-assess the marketplace and its position in the industry (Porter 5 forces analysis, 2007). For new business entrants, it is a framework for assessing the attractiveness of a market (Industry and Competitive Analysis for Entrepreneurs, 2007). Successful entry into a specific market would depend on how well the entrant was able to assess the environment and the strategies the firm adopted in order to gain some competitive leverage to establish itself as a prime player. The illustration below describes Porter’s model: *Figure adapted from Value Based Management.net. According to this model, there are 5 fundamental competitive forces in an industry: 1) the threat of new entrants; 2) the threat of substitutes; 3) the bargaining power of buyers; 4) the bargaining power of suppliers; and 5) the rivalry among existing players. Conceptualizing business strategies means analyzing these 5 forces and formulating action plans to address these forces. Competition in many industries had increased at the advent of the Internet and E-commerce. The Internet has made it possible for many companies to expand their market and reduce costs. Many products and services are offered solely online, while other companies had established a Web presence to augment their brick and mortar operations. The playing field has extended all the way to the edges of the cyberfield, where ever that is. A business person can use Porter’s model to identify competition, make a plan, and implement processes (Bennett, 2007). Threat of New Entrants New entrants to an industry can raise the level of competition. However, the threat of new entrants largely depends on the existing barriers to entry. Some industries, simply because of their nature, have inherent barriers to entry, while some industries are very easy to enter (strategy – analysing competitive industry structure, n.d.). Threat of new entrants is high when it is easy for new firms to enter the market, decreasing the market share for the existing businesses (Bennett, 2007). When an industry becomes lucrative, new firms often enter the market to take advantage of the high profit levels, ultimately driving down the profit levels of pre-existing firms. When profits decrease, the exit of some firms can be expected, restoring market equilibrium (Porter’s 5 forces, 1999-2007). Some barriers exist as normal accommodations to market conditions. One such barrier is falling prices, or the expectation that future prices will fall. Competitors would think twice in entering a market when they expect it to be less profitable in the future. Another barrier is the uncertainty of a market. Firms would rather invest in stable and profitable markets than those that might not make it through the decade. Existing firms, as an individual strategy, can also create a barrier to entry by keeping prices artificially low. This would discourage new entrants to the market as low prices would mean lesser profits (Porter’s 5 forces, 1999-2007). Barriers are unique industry characteristics that reduce the rate of entry of new firms, thereby maintaining a level of profits for those already in the industry. To maintain competitive advantage, firms can create or exploit barriers to entry by influencing the sources from which barriers of entry can arise (Porter’s 5 forces, 1999-2007). One such source is the government. Government can both preserve and restrict competition. Regulation and granting monopolies are two ways in which the government can restrict competition. In some cases wherein having just one firm is more efficient, such as in the case of utilities and electric companies, the government grants monopoly to only one firm, but regulates the firm’s prices to protect the public (Porter’s 5 forces, 1999-2007). A second source of barrier that firms can utilize in order to maintain competitive advantage is through patents and proprietary knowledge. Ideas, knowledge and products that keep competitive advantage can be patented and treated as private property. As such, this keeps other firms from marketing the same idea or product. A third barrier to entry in asset specificity, or when an industry needs specialized assets in order to operate. Specialized assets are usually very expensive, and so new entrants are reluctant to enter the market because there is much to lose if their venture should fail. Also, new entrants can expect aggressive rivalry from other firms already existing in the industry. Due to the large capital invested in specialized assets, existing firms would act aggressively to protect their market share. Another barrier to entry can be Organizational Economies of Scale. The term Minimum Efficient Scale (MES) is used to describe the most efficient cost level of production. In an industry wherein the MES is known, the amount of market share necessary for low cost entry or cost parity with rivals can be determined. The greater the difference between an industry MES and entry unit costs, the greater the barrier to entry. Industries with high MES often discourage small start-up businesses from entering the same market. To summarize, an industry is easy to enter if it requires common technology, little brand franchise, has easy access to distribution channels, and has a low scale threshold. Meanwhile, an industry would be difficult to enter if the product is patented or the know-how is proprietary, there is difficulty in brand switching, there are limited distribution channels, and if there is a high scale threshold (Porter’s 5 forces, 1999-2007). If a firm knows how easy or difficult it is to enter the industry in which it currently operates, the firm could create the appropriate strategies to gain and maintain competitive advantage. Threat of Substitutes Substitute products refer to products from other industries that customers have the option to switch to. When a price change in substitute products affects a product’s demand, then a threat of substitutes exists. If more substitutes exist in other markets, the price of a product becomes more elastic because customers are presented with more alternatives. The price and availability of substitutes for a certain product places a ceiling on the prices which the producers of the product can charge (Bowman & Devinney, 1997). There is a risk of low growth rate in sales and profits because of substitutes’ pull on market share. This risk can be mitigated if firms are able to upgrade the quality of their products, reduce prices via cost reduction, or differentiate their products from its substitutes (Bowman & Devinney, 1997). Competition from substitutes is dependent on the ease with which customers can switch over. If the cost for switching to a substitute is relatively lower in the long run, there is a high probability that customers would opt to buy substitutes, and firms in the existing industry will have to fight for a smaller market share. Bargaining Power of Suppliers An industry cannot operate without raw materials, whether it be labor, components, or other supplies. This creates a buyer-supplier relationship between two firms. Suppliers can exercise power by increasing the prices of raw materials, thereby capturing some of the industry’s profits (Porter’s 5 forces, 1999-2007). Suppliers have more bargaining power if the following parameters hold true: 1) the input, in one way or another, is important to the firm; 2) there is no intense competitive conditions in the supplier industry, and the industry is dominated by a few large producers enjoying secure market positions; 3) the suppliers’ products are differentiated in such that firms cannot easily switch to other suppliers; 4) the buying firm is not an important customer to the supplier; and 5) when one or more suppliers pose a credible threat of forward integration (Bowman & Devinney, 1997). Firms must then include in their strategies action plans that would control the bargaining power of suppliers. When suppliers possess more power over the buying firm, the firm is at a great disadvantage. One method of controlling the power of suppliers would be to have several suppliers for the same product. Or if the firm is considerably larger than the supplier, a backward integration might be profitable to the firm. Bargaining Power of Buyers Customers have the biggest impact on an industry. The power that customers hold over firms is almost absolute, and customer loyalty is highly sought after. Buyer or customer power is measured by the impact customers have on a producing industry. When buyer power is strong, the relationship that exists is a monopsony---a market wherein there are many suppliers but only one buyer. In this kind of market, it is the buyer who sets the price (Porter’s 5 forces, 1999-2007). Customers have leverage and great bargaining power when: 1) the customers are few and make purchases in large quantities; 2) the customer’s purchases represent a relatively large percentage of the selling industry’s total sales; 3) the supplying industry is made up of mostly relatively small sellers; 4) the products are standardized and common among many firms that customers can easily find alternatives and switch to a different firm at virtually zero cost; 5) the customers pose a threat of backward integration; 6) the products the industry markets are not important to the customer; and 7) it is more economically feasible for customers to purchase the same product from several firms rather than just a single firm (Bowman & Devinney, 1997). Most businesses live on the mantra that ‘the customer is always right.’ This is a classic example of how customer power can greatly influence the strategies of many firms. But likewise, firms can strategize in order to influence customers and use this power to their advantage. Rivalry “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.” Sun Tzu, The Art of War Competition is a characteristic of any industry, except perhaps when there is a monopoly or an oligarchy, in which case the partnerships become illegal. Firms aim to outdo each other and gain competitive advantage over one another. Rivalry tends to intensify if the number of competitors increases, and if they become more equal in size and capacity. The slow growth of product demand can also cause competition to become more aggressive. When one firm initiates a drive for advantage such as price cuts and other competitive weapons, other firms would tend to retaliate and an aggressive rivalry begins. Another factor that increases rivalry is product differentiation. When there is less differentiation between products, customers tend to shift from one product to another, especially when the cost of switching is at a minimum (Bowman & Devinney, 1997). Rivalry will also tend to be more aggressive when it costs more to get out of an industry than to stay in and compete. Adding to the volatility and unpredictability of rivalry is the diversity of competitors, their strategies, personalities, corporate priorities, resources, and even countries of origin (Bowman & Devinney, 1997). Also, rivalry increases when weak firms within the industry are acquired by bigger firms from outside the industry. The first goal of the bigger firms would be to launch aggressive well-funded strategies that would turn the small competitor into a major market contender (Bowman & Devinney, 1997). To gain advantage over rivals, firms can choose from several competitive options such as changing prices, improving product differentiation, creatively using channels of distribution, and exploiting relationships with suppliers (Porter’s 5 forces, 1999-2007). Conclusion Porter’s model of competitive behaviour can be a useful tool from which firms can devise their strategies. Although the model also has it weaknesses, such as the proposition that the different forces are independent of each other, it is a good starting ground from which to evaluate a firm’s position and leverage in a specific market. If a firm knows enough of the forces that affect the business’ performance in the industry, effective strategies can be deployed to gain and maintain competitive advantage. Read More