Idea 21 - The five process of competition (50 Management ideas you really need to know)

Idea 21 -  The five process of competition

The four Ps, the seven Ss’ - management thought is often packaged in this mnemonic, slightly gaudy way. There's a whiff of Barnum & Bailey, cheap gimmickry designed to catch the crowd's attention. Today's most successful management thinkers are certainly in the entertainment business, complete with public appearances, book signings and, if they touch the right button, large cheques.

Don't get the wrong idea about the five forces, however. The phrase and the ideas it represents come from the most serious, rigorous management thinker of them all, and one who is not tempted by the spirit of vaudeville - Michael Porter. The five forces playa central part in Porter's theories of sustainable competitive advantage. He stakes out his ground by saying there can be only three generic strategies for competitive advantage

You make something more cheaply than anyone else and become the lowest cost producer. Or you make something special that allows you to charge more for it than anyone else. Or you dominate a niche market that others find hard to enter. In deciding which strategy to adopt, managers need to consider in which type of market their industry sits - is it fragmented or emerging, mature or declining, or global? Then, to decide how attractive it is, they should analyse the chosen market in terms of the following five forces of competition. His point is that direct competition is only part of the competitive landscape. Only one of his five forces - rivalry

- is internal to the industry, while the other four come from outside.

Competitive rivalry between existing players What is it like out there? The more intense the competition, the higher the pressure on prices and margins for everyone. Competition will be higher if:

Ø  a large number of companies is competing, particularly if they are all of a similar size;

Ø  slow market growth forces firms to fight for market share (in fast-growing markets, revenues rise even while share is stable);

Ø  there is little differentiation between competing products, and so competition is focused on price;

Ø  barriers to exit are high because equipment is specialized and expensive

The bargaining power of suppliers Will your suppliers have you over a barrel? 'Supplies' cover all the inputs required to produce - including labor, raw materials and components. Powerful suppliers will raise their prices to capture some of the producer's profits. Supplier bargaining power is likely to be high if:

Ø  The market is dominated by a few large suppliers;

Ø  There is a significant cost involved in switching suppliers;

Ø  There are no substitutes for the input;

Ø  Their customers are fragmented and weak;

Ø  There is a threat of consolidation (forward integration) among suppliers, which would lead to higher prices.

The opposite of any of these would put suppliers in a weaker position.

The bargaining power of customers Will your customers have you over- a barrel? Customers in a powerful bargaining position can force down prices and margins. The extreme example is a monopsony, a market with one buyer and many suppliers, in which the buyer dictates the price. Customer bargaining power is likely to be high if:

Ø  There are a few, large buyers;

Ø  They have many small suppliers; their suppliers have high fixed costs

Ø  The product can be replaced by substitutes;

Ø  Switching suppliers is simple and inexpensive;

Ø  They are price-sensitive (perhaps they have low margins themselves);

Ø  Customers can threaten to take over the supplier or its competitor (backward integration).

Again, the reverse of these positions would make customers weaker

Threat of new entrants Any profitable market will attract new players, who will almost certainly make it less profitable, unless there are barriers to entry. The easier the entry, the more competitive the industry. New entrants are more likely to be deterred if:

Ø  Patents and proprietary knowledge restrict entry;

Ø  Economies of scale dictate substantial minimum volumes in order to be profitable;

Ø  The industry has high investment and/or fixed costs;

Ø  Existing players have cost advantages thanks to their experience curve;

Ø  Important resources (people included) are scarce;

Ø  Existing players control raw materials access or distribution channels;

Ø  Government-created barriers, as in utility monopolies or cable TV franchises;

Ø  High switching costs for customers.

Widely available technology, weak brands, easy access to distribution channels and low economies of scale will all attract newcomers and intensify competition.

Threat of substitutes Substitutes are products from other industries, and their availability limits a company's ability to raise prices. So makers of aluminium soft drink cans are constrained by the availability of glass and plastic bottles. Disposable nappy (or diaper) producers must remember that, at a certain price, reusable washable versions become a substitute. Factors that may raise or lower the threat of substitutes include:

Ø  Relative price performance of substitutes;

Ø  Brand loyalty;

Ø  Switching costs.

In 1980, Porter wrote his first book on competitive advantage, Competitive Strategy: Techniques for Analyzing Industries and Competitors. It included his five forces and was an instant and widespread success. So was the second, The Competitive Advantage: Creating and Sustaining Superior Performance, five years later. Some have noted the irony of so many competitors all using Porter's model to differentiate themselves from each other though, to be fair, he offers it as a stimulus to thought rather than as a blueprint.

Reference: 50 Management Ideas You Really Need to Know

Book by Edward Russell-Walling