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Porter's five forces analysis
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== Five forces that shape competition == {{strategy}} === Threat of new entrants === New entrants put pressure on current within an industry through their desire to gain market share. This in turn puts pressure on prices, costs, and the rate of investment needed to sustain a business within the industry. The threat of new entrants is particularly intense if they are diversifying from another market as they can leverage existing expertise, cash flow, and brand identity which puts a strain on existing companies profitability. Barriers to entry restrict the threat of new entrants. If the barriers are high, the threat of new entrants is reduced, and conversely, if the barriers are low, the risk of new companies venturing into a given market is high. Barriers to entry are advantages that existing, established companies have over new entrants.<ref>{{Citation|title=13. Building Social Strategy at XCard and Harvard Business Review|date=2014-12-31|url=http://dx.doi.org/10.1515/9781400850020-014|work=A Social Strategy|pages=220β248|place=Princeton|publisher=Princeton University Press|doi=10.1515/9781400850020-014|isbn=978-1-4008-5002-0|access-date=2020-11-08|url-access=subscription}}</ref><ref>{{Cite book|last=Rainer, R. Kelly Jr. |title=Introduction to information systems.|others=Cegielski, Casey G.|year=2012|isbn=978-1-118-09230-9|edition=4th international student version|location=Hoboken, N.J.|oclc=829653718}}</ref> Michael E. Porter differentiates two factors that can have an effect on how much of a threat new entrants may pose:<ref name=":2">{{Cite journal|title=The Five Competitive Forces That Shape Strategy|journal=Harvard Business Review|url=https://hbr.org/2008/01/the-five-competitive-forces-that-shape-strategy|last=Porter|first=Michael E.|volume=86|pages=78β93, 137|issue=1|year=2008|pmid=18271320|department=Competitive strategy}}</ref> ; [[Barriers to entry]] : The most attractive segment is one in which entry barriers are high and exit barriers are low. It is worth noting, however, that high barriers to entry almost always make exit more difficult. : Michael E. Porter lists seven major sources of entry barriers: :* [[Economies of scale|Supply-side economies of scale]] β spreading the fixed costs over a larger volume of units thus reducing the cost per unit. This can discourage a new entrant because they either have to start trading at a smaller volume of units and accept a price disadvantage over larger companies, or risk coming into the market on a large scale in an attempt to displace the existing market leader. :* [[Network effect|Demand-side benefits of scale]] β this occurs when a buyer's willingness to purchase a particular product or service increases with other people's willingness to purchase it. Also known as the network effect, people tend to value being in a 'network' with a larger number of people who use the same company. :* [[Switching barriers|Customer switching costs]] β These are well illustrated by structural market characteristics such as supply chain integration but also can be created by firms. Airline frequent flyer programs are an example. :* [[Capital requirements]] β clearly the Internet has influenced this factor dramatically. Websites and apps can be launched cheaply and easily as opposed to the brick-and-mortar industries of the past. :* Incumbency advantages independent of size (e.g., [[customer loyalty]] and [[brand equity]]). :* Unequal access to distribution channels β if there are a limited number of distribution channels for a certain product/service, new entrants may struggle to find a retail or wholesale channel to sell through as existing competitors will have a claim on them. :* [[Government]] policy such as sanctioned monopolies, legal franchise requirements, [[patents]], and [[regulatory authority|regulatory requirements]]. ; Expected retaliation : For example, a specific characteristic of [[oligopoly]] markets is that prices generally settle at an equilibrium because any price rises or cuts are easily matched by the competition. === Threat of substitutes === A substitute product uses a different technology to try to solve the same economic need. Examples of substitutes are meat, poultry, and fish; landlines and cellular telephones; airlines, automobiles, trains, and ships; beer and wine; and so on. For example, tap water is a substitute for Coke, but Pepsi is a product that uses the same technology (albeit different ingredients) to compete head-to-head with Coke, so it is not a substitute. Increased marketing for drinking tap water might "shrink the pie" for both Coke and Pepsi, whereas increased Pepsi advertising would likely "grow the pie" (increase consumption of all soft drinks), while giving Pepsi a larger market share at Coke's expense. Potential factors: * Buyer propensity to substitute. This aspect incorporated both tangible and intangible factors. Brand loyalty can be very important as in the Coke and Pepsi example above; however, contractual and legal barriers are also effective. * Relative price performance of substitute * Buyer's [[switching costs]]. This factor is well illustrated by the mobility industry. [[Uber]] and its many competitors took advantage of the incumbent taxi industry's dependence on legal barriers to entry and when those fell away, it was trivial for customers to switch. There were no costs as every transaction was atomic, with no incentive for customers not to try another product. * Perceived level of [[product differentiation]] which is classic [[Michael Porter]] in the sense that there are only two basic mechanisms for competition β lowest price or differentiation. Developing multiple products for niche markets is one way to mitigate this factor. * Number of substitute products available in the market * Ease of substitution * Availability of close substitutes === Bargaining power of customers === The bargaining power of customers is also described as the market of outputs: the ability of customers to put the [[firm]] under pressure, which also affects the customer's sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers' power is high if buyers have many alternatives. It is low if they have few choices. Potential factors: * Buyer concentration to [[firm]] [[concentration ratio]] * Degree of dependency upon existing channels of distribution * Bargaining leverage, particularly in industries with high [[fixed cost]]s * Buyer switching costs * Buyer information availability * Availability of existing substitute products * Buyer [[price sensitivity]] * Differential advantage (uniqueness) of industry products * [[RFM (customer value)]] Analysis === Bargaining power of suppliers === The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labour, and services (such as expertise) to the [[firm]] can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources. Potential factors are: * Supplier switching costs relative to [[firm]] switching costs * Degree of differentiation of inputs * Impact of inputs on cost and differentiation * Presence of substitute inputs * Strength of the distribution channel * Supplier concentration to the [[firm]] concentration ratio * Employee solidarity (e.g. [[labor unions]]) * Supplier competition: the ability to forward vertically integrate and cut out the buyer. === Competitive rivalry === Competitive rivalry is a measure of the extent of competition among existing firms. Price cuts, increased advertising expenditures, or investing in service/product enhancements and innovation are all examples of competitive moves that might limit profitability and lead to competitive moves. For most industries, the intensity of competitive rivalry is the biggest determinant of the competitiveness of the industry. Understanding industry rivals is vital to successfully marketing a product. Positioning depends on how the public perceives a product and distinguishes it from that of competitors. An organization must be aware of its competitors' marketing strategies and pricing and also be reactive to any changes made. Rivalry among competitors tends to be cutthroat and industry profitability is low while having the potential factors below: Potential factors: * [[Competitive advantage]] through [[innovation]] * Competition between online and offline organizations * Level of [[advertising]] expense * Powerful competitive strategy which could potentially be realized by adhering to Porter's work on low cost versus differentiation. * Firm [[concentration ratio]]
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