Burning Ideas

Profits are the economic rewards to a business for providing value to customers better than the rest and running an efficient operation. If we briefly examine a few sources of profit, we can get a good preview to the upcoming discussion of the anatomy of competition. Competition is more than industrial rivals cutting prices in an effort to gain market share. It has a structure that can be described and analyzed.

Five Forces

The preceding scenarios suggest that firms have improved profit capabilities to the extent that they can withstand price pressures in the business environment. If we pause to reconsider each scenario, we see that price pressures come from five distinct sectors.

Rivalry in the Industry Not all businesses face the same amount of price pressure from their competitors in the same business. In Atlanta during the 1996 Olympics, hotels enjoyed great pricing latitude because demand outpaced the supply of local rooms. Like the lodging business, other industries are partitioned by natural boundaries or customer purchasing constraints.
If industry rivals offer relatively undifferentiated products or if demand is significantly less than overall capacity, firms will tend to find intense rivalry. Price competition frequently intensifies in declining markets because firms try to grab market share to cover fixed expenses that can’t be shrunk as rapidly as the market.

Powerful Suppliers A manufacturer that relies heavily on a unique input for its product becomes vulnerable to price hikes or other means of “holdup” from the supplier. Of course, the unique input may provide a means of differentiation for the manufacturer. The “Intel inside” sticker on a desktop computer provides many buyers assurance of a top-quality Pentium processor, no matter what the brand name on the PC. The buying firm must carefully weigh the benefits from depending on a powerful source of supply. A key question may be what the future supply situation looks like. Perhaps there will be alternative suppliers when patent protection expires or when another source—maybe even one internal to the firm— has been brought up to speed.

Threat of Substitutes Industries are typically defined by their channel position and their output. Are they manufacturers or distributors? Do they sell chemicals or rolled wire? Notice that user considerations get no mention. But clearly, if a buyer regards the products from two different industries as substitutes, the makers of those products must be considered competitors.

Threat of Potential Entrants Rapidly growing or profitable markets tend to attract new sellers. And newcomers can
change the competitive landscape in several ways. First, new participants in the market increase the productive capacity serving the market; therefore the existing demand from customers has to cover more fixed costs. Second, a new rival will fight to increase market share, perhaps displacing incumbents in the assortments of resellers or underbidding the established firms. Third, new rivals can bring new or substantial resources to the fray.