Burning Ideas

If you know that your backpacking trip will take you through snowy mountain roads and swampy hiking trails, you would be wise to put on your snow tires and double up on insect repellant. Similarly, if you know the nature of competitive challenges in your market, you should be sure your firm is adequately prepared to meet them. Every firm has both strengths and weaknesses, but it is how they match up against the competitive structure of the market that determines success.
Three broad types of action plans are implicated by competitive analysis. A firm will want to choose its competitive battlegrounds judiciously. If it is the low-cost producer, it might enjoy profitable business from a large, powerful buyer. A firm that is disadvantaged on the cost side should probably not pursue business from the powerful buyer, but compete in another customer sector where quick response and specialized technical service are critical. Solar Kids, a Cincinnati-based computer training company, faced up to the waning profit opportunities at elementary and high schools: lots of rivals, impoverished and slow-paying customers. It changed its name to Solar Comp and moved into corporate training, where competition pivots on expertise with the latest applications software and personal productivity tools.
Innovative organizations will sometimes pursue a strategy designed to change the competitive structure of the industry. Advertising and a sophisticated means of programmed merchandising for resellers may transform a market characterized by small regional manufacturers into one dominated by a few national marketers. In markets where this has occurred, the new competitive structure creates barriers to entry through new distribution requirements and product differentiation by branding.
The third strategic approach is to anticipate and exploit change in the competitive structure of the industry. Our challenge is to look carefully at each competitive force, understand its root causes, and forecast its impact on the profitability of an industry. Then, with insight and mobility superior to our competition, we try to secure a position to capitalize on the evolution of the field. In the opening vignette to this chapter, we profiled the moves to stake out a commercial presence in the developing digital economy. It is a reasonable bet that its growing experience and reputation will earn it superior profits and up the stakes for potential rivals in these evolving markets.

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.