Section Nine - Analysing the External Environment - Business and the Competitive Environment Flashcards
What does Porter’s Five Forces model show?
3 bullets
1) Shows an industry being influenced by five competitive forces (Barriers to Entry, Buyer Power, Supplier power, Threat of Substitutes and Industry Rivalry)
2) It analyses the state of the market and helps managers of existing businesses to figure out the best strategy to gain a competitive advantage - it is a decision-making tool.
3) It can show potential market entrants how profitable the market is likely to be and whether it is worth getting into - and if it is, where best to position themselves.
Explain barriers to entry. (It judges how easy it is for new firms to enter the market.)
1) New entrants to the market will want to compete by selling similar products - it’s in the interests of existing firms in the market to make it hard for new firms to get in.
2) High start-up costs (e.g. expensive equipment) might deter new firms from entering the market.
What are strategies to raise barriers to entry?
3 bullets
- Patents or trademarks can be used to make it harder for new entrants to sell similar products.
- Established businesses may take control of distribution channels. This is known as ‘forward vertical integration’. It makes the channel unavailable to new entrants and makes the market less attractive. E.g. an outdoor clothing manufacturer which buys out or merges with an outdoor clothing retailer.
- Threatening new entrants with a price war. Large existing businesses are likely to be benefitting from economies of scale, so can undercut the prices of new entrants (predatory pricing).
However, selling goods at a loss to force competitors out of the market is against EU competition law.
Explain Buyer Power (Buyers have more power when there are few buyers and many sellers.).
3 bullets
1) Buyers have more power when there are few buyers and many sellers.
2) Buyers have more power when products are standardised - it’s easier for firms to charge a premium price for differentiated goods and services.
3) A supplier’s main customer can negotiate special deals and lower prices.
What are strategies to influence buyer power?
- A company might** buy the supplier out** - this is ‘backwards vertical integration’, e.g. a burger chain which buys a beef farm.
- Similar businesses could come together to form a buying group. They’ll be buying bigger volumes so will be able to demand a better deal and so increase their profits. Buying groups help smaller businesses compete with large businesses.
Explain supplier power (Suppliers want to get as a high a price as possible).
1) Suppliers have more power when there are few suppliers and lots of firms buying from them.
2) If it costs customers to switch suppliers, then this gives suppliers more power.
What are strategies to influence supplier power?
- Businesses can try to tie buyers into long-term contracts to make it harder for them to switch suppliers.
E.g. mobile phone companies often have 2-year contracts and lock handsets to their network. - Suppliers can use forward integration to gain power - e.g. by setting up their own retail outlets or buying the retailers they supply to.
- Businesses could develop new products and protect them with patents to gain supplier power.
They’ll be the only ones selling the product, so will be able to charge a premium if it’s a hit.
Explain Rivalry within the industry (how much competition there is)
1) Rivalry is intense in a market with lots of equally-sized competitors.
2) Industries with high fixed costs are very competitive, e.g. parcel delivery companies which have invested in vehicles. Firms have to sell a lot to even cover their fixed costs. So in competitive environments, they cut prices to raise demand. Even if they’re not making a profit, it’s often hard for them to get out of the market as their expensive equipment is hard to sell on - this increases rivalry even more.
3) Industries producing standardised goods (e.g. steel, milk, flour) have intense rivalry.
4) Rivalry is also intense in young industries where competitors are following growth strategies.
Explain the threat of substitutes (how likely consumers are to buy an alternative)
1) The willingness of customers to substitute is a factor affecting competitiveness.
2) Relative price and quality are important - buyers are unlikely to change to a poor value product.
3) For undifferentiated products, e.g. washing powder, the threat is higher than for unique products.
What are strategies to reduce the effects of rivalry?
- Some businesses try to make it easy for customers to switch between standardised goods.
E.g. it’s a hassle to switch bank accounts no matter what incentives are offered so your new bank often handles the process of switching direct debits for you. - Businesses with a bigger promotional budget might do better in markets with intense rivalry.
