Rules of Competition

Class #5

The Role Of Competition

Competition what is it

• Competition is often thought of in a narrow sense (rivalry) but it is for more comprehensive than that
• Competition is any force that makes it difficult for a company to achieve its financial and market goal
• To understand competitive threats we must determine the source of the threat
• After identifying the competitive threat, a company’s policies usually take on an offensive or defensive.

• Michael Porter 5 force model.

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• A new entrant comes to an existing market with new capacity and a desire to gain market share. New Entrant = New Competitor
• Example: ICE to Coke and Pepsi
• When new entrants pose a high threat, incumbents must fold down their prices or boost investment to hold off the competitors
• It is the threat of entry- not whether the actual threat occurs-that holds down profitability
• The threat of new entry is difficult because new entrants must address barriers to entry in the industry. But, it can be done.

• Barriers to entry is any condition that makes it difficult to come into an existing market

• The threat of new entrants is low and high

• Barriers of entry

• Economies of scale

• Economies of scale occur when a company produces larger volumes that drive down costs per unit because the company can spread fixed cons over more units, use more efficient technology or command better terms from suppliers
• So, new entrants either have to enter on a large scale or accept a con. Disadvantage. Typically new entrants come in on a small scale.
• The bigger you are you can drive down per unit costs

• Network Effects

• Network Effects relate to the number and intensity of buyers and tell others of their buying decisions
• Put another way, a buyers willingness to pay for a company’s products increases with the number of other buyers
• Strong brand loyalty and lots of loyal buyers can serve as a barrier to entry for newcomers

• Switching Costs

• Switching costs are those buyers face when they change suppliers. The larger the switching cost, the stronger it serves as a barrier to entry
• Switching Costs (hard dollar and soft dollar) exist for both business and consumers. Examples: re-training costs, adaptations to existing systems and processes, disruption to existing work flows, and of course “pain in the neck” costs
• Switching generates risk since the new vendors or technologies may be unproven

• Capital Requirements

• New markets

• Incumbency Advantage

• Independent of Size
• Intellectual property, established brands, cumulative experience, and access to the best raw material and geographic locations are incumbent advantages. Might not be available to new entrants

• Distribution Channels

• Even the best new products must move through a distribution channel from factory to truck/ship to warehouses to retail shelves. Establishing infrastructure take time and capital

•  Government policy

• On the one hand, government can subsidize new entrants making it easier for them to enter a market. Governments might do this for reasons of national security, anti-trust or to protect declining industries.
• On the other hand governments can enact regulations (safety, licensing)

Substitutes

• A substitute looks to provide the same or similar utility as another( the original ) industry or product
• High substitute threat reduces industry profitability by placing a ceiling on prices. The industry has to invest in added product performance or marketing to stand apart from substitutes
• Characteristics of Substitutes

• They are credible alternative to the incumbents product
• They offer an attractive price-performance trade-off to the industry’s product. The better the relatives value of the substitute the bigger the threat to the incumbent
• The buyers cost of switching to the substitute is low
• The underlying industry is changing through technological or production shifts.
• Substitutes aren’t always clearly labeled as substitutes In the same industry,

Rivalry

• Rivalry among existing companies is a familiar way to look at comparison
• Rivalry drives down an industry’s profit potential depending on how intense the competition is

• Rivalry is intense when:

• Competitors are numerous or roughly equal in sixe and power
• Industry growth is slow thus leading to intense market share wars
• There are no or Few switching costs
• There is lack of differentiation
• Exit Barriers are high (specialized assets, managements desire to stay in a business.
• Rivalry are deeply committed to the business

• Solution to Rivalry

• Price wars-no body wins
• Product Differentiation
• Better distribution
• Network effect
• Carved niches

• Generic policies to address Rivals

• Offensive policy

• Offensive polices seek to take market share away from competitors. This is used when:

• Industry growth is slow so competitors can only grow by taking away from each other
• Incumbent firms have a clear point of weakness such as a ‘product leakage” or an un-served market area
• Incumbents are experiencing negative publicity (product recalls) for Example

• Defensive Policies

• Defensive Policies seek to protect market position from competitors. This used when
• Competitors have a unique value proposition
• Incumbent firms have a clear advantage over competitors

Supplies

• Suppliers provide critical inputs to the production of goods. They can exert competitive pressure when they capture more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to the industry.

• It is more concentrated than the industry it sells to (few suppliers)
• The supplier group does not depend heavily on the industry for its revenue
• Industry participants face switching costs in changing suppliers
• Suppliers offer products that are differentiated
• The supplier group can credibly integrate forward into the industry

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• How would Cotton king become a supplier threat to Hanes?
• Why doesn’t Cotton king integrate forward?
• Can Hanes become a threat to cotton king?
• How do you rate the intensity of supplier competition given:

Buyers

• Powerful customers can force down prices, demand better quality or more service (thus drive up costs) and play industry participants against one another
• A buyer group is powerful when

• There are few buyers or when they are large volume buyers of a single supplier
• The industry’s products are standardized or undifferentiated
• Buyers face few switching costs in changing vendors
• The buyer group can credibly integrate backward into the industry (produce themselves)