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Chapter 12: Competitive factors

Chapter learning objectives Upon completion of this chapter you will be able to:

briefly explain Porter's ideas on competitive advantage: o differentiation o cost leadership o focus briefly explain the factors that influence the level of competitiveness in an industry using Porter's five forces model: o competitive rivalry o power of buyers o power of suppliers o threat from substitutes o threat of new entrants using Porter's value chain, describe how a firm's competitiveness is affected by the following departments' activities: o purchasing o production o marketing o service. identification of an organisation's SWOT within a market

1 Competitive advantage 1.1 Environmental analysis Part of a firm's external analysis will involve assessing thedegree and sources of competition within the industry. The key issuehere is whether the firm has a sustainable competitive advantage. This will be analysed in three steps:

the different ways a firm can achieve a competitive advantage the main competitive forces in an industry how different activities and departments within the firm contribute to its competitiveness.

1.2 Competitive advantage Michael Porter stated that a firm wishing to obtain a competitive advantage over its rivals is faced with two choices. Choice one (Cost leadership versus differentiation)

Is the company seeking to compete by achieving lower costs than its rivals for similar products and services? If so, then it can either undercut competitors on price, or charge similar prices and enjoy superior margins.

OR

Is the company wishing to differentiate itself by offering a better product than competitors? Here the customer is prepared to pay a premium price for the added value which the customer perceives in the product. The firm thus enjoys a greater margin than the undifferentiated product.

Choice two (Degree of focus)

What is the scope of the area in which the company wishes to obtain competitive advantage? Is it industry-wide or is it restricted to a specific niche?

The answers to these two choices leave the organisation faced with three 'generic' strategies:

cost leadership differentiation focus.

Porter argues that trying to be both a cost leader and adifferentiator usually results in the firm becoming 'stuck in themiddle' with no clear competitive advantage a recipe for disaster.

Illustration 1 Competitive advantage In the car industry one can identify the following strategies:

differentiation e.g. BMW, Jaguar, Mercedes cost leadership e.g. Nissan, Ford, Honda focus - e.g. Ferrari, Rolls Royce.

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Cost leadership For companies competing in a 'price-sensitive' market, this genericstrategy calls for being the low-cost producer in an industry for agiven level of quality. This does not mean that products are 'cheap andcheerful' merely that competitors' quality is matched rather thanbettered. The firm sells its products either at average industry prices toearn a profit higher than that of rivals, or below the average industryprices to gain market share. In the event of a price war, the firm canmaintain some profitability while the competition suffers losses. Evenwithout a price war, as the industry matures and prices decline, thefirms that can produce more cheaply will remain profitable for a longerperiod of time. The cost leadership strategy usually targets a broadmarket. Some of the ways that firms acquire cost advantages are byimproving process efficiencies, gaining unique access to a large sourceof lower cost materials, making optimal outsourcing and verticalintegration decisions, or avoiding some costs altogether. If competingfirms are unable to lower their costs by a similar amount, the firm maybe able to sustain a competitive advantage based on cost leadership. Differentiation A differentiation strategy calls for the development of a productor service that offers unique attributes that are valued by customersand that customers perceive to be better than or different from theproducts of the competition. In the differentiation focus strategy, abusiness aims to differentiate within just one or a small number oftarget market segments. The special customer needs of the segment meanthat there are opportunities to provide products that are clearlydifferent from competitors who may be targeting a broader group ofcustomers. The important issue for any business adopting this strategyis to ensure that customers really do have different needs and wants in other words that there is a valid basis for differentiation andthat existing competitor products are not meeting those needs and wants. Differentiation strategies may be successful if a company can:

reduce the ongoing cost to the customer of using the product (e.g. manufacture a better quality product, easier to use, cheaper to run, etc.) increase customer satisfaction with the product (e.g. manufacture a product that performs better than its rivals) modify the customer's perception of value (this is very common in industries such as clothes manufacturing where brand names are marketed).

Focus A focus strategy concentrates on a narrow segment (a particularbuyer group, market segment, geographical region, service need, productfeature or section of the product range) and within that segmentattempts to achieve either a cost advantage or differentiation. Thepremise is that the needs of the group can be better serviced byfocusing entirely on it. A firm using a focus strategy often enjoys ahigh degree of customer loyalty, and this entrenched loyalty discouragesother firms from competing directly. An important advantage of focus strategies is that they may be theonly way into a market for a small company competing against largercompanies.

Test your understanding 1 Identify examples of the three generic strategies in the food retail industry.

Test your understanding 2 What type of generic strategy is adopted by EasyJet? What are the key drivers of its success?

2 Porter's five forces analysis 2.1 Introduction A PEST analysis is particularly good at identifying whether andwhy certain markets will be expected to grow in the future. However,just because a market is growing, it does not follow that it is possibleto make money in it. Porter's 5 forces approach looks in detail at the firm's competitive environment by analysing five forces. Together these forces determine the overall profit potential of theindustry. Looking at an individual firm, its ability to earn higherprofit margins will be determined by whether or not it can manage thefive forces more effectively than competitors. 2.2 Porter's five forces model

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PORTER'S FIVE FORCES MODEL Competitive rivalry High competitive rivalry will put pressure on firms to cut pricesand/or improve quality to retain customers. The result is reducedmargins. Intensity of existing competition will depend on the following factors:

Number and relative strength of competitors where an industry is dominated by a few large companies rivalry is less intense (e.g. petrol industry, CD manufacture). Rate of growth where the market is expanding, competition is low key. Where high fixed costs are involved companies will cut prices to marginal cost levels to protect volume, and drive weaker competitors out of the market. If buyers can switch easily between suppliers the competition is keen. If the exit barrier (i.e. the cost incurred in leaving the market) is high, companies will hang on until forced out, thereby increasing competition and depressing profit. An organisation will be highly competitive if its presence in the market is the result of a strategic need.

Threat of entry New entrants into a market will bring extra capacity andintensify competition. The threat from new entrants will depend upon thestrength of the barriers to entry and the likely response of existingcompetitors to a new entrant. Barriers to entry are factors that make itdifficult for a new entrant to gain an initial foothold in a market. There are six major sources of barriers to entry.

Economies of scale, where the industry is one where unit costs decline significantly as volume increases, such that a new entrant will be unable to start on a comparable cost basis. Product differentiation, where established firms have good brand image and customer loyalty. The costs of overcoming this can be prohibitive. Capital requirements, where the industry requires a heavy initial investment (e.g. steel industry, rail transport). Switching costs, i.e. one-off costs in moving from one supplier to another (e.g. a garage chain switching car dealership). Access to distribution channels may be restricted (e.g. for some major toiletry brands 90% of sales go through 12 buying points), i.e. chemist multiples and major retailers. Therefore it is difficult for a new toiletry product or manufacturer to gain shelf space. Cost advantages independent of scale, e.g. patents, special knowledge, favourable access to suppliers, government subsidies.

Threat of substitute products This threat is across industries (e.g. rail travel versus bustravel versus private car) or within an industry (e.g. longlife milk asa substitute for delivered fresh milk). Porter explains that,'substitutes limit the potential returns by placing a ceiling on theprice which firms in the industry can profitably charge'. The betterthe price-performance alternative offered by substitutes, the morereadily customers will switch. Bargaining power of customers Powerful customers can force price cuts and/or qualityimprovements. Either way margins are eroded. Bargaining power is high(as, for instance, Sainsbury and Tesco in relation to their suppliers)when a combination of factors arises. Such factors could include the following.

Where a buyer's purchases are a high proportion of the supplier's total business or represent a high proportion of total trade in that market. Where a buyer makes a low profit. Where the quality of purchases is unimportant or delivery timing is irrelevant, prices will be forced down.

Where products have been strongly differentiated with good brand image, a retailer would have to stock the complete range to meet customer demands.

Bargaining power of suppliers The power of suppliers to charge higher prices will be influenced by the following:

the degree to which switching costs apply and substitutes are available the presence of one or two dominant suppliers controlling prices the extent to which products offered have a uniqueness of brand, technical performance or design not available elsewhere.

Illustration 2 Porter's five forces model Porter's five forces can be applied to the house building industry as follows: Competitive rivalry very high

large number of domestic and international firms it is difficult to differentiate your product firms typically have high fixed costs.

Threat of entry - high

For new firms entering the industry the main barriers are as follows: o capital requirements are low construction is labour intensive, most equipment can be hired if necessary o some economies of scale e.g. purchasing bricks o need initial finance to acquire land o need good relationships with planning offices to get planning permission overall these barriers are low, resulting in a high threat of entry.

Threat of substitutes - high

Main threat is the availability of second-hand property for rent or purchase. This will depend on the country concerned some countries have housing shortages (e.g. Turkey) whereas others have booming housing property markets.

Power of suppliers low for materials, higher for land and planning permission

Material suppliers have low power numerous suppliers, undifferentiated products. Suppliers of prime land sites are in a strong position and can command high prices. Local planning office has very high power.

Power of customers low

In the housing sector customers have more choice but individually have low buying power.

Summary: key issue is competitive rivalry.

Test your understanding 3 Use Porter's five forces to identify the most important competitive force for a burger chain, such as McDonalds.

Test your understanding 4 Discuss why a generic competitive strategy of differentiation makes sense by reference to Porter's five forces model.

Test your understanding 5 Would low industry profitability be a barrier to entry?

3 Porter's value chain 3.1 Introduction Porter developed his value chain to determine whether and how a firm's activities contribute towards its competitive advantage. 3.2 The value chain The approach involves breaking the firm down into five 'primary'and four 'support' activities, and then looking at each to see if theygive a cost advantage or quality advantage. Primary activities

Support activities

Results of analysis The results of the analysis are often summarised in the following diagram.

3.3 How different departments contribute to competitive advantage Porter's value chain can now be used to explain how different departments contribute to competitiveness as follows:

Purchasing

Cost advantages sourcing cheaper materials, bulk discounts, centralised buying. Quality advantages sourcing higher quality materials, employing expert buyers.

Production

Cost advantages mass production lines, standardisation, employing workers just above the minimum wage, keeping stock levels low. Quality advantages using better quality materials, more quality control procedures, employing highly skilled staff, flexible manufacturing systems, use of technology to ensure better consistency, ongoing training of staff.

Marketing

Cost advantages word-of-mouth promotion, sell direct to cut distribution costs. Quality advantages market research can help tailor products to meet customer needs, large promotional budgets, sponsorship, perceived quality pricing, brand development.

Service

Cost advantages outsourcing (?), not offering service provision, low paid staff. Quality advantages outsourcing (?), highly skilled staff.

Test your understanding 6 How would a flexible manufacturing system affect competitiveness?

Test your understanding 7 The marketing department of a High Street clothes retailer plans tointroduce a loyalty card scheme. How would this affect the firm'scompetitiveness?

Test your understanding 8 Human Resources (HR) is set up as a service department with a firm.How can this department contribute towards competitive advantage?

4 Corporate appraisal (SWOT)

SWOT analysis examines the Strengths, Weaknesses, Opportunities and Threats of an organisation. This is an integral part of strategic analysis. Unlike PESTanalysis, which focuses on external environmental issues, SWOT analysisis used to view the internal and external situation that an organisation finds itself in. Strengths and weaknesses examine what an organisation internallydoes well or badly, while opportunities and threats look at positiveand negative factors that might impact on the organisation externally. To do this, it draws on PEST analysis, as well as the other modelsexamined in this chapter so far. Because of this, SWOT analysis is avital tool that an organisation uses in its long-term strategic planningprocess.

Once identified, management can consider:

or:

matching strengths to opportunities may highlight new areas for organisational development

methods of removing weaknesses or dealing with the threats the organisation faces

Chapter summary

Test your understanding answers

Test your understanding 1

Differentiation e.g. Marks and Spencer, Harrods Food Hall. Cost leadership e.g. Tesco, ASDA. Focus e.g. traditional stores such as a local delicatessen, fruit and vegetable shop, fishmonger, butcher.

Test your understanding 2 EasyJet is adopting a cost leadership strategy. Low costs are achieved by cheap airport fees (e.g. by not operatingout of major airports), quick turnaround facilities, no free drinks orfood in flight, and efficient booking and operating procedures (e.g. notickets or boarding cards). Note: you could argue that EasyJet also has a degree of focus as it only operates on more popular short-haul routes.

Test your understanding 3 Competitive rivalry very high

Many major competitors e.g. Burger King.

Threat of entry low

Significant barriers to entry include economies of scale, capital investment required and strength of incumbents' brand names.

Threat of substitutes medium

Many substitutes - e.g. sandwiches, pizzas, etc.

Power of customers low

Customers have low switching costs and can easily go elsewhere BUT have very low individual buying power.

Power of suppliers low

McDonalds buys from small suppliers all over the world.

Summary: key issue is competitive rivalry.

Test your understanding 4 Threat of entry The differentiation will be based on high quality and/or a strongbrand name. These increase the development and marketing costs of newentrants and create switching barriers. Competitive rivalry Rivalry is reduced as competitors do not have comparable productsat the price. Taken further, differentiation can enable the firm tocarve out its own niche in the industry. Threat of substitutes The high quality associated with differentiation makes substitutes less attractive. Power of buyers Customer bargaining power is reduced as they will have to buy inferior goods if they switch to competitors. Power of suppliers

Supplier power is only affected if suppliers want to be associated with the differentiator's high profile brand name.

Test your understanding 5 NO While low profitability may make an industry unattractive, it doesnot make it more difficult for firms to enter should they wish to do so.

Test your understanding 6 A flexible manufacturing system will allow a firm to make bespokeproducts in response to differing customer needs. This additional focuson customer requirements will give a quality advantage.

Test your understanding 7 A loyalty card will make customers feel that they are getting 'something extra' so would contribute towards perceived quality.

Test your understanding 8 HR can contribute towards competitive advantage through selection,recruitment, training and appraisal schemes. These can all contributetowards lower staff turnover and greater motivations, which in turn willsave costs and improve quality and productivity.

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