Page 58 - DCOM506_DMGT502_STRATEGIC_MANAGEMENT

Strategic Management

Notes Porter argues that the stronger each of these forces are, the more limited is the ability of established
companies to raise prices and earn greater profits.
With Porter’s framework, a strong competitive force can be regarded as a threat because it
depresses profits. A weak competitive force can be viewed as an opportunity because it allows
a company to earn greater profits. The strength of the five forces may change with time as
industry conditions change. For example, in industries such as airlines, textiles and hotels,
where these forces are intense, almost no company earns attractive returns on investment. In
pharmaceuticals and toiletries, where these forces are benign, many companies earn attractive
profits.

Notes Understanding the competitive forces, and their underlying causes, reveals the
roots of an industry’s current profitability, while providing a framework for anticipating
and influencing competition and profitability over time. Understanding industry structure
is also essential to effective strategic positioning. Defending against the competitive forces
and shaping them in a company’s favour are crucial to strategy.

4.2.2 Forces that Shape Competition

The configuration of the five forces differ from industry to industry. For example in the market
for commercial aircraft, fierce rivalry among existing competitors (i.e. Airbus and Boeing) and
the bargaining power of buyers of aircrafts are strong, while the threat of entry, the threat of
substitutes, and the power of suppliers are more benign. Thus, the strongest competitive force
or forces determine the profitability of an industry and becomes the most important to strategy
formulation.
1. The Threat of New Entrants: The first of Porter’s Five Forces model is the threat of new
entrants. New entrants bring new capacity and often substantial resources to an industry
with a desire to gain market share. Established companies already operating in an industry
often attempt to discourage new entrants from entering the industry to protect their share
of the market and profits. Particularly when big new entrants are diversifying from other
markets into the industry, they can leverage existing capabilities and cash flows to shake
up competition. Pepsi did this when it entered the bottled water industry, Microsoft did
when it began to offer internet browsers, and Apple did when it entered the music
distribution business.
The threat of new entrants, therefore, puts a cap on the profit potential of an industry.
When the threat is high, existing companies hold down their prices or boost investment to
deter new competitors. And the threat of entry in an industry depends on the height of
entry barriers (i.e. factors that make it costly for new entrants to enter industry) that are
present and on the retaliation from the entrenched competitors. If entry barriers are low
and newcomers expect little retaliation, the threat of entry is high and industry profits
will be moderate. It is the threat of entry, not whether entry actually occurs, that holds
down profitability.
2. Barriers to entry: Entry barriers depend on the advantages that existing companies have
relative to new entrants. There are seven major sources:
(a) Economies of scale: These are relative cost advantages associated with large volumes
of production, that lower a company’s cost structure. The cost of product per unit
declines as the volume of production increases. This discourages new entrants to
enter on a large scale. If the new entrant decides to enter on a large-scale to obtain
economies of scale, it has to bear high risks associated with a large investment.

52 LOVELY PROFESSIONAL UNIVERSITY