This article focuses on strategic analysis and strategic development for companies operating in today's dynamic, competitive business environment. This article will introduce tools for analyzing the external and internal factors that a firm faces. We will then apply that insight to the formulation of a competitive strategy.
In the dynamic environment of the business world, a firm needs to constantly focus on improving its competitive strategy. Competitive strategy refers to the way a firm can gain advantage over others operating in a similar market. Rivalry drives improvement and innovation. Without competition, strategy would be irrelevant.
Strategy goes beyond operational improvement. Tactics that are easily imitated do not constitute a strategy. Simply improving operations or quality cannot lead to a competitive strategy. A competitive strategy utilizes analysis of the structure of an industry and its competitors in order to identify an optimal position. A competitive strategy will also integrate the strengths and resources of the firm to develop a competitive advantage. A sustainable competitive strategy involves continuous improvement with strategic continuity.
This article will focus on the process by which a successful competitive strategy can be developed. The first step to creating a competitive strategy is to analyze the structure of the industry and the nature of competition. Next, we will discuss how to assess the firm's internal environment. Once a clear picture of the industry structure and firm attributes are identified, we can consider the options for achieving goals and sustaining a competitive advantage.
In 1979, Michael Porter introduced the business world to a framework for analyzing the structure of an industry. His model, commonly referred to as Porter's Five Forces, takes a broad approach to competitive analysis. He moves beyond focusing on direct competitors in the market and expands his scope to all players in the value chain. Customers, suppliers, potential new entrants and substitute products are all taken into account in shaping the competition of an industry. Porter's Five Forces model is internationally recognized as the foundation for a thorough competitive analysis. This framework can assess the attractiveness of an industry and help clarify how value is divided among different players in the value chain. According to Porter, the nature and degree of competition is influenced by the five major forces that will be discussed in detail below.
Threat of New Entry
New entrants into a market can really shake up an industry. A firm can lose market share, enter a costly battle to defend territory or lose leverage with customers and suppliers. When assessing the attractiveness of an industry with respect to new entrants, we look to mitigating factors called barriers to entry. These characteristics can help protect an industry from new entrants. There are nine major barriers to entry that we will discuss:
- Economies of scale -- Economic efficiencies are vital to successfully competition in many industries. In many cases, the higher the production volume, the lower the unit cost of production. This increased efficiency provides an advantage to firms that can produce large volumes. If economies of scale come into play in the industry, then a new entrant would either have to match the scale of the large producers or accept a cost disadvantage.
- Brand Identity -- Recognition in the marketplace can be hard for a new entrant to overcome. Brand loyalty takes time and money to build. A new entrant may need to spend heavily on advertising and in other areas such as customer service to displace the entrenched players.
- Proprietary Product Differences -- Companies which have patents or other proprietary knowledge can hamper a new entrant's success in the marketplace.
- Capital Requirements -- The requirement to invest significant financial resources to enter an industry can also inhibit new entrants. Whether it is manufacturing equipment, research and development, or advertising expenditures, any large capital outlay will make a new firm think twice about market entry.
- Absolute Cost Advantages -- Independent of the size of a company, there are some advantages that come with a track record in the industry. These advantages can arise from the effects of the experience curve, access to a superior supplier, favorable location, etc. New entrants may not be able to match established firms when it comes to these advantages.
- Switching Costs -- In some cases, consumers will incur additional expenses for switching from a product or service. Monetary penalties, such as an exit fee for breaking a contractual obligation, are employed in many industries. There can also be psychological switching costs that must be overcome to get consumers to change from the status quo.
- Government Policy -- The government can curb competition in an industry through policies and regulations. The government may have a limited number of licenses that can be given out to set up operations in a certain industry. Environmental regulations and granting of monopolies can also prevent a new firm from entering the market.
- Access to Distribution -- In many industries, there is a finite number of products that can be offered to consumers. Wholesalers and retailers do not have unlimited capacity. Therefore, there will always be a fight for shelf space. Existing players can lock up the distribution, making it hard for new entrants to get their products to the market. The more constrained the distribution outlet, the more limited the pool of players.
- Expected Retaliation -- The threat of new entrants can also be influenced by the expected reaction of existing players. If the existing players possess substantial resources to mount a fight or cut prices, new entrants are less likely.
Bargaining Power of Suppliers
The relationship between a supplier and buyer is one of the most important aspects in business. Procurement of raw materials, labor and other supplies is vital to ongoing operations. Profits of a firm can be squeezed by suppliers exerting their power. Suppliers can raise prices, reduce quality, limit supply or even sign exclusive contracts with competitors. In general, powerful supplier groups possess one or several of the following characteristics.
1. Supplier Concentration -- If the industry is dominated by a few suppliers, this provides little choice for the buyer.
- 2. High Switching Costs -- As discussed in the previous section, switching costs can prevent buyers from taking advantage of alternatives. In the case of a supplier-buyer arrangement, there may also be product specifications that tie a buyer to a particular supplier or the buyer could have invested in expensive equipment to process a particular supplier's raw materials. If the buyer will incur switching costs, then the supplier has more strength.
- 3. Unique Product -- When there are few viable substitutes for the materials a firm is trying to procure, the supplier gains more power in the relationship. For example, the buyer could require a special component that has proprietary technology.
- 4. Viable Forward Integration Threat -- When a supplier has the ability to enter the business themselves, it will prevent the buyer from getting too greedy.
- 5. Serves Multiple Industries -- If a supplier's product can be used for many purposes in several different industries, then the supplier can be picky about whom they do business with.
- 6. Marginal Customer -- A buyer may be an...
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