Since its introduction in 1979, Porter’s Five Forces has become the de facto framework for industry analysis. The five forces measure the competitiveness of the market deriving its attractiveness. The analyst uses conclusions derived from the analysis to determine the company’s risk from in its industry (current or potential). The five forces are (1) Threat of New Entrants, (2) Threat of Substitute Products or Services, (3) Bargaining Power of Buyers, (4) Bargaining Power of Suppliers, (5) Competitive Rivalry Among Existing Firms. Don’t forget to check out our example of the Porter’s Five Forces analysis of Coca-Cola.
5. Competitive Rivalry Among Existing Firms: Rivalry among industry players can affect industry profits through (a) downward pressure on prices, (b) increased innovation, (c) increased advertising, (d) increased service/product improvements, among others. In economics, a monopoly industry structure earns the most profit while the “perfect competition” industry structure earns the least. An increase in competitive rivalry among existing firms brings an industry closer to the theoretical “perfect competition” state. Factors that increase competitive rivalry among existing firms include:
- Large Number of Firms: If there are more firms within an industry, there is an increased competition for the same customers and product resources. There is even greater competition if industry players are equal in size and power, as rivals compete for market dominance.
- Slowed Industry Growth: When an industry is growing rapidly, firms are able to increase profits because of the expanding industry. When growth slows and industries reach the maturity stage of the industry lifecycle, competition increases to gain market share (and continue the profit growth that investors require).
- High Fixed Costs or High Storage Costs: In industries where the fixed costs are high, firms will compete to gain the largest amount of market share possible to cover the fixed costs.
- High Exit Barriers: When high exit barriers exist, firms will stay and compete in an industry longer than they would if no exit barriers existed
In addition, price competition is more likely to exist when:
- Products or services are identical and/or low switching costs: This encourages price competition to gain market share.
- Fixed costs high and/or marginal costs low: This encourages competitors to cut prices below their average costs (but not below marginal costs) to recoup some of their fixed costs.
- Capacity must be expanded in large increments to be efficient:
- The products are perishable: When a product is perishable, at a certain time it loses its value completely. This creates pressure on a competing firm to sell its product at a price while it still has value. This is true not only for food but for many industries where technology is consistently being improved (e.g. cars, computers, etc).