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Industry Structure and Firm Strategy: The Five Forces Model

Q: What is the 'Five Forces Model'?

A framework that identifies five forces that determine the profit potential of an industry and shape a firm's competitive strategy.

36 important questions on Industry Structure and Firm Strategy: The Five Forces Model

What is a Strategic position?

A firm's strategic profile based on the difference between value creation and cost. (V - C)

It relates to its ability to create value for customers (V) while containing the cost to do so (C).

What is the 'Five Forces Model'?

A framework that identifies five forces that determine the profit potential of an industry and shape a firm's competitive strategy.

What are Porter's 2 Key Insights?

1) Competition must be viewed more broadly.
2) The profit potential of an industry is a function of the five forces that shape competition.

What are the 5 key competitive factors managers need to consider when analysing the industry environment and formulating competitive strategy?

1) Threat of Entry
2) Power of Suppliers
3) Power of Buyers
4) Threat of Substitutes
5)Rivalry among existing Competitors

In what 2 ways does potential new entry depresses industry profit potential?

1) Incumbent firms may lower prices to make entry appear less attractive to potential new competitors. (= overall industry profit reduces)

2) Incumbent firms might be forced to spend more in order to satisfy their existing customers more.

! the more profitable an industry, the more attractive it is for new competitors to enter !

What are Barriers to Entry?

Obstacles that determine how easily a firm can enter an industry and often significantly predict industry profit potential.

What are 7 important Entry Barriers of which incumbent firms benefit?

- Economies of Scale
- Network effects
- Customer switching costs
- Capital Requirements
- Advantages independent of size
- Government Policy
- Credible threat of retaliation (wraak)

Barriers to Entry: Economies of Scale

Cost advantages that accrue to firms when they increase their output because they can spread fixed costs over more units.

ATC decrease when Q increases as costs are more spread over TFC (drives the fixed cost per unit down)

Barriers to Entry: Network Effects

When the value of the product or service increases with the number of users.

(= Network externalities)
Example: Facebook, Instagram,...

Barriers to Entry: Switching Costs

Costs incurred by moving from one supplier to another.

switching costs are sunk costs

Barriers to Entry: Capital Requirements

Describes the price of the entry ticket into a new industry. How much capital is required to compete in a certain industry and which firms are willing/able to make such an investment?

The threat of entry is high when capital requirements are low in comparison to expected returns.

Barriers to Entry: Advantages independent of size + Examples

Incumbent firms often possess (bezitten) cost and quality advantages that are independent of size.

Examples: Brand loyalty, Location, Distribution channels, Patents, Own technology,...

Barriers to Entry: Government Policy

Frequently government policies restrict or prevent new entrants.

Examples:

Barriers to Entry: Credible threat of retaliation

Potential new entrants must also anticipate how incumbent firms will react.

A credible threat of retaliation (revenge) often deters (schrikt af) entry.

Example: price war, litigation, sales promotions, innovation,...

FIVE FORCES MODEL: The Power of Suppliers

Reduces a firm's ability to obtain superior performance due to two reasons:

Powerful suppliers might...

1) Raise the cost of production
2) Reduce industry's profit by capturing part of the economic value created

FIVE FORCES MODEL: The Power of Buyers

The pressure an industry's customers can put on the producer's margins in the industry by demanding a lower price or higher product quality.

What is Backward Integration?

It occurs when a buyer moves upstream in the industry value chain, into the seller's business.

In what scenario's is the Power of Suppliers HIGH?

- No available substitutes
- Differentiated products
- Incumbent firms face switching costs
- Suppliers industry is more concentrated
- Almost) independent on the industry for their revenues
- Threaten to forward-integrate into the industry

In what scenario's is the Power of Buyers HIGH?

- Few buyers
- Low/No switching costs
- Threaten to backwardly integrate into industry
- Industry products are standardised/ undifferentiated commodities

FIVE FORCES MODEL: The Threat of Substitutes

The idea that products or services available from outside the given industry will come close to meeting the needs of current customers.

When is the threat of substitutes high?

- Substitute offers an attractive price-performance trade-off
- Buyer's switching costs are low

What is 'Rivalry among existing competitors'?

It describes the intensity with which companies within the same industry jockey for market share and profitability.

What determines the intensity of rivalry among existing competitors?

- Competitive industry structure
- Industry Growth
- Strategic Commitments
- Exit Barriers

What captures the structure of an industry? (Common to all industries)

- Nr and size of competitors
- Firms degree of pricing power
- Type of product/service
- Height of entry barriers

What are the 4 main Competitive Industry Structures?

1) Perfect Competition
2) Monopolistic Competition
3) Oligopoly
4) Monopoly

Competitive Industry Structures: Perfect Competition

- Many (small) firms
- No barriers to entry
- Commodity product (grondstoffen)
- Price taker (No pricing power)

Example: wheat, corn,...

Competitive Industry Structures: Monopolistic Competition

- Many firms
- Some barriers to entry

- Differentiated product
- Price maker (for unique product)

What is Non-price Competition?

Competing by offering unique product features or services rather than competing based on price alone.

Competitive Industry Structures: Monopoly

- Only one (large) firm
- High barriers to entry
- Price maker (Pricing power)

!!! The one firm IS the industry !!!

What is a Natural Monopoly?

Natural Monopolies exists due to the high fixed or start-up costs of conducting a business in a specific industry. They can arise in industries that require unique raw materials, technology or similar factors to operate.

! The government will provide regulation in order to ensure consumers get a fair deal !
Public utilities supplying gas, water and electricity to businesses and homes are often monopolies.

What are Near Monopolies?

Firms that have accrued significant market power.

Example: by owning valuable patents, their own technology,...

What is Industry Growth?

It directly affects the intensity of rivalry among competitors. In periods of high growth,

What are Strategic Commitments?

Firm actions that are costly, long-term oriented and difficult to reverse.

What are Exit Barriers?

Obstacles that determine how easily a firm can leave an industry.

What is a Complement?

A product, service or competency that adds value to the original product offering when the two are used together.

What is a Complementor?

Company A is a complementor to company B when customers value the product/service of A more when they are able to combine it with the product/service of company B

The question on the page originate from the summary of the following study material:

Strategic Management | 1259913747 | Frank T Rothaermel

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