Michael Porter is one of the marketing pioneers. He is a father and a great researcher, a business leader, a magnificent author, and an awesome teacher.
The first article I wrote " Which automobile would satisfy a Brazilian customer" http://jar.ma/1P_vGi involved the "Porter's five forces model" which is a great model, in my opinion, to analyze a competitive environment in general and get a perfect knowledge of it and the forces or factors affecting it. Today I am devoting this article to discuss the model deeply and I am using the gasoline industry in my examples to explain each force.
Porter introduced in 1980, 1985 and developed over time, a model that consists of five precise forces that determine the level of profitability of any industry. The forces analysis reveals the industry's real attributes, expose the roots of its actual profitability, highlight its attractiveness and furnish a framework with which it is possible to predict and control the competition moves. These forces might represent a major threat to a firm's ability to forge or sustain a competitive advantage
It is possible to draw the model differently depending on which force is affecting your business the most. The picture above, for instance, show that all the forces affect the business more or less equally apart from the substitute threat which looks here minimal.
The threat of new entrants:
The high performance that certain incumbents are achieving in the industry might be the major motivation of new entrants. Attracted to the high-profit the incumbents are making, new entrants to the industry could cause a fierce competition, reduce some of the existing firm's performance and endanger their survival. The threat of entry depends on the industry's structure and its attributes that constitute and raise the cost of entry which also depends on the height of the existent barriers to entry.
The only substantial barriers to entry in the gasoline industry, for instance, are the costs necessary to purchase the land and the equipment as well as the capital required to invest and operate efficiently in addition to the legal barriers and the government policy.
The threat of rivalry:
The intense competition among existing firms represents a great threat to the ability to generate profit. The strength of rivalry is indicated by several actions undertaken by established firms such as frequent price cuts, the launch of new products, advertising, and quick competitive moves and contractions.
The level of competitiveness is more likely to increase due to certain attributes of the industry. First, rivalry tends to intensify when a large number of firms desire to reach the same size. Second, the growth decline leads the firms to maximize their market share by acquiring the existing competitor's market shares. Finally, when product differentiation is not a possible strategy to opt for, firms tend to base their competitive strategies on price only.
The threat of substitutes:
A substitute is a product or a service that the same customer might turn to meet the same basic needs but in a different way. The substitute might become a long-term or a permanent solution when the primary product or service loses its attractiveness. Also, substitutes represent a threat as they place a ceiling on the prices that firms might be able to charge as well as on the profit allowed to generate. for example, in the 70s when the barrel price exceeded $ 40 in the US market, many alternatives appeared such as solar energy so if the situation remained the same for a long period, those alternatives could take the crude oil and its resulting products place permanently.
The threat of suppliers:
Suppliers are powerful when they possess a unique product or service and the cost to change them is significantly high. They might threaten a firm's performance through reducing the quality or augmenting the prices of their supplies to extract high profit especially if the firms demonstrate a lack of ability to increase their prices by themselves when the costs increase.
For instance, the filling stations that are not contractually attached to the wholesaler via the vertical integration limits' the wholesaler or refiner ability to squeeze out high profit from them. Another example, Shell, for instance, should be supplied by a jobber or through direct supply from the local Shell terminal which always involves one additional financial transaction to pay at the point of delivery.
The threat of buyer
While suppliers might increase the firm's costs, the customers can decrease their revenue. Customers might be powerful to the extent of being able to influence price decrease, demand higher quality or better services and overall push firms to ferocious competition against each other. The buyer power increase particularly when the volume purchased is relatively big and if the products are difficult to differentiate.
The second model is very useful and worth being explained as well. It is Porter Generic model:
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The first article I wrote " Which automobile would satisfy a Brazilian customer" http://jar.ma/1P_vGi involved the "Porter's five forces model" which is a great model, in my opinion, to analyze a competitive environment in general and get a perfect knowledge of it and the forces or factors affecting it. Today I am devoting this article to discuss the model deeply and I am using the gasoline industry in my examples to explain each force.
Porter introduced in 1980, 1985 and developed over time, a model that consists of five precise forces that determine the level of profitability of any industry. The forces analysis reveals the industry's real attributes, expose the roots of its actual profitability, highlight its attractiveness and furnish a framework with which it is possible to predict and control the competition moves. These forces might represent a major threat to a firm's ability to forge or sustain a competitive advantage
It is possible to draw the model differently depending on which force is affecting your business the most. The picture above, for instance, show that all the forces affect the business more or less equally apart from the substitute threat which looks here minimal.
The threat of new entrants:
The high performance that certain incumbents are achieving in the industry might be the major motivation of new entrants. Attracted to the high-profit the incumbents are making, new entrants to the industry could cause a fierce competition, reduce some of the existing firm's performance and endanger their survival. The threat of entry depends on the industry's structure and its attributes that constitute and raise the cost of entry which also depends on the height of the existent barriers to entry.
The only substantial barriers to entry in the gasoline industry, for instance, are the costs necessary to purchase the land and the equipment as well as the capital required to invest and operate efficiently in addition to the legal barriers and the government policy.
The threat of rivalry:
The intense competition among existing firms represents a great threat to the ability to generate profit. The strength of rivalry is indicated by several actions undertaken by established firms such as frequent price cuts, the launch of new products, advertising, and quick competitive moves and contractions.
The level of competitiveness is more likely to increase due to certain attributes of the industry. First, rivalry tends to intensify when a large number of firms desire to reach the same size. Second, the growth decline leads the firms to maximize their market share by acquiring the existing competitor's market shares. Finally, when product differentiation is not a possible strategy to opt for, firms tend to base their competitive strategies on price only.
The threat of substitutes:
A substitute is a product or a service that the same customer might turn to meet the same basic needs but in a different way. The substitute might become a long-term or a permanent solution when the primary product or service loses its attractiveness. Also, substitutes represent a threat as they place a ceiling on the prices that firms might be able to charge as well as on the profit allowed to generate. for example, in the 70s when the barrel price exceeded $ 40 in the US market, many alternatives appeared such as solar energy so if the situation remained the same for a long period, those alternatives could take the crude oil and its resulting products place permanently.
The threat of suppliers:
Suppliers are powerful when they possess a unique product or service and the cost to change them is significantly high. They might threaten a firm's performance through reducing the quality or augmenting the prices of their supplies to extract high profit especially if the firms demonstrate a lack of ability to increase their prices by themselves when the costs increase.
For instance, the filling stations that are not contractually attached to the wholesaler via the vertical integration limits' the wholesaler or refiner ability to squeeze out high profit from them. Another example, Shell, for instance, should be supplied by a jobber or through direct supply from the local Shell terminal which always involves one additional financial transaction to pay at the point of delivery.
The threat of buyer
While suppliers might increase the firm's costs, the customers can decrease their revenue. Customers might be powerful to the extent of being able to influence price decrease, demand higher quality or better services and overall push firms to ferocious competition against each other. The buyer power increase particularly when the volume purchased is relatively big and if the products are difficult to differentiate.
The second model is very useful and worth being explained as well. It is Porter Generic model:
Porter generic model identify three strategies to create a competitive advantage that can be used by any firm, regardless of the industry context. Whether the choice is to adopt a defensive or aggressive position in the competitive terrain. Porter highlighted that the right direction toward a competitive advantage is the coherent execution of an internal competitive strategy.
The firm that adopts the generic strategy of differentiation hope to achieve brand loyalty through its distinctive offerings and by consequence create price inelasticity for the customers, those who base their purchasing decisions on the perceived quality, who are willing to pay a premium price to acquire the unique service or product. It represents an organizational choice that involves setting apart the product or the service from the one offered by the competitors. The common approach to differentiation is the investment in the capabilities required to understand the customer's needs and wants more than the competition and meet them adequately.
In the regulated energy markets, the supplier's needs for the products and services diversification was not an important strategic element to compete. While in the open markets, responding to consumer's needs and wants is essentially dictated by service offerings. Even though it is commonly thought that energy suppliers offer similar services. The implementation quality can separate the firm from the competitors and emphasize customer loyalty. On the other hand, the cost leadership generic strategy is the most commonly pursued when the firms’ primary aim is to outperform the competition by offering products or services at the lowest price in the market. Two advantages can be highlighted. First, the cost leader can make the same profit as the competition even with charging lower prices, the cost leader also may make a higher profit while charging the same price. Second, the cost leader will be well positioned to resist price wars. This strategy targets consumers who consider essentially the lower price possible. Emphasis is created through the reduction of costs at the maximum possible points. In the energy industry, there is limited price advantage for the suppliers who obtain the commodity from the wholesale market although the timing and the supply contract terms that involve higher risk for the supplier might permit the firm to gain a competitive advantage via cost leadership.
The third generic strategy which is focus can be chosen either because the organization cannot approach a broader market due to its resources restrictions for instance or to target a narrowly defined market segment for which the organization concentrates its efforts to customize its product or service to ideally benefit the chosen customers. the reason behind such choice might also be because the firms’ offerings to the broad market is limited to a small line of products or services.
When it comes to defend or to take over a market share, the choice of the price strategy is crucial. Although price decisions are highly important and require great attention, very often decision makers rely their decisions on the simple tactical basis or competitive counteractions which are rapid responses due to the challenging market conditions. To no ones’ surprise. With a large number of competitors, firms opt for lower prices to gain market share. This way of capturing attention works well when the firms offer similar products that are easy to compare.
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