Competitive Environment: Meaning, Michael Porter’s Five Forces Analysis
A competitive environment is the dynamic external system in which a business competes and functions. The more sellers of a similar product or service, the more competitive the environment in which you compete. Look at fast food restaurants – there are so many to choose from; the competition is high. However, if you look at airlines servicing Hawaii, very few actually fly to the islands.
Direct competitors are businesses that are selling the same type of product or service as you. For example, McDonalds is a direct competitor with Burger King. Indirect competitors are businesses that still compete even though they sell a different service or product. The products or services offered by indirect competitors tend to be those that can be substituted for one another. Again, considering travel, you have the option to travel by plane, train, or car. Therefore, airlines are also competing with train lines and buses (assuming the travel does not go overseas).
There are several examples of competitive business environments. The first that comes to mind is smart phones. How many choices do you have when it comes to buying a smart phone? They seemed to have multiplied overnight! That is an extremely competitive business environment.
Companies are constantly trying to one-up the latest best-selling model – a good indication of a competitive environment. Additionally, prices of comparable smart phone models are relatively close.
Another competitive business environment is the automobile industry. Again, almost every company produces a car in every category. Therefore, when someone is looking at buying a new hybrid sedan or full-size truck, they have so many options to choose from. Obviously, the automobile industry can be segmented in economical and luxury brands, but when comparing within the same segment, there is significant competition.
Michael Porter’s Five Forces
Michael Porter’s analysis of the competitive environment isn’t complex. On the contrary, it’s straightforward and easily understood. He proposes that competition in a given industry depends upon the interaction of five separate forces. How profitable or difficult the competitive environment may be varies widely among given industries. Producers of steel cans, for example, operate in a competitive environment which ensures that profits remain generally low. Other industries, such as manufacturers of soft drinks and toiletries, exist in competitive environments “where there is room for quite high returns.”
(i) Threat of Entry
Competitors can arise from more than one area. In an industrialized economy, a company can make a strategic decision to enter an area for any number of reasons, among them: because the area is under-served, because profit margins are unusually high or because the entering company benefits from a patented process or product that gives them a unique advantage. It should be noted that these advantages aren’t permanent. The shape of the competition changes nearly continuously. Porter observes that when Polaroid’s instant photography patents expired, Kodak was well-equipped to enter the market. Writing in 1979, Porter couldn’t have known that in a few years digitization would drive one company out of business and the other into Chapter 11. As it turned out, the most significant competition was a company that in 1979 sold a grand total of 35,000 relatively inexpensive hobby products worldwide. By 2017, Apple was the world’s ninth largest company, with annual sales of $217 billion. Porter’s analysis indicates that Apple’s security is no greater than Polaroid’s. Threats can come from anywhere, and are difficult to anticipate. In fact, Porter maintains that concentrating on future sources of competition rather than on present products is key for company survival.
(ii) Supplier Power
Porter points out that when there are only a few sources of supply but many buyers, suppliers will dominate and command a greater share of profits. China’s strategy for solar panel cells is an example of a business strategy based on the expectation of driving prices down far enough that suppliers in countries with higher labor costs can’t compete, eventually leaving China’s solar industries as the predominating major supplier, at which point China will be able to control profits throughout the industry.
(iii) Buyer Power
In the reverse situation, where there are only a few buyers and many suppliers, buyers will dominate and will control supplier’s profits. Apple, for instance, has more than 200 Chinese component suppliers for its iPhone. Competition among these suppliers for a single buyer has repeatedly driven down supplier prices to the point where workers have been mistreated and forced to work long hours without breaks under difficult conditions. Even FoxConn (Hon Hai Precision Industry) Apple’s largest Asian supplier, has been caught using student interns and forcing them to work overtime without overtime pay in an effort to maintain market share. Apple has been criticized for the situation and has made some attempts to ensure equitable working conditions for workers in these factories, but as Porter might have predicted, when the supplier/buyer imbalance shifts in favor of the buyer to such an extreme, the resulting competition will drive prices down to a point where suppliers may believe that their survival depends on lowering prices below the point at which keeping the workplace equitable and humane for its workers is possible.
(iv) Threat of Substitutes
Another competitive threat comes from the availability of substitutes for a company’s existing product. The pharmaceutical industry’s attempts to devise strategies that hold off the entrance into the marketplace of generic drugs are an instance of a strategy opposing this threat.
Sometimes, however, the substitute can come from an unpredictable place. The volume of first-class mail the U.S. Postal Service handles has declined dramatically since the introduction of email. Suppliers of components for gasoline and diesel-powered automobile engines may soon find that the coming proliferation of electric cars over the next decade or so threatens their industries with substitution of components for electric vehicles, whereas other suppliers have more experience and are better equipped to compete.
(v) Competitor Rivalry
Porter’s fifth force is the cumulative effect of the first four. Competition can come from anywhere, from innovative new products, from the emergence of powerful new suppliers or buyers who control the marketplace, or from product substitutions made possible by deregulation, innovation or more cost efficient industrial processes, relying on innovative technology, a lower-cost labor force, or both.