Threat of Entry
How easy or difficult is it for new entrants to start competing?
It is not only incumbent rivals that pose a threat to firms in an industry; the possibility that new firms may enter the industry also affects competition. In theory, any firm should be able to enter and exit a market, and if free entry and exit exists, then profits always should be nominal. In reality, however, industries possess characteristics that protect the high profit levels of firms in the market and inhibit additional rivals from entering the market. These are barriers to entry.
Barriers to entry are more than the normal equilibrium adjustments that markets typically make. For example, when industry profits increase, we would expect additional firms to enter the market to take advantage of the high profit levels, over time driving down profits for all firms in the industry. When profits decrease, we would expect some firms to exit the market thus restoring a market equilibrium. Falling prices, or the expectation that future prices will fall, deters rivals from entering a market. Firms also may be reluctant to enter markets that are extremely uncertain, especially if entering involves expensive start-up costs. These are normal accommodations to market conditions. But if firms individually (collective action would be illegal collusion) keep prices artificially low as a strategy to prevent potential entrants from entering the market, such entry-deterring pricing establishes a barrier.
Barriers to entry are unique industry characteristics that define the industry. Barriers reduce the rate of entry of new firms, thus maintaining a level of profits for those already in the industry. From a strategic perspective, barriers can be created or exploited to enhance a firm's competitive advantage.
Threat of new entrants depends on:
The Power of Suppliers
How strong is the position of sellers? Suppliers, if powerful, can exert an influence on the producing industry, such as selling raw materials at a high price to capture some of the industry's profits. In some cases, monopolist supplier can dictate its terms to entire industries. This force determines the cost of raw materials and other inputs.
The bargaining power of suppliers depends on:
The Power of Buyers
How strong is the position of buyers? Can they work together in ordering large volumes? This force influences the prices that firms can charge. It can also influence cost and investment as powerful buyers demand costly service.
This competitive force depends on many factors:
The Threat of Substitutes
This force also influences the prices that firms can charge. It depends on:
Rivalry among Existing Competitors
Does a strong competition between the existing players exist? Is one player very dominant or are all equal in strength and size? This force is located at the center of the diagram below. The intensity of rivalry depends on:
The collective strength of these five forces determines the ability of firms in an industry to earn, on average, rates of return on investment in excess of the cost of capital. Note that:
I. Bargaining power of suppliers.
I. Economies of scale.
Proprietary product differences, access to distribution, absolute cost advantages, government policy and expected retaliation are also determinants of entry barriers.
I. Baxter International, manufacturer of hospital supplies, acquired American Hospital Supply, a distributor.
I. Credible forward integration threat by suppliers.
I. Industry growth.
Determinants include Industry growth, concentration and balance, diversity of competitors, intermittent overcapacity, product differences, brand identity, switching costs, exit barriers, etc.
A. Presence of substitute inputs.
Determinants of supplier power include differentiation of inputs, switching costs of suppliers, presence of substitute inputs, supplier concentration, importance of volume to supplier, cost relative to total purchases in the industry, impact of inputs on cost or differentiation, and threat of forward integration relative to threat of backward integration by firms in the industry.
I. The U.S. Dept. of Defense (DOD) purchases from defense contractors.
I. Buyers are concentrated - there are a few buyers with significant market share.
I. buyer concentration vs. firm concentration.
Additional determinants include: price/total purchases, impact on quality/performance, buyer profits, decision maker's incentives, substitute products, etc.
I. If the cost of the industry product to the buyer is relatively small compared to the buyer's total expenditures, then the buyer is deemed to have more bargaining power.
II is incorrect because if switching among the various products proves to be costly for a buyer, then the industry would be less competitive as most firms will realize that buyers will not easily be lured away from their current suppliers.
IV is true because if the customer base if profitable, they will be inclined to bargain, and hence competition among firms id less likely to escalate.
A. Relative price and performance of substitutes.
I. A large number of firms.
I. This is because more firms must compete for the same customers and resources.
I. Buyer power.
A. I, II and III
According to Porter, brand identity is a determinant of buyer power, new entrants and rivalry within the industry.
I. Buyer power.
A. I, II and III
According to Porter, product differences is a determinant of buyer power and rivalry within the industry.
I. Costly exit barriers have just as much impact on industry competitiveness as do costly entry barriers.
A. I and III
II is incorrect because economies of scale would be regarded as an obstacle for entry in both manufacturing and service industries.
III While it is true that governments prefer to promote competition, their policies more often than not act to increase the barriers to entry into an industry. For instance, patent protections and license eligibility are just some of the ways that governments directly impose barrier to entry.
I. Industries characterized with smaller firms but more of them, will be less competitive than industries whereby there are clear leaders.
A. II and III
I is incorrect because industries characterized with smaller firms but more of them, will be far more competitive than industries whereby there are clear leaders. In the latter case, there would be more order among the fewer number of firms.
II is incorrect because industries exhibiting a higher growth rate will mean that there is more business to go around for its members; thus it will involve less rivalry. On the other hand, rivalry for any remaining business will increase if an industry is exhibiting a slower growth.
III is incorrect because its industries characterized with a heavier fixed cost structure that find themselves with higher break-even points, and thus, there will be a greater degree of rivalry amongst its members.
I. Supplier groups that are generally comprised of many firms, will impose a greater bargaining power.
A. I, II, and IV
I is incorrect because supplier groups that are generally comprised of many firms, will impose a weaker bargaining power.
III is incorrect because frequent shortages of suppliers' product would imply that demand for that product exceeds its supply, thus giving the suppliers a greater bargaining position.
I. Drug industry's relationship to hospitals.
A. I and II
Both I and II are examples of powerful suppliers.
I. Suppliers concentrated.
A. Walmart and Sears' large retail market provides power over appliance manufacturers.
A. Buyers purchase a significant proportion of output - distribution of purchases or if the product is standardized.
B. Significant buyer switching costs - products not standardized and buyer cannot easily switch to another product.
C. Producers supply critical portions of buyers' input - distribution of purchases.
A. I, II and III
This has nothing to do with the power of suppliers.
A. Cost leadership
The third generic strategy is Differentiation.