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The model of the Five Competitive Forces was developed by Michael E. Porter in his book "Competitive Strategy: Techniques for Analyzing Industries and Competitors" in 1980. Since that time it has become an important tool for analyzing an organizations industry structure in strategic processes.
Porters model is based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Especially, competitive strategy should base on and understanding of industry structures and the way they change.
Porter has identified five competitive forces that shape every industry and every market. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The objective of corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Porters model supports analysis of the driving forces in an industry. Based on the information derived from the Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry.
The Five Competitive Forces
The Five Competitive Forces are typically described as follows:
1 Bargaining Power of Suppliers
The term 'suppliers' comprises all sources for inputs that are needed in order to provide goods or services.
Supplier bargaining power is likely to be high when:
· The market is dominated by a few large suppliers rather than a fragmented source of supply,
· There are no substitutes for the particular input,
· The suppliers customers are fragmented, so their bargaining power is low,
· The switching costs from one supplier to another are high,
· There is the possibility of the supplier integrating forwards in order to obtain higher prices and margins. This threat is especially high when
· The buying industry has a higher profitability than the supplying industry,
· Forward integration provides economies of scale for the supplier,
· The buying industry hinders the supplying industry in their development (e.g. reluctance to accept new releases of products),
· The buying industry has low barriers to entry.
In such situations, the buying industry often faces a high pressure on margins from their suppliers. The relationship to powerful suppliers can potentially reduce strategic options for the organization.
2 Bargaining Power of Customers
Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes.
Customers bargaining power is likely to be high when
· They buy large volumes, there is a concentration of buyers,
· The supplying industry comprises a large number of small operators
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· The product is undifferentiated and can be replaces by substitutes,
· Switching to an alternative product is relatively simple and is not related to high costs,
· Customers have low margins and are price-sensitive,
· Customers could produce the product themselves,
· The product is not of strategical importance for the customer,
· The customer knows about the production costs of the product
· There is the possibility for the customer integrating backwards.
3 Threat of New Entrants
The competition in an industry will be the higher, the easier it is for other companies to enter this industry. In such a situation, new entrants could change major determinants of the market environment (e.g. market shares, prices, customer loyalty) at any time. There is always a latent pressure for reaction and adjustment for existing players in this industry.
The threat of new entries will depend on the extent to which there are barriers to entry. These are typically
· Economies of scale (minimum size requirements for profitable operations),
· High initial investments and fixed costs,
· Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets,
· Brand loyalty of customers
· Protected intellectual property like patents, licenses etc,
· Scarcity of important resources, e.g. qualified expert staff
· Access to raw materials is controlled by existing players,
· Distribution channels are controlled by existing players,
· Existing players have close customer relations, e.g. from long-term service contracts,
· High switching costs for customers
· Legislation and government action
4 Threat of Substitutes
A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category also relates to complementary products.
Similarly to the threat of new entrants, the treat of substitutes is determined by factors like
· Brand loyalty of customers,
· Close customer relationships,
· Switching costs for customers,
· The relative price for performance of substitutes,
· Current trends.
5 Competitive Rivalry between Existing Players
This force describes the intensity of competition between existing players (companies) in an industry. High competitive pressure results in pressure on prices, margins, and hence, on profitability for every single company in the industry.
Competition between existing players is likely to be high when
· There are many players of about the same size,
· Players have similar strategies
· There is not much differentiation between players and their products, hence, there is much price competition
· Low market growth rates (growth of a particular company is possible only at the expense of a competitor),
Beverage Industry Vs. Pepsi
Earnings for major soft-drink companies showed substantial improvement in the
first three quarters of 2002, and full-year operating earnings increased 7% to 9on
average. Companies are still dealing with sluggish carbonated soft drink trends in theUnited States. However, despite higher levels of marketing and promotional spending, and economic weakness in many international markets, noncarbonated beverage products continue to drive growth. Operating profits for the beverage industry are projected to rise 9%-10% in 2003 reflecting 7%-8% higher North American profits, a strong 14%-15% increase in Gatorade/Tropicana profits and a 4%-5% increase for international beverages. Beverage profits should benefit from a favorably pricing environment. For 2003, modestly higher prices for soft drinks and other beverage products in U.S.
supermarkets should boost profits for manufacturers. Noncarbonated drinks should continue to show strong growth, while volume trends for carbonated beverages should continue to show improvement. In addition to marketing and promotions, aggressive new product introductions by the major manufacturers should also help to boost volume trends. The projected increases in operating profits for the beverage industry in 2003 will be driven by a further rise in per capita consumption in the United States and abroad, strong growth in sales of new products, lower advertising costs, and modest price increases. The consolidation of bottling networks by both the Coca-Cola Co. and PepsiCo has helped to reduce retail price competition; after several years of intense pressure, softdrink prices have risen steadily since mid-1999. While raw material costs appear more challenging than in recent years, most companies are not expecting substantial increases in their overall cost structure.
Year to date the S&P Soft Drink Index fell 3.8% versus a 1.4% rise in the S&P 1500. During 2002, the industry index significantly outperformed the broader market with a decline of 8.0% versus a 22.5% decrease in the S&P 1500. Performances in recent months has been affected by volatility in the shares of Coca-Cola as investors question whether drink volumes and earnings will resume their historical growth patterns. Shares of PepsiCo have also experienced some weakness on concerns of slowing growth. We however expect the industry to outperform the market in the near term with rebounds in growth and margin trends. Sales and earnings for PepsiCo in 2003 are expected to show positive gains, benefiting from favorable material costs and retail pricing in the U.S Domestic unit sales. Volumes in 2003 should benefit from increased penetration into non-traditional distribution channels and growing consumer demand for non- alcoholic beverage products (soft drinks, ready to drink teas, juices, bottled water and sport drinks) which should continue to raise non- alcoholic beverage consumption levels and margin per capita.
Michael Porter Method of Analysis
The use of the Michael Porter Method further analyzes PepsiCo’s competitive forces.
Rivalry - There are many aspects of the competitive force of rivalry. Rivalry is
the amount of direct companies in an industry. In most industries, such as the
food and beverage industry, corporations are mutually dependent. A move by one firm can be expected to have an effect on its competitors. Just as if Pepsi comes out with a new flavor, its competitor Coca-Cola may want to duplicate it so they won’t fall behind.
Threat of new entrants - Newcomers to an industry typically bring new capacity and a desire to gain market share. This is why they are a threat to an established corporation. An entry barrier is an obstacle that makes it difficult for a company
to enter an industry. There are various entry barriers in any industry. Some
possible entry barriers are:
1. Product Differentiation - In the food and beverage industry, the companies
have to have a good R&D so they can differentiate there products with new
flavors and looks. They need to be able to be ahead of their competition so
they can make their product look more appealing to the average consumer.
Just like Pepsi is planning to come out with a new, rived look this summer.
2. Economies of Scale - The larger the companies, the more of a chance they
will have for survival. This is why in the food and beverage industry only
companies with a large scale of production and sale can last. Therefore
companies such as PepsiCo make it hard for new entrants with low capital to
Threat of substitute products - Substitute products are those products that appear to be different but can satisfy the same need as another product. According to Porter, “Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge.” A substitute product in the food and beverage industry can be high since there are so many various products out there. In this industry, the consumer will stick with a brand because they like the taste, and they will stick with that for a while.
Bargaining power of suppliers - The bargaining power of suppliers has various
characteristics affecting the industry. These characteristics are as follows:
• The industry is dominated by a few suppliers
• Suppliers are more concentrated than the buyers
• No substitutes in the industry
• The supplier has more important customers
• The supplier’s input is critical
• There is differentiation among products
• High switching costs
• Threat of forward integration
Bargaining power of buyer - The bargaining power of buyers’ characteristics are as follows:
• The industry is concentrated
• Buy in volume
• Big ticket items
• Standardization or undifferentiated products
• Low switching costs
• Low profit margins
• Threat of backward integration
• Purchase is not very important to buyer
• Buyer has all the relevant information.