Understanding the competitive environment

• Posted by Entri Admin August 24, 2019 - Filed in Strategy - #competition  #strategy  - 535 views

  Many of us have had at least one light-bulb moment where we come up with a dazzling business idea. In that moment, we are convinced the idea is fresh, brilliant and marketable. But chances are someone has already thought of it. So, before we dive head first into our business venture, we need to assess the competitive environment and gauge how severe or attractive it is.        

  Why is it important to understand the level of competition?

  Ultimately, it helps set your expectations for profitability. If there are many businesses offering the same product or service as you, you may need to lower your price to attract customers, which could then lead to lower profitability. But this is only one of many considerations. Professor Porter developed a framework that outlines an industry as being defined by 5 competitive forces aka Porter’s 5 Forces. Let’s look at them one by one and use the metered taxi industry as an example to see this framework in action:

   

  

  1.   Threat of new entries

  The easier it is for newcomers to enter your space, the higher the level of competition. To assess how high the barriers of entry are, consider the following:

  • How much time and money would it take for a similar business to emerge?
  • Is there a lot of red tape deterring new entrants?
  • Is specialist knowledge required?
  • How important is brand identity?
  • Is there a threat of technological advances?

  2.   Threat of substitutes

  As new products or services enter the market, your customers gain more alternatives and become more price-sensitive. In this way, an increase in substitutes could put pressure on your existing sales. To assess the extent of this threat, ask yourself the following:

  • How good is the substitute? If it is superior to your product and at a lower price, you might have a problem.
  • Does it cost anything for your customer to switch products? While a customer may want to switch suppliers, she may end up not doing so because of the cost involved. Cost not only relates to monetary value, but also time and effort.

  3.   Bargaining power of suppliers

  The cost of your suppliers directly impacts your profit margin. The more power your suppliers have over you, the less control you have over your input costs and the less likely you are to negotiate better prices or payment terms. Here are a few key things to consider when assessing the bargaining power of suppliers:

  • The number and size of suppliers: If there are only a few large suppliers, they most likely have the bargaining power.
  • The uniqueness of their products and your ability to substitute: If you require a very specialised product that only a few suppliers can accommodate, then they have the power.
  • The ease of switch between suppliers: If switching suppliers is relatively difficult, the suppliers probably have more power than you.

  4.   Bargaining power of customers

  This is the power of the consumer to affect pricing and quality. If your customers have the bargaining power, then they have the ability to drive prices down or demand better quality from you. This may force you to offer unrealistically low prices to avoid losing clients. Key factors include:

  • The number and size of your clients: If you rely heavily on a handful of clients, then they have more power.
  • The availability of substitutes: If your clients have many other suppliers to choose from and can switch easily, then they have more power.

  5.   Rivalry amongst competitors

  All of the above factors affect the intensity of competition in the market place. Competitive rivalry is largely driven by a small number of similar businesses with high dominance in a growing industry. Consumers can then easily and affordably switch to a competitor’s offering. This can cause pricing wars, which could hurt profitability.

  The metered taxi industry as an example:

  1. High threat of entrants: It’s fairly easy to use a regular car to offer lifts to commuters. The red tape is not stringent enough to deter newcomers and the threat of new technology is rife with the likes of UBER totally changing the way the industry operates.
  2. High threat of substitutes: There are many cab services out there and it is easy to download a different cab hailing app if customers are unhappy with their current one.
  3. Low bargaining power of suppliers: No specific type of car is required and fuel prices are regulated.
  4. High bargaining power of customers: There are more customers than suppliers and they will always choose the cheaper, most convenient option.
  5. Rife competitive rivalry: We have all seen the disputes between traditional metered taxis and UBER. The traditional taxis are distressed as they are losing market share and can’t compete on price while operating profitably.

  Suffice it to say, the metered taxi industry is rife with competition, which ultimately squeezes margins and puts pressure on profitability.

  What do you do when your industry is rife with competition?

  Competition is not necessarily a bad thing. It’s great for customers as they gain more options and could potentially save more than in an uncompetitive environment. It also keeps businesses on our toes as we need to continually come up with innovative ways to keep our customers. 

  When applying Porter’s 5 Forces, you should look at them in the context of your specific market. If you only have one store servicing a local market, you may only need to look at the competition in your city or suburb and not necessarily the broader national or international market.

  In a highly competitive environment, it is hard to compete on price and highly likely that a competitor will offer a lower price that could be unsustainable from a profitability perspective. You may then need to differentiate yourself so that the customers choose you instead of a competitor and pay a premium for your product or service.

  You could also focus on a niche market and tailor your business to what is important to them. For example, you can focus on a certain demographic (gender, age etc.) or location.

  Now, this framework is primarily used by more established businesses to evaluate what effect “disrupters” will have on their business. However, we are probably those very new entrants that are coming up with our fresh ideas and challenging the status quo! That said, you still have to be wary of these five forces in order to stay on top of your game.