Factors affecting Competitive Advantage

Factors affecting Competitive Advantage

The five-forces model:

• Rivalry among existing competitors
• Threat of new entrants
• Threat of substitute products and services
• Bargaining power of buyers
• Bargaining power of suppliers

1. Rivalry among existing competitors

Rivalry among industry players can affect industry profits through downward pressure on prices,  increased innovation, increased advertising, increased service/product improvements, among others. In economics, a monopoly industry structure earns the most profit while the “perfect competition” industry structure earns the least. An increase in competitive rivalry among existing firms brings an industry closer to the theoretical “perfect competition” state. Factors that increase competitive rivalry among existing firms include:

• Large Number of Firms: 
• Slowed Industry Growth
• High Fixed Costs or High Storage Costs
• High Exit Barriers

2. Threat of new entrants

Threat of new entrants refers to the threat new competitors pose to existing competitors in an industry. A profitable industry will attract more competitors looking to achieve profits. If it is easy for these new entrants to enter the market – if entry barriers are low – this poses a threat to the firms already competing in that market. More competition – or increased production capacity without concurrent increase in consumer demand – means less profit to go around.

High Threat of entry of new competitors when:

• Profitability does not require economies of scale
• Products are undifferentiated
• Brand names are not well-known
• Initial capital investment is low
• Consumer switching costs are low
• Accessing distribution channels is easy
• Location is not an issue
• Proprietary technology is not an issue
• Proprietary materials is not an issue
• Government policy is not an issue
• Expected retaliation of existing firms is not an issue

3. Threat of substitute products and services

Threat of substitutes definition is the availability of a product that the consumer can purchase instead of the industry’s product. A substitute product is a product from another industry that offers similar benefits to the consumer as the product produced by the firms within the industry.

The Threat of Substitutes Porter places High risk on:

• Consumer switching costs are low
• Substitute product is cheaper than industry product
• Substitute product quality is equal or superior to industry product quality
• Substitute performance is equal or superior to industry product performance

4. Bargaining power of buyers

An advantage to consumers that comes from gathering together to put collective pressure on producers to lower prices or improve quality. The bargaining power of buyers typically has the strongest effect on pricing when buyers are organized and they collectively account for much of the producer's income, they are interested in a product that has an excess of suppliers, and they are interested in making substantial purchases.

• The buyer group is concentrated, or purchases large volumes relative to the seller’s sales
• Products purchased from the industry represent a significant percentage of the buyer’s costs or purchases
• Products purchased from the industry are standard or undifferentiated

5. Bargaining power of suppliers

The bargaining power of suppliers comprises one of the five forces that determine the intensity of competition in an industry. The others are barriers to entry, industry rivalry, the threat of substitutes and the bargaining power of buyers.

The following conditions indicate that a supplier group is powerful:

• It is dominated by a small number of companies and is more concentrated than the industry to which it sells
• It is not required to contend with substitute products for sale in the industry
• The industry is not one of the supplier’s important customers
• Its products are an important part of the buyer’s business
• Its products are differentiated or there are built-up switching costs
• It poses a definite threat of forward integration