CHAPTER 2 LITERATURE REVIEW
2.3 THE FIVE FORCES FRAMEWORK
2.3.1 THREAT OF ENTRY
Porter (1985) suggests "the threat of entry determines the likelihood that new firms will enter an industry and compete away the value, either passing it on to buyers in the form of lower prices or dissipating it by raising the costs of competing."
A cursory understanding of basic micro economics would generally be sufficient to demonstrate that in markets where firms make abnormal profits, new firms are likely to be attracted to and therefore enter that market, which in turn places pressure on prices and has the long term effect of reducing all firms in that industry to a level where they can only earn normal profits (in the long run). Such a theory does assume, of course, that firms operate under conditions of perfect competition.
Hence, it follows that, in the first instance, the threat of entry assumes conditions of perfect competition, whilst firms already within the industry and seeking to reduce such a threat, would wish to create inter alia conditions of imperfect competition, under which they may continue to earn abnormal profits in the long run.
forces that are critical to competition, the framework allows the strategist to identify those strategic innovations that would add the most to its firm's profitability.
Each force will now be discussed individually.
2.3.1 THREAT OF ENTRY
Porter (1985) suggests "the threat of entry determines the likelihood that new firms will enter an industry and compete away the value, either passing it on to buyers in the form of lower prices or dissipating it by raising the costs of competing."
A cursory understanding of basic micro economics would generally be sufficient to demonstrate that in markets where firms make abnormal profits, new firms are likely to be attracted to and therefore enter that market, which in turn places pressure on prices and has the long term effect of reducing all firms in that industry to a level where they can only earn normal profits (in the long run). Such a theory does assume, of course, that firms operate under conditions of perfect competition.
Hence, it follows that, in the first instance, the threat of entry assumes conditions of perfect competition, whilst firms already within the industry and seeking to reduce such a threat, would wish to create inter alia conditions of imperfect competition, under which they may continue to earn abnormal profits in the long run.
Geroski (1999) offers two important lessons on the issue of new firms entering a market, the first of which is that successful market entry occurs due to product or process innovation, together with sound business planning, and the second that incumbent firms are frequently surprised by the onset of new entrants, because of their preoccupation with themselves and their activities.
Geroski (1999) also reasons that new entrants are likely to come from certain identifiable arrears, viz. firms operating in related product markets, firms that are either up or down the value chain and firms with related competencies.
Firms operating in related product markets are potential entrants largely as a result of their understanding of the needs of the sane customers, given that they are present in the same markets (Geroski, 1999). Moreover, this presence also places them in a position where they are able to identify potential opportunities and finally, given that fact that they are already established in the same market, albeit with a different product, they already enjoy brand recognition and customer trust.
Firms that are either up or down the value chain are in a very similar position as those in related product markets in terms of understanding of customers, access to information, ability to spot opportunities and brand recognition, and hence, pose a similar threat of entry (Geroski, 1999).
Finally, firms with related competencies also present a threat of entry, largely as a result of their ability to use those competencies in different industries.
Geroski (1999) offers two important lessons on the issue of new firms entering a market, the first of which is that successful market entry occurs due to product or process innovation, together with sound business planning, and the second that incumbent firms are frequently surprised by the onset of new entrants, because of their preoccupation with themselves and their activities.
Geroski (1999) also reasons that new entrants are likely to come from certain identifiable arrears, viz. firms operating in related product markets, firms that are either up or down the value chain and firms with related competencies.
Firms operating in related product markets are potential entrants largely as a result of their understanding of the needs of the sane customers, given that they are present in the same markets (Geroski, 1999). Moreover, this presence also places them in a position where they are able to identify potential opportunities and finally, given that fact that they are already established in the same market, albeit with a different product, they already enjoy brand recognition and customer trust.
Firms that are either up or down the value chain are in a very similar position as those in related product markets in terms of understanding of customers, access to information, ability to spot opportunities and brand recognition, and hence, pose a similar threat of entry (Geroski, 1999).
Finally, firms with related competencies also present a threat of entry, largely as a result of their ability to use those competencies in different industries.
Given the understanding of where new entrants are likely to come from, Geroski (1999) also provides suggested ways of identifying probable or possible entrants. These include following the flow of valuable information outward from the market, which would assist in identifying those companies in nearby markets who may know or have an understanding of the same customers or be familiar with parts of the firm's value chain;
considering firms with especially relevant capabilities and assessing whether these capabilities can be profitability applied in the industry concerned. Geroski (1999) also acknowledges that market entry as a result of a related competency is arguably the most difficult to anticipate, and suggests therefore that the analyst remain sensitive to this difficulty, in order that he not overlook it completely.
Geroski (1999) recommends further that answenng the following questions would facilitate the identification of firms who are likely entrants:
• What are the key competencies that an entrant will need to enter the market?
• Who is likely to possess such competencies?
• What observable actions do they have to take as to assemble the skills and assets that they will need?
Assuming that the strategist is able to identify the potential entrants to the market, he would need to pursue some course of action that would allow the finn to defend itself against this threat. Porter (1985) lists the following underlying characteristics that increase or decrease the ease of entry into a market:
Given the understanding of where new entrants are likely to come from, Geroski (1999) also provides suggested ways of identifying probable or possible entrants. These include following the flow of valuable information outward from the market, which would assist in identifying those companies in nearby markets who may know or have an understanding of the same customers or be familiar with parts of the firm's value chain;
considering firms with especially relevant capabilities and assessing whether these capabilities can be profitability applied in the industry concerned. Geroski (1999) also acknowledges that market entry as a result of a related competency is arguably the most difficult to anticipate, and suggests therefore that the analyst remain sensitive to this difficulty, in order that he not overlook it completely.
Geroski (1999) recommends further that answenng the following questions would facilitate the identification of firms who are likely entrants:
• What are the key competencies that an entrant will need to enter the market?
• Who is likely to possess such competencies?
• What observable actions do they have to take as to assemble the skills and assets that they will need?
Assuming that the strategist is able to identify the potential entrants to the market, he would need to pursue some course of action that would allow the finn to defend itself against this threat. Porter (1985) lists the following underlying characteristics that increase or decrease the ease of entry into a market:
•
Economics of scale;•
Proprietary product difference;•
Brand identity;•
Switching costs;•
Capital requirements;•
Access to distributions;•
Absolute cost advantages;•
Government policy;•
Expected retaliationFirms within an industry seeking to reduce the threat of new entrants could essentially influence some or all of the above factors in a way that makes entry more difficult or less attractive to potential entrants.