2.4 Competitive rivalry and industry profitability
8 min read•august 14, 2024
is a key force shaping . It's influenced by factors like the number of competitors, fixed costs, growth rates, and . High rivalry often leads to lower profits as firms compete away margins through price cuts and increased spending.
Managing rivalry is crucial for firm success. Strategies include differentiation, , building , and . Some industries also use or to maintain profitability. Understanding these dynamics helps firms navigate competitive landscapes.
Competitive Rivalry Intensity
Factors Influencing Rivalry Intensity
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- The number and size of competitors in an industry impacts rivalry
- More firms of relatively equal size lead to higher intensity of competition
- Industries with a few dominant players tend to have lower rivalry (oligopolies)
- High fixed costs and low marginal costs create pressure to cut prices and fill capacity, increasing rivalry
- Examples include airlines, hotels, and manufacturing industries with high capital investment
- Slow industry growth motivates firms to fight for
- Fast growth provides opportunities for firms to improve results without taking share from competitors
- Low levels of product differentiation result in higher rivalry
- Products are seen as interchangeable commodities when differentiation is low (gasoline, basic materials)
- High strategic stakes can drive more intense competition
- Firms may accept losses to establish a foothold in a key market or achieve minimum efficient scale
Exit Barriers and Rivalry
- Exit barriers incentivize firms to remain in an industry even when earning low or negative returns, prolonging rivalry
- Specialized assets that cannot be easily redeployed or sold (custom manufacturing equipment)
- Loyal customers that a firm is reluctant to abandon
- Emotional ties or personal pride of management
- Fixed costs of exit like contract termination fees or severance pay
- Firms operating below breakeven are often desperate competitors
- May engage in aggressive price cutting or high-risk strategies to survive
- Can be especially disruptive in industries with high fixed costs and low marginal costs
Rivalry and Industry Profitability
Negative Impact of Rivalry on Profitability
- Intense rivalry generally leads to lower average profitability within an industry
- Firms compete away profits through tactics like price cutting, increased advertising spend, or product improvements
- Value is captured by customers in the form of lower prices or more features
- In industries with very high rivalry, the costs of competition can rise faster than customer value
- Leads to a "race to the bottom" destroying profitability for all industry participants
- Classic example is the U.S. airline industry which struggled for decades to earn its cost of capital
Rivalry and Differentiation
- Some forms of non-price rivalry may actually increase industry profitability if they create meaningful differentiation
- Competing on product features, brand image, or service levels can raise customer willingness-to-pay
- Successful differentiation reduces customer price sensitivity and shifts competition away from price
- Examples include rivalry between luxury car brands or prestige beauty products
- Commodity products are more susceptible to destructive price-based rivalry
- Lack of differentiation means price is the main basis for competition
Interactions with Other Industry Forces
- Competitive rivalry interacts with other forces that impact industry profitability
- Bargaining power of buyers and suppliers
- Threat of new entrants
- Threat of substitutes
- Rivalry may have a more muted effect on profitability in industries where these other forces are favorable
- A concentrated buyer base can limit the ability of rivals to raise prices even if rivalry is low
- High can allow incumbents to avoid mutually destructive competition
- Lack of close substitutes reduces the incentive for rivals to cut prices
Managing Competitive Rivalry
Differentiation Strategies
- Firms can reduce exposure to intense rivalry by differentiating their offerings
- Creating unique value propositions that are hard for rivals to imitate
- Establishing a clear competitive position distinct from rivals
- Differentiation can be based on product features, quality, brand image, customer service, or other factors
- Mercedes commands a price premium based on brand prestige and cutting-edge safety technology
- Nordstrom differentiates through personalized customer service and liberal return policies
- Successful differentiation builds customer loyalty and raises switching costs
- Reduces pressure to match rival price cuts or other aggressive moves
Market Segmentation and Positioning
- Focusing on different customer segments, geographic markets, or product categories than competitors
- Allows a firm to avoid head-to-head competition
- Often requires tailoring the value proposition to the needs of specific segments
- Identifying underserved or niche markets can provide opportunities for profitable growth
- Luxury and budget hotel chains typically target distinct customer groups
- Private label products avoid direct competition with national brands
- Clear strategic positioning makes it easier for firms to avoid attacking rivals' core markets and starting price wars
Customer Captivity
- Building strong brand loyalty and customer switching costs creates "stickiness"
- Insulates a firm from short-term competitive pressures
- Allows for premium pricing and higher margins vs. rivals
- Frequent flyer programs and loyalty rewards are explicit switching cost strategies
- Customers are reluctant to sacrifice earned perks and privileges by defecting to a rival
- Proprietary technologies or products can create de facto switching costs
- Customers may be locked into a specific software ecosystem (Microsoft Office, iOS apps)
- Gillette's patented razor systems prevent customers from buying competitors' blades
Expanding the Scope of Competition
- Expanding into adjacent industries or new geographies
- Allows a firm to deploy its key resources and capabilities into areas with less intense rivalry
- Leverages strengths from core business to establish in new domains
- Examples include retailers expanding into new product categories or consumer goods firms entering emerging markets
- Walmart expanded from general merchandise into groceries, pharmacy, auto services, etc.
- Procter & Gamble leveraged its branding and distribution strengths to expand into developing countries
- Diversifying revenue streams and growth opportunities reduces dependence on intensely competitive core markets
Cost Leadership
- Pursuing cost leadership through scale economies, experience curve effects, or unique low-cost assets
- Gives a firm more pricing flexibility vs. rivals
- Allows a firm to earn above-average margins at prevailing price points or drive competitors out by cutting prices
- Cost leadership is especially powerful in commodity industries where price is the main differentiator
- Alcoa's low-cost aluminum production allowed it to be the price leader for decades
- Walmart's scale and supply chain efficiencies make it the low-cost leader in mass market retail
- Cost leaders must continuously improve efficiency to stay ahead of the competition
- Rivals will seek to imitate or leapfrog the cost leader's business model
Capacity Management
- strategies can prevent the type of oversupply that tends to trigger price wars
- Avoiding overbuilding in cyclical industries
- Keeping supply in line with projected demand growth
- Industries prone to overcapacity include airlines, hotels, oil & gas, and commodity chemicals
- High fixed costs create an incentive to fill capacity even at the expense of price integrity
- Optimistic demand forecasts and long lead times for capacity expansion lead to overbuilding
- Pursuing more flexible capacity like contract manufacturing or outsourcing overflow production
- Allows firms to better match supply with demand fluctuations
- Reduces fixed costs and increases variable costs, lowering breakeven points
Collaboration vs Competition
Coordinated Pricing
- Explicit collusion to fix prices is illegal, but firms may be able to legally coordinate in ways that improve industry profitability
- Following a price leader and avoiding deviations from established levels
- Focusing on growing the overall market rather than taking share from each other
- Avoiding provocative competitive moves that might trigger a response
- Requires a degree of trust and shared understanding between competitors
- Game theory suggests that coordination is more likely with a small number of competitors, repeated interactions, and high costs of "cheating"
- Most common in markets with a few dominant firms
- OPEC has a history of coordinating production levels to influence global oil prices
- Mobile carriers tend to match each other's pricing moves rather than undercut to steal share
Relationships and Information Exchange
- Participating in industry trade associations and developing relationships with competitors
- Helps managers better understand their rivals and reduce the chance of mutually destructive actions
- Provides forums for identifying shared challenges and brainstorming collaborative solutions
- Facilitates legal information sharing that can level the playing field and reduce uncertainty
- Competitor and market intelligence gathering are widely accepted practices
- Firms routinely analyze public filings, press releases, hiring patterns, etc. to gain insight into rival strategies
- Interpersonal relationships between executives can provide back-channel communication to clarify intent and de-escalate potential conflicts
- Social norms and reputational concerns discourage blatantly aggressive acts when CEOs know each other personally
Co-opetition
- Co-opetition strategies involve collaborating with rivals in certain domains while still competing in others
- Allows the industry as a whole to avoid some unnecessary costs and focus rivalry in areas that grow value
- Collaborating to establish shared technology standards or infrastructure
- Joint lobbying for favorable regulations or tax policies
- Co-funding basic research or public awareness campaigns to grow the overall market
- Partnering with rivals can be an effective way to pool resources and share risk for large-scale projects
- Automakers often co-develop shared vehicle platforms while maintaining distinct brand identities
- Pharmaceutical companies collaborate on drug development and clinical trials but compete on marketing and distribution
- Co-opetition requires clear boundaries and legal frameworks to prevent anti-competitive spillovers
- Antitrust authorities may scrutinize collaborations for collusive elements
- Tensions can arise if some participants feel others are benefiting disproportionately
Licensing and Diffusion
- proprietary technologies or processes to competitors
- Improves industry profitability by raising overall customer value
- Allows the innovator to extract returns from their R&D investment
- Diffusing best practices across an industry can lift all boats
- Automotive firms often license patented technologies to competitors to promote adoption of new features
- Semiconductor firms cross-license chip designs to avoid costly patent battles and ensure interoperability
- Broad licensing can be especially beneficial for innovations that exhibit network effects
- The more users adopt the technology, the more valuable it becomes for all players
- Attracts complementary products and services that expand the market
- Selectively licensing to weaker rivals can sometimes deter more threatening competitors from developing their own alternatives
Key Terms to Review (27)
Barriers to entry: Barriers to entry are obstacles that make it difficult for new competitors to enter a market. These can take various forms, including high startup costs, strong brand loyalty among existing customers, regulatory requirements, and access to distribution channels. Understanding these barriers is crucial as they influence market competition, industry profitability, and the strategies that entrepreneurs might pursue when launching new ventures.
Benchmarking: Benchmarking is the process of comparing an organization's practices, performance metrics, and processes against those of leading competitors or industry standards to identify areas for improvement. This practice helps organizations understand their position in the market, optimize operations, and enhance competitive advantage by learning from the best in the field.
Blue Ocean Strategy: Blue Ocean Strategy is a business approach that encourages companies to create new market spaces, or 'blue oceans', where competition is minimal or non-existent, instead of competing in overcrowded markets, or 'red oceans'. This strategy focuses on value innovation, aiming to offer customers unique products or services while reducing costs, thus creating new demand and fostering sustainable growth.
Capacity Management: Capacity management refers to the process of ensuring that an organization has the right amount of resources available to meet current and future demand. This involves balancing the capacity of production, service delivery, and operational resources to optimize efficiency and profitability. Effective capacity management is crucial for maintaining competitive advantage, as it directly impacts the ability of a business to respond to market fluctuations and customer needs.
Co-opetition: Co-opetition is a strategic framework where companies simultaneously compete and collaborate to create mutual benefits in the marketplace. This approach recognizes that businesses can derive value from both competitive and cooperative relationships, enabling them to innovate, share resources, and enhance overall industry profitability while achieving individual goals.
Competitive Advantage: Competitive advantage refers to the unique attributes or resources that allow a company to outperform its competitors and achieve greater profitability. This concept is crucial for businesses as it helps to define their market position, influence strategy, and drive long-term success.
Competitive Rivalry: Competitive rivalry refers to the ongoing battle between firms in the same industry to gain market share, enhance performance, and achieve competitive advantage. This rivalry influences various aspects of strategic planning, including resource allocation, pricing strategies, and innovation efforts, shaping how companies position themselves in the marketplace.
Coordinated Pricing: Coordinated pricing refers to the strategy where firms within an industry work together, either explicitly or implicitly, to set prices at similar levels, thus minimizing competition. This practice can lead to higher prices and reduced price competition, ultimately impacting consumer choices and market dynamics. Such behavior may arise from tacit agreements or through formal collusion, influencing overall industry profitability by aligning firms' interests.
Cost Leadership: Cost leadership is a competitive strategy where a company aims to become the lowest-cost producer in its industry, allowing it to offer lower prices to customers while maintaining acceptable quality. This strategy is crucial as it helps companies achieve a competitive edge, ensuring higher market share and profitability through economies of scale, efficient operations, and cost control.
Customer Loyalty: Customer loyalty refers to the ongoing preference of consumers for a particular brand or company, which often leads to repeat purchases and strong emotional connections. This loyalty is critical as it not only helps businesses retain customers but also significantly enhances profitability and market share in competitive environments. Strong customer loyalty can be a significant barrier for competitors and plays a crucial role in establishing a company's strategic positioning and direction.
Differentiation strategy: A differentiation strategy is a business approach that aims to develop unique product or service offerings that stand out from competitors, providing value that justifies a premium price. This strategy focuses on creating perceived differences through quality, features, branding, or customer service, making products more attractive to consumers in a competitive market. By doing so, companies can build customer loyalty and reduce the intensity of competitive rivalry.
Diffusion of Best Practices: Diffusion of best practices refers to the process through which successful strategies, techniques, and methodologies are shared and adopted across organizations or industries. This concept is crucial as it can lead to improved performance, increased efficiency, and competitive advantage, ultimately impacting competitive rivalry and industry profitability. As organizations adopt proven methods from others, it fosters innovation and can raise industry standards, thereby shaping the competitive landscape.
Exit Barriers: Exit barriers are obstacles that make it difficult for a company to leave an industry or market. These barriers can take various forms, such as high fixed costs, contractual obligations, or the loss of customer relationships. They play a crucial role in influencing competitive dynamics and overall industry profitability, as they affect firms' decisions on whether to stay or exit the market.
Industry Profitability: Industry profitability refers to the overall financial performance and potential for earning returns within a specific industry, driven by various competitive forces and market dynamics. It is influenced by factors such as pricing power, cost structures, barriers to entry, and the intensity of competition among firms. Understanding these elements helps businesses assess their strategic position and identify opportunities for improving their profitability within the competitive landscape.
Industry saturation: Industry saturation occurs when a market reaches a point where the growth potential diminishes because most potential customers are already served or the market is oversupplied. This condition often leads to heightened competition among existing players, pushing prices down and reducing overall profitability. As firms vie for the same customer base, they may resort to aggressive marketing strategies or price cuts, further intensifying competitive rivalry.
Licensing: Licensing is a strategic arrangement where one party (the licensor) allows another party (the licensee) to use its intellectual property, brand, or technology in exchange for compensation, often in the form of royalties. This arrangement enables companies to expand their reach and generate revenue without the need for significant investment in new markets or product development. Licensing can play a key role in competitive dynamics, product-market strategies, and international market entry.
Market Segmentation: Market segmentation is the process of dividing a broad target market into smaller, more defined groups of consumers who share similar needs, characteristics, or behaviors. This approach enables businesses to tailor their marketing strategies and product offerings to meet the specific preferences of different segments, enhancing customer satisfaction and increasing the effectiveness of marketing efforts.
Market share: Market share is the percentage of an industry's sales that a particular company controls, representing its portion of total sales within that market. Understanding market share is crucial as it reflects a company's competitiveness, customer loyalty, and overall performance in relation to its rivals.
Niche market: A niche market is a specific, defined segment of a larger market that is targeted by a business based on unique preferences or needs. This specialized focus allows businesses to tailor their products and marketing efforts, potentially leading to higher customer loyalty and reduced competition within that segment. By addressing the unique demands of niche customers, businesses can create distinctive offerings that differentiate them from competitors in broader markets.
Non-price competition: Non-price competition refers to strategies that businesses use to attract customers and gain market share without altering the price of their products or services. This includes enhancing product quality, improving customer service, branding, and innovating features that differentiate their offerings from competitors. These tactics can create a competitive edge and influence consumer perceptions, which ultimately impact industry profitability.
Oligopoly: Oligopoly is a market structure characterized by a small number of firms that dominate the market, each holding significant market power. In this setup, the actions of one firm can greatly influence the decisions of the others, leading to interdependent pricing and output decisions. This unique competitive landscape often results in strategic behavior among the firms, where they may collaborate, compete fiercely, or engage in price wars, ultimately impacting industry profitability and dynamics.
Price Competition: Price competition refers to the strategy where businesses compete primarily by lowering prices to attract customers and gain market share. This approach is crucial in markets with similar products or services, as it encourages firms to differentiate themselves through pricing rather than other features. The intensity of price competition can significantly influence overall industry profitability and shapes the actions and responses of competitors in the marketplace.
Profit Margin: Profit margin is a financial metric that reflects the percentage of revenue that exceeds the costs associated with producing and selling goods or services. This measure helps businesses understand their profitability relative to their sales, providing insight into how effectively they can convert revenue into profit. A higher profit margin indicates better financial health, which is crucial when analyzing competitive dynamics, making resource allocation decisions, and evaluating the success or failure of strategies within various markets.
Relationships and Information Exchange: Relationships and information exchange refer to the dynamic interactions between businesses, stakeholders, and consumers where information is shared, creating connections that drive value creation. This concept highlights the importance of communication, trust, and collaboration among competitors, suppliers, and customers, ultimately influencing competitive behavior and industry profitability.
Return on Investment (ROI): Return on Investment (ROI) is a financial metric used to evaluate the profitability of an investment by comparing the gain or loss relative to its cost. This measure is crucial in assessing how effectively a company can generate profit from its investments, whether in projects, products, or strategic initiatives. High ROI indicates effective use of resources, while low ROI may signal a need for strategic reevaluation.
SWOT Analysis: SWOT analysis is a strategic planning tool used to identify and evaluate the Strengths, Weaknesses, Opportunities, and Threats of an organization. This framework helps businesses assess their internal capabilities and external environment, guiding strategic decision-making and resource allocation.
Value Chain Analysis: Value chain analysis is a strategic tool used to identify the primary and support activities that create value for a business, helping to understand how each step contributes to the overall competitive advantage. This analysis allows firms to pinpoint areas where they can improve efficiency, reduce costs, or enhance differentiation, aligning closely with strategic thinking and decision-making processes.