Arguably, the most widely used model for understanding competitive advantage is Michael Porter’s competitive forces model (see Figure 3.8). This model provides a general view of the firm, its competitors, and the firm’s environment. Earlier in this chapter, we described the importance of a firm’s environment and the dependence of firms on environments. Porter’s model is all about the firm’s general business environment. In this model, five competitive forces shape the fate of the firm.
1. Traditional Competitors
All firms share market space with other competitors who are continuously devising new, more-efficient ways to produce by introducing new products and services, and attempting to attract customers by developing their brands and imposing switching costs on their customers.
2. New Market Entrants
In a free economy with mobile labor and financial resources, new companies are always entering the marketplace. In some industries, there are very low barriers to entry, whereas in other industries, entry is very difficult. For instance, it is fairly easy to start a pizza business or just about any small retail business, but it is much more expensive and difficult to enter the computer chip business, which has very high capital costs and requires significant expertise and knowledge that are hard to obtain. New companies have several possible advantages: They are not locked into old plants and equipment, they often hire younger workers who are less expensive and perhaps more innovative, they are not encumbered by old worn-out brand names, and they are “more hungry” (more highly motivated) than traditional occupants of an industry. These advantages are also their weaknesses: They depend on outside financing for new plants and equipment, which can be expensive; they have a less-experienced workforce; and they have little brand recognition.
3. Substitute Products and Services
In just about every industry, there are substitutes that your customers might use if your prices become too high. New technologies create new substitutes all the time. Ethanol can substitute for gasoline in cars; vegetable oil for diesel fuel in trucks; and wind, solar, coal, and hydro power for industrial electricity generation. Likewise, Internet and wireless telephone service can substitute for traditional telephone service. And, of course, an Internet music service that allows you to download music tracks to an iPad or smartphone has become a substitute for CD-based music stores. The more substitute products and services in your industry, the less you can control pricing and the lower your profit margins.
A profitable company depends in large measure on its ability to attract and retain customers (while denying them to competitors) and charge high prices. The power of customers grows if they can easily switch to a competitor’s products and services or if they can force a business and its competitors to compete on price alone in a transparent marketplace where there is little product differentiation and all prices are known instantly (such as on the Internet). For instance, in the used college textbook market on the Internet, students (customers) can find multiple suppliers of just about any current college textbook. In this case, online customers have extraordinary power over used-book firms.
The market power of suppliers can have a significant impact on firm profits, especially when the firm cannot raise prices as fast as can suppliers. The more different suppliers a firm has, the greater control it can exercise over suppliers in terms of price, quality, and delivery schedules. For instance, manufacturers of laptop PCs almost always have multiple competing suppliers of key components, such as keyboards, hard drives, and display screens.
Source: Laudon Kenneth C., Laudon Jane Price (2020), Management Information Systems: Managing the Digital Firm, Pearson; 16th edition.