Contents
Rivalry among existing companies is a critical force within Porter’s Five Forces framework, directly impacting an industry’s profitability. Investors seeking attractive opportunities need to understand how intensely companies within an industry compete. This fierce competition can significantly erode profits, while a more moderate level of rivalry among existing companies can allow companies to maintain healthy margins. By analyzing the key factors that intensify rivalry, investors can gain valuable insights into the competitive landscape of an industry and identify sectors with the potential for sustainable profitability.
Key dimensions of rivalry among existing companies
When evaluating competition within an industry, investors should consider the two main battlegrounds: price and non-price competition.
Price competition
Price is a fundamental weapon in any company’s arsenal. Companies may engage in price competition to:
- Gain market share: Lower prices can attract new customers, especially in industries with a large number of competitors (fragmented industries). This is often seen in the grocery store, where multiple brands compete for your business on basic household items.
- Move inventory: Companies with excess stock may resort to temporary price cuts to clear out their inventory.
- Compete with homogeneous products: When products offer little differentiation in features or quality (homogeneous products), price becomes a major deciding factor for consumers. This can be seen in the commodity market, where basic materials like steel or copper are largely similar across different producers.
- Offset high fixed costs: Companies with substantial fixed costs, like factories or machinery, need high sales volume to spread those costs and be profitable. Price reductions can be a strategy to boost sales volume quickly.
However, a relentless focus on price competition can lead to price wars, eroding profitability for all industry participants.
Non-price competition
Astute companies understand that long-term success goes beyond just price. Here’s how they differentiate themselves:
- Product features and innovation: Offering unique features, functionality, or cutting-edge technology can attract customers willing to pay a premium. This is evident in the smartphone industry, where brands compete with innovative features like better cameras or faster processors.
- Branding and reputation: Building a strong brand identity and positive customer perception allows companies to command higher prices and customer loyalty. Think of luxury car brands that differentiate themselves through prestige and heritage.
- Customer service: Exceptional customer service can create a loyal customer base willing to pay a slight premium for a superior experience. This is crucial for airlines or hospitality companies where service quality directly impacts customer satisfaction.
- Distribution channels: Controlling distribution channels, such as having a strong network of retail partners or a user-friendly online platform, allows companies greater control over customer access and brand experience. This is a key advantage for e-commerce giants like Amazon.
Factors intensifying rivalry among existing companies
Understanding the factors that fuel intense competition within an industry is crucial for investors. Here’s a breakdown of key elements that can turn rivalry into a cutthroat battleground:
Fragmented industry
A large number of competitors vying for a limited market share in a fragmented industry can lead to fierce competition, particularly on price. These industries often have low barriers to entry, meaning new players can easily enter and chip away at market share.
This dynamic can trigger price wars as companies resort to aggressive discounting to attract customers. Imagine the airline industry, where numerous carriers compete for passengers on similar routes, leading to frequent price fluctuations and discount offers.
Similar size and resources
When companies within an industry possess comparable resources, capabilities, and brand recognition, they’re more likely to engage in intense head-to-head competition on both price and non-price dimensions. This can lead to a constant push for innovation as companies strive to develop features or technologies that give them an edge.
Aggressive marketing campaigns and feature wars, where companies add features to outdo each other, also become common. The smartphone industry exemplifies this, with major brands constantly innovating with faster processors, better cameras, and unique features to win over customers.
Slow industry growth
In slow-growth industries with limited overall market expansion, companies are forced to fight for a bigger slice of a stagnant pie. This intensifies competition on both price and non-price aspects.
As the total customer base isn’t growing significantly, companies vie for existing customers by offering lower prices, improved customer service, or additional features. This fierce competition can put pressure on profit margins and hinder overall industry profitability.
The beverage industry, with its established brands and slow market growth, is an example of a company competing fiercely for market share through aggressive marketing and promotional campaigns.
Homogeneous products
When products within an industry offer little differentiation in terms of features, functionality, or quality, competition becomes purely price-driven. Since there’s no clear advantage based on features, customers primarily base their decisions on price. T
his scenario often leads to intense price wars and a constant barrage of promotional offers as companies fight to undercut each other. Commoditized products like gasoline or bulk office supplies are prime examples of this type of competition.
High fixed costs
Companies with substantial fixed costs, such as factories, machinery, or a large administrative staff, need high sales volume to spread these costs and achieve profitability.
When faced with high fixed costs, companies may resort to price cuts or aggressive sales tactics to boost sales volume quickly. This can intensify competition within the industry, as other companies are pressured to respond with similar tactics to maintain their market share.
The airline industry exemplifies this with its expensive airplanes and ground crew. Airlines often offer discounted fares to fill empty seats and spread the cost of operating their flights.
However, it’s important to note that non-price factors like efficient operations and cost management can help companies with high fixed costs remain competitive without solely relying on price reductions.
Excess capacity
If companies have idle production capacity, meaning their factories are underutilized, they may resort to price reductions or introduce new product lines to stimulate sales and make use of their excess capacity. This excess capacity can intensify rivalry among existing companies within the industry.
In a bid to clear out stock or utilize their full production capabilities, companies may engage in price wars, driving down prices across the board. This can be particularly disruptive in certain industries, like the steel industry, where periods of excess production capacity can trigger price wars between manufacturers, squeezing profit margins for all players involved. The resulting race to the bottom can be detrimental to industry health in the long run.
High exit barriers
Certain factors can make exiting an industry difficult and expensive, even when profits are low. These factors, known as high exit barriers, can include sunk costs (investments that cannot be recovered), specialized assets that have limited use outside the industry, or contractual obligations.
When companies are trapped in an industry due to high exit barriers, they are more likely to stay competitive and fight for market share, even in low-profit situations. This can further intensify rivalry among existing companies as companies struggle for survival. The nuclear power industry exemplifies this, with its massive power plants representing sunk costs that are difficult to recoup if a company decides to exit the market.
Investor takeaway: Rivalry and the path to profitability
Understanding the intensity and dimensions of rivalry among existing companies is a critical step in any industry analysis for investors. A fierce rivalry characterized by constant price wars and aggressive tactics can significantly erode profitability. On the other hand, a more moderate level of competition, with a focus on non-price differentiation, can create opportunities for sustainable profits.
Here’s how this knowledge translates into action for investors:
Identify industries with weaker rivalry among existing companies: Seek out industries with characteristics that naturally limit competition. This could include industries with high barriers to entry, such as regulations or patents, or those with distinct product differentiation that allows companies to compete on factors beyond just price.
For example, the pharmaceutical industry, with its high research and development costs and regulatory hurdles, presents a significant barrier to entry for new players. This allows established pharmaceutical companies to focus on innovation and brand building, potentially leading to higher profit margins.
Favor non-price competition: Look for industries where companies prioritize non-price factors like product innovation, brand loyalty, superior customer service, or efficient distribution channels. These factors can create a sustainable competitive advantage and allow companies to command premium prices.
A strong brand in the athletic footwear industry, for instance, can justify higher prices due to customer loyalty and brand recognition, even if competitors offer similar products at lower costs.
Case studies
Understanding the impact of rivalry among existing companies on profitability is best illustrated through real-world examples. Here, we explore industries with contrasting levels of price vs. non-price competition, highlighting their investment potential:
High rivalry, price focus: The discount airline market
The discount airline sector exemplifies intense rivalry, primarily driven by price competition. Numerous airlines compete for budget-conscious travelers, leading to frequent sales, discount fares, and limited differentiation in service offerings.
While this price competition can benefit consumers looking for the cheapest option, it can also lead to thin profit margins for airlines and limit investment in amenities or in-flight experiences. This sector may be less attractive for investors seeking companies with strong profitability potential.
Moderate rivalry, brand, and service focus: The premium airline market
In contrast, the premium airline market exhibits a more moderate level of rivalry, with a focus on non-price competition. Here, airlines compete on brand reputation, superior customer service, luxurious amenities, and comfortable flying experiences.
This focus on differentiation allows premium airlines to command higher prices and potentially enjoy healthier profit margins. For investors seeking companies with a focus on customer experience and
High rivalry, homogeneous products: The personal computer market
The personal computer (PC) market showcases the challenges of intense rivalry with homogeneous products. While major brands exist, the core functionalities of most PCs are quite similar. This leads to a significant focus on price competition, with manufacturers offering various configurations and features at different price points. The commoditized nature of the PC market can make it difficult for companies to maintain high-profit margins.
Moderate rivalry, innovation, and brand strength: The smartphone market
The smartphone market, while still competitive, exhibits a more moderate level of rivalry compared to PCs. Here, brands compete fiercely on innovation, with constant advancements in processing power, camera technology, and unique features.
Strong brand recognition and loyal customer bases also play a significant role. This focus on non-price factors allows smartphone companies to command premium prices and potentially enjoy higher profit margins than PC manufacturers. For investors seeking companies at the forefront of technological innovation, the smartphone industry could be a more attractive option.
