Michael Porter developed his Five Forces framework as an associate professor at the Harvard School of Business in 1979 as a way to help evaluate the attractiveness of different industries based on the primary five forces he saw driving the competitive environment of those industries. We’ve covered the framework generally, and now we’re looking at each individual force. Today we look at competitive rivalry.
What is “Competitive Rivalry”?
Competitive rivalry represents perhaps the most easily understood of Porter’s Five Forces. That’s not to say that the other four are difficult to comprehend, but competitive rivalry is particularly intuitive because it’s right in your face for most businesses. While the threat of substitutes and the threat of new entrants are potential competitors, competitive rivalry looks at the competition that’s already there.
Additionally, competitive rivalry is often seen as the most significant determination of the competitiveness of an industry. Again, these are competitors that are already there. Graphically, Porter’s Five Forces often shows the other four forces feeding into competitive rivalry.
Why it Matters: Driving the Need to Steal
Intense competition typically ensues when a market is saturated. When the first cars were built, nobody had one, so there was a huge untapped market. Today, most people who might want a car have one. That means it’s hard to find an untapped market, and companies have to steal market share from each other. As Katherine Arline writes for Business News Daily, “When rivalry competition is high, advertising and price wars can ensue, which can hurt a business’s bottom line.”
Contributing Factors
Many factors contribute to competitive rivalry. For example, if there are large exit barriers in an industry, competitors will be unlikely to leave. Relatedly, large fixed costs relative to variable costs can increase competitive rivalry. Think of two examples: railroads and public utilities. Both require large upfront capital investments: miles and miles of railroad tracks, or power plants. Once those costs are incurred, such companies would take a big hit it they were to leave the industry. It’s hard to liquidate these fixed assets. This means competitors must fight viciously to retain market share. Similarly, brand identity can lead to very intense competitive rivalry. Think of people with an almost religious preference for Coke or Pepsi; Ford, Dodge, Chevy or Toyota; Nike or Reebok. When such brand loyalty exists, it can be tough for a new business to draw customers away.
Concentration Ratio
We typically quantify the concentration of an industry with a value known as the concentration ratio (CR). The CR is typically defined as the percent of market share or output accounted for by a group of the largest companies. Different numbers may be more appropriate for different industries. For example, accounting firms are often thought of in terms of the Big Four. Other industries are more diverse. Restaurants, for example, have a very low concentration ratio. While one might think of the fast food industry as dominated by large fast food giants like McDonald’s and Burger King, the overall restaurant market is very dispersed, so the CR of even a very large number of restaurants would probably be quite low. Even though the math is straightforward, you don’t need to do the computations yourself. The Department of Commerce provides data on the CR of major industries, using the top four, eight, 20 and 50 companies in a survey of industries.
Competitive rivalry, as we said, is perhaps the single more important of Porter’s Five Forces. Once you gain a firm understanding of competitive rivalry, the threat of new entrants and threat of substitutes become even easier to grasp.
What is the CR in your market? More importantly, what will you do about it?
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Tags: brand value, competing for business, competition, competitive rivalry, competitiveness, Porter's Five Forces, Strategy