Leg Zero: Porter´s model explained. Force number One: Industry Rivalry (part IV).
Hope you are doing well.
We will continue with the first force of Porter´s model, called Degree of Rivalry: Industry Rivalry between established competitors.
We have already covered three determinant factors of this first force. We already covered concentration, diversity of competitors, product differentiation. Today it is the turn of Excess Capacity and Exit Barriers.
EXCESS CAPACITY: This term is related to supply and demand balance. When we start to distribute our products to the market, we expect clients to buy them. What happens if you have excess supply? To have a supply in excess of the demand signifies a presence of unused capacity, and firms tend to offer price cuts when seeking additional revenues.
Excess capacity happens usually in highly cyclical industries or because of declining market demand. Some highly cyclical industries are construction, building materials, leisure and recreation, oil & gas, heavy equipment, durable goods, etc. In the case of highly cyclical industries, the companies must adapt to keep a balance of their products according to the cycle of high demand. For example, the industry of Christmas and Holiday decoration products is clearly seasonal.
New disruption variables such as emerging technologies or external causes such as a war or economic recession can cause a declining market demand for several industries. Examples of declining industries caused by new disruptive technologies are financial services intermediation, directory and mailing list publishers, manufacturing of fixed telephone apparatuses, photo finishing or film developing, DVD, video and game rentals.
Excess capacity may happen also because of over-investment. Before starting to sell your products, it is important to realize a market demand analysis. Otherwise, over-investment may also lead to periodic excess capacity. Excess Capacity is most commonly the result of declining market demand, which may be long term.
If excess capacity remains functioning, the profitability of the healthy competitors suffers as the sick ones hang on. If the entire industry suffers from overcapacity, it may seek government help—particularly if foreign competition is present.
It refers to the obstacles, costs and other impediments that prevent a company from exiting the market. Where resources are durable and specialized and where employees are entitled to job protection, barriers to exit may be substantial. In addition, typical barriers to exit include highly specialized assets, which may be difficult to sell, relocate, or inter-related businesses making it infeasible to sell them. Exit barriers, such as management’s loyalty to a particular business, keep companies competing even though they may be earning low or even negative returns on investment.
Another common barrier to exit is the loss of customer goodwill.
It is important to understand the industry rivalry factors in which you wish to compete before we invest our money on it. To consider each of these key variables will make you think, analyze ahead of time and build several exit scenarios. Ideally, an entrepreneur will develop an exit strategy in the business plan, just in case things go wrong, and before actually going into business, because the choice of exit can influence business development decisions and in consequence the strategy.
Of course, there are entrepreneurs who will never give up, and that is OK too. It is perfectly OK. When we love to do something, we must follow our inner desire to make it happen, and if we are persistent no matter what, as Claude Monet did it, we will arrive at our destiny.
Contemporary Strategy Analysis, by Professor Robert Grant.
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