Industry Rivalry

Summary

  • Concentration – collusion/parallel pricing
  • Growth rates
  • Little differentiation
  • Excess capacity & high fixed costs
  • Exit barriers
    • specialised assets
    • long term contracts
    • vertical integration or synergies
    • emotional ties

Industry rivalry can be so devastating that on its own, it is one of the five pathways for the Profit Tipping Point. Fierce rivalry can destroy any chance of current profitability and because of its impact on customer expectations and reference prices which stick long in the memory, it may never recover.

A highly concentrated industry – where the top 4 or 5 companies dominate the market – can lead to fierce competition or a cozy arrangement where competition is carefully limited and never becomes all out war.

You can measure concentration with the concentration ratio – a CR4 of 80% means that the top 4 competitors control 80% of the market, a CR6 of 70% means the top 6 have a 70% total share.

The smaller the number and the more market control, then the easier it is to collude and form cartels to control prices and trading arrangements. It’s much easier to talk to and monitor 2 other competitors than 20 competitors. These are illegal in most (if not all countries) so don’t do it. Fines are very high for any company caught acting in a way that is anti-competitive.

However if the market is dominated by a small number of competitors, you don’t need to collude with official talks since you can decide to match prices – something called parallel pricing.

Market Trader Parallel Pricing

Imagine you are a market trader and you sell vegetables and you compete against two other stalls. You all get your fruit and veg from the same wholesaler so there’s little difference in price or quality on the purchasing side.

You could aim for the most business by having the cheapest potatoes, the cheapest carrots, the cheapest apples…

But what do you think your two competitors are going to do when they see long queues at your stall and few people at theirs. They’ll slash their prices, not to match you but beat you.

So what if you all marked up your stocks and came to independent price decisions. Perhaps there’s a trade convention that says most people add 100% mark-up.

Buy carrots at 20p per pound so sell at 40p per pound.

You walk around and take a look at the others prices and most of them seem reasonable – within a few pence of each other. You see two anomalies.

For some reason you are selling cauliflowers 50% cheaper than the others. Since you haven’t thought of this as a special, you go back and bump up the price to just below the others.

You also see one of the market stalls has a special offer on strawberries – 40% less than you and you see that there are a huge stack of strawberry punnets to be sold. This has been bought as a special promotion and you’ve got a choice – to ignore it, to match it (but you don’t have big stocks) or to go some way there. Your reaction will depend on how many strawberries you have to sell (since they won’t last and you don’t want waste) and how your competitors reacted when you tried something similar. If they let you have your promotion and have a bumper week, then your reaction is different than it will be if they cut their prices to the bone and matched you.

Next time you walk around a market, take notice of how similar prices are.

Growth rates

The growth rate of a market can make a huge difference to the attitudes of competitors.

If markets are growing fast and everyone has more than enough demand, there is no incentive to compete aggressively with silly prices and special bonuses. (See product life cycle).

Things get more interesting when grow rates slow from “it’s great but it’s chaos” 25% to a steady 5%. The market is still growing but all the businesses have got used to growing quickly and they’ve probably planned the same thing to happen again. Incentives are based on big growth and spending decisions have been made assuming big growth.

Worse, since trade associations don’t often report market predictions (which are guesses anyway) but history, business managers are in the dark. Because their sales growth has slowed sharply, perhaps it’s not the market but aggressive action by one or more competitors.

Or perhaps customer tastes are shifting away from their product to a competitor?

Things start getting edgy and competition increases, cutting costs to get back lost sales and recover any perceived value for money problems.

Things get even worse if the market goes into decline.

It’s one thing to see sales increasing slower than expected, another to see your lovely sales graph with the rising line sudden dip down for several months in a row.

Little differentiation

If products and services are the same, it lets customers make easier comparisons.

This can act as a disincentive to cut price for some because they expect to get caught but others will see it as their opportunity to get extra business because price is the only lever they’ve got.

Large amounts of differentiation can also cause trouble since it makes it difficult for competitors to understand enough to make a price/value check.  Different types of firms or those from different countries and cultures can also be mistrusted because their intentions and motivations are not understood.

Excess Capacity & High Fixed Costs

If we split the world into two types of business:

  • Low margin, low fixed costs
  • High margin, high fixed costs

we can see the different pressures on management to make extra sales.

A low margin, low fixed costs business has a flattish break even line – at low sales losses are small and at high sales, profits are still modest.

It’s very different for high margin high fixed cost firms. A large loss is made at low sales since only a small proportion of fixed costs are covered. Each extra sale takes a big chunk out of the loss and then, past the break even point, quickly creates impressive profits.

There is much more incentive to get competitive and get that extra volume, even if it means price cutting on the high margin business.

Fixed capacity service providers like airlines and cruise ships have very sophisticated pricing mechanisms to get capacity filled at the best possible price and through computerised booking systems, prices can jump around based on capacity levels versus expectations.

Every extra passenger matters and because of the upsells and cross-sells with drinks, excursions etc, the cruise company will make money on every passenger because fixed costs are such a large share of the total.

Imagine a cruise ship – it’s three months before it sales and it has 25% of its cabins to sell.

The cruise ship operators expects only 15% spare at this stage so it decides to offer a special deal – cabins at 40% of the price.

Bookings fly in and one week later, the ship is 90% booked (compared with a target of 87%) so the deal is taken away and any one who wants to book is now quoted the full price.

Three weeks before the cruise, the target is to be 98% booked and this ship is at the 96% level. Out come the special deals to get some business, this time a discount of 20%.

Cruise ships and airlines are special, right?

Along way from your business and much bigger and more sophisticated.

So what do you think our vegetable marketer trader does as the afternoon gets on and he has more stock left than he thinks appropriate. He cuts his prices and offers some special deals but he doesn’t want to sell all of it at a discount. He wants to catch the people coming out from work who need something for dinner and are willing to pay the full price.

Exit barriers

Exit barriers trap unprofitable businesses when there is little hope of a successful turnaround and are bad news for everyone in the industry.

The first exit barrier is based around specialised assets and know-how. If you’re doing what you’ve always done and you don’t know any other kind of business, the idea of making a big change will be very scary and appear more dangerous than staying where you are.

If your main asset is a retail store in a good position with high passing foot traffic, then if you’re not competitive selling shoes, yo u can switch to leather goods and fashion accessories if that’s where you see the opportunity.

But if you’re a specialist manufacturer producing deep drawn pressings like saucepans and you’ve found that much of the demand for deep drawn presswork has gone offshore to the low wage economies, then you don’t have equipment which can be adapted. Your presses are obsolete and your tools and dies useless.

The second exit barrier which can leave business owners feeling trapped is when they’ve got long term contracts with some big customers and there are onerous conditions on cancellation. You’ve given your word and legally you may be trapped. Security and reliability of service was important to the customer.

The third exit barrier is if the business is part of a group and one element in a chain of supplier-customer relationships – A sells 80% to B and B sells 60% to C. If B is losing money (and the group transfer prices are fair) then selling or closing B may not be an option because of the potential damage done to A and C.

The final common exit barrier¬† which can stop a business owner from getting out of a loss making business is emotional commitment. If the owner has a number of successful businesses, then the one in trouble may be where it all began and he spent ten years of working in it day after day. Or it may be an issue of pride – the story is that Italian car manufacturer Lamborghini was started when the owner had an argument with Enzo Ferrari and he swore he’d make better, more exciting cars. Pride can keep an entrepreneur in a business long after common sense said get out.

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