Subject Entrepreneurship

Segment Sources of Opportunity

Topic Competitive Analysis

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Table of Contents
1. Overview
2. The Perfect Competition Model
3. Framework of Competitive Analysis
4. The Five Forces and Entrepreneurship
5. The Paradox of Entrepreneurship
6. Self-Assessment
7. Summary

1. Overview
You learned about a number of different but important frameworks to understand
and analyse new enterprise opportunities, and to design and develop your own
entrepreneurial efforts. We discussed that the entrepreneur needs to understand the
macro-environment under which the new firm will operate. The entrepreneur also
needs to scan and monitor the macro-environment to identify the opportunities and
the threats. You also explored a number of creative techniques that entrepreneurs
and the entrepreneurial team can use to generate creative ideas and solutions.
Understanding the elements and processes of the competitive market enables the
entrepreneur to discover the forces that make an industry attractive. In this topic,
we will discuss a model for competitive industry analysis. Since this model depends
on understanding some basic microeconomics, we will begin with exploring the
model for perfect competition.
Objectives: Competitive Analysis
Upon completion of this topic, you should be able to:
 identify the five competitive forces and explain how they determine an
industry's profit potential
 explain the paradox of entrepreneurship
 explain how an entrepreneur uses competitive industry analysis and employs
resources to obtain SCA

2. The Perfect Competition Model

The microeconomic model of perfect competition helps you understand the dynamics
of industry profitability and industry attractiveness. The model is based on the
following two assumptions:
 Markets are free from intervention, whether in the form of formal regulation,
moral persuasion or collusion
 The entrepreneur is a profit maximiser
Perfect competition can be defined as "an economic model of a market possessing
the following characteristics: each economic agent acts as if prices are given, that is,
each acts as a price taker, the product is homogeneous; there is equality and free
mobility of all resources, including free entry and exit of business firms; and all
economic agents in the market possess complete and perfect knowledge".
(Gould and Ferguson, 1980, 215)

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Subject Entrepreneurship
Segment Sources of Opportunity
Topic Competitive Analysis

Note that the assumptions of the perfect competition model are radically different
from the resource-based view that we discussed in topic, "Types and Attributes of
Resources". According to RBV, the firm can escape being a price taker and create
entry barriers through developing a non-homogenous product, based on knowledge
and other resources not available to every other firm.
Analysis of perfectly competitive markets and their close approximations lead to the
proposition of market efficiency, which states, "when prices reflect information
instantaneously; extraordinary profits are dissipated by the action of profit-seeking
individuals".
(Oster, 1990, 18)

Price/cost relationships and New entry are the two most

important aspects of the perfect-competition model for
new venture creation. The efficient-market model
demonstrates that the price charged in a market is just
high enough for a firm to cover its costs and make a
small profit, which is equivalent to the average return on
capital in the economy. In this model, the firm's margins
(the difference between price and cost) are low, and the
normal profitability levels do not attract much attention
from profit seekers outside the industry. Such a market
is said to be in equilibrium.

However, when margins are high, firms have above normal profits. These high
profits attract new entrants seeking to share some of this extraordinary profit. New
entrants can:
 Bid up the prices of inputs, thereby raising costs
 Lower their prices to attract customers
The effect of these activities reduces margins, thereby making the industry less
profitable once again. As a result, the less-efficient firms, those with the highest
costs, will have to go out of business, and the industry will once again be in a state
of equilibrium.
This simplified version of the perfect competition model emphasises its most
important aspects for new venture creation and analysis.

3. Framework of Competitive Analysis

The purpose of industry analysis is to determine what makes an industry attractive
and to decide which segments of the industry are the most attractive. A
comprehensive analytical tool for determining the attractiveness of an industry is the
model of competitive analysis. You may already be familiar with this model because
it is frequently employed in marketing, strategy and applied economics. The model is
alternatively called the Five Forces or Porter model because Michael Porter of the
Harvard Business School developed it. In this model, Michael Porter has applied
industrial organisation economics to business analysis.
Being a "second cousin" to the theory of perfect competition, Porter's model also
under-emphasises heterogeneity among firms within an industry. In fact, this
shortcoming of the Porter's model paved the way for the RBV paradigm that now

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Subject Entrepreneurship
Segment Sources of Opportunity
Topic Competitive Analysis

dominates the strategy field. Nonetheless, Porter's model is still useful when
analysing the attractiveness of a business opportunity. This is because understanding
each dimension of the marketplace is critical to survival of a new venture.
The model consists of five forces that influence the attractiveness (profitability) of an
industry and the way a firm might choose to conduct strategy within an industry. The
following five forces determine the price/cost relationship within the industry, and,
therefore define the industry's margins:
1. The power of the buyers
2. The power of the suppliers
3. The threat of substitutes
4. The threat of new entrants
5. The intensity of rivalry
Let us review the Five Forces Model in the presentation below.

The Five Forces Model

Let us review each force in the Porter model.
The threat of new entrants
Can other firms enter the business, thereby bid up the price of inputs, and cause
price to fall with increased industry production?
The power of suppliers
Can your vendors raise their price or decrease quality of the inputs without a price
decrease? The intensity of rivalry among Industrial competitors
The intensity of rivalry among Industrial competitors
Will the firms in the industry compete in such a manner, primarily through price
competition, wherein few of them will be able to make a profit above the normal
profit of the cost of capital?
The threat of substitutes
Can buyers find other products that are functionally equivalent to the products of
your industry?
The power of buyers
Can your customers cause you to lower price or increase quality without a price
increase?

4. The Five Forces and Entrepreneurship

Let us review start-up businesses and their survival rate.

The following is a ranking of businesses most frequently started, along with their
survival ranks.
Rank 1: Miscellaneous business services have a survival rank of 132.

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Subject Entrepreneurship
Segment Sources of Opportunity
Topic Competitive Analysis

Rank 2: Eating and drinking places have a survival rank of 161.

Rank 3: Miscellaneous shopping goods have a survival rank of 159.

Rank 4: Auto repair shops have a survival rank of 78.
Rank 5: Residential construction has a survival rank of 141.
The following is a ranking of businesses most likely to survive, along with their
survival ranks.
Rank 1: Veterinary services have a start-up rank of 125.
Rank 2: Funeral services have a start-up rank of 158.
Rank 3: Dentists' offices have a start-up rank of 108.
Rank 4: Commercial savings banks have a start-up rank of 93.
Rank 5: Hotels and motels have a start-up rank of 27.
These rankings are out of a total field of 236 firms. Source: David Birch, ?The Truth
about Start-ups?, Inc., January 1988, 14-15.

The top half of the table shows those businesses that are most frequently started
and their respective survival rank. The bottom half of the table shows the businesses
that are most likely to survive, and their start-up rank.
What conclusions can you draw from this table? To help analyse the table, here is a
rough sketch of the distribution across the two ranks.

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Subject Entrepreneurship
Segment Sources of Opportunity
Topic Competitive Analysis

We can clearly see that the businesses that are most frequently started are the
easiest to get into but rank relatively low on the survival scale. On the other hand,
the businesses that are highest on the survival scale are difficult to get into. These
businesses require special training, licensing, certification or large amounts of initial
start-up capital. An entrepreneur needs to make the judgement and choose wisely!
Read the following article to learn more about start-ups and their chances of growth
and survival.
Birch, D.L., “ The truth about start-ups”, Inc. 10 no.1 (Janurary 1988): 14-15

5. The Paradox of Entrepreneurship

The conclusions on the survival of new ventures also lead us to the paradox of
entrepreneurship. The very businesses that you would like to be in are the hardest to
enter.

How does an entrepreneur start a new venture and obtain a sustainable competitive
advantage?

 First, you must have some sort of edge, such as an asset, a resource, a skill
or a capability. This edge should make it possible for you to enter the market
and block the others. This is where RBV and its emphasis on SCA come in.
Regardless of the general attractiveness of the industry, it may be possible to
find or create and sustain an attractive niche within it, based on some unique
resource combination.
 Second, you need to execute very well because the existing competitors will
be on alert for new entrants. The incumbents can also use retaliatory pricing
or other techniques to make your survival problematic.

Reading: Easy Entry Can Cause Problems

Sara Chambers, founder of Hugger Mugger Yoga Products, started her business
selling Yoga mats, shorts and other equipment. Read the following article and reflect
on the questions given below.
Nicole, G. “ Just Say Om”, Inc. 25 issue 7 (July 2003): 42-43
 Did Sara find it difficult to enter the industry?
 What was the initial customer response to Hugger Mugger products?
 What are the current challenges that Hugger Mugger is facing?
You will learn that Sara found it quite easy to enter this industry because all it
required was some knowledge and interest in yoga. When she stumbled into this
business, not too many Americans knew what yoga was. She was able to grow the
business to US$7.5 million in sales and 40 employees. Now, with a much high level
of customer awareness, many additional entries have made Yoga business highly
competitive. It is tough to figure out how Hugger Mugger will survive in the midst of
competition from the likes of Nike and Reebok.

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Subject Entrepreneurship
Segment Sources of Opportunity
Topic Competitive Analysis

6. Self-Assessment
Now, try the self-assessment questions to test your understanding of the topic. Click
the following link to open the Self-Assessment in a new window.
Self-Assessment
Q1. Which of the following is consistent with an attractive industry?
1. High buyer power, high supplier power
2. High buyer power, low supplier power
3. Low buyer power, high supplier power
4. Low buyer power, low supplier power
Q2. The low-cost strategy occurs when a firm:
1. Concentrates on developing a distinctive product.
2. Has a product identical to that of the competition
3. Has a product that is typically not identical to that of the competition
4. Focuses on a market sub-segment
Q3. Which of the following situation leads to the highest buyer power?
1. Extensive switching costs, high buyer group concentration
2. Extensive switching costs, low buyer group concentration
3. Low switching costs, low buyer group concentration
4. Low switching costs, high buyer group concentration
Q4. Which of the following steps can an organisation take to decrease buyer power?
1. Backward integration
2. Vertical integration
3. Forward integration
4. Differential integration
Q5. Which of the following situations leads to the highest supplier power?
1. High switching costs, several good substitutes
2. Low switching costs, few good substitutes
3. Low switching costs, several good substitutes
4. High switching costs, few good substitutes
Q6. Which of the following is a structural barrier to entry?
1. Price-cutting
2. Legal challenges
3. Access to distribution channels
4. Exit barriers
Q7. Which of the following is an example of a retaliatory barrier?
1. Economies of scale
2. Price-cutting
3. Excess capacity
4. Product differentiation core
Q8. In which of the following situations is price-cutting likely to occur as a means of
retaliation?
1. The product is commodity-like
2. The industry has low fixed costs
3. There is no excess capacity
4. The entry occurs in a high-growth industry
Q9. Which of the following is a determinant of rivalry between firms?
1. Economies of scale
2. Slow industry growth

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Subject Entrepreneurship
Segment Sources of Opportunity
Topic Competitive Analysis

3. Buyer information
4. Access to distribution
Q10. Which of the following steps do suppliers take to exert bargaining power over
an industry?
1. Decreasing the prices charged for products or services
2. Decreasing the quality of products or services
3. Increasing the quality of products or services
4. Providing volume discounts

7. Summary
This topic covered the following points:
 Entrepreneurs must be able to analyse and evaluate the competition and the
industry they are considering entering.
 Industry and competitive analysis will help us answer the questions of
industry attractiveness.
 The Porter (five forces) Model of competitive industry analysis requires that
we consider the power of the buyers, the power of the suppliers, the threat of
substitutes, the threat of the entry barriers and the intensity of rivalry.
 Businesses most likely to survive and prosper are those that are able to enter
an industry with high entry barriers, but have the resources to overcome this
impediment.
 According to RBV, irrespective of the general attractiveness of the industry, it
is the entrepreneur's task to find, or create and protect an attractive market
niche through developing sustainable competitive advantage.
Credits and Disclaimer
Microsoft is a registered trademark of Microsoft Corporation in the United States and/or other countries.
Netscape and Navigator are registered trademarks of Netscape Communications Corporation.
Adapted with the permission of The Free Press, a Division of Simon & Schuster Adult Publishing Group, from
COMPETITIVE ADVANTAGE: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998
by Micheal E. Porter. All rights reserved.

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