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Exit Barriers Intensify Competitive Rivalry

Exit barriers intensify competitive rivalry by stopping businesses that are losing money from leaving the industry when there is little or no hope of future profitability.

The Five Forces model  from Michael Porter is an important way to understand the competitive pressures within an industry and at the centre is competitive rivalry.

What Are The Major Exit Barriers?

I’ve split the discussion of exit barriers into two sections for rational barriers backed up with economic logic and emotional barriers which create commitment beyond the level where it makes sense financially.

Rational Exit Barriers

  • Specialised assets – some industries require specialised assets and capabilities which cannot create value in other markets. Assets that can be re-used elsewhere or those that are easily adapted make it easier for a business to move from one market where it is struggling to another where prospects look brighter.
  • Contractual arrangements – the business may have entered into contracts with customers and suppliers where breach of contract creates punitive damages which the business cannot afford. Even if there is nothing in writing, a business may be unwilling to break its commitments because of relationship and reputation damage that could affect other parts of the business or group.
  • Vertical integration with other business units – a group may have a number of subsidiaries connected in the industry value chain. While one may be losing money (although transfer pricing makes it difficult to get a realistic arms-length assessment), damage may be done to the other businesses.

Emotional Exit Barriers

  • The business may come under political or social pressure to keep an important factory unit open because it is a key part of the local economy. Sometimes financial help may be available but more often the business fears damage through bad publicity.
  • The owner or senior managers may have an emotional commitment to the business which makes it unwilling to concede defeat even when the economic justification for exit is compelling. Perhaps the business was where it all began and therefore there are heritage reasons to keep the business going which link into the core story. Perhaps there is loyalty to employees or fear for what it means for their own personal positions.

The Impact Of Barriers To Exit

Whatever the cause of the barriers to exit, the end result is that firms stay in the market when it is better for them and their competitors that they leave in an orderly manner.

It therefore makes sense for the market leader or someone determined to win the “last man standing” strategy in a declining market to help struggling firms to leave and take out the excess capacity.

The worst that can happen is for the business to go bankrupt and to be bought for a song by an ambitious management team with an idea to shake-up the industry with a strategic innovation and the financial backing to make it happen.

More often, the existing management and shareholders find the finance to buy the business back in a pre-pack administration deal, free of the high levels of debt and contingent liabilities that stopped an effective turnaround taking place.  It may lead to a viable business or the industry economics may cause future problems.

in 3 – Your Strategic Positioning

How To Survive A Price War

This article looks at prices wars and in particular, how to survive a price war if you find yourself being dragged into one by competitive rivalry by undifferentiated competitors or a particularly aggressive strategy by one competitor who may be differentiated but whose actions damage the entire market.

This is at the conflict end of the 5 levels of competition.

My Experience Of Price Wars

I have experienced a number of price wars while I was a senior manager in business and seen the effect of others since I’ve been a consultant/coach.

It’s a bloody business.

Each price war has been extremely damaging.

The big lesson I’ve learnt is that the best way to survive a price war is do you best to stop it from starting in the first place.

Unfortunately sometimes, competitors are so stupid and behave so irrationally that a price war is inevitable.

The prolonged financial crisis and recession is increasing pressure on businesses to keep sales high and owners and managers can feel forced into cutting prices to keep their businesses above the survival line.

Why Do Price Wars Start?

Price wars start because:

  • The market is declining and firms are fighting for a larger share of a smaller cake; or
  • One (or more) firms have very aggressive growth objectives
  • Price wars can even start by accident.

Aggressive competitors believe that they can make more money by:

  • Trying to force competitors out of business because they have major cost advantages or can withstand the losses for a longer period. Once competitors leave, the aggressor believes they will have a dominant position in the market which allows them to control prices.
  • They don’t understand how their own cost/volume/profit relationship works and may underestimate the cost of the product or service.T
  • They don’t realise that if they lower prices, their competitors are likely to find out what is happening and respond. All too often strategies are considered in isolation without thinking about how competitors will react.

Price Wars Can Start By Accident

Competitors’ actions are misunderstood.

Perhaps there is a temporary special offer from one competitor to turn slow moving stock into much needed cash which escalates into a series of tit-for-tat price reductions as the other competitors respond to what they perceive as an aggressive action.

Or fluctuations in market demand are not understood and firms think that competitors must be stealing their business. I have written an extensive review of the beer game and how systems thinking can help you interpret fluctuations in demand.

There is also the risk that price wars can start because of manipulation by buyers and fear based naivety of suppliers. A buyer gains by paying a lower price so an unscrupulous buyer can:

  • Exaggerate the offer from a competitor by outright lying – “Smith & Jones have offered us a price of £2.50 per unit when you are charging £3.30” (when their best price is actually £2.95)
  • Mislead by missing out key terms – “Smith & Jones have offered us a price of £2.95 when you are charging £3.30” (but they want us to order and take immediate delivery of 10,000 units – their price for the 1,000 units that you provide us with is £3.35)

There Is Usually No Winner In A Price War

There are often no winners in a price war.

A price war can destroy the profitability of an industry for many years hurting every single competitor. Many industries have found that it is much easier to cut prices than it is to increase them again afterwards.

Even customers may lose out if a product is treated as a price based commodity when there are really valuable differences in either the product or the service. As struggling competitors withdraw from the market, either voluntarily of through bankruptcy and liquidation, customers are left with less choice.

What You Can’t Do To Survive A Price War

You can’t reach an agreement with competitors to fix prices to particular customers.

Cartels are illegal in the European Union, the USA and many other countries.

What You Can Do To Survive A Price War

  • Emphasise the extra quality or service of your offering – don’t allow the customer to that the product or service is a commodity and  that all competitive products are equal so that price is all that matters
  • Remind the customer of the risks in taking a low cost option
  • Create a low cost, lower value alternative product of your own that gives extremely price conscious customers a chance to stay loyal to your business and brand.
  • Work together to take costs out of the transactions. Recognise the difference between saving the customer money and your cutting your prices.
  • Lower prices through a rebate scheme that rewards extra volume and not just promises of extra volume.
  • Re-align your price lists. Supermarkets have low prices on the staple products like bread but make their margin on the extras that people buy. Can you use loss leaders to keep customers who will buy premium priced items out of convenience.
  • Make it difficult to compare prices – e.g. mobile phone tariffs – although makes it difficult to win customers on price as well.

The Risks Of Buying From The Cheapest Competitor

Price is often used as an excuse for changing suppliers but it can be a disguise a service problem or general dissatisfaction with the customer supplier relationship.

Alternatively the customer may take for granted the customer service you provide and believe that is the industry norm when your service and dissatisfaction with that of your competitors wins you business elsewhere.

So make sure that the customer is aware of the risks of buying from a cheaper competitor:

  • What will the customer lose that he takes for granted from you?
  • What short cuts/cost savings must the competitor have made to sell at this price profitability? How will this impact on the customer?
  • Why is the competitor so desperate to get extra business? Is this a last desperate attempt to win enough volume to stave off financial collapse and if that happens, where will that leave the customer.

Communicate By Signalling To Competitors Within The Market

Collusion is illegal and the punishments are high.

But that doesn’t mean that there can’t be some kind of indirect communication with competitors – perhaps with the market in general via the trade press, through customers (although you have to be careful that the true message is passed on) and through trade associations.

It’s what business strategists call signalling – making clear what is happening in the market and what you are doing so that the competitors are better informed and not left to make up their own minds.

Some of this signalling is counter-intuitive but it has to be to fight the idea that “more sales equals more profit”.

If the market is in severe decline, like the housing and car markets at the moment in the UK, it makes it much easier for business owners to understand why their sales volumes are down by 30%.

The market leader needs to make sure that they are not caught up in a bravado exercise for their own public relations – the industry is down a long way but we are selling more. That kind of statement signals to competitors that their volume is being “stolen”.

The same education is needed to explain the impact of the Beer Game and how de-stocking along the supply change exaggerates the impact of demand changes at the other end.

And if you are having a sale to sell off excess stocks, signal the fact that the sale is limited in quantity and duration. It may cause competitors some short term pain but it won’t last long.

If there is a danger of a price war, the trade can be educated on the dangers of cutting price and the devastating effect on profit of just moving the purchase volumes around.

The aim of effective signalling is to stop the price war happening.

The Signals Of An Aggressive Competitor

Sometimes a competitor will signal an aggressive move. “It is our intention to grow market share to 40% and we will do whatever is necessary to get it there.”

This type of signal gives competitors a problem and a price war may be inevitable.

There are some key questions to ask?

  • Is the threat credible? Does the competitor have the financial muscle to back up the intention?
  • Will the expansion stop at 40% or will it then be 50%, then 60%…?

You need to reach a decision.

In fact it’s the classic survival decision of fight or flight.

If you are going to have to fight, it  may be better to fight the battle early.

What will it take to stop the competitor and is the fight worthwhile or should the business withdraw from the market?

It is better to withdraw early than suffer huge losses and being forced out.

Disciplining The Aggressor In A Price War

Some price wars are fought in public and in full view of all the market participants.

The market trader selling vegetables knows when his competitor has cut prices and can react immediately. The other party sees the reaction and has a choice of cutting price again, matching the price or increasing the price hoping the competitor will follow again.

Other price wars are in private.

The first the incumbent supplier may know that an aggressor is taking action is when the orders stop or a phone call comes in asking for a new competitive quote.

The choice is to match the lower price or to hold. Keep the business at a lower price, then your competitor has not gained but you have lost profit – and the customer may now be very marginal.

But do you leave it there, or should you try to rap the competitor across the knuckles?

It’s another signalling issue.

If you know the industry well, you can go to your competitors customers – not all of them but enough to get the point across – and either

  • Submit a lower price yourself and threaten the established competitor’s volume.
  • Discover the prices offered by your competitor and make their customers aware that the firm is aggressively offering new customers deals which may be far better than given to existing customers.

It’s one thing to try to increase profit by getting extra profit by winning your competitors customers on price but it is another to see the profit on the established business damaged.

What Are Your Thoughts On Price Wars?

Have you found yourself caught in a price war?

What happened and how did you get out of it? Which of the tactics to survive a price war mentioned above do you think could have helped you?

Let me know by leaving a comment?

in 3 – Your Strategic Positioning, Business Problems And Mistakes

When you are thinking about business strategy it is important to focus on the business competition and the different levels of competitions. The 5 C”s Model of Competition is a very useful framework for assessing the level of competitive intensity in your market and thinking about the opportunities and threats that competition presents.

It is easy to take competition for granted and not to recognise the subtle different forms that exist. I know from my experience with price wars, your actions can influence your competitors for better or worse, intentionally or unintentionally.

What is Business Competition?

According to Wikipedia competition is

“a contest between individuals, groups, animals, etc. for territory, a niche, or a location of resources.”

The Five Levels of Business Competition

The Five C’s of Competition are:

  • Collusion
  • Co-operation
  • Coexistence
  • Competition
  • Conflict

Level 1 Collusion

Collusion is when competitors work together to control the market supply and price by forming cartels or coming to an arrangement to fix prices.

Collusion is illegal in many countries including the UK, European Union and USA. Don’t go there. If found guilty of price fixing, penalties are harsh. The airline industry has been found guilty of conspiring together in a number of cases.

Level 2 Co-opetition

In co-opetition, competitors cooperate and work together in alliances and joint ventures but not in ways that distort the price customers pay.

The motor industry has seen companies to work together to develop new engines which gives each participant the chance to benefit from sharing costs for research and development while providing economies of scale and experience in the manufacturing stage.

There is a famous book Co-opetition that looks at how competitors can work together whilst still competing using a game theory perspective.

Level 3 Co-existence

In coexistence, competitors don’t have a formal agreement but recognise each other’s position in the market and don’t try to compete aggressively.

A simple example would be if two chains of discount shoe stores compete in the same general geographic area. Each could have a policy that it will open new stores in towns with a  population of 20,000 or more but won’t open a competing store unless the population is over 100,000. The logic is that it is better to have a few highly profitable stores than many stores that struggle to break even.

This coexistence strategy recognises that competition can be a zero-sum game where if one wins, the other loses.

It is one of the reasons why the idea of finding a special niche can work so well. Once you establish “ownership” of a strategic position in the market, any competitor will recognise that you are established and has a simple choice:

  • to ignore the niche; or
  • to challenge you in the niche with all the dangers of a frontal aggressive strategy, going up against your existing strengths.

No formal agreement is required for the co-existence level of competition to exist between competitors and to be stable. It is just common sense based around plentiful opportunities for making money.

The strategic threat is if profit opportunities dry up and one or more competitors are committed to further growth.

Level 4 “Competition”

This is the normal situation as businesses compete head to head for customers.

Prices are kept in check by the other competitors but everyone behaves sensibly, recognising that a price war is bad for the long term profit prospects in the entire industry.

Level 5 Conflict

In conflict, competitors fight toe to toe and slug it out for any and all customers with a combination of offensive strategies and defensive strategies.

The aim has moved to making short terms profits to hurting the competition and potentially either permanent weakening them or even driving them out of business.

Price is often the common weapon but mass marketing campaigns, product bonuses and higher levels of service can all be used to slug it out.

But just like collusion, conflict can be illegal.

While customers benefit from lower prices, predatory pricing is deemed anti-competitive. While legal definitions of just what predatory pricing vary – and can be difficult to prove – think of it as selling at a price below the variable cost of production.

Five Levels of Business Competition Model

So there we have the five levels of business competition – collusion, co-opetition, coexistence, competition and conflict.

Can you use these ideas and make money by thinking more carefully about your competition and how your competitive rivalry helps or hinders your search for profit?

A mistake I see too often is that businesses plan for growth but don’t take their competition and how they are likely to react into account. It’s therefore no surprise that this superficial level of strategic thinking and planning doesn’t prepare the business for long term success.

Michael Porter and Competitive Rivalry

The Five Forces model created by Michael Porter is a very useful way to look at industry analysis.

At its core is the rivalry among existing firms which creates its own profits to compete away profits but its effects are exaggerated by the other forces. His book Competitive Strategy is an important read if you want a deeper understanding of business competition.

What Do You Think About The Five Levels of Competition?

As always I am eager to read what you think about the different levels of competition.

Do you have stories about how you have co-operated with a competitor in an alliance to create value for customers that you couldn’t on your own?

Have you been caught in a competitive conflict? I have and I’ve seen profits fall at an alarming rate as prices plummeted – each of us convinced that the other person started it that our reactions were just defending our turf. I’ve even worked for one side of a price war (as a senior manager) and later worked as a consultant in the major competitor.

in 3 – Your Strategic Positioning

Competitive Rivalry : The Most Powerful Of The Five Forces?

I’m ending my look at Michael Porter’s Five Forces Analysis with a look at competitive rivalry, perhaps the most powerful and destructive of the five forces as competitors carelessly compete away any profits and even create price wars that cause long term damage to industry profitability.

Competitive Rivalry Or Rivalry Amongst Existing Firms

Michael Porter introduced the Five Forces model in his book Competitive Strategy and it has since become the standard way to examine the existing industry structure and how it might change in the foreseeable future.

It’s not a coincidence that Michael Porter placed competitive rivalry in the centre of his famous Five Forces diagram.

The 5 Levels of Competition

It’s easy to falls into the trap of thinking that all competition is bad but without competitors, you’ve got no one to look good against. It’s been established that it is easier to make a decision between A and B because the brain can compare and contrast than it is to decide to buy A on its own.

I recently wrote about the 5 Levels Of Business Competition which is an important framework for assessing the intensity of competitive rivalry and what you can do to move it in the right direction.

The Symptoms of Competitive Rivalry

Competitive rivalry become intense when one or more competitors either sees an opportunity to grow and acquire the customers of competitors or feels the need to attract more customers because of low profitability.

Industries where competitive rivalry is a major issue will usually have many competitors who are struggling to make an adequate return on investment so profitability will generally be low. A few competitors – those that have established competitive advantage – will make a treasonable profit but more many, intense competitive rivalry means a fight to break even and generate enough cash to survive.

Competitive rivalry intensifies through retaliation as competitors react to aggressive strategies with their own aggressive or defensive strategies.

This rivalry often comes through in terms of lower prices, as competitors use marginal costing to justify a contribution to overheads. However, competitive rivalry can also come through in advertising, product introductions and customer service battles.

Much of the competitive rivalry is damaging to long term profitability in the industry since it raises customer expectations of value for money although advertising can expand the market or establish differentiation through branding.

Richard D’Aveni came up with the term hypercompetition to describe situations where rivals fight hard against each other. The danger is that the firms head toward the model economists call perfect competition.

The Factors That Determine Competitive Rivalry

Competitive rivalry arises from a number of factors that work together to either give competing firms an incentive to try to break ranks or a vulnerability to the other Five Forces.

Moving from the growth to the maturity stage of the product life cycle and then into decline can increase rivalry. In the growth stage, firms get used to the business growing as more customers come into the market. However new demand eventually reaches saturation point and replacement demand isn’t sufficient to continue to provide growth opportunities. Firms will therefore look to grow through taking existing customers away from competitors.

It gets worse if the industry moves into the decline stage of the product life cycle or if the wider economy goes into recession, especially if the industry is cyclical and exaggerates the effect. Competitors will see their own sales volumes go down and in the absence of industry-wide  information, assume that their rivals are cutting prices.

High fixed costs, low variable costs and low capacity utilisation provide the economic rationale for trying to increase market share because a small increment of extra volume has a disproportionate effect on profitability. Unfortunately the reverse is also true, lost volumes in this situation has a significant downward impact on competitors’ profitability making a response the natural reaction. Price wars can develop very quickly and especially if competitors are manipulated by big customers into believing short term offers are bigger and more long term than they really are.

Competitive rivalry increases with commodity products and reduces if there is effective differentiation or switching costs. Customers have an incentive to stay loyal rather than shop around for the lowest prices.

Competitive rivalry is also a function of the competitors in the market. The most orderly markets tend to be where one has established a clear leadership position and the others are tucked in behind, taking advantage of the price umbrella established by the leader. These firms can coexist if they know their place in the market and stick to it.

However, if two or more firms are competing for market leadership and market share offers economies of scale and experience curve savings (see the Competitive Advantage matrix) then rivalry intensifies. It gets worse if competitors don’t understand each other and find it difficult to interpret the intentions of each other because of different goals. Competitors from different countries and cultures can make the existing firms particularly sensitive because of fears over low-cost competition.

Competition makes it difficult for the weak firms to make a profit. It’s therefore important that the loss-making firms can exit the market easily. If there are high exit barriers, then competition increases in a desperate fight for survival.

Using The Generic Strategies To Defend Against The Damage Done By Competitive Rivalry

Michael Porter’s generic strategies offer a way out of the worst damage from competitive rivalry.

If the business is differentiated, then it effectively creates its own private market, insulated to some extent from what’s happening in the wider market. The business can’t be complacent because big changes will cause the customer value line to shift, making established positions uncompetitive without a response to improve customer value or reduce price.

If the business genuinely has a substantial cost advantage, it can afford to sell at prices that will make its competitors weep. A strong short term argument can be made for pricing based on marginal costs with its contribution to overheads but it makes no sense for any competitor to go below marginal cost unless it is desperate for cash to stave off imminent bankruptcy.

It is the businesses that are stuck in the middle that have the most strategic threat if rivalry increases.

Other Articles On The Five Forces

Michael Porter has developed the standard way to look at industry analysis with the Five Forces model.

If you are new to it and you want to understand how the forces interact, you should read the other articles:

Five Forces Analysis

Barriers To Entry & The Threat Of New Entrants

Bargaining Power Of Buyers

Bargaining Power Of Suppliers

Threat of Substitutes

Have You Experienced The Damage Done By Intense Competitive Rivalry?

Has your business been caught in a price war or other competitive battle which seriously eroded profits. I’d like to hear the story so please leave a comment.

I’ve seen several.

The first was a company I worked for when the recession of 1990/91 was the trigger to shift us from co-existence to conflict. WE were caught in the classic profit squeeze of falling sales volumes, price cuts and lower productivity as the hourly paid workers tried to stretch their work out to fill the week. Profits fell from £100k or more a month to a £30k loss in three months and whilst the business was restored to profit, margins never returned to the old levels.

The second was a client I started working with after the damage was done. They couldn’t understand why their accounts showed losses every month but investigation into their price changes showed that competitive rivalry from the main competitor changing its value chain by outsourcing inefficient operations had forced them to slash prices beyond a level that was sensibly economically.

in 3 – Your Strategic Positioning

What Are You Doing On Saturday Night?

It’s the weekend.

It’s good to do something special and especially if you don’t have to get up early on Sunday morning.

So what are you going to do?

  • Go to the theatre
  • The cinema
  • A concert
  • A disco
  • A meal at the nice Italian restaurant short walk away from where you live
  • Or collapse in front of the TV with a Chinese takeaway and a DVD from Blockbuster

The point I’m making is that these are all solutions to the “what shall we do on Saturday night” question but the disco probably doesn’t see itself as a competitor to the Italian restaurant.

But you, the customer, do.

Each has its attractions and drawbacks and the TV and takeaway may often win on an regular Saturday night.

But what if we change the situation.

Let’s forget about a normal Saturday night and think about what to do for dinner on your wife’s birthday – and you know she loves Italian food.

Your local Italian restaurant may still be in the race but new competitors emerge – all the respectable Italian restaurants in your local area are possibles. In fact, because you want it to be a special occasion, your local Italian may be at a severe disadvantage because you go there so regularly.

Now you want something special. Something to be remembered.

Will it be the Michelin starred restaurant or the place that reminds you both of a little trattoria you went to in Venice on your honeymoon?

Probably the second because it’s more romantic.

Competitors for your money vary depending on what’s known as your “use-situation”.

A typical Saturday night is very different from your wife’s birthday.

So too is choosing a restaurant to entertain an important client who thinks of himself as a gourmet and likes Italian food. This time the Michelin starred restaurant is an obvious choice.

You can be too static in your thinking about who your competitors are and what are likely to be the order winning criteria.

I recommend you think about the use situations you want to attract people from – it will change your thinking about what you need to do to attract clients away from your most serious competitors.

This changing competitors concept is one that Shiv Mathur and Alfred Kenyon refer to as a private market.

Just because A competes with B and B competes with C, doesn’t mean that A competes with C.

If we stay with the restaurant example, let’s assume that you’re prepared to travel 15 miles to go to a good restaurant.

Imagine looking at a map and drawing a radius around where you are. You’ll pick up a range of restaurants you could go to.

But if you move house, and move 10 miles away, the circle is different. It includes some old restaurants and some new ones.

in 3 – Your Strategic Positioning