Question

Michael Porter has argued that “the intensity of competition in an industry is neither a matter of coincidence nor bad luck. Rather, competition in an industry is rooted in its underlying economic structure.” What does Porter mean by “economic structure”? What factors besides economic structure might be expected to determine the intensity of competition in an industry?

Answer 1

Intense competition in an industry is neither coincidence nor bad luck according to Porter, rather it is rooted in underlying economic factors that may extend beyond established stakeholders in a particular industry. These factors may include Customers, suppliers, potential entrants, and substitute products.
The competition and profit potential in an industry depends on 5 economic forces collectively. These 5 forces together can be termed as 'economic structure' that determine the intensity of competition in an industry. These 5 forces are as follows:
1. Threat of new entrants: Industries giving high returns attract new players which will decrease profitability of existing players. Unless there are bariers to the new entry, return in the industry will fall to the level of normal profit. Such entry bariers may take the form of government policies, legal and regulatory requirements, capital requirements, economies of scale, Brand equity, customer loyalty, overall industry profitability etc. More are the bariers to the entry, less is the competition in the industry.
2. Threat of substitutes: a substitute good is a product or service that a consumer considers same or similar to another product. I.e. a substitute is a good that can be used instead of other good. e.g. beer and wine, automobile and train, landline and mobile phones etc. It may take form of buyer propensity to substitute (Brand loyalty, legal bariers), buyer's switching cost to the substitute, level of product differentiation, number of available substitutes and ease and availibility of substitution; all play an important role in determining the competition in an industry.
3. Bargaining power of customers: bargaining powers of customers is high if they have many alternatives to a product. price elasticity of a product is relevant here. more elastic the dmand, higher is the bargaining power of customer. Other factors affecting buyer's bargaining power may include Buyer concentration to firm concentration ratio, Buyer switching costs, information availability to buyer's, uniqueness of the products in the industry, etc. COmpetition will be high if customer's bargaining power is high.
4. Bargaining power of suppliers: Suppliers of raw materials, components, labor, and services can be important determinant of competition when there are few substitutes. For instance, if you are making bread and there is only one supplier of flour, you have to buy it from him at any price that supplier charges. Bargaining power of supplier may be affected by labour unions, Supplier concentration to firm concentration ratio, Strength of distribution channel, Presence of substitute inputs, Impact of inputs on cost and differentiation etc.
5. Competitive rivalry: It is one of the major determinant of competition in an industry. Level of competition depends upon marketing and pricing strategies of different rival competitors, and reaction to changes in these stratigies by competitor firms. competitive rivalry is influenced by factors such as, Sustainable competitive advantage through innovation, advertising expense, low cost differentiation, etc.
Strength of this economic structure collectively determines the intensity of competition and profitability in an industry in long run. However, there can be other factors that may also influence the level of competition in an industry. These factors may include uncertainty in the market, presence of market structures like oligopoly in an industry, practise of overall customer centricity in the industry etc. For instance, most of the firms today attempt to focus on customer needs and creating value for customers. They try to build customer confidence and establish loyalty through various loyalty programs that incentivise the customer to remain with a particular product. Apart from this, intensity of competition also depends on presence of complement products which leads to strategic alliances in the industry.