Evaluating a Firm's External Environment - Illinois State University

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M02_BARN4586_03_SE_C02.qxd 7/1/09 7:34 AM Page 37 Chapter 2: Evaluating a Firm’s External Environment 37 The relationship between the five forces framework and the S-C-P model turns on the relationship between the threats identified in the framework and the nature of competition in an industry. When all five threats are very high, competition in an industry begins to approach what economists call perfect competition. When all five threats are very low, competition in an industry begins to approach what economists call a monopoly. Between perfect competition and monopoly, economists have identified two other types of competition in an industry—monopolistic competition and oligopoly—where the five threats identified in the framework are moderately high. These four types of competition, and the expected performance of firms in these different industries, are summarized in the table below. Industries are perfectly competitive when there are large numbers of competing firms, the products being sold are homogeneous with respect to cost and product attributes, and entry and exit costs are very low. An example of a perfectly competitive industry is the spot market for crude oil. Firms Strategy in Depth The Five Forces Framework and the S-C-P Model in perfectly competitive industries can expect to earn only competitive parity. In monopolistically competitive industries, there are large numbers of competing firms and low-cost entry into and exit from the industry. However, unlike the case of perfect competition, products in these industries are not homogeneous with respect to costs or product attributes. Examples of monopolistically competitive industries include toothpaste, shampoo, golf balls, and automobiles. Firms in such industries can earn competitive advantages. Oligopolies are characterized by a small number of competing firms, by homogeneous products, and by high entry and exit costs. Examples of oligopolistic industries include the U.S. automobile and steel industries in the 1950s and the U.S. breakfast cereal market today. Currently, the top four producers of breakfast cereal account for about 90 percent of the breakfast cereal sold in the United States. Firms in such industries can earn competitive advantages. Finally, monopolistic industries consist of only a single firm. Entry into this type of industry is very costly. There are few examples of purely monopolistic industries. Historically, for example, the U.S. Post Office had a monopoly on home mail delivery. However, this monopoly has been challenged in small-package delivery by FedEx, larger-package delivery by UPS, and in mail delivery by e-mail. Monopolists can generate competitive advantages—although they are sometimes managed very inefficiently. Source: J. Barney (2007). Gaining and sustaining competitive advantage, 3rd ed. Upper Saddle River, NJ: Pearson Higher Education. Types of Competition and Expected Firm Performance Type of Competition Attributes Examples Expected Firm Performance Perfect competition Large number of firms Stock market Competitive parity Homogeneous products Crude oil Low-cost entry and exit Monopolistic Large number of firms Toothpaste Competitive advantage competition Heterogeneous products Shampoo Low-cost entry and exit Golf balls Automobiles Oligopoly Small number of firms U.S. steel and autos in the 1950s Competitive advantage Homogenous products U.S. breakfast cereal Costly entry and exit Monopoly One firm Home mail delivery Competitive advantage Costly entry
M02_BARN4586_03_SE_C02.qxd 7/1/09 7:34 AM Page 38 38 Part 1: The Tools of Strategic Analysis TABLE 2.1 Barriers to Entry into an Industry 1. Economies of scale 2. Product differentiation 3. Cost advantages independent of scale 4. Government regulation of entry greater than the potential profits a new entrant could obtain by entering, then entry will not be forthcoming, and new entrants are not a threat to incumbent firms. However, if the cost of entry is lower than the return from entry, entry will occur until the profits derived from entry are less than the costs of entry. The threat of entry depends on the cost of entry, and the cost of entry, in turn, depends on the existence and “height” of barriers to entry. Barriers to entry are attributes of an industry’s structure that increase the cost of entry. The greater the cost of entry, the greater the height of these barriers. When there are significant barriers to entry, potential entrants will not enter into an industry even if incumbent firms are earning competitive advantages. Four important barriers to entry have been identified in the S-C-P and strategy literatures. These four barriers, listed in Table 2.1, are (1) economies of scale, (2) product differentiation, (3) cost advantages independent of scale, and (4) government regulation of entry. 14 Economies of Scale as a Barrier to Entry Economies of scale exist in an industry when a firm’s costs fall as a function of its volume of production. Diseconomies of scale exist when a firm’s costs rise as a function of its volume of production. The relationship among economies of scale, diseconomies of scale, and a firm’s volume of production is summarized in Figure 2.4. As a firm’s volume of production increases, its costs begin to fall. This is a manifestation of economies of scale. However, at some point a firm’s volume of production becomes too large and its costs begin to rise. This is a manifestation of diseconomies of scale. For economies of scale to act as a barrier to entry, the relationship between the volume of production and firm costs must have the shape of Figure 2.4 Economies of Scale and the Cost of Production $ Per Unit Cost of Production Low X Volume of Production High
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Evaluating a Firm's External Environment - Illinois State University

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