Evaluating a Firm's External Environment - Illinois State University

M02_BARN4586_03_SE_C02.qxd 7/1/09 7:34 AM Page 47
Chapter 2: Evaluating a Firm’s External Environment 47
Third, buyers are likely to be more of a threat when the supplies they purchase
are a significant portion of the costs of their final products. In this context,
buyers are likely to be very concerned about the costs of their supplies and constantly
on the lookout for cheaper alternatives. For example, in the canned food
industry, the cost of the can itself can constitute up to 40 percent of a product’s
final price. Not surprisingly, firms such as Campbell Soup Company are very concerned
about keeping the price of the cans they purchase as low as possible. 35
Fourth, buyers are likely to be more of a threat when they are not earning significant
economic profits. In these circumstances, buyers are likely to be very sensitive
to costs and insist on the lowest possible cost and the highest possible quality
from suppliers. This effect can be exacerbated when the profits suppliers earn
are greater than the profits buyers earn. In this setting, a buyer would have a
strong incentive to enter into its supplier’s business to capture some of the economic
profits being earned by the supplier. This strategy of backward vertical
integration is discussed in more detail in Chapter 6.
Finally, buyers are more of a threat to firms in an industry when they have
the ability to vertically integrate backward. In this case, buyers become both buyers
and rivals and lock in a certain percentage of an industry’s sales. The extent to
which buyers represent a threat to vertically integrate, in turn, depends on the
barriers to entry that are not in place in an industry. If there are significant barriers
to entry, buyers may not be able to engage in backward vertical integration, and
their threat to firms is reduced.
The Five Forces Model and Average Industry Performance
The five forces model has three important implications for managers seeking to
choose and implement strategies. First, this model describes the most common
sources of local environmental threat in industries. These are the threat of entry,
the threat of rivalry, the threat of substitutes, the threat of suppliers, and the threat
of buyers. Second, this model can be used to characterize the overall level of threat
in an industry. Finally, because the overall level of threat in an industry is, according
to S-C-P logic, related to the average level of performance of a firm in an
industry, the five forces model can also be used to anticipate the average level of
performance of firms in an industry.
Of course, it will rarely be the case that all five forces in an industry will be
equally threatening at the same time. This can sometimes complicate the anticipation
of the average level of firm performance in an industry. Consider, for example,
the four industries in Table 2.6. It is easy to anticipate the average level of performance
of firms in the first two industries: In Industry I, this performance will be
Industry I Industry II Industry III Industry IV
Threat of entry High Low High Low
Threat of rivalry High Low Low High
Threat of substitutes High Low High Low
Threat of powerful suppliers High Low Low High
Threat of powerful buyers High Low High Low
Expected average firm
performance
Low High Mixed Mixed
TABLE 2.6 Estimating the
Level of Average Performance in
an Industry