- 15 Marks
Question
Michael Porter, in his book “Competitive Advantage: Creating and Sustaining Superior Performance,” suggested that a firm must assess the industry’s market attractiveness by considering the following:
- The extent of the rivalry between existing competitors;
- The bargaining power of suppliers;
- The bargaining power of buyers;
- The threat of substitutes; and
- The threat of new entrants.
Required:
a. Recommend FIVE factors that should be included in the monitoring system implemented by the firm if a firm wishes to monitor the bargaining power of buyers. (5 Marks)
b. Explain FOUR different methods whereby a firm can reduce the threat of new entrants to an industry. (7 Marks)
c. Explain the reason why firms often continue to operate in an industry that is generating below-normal returns in the short run. (3 Marks)
Answer
a. Factors to Monitor the Bargaining Power of Buyers:
To monitor the bargaining power of buyers, the following factors should be considered:
- Buyer Concentration: How many buyers are there, and do a few large buyers dominate the market?
- Switching Costs: The cost for buyers to switch to competing products or services. Low switching costs increase buyer power.
- Price Sensitivity: The degree to which buyers are price-sensitive or willing to pay a premium.
- Product Differentiation: How unique or differentiated the firm’s products are compared to competitors.
- Buyer’s Profitability: Buyers with higher profit margins are less likely to press for price reductions and demand better terms.
b. Methods to Reduce the Threat of New Entrants:
Firms can reduce the threat of new entrants through the following strategies:
- Economies of Scale: Achieve cost advantages by producing on a larger scale, making it difficult for new entrants to compete on price.
- Product Differentiation: Develop strong brand loyalty or unique product features that make it hard for new firms to attract customers.
- Capital Requirements: Increase the initial investment required to enter the industry by raising the costs of capital investment or R&D.
- Access to Distribution Channels: Control or limit access to key distribution channels, making it harder for new entrants to reach customers.
- Government Regulations: Leverage industry-specific regulations or patents to create legal barriers for new entrants.
c. Reasons for Operating in Low-Return Industries:
Firms may continue to operate in industries generating below-normal returns in the short run due to:
- Covering Fixed Costs: As long as the firm can cover its variable costs, it can contribute to fixed costs, minimizing losses.
- Market Share: Maintaining market presence and customer relationships in anticipation of improved future conditions.
- Exit Barriers: High costs associated with exiting the industry, such as contractual obligations or specialized equipment, can prevent firms from shutting down.
- Topic: Strategic Management Accounting
- Series: NOV 2016
- Uploader: Kwame Aikins