Analysing the external environment to assess opportunities and threats: the competitive environment

Welcome to Your Guide on the Competitive Environment!

Hi there! In this chapter, we are going to dive into how businesses look at the world around them to spot opportunities and stay away from threats. Specifically, we are looking at the competitive environment. This is a crucial part of the "Analysing the strategic position of a business" section of your AQA A Level course.

Think of this like a sports coach studying the opposing teams before a big game. You need to know who is strong, who is weak, and what might happen next so you can pick the best strategy to win. Let’s get started!

What is Porter's Five Forces?

In 1979, a professor named Michael Porter decided that just looking at direct competitors wasn't enough. He created a framework called Porter's Five Forces to help businesses understand how much "power" they actually have in their industry.

The Main Goal: To determine how profitable an industry is. If the forces are strong, profits go down. If the forces are weak, there is a better chance for high profits!

Memory Aid: B.E.S.S.R.
To remember the five forces, think of B.E.S.S.R. (like a "better" way to see competition):
1. Buyer Power
2. Entry Threat (New Entrants)
3. Substitute Threat
4. Supplier Power
5. Rivalry amongst existing firms

Analogy: Imagine you are opening a lemonade stand. It's not just about the kid next door selling juice. It's about how much the lemons cost (Suppliers), if people can just drink water instead (Substitutes), if customers can demand a lower price (Buyers), and how easy it is for five more kids to open stands (New Entrants).

Force 1: Threat of New Entrants (Entry Threat)

This force looks at how easy (or hard) it is for a new business to start up in your industry. If it’s easy, you’ll constantly have new people trying to steal your customers.

Businesses try to create Barriers to Entry to keep people out. These include:
- Economies of Scale: Big companies like Amazon can do things so cheaply that a small startup can't compete on price.
- Brand Loyalty: People love Apple so much they might not even look at a new phone brand.
- Capital Requirements: It costs billions to start a car company, but very little to start a dog-walking business.
- Patents: Legal protection that stops others from copying your invention.

Key Takeaway: High barriers to entry = Lower threat = Higher potential profit for those already inside.

Force 2: Bargaining Power of Suppliers

This is about the businesses you buy your materials from. If there are only a few suppliers, they have the power to raise prices, which hurts your profit.

Supplier power is HIGH when:
- There are only one or two suppliers (e.g., if you make PCs, you almost have to buy processors from Intel or AMD).
- It is expensive to switch to a different supplier (Switching Costs).
- The supplier's product is unique.

Quick Review: If your supplier raises their price and you can't go anywhere else, your costs go up and your profit goes down!

Force 3: Bargaining Power of Buyers

The "Buyer" is your customer. In some industries, the customer has all the power to demand lower prices or better quality.

Buyer power is HIGH when:
- There are many small businesses selling to one or two massive customers (e.g., small farmers selling to giant supermarkets like Tesco).
- The product is a "commodity" (it's the same everywhere, like milk or petrol), so the customer just picks the cheapest one.
- It’s easy for the customer to switch to a rival.

Don't worry if this seems tricky: Just remember that "Buyer Power" means "Customer Power." If the customer can walk away easily, they have the power.

Force 4: Threat of Substitutes

Common Mistake Alert! Students often confuse substitutes with competitors. A competitor for Burger King is McDonald's. A substitute for Burger King is a salad from a grocery store or a home-cooked meal. It's a different product that does the same job (feeding you).

The threat is high when:
- There is a cheaper alternative that works just as well.
- Technology changes (e.g., Netflix was a substitute that eventually destroyed DVD rental shops like Blockbuster).

Force 5: Intensity of Rivalry

This is the "classic" competition—how hard are the existing businesses fighting each other?

Rivalry is intense when:
- There are many businesses of similar size.
- The market is not growing (the only way to get a new customer is to steal one from a rival).
- Exit Barriers are high (it's too expensive to close down, so everyone stays and fights for survival).

How and Why These Forces Change

The competitive environment isn't static; it's always shifting!
- Technological Change: The internet made "Entry Threats" higher for retail because anyone can start a shop from their bedroom.
- Economic Change: In a recession, "Buyer Power" increases because customers are more careful with their money.
- Social Change: More people wanting vegan food creates a "Substitute Threat" for traditional meat companies.

Did you know? Michael Porter’s model is used by almost every major CEO to decide which industries are worth entering. If all five forces are "High," it’s often called a "dead" industry where no one makes money.

Implications for Strategic and Functional Decision Making

So, why does a business care about these forces? It helps them make decisions!
1. Pricing Decisions: If Buyer Power is high, the business must keep prices low to stay competitive.
2. Product Development: If Substitute Threats are high, a business might spend more on R&D to make their product more unique.
3. Marketing: If Rivalry is high, a business might spend millions on advertising to build Brand Loyalty (a barrier to entry).
4. Operational Decisions: If Supplier Power is high, a business might try to buy out its supplier (Vertical Integration) to gain control.

Profitability Summary:
Strong Forces = High Costs/Low Prices = Lower Profits
Weak Forces = Low Costs/High Prices = Higher Profits

Quick Review: Common Pitfalls to Avoid

- Confusing Buyers and Suppliers: Always ask: "Who is the business paying?" (Supplier) and "Who is paying the business?" (Buyer).
- Ignoring Substitutes: Don't just look at direct rivals. Think outside the box (e.g., Zoom is a substitute for business travel).
- Thinking "High" is always good: In this model, "High" forces are usually bad for the business's profit!

Key Takeaways for Your Exam

- Porter's Five Forces is a tool to assess the attractiveness and profitability of an industry.
- Barriers to Entry are the "walls" that protect a business from new competition.
- Businesses use this analysis to choose their strategy (e.g., should we compete on price or be different?).
- External factors like technology and the economy can change the strength of these forces at any time.