The threat of new entrants is determined by the level of barriers in place and how easy it would be for new competitors to enter the market. Substitutes are what may be used in lieu of what your company is offering in that market. The power of buyers and customers identifies what level they have the ability to dictate what price they will pay for your product. The power of suppliers EXPLAINS to what extent they can dictate the price you pay for the product. Finally rivalry within the industry can also be linked to the threat of new entrants, the more new suppliers of your product in the marketplace the more other companies become rivals and price wars can start.
“Understanding the nature and strength of each of the five forces within an industry assists managers in developing the competitive strategy of their organisation” (P134, Business Strategy, Campbell, Stonehouse, Houston)
Porter states that for a company to have long-term profitability it must make a choice between three generic strategies that he has outlined, he argued that there are three fundamental ways in which companies can sustain a competitive advantage, these are as follows:
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A Cost Leadership Strategy, where ‘a firm sets out to be the low-cost producer in it’s industry…a low-cost producer must find and exploit all sources of cost advantage. Low-cost producers typically sell a standard, no-frills product and place considerable emphasis on reaping scale or absolute cost advantages from all sources…If a firm can achieve and sustain overall cost leadership, then it will be an above average performer in it’s industry provided it can command prices at or near the industry average.’
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A differentiation strategy, which Porter defines as seeking ‘to be unique in it’s industry along with some dimensions that are widely valued by buyers…It is rewarded for it’s uniqueness with a premium price…A firm that can achieve and sustain differentiation will be an above average performer in it’s industry if it’s price premium exceeds the costs incurred in being unique…The logic of the differentiation strategy requires that a firm choose attributes in which to differentiate itself that are different from it’s rivals.
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A focus strategy based on ‘the choice of a narrow competitive scope within an industry. The focuser selects a segment or group of segments in the industry and tailors it’s strategy to serving them to the exclusion of others.’ There are two variants here. ‘In cost focus a firm seeks a cost advantage in it’s target segment, while in differentiation focus a firm seeks differentiation in it’s target segment.
(Exploring Corporate Strategy, Johnson & Scholes, 1993)
Case Study
All of the following information is derived from various communications with Nick Gibbons, Strategic Planning Manager for British Gas and is highly sensitive. I trust that it will not be used for anything other than the academic purpose that it is meant for.
British Gas used both SWOT and PEST analysis early on in the process although they were seen to have limited value, as they can be very vague and generic.
SWOT is limited because it only looks at the internal strengths, weaknesses and opportunities and threats. SWOT fails to consider the economical and social trends. The strengths of British Gas were its reputation as the only gas supplier when the market was in a state of monopoly. The weaknesses being the fact that when the market opened up British Gas were tied into long-term contracts with the gas extractors to pay fixed prices for a fixed period of time, making it impossible for us to decrease our prices competitively. The main opportunity of British Gas is diversification, we have gone from being solely a gas supplier to supplying electricity and a telephone service too. The threats affecting British Gas are our competitors; their prices and levels of service can have an impact on our customer turnover.
PEST looks at the economical and social trends, however doesn’t look at strengths and weaknesses. The political aspect of British Gas is that it has previously held a monopoly of its market, this has proved to be an advantage and also a disadvantage at times. As a company, British Gas is set a certain Grade of Service by the industry regulators. This basically ensures that our customers do not have to wait too long before their telephone call is answered, are not left on hold for too long and are not transferred to too many different departments before arriving at the correct one. Our Grade of Service has to be upheld at 90% and we will get fined if we do not meet this target consistently. The economical side of the coin relates to inflation and share prices and how these impact upon the prices we charge. The socio-cultural factor depends on the demographics of the market, for eg, do we need to bring people in from other countries for extra IT support? The technological aspect is probably the most relevant to British Gas at the present time, having just brought in a new IT billing system the impacts of this on the business need to be monitored closely.
More usefully, Porters Five Forces was used, this was in order to see how customer, supplier, competitor, substitute product, and new entrant trends were likely to effect the business and whether these trends were likely to make it more or less profitable in the future.
Lets begin with the effects the customer has on the prices of British Gas. Customer volumes were found to be one of the most significant profit levers so it was important to keep this at an optimum level. The problem we had as a company when devising our pricing policy was that we didn’t have enough understanding of how price changes affected our customers. We needed a deeper level of understanding but there hadn’t been enough price fluctuations in the market to provide this. We didn’t want to raise our prices to the extent that we lost a great degree of our customers yet we didn’t want to remain so cheap that the level of service we provided suffered. We ideally wanted to remain competitive whilst also providing a world class level of customer service. We were unable to predict as to how much the customer would be able to dictate future price changes and this was experience we were looking to build up from making changes to our prices.
British Gas is a supplier of gas and electricity to the general public and businesses, however we also have to be supplied with the raw materials in the first place. When the market was opened up and British Gas no longer held the monopoly on gas supply, we as a company were already tied into some long term contracts with our suppliers where by we would take gas from them at a certain price for a certain period of time. This meant we were unable to be very flexible with our gas prices in the competitive market for a good few years. Our suppliers basically dictated the price that we paid for the product therefore also having a great impact upon the prices that we were able to offer our customers. However the tables were reversed for the supply of electricity, it was the local electricity boards who were tied into the contracts with their suppliers and British Gas were able to offer much cheaper electricity prices along with a guarantee to beat the local supplier in each area on price. As a result of this, we seemed to be losing gas customers and gaining electricity customers as it was cheaper for a while to have your gas supplied by a company who was originally an electricity supplier and have you electricity supplied by British Gas.
The competitors in the same market as British Gas do not have so much of an impact on our prices as one may first think. Of course it is important to be aware of your competitors and their position in the market, however it is more important to ensure that the business runs according to it’s means and as competitively as is possible. A good way to decipher your position in the market is to draw an MECP (Market Economics Competitor Position) chart. On such a chart you would plot the profitability of your competitors and then your own company’s position, you would see how far above/below your competitors you currently stand and your expected position in the future.
Substitute products are not really a big worry in this market as there are few substitutes for gas and electricity. There is solar power, wind power and more closely related LPG (Liquid Petroleum Gas) which comes in canisters which have to be constantly exchanged etc. Oil is also another fuel that is available but rarely used. Simply due to the lack of choice of substitutes and the prohibitive costs and inconvenience of the few that are available it is very unlikely that customers would choose to employ a substitute for either gas or electricity. Therefore it is not essential that British Gas adjust any aspect of their service or their prices to counteract the threat of substitute products, as the threat is minimal.
New Entrants into the energy market can have large short-term affects on our company. This is because new companies will enter the market promising low prices and excellent service to the customers and lots of them will agree to join them resulting in a small decrease in our customer base. We will then retrieve some of these customers through outbound save campaigns where our agents call the customers who are leaving and try to persuade them to rejoin British Gas. Some of the other ex-customers will also choose to return to us when they have a less than optimal experience with the new company. Therefore the damage caused to British Gas through new entrants into the market may not be so drastic as it may first appear. It is also important to remember that the market in which British Gas operates is already quite diverse and the degree of competition already somewhat high. New entrants into this market will increase competitiveness and this is when price wars may begin.
Although the use of Porter’s five forces was a useful exercise in the development of the pricing strategy of British Gas, Porter’s Generic strategies were also extremely fundamental. British Gas’s strategic planning team worked on presenting a forecast of how British Gas would fare for the next five years under the adoption of each strategy. These three scenarios were presented to the managing director, Mark Clare who had the final decision upon which strategy we would adopt.
A Differentiation Strategy was chosen as it was decided that the company was to aim to be unique within its market. We already have a diverse range of products including gas, electricity, telephone services, and a wide range of home service care products and we are looking to diversify even further with the possibility of supplying water even on the horizon. Although this strategy doesn’t ensure the lowest possible prices it does promote customer loyalty and one point of contact for the customer. This strategy supports customer volumes and also price, which are the biggest profit levers we experience as a company. Our customer base is also increasing and we feel this is due to customers becoming more positive about the idea of receiving all the available products from one company.
This strategy proves to have been particularly successful in view of the fact that British gas have since survived three price increases and still manage to hold the spot as leading electricity supplier in the UK.
Bibliography
Exploring Corporate Strategy
Gerry Johnson & Kevan Scholes
Prentice Hall International (UK) Ltd
1993
Business Strategy
David Campbell, George Stonehouse & Bill Houston.
Butterworth-Heinemann
2002
The Business Environment
Ian Worthington & Chris Britton
Pearson Education Ltd
2000
