CHAPTER 7: COMPETITIVE FORCES CAF 6: MFA

1. COMPETITION AND MARKETS

1.1 Customers and markets
A market is a place where buying and selling takes place. A market can be defined in different ways.
▪ Product market – It can be defined by the products or services that are sold, such as the fashion clothes
market, the banking market or the market for air travel.
▪ Customer market – It can be defined by the customers or potential customers for products or services,
such as the consumer market or the ‘youth market’.
▪ Geographical market – Customer markets might also be defined by geographical area, such as the
North American market or European market.
Markets can be global or localised.

1.2 Industries and sectors

An industry consists of suppliers who produce similar goods and services. For example, there is an aerospace
industry, an automobile manufacturing industry, a construction industry, a travel industry, a leisure industry, an
insurance industry, and so on.
Within an industry, there may be different segments. An industry segment is a separately-identifiable part of a
larger industry. For example, the automobile industry can be divided into segments for the assembly of
automobiles and the manufacture of parts. Similarly, the insurance industry has several sectors, including
general insurance, life assurance and pensions.
Companies need to make strategic decisions about:
the industry and industrial segment (or segments) they intend to operate in, and
the market or markets in which they will sell their goods or services.
A distinction should be made between products and markets.
Companies in different industries might sell their goods or services to the same market.
Example:
Customer Company 1 Company 2
Individuals who want Building companies (who sell their Retailers of do-it-yourself tools
minor construction and services for minor construction and other products (which enable
maintenance work in and maintenance work such as home-owners to perform those
their houses repairs and decorating in people’s minor construction and
private homes) maintenance jobs themselves).
Customer Company 1 Company 2
Individuals who need Laundry service providers Manufacturers of domestic
their clothes washed washing machines.

Companies in the same industry might not compete because they operate in different markets.
Example:
Customer Company 1 Company 2
Soft drinks consumers Highlands drinks sell their soft- Gourmet sell their soft-drinks in
drinks in African market Pakistan
Customer Company 1 Company 2
travelers Ferry companies operating Ferry companies operating
passenger services between the UK passenger services between the
and France Greek islands

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Generic types of industry

Porter suggested that there are five generic types of industry. The strategic position of a company depends to
some extent on the type of industry it is operating in. The five industry types are as follows:
Fragmented industries. In a fragmented industry, firms are small and each sells to a small portion of
the total market. Examples are dry cleaning services, hairdressing services, and shoe repairs.
Emerging industries. These are industries that have only just started to develop, and are likely to
become much bigger and much more significant in the future. Examples are the global space travel
industry and the telecommunication industry in Africa.
Mature industries. These are industries where products have reached the mature phase of their life
cycle. (The product life cycle is described later.) Examples are automobile manufacture and soft drinks
manufacture.
Declining industries. These are industries that are going into decline: total sales are falling and the
number of competitors in the market is also falling. An example in coal mining in Europe.
Global industries. Some industries operate on a global scale, such as the microprocessor industry and
the professional football industry.

1.3 Convergence
Occasionally, two or more industries or industrial segments converge, and become part of the same industry,
with the same customer markets. When convergence is happening, or might happen in the future, this can have
a major impact on business strategy.
▪ Demand led convergence – With demand-led convergence, the pressure for industry convergence comes
from customers. Customers begin to think of two or more products as interchangeable or closely
complementary.
▪ Supply led convergence – With supply-led convergence, suppliers see a link between different industries and
decide to bridge the gap between the industries. The convergence of the entertainment, voice
communication and data communication industries, discussed in the previous example, is probably supply-
led, because suppliers became aware of the technological possibilities before consumers became aware of the
convenience.
Example:
PTCL has now merged television broadcasting, telephone services and internet services all of which once used to
be separate industries.

2. INDUSTRY COMPETITION – PORTER FIVE FORCES MODEL

Analysing competition is an important part of strategic position analysis.
It is also important to assess the strength of competition in a market, and try to understand what makes the
competition weak or strong.
A company should also monitor each of its major competitors, because in order to obtain a competitive
advantage, it is essential to know about what competitors are doing.
Lecturer’s note for students:
▪ Understand whole discussion from the point of view of existing companies (i.e. competitors) in market.
▪ Summary of porter model:

Competitor’s fear Competition in market Profits

High High Low
Low Low High

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Porter’s Five Forces model provides a framework for analysing the strength of competition in a market. It is not a
model for analysing individual competitors, or even what differentiates the performance of different firms in
the same market. In other words, it is not used to assess why some firms perform better than others.
In addition, the Five Forces model can be used to explain why some industries are more profitable than others,
so that companies operating in one industry are able to make bigger profits than companies operating in another
industry.
Profitability is affected by the strength of competition: the stronger the competition, the lower the profits.
Porters’ five forces are:
1. threats from potential entrants
2. threats from substitute products or services
3. the bargaining power of suppliers
4. the bargaining power of customers
5. competitive rivalry within the industry or market.

When competition in an industry or market is strong, firms must supply their products or services at a
competitive price, and cannot charge excessive prices and make ‘supernormal’ profits. If they do not charge the
lowest prices, firms must compete by offering products that provide extra value to customers, such as higher
quality or faster delivery.
When any of the five forces are strong, competition in the market is likely to be strong and profitability will
therefore be low. Analysing the five forces in a market might therefore help strategic managers to choose the
markets and industries for their firm to operate in.

2.1 Threat from potential entrants

One of the Five Forces is the threat that new competitors will enter the market and add to the competition. New
entrants might be attracted by the high profits earned by existing competitors into the market, or by the potential
for making high profits. When they enter the market, new entrants will try to establish a share of the market that
is large enough to be profitable. One way of gaining market share would be to compete on price and charge lower
prices than existing competitors.
The significance of this threat depends on how easy or how difficult it would be for new competitors to enter
the market. In some markets, the cost of entering a new market can be high, with new entrants having to invest
in assets and establish production facilities and distribution facilities. In other markets, the cost of entering the
market can be fairly low.
The costs and practical difficulties of entering a market are called ‘barriers to entry’.
When barriers to entry are low. If new entrants are able to come into the market without much
difficulty, firms already in the market are likely to keep prices low and to meet customer needs as effectively
as possible. As a result, competition in the market will be strong and there will be no opportunities for high
profit margins.
When barriers to entry are high. When it is difficult for new competitors to enter a market, existing
competitors are under less pressure to cut their costs and sell their products at low prices. As a result,
competition in the market will be weak.

Entry barriers
A number of factors might help to create high barriers to entry:
a) Economies of scale. Economies of scale are reductions in average costs that are achieved by producing and
selling an item in larger quantities. In an industry where economies of scale are large, and the biggest firms can
achieve substantially lower costs than smaller producers, it is much more difficult for a new firm to enter the
market. This is because it will not be big enough at first to achieve the economies of scale, and its average
costs will therefore be higher than those of the existing large-scale producers.

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b) Capital investment requirements. If a new entrant to the market will have to make a large investment in
assets, this will act as a barrier to entry, and deter firms from entering the market when they do not want the
investment risk.
c) Access to distribution channels. In some markets, there are only a limited number of distribution outlets
or distribution channels. If a new entrant will have difficulty in gaining access to any of these distribution
channels, the barriers to entry will be high.
d) Time to become established. In industries where customers attach great importance to branding, such as the
fashion industry, it can take a long time for a new entrant to become well established in the market. When it takes
time to become established, the costs of entry are high.
e) Know-how. This can be time-consuming and expensive for a new entrant to acquire
f) Switching costs. Switching costs are the costs that a buyer has to incur in switching from one supplier to a
new supplier. In some industries, switching costs might be high. For example, the costs for a company of
switching from one audit firm to another might be quite high, and deter a company from wanting to change
its auditors. When switching costs are high, it can be difficult for new entrants to break into a market.
g) Government regulation. Regulations within an industry, or the granting of rights, can make it difficult for
new entrants to break into a market. For example, it might be necessary to obtain a license to operate, or to
become registered in order to operate within an industry.

2.2 Threat from substitute products

There is a threat from substitute products when customers can switch fairly easily to buying alternative products
(substitute products).
The threat from substitutes varies between markets and industries, but a few examples of substitutes are listed
below:
Domestic heating systems in the cold climates – Consumers might switch between gas-fired, oil-fired
and electricity-fired heating systems.
Transport – Customers might switch between air, rail and road transport services.
Food and drink products – Consumers might switch between similar products, such as coffee and tea.
When there are substitute products that customers might buy, firms must make their products more attractive
than the substitutes. Competition within a market or industry will therefore be higher when the threat from
substitute products is high.
Threats from substitute products may vary over time. There are many examples in the past of industries that
have been significantly affected by the emergence of new substitute products.
Plastic containers and bottles became a significant substitute for glass containers and bottles.
Synthetic fibers became a substitute for natural fibers such as wool and cotton.
Word processors and personal computers became a substitute for typewriters, and the market for
typewriters was destroyed.

2.3 Bargaining power of suppliers

In some industries, suppliers have considerable power. When this occurs, they might charge high prices that
firms buying from them are unable to pass on to their own customers. As a result, profitability in the industry
is low, and the market is highly competitive.
Porter wrote: ‘Suppliers can exert bargaining power over participants in an industry by threatening to raise
prices or reduce the quality of purchased goods or services. Powerful suppliers can thereby squeeze profitability
out of an industry unable to recover cost increases in its own prices.’
Porter suggested that the bargaining power of suppliers might be strong in any of the following situations:
▪ When there are only a small number of suppliers to the market
▪ When there are no substitutes for the products that are supplied
▪ When the products of a supplier are differentiated, and so distinctly ‘better’ or more suitable than the
products of rival suppliers

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▪ When the supplier’s product is an important component in the end-products that are made with it (e.g.
supply of engine is more important than supply of car mirrors for car manufacturers)
▪ When the industry (under discussion) is not an important customer for the suppliers
▪ When the suppliers could easily integrate forward, and enter the market as competitors of their existing
customers.

2.4 Bargaining power of customers

Buyers can reduce the profitability of an industry and thus increase the competition in market when they
have considerable buying power. Powerful buyers are able to demand lower prices, or improved product
specifications, as a condition of buying. Strong buyers also make rival firms compete to supply them with their
products.
Porter suggested that buyers might be particularly powerful in the following situations:
▪ when the volume of their purchases is high relative to the size of the supplier
▪ when the products of rival suppliers are largely the same (‘undifferentiated’)
▪ when the costs of switching from one supplier to another are low
▪ when the cost of a purchased item is a significant proportion of the buyer’s total costs (as the buyer is more
likely to be motivated to switch to a lower-cost supplier)
▪ when the profits of the buyer are low (once again, as the buyer is more likely to be motivated to switch to a
lower-cost supplier)
▪ when the buyer’s product is not affected significantly by the quality of the goods that it buys
▪ when the buyer has full information about suppliers and prices.

2.5 Competitive rivalry

Competition within an industry is obviously also determined by the rivalry between the competitors. Strong
competition forces rival firms to offer their products to customers at a low price (relative to the product
quality) and this keeps profitability fairly low.
Porter suggested that competitor rivalry might be strong in any of the following circumstances:
▪ when the rival firms are of roughly the same size and economic strength
▪ when there are many competitors
▪ when there is only slow growth in sales demand in the market
▪ when the products of rival firms are largely the same (‘undifferentiated’)
▪ when fixed costs in the industry are high, so that firms still make some contribution to profit even when they
cut prices
▪ when supply capacity can only be increased in large incremental amounts (for example, in electricity
supply industry, where increasing total supply to the market might only be possible by opening another
power generation unit)
▪ when the costs of withdrawing from the industry are high, so that even unprofitable companies are
reluctant to leave the market.

Using the Five Forces model

Example: Five forces – legal services
The Five Forces model can be used to analyse the market for legal services (the services of firms of solicitors) in
a local area, where competition is between small and medium-sized firms.
Threat from potential entrants. This is likely to be fairly low. New entrants must be qualified solicitors, and
it could take time to establish a sufficiently large client base.
Suppliers’ bargaining power. Solicitors have no significant suppliers; therefore, the bargaining power of
suppliers is non-existent.
Customers’ bargaining power. Most firms of solicitors have a fairly large number of customers. Customers
need legal services. The bargaining power of customers is probably low.

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Threat from substitutes. There are no substitutes for legal services, except perhaps for some ‘do-it-yourself’
legal work.
Competitive rivalry. This is likely to be very weak. Firms of competitors will not usually seek to compete with
other firms by offering lower fees.
The conclusion is that competition in the market for legal services in a local region is very weak.
Example: Five forces – CDs and DVDs
The Five Forces model can be used to analyse the competition for Amazon, the company that supplies books,
CDs and DVDs through online ordering on its website. It has no direct competitor.
Threat from potential entrants. This is likely to be fairly low, because of the costs of establishing a selling
and distribution system and the time it might take a new competitor to create ‘brand awareness’.
Suppliers’ bargaining power. Amazon obtains its books and other products from a large number of
different suppliers. The bargaining power of most suppliers is therefore likely to be weak, with suppliers
needing Amazon more than Amazon needs individual suppliers.
Customers’ bargaining power. Amazon has a very large customer base, and the bargaining power of
customers is non-existent.
Threat from substitutes. Substitutes are bookshops, shops selling CDs and DVDs, internet downloads of
films and music, and possibly eBay and other online auction sites as a channel for selling second-hand books.
In the longer term electronic books might be another substitute.
Competitive rivalry. Amazon has no direct competitor.
In conclusion, the major competition in the market served by Amazon is probably the threat from substitute
products.

3. LIFE CYCLE MODEL

3.1 The ‘classical’ product life cycle
A ‘life cycle’ is the period from birth or creation of an item to the end of its life. Products, companies and industries
all have life cycles. A product life cycle begins with its initial development and ends at the time that it is eventually
withdrawn from the market at the end of its life.
A life cycle is said to go through several stages. The ‘classical’ life cycle for a product, or even an entire industry,
goes through four stages or phases:
Introduction
Growth
Maturity
Decline.
Introduction phase. During this stage of a product life cycle, there is some sales demand but total sales are low.
Firms that make and sell the product incur investment costs, and start-up costs and running costs are high. The
product is not yet profitable.
Growth phase. During the growth phase, total sales demand in the market grows at a faster rate. New entrants
are attracted into the market by the prospect of high sales and profits. At an early stage during the growth phase,
companies in the market begin to earn profits.
Maturity phase. During the maturity phase, total annual sales remain fairly stable. Prices and profits stabilise.
The opportunity for more growth no longer exists, although the life of the product might be extended, through
product updates. More companies might seek to improve profits by differentiating their products more from
those of competitors, and selling to a ‘niche’ market segment.

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Decline phase. Eventually, total annual sales in the market will start to fall. As sales fall, so do profits. This leads
to companies leaving the market, which continues until it is no longer possible for any company to turn a profit
from the product. When the last supplier exits the market the product lifecycle is complete.
A ‘classical’ product life cycle is shown in the following diagram.

Not all products have a classical life cycle. Unsuccessful products never become profitable. A business entity
might be able to ‘revitalise’ and redesign a product, so that when it enters a decline phase, its sales can be
increased again, and it goes into another period of growth and maturity.

The length of a product life cycle can be long or short. A broad type of product, such as a motor car, has a longer
life cycle than particular types of the product, such as a Volkswagen Beetle or a Ford Escort.
At each phase of a product’s life cycle:
selling prices will be altered
costs may differ
the amount invested (capital investment) may vary
spending on advertising and other marketing activities may change.

3.2 Cost implications of the product life cycle

Life cycle costing can be important in new product launches as a company will of course want to make a profit
from the new product and the technique considers the total costs that must be recovered. These will include:
Research and development costs (decisions made at the development phase impact later costs)
Training costs
Machinery costs
Production costs
Distribution and selling costs
Marketing costs
Working capital costs
Retirement and disposal costs

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Stage Costs
Product R&D costs
development Capital expenditure decisions
Introduction to Manufacturing costs (high costs due to lack of economies of scale)
the market Operating costs including marketing and advertisement costs
Set up and expansion of distribution channels
Growth Costs of increasing capacity
Increased costs of working capital
Maturity Maintenance and operating costs
Marketing and product enhancement costs to extend maturity
Decline Maintenance and operating costs
Costs to keep sales (e.g. discounts)
Withdrawal Asset decommissioning costs
Possible restructuring costs
Remaining warranties to be supported

Benefits of Life cycle costing

Life cycle costing compares the revenues and costs of the product over its entire life. This has many benefits:
The potential profitability of products can be assessed before major development of the product is
carried out and costs incurred. Non-profit-making products can be abandoned at an early stage before
costs are committed.
Techniques can be used to reduce costs over the life of the product.
Pricing strategy can be determined before the product enters production. This may lead to better control
of marketing and distribution costs.
Attention can be focused on reducing the research and development phase to get the product to market
as quickly as possible. The longer the company can operate without competitors entering the market the
more revenue can be earned and the sooner the product will reach the breakeven point.
By monitoring the actual performance of products against plans, lessons can be learnt to improve the
performance of future products. It may also be possible to improve the estimating techniques used.

3.3 Relevance of the product life cycle to strategic management

When a decision is being made about whether or not to develop a new product, management should consider
the likely sales and returns over the entire life cycle. For existing products, management need to assess the
position of a product in its life cycle, and what the future prospects for the product, in terms of profits and cash
returns, might be.

Timing market entry and market exit

The product life cycle concept might help companies to make strategic decisions about when to enter a market
and when to leave it.
Entrepreneurial companies might look for opportunities to enter a new market during the introductory phase,
in the expectation that the product will become successful and the company will win a large share of the market
by being one of the first companies to enter it.
More cautious companies, looking for growth opportunities, might delay their entry into the market until the
growth phase, when the product is already making a profit for its producers.

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Companies are unlikely to enter a market during the maturity phase unless they see growth opportunities
in a particular part of the market, or unless the costs of entry into the market are low.
A company might need to make a strategic decision about leaving a market, when the product is in its decline
phase. It should be possible to make profits in a declining market, but better growth opportunities might exist
in other markets and a company might benefit from a change in its strategic direction.

3.4 Cycle of competition

A cycle of competition is another concept for understanding the behaviour of competitors in a market.
When one company achieves some success in a market, competitors might try to do something even better in
order to gain a competitive advantage. A new initiative by one company will result in a counter-measure from
another company. Each company in the market tries to do something different and better.

A typical cycle of competition affects prices and quality. If one company has a large share of a profitable market,
a rival company might start to sell its product at a lower price. Another rival company might improve the quality
of its product, but sell it at the same price as rivals in the market. The first company might respond to these
initiatives by its rivals by improving its product quality and reducing the selling price.
The effect of a cycle of competition in a growing market is that prices fall and quality might improve.
In the maturity phase of a product’s life cycle, or in the decline phase, it becomes more difficult to lower prices
without reducing quality. Competitors might try to gain a bigger share of the market by selling at a lower price,
but the product quality might be reduced. This can lead to a ‘spiral’ of falling prices and falling quality, to the
point where the product is no longer profitable, and it is less attractive to customers.
Example
Glory is a series of high-end smartphones and tablets designed, manufactured and marketed by Marvel Group
(MG). MG is highly regarded for innovative product designs and aggressive marketing campaigns. The mobile
phone industry is one of the fastest growing sectors of economy where a number of competitors attempt to
outperform each other in terms of product designs, features and pricing.
MG is in the process of introducing new series of foldable smartphones (Glory Ultimate) that could be a vital
breakthrough in mobile phone industry. The management of MG intends to adopt life cycle costing for Glory
Ultimate.
Required:
a) Discuss the benefits that MG may enjoy by adopting life cycle costing.
b) List the costs that MG might have to incur in each phase of the life cycle of Glory Ultimate.
c) Suggest the strategies that MG may adopt to extend the maturity phase of Glory Ultimate.

Solution:
a) MG may enjoy the following benefits by adopting life cycle costing:
The potential profitability of Glory Ultimate would be assessed before major development is carried out
and further costs are committed. It may assist management in deciding whether to introduce new series
at all or not.
It may assist in identifying various types of costs over the life of Ultimate Glory.
Strategies may then be devised to reduce / control these costs.
It may assist in developing a pricing strategy that would cover the costs and achieve desired level of profits.
b) MG might have to incur following costs in each phase of the life cycle of Glory Ultimate:
i. Introductory phase
Manufacturing costs (costs of operations)
Marketing and advertising costs to raise product awareness

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Costs of setting up and expansion of distribution channels

ii. Growth phase
Increased costs of working capital
Costs of increasing capacity
Marketing and advertising costs to raise customer base

iii. Maturity phase

Costs to maintain manufacturing capacity
Marketing and product enhancement costs to extend maturity
iv. Decline phase
Costs of withdrawals (costs of remaining warranties)
Discounts to attract customers
c) MG may adopt any or combination of the following strategies to extend the maturity phase:
Differentiate by modifying design, features, packaging, etc. to extend product life.
Sell to untapped markets in terms of geographical area, gender, type of customer, life style etc.
Revisit pricing strategy by offering discounts or promotional schemes to attract customers who are
happy to purchase ‘old models’ for a lower price and avoid paying the premium required for the new
models.

4. STRATEGIC GROUPS AND MARKET SEGMENTATION

4.1 Strategic groups
Another approach to analysing and understanding the competitors in a market is to group them into strategic
groups.
A strategic group is a number of entities that operate in the same industry and that have similar strategies
or that are competing in their markets in a similar way. Strategic groups have been defined as: ‘Clusters of
firms within an industry that have common specific assets and thus follow common strategies in key decision
variables’ (Oster).
Example: Bottled soft-drinks
There are many companies in the industry for making and selling bottled soft-drinks. To facilitate
competitor analysis, they can be grouped into the following strategic groups. (All the companies in each group
promote their brand image, so all the products are branded.)
Companies that operate globally and make and sell a broad range of different bottled soft-drinks (e.g.
Coca-Cola and PepsiCo)
Companies that operate regionally, for example in Asia only, and make and sell a broad range of different
bottled soft-drinks.
Companies that operate in a national market, and make and sell a broad range of different bottled
soft-drinks. (e.g. Britvic in the UK)
Companies that operate internationally, but offer a relatively limited range of soft- drinks. (e.g. Vittel
and Perrier)
Local specialists that make a small range of products for a local market (e.g. Aura water in Thailand).
The strategies of all the companies in a strategic group will be similar. When there are only a few competitors in
the same industry, the concept of strategic groups has no practical value, because each competitor can be analysed

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individually. However, when there are many competitors in the industry, it can simplify the analysis to put
them into strategic groups of entities with similar resources and similar strategies. For the purpose of
competitor analysis, all the entities in the same strategic group can then be treated as if they are a single
competitor. Instead of analysing each competitor individually, they can be analysed collectively, in groups.
Example: Manufacturing industry
Companies in a manufacturing industry might be grouped according to their strategic priorities. Three strategic
groups might be identified:
Companies that seek to maintain their position in the market
Companies that seek to innovate and develop new products
Companies that consider marketing to be the key to strategic success. The strategic priorities of the
companies in each group might differ as follows.

Note: A lead time is the time between a customer placing an order and delivering the product to the customer.
When the strategic objective is a short lead time, the aim is to deliver the product as quickly as possible after a
customer has ordered it.
Dependable delivery means being able to state when and where a product will be delivered to the customer and
meeting this promise.
The main concerns of all manufacturing companies are broadly similar, but their priorities differ. This means that
their strategies are likely to be different, as companies in each strategic group pursue their own priorities.

4.2 Strategic space

When all the companies in an industry are put into strategic groups, and these groupings are analysed, a strategic
space might become apparent.
A strategic space is a gap in the market that is not currently filled by any strategic group. The existence of strategic
space might provide an opportunity for a company to make a strategic initiative, and attempt to fill the space that
no other rivals occupy.
Example: Price v. quantity
One way of identifying strategic groups within an entire market is to classify market position in terms of price
and quality. Some firms will offer lower-priced products, but their quality is probably not as good. Other firms
might offer higher-quality products for a higher price.

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The strategic groups in a market might be mapped according to price and quality as follows:

This map indicates that there are four strategic groups, each in a different market position in relation to price
and quality. The largest group, Group 2, sells products with a middle-range price and middle-range quality.
This method of analysis can help an entity to identify possible gaps in the market – strategic space. When there
is a perceived gap in the market, an entity might decide on a strategy of filling the empty space by offering a
product with the characteristics that are needed to fill the gap.

If the positioning of entities in a market is analysed by price and quality, as above, possible strategic spaces
might be identified as follows:

In this example, an entity might decide to target a position in the market where it sells a high-quality product
for a low price, because there are no firms yet in this part of the market. Alternatively, there might be a market
for even higher-quality products at an even higher price. The entity might even decide to fill the gap between
Group 1 and Group 2.

4.3 Product differentiation

A market can be identified as a group of customers or potential customers for a particular product or range of
related products.
In a very small number of markets, all suppliers provide an identical product that is the same in every respect to
the product supplied by its competitors. An example is foreign exchange. Banks selling US dollars in exchange for
euros are all trading exactly the same product.
In most markets, products are differentiated in various ways. They are similar, but there are also noticeable
differences.

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Differences in products include differences in:

product design
pricing
branding.
Products might also be differentiated by the way in which they are delivered to customers. For example, banking
services might be delivered through a branch network or as an internet service. Similarly, consumers can buy
products in shops or through the internet; or they can buy a hot meal by going to a cafeteria or restaurant, or by
ordering a home-delivery meal.
Business entities often use differentiation to make their products attractive to customers in the market, so that
customers will buy their products rather than those of competitors.

4.4 Market segmentation

A business entity might try to sell its products to all customers in the market. However, a business entity might
choose instead to target its products at a particular section or segment of the market. A market segment is a
section of the total market in which the potential customers have certain unique and identifiable characteristics
and needs.
Market segmentation is the process of dividing the market into separate segments, for the purpose of developing
differing products for each segment.
Example: Cars
The market for motor cars might be segmented according to the design of the car, for example:
four-door or two-door family saloon car (with or without hatchback) – and with differing engine sizes
two-seater sports cars
estate cars
people carriers
4 × 4 vehicles
electric-powered cars
cars that can be powered by ethanol (bio-fuel).
For car dealers, the market for cars can also be segmented into the new cars market and the used cars market.

4.5 Methods of segmenting the market

Methods of segmenting the market include segmentation by:
geographical area
quality and performance
function (for example, within the market for footwear, there are market segments for running shoes,
football boots, hiking boots, riding boots, snow boots, and so on)
type of customer: for example, consumers and commercial customers
social status or social group
age: adults, teenagers and younger children might all buy different types of similar products, such as
computer games or music downloaded from the internet
life style.
Example: Socio-demographic
An entity might decide to segment a market according to the life style of customers. Possible life style segments
include single people under 30 years of age, newly-married couples with no children, married couples with
young children, married couples with teenage children, married couples whose children are grown up and have
left home, retired couples, and retired single people.

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This form of market segmentation can be useful for certain products and services such as:
holidays
motor cars
some food and drink products
entertainment products.

4.6 Market segmentation and strategic space

A similar analysis of strategic groups can be made to identify possible target market segments. In the example
below, the strategic groups are analysed by life style of customers.

This analysis suggests that there are possibly gaps in the market for a product, and that a product is not
currently being made and sold that might appeal specifically to individuals whose children have left home or to
individuals who have retired from working.
Having analysed the market and identified these strategic spaces, management can go on to assess whether a
strategy based on developing an amended product specifically for these gaps in the market might be strategically
desirable and financially worthwhile.
Identifying gaps in a market can be a particularly useful method of competition analysis for companies that are
considering whether or not to enter into a market for the first time.

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5. BOSTON CONSULTING GROUP MATRIX (BCG MATRIX)

5.1 Boston Consulting Group matrix (BCG matrix)
The Boston Consulting Group developed a product-market portfolio for strategic planning. It allows the strategic
planners to select the optimal strategy for individual products or business units, whilst also ensuring that the
selected strategies for individual units are consistent with the overall corporate objectives.
The objective of the matrix is to assist with the allocation of funds to different products or business units.
The matrix is a 2 × 2 matrix.
One side of the matrix represents the rate of market growth for a particular product or business unit.
The other side of the matrix represents the market share that is held by the product or business unit.

Notes
Market growth. The mid-point of the growth side of the matrix is often set at 10% per year. If market growth is
higher than this, it is ‘high’ and if annual growth is lower, it is ‘low’. It should be said that 10% is an arbitrary
figure.
Market share is usually measured as the annual sales for a particular product or business unit as a proportion
of the total annual market sales. For example, if the product of Entity X has annual sales of Rs. 100,000 and total
annual sales for the market as a whole are Rs. 1,000,000; Entity X has a 10% market share.
In the BCG matrix, however, market share is measured as annual sales for the product as a percentage or ratio of
the annual sales of the biggest competitor in the market. The mid-point of this side of the matrix represents a
situation where the sales for the firm’s product or business unit are equal to the annual sales of its biggest
competitor. If a product or business unit is the market leader, it has a ‘high’ relative market share. If a product is
not the market leader, its relative market share is ‘low’.
The BCG matrix is shown as follows. The individual products or business units of the firm can be plotted on the
matrix as a circle. The size of the circle shows the relative money value of sales for the product. A large circle
therefore represents a product with large annual sales.

BCG matrix

The products or business units are categorised according to which of the four quadrants it is in. The four
categories of product (or business unit) are:
Question mark (also called ‘problem child’)
Star
Cash cow
Dog.

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Question mark
A question mark is a product with a relatively low market share in a high-growth market. Since the market is
growing quickly, there is an opportunity to increase market share, but initially it will require a substantial
investment of cash to increase or even maintain market share.
A strategic decision that needs to be taken is whether to invest more heavily to increase market share in a
growing market, whether to seek a profitable position in the market, but not as market leader, or whether to
withdraw from the market because the cash flows from the product are negative.

Star
A star has a high relative market share in a high-growth market. It is the market leader. However, a considerable
investment of cash is still required to maintain its leading position. Initially, they probably use up more cash than
they earn, and at best are cash-neutral. Over time, stars should gradually become self-financing. At some stage in
the future, they should start to earn high returns.

Cash cow
A cash cow is a product in a market where market growth is lower, and possibly even negative. It has a high
relative market share, and is the market leader. It should be earning substantial net cash inflows, because it has
high economies of scale and will have become efficient through experience. Other companies will not mount an
attack as they perceive that the market is old and near decline.
Cash cows should be providing the business entity with the cash that it needs to invest in question marks and
stars.

Dog
A dog is a product in a low-growth market that is not the market leader. It is unlikely that the product will gain a
larger market share, because the market leader will defend the position of its cash cow. A dog might be losing
money, and using up more cash than it earns. If so, it should be evaluated for potential closure.
However, a dog may be providing positive cash flows. Although the entity has a relatively small market share in
a low-growth market (or declining market), the product may be profitable. A strategic decision for the entity may
be to choose between immediate withdrawal from the market (and perhaps selling the business to a buyer, for
example in a management buyout) or enjoying the cash flows for a few more years before eventually
withdrawing from the market.
It would be an unwise decision, however, to invest more capital in ‘dogs’, in the hope of increasing market share
and improving cash flows, because gaining market share in a low-growth market is very difficult to achieve.

5.2 Weaknesses in BCG model analysis

There are several criticisms of the BCG model.
The BCG model assumes that the competitive strength of a product in its market depends on its market share,
and the attractiveness of a market for new investment depends only on the rate of sales growth in the
market. It can be argued that these assumptions are incorrect.
- A product can have a strong competitive position in its market, even with a low market share.
Competitive strength can be provided by factors such as product quality, brand name or brand
reputation, or low costs. Porsche earns very high profits but its market share is small compared to bigger
car manufacturers such as General Motors, Ford and Toyota.
- A company might benefit from investing in an industry or market where sales growth is low.
- Other factors, apart from market share and market size will influence what a company should do with a
product: strength of competition, cost base and brand strength are all important considerations.

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It might be difficult to define the market.

- There might be problems with defining the geographical area of the market. A market might be
defined in terms of a single country, a region of a country or as an international or global market.
- It might also be difficult to identify which products are competing with each other. For example, the total
market for cars may be divided into different categories of car, but there may be problems in deciding
which models of car belong to each category.
It might be the BCG matrix is better for analysing the performance of strategic business units (SBUs) and
market segments. It is not so useful for analysing entire markets, which might consist of many different
market segments.
It might be difficult to define what is meant by ‘high rate’ and ‘low rate’ of growth in the market. Similarly, it
might be difficult to define what is meant by ‘high’ market share and ‘low’ market share.
BCG analysis should be carefully interpreted. For example, there are major differences in suggested R&D and
marketing spending depending on whether a product is a star or a cash cow. It would be wrong to
dramatically reduce marketing and R&D simply because the market growth rate fell from 10.1 to 9.9 (if 10 is
taken as the low/high cut-off).

Summary

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