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Understanding the five competitive forces that shape industry’s structure is the first step in the strategy design process. Every business should understand the key factors that determine the current profitability, as well as the ones responsible for the profitability shifts at least in the recent past.

Understanding the industry structure orientates corporate strategists in finding the best opportunities and shaping the right strategies to catch them, or foreseeing threats and designing the strategies to anticipate and prevent them from harming the business.  Some of the strategic moves that the 5 forces analysis may suggest to do are the following:

Positioning the destination. This strategy is to find a position in the market where the destination businesses are better protected from the strongest forces threatening the business profitability. Furthermore, the five forces analysis may also help the businesses analyze the convenience of entry or exit in an industry.

A thorough foresight analysis of an industry’s 5 forces may even spot levels of profitability that are not yet reflected in the share value of incumbents. A good case study of a destination finding its most profitable positioning is that of Macau (PRC), which positioned itself as the best destination for gambling all over Asia, and is actually the world’s number 1 destination making profits from gambling, ahead of Las Vegas.

Exploiting industry change. Industry changes are source of threats and opportunities, and so the visionary strategists have to be the first to foresee these changes and drive the business towards advantageous positions to catch the new opportunities and avoid the new threats. Structural changes may generate new needs or new ways to satisfy the current ones.

Industry leaders are more likely to overlook some of the new opportunities and may have more difficulties to change their business model due to their size constraints. So these changes are usually the opportunity of small or middle size players to grow towards industry leadership positions, thanks to the agility allowed by their smaller size.

In Europe, the boom of Ryanair as a low cost carrier operating in small airports some kilometers away from the main destinations changed the airline industry boosting the number of travelers and taking business from the tour operating industry in favor of the FITs. This benefited many businesses developing a strategy to get the Ryanair travelers, many of whom used to travel through tour operators’ packages. At the same time, many new destinations emerged, especially those near the airports where Ryanair was flying, many of whom were not so popular before Ryanair’s flights.

Shaping industry structure. Sometimes, a company manages to transform the industry structure through revamping their business model and altering the five forces. In these cases, the other industry players are somehow forced to follow this industry leader so as not to lose their market position and eventually the entire industry structure is transformed. The new industry leader reshaping the industry structure is likely to get the most benefit by reshaping competition in a way that can let its strengths shine.  The industry restructure may be carried out in two different ways: redistributing profitability among incumbents or expanding the overall profitability.

Redistributing profitability. To attract more profits to the industry it is necessary to identify the main force or forces that are most constraining to profitability and neutralize them. A firm may potentially influence any of the competitive forces.  To counter supplier power, the incumbents may standardize the features of its inputs to reduce or eliminate switching costs.

To neutralize buyer power, incumbents may offer value added services that raise customers’ switching costs, or find new channels to reach customers without the established powerful ones. To keep new entrants away from the industry, incumbents may create barriers to entry such as the marketing expenditure or the R+D budget. To reduce the threat of substitutes, companies can differentiate the product with new features or value added services to better satisfy the needs of its customers.

Expanding the overall profit.  When the “industry pie” expands all players are likely to benefit from the growth. That occurs when the industry discovers new markets to satisfy undiscovered needs that were not satisfied, or by developing new product categories that generate new demand and expand the potential market.

Overall profitability may also grow due to improved collaboration with suppliers or buyers to reduce inefficiencies. Also, agreeing on industrywide quality standards raises the reputation of the whole industry benefiting all players and allowing price raises. The distribution of the newly expanded profit pie is to be determined by the five forces. The most successful strategists will be those who manage their business to take the highest percentage of the new profits.

Continuing with the Ryanair case study, this expanded the tourism business in existing destinations and also developed many new local destinations. The low cost flights stimulated new demand both from the current outbound markets and from some new outbound markets that were not used to having international flights to travel abroad directly.

Defining the industry. It is necessary for companies operating in many industries to well define the industry boundaries, to assign every business unit to the corresponding industry and to analyze profitability and design strategy for every business unit separately. It is essential to identify when two similar products are different enough to actually play in different industries, and so they are to be separated in two business units to properly set their own strategy.

In the hotel industry, it is quite common –among large hotel operators- to create different brands depending on the segment they are operating in or targeting: business, vocational, city trip, luxury, etc.

Do you think of other case studies that showcase these strategic moves?

 

 

 

 

 

 

 

 

1. Introduction 2
2. The tourism industry structure and its key players 3
3. The 5 competitive forces in the tourism industry 5
4. Business portfolio strategy method for destinations 15
CONTENTS
The 5 competitive forces

& Business Strategy

<<PLANNING METHODS WHITEPAPER SERIES >>

 

 

 

 

BP1 Crafting the business portfolio strategy

When crafting Strategic Plans for destinations, one of the essential strategies to design is the Business Strategy, to depict the portfolio of sectors in which the destination will compete. Nowadays, more than ever before, the tourism market is segmented in an increasing amount of sectors or businesses, each of which has enough specificities to deserve its own competitiveness and attractiveness analysis and assessment.

Moreover, destinations need to diversify their risk, reduce demand seasonality, and renovate their products to sustain their competitive position. The ultimate purpose of this methodology is to establish a scale of priorities in the assignation of the funds to carry out the necessary renovations and investments.

In the case of Tourism 3.0, as explained in other Whitepapers, the Special Interest travel and other minor sectors play a very important role on the success of its development, and so a sound analysis should be carried out on an extensive range of Special Interest sectors.

The methodology based on the McKinsey matrix analyzes for every sector the capacity of the destination to compete and the attractiveness of the sector, considering the market volume and growth potential, seasonality of demand, tourists’ expenditure, multiplying effect, customer loyalty potential, and the 5 competitive forces that shape long term profitability. This 5 forces analysis is the most complex and sound to be carried out, for a specific section is dedicated to it in this Whitepaper.

Then, the challenge is to assess the proportional relevance of every player in relation with its corresponding force, and determine the proportional strength of every force in the sector. To rate the importance or strength of every force in shaping the industry’s long-term profitability, it is necessary to combine both quantitative and qualitative analysis. In this regard, statistical data corresponding to the business volume, the purchasing and sales volumes, prices and price differences between different dealers, margins corresponding to business with different dealers should be obtained for every incumbent.

Furthermore, it is necessary to gather data related to possible barriers to entrance, barriers to exit –it is possible to quantify the switching costs, for instance- and other factors mentioned in the explanation of the framework.

Finally, the assessment of a pool of industry experts is also necessary to find important insights that are specific to every sector, or not properly explained in the available secondary sources. Industry experts may also lead to new secondary sources, for it is convenient to interview them rather at the beginning of the research, so as to help us orientate its process.

An industry experts pool should comprehend many profiles, such as directors of travel agencies –outbound & incoming-, tour operators, hotels, tourism facilities, transportation services; consultants, journalists, government officials, etc.

What other methodologies would you use for the business portfolio strategy?

 

 

 

 

BP2 Attractiveness assessment for the tourism industry

As with any other industry, the development of the tourism businesses requires a prior strategic assessment on the attractiveness of its various sectors to determine the optimum business portfolio to invest in. To do so, the 5 competitive forces framework analyses the structure of every sector through the five forces that shape its long term profitability:

  • The threat of new entrants
  • The suppliers’ negotiation power
  • The buyers’ negotiation power
  • The threat of substitutes
  • The competitive rivalry

These five forces determine how the generated value is to be distributed among the different types of players: how much is retained by incumbents, how much is taken by suppliers and customers using their bargaining power, and also how the profitability is limited by the threat of new entrants and substitutes.

The strength balance between the different forces is to determine the average industry profitability, and a key to formulate the adequate strategy. Hereby, we will analyze the application of the five forces model for the tourism industry.

Apart from the 5 forces analysis, there are some more factors to be considered when assessing the sectors’ attractiveness:

  • Market volume and main segments volume
  • Market growth trends and potential: current and foreseen market growth
  • Seasonality of demand, considering length of high, mid and low seasons.
  • Price elasticity of the demand: price sensitivity of all kinds of buyers, adjusted according to the share of everyone.
  • Expenditure in accommodation, food & beverage, activities and shopping (% of each).
  • Multiplying effect: strategic value of the business in terms of its capacity of fostering the prestige of the destination and marketing it for other businesses.
  • Loyalty potential: capacity of the business in retaining customers (%)

When composing the attractiveness matrix we will adjust the value of every factor according to its impact on the sector attractiveness.

Would you consider other factors when assessing a sector’s attractiveness?

 

 

 

 

 

 

 

 

 

 

 

BP3 Key tourism industry players

There are 3 groups of players: first level suppliers, service operators and marketing operators

 

1st level suppliers. Human resources, land owners, infrastructure operators, utility operators, government as license supplier and the construction sector are the basic suppliers for the tourism industry operators. As we have seen in the five forces model, they play a key role in defining the industry’s profitability when tourism is not so developed in a territory or we are analyzing the attractiveness of a tourism sector that would require the construction of new facilities and services. We may take into account Governments as active players in the industry whenever they are in charge of marketing the destinations.

Service operators. Food & beverage, accommodation, transport and activities providers are the key operators of the industry, as service providers. Whenever we analyze the attractiveness of tourism business that would be based on existing services and facilities, we will consider them as suppliers, except for the activities’ operators, which could be considered as incumbents in this case.

Marketing operators. Here lies the complexity of the tourism industry, where we define several kinds of operators, which may be either competitors or partners.

  • Booking centers & portals: online and/or telephone based commercial platforms managing bookings for one or more kinds of services operators –mostly focused on accommodation and also activities-, usually gathering the tourism services offered within a local or regional territory. They usually get their profits by keeping a percentage of the business they bring to their local service suppliers. In this concept we can also include new business models like Airbnb, whose service suppliers are local householders marketing their spare rooms.
  • Incoming agencies: operators located in the destination in charge of creating packages including accommodation, transportation and activities. These are the most genuine marketing operators, as they are in charge of product development, combining services and experiences available in the destination for the satisfaction of every target. They may sell their packages to tour operators, travel agencies or directly to the final customer. In many cases, they are also the activity providers.
  • Tour operators: operators located in the outbound market in charge of creating packages, usually marketing several destinations and several kinds of products. However they may be tour operators specialized in one destination and more often in one kind of product (golf, ski, sun & beach, cultural touring, incentive trips, etc.). These may deal directly with the service operators or with the incoming agencies, and then sell their packages to the travel agencies or directly to the final customer. They usually buy service capacity long in advance to the service operators or incoming agencies at a lower price ensuring them business, and then have to sell this capacity to the outbound markets.
  • Travel agencies: service retailers usually located near to the customer, selling either incoming agencies’ or tour operator’s packages, or directly booking to the services’ operators. Many travel agencies sell through the internet. Their value is based on the confidence of the customer, offering packages from different operators and sometimes specialization in certain products.
  • Travel social media sites: even if they are not included in the previous scheme as business players, sites like Tripadvisor and many similar models are key influencers in the decision making process of both the chosen destination and mostly the chosen operators within, therefore they deserve a relevant mention as key players in the tourism industry.

In this table are summarized the main features that define each of the marketing operators:

Marketing operators conceptual features
  Location Product development Dealing with final customer Marketing focus
Booking center Destination No ··· One destination. One or many products
Incoming agency Destination Yes · One destination. One or many products
Tour operator Outbound market Yes · Many destinations.  One or many products
Travel agency Outbound market No ··· Many destinations.  One or many products
Travel social site Internet No ··· All destinations.

All services

 

Being that this conceptual outline is representative for most of the industry operators’ models, we should also note that many operators have developed business models integrating several concepts and functions altogether, in most cases as a result of a forward integration process.

Would you consider other key players when analyzing the tourism industry structure?

 

BP4 The 5 Competitive forces: the threat of new entrants. Initial barriers to entry

The entrance of new competitors in the industry expands the overall offer and challenges the market share of the incumbents, pressing on prices, costs, value added and investment needed to keep their position in the market.

In the tourism industry, the new entrants tend to be the focus of attention of many travelers, at least those who are always willing to explore unknown destinations. Needless to say that there is an almost unlimited number of potential new entrants, if we consider the entire tourism industry, though we will carry out this analysis for each tourism sector separately, thus reducing significantly the number of potential entrants. In general, new destinations have to face some particular challenges or initial barriers to enter the market:

Product differentiation: a new entrant has to have a unique selling proposition and enjoy a credible image as a tourist destination. This is not easy to achieve in a few years, given that brand image is a result of consistent communication efforts over a long period. Positive image development takes time and should be followed by substantive action.

Capital investment: any territory that wants to develop tourism needs substantial investments in hotels, roads and other infrastructures to meet demand requirements. To do so, it will have to convince investors proving political stability and offering a business friendly environment.

Access to distribution channels: most destinations will need well-established distribution of their new products via tour operators. In that respect there has been a process of concentration in the tour operating industry, thus playing a key role and strengthening their force. Despite the increasing role of the internet as a direct distribution channel, tour operators still play a major role and tend to promote only easy to sell destinations due to high demand.

Government policy: Governments often regulate the industry including limiting the entrance of new operators through a licensing system to protect the heritage or the environment. Many kinds of regulations may limit the development of tourism, such as those related to either natural or cultural heritage protection, environmental protection affecting the development of ski or golf resorts, regulation against gambling, etc. Governments may also subsidize some incumbents thus creating a disadvantage for potential entrants.

The threat of entry –and not the fact that new entries actually occur- puts a cap on the profitability potential of the industry, as if the threat is high, incumbents have to hold down their prices to deter new competitors. This threat will depend on the extent of entry barriers and the retaliation that new entrants may expect from incumbents.

Would you consider other key challenges as initial barriers to entry?

BP5 The 5 Competitive forces: the threat of new entrants. Barriers to entry or challenges to compete successfully

Apart from the main challenges explained above, there are other kinds of barriers to overcome, related to the challenges to compete successfully in the market:

Supply-side economies of scale: They are created when large volumes of production manage to spread fixed costs over more units and thus lower the cost per unit, or obtain better deals with suppliers due to larger orders. That makes new entrants have to choose between investing on a large scale or assume a cost disadvantage that should be compensated via a differentiated product. Such is the case of mass tourism destinations, which can often be only competed against with smaller scale differentiated products at higher prices. Or even in the same destination, this is the competition between large hotels and boutique hotels. The most cost efficient level of production is termed Minimum Efficient Scale (MES). If MES for firms in an industry is known, then we can determine the amount of market share necessary for low cost entry or cost parity with rivals.

Demand-side benefits of scale: This advantage arises when a larger network of clients increases the attractiveness of the destination. In the tourism industry, this is the case of some popular destinations among a certain target of tourists, whose leaders attract most of the group, niche or segment to that destination, based on either objective or prestige criteria, or because spending holidays with the group is an essential part of the motivation.

Customer switching costs: These are costs that clients have to assume if they change to another supplier. In the tourism industry, this is the case of the residential tourism, in which the tourists own a property in the destination where they go most frequently. All the cost of selling the property and moving to the new destination is a significant barrier.

Incumbency advantages independent of size: Incumbents build often their competitive advantage on some proprietary assets such as exclusive licenses to access natural heritage or to operate in a certain location, reputable brand identity, or a specific know-how that sets them apart from competitors. This is the most typical kind of barrier to entry in the tourism industry, for which we could find an endless amount of examples, especially related to access to natural resources, geographic locations and brand identities. Technology in the tourism sector applies to the capacity to produce unique experiences due to a specific know-how, like the wellness & spa, gastronomy, cultural & art performances, etc.

Government advisories: countries presenting some kind of safety risk due to conflicts or health threats for travelers are evaluated by other countries governments, which advise their citizens about such threats. Presenting any relevant threat for the tourist is likely to prevent any destination from being marketed through the main distribution channels.

Investment and asset specificity: needless to say that for many tourism businesses, significant investments need to be carried out, some of which correspond to special equipment that cannot be used for other purposes or not easily sold if the venture fails, thus becoming a barrier to exit. Such is the case of ski resort lifts, sailing marinas and many others.

Brand loyalty and advertising expenses: incumbents’ brand loyalty may be a significant barrier to entry, as long as new entrants will have to develop expensive marketing campaigns to gain a position in the market. Those campaigns will only be profitable in the long term. Incumbents’ advertising expenses are themselves a barrier to entry, as new entrants will need to invest much more than incumbents to gain significant brand awareness and market share.

Apart from the barriers to entry, we should take into account the expected retaliation by incumbents towards new entrants. Newcomers are expected to fear retaliation if:

  • Incumbents have previously reacted effectively against the entrance of new players.
  • Incumbents have proven capacity to strike back (cash, borrowing power, productive capacity or influence in the distribution channels).
  • Incumbents appear to be likely to cut prices in order to retain market share, due to a high fixed cost structure.
  • The low industry growth so newcomers can only develop business by taking it from incumbents.

When carrying out the 5 competitive forces assessment for a destination’s strategy plan, we consider incumbents all the local operators: accommodation providers, local operators organizing activities, transport operators, and incoming agencies.

Would you consider other challenges to compete successfully?

 

 

 

BP6 The 5 Competitive forces: The power of suppliers

Powerful suppliers may leverage their bargaining power by raising prices, or by reducing product quality or related services among many possibilities. A supplier is powerful when:

  • Its business volume is much larger than its clients’ or there is higher concentration in the suppliers’ side than in the client side.
  • It supplies to several industries and therefore its business does not depend on one industry.
  • The supplied inputs are critical for the industry.
  • Its clients have to face switching costs when changing to another supplier.
  • It markets differentiated products.
  • Its product has no possible substitutes
  • It can seriously threaten its clients to integrate forward into the industry.

In the tourism industry, the main suppliers to be considered are human resources, land owners, energy and utility suppliers and the government as license provider, responsible for urban planning and key infrastructure owner. Besides, every sector may have their specific suppliers related exclusively to their activity. Whenever we are analyzing a sector for a developed destination, in which there is no need to build new accommodation, we may take the accommodation and transport providers as suppliers as long as this sector needs the tour operators to market the destination –because they provide key added value- or the rate of FITs in this sector is insignificant.

What other relevant suppliers would you consider when analyzing this force for a destination?

 

BP7 The 5 Competitive forces: The power of buyers

In a similar way, powerful clients can leverage their bargaining power by pushing prices down, demanding higher product quality or more added services, etc. In the tourism industry, buyers are FIT, outbound tour operators, internet portals, travel agencies, corporate clients and sometimes also DMCs. However, every tourist sector may have a different buyer structure (%FIT, TTOO concentration, relevance of corporate clients and associated clients). Tour operators can be identified as the main buyers of most tourist products. Buyers have negotiating power when:

  • There is higher concentration in the buyers’ side than in the suppliers’, or the business volume of the buyers is significantly larger than their suppliers’. In this respect, there has been an increasing concentration of the outbound tour operators in the major outbound markets, especially in the sectors with the highest concentration of travelers.
  • The products tend to be commoditized. That occurs with destinations that do not care for their heritage and do not foster their culture as an essential part of the experience, in those sectors that are not culture focused.
  • There are few or no switching costs for customers. Switching costs are barely ever relevant apart from residential tourism (when the tourist own a property in the destination).
  • Customers may seriously threaten with backward integration to take a stake on suppliers’ business. Some outbound tour operators buy hotels in the destinations and set their own inbound travel services.
  • Buyers have very good information about the demand, prices and the supplier. In the tourism industry it is not easy to hide information of the suppliers.

 

  • If the utility of the product is low for the buyer, this will be more likely to press the prices down to compensate the low utility. This is unlikely to happen in the tourism industry.

Instead, buyers are weak if:

  • Producers threaten with forward integration, acquiring the distribution channel. This happens when accommodation operators market their services directly to the client, usually through the internet. It could also happen that these operators create packages including transportation and activities and market directly to the final customer through the internet, travel agencies or its own retailers.
  • Significant buyer switching costs. Only in the case of residential tourism.
  • Buyers are fragmented. This is the case of FITs and sometimes small tour operators.
  • Producers supply critical portions of buyers’ input distribution of purchases. This refers to the uniqueness of the accommodation or activities operator as a supplier within the tour operator package.

A buyer group is price sensitive if:

  • The purchased product accounts for a significant proportion of the procurement budget. Accommodation is usually the most significant fraction of the package, along with transportation depending on the length of the trip.
  • The customer is under pressure to reduce its costs due to low profits, tensions in the cash flow, etc. This happens quite often with the tour operators when negotiating with incoming services suppliers.
  • The product object of negotiation has little impact on the buyer’s product quality. This cannot happen in the tourism business, as all the main components are clearly visible to the final customer.
  • The product has little impact on the customer’s other costs. This is not likely to apply to the tourism industry. Only in very special cases.

Many producers try to counter the channel power with exclusive deals with specific distributors or simply by selling directly to final customers through their own channel.

Through a series of mergers and acquisitions, a few tour operators control most of the sales outlets today. Operators such as Kuoni are also in a position to centralize purchasing for an entire brand in all European countries. A common complaint by hoteliers is that if the requested price is not given, tour operators have the ability to take their clients to another destination. Tour operators identify new destinations with low startup costs and compete with existing destinations which are then forced to reduce prices. Certain European charters recently pulled out citing price issues.

Would you add more considerations on analyzing the power of buyers in destinations?

 

BP8 The 5 Competitive forces: The threat of substitutes

A substitute is a product or service that satisfies the same need in a different way. A threat of substitutes exists when a product’s demand is affected by the price change of a substitute product. A product’s price elasticity is affected by substitute products –as more substitutes become available, demand becomes more elastic since customers have more alternatives.

 

Many substitutes may be overlooked because of their different nature, as they are not direct competitors. They limit the industry’s profitability by pressing the product prices, just as another competitor would. There is a high threat of substitutes when:

  • The substitute product or service offers an advantageous price-performance relationship compared to the industry product
  • There are little or no switching costs associated to the substitute product or service.

Strategists should monitor all the potential substitute industries’ evolution, to detect changes that may turn these potential substitutes into attractive alternatives due to a price downturn, emerging risks concerning security or health issues, a crisis diminishing the buyer’s available budget, or new entertainment trends, for instance. In the tourism industry we consider substitutes –in most cases- those other tourism sectors that may satisfy the same or similar needs. For instance, we consider that two ski resorts are competitors, but a rural villa or a golf resort is a potential substitute as long as it satisfies the need for vacation. Other conventional substitutes could be residential tourism with relatives or friends, or activities related to the entertainment industry. However, sometimes the substitutes may come from technological industries, such as videoconference services in the case of business tourism.

How would you assess the power of substitutes in the tourism industry?

 

BP9 The 5 Competitive forces: Rivalry among competitors

Competitors’ rivalry may be shown through much evidence, such as advertising campaigns, new product launches, price discount campaigns, product or service improvements, etc. The extent to which rivalry affects the industry’s profitability depends upon the intensity of the competition and the basis of the competition.

The intensity of rivalry is greater when:

  • There are a large number of competitors, or many of them are similar in size.
  • The slow industry growth intensifies the fights for market share.
  • Participants have industry leadership aspirations beyond economic performance, and so they have a passionate commitment to their business. This happens sometimes in the great international events, which are not profitable themselves but foster the reputation of the destination.
  • Different business models measure performance in different ways due to different strategic goals, and so it is difficult for them to monitor their rivals’ evolution, success and chances to gain market share. A diversity of rivals with different cultures, histories and philosophies make an industry unstable. There is greater possibility for mavericks and for misjudging rival’s moves.
  • Strategic stakes (investments) are high when a firm is losing market position or has potential for great gains. Over the last decade there has been a process of concentration affecting most of the major tour operators throughout Europe, taking advantage of the market growth.
  • Industry shakeout. The industry may become crowded if its growth rate slows and the market becomes saturated, creating a situation of excess capacity with too many goods chasing too few buyers. A shakeout ensues, with intense competition, price wars, and company failures.

 

  • Significant increase of the used production capacity increases offer and hence competition.
  • High exit barriers. This happens in some businesses with very specific assets that cannot be resold for other purposes, thus making it imperative to compete to recover the investment.

The dimensions in which rivals compete and the extent to which they compete in the same dimensions have a significant impact on the industry’s profitability. Rivalry is especially harmful to profitability when it is focused on price competition, as this pushes the prices down and favors only the customers. Price competition also makes the customers overlook other product features and focus only on price. Price competition is more likely to take place when:

  • Product differentiation is low (and there are few switching costs for buyers).
  • The overheads are high and the variable costs are proportionately low, pushing the prices down in some cases to near the marginal costs. This happens especially in the low season.
  • There needs to be a significant increase in capacity to make the business profitable.
  • The perishability of the product forces the price down to what the market is willing to pay, which in some cases is ridiculous. Over the last years there has been a trend to market the vacant rooms or packages through specialized “last minute” channels.

When the competition is based in other dimensions such as product differentiation, design, or branding, profitability is less likely to be damaged, as the competition drives rivals to innovate in creating more value for the customer, which is actually likely to end up pushing the prices up rather than cutting them. Further, value based competition builds barriers to entry and makes the potential substitutes less attractive or suitable.

Stronger rivalry occurs when competitors aim for the same positioning in the market, focusing on the same dimensions and so are trying to satisfy the same needs for the same targets. This usually ends up in a zero-sum competition, not increasing the profitability.

Rivalry turns into a positive sum –increase the industry’s average profitability- when each participant focuses on different targets, offering different products and services adapted to the target segment’s needs, with different features, different value added services, different branding, different price mix, etc. In this case, so long as the companies’ products satisfy better the clients’ needs, they build more barriers to entry, differentiate from substitutes and so they can also charge higher prices and increase their margins, increasing the business profitability. It is the challenge of the strategist to shift the nature of competition towards segmentation and differentiation in order to increase and secure profitability.

Industry rivalry may be measured by the Concentration Ratio (CR), indicating the percentage of market share held by the four largest firms in the industry. With only a few firms holding a large market share, the competitive landscape is less competitive (closer to a monopoly). A low concentration ratio indicates that the industry is characterized by many rivals, none of which have a significant market share. These fragmented markets are said to be competitive.

If rivalry among firms in an industry is low, the industry is considered to be disciplined. However, a maverick firm seeking a competitive advantage can displace the otherwise disciplined market. The intensity of rivalry commonly is referred to as being cutthroat, intense, moderate or weak, based on the firms’ aggressiveness in attempting to gain an advantage.

In the tourism industry, there are two key trends that favor value based rivalry: market segmentation and leverage of the destination’s cultural identity to build more powerful brands.

However there is a considerable market for price sensitive customers, and once in the destination there is usually plenty of information about all accommodation and services choices, in which the price is one of the most visible features. Massive tourism destinations tend to compete on a price based type of rivalry.

To gain advantage over rivals, a destination may choose among several strategic moves:

  • Developing new products
  • Improving their segmentation strategy
  • Using the distribution channels more creatively to gain awareness and offer attractive deals
  • Developing a cost advantage to lower prices
  • Improving other aspects related to the destination’s competitiveness

How would you measure rivalry between destinations?

 

BP10 Factors to consider when analyzing the industry profitability

Beyond analyzing the five competitive forces that shape the industry structure and its long term profitability, there are other factors that are usually analyzed but also overvalued as key indicators when estimating long term profitability. These are the following:

Industry growth rate. A usual mistake is to overestimate the importance of industry growth. This only means that the industry business is going to grow in volume, but not necessarily in profitability. It only occurs so long as there are few or no entrants and the incumbents manage to develop further economies of scale as a result of the business volume increase. But still, many other forces play a decisive role in shaping profitability.

Innovation. In Tourism this refers mostly to business model and product innovation. Even if new technologies are developed to optimize operational efficiency, this is rarely a significant advantage for a destination, mainly because new technologies are developed by third party players –not tourism operators- and therefore the technology is soon available to all operators.

Government. To properly assess the influence of government policies in the industry, it is convenient to analyze how every policy affects each of the competitive forces.  In the tourism industry, the government plays a decisive role, being the owner of key infrastructures, the license/permit provider either for the construction of facilities or for the exploitation of cultural or natural resources as tourist attractions, responsible for the planning of the territory and quite often also responsible for the marketing of the territory as a tourist destination.

Complementary products and services. Some products or services are consumed or used along with others as a matter of need or to enhance value. Complements become relevant to the strategic analysis when they influence the demand for the industry product, and influence profitability through the way they influence the 5 forces.

The strategist should assess whether the influence of every component on every force is positive or negative, as well as to estimate the strength of such influence. For instance, complements usually directly affect the barriers to entry, depending on the nature of the complement and its relationship with the main product or service. It also tends to affect the thread of substitutes. In the tourism industry, all tourism activities requiring specific equipment (golf, ski, sailing, etc.) are subject to such complement factor, especially as they create a barrier to entry for new customers.

Complements may also affect other forces as they raise switching cost or reduce product differentiation, up to the extent that some companies enter the complement industry to alter it in their favor. This is to say that analyzing complement industries and its impact in the five forces may be an essential part of the strategist work.

Would you consider other factors?

 

BP11 Changing forces, reshaping profitability

Industry structures tend to be rather stable, though there are usually some adjustments and occasionally some radical disruptions. Change drivers may come from outside or from within the industry: technological disruptions such as the rise of internet and social media, changes in customer needs and rise of new segments, development of new business models, etc.

Shifting threat of new entry. Changes in the aforementioned barriers to entry are to shift the threat of new entrants. One of the most usual barriers to entry is the Government policy in urban planning and license concessions for building and operating tourism facilities. They are also decisive in the development and maintenance of communication infrastructures to facilitate a good accessibility to the destination. A lack of Government commitment and investment is a considerable barrier to entry for the destination’s operators.

Another common barrier to entry, at least concerning distant markets, is the flight connection. A good case study is that of the low cost airlines -namely Ryanair- that created flight connections with many unknown destinations in Europe. In this case, the Government policy is also decisive, as owner and operator of the airports in most of the cases.

Changing supplier or buyer power.  The factors influencing the bargaining power of both buyers and suppliers are to change over time in both directions. The rise of the internet as sales and communication channel and internet based business models –namely low cost airlines- changed significantly the negotiation power of many local operators in front of the tour operators, as it was much easier for the suppliers to market their services directly to the client, and these two factors also boosted the rise of FITs, who could easily organize their trip comparing many options “at a click” at very competitive prices.

However, despite the loss of market share by the tour operators, this setback was rapidly countered through a process of concentration affecting many big and middle sized tour operators to regain negotiation power in front of the destinations’ operators.

Shifting threat of substitution. The shifts in the threat of new substitutes come from new product developments that shift the price-performance comparisons between different options. In the case of the tourism industry, the rise of the collaborative business models such as Airbnb is a serious threat for the traditional accommodation suppliers. Other examples are the car sharing models taking business from the regular transportation services, and even some platform based models where locals offer special interest experiences to visitors. In all cases, non-professional services are competing with the destinations’ operators, and so are considered as substitutes rather than rivals.

Do you think of other case studies in which a force shift significantly reshaped profitability?

 

 

 

 

BP12 Understanding the forces to design strategy

Understanding the five competitive forces that shape industry’s structure is the first step in the strategy design process. Every business should understand the key factors that determine the current profitability, as well as the ones responsible for the profitability shifts at least in the recent past.

Understanding the industry structure orientates corporate strategists in finding the best opportunities and shaping the right strategies to catch them, or foreseeing threats and designing the strategies to anticipate and prevent them from harming the business.  Some of the strategic moves that the 5 forces analysis may suggest to do are the following:

Positioning the destination. This strategy is to find a position in the market where the destination businesses are better protected from the strongest forces threatening the business profitability. Furthermore, the five forces analysis may also help the businesses analyze the convenience of entry or exit in an industry. A thorough foresight analysis of an industry’s 5 forces may even spot levels of profitability that are not yet reflected in the share value of incumbents. A good case study of a destination finding its most profitable positioning is that of Macau (PRC), which positioned itself as the best destination for gambling all over Asia, and is actually the world’s number 1 destination making profits from gambling, ahead of Las Vegas.

Exploiting industry change. Industry changes are source of threats and opportunities, and so the visionary strategists have to be the first to foresee these changes and drive the business towards advantageous positions to catch the new opportunities and avoid the new threats. Structural changes may generate new needs or new ways to satisfy the current ones.

Industry leaders are more likely to overlook some of the new opportunities and may have more difficulties to change their business model due to their size constraints. So these changes are usually the opportunity of small or middle size players to grow towards industry leadership positions, thanks to the agility allowed by their smaller size.

In Europe, the boom of Ryanair as a low cost carrier operating in small airports some kilometers away from the main destinations changed the airline industry boosting the number of travelers and taking business from the tour operating industry in favor of the FITs. This benefited many businesses developing a strategy to get the Ryanair travelers, many of whom used to travel through tour operators’ packages. At the same time, many new destinations emerged, especially those near the airports where Ryanair was flying, many of whom were not so popular before Ryanair’s flights.

Shaping industry structure. Sometimes, a company manages to transform the industry structure through revamping their business model and altering the five forces. In these cases, the other industry players are somehow forced to follow this industry leader so as not to lose their market position and eventually the entire industry structure is transformed. The new industry leader reshaping the industry structure is likely to get the most benefit by reshaping competition in a way that can let its strengths shine.  The industry restructure may be carried out in two different ways: redistributing profitability among incumbents or expanding the overall profitability.

Redistributing profitability. To attract more profits to the industry it is necessary to identify the main force or forces that are most constraining to profitability and neutralize them. A firm may potentially influence any of the competitive forces.  To counter supplier power, the incumbents may standardize the features of its inputs to reduce or eliminate switching costs.

To neutralize buyer power, incumbents may offer value added services that raise customers’ switching costs, or find new channels to reach customers without the established powerful ones. To keep new entrants away from the industry, incumbents may create barriers to entry such as the marketing expenditure or the R+D budget. To reduce the threat of substitutes, companies can differentiate the product with new features or value added services to better satisfy the needs of its customers.

Expanding the overall profit.  When the “industry pie” expands all players are likely to benefit from the growth. That occurs when the industry discovers new markets to satisfy undiscovered needs that were not satisfied, or by developing new product categories that generate new demand and expand the potential market.

Overall profitability may also grow due to improved collaboration with suppliers or buyers to reduce inefficiencies. Also, agreeing on industrywide quality standards raises the reputation of the whole industry benefiting all players and allowing price raises. The distribution of the newly expanded profit pie is to be determined by the five forces. The most successful strategists will be those who manage their business to take the highest percentage of the new profits.

Continuing with the Ryanair case study, this expanded the tourism business in existing destinations and also developed many new local destinations. The low cost flights stimulated new demand both from the current outbound markets and from some new outbound markets that were not used to having international flights to travel abroad directly.

Defining the industry. It is necessary for companies operating in many industries to well define the industry boundaries, to assign every business unit to the corresponding industry and to analyze profitability and design strategy for every business unit separately. It is essential to identify when two similar products are different enough to actually play in different industries, and so they are to be separated in two business units to properly set their own strategy.

In the hotel industry, it is quite common –among large hotel operators- to create different brands depending on the segment they are operating in or targeting: business, vocational, city trip, luxury, etc.

Do you think of other case studies that showcase these strategic moves?

 

Posted by Jordi Pera

Jordi Pera is an economist passionate about tourism, strategy, marketing, sustainability, business modelling and open innovation. He has international experience in marketing, intelligence research, strategy planning, business model innovation and lecturing, having developed most of his career in the tourism industry. Jordi is keen on tackling innovation and strategy challenges that require imagination, entail thoughtful analysis and are to be solved with creative solutions.

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