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Industry analysis

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  • 1. INDUSTRY ANALYSISIntroduction Porter’s five forces´ model of industry competition is used to inspect a competitiveenvironment and establish a firm’s possible profits. The model uses five competitive forcesthat determine a particular firm’s capability to compete. The chocolate and cocoa industrycan use the five forces´ model as an analytical tool to determine the competitive market. Thefive competitive forces used in the model are threat of new entrants, bargaining power ofbuyers, bargaining power of suppliers, threat of substitute products, and intensity of rivalryamong competitorsThreat of New Entrants The threat of new entrants is a competitive force that determines how easily a firm’sprofits can be lowered because f new competitors in the industry. There are six barriers thatdetermine the risk of new entrants. These include economies of scale, product differentiation,capital requirements, switching costs, access to distribution channels and cost disadvantagesindependent of scale .Economies of scale reduce the per-unit cost of a product as the numberof units being produced increases. The chocolate and cocoa industry does have a significanteconomy of scale entry barrier because large companies existing the industry that has highproduction output, which reduces the cost to produce chocolate and cocoa. If a newcompetitor wanted to enter the market, the company would have to enter the marketproducing a large quantity at the same low price as competitors or the company would haveto compete with a cost disadvantage. Because economies of scale exist in the industry, itdeters smaller competitors from entering into the market and reduces the threat of entrants.In addition to economy of scale, product differentiation is another entry barrier in thechocolate and cocoa industry. There are many competitors in the industry that haveremarkably identifiable brand names and customer loyalty. Some of the strongestcompetitors in the industry are Hershey Foods Corporation, Farley Candy Company,World’s Finest Chocolate, Inc., Merckens Chocolate Company, and Ghirardelli ChocolateCompany. All of the companies have established brand names and customer loyalty, whichcreates a considerable entry barrier for new companies. Thus, the new company mustincrease spending to overcome the reputation and large customer base of the existingcompanies.Another entry barrier is the presence of large capital requirements that are required in thechocolate and cocoa industry. Large capital requirements create an entry barrier for newentrants because it requires the company to have a significant source of capital to get started.The large capital investment entails costs for items such as production equipment, labor,raw materials, and research and development. In addition to these costs, a new companywould need to spend a large amount of money on advertising and marketing to overcomeproduct differentiation. An example of the large capital requirement needed for production isGrace Cocoa’s new production plant that cost $95million dollars .It would be difficult for anew company to enter the market because of this significant need for capital. Furthermore,
  • 2. switching cost create a barrier to entry for new companies entering the chocolate and cocoaindustry. Switching the supplier of chocolate’s raw materials such as cocoa beans, sugar, andmilk create additional testing and research that must be completed by the company to ensurecorrect quality, safety and taste. Additionally, the expense and network that must be presentto obtain access to distribution channels is an entry barrier for new companies. A newcompany must acquire distribution channels for their chocolate and cocoa products. Thisrequires the company to create a network of buyers, which is time and money intensive.Further, the new companies have to compete for shelf space in stores with the larger playersin the industry that have existing distribution channels already established. Costdisadvantages independent of scale such as patents, favourable access to raw materials,government subsidies and polices create barriers of entry for new companies. Because theindustry produces food for the end consumer, companies in the industry must meet severalgovernment standards. For these companies, the Food and Drug Administration is thegovernment agency that sets the guidelines and regulations. These regulations increasebarrier to entry for new companies in the chocolate and cocoa industry. There is a low threatof new entrants in the chocolate and cocoa product industry because the existence ofeconomy of scale, the differences in products, the need for large capital requirements, theexistence of switching costs, the lack of access to distribution channels, and the regulationsthat are in place for food manufacturers.Bargaining Power of Buyers The bargaining power of buyers is a competitive force that can result in lower pricesfor a product and increase the quality of service, which decreases profits and increases costsfor the industry. Buyer’s power increases if large volumes of the product are purchased, theproduct is undifferentiated, few switching costs exist, low profits are earned, backwardintegration is possible, and the quality of the buyer’s product is not affected by the supplier’sproduct. If a buyer represents a large percentage of the supplier’s sales, the buyer has morebargaining power over the supplier. The chocolate and cocoa industry has several largevolume retailers, like Wal-Mart, that have significant bargaining power. These large volumeretailers can bargain for lower prices and reduce the industry’s profits. Another conditionthat affects the power of buyers is product differentiation. If the product is undifferentiated,the buyer has the power to play competitors against each other and reduce the cost. Thechocolate and cocoa industry has a differentiated product, which reduces the power ofbuyers. The industry has several large players that have brand identification and customerloyalty, which makes it hard for buyers not to use a particular supplier. The lack ofswitching costs also increases the power of buyers in a particular industry because the buyercan threaten to change suppliers if they are not getting an adequate price or service from thesupplier. The buyer’s switching costs in the chocolate and cocoa industry is moderate tohigh. Specifically, the industry’s industrial-use buyers have significant switching costsbecause the supplier’s product can change the flavour or texture of the buyers’ product. If thebuyer wanted to play competitors against each other, the buyer would have to extensivelytaste test different recipes for different products. In addition, the buyer’s customers may react
  • 3. poorly to new flavours, forcing the buyer to switch back to the original supplier. The highswitching costs decrease the power of buyers in the chocolate and cocoa industry.Furthermore, if the buyer earns low profits on products they sell, they are more price-sensitive. This causes buyers to shop around the industry and create more bargaining power.The chocolate and cocoa industry’s buyers usually make low profits on the products theysell, forcing the buyer to lower purchasing costs. This gives the buyer more power in theindustry. However, the buyer must be willing to accept taste changes in the product, whichrestricts their bargaining power. The buyer can gain power if they pose a threat of backwardintegration. If a buyer can successfully become his or her own supplier, the bargainingpower of the buyer increases. Both retail buyers and industrial-use buyers are limited whenposing a threat of backward integration because the ability to produce chocolate and cocoaproducts requires significant capital investment and other barriers to entry. This lack of threatreduces the buyer’s bargaining power. Buyers are able to increase bargaining power if thequality of their product is not affected by the industry’s product. When it is unimportant tothe buyer’s product, the buyer is able to be more price-conscious. The industrial-use buyer ofthe chocolate and cocoa industry relies heavily on the industry’s input product. The inputproduct directly affects the quality and taste of the buyer’s end product. This dependencydecreases the buyer’s bargaining power. The bargaining power of buyers is increased bytwo factors: a number of large volume buyers and the buyers’ relatively low profits from theproduct. However, the bargaining power of buyers is low to moderate because of the industry’s differentiated products, the presence of switching costs, the lack of threat ofbackward integration and the reliance on the industry’s product.Bargaining Power of Suppliers The bargaining power of suppliers is a competitive force that can diminish a firm’sprofitability by raising prices or reducing the quality of the supplier’s product. In manyinstances, the profitability is reduced such that the firm cannot recover from raw materialexpenses. The six conditions that increase a supplier’s power are a concentratedsupplier group, no substitute products available, industry is an unimportant customer to thesupplier, supplier’s product is essential to the industry’s business, supplier’s product isdifferentiated, and justifiable threat of forward integration .If the industry’s suppliers areconcentrated, then the supplier has more bargaining power over the industry. The suppliersof the chocolate and cocoa industry have significant bargaining power over the industrybecause of the limited number of these suppliers. Because the cacao tree is grown in areasthat have a tropical climate, many players in the industry are forced to import the product.Tropical climates are often at risk for natural disasters, such as hurricanes, which candramatically reduce the number of suppliers. In addition, civil unrest in areas that grow thecacao tree can have an adverse affect on the amount of suppliers to the industry. Thebargaining power of the industry’s suppliers is increased because of the limited number ofthese suppliers. In addition to concentrated suppliers, the supplier groups’ bargaining poweris increased if there are no substitute products that they must contend with in the market.Because the cocoa bean is a required ingredient in chocolate and cocoa industry, the
  • 4. suppliers do not have any substitute products for which they must compete. This lackof substitutes increases the bargaining power of the chocolate and cocoa industry’s suppliers.The bargaining power of a supplier is increased if the industry is not an important customerof that supplier. The chocolate and cocoa industry is an extremely important customer of itssupplier group. The cocoa bean is an important export of the countries that produce thecocoa bean. The bargaining power of the suppliers is reduced because of the importance ofthe chocolate and cocoa industry as a customer. Another condition that enhances thebargaining power of the supplier group is the dependency of the industry’s product on thesuppliers’ product. The chocolate and cocoa industry relies on suppliers to deliver highquality products that meet food regulations and consumer taste tests. If the suppliers’ productis not available or does not meet the quality expected, the industry will suffer greatly. Thisdependency on the suppliers’ product increases the suppliers’ bargaining power. Thebargaining power of a supplier group is increased if the product they supply is differentiatedor has switching costs. If differentiation or switching costs exist, then the industry has limitedability to increase the competition among the suppliers. The chocolate and cocoa industryhas moderate differentiation among their suppliers. It is important for the suppliers¶ productto be a certain quality or grade; however, if the product meets grade guidelines, it isrelatively undifferentiated. This is true of all suppliers of the industry including cocoa bean,milk, and sugar suppliers. Additionally, the bargaining power of a supplier is increased if thesupplier can threaten to forward integrate. If the supplier can become a producer ofchocolate and cocoa products, then it can increase its bargaining power. Suppliers to thechocolate and cocoa industry do not pose a reasonable threat of forward integration. Aspreviously stated, the threat of entrants into the industry is low. The suppliers would have tospend a significant amount of money in research and development, capital requirements,and obtaining customer contacts. They would also have to overcome strong industry leaderswho have significant brand identification and customer loyalty. The lack of threat of forwardintegration decreases the bargaining power of suppliers. The bargaining power of suppliersis decreased because the industry is an important customer of the supplier group and thesupplier does not pose a threat of forward integration. But the bargaining power of suppliersis moderate to high because the supplier group is concentrated; there are no substituteproducts, and the importance of the supplier’s product to the industry.Threat of Substitute Products and Services The threat of substitute products is a competitive force that can set a ceiling on theprice the industry can charge for their product. If there are substitutes available to theconsumer, an industry’s potential returns are limited. One ratio that can be used to measurethe threat of substitute products is the price-performance ratio .The chocolate and cocoaindustry must compete with numerous substitute products that can threaten the industry’sprofitability. Alternate cooking flavours are a substitute product to chocolate and cocoa.These flavours include vanilla, lemon, butter, or mint flavour. These flavours can be used bythe industry’s customers that use chocolate and cocoa products for industrial and cookinguse. Another significant category of substitutes is snacks. Many non-chocolate snacks are
  • 5. available, such as peanut butter, fruits, potato chips, ice cream, etc. There is no need to stickwith a specific snack other than personal preference. Further, many consumers considerchocolate unhealthy and are willing to substitute it readily. In addition to flavour and snacksubstitute products, the chocolate and cocoa industry must compete with substitute productsin the retail arena. Specialty chocolate and cocoa products are used as gifts during numerousseasons and celebrations including Christmas, Easter, Halloween, Valentine’s Day,anniversaries and birthdays. Other types of gifts during these seasons are viewed assubstitute products. These products are flowers, fruit, jewellery and stuffed animals. All ofthese products can be purchased instead of chocolate and cocoa products. Many differentcooking flavours, a hugely diverse selection of alternate snacks, and a wide variety ofseasonal gifts make the threat of substitute products high in the chocolate and cocoa industry.Intensity of Rivalry among Competitors in an Industry The final competitive force of Porter’s five forces model is the intensity of rivalryamong competitors in an industry. This competitive force can create price wars, advertisingbattles, new product lines, and higher quality of customer service. There are sixcircumstances that intensify rivalry: many balanced competitors, a slow growing industry,high fixed or storage costs, undifferentiated products or no switching costs, large incrementsof capacity, and high exit barriers. An industry’s competitor rivalry is increased if there arenumerous competitors or if the competitors are equally balanced. This condition can create astrain on raw materials and consumer groups. The chocolate and cocoa industry hasnumerous industry leaders that are similar in size and product offerings. Many of the leaderscreate new product lines and actively participate in advertising wars. Because there arenumerous competitors that are equally balanced, competitor rivalry is increased. In additionto numerous competitors, slow industry growth increases the intensity of rivalry amongcompetitors. Because the market is growing slowly, companies in a slow industry mustcompete for market share in order to increase sales. The chocolate and cocoa industry is amature market that is growing slowly. This slow growth increases the rivalry amongcompetitors in the chocolate and cocoa industry. Another condition that increases theintensity of rivalry among competitors is if the industry has high fixed or storage costs. Iffixed costs are high, firms in an industry are under pressure to increase capacity. Thechocolate and cocoa industry has both high fixed costs and high storage costs. Theindustry’s fixed costs consist of large amounts of equipment and huge facilities to housemanufacturing operations. Although the industry consists of perishable food sandingredients, which typically have a short shelf-life, the storage costs are high due to theprecise storage environment needed. For example, both milk and chocolate must be kept at aproper temperature and humidity. Lack of differentiation or switching costs is acircumstance that increases the intensity of competitor rivalry in an industry. If the industry’sproduct is not differentiated, buyer’s base their purchasing decision purely on price or qualityof service. Likewise, if no switching costs are involved, buyers can play competitors againsteach other and obtain a lower price. The chocolate and cocoa industry does have many
  • 6. companies that offer iconic brands which are differentiated. The industry’s buyers mustsacrifice specific taste to switch products. In addition, the industry’s industrial-use customersrely heavily on a certain brand of the industry’s product to produce the customer’s productwhich increases switching costs. The differentiated product and moderate switching costsreduce the intensity of rivalry among competitors in the chocolate and cocoa industry. Thehigh exit barriers factor also determines the degree of rivalry among competitors in anindustry. If an industry has particular assets, high fixed costs associated with exit, strategicrelationships among the particular business unit and others within the same firm, emotionalbarriers, and other pressures from a social point or government aspect; then the firms in theindustry may compete, despite low earnings. The chocolate and cocoa industry has high exitbarriers that increase the intensity of rivalry among the industry’s competitors. The industryrequires specialized assets that would be difficult to recover upon exit. In addition tospecialized assets, the chocolate and cocoa industry has several companies that may havesocial pressures not to exit the industry. These high exit barriers increasecompetitor rivalry. Although the chocolate and cocoa industry has partially differentiatedproducts, the industry’s intensity of rivalry among competitors is high. The industry hasnumerous, equally balanced competitors, is slow growing, has high storage and fixed costs,and has high exit barriers. All of these conditions create price wars, advertising battles, newproduct lines and higher quality of customer service in the chocolate and cocoa industry.