Barnes & Noble and the Publishing Free for All

THE advent of blogging during the late 1990s significantly lowered the barriers to entry in the publishing industry. Any person with a computer, a blogger account and a half baked idea could get into the industry, and they did. To shake things up further, the advent of blogging reduced the cost of distribution and the price of consuming content to zero. In 2010, eBook sales almost doubled and now make up more than 9% of total consumer book sales.

Despite these significant changes to the industry and a decade of warnings from visionaries like Seth Godin, the publishing industry has been far too slow to respond. The cost structure for physical book publishing is under big pressure, and the following cost breakdown shows where the cracks have appeared:

Cost of Physical Book Publishing:
Author gets 15%
Publisher gets 35%
Distributor gets 10%
Retailers get 40%

Earlier this year a number of major brick and mortar book stores closed their doors. In the US, Borders Group filed for Chapter 11 bankruptcy protection in New York. In Australia, REDGroup Retail, the owner of the Australian book chains Borders and Angus & Robertson, was forced into voluntary administration.

And this is not the end of the story. US based Barnes & Noble and Australian based Dymocks have their heads on the chopping block and are likely to suffer a similar fate, unless significant changes can be made to their respective business models (hint: get out of the bricks and mortar book business while you still can).

If you have any thoughts on how this train wreck waiting to happen will play out, please comment below.

Understanding the Competition

“Know your [competition], know yourself and you can fight a hundred battles without disaster.”
~ Sun Tzu

YOU are running a company, advising companies or would one day like to be.  A company needs to understand its competition, and here are 11 points to help you do that.

1. Identify the competition

Who are the company’s major competitors? Taking Cadbury as an example, some of its major competitors are Lindt, Ferrero, Nestlé, Hershey and Mars.

2. Segment

Are you able to segment the competition in a meaningful way? You may be able to segment by distribution channel, region, product line, or customer segment. For example, the FOX Broadcasting Company may want to segment its competition by region. In America, some of its major competitors include PBS, NBC, CBS and ABC. In Australia, its competitors include Channel 7, 9 and 10 as well as ABC and SBS.

3. Concentration

What is the concentration of competitors in the market? That is, are there lots of small competitors (a low concentration industry) or a few dominant players (high concentration industry)? Examples of high concentration industries include oil, tobacco and soft drinks. Examples of low concentration industries include wheat and corn.

4. Size

What is the sales volume and market share of the major competitors?

5. Growth

What are the historical growth rates of the competition?

6. Performance

What is the historical performance of the competition? Relevant indicators of performance include profit margins, net income, and return on investment.

7. Competitive Advantage

What is the competition good at? What are the competition’s capabilities? How sustainable are these advantages?

What are their weaknesses? How easily can these weaknesses be exploited?

8. Competitive strategy

What are the competition’s strategic priorities? What motivates them? What are their plans? How can these plans be upset?

9. Competitive response

How will the competition respond to the company’s actions?

10. Substitutes

Are there any other products that people can use that are as good or almost as good as the company’s products? These substitute goods represent a form of indirect competition, think Coke and Doctor Pepper, Vegemite and Nutella, coffee and tea, pizzas and hamburgers, tennis and basketball. Not the same, but it may be a decent substitute.

11. Barriers to entry

Are there barriers to entry that would stop competitors from entering the market? If the market has low barriers to entry then we can expect that the market, if not already heavily contested, will soon be filled with a large number of competitors.

Barriers to Entry

You may want to launch a new product, start a new business or enter a new market. What’s stopping you?

No entry

BARRIERS to entry are costs that must be paid by a new entrant but not by firms already in the industry.  Barriers to entry have the effect of making a market less contestable and allow existing firms to maintain higher prices than would otherwise be possible.

Here are seven (7) examples of barriers to entry:

1. Economies of Scale

The existence of economies of scale in an industry creates barriers to entry. Since existing firms are already producing they are often better position to exploit economies of scale than a new entrant and, as such, can often undercut on price. A new entrant is forced either to accept the cost disadvantage or enter the industry on a large scale (which increases the likely financial loss if they are later forced to exit the industry).

2. Product Differentiation

If there is a high level of product differentiation in the industry then this creates a barrier to entry since new entrants will not be able to compete merely on price, but will need to provide a unique value proposition.

Brand recognition: If existing firms and products have strong brand recognition that will deter new entrants. If customers perceive existing products as unique or high quality then a new entrant will need to spend money to educate customers about the unique qualities and benefits of its new products.  This will increase the cost of gaining market share and deter entry into the market.

Customer service: If existing firms have strong customer relationships formed through strong customer service and customer loyalty programs then it may be difficult for new entrants to gain market share.

Network Effects: The term “network effect” refers to the situation where a product or service becomes more valuable as more people use it. One example is eBay; as more buyers use the online auction site it becomes more valuable to each seller, and as more sellers use the site it becomes more valuable to each buyer.

If existing products or services in the industry benefit from network effects then it may be difficult for new firms to enter the industry.

Product differences: Existing products in the industry may be different due to differing design, quality, benefits, and other features.

3. Capital Requirements

High start-up costs: High fixed start-up costs will deter new firms from entering an industry. Examples of capital intensive industries with high fixed costs include the automotive and telecommunications industries.

High sunk costs: If a large portion of the start-up costs cannot be recovered (i.e. they are sunk costs) then the new entrant risks having to absorb the loss if it decides to exit the industry. Examples of sunk costs include:

  • Specialised assets: Highly specialised technology or equipment that cannot be used for other purposes and which cannot be sold (or can only be sold at a massive discount).
  • Industry specific expenditure: Industry specific expenditure, such as marketing or R&D, which cannot be used to benefit the firm’s operations in other industries.

4. Intangible Assets

Proprietary product technology: The existence of proprietary product technology represent a barrier to entry. If an existing product is protected by patent then it will not be possible for a new entrant to use the patented technology without permission from the patent owner.

Specialised knowledge: Incumbents may possess specialised knowledge, skills or qualifications which are difficult and costly to acquire: e.g. legal or medical skills.

5. Access to Suppliers and Buyers

Access to raw materials: If a new entrant cannot gain access to raw materials then this represents a barrier to entry. If existing firms have exclusive long term contracts with suppliers (or existing firms own key suppliers) this will make it difficult for a new entrant to obtain the raw materials it needs to operate effectively in the industry.

Access to distribution channels: If a new entrant cannot gain access to distribution channels then this represents a barrier to entry. If there are a limited number of wholesale or retail distribution channels, or existing firms have exclusive long term contracts with distributors then this will make it difficult for a new entrant to reach the customer. For example, McDonalds has stores in the best locations which makes it more difficult for new entrants to compete.

6. Government Regulation

The government may limit or restrict entry into a market by imposing licencing requirements or controlled access to raw materials.

Market participants may require a licence or other government approval in order to carry on its business; examples include taxi licenses, safety standard compliance certificates, mining permits, or investment approvals.

In extreme cases, the government may make competition illegal by establishing a statutory monopoly. For example, AT&T had a statutory monopoly in the telecommunications industry in the United States until the early 1980s.

Note that government regulations that limit or restrict the activity of all industry participants would not be considered as barriers to entry. For example, tariffs or quotas that apply equally to incumbents and new entrants would not be a barrier to entry.

7. Competitive Response

A potential entrant’s expectations about how existing firms will respond to market entry by a new player will affect their entry decision. If a potential entrant reasonably expects, or irrationally fears, that existing firms will competing aggressively then this may deter entry.

Expectations of a strong competitive response from incumbents will be higher where:

  1. Industry growth is slow, which means the industry will not be able to absorb a new entrant without incumbent firm profitability being hurt.
  2. Incumbents have a lot of fighting potential including large cash balance, strong cash flow, unused credit facilities, or clout with government, distribution channels and customers.
  3. Incumbents are likely to cut prices due to industry wide excess capacity or a desire to retain market share.

Porter’s Five Forces Analysis

The Porter’s Five Forces framework is used to determine the competitive intensity and attractiveness of an industry

Porter's Five Forces

HARVARD Business School professor Michael Porter, in his 1979 book Competitive Strategy, developed the Porter’s Five Forces.

The Porter’s Five Forces framework is used to determine the competitive intensity and attractiveness of an industry. Attractiveness in this context refers to the overall industry profitability. You can use this framework when introducing a new product, expanding into a new market, divesting a product line, acquiring a new business, or assessing the cause of declining sales or profitability.

In determining the competitive intensity of an industry, Porter’s Five Forces include three forces from ‘horizontal’ competition (1, 2 and 3), and two forces from ‘vertical’ competition (4 and 5):

  1. Existing competition: How strong is the rivalry posed by the present competition?
  2. Barriers to entry: What is the threat posed by new players entering the market?
  3. Substitutes: What is the threat posed by substitute products and services?
  4. Supplier bargaining power: How much bargaining power do suppliers have?
  5. Customer bargaining power: How much bargaining power do customers have?

Porter's Five Forces

1. Competition: How strong is the rivalry posed by the present competition?

The intensity of competition in an industry is affected by various factors, including:

  1. The number of firms in the industry, the more firms the stronger the competition because there are more firms competing for the same customers;
  2. Slow market growth leads to increased competition because there is only a small number of new customers entering the market each year, firms must compete to win existing customers;
  3. Where firms have economies of scale, that is they have relatively high fixed costs and low variable costs, the more they produce the lower their per unit costs become. This results in more intense rivalry between firms as they compete to gain market share;
  4. Where customers have low switching costs, this intensifies competition as firms compete to retain their current customers and steal customers from other firms;
  5. Low levels of product differentiation between firms leads to increased competition. Where a firm has a strong brand name or a highly differentiated product, this reduces the intensity of competition;
  6. Diversity of competition (for example, firms from different countries and cultures) reduces the predictability and stability in the market.  Uncertainty in the market leads firms to compete more agressively, thereby driving down firm profits in the industry;
  7. High exit barriers increase competition because firms that might otherwise exit the industry are forced to stay and compete. A common exit barrier is where a firm has highly specialised equipment that it cannot sell or use for any other purpose; and
  8. An industry shakeout will result in a short period of intense competition. Where a growing market induces a large number of new firms to enter the market, a point is reached where the industry becomes crowded with competitors. When the market growth rate slows and the market becomes overcrowded, a period of intense competition, price wars and company failures ensues.

2. Barriers to entry: What is the threat posed by new players entering the market?

In theory, any firm should be able to enter a market, however, in reality industries often possess characteristics that prevent new players from entering the market (barriers to entry).  Barriers to entry reduce the rate of entry of new firms, thus maintaining the level of profits for those firms already in the industry.

Barriers to entry may exist for various reasons, including:

  1. high capital costs of setting up a business in a particular industry;
  2. where an industry requires highly specialised equipment, potential entrants may be reluctant to commit to acquiring specialised assets that cannot be sold or converted into other uses if the venture fails;
  3. lack of the proprietary technology or patents that are needed to become a player in the industry;
  4. extensive scale and branding of existing competitors may prevent potential entrants from gaining market share and hence deter entry into the market;
  5. government regulations: Government may regulate to prevent new firms from entering an industry. It might do this because of the existence of a natural monopoly. A natural monopoly is an industry where one firm is able to produce the desired output at a lower social cost than could be achieved by two or more firms (social costs being the sum of private and external costs). Natural monopolies exist because of the existence of economies of scale, and examples include railways, water services, and electricity; and
  6. Individual firms may have economies of scale. The existence of such economies of scale creates a barrier to entry because an existing firm can produce at a much lower cost per unit than a new firm.

3. Substitutes: What is the threat posed by substitute products and services?

Economics defines substitute goods as goods for which an increase in demand for one leads to a fall in demand for the other. In the Porter’s Five Forces framework, a reference to a substitute good refers to a good in another industry. For example, natural gas is a substitute for petroleum.

Good A and good B are substitutes if they can be used in place of one another (at least in some circumstances). The existence of close substitutes constrains the ability of a firm to raise prices and, as the number of substitutes increase, the quantity demanded will become more and more sensitive to changes in the price level (i.e. price elasticity of demand for the product increases).

The threat posed by substitute goods is affected by various factors, including:

  1. the cost to customers of switching to a substitute product or service (switching costs). For example, the cost of switching between the Windows operating system and Apple operating system might be prohibitive because computer programs and accessories are built to work with one operating system or the other;
  2. buyer propensity to substitute;
  3. relative price-performance of substitutes; and
  4. perceived level of product differentiation.

4. Supplier bargaining power: How much bargaining power do suppliers have?

Suppliers are providers of the inputs to the industry, for example, labour and raw materials. Factors that will effect the bargaining power of a supplier include:

  1. The number of possible suppliers and the strength of competition between suppliers;
  2. Whether suppliers produce homogenous or differentiated products;
  3. The importance of sales volume to the supplier;
  4. The cost to the firm of changing suppliers (switching cost);
  5. The presence of substitute inputs; and
  6. Vertical integration of the supplier or threat to become vertically integrated. Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers. For example, a car manufacturer may also own a tyre manufacturer.

5. Customer bargaining power: How much bargaining power do customers have?

Customers are the purchasers of the goods or services produced by the company.  Factors that will effect the bargaining power of a customer include:

  1. The volume of goods or services purchased. If the customer purchases a significant proportion of output, then they will have a significant amount of bargaining power;
  2. The number of customers. The fewer customers there are, the more bargaining power they will have to negotiate price. For example, in America the market for defence equipment is a monopsony, a market in which there are many suppliers and only one buyer. As such, the Department of Defence has strong bargaining power to negotiate the terms of supply contracts;
  3. Brand name strength. A product that has a stronger brand name will be able to be sold for a higher price in the market;
  4. Products differentiation. A firm that produces a product or service that is unique in some way will have more bargaining power and will be able to charge a higher price in the market; and
  5. The availability of substitutes.

[For more information on consulting concepts and frameworks, please download “The Little Blue Consulting Handbook“.]