Research Proposal on "Industry Analysis Discount Variety Stores"

Research Proposal 5 pages (1504 words) Sources: 2 Style: APA

[EXCERPT] . . . .

Industry Analysis

Costco competes in the discount/variety store industry. Competition in this industry is very intense, but Costco has developed some competitive advantages that help it to perform at the highest level. One method for evaluating the competitiveness of an industry is Michael Porter's Five Forces Model. This model evaluates competitiveness based on five dimensions -- supplier power, buyer power, threat of new entrants, threat of substitutes, and degree of rivalry. Each of these dimensions is weighed and graded in terms of whether or not it is favorable to competition. The findings for of each these dimensions then contributes a determination of whether or not the industry is favorable. Favorable industries offer significant opportunities for profit and/or growth; unfavorable industries are more difficult places in which to thrive (QuickMBA, 2007)

The first dimension is that of buyer power. The buyers in the discount/variety store category are the end consumers. Buyers have no bargaining leverage -- they are price takers. Each individual buyer is a low volume customer, as the business is modeled around the low-margin, high-volume model. Costco has approximately 25.657 million customers, based on their reported membership figures (Costco 2008 Annual Report). There is strong brand identity in the industry, in particular with respect to Costco, which engenders brand identity in a variety of ways, including through membership. There is moderate price sensitivity. It is price sensitivity that drives customers to these stores in the first place, but once captive they become price takers. There is no threat of backward integration from Costco's buyers. There is no buyer concentration. There are substitutes available in the form of thousands of competitors, even outside of the discount store segment. There is limited use of buyer incentives in the industry, but with prices already low many operators in this segment do not discount further, making the segment an anomaly in retail.

While the buyers do have some flexibility with the stores from which they choose to shop, they are also brand loyal, especially with Costco. In broadening its product line into items such as furniture and appliances, Costco has eliminated the possibility of some substitutes but has thereby initiated competition with more stores. Thus, in an industry where buyers have little power, Costco has taken steps to reduce buyer power further. The only major hammer buyers have is the ability to switch to other competitors. This is a fairly significant source of power. Thus, buyer power is low-medium.

Suppliers have low power. The products that Costco sells are basic commodities, so supplier concentration is low. The volume offered by Costco is vital to a supplier. There is little differentiation of inputs. The switching costs for Costco and its competitors is typically very low; the switching costs for suppliers is high as these major accounts are difficult to come by. There is little threat of forward integration.

For almost all suppliers, this industry is critical to success. Competitors -- be they Wal-Mart, Target, Family Dollar, BJs or Costco are the major source of retail volume in the United States. Even within food products -- the bulk of Costco's business -- discount stores are a source of substantial volume. While most supplier firms would survive without the industry, that survival would be difficult for most. Because of the emphasis that firms in the discount retail industry place on driving down costs combines with the importance of volume to make suppliers price takers. They have low power.

The threat of substitutes is high. The discount segment represents one subset of the retail sector. Other subsets include grocery stores, the large drug store chains (Walgreen's, CVS), specialized retailers and online retailers. Any of those could act as a substitute for the discount stores. Each of these subsets competes on slightly different metrics but by and large they all compete for the mass market. With some, such as a big box electronics store, there is little in the way of differentiation between them and Costco.

There are low switching costs for customer to utilize a substitute to a discount store. The only real cost would be that the good in question might cost more, but even that is not necessarily the case. Buyers are inclined to substitute. The companies competing in these other sectors are some of the largest, best and most well-run retailers in the world. They are more than capable of enticing buyers. Most consumers regularly shop at these other outlets. The main point of differentiation is the price-performance tradeoff. Substitute firms and discount firms (especially Costco) compete on both the basis of price and the basis of service. The vast majority of these firms compete largely on price, sometimes on selection and ultimately service tends not to be a major differentiating factor. This increases the likelihood of switching. As a result, the threat of substitutes is high.

The threat of new entrants is high. On the surface, there are significant barriers to entry. However, history has shown that there are plenty of firms capable to knocking down these barriers. There are absolute cost advantages, and these are critical to success in this industry. There is a high proprietary learning curve. It is difficult for firms in this industry to keep their costs down. Doing so involves exceptional skills in merchandising, logistics, and purchasing. The competencies that firms like Wal-Mart and Costco have developed over the years are not easily replicable. Government policy is not a barrier to entry. Economies of scale are a barrier to entry, as they must be attained by strong growth. Companies in this sector are some of the largest in all of retailing -- economies of scale take years if not decades to build. There are tremendous capital requirements to starting in this industry. There is low brand identity. While the brands are well-known, there is fairly limited brand loyalty. Switching costs do not exist. Distribution is widely available. Retaliation is minimal -- firms in the industry compete by focusing on developing their own operational excellence.

Most of these factors would appear to erect high barriers to entry. However, firms routinely enter this industry. The largest competitor, Wal-Mart, was a regional chain in the 1980s. Costco is only 25 years old. Family Dollar has been around for decades, but has only emerged as a serious competitor in this industry in the past ten years, when 3000 of its 6500 stores were added. This has occurred because the industry has developed rapidly over that time, becoming a major segment within the retail industry as a whole. The result of this is that even though there appear to be major barriers to entry, it is not at all inconceivable that there is another Family Dollar or Costco out there, ten or twenty years away from prominence.

The degree of rivalry is moderate-high. Barriers to exit are high, since this industry's players have high fixed real estate costs and do not compete in other businesses. The industry is not yet concentration yet. The industry is growing which reduces intensity of competition. There are product differences, however. Wal-Mart, Costco and Family Dollar, for example, each have major differences in their business models. So while there may be intense competition between Costco, BJs and Wal-Mart subsidiary Sam's Club, there is little competition with firms outside the immediate competitive landscape even though they are all competing for the same dollars from the same consumers. This diversity of rivals reduces the degree of rivalry. However, the prevalence off substitutes results in fairly intense competition for customers, due to the compounding effect of having multiple industries competing for the same customers.

In summation, we have low buyer power, low supplier power, high threat of substitutes, high threat of new entrants and moderate-high degree of rivalry. The low power of both buyers and suppliers makes the industry attractive. This… READ MORE

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