The intensity of the rivalry amongst the firms in a given industry will have an effect on the profits of all firms within that industry. Within an industry, when firms are fiercely competitive, the cost of competition will increase because when one firm acts, other firms will feel the need to counteract. Costs for advertising and promotions, profits lost through price reductions, and competitive rivalries occurring over the research and development of new products will erode the profits of competing firms.
The firms within an industry are likely to be plagued by similar problems. One common problem that entrepreneurs prefer to avoid is associated with industries with high fixed costs. High fixed costs are common in manufacturing, communications, and transportation industries. When a product is encumbered by a high fixed cost, the firm will usually make every effort to recover at least a portion of those fixed costs and may resort to offering buyers a range of incentives, from drastic price cuts to rebates, to move the product. These incentives are often met with a swift competitive response on the part of industry competitors. These competitive actions can drive all profits out of the industry.
A problem accompanying, or similar, to high fixed costs can be found in mature industries. When industry growth slows, competition typically heats up. This occurs because the firms within the slow growth industry are competing for the same pool of buyers and often that pool of buyers is in decline. Again, the competitive actions taken by firms to attract this pool of buyers will drive profits out of the industry.
Rivalry also intensifies when consumers see little differentiation between the products offered by firms within an industry. For example, few consumers see the difference between various brands of ketchup and are likely to simply purchase the brand that has the lower price. When consumers see little difference between products within an industry, these products become known as commodities. As expected, rivalry between US ketchup makers Heinz and Hunt’s is intense.
High fixed costs, industry maturity, and commodity-like products contribute to a high-level of competition within an industry, but there are often other factors that drive competition. The entrepreneur needs to study and understand the industry and if possible, avoid industries where the level of competition is high as this means the profit potential is low. Still, the entrepreneur may identify an under served niche or a need that the entrepreneur is uniquely qualified to fill, in which case entry into the industry may be profitable for the entrepreneur.
In comparison, firms that are highly differentiated from their rivals often are not engaged in strong competition because these firms know that their product is meeting a need for their consumer base and their customers are going to return to fulfill that need.