Application of Porter’s Five Forces Model of Competition
The following figure presents the Porter’s five forces in the woven garments industry.
Rivalry among the Existing Competitors (High) -Intense rivalry propagated by barriers to exit such as heavy capital investment. -High fixed cost leads to price war as all want to run at full capacity.
-On the domestic level firms do not have high difference in their size.
-On the international level, Chinese and Indian producers enjoy a monopolistic advantage over the others which do not have domestic cotton production.
Threat of New Entrants (Low)
-Large start-up costs -Low current prices relative to high capital investments -Long time needed to pass test of quality.
Threat of Substitute Products (High) Knitwear is the main substitute product for woven garments. Over the last few years demand for knit is growing faster than woven wear.
Bargaining Power of Buyers (High) –European can buy from home textile producers of many other countries such asChina,India, andPakistan. -Due to the long-existing nature of the business, the buyers have information about cost of production
Bargaining Power of Suppliers (High for cotton but low for labor) -Domestic cotton production is very low inBangladeshcompared to its demand.
-Escalating growth in textiles and garments ofChina,India, and other countries
always keep the demand for cotton up. For example,Chinaalone eyes an increase of 77% in its demand for cotton. -Labor surplus in the country does not allow the labors ofBangladeshto bargain over wage. In the year 2005, unemployment rate is 40% (includes underemployment).
Rivalry among the Existing Competitors (High) The following woven garments industry characteristics make the industry more competitive among the existing rivals:
Existence of a larger number of firms: It increases rivalry because more firms must compete for the same customers and resources. The rivalry intensifies if the firms have similar market share, leading to a struggle for market leadership.
Slow market growth: causes firms to fight for market share. In a growing market, firms are able to improve revenues simply because of the expanding market. On the contrary on a stagnant market existing rivals struggle to survive or expand the market share. The following table provides the U.S. import in woven garments from exporting countries.
Table 5.1 US Import in Woven Garments
Product
2005
2006
2007
Apparel 71950.84774585.63071447.529Woven Garments*6.0135.5885.257 OTEXA Trade data (Values are in Mn. US $)
* Product code 9912.62
The table shows a declining import trends. U.S. apparel market is the largest export market for Bangladesh.
High fixed costs: result in an economy of scale effect that increases rivalry. When total costs are mostly fixed costs, the firm must produce near capacity to attain the lowest unit costs. Since the firm must sell this large quantity of product, high levels of production lead to a fight for market share and results in increased rivalry.
For woven garments industry the start-up cost is high. Typical minimum cost for a single line to sew parts of garments for final sewing assembly at local garment factory is as follows: Table 5.2 Start-up Cost of Woven Factories Description
Qty
Cost/Qty
Total
Sewing Machines
10
$300
$3,000
Metal Case to safe keep goods
2
$100
$200
Over Lock Machine
1
–
$600
Rent Advance – (1 room)
1
–
$1,450
1 Generator
1
–
$1,400
Transportation and Sales
–
–
$300
Deposit for Inventory of Garments & Materials
–
–
$1,400
Legal registration, Tax & TIN No.
–
–
$400
Furniture: Table & Almirah Fixture
–
–
$700
Electricity, Air conditioner & other equipment
–
–
$2,800
Phone, Computer & other communication equip
–
–
$2,200
Total
$14,450
Source: Wikipedia Search (2008)
Low switching costs: Low switching cost increases rivalry. When a customer can freely switch from one product to another there is a greater struggle to capture customers. Bangladesh, India, China, Srilanka, Nepal etc. are competing with each other for the same market. Firms’ size and structure also almost same. So, the switching cost for the buyer is very low.
Low levels of product differentiation: Woven garments industry is a industry of low levels of product differentiation. This kind of industry associated with higher levels of rivalry. Brand identification, on the other hand, tends to constrain rivalry. Over the years woven products remain the same. The main woven products of Bangladesh are shirts, trousers, and jackets, mostly made from cotton. These three products, the majority of which are woven, constitute over 40% of the total apparel export of Bangladesh. Usually buyers specify the fabric and design which make the industry of low level of product differentiation.
High exit barriers: high exit barriers place a high cost on abandoning the product. The firm must compete. High exit barriers cause a firm to remain in an industry, even when the venture is not profitable. A common exit barrier is asset specificity. When the plant and equipment required for manufacturing a product is highly specialized, these assets cannot easily be sold to other buyers in another industry. Litton Industries’ acquisition of Ingalls Shipbuilding facilities illustrates this concept. Litton was successful in the 1960’s with its contracts to build Navy ships. But when the Vietnam war ended, defense spending declined and Litton saw a sudden decline in its earnings. As the firm restructured, divesting from the shipbuilding plant was not feasible since such a large and highly specialized investment could not be sold easily, and Litton was forced to stay in a declining shipbuilding market.
A diversity of rivals with different cultures, histories, and philosophies: This makes an industry unstable. There is greater possibility for mavericks and for misjudging rival’s moves. Rivalry is volatile and can
be intense. The hospital industry, for example, is populated by hospitals that historically are community or charitable institutions, by hospitals that are associated with religious organizations or universities, and by hospitals that are for-profit enterprises. This mix of philosophies about mission has lead occasionally to fierce local struggles by hospitals over who will get expensive diagnostic and therapeutic services. At other times, local hospitals are highly cooperative with one another on issues such as community disaster planning.
Threat of Substitute Products (High) In Porter’s model, substitute products refer to products in other industries. To the economist, 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, the demand becomes more elastic since customers have more alternatives. A close substitute product constrains the ability of firms in an industry to raise prices. The competition engendered by a Threat of Substitute comes from products outside the industry. The woven garments industry is facing challenge from knit garments.
Bargaining Power of Buyers (High) The power of buyers is the impact that customers have on a producing industry. In general, when buyer power is strong, the relationship to the producing industry is near to what an economist terms a monopsony – a market in which
there are many suppliers and one buyer. Under such market conditions, the buyer sets the price. In reality few pure monopsonies exist, but frequently there is some asymmetry between a producing industry and buyers. The following tables outline some factors that determine buyer power.
Global textile & clothing industry is currently pegged at around US$ 440 bn. US and European markets dominate the global textile trade accounting for 64% of clothing and 39% of textile market. With the dismantling of quotas, global textile trade is expected to grow (as per Mc Kinsey estimates) to US$ 650 bn by 2010 (5 year CAGR of 10%). Although China is likely to become the ‘supplier of choice’, other low cost producers like Bangladesh would also benefit as the overseas importers would try to mitigate their risk of sourcing from only one country.
The key apparel market for Bangladesh and other apparel exporting countries are U.S. and EU Markets. Both the markets have the opportunity to buy from Asia, Africa or Latin America. More over the buyers are in the market for a long time due to the long-existence nature of the business. The opportunity to switch the market for low cost and knowledge about the cost of production enable the buyer with high bargaining power. The buyers are always demanding for better quality and lower costs from the garments manufacturer. The following recommendation in Bangladesh National MFA Forum conference action point depicts the immense buyers’ bargaining power over the manufacturers. “Buying practices need to be reviewed, collaboratively, to ensure that a fair price is paid for sourced products and to minimize the detrimental impact on suppliers, specifically from unrealistic delivery schedules.”
Bargaining Power of Suppliers (High for cotton but low for labor) A producing industry requires raw materials – labor, components, and other supplies. This requirement leads to buyer-supplier relationships between the industry and the firms that provide it the raw materials used to create products. Suppliers, if powerful, can exert an influence on the producing industry, such as selling raw materials at a high price to capture some of the industry’s profits.
Cotton, a key raw material in the textile and garment industry, accounts for about 30% of the fabric cost and 13% of the garment cost. Bangladesh produces cotton very low volumes. It Domestic cotton production is very low in Bangladesh compared to its demand. Escalating growth in textiles and garments of China, India, and other countries always keep the demand for cotton up. For example, China alone eyes an increase of 77% in its demand for cotton.
India has an abundant supply of locally grown long staple cotton, which lends it a cost advantage in the home textile and apparels segments. Bangladesh including other countries, like China and Pakistan, have relatively lower supply of locally grown long staple cotton. The following graph shows the cotton production and cotton required for textile and apparel by India, China, USA and Pakistan. China, USA and India ranked 1,2 and 3 in terms of production in the world market. Bangladesh produce only 15 Mn kg of Cotton where as its annual requirements is 450 Mn kg.
Labor surplus in the country does not allow the labors of Bangladesh to bargain over wage. In the year 2002, unemployment rate is 40% (includes underemployment).
Threat of New Entrant It is not only incumbent rivals that pose a threat to firms in an industry; the possibility that new firms may enter the industry also affects competition. In theory, any firm should be able to enter and exit a market, and if free entry and exit exists, then profits always should be nominal. In reality, however, industries possess characteristics that protect the high profit levels of firms in the market and inhibit additional rivals from entering the market. These are barriers to entry.
We have seen the start-up cost for woven garments is very high which made the industry unattractive in nature. There exist economies of scale also. To be competitive the factory will require a number of production lines. Such large start up cost discourages new entrants in the industry. The following table shows the growth in export is not proportional to the growth in number of woven factory. The existing firms are more competitive in terms of passing the test of quality with the buyer over a long period. So, the existing firms are enjoying incremental export opportunity.
Table 5.3Factories Growth and Export per Factory
Year
No of woven factories
% Increase in the number of factories
Avg. Export per factory
1992
756
16.13%
1.41
1993
1049
38.76%
1.18
1994
1249
19.07%
1.03
1995
1409
12.81%
1.30
1996
1552
10.15%
1.26
1997
1571
1.22%
1.42
1998
1656
5.41%
1.72
1999
1800
8.70%
1.66
2000
1899
5.50%
1.62
2001
2000
5.32%
1.68
2002
2099
4.95%
1.49
2003
2145
2.19%
1.52
2004
2181
1.68%
1.62
Source: BGMEA Research Department
