Tag Archives | Pricing

Black Friday

In America, Black Friday is an event that is not only the most shopped on day during a typical year, but it also generates huge sales.

“Only in America do people trample others for sales exactly one day after being thankful for what they already have.”

~Author Unknown

Black Friday Definition

The Black Friday definition is a retail store sale that occurs the Friday after Thanksgiving – an American holiday in November. Many consider this event to be the kick-off to the Christmas shopping season. Many retailers, such as Walmart, Kohls, Kmart, Macy’s, Express, and other major retailers, open their stores in the early hours of the morning to receive the first rush of customers. Door busters, sales, huge discounts, and giveaways are all part of this event.

The History Of Black Friday

Black Friday originated in 1952 as the start of the Christmas shopping season. Because many states in the United States considered the day after Thanksgiving to be a holiday as well, retail shops realized that there were enormous amounts of potential shoppers available during this four-day weekend. But since 2005, this event has launched into record numbers for sales, shoppers, etc. For example, sales dropped for the first time since the 2008 recession in 2014. Yet, sales boasted $50.9 billion over that weekend.

Although not all states in the United States permit workers to work on national holidays or even the day after Thanksgiving, companies have broken many boundaries to take advantage of this rush of customers. Over time, retail stores and e-commerce platforms have expanded on Black Friday to include Cyber Monday. It’s become a tradition to many.

Cyber Monday

Because Black Friday became such a hit, online companies created another shopping event – Cyber Monday. It occurs the Monday after Thanksgiving and encourages shoppers to purchase more gifts and things on Monday. Originally, it was launched in 2005.

The Cost of Black Friday

While it may be tempting to join in on Black Friday specials and sales, you have to consider the cost. Remember, a sale isn’t necessarily a good sale. It has to be a profitable sale.

Some of the costs associated with Black Friday include.

How to Win on Black Friday

In order to win on Black Friday, you have to price your products for profit. Especially since you project to sell large quantities of product, you need to make sure you don’t start with a pricing problem. If you cut prices off a product that is already not profitable, then you will loose more potential profit. Before you start planning for Black Friday, make sure your pricing is in check. Click here to download our Pricing for Profit Inspection Guide.

Price for Profit During These Sales

Each sale you make has to return a profit. Therefore, you need to allocate as many costs to each good to make it easier. How much inventory do you need to push in order to turn a profit? But also, what prices are customers willing to spend? The trick with Black Friday is that since everyone is competing for the best deal, you must know what others are pricing the same product at.

Reduce DSO by Turning Over Inventory

The risk for big sales like Black Friday is that there will be some that cancel their credit card transaction for $1,800 worth of product. Because you are putting a lot of cash up front to increase inventory, you need to collect cash as quickly as possible. For example, you can offer discounts for cash only. For other pricing tips, download the free Pricing for Profit Inspection Guide to learn how to price profitably.

Black Friday

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Black Friday

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Why You Need a New Pricing Strategy

Larry is operating a lemonade stand, and he thinks that his lemonade is the most valuable drink available. Because he interprets his lemonade as highly valuable, he decides to charge $85 for a glass of lemonade. Larry wonders why no one buys his lemonade. Although he may seem highly profitable when you work out his unit economics, he has not sold a single glass of lemonade. Like Larry, you may need a new pricing strategy.

What is your current pricing strategy? For example, you may be setting the prices on your perceived value of your product/service like Larry. But have you thought about how you could price your products/services better to improve your company’s profitability?

need a new pricing strategy

What is a Pricing Strategy?

To determine if you need a new pricing strategy, you need to identify what pricing strategy you are currently using.

Often, pricing is seen as the marketing and sales department’s role. But as the financial leader’s role morphs into a value adding position, you must work with every department (including marketing/sales) to be able to squeeze profits from every corner of the business.

The Variety of Pricing Strategies

When you are looking for a new pricing strategy, you should assess the different types of pricing strategies and the reasons for picking a one over another. Some of the more common pricing strategies include neutral, penetration, forward, skimming, and value-based. Although there are other strategies that we could dig into, these are among the most popular.

Neutral Pricing Strategy

The first pricing strategy that companies can use is the neutral pricing strategy. As the most common strategy, businesses price their products or services so that their customers are indifferent between a competitor’s product and yours. After taking into account all the features and benefits of the product, the price is set – essentially making you neutral in the pricing game.

While this may seem intelligent, it makes it difficult to expand your customer base as they have no real reason to choose your product over another of the same price. There is no value expressed in the neutral pricing strategy – thus, limiting the profit capabilities.

If you want to gain more profit margin, neutral pricing strategy is a safe (and ). To price your product or service correctly, download our Pricing for Profit Inspection Guide whitepaper!

Penetration Pricing Strategy

If you want to be more aggressive than the neutral pricing strategy, you may want to choose the penetration pricing strategy. This strategy is used to gain market share, but it has several drawbacks. For example, price wars can start between competitors. Because you don’t want to lose your market share, you may be tempted to lower your prices. But your competitors will likely lower their prices as well to compete for their customers. If you continue to lower your prices, your margin will be squeezed until you are unprofitable.

Grocery stores most commonly use the penetration pricing strategy. Most recently, Amazon acquired Whole Foods (a traditionally expensive grocery store chain) to compete with other grocery stores such as Walmart, Target, Kroger, and other local stores. As Whole Foods slashes their prices, stock prices in major grocery stores have declined in anticipation of them having to reduce their prices to compete. It’s too soon to see the result of implementing a penetration pricing strategy; but unless these stores gain more customers or offer other profitable products, they will become less profitable.

Forward Pricing Strategy

Like the penetration pricing strategy, a forward pricing strategy focuses on the future costs associated with that product or service. Companies are willing to price below cost of goods sold at first if they know that in the future, they will have higher margins. If a company cannot predict that if they sell X units by Y date, then having a forward pricing strategy may not be the best strategy for your business.

If you need a new pricing strategy, you need to think about pricing for profit. Download our Pricing for Profit Inspection Guide to learn if you have a pricing problem and how to fix it.

Skimming Pricing Strategy

Converse to the penetration pricing strategy, skimming pricing strategy allows companies to segment the market to gain access to those customers who are willing to spend more per unit. Most commonly, a company utilizes skimming at two different periods in the product life cycle, the beginning and the end of the product’s life.

Apple’s Skimming Pricing Strategy

For example, businesses that are in a semi-monopolistic positions use the skimming pricing strategy when launching the product. Think of the iPhone. Apple set their prices for the iPhone high as they were only wanting to sell to those customers with the willingness and ability to pay. As that small market depletes or slows down, Apple reduces their prices to sell to the next tier and then the next. Recently, Apple released the next generation of iPhones – iPhone 8 and iPhone X. If you’re looking to access the iPhone 8 with 256GB, expect to pay $849. You can get the iPhone X for $1,149 with the same storage as the iPhone 8.

If you look at the prices of each of their products, expect to pay 2-3 times as much for a similar product compared to other competitors. So how are they so successful? Apple has created a culture in which people are willing to spend a large amount to remain in the Apple community. Unfortunately, not every company will be able to replicate Apple’s pricing strategy. But it’s important for you as a financial leader to study what other brands are doing in regard to pricing.

Value-Based Pricing

Ask yourself this question: How much is your customer willing to pay for your product or service? There is a price that your customer is willing to pay for something without having any knowledge to how much it costs to produce or anything else. Value-based pricing is the next pricing strategy. While implementing this strategy is not simple, you can potentially gain more profit than using any other pricing strategy available.

In business school, students are taught to use the cost-plus method. Instead of adding value with their product, business leaders simple decide on the margin that they would like to have. There’s no real thought process in cost-plus pricing, but it is an easy way to bypass your customer and be in sync with your competitors.

For example, Apple has created a value for its products. They didn’t decide on a margin, but instead established such a perceived value that people cannot wait to get their hands on the next product. Some have converted all their technology over to Apple because of that added value. It’s not going to be the cheapest technology on the market and may not even be the best. But the customer is willing to pay for it at the price Apple has set. According to CNN, Apple is worth $750 Billion so they are doing something right!

need a new pricing strategyWhy You Need a New Pricing Strategy

Unfortunately, your company may be pricing your products or services too low (or too high). And your customers are not buying. You may need a new pricing strategy. Ask yourself some of the following questions:

  • When did you last interview your customers about your pricing?
  • When did you review your pricing strategy last?
  • Have you ever tested your pricing on different groups?
  • Which markets have you not be able to get into yet?

Pricing is the basis of your business and is the most important factor in profitability. If your company is solely relying on something other than pricing to improve profitability, you may need to assess why.

Buttress The Business

As you decide if you need a new pricing strategy, assess whether your pricing is a buttress of the business. We can agree on the fact that businesses exist to provide real value. Your business should be structured to support and validate the reason for the price per unit (and the value provided). McKinsey & Company highlights that most businesses do not pay enough attention to their pricing!

Most businesses fail to test customer value perceptions and price sensitivity after products launch and have no idea how the critical trade-off between price and volume shifts over time. Second, companies must make pricing decisions in the context of their broader product portfolios because when they have multiple generations of a product in a market, a price move for one can have important implications for others.

Increase Profitability

Price Intelligently references to a “landmark study [that] was published in a 1992 Harvard Business Review by Michael Marn and Robert Rosiello, both senior pricing folks at McKinsey and Company. The dynamic pricing duo studied the unit economics of 2,463 companies and found that a 1% price improvement results in an 11.1% increase in operating profit, which compares to 1% improvements in variable cost, volume, and fixed cost only resulting in profit increases of 7.8%, 3.3%, and 2.3% (respectively)” Having a value-based pricing strategy will improve your profitability. If you are looking to drive more profits this next quarter, you need a new pricing strategy. To learn how to price for profit, download our Pricing for Profit Inspection Guide.

need a new pricing strategy

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need a new pricing strategy

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Supplier Power (one of Porter’s Five Forces)

See also:
Supplier Power Analysis
Porter’s Five Forces of Competition
Threat of New Entrants
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry

Supplier Power Definition

In Porter’s five forces, supplier power refers to the pressure suppliers can exert on businesses by raising prices, lowering quality, or reducing availability of their products. When analyzing supplier power, you conduct the industry analysis from the perspective of the industry firms, in this case referred to as the buyers. According to Porter’s 5 forces industry analysis framework, supplier power, or the bargaining power of suppliers, is one of the forces that shape the competitive structure of an industry.

The idea is that the bargaining power of the supplier in an industry affects the competitive environment for the buyer and influences the buyer’s ability to achieve profitability. Strong suppliers can pressure buyers by raising prices, lowering product quality, and reducing product availability. All of these things represent costs to the buyer. Furthermore, a strong supplier can make an industry more competitive and decrease profit potential for the buyer. On the other hand, a weak supplier, one who is at the mercy of the buyer in terms of quality and price, makes an industry less competitive and increases profit potential for the buyer.

Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces, such as it being a buyer’s market.

Supplier Power – Determining Factors

The supplier power Porter has studied includes several determining factors. If suppliers are concentrated compared to buyers – there are few suppliers and many buyers – supplier bargaining power is high. Conversely, if buyer switching costs – the cost of switching from one supplier’s product to another supplier’s product – are high, the bargaining power of suppliers is high. If suppliers can easily forward integrate or begin to produce the buyer’s product themselves, then supplier power is high. Supplier power is high if the buyer is not price sensitive and uneducated regarding the product. If the supplier’s product is highly differentiated, then supplier bargaining power is high. The bargaining power of suppliers is high if the buyer does not represent a large portion of the supplier’s sales. If substitute products are unavailable in the marketplace, then supplier power is high.

And of course, if the opposite is true for any of these factors, supplier power is low. For example, low supplier concentration, low switching costs, no threat of forward integration, more buyer price sensitivity, well-educated buyers, buyers that purchase large volumes of standardized products, and the availability of substitute products. Each of the four mentioned factors indicate that the supplier power Porter’s five forces emphasize is low. To help determine the level of supplier power in your industry, start by performing an external analysis. This tool will easily help you determine the level of all of Porter’s Five Forces. Download the free External Analysis whitepaper by clicking here or the image below.

supplier power

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Markup Percentage Calculation

See Also:
Margin vs Markup
Margin Percentage Calculation
Retail Markup
Gross Profit Margin Ratio Analysis
Operating Profit Margin Ratio Analysis

Markup Percentage Definition

Define the markup percentage as the increase on the original selling price. The markup sales are expressed as a percentage increase as to try and ensure that a company can receive the proper amount of gross or profit margin. Markups are normally used in retail or wholesale business as it is an easy way to price items when a store contains several different goods.

Looking to price for profit? Download your free Pricing for Profit Inspection Guide now.

How to Calculate Markup Percentage

By definition, the markup percentage calculation is cost X markup percentage, and then add that to the original unit cost to arrive at the sales price. The markup equation or markup formula is given below in several different formats. For example, if a product costs $100, the selling price with a 25% markup would be $125.

Gross Profit Margin = Sales Price – Unit Cost = $125 – $100 = $25.

Markup Percentage = Gross Profit Margin/Unit Cost = $25/$100 = 25%.

Sales Price = Cost X Markup Percentage + Cost = $100 X 25% + $100 = $125.

One of the pitfalls in using the markup percentage to calculate your prices is that it is difficult to ensure that you have taken into consideration all of your costs. By using a simple rule of thumb calculation, you often miss out on indirect costs.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

Markup Percentage Example

Glen works has started a company that specializes in the setup of office computers and software. He has decided that he would like to earn a markup percentage of 20% over the cost of the computers to ensure that he makes the proper amount of profit. Glen has recently received a job to set up a large office space. He estimates that he will need 25 computers at a cost of $600 a piece. Plus, Glen will need to set up the company software in the building. The cost of the software to run all the computers is around $2,000. If Glen wants to earn the desired 20% markup percentage for the job what will he need to charge the company?

(Looking for more examples of markup? Click here to access a retail markup example.)

Step 1

Glen must calculate the total cost of the project which is equal to the cost of software plus the cost of the computers.

$2,000 + ($600*25) = $17,000

Step 2

Glen must find his selling price by using his desired markup of 20% and the cost just calculated for the project.The formula to find the sales price is:

Sales Price = (Cost * Markup Percentage) + Cost
or
Sales Price = ($17,000 * 20%) + $17,000 = $20,400

This means that to earn the return desired Glen must charge the company $20,400. This is the equivalent of a profit margin of 16.7%. For a list of markup percentages and their profit margin equivalents scroll down to the bottom of the Margin vs Markup page, or they can be found using the above markup formula.

Using what you’ve learned from how to calculate your markup percentage, the next step is to download the free Pricing for Profit Inspection Guide. Easily discover if your company has a pricing problem and fix it.

markup percentage calculation

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https://strategiccfo.com/pricing-for-profit-inspection-guide

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Margin vs Markup

See Also:
Gross Profit Margin Analysis
Retail Markup
Chart of Accounts (COA)
Margin Percentage Calculation
Markup Percentage Calculation

Markup vs Margin Differences

Is there a difference between margin vs markup? Absolutely. More and more in today’s environment, these two terms are being used interchangeably to mean gross margin, but that misunderstanding may be the menace of the bottom line. Markup and profit are not the same! Also, the accounting for margin vs markup are different! A clear understanding and application of the two within a pricing model can have a drastic impact on the bottom line. Terminology speaking, markup percentage is the percentage difference between the actual cost and the selling price, while gross margin percentage is the percentage difference between the selling price and the profit.

So, who rules when seeking effective ways to optimize profitability?. Many mistakenly believe that if a product or service is marked up, say 25%, the result will be a 25% gross margin on the income statement. However, a 25% markup rate produces a gross margin percentage of only 20%.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

Markup vs Gross Margin; Which is Preferable?

Though markup is often used by operations or sales departments to set prices it often overstates the profitability of the transaction. Mathematically markup is always a larger number when compared to the gross margin. Consequently, non-financial individuals think they are obtaining a larger profit than is often the case. By calculating sales prices in gross margin terms they can compare the profitability of that transaction to the economics of the financial statements.

Steps to Minimize Markup vs Margin Mistakes

Terminology and calculations aside, it is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimizes profits while maintaining a competitive advantage. Below are steps you can take to avoid confusion when working with markup rates vs margin rates:

Still deciding whether to use margin or markup to establish a price? Easily discover if your company has a pricing problem and fix it with either margin or markup. Download the free Pricing for Profit Inspection Guide to learn how to price profitably.

margin vs markup

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margin vs markup

Margin vs Markup Chart

15% Markup = 13.0% Gross Profit
20% Markup = 16.7% Gross Profit
25% Markup = 20.0% Gross Profit
30% Markup = 23.0% Gross Profit
33.3% Markup = 25.0% Gross Profit
40% Markup = 28.6% Gross Profit
43% Markup = 30.0% Gross Profit
50% Markup = 33.0% Gross Profit
75% Markup = 42.9% Gross Profit
100% Markup = 50.0% Gross Profit

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Margin Percentage Calculation

See Also:
Margin vs Markup
Markup Percentage Calculation
Retail Markup
Gross Profit Margin Ratio Analysis
Net Profit Margin Analysis

Margin Percentage Definition

Gross margin defined is Gross Profit/Sales Price. All items needed to calculate the gross margin percentage can be found on the income statement. The margin percentage often refers to sales or profitability which may help lead to several key understandings about the company’s business model as well as how successful the company is at maintaining its cost structure to gain the proper amount of sales. Analysis of margins within a business is often useful in controlling the price in which you need to sale as well as a control on the cost associated to make the sale.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

How to Calculate Margin Percentage

In this example, the gross margin is $25. This results in a 20% gross margin percentage:

Gross Margin Percentage = (Gross Profit/Sales Price) X 100 = ($25/$125) X 100 = 20%.

Not quite the “margin percentage” we were looking for. So, how do we determine the selling price given a desired gross margin? It’s all in the inverse…of the gross margin formula, that is. By simply dividing the cost of the product or service by the inverse of the gross margin equation, you will arrive at the selling price needed to achieve the desired gross margin percentage.

For example, if a 25% gross margin percentage is desired, the selling price would be $133.33 and the markup rate would be 33.3%:

Sales Price = Unit Cost/(1 – Gross Margin Percentage) = $100/(1 – .25) = $133.33

Markup Percentage = (Sales Price – Unit Cost)/Unit Cost = ($133.33 – $100)/$100 = 33.3%

Margin Percentage Example

Glen charges a 20% markup on all projects for his computer and software company which specializes in office setup. Glen has just taken a job with a company that wants to set up a large office space. The total cost needed to set up the space with computer and the respective software is $17,000. With a markup of 20% the selling price will be $20,400(see markup calculation for details). The margin percentage can be calculated as follows:

Margin Percentage = (20,400 – 17,000)/20,400 = 16.67%

Using what you’ve learned from how to calculate your margin percentage, the next step is to download the free Pricing for Profit Inspection Guide. Easily discover if your company has a pricing problem and fix it.

margin percentage calculation

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Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

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margin percentage calculation

 

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Intensity of Rivalry (one of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Threat of New Entrants
Supplier Power
Buyer Bargaining Power
Threat of Substitutes
Complementors (Sixth Force)

Porter’s Intensity of Rivalry Definition

The intensity of rivalry among competitors in an industry refers to the extent to which firms within an industry put pressure on one another and limit each other’s profit potential. If rivalry is fierce, then competitors are trying to steal profit and market share from one another. As a result, this reduces profit potential for all firms within the industry. According to Porter’s 5 forces framework, the intensity of rivalry among firms is one of the main forces that shape the competitive structure of an industry.

Porter’s intensity of rivalry in an industry affects the competitive environment and influences the ability of existing firms to achieve profitability. For example, high intensity of rivalry means competitors are aggressively targeting each other’s markets and aggressively pricing products. This represents potential costs to all competitors within the industry.

High intensity of competitive rivalry can make an industry more competitive and decrease profit potential for the existing firms. On the other hand, low intensity of competitive rivalry makes an industry less competitive and increases profit potential for the existing firms.

Conducting an competitor analysis can be overwhelming and confusing. Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces. 

Porter’s Intensity of Rivalry Determining Factors

Several factors determine the intensity of competitive rivalry in an industry.

Porter’s Rivalry Intensity Increased

If the industry consists of numerous competitors, then Porter rivalry will be more intense. Whereas if the competitors are of equal size or market share, the intensity of rivalry will increase. The intensity of rivalry will be high if industry growth is slow. If the industry’s fixed costs are high, then competitive rivalry will be intense. Additionally, rivalry will be intense if the industry’s products are undifferentiated or are commodities. If brand loyalty is insignificant and consumer switching costs are low, then this will intensify industry rivalry. Industry rivalry will be intense if competitors are strategically diverse – which means that they position themselves differently from other competitors. Then an industry with excess production capacity will have greater rivalry among competitors. And finally, high exit barriers – costs or losses incurred as a result of ceasing operations – will cause intensity of rivalry among industry firms to increase.

Porter’s Rivalry Intensity Decreased

And of course, if the opposite is true for any of these factors, the intensity of Porter rivalry among competitors will be low. For example, the following indicates that the Porter intensity of rivalry among existing firms is low:

  • A small number of firms in the industry
  • A clear market leader
  • Fast industry growth
  • Low fixed costs
  • Highly differentiated products
  • Prevalent brand loyalties
  • High consumer switching costs
  • No excess production capacity
  • Lack of strategic diversity among competitors
  • Low exit barriers

Porter’s Intensity of Rivalry Analysis

When analyzing a given industry, all of the aforementioned factors regarding the intensity of competitive rivalry Porter placed among existing competitors may not apply. But some, if not many, certainly will. And of the factors that do apply, some may indicate high intensity of rivalry and some may indicate low intensity of rivalry. The results will not always be straightforward. Therefore it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

Intensity of Rivalry is High if…

If any of the following occurs, then intensity of rivalry is high.

• Competitors are numerous

• Industry growth is slow

Fixed costs are high

• Competitors have equal size

• Products are undifferentiated

• Brand loyalty is insignificant

• Consumer switching costs are low

• Competitors have equal market share

• Competitors are strategically diverse

• There is excess production capacity

• Exit barriers are high

Intensity of Rivalry is Low if…

If any of the following occurs, then it may indicate that the intensity of rivalry is low.

• Competitors are few

• Unequal size among competitors

• Competitors have unequal market share

• Industry growth is fast

• Fixed costs are low

• Products are differentiated

• Brand loyalty is significant

• Consumer switching costs are high

• Competitors are not strategically diverse

• There is no excess production capacity

• Exit barriers are low

Porter’s Intensity of Rivalry Interpretation

When conducting Porter’s 5 forces industry analysis, low intensity of rivalry makes an industry more attractive and increases profit potential for the firms already competing within that industry, while high intensity of rivalry makes an industry less attractive and decreases profit potential for the firms already competing within that industry. The intensity of rivalry among existing firms is one of the factors to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework.

Start preparing your external analysis so you can react in realtime when the intensity of rivalry threatens your company. Don’t loose out because of an external force. Download the free External Analysis whitepaper by clicking here.

Intensity of rivalry

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Intensity of rivalry

Sources on Porter’s Intensity of Rivalry

Harrison, Jeffrey S., Michael A. Hitt, Robert E. Hoskisson, R. Duane Ireland. (2008) “Competing for Advantage”, Thomson South-Western, United States, 2008.

Porter, M.E. (1979) “How competitive forces shape strategy”, Harvard Business Review, March/April 1979.

Porter, M.E. (1980) “Competitive Strategy”, The Free Press, New York, 1980.

Porter, M.E. (1985) “Competitive Advantage”, The Free Press, New York, 1985.

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