POERTER FIVE FORCES

Brendan Analysing the competitive environment The Five Forces Framework of Industry Analysis BP: An analysis using the Five Forces Framework Industry Rivalry British Petroleum (BP) operates in the energy industry. There are only a small number of firms within the energy industry. This is an oligopoly market there are a small number of producers enjoying a large market share. The oligopoly market structure is a fundamental driver of BPs profit maximising operation. BP and its rivals are able to make abnormal profits due to the market structure in which they compete. There is mutual interdependence between companies in an oligopolistic market structure. BPs main competitors are; Exxon Mobile, Total SA, Chevron, ConocoPhillips and Royal Dutch Shell. BP are able to make abnormal profits similar to the way that monopolist operate. A firm like BP may not be fully efficient; however they remain able to survive due to high barriers to entry in an oligopoly market. Bain (1956) described barriers to entry as factors which allow established firms in an industry to earn supernormal profits without attracting entry. An oligopoly structure is characterised by high interdependence between rivals. The decisions of BP are heavily based upon the decisions of their competitors. So how does BP remain competitive in the market if they cannot take market leadership? Part of the answer lies with the dependency of competitor decisions and an inability to take a cost leadership strategy. The danger of taking this type of strategy could induce a price war and reduce profits. If BPs rivals decrease fuel prices then BP will probably lower their price to avoid losing customers. However if a firm decides to raise prices then its rivals will be reluctant to follow. This is why prices are considered to be sticky as prices tend to be resistant to change. Sticky price levels can be explained by a kinked demand curve developed by Hall and Hitch and Sweezy (1939), shown in figure 1.1. The kink is at price P. Any increase in price above P will result in a more than proportionate fall in quantity demanded as consumers will buy from other firms who have not increased their price. Above the price P the price elasticity demand is higher and more elastic. A decrease in price below P demand becomes inelastic and less susceptible to a change in demand. Due to the tight oligopoly market BP compete in it appears that BP they could be colluding with their competitors on prices. The products they sell are very homogenous, the price elasticity of demand is low and there are very high barriers to entry, making for ideal conditions for collusion. Oligopolists are circular dependent (Lipczynski and Wilson 2001). The degree of transparency regarding price is high, which enables BP and its rivals to consistently match the price of a leading member. Scherer 1996 describes this as collusive price leadership. By colluding on prices it is possible to earn abnormal profits. The leader acts as a barometer, whose price announcements reflect market supply and demand conditions (Scherer 1996). I (an oligopolist) cannot define my best policies unless I know You (my rival) are going to do; by the same token, however, you cannot define your best move unless you know what I will do (Asch 1964, p.54). Threat of new entrants

The mining, oil and gas industry is one of the most profitable. The Global 500 ranks BP the 4th most profitable. So why are there only a number of firms in the energy industry enjoying abnormal profits and total market share? Earning high profits generally attracts new entrants, however new entrants may experience barriers to entry stopping them from entering the market. There are no barriers to entry in perfect competition markets, new firms can set-up and leave with relative ease. It is not as simple for new firms to set-up in an oligopolistic market. There are several barriers to entry preventing firms from doing so. Bain describes barriers to entry as factors which allow established firms in an industry to earn supernormal profits without attracting entry. One of the largest barriers to entry for new firms is the large amount of capital required to set-up in the industry illustrated by figure 1.2. The cost to a new firm would be much higher than the average costs of existing firms. Another barrier to entry is BPs vertically integrated structure. They are involved all the way along the supply chain, from locating oil deposits, drilling and extracting crude, refining into petroleum products, distributing and selling at BP owned retail outlet franchisees, further denying access to new entrants. They are able to make profits along the supply chain, called upstream and downstream profits. Vertical integration exclusions can be classed as restrictive practice, such as limit pricing price strategies (Lipczynski and Wilson 2001). Economies of scale prevent new entrants gaining access into the market. BP is an established, global organisation in the industry which able to source, extract, refine and distribute petroleum at a greatly reduced cost compared with a small start-up firm setting up from scratch. At higher levels of output a vertical integrated firm such as BP can specialise in factors of production over the entire product life cycle, from the exploration and extraction of oil (upstream) to distribution refining and selling petrol (downstream) to consumers through many of their own retail outlets. Trade barriers are lower in the fuel retail market. At first approximation fuel retailers appear to fall into the monopolistic competition category Scherer (1996). However, it is important for retailers to understand the actions of their rivals. Machlup describes fuel retailers in a local area as chain oligopolists. Petrol is an inelastic good, a large change in price will not change quantity demanded. In order to reduce the uncertainty with pricing, fuel retailers collude on prices. This helps them to gain the best profit and may help to avoid one retailers losing out.

For example, imagine there are two retailers A and B on opposite side of the road. If A drops its fuel price, B will loose out if he does not mirror the price of A. Selling fuel at the lower price will result in both A and B making less profit. By colluding on a set price, it is possible for both A and B to not loose out. This is called duopoly tacit collusion and is similar to Cournots model of oligopoly. There is however, the temptation for one firm to break the rules, or cheat by lowering price below the agreed level in order to gain competitive advantage over rivals, which may lead to a price war. The threat of new entry seems in the oil market seems unlikely in the short term. There are a handful of extremely large petroleum and energy companies who dominate the industry which benefit from economies of scale, vertical integration and very high barriers to entry. The industry resembles a monopoly as rivals co-operate to enjoy monopoly style profits, further restricting new entrants. Perhaps the threat of new entrants may present themselves with the development of new fuel technologies as gradual fossil fuel demand declines. With ever increasing pressure from government and pressure groups, coupled with the depletion of world oil reserves, eventually there will be a shift

from oil consumption as supplies run out and new fuel alternatives become a more attractive. Figure 1.4 shows the extraction of crude oil as we move into the long run. The price will rise gradually over time as supply dries up. Aware of this problem, BP in 2007 selected the University of California, Berkley to lead a $500 million energy research programme. The programme will develop new sustainable technologies for BP. By diversifying BP will continue to a main player in the industry moving into the long run. BP has also pledged to invest another 500 million over 10 years to fund bioscience research programmes for new and cleaner energy development. Threat of substitute products Oil is a scarce commodity that is greatly in demand. The world depends on oil and currently there are not many viable substitutes for oil currently available. With large countries such as China and India rapidly expanding the problem is only going to get worse. The current alternatives for fuels include; coal, LPG (Liquid Petroleum Gas) both fossil fuels and hydrogen (which requires the use of fuel to produce). Beyond these alternatives there is wind power, solar power, geothermal power and nuclear power. BP Many of the substitutes for petroleum such as LPG are already distributed by BP. BP seem well prepared for any potential threats from potential innovative firms entering the market, partly because BP have large amounts of investment already in research and development. Bargaining power of buyers and suppliers Consumers buy petroleum products from BP owned fuel retailers. The retailers purchase their fuel from BP, who extract and refine crude from several of their own locations around the globe. Effectively BP has no suppliers, as they supply themselves, although they are at the mercy of the market price of oil. The price oil is determined by the supply of oil, mainly from the cartel of OPEC the worlds 13 largest oil producing groups. By working as a cartel the oil producing countries (who rely heavily on oil revenues), can manipulate the price of oil by increasing or decreasing the supply of oil. BP is forced to sell petroleum to its retailers at the market price which in turn is passed on to consumers. The price of oil affects the whole supply chain. BP and other competitors make larger profits when the price oil is high, when the price of oil falls, generally consumers benefit from lower prices at the pump and oil producers make smaller profits or possibly loses. Figure 1.5 illustrates a rise in prices when supply is restricted by oil suppliers. The bargaining power of consumers as buyers is very limited. They are at the mercy of the chain oligopolist retailers who collude on prices, following barometric price level on the basis of the market price leader. Although BP is a large firm they are small in comparison with large oil producing countries such as Saudi Arabia. Principle countries such as Saudi Arabia are in a position to take dominant firm price leadership. They are able to do this by collaborating with the OPEC cartel adjusting output levels to keep prices high. This is called joint profit maximisation, although there can be a tendency for countries within the cartel to cheat or increase output in order to make more money. The cartel pricing strategy works well if all players stick to the rules and supply the correct quantity agreed by the cartel. This is illustrated by figure 1.6. The cartel enjoy price PCartel at the quantity QCartel. If a player decides to cheat and produce more oil he can secretly sell more oil at quantity QCheat and at a reduced price PCheat. Countries breaking the rules may get away with it for awhile, however eventually the market will respond to the extra output and a reduction in the price of oil will

result.

Government The role of government plays an important role in controlling the amount of profits received from sales of petroleum. Windfall taxes were introduced by the labour government in 1997 on utility and energy companies such as BP in an attempt to reduce the growth of the recently privatised industry (BBC News [online] 31 January 2008). During 2007 the price of a barrel of oil reached $147. Companies such as BP recorded a 6% rise in profits. Unions called for a windfall tax on BP and other producers. BP argued that they already are one of the largest taxpayers (BBC News [online] 29 July 2008). BP also argued that the price of oil is set in the relatively free market. Others say that even OPEC can do little about the control on oil prices anymore. Limitations using the Porters Five Framework There are many external forces that affect the competitiveness within a market. Competitiveness varies in different markets. Porters Five Forces model helps organisations understand industry structure and shapes the rivalry that results from competing in different structures. It is important for firms to know and understand market structure in which they operate (Worthington et al 2001). An analysis of BP using the five forces framework presents a number of problems. The model does not consider the macroeconomic environment, especially as BP is a global player. Political and legal issues need to be considered. What is the current legislation concerning cartels, monopolies and foreign trade regulations? Similarly economic and technological changes are very important for a company such as BP, always looking toward the long term. A prime example of economics factors affecting BP is the current economic downturn which has drastically reduced the demand for oil and company profits. Although the oil industry currently appears to be a relatively stable for profitability, there is no doubt that eventually there will be a shift from oil. Jergin identifies a change may come in the form of a major technological breakthrough in alternate energy production or perhaps from an environmental crisis, diminishing oils importance. Either way Porters framework fails to identify some of these key issues. If used correctly the model can be used very well, although if use wrongly, without considering underlying forces, then it could be meaningless.

References

Jergin, D., 1992. The Prize: The Epic Quest for Oil, Money and Power. New York: Touchstone. Lipczynski, J. and Wilson, J., 2001. An Analysis of Competitive Markets. Harlow: Financial Times Prentice Hall. Scherer, F. M., 1996. Industry Structure and Public Policy. New York: Harper Collins. Worthing, I. Britton, C. and Rees, A., 2001. Economics for Business. Harlow: Financial Times Prentice Hall.

Websites Anon., Fortune 500 Website, Most Profitable Industry [online], Available from: HYPERLINK "http://money.cnn.com/magazines/fortune/fortune500/2008/performers/industries/profits/"http://mo ney.cnn.com/magazines/fortune/fortune500/2008/performers/industries/profits/[Accessed 17 Feb 2009]. Anon., 2008, BBC News, Q & A: Windfall tax on Shell [online], Available from: HYPERLINK "http://news.bbc.co.uk/1/hi/business/7219685.stm"http://news.bbc.co.uk/1/hi/business/7219685.stm [Accessed 17 Feb 2009]. Anon., 2008, BBC News, Higher oil price boosts BP profit [online], Available from: HYPERLINK "http://news.bbc.co.uk/1/hi/business/7530213.stm"http://news.bbc.co.uk/1/hi/business/7530213.stm [Accessed 12 Feb 2009].

SWOT Analysis Of British Petroleum (BP)

Participates in London Stock Exchange, IPO in New York Stock Exchange. and is listed in the FTSE 100 Index;

BP Amoco strong brand loyalty for oil; Strong brand management driven by the Beyond Petroleum slogan. BO Q3 net profit increase by 83% due to record oil and gas prices. The indicator amounts to $53.43 per share compared to $21.27 during the same period in 2007.

Weaknesses
Launch of controversial business with the Baku-Tbilisi-Ceyhan pipeline; Increase in petrol prices in the UK; Explosion of BP refinery in Texas that caused 100 injuries and 15 deaths in 2005; Criminal charges due to the spread of 270.000 gallons of crude oil in the Alaskan tundra in 2006; Toxic spill of 2,000 gallons of methanol in the oil field (Prudhoe Bay) managed by BP. Closing of Alaskan oil wells.

Opportunities
8 b. USD investment in the research of alternative fuel methods, including hydrogen, natural gas, wind and solar over the forthcoming decade; Expansion of frontier areas suitable for BPs future reserves (post-Soviet Union territories); Extension of strategic oil and gas acquisitions in North Sea area; Launch of more flexible price policy to compete main rivals;

Threats
Environmentally unsound policies due to oil and toxic spills; Occasional refinery explosions; Corrosion in pipelines; Competition from Shell and Chevron Ceasing operations in a number of potential locations with their further re-branding (Conoco); Sale of corporate-owned stations; More than 5.000 shortages within coming months;

$66,71 per barrel creates considerable tensions for running oil business;

Free SWOT Analysis Example On ExxonMobil

Strengths
A long established name that has been in existence for over one hundred years. This gives the customers a sense of security when dealing with the organization. The organization has diversified into many different areas of the energy industry and has many strong brands under its main umbrella group. The organization in the past has been able to survive without much damage to its reputation even after the Exxon Valdez oil spill. This is partly due to a few reasons, the good corporate citizenship of the organization, the correct and appropriate crisis management and crisis communication management strategy. The organization has been innovative in the past and continues to be very innovative currently too by spending a lot on research and development to come up with more efficient and effective ways to manage the energy resources and reduce the negative impact to the environment. The organization has a global presence and thus has access to a wider customer base and a larger market than other energy companies. The organization has a very strong presence in both India and China, the emerging markets that have been known to increase their energy demands exponentially thus the organization has been profiting from this at a higher rate than most other organizations.

Weaknesses
The organization has been accused of not doing enough to go green and conserve the environment, rather that it is polluting and destroying the environment. There has been much negative publicity generated from the Exxon Valdez spill and also the human rights or rather the employee rights records of the organization has been under a cloud, which is a significant weakness of the organization. Inappropriate handling of the environmental interest groups is a very big weakness of the organization and can be detrimental to it in the future.

Further the organization has been known for exorbitant profits in the last few years as energy prices were increasing, which gave it quite a lot of negative publicity that the organization did not handle very well and has cost it the good will of its consumers, who consider the organization to be becoming rich at the expense of the poor consumer.

Opportunities
The biggest opportunities that are available to the organization currently is the increased demand of energy by developing economies in the South Asian and South East Asian regions likes Malaysia, Indonesia, Korea and Vietnam.

Threats
The emerging economies of China and India that have been the biggest demanders of energy in the past few years are being hit by the recession in the developed economies and thus have reduced their rates of energy consumption that has caused the organization to loose out on projected levels of profit. The increased attention to the conservation of the environment has resulted in the reduction of the use of energy and energy savings and in the future this will only increase thus reducing the profitability of the organization.