Professional Level – Essentials Module, Paper P3
June 2008 Answers
Tutorial note: These model answers are considerably longer and more detailed than would be expected from any candidate in the examination. They should be used as a guide to the form, style and technical standard (but not in length) of answer that candidates should aim to achieve. However, these answers may not include all valid points mentioned by a candidate – credit will be given to candidates mentioning such points.
One possible approach to answering this question is provided by using Michael Porter’s five forces framework. The framework is designed to analyse ‘the structure of an industry and its competitors’ (Porter, 2004). There are five inter-connecting forces in the framework; potential entrants (the threat of entry), the bargaining power of suppliers, the bargaining power of buyers, the threat of substitutes and the competitive rivalry that exists amongst existing organisations in the industry. Each of these is now considered in turn in the context of AutoFone, focusing on those factors that have a significant effect on their industry. It must be recognised that other models might have been used in framing this answer and credit will be given for using appropriate models in the context of the AutoFone retail shops division. Potential entrants (the threat of entry)
New entrants into an industry bring new capacity and resources with which they aim to gain market share. Their entry may lead to price reductions, increased costs and reduced profitability for organisations already in that market. Potential entrants may be deterred by high barriers to entry and by the threat of aggressive retaliation from existing competitors in the industry. In the context of AutoFone’s retail sales business, the following barriers appear to be the most significant: Access to supply channels
The retail outlets of AutoFone were established before the network providers developed their own retail outlets. At the time, the network providers were sceptical that mobile phones could be sold through shops. Consequently, AutoFone was able to negotiate favourable long-term supply deals. It now seems unlikely that the network providers would sign such deals (because the new entrant will be a competitor of their own retail business) and, if they did, any deals would be at less favourable terms. As the managing director of one of the networks suggested, ‘AutoFone had got away with incredible profit margins’ when they signed the original deals in 1990. Improved supply terms would be attractive to the network provider and phone manufacturers (who would increase their profitability on each unit sold) but it would also cause profitability problems for the new entrant. Furthermore, the provision of networks is currently highly regulated, with licences still having thirteen years to run. It seems unlikely that public policy restricting the number of network providers allowed to provide services will change in the foreseeable future and so access to supply channels will remain a very significant barrier to entry. Economies of scale deter entry by forcing the new entrant to come in at such a large scale that they risk strong reaction from existing firms in the marketplace. In the context of AutoFone, these economies of scale are associated with purchasing, service and distribution of products through a large scale retail network of 415 shops. Any new entrant would have to enter at a scale that would incur relatively significant capital investment. Furthermore, evidence suggests that the AutoFone brand is well known in the market place, with consumers identifying it, in 2005, as one of the ‘top 20’ brands in the country. New entrants would not only have to fund a large number of retail outlets, they would also have to support their entry by investing heavily in ‘un-recoverable up-front advertising’ (Porter, 2004). Capital will also be...