- About the five forces model
- Bargaining power of suppliers
- Bargaining power of buyers
- Threat of substitutes
- Threat of new entrants
- Intensity of competitive rivalry in the industry
Caterpillar Inc is the leading manufacturer of construction and mining as well as a large range of other heavy equipment used across various industries. The company has earned a strong reputation industry-wide through a consistent focus on innovation and product quality. It was founded in 1925 and has expanded its business worldwide to 192 countries. The company’s leading position in the industry is a result of its dedication to quality and customer satisfaction. It sells its products worldwide through a network of 161 independent dealers (as of 2020).
The company experienced a significant decline in revenue in 2020 mainly due to the pandemic which caused end-user demand to decline. The supply chain disruption and work stoppage caused by the pandemic led to a swift decline in user demand industry-wide. The level of competition in the industry has grown. There are a large number of big and small companies worldwide that compete with Caterpillar. Caterpillar is investing in automation and innovation to grow its operational efficiency, market share, and customer base.
This is a five forces analysis of Caterpillar Inc. The five forces analytical model is one of simplest and most widely used analytical tools that helps companies analyze the impact of competition and other prominent forces and develop strategies to mitigate the impact and grow the firm’s competitive edge.
What is the Porter’s Five Forces Model?
In a 1979 article titled How Competitive Forces Shape Strategy, published in the Harvard Business Review, Michael E Porter noted regarding this model that the collective strength of these five forces finally determines the profit potential of any industry; and it can range from intense to mild. The profit potential grows as these forces grow weaker. For example, weaker bargaining power of buyers and suppliers can result in higher profits for the business.
In each industry, a different force may grow more prominent compared to the others. Porter offers three examples in his HBR article. In the ocean-going tankers industry, the buyers are the most prominent force, whereas, in the tires industry, it is the powerful OEM buyers and the tough competitors that are more prominent compared to the other forces. On the other hand, foreign competitors and substitutes are the most prominent forces in the steel industry.
In Porter’s words,
“Every industry has an underlying structure, or a set of fundamental economic and technical characteristics, that gives rise to these competitive forces. The strategist, wanting to position his or her company to cope best with its industry environment or to influence that environment in the company’s favor, must learn what makes the environment tick.”Michael E Porter in his HBR article, How Competitive Forces Shape Strategy.
Let us take a look at how these forces work in the heavy equipment industry and how Caterpillar can best mitigate the possible negative impact of these forces.
Bargaining power of suppliers :-
Suppliers can enjoy higher bargaining power in the following cases:
- When the supplying industry is dominated by a few companies and is more concentrated than the industry it is selling to.
- If the supplier sells unique or differentiated products or has built up switching costs.
- It is not obliged to contend with other products for sales to the industry or the level of competition against the supplier’s products is too low.
- In the case of forward integration, the supplier can become a threat to the firm it sells to.
- If the industry is not a significant customer for the firm or if the industry does not generate significant revenue for the supplier.
For Caterpillar Inc, its suppliers’ bargaining power is low to moderate, mainly because the suppliers are smaller firms scattered over various market regions. Caterpillar does not depend heavily on individual suppliers for raw materials. Another factor that reduces the bargaining power of suppliers is that the heavy equipment industry is a major buyer which grows the dependence of supplier firms on large buyers like Caterpillar.
There is heavy competition among the suppliers as well since small firms have to compete among themselves to become supply chain partners for notable companies like Caterpillar. So, the company is able to set standards for its suppliers. In this regard, the company is at a significant advantage as an industry leader and enjoys significant bargaining power compared to its suppliers that do not pose any credible threat of forward integration either.
Bargaining power of buyers:-
The bargaining power of buyers and buyer groups can be higher in the cases listed below:
- Buyer groups can be powerful and hold higher bargaining strength if they are concentrated and buy in larger volumes.
- The products the company sells are just standard or undifferentiated or if the buyer poses a threat of backward integration.
- If the buyers earn low profits or they are highly price sensitive.
In the case of Caterpillar, its buyers enjoy moderate bargaining power. The company produces heavy equipment mainly for use across various industries and its buyers are mainly industrial players in construction, mining, and other industries. Construction, mining, energy, and transportation industries are among the leading buyers for Caterpillar Inc. Since most of them are medium-sized or large companies it gives them a little extra bargaining power.
However, several factors help Caterpillar mitigate the bargaining power of customers, including its differentiated products and technologies, brand image and equity, innovation, and product quality. The switching costs can also be high for the customers and since Caterpillar is the leading manufacturer of some equipment, it offers Caterpillar extra leverage. It holds a strong competitive edge over its rivals in several areas, which gives the company extra bargaining strength.
While some buyers can be price sensitive, a large number of Caterpillar customers are more concerned about productivity rather than prices. It is mostly true about the customers in the emerging economies where customers consider the prices of equipment before making their purchasing decisions. In the developed economies, productivity and other factors that make the costs of ownership of equipment over its lifetime lower are given a priority. Caterpillar also uses its bargaining strength to charge premium prices from customers. Overall, the bargaining strength of the customers remains moderate.
Threat from substitute products:-
The threat from substitute products mainly comes from the products made by rival brands. The leading rivals of Caterpillar include John Deere, Komatsu and Hitachi. Apart from these, there are several more rivals in the global market including large brands like Hyundai as well as several more big and small local brands in various markets.
In the case of Caterpillar, the threat from substitute products is moderate. The threat from substitute products becomes higher in the cases where the price-performance trade-off offered by substitute products is more attractive. However, the factor that helps Caterpillar against rivals and substitute products is the upgraded quality, product differentiation and marketing. Caterpillar is known industry-wide for its quality products that offer higher productivity and superior performance. Apart from these things, the marketing strategy of Caterpillar also plays a key role in helping the company battle the threats from substitute products. The overall threat from substitute products is moderate. It is because several of the leading competitors of Caterpillar are also well known names in the industry and produce high quality products.
The Threat of New Entrants:-
According to Michael E Porter, the threat from new entrants is magnified in cases where the barriers to entry are low and there is a minimum threat of retaliation from the existing players in the industry.
In Porter’s words:
New entrants to an industry bring new capacity, the desire to gain market share, and often substantial resources. Companies diversifying through acquisition into the industry from other markets often leverage their resources to cause a shake-up, as Philip Morris did with Miller beer… The seriousness of the threat of entry depends on the barriers present and on the reaction from existing competitors that entrants can expect. If barriers to entry are high and newcomers can expect sharp retaliation from the entrenched competitors, obviously the newcomers will not pose a serious threat of entering.Michael E Porter
For Caterpillar, the threat from new entrants is minimized due to the high barriers to entry and the threat of retaliation from the existing players. The leading and established players focus on maintaining their market share. Apart from investing in research and development, they also invest in marketing and customer relationship management to retain their market position. The other leading brands in the industry include John Deere, Hitachi, Komatsu, and more.
The barriers to entry in this industry are also high. Any new player can enter with a large investment and to grow into a global brand requires a focus on product quality, innovation, marketing, technology, and qualified human resources. The required know-how also acts as a barrier for any new entrant trying to become an influential player in the industry. Some companies have entered the fray at a small scale in local markets in various parts of the world but then, they are not able to bite into a large chunk of Caterpillar’s market share and they are not any major threat to Caterpillar’s growth and market position either. Apart from everything, ensuring access to good quality raw material is also an important barrier for businesses trying to enter the industry on a very large scale. So, overall the threat of new entrants for Caterpillar is very low.
Intensity of competitive rivalry in the industry:-
The intensity of competitive rivalry in the industry has grown higher due to several factors including an increased focus on innovation of the leading brands as well as growth in the opportunities of marketing and branding for large businesses due to the proliferation of digital technology.
The number of competitors of the company is very high and while some of them are large and established industry players like John Deere, Komatsu, and Hitachi, the list of competitors of Caterpillar is quite extensive and includes several smaller players too that have significantly improved their presence in their local markets.
The factors that help the company beat the competitive pressures include high level of differentiation, higher switching costs, the premium quality of Caterpillar products and the company’s marketing.
However, the level of competition among the existing players is still very high since the exit barriers are very high. So, the firms will still compete among themselves even when the situation is very tough. Acquiring growth in this scenario requires Caterpillar to remain focused on innovation and product quality. Technology-based product differentiation also helps it keep the competitive pressure under control.