Porter’s Five Forces Model of the American Automotive Industry

Abstract

The U.S. automotive industry is among the most competitive in the world. Both domestic and foreign carmakers have invested heavily to compete in this industry. With the changes witnessed over the years in this and other American industries, it remains necessary for firms to carry out a competitive strategic analysis. Porter’s Five Forces Model is the most suited as far as the dynamics of the American auto industry are concerned. This framework considers the industry’s rivalry intensity, bargaining power of buyers, the threat of substitutes, bargaining power of suppliers, and the threat of entrants. Evaluating the industry using these forces indicates that the American auto industry is significantly unattractive because of a minimal to moderate threat of entrant, high substitute threat, high buyer bargaining power, moderate bargaining power of the suppliers, and high rivalry levels. This paper summarizes the forces using information from past studies and other internet-based sources.

Porter’s Five Forces Model of the American Automotive Industry

In the 1950s, the majority of cars sold in the United States were domestically-produced. Today, it is no longer the case. More than 30 percent of the vehicles within Canada and the American market are Japanese, made in Asia but sold under the Big Three names (General Motors, Ford, and Chrysler). However, the Big Three no longer control the market as they did several decades ago. The American auto industry has made significant strides since. Companies that were the pillars of the national economy face stiff competition from domestic and foreign brands. This paper seeks to discuss the American auto industry applying Porter’s five forces model – substitutes, bargaining power of buyers, the threat of entrants, competition, and bargaining power of suppliers. The paper’s organization is as follows; the first section introduces the auto industry, focusing on the historical developments over the years. The second section focuses on porter’s five forces in analysis of the auto industry, with final remarks in the conclusion segment.

Introduction to the Auto Industry

Industry Definition

Britannica defines the automotive industry as all those companies and activities within the motor vehicle manufacturing and most of their components such as engines and bodies (Binder, n.d). Several popular products associated with this industry include passenger automobiles and light trucks, and commercial vehicles are considered secondary product types. Notably, the North American Industry Classification System (NAICS) has no formal definition of this industry. However, the Bureau of Labor Statistics calls a group of detailed industries as “automotive industry” for analysis purposes. Even though this definition is inconclusive, it includes industries affected by the changes in the production and sale of motor vehicles within the United States.

Industry Profile

The automotive industry has long retained its significant role in the economy of the United States. As late as 1980, the southern parts of America had little production activity. In the 80s, out of the southeastern states, only Georgia ranked top ten among the states with the highest production activity. The state produced over 500 thousand units, approximately 7 percent of the entire nation’s industrial production (Mayes et al., 1999). A few years later, Kentucky and Tennessee joined the most productive states. They ranked fourth and fifth, respectively. These two states together accounted for almost 900 thousand units and over ten percent of the domestic production in the period. At this particular time, Georgia’s production had declined marginally, recording over 250 thousand units.

Over the years, the southeastern parts have witnessed substantial industry growth after the new assembly facilities that shifted the manufacturing sector in the region from reliance on a low wage and low capital intensity production of nondurable goods. They created new supplier linkages that raised market pressure and became influential to the productivity and efficiency of the region. It resulted in substantial industry growth to levels that competes well on a global scale. The economic contribution of this growth is notable, with the expansion of the labor market in several southeast states. Jobs in Tennessee’s automotive parts manufacture and automobile assembly sector provided workers with income 40 percent above the average earnings on the state’s manufacturing sector.

The industry has witnessed significant changes and trends that have shaped the industry permanently. During the general economic growth experienced in the 80s, the industry’s annual after-tax rate of profit was above $5 billion (Mayes et al., 1999). However, less than a decade later, there came a recession that caused a sharp decline in automakers’ profits. Mayes et al. note that between 1990 and 1992, the industry lost over $3 billion on average annually. After the end of the recession, these profits rose sharply. By 1999, the industry had been over-stretched to its capacity by the rise in consumer demand. Since 2000, the industry has experienced a dramatic increase in competition from foreign companies. It has risked the sustainability of some known brands, such as General Motors. The government has had to come up with supporting measures to revive these companies time after time.

Industry Market Structure

From a global perspective, the global automotive industry is in the middle of a significant transition. This shift started in the 1980s, from a series of discrete national sectors to the current form that is highly integrated and more global (Sturgeon et al., 2008). According to Lung et al. (2004), the efficiency of regional patterns caused the rise in international ties in the modern industry. There is substantial market saturation and political pressures for firms to focus on their immediate environment instead of prioritizing overseas. It has resulted in massive dispersion of final assembly. Sturgeon et al. explain that the number of countries with a sizeable contribution in the industry has risen over the years. For instance, the record that in 1975, only seven countries accounted for about 80% of the global production. This number went up 11 countries in 2005.

The market experiences profound pressure from consumer preferences that often cause automakers to change the design of their vehicles to match the characteristics of a specific segment. Even though most automakers have recently focused on establishing a series of affiliated design centers in several regions unconsidered before, such as China, the heavy engineering work behind the manufacturing process remains centralized in or near design clusters close to the firms’ headquarters. As a result, it may not be plausible to conclude that the industry is yet fully global, nor is it tied to specific localities or states as some service industries (Sturgeon et al., 2008). Most automakers transfer their activities to places with lower operating costs, such as the United States South and China in Asia. Nationally, production is in a few regions labeled industrial. For timely delivery, most companies prefer to locate their plants close to the final assembly plants.

Future Outlook

Electric mobility, driverless cars, automated factories, and ridesharing are only a few disruptions witnessed in the auto industry in the United States and the rest of the world before the COVID-19 crisis. With severely altered travel schedules because of the pandemic and amid factory shutdowns, the decline in car sales, and massive layoffs, it is just an imagination of what the future of this industry will resemble. Many recent developments raise serious concerns. For instance, the COVID-19 pandemic has forced many automotive-related companies to put their workforce on short-term work during the shutdown. Operationally, industrial developments that started long ago are not getting implemented at an accelerated rate. If the automakers negate the crisis, they may gain an advantage by reimagining their operations and structures by focusing on innovation, research, and development.

The automotive future will be electric, autonomous, shared, connected, and yearly updated. Most automakers understand the trends that may influence their designs to achieve a competitive advantage and improve the brand’s sustainability. For instance, future vehicles will emit fewer exhaust fumes and noise because many firms are expanding into electric cars. The world has invested a lot in reducing emissions from the national level to specific firms’ corporate responsibility. The rapid progress made in technology, specifically artificial intelligence, machine learning, and deep neural networks, will make it possible to have autonomous vehicles in the future. Vehicle inventory will fall significantly in some markets. According to PricewaterhouseCoopers, vehicle inventory in Europe will decrease by a substantial margin. It notes that the 280 million European inventory is estimated to fall to 200 million by 2030, a 25 percent change (PWC, n.d.). For the United States, the change will be 22 percent, down to 212 million vehicles. Several other trends indicate the potential in the future of the auto industry. They necessitate a thorough analysis by market players using models such as the PEST analysis.

Porter’s Five Forces Strategy Analysis as it Applies to the Auto Industry

The intensity of competition in an industry determines the degree to which an investment gets returns and the ability of firms to sustain above-average returns. The industry’s economic and technological characteristics influence the strength of the five primary competitive forces (threat of new entrants, bargaining power of buyers, the rivalry between existing competitors, the threat of substitute products, and bargaining power of suppliers). Whether in the automotive industry or another sector, the goal of a competitive strategy is to realize a position in which the competitive forces will do the least harm to a firm. The company can take a defensive or an offensive approach. The former entails positioning in a way that offers the highest defense against the industry’s competitive forces. The latter encompasses strategies that influence the balance of existing factors in which the firm seeks to take advantage of a change before the rivals recognize it.

Bargaining Power of Buyers

In the modern competitive markets that are customer-driven, the bargaining power of buyers is critical and may influence every decision that a manufacturer makes. According to Porter (2008), the bargaining power of buyers depends on many factors, including the number of buyers in the market, the availability of substitutes, switching costs, and the contribution buyers make to the products’ total cost and quality. The power of choosing from the wide range of alternatives in the American auto market lies with the customers. Contrary to the most recent times when General Motors, Chrysler, and Ford dominated the auto industry, many new automakers have expanded considerably to the point of gaining massive market share initially controlled by these traditional brands (Anderson & Lee, 2009). Japan and America are the countries with more than one top automobile producer (DYER, 1996). In the relationship between the car manufacturers and the consumer, the power balance tilts towards the customers. They enjoy greater power because of the minimal cost of switching from one producer to another. However, the industry remains significantly powerful overall because of the large consumer to producer ratio.

Many foreign manufacturers in the country pose a threat to domestic automakers. Despite this being a force in the strategic analysis, it influences the bargaining power of buyers significantly. At times, a country like China or South Korea may produce some cheaper goods than others because of its absolute advantage. Hence, these imported cars may be inexpensive than domestically produced ones. There are differences in quality and preferences that cause some Americans to prefer domestically produced ones. It affects domestic automakers by forcing them to focus on differentiation strategies. It is this differentiation that is associated with customer loyalty to a brand. Whenever a customer associates a brand with a specific quality attribute, the elasticity of demand reduces considerably. In that case, they are more likely to pay higher prices to obtain the same product that they would get cheaply elsewhere. Therefore, the increase in the number of manufacturers and entrance of numerous foreign companies into the American auto industry has significantly raised consumers’ bargaining power to new levels, reducing the industry’s attractiveness to low levels.

Threat of Substitutes

The threat of substitutes influences the bargaining power of consumers. Car manufacturers are not concerned only about the threat of a rival’s products, but also the likelihood of the customer selecting other modes of transport, such as a train. The higher the cost of purchasing and operating a vehicle, the more likely the consumers are willing to take these alternative modes. For instance, in recent months, the cost of fuel has been rising gradually. It has indirectly increased fares in public and private means across the country, especially during the COVID-19 pandemic. Gasoline price changes can also make consumers shift to areas closer to their workplaces and avoid using cars (Safaei et al., 2021). Safaei et al. say that as gasoline price increases, most travelers change their transportation modes and reduce their frequency of using four-wheel vehicles. They might shift to trains, motorcycles, or bicycles. As far as other transport mediums are concerned, a sizeable percentage of Americans use trains and air modes. There are minimal switching costs involved in choosing a train instead of a car or taxi. This ease of choosing between different mediums again raises further the consumer’s bargaining power.

In cities like New York, a massive number of travelers use trains compared to other states. In the wake of the COVID-19 pandemic, the influence of these alternative means of transport is profound. This pandemic came with immense effects on the economy, causing many people to lose their jobs. The decline in income levels has decreased the extent to which consumers can consider the price of a commodity instead of the quality perspective. If there is a cheaper alternative, the consumers are more likely to choose it than pre-pandemic. This trend will change as the employment rate increases gradually. As far as the threat of substitutes is concerned, the auto industry’s attractiveness is low.

Bargaining Power of Suppliers

The automobile industry is labor and capital-intensive. Companies incur significant labor wage bills, material costs, and intensive practices to increase competitive power, such as advertising. Auto parts make up almost half of this industry. It encompasses the original manufacturers of different equipment and the accessories procured from various suppliers. Suppliers play a critical role in the value chain of the industry. They significantly affect lead times and product quality. In this sense, analyzing the bargaining power of the suppliers is crucial in the auto industry. Porter (2008) states that the assessment of suppliers’ bargaining power uses several critical parameters. They include suppliers’ contribution to cost and quality, the importance of the entire industry to these suppliers, and the availability of substitutes for suppliers available to the manufacturers.

There is a considerable number of auto parts suppliers in the American automotive industry. Apart from numerous suppliers in almost every car component, the automakers can shift their demand to other countries that offer cheaper auto components or whose countries have fair trading policies with America. For instance, a sizeable percentage of manufacturers get various car components from Japan and other parts of Asia. The value of Japanese auto parts exports to the American market amounts to over two trillion yen per year (Terada, 2019). The number of alternatives available to the manufacturers from large domestic suppliers to globally available sources does not extend the bargaining power to the suppliers in this industry. Thus, based on the dependence of the component suppliers on the domestically growing auto industry, the overall bargaining power of suppliers is moderate to low.

Competitive Rivalry in the Industry

The U.S. auto industry is a form of oligopoly market structure. For this reason, there is minimal price-based competition. Yet, the United States is the second-largest automotive market globally, with General Motors and Ford among the leading manufacturers by market share, alongside Toyota, Chrysler, Honda, and Hyundai. In the electric vehicle segment, Tesla is the dominant brand. It is the most successful electric car producer by far. Among the non-domestic manufacturers, Asian automakers are the most successful group in the U.S. market. The Brands that dominate this group are Toyota, Honda, Nissan, Hyundai, and Subaru. By equity, Toyota remains the most valuable brand globally. GM, Ford, and Toyota are the industry leaders when compared with their corresponding market share.

There is an intense product war in the market, with every player focusing on differentiation strategies to increase their market share. This product war is so extreme that the major players, such as General Motors, find it hard to sustain their market share. These domestic producers are facing stiff competition from foreign brands. For instance, Japanese automakers have a strict commitment to quality (Maniam, 2010). When they brought their products to the U.S., they built transplant organizations in locations outside the known industrial area of Detroit. Doing so helped them avoid union employment. The Japanese have since gained significant market share through the quality of their automobiles and have always been innovative to mitigate the consequences of fluctuations in oil prices. This focus on quality has hurt domestic automakers. For instance, a study by Barber and Darrough (1996) found that most automobile recalls in the U.S. were by domestic manufacturers. General Motors lost more than $2.9 billion due to recall announcements. Most of the competitors are enjoying a growing market share because of their minimal quality complaints. The intensity of rivalry in the industry is high, so its attractiveness is considerably low.

The threat of New Entrants

The threat of new entrants puts a maximum possible profits that other automakers can earn from the industry. This threat is dependent on some barriers, including economies of scale, capital requirements, brand identity, product differentiation, and government policies and protection. For economies of scale, an enormous amount of capital is necessary for a new firm to compete in this industry. An entrant must have extraordinary implicit and explicit knowledge to design and manufacture a product that has is not in the market. Additionally, the cost of failure and repairs for a slight mistake on these products could be devastating to small firms.

High-quality car brands, such as Tesla and Ford, have established a high brand equity value over time, which is the reason why most customers are willing to pay high prices for their products. Companies that intend to join the market could find themselves at a hard place trying to convince consumers to purchase their cars. Government policies are relatively favorable in such a period when Biden’s administration is trying to encourage growth in various industries to combat the massive decline in employment rates. However, when combined, all these factors make it almost inconceivable for a new entrant to compete with brands such as Toyota without investing substantial funds, which most entrants cannot risk. Thus, from this perspective, the industry’s attractiveness is low.

Conclusion

The United States, assisted by the increasing government policies intended to encourage growth in various industries, has experienced sharp growth of domestic and foreign car manufacturers in the recent past. Foreign manufacturers understand the opportunities of the large U.S. market and are employing research and development strategies to compete with domestic brands. The American automobile industry is experiencing a decline in demand because of the changes emanating from the COVID-19 crisis. However, even before the COVID-19 pandemic, the market has witnessed several changes that have consequently limited the sustainability of some brands, such as General Motors, causing the government to chip in and provide financial assistance. The overall attractiveness of the American auto industry presently remains low. There is minimal to a moderate threat from new entrants, little bargaining power of suppliers, considerably high bargaining power of buyers, substantially high threat of substitutes, and extraordinary rivalry intensity. Still, with the projections of the fiscal and monetary policies by the government and Congress in recent times, these trends might change to influence the industry substantially.

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