Threat of new entrants

New entrants to an industry bring new capacity and desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete. (Porter, 2008) As new entrants limit the profitability

potential of an industry, (Porter, 2008) argues, that it is the threat of entry, not necessarily the actual entry that holds down profitability.

This threat is directly dependent on the current or potential profitability of an industry, and on the present entry barriers for challengers. In the following, footwear industry’s profitability and the main entry barriers will be discussed.

5.2.2.1 Industry profitability

Excluding the barriers to entry, industry profitability is one of the main drivers of attractiveness to new entrants. Therefore, industries that generate above normal profits induce new competition, which in turn decreases the overall profitability as the number of players in the market increases.

Figure 25 puts the footwear industry’s profitability into perspective with other selected industries in the US.

As the selected industries on the graph are not exhaustive, the market average profitability is also included for comparability. The industry profitability is measured by return of equity (ROE) as of January 2014, which can be estimated by dividing the net income by the book value of equity. This measure is an excellent indicator of a corporation’s profitability as it reveals how much profit a company generates with the capital that its shareholders have invested. (Investopedia, 2014) The graph clearly indicates that the ROE in footwear industry is significantly higher than the market average, which means that it is relatively more attractive to potential entrants. The latter statement is further consolidated by ECCO’s ROE of 25,1% in 2013. It is important to note that ECCO’s ROE calculation is based on original financial statements, and is calculated as profit before minority interests divided by shareholders’ equity including minority interest. This way, the metric will reflect the performance of a consolidated company. (The Finatics Blog, 2010) Also, as seen later in competitive rivalry analysis, the historical and forecasted growth of the size of the footwear market is expanding progressively, indicating that the expected retaliation of incumbents in the market will be reduced, because newcomers are able to gain market share from the growing market.

( 6,7%) ( 0,1%)

3,6%

5,8%

6,3%

6,7%

8,0%

8,3%

9,5%

11,8%

13,1%

14,8%

15,7%

17,9%

19,7%

21,5%

24,3%

30,8%

39,5%

42,7%

( 20%) ( 10%) - 10% 20% 30% 40% 50%

Steel Educational Services Construction Telecom, Services Metals & Mining Oil/Gas Electronics Environmental & Waste Banks (Regional) Internet software Healthcare Services Transportation Machinery Apparel Pharma & Drugs Computer Software Shoe Retail (Automotive) Computer Services Air Transport

Return on equity

Figure 25 - Return on equity across industries in US Market average

Source: Damodaran, S&P Capital IQ, Bloomberg, Independent analysis

5.2.2.2 Capital requirements and economies of scale

The need to invest large financial resources in order to compete can deter new entries to the market. (Porter, 2008) In footwear industry, the level of capital investments is highly dependent on the strategy that new competition pursues. If the newcomer decides in favour of outsourcing strategy, the investment to enter the market will be relatively lower as there is no need to purchase production supplies and machinery, and there is a large number of manufacturers supplying the market. Although, if the entrant chooses similar business model as ECCO has adopted, it incurs large capital investments that greatly heighten the barrier to entry. It is important to note that if the industry returns are attractive and capital markets are efficient, the new entrants are likely to find funding for their undertakings.

For new players in the market, economies of scale wields a significant role in cost reduction, increased profitability and in the likelihood of market entry entirely. For outsourcing and in-house production strategies, the supply-side economies of scale provide the incumbents obvious cost advantage. Incumbents such as ECCO have lower costs per unit due to their large volumes, whereas other large established companies that follow outsourcing strategy enjoy the benefit of purchasing in bulk and the pooling of certain operations. There are also demand-side benefits of scale for the well-established incumbents in the market. These benefits arise from the network effects, in which the buyer’s willingness to pay for a company’s product increases with the number of other buyers who also patronize the company. (Porter, 2008) Not only do these effects of economies of scale deter the entry of new competition, but also make it difficult for them to expand in size considerably.

5.2.2.3 Access to suppliers and distribution

As the world is becoming more globalised and interconnected, the entry barriers to access suppliers and distributors are gradually lowering.

For example, developing countries in Asia actively seek foreign investments in order to develop their industries and to exploit the comparative advantage they have over more developed countries. (IBISWorld, 2010) These opportunities encourage the newcomers to set up their production facilities in an environment, where they can access cheap labour and use the market as a stepping stone to compete with the incumbent multinationals. For outsourcing opportunities, there is a large number of low cost manufacturers present in the market, making it relatively easy for new players to establish their operations. (MarketLine, 2013)

Similar trend of lightening barriers is taking place between distribution channels, in which there is an increasing share of sales in e-commerce channels in contrast to conventional stores. As the space in stores and outlets is limited, the advanced solutions in internet technology enable new competition to access customers around the world with minimum costs. Be that as it may, a company selling its products only online will have several disadvantages compared to a company that provides its customers a more tangible experience. Another option for newcomers is to establish their own distribution channels by selling their products on their website or setting up a shop. In the latter option, brand awareness and larger capital investments are required.

5.2.2.4 Other barriers

In contrast to the barriers discussed above, there are also important exogenous factors that may limit the entry of potential competition.

Firstly, important barriers to consider are the incumbent’s advantages that are independent of their size. These barriers come in the form of product differentiation, the use of superior technology, which results in higher quality and efficiency, brand recognition and experience in the industry. For example, not only has ECCO

accumulated invaluable operational experience over half a century, but also established a strong brand awareness around the world.

Secondly, taxes, legislation and government policies may impose obstacles that make the entry unattractive.

In case of footwear industry, there are no industry specific taxation regulations except tariffs, which vary among countries. At the same time, the main regulated areas are environmental and anti-dumping laws.

(IBISWorld, 2010)