Joe Smith argues, "Your analysis of the five forces that affect industry profitability is incomplete.For example, in the banking industry,I can think of at least three other factors that are also important--namely, government regulation, demographic

Question

trends, and cultural factors.". His classmate Jane Brown disagrees and says, "These three factors are important only to the extent that they influence one of the five forces.". Explain how, if at all, the three factors discussed by Joe affect the five forces in the banking industry.

Answer 1

Government regulation, demographic trends, and cultural factors will each impact the analysis of the banking industry. While these may be important, they can each be recast using the five forces framework to provide a deeper understanding of the industry. The power of the five forces framework is its ability to incorporate industry-specific characteristics into analysis for any industry. Tosee how government regulation, demographic trends, and cultural factors are important in the banking industry, we can apply the five forces framework as follows:
Rivalry Among Existing Firms. Government regulation has played a central role in promoting, maintaining, and limiting competition among banks. Banks are regulated at the federal and state levels. In the past, these regulations restricted banks from operating across state lines or even within different regions of the same state, and from paying market rates on deposits. The government also regulates the riskiness of a bank's portfolio in an effort to prevent banks from competing for new customers by taking on too many high-risk investments, loans, or other financial instruments. These regulations have limited the degree of competition among banks. However, recent deregulation of the industry has allowed banks to expand into new geographic areas and to pay market rates on deposits, increasing the level of competition.
Threat of New Entrants. Government regulations at both the federal and state levels have limited the entry of new players into the banking industry. New banks must meet the requirements set by regulators before they can begin operation. However, as noted above, deregulation of some aspects of banking has made it easier for out-of-state banks to enter new markets. Further, it appears to be relatively easy for non-banking companies to successfully set up financial services units (e.g., AT&T, GE, and General Motors). Finally, as consumers have become more comfortable with technology, "Internet banks" have formed. These "banks" provide the same services as traditional banks, but with a very different cost structure.
Threat of Substitute Products. The primary functions of banks are lending money and providing a place to invest money. Thrifts, credit unions, brokerage houses, mortgage companies, and the financing arms of companies, such as GMAC, provide potential substitutes for these functions. Government regulation of these entities varies dramatically, affecting how similar their products are to those of banks. In addition, with the expansion of IRA and 401(k) retirement savings accounts, consumers have been become increasingly familiar with non-bank options for investing money. As another example, some brokerage houses provide money market accounts that function as checking accounts. As a result, the threat of substitutes for bank services has grown over time.
Bargaining Power of Buyers. Business and consumer buyers of credit have little direct bargaining power over banks and financial institutions. The decline in relationship banking towards a transactions approach, where consumers seek the lowest-cost lender for each new loan, probably also reduces the buying power of customers.
Bargaining Power of Suppliers. Depositors have historically had little bargaining power.
In summary, bank regulations have historically had a very important role in determining bank profitability by restricting competition. However, recent deregulation in the industry as well as the emergence of non-bank substitutes has increased competition in the industry.