Competitive Environment in Business: What It Is and How To Analyze It

Competitive environment definition

Competitive environment in economics and marketing is a dynamic system within a defined marketplace where different businesses compete. This system has its rules and regulations and is affected by numerous factors, such as the number and type of competitors, barriers to entry, and more.   

How competitive environment affects businesses

No business exists in a vacuum. Typically, there are multiple external forces that affect it in various aspects. One of the most powerful among these forces is competition. 

Generally, competition is good for both businesses and customers. For the former, it creates incentives for innovation and provides the push to outperform their rivals. For the latter, competition ensures that they get quality products at reasonable prices. 

Yet competition also makes life harder for businesses, especially new ones. Therefore, it’s vital for them to understand their competitive environment, analyze it, and take it into account when outlining strategies.

Factors that influence competitive environments

There are several factors that impact competitive environments and affect the choices consumers make. 

These are: 

• Product features
• Number of sellers
• Barriers to entry
• Access to information 
• Location

External factors also impact competitive environments, adding to the dynamics between the rival companies. 

These factors are:

• Politics
• Economy
• Society
• Technology
• Legislation
• Environment

Types of competitors

Within a competitive environment, businesses typically face either of these two types of competitors: 

Direct competitors

Firms that sell identical or similar products or services to the same target audience in the same market are direct competitors.

Indirect competitors

Sellers that offer products or services that are not identical but can be used as substitutes are indirect competitors. Such companies target the same audience and aim to satisfy similar needs — therefore, they are rivals to some extent.

Understanding these two types and knowing their direct and indirect competitors helps companies devise marketing campaigns and reach out to new audiences.

Four types of competitive environments

Economists define two main categories of competition: perfect (pure) and imperfect. 

Imperfect competition is represented by three types: monopolistic competition, oligopoly, and monopoly. 

These types plus pure competition are commonly referred to as the four types of competitive environments. Let’s zoom in on each of them.  

Pure competition

Pure (or perfect) competition is an economic structure in which numerous sellers offer identical products to a large pool of customers. Within this system, companies are typically small, and prices are regulated by supply and demand — i.e. the sellers are price takers.  This type is largely a theoretical model that can hardly exist in the real world.

Monopolistic competition

This environment is a market structure with several relatively small firms who offer similar, but not identical, products. These firms are price makers because they can differentiate their goods or services from those offered by their competitors via quality, positioning, and other means. Monopolistic competition is the most common competitive environment type.

Oligopoly

In an oligopoly, a few large organizations offering similar products dominate the market. They control prices together or under the leadership of the strongest player who sets the bar. High barriers to entry make it hard for new players to enter the system, and collusions, as well as merger agreements, between the dominating companies are rather common. 

Monopoly

In a monopolistic environment, one very large company controls the market. It offers a unique product or service that has no substitutes, and single-handedly controls the price. Monopolies are usually detrimental to the market, but sometimes they are virtually inevitable — like natural monopolies, for example. Such monopolies emerge when one large company can provide goods or services at lower costs than several smaller ones. 

Competitive environment examples

Now, let’s take a look at some real-life examples. 

• Within the American fast food market, there are several chains that offer similar products to the same target audience: McDonald’s, Burger King, KFC, Wendy’s, and more. They are direct competitors that face monopolistic competition. To make their offers stand out and attract customers, they rely heavily on marketing. 
• The operating systems market is an example of oligopoly as it is largely dominated by three companies: Microsoft, Apple, and Google. These tech giants control the lion’s share of the market and set prices, while other players struggle to compete due to barriers to entry. However, some consider this market a monopoly because Microsoft has more than 70% of the desktop OS market share. 
• The US Postal Service illustrates a monopoly. It functions according to a very specific set of rules and regulations, and barriers to entry (particularly, the legal barrier) are extremely high in this industry.

Analyzing competitive environment: 5 popular frameworks

Competitive environment analysis is fundamental to ensuring a company’s growth and maintaining its financial stability. Here are the five proven tools, or frameworks, that are commonly used to conduct it. 

SWOT analysis

One of the most popular methods of business environment analysis is the SWOT analysis. It was developed in the 1960s at Stanford University. Today, companies use it to identify both external and internal factors at play which helps businesses assess the competitive environment from all perspectives.  

In this framework, strengths and weaknesses represent the internal factors, like unique products or a strong brand identity. Opportunities and threats refer to the external factors, such as competitors, technology, or legislation. 

To visualize the analysis results, use the SWOT matrix:  

SWOT analysis insights can be used to make the most of your company’s strengths and to minimize the effects of its weaknesses while finding ways to seize the opportunities and avoid the threats. 

Porter’s five forces

Michael Porter is an American economist and one of the most prominent figures in modern business strategy studies. In 1979, he offered a model that is known today as Porter’s 5 forces. 

The model defines the five competitive forces within a given industry. The interaction between these forces, the model implies, is what makes the competitive environment more or less fierce.  

These five crucial elements are:

• Rivalry within a given industry
• Threat of new entrants 
• Power of suppliers 
• Power of buyers  
• Threat of substitute products (services) 

Here’s what the model looks like in a visual form:

This framework is great for determining an industry’s strong and weak points. To take your analysis further, you can also use the PEST (PESTLE) framework to assess the overall external business environment in a given country or area. 

Strategic group analysis

This complex tool is based on comparing the so-called strategic groups — i.e., firms within an industry that pursue a similar strategy across various dimensions (price, product type, etc.). Once you divide your competitors in groups and compare them, you can see how your company fares against them.

Strategic group analysis also helps identify the closest competitors within a group and pinpoint the key aspects of success.  

Perceptual mapping

Perceptual maps are graphs that represent in a visual form how customers perceive certain brands or products. Typically, these maps are two-dimensional, but some can be more complex. In a two-dimensional perceptual map, the opposite ends of each axis represent the extremes of the spectrum (i.e. high price vs. low price). In all cases, customer survey data is necessary to complete the graph. 

Businesses use perceptual mapping to see where they stand against competitors (from their customers’ perspective) and glean insights to improve positioning. The framework can also help identify a product’s or company’s weak points, such as high pricing or low trustworthiness. 

Growth share matrix

This framework, also known as the BCG matrix or the Boston matrix, was devised in the 1970s by Boston Consulting Group. Essentially, it’s a portfolio management tool that helps companies prioritize certain products or business units and devise investment strategies. 

The visual representation of the matrix is a table split into four quadrants. It divides the product portfolio into four categories based on their degree of profitability: stars, question marks, cash cows, and pets (or dogs).

The overall strategy, according to the premise behind this matrix, should aim at investing in products or units with high growth potential and divesting from those having no perspective. Companies use this tool to maintain a well-balanced portfolio that can ensure them market leadership and, therefore, competitive advantage. 

Final thoughts

Understanding the competitive environment is fundamental to building a viable business and marketing strategy. To analyze it, companies use tools, or frameworks, specifically built for that purpose. In this article, we’ve explained the basics of the competitive environment and the common tools for its analysis.  

To gain practical experience, try analyzing the companies already on the market using these tools. Then, you’ll be able to apply the skills and knowledge acquired to build or improve a strategy for your own (or your client’s) company.