GEICO's Competitive Strategy: Porter's Five Forces Analysis

Introduction

GEICO began life in 1936 as the Government Employees Insurance Company but is better known by its acronym. The company has always focused on the auto insurance industry. Today, GEICO is a wholly-owned subsidiary of Berkshire Hathaway. The original business model was to focus on government employees, but the company soon expanded to serve a broader audience (GEICO, 2015).

Industry Value Chain

The value chain consists of five elements of a business from which a company can derive competitive advantage: inbound logistics, operations, outbound logistics, marketing and sales, and service (MindTools.com, 2015). Inbound and outbound logistics are not usually a major part of the service value chain. However, in GEICO's case, the company sells exclusively over the Internet, which is a key point of differentiation and reduces operating costs (Aho, 2014). The key elements for GEICO are operations, marketing, and service.

Marketing is a means by which new customers are attracted. There is very little, in terms of the insurance product itself, that GEICO can do to differentiate itself. However, the company can differentiate through marketing, and has been successful in doing so. The company's advertisements have given it a strong brand and attracted many new customers. The company spent $935 million in advertising in 2013—three times the industry average—and passed Allstate to become the industry's number two player, with a premium income increase of 11.2%, much higher than any other competitor in the industry (Aho, 2014).

Within the insurance industry, operations are another critical element of the value chain. Margins can be quite slim because of intense competition, so containing costs is particularly important. Actuarial work is also vital, because payouts are one of the major cost drivers—premiums need to be both competitive and aligned with actual claim payouts. Finally, service is another critical factor. Generally, there is not much to differentiate between insurance companies on service, but service is considered by customers to be very important in their retention (Joseph, Stone & Anderson, 2003). Customers place special emphasis on the service they receive during a time of crisis, rather than the service they receive during normal times.

Five Forces Analysis

Profit in any industry is derived from the bargaining power a company has and the different factors that influence that power. The insurance industry does not really have suppliers—aside from labor and computers. Capital is supplied, in GEICO's case, by parent company Berkshire Hathaway, but mostly it comes from the buildup of capital since the company's inception. The bargaining power of buyers in the industry is moderate. On one hand, the insurance industry is highly competitive, which allows buyers to have low switching costs and a high propensity to switch. On the other hand, this is balanced by the fact that buyers have very low information, and insurance companies can take advantage of information asymmetry to increase their profits.

There are no credible threats of substitutes for auto insurance. You either have it, or you do not—and laws regarding auto insurance vary from state to state. There is some threat of new entrants. Joseph (2003) notes that many financial institutions have a desire to enter the insurance business, which increases risk for existing players. Furthermore, other insurance companies could choose to enter the auto insurance market, and foreign players could seek access to the U.S. market.

The most important factor among the five forces is the intensity of rivalry between firms in this industry. There is a lot of money on the table, and many companies seeking to win market share. Because product and service are poorly differentiated and switching costs are low, the competition for customers is intense. This manifests in competition on the basis of price, but also in intensive marketing. GEICO spends more on marketing than its rivals, but it is by no means the only company in the industry that spends hundreds of millions of dollars per year on marketing (Aho, 2014).

The strongest competitive force is the intensity of rivalry, for the reasons noted above. The intensity of rivalry essentially counters the information asymmetry, so that in an industry where profit potential should be massive, most firms have very slim margins. The weakest competitive force is the bargaining power of suppliers, as this is almost entirely a non-factor. Most firms in the industry rely on their own capital—they use the premiums they earn to pay out claims. At best, it could be argued that buyers and suppliers are the same thing, which is a characteristic unique to financial firms.

Competitive Advantage

In the insurance business, experience is important because the more data that a company has, the better able it is to align competitive premiums with the actual risk of a payout. However, all of the major players in auto insurance have been around for a long time, and they all have roughly the same capabilities in this regard. Service can be a differentiator, but these companies employ tens of thousands of workers. At that scale, there is little opportunity for differentiation.

Thus, the only real advantages that an insurance company can have are size and brand. Size is valuable in a few ways. First, greater size usually results in greater stability. GEICO, for example, has strong credit ratings because of its size and the size of its parent company. This gives it a lower cost of capital, which helps because financing is an important aspect of the business. The second way that size matters is with respect to market reach. This is perhaps less important for GEICO because it is focused on online sales, but for other insurance companies this is important because they rely on physical distribution through agents.

Brand is also a source of competitive advantage. Brand recognition is valuable, but having the most positive brand attributes attracts customers and makes a given brand the first choice among consumers. This is an especially important advantage when there is little to differentiate the major competitors with respect to service, product, or price. GEICO has done an excellent job of differentiating its brand, in particular with its anthropomorphic mascots (Aho, 2014). It is worth noting that because there are many very large auto insurance companies, brand is the most sustainable of these competitive advantages.

Macroenvironment Analysis

The insurance business is highly stable. The political environment concerns the regulatory regime. Regulations on the insurance business are tight, and GEICO is affected whenever regulations change. There is a risk that changes could, for example, open up the industry to more competition either from other financial institutions or foreign companies. GEICO is well insulated from new competitors, however. The economic environment does not affect GEICO as much relative to other financial firms, because people still need car insurance as long as they still have cars.

This raises an interesting consideration for the social environment. Millennials in particular are drawn to small spaces, urban environments, and avoiding cars. While the vast majority of Americans still own cars, auto ownership among younger Americans, and indeed attainment of driver's licenses, is declining (Weismann, 2012). Fewer car owners means a decline in business for auto insurance companies, and these companies are not necessarily well positioned to offer insurance on other products—there is a significant learning curve because there is insufficient data on new products.

Technology is another interesting area of the macroenvironment. GEICO's growth has coincided with a move to feature online sales. The company's business model has become differentiated, and GEICO has become better at exploiting the Internet than its competitors. Mobile is the big growing consumer technology now, and there is a movement towards post-mobile technologies as well. GEICO needs to stay on top of new technological developments to ensure that it outperforms its competitors in applying these new technologies to the auto insurance business. An interesting area of application, for example, is the use of GPS to track driving habits, and using that data to tailor insurance price and product offerings based on quantifiable differences in the way that people drive.

There are a couple of key assumptions that can be made on the basis of this analysis. First, GEICO has to maintain its technological competitive advantage. It has enjoyed great success by being the technological first mover, but it needs to maintain this advantage going forward, even though the technological environment is moving quickly. The second key assumption is that GEICO is going to have to work harder for customers in the future. While there may not be any major competitive threats, there is real risk that the market declines in the coming years, and that will only intensify the rivalry between auto insurance companies as they struggle to maintain share in a declining market.