Porter’s Five Forces Model of Competition Analysis
Managers in a firm/company can use various models for analyzing the industry environment. However, the most widely used model for an industry’s competition analysis is Porter’s 5 Forces or Michael Porter’s Five Forces Model. Strategic managers can analyze the competitive environment by using this model in the industry. The Porter’s Five Forces Model provides a framework to identify industry-related opportunities and threats. We discuss this porter’s 5 forces here in details.
Michael Porter’s Five Forces Model:
Michael Porter published a book that named “How Competitive Forces Shape Strategy” from Harvard Business Review in 1979 (March-April). In where he developed a framework of the Strategic Management Models that named Porter’s Five Forces Model of Competition. Managers can use to analyze competitive forces in the industry’s environment. It helps them identify the industry-related opportunities and threats confronting their company. A look at Porter’s five forces model that appears in the following infographic would enable you to have a broad view of the elements of the model. You will find that there are porter’s 5 forces or factors that shape competition in an industry. These are:-
- Threat of New Entrants
- Bargaining Power of Suppliers
- Bargaining Power of Buyers
- Threat of Substitute Products
- Rivalry among the Existing Firms
We provide here a discussion on the impact that individual force of Porter’s 5 forces in the industry can have on a firm within the industry.
Threat of New Entrants:
The threat of new entrants is the first one of Porter’s five forces model. It refers to the risk of new entry by potential competitors. In the marketplace, some competitors are already operating their business. They are called existing competitors. Some other upcoming competitors are not now operating the business in the industry but they can enter into the industry if they have the capability and desire to enter. They are potential competitors. BTTB was once considered a potential competitor in the cellular phone industry. In fact, BTTB (BTCL) entered into the industry with its cheaper mobile phones, although it could not initially manage the market-situation well.
Porter’s 5 forces or Porter’s five forces model think that… Potential competitors generate threats to standing companies. Because if they arrive they can create competition harder by taking away market share from the remaining companies. Thus, present companies disappoint potential competitors from inflowing into the industry by making barriers to entry. ‘Barriers to entry’ are created by undertaking some measures that are very costly for the competitors to adopt. Such barriers may strong brand loyalty, absolute cost advantage, sizable economies of scale, high capital requirements, difficulties of building distribution network of distributors and retailers, restrictive, tariffs, international trade restrictions and government regulations. In contrast, if the threat of access by potential competitors is low-slung, the prevailing companies can increase prices and generate higher profits. When entry barriers are low, it is easy for potential competitors to enter the industry. Despite entry barriers, many entrants enter the industry with appealing products. The strategy-creators need to pinpoint the entrants, screen out their tactics and strategies, and take on counter-plan and deal with the evolving issues building on the firm’s surviving capabilities and resources.
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Bargaining Power of Suppliers:
Bargaining power of suppliers is the second of Porter’s five forces model. A business has to make many types of ‘supplies’ from the suppliers such as components, raw materials, parts and other resources necessary for manufacturing a product. When dependency of the customers is high, the bargaining power of suppliers is enhanced. Powerful suppliers can raise prices of materials. So, influential suppliers are a risk to the businesses who have to purchase at that rate. If suppliers are no stronger, a firm may be in a beneficial situation. It can claim high quality at a minor rate from the suppliers. The amount of suppliers is very few and they are very strong in negotiating prices in the paper industry. This has created a threat to the publishing industry. Nevertheless, this threat has been to some range weak due to imported paper. If the materials they sell are available from different parties, Suppliers have very little or no negotiating power. Their power increases if the supply of the materials is limited or if the materials are such that they are inevitable for the company. For instance, in the computer marketplace, Intel Corporation is the most influential on account of its exceptional situation in manufacturing microprocessor (Pentium).
According to Michael Porter’s Five Forces Model, suppliers are most powerful. Such as:-
- When their respective products are differentiated to such an extent that is costly for a company to switch from on suppliers to another. In such case, the company depends on its suppliers and cannot play them off against each other.
- When buying companies cannot use the treat of vertically integrating backward and supplying their own needs as a means to reduce input prices.
- When the company’s industry is not an important customer of theirs. In such cases, the supplier does not depend on the industry or company. The suppliers have little benefits to improve quality and reduce prices.
- The product that they sell has few substitutes and is important to the company.
- When to raise prices, they can use the threat of vertically integrating forward into the industry and competing directly with the company.
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Porter’s Five Forces Model says that the bargaining power of suppliers is weaker under the following circumstances in the industry. Such as:-
- The customers can buy the same products from many suppliers at the same prices.
- When substitute products acceptable to the buyers are easily available.
- When continued large purchases on the part of the customers are important for the suppliers.
- When the huge quality of products is available in the market.
- When the customers have ample opportunities to develop the strategic alliance with other suppliers, and thus can have the win-win gain.
- When buyer-firms have the capacity to integrate backward into the business of the supplier and thus can satisfy the customer’s own requirements.
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Bargaining Power of Buyers:
Bargaining power of buyers is the third one of Porter’s five forces model. Buyers of products may be ultimate consumers or even the intermediaries such as dealers, wholesalers, and retailers. When suppliers have to depend on them for some reasons, the buyer’s bargaining power becomes high. On the other hand, their bargaining power is weak when suppliers or sellers are capable to raise prices. Whether seller-buyer relationships denote a weak or strong competitive power. It depends on the bargaining power of buyer to influence the rules and regulations of sale in their deserved and the range of buyer-seller strategic partnership in the industry.
According to Michael Porter’s Five Forces Model, the buyer’s bargaining power is highest. Such as:-
- Buyers purchase in large qualities.
- Through vertical integration as a device for forcing down prices, buyers can use the threat to supply their own needs.
- The supply industry is composed of many small companies and the buyers are few in number as well as they are large.
- The supply industry depends on the buyers for a large percentage of its total orders.
- It is economically feasible for the buyers to purchase the input from several companies at once.
- Buyers can switch orders between supply companies at a low cost.
According to Michael Porter’s Five Forces Model, Buyer’s bargaining power is generally weaker. Such as:-
- When the cost of procuring products from alternative sources is very high.
- The buyer depends on the seller because of the fact that the brand reputation of the seller is very important to the buyer.
- The buyer purchases a particular product from the seller in small quality or does not purchase frequently.
- When there is high demand for the seller’s products in the market and as a result, a ‘sellers’ market prevails in the industry.
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Threat of Substitute Products:
It is the fourth factor of Porter’s five forces model of competition analysis. A company needs to consider the competitive pressures from substitute products. The substitute products may originate from either the same business firm or from another business firm. For instance, cotton producers are in direct competition with the producers of polyester fabrics. Newspapers compete against television in providing the latest news. E-mail is a substitute for the overnight delivery of documents by the courier service companies. Coffee is a substitute for tea. Bottled water is a substitute of juices and soft drinks. Plastic bottles are substitutes for aluminum cans for beverages. Traditional film cameras are fighting hard against their substitute-enemy – the digital cameras.
If the buyers view the substitute products as ‘good substitutes’. Competitive pressure automatically emerges from the actions of the companies producing substitute products. For example, Lasik cooperation of eyes has created a strong competitive pressure on the producers of eye-glasses and contact lenses. Similar is the situation between VCRs/video tapes and DVE players, and between landline telephones and mobile phones.
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Accordance with the fourth factor of Porter’s five forces model, the major factors that determine the strength of the competition from substitutes are:-
- The attractiveness of the prices of substitutes
- Buyers satisfaction with the substitutes in terms of quality and other features
- The easiness to switch to substitutes.
When the substitutes are available at cheaper prices, the producers of the normal product are in a highly competitive pressure to reduce prices. When substitute produces are available, the customer begins to compare prices, quality etc. with the normal products. Similarity, when swapping cost from the usual product to substitute products are low, buyers turn into more disposed to the substitutes.
Besides Porter’s Five Forces Model, Thompson et al. have indicated three sings that point to strong competition from substitutes. These are:-
- Sales of substitutes are growing faster than sales of the industry
- Producers of substitutes are moving to add new capacity
- Profits of the producers of substitutes are on the rise.
A company’s threat may be the existence of substitute products in the industry. Thus, the profit of the company is likely to reduce due to cutting down prices. If a company has few substitutes. It has the opportunity to raise prices and thereby increase profits.
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Rivalry among the Existing Firms:
A very important force in the Michael Porter’s Five Forces Model is the extent of rivalry among the established firms in the industry. In an environment of weak rivalry, a firm can raise prices and make higher profits. When competition is strong, the industry may face severe price-ware in which firms compete against each other on the basis of price cuts. If there is a simple competition among the companies in the industry, cost-effectiveness declines substantially. Arthur A. Thompson and A. J. Strickland III regard this force of rivalry as the ‘strongest of the five forces’.
Michael Porter identified several factors through Porter’s five forces model in competition stems or Inter-company rivalry. And these factors mentioned in his famous book Competitive Strategy. These are as follows:-
- Competition is usually stronger when demand for the product is growing slowly.
- Competition increases as the number of competitors increases.
- Competition is stronger when the customer’s costs to switch brands are low.
- When industry conditions encourage competitors to cut prices, competition is more intense.
- When it costs more to get out of a business than to stay in the industry, competition tends to be more intense.
- Competition is stronger when one or more competitors are dissatisfied with their market position and undertake other measures dissatisfied with their market position and undertaker other measures to win the battle for market share.
- When strong companies get the incapable companies in the business from outdoor the industry and takeoff aggressive movements to make the picked up companies money-spinning, competitions increases.
- When competitors are diverse, competition becomes more volatile in their objectives, strategies resources etc.
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Porter’s Five Forces Model has major drawbacks as a tool for competition analysis. It can be used for analyzing only the degree of competition in the industry. It cannot discover such forces as the dominant economic aspects in the industry that are relevant to managerial strategy-making. It also unable to isolate the driving forces – main reasons of changing industry circumstances. This model their likely strategic moves, and overall industry attractiveness. These drawbacks can be overcome by using Thompson and Strickland’s Seven Factors Model of Industry Analysis.