Porter’s Five Forces Model
The main text dealing with competitive analysis is Professor Michael Porter’s work Competitive Strategy : Techniques for Analyzing Industries and Competitors and this provides a useful guide to study Porter’s five forces models.
Porter states that competition in an industry is rooted in its underlying economics and competitive forces exist that go well beyond the established combatants in a particular industry. The problem for the strategist is to determine which of these forces are relevant, and to what extent.
The five forces model is explained under Competitive Rivalry, Threats from Potential Entrants, Buyer’s Bargaining Power, Threats from Substitutes and Suppliers’ Bargaining Power.
Threats from Potential Entrants include increasing the extent of the competition and barriers to entry
New competitors to an industry may make it more competitive in three ways.
- Expanding capacity without necessarily increasing market demand.
- Their need to penetrate the market to achieve critical mass and then build market share, which may include product and marketing innovations.
- Increasing costs as they bid for factors of production.
It is in the interest of existing competitors to deter new entries. there are seven main barriers to entry - economies of scale, brand (or product) differentiation, capital requirements, switching costs, access to distribution channels, cost disadvantages independent of scale, government regulations (including legal barriers)
Threats from Substitutes – There are alternative products that serve the same purpose example, gas central heating system in competition with solid fuel systems. the main threat posed by substitutes , though, is that they limit the rice that the company can charge for its products. There is also the danger that the threat of a substitute may not be realized until it is too late to arrestt heir entry. Substitute products that warrant the most attention are those that are subject to an environment improving their price-performance trade-off with the industry’s product or produced by industries earning high profits and who have the resources available to bring them rapidly into play.
Threats from the Bargaining Power of Buyers – The power used by buyers in an industry may make it more competitive in three ways by forcing down prices, bargaining for higher qulaity or improved services and playing competitors against each other. All these are at the expense of the industry profitability. Porter claims that the power of the industry’s buyer groups depends on the characteristics of the market situation and of the relative importance of its purchase from the industry compared with its overall business, he suggests that buyers are particularly powerful in seven situations . then holds where the purchase are large relative to sellers, purchases represent a significant proportion of the buyer’s cost, purchases are undifferentiated, buyers earn low profits, buyers have the potential for backward integration, the buyer’s product is not strongly affected by the quality of the supplier’s product and where the buyer has full information.
Threats from Power of Suppliers – Suppliers can exert bargaining power over companies within an industry by threatening to raise thir prices or threatening to reduce the quality of their goods and services. The effect of this power will be to squeeze the profitability out of an industry unable to recover cost increases by raising its own prices. Porter suggests that suppliers are particularly powerful in situations where there few suppliers, there are few substitutes for their products, the industry supplied is not an important customer, the supplier’s product is an important component to the buyer’s business, the supplier’s product is differentiated and the suppliers can integrate forward.
Rivalry and competition among competitors – Conflict among existing competitors takes some form of offensive strategy. Tactics commonly used to implement such strategy include product innovation and improvements, price competitions, advertising battles and increased customer services. Rivalry occurs because one or more companies feels threatened or sees a market opportunity to improve its position although competitive moves by the initiator company usually result in counter-defensive strategies from its competitors. This interactive pattern of offensive and defensive strategies may not leave the initiating company and the industry better off, and on the contrary may leave all the companies in the industry worse off than before. Porter suggests that there are seven main determinants relating to the strength of internal competition and rivalry within an industry. They are many equally balanced competitors, slow rate of industrial growth, lack of differentiation, capacity can only be increased by large amounts, high fixed costs in the industry, many diverse competitors, high exit barriers.
Porter’s five forces model has been influential in the development of competitive strategy and business strategy formulation to identify the competitive advantages that the business holds and to build on that, denying any existing or potential competition the opportunity to meet it. However, any rigorous strategic formulation involves analyzing the competitor’s strategy before developing your own.