Porters’ competitive forces model is probably one of the most often uses business strategy tools and has proven its usefulness on numerous occasions. It’s hard to understand the dynamics of competitors with in an industry. If you are entering this industry as a new comer it can help to assess the potential opportunities for your venture. Porters’ Five Forces Model assists with this analysis in respected models. This model created by Michael E. Porter to analyze the level of competition and business strategy development. It draws from Industrial Organization economics to derive five forces. It attempts to realistically assess levels of profitability, risk based and opportunity on five key elements within an industry.
Actually, it focuses five forces that determine the long run profitability of a market segment Suppliers, Buyers, Entry Barriers, Substitutes and Rivalry.
Threat of New Entrants
In an industry the competition level will be the higher, to enter this industry the other companies find it easier. In such situation new comer could change the determinants of the market environment at any sort of time. The entry of new firm can be block by incumbents. There is always a latent pressure for reaction and adjustment for existing players in this industry. Actually, the new entries threat depends on the extent to which there are barriers to entry. The following factors shows the new entrants may pose:
- High initial investments and fixed costs
- Brand loyalty of customers
- Distribution channels are controlled by existing players
- Protected intellectual property like patents, licenses etc,
- Government policy
- Cost disadvantages independent of size
- Industry profitability (the more profitable the industry the more attractive it will be to new competitors.
Example: The entry barriers are relatively low for soft drink industry. It has no consumer switching money and found zero capital requirements. Similarly, we have found there are other similar new brands appearing in the market with same cost than Pepsi products. As a big brand beverage company, its hold a significant market share for a long time and his loyal customers are not very likely to try a new brand.
Threat of substitute products or services
Porter’s model refers to substitute products as same products that available in other company’s looks similar need for the end user. This substitute product may limit the ability of firms to raise prices and to improve their margins. A close substitute commodity exist in a market, it raise the likelihood of customers swapping to other response to price increases. This reduces both the power of suppliers and attractiveness of the market. It has seen, a more substitutes available and affordable, the demand becomes more elastic as consumer have more alternatives. Similarly to the new entrants, the threat of substitutes is determined by factors like:
- Number of substitute products available in the market
- Ease of substitution
- Substandard product
- Quality depreciation
- Close customer relationships
- Brand loyalty of customers
Example: The price of aluminum cans is constrained by the price of steel cans, glass bottles and plastic containers. These aluminum cans are substitutes, yet they are not seen rivals in the same industries. Another example of substitute, the wireless networks offers various services to the customers. The same services and technology is being also used by rivals companies yet it is the customer’s loyalty to his own use product.
Bargaining Power of Suppliers
In order to provide goods and services the term suppliers comprises all sources for inputs. In simple term an industry that produces or supply goods required raw material is suppliers. The suppliers may refuse or revoke to work with the agreed company or change excessively their prices for unique resources. A segment is unattractive when an organization’s suppliers have the ability to:
- Organize in a formal or informal manner
- Impose switching costs on their customers when they depart
- Reduce the quantity supplied
- Degree of differentiation of inputs
- Employee solidarity (e.g. labor unions)
- Supplier competition: the ability to forward vertically integrate and cut out the buyer.
- Presence of substitute inputs
Example: Giving another example of soft drink, the main ingredients for soft drink include phosphoric acid, sweetener, water and caffeine. In such the suppliers are not differentiated. Coca-Cola is likely a huge of largest customer of any of these suppliers.
Another example of supplier is the Crude Oil industries from Middle East supplies tones of crude oil to America and other developed nations, shows the power of suppliers to build better win relationship with suppliers.
Bargaining Power of Customers
This power determines how much customers can impose pressure on margins and volumes. Normally, it has seen the buyer power is high when he has many alternatives. In such case the firms can take measures to reduce buyer power, such as implementing a loyalty program. For example: if there are large number of customers using similar product and if they get interacts and ask to make the prices low of the product the company will have no other alternative choice rather than to reduce the price. If a buyer power is strong, the proportion to the producing industry becomes closer to what economists term a monopsony. The bargaining power of buyers increases when they have the ability to:
- The supplying industry comprises a large number of small operators
- Customers have low margins and are price-sensitive
- Force down prices
- Availability of existing substitute products
- RFM (customer value)Analysis
- Bargaining leverage, particularly in industries with high fixed costs
- Buyer switching costs relative to firm switching costs
To reduce the power of buyers, sellers can seek with buyer with less power to negotiate, switch suppliers, and develop offers that buyers cannot refuse.
Example: Large retailers, like Cosco, Wal-Mart, have great bargaining power because of the large order quantity, but the bargaining power is lowered because of the end consumer brand loyalty. Similarly, in case of individual buyer there is no pressure on Coca-Cola.
Competitve Rivalry
Most industries the intensity of competitive rivalry is the major determinant of the competitiveness of the industry. A high competitive pressure also results on prices, margins and on profitability for every company in the industry. The intensity of rivalry varies within each industry and the differences can be important in the strategy development. In pursuing an advantage over its rivals, a firm can choose from several competitive moves:
- Level of advertising expense
- Powerful competitive strategy
- Players have similar strategies
- Changing prices
- Exploiting relationships with suppliers.
- Improving product differentiation
Example: the intensity of rivalry is increased when large competitors that is strong in competing the same customers and resources. It has also seen when there is a decline in sales revenues and volume which results in slow market growth, create the actual need to actively fight for market share.
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