Eleanor Finch
Porter's Five Forces model is a framework for industry analysis that explains why some organisations are more profitable than others. The model, developed by Michael E. Porter and published in 1979, identifies five forces that shape the competitive business landscape and influence every industry. The five forces include the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitute products or services, and competitive rivalry. By understanding these forces, businesses can make informed decisions, adapt to evolving markets, and maximise profitability. Porter's model has been widely adopted as a strategic planning tool, but it has also faced critiques for its emphasis on industry-wide forces and lack of consideration for collaboration and rapid technological changes.
| Characteristics | Values |
|---|---|
| Number of factors | 5 |
| Focus | Industry analysis |
| Purpose | Understand why some organisations are more profitable than others |
| Function | Determines the profitability of an industry and its sustainability |
| Applicability | Used to analyse an industry or a market's competitive intensity and attractiveness |
| Factors considered | Threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitutes, competitive rivalry |
| Advantages | Clear industry breakdown, profitability insights, strategic insight, risk mitigation, opportunity identification, long-term sustainability |
| Limitations | Doesn't address the role of collaboration, too static, doesn't account for rapid changes in technology and consumer preferences, generalises competition, backward-looking |
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What You'll Learn
Threat of new entrants
Porter's Five Forces model is a strategic planning framework that helps businesses assess a market's competitive intensity and attractiveness. One of the five forces is the "threat of new entrants", which refers to how easy or difficult it is for new competitors to enter a market.
The threat of new entrants is influenced by various factors, including barriers to entry such as capital requirements, economies of scale, brand loyalty, and regulatory hurdles. Low barriers to entry imply a high threat of new entrants. For example, in the food and beverage industry, anyone can open a new restaurant with a modest capital investment and some culinary skills. As a result, the industry becomes highly competitive, and restaurants often struggle to survive. On the other hand, high barriers to entry imply a low threat of new entrants. For instance, global credit card networks like Visa and MasterCard have high barriers to entry, allowing them to maintain their market position without worrying about new competitors.
The switching costs for customers also play a role in the threat of new entrants. If it is costly or difficult for customers to switch from existing firms to new entrants, the threat of new competition is reduced. For example, Uber's entry into the mobility industry was facilitated by the absence of legal barriers, making it effortless for customers to switch from traditional taxis.
The threat of new entrants is a critical consideration for businesses, as new market players can bring increased competition, agility, and growth motivation. A thorough competitive analysis, such as Porter's Five Forces model, helps businesses understand the industry structure and identify areas where they can position themselves to maximise profitability.
While Porter's model provides valuable insights, it has been critiqued for its emphasis on industry-wide forces, static nature, and lack of consideration for collaboration and rapid technological changes. However, the model remains a widely used tool for strategic analysis, helping companies navigate competitive forces and make informed decisions.
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Bargaining power of suppliers
Porter's Five Forces is a tool used to analyse a market or industry and determine its competitiveness. The five forces are: internal competition, the potential for new entrants, the negotiating power of suppliers, the negotiating power of customers, and the ability of customers to find substitutes.
The bargaining power of suppliers is one of the five forces that make up Porter's Five Forces model. It refers to the ability of suppliers to manipulate prices, delivery times, availability, and even the quality of supplied products. Suppliers have direct input into a firm's products or services, and their actions can greatly affect the profitability of a business that relies on them to satisfy operational needs.
The concentration of suppliers and the availability of substitute suppliers are important factors in determining supplier power. The fewer there are, the more power they have. For example, if there are only one or two suppliers of an essential input product, or if switching suppliers is expensive or time-consuming, those suppliers have more power.
The power of suppliers can also be influenced by the switching costs of companies in the industry, the strength of their distribution channels, and the uniqueness or level of differentiation in the product or service they offer.
A company's buyer-supplier ratio also affects the bargaining power of suppliers. If a company depends on one or two suppliers, those suppliers have more power. Additionally, if a small percentage of a supplier's revenue is from a particular company, they will be less willing to negotiate on terms, which increases their purchasing power.
The bargaining power of suppliers can vary depending on the industry and country. For example, the bargaining power of suppliers in the airline industry is considered very high, as aircraft and fuel are major inputs that are heavily influenced by external factors beyond the control of airlines.
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Bargaining power of buyers
Porter's Five Forces Framework is a method of analysing the competitive environment of a business. It identifies five forces that determine the intensity of competition and the attractiveness or unattractiveness of an industry with respect to its profitability. The five forces are:
- Competition
- The threat of new entrants to the industry
- Supplier bargaining power
- Customer bargaining power
- The ability of customers to find product substitutes
This answer will focus on the fourth force, the bargaining power of buyers.
The Bargaining Power of Buyers
The bargaining power of buyers is extremely important to providers. Buyers are the people who pay for a company's products and services, and their behaviour drives a firm's profits. Buyers often demand low prices and high quality. Lowering prices may affect revenues, while increasing quality could inflate production costs. The power of buyers determines how prices are set. Knowing the bargaining power of customers creates a strong competitive advantage for an organisation.
The power of customers is higher when they are few in number and have many sellers to choose from. If a large portion of a seller's revenue is determined by a handful of buyers, those buyers will have more power. Sales percentage has to do with the size of a client. For example, a buyer that contributes to 50% of a company's annual revenue will be more powerful than those bringing in 1% or less.
Undifferentiated products are usually a prerequisite for high buyer power, where brand loyalty is low. Many firms selling the same thing allow buyers to become more powerful and look for the best deal on the market. In this way, customers can easily switch providers as they like. Switching costs relate to the costs involved in changing providers. High switching costs generally presuppose low buyer power.
Price sensitivity touches on the price sentiment of buyers. Sensitive buyers may switch providers because of a price change. If so, producers are forced to respect clients' wishes, giving them the upper hand in the bargaining process. Customers with many product options to choose from outpower the providers selling them.
Examples
The bargaining power of buyers in the airline industry is high. Customers are able to check the prices of different airline companies fast through the many online price comparison websites such as Skyscanner and Expedia. There are no switching costs involved in the process.
Uber faces threats from the bargaining power of buyers (riders). With strong competition from ride-hailing alternatives, traditional taxis, and high car ownership, riders have numerous options to choose from, giving them significant influence over pricing and service quality.
Limitations of Porter's Model
Porter's model has been critiqued for its emphasis on sector affiliation. It concentrates on industry-wide forces, which can sideline an individual company's unique strategies and advantages. It has also been criticised for being too static and not applying well to quick-changing markets.
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Threat of substitute products
Porter's Five Forces is a market competition analysis model developed by Michael E. Porter to explain the five categories of forces that influence the level of market competition experienced by a business. One of these five forces is the threat of substitute products.
Definition of Substitute Products
A substitute product is an alternative product or service that a customer can buy instead of another offering. Importantly, this substitute does not come from a direct competitor but is a product or service that can do the same thing as the original offering but is from another industry. For example, social media is a substitute for newspapers, and Zoom conferencing is a substitute for train rides. Substitute products are usually homogeneous and offer the same or a very similar level of satisfaction to customers. Examples include tea versus coffee, McDonald's versus Burger King, Coke versus Pepsi, and Home Depot versus Lowe's. These products offer consumers the same or almost similar value, and their prices are also comparable.
Impact on Profitability
The threat of substitute products affects the profitability of an industry because consumers can choose to purchase the substitute instead of the original product. A high threat of substitute products makes an industry less attractive and decreases the level of potential profit that can be achieved. On the other hand, a low threat of substitute products makes an industry more attractive and increases the potential profit capability. The availability of close substitute products will make an industry more competitive, while a lack of comparable substitute alternatives makes an industry less competitive.
Strategies to Minimize the Threat of Substitute Products
The threat of substitutes can be minimized through product differentiation or customer value promotion. Product differentiation involves making a product stand out from its competitors, either by offering better prices for the same quality or adding a unique feature. Customer value promotion, on the other hand, involves promising and delivering a better quality of products and services, giving customers a new perspective that makes them believe the product offers better value.
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Competitive rivalry
In industries with slow growth, competition is usually more intense as companies have little choice but to fight for customers. For instance, in the case of the early 20th-century automobile industry, rivalry was less dramatic because the market grew so fast. On the other hand, competition can be ferocious in a declining industry, as firms fight for a larger piece of a shrinking pie. An example of this is the present-day print media industry.
The level of differentiation among products and services also plays a role in competitive rivalry. When goods and services are very similar, customers can easily switch, leading to intense competition. For instance, Uber and its competitors took advantage of the traditional taxi industry's dependence on legal barriers to entry, and when those barriers fell, it was easy for customers to switch, resulting in fierce rivalry.
A unique offering or brand loyalty can reduce competitive rivalry. For example, Apple in the tech industry, or Rao's Italian sauces in the supermarket aisles, can charge a higher price due to their unique offerings or brand loyalty.
Porter's model has been criticised for not adequately addressing the role of collaboration. Although Porter acknowledged that rivalry wasn't just a "war to the death", critics argue that he didn't go far enough in exploring the importance of alliances and cooperative strategies in an interconnected global economy. Additionally, some critics argue that the model is too static and fails to account for industries with rapid technological advancements and changing consumer preferences.
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