Porter's 5 Forces Model

Porter’s 5 Forces Model

Michael E. Porter’s well known framework, known as the five forces model, helps managers to analyse competitive forces in the industry environment to identify opportunities and threats. The forces that shape competition within an industry are-

-       The risk of entry by potential competitors [Threat]

-       The intensity of rivalry among established companies within an industry [Rivalry]

-       The bargaining power of buyers [Power]

-       The bargaining power of suppliers, and [Power]

-       The closeness of substitute to an industry’s products [Threat]

It can also simply be said that, 2 Power + 2 Threat + 1 Rivalry = 5 Forces

Risk of Entry by Potential Competitors:

Potential competitors are companies that are not currently competing in an industry but have the capability to do so if they choose. For example, cable television companies have currently emerged as potential competitors to traditional phone companies. New digital technologies have allowed cable companies to offer telephone service over the same cable that transmit television shows.

The intensity of rivalry among established companies within an industry:

Rivalry is concerned with the intensity of competition within the industry. There is a high level of rivalry if competitors are continually reducing prices, introducing new products and advertising. It identifies the existing barriers, product differences, brand power, growth rate in industry, fixed costs among firms, concentration of firms in market share, etc. (Mehta, 2008)

The bargaining power of buyers:

An industry’s buyers may be the individual customers who ultimately consume its products (its end users) or the companies that distribute an industry’s products to end users, such as retailers and wholesalers. For example, whole soap powder made by Procter & Gamble and Unilever is consumed by end users, the principal buyers of soap powder are supermarket chains and discount stores, which resell the product to end users. The bargaining power of buyer refers to the ability of buyers to bargain down prices charged by companies in the industry by demanding better product quality and service. By lowering prices and raising costs, powerful buyers can squeeze profits out of an industry. Thus, powerful buyers should be viewed as a threat and vice versa. (Hill, and Jones, 2010),

                                                                                       

The bargaining power of suppliers:

The organisations that provide inputs into the industry, such as material, services, and labor (which may be individuals, organisations such as labor unions, or companies that supply contract labor).  The more the demand of a product, the more it drives the price of the suppliers up in a market-based system. Greater uniqueness of an input allows a higher price to be charged and decreases the ability of client firms in the industry to switch easily between suppliers. A credible threat of a backward integration (that is, owning own supply) will weaken the power of suppliers. (Ahlstrom, and Bruton, 2010)

The closeness of substitute to an industry’s products:

The more brand loyal the customers are, the less the threat of substitutes and the higher in the incumbent’s sustainable profitability will be. Also, the more distant the substitutes outside the relevant market, the less price responsive will be demand, and the larger will be the optimal markups and profit margins. For example, Flavored and unflavored bottled water and other noncarbonated beverages such as juice, tea, and sports drinks are growing as much as eight times faster that U.S. soda sales. This trend will tend to erode the loyalty of Pepsi and Coke drinkers. If so, profitability will decline. (McGuigan, Moyer, and Harris, 2011)

Bibliography:

Ahlstrom, D. and Bruton, G. (2010), International Management: Strategy and Culture in the Emerging World, USA: Cengage Learning

Hill, C. and Jones, G. (2010), Strategic Management Theory: An Integrated Approach, 9^th ed, USA: South-Western Cengage Learning.

McGuigan, J., Moyer, R. and Harris, F. (2011), Managerial Economics: Applications, Strategy and Tactics ,12^th ed, USA: South-western, Cengage Learning

Mehta, S. S. (2008), Commercializing Successful Biomedical Technologies: Basic Principles for the Development of Drugs, Diagnostics and Devices, UK: Cambridge University Press

Mclvor, R. (2005), The Outsourcing Process: Strategies for Evaluation and Management, UK: Cambridge University Press