II. Barriers to Entry
Barriers to entry deter new competitors from entering the market and creating more competition for established firms. There are several major barriers to entry and they include economies of scale, capital requirements, product differentiation, switching costs, cost disadvantages independent of scale, access to distribution channels, and government policy. One example of an industry with high barriers to entry is computer chip manufacturing. The extremely high cost of building a fabrication plant makes entry into this industry very risky. The resturaunt industry on the other hand has considerably fewer barriers to entry since almost everything can be leased and employees need not be highly experienced and trained. (Porter, 7).
Economies of scale exist when per unit costs of a product decline as production volume increases. This puts new companies at a disadvantage because they are forced to either manufacture their product at a higher cost than their competitors or begin producing a new and unproven product at a high volume (Porter, 7).
The capital requirements for starting a new business include the costs of building or purchasing facilities and equipment, extending credit to customers, and creating inventories. This is less of a problem for large companies seeking to enter a new industry but still poses a great risk to them (Porter, 9).
Product differentiation is a problem for new companies because existing firms have already marketed their product and have a number of loyal customers. A new firm must spend a lot of money to get their name out and convince consumers to begin buying their product instead of what they previously used. A related problem is switching costs, which were discussed earlier (Porter, 9).
Some cost disadvantages independent of scale are technology and patents, access to raw materials, favorable locations, government subsidies, and experience. Another major problem for new businesses is getting their products distributed. Retailers do not want to waste shelf space on something that will just collect dust to they must be convinced before they choose to carry a new product (Porter, 10-11).
Government policy can also hinder the entry of new competitors. In certain industries the government creates monopolies because the cost of having competition would be much too high. Examples include utilities such as electricity, water, and gas (Porter, 13).
III. THREAT OF SUBSTITUTES
Threat of Substitutes exist when the demand for a product declines due to either lower prices of a better performing substitute product, low brand loyalty, new current trends, or low switching cost. When threat of substitutes is low the outcome is favorable to the industry, because fewer alternatives exist.
An example of a high threat of substitutes is the Breakfast Cereal Industry. The substitutes are Waffles, Granola Bars, Yogurt, Breakfast Shakes, Fruits, Oatmeal, etc. A low threat of substitutes is the Postal Service Industry with the only substitute being the Internet Service Provider Industry, because packages and products cannot be delivered through the computer.
VI. BUYER POWER
A few things determine the force of a buyer’s power in Porter’s 5-Force analysis. The first and foremost factor is the ratio of suppliers to buyers in the market. If there are many suppliers, and only a few buyers, the buyer’s have the power to negotiate the price of the goods or services. The idea is that the buyers in this case would have many choices of where to buy the materials they need. If the price of the goods or service is too high with one supplier, then they could easily go to another company that would offer the same product for less. If the ratio was switched around, and many buyers needed to purchase goods or services from only a few suppliers, the suppliers would now have the bargaining power, and would be able to set prices.
A low buyer power rating in the analysis of an industry would mean that the market conditions present would allow entrepreneurs to easily break in to the market because of the wide dispersion of power throughout the industry. A good example of this would be in the industry of household video game consoles. Nationally, there are only a few suppliers in this industry, such as Microsoft, Nintendo, and Sony, yet there are many video game stores locally such as Toys n Joys, Software Etc., K*B Toys, Wal Mart, K Mart, Sam Goody, Costco, Sam’s Club, Blockbuster, and many other smaller businesses. If one were to look around nationally, it would be apparent that the local market here in Hawaii is a mere fraction of the market as a whole.
A high buyer rating in an industry would mean that entry into the industry would be very difficult. The buyers in this type of industry would generally have the last word when it came down to the pricing of products. A prime example of this would be military hardware industry.
Keep in mind that there are other ways in which to be classified as an industry with a high or low buyer power. One other way to claim the status of a low buyer power industry would be if the switching costs, the monetary cost or simply the ease of converting to another system, for the buyer to change from one supplier to another is high. One such example of this would be computer operating systems. Another way an industry could be considered to have a high buyer rating is if the industry deals with a luxury good, such as a high end automobile or multi-million dollar homes. When an item is not an essential one, people have the option of going without that good, and therefore reduce the bargaining power of the supplier
V. DEGREE OF RIVALRY
Degree of rivalry or the intensity of competition is the final force of Michael Porter's Five-force theory. This point is crucial in evaluating possible entry into various industries. Favorable competition levels of an independent entrepreneur depend greatly on personal strategy and desired outcome.
Examples of industries with low-level competition include monopolies or near monopolies such as public utilities. Companies such as Hawaiian Electric and Board of Water Supply are the industry when it comes to public utilities. Although federal restrictions somewhat regulate these "monopolies", their low degree market sharing provides them very healthy profit margins. On the other hand a high level of competition creates price wars and market sharing. These conditions cause profit sharing among the rivals in a particular industry and higher savings for consumers. A prime example of this high degree of competition is the current computer industry. Although the computer market, at its pioneering stages, was categorized as an industry with fairly low competition, the advancement of modern technology has pushed the industry to new frontiers. In these recent years many companies have dove headfirst into the computer industry, creating an unbelievably high level of rivalry.
In the case of Porter’s 5-Force Analysis, there are other types of tools, which can help aid in analysis of competitive structures. However, there are other things Porter has developed that complement the use of his five-force analysis. One of these tools would be Porter’s Diamond Of national Advantage. In short, this tool is used to analyze a country’s ability to develop an advantage in the international trade market through means other than their global position, and resources found there. Another strategy that Porter had developed is his ‘Generic Strategies’. These strategies are used to determine what type of approach a company should take to optimize its position in their industry, and to ultimately maximize the profits they are able to generate.
Michael Porter’s 5-force Analysis processes market data into useful information for decision-makers when determining possible entry into various industries. By analyzing industries, entrepreneurs can determine the optimal industry in which to enter. Although this theory has withstood the test of time, there are a few objective aspects that the five forces do not and cannot analyze. Overall Porter’s Five Force Analysis provides basic understanding of the competitive structure of industries, though particular organizations may be uniquely poised to compete within any given industry. Though this tool is over 20 years old, it is still popular with management consultants, and is a staple of the MBA curriculum.
Bibliography
- http://www.essaynow.com (28 January 2003)
This website is a compilation of different essays written by different authors on Porter’s Five Force Analysis. These essays offer evaluations of specific industries using Porter’s Five Force Analysis. Examples of such industries include banking, telecommunication, supermarkets and much more.
- http://www.fedex.com (31 January 2003)
This website is FedEx’s main website including general information about the FedEx Corporation.
- http://www.geocities.com (30 January 2003)
This website also offers general information about Porter’s Five Force Analysis.
- http://www.Kelloggs.com (31 January 2003)
This website is Kellogg’s main website including general information about the Kellogg Corporation.
- http://www.legamedia.net (30 January 2003)
Legamedia.net is mainly a foreign website written in Dutch about Porter’s Analysis.
- http://panko.com (30 January 2003)
This website is a Ray R. Panko’s personal business website. Ray Panko is a Professor at the University of Hawaii and has written a number useful sources about information systems and communications.
- http://www.quickmba.com (29 January 2003)
This website includes a detailed summary of Porter’s Analysis. Information used from this site includes a diagram of Porter’s Five Forces.
- http://www.themanager.org (31 January 2003)
This website offers a description of various management tools including Porter’s Five Force Analysis.
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Porter, Michael E. Competitive Strategy. New York, New York: The Free Press, 1980.
This book written by Michael Porter is unaltered information about his theory.