the market share those products obtain and those firms’ plans for increased capacity and market penetration.
Bargaining Power of Suppliers
Suppliers are the businesses that supply materials & other products into the industry (Wheelen and Hunger, 7th Ed, pg 64). Suppliers can affect an industry through their ability to raise prices or reduce quantity of supply. The cost of items bought from suppliers (e.g. raw materials, components) can have a significant impact on a company's profitability. The bargaining power of suppliers affects the intensity of competition in an industry especially when there are a large numbers of suppliers, when there are only a few good substitute raw materials, or when the cost of switching raw materials is costly. If suppliers have high bargaining power over a company, then in theory the company's industry is less attractive.
Firms may pursue backward vertical integration to gain control or ownership of suppliers. This strategy is effective when suppliers are unreliable, too costly, or not capable of meeting a firm’s needs on consistent basis. Firms can negotiate more favourably with suppliers when backward vertical integration is a commonly used strategy among rival firms in an industry.
Bargaining Power of Buyers
Buyers are the people or organisations that create demand in an industry (Wheelen and Hunger, 7th Ed, pg 64). When the buyers are concentrated or large, or buy in big volume, their bargaining power represents a force affecting the intensity of competition in an industry. Buyers affect an industry through their ability to force down prices, bargain for higher quality or more services, and play competitors against each other. The bargaining power of buyers is higher when the products being purchased are standard or undifferentiated. Whenever the bargaining power of buyer is substantial, rival firms may offer extended warranties or special services to gain customers loyalty
Intensity of Rivalry among Existing Competitors.
In most industries, firms are mutually dependent of each other. As such, rivalry among competing firms is usually the most powerful of the five forces. A strategic move by one firm can be expected to have a noticeable effect on its competitors and thus may cause retaliation or counter efforts such as lowering prices, enhancing quality, adding features, providing services, extending warranties and increasing advertising. The intensity of rivalry between competitors in an industry tends to increase due to the following:
- The structure of competition ⇒ for example, rivalry is more intense where there are many small or equally sized competitors; rivalry is less when an industry has a clear market leader
- The structure of industry costs ⇒ for example, industries with high fixed costs encourage competitors to fill unused capacity by price-cutting
- Degree of differentiation ⇒ industries where products are commodities (e.g. steel, coal) have greater rivalry; industries where competitors can differentiate their products have less rivalry
- Switching costs ⇒ rivalry is reduced where buyers have high switching costs: i.e. there is a significant cost associated with the decision to buy a product from an alternative supplier
- Strategic objectives ⇒ when competitors are pursuing aggressive growth strategies, rivalry is more intense. Where competitors are "milking" profits in a mature industry, the degree of rivalry is less
- Exit barriers ⇒ when barriers to leaving an industry are high (e.g. the cost of closing down factories): then competitors tend to exhibit greater rivalry
Relative Power of Other Stakeholders
A sixth force should be added to Porter’s list to include a variety of stakeholder groups from the task environment. Some of these groups are government, local communities, creditors, trade associations, special interest groups, and shareholders. The importance of these stakeholders varies by industry.
Use of the Information from Five Forces Analysis
Five Forces Analysis can provide valuable information for three aspects of corporate planning:
Statistical Analysis:
The Five Forces Analysis allows determining the attractiveness of an industry. It provides insights on profitability. Thus, it supports decisions about entry to or exit from and industry or a market segment. Moreover, the model can be used to compare the impact of competitive forces on the own organization with their impact on competitors. Competitors may have different options to react to changes in competitive forces from their different resources and competences. This may influence the structure of the whole industry.
Dynamical Analysis:
In combination with a PEST-Analysis, which reveals drivers for change in an industry, Five Forces Analysis can reveal insights about the potential future attractiveness of the industry. Expected political, economical, socio-demographical and technological changes can influence the five competitive forces and thus have impact on industry structures. Useful tools to determine potential changes of competitive forces are scenarios.
Analysis of Options:
With the knowledge about intensity and power of competitive forces, organizations can develop options to influence them in a way that improves their own competitive position. The result could be a new strategic direction, e.g. a new positioning, differentiation for competitive products of strategic partnerships.
Thus, Porters model of Five Competitive Forces allows a systematic and structured analysis of market structure and competitive situation. The model can be applied to particular companies, market segments, industries or regions. Therefore, it is necessary to determine the scope of the market to be analysed in a first step. Following, all relevant forces for this market are identified and analyzed. Hence, it is not necessary to analyse all elements of all competitive forces with the same depth.
The Five Forces Model is based on microeconomics. It takes into account supply and demand, complementary products and substitutes, the relationship between volume of production and cost of production, and market structures like monopoly, oligopoly or perfect competition.
Validity of Porter’s Model of Five Competitive Forces
Porter’s model of Five Competitive Forces has been subject of much critique. Its main weakness results from the historical context in which it was developed. In the early eighties, cyclical growth characterized the global economy. Thus, primary corporate objectives consisted of profitability and survival. A major prerequisite for achieving these objectives has been optimisation of strategy in relation to the external environment. At that time, development in most industries has been fairly stable and predictable, compared with today’s dynamics.
In general, the meaningfulness of this model is reduced by the following factors:
- In the economic sense, the model assumes a classic perfect market. The more an industry is regulated, the less meaningful insights the model can deliver.
- The model is best applicable for analysis of simple market structures. A comprehensive description and analysis of all five forces gets very difficult in complex industries with multiple interrelations, product groups, by-products and segments. A too narrow focus on particular segments of such industries, however, bears the risk of missing important elements.
- The model assumes relatively static market structures. This is hardly the case in today’s dynamic markets. Technological breakthroughs and dynamic market entrants from start-ups or other industries may completely change business models, entry barriers and relationships along the supply chain within short times. The Five Forces model may have some use for later analysis of the new situation; but it will hardly provide much meaningful advice for preventive actions.
- The model is based on the idea of competition. It assumes that companies try to achieve competitive advantages over other players in the markets as well as over suppliers or customers. With this focus, it dos not really take into consideration strategies like strategic alliances, electronic linking of information systems of all companies along a value chain, virtual enterprise-networks or others.
Overall, Porters Five Forces Model has some major limitations in today’s market environment. It is not able to take into account new business models and the dynamics of markets. The value of Porters model is more that it enables managers to think about the current situation of their industry in a structured, easy-to-understand way as a starting point for further analysis.
References
Thomas L. Wheelen and J David Hunger (2000) Strategic Management And Business Policy 7th Edition Prentice Hall International
Fred R. David (2001), Strategic Management – Concepts And Cases 8th Edition. Prentice Hall International
Mary Coulter and Stephens P. Robbins (1999) Management 6thEdition, Prentice Hall International
J. David Hunger and Thomas L. Wheelen (2003) Essentials of strategic management, Prentice Hall International
Charles W.L. Hill and Gareth R. Jones (2002) Strategic management : an integrated approach 2nd Edition, Houghton Mifflin
