Michael Porter’s 5 Forces Model

Michael Porter’s 5 forces model

Porter’s 5 forces model is one of the most recognized framework for the analysis of business strategy. These forces are defined as follows:

1. The threat of the entry of new competitors
2. The intensity of competitive rivalry
3. The threat of substitute products or services
4. The bargaining power of customers
5. The bargaining power of suppliers

Threat of new entrants

Profitable markets that yield high returns will attract new firms. This results in many new entrants, which eventually will decrease profitability for all firms in the industry. The following factors can have an effect on how much of a threat new entrants may pose:

·         The existence of barriers to entry (patents, rights, etc.). The most attractive segment is one in which entry barriers are high and exit barriers are low. Few new firms can enter and non-performing firms can exit easily.

·         Government policy

·         Capital requirements

·         Absolute cost

·         Cost disadvantages independent of size

·         Economies of scale

·         Economies of product differences

·         Product differentiation

·         Brand equity

·         Switching costs or sunk costs

·         Expected retaliation

·         Access to distribution

·         Customer loyalty to established brands

Threat of substitute products or services

The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives. For example, tap water might be considered a substitute for Coke, whereas Pepsi is a competitor's similar product. Another example is the substitute of traditional phone with a smart phone.

Potential factors:

·         Buyer propensity to substitute

·         Relative price performance of substitute

·         Buyer switching costs

·         Perceived level of product differentiation

·         Number of substitute products available in the market

·         Ease of substitution

·         Substandard product

·         Quality depreciation

·         Availability of close substitute

 

Bargaining power of customers (buyers)

The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. The buyer power is high if the buyer has many alternatives. The buyer power is low if they act independently e.g. If a large number of customers will act with each other and ask to make prices low the company will have no other choice because of large number of customers pressure.

Potential factors:

·         Buyer concentration to firm concentration ratio

·         Degree of dependency upon existing channels of distribution

·         Bargaining leverage, particularly in industries with high fixed costs

·         Buyer switching costs relative to firm switching costs

·         Buyer information availability

·         Force down prices

·         Availability of existing substitute products

Bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources.

Potential factors are:

·         Supplier switching costs relative to firm switching costs

·         Degree of differentiation of inputs

·         Impact of inputs on cost or differentiation

·         Presence of substitute inputs

·         Strength of distribution channel

·         Supplier concentration to firm concentration ratio

·         Employee solidarity (e.g. labor unions)

·         Supplier competition: the ability to forward vertically integrate and cut out the buyer.

Intensity of competitive rivalry

For most industries the intensity of competitive rivalry is the major determinant of the competitiveness of the industry.

Potential factors:

·         Sustainable competitive advantage through innovation

·         Competition between online and offline companies

·         Level of advertising expense

·         Powerful competitive strategy

·         Firm concentration ratio

·         Degree of transparency

 

Reference:

http://business-fundas.com/2011/michael-porters-5-forces-model/

http://www.notesdesk.com/notes/strategy/porters-five-forces-model-porters-model/

https://en.wikipedia.org/wiki/Porter_five_forces_analysis