MICHAEL PORTERS FIVE FORCES

Five forces model is a strategy for companies to use to analyze the relative attractiveness or value of an industry before they enter the industry. It also helps existing companies in the industry to understand the strengths and weaknesses of their product or service for further improvement. It is important for companies to fully understand their industries' situation, so that they can plan a effective business strategy for the company.

The five competitive forces are:

 

1) Competitive Rivalry --

Competitors in an industry are chasing for a competitive advantage over other rivals. The intensity of competitions is different in different industries. So, the company’s business strategic manager should first look at the competitive rivalry when analyzing an industry. It means to see whether the industry has a strong competition between existing players.

Competitive rivalry is usually high when:

 

2) Power of suppliers –

 

The second thing to look at is to see how strong the position of sellers is.

Suppliers have great influence in an industry, especially in producing industries because they need raw materials, labor, and other supplies to make a finished product. If the power of suppliers is high, suppliers can set a high price for their products to earn more profit because buyers have no choice but to go by the high prices.

 

Power of suppliers is high when:

  • The switching cost from one supplier to another supplier is high.
  • There are few suppliers or there is a monopoly.
  • The supplies have no other substitutes.

 

Power of suppliers is low when:

  • There are many suppliers to choose from

 

3) Power of buyers –

 

Power of buyers is also called the customer’s power. It takes an important role in an industry. Managers can reduce the power of buyers by setting up loyalty program for customers, such that the company will reward customers for constantly choosing that company to do business.

 

The power of buyers is high when:

  • The level of product differentiation is low
  • Substitutes exist
  • Switching cost for buying a product from another firm is low
  • There are few buyers with lots of suppliers
  • Buyers are sensitive to price

 

The power of buyers is low when:

  • Buyers have few choices of whom to buy from
  • There are many different buyers in the market
  • Switching cost is high


4) Threats of substitutes --.

 

A strategic manager should also consider the threats of substitutes, which is the easiness of product or service to be substituted by product or service in other industries. Usually, threats of substitutes occur in an industry through price competition.

 

The threat of substitutes is high when:

  • Customers have many alternative choices in purchasing a product
  • Customers are willing to buy a substitute product
  • The price of the substitute product goes down
  • Switching cost is low


5) Threat of new entrants –

 

The last force in the model is the threat of new entrants, which is the easiness of new competitors to enter the industry. When entry barriers are low, the threat of new entrants is high and vice versa. Having a high entry barrier in the industry can protect the level of profits of existing competitors by reducing the rate of new entrants.

 

Sources of entry barriers:

  • Businesses have different rates in achieving economy of scales. The greater differences between the times required in achieving economy of scales among different companies, the greater the entry barriers.
  • Patented ideas and products create an entry barrier. When ideas and knowledge in a specific business are patented, they are treated as private property. So, other rivals cannot easily enter the industry by producing similar product because the patented idea is protected by law.
  • Government legislation creates entry barriers. Sometimes, government regulations prevent businesses from entering the industry, like electric company and local cable company. The government prefers to permit one company to produce power and cable service to the public than having many companies to compete in the market because it is easier to monitor the price of one company than many companies.