PORTER’S FIVE FORCES MODEL

UNIT

Porter’s five forces model helps managers to analyze competitive forces in the industry.

Five forces

(1). The risk of entry by potential competitors.

(2).The intensity of rivalry among established companies within an industry.

(3).The bargaining power of buyers.

(4).The bargaining power of suppliers.

(5). Substitute Products.

A strong competitive force is a threat because it reduces profits.

A weak competitive force is an opportunity because it increases profits.

1.RISK OF ENTRY BY POTENTIAL COMPETITORS.

Competition in reality is much broader.

The risk of entry by potential competitors can be from other industries also.

E.g. Conglomerates like Salt to Software Tata Group can enter any industry.

Their recent entry into Airlines (Air Asia & Vistara Airlines)

Established companies discourage potential competitors from entering the industry.

(i). Government Regulations:

E.g. Indigo creates entry barriers for new airlines through government regulations (5/20 rule for domestic carriers to fly International routes in Indian airline industry)

More the number of companies enter, it squeezes the market share and profits.

(ii). Economies of Scale.

Economies of scale are the relative cost advantages associated with large volumes of production

that lower a company’s cost structure.

Cost advantages are significant, a new company that enters the industry and produces on a small scale

suffers significant cost disadvantage relative to established companies.

(iii). Brand Loyalty.

Brand loyalty is buyers’ preference for the products of any established company.

A company can create brand loyalty through continuous advertising of its brands (products) and company name,

patent protection of products, product innovation achieved through company R&D

programs, an emphasis on high product quality

makes it difficult for new entrants to take market share away from established companies.

2. RIVALRY AMONG ESTABLISHED COMPANIES.

The intensity of rivalry among established companies within an industry.

Rivalry refers to competitive struggle to gain market share from each other.

Eg: Indian Smart Phone Market- Samsung Vs Micromax (21.5% Vs 17.9%) – Counterpoint Research

The competitive struggle can be fought using Price (discount war between Flipkart vs Snapdeal), Product design (Patent war between Apple Vs

Samsung),Advertising and promotion spending (Pepsi Vs Coke)

, Distribution (Maruti Suzuki’s Premium Nexa

Network), and After-sale service and support (Maruti Suzuki Vs

Hyundai).

More intense rivalry implies lower prices.

Intense rivalry raises costs, it squeezes profits out of an industry.

E.g. Price war in Airline Industry (Indigo Vs Spice Jet)

If rivalry is less intense, companies may have the opportunity to raise prices which leads to a higher level of industry profits.

E.g. Airbus Vs Boeing

The intensity of rivalry is based on three factors:

(1). Industry competitive structure

(Fragmented-price war, Low entry barriers)

(Oligopoly, Duopoly, Monopoly)

(2). Demand conditions (Growing demand from new

customers and existing customers reduces rivalry )

(3). The height of exit barriers in the industry (it leads to price cut and intense competition and rivalry)

3. THE BARGAINING POWER OF BUYERS

An industry buyers may be B2B, retailers, wholesalers, Dealers

The bargaining power of buyers refers to:

Buyers bargain down prices charged by companies in the industry

Buyers raise the costs of companies in the industry by demanding better product quality.

By lowering prices and raising costs, powerful buyers can squeeze profits out of an industry.

According to porter, buyers are most powerful in the following circumstances:

Suppliers are small and more in numbers and

the buyers are large and few in numbers.

When buyers purchase in large quantities, they leverage their purchasing power for price reduction.

Supply industry depends on the buyers for a large percentage of its total orders

Buyers can threaten to enter the industry and produce the product themselves and thus supply their own needs.

Also a tactic for forcing down industry price.

E.g. The auto component supplier industry in Chennai.

THE BARGAINING POWER OF SUPPLIERS

Suppliers are the organizations that provide inputs to the industry, such as materials, services and labor.

According to porter, Suppliers are most powerful in the following circumstances:

The product that suppliers sell has few substitutes and vital to the companies in an industry.

If a particular suppliers products are unique or different.

An example of an industry in which companies are dependent on a powerful suppliers is the personal computer industry.

They are heavily dependent on Intel, the world’s largest supplier of microprocessors for PC’s.

5. SUBSTITUTE PRODUCTS

The products of different businesses or industries that can satisfy similar customers needs.

For example, companies in that coffee industry compete indirectly with those in the tea and soft drink industries because all these serve customer needs for non –alcoholic drinks.