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Porter Five(5) Forces - The Five Forces That Shape Industry Competition
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Porter Five (5) Forces analysis can help an organization to assess industry attractiveness, understand what are the different trends that can affect industry competition, and provide a framework to choose which industries a firm can compete in relation to other companies in the industry to achieve a sustainable competitive advantage.
The job of strategists in an organization is to understand and devise strategy to thwart competition. The success in achieving so often comes down to how the managers of the firm define competition. If they define competition too narrow then the organization may likely to blind sided by new entrants in the industry. If the managers of the organization define the competition too broad then the organization may not able to make the strategic choices it needs to build a sustainable competitive advantage.
Even though most of the industries appear vastly different from one another on the surface, the underlying drivers of profitability in all the industries the same. To understand the underlying drivers of profitability in each industry Michael Porter identified– “The Five Forces That Shape Industry Competition”.
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The Five Forces That Shape Industry Competition
Michael Porter in his Harvard Business Article –“The Five Competitive Forces that Shape Strategy” suggested that if the five force are intense – for example in industries such as Airlines, Textiles & Hotels – then the industries are not very attractive as most of the firms in these industries can’t make long term sustainable profits. According to Michael Porter – “the configuration of the five forces differs from industry to industry”. Managers need to carefully analyze the configuration of the Five Forces and make choices based on the strategy and fit of organization.
The Porter Five (5) Forces are -
Threat of New Entrants
New entrants in an industry brings innovation, new ways of doing things and put pressure on established players through efficient pricing, streamlining costs, providing new value propositions to the customers.
When the new entrants are branching out from their core business then they can easily overcome the entrenched players’ advantage of capital required.
The threat of new entrants put a limit to profitability within the industry. If the industry is easy to enter and have high profits then new entrants will rapidly bring down the profitability of the entrenched players.
There are numerous entry barriers that are subject to nature of industry. For example in the Beer industry it is easy to enter buy the bigger barrier for new players is to build a supply chain network. It is the same for an online retailer. It takes couple of 100 USD to start online store but require huge investment in to solve the last mile challenge in online retailing.
One of the prominent barriers to entry for new entrants in various industries is – economies of scale. In capital intensive industry if a firm able to scale rapidly then it can produce cheaply compare to its competitor by distributing the fixed cost over the large number of units produced.
Bargaining Power of Suppliers
If the industry is host to powerful suppliers then those powerful suppliers limit the scope of profitability for the firm as based on their market power the suppliers make the most margins and leave little room for other partners in the supply chain to make money.
For example most Personal Computer manufacturers are dependent upon Microsoft for operating system. Microsoft can easily limit their margins by increasing the price of Windows as the manufacturer will find it really difficult to pass on that cost to the customers.
Shifting suppliers can be an expensive endeavor for an organization and may hurt the brand in the long run. For example numerous PC makers start shipping computers with Ubuntu loaded but in such a scenario the manufacturer risks losing customers who are comfortable with the Windows environment.
Bargaining Power of Buyers
Powerful and influential buyers can also squeeze the margins for the firm by demanding more value, forcing prices down, by asking extra services and by playing one company against another in the market player.
Commodity supplying firms are the most vulnerable to such pressures as they don’t have a unique product and most of their differentiation comes from factors such as location and market gap. With increasing education among the customers regarding salt composition, Pharma marketing companies are also facing similar threats where customers can easily switch from one brand to another with a signification price trade off.
The Threat of Substitutes
The substitutes perform the same or similar function to that of an industry’s product but by a different means. For example Video Conferencing is a substitute to traveling. Email is a substitute to sending documents.
Most of the delivery companies’ lucrative business use to be delivery of corporate documents safely. With the advent of electronic mail and storage technology the document transportation business has almost disappeared.
Similarly the electronic storage options such as – Dropbox & Google drive have significantly impacted the physical storage hard drive manufacturers.
Rivalry between Existing Companies
The intensity of rivalry among existing players can significantly limit the profitability proposition for the firm. Rivalry among existing players come in similar forms such as – discounting products, new product introductions, service improvements and advertising campaigns.
The rivalry is intense if the firms operating in the industry are of similar size and none have a leadership in the industry. In such situations businesses try to poach business from each other by either undercutting the price or by providing cost adding value proposition.
If the initial investment is high and exit is difficult then it can lead to intense competition and often selling below the cost of production. This trend is prevalent in utilities and heavy metal industries such as Steel & Aluminum where cost of setting a plant is high and shutting it down is equally expensive. Companies often sell products above variable costs to buy time to be profitable.
Porter Five Forces Conclusion
Michael Porter suggests that even though most industries on the surface may look vastly different, the underlying levers of profitability in all industries are the same. He called them “Five Forces that Shape Industry Competition”. The understanding and utilization of these five forces can help strategy managers in the organization to make prudent strategic choices and build a sustainable competitive advantage.