Porter’s Five Forces Model – Competitive Analysis

 

Model -Competitive Analysis

Every business operates in the competitive environment. Michael Porter believes that it is the industry where competitive advantage is ultimately win or lose. It is through competitive strategy that the organization attempts to adopt an approach to compete in the industry. Porter’s five forces model is one of the most effective conceptual frameworks used to assess the nature of the competitive environment and to describe an industry’s structure. The interrelationship among these five forces gives each industry its own particular competitive environment. By applying Porter’s five forces model of industry attractiveness to their own industries, the managers can gauge their own firm’s strengths, weaknesses, and future opportunities.New entrants can reduce industry profitabilitybecause they add new production capacity, leading to increase in supply of the product even at a lower price and can substantially reduce existing firm’s market share position.A firm’s profitability tends to be higher when other firms are blocked from entering the industry.

Bargaining Power of Buyers

Buyers of an industry’s product or services can sometimes exert considerable pressure on existing firms to get at lower prices or better services.

1. Especially when buyers have full knowledge of the sources of products and their substitutes.
2. This is also possible when numbers of buyers are limited.
3. They can easily switch to the substitutes available.

 

Bargaining Power of Suppliers

Suppliers can influence the profitability of an industryin a number of ways. Suppliers can command bargaining power over a firm when,

1. Their products are crucial to the buyer and substitutes are not available.
2. They can erect high switching costs.
3. This is possible when number of suppliers is limited.

 

Nature of Rivalry in the Industry

Rivalry among competitors directly influences the profitability of the industry.

The intensity of rivalry can influence the costs of suppliers, distribution, and of attracting customers and thus directly affect the profitability.

 Steps for Using Porter’s Five Forces

The strategists can use the five-force model to determine what competition is like in a given industry by undertaking the following steps:

Step 1: Identify the specific competitive pressures, associated with each of the five forces.

Step 2: Evaluate how strong the pressures comprising each of the five forces are (fierce, strong, moderate to normal, or weak).

Step 3: Determine whether the collective strength of the five competitive forces is conducive to earn attractive profits.

 

Barriers to new entrants

Meaning of Barriers of new entrants

To discourage new entrants, existing firms can try to raise barriers to entry. Barriers to entry represent economic forces (or ‘hurdles’) that slow down or make difficult to enter.

Common barriers created by Existing firms

Common barriers to entry include the following:

-              Brand identity

-              Access to distribution channels

-              Requirement of capital

-              Retaliation aggressively by existing players

-              Innovative product differentiation

-              Economies of scale

-              Switching costs

 Brand Identity

The brand identity of products or services offered by existing firms can serve as an entry barrier. Brand identity is particularly important for infrequently purchased products that carry a high unit cost to the buyer. New entrants often encounter significant difficulties in building up the brand identity, because to do so they must commit substantial resources over a long period.

 

For example, during the 1970s, Japanese companies such as Toyota, Nissan, and Honda had to spend huge sums on new product development and promotional activities to overcome the American consumer’s preference for domestic cars.

Access to Distribution Channels

The unavailability of distribution channels for new entrants poses another significant entry barrier. Despite the growing power of the internet, many firms may continue to rely on their control of physical distribution channels to sustain a barrier to entry to rivals. Often, the existing firms have significant influence over the distribution channels and can retard to impede their use by new firms. For example, because of control over distribution channels in India by HUL, P & G and Godrej, etc. small entrepreneurs find it very difficult to sell their products through the existing channels.

Requirements of Capital

When a large amount of capital is required to enter in an industry, firms lacking funds are effectively barred from the industry thus enhancing the profitability of existing firms in the industry. For example, huge investments are needed to build production facilities and establish brand awareness among people for entry into the pharmaceutical industry. This makes the entry of new companies into this sector very difficult.

Retaliation Aggressively by Existing Players because of New Entrants

Sometimes the mere threat of aggressive retaliation by incumbents can deter entry by other firms into an existing industry. For example, introduction of products by a new firm may lead incumbent’s firms to reduce their product prices and increase their advertising budgets.

Innovative Product Differentiation

Product differentiation refers to the physical or perceptual differences or enhancements that make a product special or unique in the eyes of customers. Firms in the personal care products and cosmetics industries actively engage in product differentiation to enhance their products’ features. Differentiation works to reinforce entry barriers because the cost of creating genuine product differences may be too high for the new entrants.

Economy of scale

Economy of scale refers to the decline in the per unit cost of production (or other activity) as volume grows. A large firm that enjoys economies of scale, can produce high volumes of goods at successively lower costs. This tends to discourage new entrants.

 

For example, in the semiconductor industry, larger companies, such as IBM, Intel, Samsung and Texas Instruments, enjoy substantial economies of scale in the production of advanced micro processors, communication chips and integrated circuits that power the most consumer electronics, personal computers (PCs) and cellular phones. This acts as a barrier for new entrants.

Switching Costs

In order to succeed in an industry, the new entrant must be able to persuade the existing customers of other companies to switch to its products. To make a switch, the buyers may need to test a new firm’s product, negotiate new purchase contracts, and train personnel to use the equipment, or modify facilities for product use. Buyers often incur substantial financial (and psychological) costs in switching between firms.

 

When such switching costs are high, buyers are often reluctant to change. For example, high switching costs in moving away from Microsoft’s Windows operating systems, used in personal computers and corporate servers, powered the company’s stunning growth over the past decade in the software industry.