Porter’s five forces model forms a useful point from which to start a thorough competitive analysis for any organisation, providing information on key elements of the micro environment. The five forces which define the competitive forces that operate in an industry are:
- the bargaining power of suppliers
- the bargaining power of suppliers
- the threat of new entrants
- the threat of substitute products and services
- the rivalry among current competitors
This can be shown as:
Industry Competitors
Key components influencing competitive rivalry include:
- Stage of the product life cycle of competing products
- Use of specialized production techniques
- Ability to differentiation and achieve brand loyalty
- Competitor intentions
- The relative size of the competitor
- Barrier of exit from the industry.
Therefore understanding the balance of various forces is critical to ensuring that the organisation makes the correct competitive response.
In addition to the direct impact of competition within the industry, Porter identified that the intensity of competition is also affected by the four other factors of threat of potential entrants, threat of substitutes along with bargaining power of suppliers and customers.
Bargaining power of the suppliers
Understanding the bargaining power of suppliers to the industry the organisation is involved in requires understanding of these areas:
- Supplier brand strength –is the brand one that all organisations will want to exploit, what effect will this have on the price of supplies?
- Supply source covers only a small number of suppliers – i.e. limited sources of supply provides the supplier with an supply and demand component in their favour, the more limited the demand, the higher the price they can charge
- Supplier switching – the cost to switch can be quite high, negotiation of new contracts, establishing relationships and enabling trust
- Substitute products of suppliers – are appropriate substitute products available?
- Forward integration – the threat of suppliers establishing their own production facilities.
Bargaining power of buyers
Similarly, it is important to understand the bargaining power of buyers as a factor affecting industry competitive intensity through these potential elements:
- Fewer buyers controlling large market volume – e.g. larger players in the electrical goods industry buying large volumes of products based on economies of scale, passing these reductions on to their customers
- Large number of smaller suppliers fighting for a share of the market – again the retail industry would be a classic example of this, particularly in the food sector, i.e. grocery and meat products
- Cost of switching supplier is low – the retail sector is a good example of how non brand loyal customers will shop around to gain the best deal.
- Undifferentiated and mass-market products – where there are many variations on the same theme, for example, toothpaste, soft drinks, etc.
- Customer power – knowledge of the market and where to attain the best deal
- Backward vertical integration – where the buyer, goes back to the supplier cutting out the middle man.
The threat of potential entrants
This element of Porter’s Five Forces model looks at the obstacles to entering new markets; primarily the barriers to entry which any potential entrant would have to overcome:
- Economies of scale – existing organisations often have economies of scale, new entrants struggle to achieve competitive economies in the short/medium term
- Access to new distribution channels – it may be difficult to gain access to the appropriate distribution channels, due to competitive operations and networks
- Brand loyalty – in a brand-loyal market it might be difficult to attract new customers and therefore marketing spend could be quite considerable.
- Capital investment – it can be cash intensive to enter into new markets and require high levels of investment – from a competitive perspective, this weakens initial positions
- Competitor retaliation – it is likely that competitors will follow suit quite closely behind, therefore competitive rivalry could be highly intensive
- Regulatory influence – what is the position in respect of fair competition, monopolies and mergers.
Threat of substitutes
The final element of the model is the threat from a substitute product to those currently operating in the industry
- A new product or service equivalence – a product or service offering the equivalent outcome for the customer, typically coming from outside the existing industry players.
- Services replacing an existing product – e.g streaming services such as Netflix and Spotify replacing physical DVDs and CDs, along with the associated equipment for playing them. Similarly, much software is now provided via monthly subscription using the Software as a Service (SaaS) model rather than outright purchase.
- Consumer substitution – consumer choice can be the basis of a threat, when the consumer chooses a new kitchen over a new car for example; buyer willingness to search for substitute products. Similar examples can apply for the business to business context where an organisation faces budget restrictions in relation to investments in future technologies and capital equipment purchases.
The Five Forces model is covered in detail by Michael Porter in his 2004 book The Competitive Strategy: Techniques for Analyzing Industries and Competitors – available here
Many CIM modules include the Five Forces model due to its relevance and usefulness as a tool to understand competition. In particular the Level 4 Marketing Impact and Level 6 Strategy and Planning modules utilise the model with reference to it in the syllabus.
We have a detailed video explanation of the model available here