Porters 5 forces

Porters five forces is most suitable when analyzing the profitability or attractiveness of an industry where a company is considering entering into. It is always advisable for the company to use the five forces in order to determine if it is a worthwhile venture. It is also useful for a company operating in an industry but considering an exit from said industry.

So what are porter’s 5 forces?

Porter’s five forces are:

• Threat of new entrants
• Threat of Substitute Products
• Bargaining power of buyers
• Bargaining power of Suppliers
• Competitive rivalry

• Threat of new entrants: The significance of the threat of new entrants is influenced by two factors which are the reaction of incumbent companies and entry barriers. Entry barriers are those factors making it difficult for companies to gain entry into an industry. The higher the entry barriers, the lower the threat of new entrants. The following are examples of entry barriers:

1. Capital requirements
2. Regulatory & Statutory requirements
3. Technology
4. Technical capability
5. Knowledge
6. Access to distribution channels

• Threat of Substitute products: This threat may arise from substitutes in other industries. If a product can satisfies the needs of consumers in other industries, then such a product becomes a substitute product. The following factors influence the threats of substitutes:

1. Sustaining costs
2. Competitiveness or performance of the substitute product
3. Cost of other substitute products

• Bargaining power of buyers: This depends on how large the customer base is and whether there is a single dominant customer. If there are only a few buyers for a product, they are easily able to dictate prices or directly influence the price for the product by refusing the buy the said product until the price Falls to the price they deem acceptable. Other factors to consider will include:

1. How important is the product to the customers own business
2. Switching costs
3. Importance of quality to the customer
4. Customer loyalty

• Bargaining power of suppliers: Suppliers provide input or raw materials to the production process. If suppliers are limited, they have more power vested in them, and they can therefore affect prices negatively. A basic rule of thumb is that the fewer the supplier choices available for your business, the more dependent you become on the available supplier and in return, the more powerful the suppliers are.

• Competitive rivalry: Competitive rivalry can sometimes make or mar the business. If there is intense competition and a business is too slow to react, it faces the risk of losing most or all of its customers. The level of competition faced determines the extent of power an individual competitor possesses. If you are in a market with a lot of competitors like a perfect competitive market where all firms sell identical products, individual sellers have little or no power in controlling prices. They become price takers and can’t influence the movement of prices. On the other hand if there are little or no competitors for your products, you have all the power to either control the price of the product or the quantity of the product available to buyers, but you cant control both.

Recommended Readings

Frank Rothaermel., Strategic Management: Concepts and Cases

Gregory Dess., Alan Eisner., GT Lumpkin., Geryy McNamara., Strategic Management: Creating Competitive Advantages