Understanding Porter’s Five Forces Model
Porter’s Five Forces Model is a comprehensive framework for assessing and analyzing the market components that are affecting the running business or can affect the new opening business firm. This model is helpful for understanding the current position of a firm in the marketplace and also the position of a firm that may look to move into another sector or the firm which may want to establish. This model argued that proper analysis of competitive five forces helps an organization to develop an effective corporate strategy that can help to sustain in long run.
This model is developed by Michael E. Porter, a Harvard University Professor and strategic management expert. It was first published in 1979 in Harvard Business Review.
This model suggests five competitive forces they are the threat of new entrants, competitive rivalry, the threat of substitute products or services, the bargaining power of buyers, and the bargaining power of suppliers. These five forces are used to analyze the industry’s competitive position to find out their weaknesses and strengths and how they are achieving those positions. Through properly analyzing the business firm can develop their strategies which may help to achieve competitive profitability in long run.
Porter’s five forces model suggests that the threat of substitute products or services, competitive rivalry, and the threat of new entrants are the forces that come from horizontal competition, and the bargaining power of customers and bargaining power of suppliers are the forces that come from vertical competition. In horizontal competition, all organizations have somehow the same products or services which may differ in quality and they compete with each other to be selected by customers. But in vertical competition, people have different factors of satisfaction may one person liked one product at a time but maybe another person does not like the same product at the same time, thus it is more challenging for organizations to catch their ideal customers.
From the above discussion, it may be concluded that the ultimate goal of Porter’s five forces model is identifying market trends, challenges, variables that affect the customer’s demand and need to best fit in the competitive market.
Lets understands Porter’s Five Forces individually,
Porter’s Five Forces are:
#1 Threats of New Entrants
In a competitive market, there is a probability of entry of new competitors. Threats of new entrants are fairly high in local products or services that required low capital investment. Similarly, threats of entrants are low for a business that requires huge capital investment. Also, threats of new entrants are high in profitable markets and vice versa.
Entrants of new competitors affect the positions of already existing competitors, may their position significantly weakened. Barriers to entry, economies of scale, huge capital requirements, high switching costs, government policies decline the competitive rate.
#2 Competitive Rivalry among Competitors
This is the competition between organizations providing the same goods or services. Rivalry competition is less where there is less number of product or service seller and rivalry is high where there are huge numbers of seller of the same products. Such competitors are involved in a price war, competitive advertising, and new product introduction. In such a situation customers move towards the competitors who offer low product prices.
But in some cases rivalry competition has not existed due to the unique quality of products or services, in such a situation, new competitors do not affect the positions of an existing company.
#3 Threats of Substitute Products
The entry of new alternative products or services may substitute the need for existing products or services. The product which has more substitutes there is likely to decrease in the product price and customers easily switch from one product to another where they find low cost, it also weakens the position of the company in the marketplace.
Similarly, the product which has fewer substitute products is more likely to maintain the position in the market for the long run.
For example, the advent of computers has reduced the demand for typewriters.
#4 Bargaining Power of Customers
The power of buyers influences the market share of the manufacturers and suppliers. This force tests the bargaining power of customers in terms of price and quality of products. When the numbers of marketers are high there is high power of customers in drowning the price of products by bargaining and they switch between products easily. When there are fewer sellers but high numbers of customers may price of products not adjusted according to the expectations of customers.
Another example, considering the products or service price and quality. In Asian countries, most people are price sensitive and in Western countries, people are quality sensitive.
#5 Bargaining Power of Suppliers
This force examines the power of suppliers that influence the company and the potential customers. In the context of the company, it assesses the power of suppliers to drive up the input costs. It is assessed by the number of suppliers of inputs, the uniqueness of their inputs, and the cost of switching between suppliers.
The fewer numbers of suppliers the company has, the more power suppliers have to control the input price, and the more numbers of suppliers the company has, the company has the power to reduce the input cost and easily switch from one supplier to another. When suppliers have the power they take other advantages by increasing the input costs and when the company has the power it reduces the input costs, saves them, and invests in profitable sectors.
In the context of customers, suppliers drive up their goods and services prices by supplying quality and the right quantity of goods to the right customers at the right time.