PORTER’S FIVE FORCES FRAMEWORK
A business has to understand the dynamics of its industries and markets in order to compete effectively in the marketplace. Michael Porter has postulated that the intensity of competition in an industry is determined by its underlying economic structure. Porter (1985) defined the forces which drive competition, contending that the competitive environment is created by the interaction of five different forces acting on a business.
In addition to rivalry among existing firms and the threat of new entrants into the market, there are also the forces of supplier power, the power of the buyers, and the threat of substitute products or services. According to Porter, industry structure is determined by five competitive forces and it is evident that all of these competitive forces will be affected by the development of the information economy. The five forces model, as developed by Micheal E. Porter, illustrates the biggest factors that may enter into the strategic decision-making process.
These are, on a vertical level, suppliers and customers, on a horizontal level, competition from products, new entrants (can also be vertical), and rivals. To explain the horizontal/vertical, it means companies and products that are on the same level as you, competing for the attention of the same customers (and suppliers). Vertical relationships are those which a company depends on, either their relationship with suppliers or their relationship with customers. Each of these also operates on their own horizontal axis. The more powerful players on that level become, the more they can affect players on the other levels.
In other words, it is an analysis deals with factors outside an industry that influence the nature of competition within it, the forces inside the industry (microenvironment) that influence the way in which firms compete, and so the industry likely profitability is conducted in Porter’s five forces model.
- Force 1: The Degree of Rivalry: The intensity of rivalry, which is the most obvious of the five forces in an industry, helps determine the extent to which the value created by an industry will be dissipated through head-to-head competition.
- Force 2: The Threat of Entry: Both potential and existing competitors influence average industry profitability. The threat of new entrants is usually based on the market entry barriers. The entry barriers exist whenever it is difficult or not economically feasible for an outsider to replicate the incumbents’ position. The most common forms of entry barriers, except intrinsic physical or legal obstacles, are as follows: Economies of scale: for example, benefits associated with bulk purchasing; Cost of entry: for example, investment into technology, etc.
- Force 3: The Threat of Substitutes: The threat that substitute products pose to an industry’s profitability depends on the relative price-to-performance ratios of the different types of products or services to which customers can turn to satisfy the same basic need. The threat of substitution is also affected by switching costs that is, the costs in areas such as retraining, retooling and redesigning that are incurred when a customer switches to a different type of product or services.
- Force 4: Buyer Power: Buyer power is one of the two horizontal forces that influence the appropriation of the value created by an industry. The most important determinants of buyer power are the size and the concentration of customers. Other factors are the extent to which the buyers are informed and the concentration or differentiation of the competitors.
- Force 5: Supplier Power: Supplier power is a mirror image of the buyer power. As a result, the analysis of supplier power typically focuses first on the relative size and concentration of suppliers relative to industry participants and second on the degree of differentiation in the inputs supplied.
The ability to charge customers different prices in line with differences in the value created for each of those buyers usually indicates that the market is characterized by high supplier power and at the same time by low buyer power. The Porter’s Five Forces model is a simple tool that supports strategic understanding where power lies in a business situation. It also helps to understand both the strength of a firm’s current competitive position, and the strength of a position a company is looking to move into.
Despite the fact that the Five Force framework focuses on business concerns rather than public policy, it also emphasizes extended competition for value rather than just competition among existing rivals, and the simpleness of its application inspired numerous companies as well as business schools to adopt its use.
LIMITATIONS OF THE FIVE FORCES MODEL
Porter’s model is a strategic tool used to identify whether new products, services or businesses have the potential to be profitable. However it can also be very illuminating when used to understand the balance of power in other situations.
Porter argues that five forces determine the profitability of an industry. At the heart of industry are rivals and their competitive strategies linked to, for example, pricing or advertising; but, he contends, it is important to look beyond one’s immediate competitors as there are other determines of profitability. Specifically, there might be competition from substitute’s products or services. These alternatives may be perceived as substitutes by buyers even though they are part of a different industry. The further limitations in today’s market environment; as it assumes relatively static market structures.
Based originally on the economic situation in the eighties with its strong competition and relatively stable market structures, it is not able to take into account new business models and the dynamism of the industries, such as technological innovations and dynamic market entrants from start-ups that will completely change business models within short times. Nevertheless, that does not mean that Porters theories became invalid. What needs to be done is to adopt the model with the knowledge of their limitations and to use them as a part of a larger framework of management tools, techniques and theories. This approach, owever, is advisable for the application of every business model.
APPLICATION OF FIVE FORCES MODEL IN E-COMMERCE
E-Commerce or Electronic commerce generally refers to use of the Internet to conduct business transactions. But it is important here to distinguish the difference between e-business and ecommerce. According to Norris, et al (2000), e-commerce focuses on efficiency in selling, marketing, and purchasing, while e-business focuses on effectiveness through improved customer, service, reduced costs and streamlined business process. In this industry are present the following firms: Amazon. com, Yahoo. com, MSN, eBay, FNAC, and others.
In this industry is being sold products such as DVD’s, CD’s, PC’s, books, phones, mobiles, perfumes, bicycles, furniture, households articles, watch’s, academic articles, clothes (for men, woman, and children), etc. Doing an analysis of five competitive forces for this industry we have that: In the present scenario, competition has increased overall as a result of the internet and e-Commerce. The internet and IT has made it possible to both focus on the top and bottom lines and market share is expanded and costs are cut. The internet offers avenues of competition to existing companies and opportunities for start ups.
Now businesses can enter the market on-line with few barriers to entry. Porter’s Five Forces Model can help demonstrate the attractiveness of starting your on-line business. A business person should use the model to identify competition, make a plan, and implement the process. Many products and services exist just online, major companies have gone online to successfully augment the brick and mortar corporations, and the playing field is all the way to edges of cyberspace, wherever that is. It can be further evaluated through Porter’s five forces model. ? Buyer power is higher when buyers have more choices.
Businesses are forced to add value to their products and services to get loyalty. Many loyalty programs include excellent services that customers demand on-line. Customers want to solve their problems and many times they are more successful on-line than on-phone. Also, many internet savvy businesses springing up offering more valuable goods and services at lower costs. Now with the advent of eBay, many people are assuming roles as drop shippers. Individuals can have a thriving business selling goods of larger companies without having to carry inventory. ? Supplier power is higher when buyers have fewer choices from whom to buy.
Firms like Microsoft due to their position in the software product market, we can say that their bargaining power as supplier of firms that sells products like Office, for example is strong, perhaps to have others firms in the industry. The drop shipping has increased the amount of suppliers available. All an individual has to do is form an agreement to sell products for the company. The company takes care of all the logistics. The same is true of associates programs that amazon. com and google. com offer. Associates allow a webmaster to earn money by recommending products from others.
This increases supplier offerings. In general level, bargaining power of supplier is low, because the products existing in this industry are sold by many firms. In case of products like Books, DVD’s and CD’s the bargaining power of suppliers is low, caused by existence of many suppliers in the Industry. Threat of substitute products or services is high when there are many product alternatives. This is different than having many suppliers. Examples of alternatives are exchanging brand names, substituting credit card capabilities, and looking at better values from cheaper sources.
For example, if the buyers do not get satisfied with price of a DVD or Book supplied by Amazon. com, for example, these can choice to buy other product that is being sold by another firm that belongs or not this industry, to a price lower. The internet allows this with the “global economy”. One can substitute product by purchasing from companies overseas where labor, services and products are cheaper, but of comparable quality. ? Threat of new entrants is high when it is easy for new competition to enter the market. Now, small operations can open shop with less than $10. 00 per month and make a lot of money.
As inventive as people are, there are always opportunities to do improve a product or service or just create and sell something new. Recently, many new entrants have made even more money authoring E-books that tell others how to do what they did. Rivalry among competitors is high when competition is more intense within industries. On-line book stores and catalog companies are an excellent example. Amazon. com and Barnesandnoble. com are very competitive.
Competitive rivalry is strong; there are divers firms in the industry, such as eBay, Yahoo, MSN, FNAC, etc. E-commerce industry is growing, and the roducts that are being sold are not very differentiated. However, there are many also smaller niche affiliate bookstores that when combined take a great deal of market share. They offer even more competition. However, both major bookstores have used IT to create value for their customers. These values include associates programs, ease of payment and shipping and others.
EXAMPLES OF E-COMMERCE
Apple, which is strictly focused on design and marketing, outsources the manufacturing of most of its products, but is fairly vertically orientated towards the customer-side, doing most of its business in its retail-locations and online stores.
Because of this concentration of power in the middle and proximity to the customer, it also has more power over its suppliers, able to make strong demands, and it’s also better equipped to compete with horizontal players like HP or Sony, who are not as vertically integrated towards the consumer. The added benefit of a close customer-presence is also that you can use this as an opportunity to create customer-focused products, something a lot of non-vertically integrated players are not so good at.
Another company is Amazon, who spotted an opportunity to surpass brick & mortar stores, by becoming a distributor with a web-based store-front. Traditionally, the book-industry was organized as follows. A book gets printed, it then gets distributed, it then lands in a store, and then the customer buys it. Amazon integrated three of these functions: distribution, store, and customers (four, if it includes eBooks into the formula). The end-result was that the customer became empowered: he could review books, even sell books second-hand.
Which disempowered other stores where this was not possible, and publishers, who were before able to simply push out best-sellers downstream? Publishers are still powerful of course, essentially acting as a gatekeeper to writers, but this will change as soon as online publishing can be consumed comfortably.
IKEA, which is surprisingly similar to Amazon. It also started as a distributor, back in the day when a store-front was a newspaper-advert and phone-line. IKEA saved money, by working closely together with manufacturers in Poland, even building and buying machinery for them.
The end-result was standardized designs, at low costs, and produced on a massive scale. It became close to the customer, by using its warehouses as store-fronts, and enabling customers to buy via catalogue and later via the web-site. Its competition was the traditional furniture store, conservative and producing designs that were both expensive and focused on exclusivity (which translates to small-scale production). Because of this perceived strength, they were arrogant enough to not worry so much about prices on the vertical axis, both from their suppliers and for their customers.
It can be concluded that the state of five competitive forces in E-commerce based industry/ economy; industries will depend always on evolution of these industries and government policies of the different countries of the world. For example if these industries are growing and if the govern permit others companies can enter into industry and can help to promote the competition in these industries, that is good for buyers, because they can choose where want to purchase something and what products or goods are according to their necessities or that permits to maximize their utility and it is according to their money amount available for it.
For one, that it is important to consider strategy on multiple axes. It is necessary for a business deal with its suppliers, its customers, and its competition. Also, it is actually a weakness to be too vertically or horizontally integrated, as that creates a certain arrogance and/or passivity towards how one deal with these parties. New entrants will eventually come, and probably on a different axis all-together. Being too integrated, means that the business has many dependencies, which will make it all that slower to react to changes. Hence, it is better to be close to customers.
By constantly adjusting strategy, so that the value proposition for customers is increased and personalized for them, one can ensure a certain loyalty (which gives time to change) and can sense it sooner when their attention drifts towards other types of products. Business is very much an art-form and in art there is one great saying: “Good artists copy, great artist steal. ” The copying refers to that everything has been done to a degree. People have sold computers, books, furniture, and those products are clearly fulfilling a demand, which, for now, continues to exist.
Where people can innovate is in creating new combinations of things. In other words, if one copies a competitor’s business-model, he gains only the part of the market that does not already get served by the existing business-model. If instead he steal the good parts from other business models, and create his own combinations of these good things, he can create greater value-propositions for customers than already exist. This applies just as much to combinations of five forces, as it does for anything else.