Introduction
In 1979, Michael E. Porter, a young associate professor at Harvard Business School, published an article in the Harvard Business Review called “The five competitive forces that shape strategy”, also known as Porter’s five forces. This article revolutionized the field of strategy and has greatly influenced academic research and business practices. Over the past thirty years, Porter’s Five Forces Analysis has become the most widely used strategy tool in academia and management training (Porter, 2008). Porter utilized a framework structure for his study, which involves using the fewest core elements to capture the full complexity of a phenomenon (Henry, 2008). I have chosen to focus on Michael Porter’s Five Forces Analysis because I believe it can provide us with valuable insights into the structure of the electronic manufacturing services industry and help us develop a successful strategy for Xeltronics.
An examination of Porter’s Five Forces
Porter’s Five Forces framework is applicable to existing businesses and can also be utilized when deciding whether to enter a new market or not. While every business is unique, the factors that impact performance and profitability are common within industries. Porter’s model serves as a tool for analyzing the competitive environment in an industry, helping to understand the causes and implications of competitive forces. These five forces, identified by Michael E. Porter, are crucial in shaping a company’s strategy: threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitute products and services, and intensity of rivalry among firms. The structure of an industry is determined by economic and technical characteristics that influence the strength of each competitive force. It is important to note that the strongest force may not always be the most apparent one.According to Porter (2008), regularly repeating the five forces analysis is crucial in order to identify any changes in the competitive environment and adjust strategy before competitors do.
The threat of new entrants is the possibility of new firms entering a market and reducing the profits of existing firms. This threat limits the profit potential of an industry. New entrants strive to gain market share and exert pressure on prices, costs, and the investment required to compete. High threat of entry compels existing firms to either lead in terms of pricing or invest heavily in their business to discourage competitors. The level of threat is determined by the height of certain entry barriers and how incumbent firms react (Porter, 2008). There are six primary entry barriers:
1. Economies of scale occur when the costs per unit decrease as the total number of units produced increases. This discourages new competitors from entering the market, as they would have to invest heavily or face a cost disadvantage starting with low volumes. It can also result from network effects, where a product’s appeal increases with the number of buyers, making it harder for new entrants to compete until a strong customer base is established.
2. Switching costs refer to fixed costs incurred by purchasers when changing their source of supply. Higher switching costs make it more difficult for new entrants to gain market share, unless they can offer significantly cheaper prices or provide a distinct advantage to consumers.
3. Capital requirements can serve as significant barriers to entry, particularly if substantial investments are needed to compete in an industry. This barrier becomes even greater if companies have to allocate their capital towards unrecoverable expenses such as research and development and advertising, which are harder to finance.
4. First-mover advantages can create cost advantages regardless of company size. Early entry into the market allows existing companies to gain experience, market knowledge, and potential benefits. Other advantages include favorable government policies, access to inexpensive raw materials, the use of patents, and established brand identities.
5. Access to distribution channels is a significant challenge for new entrants as it is necessary for effective competition in the industry. The strength of the ties between incumbent firms and distribution firms determines the difficulty of entry. Sometimes, new entrants must find alternative ways to distribute their products.
6. Restrictive government policies can impede entry by imposing licensing requirements and restrictions on foreign investment. However, governments can also support entry through subsidies or research funding. Government intervention can either amplify or nullify other entry barriers.
(Porter 2008) (Porter 1979) (Henry 2008)
Xeltronics has several advantages in both its business units (components and custom solutions) compared to new entrants. In the components business, economies of scale, high capital requirements, and favorable access to distribution channels provide Xeltronics with an advantage when competing against new entrants. In the Custom Solutions business unit, favorable conditions include the existing brand identity, the utilization of our patents, and our superior expertise in EMS research and development.
The power of suppliers is highly influential in an industry. They have the ability to increase prices, lower product quality, or transfer costs to other industry participants. Such powerful suppliers can extract profits from an industry that cannot pass on the added expenses to customers, particularly when faced with intense competition. The bargaining power of suppliers is deemed high under the following conditions:
1. The supplier’s side is highly consolidated, whereas the industry it serves encompasses various sectors. 2. The supplier’s group caters to multiple industries. 3. The industry encounters significant challenges when switching suppliers due to high costs involved. 4. Suppliers provide a unique product that is difficult to replicate, primarily due to patents. 5. There is no alternative product available in the market.
There is a potential risk of forward integration, in which suppliers may enter the market themselves if a customer becomes significantly more profitable than the supplier. (Porter 2008) (Henry 2008)
Xeltronics, a vertically integrated EMS provider, relies less on various suppliers but relies heavily on the market price of raw materials.
The power of buyers is strong. Buyers who have a strong bargaining power can lower prices, request higher quality or services (which can increase costs), and pit competing firms against each other within an industry. Customers have the ability to exert pressure on sellers if certain conditions are met.
The presence of few buyers or buyers with high volumes compared to a single seller allows them to negotiate significant discounts. Additionally, if an industry’s products are standardized and purchasers believe they can easily find another supplier, it implies that there is always a substitute available. Moreover, buyers experience low switching costs.
4. The power of buyers is influenced by two factors: the threat of integration backwards and price sensitivity. According to Magretta (2012), Porter (2008), and Henry (2008), customers can credibly threaten to integrate backwards if suppliers are earning more profit than they are.
Buyers exert significant bargaining power over Xeltronics’ components business due to the production of standardized mass products and low switching costs. In this sector, buyers are highly price sensitive and more likely to change their supplier in pursuit of a cost advantage. Conversely, the bargaining power of buyers is low for Xeltronics’ Custom Solutions products given their non-standardized nature and the need for extensive collaboration between the supplier and the customer.
According to Michael E. Porter (1979), if the threat of substitution is high, it can have a negative impact on industry profits by limiting the potential prices that can be charged. In order to combat this, an industry must find ways to differentiate itself from potential substitute products, whether through performance, marketing, or other methods. The threat of substitution is considered high when:
According to Porter (1979), it is important for strategists to always be aware of possible substitutes in other industries that may offer better relative value and have low switching costs for buyers compared to industry products.
The component business of the company faces potential substitution as customers can easily replace their products. However, Custom Solutions, which are tailored to customers’ requirements through long-term cooperation, faces a lower threat of substitution.
The profitability of an industry is limited by high rivalry between competitors, which takes various forms such as price discounts, new products, advertising campaigns, and new service offers. The impact of rivalry on an industry’s profits depends on the intensity of competition and the basis of competition. If competitors perceive an opportunity to increase their market share, rivalry can escalate and prompt retaliation from other competitors (Porter, 2008). Several factors influence rivalry among competitors:
1. Factors contributing to a competitive market include many or equal competitors, slow industry growth rates, high fixed costs, lack of differentiation or switching costs, the addition of large extra capacity, and high exit barriers (Henry 2008).
Given the highly competitive nature of the Electronic manufacturing services industry, Xeltronics experiences significant pressure from its rivals. This pressure is especially pronounced in the components business, as such products are considered mass-produced and easily replaceable with no differentiation or high costs associated with switching. Furthermore, fierce competition for market shares may lead to a destructive price war among industry competitors.
