Porter’s Five Forces Analysis is centered around the notion that the primary goal of any company should be to achieve a competitive advantage over its rivals. The industry in which a company operates is not as significant as the specific area within that industry where the company chooses to compete. This competition is influenced by the rivalry between current firms, the potential threat of new entrants and substitutes, and the bargaining power of suppliers and buyers (Lowson, 2002).
The five-forces model is a valuable tool for analyzing the competitive pressures in a market and gauging their strength and significance. This widely employed technique helps in understanding the rivalry among sellers and its impact. The competitive battle among rival firms stands out as the strongest of the five forces, with the use of competitive weapons determining the intensity of this force and the ability to gain an advantage over competitors.
Competitive strategy, a component of business strategy, emphasizes a company’s approach to achieving success in the market. It encompasses offensive tactics to gain an edge over rivals and defensive measures to safeguard its position. Fleisher and Bensoussan (2003) posit that strategic group analysis examines Porter’s fifth force, competitive rivalry, along with the other four forces, exploring how they interact.
According to Porter (1980, as cited in Bowman, 1998), the level of competition among existing producers, known as rivalry, can be influenced by various factors. One significant factor is the market structure, as it plays a crucial role in determining the intensity of rivalry. In a monopolistic market, where a single firm dominates the market, priorities for rivalry include quality, availability, price, and primarily product differentiation.
In regard to this matter, it should be acknowledged that according to an article from Business World (2005), there are plans to review and revise the legislation regarding the exploitation of dominant market positions by companies in the near future. Conversely, companies operating within oligopoly conditions may observe significant differences in the international landscape with regards to the identity, quantity, and size distribution of their competitors, such as Burger King and McDonald’s (John et al, 1997).
Various factors can influence the level of rivalry in an industry. These include slow or declining demand and high fixed costs that remain constant regardless of production levels. Additionally, competition can be impacted by the potential entry of new competitors. New entrants often bring fresh production capabilities, a desire to establish themselves in the market, and sometimes significant resources to compete. The significance of the threat posed by new entrants depends on two factors: barriers to entry and how existing firms are expected to react to the new competition.
A barrier to entry can occur when a new entrant encounters challenges in entering a market and/or faces economic disadvantages compared to their competitors. Even if the potential entrant is willing to address these entry barriers, they must also consider how existing firms will respond. Will these firms passively react or actively defend their market positions by lowering prices, increasing advertising efforts, improving products, and taking other actions that may pose difficulties for the new entrant as well as other competitors?
When incumbents send clear signals that they will vigorously protect their market positions and have the financial means to do so, potential entrants often reconsider. Additionally, if incumbent firms possess the ability to influence distributors and customers, a potential entrant may be deterred. To determine the strength of potential entry as a competitive force, it is essential to evaluate whether the industry’s growth and profit prospects are appealing enough to entice further entry.
When potential entry is not a source of competitive pressure, it means that the answer is no. However, in industries where lower-cost foreign competitors are looking for new markets, potential entry becomes a strong force. In this case, incumbent firms are motivated to strengthen their positions against newcomers in order to make entry more challenging or costly. The level of threat from potential entry varies depending on changes in industry prospects and fluctuations in entry barriers.
For instance, the expiration of a key patent can significantly heighten the risk of new competitors entering the market. A technological breakthrough can establish economies of scale and competitive advantages that were previously non-existent. Incumbent firms can hinder new entrants by intensifying advertising efforts, enhancing relationships with distributors and dealers, or enhancing product quality. In global markets, barriers to entry for foreign companies lessen as tariffs decrease, domestic wholesalers and dealers opt for cheaper foreign-made products, and domestic buyers show more willingness to buy foreign brands.
Barriers to entry, a component of the five forces framework, encompasses five primary factors that impact a company’s capacity to penetrate new markets: economies of scale and product differentiation. Economies of scale, which arise from large-scale production, enable cost reduction and subsequently result in lower prices. On the other hand, product differentiation facilitates customer loyalty and increases switching costs. A notable illustration of this concept is Toyota’s recently launched electric car.
Advertising campaigns may also serve as entry barriers, as they allow existing markets to increase product awareness while new entrants may struggle to afford the associated costs. Additionally, backward vertical integration can be considered a potential entry barrier. It is also important to consider the competitive force of substitute products, as firms in different industries often compete closely due to the similarities between their respective offerings.
The competitive force of substitute products affects industries in multiple ways. Firstly, when there are easily accessible and competitively priced substitutes, it limits the maximum prices that companies can charge without causing customers to switch to substitutes and harming their own market position. This price limit also hinders industry members from earning high profits unless they can reduce costs. Secondly, the presence of substitutes encourages customers to compare not only price but also quality and performance.
The competitive force of substitutes is influenced by the difficulty and expense involved in customers switching to them. High switching costs require substitute sellers to provide significant cost or performance advantages to attract customers from the industry. Conversely, low switching costs make it easier for substitute sellers to attract buyers. For instance, Apple Inc launches a new version of the iPod touch with added features like a camera, while maintaining the same price as the previous version. The suppliers’ power is another determinant.
The strength of suppliers as a competitive force is determined by market conditions and the importance of the product they supply. If the product is a common commodity readily available from multiple suppliers, their influence is diminished. Likewise, if there are suitable alternatives and switching is easy, suppliers have less bargaining power. Furthermore, their leverage is reduced when the buying industry is a significant customer.
On the other hand, suppliers who hold significant power can negatively impact an industry’s profitability by implementing price hikes that cannot be fully transferred to the industry’s customers. Suppliers become a formidable competitive force when their product plays a substantial role in an industry’s costs, is vital to the industry’s production process, and/or significantly influences the quality of the industry’s product. Similarly, suppliers (or a group of suppliers) gain stronger negotiation power when it is more challenging or expensive for consumers to switch to alternative suppliers.
The bargaining power of suppliers is influenced by various factors. Suppliers with a strong reputation and high demand for their products are less likely to offer concessions compared to struggling suppliers trying to expand their customer base. Additionally, suppliers hold more power when they can provide components at a lower cost than industry competitors can produce them internally. However, this power dynamic changes when a customer requires enough parts to warrant backward integration. At this point, the balance of power shifts away from the supplier. The level of credibility in the threat of backward integration determines how much leverage companies have in securing favorable terms during negotiations with suppliers.
In certain cases, the suppliers of an industry can have a significant impact on its competitiveness. This occurs when suppliers are unable or lack motivation to deliver products of satisfactory quality. Such suppliers can greatly harm the businesses of their customers. For instance, Ayamas is the supplier for KFC. When Ayamas raises their prices, KFC is forced to raise theirs as well. This demonstrates the influence buyers hold over the industry. Similar to suppliers, the competitive strength of buyers can vary from strong to weak.
Buyers have significant bargaining power in various situations. This is particularly evident when buyers are large and purchase a significant portion of the industry’s output. Additionally, buyers gain leverage when it is relatively easy to switch to competing brands or substitutes. When buyers can meet their needs by sourcing from multiple sellers, they have more flexibility in negotiations. If sellers offer virtually identical products, buyers can switch without much cost. However, if sellers’ products are highly differentiated, buyers face higher switching costs and thus have less freedom to switch.
In terms of bargaining power, buyers and sellers do not have equal positions. Some buyers may be less affected by factors such as price, quality, or service. To address competitive pressure, there are certain strategies that should be implemented. One such strategy is cost leadership, which involves creating products and/or services at the lowest industry cost. This can be achieved through frugal purchasing practices, efficient business processes, influencing competitors to pay higher prices, and assisting customers or suppliers in reducing their costs.
A cost leadership example is the Wal-Mart automatic inventory replenishment system. This system allows Wal-Mart to minimize storage needs, resulting in high sales floor space ratios compared to the industry. Essentially, Wal-Mart utilizes floor space primarily for selling products rather than storing them and avoids tying up capital in inventory. Cost savings from this system and other strategies enable Wal-Mart to offer low-priced products to customers while generating significant profits. Additionally, differentiation strategy is another approach, involving the provision of distinct products, services, or product features.
< p>Companies can increase prices, boost sales volume, or achieve both by offering superior products. Southwest Airlines has successfully positioned itself as a low-cost carrier specializing in short-haul flights to stand out in the competitive airline industry. Dell has differentiated its brand in the personal computer market by implementing a mass-customization approach. Another effective strategy is innovation, which involves introducing new products and services, incorporating new features into existing offerings, or developing innovative methods of production.
Innovation is akin to differentiation, but with a much greater impact. Differentiation involves making minor adjustments to existing products and services in order to provide customers with something unique and distinct. On the other hand, innovation refers to something completely new and different that fundamentally transforms the industry. A prime illustration of this is the launch of automated teller machines (ATM) by Citibank. The convenience and cost-saving aspects of this innovation bestowed Citibank with a significant advantage over its rivals.
The ATM revolutionized the banking industry, making an ATM network essential for any bank. Additionally, considering a PEST and SWOT analysis can prove helpful when examining an organization. A PEST analysis examines the external political, economic, social, and technological factors that influence the organization, expanding thinking to encompass environmental influences on the company. On the other hand, a SWOT analysis evaluates internal strengths and weaknesses as well as external opportunities and threats (Bowman, 1998).
According to Recklies (2001), the model is most suitable for analyzing simple market structures. However, in complex industries, it becomes challenging to give a comprehensive description and analysis of all five forces. On the other hand, narrowing the focus too much on specific segments of such industries may result in overlooking important elements. Additionally, Porter’s model assumes that companies aim to gain a competitive advantage over other market players, as well as suppliers and customers.
In regards to this focus, it does not consider strategies such as strategic alliances, which are highly prevalent in today’s market. According to Thompson and Strickland (2003), these alliances not only help counter competitive disadvantages or create a competitive advantage, but also enable firms to prioritize mutual rivals over each other.
