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The objective of Porter’s 5 Forces model is to assess the overall competitive landscape of a particular business sector. Each of these five forces corresponds to a key component of market intensity. Other than the Threat of New Entrants in Porter’s 5 Forces model, there are other three forces which will be discussed in this section.
Porter’s 5 Forces: The Threat from Substitute Products
A substitute product is a product /service produced by another industry which satisfies the same customer needs.
Substitutes affect profitability of an industry through:
Putting a ceiling on prices e.g. air fares will determine the maximum level of train fares over similar
routes
Affecting volumes of demand
Forcing expensive investments and service improvements e.g. CDs + DVDs supplied with booklets,
posters and other offers to make them more attractive as artefacts compared to virtual downloads.
Threat from Substitutes Determined by:
Relative price/performance e.g. speed of plane travel against the speed of train travel may be higher
but does it justify the higher price?
Switching costs from one to another e.g. download may be cheaper than CD but necessitates buying
an MP3 player.
Porter’s 5 Forces: The Bargaining Power of buyers (customers)
Buyers (customers) may include:
Industrial customers and distributors seeking to obtain lower costs to boost their own margins, or better inputs and smoother transactions with suppliers
Governmental or other not-for-profit organizations seeking to gain more benefit for their clients
Consumers wanting better quality products and services at a lower price
Satisfying their wants may lead them to trade around the industry, forcing down the profitability of the
industry. Buyer power is increased by:
The customer buying a large proportion of total industry output
The product not being critical to the customer’s own business and a lack of proprietary product differences which would otherwise make them favor or be locked into one supplier
Low switching costs (i.e. the cost of switching suppliers)
Products are standard items and hence easily copied
Low customer profitability forcing them to prioritize cost reductions
Ability to bypass (or acquire) the supplier
The skills of the customer’s purchasing staff
High degrees of price transparency in the market
Porter’s 5 Forces: The bargaining power of suppliers
In Porter’s 5 Forces model, suppliers can exert pressure for higher prices but this depends on a number of factors.
Are there just one or two dominant suppliers to the industry, able to charge monopoly or oligopoly
prices?
The threat of new entrants or substitute products to the supplier’s industry.
Whether the suppliers have other customers outside the industry, and do not rely on the industry for
the majority of their sales.
The importance of the supplier’s product to the customer’s business.
Whether the supplier has a differentiated product which buyers need to obtain.
Would switching costs for customers be high?
The level of switching costs for their customers
Porter’s 5 Forces: Competitive Rivalry
The intensity of competition will depend on the following factors.
Market growth: Rivalry is intensified when firms are competing for a greater market share in a total market where growth is slow or stagnant.
Cost structure: High fixed costs may lead a company to compete on price, as in the short run any contribution from sales is better than none at all.
Switching: Suppliers will compete if buyers switch easily (e.g. Coke vs Pepsi).
Capacity: A supplier might need to achieve a substantial increase in output capacity, in order to obtain reductions in unit costs.
Uncertainty: When one firm is not sure what another is up to, there is a tendency to respond to the uncertainty by formulating a more competitive strategy.
Strategic importance: If success is a prime strategic objective, firms will be likely to act very competitively to meet their targets.
Exit barriers: These make it difficult for an existing supplier to leave the industry.
Non-current (fixed) assets with a low break-up value (e.g. there may be no other use for them, or they may be old)
The cost of redundancy payments to employees
If the firm is a division or subsidiary of a larger enterprise, the effect of withdrawal on the other operations within the group
READ MORE: The Threat of New Entrants in Porter’s 5 Forces
