by Dagmar Recklies
The model of the Five Competitive Forces was developed by Michael E. Porter in his book „Competitive Strategy: Techniques for Analyzing Industries and Competitors“ in 1980. Since that time it has become an important tool for analyzing an organizations industry structure in strategic processes.
Porters model is based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Especially, competitive strategy should base on and understanding of industry structures and the way they change.
Porter has identified five competitive forces that shape every industry and every market. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The objective of corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Porters model supports analysis of the driving forces in an industry. Based on the information derived from the Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry.
The Five Competitive Forces are typically described as follows:
The term 'suppliers' comprises all sources for inputs that are needed in order to provide goods or services.
Supplier bargaining power is likely to be high when:
· The market is dominated by a few large suppliers rather than a fragmented source of supply,
· There are no substitutes for the particular input,
· The suppliers customers are fragmented, so their bargaining power is low,
· The switching costs from one supplier to another are high,
· There is the possibility of the supplier integrating forwards in order to obtain higher prices and margins. This threat is especially high when
· The buying industry has a higher profitability than the supplying industry,
· Forward integration provides economies of scale for the supplier,
· The buying industry hinders the supplying industry in their development (e.g. reluctance to accept new releases of products),
· The buying industry has low barriers to entry.
In such situations, the buying industry often faces a high pressure on margins from their suppliers. The relationship to powerful suppliers can potentially reduce strategic options for the organization.
Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes.
Customers bargaining power is likely to be high when
· They buy large volumes, there is a concentration of buyers,
· The supplying industry comprises a large number of small operators
· The supplying industry operates with high fixed costs,
· The product is undifferentiated and can be replaces by substitutes,
· Switching to an alternative product is relatively simple and is not related to high costs,
· Customers have low margins and are price-sensitive,
· Customers could produce the product themselves,
· The product is not of strategical importance for the customer,
· The customer knows about the production costs of the product
· There is the possibility for the customer integrating backwards.
The competition in an industry will be the higher, the easier it is for other companies to enter this industry. In such a situation, new entrants could change major determinants of the market environment (e.g. market shares, prices, customer loyalty) at any time. There is always a latent pressure for reaction and adjustment for existing players in this industry.
The threat of new entries will depend on the extent to which there are barriers to entry. These are typically
· Economies of scale (minimum size requirements for profitable operations),
· High initial investments and fixed costs,
· Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets,
· Brand loyalty of customers
· Protected intellectual property like patents, licenses etc,
· Scarcity of important resources, e.g. qualified expert staff
· Access to raw materials is controlled by existing players,
· Distribution channels are controlled by existing players,
· Existing players have close customer relations, e.g. from long-term service contracts,
· High switching costs for customers
· Legislation and government action
A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category also relates to complementary products.
Similarly to the threat of new entrants, the threat of substitutes is determined by factors like
· Brand loyalty of customers,
· Close customer relationships,
· Switching costs for customers,
· The relative price for performance of substitutes,
· Current trends.
This force describes the intensity of competition between existing players (companies) in an industry. High competitive pressure results in pressure on prices, margins, and hence, on profitability for every single company in the industry.
Competition between existing players is likely to be high when
· There are many players of about the same size,
· Players have similar strategies
· There is not much differentiation between players and their products, hence, there is much price competition
· Low market growth rates (growth of a particular company is possible only at the expense of a competitor),
· Barriers for exit are high (e.g. expensive and highly specialized equipment).
© Dagmar Recklies, June 2001
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Status: 24. Oktober 2012