A tool that must be in the toolbox for everyone working in business or with products is Michael Porter’s Five Forces. This framework helps to evaluate an industry or market. The framework enables companies to find an attractive industry and serves as a starting point for understanding the competitive landscape. In addition, it assists in creating a strategy to find a competitive advantage. The research done by Porter could help explain why some industries are more profitable than others and why companies within the same industry are more profitable than others (Hitt et al., 2012).
Porter’s Five Forces are potential entry barriers for new competitors, the threat of substitutes, the bargaining power of the suppliers, the bargaining power of the buyers, and Rivalry among competing firms.
Potential Entry Barriers for New Competitors
How easily can new competitors enter the market? If it is easy for new products and companies to enter the market, you will have more competition that will take more pieces of the pie. The new entrants will push the prices downwards, reducing margins, and the declining profitability of the industry in the long run (Keegan & Green, 2013). Other barriers to entering a new market include brand recognition, lack of experience, brand recognition, customer loyalty, economies of scale, policies and regulations, tariffs, locations, and more (David & David, 2017).
As a manager or business person, you want higher barriers because you will have less competition. Industries that have a lot of regulations or need to invest in R&D have usually higher barriers. For example, it is not easy to enter the pharmaceutical field because it requires a lot of resources and meeting the highest standards set by regulations.
Product differentiation is another factor that determines a barrier to enter the market. Unique products and brand recognition could force new entrants to invest a lot of resources in R&D and marketing for their products to stand out (Keegan & Green, 2013).
Threat of Substitutes
As a customer, if you cannot afford coffee, you might decide to go for tea, hot chocolate, hot milk, or even a soda. A product with many cheap substitutes could have problems because when the price increases, people won’t be willing to spend the money. Also, when thinking of substitutes, it has to be broader than just direct substitutes. For example, for a gym, a good substitute would be a personal trainer. However, you must consider people getting into a diet, walking in the park, or having surgery.
Your product might not have a direct competitor but having a substitute could limit the reach that you might want. Furthermore, as explained before, substitutes will put a price ceiling on your products because consumers will be switching to the substitutes (David & David, 2017).
Bargaining Power of Suppliers
Are there a few suppliers for raw materials needed by your company? If so, the suppliers could have the power to raise the prices; and you have to absorb those costs to maintain a competitive price. Similarly, if the cost of switching raw materials is too high because the investment needed to change makes it difficult for firms to take this path (David & David, 2017).
Suppliers will leverage their powers if their products are important inputs for buying firms because they cannot be replaced with ease. Additionally, if the suppliers see a good market or buyers are not willing to pay the new prices, they might enter the market with finished products at lower prices.
Bargaining Power of Buyers
This force refers to the bargaining power of buying firms that depend on your product. They could be the ones dictating the prices because of the large number of items they acquire, and your firm depends on them. A good example is Walmart because as they sell in large quantities, every firm would love to have their products in Walmart’s inventory. Thus, Walmart force firms to sell at cheaper prices if they want to be displayed in Walmart stores.
Rivalry Among Firms
When there is fierce competition in the market and the products are homogeneous, the competition concentrates on pricing. Competition on pricing is harmful to the industry because profits will be low.
When there is little competition, there are customers for all firms and they don’t have to fight each other. Another example of low rivalry among firms is when each one has a unique position with differentiation, so customers buy the ones that fit their needs (Bright et al., 2019).
Conclusion
In summary, the five forces model is a useful tool to evaluate an industry. In your evaluation, you would like to have an industry that has high barriers to entry for newcomers, little threat from substitutes, little bargaining power from the buyers and sellers, and the rivalry among companies is no competition based on price.
References
Bright, D. S., Cortes, A. H., Hartmann, E., Parboteeah, P., Pierce, J. L., Reece, M., Shah, A. J., Terjesen, S., Weiss, J. W., & White, M. A. (2019). Principles of Management. OpenStax, Rice University.
David, F. R., & David, F. R. (2017). Strategic Management Concepts and Cases: A Competitive Advantage Approach (16th ed.). Pearson.
Hitt, M. A., Black, S., & Porter, L. W. (2012). Management. Pearson Prentice Hall.
Keegan, W. J., & Green, M. C. (2013). Global Marketing (7th ed.). Pearson.