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.
Porter’s model is based up on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Competitive strategy should be developed based upon forecasting of the available information on the developing competitive environment and other threats faced .Porter was able to identify five competitive forces that that shapes the different industry and market. Porter five forces do was able to interpret the intensity of the competition and also the profitability and attractiveness of an industry. The corporate strategy is devised to improve the position of the respective industry in there market position as well as in brand form. Porter’s model provides the analysis of the driving forces in an industry. Based on the information derived from the Five Forces Analysis, management can decide on how to influence or to exploit particular characteristics of their industry.
The Five Competitive Forces
The Five Competitive Forces are typically described as follows:
1 Bargaining Power of Suppliers
Suppliers comprises of all the sources for inputs that are needed in order to provide/produce goods or services. Supplier bargaining power is likely to be high when:
1. The market is dominated by a few large suppliers rather than a fragmented source of supply,
2. There are no substitutes for the particular input,
3. The suppliers customers are fragmented, so their bargaining power is low,
4. The switching costs from one supplier to another are high,
5. There is the possibility of the supplier integrating forwards in order to obtain higher prices and margins. This threat is especially high when
6. The buying industry has a higher profitability than the supplying industry,
7. Forward integration provides economies of scale for the supplier,
8. The buying industry hinders the supplying industry in their development (e.g. reluctance to accept new releases of products),
9. The buying industry has low barriers to entry.
In these situations, the buying industry does face a high pressure on margins from their suppliers. The relationship to powerful suppliers can enormously reduce strategic options for the organization.
2 Bargaining Power of Customers
Similarly, the bargaining power of customers determines how much customers can influence pressure on margins and volumes. Customers bargaining power is likely to be high when
1. They buy large volumes, there is a concentration of buyers,
2. The supplying industry comprises a large number of small operators
3. The supplying industry operates with high fixed costs,
4. The product is undifferentiated and can be replaces by substitutes,
5. Switching to an alternative product is relatively simple and is not related to high costs,
6. Customers have low margins and are price-sensitive,
7. Customers could produce the product themselves,
8. The product is not of strategically importance for the customer,
9. The customer knows about the production costs of the product 10. There is the possibility for the customer integrating backwards. 3 Threat of New Entrants
If the competition in an industry is higher, the easier it is for other companies to enter this industry. In such situations, new entrants could create major determinants of the market environment (e.g. market shares,
prices, customer loyalty) at any time. There is always pressure for reaction and adjustment for existing players in the industry. The threat of new entries will depend on the extent to which there are barriers to entry. These are typically
1. Economies of scale (minimum size requirements for profitable operations),
2. High initial investments and fixed costs,
3. Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets,
4. Brand loyalty of customers
5. Protected intellectual property like patents, licenses etc,
6. Scarcity of important resources, e.g. qualified expert staff
7. Access to raw materials is controlled by existing players,
8. Distribution channels are controlled by existing players,
9. Existing players have close customer relations, e.g. from long-term service contracts,
10. High switching costs for customers
11. Legislation and government action
4 Threat of Substitutes
A threat from substitutes exists if there is an alternative product with lower prices of better performance parameters for the same purpose. This could attract a significant proportion of market volume and hence reduce the sales volume for existing players. This category also relates to complementary products. Similarly to the threat of new entrants, the treat of substitutes is determined by factors like
1. Brand loyalty of customers,
2. Close customer relationships,
3. Switching costs for customers,
4. The relative price for performance of substitutes,
5. Current trends.
5 Competitive Rivalry between Existing Players This force describes the intensity of competition between existing players (companies) in an industry. High competitive pressure results in pressure on pricing, margins, and also, on profitability for every single company in the industry. Competition between existing players is likely to be high when
1. There are many players of about the same size,
2. Players have similar strategies
3. There is not much differentiation between players and their products, hence, there is much price competition
4. Low market growth rates (growth of a particular company is possible only at the expense of a competitor),
5. Barriers for exit are high (e.g. expensive and highly specialized equipment).
Use of the Information from Five Forces Analysis
Five Forces Analysis can provide valuable information for three aspects of corporate planning:
The Five Forces Analysis allows the user to determine the attractiveness of an industry. Also, it provides visibility on profitability. Thus, it helps to decide about the entry or exit from an industry or a market segment. Moreover, the model can be used to compare the impact of competitive forces on the own organization with their impact on competitors. Competitors may have different options to react to changes in competitive forces from their different resources and competences. This may influence the structure of the whole industry.
If done along with a PEST-Analysis, which provides the drivers for change in an industry, Five Forces Analysis can help to give insights on the potential future attractiveness of the industry. Expected political, economical, socio-demographical and technological changes can influence the five competitive forces and thus have impact on industry structures. In general term to determine potential changes in competitive forces.
Analysis of Options:
With this knowledge on intensity and power of competitive forces, organizations could develop options to control them in a way so to improve their own competitive position. The result could be a new strategic decision, e.g. a new positioning, differentiation for competitive products of strategic partnerships.
Thus, Porters model of Five Competitive Forces gives a systematic and structured analysis on market and their structure and what likely be competitive situation. The model can be used on particular companies, market segments, industries or regions. Hence, it is needed to determine the scope of the market to be analyzed in a first step. Then, all relevant forces for this market are identified and analyzed. Though, it is not necessary to analyze all elements of all competitive forces with the same depth.
The Five Forces Model is based on microeconomics. It also takes into account the supply and demand, complementary products and substitutes, the relationship between volume of production and cost of production, and market structures like monopoly, oligopoly or perfect competition etc.
Influencing the Power of Five Forces
After the analysis of current and potential future state of the five competitive forces, Users can search for options on how these forces influences in their organization’s interest. Although industry-specific business models will limit options, the own strategy can create different impact of competitive forces on organizations. The objective is to reduce the influence of competitive forces.
The following figure provides some examples. They are of general nature. Hence, they have to be adjusted to each organization’s specific situation. The options of an organization are determined not only by the external market environment, but also by its own internal resources, competences and objectives.
4.1 Reducing the Bargaining Power of Suppliers 4.2 Reducing the Bargaining Power of Customers
2. Supply chain management
3. Supply chain training
4. Increase dependency
5. Build knowledge of supplier costs and methods
6. Take over a supplier
2. Supply chain management
3. Increase loyalty
4. Increase incentives and value added
5. Move purchase decision away from price
6. Cut put powerful intermediaries (go directly to customer)
4.3 Reducing the Treat of New Entrants
4.4 Reducing the Threat of Substitutes
1. Increase minimum efficient scales of operations
2. Create a marketing / brand image (loyalty as a barrier)
3. Patents, protection of intellectual property
4. Alliances with linked products / services
5. Tie up with suppliers
6. Tie up with distributors
7. Retaliation tactics
1. Legal actions
2. Increase switching costs
4. Customer surveys to learn about their preferences
5. Enter substitute market and influence from within
6. Accentuate differences (real or perceived)
Porter’s model of Five Competitive Forces has been subject of critique for many years. Its main weakness results from which year it was developed. In the early eighties, the global economy. was characterized by cyclical growth Thus, primary objectives consisted of profitability and survival. A major prerequisite for achieving these objectives has been optimizing strategy in relation to the external environment. In early days, development in most industries has been fairly stable and predictable, compared with today’s dynamics. In general, the meaningfulness of this model is reduced by the following factors:
a. In the economic sense, the model assumes a classic perfect market. The more an industry is regulated, the less meaningful insights the model can deliver. b. The model is best applicable for analysis of simple market structures. A comprehensive description and analysis of all five forces gets very difficult in complex industries with multiple interrelations, product groups, by-products and segments. A too narrow focus on particular segments of such industries, however, bears the risk of missing important elements. c. The model assumes relatively static market structures. This is hardly the case in today’s dynamic markets. Technological breakthroughs and dynamic market entrants from start-ups or other industries may completely change business models, entry barriers and relationships along the supply chain within short times.
The Five Forces model may have some use for later analysis of the new situation; but it will hardly provide much meaningful advice for preventive actions. d. The model is based on the idea of competition. It assumes that companies try to achieve competitive advantages over other players in the markets as well as over suppliers or customers. With this focus, it dos not really take into consideration strategies like strategic alliances, electronic linking of information systems of all companies along a value chain, virtual enterprise-networks or others.
Overall, Porters Five Forces Model still has some major limitations in today’s market environment. It is not able to take into account new business models and the dynamics of markets. The value of Porters model is more that it enables managers to think about the current situation of their industry in a structured, easy-to-understand way – as a starting point for further analysis.
Case Analysis Facebook
Facebook (formerly [thefacebook]) is an online social networking service headquartered in Menlo Park, California. Its name comes from a colloquialism for the directory given to students at some American universities.] Facebook was founded on February 4, 2004, by Mark Zuckerberg with his college roommates and fellow Harvard University studentsEduardo Saverin, Andrew McCollum, Dustin Moskovitz and Chris Hughes. The founders had initially limited the website’s membership to Harvard students, but later expanded it to colleges in the Boston area, the Ivy League, andStanford University. It gradually added support for students at various other universities and later to their high-school students
Porters Five Force analysis on Facebook
1. The Power of Consumer
Here customers are those company which are advertising in facebook. Being a large social network , it attracts a large number of advertisers who want to advertise in the platform. Hence, , the bargaining power of customer is low. , in later years if there is a new competion emergence power balance can vary. 2. The power of supplier:
Users are the suppliers,As of 2012 report the users numbers are more than 1 billion globally. the power of suppliers is low. Here the suppliers have no other customer , that is there is no other availiable social sites hence they have to stand by facebook for the time being. 3. The threat of substitute products
There are many upcoming products which is providing servie similar to that of facebook. Products such as Skype, WhatsApp, Google+, etc. are always a danger being substitutes for Facebook. Hence, the threat of substitute product is high. To maintain dominance, they always have to stay ahead of the tech ,also the trend and outperform possible substitute products.
4. The threat of new entrants
The chance of new entray is high. There are always disruptive innovations happening in the social space. As a result new similar products keep creeping. Facebook especially needs to improve its product 5. The competitive rivalry:
The field of social network is highly competitive. The most recent example was when Google launched social network Google+ that could be accessed by all Gmail users through the web as well as Android devices. Although Google+ has not been greatly successful in outwitting Facebook, we cannot rightly predict what lies ahead in future. Hence, the competitive rivalry that Facebook faces is high.