Five Forces Framework Essay
Five Forces Framework
Porter’s Five Forces Model is a model that analyzes an industry to help develop a business strategy. The model uses five forces that have been identified to categorize an industry as intensely competitive or not competitive at all and this will then determine the attractiveness of the market.There are many features of an industry in which a company competes that determines the level of competition it will face and the profits it will get. The most famous classification was done by Michael Porter, known as Porters Five Forces framework which can help a company determine its potential profits by looking at five sources of competitive pressure. The five sources of competition are:
1. Threat of new entrant
2. Threat of substitutes
3. Rivalry among existing competitors
4. Bargaining power of suppliers
5. Bargaining power of buyers.
Porter’s Five Forces
In particular, we will focus on three different industries; We will start analyzing the five forces in the smartphone industry and then we will continue dealing with the personal computer industry and finally we will present digital music portable industry.
In general the smartphone market is rapidly changing, with constant product introductions. It is characterized by quickly evolving technology and designs, short product life cycles, aggressive pricing, rapid imitation of product and technological advancements, and highly price sensitive consumers. Self-elasticity and cross-elasticity are high. No one firm in the market has sufficient market share to control prices, resulting is strong rivalry and competitive pricing. 1. Threat of new entrant: The barriers to entry are high due to the existence of patents, high fixed costs and economies of scale, regulation, and brand loyalty. The individual market participants engage in attempts at product differentiation, some being more successful than others.
The standout is Apple, which has successfully differentiated its iPhone, and stands a good chance of maintaining that differentiation due to its closed and all-inclusive model or development and use.Barriers to entry in the smartphone market are relatively high, but the rapid growth of the market is providing opportunities despite this. There are significant fixed costs associated with smartphone manufacturing. While most firms have the hardware of the phones manufactured overseas by foreign companies, the costs of developing the research and engineering personnel to design and test the smartphone and software can be prohibitively expensive for an entering firm.
These fixed costs include not just the cost of the manpower, intellectual knowhow, intellectual property, computers, test equipment, prototyping devices and supplier and manufacturer contracts, but also the time necessary to develop all of these. Because the industry moves so quickly, an entering firm would either have to enter with existing resources targeting the smartphone market, or it would have to have another significant competitive. Moreover consumer will face an high switching costs if they decide to change their products, as a result of the fidelity every brand put on its product. Because all these reasons smartphone industry is extremely difficult to enter. As a result the threat of new competition is low. Smartphone production needs huge number of money and high technology. Even if established the company, it is impossible for new brand to compete with big company like Apple and Samsung.
2. Threat of substitutes : As a result of the high barrier to entry, to build and launch a substitute product is a hard work. Thus Threat of substitute is low. It’s extremely difficult to enter Smartphone production; because this industry base on high technology. As a result, it’s very hard to invent the substitute to replace smartphone with low price and more power function.
3. Rivalry among existing competitors:With rapid innovation necessary for a rapidly changing market, where customers are very price conscious, rivalry among firms in the smartphone market is fierce. Firms in the smartphone market actively work to adopt the successful ideas and technology of their competitors. This has been the trend with large touch screens, touch friendly operating systems, embedded cameras, and availability of an easy to use app store, among other things. As consumers are more and more driven to purchase by the features that are available on the smartphone, there is a constant rivalry among firms to match each other on features. There is also an effort to stifle each other’s efforts to develop those technologies through obtaining of patents and filing lawsuits seeking injunctions and trade restrictions. No particular firm in the market has a significant amount of market power; every firm is vying for a greater piece of the pie. This has resulted in driving down of smartphone prices and relative price parity for flagship smartphones from each major firm.
Firms are heavily involved in price discrimination, pricing their phones differently based on the sale outlet. Smartphones sold through retailers are frequently cheaper than those sold through network service providers. The one exception to this is Apple. Apple maintains price equivalency no matter the outlet, and the prices it charges for its smartphones is in many cases much higher than its competitors. Because Apple has been able to do this, its smartphone sales are reportedly highly profitable, while smartphone sales for Motorola have not been profitable at all. Rivalry also comes from outside the manufacturers’ market as other firms try to cash in on the smartphone profits. Google open sourced the Android OS so that it could find revenue from sales of apps and ads through the smartphones that run the OS.
This cuts directly into Apple’s effort to become the dominant player in the smartphone manufacturer market, changing the nature of the market significantly. Such changes are likely to continue as other firms attempt to enter the market. Therefore, threat of substitute might have two factors (price and performance) which allows customer to switch the product as well as willingness of buyers to switch. Threat of substitute can be reduced as much as buyers become loyal to the products. To give an example, Apple has been able to create an “ecosystem”. People buy iPhone for standard, apps and other Apple’s product for upgradeability and stability which gives customer the ability to transfer knowledge and apps among devices
4. Bargaining power of suppliers: Bargaining is very high; Smartphones’ producers have to deal with two different categories of supplier: the hardware producers and the software. Because smartphone production market is not easy to enter , also supplier are limited. If the smartphone company changes their supplier of components or CPU, the performance of smartphone will change a lot. So the company have to stay under their suppliers’ rule and they have to accept their price, that will be reflected in the price of the final product inevitably. The smartphone company are not willing and will be not willing to take the risk to change their suppliers, in order to maintain the quality of their products.
5. Bargaining power of buyers: customers are not concentrating on price; when they decide to buy a new smartphone they will take into consideration the design and the prestige the product will give them. Sometimes they choose basing on the advertising they receive. So they do not have a strong influence on this industry. Firms get the power to influence their customer and their ability is to make them trust in their own brand, providing for some value added. Take iPhone for example, the function of iPhone is just as good as some that other smartphone could have; However, the price of iPhone is one of the highest in the entire variety of smartphone present in the market, just because the prestige of iPhone is very high. This example shows that the bargaining power of customer is quite low.
The computer hardware industry consists of companies that manufacture and assemble personal computers, computer hardware, and computer peripherals. This industry is highly competitive, which means that companies must continuously be innovative in order to sustain a competitive advantage. The major companies of this industry include Oracle, IBM, HP, Dell, Apple, and Toshiba. This analysis will focus on computer manufacturing since it is the largest component of the industry, containing 43.7% of the market’s total value. The computer industry has been rapidly growing and shows no signs of slowing despite the recent economic downturn.
1. Threat of New Entrants :PC market is dominated by some major competitors as Hp, Dell, Acer, Apple, and others who currently have nearly the entire market share; this will likely discourage any potential new companies from entering the market. So we can state that the personal computer industry is characterized by a very weak threat of new entrants. A huge problem that has to be faced in order to entry this market is that the market requires significant investments to be made in research and development to continually develop innovative products as well as large fixed start-up costs for manufacturing and employees and customer service.Existing firms can benefit from their capabilities of manufacturing at lower prices because of the advantage of economies of scale, where the will have fewer per unit costs as a result of their large scale production.
Companies trying to enter the market will initially have smaller production and will consequently have higher prices. In the personal computer industry there is currently much emphasis put on price because consumers have become more price sensitive as personal computers have become more or less a commodity. New entrants will not only have higher prices but they will likely have a less innovative product as well because they do not have equal funding for research and development as other established brands and they will also have to deal with the brand loyal customers that have trusted the existing players in the industry for years.
By attempting to join the market without any market share it will also be important for a new entrant to focus its investments more heavily on advertising and marketing then existing brands. A new entrant to the personal computer market will likely not fare well and is almost guaranteed to always be a second mover as the larger companies will develop more innovative products more rapidly because of their many competitive advantages.
2. Bargaining Power of Suppliers: It is possible to identify three different groups of suppliers in the personal computer industry including hardware suppliers, software suppliers and service suppliers. The first group is not able to exert a significant power. The core of their products are generally standardized and they compete by focusing on creating better, more advanced products at a better price and not through their attempts to differentiate them. As a result, firms within the industry are able to switch between this kind of suppliers relatively easily. It is really in the hands of the firm and which strategy they are committed to that will determine whether or not they will utilize a high or low end supplier. On the other hand, suppliers of hardware and software within the industry play a critical role in the pricing of products.
With the quality of a computer being largely determined by their microprocessors and application system installed within them. If a firm is following a high quality strategy then it can be expected that their prices will generally be higher to reflect the higher prices they are paying their suppliers.In terms of service suppliers, the service that can be offered within the personal PC industry include internet, tech support and repair services. These suppliers focus highly on operational performance and relational performance in order to increase customer satisfaction. They also offer a variety of customer loyalty programs in attempts to lock in and expand their customer base while trying to gain the competitive edge over competitors within the service industry of personal computers.
While the PC industry changes regularly, it can be observed that only the central processing unit (CPU) is a key input. All other items are commodity in nature and so don’t command a bargaining power. Intel has a significant market power as it is a single major supplier of microprocessor and has an 80% of market share.Thus, Dell as computer manufacturer holds a power over the suppliers as opposed to the suppliers holding a power over the manufacturers. It is the suppliers that are in direct competition with each other. The suppliers are often forced to slash prices or merge with larger companies in order to survive. Hence, the bargaining power of suppliers is moderate.
3. Bargaining Power of Buyers: The personal computer industry is somewhat vulnerable against the bargaining power of buyers. Personal computer buyers are price-sensitive. Buyers are interested in quality and specifications thus making consumer loyalty low. Should one company not offer a product a product to suit the customer’s needs, they will find one that will. Buyer power is reduced slightly as computers are increasingly seen as a necessity due to the importance of online communication and information processing. Moreover, in the last recent years, some new technologies came on the market providing customers with the possibility to have more and more alternative options to the personal computer as smartphones, tablet computers, and other handheld devices like Ipods have most of the same capabilities as a personal computer. Because of the availability, sleekness, and trendiness of these alternatives, personal computers are becoming more and more obsolete.
Personal computer must differentiate itself in order to regain market share and compete with these newer alternative options. Large businesses, governments and schools which buy computers in large volumes have the power to bargain on price, quality and service. PC manufacturers can reduce a threat of buyer power by differentiating their product.DELL has introduced a new way of selling (direct model concept); buyers can directly buy computers with DELL without a so called middle man. By using this concept, computers cost per unit can be reduced. Furthermore, buyers are able to customize the PC based on their needs.
The basis of this model, the direct model concept is to improve efficiency by effectively eliminating the intermediaries thereby allowing the company to speak directly to the customer. Dealing directly with customers allows Dell to customize their orders according to the customers’ needs. But, despite several ways in which manufacturers have differentiated their products and found ways to increase switching costs, customers still see units as very similar and thus choose primarily on price.To conclude we can consider a strong bargaining power of buyers.
4. Rivalry among Existing Firms: There is fierce competition between the top manufacturers in the personal computer industry. As the PC has increasingly become a commodity in a household, the fight to keep costs low while bringing the best product to the market has become a never ending battle. Thus competitors are trying to produce a low cost, powerful machine with the most efficient operating system. Firms specialize in different areas in order to compete amongst their rivals. Some focus on innovation and attempt to bring the newest technology to their customers first. Nevertheless, others may focus on their distribution channel and services throughout their firm. For example, DELL is focusing on distribution channel and high quality service while others such IBM and Apple focus more on innovation.
All these create differentiation to some extent. Low-cost production at DELL contributes its positive growth rate, while other major manufacturers are experiencing negative growth rates. However, one of the fiercest areas is the price competition throughout the industry. It is to underline that the determinants of a pc’s quality are the microprocessor and application systems installed. As a result, there is a direct correlation between the firm’s profitability and the profitability of the firm’s suppliers.The major manufacturers as DELL, IBM, HP, Acer and Apple are in competition to produce the least expensive and most efficient machine. Japanese companies such as Fujitsu, Toshiba, Sony and NEC also have large market shares.This intense competition are beginning to be felt its effect.Some companies exit via selling to other companies or simply exiting the industry altogether. For example, Compact Computers was acquired by Hewlett-Packet in 2002 while Xerox exited the computer business and concentrate on printers.
Today, regardless of the number of companies present, the computer industry will continue to expand and remain competitive for a number of years to come, although threat to industry rivalry will continue to be strong. 5. Threat of Substitutes and Complements: Although it is very hard and challenging for a new entrant to join the personal computer industry there are currently other growing industries such as the smartphone, tablet, TV set/top boxes industries which are predicted to affect the sales of personal computers. All those alternatives started to encroach on functionality that was once the sole purview of the PC. Also if those products have different major players, their offers similar benefits to consumers that a personal computer also has. Moreover the technology advances are improving those products day by day.
Thus they continue to increase in popularity and in performance, leading the sales of personal computers to a decline. The internet can now be accessed through phones and tablets and they are more portable than a laptop. Currently laptops and personal computers offer many unique applications and are compatible with much more software than smartphones and tablets. If smartphones and tablets can attain greater memory space, processing speeds, and compatibility with similar software, smartphones and tablets may be an all-in-one alternative to personal computers. Not only smartphone and tablet, but also some advanced game device like Sony PS3 allowed consumers to watch DVDs, surf the web, and play the game directly online in addition to play traditional video games. As technology continues to increase these separate industries may merge into one, or at least drastically affect each other.Hence we can conclude that threat from substitutes is strong in the PC industry.
Digital Music Portable Industry
1. Threat of new entrant: In this industry, threat of entry is medium because the production cost is quite low. For example, the cost of material, packaging, assembly of iRiver (H320) only costs £69 and the company can sell it in retail shop at £153 (Skee G., 2005) Therefore, it may attract new competitors to enter into the market due to the low cost of material and the high product margin. Furthermore, the International Federation of the Phonographic Industry (IFPI) reports that the demand for music on the internet and mobile phones is booming and it may replace physical formats such as tape, CD, and DVD in the future; hence, it can be predicted that the market is still growing gradually (The Computer & Internet Lawyer, 2005). As a result, many companies come into the market and pose new threat to existing companies.
For example, Microsoft has recently entered to this industry and launched “Zune” into the market. Many experts believe that Zune might be a competitive rival with iPod; however, it is not easy for new entrants to gain market share in this industry. It is obvious that Apple is still the market leader because Apple has economies of scale in its production that Apple produces and sells iPod more than 10 million with the high margin cost in each year. Next, Apple’s product is highly differentiated from other brands that customers still buy iPod due to its differentiation. For instance, iPod Nano, the latest model from Apple, has attractive features such as full color screen and the copyright-click wheel button, and iTune system which customers can use it easily to buy and download songs into iPod from internet. As a result, it is difficult for new entrants which have recently entered into the market to develop product to overcome existing companies in the industry.
2. Threat of substitutes : he threat of substitute product in the industry is medium because digital portable music products are quite unique which could not be easily replaced by other products. Products have many advantages for customers. For example, it is cheaper to download songs from internet into iPod than buy CD audio. Next, the quality of sound is equal to an original CD after encoding into audio file format. Customers can enjoy listening music as the same as they enjoy listening music from original CD but cheaper price. Therefore, these are reasons why a MP3 player is still popular today.
However, in this last recent years we can see the birth of new product which perhaps can replace MP3 player. They are the new mobile phone and smartphone that are provided with an integrated music players ( previously Nokia N91 with a built-in 4GB hard drive or Motorola E398 with removable memory card and now iPhone, Galaxy and so on). Music phone can download songs via WAP or GPRS and store it in a built-in or removable memory. Importantly, many experts believe that the music phone will be the most serious threat to the industry in the near future because it is all-in-one functions that customers can use it for both communication and entertainment. According to some recent research, the benefit of music phone will make some consumers may hesitate to spend £149 on MP3 Player when they could buy music phone with £169 or £189.
3. Rivalry among existing competitors: In this industry, the intensity of competition is high because there are many players in the industry and each company try to complete with each other by developing new products in the market all the time. For example, Microsoft has recently launched their new product which is MP3 player “Zune”. It has many features which is different from other products in the market such as an integrated FM tuner, bigger screen, and WiFi connection. Microsoft reports that Zune can penetrate into the market and gain the market share from dominant companies. Two weeks after launching, it took the second place of the market from SanDisk and grabbed 9% of the U.S.A. market but following Apple whose its product (iPod) still dominated the market (Martell, D., 2006) Moreover, “Cut Price” is popular business strategies in the industry.
Most companies use it to overcome with other competitors and it can drive the industry to be more competitive. For example, Creative is a MP3 Player manufacturer that lost the market position to Apple two years ago. In 2005, Sim Wong Hoo, the founder of Creative, declared war on Apple’s iPod by launching new and modern product (Creative Zen Neeon) which Apple tried to counter by cutting price on its product that it forced Creative to do the same thing in its product; therefore, the intensity of rivalry was increasing gradually from this situation. (Sudhaman A., 2005)
Besides, the market is growing very fast in the industry that it could also make the industry to be more competitive as well. For instance, iRiver anticipates that MP3 player market in Thailand will continue to grow increasingly and consumer’s demand will double in the near future; therefore, iRiver has launched new product in the market which it hopes to gain more market share from 13.7% up to 20%. (Veerasak, 2005) When the market is growing very fast; it tends to stimulate many companies to enter and launch their product in the market to gain profit in the industry.
4. Bargaining power of suppliers: In this industry, the bargaining power of supplier is medium because, firstly, there are a lot of suppliers which provide materials for companies such as flash memory, hard disk, semiconductor, and so forth. These suppliers mostly come from Asia region especially in China which is a major source for many companies due to the low price of material. Secondly, according to a supplier in the industry, iSuppli anticipates that the shipment of MP3 players with Hard Disk Drive (HDD) – based product is growing up to 42.6% in 2009 from 26.6% in 2004. Consequently, it made many suppliers come to produce material for MP3 Player market. (Electronic News, 2005) Thirdly, most companies in the industry have power to negotiate with suppliers regarding the price of material.
Nowadays, the demand of digital music player is growing dramatically; therefore, the growth of the market made many companies have to produce their product in high volume in order to serve market’s need and it made suppliers lost bargaining power because the large production gives company to be able to order material in high volume from suppliers. Furthermore, some companies that need lots of material in their production tend to have a long-term agreement with supplier to supply them material. For example, Apple need to have lots of material such as flash memory and hard disk memory for its product; therefore, Apple decided to make a long-term supply agreement with flash memory manufacturers such as Samsung, Toshiba in order to get good deal of price and ensure to have material for their product up until 2010.
5. Bargaining power of buyers. The bargaining power of buyer in the industry is low. Although, there are a lot of competitors in the market, products in some companies made a great success in sales volume because of their specific characteristics, such as iPod for example. It is not product’s price but it is product’s differentiation and the brand of the product. Firms have the power to address customers to choose their specific product focusing on marketing tools.
As a result, Apple can set price for its product and it can push high switching cost to customers if they want to change to other products in the market. Importantly, customers buy iPod because it also contains good features and attractive appearance. For instance, although, the price of iPod Nano is higher than other competitors in the market, the excellent features and functions of the product such as it can be played movies and it has higher storage capacity compared to previous model (iPod Mini) made Apple to get lots of profit from iPod Nano in 2005 which iPod Nano is not only just Apple’s best-selling iPod, but also the best – selling digital music player model worldwide.