Real Estate (Porter’s 5 Forces) Essay
Real Estate (Porter’s 5 Forces)
What can we do to ensure the business keeps running? That’s a question everyone wonders. Insurance for life time of existence is hard to get, but companies can use many strategies to last longer and maybe lead in their industry. This paper conveys the analysis of Porter’s 5 forces on the real estate industry. The results of this research will help any party in the real estate industry, developer, broker, or agent be aware of the surrounding environment, and in a way predict the market and get ready for possible threats.
With Micheal Porter’s 5 forces analysis, the real estate turned out to be not a very favourable industry to start business or invest in at this moment. Being a not very profitable industry, in addition to the new restrictions from the government now a day unlike two years back the real estate has no or little threat of new entrants. On the other hand, the competition is still high because of the existence of many competitors in the market.
The bargaining power of the buyers is high, and bargaining power of suppliers is lower because of lack of new projects but still exists, substitutes are found for people having cash, they will invest in more secure industries if they are new investors, but if they already have invested in real estate the cost of switching to any other project or alternative will be very high, and buyer’s would choose renting instead of selling because of lack of funding facilities from banks. Shortly said the real estate industry is on hold, whoever is already involved can’t leave because of the very high costs and anyone outside will not get involved till the situation is changed.
Porter’s 5 Forces
Porter’s 5 forces are considered an effective strategy for reducing risk at an organization and enhancing the performance. Dr. Micheal Porter (1947) thought about the 5 forces that will help managers analyse and evaluate the strength of five distinct competitive forces in surrounding environment for an organization and help build up effective strategies accordingly that will protect the organization from possible threats. Each threat and point is marked as having either a positive or negative effect, weak or strong that helps organizations build up an effective plan that could protect their business today and in the future, and the more a company is familiar about the existing market, the more its strategies can be directed to increasing the success in that same market. “Porter’s model depends on the concept of power within the relationships of the five forces. “ By Hal P. Kirkwood , Jr * Competitive Rivalry within the industry: Is the core of the Porter’s 5 Forces, competitive rivalry states what an organization has to differentiate itself from others and how do they define themselves among other competitors, using their competitive advantage, advertising, pricing strategy, and promotions .
* Bargaining power of Buyers (Buyer’s power): In the market one side has the power and is able to control how the market in that industry is running. When there is over supply in the market or the buyers are very few, buyers get the opportunity to be picky and state their own conditions; this might affect the price the quality of the product and other factors like service. Besides the number of buyers, the elasticity of the demand of that product plays a big role. In case the elasticity of the product is very low the buyers have no power since they are not sensitive to price at all and the power is with the supplier, on the other hand if elasticity is very high, the power is in the hands of the buyers.
* Bargaining power of Suppliers: the rarity of supply of any important input such as raw materials or/and working power to the organization’s operations would put the power in the suppliers’ hands and give them the opportunity to rule the market by the prices and the quality. On the hand the oversupply of the input for the organization reduces the power of the supplier as the organizations gets the privilege of choice among the many alternatives. * Threat of new entrants: states how easily it is for a competitor to enter your industry. This factor controls in a way or another all other factors, as the number of the competitors dictate who has the power in the market. This could be controlled by building barriers for new entrants like: * The government could play a big role at controlling the ability of new entrants with restrictions, regulations, and licensing.
* Economies of scale
* Product differentiation
* Capital requirements for entry
* Switching costs
* Cost disadvantages independent of scale
* Threat of Substitutes: The availability of other alternative for the buyer, and how easy it is for them to switch to other options. The nature of competition in an industry is strongly affected by the above mentioned five forces. The stronger the power of buyers and suppliers, and the stronger the threats of entry and substitution, the more powerful competition is likely to be within the industry.
The Dubai Real Estate Sector
Residential property, commercial property, or vacant land, no matter of the type of property real estate in the past few years made many rich, from real estate brokers , developers staff, to the investors all made millions. Off course many others paid the price at the end of the day. From a desert to the centre of business and technology Dubai was said to be the fastest growing city, the real estate industry attracted many local and nonlocal from around the world, as it was booming it pulled along with it many other industries all that brought Dubai to the place it is today, the dream home of many.
But after the unfortunate incident with the economic crisis things turned around, all started plans that were sold on paper had to be completed and after the dramatic decrease of demand for real estate (figure 1), Dubai was left over with a huge over supply which caused investors’ interest in real estate to diminish and drag many other industries down with it. Situations changed dramatically for the industry, for the companies, and for the end users themselves. It is impossible to predict the future, whoever succeeds by any means, chance, luck, or knowledge is the real winner and the future richest man on the planet.
(Figure 1) The change of price from July 2008 till November 2010, because of the decrease of demand according to study from Bando Engineering & Construction Co. Ltd.
Applying Porter’s 5 forces to Dubai Real Estate Sector
Applying Porter’s 5 forces on the real estate industry will help put together sound strategies from companies in that industry and assist in a way or another surviving the current situation.
Competitive Rivalry within the Industry
At the booming days, two years ago, having that less barriers to entry the industry left the door open for new competitors in the real estate, and that created such a competitive environment. Now after the crisis the industry is packed with organizations who thought the real estate will continue in the booming period longer, they are stuck with no other option but compete to survive. Developers have property to offer, many try to focus on specific segment and differentiate their units with the location and the luxurious finishing to attract as much as possible investors. Magazines and papers are full with articles for new completed projects, units available, best selling and renting prices, there is something for everyone. Even after the world crisis, the organizations that are still standing try hard to win the few investors left in the market and attract them to their projects.
Bargaining Power of Buyers
In real estate, no matters of the time or the economic situation buyers have bargaining power, since not everyone can afford to buy a property and it’s not that essential for buyers. Off course the power level differs because of different factors but after all, its not medicine that people will die without it.
In the real estate industry, when the market for real estate was growing and especially in Dubai it had all the opportunities and capabilities to do so, plans of projects were sold in the same day they were approved by the government, sometimes in the same day a unit would be sold and resold. At that time the bargaining power of buyers was very low, buyers could hardly affect the prices or the quality of the outcome, the demand was very high for units that sellers didn’t waste time negotiating with buyers, it was more like a “take it or leave it” situations for them since another buyer was on the door waiting. That explains the unrealistic prices properties were sold and rented at (Figure1).
After the crisis
After the unfortunate world crisis, as most of the industries, the real estate got affected badly. Cash is missing, loans and mortgages are difficult to get and so did the demand for properties decrease dramatically leaving very little demand but many unfinished, just completed, and projects still on paper that are waiting to be sold, causing an oversupply in the real estate industry . Having that little demand, and over supply of properties gave the opportunity to buyer to negotiate, decrease prices and enhance the quality of the properties to suit their desires. That increased the bargaining power of the buyers giving them the ability of leading the market.
Bargaining Power of Suppliers
The well being of many industries depend on each other, when the real estate industry was booming, suppliers of iron, cement, glass, and other materials needed for construction were demanded, and as there were many projects waiting for their raw materials, suppliers had the power to dictate their prices and terms. Having only few suppliers for the raw materials of construction and a lot of demand created a shortage and that by its turn gave the power to the suppliers.
After the crisis
Projects stopped to be launched as a result of the dramatic decrease of demand and the lack of cash and finance options for many, the market is left with only the projects that were started and need to be completed. Suppliers have witnessed the decrease in the orders and started decreasing prices and increasing quality of service to attract the few left customers to their company and that obviously decreases the supply power over the real estate sector, but they will always have power since construction companies can’t replace the main raw materials for construction like cement, this makes the product extremely important for developers and they can’t do without it.
Threat of New Entrants
Entering the real estate industry was easier than entering a concert for a famous singer. As long as one is able to put a plan on a paper they are in the industry, getting a trade license was very easy in Dubai, requirements were few, no taxes and Dubai supported and encouraged by speeding up the process. Dubai government made it very simple and they welcomed anyone who applied for it. The capital was not an issue since banks were available and happy to fund. “In the golden days we were tensed to release as much funds as possible without worrying about studying the plan and the company or the person’s history. Unlike now were our main concern is to choose carefully to whom to offer , and that made it difficult to many to receive any funds” said Afaq Ahmad, Business Development Officer, Mortgage Department, Al Mashreq Bank. Moreover, the demand for real estate was so big that there were always buyers waiting to buy at whatever price.
And that explain why the new entrants threat was very high at that time, the barriers to enter were very easy to resolve, unlike today were government although there is no rules on paper but they became more strict with rules and regulations, it became harder getting fund support from banks. Moreover, as a result of the dramatic decrease of prices, it’s a very bad idea to sell and buy now because there will be a huge loss. The industry was very attractive few years ago for new businesses, since they were supported from every corner and were able to survive. Funding institutions, the demand, the growth rate of the industry, all played a big role in encouraging new entrants to the market.
Threat of Substitutes
In the real estate industry substitutions depend on the purpose of the demand. Customers are mainly divided into two groups those who buy to invest and others who buy for a personal use. The threat of substitutes in the real estate was pretty high in the booming days, as exchanging one property for another in a new project was very easy, switching cost was very low and sometimes there was even revenue. Unlike today, people sell their properties if and only if they need cash because the cost of substitution for any other alternative is very high.
Is the segment which purchases properties for business, to resale and make money or to lease and get revenues over time. The substitute threats to real estate concerning this segment are the availability of other alternatives for investment like banks. The threat of substitutes is very high for the real estate industry specially these days; people with money are not that confident in the real estate industry any more so they avoid investing in the real estate and instead choose the more secure options like gold.
Buyers are the segment that purchases properties for their own use, to live in. The main threat for this segment is renting. Before people who had some savings preferred to get some support and purchase their own place instead of spending so much on renting and at the end of the day they still possess nothing. But as today mortgages are so difficult, with tough conditions and renting prices have decreased people went back to renting. There is no threat of substitutes for the real estate industry in this segment other than renting.
Summary and Conclusions
Any developer or any party that would consider entering the real estate industry today needs to think twice. According to the above analysis, the buyers have high bargaining power, suppliers have some power, there are entry barriers such as the lack of funding support from the banks, and government restrictions, the existence of many competitors in the market who are wildly struggling to survive, and the availability of substitutes for buyers. Starting a business in this industry is not a wise decision.
* http://www.referenceforbusiness.com/management/Or-Pr/Porter-s-5-Forces-Model.html * http://university-essays.tripod.com/porters_5_forces_analysis.html * http://www.zimbio.com/United+Arab+Emirates/articles/DpeLRU05gOE/Real+Estate+Property+Report+Dubai+third+quarter * Interview dated 29-11-2010 for Afaq Ahmad, Business Development Officer, Mortgage Department, Al Mashreq Bank * Market study from Bando Engineering & Construction Co. Ltd.