Michael Porter’s Five Force Model is one of today’s leading models on how certain forces that arise within industries creates change in both a negative and positive aspects. Many executives use his model to analyze the different industries and see where there may be a potential star performers and utilize their current company’s capabilities and resources to enter that new industry in a successful manner (Daft, 2007). His model can also help companies move into other market segments and help prevent others from joining in afterwards.
The strength of the five forces varies from industry to industry, and can change as an industry evolves (Hill & Jones, 2008). The Five Forces are composed of: Risk of Entry by Potential Competitors, The Bargaining Power of Buyers, The Bargaining Power of Suppliers, The Threat of Substitute products, and Rivalry Among Established Companies (Hill & Jones, 2008). Each of these forces in some shape or form has a unique impact within the market segment being analyzed.
Porter once said, “Awareness of the five forces can help a company understand the structure of its industry and stake out a position that is more profitable and less vulnerable to attack (Porter, harvardbusinessonline. hbsp. harvard. edu, 2008). Let us take a closer look at each of these forces and see what negative and positive aspects each one has. The Risk of Entry by Potential Competitors is any industry that may be worried about more competitors entering their market and leeching sales away from their bottom line.
If a company has a low risk of new entries this is a very good thing because the company can charge premium pricing since there are not that many suppliers of that product. However, if a company has a high risk of new entries this could be construed as very bad thing because the more sellers you have the more competition which would eventually lower prices to the market average. New competitors can not just enter most established markets. Usually there are barriers to entry in place such as government regulations, switching costs, economies of scale, brand loyalty, and absolute cost advantage (Hill & Jones, 2008).
Another one of Porters Forces is The Bargaining Power of Buyers. Buyers have tremendous buying power when they can order large quantities of product and as a result demand a lower price or higher quality. A good example is Boeing. Boeing is worldwide and is a top 5 in aviation equipment. When they demand a lower price companies will bow to them simply for the large volume that they do. Buyers also have power if they can easily order from another supplier for the same product. Auto-zone and Napa are a great example of this, the only difference then would be price if it is the same product.
Buyers can also stop ordering all together if the product is simple enough and just make it themselves (Hill & Jones, 2008). Another one of Porters Forces is The Bargaining Power of Suppliers. Suppliers can have a negative effect on a company’s business when 1 supplier is the only company making a product. Apple’s Iphone is a great example; they are currently the only company supplying it which makes consumers and 3rd party retailer’s pay premium pricing. Suppliers can also be powerful if they have the capability and resources to enter the market that they are currently selling to by simply entering the markets industry.
A friend of mine owns a business payments company and he charges his customers a fee for switching to a different vendor. This helps keeps companies from leaving him. If the supplier is big enough losing a particular company will not affect them in any way so they may not care if the company goes elsewhere (Hill & Jones, 2008). Yet another one of Porters Forces is The Threat of substitutes is big when dealing with commodities such as electricity, oil, wheat, etc. This is because electricity is the same no matter where you go.
The only difference is the price a company charges which reflects how efficient a company is (Hill & Jones, 2008). The last of Porters Five Forces is Rivalry among Established Companies. Price wars are the result of strong rivalry between companies which only benefit the consumer, but have dramatic affects on returns. However, low rivalry creates an opportunity because there are fewer suppliers which allow the few select companies to charge higher prices which give a better return (Hill & Jones, 2008). The extent of rivalry depends on four factors.
The first is the competitive structure which means that rivalry is determined by the number and size distribution of companies in its industry. Each composed of different numbers and sizes. It is comparable to that of a pyramid; there are more fragmented small and medium businesses on the very bottom. Above that are a small number of large companies and at the very top there is a monopoly (Hill & Jones, 2008). The second is demand conditions. If the market demand is growing more people are buying or the same buyers are purchasing more.
Since more money is flowing in rivalry will decrease, but if demand goes down rivalry goes up. The third is cost conditions in markets that have fixed pricing where no matter how efficient a company is there is a fixed cost which they must intern pass on to customers and they only way to increase profits is to increase the volume of sales. If sales are low firms can not cover the fixed cost to make the product which means the they either have to lower prices, increase marketing, or a combination of the two (Hill & Jones, 2008).
The last factor is exit barriers. These are composed of economic, strategic, and emotional factors that prevent a company from leaving an industry. If these barriers are high then the companies can become locked in which will result in losses. Many times companies do not want to do away with a trademark product because it has sentimental value, but is no longer turning a profit (Hill & Jones, 2008). Porter said, “If all you’re trying to do is essentially the same thing as your rivals, then it’s unlikely that you’ll be very successful.
” (Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors. , 1980) Inter-firm rivalry is influenced by each of the five forces in different ways. With risk of potential competitors firms must be efficient, innovative, and keep barriers to entry high else there industry will be penetrated and loss of sales will occur. With inter-firm rivalry among established companies with fixed costs not having the right marketing or low enough price could result in the loss of big volume sales by having customers go with a competitor which results in a loss.
With inter-firm rivalry the bargaining power of buyers could cause the buyer to go elsewhere to buy the products if the quality isn’t high enough or if the price is too high. With inter-firm rivalry the bargaining power of suppliers could cause prices to drop which again results in the loss of sales. Lastly Inter-firm rivalry with the threat of substitutes could cause customers to switch to lowest cost provider which would make returns extremely low. ? Works Cited Daft, R. L. (2007). Organization Theory and Design.
Mason: Thomson South-Western. Hill, C. W. , & Jones, G. R. (2008). Strategic Management. Boston: Houghton Mifflin . Porter, M. E. (2008, Janaury). Retrieved January 16, 2008, from harvardbusinessonline. hbsp. harvard. edu: http://harvardbusinessonline. hbsp. harvard. edu/hbsp/hbr/articles/article. jsp? value=BR0801&ml_subscriber=true&ml_action=get-article&ml_issueid=BR0801&articleID=R0801E&pageNumber=1 Porter, M. E. (1980). Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: Free Press.