Porter's Five force model.

Porter's Five force model.

Porter in his five force model of industrial competition,describes the competitive forces of 'shopping' as an industry. This model as become very popular and widely used in strategic management. According to him, by analysing the five forces,one can assess the forces driving competition in a specific industry and evaluate the odds of a firm's successful entry and competition in that industry. This would make it possible for an intending entrant to measure the attractiveness for entry or perhaps the need to exit,analyse the competitive trends in the market and able to plot future strategies.

The five forces according to porter are:

1) Threat of entry: 

Threat of entry describes the risk that potential competitors will enter the industry. It should be known that as more firm's enter an industry,it depresses overall profit for the industry. This is due to the fact that as additional capacity comes into the industry in the form of the new entries, already existing firms may lower prices to make entry appear less attractive to the potential new competitors,which would in turn reduce the overall industry's profit potential,especially in industries with slow or no growth potential.

Secondly,the threat of entry by additional competitors may force incumbent firms to spend more to satisfy their existing customers. This increase in investments by incumbent firms in the process of value creation further reduce an industry's profit potential if prices cannot be raised.

Entry barriers which are advantageous for incumbent firms,are obstacles that determine how easy a firm can enter an industry. Some of the sources of entry barrier includes

a) Economics of scale

b) Network effects

c) Capital requirements

d) Government policies

e) Credible threat of retaliation

2) The power of Suppliers

The bargaining power of suppliers captures pressures that industry suppliers can exert on an industry's profit potential.This bargaining power of suppliers can reduce the firm's ability to obtqin superior performance and profit potential because powerful suppliers can raise the cost of production by demanding higher prices for their inputs,or by reducing the quality of the input factor or service level delivered.

The relative bargaining power of suppliers are high when

a) The supplier's industry is more concentrated than the industry it sells to

b) Suppliers do not depend heavily on the industry for a large portion of their revenues

c) Suppliers offer products that are differentiated

d) They are no readily available substitutes for the products or services that the suppliers offer

e) Suppliers can credibly threaten to forward integrate into the industry.

3) Power of Buyers

Buyers are the consumers or customers of an industry, the power of the buyers concerns the pressure an Industry's customers can put on the producer's margins in the industry by demanding a lower price or higher product quality. When buyers obtain price discounts,it reduces a firm's top line revenue,and when they demand higher quality and more service,it generally raises production costs.

The power of suppliers is high when

a) They are few buyers of the products and each buyer purchases large quantities relative to the size of a single seller.

b) The industry's products are homogenous or undifferentiated commodities.

c) Buyers face low or no switching costs

d) Buyers can credibly threaten to backwardly integrate into the industry.

4) The Threat of Substitutes:

Substitutes meet the same basic customer needs as the industry's product but in a different way. The threat of substitutes is that the current customers may defect to products of competing firms that are close substitutes and are produced to tend to the same needs. A high threat of substitutes reduces industry profit potential by limiting the price the industry's competitors can charge for their products and services. The threat of substitutes is high when:

The substitute offers an attractive price-performance trade off

The buyer's cost of switching to the substitute is low.

5) Rivalry among existing competitors:

Rivalry among existing competitors describes the intensity with which companies within the same industry jockey for market share and profitability. The other four force discussed earlier affects the degree of competition or rivalry among firms. The stronger the forces,the stronger the expected competitive intensity,which in turn limits the industry's profit potential. Some companies might use a strategy of lower prices to attract customers from rivals. Alternatively,competitors can use non-price competition in terms of product features and design,quality,promotional spending and after sales service and support.

The intensity of rivalry among existing competitors is determined largely by the following:

a) Competitive industry structure

b) Industry growth

c) Strategic commitments

d) Exit barriers.