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Awareness of these forces can help a company stake out a position in its industry that is less vulnerable to attack. Peter Walton Photography/Getty Images
Major contending forces, says this expert on business strategy, determine the state of competition in an industry: the threat of new entrants, the bargaining power of customers and of suppliers, the intense rivalry of competitors, and the threat of substitute services or products. Once the corporate strategist has assessed these forces, he can identify his own company’s strengths and weaknesses and act accordingly to put up the best defense against competitive assaults.
The essence of strategy formulation is coping with competition. Yet it is easy to view competition too narrowly and too pessimistically. While one sometimes hears executives complaining to the contrary, intense competition in an industry is neither coincidence nor bad luck. A version of this article appeared in the March–April 1979 issue of Harvard Business Review.
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Porter’s Five Forces Model FrameworkIndustry Analysis of Competitive DynamicsThe originator of the five forces model is Michael Porter, a Harvard Business School (HBS) professor whose theories remain instrumental to business strategy even today. Porter’s five forces framework is utilized for strategic industry analysis, and focus on the following:
Competitive industry structures can be analyzed utilizing Porter’s five forces model, as each factor influences the profit potential within the industry. Moreover, for companies that are considering whether to enter a particular industry, a five forces analysis can help determine whether the profit opportunity exists. If there are substantial risks making the industry unattractive from a profitability perspective and negative industry trends (i.e. “headwinds”), it may be better for the company to forgo entering a given new industry.
Importance of Porter’s Five Forces ModelLong-Term Protection of ProfitsThe premise of the five forces model is that for a company to obtain a sustainable, long-term competitive advantage, the profitability potential within the industry must be identified. However, identification is not sufficient, as it must be followed up with the right decisions to capitalize on the proper growth and margin expansion opportunities. By analyzing the prevailing competitive environment, a company can objectively recognize where it currently stands within an industry, which can help shape corporate strategy going forward. Certain companies will identify their competitive advantages and attempt to extract as much value as possible from them, whereas other companies might focus more on their weaknesses – and neither approach is right or wrong as it depends on each company’s particular circumstances. Threat of New EntrantsIndustries constantly undergo disruption or are prone to it, especially given the modern pace of technological growth. Seemingly every year, new features or updates to existing technology are introduced to the market with claims of more efficiency and improved capabilities to accomplish difficult tasks. No company is entirely protected from the threat of disruption, but differentiation from the market provides more control to the company. Hence, many of the market leaders nowadays allocate a significant amount of capital each year into research and development (R&D), which makes it more challenging for others to compete while protecting themselves from being blindsided by new breakthrough technologies or trends. Potential barriers to entry include:
Bargaining Power of BuyersOn the topic of the bargaining power of buyers, the first question to ask is if the company is:
In general, commercial customers (i.e. SMBs, enterprises) are more likely to have more bargaining power due to having more spending power, whereas everyday consumers typically have far less money to spend. However, the universe of commercial clients is limited compared to that of consumers. For reputable buyers with significant purchase volumes or order sizes, suppliers tend to be willing to accept lower offer prices to retain the customer. By contrast, if a B2C company with millions of individual customers were to lose a single customer, the company would likely not even notice. Bargaining Power of SuppliersThe bargaining power of suppliers stems from selling raw materials and products that other suppliers do not carry (i.e. more scarcity results in greater value). If the items provided by the supplier constitute a significant proportion of the product as sold by the buyer, the bargaining power of the supplier directly increases, as the supplier is a major component of the buyer’s operations. On the other hand, if the suppliers for a certain product are not differentiated, the competition will be more heavily based around pricing (i.e. a “race to the bottom” – which benefits the buyers, not the sellers). Threat of Substitute Products/ServicesOften, products or services can have substitutes that make them more vulnerable, as customers in these instances have more optionality. More specifically, if a certain condition is met – e.g. an economic downturn – customers could opt for cheaper products despite lower quality and/or lower-tier branding. Rivalry Among Existing CompetitorsThe degree of rivalry within an industry is a direct function of two factors:
The two are closely linked, as the greater the revenue opportunity, the more companies will enter the industry to grab a piece of the pie. Furthermore, if the industry is growing, there is likely going to be more competitors (and vice versa for stagnant or negative growth industries). Porter’s Analysis – Attractive vs. Unattractive IndustriesSigns of a Profitable Industry
Signs of an Unprofitable Industry
Step-by-Step Online Course Everything You Need To Master Financial ModelingEnroll in The Premium Package: Learn Financial Statement Modeling, DCF, M&A, LBO and Comps. The same training program used at top investment banks. Enroll Today What are the 5 competitive forces that affect your company's profitability?Porter's five forces is an amazing tool enabling organizations to evaluate the profitability of a market or industry. It is based on five forces that affect attractiveness: competitive rivalry, supplier power, buyer power, threat of substitution and threat of new entry.
What are the 5 industry forces?The Five Forces. Threat of New Entrants. The threat of new entrants into an industry can force current players to keep prices down and spend more to retain customers. ... . Bargaining Power of Suppliers. ... . Bargaining Power of Buyers. ... . Threat of Substitute Products. ... . Rivalry Among Existing Competitors.. Which is one of the 5 forces of industry structure for a business?Customers, suppliers, substitutes and potential entrants—collectively referred to as an extended rivalry—are competitors to companies within an industry. The five competitive forces jointly determine the strength of industry competition and profitability.
What are some of the five forces driving industry competition that are affecting the profitability of Apple?The Porter 5 Forces Model.. Apple in the Marketplace From a 5 Forces Perspective.. Industry Competition.. Bargaining Power of Buyers.. The Threat of New Entrants to the Marketplace.. Bargaining Power of Suppliers.. The Threat of Buyers Opting for Substitute Products.. |
