The use of Porter's five forces model (see Figure 1) will help identify the sources of competition in an industry or sector.
THE POWER OF BUYERS
The power of the buyer will be high where:
there are a few, large players in a market. For example, large supermarket chains can apply a great deal of price pressure on their potential suppliers. This is especially the case where there are a large number of undifferentiated, small suppliers, such as small farming businesses supplying fresh produce to large supermarket chains
the cost of switching between suppliers is low, for example from one haulage contractor to another
the buyer's product is not significantly affected by the quality of the supplier's product. For example, a manufacturer of foil and cling film will not be affected too greatly by the quality of the spiral-wound paper tubes on which their products are wrapped
buyers earn low profits
buyers have the potential for backward integration, for example where the buyer might purchase the supplier and/or set up in business and compete with the supplier. This is a strategic option which might be selected by a buyer in circumstances where favourable prices and quality levels cannot be obtained
buyers are well informed. For example, having full information regarding availability of supplies.
THE POWER OF SUPPLIERS
The power of the seller will be high where (and this tends to be a reversal of the power of buyers):
there are a large number of customers, reducing their reliance upon any single customer
the switching costs are high. For example, switching from one software supplier to another could prove extremely costly
the brand is powerful (BMW, McDonalds, Microsoft). Where the supplier's brand is powerful then a retailer might not be able to operate a particular brand in its range of products
there is a possibility of the supplier integrating forward, such as a brewery buying restaurants
customers are fragmented so that they have little bargaining power, such as the customers of a petrol station situated in a remote location.
THE THREAT OF SUBSTITUTES
The threat of substitutes is higher where:
there is product-for-product substitution, eg for fax and postal services
there is substitution of need. For example, better quality domestic appliances reduce the need for maintenance and repair services. The information technology revolution has made a significant impact in this particular area as it has greatly diminished the need for providers of printing and secretarial services
there is generic substitution competing for disposable income, such as the competition between carpet and flooring manufacturers.
COMPETITIVE RIVALRY
Competitive rivalry is likely to be high where:
there are a number of equally balanced competitors of a similar size. Competition is likely to intensify as one competitor strives to attain dominance over another
the rate of market growth is slow. The concept of the life cycle suggests that in mature markets, market share has to be achieved at the expense of competitors
there is a lack of differentiation between competitor offerings because, in such situations, there is little disincentive to switch from one supplier to another
the industry has high fixed costs, perhaps as a result of capital intensity, which may precipitate price wars and hence low margins. Where capacity can only be increased in large increments, requiring substantial investment, then the competitor who takes up this option is likely to create short-term excess capacity and increased competition
there are high exit barriers. This can lead to excess capacity and, consequently, increased competition from those firms effectively 'locked in' to a particular marketplace.
In summary, the application of Porter's five forces model will increase management understanding of an industrial environment which they may want to enter.
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