Michael Porter developed this model in the early 1980s as a structural tool to assess the attractiveness of any industry. Porter suggests that the attractiveness of and therefore the ability of businesses to compete in, any industry or segment is influenced by the action and interaction of five basic forces that make up any industry. Not every force will have influence on every industry or market, but when a force does have impact it will create its own effect and may also interact with the intensity of competition to generate a combined impact.
THE FIVE FORCES MODEL
Porter identified five factors that act together to determine the nature of competition within an industry. These are the:
1. The intensity of rivalry/ competition between existing competitors.
2. The threat of new entrants to the market, and the ease with which they can enter.
3. The threat of substitutes linked to the ease with which customers will be tempted to switch.
4. The bargaining power of suppliers and their ability to influence costs
5. The bargaining power of buyers (channel or end users) and their ability to influence price.
1. Intensity of rivalry / competition
The intensity of competition in any market or industry will have an impact on the attractiveness of the market or industry. If the greater the competitive rivalry, the harder it is for individual businesses that will achieve sales and profit objectives. However, if the competitive rivalry is lower, and competitors are reasonably content to share the market between them, so that it is easier to achieve sales and profit objectives. Competitive rivalry will be determined by:
a) Number of competitors
b) Relative dominance of competitors
c) Attitude or corporate commitment of competitors
d) The level of differentiation within the industry
e) The cost structures within the industry
f) The existence of high exit barriers
g) The stage of the product life cycle
h) Low buyer switching cost
i) Perishability of the product
• The greater the number of competitors fighting to gain a share of the available customers in any given market or industry, the harder each will need to work in order to convince customers to choose their product. A large number of firms increases rivalry because more firms must compete for the same customers and resources. The rivalry intensifies if the firms have similar market share, leading to a struggle for market leadership.
• In addition, it is suggested that if one or two firms are relatively dominant, competition tend to be less intense. The attitude or corporate commitment of competitors may override the general trend. For instance, in the soft drink market like Coca-Cola and Pepsi are by far the dominant brands, with all other competitors being significantly smaller. This does not stop intense competition between the two major brands, who also behave quite aggressively towards any smaller brand that may seen as a threat.
• The greater the differentiation the less likely competitors are to resort to price competition as they will be targeting different segments or sub-segments. The lower level of product differentiation is associated with higher levels of rivalry. Brand identification, on the other hand tends to constrain rivalry.
• Different cost structures will have different effects on competition. High fixed costs result in an economy of scale effect that increase rivalry. When total costs are mostly fixed costs, the firm must produce near capacity to attain the lowest unit costs. Since the firm must sell this large quantity of product, high levels of production lead to a fight for market share and results in increased rivalry.
• High exit barriers place a high cost on abandoning the product. The firm must compete. High exit barriers cause a firm to remain in an industry, even when the venture is not profitable. High exit barriers such as the high costs of leaving an industry or market, also effect competition. The inability to convert fixed cost structures to alternative production and redundancy costs will lead t business feeling ‘stuck’ and therefore competing aggressively.
• The stage of product life cycle will also have an impact. Growth markets are always going to be more attractive, and therefore generate more competition, than mature or declining markets. At these later stages many businesses tend to move on, lowering the competitive pressure. That is, of course, unless high exit barriers exist, when competitive intensity will increase ‘stuck’ firms fight over the remaining customers.
• Low switching costs increase rivalry. When a customer can freely switch from one product to another there is a greater struggle to capture customers.
• The more perishable the product, the faster businesses will need to sell it.
The impact of competitive rivalry :
• Strong differentiation
• Loyalty programs
• Promotions and sponsorships
• Strategic alliances with retailers/distributors
2. Threat of new entrants
If new entrants move into an industry they will gain market share & rivalry will intensify. The position of existing firms is stronger if there are barriers to entering the market. Moreover, if barriers to entry are low then the threat of new entrants will be high, and if barriers to entry are high, the threat of new entrance will be low.
Industries with high entry barriers require businesses to have substantial resources or expertise. This tends to restrict the number of competitors to a few large firms, such as airline industries. Those with low entry barriers are more likely to have larger numbers of smaller firms because the resource and expertise requirements are easy to obtain. For example, tourism industry, hospitality and others service industries.
Entry barriers include:
➢ High capital, expertise or technology requirements
➢ Regulatory policies/legislation that place added costs or conditions
➢ Tariff and international trade barriers that restrict the ability of businesses to expand into new geographic territories
➢ Cost advantage held by existing competitors. Businesses with higher cost structure will be more difficult to compete.. will achieve lower returns, and will run the risk of elimination via price wars. This cost advantage can be achieved through economies of scale.
➢ Strong patents held by existing competitors
➢ Brand image resulting in high levels of customer loyalty for existing competitors
➢ Access to distribution channels.
3. Bargaining power of suppliers
➢ The bargaining power of suppliers as meant in the five forces model of Porter is the ability of suppliers of goods and services to influence the establishment of prices of these commodities.
➢ Bargaining Power of supplier means how strong is the position of a seller. How much your supplier has control over increasing the Price of supplies. Suppliers are more powerful when:
• Suppliers are concentrated and well organized
• a few substitutes available to supplies
• Their product is most effective or unique
• Switching cost, from one suppliers to another, is high
• You are not an important customer to Supplier
➢ When suppliers have more control over supplies and its prices that segment is less attractive. It is best way to make win-win relation with suppliers. It’s good idea to have multi-sources of supply.
➢ Supplier power may be reduced by:
• Better supply chain management
• Developing a better understanding of suppliers’ costs and operations
• Developing partnerships or strategic alliances with selected suppliers
• Redesigning products so substitute materials or ingredients may be used
4. Bargaining power of buyers
➢ The buyer’s power is significant in that buyers can force prices down, demand higher quality products or services, and, in essence, play competitors against one another, all resulting in potential loss of industry profits.
➢ Bargaining Power of Buyers means, How much control the buyers have to drive down your products price, Can they work together in ordering large volumes. Buyers have more bargaining power when:
• Few buyers chasing too many goods
• Buyer purchases in bulk quantities
• Product is not differentiated
• Buyer’s cost of switching to a competitors’ product is low
• Shopping cost is low
• Buyers are price sensitive
• Credible Threat of integration
➢ Buyer’s bargaining power may be lowered down by offering differentiated product. If you’re serving a few but huge quantity ordering buyers, then they have the power to dictate you.
➢ Buyer power may be reduced by:
• Forward integration, where businesses set up their own distribution or retail outlets or sell direct via the internet or direct mail
• Value adding in the forms of additional service or convenience to make the offering more valuable to the buyer
• Seeking new buyers and markets-usually in new geographic locations
• If the product is commodity in nature, branding it anyway.
Even fresh fruit growers are doing this today
5. Threat of substitutes
➢ A substitute is something that can take the place of your product without impacting on the satisfaction of the customer as it is a complete replacement.
➢ The threat of a substitute is present if there are alternative products available to the customers that can satisfy the need of the customer at prices better that the existing products or if these products can better satisfy the required performance parameters of the clients for the same or a better price. As a result of this the opposition could potentially draw a considerable percentage of the market segment and thus drive down the prospective sales volume of existing market proponents.
➢ The treat of substitutes also includes the potential of buyers switching to complementary products. A complimentary product is a product for which the demand is related to another product in such a manner that an increase in the price of the first product will cause a shift in the demand for the other product. In other words, less of the primary product will be demanded at any given available price of the complimentary product. This is particularly important in situations where the two products are commonly consumed or used together in relatively fixed or standardized proportions to one another.
➢ Substitute threats come from either direct or indirect substitutes. Direct substitutes are those that perform basically the same function for the customer. For example:
• Sugar versus artificial sweeteners
• Butter versus margarine
• Glasses versus contact lenses
➢ Indirect substitutes are products that customers choose between when spending discretionary income. For example:
• Restaurant versus theatre/cinema
• Home renovation versus tourism
• Education versus entertainment
➢ Threat of substitute products means how easily your customers can switch to your competitors product. Threat of substitute is high when:
• There are many substitute products available
• Customer can easily find the product or service that you’re offering at the same or less price
• Quality of the competitors’ product is better
• Substitute product is by a company earning high profits so can reduce prices to the lowest level.
➢ In the above mentioned situations, Customer can easily switch to substitute products. So substitutes are a threat to your company. When there are actual and potential substitute products available then segment is unattractive. Profits and prices are affected by substitutes so; there is need to closely monitor price trends. In substitute industries, if competition rises or technology modernizes then prices and profits decline.
41 Degrees South: Family advances unique salmon market
Tasmania is a home for Australian Atlantic Salmon Industry. Tasmania was known for its clean, green, gourmet image. 41 Degrees South has developed a market all of its own for the baby salmon it grows in fresh-water tanks to hot-smokes. 41 Degrees South is now one of the most eco-friendly fish farm in the country.
The Five Forces
1. Intensity of rivalry/competition
– The higher the competitive, the harder to achieve sales/profit objectives. There are many competitors in Australian Atlantic Salmon industry.
– Low product differentiation led to higher price competition. However, Atlantic salmon products able to attract premium prices due to its known quality of benefits.
– The more perishable the product, the faster business need to sell it, led to financial damage which consists cost for disposal of unsold Atlantic salmon products.
– To counter competitive impact, the business should consider on improving product’s quality, image, price, service, and promotion. For example, Secret blends of spices and herbs, high quality product and promote eco-friendly business.
2. Threats of new entrants
– Low entry barriers cause enlargement with the number of competitors. Easy to entry the market. For instance, Tassal Group Ltd, Huon Agriculture Group P/L and Petuna Aquaculture P/L
– Australian Atlantic Salmon industry requires large capital, expertise/knowledge to grow the fish, and technology requirement. However, they are easy to attain through support and training.
– Australia’s farmed fishing industry is regulated by the Australian Government’s Department of Agriculture, Fisheries and Forestry caused difficulties for entrants.
– To lower threat ;- Technology Innovation – Improve water quality, Wetlands and promote Eco-friendly systems
3. Threat of substitute
– 41 Degrees South facing a direct substitutes threat
– Competitors perform same function for customers
– Competitors produce products from Atlantic Salmon.
– Little differentiation between competitor’s products cause high substitute’s threats.
– For example : Tassal Group produces Hot Smoked Salmon Flakes & 41 Degrees South produce Classic Hot Smoked Salmon Fillet
4. Bargaining power of buyers
– High buyer’s power since the industry competitors’ have little differentiation
– The industry’s product represent only a minor part of buyer’s purchases
– Buyers have the ability to pick and choose between products produce by 41 Degrees South and other producers.
– Buyer’s power can be reduces by seeking new buyers or markets in new geographic locations. Exports for Australian Atlantic Salmon now have spread throughout Asia.
5. Bargaining power of suppliers
– For Australian Atlantic Salmon have few suppliers but many buyers which led to price wars and high suppliers’ power
– A few substitutes available to supplies and switching cost is high.
Limitations and Relevance Today
Porter developed his five forces model in the early 1980s. After dot-com revolution, business conditions have changed radically, the theory as first described by Porter no longer applies. The growth of Internet and e-business has changed the way many companies operate. Everything is more dynamic and therefore less predictable, and therefore Porter’s model is less useful if not obsolete (outdated).
Threat of new entrants
Intensity of rivalry between existing competitors
Bargaining power of buyers
Bargaining power of suppliers
Threat of substitutes