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  • 11Dec, 2019

    Porter’s Five Forces Model Industry Analysis: A Complete Overview

    Porter’s Five Forces Model Industry Analysis: A Complete Overview

    It was Professor Michael Porter who devised a Five Forces Model Industry Analysis that provides a thorough analysis of the Nature of competition within the industry. Each industry and market differs in Nature and the differences can be in terms of size, growth, structure and distribution etc.

    Here is a brief intro and background-

    Introduction and Background:

    Market or an industry differs on the following aspects:-

    • Size (in terms of volume, number of customers and sales revenue)
    • Structure (number of competitors and brands)
    • Distribution channels (how the products get from producers to the final consumers)
    • Customers requirements and demands ( basis of marketing segmentation)
    • Growth (the rate of growth and the businesses that are growing slower or faster in the market)
    • Product life cycle
    • Substitutions or alternatives available to the consumers.

    Industries vary in terms of the profits that they make.

    Here are some instances:

    Industries make hardly any profits because of these factors:-

    • There is very intensive rivalry primarily on the price front.
    • Low-barriers to the entry and a lot of new airlines who want to make set-ups.
    • Suppliers of aircrafts & equipments are all powerful and can take high-margins.
    • Customers have many alternative modes of transportation (cars, rails and more)
    • High fixed costs airlines losses raise significantly and the revenues fall only when the flight is not full because even the half-filled flights cost the same.

    Contrary to this, soft drink industry takes up a good amount profit-margins.

    Here are the reasons why:-

    • Suppliers and customers have a little power only. A well-known soft drink brand like Pepsi or Coke can have millions of consumers and several thousands of retail distributors that do not have much impact over the business.
    • There is loyalty and high brand awareness which means less consumer desires for the substitutes.
    • High barriers to the entry- how do you enter a market dominated by the most important market players.

    Porter identified the top 5 most important factors that act in tandem to determine nature of the competition within the Industry.

    Here are those top highly acknowledged five force model:-

    • Threat of new competitors in the market.
    • Negotiating or bargaining power of the suppliers
    • Negotiating or bargaining power of customers
    • Threat of substitute products
    • Degree of the competitive opposition.

    Porter identified high or low industry profits for all the market and acknowledged the fact that they are associated with the following characteristics:

    Threat of New Entrants:

    If new entrants enter the industry they gain market share and competition tends to intensify. Position of the existing firms become stronger if there are barriers in the market. If barrier to the entry point is low then the threat to the new entrants would be high and vice-versa.

    Barriers to the entry are very important for determining threats to the new entrants. Market can have multiple barriers. What makes a market difficult or easier to enter?

    Given here is a table which will help you summarise the issues that you should consider.

    Easy to Enter Market:

    • Common technology
    • Access to the distribution channels
    • Low capital requirements
    • No specific need of high output and capacity
    • Absence of customer loyalty and strong brands.

    Difficult to Enter Market:

    • Patented know-how
    • Well-established brands
    • High capital needs
    • Limited distribution channels

    Negotiating Power of the Suppliers:

    If any industry has a strong bargaining or negotiating power then:

    • They can exercise that power
    • Sell their products at a high price
    • Squeeze the industry profits.

    If the supplier forces-up the price for the supplied inputs, profit margin will be reduced naturally. More powerful the customers are the lower the price they need to pay.

    Suppliers are in the powerful position in the following situations:

    • When there are only a few suppliers
    • Resource that they supply is scarce
    • Cost of switching to the alternative supplier is high
    • Customers are small and not so important
    • Products are easy to distinguish and the loyal customers do not want to switch.
    • Supplier can threaten to integrate vertically.
    • There are hardly any substitute resources available.

    Uniqueness of the Input Supplied:

    If the resource supplied by the firm is unique to the buying firm and no substitutions are available in the market, suppliers are in the strong position.

    Size and Number of the Firms Supplying the Resources:

    If there are only a few large suppliers then suppliers are in a strong position because they can exert more power over the prices than the smaller suppliers.

    Competition for the Input from Other Industries:

    If competition is tougher than suppliers are in a better and stronger position.

    Cost of Switching to Alternative Sources:

    If the cost associated with the alternative sources is very high then suppliers are in a stronger position.

    NEGOTIATING OR BARGANAING POWER OF CUSTOMERS:

    It is important to remember that the powerful customers are able to exert pressure by their skills of bargaining to bring down the prices or increase the quantity for the same price. It is due to this reason that the profit-margins get reduced.

    The power of bargaining can exert a great pressure on the supplier firms. There are a number of factors that determine the bargaining power of customers.

    • Smaller the number of customers, the greater their bargaining power would be.
    • Larger the volume of products purchased, the greater the bargaining power will be.
    • Smaller the alternative suppliers, better and bigger the opportunities customers have for shopping around.
    • If consumers pose a threat of integrating backwards, they will have better power.
    • Customers that are loyal and tied to certain products are in a powerful position.

    THREAT OF SUBSITUTE PRODUCTS

    A substitute product is the product that meets customers’ requirements. Substitute or the alternate products are the ones that can satisfy the need of customers. If there are a number of credible substitutes that customers think they can rely on for meeting their needs, it would limit the price and reduce the profits of industry automatically.

    Extent of the threat depends on the following:

    • Willingness of consumers to switch to another product
    • Extent to which performance and price of the alternative product available to them can match.
    • Loyalty of customers and the switching costs

    DEGREE OF COMPETITVE OPPOSITION

    If there is any threat from the competitive product, the firm will need to improve their performance by bringing down the costs and the final prices. If there is an intense competition on the market, it would encourage the businesses to engage in the price wars and investment in buying new products or technologies. All these activities will increase the costs and brings down the profit.

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