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.
Market or an industry differs on the following aspects:-
Industries vary in terms of the profits that they make.
Industries make hardly any profits because of these factors:-
Contrary to this, soft drink industry takes up a good amount profit-margins.
Porter identified the top 5 most important factors that act in tandem to determine nature of the competition within the Industry.
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?
Easy to Enter Market:
Difficult to Enter Market:
Negotiating Power of the Suppliers:
If any industry has a strong bargaining or negotiating power then:
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:
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.
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.
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:
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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