Porter's Five Forces is a model that identifies and analyzes five competitive forces that shape every industry and helps determine an industry's weaknesses and strengths. Five Forces analysis is frequently used to identify an industry's structure to determine corporate strategy. Porter's model can be applied to any segment of the economy to understand the level of competition within the industry and enhance a company's long-term profitability. The Five Forces model is named after Harvard Business School professor, Michael E. Porter.
The five forces are as follows:
1. Bargaining power of Buyers: The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers' power is high if buyers have many alternatives. It is low if they have few choices.
2. Bargaining power of Suppliers: The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources.
3. Threat of substitute products or services: A substitute product uses a different technology to try to solve the same economic need. Examples of substitutes are meat, poultry, and fish; landlines and cellular telephones; airlines, automobiles, trains, and ships; beer and wine; and so on. Potentials factors for this are buyer's propensity to substitute, relative price performance of substitute, ease of substitution, availability of close substitute, etc.
4. Threat of New Entrants: Profitable industries that yield high returns will attract new entities. New entrants eventually will decrease profitability for other firms in the industry. Unless the entry of new firms can be made more difficult by existing players, abnormal profitability will fall towards zero (perfect competition), which is the minimum level of profitability required to keep an industry in business. Some examples of entry barriers are sophisticated technology, legal factors, limited access to raw materials, etc.
5. Intensity of competition amongst firms: For most industries the intensity of competitive rivalry is the biggest determinant of the competitiveness of the industry. Having an understanding of industry rivals is vital to successfully marketing a product. Positioning depends on how the public perceives a product and distinguishes it from competitors‘. An organization must be aware of its competitors' marketing strategies and pricing and also be reactive to any changes made.
Porter's framework has been challenged by other academics and strategists. For instance, Kevin P. Coyne and Somu Subramaniam claim that three dubious assumptions underlie the five forces:
[ ] That buyers, competitors, and suppliers are unrelated and do not interact and collude.
[ ] That the source of value is structural advantage (creating barriers to entry).
[ ] That uncertainty is low, allowing participants in a market to plan for and respond to changes in competitive behavior.
Five forces analysis helps organizations to understand the factors affecting profitability in a specific industry, and can help to form decisions regarding : whether to enter a specific industry , whether to increase the capacity in a specific industry and developing competitive strategies.
The five forces are as follows:
1. Bargaining power of Buyers: The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers' power is high if buyers have many alternatives. It is low if they have few choices.
2. Bargaining power of Suppliers: The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources.
3. Threat of substitute products or services: A substitute product uses a different technology to try to solve the same economic need. Examples of substitutes are meat, poultry, and fish; landlines and cellular telephones; airlines, automobiles, trains, and ships; beer and wine; and so on. Potentials factors for this are buyer's propensity to substitute, relative price performance of substitute, ease of substitution, availability of close substitute, etc.
4. Threat of New Entrants: Profitable industries that yield high returns will attract new entities. New entrants eventually will decrease profitability for other firms in the industry. Unless the entry of new firms can be made more difficult by existing players, abnormal profitability will fall towards zero (perfect competition), which is the minimum level of profitability required to keep an industry in business. Some examples of entry barriers are sophisticated technology, legal factors, limited access to raw materials, etc.
5. Intensity of competition amongst firms: For most industries the intensity of competitive rivalry is the biggest determinant of the competitiveness of the industry. Having an understanding of industry rivals is vital to successfully marketing a product. Positioning depends on how the public perceives a product and distinguishes it from competitors‘. An organization must be aware of its competitors' marketing strategies and pricing and also be reactive to any changes made.
Porter's framework has been challenged by other academics and strategists. For instance, Kevin P. Coyne and Somu Subramaniam claim that three dubious assumptions underlie the five forces:
[ ] That buyers, competitors, and suppliers are unrelated and do not interact and collude.
[ ] That the source of value is structural advantage (creating barriers to entry).
[ ] That uncertainty is low, allowing participants in a market to plan for and respond to changes in competitive behavior.
Five forces analysis helps organizations to understand the factors affecting profitability in a specific industry, and can help to form decisions regarding : whether to enter a specific industry , whether to increase the capacity in a specific industry and developing competitive strategies.
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