The Five Competitive Forces - by Michael E. Porter

Bargaining Power of Suppliers

The term 'suppliers' comprises all sources for inputs that are needed in order to provide goods or services.
Supplier bargaining power is likely to be high when:

•The market is dominated by a few large suppliers rather than a fragmented source of supply,
•There are no substitutes for the particular input,
•The suppliers customers are fragmented, so their bargaining power is low,
•The switching costs from one supplier to another are high,
•There is the possibility of the supplier integrating forwards in order to obtain higher prices and margins. This threat is especially high when
•The buying industry has a higher profitability than the supplying industry,
•Forward integration provides economies of scale for the supplier,
•The buying industry hinders the supplying industry in their development (e.g. reluctance to accept new releases of products),
•The buying industry has low barriers to entry.

In such situations, the buying industry often faces a high pressure on margins from their suppliers. The relationship to powerful suppliers can potentially reduce strategic options for the organization.

Bargaining Power of Customers

Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes.
Customers bargaining power is likely to be high when
•They buy large volumes, there is a concentration of buyers,
•The supplying industry comprises a large number of small operators
•The supplying industry operates with high fixed costs,
•The product is undifferentiated and can be replaces by substitutes,
•Switching to an alternative product is relatively simple and is not related to high costs,
•Customers have low margins and are price-sensitive,
•Customers could produce the product themselves,
•The product is not of strategical importance for the customer,
•The customer knows about the production costs of the product
•There is the possibility for the customer integrating backwards.


Threat of New Entrants

The competition in an industry will be the higher, the easier it is for other companies to enter this industry. In such a situation, new entrants could change major determinants of the market environment (e.g. market shares, prices, customer loyalty) at any time. There is always a latent pressure for reaction and adjustment for existing players in this industry.
The threat of new entries will depend on the extent to which there are barriers to entry. These are typically:-

•Economies of scale (minimum size requirements for profitable operations),
•High initial investments and fixed costs,
•Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets,
•Brand loyalty of customers
•Protected intellectual property like patents, licenses etc,
•Scarcity of important resources, e.g. qualified expert staff
•Access to raw materials is controlled by existing players,
•Distribution channels are controlled by existing players,
•Existing players have close customer relations, e.g. from long-term service contracts,
•High switching costs for customers
•Legislation and government action

Threat of Substitutes

A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category also relates to complementary products.

Similarly to the threat of new entrants, the treat of substitutes is determined by factors like:-

•Brand loyalty of customers,
•Close customer relationships,
•Switching costs for customers,
•The relative price for performance of substitutes,
•Current trends.

Competitive Rivalry between Existing Players

This force describes the intensity of competition between existing players (companies) in an industry. High competitive pressure results in pressure on prices, margins, and hence, on profitability for every single company in the industry.
Competition between existing players is likely to be high when:-

•There are many players of about the same size,
•Players have similar strategies
•There is not much differentiation between players and their products, hence, there is much price competition
•Low market growth rates (growth of a particular company is possible only at the expense of a competitor),
•Barriers for exit are high (e.g. expensive and highly specialized equipment).

Influencing the Power of Five Forces

After the analysis of current and potential future state of the five competitive forces, managers can search for options to influence these forces in their organization’s interest. Although industry-specific business models will limit options, the own strategy can change the impact of competitive forces on the organization. The objective is to reduce the power of competitive forces.

The following summary provides some solutions. They are of general nature. Hence, they have to be adjusted to each organization’s specific situation. The options of an organization are determined not only by the external market environment, but also by its own internal resources, competences and objectives.

Reducing the Bargaining Power of Suppliers

- Partnering
- Supply chain management
- Supply chain training
- Increase dependency
- Build knowledge of supplier costs and methods
- Take over a supplier

Reducing the Bargaining Power of Customers

- Partnering
- Supply chain management
- Increase loyalty
- Increase incentives and value added
- Move purchase decision away from price
- Cut put powerful intermediaries (go directly to customer)

Reducing the Treat of New Entrants

- Increase minimum efficient scales of operations
- Create a marketing / brand image (loyalty as a barrier)
- Patents, protection of intellectual property
- Alliances with linked products / services
- Tie up with suppliers
- Tie up with distributors
- Retaliation tactics

Reducing the Threat of Substitutes

- Legal actions
- Increase switching costs
- Alliances
- Customer surveys to learn about their preferences
- Enter substitute market and influence from within
- Accentuate differences (real or perceived)

Reducing the Competitive Rivalry between Existing Players

- Avoid price competition
- Differentiate your product
- Buy out competition
- Reduce industry over-capacity
- Focus on different segments
- Communicate with competitors


Source: http://www.mindtools.com/pages/article/newTMC_08.htm