Porter’s Five Force Model or Five Force Analysis is an analysis that helps in analyzing competition in an industry and business strategy development. Porter’s Five Force Model uses industrial organization economics. Porter’s five force model is based on the assumption that a firm in an industry is subject to forces within the industry which have an influence on most of its moves. So, it is important to understand these forces that act upon a firm and it also helps in developing a winning strategy for the firm.
The five forces in Porter’s Five Force model include new entrants, buyers, substitutes, rivalry and suppliers. Elaborating these in detail, we have threat from new entrants, bargaining power of buyers, threat of substitutes, competition or rivalry, bargaining power of suppliers.
Giving a closer look at each of the forces, we have
- Threat of new entrants: There is always a threat of new entrants in every industry. New entrants entering into an industry make the industry more and more competitive. Apart from the incentives that are offered by government, tax policy, availability of capital, economies to scale, brand equity, etc and such other advantages make the industry lucrative for new entrants. Thus, new entrants can have a negative effect on already existing companies.
- Bargaining Power of Buyers: In any industry, buyers enjoy an advantage of bargaining. Bargaining power of buyers is such that if one business is not willing to bargain, then buyers can easily shift to another company. This is one major force or disadvantage affecting business in an industry. This reduces high profit margin of firms operating in the industry. Bargaining power of buyers mainly depends on the number of the firms operating in the industry to a ratio of number of consumers in the industry. The higher the number of firms, the greater the bargaining power for consumers due to competition.
- Bargaining power of Suppliers: In many industries, suppliers can also have an advantage of bargaining with businesses in terms of increasing prices of supplies. This can put a business in trouble, because, suppliers play an important role in producing the goods. If suppliers bargain for a higher price on a regular basis, the entire industry can suffer. This is one of the major issues faced by business. Again bargaining power of suppliers can depend upon less suppliers and more producers. If suppliers are more then bargaining power of suppliers can come down.
- Threats of substitutes: Substitutes generally become the immediate rivals for most businesses. The number of substitute products can be high if the industry does not have higher entry barriers. If the industry has lower entry barriers then, a new firm can easily enter into business and start selling substitute goods in that particular industry. But, if the industry has higher entry barriers such as patents, trademarks, goodwill, etc then the issue of threat from substitutes can be lower. Also, if the products offered are homogeneous, then there can be higher level of substitution leading to higher competition.
- Threats of rivalry: Rivalry is another factor that a business in an industry must look at. Rivalry comes from advertising and the intensity of advertising, firms enjoying concentration of market share, competition not just from price point of view but from innovation point of view, etc. and such other factors affect threats from rivalry a firm faces in an industry.
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