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Strategy and Case Analysis: Porter’s Five Forces Model

Purpose

The purpose of this report is to examine in detail Porter’s five forces model for determining the level of competition within a particular industry as well as the expected profitability within the same industry. The paper examines the different components within the model including the role played by each component in determining the competition within a particular market. The paper digs deeper into the advantages and disadvantages of each of the five forces of competition and how the forces affect the profitability of firms within a specific industry. It is the author’s hope that this paper shall prove useful to firms looking to enter into new markets and shall serve the said firms in measuring the level of competition within particular industries as well as the barriers to entry and the expected profitability of the firm. The report can also be useful to firms that are already in a market as it can help such firms to gain a better understanding of their specific industries and how to utilize the five forces to their advantage (Grundy, 2006). The paper can also be used as an academic resource by other students who want to gain a deeper understanding of Porter’s five forces model. 

Background

The Five Forces model was developed by Michael Porter in1979 to help companies assess the competitiveness of their respective industries in order to create appropriate corporate strategies to beat the competition. The model examines five crucial factors that can be used to determine whether a business venture will be successful in a particular industry and what needs to be done to make the business a success. The model measures the attractiveness of a particular industry to a firm based on forces that might impact the profitability of the firm within the industry. These factors include the ability of other firms to enter into the market and raise competition within a certain niche as well as the easy availability of substitutes within the same market. The market forces also include the bargaining power of buyers and sellers, which have a direct impact on the profit levels within the industry. Each of the five forces within Porter’s model plays a crucial part in determining the level of competition within a particular industry and the profitability of firms within the particular industries (Hoang, 2014). Each industry has a unique structure based on the five forces model, which influences each aspect of the industry structure. To understand the structure of each industry as well as the profitability levels within a specific industry, an individual must apply the five forces model in the analysis of the industry in order to reveal the specific structure of the industry. Therefore, the five forces model is crucial to understanding the structure, competition levels and profitability of firms within a specific industry.

Porter’s Five Forces Framework

Diagram

Components

1. Competitive rivalry: the level of competitive rivalry within a particular industry is based on the number of competing firms that operate within a particular industry. If there are many competitors within an industry, who offer quality product to consumers, the power of an individual firm might be drastically reduced as customers and suppliers can easily switch firms if one firm does not offer a good deal. However, if the products or services offered by a firm are unique, then the firm might have great power over its industry as the sole provider of such goods or services. The competitive rivalry might be higher in industries where firms of a similar size operate in the same market, using the same strategies and offering products that have similar features. Such industries usually have low growth rates and might have significant barriers to exit, while having lower barriers to entry, hence, when firms enter the industry, they do not exit easily (Rice, 2010). The higher the degree of competition between different firms in the same market means that the strategies, prices and profits of firms in the industry shall be driven by the intense competition.
2. Bargaining power of suppliers: the bargaining power of suppliers implies the ability of suppliers to raise or lower prices without due considerations for the needs of the firm. This ability is determined by the number of suppliers of specific raw materials required in the production process. The higher the number of suppliers the lesser their bargaining power as a company can easily switch suppliers in case of any changes in prices (Lee, Kim and Park, 2012). The power suppliers have over a specific firm varies depending on the uniqueness of the materials they supply, the costs of switching from one supplier to another as well as the strength and control of each supplier over a supply relationship. The lesser the number of supply options that a company has, the greater the power of such suppliers over the firm. Suppliers are usually powerful if there is a credible threat of forward integration by suppliers, such as where there is a threat of a supplier purchasing a distributor’s business. Other factors that contribute to the power of suppliers include situations where suppliers are concentrated and situations where the customers are powerful. Suppliers are weak where there are many competitive suppliers, where there is a credible threat of backward integration and where the purchasers are concentrated.
3. Bargaining power of buyers: the bargaining power of buyers relates to the degree of control that buyers have over producers and suppliers. The power of buyers usually emanates from situations where a company has very few buyers who purchase products in bulk such as the DoD and defense contractors. In such cases, the buyers have significant control over the producers and suppliers, hence they can dictate prices. Other scenarios include when buyers purchase a significant amount of a company’s total output, which gives them immense power over the producers. This case is best demonstrated by large retailers such as wall mart and Target who have significant control over their suppliers and can dictate terms because of the terms of their purchasing agreements (Prasad, 2011). Buyers are also strong of they can easily purchase the supplying firm through backward integration, which is the case of tire manufacturers and car manufacturers. Buyers are weak if there is a threat of forward integration by producers, if there are significant switching costs from one supplier to another and if there are many fragmented buyers who cannot exercise significant control over the suppliers.
4. Threat of substitutes: the threat of substitutes refers to alternative products from different industries that can be used y consumers in place of a company’s existing products. Substitute products are usually not part of the industry rivalry as they are typically from an outside industry, but have a direct impact on the sales of a company’s products. Substitute products affect the price elasticity of most products as customers have numerous alternatives to choose from hence they can easily switch to other products if the supplier raises the prices of his products. Cases where it is easy and viable to substitute a product, the supplier’s power is greatly reduced as consumers can easily substitute his product for another (Dulčić, Gnjidić and Alfirević, 2012). For example, the prices of aluminum cans for beverages are greatly affected by the prices of plastic beverage bottles, glass bottles and steel cans, which are all substitute products. This means that an increase in the prices of aluminum cans could lead manufacturers to witch to plastic or glass bottles hence affecting producers of aluminum cans negatively.
5. Threat of entry: the threat of entry refers to the possibility that new firms might be attracted to the industry and decide to enter the same industry. The ability of other firms to enter a market is a crucial determinant of the power of each of the firms in a specific industry. Under normal circumstances, firms should be able to enter and exit a market at will, which means that it would be easy for firms to enter or exit a market. However, in practice most industries have barriers to entry of new firms, which gives power to the firms that are already in a specific market. Some barriers to the entry of new firms in market include government regulations that might make it difficult for other firms to join a lucrative market. Firms in an industry might also possess proprietary or patented and technology that might serve to deter the entry of other firms into the industry (Kumar, Dass and Kumar, 2015). Industries that require highly specialized technologies also pose great barriers to entry, especially if the technologies cannot be used for other purposes. The existence of economies of scale or lack thereof is a significant barrier to the entry of firms in industries that require high internal economies of scale as evidence by the telecommunications industry.

Advantages and challenges

A major advantage of Porter’s five forces model is that it examines the threat of substitutes to a particular industry or firm and can be used to identify future risks to a company’s profits posed by the threat of substitutes. By identifying the substitutes that might affect the sales of a company’s products, a firm can take measures to eliminate this threat by offering services that cannot be matched by other firms in different industries. Another advantage is that it enables a firm to assess the threat of new entrants into their industry by looking at factors that would make it easy for other firms to enter the market and reduce the profits earned by firms that have already established operations within the same market. By examining the power of both suppliers and buyers, the model allows firms to explore ways in which they can extend their market power while limiting the power of their suppliers and the buyers if their products (Yetkin, 2013). This assessment also enables the firms to identify ways in which they can limit the power of buyers and suppliers so that they can have an advantageous position in their operations. Although the firm does not have much control over its external environment the five forces model can allow a firm to work on its internal environment and create the most beneficial set of factors for its operations.

Some of the challenges associated with Porter’s five forces model include the fact that the pace of change in the modern business environment has evolved greatly since the late 1970s and the model might not be able to accurately predict these changes today. The model also has a major shortcoming in that it does not consider non-market forces in its analysis yet there are crucial forces outside the market that might affect the profitable operation of a business (Bogdan, 2014). It is also quite difficult to define an industry using the model in today’s dynamic business environment where industries overlap to a great extent. It is also impossible to use Porter’s model in analyzing simple market structures as the model is based on a complex competitive market structure. The model generally assumed a static business environment, but today’s business environment is quite dynamic and the rate of change is extremely high, which renders the model quite inefficient in today’s market structures. The model also does not provide meaningful details on how a company can react to buyer and supplier power as well as the other market forces in its environment in order to provide firms with effective strategies for reducing such power (Wu, Tseng and Chiu, 2012). The changes in the present business environment include the easy availability of venture capital that allows business to acquire the necessary capital needed to enter into markets with high financial barriers to entry. These changes are not accounted for, or factored into the five forces model, which is extremely static.

Discussion

Although Porter’s five forces model can be used to provide a snapshot of the forces within a particular market from the suppliers to the buyers among other forces that contribute to competition within a particular industry, the model does not provide a specific detailed plan for dealing with the said forces. The five forces model is appropriate for obtaining a general overview of the market forces within a specific market segment, but might not be appropriate for analyzing niche markets dominated by small businesses. Many critics argue that porter’s five forces model is not applicable to the business environment today, but many business analysts use it as a method of establishing a strong base model for further analysis using different analytical tools (Hoang, 2014). The forces examined in Porter’s model can be used to determine attractive industries where the forces combine to create an environment where supernormal profits can be earned by firms operating in the specific market. However, the same forces can be applied to result in a highly unattractive industry where the firms operating in the industry earn a nominal profit and cannot raise their profit margins due to factors such as the easy availability of substitute products.

Other factors such as powerful suppliers and powerful buyers might contribute negatively to the profit margins of firms in the particular market as the buyers and suppliers will be able to dictate the terms of their dealings with the firm. In such a case, the firm cannot increase its prices and profit margins as the firm’s power is lesser than the power of suppliers and buyers who have greater control over the industry and market (Prasad, 2011). However, a firm such as a monopoly has greater power than both its buyers and suppliers and can raise its prices with minimal effect on its sales and profits as buyers have no substitute products and suppliers have no alternative buyers. In such a scenario, the monopoly firm can earn supernormal profits due to the high barriers to entry prohibiting competitors from entering the market.

Conclusion

In summary, the following conclusions about Porter’s five forces model can be derived from the analysis of the said forces within this paper. One of the conclusions is that industries with powerful suppliers and buyers are generally unattractive industries as firms within such industries usually end up earning nominal profits. Industries where the firms involved have significant power over suppliers and buyers are generally attractive industries as the firms earn supernormal profits. It is also evident from the above analysis that the five forces model is best suited to a static industry where the pace of change is quite slow, which is not the case for modern business environments, which change at a rapid pace and are highly dynamic. The five forces model can be used within modern industries to provide a brief overview of the market and the forces operating in the market, which means that it can be used in conjunction with other tools to get a good understanding of the modern business environment. The five forces model is a tool that can be sued by business to identify where the power lies in their business as well as areas of weakness that can be strengthened. Therefore, such companies can exploit areas of strength and strengthen areas of weakness in their businesses.