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In his book Competitive Strategy Techniques for Analyzing Industries and Competitors, Michael Porter discusses five forces that drive competition within every industry and every market. The forces that he identifies are the threat of entry by new competition, the intense rivalry amongst existing competitors, the threat of substitute products, the bargaining power of suppliers, and the bargaining power buyers.
The first part of Porter’s model deals with the threat of new competition. According to Porter, the easier that it is for other companies to enter the market, the higher the level of competition will be amongst the existing companies within the industry. This threat of new competition drives companies to set a high level of service or value to customers that will be extremely difficult or costly for new entrants to duplicate. Porter identifies some key barriers that would discourage a company from attempting to enter into the market. Companies that already have footing in the industry benefit from the cost advantages of a large-scale operation. This is known as economies of scale, and makes it difficult for smaller firms to run profitable operations. Brand preference and customer loyalty makes it difficult for new competition to draw customers away from companies already in the market. Government policies such as tariffs and legal monopolies are another important barrier that faces new competition. These are just a few of the barriers that face new companies that attempt to enter into a market.
The intense competition amongst existing firms in an industry is another of Porter’s competitive forces. This high level of competition is influenced by many factors in the industry. A larger number of firms increases the level of competition, because the firms are forced to compete for the same customers. If the market’s growth has slowed, this will also increase the competition as firms struggle to gain market share. There is little difference in the products offered by companies in the same industry which forces a high level of price competition. High fixed costs also increase competition. Firms must produce a high level of product in order to keep low unit costs. The firms are in turn stuck with a large inventory to sell which in turn leads to even more price competition. As the ability of customers to switch from one product to another becomes easier, the competition to maintain customers increases. Finally, high exit barriers keep companies stuck in the industry. In an industry with highly specialized equipment the ability to sell it becomes increasingly difficult. This forces a firm to remain in business no matter how unprofitable the venture has become. All these factors cause the intense competition that Porter discusses.
Porter also discusses the threat of substitute products as yet another force that drives competition. If substitute products are being offered at lower prices and perform better than a threat exists. Firms offering the substitute products could take a significant market share from the existing competition. There are many factors that affect how much of a threat a substitute product poses. The threat of substitute products shares some of the same determining factors as the threat of new competition. Brand loyalty of customers, the switching costs for customers, and the performance of substitutes are just some of these factors. A firm whose customers have little brand loyalty will suffer greatly from substitute products. However an industry in which products are switched between with a high cost to the customer will diminish the threat of substitute products. Finally, if a substitute product provides equal quality and function at a lower cost than products already in the market than existing firms will lose a large market share.
The fourth competitive force that Michael Porter discussed in his book was the bargaining power of suppliers. A powerful supplier can have a powerful control over the industry. Certain aspects must fall into place if a supplier is to have a powerful control over the industry. A supplier’s bargaining power will be high in cases where there are a few major suppliers instead of many smaller suppliers. If a supplier provides a material that cannot be substituted than once again the suppliers will have the upper hand. As with the other forces described earlier, a high cost of switching suppliers increases the bargaining power of suppliers.
The final competitive force is the bargaining power of buyers. The factors that control the power of the buyer are nearly identical to those that control the power of suppliers. A small amount of buyers forces competitors to offer the highest quality products at competitive prices. Buyers will have little bargaining power when there are high costs associated with switching products.
The threat of new competition, rivalry amongst competitors, the threat of substitute products, the bargaining power of suppliers, and the bargaining power of buyers are all a part of Porter’s competitive force model. The five competitive forces Porter presented drive competition in all industries. The impact of each of the five forces is controlled by several factors. In many ways the factors that control the affects each force has are related. For example, switching costs influence every one of the five competitive forces. These competitive forces affect markets and industries all over the world, and firms must be able to control these forces in order to remain competitive in the market.
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