Michael Porter's Five Forces
Written by Richard San Juan for Gaebler Ventures
According to Wikipedia, Porter's 5 forces analysis is a framework for the industry analysis and business strategy development developed by Michael Porter of Harvard Business School in 1979 . It is helpful in particular to small businesses and startups, because it determines how competitive the market already is and how it would respond to a new brand or product entering it.
Porter's Five Forces deals with the factors involved in creating rivalry between competing products and how they try to gain advantage on each other.
The significance of understanding the dynamics of competition between companies within an industry cannot be underestimated for several reasons.
For one thing, this concept can help identify possible opportunities for your business, especially if you are hoping to enter into the industry as a new brand or product. Knowing the opportunities and how they may relate to your future competitors will give you an advantage of differentiating your product or service from similar offerings.
Furthermore, emphasizing these differences as you begin to enter the industry will right away bring attention and media exposure to your product or service. It can also help determine if the industry is attractive or unattractive to new companies. The 5 forces that affect competitor relationships according to Porter are the following: suppliers, buyer, entry/exit barriers, substitutes, and rivalry. This article will provide a brief overview of each of the forces.
First, the power of suppliers is a key part of Porter's model for this reason: every industry that produces goods requires raw materials. This obviously leads to buyer-supplier relationships that can sometimes be complex between the industry and the firms that provide the raw materials. It can then be inferred that suppliers can exert a great deal of influence on the industry that produces the goods, depending on who has the leverage on power.
Thus, it is within reason that suppliers could ultimately dictate price and influence availability.
Customer demand has always been a strong force and is the main concept when describing the power of buyers. When buyer power is very strong, the relationship to the producing industry becomes skewed closer to a market where many suppliers exist but only one buyer. With this type of market, the ability of the buyer to affect product price becomes much more enhanced. While this type of market condition is relatively rare in its purest form, the relationship between industry and buyer segment should always be observed.
Whenever new firms or companies enter an existing industry, it impacts competition. An important part to see is how easy it is for a new company to enter an industry.
Obviously, the most attractive segment has high entry barriers and low exit barriers. In each industry, companies and firms that are already situated there, seek to protect areas where they are most profitable and attempt to prevent any additional competitors from entering the market. It is not uncommon for rivals within the industry to work together temporarily to keep any new rivals out. Barriers to exit the industry are similar to barriers to entry.
Exit barriers limit the ability of a company to leave the market even if they desire to. This definitely can make competition more bitter and aggravate the rivalry further because one company is being forced to stay in the industry and compete. One may ask, why would one company choose to keep the main rival in the industry? The reasoning behind this can be summarized as follows: potential for more profits exists when both entry and exit barriers are high.
This type of market condition keeps out companies who perform poorly. If one of the main rivals left the industry, it would open the door for the weaker companies to come in. This would both increase the supply and lessen the quality of similar products. Thus, profits would decrease
Moreover, Porter's model mentions substitute products as those that are readily available in other industries that satisfy a similar need for customers. As more substitutes become available and affordable, the competition is less intense since customers have more alternatives. Substitute products may limit the ability of firms within an industry to raise prices and improve margins.
Companies, especially startups and small businesses, always look to secure a unique and competitive advantage over their rivals. There is more at stake for entrepreneurs and small businesses because they do not have the same financial capital of their bigger rivals. Thus, all factors of competition as discussed in Porter's model have to be considered and are magnified even more.
Richard San Juan is currently pursuing an MBA degree with an emphasis in Finance from DePaul University in Chicago. He is particularly interested in writing about business news and strategies.
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