The Porter’s Five Forces
A framework for assessing the degree of rivalry within a given industry is Porter’s Five Forces study. When launching a new company or entering a new industrial area, it is extremely helpful. This concept claims that rivals are not the sole sources of competitiveness. Instead, five fundamental forces—the danger of new entrants, suppliers’ negotiating strength, buyers’ bargaining power, the threat of alternative goods or services, and existing industry rivalry—determine the level of competition in a given sector. The potential profitability of an industry and, therefore, its appeal, are determined by the combined strength of these influences. Nearly no business in the sector generates enticing returns on investments when the five factors are strong (for example, in the airline industry). However, there is possibility for larger returns if the pressures are moderate (for example, in the soft drink sector). Below, each force will be further discussed using examples from the aviation industry to show how it is used.
Also Read: Point of Sale Materials (PoSM) Market Growth, Size, Share, Price, Trends, Report, Forecast 2021-2026
Threat of new entrants
An industry gains fresh capacity and the ambition to increase its market share from new competitors. The difficulty of entering a certain business determines how significant the danger is. The danger to incumbent players decreases as these entry barriers rise. The necessity for economies of scale, strong consumer brand loyalty, high financial needs (such as significant expenditures in marketing or R&D), the demand for accumulated experience, government regulations, and restricted access to distribution channels are a few examples of entrance barriers. The table below lists more obstacles.
Example
It is safe to say that the danger posed by new competitors in the aviation sector is low to medium. To launch an airline firm, significant upfront investments are required (e.g. purchasing aircrafts). Additionally, as they are new to the market, it might be difficult to get the licenses, insurance, distribution networks, and other credentials that newcomers need (e.g. access to flight routes). In addition, it is reasonable to assume that current players have amassed a sizable amount of expertise over the years to reduce expenses and improve service standards. A newcomer will probably lack this sort of knowledge, which will put them at a competitive disadvantage from the outset. However, new avenues are opening for prospective entrants as a result of the liberalization of market access, the availability of leasing alternatives, and external financing from banks, investors, and aircraft manufacturers. Even while it doesn’t seem like it would be very appealing for businesses, it is NOT impossible. By implementing creative cost-cutting business methods, several low-cost airlines, like Southwest Airlines, RyanAir, and EasyJet, have successfully joined the market throughout the years, upsetting established competitors like American Airlines, Delta Air Lines, and KLM.
Bargaining power of suppliers
This force examines the degree to which a company’s supplier, often referred to as the market of inputs, has the capacity to increase prices or diminish the quality of products or services acquired, both of which would lessen the likelihood that an industry would be profitable. Supplier power is mostly influenced by the concentration of suppliers and the accessibility of replacement providers. They have greater influence the fewer there are. When there are several suppliers, businesses are in a better position. Additionally, switching costs for businesses operating in the sector, the availability of alternatives, the effectiveness of their distribution networks, and the distinctiveness or degree of difference of the product or service the supplier is providing are all sources of supplier power.
Example
The airline industry’s suppliers have a very strong level of negotiating leverage. The two main inputs that airline firms need are fuel and aircrafts, which are very important to them. However, the external environment—which the airline firms themselves have limited influence over—has a significant impact on these inputs. The global oil market is vulnerable to huge swings in price due to geopolitical and other variables, and this affects the price of aviation fuel. For instance, there are only two main providers of aircraft: Boeing and Airbus. Therefore, Boeing and Airbus have a lot of negotiating leverage over the rates they charge.
Bargaining power of buyers
The market of outputs is another term for the purchasing power of consumers. This force examines the degree to which consumers may exert pressure on the business, which influences the customers’ susceptibility to price fluctuations. When there are few consumers and there are numerous places for them to purchase from, the customers are quite powerful. Additionally, it should be simple for them to change companies. Customers’ purchasing power is reduced, however, when they make sporadic, independent purchases and when a seller’s product differs significantly from that of its rivals. Customers are now more knowledgeable and hence more powerful thanks to the internet. Customers may quickly and simply compare prices online, learn more about a broad range of items, and instantaneously access deals from other businesses. Companies might establish loyalty programmes or differentiate their goods and services as examples of tactics to lessen buyer power.
Example
In the airline sector, customers have significant negotiating power. Through the many internet price comparison services like Skyscanner and Expedia, customers can quickly compare costs of various airline companies. Additionally, there are no switching fees associated with the procedure. When the cost is cheaper, customers nowadays are more inclined to travel to and from their destination with other airlines. As a result, brand loyalty doesn’t seem to be very great. With frequent flyer programmes designed to reward consumers who sometimes use their services, several airline firms are attempting to alter this.
Threat of substitute products
Customers are more likely to switch to alternatives when items exist that are beyond the typical product limits. One should go beyond comparable items that are labelled differently by rivals in order to find these alternatives. Instead, any product that fulfils a comparable need for consumers should be considered. Energy drinks like Redbull, for example, are often not seen as Nespresso or Starbucks competitors. However, since both coffee and energy drinks help people remain awake and gain energy, consumers may be prepared to move from one to the other if they believe that the price of coffee or energy drinks has increased too high. This should also be considered when assessing an industry’s appeal since it will eventually effect profitability.
Example
It may be claimed that the general requirement of the airline industry’s clients is travel. It may be obvious that there are several alternatives to flying for travel. Customers had the option of using the train or driving, depending on the distance and urgency. More and more people are using high-speed trains like Bullet Trains and Maglev Trains, particularly in Asia. Furthermore, Elon Musk’s Hyperloop proposal, in which passengers would travel in capsules in a vacuum tube at speeds up to 1200 km/h, might pose a severe threat to the airline sector in the future. The danger of replacements in the airline business might be rated as at least medium to high when all of this is considered.
Rivalry among existing competitors
The market’s present level of competition is examined by this final force of Porter’s Five Forces, which is based on the number of competitors already in existence and their respective capabilities. Competition is fierce when there are many firms with nearly similar size and strength, when business expansion is gradual, and when customers may quickly move to a rival’s product at minimal expense. The industry’s concentration ratio is a reliable predictor of competitive competition. The competition will likely be more heated the lower this ration is. Competitors are more inclined to actively participate in pricing and advertising battles when competition is fierce, which may be detrimental to a company’s bottom line. Intense competition will also result from high obstacles to leave, which will force businesses to stay in the market even if profit margins are decreasing. Examples of these exit obstacles include lengthy loan terms and hefty fixed expenditures.
Example
The entry of low cost carriers, the industry’s strict regulation, which has made safety a top priority and resulted in high fixed costs and high barriers to exit, and the fact that the industry’s growth is currently very stagnant all contribute to the fact that the airline industry in the United States is extremely competitive. Due to the low switching costs for clients and the fact that many industry participants are of a similar size (see graph below), there is an especially intense level of rivalry amongst those businesses. When seen as a whole, the airline industry’s current rivals are very competitive.
The focus industry and its allure may be approximately mapped out by looking at each competing factor separately. Keep in mind that the desirability of different businesses may vary based on the nation you are considering. Government regulations, for instance, are probably going to change from one country to the next, as well as the number of suppliers and customers. Porter’s Five Forces are an excellent place to start when analyzing an industry, but they shouldn’t be employed in isolation. For example, you may combine it with a Value Chain Analysis or the VRIO Framework to better understand where your company’s competitive advantage comes from and to position your business more effectively among competitors. In addition, Porter’s Five Forces and PESTEL analysis are often coupled to provide a thorough picture of the environment in which a firm operates. Finally, it should be noted that a number of writers have voiced some criticism of the framework. To explain the rationale for strategic alliances and joint ventures, some writers have claimed that the model requires a sixth factor dubbed “complementors.” The Value Net Paradigm is another name for this enhanced model. Porter’s Five Forces is still one of the most popular frameworks for developing strategies today, despite the criticism it received, and it is likely to stay that way for some time to come.
Full list of Porter’s Five Forces factors:
Threat of new entrants
- Economies of scale
- Product differentiation
- Brand identity/loyalty
- Access to distribution channels
- Capital requirements
- Access to latest technology
- Access to necessary inputs
- Absolute cost advantages
- Experience and learning effects
- Government policies
- Switching costs
- Expected retaliation from existing players
Bargaining power of suppliers
- Number of suppliers
- Size of suppliers
- Supplier concentration
- Availability of substitutes for the supplier’s products
- Uniqueness of supplier’s products or services (differentiation)
- Switching cost for supplier’s products
- Supplier’s threat of forward integration
- Industry threat of backward integration
- Supplier’s contribution to quality or service of the industry products
- Importance of volume to supplier
- Total industry cost contributed by suppliers
- Importance of the industry to supplier’s profit
Bargaining power of buyers
- Buyer volume (number of customers)
- Size of each buyer’s order
- Buyer concentration
- Buyer’s ability to substitute
- Buyer’s switching costs
- Buyer’s information availability
- Buyer’s threat of backward integration
- Industry threat of forward integration
- Price sensitivity
Threat of substitute products or services
- Number of substitute products available
- Buyer’s propensity to substitute
- Relative price performance of substitutes
- Perceived level of product differentiation
- Switching costs
- Substitute producer’s profitability & aggressiveness
Rivalry among existing competitors
- Number of competitors
- Diversity of competitors
- Industry concentration and balance
- Industry growth
- Industry life cycle
- Quality differences
- Product differentiation
- Brand identity/loyalty
- Switching costs
- Intermittent overcapacity
- Informational complexity
- Barriers to exit
Frequently Asked Questions (FAQs)
How does Porter’s five forces model help analyze an industry?
Employing Porter’s Five Forces Analysis, a strategy for analyzing industries, may be very advantageous for business strategists. It is based on the understanding that profit margins vary among industries, a fact that may be explained by the organizational structure of a business.
What is competitive rivalry in Porter’s five forces?
A measure of how fiercely modern firms compete with one another is called competitive rivalry. Intense rivalry may reduce profits and force aggressive measures like price reductions, an increase in advertising expenditures, or investments in service/product improvements and innovation.
Is Porter’s five forces still relevant today?
Porter’s Five Forces cannot hardly be considered outdated. Contrarily, the basic idea that every organization functions within a network of customers, suppliers, rivals, and replacements still holds true today.
