Porter’s Five Forces framework is a tool used to analyse the competitive dynamics within an industry. It helps businesses understand the opportunities and risks in the industry.
Porter’s five competitive forces:
- Bargaining power of customers
- Bargaining power of suppliers
- Threat of new entrants
- Rivalry among existing firms
- Threats of substitutes
Bargaining power of customers
The bargaining power of customers refers to the ability of customers to influence the prices, quality, and terms of purchases.
- High bargaining power Customer can demand lower prices, higher quality, or better services. Businesses reduce profitability and have to lower prices or improve quality.
- Low bargaining power Customers have fewer options. businesses have more control over pricing and terms, leading to better profitability.
Factors that increase customer power
- Few buyers, many sellers
- If there are only a few buyers but many sellers, buyers have more power because they have multiple alternatives.
- Undifferentiated products
- If products or services are similar across suppliers, buyers can easily switch between suppliers.
- Price sensitivity
- When customers are sensitive to price changes, they are more likely to negotiate for better terms.
- Low switching cost
- It is easy and inexpensive for customers to switch between suppliers.
Bargaining power of suppliers
The bargaining power of suppliers refers to the influence that suppliers can exert on businesses by controlling prices, quality, and availability of the products they provide.
- High bargaining power Suppliers can demand higher prices, impose stricter terms, or reduce the quality or availability of their products.
- Low bargaining power Businesses have more control over pricing, quality, and terms. This allows companies to negotiate more favourable conditions.
Factors that increase supplier power
- Few suppliers
- If there are very few suppliers in the market, they can dominate the market and dictate terms.
- Unique or differentiate product
- When suppliers offer a product that is specialised, proprietary or not easily substituted, they have more leverage.
- High switching costs
- When it is expensive or difficult for a business to change suppliers
Threat of new entrants
This refers to the risks that new companies would entre the industry and increase competition.
- High threat of entrants
- Increased competition, the existing businesses might reduce profitability, and require innovation among existing firms to maintain market share.
- Low threat of entrants
- Low incumbent companies to enjoy more stable competition, higher profitability, and fewer pressures to constantly innovate
Factors that increase new entrants threat
- Low capital requirements
- Low costs of setting up a business (e.g. factories, technology, R&D).
- Low economies of scale
- Established firms do not benefit cost advantage from lower per-unit costs from mass production, which makes new entrants easier to compete on cost.
- Weak brand loyalty
- Customers are not particularly loyal to existing brands, they are more likely to switch to a new company’s product or service.
- Weak customer switching cost
- Customers face little to no cost or difficulty in switching to purchase product or service from a new company.
- Lack of proprietary technology
- There is little proprietary technology or intellectual property in an industry, new entrants can more easily copy or replicate existing products.
- Easy access to distribution channels
- New entrants can easily access distribution channels to get their products or services to customers, they are more likely to entre the market.
- Low product differentiation
- The product or services offered in an industry are highly standardised or undifferentiated, new entrants can compete on price or minor features.
- Availability of skilled labour
- Skilled workers are readily available, new entrants can hire talent without much difficulty. They enjoy reduced barrier related to human resources.
- Low cost of technology or infrastructure
- The cost of the technology or infrastructure required to entre an industry is low.
- e.g. cloud computing platforms like AWS have lowered infrastructure costs for tech startups
Rivalry among existing firms (Competition)
This refers to the intensity of competition between existing firms in an industry.
- High rivalry
- Results in intense competition, lower profitability, price wars, and frequent product innovation.
- Low rivalry
- Leads to stable markets, higher profitability, brand loyalty, and less aggressive competition.
Factors that increase rivalry force
- Many competitors
- Numerous companies are competing for the same customers, increasing the intensity of competition.
- Undifferentiated products
- Products or services are very similar across firms, competition is based on price rather than unique features, leading to price wars.
- Low customer loyalty
- Customers can easily switch between brands or products, rivalry increases as firms compete for the same pool of buyers.
Threat of substitutes
A substitute provides same or similar utility for customer, but with different a form or technology.
Note
A competitor’s product or service is NOT a substitute.
Use the statement to determine whether a product is a substitute of another. “This is a <Product>, which is a type of <Product Type>” Same <Product Type> but different <Product> is a substitute.
For example, “This is a car, which is a type of transport vehicle.” Bicycle is a transport vehicle, it is a substitute of a car.
- High threat of substitute
- There are many alternative products or services that customers can easily switch to. This usually put significant pressure on a company to maintain competitive pricing, innovate, or improve quality to retain customers.
- Low threat of substitute
- There are few or no viable alternatives for customers, meaning they are more likely to stay loyal to the current brands or companies.
Factors that increase substitute threats
- Many alternatives
- There are many products or services that fulfil the same need or function.
- e.g. In the beverage industry, soft drinks face a high threat of substitute from healthier drinks like juice.
- Cheaper alternatives
- The substitutes’ products or services are cheaper than the industry’s products and services.
- Higher quality and differentiate products
- The substitutes have higher quality or functionality. The performance of the substitutes are equal or superior to the industry’s products or services.
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