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How to perform Porter’s Five Forces Analysis and what to do with the resulting insights? – Additional resources
Porter’s five forces framework is an important analytical tool that you can use to assess the competitive dynamics of an industry to understand whether the industry is competitively attractive or unattractive. With this information, you will be able to craft a strategy that best fits your company’s situation within the industry environment. The five forces include:
1. Rivalry among competing sellers
2. The threat of potential new entrants
3. The threat of substitute products
4. Supplier bargaining power
5. Buyer/customer bargaining power
1. Rivalry among competing sellers
It is the most important of the five forces. The rivalry among competing sellers within an industry is likely to be strong if:
The products are lowly differentiated such as commodity products like orange, crude oil, wheat, rice, coffee beans, or iron ore). Other factors could include
The presence of a large number of competitors with similar competitive strengths
The firms within the industry have high fixed costs and excess production capacity
It is easier for customers to switch brands (for example, Over the counter drugs, bread, casual clothing, etc.), and
The demand for the product is increasing quite slowly or even demand is declining (Thompson et al. 2022). An example could be the demand for gym membership in the post COVID period.
The analysis of this force needs to involve taking all these factors into consideration and determine whether the Rivalry among competing sellers is strong, moderate or weak. Strong rivalry indicates low profit potential for firms within the industry, whereas weak rivalry indicates the absence of any downward pressure on industry profitability. When the rivalry among competing sellers is high, strategic actions could include using effective competitive weapons in relation to Price, Cost and Value such as:
Launching new sales and marketing campaigns
Product innovation, and
Strengthening distribution channels.
2. The threat of new entrants
The threat of potential new entrants mainly depends on two factors – whether entry barriers for newcomers to enter your industry are high or low, and how the existing firms are likely to react to the entry of newcomers. Some industries are difficult to enter due to factors such as:
Existing firms enjoy economies of scale or cost advantages arising from large scale production, distribution, and marketing
They have a large pool of brand loyal customers and a strong network of distributors, patents, and intellectual property protection
Existing firms have the ability to benefit from restrictive regulatory or trade policies (Thompson et al. 2022).
Still newcomers enter the market with a variety of competitive weapons such as:
Large-scale investment
Aggressive promotion
Innovative products and/or marketing techniques
(Thompson et al. 2022)
Let’s take the example of ALDI, the German-based global supermarket chain. ALDI opened its first outlet in January 2001, by 2022, ALDI was operating around 570 outlets in Australia and claiming about 11% of the Australian supermarket industry. ALDI’s gain in market share has come at the expense of other supermarkets including Coles, Woolworths, and IGA. Clearly, ALDI’s entry has increased competition in the Australian supermarket industry. Interestingly, Coles and Woolworths have responded to ALDI through price cuts and by increasing their share of private brands.
The analysis of this force involves coming to a conclusion whether the threat of potential new entrants is low, moderate or high. When the threat of potential new entrants is high, new strategic actions could include:
Increased investment in R&D
Product innovation
Strengthening distribution channels, and
Concentrated sales and marketing campaigns.
3. The threat of substitute products
A substitute product or service is one that comes from another industry that offers similar benefits to the consumer. Therefore, the threat of substitute products doesn’t come from other brands within your industry, rather from companies outside the industry. Companies are worried that if the pressure from substitute products is high, customers may purchase substitute products and make their products or services redundant and decrease their profit potential. There are numerous recent examples of such scenario. Video rentals have been replaced by streaming services, brick and mortar universities face competition from online education providers, domestic air travel market face competition from high-speed train services, hotels face competition from temporary rentals of apartments as offered by Airbnb. I think the most interesting example is how smartphone manufacturers have placed competitive pressure on the makers of cameras, watches, and alarm clocks, voice recorders, radios, mp3 players, game consoles, torches, calculators, GPS system, it should be a long list.
Competitive pressures from substitute products are strong when:
Good substitutes are easily available at attractive prices
Customers see the substitutes as similar or superior in regard to relevant attributes quality and performance.
Customers experience low switching costs to the substitute products or services
(Thompson et al. 2022)
The analysis of this force involves coming to a conclusion whether the threat of substitute products is low, moderate or high. When the threat of substitute products is high, new strategic actions could include:
Focusing on differentiation that involves improving product offerings through innovation (such as adding innovative features to products)
Enhancing customer value proposition, and
Improving brand loyalty to discourage customers to switch to the substitute products.
4. The Supplier bargaining power
Suppliers with high bargaining power can influence the terms and conditions of supply in their advantage. They can put pressures on companies by charging higher prices, lowering the quality of products or reducing their availability. Suppliers include manufacturers, distributors, wholesalers, independent suppliers and exporters. The supplier bargaining power is high when buyers are constrained by suppliers, in other words, if they rely heavily on suppliers. It may decrease profitabilty and create a less attractive industry. In contrast, the supplier bargaining power is low when firms are not constrained by suppliers, I mean if they don’t rely heavily on suppliers. In this situation, profit potential is high, which creates a less attractive industry.
Competitive pressures from suppliers are strong when:
Suppliers’ products have high demand due to limited supply
A small number of large companies dominate the supplier industry
Suppliers provide differentiated inputs that are critical for high quality products
Suppliers’ products are non-substitutable
Backward integration to self-manufacture inputs is difficult or costly for industry members
It is costly or difficult for firms to switch from one supplier to another
Buyers are less sensitive to price increases as suppliers provide only a small fraction of the inputs for the industry’s products
Industry members are not major customers of suppliers
(Thompson et al. 2022)
The analysis of this force involves coming to a conclusion whether the supplier bargaining power is low, moderate or high. When the supplier bargaining power is high, new strategic actions could include:
Negotiating with suppliers to establish long-term exclusive agreements to get quality inputs
Incentivizing competition between suppliers by sourcing from multiple suppliers, and
In-house production of inputs, and backward integration through partnerships, strategic alliances, mergers and acquisitions.
5. Buyer/customer bargaining power
When buyers have high bargaining power and they are highly price-sensitive, they are able to exercise strong competitive pressures on firms within the industry. Customers with strong bargaining power may reduce industry profitability by claiming discounts, favourable payment terms, or extra features and service. Buyers’ sensitivity to price also reduce industry profitability as industry members are unable to raise revenue by increasing prices as that will lead to lower revenue. However, different customers have different levels of price sensitivity. Large business buyers have more bargaining power than individual customers. For example, Australian large supermarket chains Coles and Woolworths have considerable bargaining powers as they purchase produces and finished products in bulk quantities. The same is the case with numerous large businesses including Kmart, Bunnings, and Target.
Competitive pressures from buyers are strong when:
Declining demand for the product that has resulted to excess supply
Sellers offer standardized or undifferentiated goods
It is easier for industry members to switch from one seller to another
Few large buyers dominate the industry
Buyers present a credible threat of integrating backward to self-manufacture inputs
Buyers have easy access to all information about the products offered by sellers (e.g., product attributes, quality, and costs), which can be used to improve their bargaining position
Buyers have the option to delay the purchase or cancel the order
Buyers are highly price sensitive (because of low profitability, quality matters little, and requires buying products in bulk)
(Thompson et al. 2022)
The analysis of this force involves coming to a conclusion whether the buyer bargaining power is low, moderate or high. When the buyer bargaining power is high, new strategic actions could include:
Implement loyalty programs
Focusing on differentiation that involves improving product offerings through innovation (such as adding innovative features to products)
Negotiating with buyers to establish long-term exclusive agreements to continue selling
Forward integration through partnerships, strategic alliances, mergers and acquisitions.
The final question:
Once you have analysed each of the Porter’s Five Forces, you need to address the following important question: Is the combined strength of all five competitive forces conducive to good profitability?
If all five forces are high in competitive intensity, then the industry will be competitively unattractive; the profit potential will be very low.
A competitively attractive industry is one where the strength of competition is low, particularly from suppliers and buyers and the rivalry among competing sellers is moderate.
(Thompson et al. 2022)
Kind regards,