Question

Describe the five competitive forces model.

Short answer

The Five Competitive Forces Model by Michael Porter includes: 1) Competitive Rivalry - the competition amongst existing businesses. 2) Bargaining power of suppliers - the ability of suppliers to set high prices. 3) Bargaining power of customers - the ability of customers to negotiate for lower prices. 4) Threat of new entrants - depends on the entry barriers. 5) Threat of substitute products or services - depends upon the possibility of replacement of a product or service.

Step-by-step solution

Competitive Rivalry

This relates to the number and capability of competitors in the market. Many competitors that offer similar services or products leads to decreased power for a company. It impacts prices, which can be driven down if competitors are offering similar goods or services.

Bargaining power of suppliers

This refers to how easily suppliers can drive up the cost of inputs. If there are few alternatives, or if they offer something unique, their bargaining power is strengthened. This can be related to the number of supplier firms, differentiation of their inputs, their size and strength, and cost of switching from one supplier to another.

Bargaining power of customers

This refers to how easily customers can drive prices down. If there are fewer customers, or each one purchases large volumes, they will have more bargaining power. The buyer's power is higher when there are fewer buyers, where the supplying industry has a large number of substitute products, or when buyers can switch easily to these substitutes.

Threat of new entrants

The threat of new entries depends on the barriers to entry. These barriers could be intangible, like brand equity, or tangible, like the need for large investments in marketing or equipment. If entry barriers are low, the threat to existing market players is higher.

Threat of substitute products or services

If a product or service can be replaced by another product or service, then it is a threat. For example, if the cost of switching to the substitutes is low, or if the substitutes are priced lower or offer better performance, then it is a real threat to the existing market players. Factors influencing this can be, for instance, relative price, quality and performance, and consumer switching costs.

Key concepts

Competitive Rivalry

One of the most dynamic forces in the five competitive forces model is competitive rivalry. It represents the intensity of competition that exists between companies within the same industry. High levels of rivalry typically lead to aggressive pricing strategies, marketing battles, and new product launches as businesses vie for market supremacy.

For students, it's important to understand that not all industries experience the same level of rivalry. An industry with many competitors offering similar products or services tends to have higher competitive pressure. Students should consider factors such as market growth, product differentiation, and the cost of leaving the market when analyzing competitive rivalry. Furthermore, strategic stakeholder alliances and business networks play a crucial role in shaping the competitive landscape.

Bargaining Power of Suppliers

The bargaining power of suppliers can alter the competitive environment of an industry by dictating terms and prices for the materials businesses need. When supplier power is high, they can demand more favorable terms, directly impacting a company's costs and profitability.

This power is influenced by several factors including the concentration of suppliers, the uniqueness of their product or service, their control over inputs, and the cost companies would incur if they switched suppliers. Scarcity of essential resources increases supplier power, as does the lack of substitute inputs. Businesses must strategize to mitigate this power, possibly through building strong relationships with multiple suppliers or integrating supply chains.

Bargaining Power of Customers

Similarly critical is the bargaining power of customers, which indicates how much pressure consumers can place on a business. This power plays out in the ability of customers to force prices down, demand higher quality or more services, and essentially play competitors off one another.

Customers wield more power when they have many alternatives or when they purchase in large quantities. The concentration of buyers, the availability of substitutes, and the relative importance of an individual buyer to a company are all key considerations. For instance, in markets dominated by a few large players, or where customized products are the norm, customer power can be particularly potent.

Threat of New Entrants

The threat of new entrants concerns the potential for new companies to disrupt the market by offering new products or services. Barriers to entry, such as patents, economies of scale, capital requirements, or government regulations, play a substantial role in determining the level of threat posed by new entrants.

When barriers are low, established businesses may face challenges such as decreased market share and increased pricing competition. This element requires businesses to continuously innovate and improve efficiency to maintain a competitive edge. It's a critical concept for students to grasp because it underscores the dynamic nature of industries and the continuous need for companies to evolve.

Threat of Substitute Products or Services

Last but not least, the threat of substitute products or services encapsulates the risk that an industry's products or services can be replaced with alternatives. This threat can swiftly redefine competitive dynamics, particularly when substitutes are cheaper or superior.

Substitutes limit the potential returns of an industry by placing a ceiling on the prices companies can charge. The relative price-to-performance ratios of substitutes, consumer propensity to switch, and the cost of switching to substitutes are heavily influential in this dynamic. Students should pay attention to trends and technological advancements that may produce substitutes which can rapidly alter the competitive landscape.