Porter 5 Forces

Abstract

The model of the Five Competitive Forces was developed by Michael E. Porter in his book Competitive Strategy: "Techniques for Analyzing Industries and Competitors" in 1980. Since that time it has become an important tool for analyzing an organizations industry structure in strategic processes.

Porter's model is based on the theory that a corporate strategy should meet the opportunities and threats in the organizations external environment. All five competitive forces equally determine the intensity of industry competition and profitability, and the strongest force or forces is governing and become crucial from the point of view of strategy formulation (Porter, 1980, pg. 6). He believes that the foundation of competitive strategy is the understanding of an industry's structure and the way it changes. Porter's competitive forces help you to profile every industry. These forces help determine the impact of the competition and the productivity and charisma of an industry. These strategies should be applied to improve the competition level of the business.

THE FIVE FORCES

POTENTIAL COMPETITORS

Every industry has to deal with the consistency of potential competitors entering into their market. Potential competitors are companies that are not currently competing in an industry but have the capability to do so if they choose (Hill & Jones, 2008, pg. 46). Established companies do their best to keep the level of market entry low. If the entry level is high, established companies are at a higher risk to lose market share and if the entry level is low those companies can raise prices and maintain their market value. Most competitors do not enter into new markets because of the entry barriers that market contains. Entry barriers are the risks companies evaluate before entering into a market. Entry barriers are:

1) Economies of scale

a) Cost reductions gained through mass producing a standardized output

b) Discounts on bulk purchases of raw material inputs and component parts

c) The advantages gained by spreading fixed production costs over a large production volume

d) The cost savings associated with spreading marketing and advertising costs over a large volume of output

2) Brand Loyalty

3) Absolute cost advantages

a) Superior production operations and processes due to accumulated experience, patents, or secret processes

b) Control of particular inputs required for production, such as labor, materials, equipment, or management skills, that are limited in their supply

c) Access to cheaper funds because existing companies represent lower risks than new entrants

4) Customer switching costs

5) Government regulation

(Hill & Jones, 2008, pg. 46- 49)

Porter's strategy to potential competitors helps us to better understand how to evaluate the entrance into a new market.

INDUSTRY RIVALRY

Every industry has rivalries because of the competitive force each company applies. Rivalry refers to the competitive struggle between companies in an industry to gain market share from each other by using price, product design, advertising and promotion spending, direct selling efforts, and after sales service and support (Hill & Jones, 2008 pg. 49). These rivalries usually lead to intensity in the market among different companies. The intensity of rivalry is influenced by the following industry characteristics:

1) A larger number of firms

2) Slow market growth

3) High fixed costs

4) High storage costs or highly perishable products

5) Low switching costs

6) Low levels of product differentiation

7) Strategic stakes are high

8) High exit barriers

i) Investments in assets such as specific machines, equipment, and operating facilities that are of little or no value in alternative uses or cannot be sold off. If the company wishes to leave the industry, it has to write off the book