Competitive forces are the factors that affect a company's competitive position in the market. In 1980s Michael E. Porter introduced a model in his book Competitive Strategy: Techniques for Analyzing Industries. It is called Five Competitive Forces Model and covers the task environment. The five forces influence the competition are Threat of New Entrants, Bargaining power of Buyers, Bargaining power of Suppliers, Threat of Substitute products, and Rivalry among existing competitors. The model determines intensity of competition. In strategy formulation process, this plays an important role (Porter, 1998).
PORTER'S FIVE COMPETITIVE FORCES MODEL
Figure 1.1: Forces driving industry competition (Porter, 1985, p.5)
Threat of New Entrants
New entrants to an industry is a threat because a new entrant brings new capacity, and desires to gain market share and significant resources (Manuel, 2007). If a particular environment is filled with entry or exit barriers, the threat of new entrant is minimal (Wheelen and Hunger, 2000). Porter identified six major sources of entry barriers; Economies of scale, Product differentiation, Capital requirements, Cost disadvantages independent of size, Access to distribution channels, and government policy (Porter, 1979).
Bargaining Power of Buyers
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Buyers make a competitive environment through their ability to bargain for prices, demand for quality products etc. If a buyer is purchasing the product in high volumes, it is a threat to the company because the buyer is more powerful with high bargaining powers (Porter, 1979). When product is standard or undifferentiated, there is a possibility of having more suppliers with alternative products. If product is less important to the end quality of the buyer's product or service then there is a threat. Moreover, if the buyer is capable of doing backward integration of the product aging the company has a threat (McNurlin et al., 2008; Wheelen and Hunger, 2000).
Bargaining power of supplier
Suppliers have the power to raise price or reduce the quality of the products and make an adverse impact to an industry. There are some factors which increases the bargaining power of suppliers. When an industry is dominated by few suppliers, supplying a unique or branded product, products have a considerable switching cost, a company is purchasing small amount of products, and supplier is having the capability of forward integration, then there is a high bargaining power of suppliers (McNurlin et al., 2008; Porter, 1979; Wheelen and Hunger, 2000).
Threat of substitutes
Substitute products are somewhat different from the product being considered but, it satisfied the needs the considering product does. When a product has close substitutes, customers are sensitive to price changes (Wheelen and Hunger, 2003). These substitutes can be found in three different ways; Product-for-product, Generic substitution, and Doing without. Most of the companies face a problem when identifying possible substitutes for their products because, some substitutes are having different appearance but satisfy the same needs of the consumer (Wheelen and Hunger, 2000).
Rivalry among existing firms
Most of the time, companies in the same industry are mutually dependent. If one company is having a competitive move, the rivals also take actions to move to an upper level than its competitors. So the competition rises (Porter, 1998; Siaw and Yu, 2004). The impact of the rivalry is based on; Number of competitors, Rate of industry growth, Product or service characteristics, Amount of fixed cost, Capacity, Height of the exit barriers, and Diversity of competitors (McNurlin et al., 2008; Papers4You, 2009; Wheelen and Hunger, 2000).
IMPORTANCE AND IMPACT OF PORTER'S FIVE FORCES MODEL
For the survival of a company, a proper environment analysis and impact of those entities are essential. This model evaluates company's competitive strengths and its position by clearly examining the environment (Frenzel, 1999; Wheelen and Hunger, 2003). When considering an organization, the level of the competition is depending on these five forces and their impact is varied from industry to industry (Porter, 1979).
Basically, this model benefited to a company to identify the intensity of the competition in various external parties. When a company is going to a new industry, this model can be used to assess the structural attractiveness, opportunities, risk, business value of the industry, and strengths and weaknesses of the company. This delivers clear actions other than the subjective judgement. Therefore a company which maps those actions with the company's goals, objectives and its requirements, then company can survive steadily in a high competitive environment (Wheelen and Hunger, 2000).
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Moreover, this model analyses most of the possible ways a competition could come and help company at the stage of strategy formulation. The management can make decisions of where the company operate and in which manner. So it is necessary to identify the strengths and direction of those forces (Byars, 1991).
This model has some limitations also. In 1980s the market structure was static. So this model basically based on 80's economic situation. Today new business models and dynamically changing environment in the industry can be seen. Therefore formulating strategies based only on the Porter's Five Forces model is not acceptable (Haberberg and Rieple, 2001). However, having limitations, the model is still valid and can use as a tool of a large framework used in strategy formulation.
Lately, another force was added to the model. It is; Relative Power of Stakeholders. This includes Government, local communities, creditors, trade associations, special interested groups, unions, and shareholders (Wheelen and Hunger, 2000).
Further, company's can use SWOT, PEST, Value Chain Analysis, Downes model etc to find the methods to have competitive advantage (McNurlin et al., 2008; Wheelen and Hunger, 2000).
After considering the influence of IT in today's economy, Downes' Three Emerging Forces was introduced. This has three new forces which can also be used to gain competitive advatage; Digitalization - new business models, Globalization - development of telecommunication, transport etc., and Deregulations - diminishing the Government influence in many industries (McNurlin et al., 2008).
SWOT, which addresses both internal and external environments can also be used to find the ways to be competitive by mapping company's Strengths, Weaknesses to outside Threats and Opportunities (Wheelen and Hunger, 2000).
The PEST analysis which determine the impact of Political, Economical, Socio-cultural and Technological factors and analysis the opportunities a company can have to gain a competitive advantage are considered (Wheelen and Hunger, 2000; QuickMBA, 2010).
The Value Chain Analysis model introduced by Porter, considers the activities which create a competitive advantage for the company. A company can have Primary activities which have direct impact to the creating and delivering of a product, and Support activities. This identifies capabilities of a company to have cost or differentiation benefits.
Critical Success Factor Method can also be used to gain competitive advantage by identifying the areas of a company where things must go right to gain competitive advantage. Likewise there are lot more models a company can use to gain competitive advantage among competitors (Wheelen and Hunger, 2000; McNurlin et al., 2008).
Porter's Five Forces Model visualizes a company's competitive position in the industry. A close study and an analysis of these five forces will help a company to formulate successful strategies and be strong to face competitions coming from the external environment. However, the structure of the industry may also affect the competition other than these five forces.