Porter Five Forces Analysis Economics Essay

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In 1979 the renowned business strategist Michael E. Porter identified five competitive forces that influence planning strategies in a model called porter's five forces. It is a management tool that allows an external analysis of an enterprise, through the analysis of the industry or sector to which it belongs.

The competitive forces that this tool considers are:

Barriers to entry

Threat of substitutes

Buyers power

Supplier power

Degree of rivalry

Sorting these forces thus allows a better analysis of the business environment or industry to which it belongs and, thereby, based on this analysis, to design strategies to exploit the opportunities and address the threats.

Barriers to entry

This point refers to the potential entry of companies that sell the same type of product. If the companies enter to the industry easy, the competition will be more cutthroat.

When trying to enter a new business to an industry, it could have entry barriers such as lack of experience, customer loyalty, scarcity of resources, market saturation, lack of distribution channels, government restrictions or legislation…

The analysis of the threat of entry of new competitors it is interesting because it allows us to establish entry barriers that prevent the entry of these competitors.

Supplier power

It refers to the ability to negotiate with suppliers that have, for example, while there are fewer suppliers, the greater its bargaining power, and that absent such input supply, they can easily increase their prices.

Some of the most typical reasons that suppliers might have power are:

Many suppliers of a particular product

There aren't substitutes

The product is very important to buyers

Switching to another (competitive) product is very costly

The analysis of the bargaining power of suppliers, we can design strategies to achieve better agreements with suppliers or, in any case, strategies that allow us to acquire or have more control over them.

Buyer power

It refers to the ability to negotiate with consumers who have or buyers, for example, while there are fewer buyers, the greater its bargaining power, and that absent such a demand for products, they can claim for lower prices.

Besides that there are many buyers, the bargaining power of buyers also might depend on:

Volume of purchase

The product is not very important to buyers

Customers are price sensitive

Switching to another (competitive) product is simple

The analysis of the bargaining power of consumers and buyers, we can design strategies to attract more customers or obtain greater fidelity or loyalty of these, for example, strategies such as increasing advertising or offering more services or warranties.

Availability of substitutes

It refers to the potential entry of firms that sell products substitutes or alternatives to the industry.

The principal problem could be the similarity of substitutes. For example, if one customer likes coffee but the price of coffee rises substantially, that customer may change the cup of coffee for a tea.

In analyzing the threat of substitute products income allows us to design strategies to prevent penetration of companies selling their products or, in any case, strategies that allow us to compete with them.

Degree of rivalry

This point refers to companies that directly compete in the same industry, offering the same type of product.

The degree of rivalry among competitors will increase as raising the amount of these, go matching in size and capacity, lower product demand, prices fall …

The analysis of the rivalry between competitors allows us to compare our strategies and competitive advantages of other rival companies thus know, for example, whether to improve or redesign our strategies.

Case study

Barriers to entry

The threat of new entities entering the oil industry is insignificant due the high barriers to entry that exist. Oil industries need a huge capital associated with the activities, but it depends on the area of the market. In addition, it is required an enormous capital for the development of oil fields. For these reasons the threat of new entries are insignificant, these costs cannot be supported by everyone. This does not only include costs for exploration of new fields, but also for drilling, oilfield services, scientific research, materials and energy, all of which create substantial barriers for potential entrants. Other areas of the oil business require highly specialized workers to operate the equipment. Another barrier prevalent here are economies of scale. Due to the increased unit costs in the exploration and production of oil, only big oil companies and refineries that are able to take advantage of economies of scale can survive. This makes things very difficult for new players, since they usually don't have access to a big number of oil reserves. The need to secure access to distribution channels can also create barriers to entry. Usually only major oil companies possess well established channels of distribution. Oil pipelines for some companies, as means of distribution, are costly and require time to build. This creates obstacles for new entrants.

However, some of the greatest impediments for potential entrants come from different government policies that favour national companies in different ways. Oil is state owned resources and governments tend to give access to these raw materials to national companies. Most of the oil-rich countries also allow other companies to engage in the exploitation of oil fields, but in partnership with the national company.

Supplier power

There are a lot of oil companies in the world, but only a small handful of powerful companies dominated the oil business. The large amounts of capital investment tend to eliminate a lot of the suppliers of rigs, refining … There isn't a big competition between them, but they have a bit power over smaller companies.

Big oil companies, like Petrobras , have a complex chain of suppliers, ranging from 'suppliers' of oil (fields), to suppliers of engineering, field development management, pipeline installations, specific equipment and materials, or even scientific researchers and engineers. Oil is a scarce resource and we have to speak about OPEC nations. Open nations were the ones to actually nationalize oil production in their countries and take over most of the business from big oil corporations. As OPEC nations own 2/3 of the world's proven reserves, with oil that is one of the cheapest to produce, they in fact possess significant bargaining power to oil corporations. Therefore OPEC's bargaining power is one of the most bargaining powers when it comes to granting oil-fields-concession rights to international companies.

The conclusion within this point is that the power distribution between oil companies and their suppliers is that it all depends on the type of the supplier. Big oil companies can exert power due to their position, However, the 'suppliers' of oil fields, with OPEC countries as a specific example, which hold most of the easy-to access oil reserves in the world.

Buyer power

The oil industry in different comparing with others because the Price of the product is determine on a global level, based on the economic relationship between global demand and supply of oil.

The oil customers are refiners, major international companies, national oil companies, marketers, distributors, traders and the countries themselves. The last point it is important due the countries can be the only customers that can exert some degree of bargaining power, through different volumes of demand. These countries are the US, the EU, China and Japan, which account for more than half of the world consumption of oil over the world.

Although nowadays countries are experiment with other renewable energies, in the next decades oil will be need and rise especially for transportation and industry.

So the conclusion is that only the largest buyers can exert some bargaining power in this market.

Availability of substitutes

Oil is a dominant and prevailing source of energy, still irreplaceable in many sectors, especially in transportation and industry. The oil exploitation technology is every day more sophisticated, for this reason oil is likely to stay one of the cheapest sources of energy in the following years.

However the policies of the countries are working in renewable energies like as: coal, natural gas, renewables (wind, solar energy, From the substitutes, based on the Energy Information Administration, natural gas... Governments around the world think also that fossil fuel make a big harm to the planet. The projections are that gas is going to gain significant market share in the industrial, residential and commercial sectors. This is a bad notice to oil industries. Renewable energies, like wind-, hydro- power or hydrogen are expected to slowly but surely increase their market share in the future. However, without major proactive governmental policies aimed at reducing the impacts of carbon dioxide emissions in the atmosphere, the process of adopting renewable energies on a large scale is going to be rather slow. So long as these sources of energy have relatively high production costs, they will not be economically competitive to fossil fuels.

The conclusion within this point is that oil energy will predominate the following decades, but the intensive search for alternative energy resources will be a real threat for this product.

Degree of rivalry

The competitive environment in the oil industry can be described as: a few big and strong players and several smaller players with less power. Most of the oil companies are inside the OPEC, so they operate as a single entity, reducing rivalry or competition among these companies.

However, it is true that exist a big rivalry between producers when they need to replace drying fields. This leads to make alliances, acquisitions or mergers.

In the end, other factors are: the high fixed and storage costs and the lack of product differentiation.