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Michael Porters forces are a combination of 5 forces that helps people to analyze and assess their business environment. The forces help various market players to know how competitive their industry is and these forces also determine whether a particular industry is attractive enough to enter or not.
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The forces are given the name of their founder, Professor Michael E Porter; he is the author of the bestselling book called Competitive strategy: Techniques for analyzing industries and competitors, which he wrote in the 1980’s. He introduced a model of five competitive forces which are widely known as the Porter’s five forces framework.
The model was originally developed as a way of assessing the attractiveness (profit potential) of different industries. (Johnson et al, 2009)
Whenever any business decides to get into a particular industry, they are advised to first analyze that industry’s environment, Is it conducive to get into that industry? Is it attractive in the sense that will it be able to generate income or revenue? And does the industry have growth potential? These are some of the questions that that person would ask himself and Michael porter’s model is just the answer to these questions. This model helps in analyzing the industry in general. The model has five basic competitive forces that shape every industry and market. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. (rapidbi.com, 2008)
As Professor Porter (1980) pointed out “The intensity of competition in an industry is neither a matter of coincidence nor bad luck. Rather, competition in an industry is rooted in its underlying economic structure and goes beyond the behavior of current competitors.” Meaning that there are more players to look at rather than the ones that are already there, it simply means exploring the external environment of the business.
Every business has suppliers, buyers, competitors or industries offering same products and services, substitutes of goods similar to the one it’s offering and new people or businesses thinking of getting into this particular industry. Hence with all these players, the industry does become competitive and the firms have to create strategies to keep running their business.
The degree of competition depends on how the five competitive forces operate or behave in a particular industry, in this case in the banking industry.
These competitive forces are:
- The threat of new entrants
- Threats of substitute goods
- Bargaining power of buyers (Customers)
- Bargaining power suppliers and
- The overall rivalry or competitiveness in that industry based on all these forces.
The use of these forces model helps in analyzing the attractiveness and also the competitive positioning of the business in the industry or market in general.
Now let us relate these five forces framework with the banking industry in Tanzania. Before that let us go through a brief history of banking industry in Tanzania.
Banking simply means putting your money in the banks for the aim of saving it and protecting it from various risks. This service and various other services like provision of loans, credit facilities, cheque books, transfer of funds from one country to another, issues relating to importing or exporting, foreign exchange rates and others is provided by banks. Banking is an act of banks to accept deposits from the people for the aim of lending and investment.
A Bank is a financial institution or building receiving money from customers and giving money when they need it. They allow customers to open accounts in which they deposit and withdraw money.
All the banks produce services or in other words are service providers. They offer to keep people’s money and valuable items, they provide loans or credit facilities to those who require them, and also facilitate transfer funds inside and outside the country.
For the last decade the banking sector in Tanzania has been developing and growing very well. There are many foreign banks as well who are opening their doors in the country. According to Dr.Elisante (2005) the number of financial institutions has been mushrooming by an alarming speed. For this very reason the players in the banking industry need to consider their competitive positioning and repositioning strategically.
According to his research conducted in 2005, Tanzania had only one bank, National Bank of Commerce in the 1960’s. Then in 1986 Corporate and Rural Development Bank (CRDB) came into the industry.
Gradually many players came into this respective industry. As per Bank of Tanzania’s official website there are 28 registered commercials banks as at 18th August 2010, 7 registered regional unit banks as at 16th Oct 2010, 5 registered financial institutions as at 18th Aug, 2010 and 176 Bureau de change as at 31st Dec 2009 updated as at 11 Aug 2010.(See Appendix attached at the end).
Commercial banks- Are types of banks that deal with offering banking services on profit. These banks are usually owned by shareholders, formed as Joint Stock Company. Shares are offered to members and people buy them. They charge a certain percentage interest for money kept in the account.
Regional unit banks – Are banks that are authorized to operate as a particular region’s bank. They do receive money for current accounts and also allow withdrawals by cheque. And it is not necessary for these banks to open other branches as they are specific to region. (Dr.Elisante, 2005)
Financial institutions- Are entities engaged in the business of banking, but limited as to size, locations served, or permitted activities, as prescribed by the Bank or required by the terms and conditions of its license. (The banking and financial institution Act, 2006, P 62)
Bureau de change- Are the institutions that are authorized to exchange foreign currency with the local currency and also convert it into foreign currency to the general public of the country.
As we can see that there are many players engaged in the same industry, there is bound to be a good deal of competition. And it is necessary for the banks to review their business environment regularly so as to keep up with the competition and move one step forward.
Now let us relate Michael Porter’s five forces based on the banking industry in Tanzania. We will begin by mentioning each competitive force and going into detail how each has an effect in the banking sector. How high or low that force is.
THREATS OF ENTRY
This is one of the competitive forces. By entry it means to have an access or a link to something. It simply means how easy or difficult it is to enter into the market or a particular industry, in our case the banking sector.
This force simply talks about those players who are not yet in the industry (banking) but who are considering to join. If there are few firms in the market, then they would all carry out their business and also enjoy their share of profitability. If another firm, one or two join, then it is likely that the existing profitability share of the existing firms would be eroded or would come down to a certain percentage because part of that share would be taken by the new entrants.
According to Michael Porter, the threat of new entrants depends on the barriers to entry which are factors that need to be overcome by new entrants if they are to compete successfully. (Johnson et al, 2009)
Barriers to entry are factors that might prevent new firms to enter in the market.
The following are the main barriers to entry relating to the banking sector:
Capital requirements – This means the amount of capital required to open a particular business. In Tanzania according to the Central bank’s rules and regulations, the banks are supposed to have a minimum capital requirement of 15 billion Tanzania shillings. Before it was 1 billion, then it was brought up to 5 billion and now from this year (2010) it is revised as 15 billion. Therefore if any bank deciding to enter Tanzania’s banking sector must fulfill this prerequisite.
Government policies – This means how the Government influences the entry of the new firms in the industry. There are certain rules and procedures to be followed. Also the Central bank, The Bank of Tanzania has specific requirements and need documentation for releasing a banking license to any banks, documents like Memorandum and Articles of Associations, proof of availability of funds, details of directors like integrity, honesty and criminal records. The central bank conducts a due diligence to know if the people involved in this industry are fit and capable enough for the positions assigned to them. (Dr.Elisante, 2005)
Customer loyalty – It means that established firms (banks) have customers that already know their product’s brand and are loyal to that particular firm. As people bank their money and valuable items with their preferred banks, they have their trust and confidence with that bank and hence it is very difficult for a new bank to expect the customers to go to the newly established bank just like that. For example: If I am a prospective customer of Bank A where I get all the necessary banking services and also discounts, I wont be easily influenced by Bank B who has recently entered the market and who is providing the same services as my bank. I am loyal to my bank.
Switching costs – These are the costs that occur when customers switch to other firms. If the switching costs are low, then the customers could easily switch from one bank to another but if the costs are high, then the customers would just remain with their original banks. In Tanzania as there are many banks who offer the same services, some switching costs are low while some are high. For example: if a customer is getting the service of transferring money from point A to B with the cost of let’s say TZS 5000 in one bank and another bank also offers the same service with the same cost, the customer would go on with the first choice of his bank but let’s say that the other bank’s costs are slightly lower like TZS 2000, then that customer would switch his bank and go to the one in which he can get the same service but at low cost.
Economies of scale – it means reduction in producing one unit cost of a product as a result of producing it in bulk. The already established banks would be enjoying this benefit in so many things like in printing the customer’s account balance statements, the printing of cheque book leaflets and also the production of the debit or credit or ATM cards. Hence it will be difficult for a new bank to enter into the market and enjoy this benefit as it will still need to be familiar with the operations. A good example in this factor can be how the already established banks who have the knowledge use it to further expand their reach by opening a number of branches around other areas which were not previously covered. A new firm who is still learning the tactics doesn’t have this advantage and hence it can cause a barrier for it to enter the industry.
Expected retaliation – It simply means the resistance or reactions by the banks that are already in the industry. If the new bank which is about to open expects reprisal from the existing ones, then this can be an obstacle for the new bank.
The above are some of the most common barriers to entry. Most of them are in the favor of the existing banks. Therefore the overall threat of entry is low as the barriers are high for the entrants. The new banks need to fulfill the required procedures and be ready to compete with the existing banks. However if the entry is made by the already well established financial institutions like the microfinance agencies who are familiar with the banking environment, then it is easy for them to enter into the industry and serve the people as a fully fledged bank.
BARGAINING POWER OF BUYERS
Buyers are the people who buy a particular firm’s products and services. Any business is opened for the aim of selling its goods and services to the people or the buyers. Buyers are one of the players in the industry who might have the influence on the way a business runs or operates. Any business in the world exists because there are buyers or customers who make use of that business’s products. By bargaining power of the buyers it simply means the power of the buyers to bring down the price of the products and hence the profitability.
Banks usually have many customers or buyers who use the banking services. The power seems to be divided among these customers. There are individual customers who keep their money or savings in the bank and get the services they require and are charged monthly charges as well as enjoy a small percentage of interest on their money kept. As there are many fully fledged banks in Tanzania, the customers do have a choice of where they can get a good service. Let’s take an example of Dar es Salaam. You seem to find a bank at every corner of the city and also they are located so close like the Diamond trust bank (T) ltd and The Savings and Finance commercial Bank on the Samora street, Standard Chartered Bank and the Stanbic bank, The Barclays bank and the Citigroup. The customers can easily go to one bank and ask their services and charges and they can also go to the nearby and could bargain to get a better price for the service they want.
There are also customers who are big business people and in the banking industry they are known as the corporate customers. These customers have got a high bargaining power as they use the banking services daily for their business purposes such as the transfer of money, salary payments, also issues relating to importing and exporting like Opening of Letters of credits, import and export documents and also they apply for big loans for their business expansion. Therefore these customers do have influence on the banks. As they use the bank’s services and also pay for them, they are bound to bargain so as to get better deals or offers and because these customers form a large share of revenue, the banks are obliged to offer better prices.
To compare between the individual customers and the corporate, the corporate customer’s power is higher as they deal with large volume of services. This is also shown on the rates offered to individual customers for their deposits and the rate offered to large customers. There would be a big difference like the interest on normal savings account is like 2 to 3 % while the fixed deposit or savings with big amounts have like 5 to 6 percent.
Also the concentration ratio determines the power of the customers. If the customers are few and all located at one place, then their power is high but if they are scattered, then their power is low.
We can say that the power is there but it’s still not developed well enough to affect the banks.
The overall power of the customers in Tanzania is low as most of the people are normal middle class ones and there are very few corporate customers. And Tanzania is still developing its knowledge in corporate banking. It is more into retail banking. Therefore the bargaining power of the buyers seems to be low.
BARGAINING POWER OF SUPPLIERS
As Professor Porter (1980) pointed out that Suppliers can exert bargaining power over participants in an industry by threatening to raise prices or reduce the quality of purchased goods and services.
Suppliers are the people who supply you with the necessary items to conduct or carry out your business. If the suppliers are powerful enough, then they can raise prices for their services and hence increase your costs and decrease your level of profitability as you will then sell your product at a high price to cover the cost.
There are a number of factors that determine whether the suppliers are powerful or not. Some of these factors are like:
When there is only one or few suppliers, then they can take advantage of their position in the market and charge high prices to the firms which use the supplier’s products.
If the products or services supplied by that supplier is unique and has no substitutes, it will also enable the supplier’s bargaining power to be high.
If the costs to move from one supplier to the other are high, then that supplier would exploit this opportunity and charge high prices for its products.
If the supplier has the power of integrating g forward meaning it could carry out the current activities carried out by its buyers, then the supplier poses high power in terms of bargaining the prices and having a good price for its supplies.
The banking industry also has its suppliers who make it possible for the banking activities to run smoothly. The suppliers are divided into two groups. Those who supply the banks with its core product i.e.: Money and the suppliers who supply the services that assist in the banking operations.
As Jules Ackerman (2008) pointed out that there are three main suppliers of the bank’s product, money. These are:
The depositors. These are the people who deposit their money in the bank’s offered accounts. There are time deposits where the bank pays a certain amount of interest to the customers and there are also demand deposits where the customers don’t get any interest but they do get the amount they demand right on the spot. Now these suppliers’s power is not high enough to influence or affect the bank’s operation in any way. In Tanzania there’s a large population of about 40 million people, so all the banks get these people’s deposits in one way or the other since the people and the banks are saturated and therefore all the banks in Tanzania are able to attract a good number of depositors.
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The large customers or corporations are usually offered with special offers and packages and they too don’t have that much influence in the banking operations. However these customers could be a risk if they threaten to go to other bank but still the bank has all the power.
The Credit market. This is another supplier of money to the banks. They are always open to the banks that satisfy their criteria and the supply of money is unlimited with this supplier.
The third supplier of money to the banks is The Central Bank. In Tanzania, The Bank of Tanzania issues all the cash currencies-coins and notes to the commercial banks and financial institutions and as these bank’s operations are important for the economy of the country, it does not pose a threat to the banks, unless a particular bank is proved to be carrying out it’s business otherwise, the central banks will be supplying it with it’s resource.
The bank’s other suppliers, who help to run the operations are the ones like the providers of Information technology (IT), security guards, the providers of furniture and also the employees who perform the banking operations.
The suppliers of Information technology do exercise some degree of power. This is because certain software allows the banks to carry out their services and therefore the banks are dependent on the suppliers for these services. And the suppliers knowing that the banks can not carry out their tasks without this technology take advantage and charge them quite a good sum of money. But we can see that Tanzania is now coming up in IT field as well, there are other firms supplying these services and hence this will result neutralizing the supplier’s power.
Also there are suppliers of security guards and the banks also use the automated alarms so this threat is minimized. As for the employees, Tanzania’s education system has developed, there is a special institute of bankers called Tanzania institute of bankers (TIOB) there are many students who graduate every year and hence there is supply of these young professionals ready to give their services in the banking sector.
The overall power of the suppliers in the banking industry can be said is low. They don’t pose a threat of affecting the decision of the banks in general.
THREATS OF SUBSTITUTE GOODS
This is the fourth competitive force. Substitute goods are those goods that are different from the ones that one firm offers but they perform the same function just like the original products. It’s like a replacement of the original product.
The availability of substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge. (Porter.M, 1980, P 23)
In the banking industry this force does show a risk as the public do have other alternatives to go to apart from the banks. We can also see this in Tanzania that there are many other institutions that provide similar services as banks like the micro-credit agencies like FINCA and SACCOS which provide loans to individuals, the Bureau de change that help the people to change their currency into foreign or also to change foreign currency to local one. So if one person was not happy by the exchange rate offered to him by the bank, then he could easily go to the bureau to get a better rate and change his money.
Nowadays there are the mobile telephone industries that provide the service of transferring funds from one place to another. Let’s take an example of Mpesa, a Vodacom service to transfer money from one point to the other. A similar service also provided by the Zain network called ZAP.
There is also the presence of Western Unions in Tanzania now. So if I want to transfer funds from here to my friend in another country, then I have the option or choice of either going to a bank or a Western union outlet to perform the task.
Therefore the above force seems to be high in the banking industry. The customers have a choice and it is up to them what they choose. This creates competition among the firms in the banking sector. However, due to the fact that it is much safe and people have much confidence in banks, this threat is minimized.
THE COMPETITIVE RIVALRY OR THE INTENSITY OF COMPETITION
Let us now see the last force of the five forces framework of Michael Porter. Competition or Rivalry simply means carrying out some tasks with the fellow members and then trying to out do or perform better than them all. To be the Best.
Being in any kind of business people must come to deal with competition. Every business wants the people to buy their products and hence that firm will do everything possible to make it happen. As Michael Porter (1980) pointed out that the businesses will use various tactics like price competition, advertising battles, product introductions and increased customer service or warranties.
In the banking sector there is a big deal of competition. As there are a number of banks in Tanzania and all aim at attracting people to bank with them, the industry is very challenging.
There are a number of factors that affect the degree of rivalry like:
Competitor balance – If the competitors are all of equal size and power and all aim at the same customers, then they would do anything in their power to win those customers. For example in Tanzania most banks offer retail banking and hence they all target the retail customers.
Industry growth rate – If the overall industry is growing, then all the participants will benefit equally but if there is slow growth, then the firms would try to achieve growth by competing fiercely. We can take the example of the recent economic crisis, it has affected all the firms and the banking sector is no different. Hence to achieve growth or advantage, all the banks are introducing different strategies so as to capture the market.
Low differentiation – Where there is no or low differentiation in the products offered, then the intensity of rivalry is high. Generally all the bank’s products are similar, all offer accounts like savings account, current account or fixed deposit accounts and other services like cheque clearing services, letters of credit and so on. So basically all the products are same. Thus as there is little differentiation, the competition is high in general to attract the customers to bank with a certain bank rather than a certain bank.
(Johnson et al, 2009)
As for concluding the research question, Michael Porter’s five forces framework has helped us in analyzing the banking sector of Tanzania. We are now in the position to say which power is high and which is low. And how the general banking environment looks like.
As discussed above, it was found out that the threats of new entrants is low, the bargaining power of buyers as well as suppliers is low, The threats of substitutes is high and taken as a whole the banking environment is competitive as there are already established players in the industry.
Therefore the overall rivalry is high in the banking sector in Tanzania as there is competition not only from the banks itself but also from other non-bank financial institutions like SACCOS, insurance companies, microfinance institutions (MFI’s). However, banks having been in this industry have got knowledge and experience and also big networks, advertising power, so they can overcome these threats.
In order to combat the competition, the banks need to review their strategies often and also be innovative. They must think of and bring new product offers so as to attract more customers. One main aspect of the banking sector is its customer service. The banks should invest in this area and make their business a success.
Banks play an important role in the economy of any country, hence the Governments should also think of some strategies in order to make this sector a strong one.
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