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Porters Five Forces Analysis aids a business in cross checking a competitive environment. It has similarities with other tools for environmental analysis, such as PEST analysis, but is more likely to focus on the single or a stand alone, business rather than a single product or range of products, before Michael E Porter devised the five forces model there was a way of think which implied that due to competition the rate of return in an industry would be constant across all firms and industries, this way of thinking contrasted a number of studies which has identified that different industries were in fact able to maintain different levels of profit which was due to the way a industry was structured. “different industries can sustain different levels of profitability” (Porter, M (23/04/10). Competitive Strategy: Techniques for Analyzing Industries and Competitors)
Michael E Porter presented a structure that replicates an industry as being influenced by five forces. These five forcers are barriers to entry, supplier power, threats of substitutes, buyer power and degree of rivalry with in the industry. “Based on this analysis, a company can develop a competitive strategy for gaining and sustaining competitive advantages over rival firms and thereby generating above-average return on investments.” (Niederhut-Bollmann, C, Theuvsen, L,. (23/04/2010). Strategic management in turbulent markets) Porters Five Forces provide a simple framework to analysis an industry structure and view its potential for profitability. It works by looking at the strength of five important forces that affect competition.
With reference to economics, “competition among companies will forces over all profits to zero” (Iupindia, D. (24/4/10). Journal of Applied Economics), but because there is no-such thing as perfect competition firms in any industry will continue to attempt to achieve a competitive advantage over rival companies, to help a company achieve an advantage over its competitors’ it can use a number of competitive moves such as: “Changing the prices of its service or product, Improving product differentiation, using the most appropriate channels of distribution or developing relationships with supplier”s. (Porter, Michael E.. (24/4/10). THE FIVE COMPETITIVE FORCES THAT SHAPE STRATEGY )
When classifying the intensity of a company’s rivalry there a number of different unique points which help to identify how competitive that industry is. “If there are a number of large firms in an industry these firms are competing for the same customers and resources” (Porter, Michael E. (25/4/10). How competitive forces shape strategy). This rivalry increases if the companies in the industry all have equal market share.
Slow market growth will also cause an increase in rivalry as firms are forced to compete for limited market share in contrast an industry which is growing rapidly will have higher revenue and a bigger market share due to the fact that there are so many emerging consumers.
Added to the slow market growth and the number of firms in an industry, low product differentiation can also affect the amount of rivalry in an industry a perfect example is the Smartphone industry, all the phone are the same and offering the same benefits to the consumer. But by offering or creating a brand identity a company can restrict the amount of rivalry in the industry again a example is in the Smartphone industry Apple has been able to create a successful brand which differentiates them from there competitors.
When an industry is producing higher profits it entices new entrants into the market this in turn increase the amount of rivalry. At a certain point in the product life cycle an industry will have too many competitors and the industry can become crowed, with all these business producing the same product the market becomes saturated creating a position of too many products and not enough buyers
Threat of Substitutes
The Threat of Substitutes means other products which are in other industries affecting the product which is being produced. If a substitute product is limiting the ability of the industry to raise prices it falls in to the category of a substitute. For example BHP Billiton is a mining company which extracts minerals from the ground such as iron ore another mining company which extracts oil from the ocean would be a substitute. While the threat of substitute normaly affects an industry via a completive price strategy it can also pose a threat in areas such as technology and resources.
When an industry has a strong buyer power it suggests that the consumers have an impact on the companies. These buyers are able to set prices and dictate to the industries what they want; this is prevalent in industries where there are many suppliers and only one buyer for example in the car manufacturing industry there are many makers of cars and they all need tires but there are only a few companies that make tiers.
If an industry requires raw materials such as metal, labor or commodities it creates a relationship with a company that supplies the specific need and want that the industry is looking for. If the supplier are powerful and have a large market share they are able to influence the producing industry a perfect example of this is BHP Billiton. BHP Billiton is able to sell its raw materials such as iron ore to countries such as china at higher price which allows the company to capture some of the profits which are had by the metal industry.
Barriers to Entry
New firms entering an industry affect competition “Barriers to entry benefit existing companies already operating in an industry because they protect an established company’s revenues and profits from being whittled away by new competitors”.( J Cramer. (01/05/2010). Barriers To Entry. Available) Barriers can be exploited and used to improve the competitive advantage of the company. These barriers can be caused by the Government who regulate some industries by allowing monopolies for example Telstra who have a monopoly over the telecommunication business, legal patents which are used by companies who have a entrepreneurial idea, having specific assets such as technology which is required to produce a particular product and having cost effective economies of scale which is the point where the cost of producing a unit is at a minimum.
Porter five forcers can also be used to determine the attractiveness of an industry or market as measured by the long-term return on investment of a average firm which depends largely on the five factors Michael E Porter developed, “these factors influence Profitability, The intensity of competition among existing competitors, the existence of potential competitors who will enter if profits are high, substitute products that will attract customers if prices become high, the bargaining power of the customer and the bargaining power of suppliers” (Aaker, D (23/04/10). Strategic Market Management)
As BHP Billiton has a lot of financial strength which has been created though well planed cash flow and balance sheets, a variety of products and customers, as well as access to global assets and an always expanding stage of prospects, they are able to determine how a buyers must act an example of this is when “BHP Billiton dictated iron-ore prices to steelmakers” (Sarah-Jane Tasker. (23/04/2010). Giant iron ore producers are dictating price, says Beijing)
In 2009 BHP Billiton and Rio Tinto Signed a Joint Venture which allowed the two companies to control and encompasses all current and future Western Australian iron ore assets and liabilities, this has decreased the amount of competition in the mining industry, as well as eliminating the threat of potential entrants, the joint venture has also allowed the two companies to increased there barging power in terms of exporting the iron-ore, at the same time cutting the bargaining power of those customers, as there is not substitutes for minerals BHP Billiton and Rio Tinto will be able to continue to create a profit in the industry.
There are some arguments which view the Porters five force model as out of date and touch with the twenty-first century way of conducting business. Dagmar Recklies who has extensive experience in the strategic analysis of markets, companies and business models also a wide knowledge in the development and implementation of concepts for strategic planning writes that “Porter’s ideas have become more and more subject of critique under the impression of the developing Internet economy during the last decade. Critics point out that economic conditions have changed fundamentally since that time. The rise of the Internet and of various e-business applications has strongly influenced nearly all industries.” (Recklies, D. (2/5/10). Beyond Porter – A Critique of the Critique of Porter)
As Michael E Porter is viewed as one of the most influential people in the strategic management way of thinking; his models have grown and are being used by managers and business all around the world, even though his models are based on the economic situations in the eighties his theories are still relent even in a time where a majority of business is done on line. I believe internet competition in any industry has increased. The internet allows business to trade and stay competitive not only locally but global. Many products and even some service operate solely online for example using the porters five force model and applying it to the internet and companies which use only internet it is possible to explain how a business can remain completive.
Customers are able to have a better buyer power when there are more choices in an industry, as with business operating via the internet offering a wider choice of goods and services at lower cost play to how a customer wants to purchase, an example of this is eBay there are millions of different products at lower then retail cost meaning that consumers have a wide choice of products.
Supplier power is the opposite to buyer power where by buyers have less choices in an industry in relation to the internet and purchasing products on the internet companies such as Google dominate the internet, other companies use this website as a vehicle to recommend there product to the consumer while paying Google for the opportunity to advertise via there site.
Threat of substitutes
As stated early the threat of substitute is high when there are many product options. The internet allows a consumer to shop around and purchase there product form other countries or business where the cost of manufacturing is cheaper.
Barriers to entry
The threat of a new entrant into the market which you are competing in is high, it is very easy for a local business to setup an internet website and start selling there product. Even though there is high competition on the internet there is always an opportunity for a business to sell or offer a new product or service.
In relation to business operating via the internet there is extensive amount of rivalry which will effect how a modern day internet business is able to gain a competitive advantage but by viewing the above factors it will allow the particular business to view the correct direction and strength to successful attain a profit
“Porter’s Five Forces Model can help demonstrate the attractiveness of starting an on-line business. A business person should use the model to identify competition, make a plan, and implement the process.” (Bennett, J. (2/5/2010). Porter’s Five Forces Model And Internet Competition) As stated in the article by J, Bennett porters five force model is still applicable to the way companies do business on the internet you still need to assess you Buyer Power, Supplier power, what threats you product or service has and what the barriers to entry are
Even through Dagmar Recklies states that: “these models cannot explain or analyze today’s dynamic changes and have the power to transform whole industries” (Recklies, D. (2/5/10). Beyond Porter – A Critique of the Critique of Porter) what needs to be understood is that the business running on the internet are still business and they are still subjected to industry competition and that porters five force model will still help a company to analysis how competitive there industry is.
There are a number of other models which would help a company determine how competitive the industry is that they are competing in. The Ansoff Matrix proposes that a company will mature whether it markets new or existing products in a new or existing market. If done correctly the Ansoff Matrix will be able to guide a company by suggesting a growth strategy such as; Market penetration, product development, market development and diversification.
This strategy consists of developing companies products to an existing market. This strategy will help a company achieve objectives such as; maintaining or increasing the market share on current products, become a market leader, it can help remove competitors from a market and increase the amount existing customers use
The Product development strategy can be used to introduce a new product into existing markets for example developing needs and wants so it can appeal to the particular existing market.
This strategy is used to help a company trade an old product in a new market for example selling a product over seas, lowering prices which will attract new customers or distributing a product via a different channel.
“Diversification is a growth strategy where by a business markets new products in new market this strategy is very riskey due to the fact the business is moving into a market that it has little or no experience in For a business to adopt a diversification strategy, therefore, it must have a clear idea about what it expects to gain from the strategy and an honest assessment of the risks. “. (Chapman, A. (2/5/2010). business plans and marketing strategy)
Compared to the Porters five force model the Ansoff matrix “can be a useful extension to encompass the degree of risk a company will experience by venturing into a new/expanding market” (Bennett, R. Vignali, C. (1996). Dancall Telecom A/S in the UK mobile telephone market) it also deals with the possibility that an industry could be attractive because certain companies are in it, such as the Smartphone industry looks like a positive industry to be in but this is only due to Apple being so dominant. The Ansoff Growth matrix is used as a tool that helps businesses decide their product and market growth strategy where as Porters Five Forces is designed as a tool to help managers view a industries opportunities and threats allowing for a completive advantage to be formed.
In conclusion Porter’s Five Forces Analysis is a significant model for reviewing the possible for profitability in an industry. It works by looking at the strength of five important forces that affect competition, Supplier Power which is the power of suppliers to drive up the prices of inputs, Buyer Power which is the power customers to drive down prices, Competitive Rivalry which is able to evaluate the strengths of business in a industry, The Threat of Substitution helps reference the amount of different products and services that can be used in place of your own and finally The Threat of New Entry which refers to the ease with which new competitors can enter the market.
If a company applies this model it will assist the business in viewing and identifying the strengths and directions in which they need to head to sustain profit in there given industry
Literature and References:
Porter, M (10/1980). Competitive Strategy: Techniques for Analyzing Industries and Competitors . NY, USA: Free Press. 34-56.
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