Michael Porter introduced a model that defines five forces that influence the industry. It’s a strategic business tool to analyze your competitive environment, and it improves the understanding of your business and the industry context in which a company operates. According to Porter, the five forces are the threat of new entrants, the threat of substitutes, supplier power, rivalry and buyer power.
The first step in performing an industry analysis is maybe to assess the impact of Porter’s five forces. This standard industry analysis tool helps individuals use a time-tested management procedure to generate an intelligent business analysis that among other things will help determine the ultimate profit potential in the industry as well as find a position in the industry where the company can best defend itself against competitive forces or influence them in its favor. In the porter’s model, the five forces that shape industry competition are:
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- Bargaining power of suppliers. This force is used to analyze how much power a business supplier has and how much control they have the potential to raise prices which consequently leads to reduced business profitability. It also explores the availability of suppliers. The higher the number of suppliers, the better the business is placed in that industry.
- Bargaining power of the buyers. This force explores the power that the consumer has to affect pricing as well as quality. Powerful buyers can actually exert pressure on small businesses by demanding lower prices, higher quality or additional services or even playing competitors off one another.
- Threat of new entrants. This force examines the ease or difficulty with which a competitor can join the marketplace in the industry under question. Barriers to entry could include economies of scale, access to inputs, absolute cost advantages as well as well-organized brands. Usually, the easier it is for competitor to join the marketplace, the greater the risk of the business market share been depleted (Brunner, 2010).
- Threat of substitute products or services. This force looks into how easy it is for consumers to switch from a business’s product to that of its competitors. It examines how many competitors there are and how their prices and quality of products compare to those of the business under examination (Puravankara, 2007).
- Competitive rivalry. This force studies the intensity of competition that is currently in the marketplace, which is determined by the number of existing competitors and what each is capable of doing. With high rivalry competition, advertisement and price wars ensue, which are not good for any business. This rivalry is quantitatively measured by the concentration ratio (CR), which usually refers to the market share owned by the four largest firms in the industry.