The Competitive Environment:

Porter’s Five Forces Model

Group 5:
Balmes, Luis
Cariño, Dianne
Regondola, Allyssa May
Maligo, Allysa Marie

BUS009 – Strategic Management

Mr. Steve De Torres

INTRODUCTION

In business, being good is not good enough unless it comes from your customers and is supported by sales and market growth (sustainability). It
is impossible for an organization to develop strong competitive positioning strategies without a good understanding of the environment and its
competitors and their strengths and weaknesses. 

Competition is one of the most inevitable forces in today’s business world. No matter what a firm is, big or small, it has competitors in the
industry and the strategies of these competitors affect the process of formulating strategic plans. It is a dynamic external system in which an
enterprise tries to compete. The more vendors of a similar product or service, the more competitive the competitive environment is.
Competition is an accepted feature of corporate life for profit-driven organizations. Analyzing organization’s competitors helps to discover its
 weaknesses as well as identify opportunities and threats from the industrial environment. The organization does a competitive analysis to
measure and or assess its standing amongst competitors.

Strategic analysis is an investigation into the external and internal environment of an organization. The organization needs to consider industry
and competitive conditions, and determine its own competitive capabilities, resources, internal strengths, weaknesses and market position
when formulating strategy.

The model of the Five Competitive Forces was developed by Michael E. Porter in the 1980s.  Since that time, it has become an important tool
for analyzing an organization’s industry structure in strategic processes.  Porter's model is based on the insight that a corporate strategy should
meet the opportunities and threats in the organization’s external environment. Especially, competitive strategy should be based on an
understanding of industry structures and the way they change. Porter has identified five competitive forces that shape every industry and every
market. These forces determine the intensity of competition and hence, the profitability and attractiveness of an industry. The objective of
corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Porter's model
supports analysis of the driving forces in an industry. Based on the information derived from the Five Forces Analysis, management can decide
how to influence or to exploit characteristics of their industry.

Each of these forces affects a firm’s ability to compete in a given market – but together they determine the profit potential for a particular
industry.

1. The threat of new entrants

2. The bargaining power of buyers
3. The bargaining power of suppliers
4. The threat of substitute products and services
5. The intensity of rivalry among competitors in an industry.

Several reasons why managers should be familiar with the Five-Models

1. Helps decide whether the firm should remain in or exit an industry.

2. Provides the rationale for increasing or decreasing resource commitments.
3. Helps assess how to improve the firm’s competitive position with regard to each of the five forces putting up higher entry barriers,
develop strong relationships with distribution channels, and others.

The goal of competitive analysis is to be able to predict a competitor’s probable future actions, especially those made in response to the actions
of the focal business. This requires information that is both quantitative and factual (what the competitor is doing and can do) as well as that
which is qualitative and intentional (what the competitor is likely to do).

The purpose of this study, therefore, is to establish the relevance of competitive analysis as a strategic management practice in contemporary
business competition.

Porter’s Five Forces Model

I.The Threat of New Entrants

In Porter's five forces, threat of new entrants refers to the threat new competitors pose to existing competitors in an industry. Therefore, a
profitable industry will attract more competitors looking to achieve profits. It also refers to the possibility that the profits of established firms in
the industry may be eroded by new competitors. The extent of the threat depends on existing barriers to entry and the combined reactions from
existing competitors. If it is easy for these new entrants to enter the market, if entry barriers are low, then this poses a threat to the firms already
competing in that market. More competition or increased production capacity without concurrent increase in consumer demand means less
profit to go around. According to Porter’s five forces, threat of new entrants is one of the forces that shape the competitive structure of an
industry. Thus, Porter's threat of new entrants definition revolutionized the way people look at competition in an industry.

Six Major Sources of Entry Barriers

1. Economies of Scale.

It refers to spreading the costs of production over the number of units produced. The cost per unit declines as the absolute volume per period
increases. As a company grows, not all costs increase with it, and some may even go down. Incumbent companies who have economies of scale
can hence have a significant cost advantage over new entrants and smaller competitors. Economies of scale can be demand-side or supply-side
and may be found in the cost of:

Original research

Raw materials

Manufacturing and production

Marketing to larger audiences

Shipments and logistics

Service and support

Attracting talented personnel

Overcoming economies of scale requires innovation and bold moves, such as devising lower-cost manufacturing methods or sourcing overseas.
In practice, economies of scale are often not as significant as they may appear, as the costs associated with their increasing complexity can
significantly offset any reduction in prices paid.

2. Product Differentiation.

When existing competitors have strong brand identification and customer loyalty, differentiation creates a barrier to entry by forcing entrants
to spend heavily to overcome existing customer loyalties. When a brand is well-established, it is known to many in the market, and customer
loyalty is more common. This leads to lower costs and hence greater profits. Products which are different to others stand out and are the
natural choice for those customers who seek what these products offer. With such differentiation and sufficient demand, companies have the
choice of charging higher prices or increasing sales through lower prices. Lower prices, which is also a part of how a brand is differentiated, acts
as a significant barrier. If you cannot make a product that is any better than one which is currently sold for the price that it is sold at, then
entering this market will be very difficult. Overcoming product differentiation barriers often needs strong innovation to create products that
leapfrog existing competitor offerings in terms of both functionality and cost. The latter may be achieved through approaches such as parts
reduction and assembly simplification.

3. Capital Requirements.

Some industries require significant investment in setting up and operating. Manufacturing, for example, can require large factories and
specialist machines. Service also can be costly to set up, for example where a large number of service personnel needs to be recruited, trained
and equipped. High capital costs are typical when setting up for the first time. There may also be ongoing capital investments required, for
example to cope with rapid changes in technology. Other capital costs include parts inventories, customer credit, and various other start-up
losses. Big and cash-rich companies are able to make a large capital investment required, or may be able to raise the funds elsewhere. Even so,
this may require careful analysis that could result in a non-entry decision. For smaller companies, capital requirements can be a significant
 barrier. Overcoming capital requirements may be achieved by starting small and growing organically, from profit, rather than seeking large
loans. When rapid growth is essential, this is a less valid approach and collaborative options such as partnering or licensing may be preferable.
When there is rapid change in the industry, with such as the need to replace out of date machinery, and incumbents are slow to made needed
investments, then this can play to the advantage of new entrants.

4. Switching Costs.

A barrier to entry is created by the existence of one-time costs that the buyer faces when switching from one supplier's product or service to
another. When customers join a bank a lot of their transactions are automated, making it difficult to leave and join another bank. Such 'lock-in'
systems make it more difficult for them to leave one supplier and move to another.

II. The Bargaining Power of Buyers

Porter’s Five Forces of buyer bargaining power refers to the pressure consumers can exert on businesses to get them to provide higher quality
products, better customer service, and lower prices. The idea is that the bargaining power of buyers in an industry affects the competitive
environment for the seller and influences the seller’s ability to achieve profitability. Strong buyers can pressure sellers to lower prices, improve
product quality, and offer more and better services. All these things represent costs to the seller. A strong buyer can make an industry more
competitive and decrease profit potential for the seller. On the other hand, a weak buyer, one who is at the mercy of the seller in terms of
quality and price, makes an industry less competitive and increases profit potential for the seller.

Buyer Groups are Powerful under these Conditions:

1. It is concentrated or purchases large volumes relative to seller sales.
If buyers are more concentrated than sellers – if there are few buyers and many sellers – then buyer power is high. The buyers have
a lot of power when there aren’t many of them and when the buyers have many alternatives to buy from. Moreover, it should be
easy for them to switch from one company to another. 
The importance of a buyer to the supplier increased when the buyer purchases greater volume. If the percentage of sales from one
buyer is significant, the supplier wouldn’t want to lose the buyer. Large volume buyers are powerful also with high fixed costs (e.g.
steel manufacturing)
2. The product it purchases from the industry are standard and undifferentiated
If the producer sells a standard or undifferentiated product, then they will usually have the potential threat of a buyer switching
producers. If there are many producers supplying the same type of product, a buyer will have the option of exploring possibilities.
Example is in community grain products.
3. The buyer faces few switching costs
Switching costs are the costs that a consumer incurs as a result of changing brands, suppliers, or products. Switching costs lock the
buyer to sellers. If the switching costs is low, the bargaining power of buyer is high.
4. It earns low profits
Low profits create incentives to lower purchasing costs. If the buyers are sensitive to changes in prices and may stop purchase, the
supplier will not be able to ignore their demands.
5. The buyer poses a credible threat of backward integration
If buyers can easily backward integrate – or begin to produce the seller’s product themselves – the bargain power of customers is
high. 
6. The industry’s product is unimportant to the quality of the buyer’s product or services
 Sometimes a firm or a set of firms in an industry may increase its buyer power by using the services of a third party – such as Free Market
Online – which has developed software enabling large industrial buyers to organize online auctions for qualified suppliers of semi-standard
parts such as fabricated components, packaging materials, metal stampings, and services.

III. The Bargaining Power of Suppliers

The bargaining power of supplier is the mirror image of the bargaining power of buyers and refers to the pressure suppliers can put on
companies by raising their prices, lowering their quality, or reducing the availability of their products.

Suppliers Group are Powerful under these Conditions:

1. The supplier group is dominated by a few companies and is more concentrated than the industry it sells to
If suppliers are concentrated compared to buyers – there are few suppliers and many buyers – supplier bargaining power is high.
2. The supplier group is not obliged to contend with substitute products for sale to the industry
If substitute products are unavailable in the marketplace, then supplier power is high.
3. The industry is not an important customer of the supplier group
When supplier sell to several industries and an industry does not represent a significant fraction of its sales, suppliers are more
prone to exert power. The bargaining power of suppliers is high if the buyer does not represent a large portion of the supplier’s
sales. 
4. The supplier’s product is an important input to the buyer’s business
When such inputs are important to the success of the buyer’s manufacturing process or product quality, meaning the buyer relies
heavily on the supplier’s product, the bargaining power of suppliers is high.
5. The supplier’s group products are differentiated, or it has built up switching costs for the buyer
If the supplier’s product is highly differentiated – the product is unique or cannot be easily copied - then supplier bargaining power is
high. If buyer switching costs – the cost of switching from one supplier’s product to another supplier’s product – are high, the
bargaining power of suppliers is high. 
6. The supplier group poses a credible threat of forward integration
If suppliers can easily forward integrate or begin to produce the buyer’s product themselves, then supplier power is high.

IV. The Threat of Substitute Product and Services

A substitute product is one that may offer the same or similar benefits to a company as a product from another industry. The threat
of a substitute is the level of risk that a company faces from replacement by its substitutes. For more generic, undifferentiated products the
threat is always higher that from more unique products. A company that has several possible substitutes that can easily be switched to has little
control over the prices it sets or how it chooses to sell the product.

Identifying substitute products involves searching for other products or services that can perform the same function as the industry’s
offerings.

Conditions that increase the risk of substitutes

1. Switching Costs:  If there are little of no switching costs for a consumer, then there is more of a chance that they may explore and
move over to a more attractive substitute
2. Product Price:  If there are little of no switching costs for a consumer, then there is more of a chance that they may explore and
move over to a more attractive substitute
3. Product Quality:  If the quality of substitute products is higher than that of any product, then it is more likely that consumers will
want to make use of this difference and switch over.
 4. Product Performance: If a substitute products functions at the same level or at a better level than a product than there is a chance
that consumers will want to switch over.
5. Substitute Availability: All of the above factors can only come into play if there are actually substitutes available in the market.

ANALYZING THREAT OF SUBSTITUTES

As mentioned previously, substitutes are not immediately recognizable since they are often from outside the industry a company operates
within. This is why there needs to be special attention paid towards identifying the threat of substitutes and developing strategies to counter it
in the long term. There is always the danger that a company may be too focused on handling its direct competitors and may miss the imminent
threat of a substitute. This can even happen at an industry scale, where in the effort to compete with companies within the industry can
overshadow threats from the outside.

 company can keep a check on possible substitutes by doing the following:

Identify Problems
Identify other Solutions
Identify Substitute Appeal
Create Counter Measures and Strategies

With understanding of substitutes, how they work and the basis of their possible appeal to consumers, the company can now create strategies
to handle these alternates. There can be two sets of strategies. One to prevent customers from leaving for a substitute and the other to entice
people over from a substitute.

MITIGATING THREAT OF SUBSTITUTES

Though not foolproof, there are steps to take in order to prevent customers from needing to explore alternates or substitutes. These include:
Differentiation: Through creating a unique product offering, customers will be able to satisfy a need through only a specific product and will not
be easily swayed by substitute products. There could be additional features or benefits that may not be available in a substitute product.
Customer Value: Customers often look for the product that provides the best value for money. This means that maximum benefits are being
gained by spending the least amount of money. If this value is created for a customer than they may not need to look at other products
Brand Loyalty: Most companies strive to create and maintain a strong brand loyalty among their customers. This helps prevent easy
switchovers to other brands or substitute products.

V. The Intensity of Rivalry Among Competitors in an Industry

The intensity of rivalry among competitors in an industry refers to the extent to which firms within an industry put pressure on one another and
limit each other’s profit potential.
 According to Porter’s 5 forces framework, the intensity of rivalry among firms is one of the main forces that shape the competitive structure of
an industry.
Porter’s Intensity of Rivalry Definition

The intensity of rivalry among competitors in an industry refers to the extent to which firms within an industry put pressure on one another and

limit each other’s profit potential. If rivalry is fierce, then competitors are trying to steal profit and market share from one another. As a result,

this reduces profit potential for all firms within the industry. According to Porter’s 5 forces framework, the intensity of rivalry among firms is

one of the main forces that shape the competitive structure of an industry.

Porter’s intensity of rivalry in an industry affects the competitive environment and influences the ability of existing firms to achieve profitability.

For example, high intensity of rivalry means competitors are aggressively targeting each other’s markets and aggressively pricing products. This

represents potential costs to all competitors within the industry.

 High intensity of competitive rivalry can make an industry more competitive and thus decrease profit potential for the existing firms. In

comparison, low intensity of competitive rivalry makes an industry less competitive. It also increases profit potential for the existing firms.

Porter’s Intensity of Rivalry Determining Factors

Several factors determine the intensity of competitive rivalry in an industry, whether it increases or decrease it.

Porter’s Rivalry Intensity Increased

If the industry consists of numerous competitors, then Porter rivalry will be more intense. Whereas if the competitors are of equal

size or market share, then the intensity of rivalry will increase. The intensity of rivalry will be high if industry growth is slow. If the

industry’s fixed costs are high, then competitive rivalry will be intense. Additionally, rivalry will be intense if the industry’s products are

undifferentiated or are commodities. If brand loyalty is insignificant and consumer switching costs are low, then this will intensify

industry rivalry. Industry rivalry will be intense if competitors are strategically diverse – which means that they position themselves differently

from other competitors. Then an industry with excess production capacity will have greater rivalry among competitors. And finally, high exit

barriers – costs or losses incurred as a result of ceasing operations – will cause intensity of rivalry among industry firms to increase.

Porter’s Rivalry Intensity Decreased

And of course, if the opposite is true for any of these factors, the intensity of Porter rivalry among competitors will be low. For example, the

following indicates that the Porter intensity of rivalry among existing firms is low:

 A small number of firms in the industry
 A clear market leader
 Fast industry growth
 Low fixed costs
 Highly differentiated products
 Prevalent brand loyalties
 High consumer switching costs
 No excess production capacity
 Lack of strategic diversity among competitors
 Low exit barriers
Intensity of Rivalry is High if..
If any of the following occurs, then intensity of rivalry is high.
 Competitors are numerous
 Industry growth is slow
 Fixed costs are high
 Competitors have equal size
 Products are undifferentiated
 Brand loyalty is insignificant
 Consumer switching costs are low
 Competitors have equal market share
 Competitors are strategically diverse
 There is excess production capacity
 Exit barriers are high

Intensity of Rivalry is Low if..

If any of the following occurs, then it may indicate that the intensity of rivalry is low.
 Unequal size among competitors
 Competitors have unequal market share
 Industry growth is fast
 Fixed costs are low
 Products are differentiated
 Brand loyalty is significant
 Consumer switching costs are high
 Competitors are not strategically diverse
 There is no excess production capacity
 Exit barriers are low
Porter’s Intensity of Rivalry Interpretation

When conducting Porter’s 5 forces industry analysis, low intensity of rivalry makes an industry more attractive and increases profit potential for
the firms already competing within that industry. In comparison, high intensity of rivalry makes an industry less attractive and
decreases profit potential for the firms already competing within that industry. The intensity of rivalry among existing firms is one of the factors
to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework.

References

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