Prompt: Describe Porter's Five-Forces model?

Describe how it relates or is supported by I/O (Industrial Economics) Porters Five Forces model is a tool used to get an understanding of what forces determine the profits in an industry. Industrial Organization economics argues that all firms in a particular industry face forces within their industry that significantly affect profitability. Bargaining power of buyers The characteristics that determine if the bargaining power of buyers is high include concentration of buyers, ability to switch among different suppliers in the industry, and impact of goods from the industry on buyers output. The bargaining power of buyers. Buyers can be individual consumers, other businesses, wholesalers, or retailers. Buyers can be viewed as a competitive threat when they force down prices or when they raise expenses by demanding higher quality and better service. The ability of buyers to make demands on a company depends on their power relative to that of the company. Buyers tend to be powerful when: 00. they are in industries that are more highly consolidated than the companys industry 00. they purchase in large quantities or constitute a significant buyer for that industry 00. buyers can easily switch to substitute product or an alternate supplier 00. buyers can readily produce the product themselves. Bargaining power of suppliers The factors that make suppliers powerful are demand for suppliers products, whether quality and performance of inputs are differentiated, and ability of the industry to vertically integrate. The bargaining power of suppliers. Suppliers are any organization that supplies materials, services, or labor to the company. Suppliers are a threat when they are able to force up the price the company must pay for inputs or to reduce the quality of goods supplied. The capacity of suppliers to make demands on a company depends on their power relative to that of the company. Suppliers tend to be powerful when: 00. the suppliers product has no substitutes or is vital to the company 00. the company is not important to the supplier 00. the company has a switching cost to change suppliers 00. suppliers can readily enter the companys industry 00. the company cannot readily enter the suppliers industry.

New entrants Ease of entry into an industry comes from the industry structure. The structural characteristics include: Obtaining economies of scale. The relationship between size and capital costs. Discouraging industries having many differentiated products. Limitation on access to distribution channels. Patents and proprietary knowledge also limits entry. One of Porters Five Forces is the risk of entry by potential competitors. Potential competitors are companies that are currently not competing in the industry but have the capability to do so. New entry into an industry expands supply. This in turn depresses prices and profits. Thus a high risk of new entry constitutes a strategic threat. A low risk of new entry allows established companies to raise their prices, so it constitutes an opportunity.0 The risk of entry by potential competitors is a function of the height of barriers to entry. The height of barriers to entry is determined by several factors. 00. The extent to which established companies have brand loyalty from their customers is one factor. Loyal customers would discourage potential competitors. 00. Potential competitors are also discouraged when established companies enjoy an absolute cost advantage over potential entrants. Cost advantages might include factors such as patents, control of a specific raw material, or access to cheaper funds. 00. Potential competitors are also discouraged when established companies have economies of scale, that is, when established companies are able to produce at a lower cost than the new entrants due to their larger size and greater experience. 00. When customer switching costs, that is costs that accrue to a consumer that intends to switch from the product offering of an established company to the product offering of a new entrant, are high, potential new entrants are discouraged. 00. Government regulation, such as establishing a protected monopoly, tends to protect established firms, and thus to constitute a barrier to entry. When industries are deregulated, new entrants usually proliferate.

Substitute products Factors impacting the power of substitutes include: Ability of customers to compare quality, performance, and price of one product with another. Ability of a product to bring good-enough performance criteria to the customer. The cost of switching from one product to another similar product. Another factor is the threat of substitute products. The existence of suitable substitute products limit the price that companies in an industry can charge without losing their customers to makers of substitutes. The threat of substitutes tends to be greater when: 00. the substitute is a close one, equally adequate in filling customers needs 00. the price of the substitute is equal to or less than the companys products.

Rivalry and complementors One of the key factors affecting rivalry is differentiation. The other factors include number of competitors, growing demand for the product, increasing payoff from successful strategic moves, and exit barriers. Complementors are products which sell well with another product or those that complement a product to make it easier to buy or use. Another of Porters Five Forces is rivalry between established companies. Strong competition tends to lower prices and raise costs, which constitutes a threat to established companies, however weak competition creates an opportunity to earn greater returns. The extent of rivalry between established firms depends on several factors. 00. One factor is industry competitive structure, which refers to the number and size distribution of companies within an industry. Structures vary from fragmented (made up of many small- and medium-sized companies) to consolidated (dominated by a small number of large companies). Different competitive structures have different implications for rivalry. a. Many fragmented industries are characterized by low entry barriers and commodity-type-products that are hard to differentiate. These characteristics tend to result in boom-and-bust cycles, with a flood of new entrants, excess capacity, and price wars, leading to low industry profits and exit from the industry. The more commodity-like an industrys product, the more vicious will be the price war. The bust part of the cycle will continue until overall industry capacity is brought into line with demand (through bankruptcies), at which point prices may stabilize again. b. Consolidated industries are interdependent, so that the competitive actions of one company directly affect the profitability of competitors, forcing a response from them.0 The consequence can be price wars like those the airline industry has experienced. Thus interdependence is a major threat. This threat can be reduced when tacit price-leadership agreements exist within the industry and when companies are successful in emphasizing nonprice competition.

The firms that are successful in both cost leadership and product differentiation can often expect to gain sustained competitive advantage. Companies that are able to differentiate successfully their products and services are likely increasing their volume of sales. An increased volume of sales can lead to economies of scale, learning curve, and other forms of cost reduction. A firm can obtain profits more than the average, by operating at a lower cost, or by charging a premium price, or by doing both. In reality differentiation is more attractive to small companies. According to the one of the survey in Europe, companies that reached growth in sales and profits were implementing the differentiation strategy.