Describe how some of Porter’s competitive force has an effect on organization relating to the external environment. Explain what factors you would analyze (supplier power, new entrants, etc.)
One must look into several factors before starting a business among which industry’s competitiveness is one of the major ones. A Harvard professor by profession, Michael E. Porter came with a model which would help analyze the industry’s competitive forces. The framework is called as Porter’s Five Forces which includes of competitive rivalry, the threat of new entrants, bargaining power of suppliers, bargaining power of customers, and threat of substitute products (Grundy, 2006). All these elements in some way have an effect on organization relating to the external environment, more on each of those are as explained below:
Considering that the competitive rivalry is high in an industry, the profitability takes a slice as well. As with higher competition, the overall cost to survive in the industry increases as well. It makes the growth slow and also reduces the customer loyalty towards the particular brand as the products or services on offer would be more or less same (E. Dobbs, 2014). Let’s take an example of an investment venture in Angel Investments which looks out for entrepreneurship ventures to make investments on. We’ll build on the same example throughout the post. The company first need to check if there is space in the investment industry for another company to exist and be profitable. The businesses trying to enter this space would require a good amount of money at hand and with the development of the industry, the capital requirement increased as well. They had the funds and this could care less about the little competition around to get on with it.
The threat of new entrants gives an idea of how difficult or easy it is for any other business to enter into that industrial space. Like in the case of Nepal, it’s quite difficult for any industry to enter into the Hydropower space however same is not true when it comes to web development companies. Thus, the ones in the industry already try to tighten their grip on it and make it as difficult as it can be for any other business to enter their space. External factors like regulations from the government, actions for pre-established brands, investments, and customer loyalty all play a part in it (Porter, 1989). Building on the same example as above. Angel Investments was presented with an offer to invest in a football kit manufacturing company. This space has a huge competition and a good number of pre-established brands like Nike, Adidas and as such. The company thus looked into the market structure, difficulties like with regard to trademark, patents, customer loyalty, and other factors to consider this investment to be too risky and thus not invest.
Whenever there too fewer things, the demand of it is often higher. Same is the case in the bargaining power of suppliers. With a limited number of suppliers, they have the control. There’s no or little room for negotiation and the buyers are left with very fewer options. In addition to it, even by paying what the supplier has quoted, chances are the buyer may have to wait for the product to arrive. Example of an investment opportunity for Angel Investment for this case would be that they’re presented with an option to buy a company that refurbishes vintage cars. In the research and discussion, they discovered that there is only one supplier for its part in the entire nation and the production of the required parts is scare worldwide as well. The cards on high demand have its part available in very few parts. The company thus decides based on the bargaining power of the supplier being too high not to invest.
Just reverse of what we looked above, bargaining power of the customer puts the customer at charge and the supplier at a disadvantaged position. With buyers all joining hand to demand lower price and if they stop purchasing or move to other product, the power of customer would be higher. This often drives the price down. Looking at the same example as above, Angel Investments and the offer on the table to invest in a vintage car. The market had a limited number of buyer as well so they could join hands and boycott the suppliers which would charge anything over reasonable to them. They could stop using the product altogether and move to other cars. Considering that the vintage car is just the hobby which is easy to change, buyers have a great power in this case.
It alerts the investors if a customer can switch to another product with little cost. It is also called a threat of substitute products. In an industry, if the substitute products exist and the company decides to hike the price, the chance of their customer moving to substitute product is a lot higher. Angel Investments, when they looked into the possibilities of investing in a company which makes football kits, it is common for customers to switch to other producers. There’s no mechanism that’s stopping them from doing so either. So, only if the company can bring something that’s unique to them rather than entering the business which is full of other substitute product, chances of success increases.
As seen through the examples and all the elements, each of them can provide an essential information needed for developing a competitive strategy and to even enter a business space. The forces also help in identifying the strengths and weaknesses of any business already operational. This is why it’s important to also analyze all the five forces.
E. Dobbs, M. (2014). Guidelines for applying Porter’s five forces framework: a set of industry analysis templates. Competitiveness Review , 24 (1), 32-45.
Grundy, T. (2006). Rethinking and reinventing Michael Porter’s five forces model. Strategic Change , 15 (5), 213-229.
Porter, M. (1989). How Competitive Forces Shape Strategy. Readings In Strategic Management , 133-143.
Porter’s five forces are regarded as a guideline for business managers and provides insight to business strategy as well. The five forces of Porter’s that relate to the external environment have been explained below. Porter explain that strategists must understand that competition is not limited to drect competitors only. Profit competition goes beyond seen competitors but is also influenced by customers, suppliers, potential entrants, and substitute products. (Eskildson, 2010)
Bargaining power of buyers:
Customers have power over the business and an entrepreneur should understand this aspect well. Customers can make or break a business. Examples can been see in the American airlines where a man was dragged out of the plane. This incident affected the image of the airlines and resulted in loss. Customer perception of the company is thus very important.
Bargaining power of Suppliers:
A business will run smoothly if a supplier supplies resources at an acceptable rate and on time. If this is hindered there can be problem in the business. Therefore the bargaining power of supplier is something that has to be understood. But in today’s scenario, business and customers alike know the price and can order from huge selection of suppliers from online markets. This has turned the tide of bargaining power of suppliers more to the buyer’s side.
Threat of Substitutes
Substitutes are a major external factor that affects a business. For example I understood this implication when I undertook fish farming in Nepal as my topic in my Marketing subject a few months back. Its substitute products of other meat products, tofu, panner, mushroom had significant impact on its market performance. "As market convergence occurs, not only within, but between industries, the financial services sector is becoming increasingly vulnerable to the threat of new entrants. The growth in eBusiness companies and the increased availability of low cost data management platforms for CRM applications, mean these threats can come from any direction (Presswire, 2003).”
Threat of competitor
This is by far understood by all entrepreneurs. The threat of competitors is an external factor that is critical to the success of a business. Strategy used by competitors to gain market shares and use of resources to gain competitive advantage should be understood very well. Understanding the competitor will provide leverage for better strategy decisions.
These are the Porter’s five forces that are external factors affecting the business.
Eskildson, L. E. (2010, April 8). 5* Michael Porter’s Five Competitive Forces . McClatchy - Tribune Business News; Washington .
Presswire, M. (2003, February 19). Research and Markets: New Entrants In European Financial Services: The out of sector threat. M2 Presswire; Coventry , p. 1.
The five forces framework developed by Michael Porter is the most widely known tool for analyzing the competitive environment, which helps in explaining how forces in the competitive environment shape strategies and affect performance. These competitive forces are as follows (Porter, 1985):
The rivalry among competitors in the industry
The potential entrants
The substitute products
The bargaining power of suppliers
The bargaining power of buyers
However, these five forces are not independent of each other. Pressures from one direction can trigger off changes in another which are capable of shifting sources of competition.
Threat of New Entrants
Entry of a firm in and operating in a market is seen as a threat to the established firms in that market. The competitive position of the established firms is affected because the entrants may add new production capacity or it may affect their market shares (Hough, 2006). They may also bring additional resources with them which may force the existing firms to invest more than what was not required before. Altogether the situation becomes difficult for the existing firms if not threatening always and therefore they resort to raising barriers to entry. These barriers are intended to discourage new entrants and this may be done by organization.
Bargaining Power of Suppliers
Business organizations have a large dependency on suppliers and the latter influence their profit potential significantly. Suppliers’ decisions on prices, quality of goods and services and other terms and conditions of delivery and payments have significant impact on the profit trends of an industry. However, suppliers’ ability to do all these depends on the bargaining power over buyers.
Bargaining Power of Customers
Customers with a stronger bargaining power relative to their suppliers may force supply prices down or demand better quality for the same price and may demand more favorable terms of business. For instance, there will always be a difference in the bargaining power between an individual’s buying different construction material like cement, steel or bricks and a real estate builder buying them for the number of properties he may have been building over so many years (Johnson & Scholes, 2004).
Threat of Substitutes
Often firms in an industry face competition from outside industry products, which may be close substitutes of each other. For example, with the new technologies in place now the electronic publishing is the direct substitutes of the texts published in print (Hitt, Ireland, & Hoskisson, 2011). Similarly, newspaper finds their closest substitutes in their online version, though it may be a smart strategic move to position them as complementary products.
The level of rivalry is minimum in a perfectly competitive market where there are large number of buyers and sellers and the product is uniform with everyone. Same is true for a monopoly market where there is only one player and the type of product is also one. However in case of oligopoly or monopolistic competition, where you will find few players and the market conditions allow them to differentiate their products and services, competition is found to be fierce.
The Porter’s Competitors Strategies
Competitive strategy creates the base in which a business competes in the marketplace. Michel E. Porter has suggested the following market based competitive strategies.
Cost Leadership Strategy
Focused Cost leadership
The Cost leadership strategy
The cost leadership strategy is an integrated set of actions taken to produce goods or service with features that are acceptable to customers at the lowest cost, relative to customers (Hough, 2006). Under this attempts are made to offer standardization products to the customers at price lower than the competitor. Its main aim is to reduce cost and increase the market share by providing acceptable products. The overall profits increases due to higher sales irrespective of the lower price. Costs are minimized with proper coordination among the functional units of the business. The strategy is successful when the customer is price sensitive.
The differentiation strategy is an integrated set of actions taken to produce goods or services (at an acceptable cost) the customer perceive as being different in ways that are important to them. Under this strategy, an organization tries to offer the products which are distinct in the perception of customers. The Differentiation may be based on product parameters, service back up, promotion and image. The product is differentiated through the unique product performance features, and services, adopting new technologies providing detail information about the product.
The focused strategy is an integrated set of actions taken to produce goods or service that serve the need of a particular competitor segment. The company focuses on a narrow segment of customer. A firm attempts to achieve either cost advantage or differentiation. The assumption is that the need of the group can be better served by focusing entirely on it. Under this, a firm can be customer loyalty. The firm focuses on market segment with high profitability and growth. The risk associated with focused strategy is imitation and change in the target segment. There are two types of focus strategy. They are focus low cost, and focus differentiation.
1. Focus - Low cost
This strategy focuses on a particular niche of the market segment through cost. The cost of the product is lowered in compare to the competitors.
2. Focus Differentiation
This strategy also focuses on a particular niche of the market. The firm tries to overcome the competition by the product differentiation. The product is attributed to the unique features or tastes or preferences in comparison on its strategies.
Hitt, M., Ireland, R., & Hoskisson, R. (2011). Strategic Management. USA: South-Western Cengage Learning , 116.
Hough, J. (2006). Business Segment Performance Redux: A multilevel approach . Strategic Management Journal , 45 - 61.
Johnson, G., & Scholes, K. (2004). Exploring Corporate Strategy. New Delhi: Prentice-Hall of India.
Porter, M. (1985). Competitive Advantage. New York: The Free Press.
The external environment in which the company operates consists of competitive and industrial forces that affect the decision regarding long-term objectives, strategy formulation and business model. The assessment of competitive and industrial environment helps to find out dominant industry characteristics, competitive forces affecting the industry, forces driving industrial changes, position of rival companies and key factors of competitive success that determine what type of strategy the company needs to implement to take the advantage of prevailing market scenario (Gamble, Petaraf, & Thompson, 2015).
Porter’s Five Forces Model is a widely used tool for accessing the strength of competitive forces affecting the industry’s attractiveness. As per Porter (1979), bargaining power of buyers, bargaining power of suppliers, threats of new entrants, threat of substitute products and competitive rivalry determine the attractiveness of an industry. If the collective impact of these forces is higher, lower will be the profitability of the industry participants and vice-versa. The industry with weak bargaining power of buyers and suppliers, high barrier of entry for new products, unavailability of good substitute products and moderate competitive rivalry offer superior profit to its participants (Gamble, Petaraf, & Thompson, 2015).
These factors are beyond the control of the company. However, proper analysis of competitive forces will highlight strengths and weaknesses of the company along with the opportunities and threats and provide a clear picture about where the company stands in terms of competition. This will help to formulate new strategies or make adjustments in the existing strategies to help the company use them in its favor (Porter, 1979).
If there are few well-informed buyers who purchase in large quantity and can switch to other products at relatively lower cost, their bargaining power will be stronger. They can ask the company to reduce the cost or increase the quality/ quantity of products keeping the price constant giving the threat to buy from the rival companies. In such situation, the company should work on the strategy to minimize the cost of production as they cannot hike the price of their products.
Similarly, the suppliers exert higher bargaining power if there is short supply of materials or the materials are not readily available and the company has no option of switching the supplier. In such case, the suppliers may demand higher price for the supplies so the strategy should be to look for alternative ways of acquiring the commodities or producing some of the materials by self so that it does not have to pay higher price to suppliers and charge higher with the customers to cover the additional cost.
If there are different substitute products available and the market competition is fierce, a slight increase in price may cause the customers to switch. In addition, if we try to increase sales through discounts and offers, the competitors can easily copy our strategy and provide more offers and discounts. Thus, the company should work on the strategy that will help in retaining the customers and is difficult for the competitors to copy.
If the new entrants can easily enter in the market, the industry attractiveness will decrease. It will definitely increase the competition and provide buyers with more choices as a result of which the company has to focus on differentiation, diversification and growth to outperform the new entrants and maintain their competitive advantage.
To conclude, all the forces of competitive members are to be looked into thoroughly to develop relevant and effective strategy for business continuity and growth.
Gamble, J. E., Petaraf, M. A., & Thompson, A. A. (2015). Essentials of Strategic Management: The Quest for Competitive Advantage (Fourth ed.). New York: McGraw Hill Education.
Porter, M. E. (1979, March). How Competitive Forces Shape Strategy. Harvard Business Review . Retrieved from https://hbr.org/1979/03/how-competitive-forces-shape-strategy