Porter's Five Forces Model
Porter's Five Forces model is a strategic tool developed in 1979 by Micheal Porter. This model summarizes the 5 marketing factors which affect the performance of a particular company.
The weight of Porter's Five Forces determines the abilities and competencies of a firm involved to make profit. If all these forces get high, then profits will be limited. Conversely, if the Porter's Five Forces are weak, it is possible to generate a significant profit. The important and vital point is therefore to prioritize all these forces so as to identify the key success factors in the industry, you can say that, these forces are the strategic elements that must be mastered to gain a competitive advantage. So these five forces give marketers and management an insight into a company's competitive position, and its profitability.
Rivalry Among the Competing Firm
Rivalry refers to the competition within an industry. Rivalry among competing firm in the industry may be weak, with few competitors that don't compete very aggressively. Or it may be intense, with numerous competitors fighting in a cut-throat environment.
Factors that affect the intensity of rivalry are:
- Number of firms in an industry – increased firms will lead to increased competition.
- Fixed costs – a company with high fixed costs as a percentage of total cost, must sell more products to cover those costs, increasing market competition.
- Product differentiation - Products that are relatively of the same nature compete each other on the base of price. Brand identification can reduce rivalry among competing firms.
Potential Entry of New Firms
One of the defining characteristics of competitive advantage is the industry's barrier for new entrants. Industries with high barriers to entry are usually too expensive for new firms to enter and with low barriers to entry are relatively cheap for new entrants.
The threat of new entrants increased as the barrier to entry is reduced in a particular marketplace. As more firms enter in a market, rivalry increase, and profitability of firm will fall to that point where there is no incentive for new firms to enter the industry.
Here are some barriers for new potential entrants:
- Patents - patented technology is a huge barrier preventing new firms from joining the market.
- High cost of entry - the more it will cost for commencement of a business in an industry, the higher the barrier to entry.
- Brand loyalty - when brand loyalty is strong within a particular industry, it can be very expensive and difficult to enter the market with a new product.
This is perhaps the most overlooked elements of strategic decision making, and therefore most damaging. It's vital that business owners must not only look at what their company's direct competitors are doing, but they must also know what other types of products people could buy as a substitute of their company’s products.
Switching cost is that cost which a customer incurs to switch to a new product and when this switching cost is low the threat of substitutes is high. When companies deal with new entrants, they aggressively price their products to keep customers from switching. When the threat of substitute products is high, profit margins will tend to be low.
Michael Porter's Five Forces Template