Are you aware of competitive forces that shape the industry? Well, there are. Porter’s Five Forces does precisely that. It is a model that identifies five competitive forces that shape every industry and helps determine its strengths and weaknesses. Porter’s Five Forces model could be applied in any segment of the industry to comprehend the competition in the sector and then use appropriate strategies to boost profitability. The Five Forces model is named after Michael E Porter, professor at Harvard Business School.
Porter refers to these forces as microenvironment as opposed to macroenvironment. These are forces close to a company that affects its ability to serve its customers and make a profit. Porter’s five forces are as follows- competition in the industry, the potential of new entrants into the industry, power of suppliers, power of customers, the threat of substitute products.
Porter’s five forces are a supporting structure for analysing a company’s competitive environment. Hence, the five forces are mostly used to measure competition intensity, attractiveness and profitability of a sector or industry.
A vital force happens to be the number of rival companies and their ability to threaten a company. The larger the number of rivals and the products and services they offer, the lesser the power of a company. Suppliers and buyers find out the competition if they can provide a better deal or lower prices. When competition is low, a company is better poised to offer a good deal and set the terms to achieve higher sales and profit.
The threat of new entrants
An industry with substantial entry barriers is ideal for a company, as it safeguards its position. In this case, the company can charge higher prices and negotiate better terms. If a new rival company could easily enter an industry, it significantly weakens the position of the existing company.
Power of suppliers
The power of suppliers is also a vital force in the five forces model. The number of suppliers can shoot up the input cost. A company’s cost is affected by the number of suppliers, their product quality, and how much it would cost a company to switch to another supplier. The demand for suppliers will be greater if there are lesser number of suppliers in the market. In this case, the supplier has greater power and maintains control over input cost price and other trade advantages. When there is a more significant number of suppliers and low switching costs among rival suppliers, a company can keep its input costs down and improve its profit.
Power of customers
Customers can drive prices lower or negotiate better terms. It, of course, depends on the number of buyers and customers a company has, how important each customer is, and how much it would cost a company to find new customers or markets for its output. A smaller set of clients means that each customer has more power to negotiate better deals. A company with a small, independent set of customers will find it easier to charge a higher price to increase profitability.
Threat of substitutes
Substitutes are similar available products or services that can be used instead of the existing ones in a company. Such products certainly pose a threat. Companies that produce unique products, with no substitute available, whatsoever, will have more power to increase prices and lock in favourable terms. When similar products are available, the company will have the option to opt for substitutes, thereby weakening its power.
Hence, it’s essential to understand the forces that impact the industry or environment. It would help you to adjust your strategy accordingly to maximise profitability. You could then leverage on a strong situation or try to improve a weak one. It can save you from a misleading trap. Rivals could always enter your market and dismantle your company from its position. By understanding Porter’s 5 force, one could save oneself from the possible pitfalls and failure that happens out of ignorance.
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