The Five Forces Model was devised by Professor Michael Porter. The model is a framework for analysing the nature of competition within an industry.
Introduction & Background - the Nature of Industry Competition
Every market or industry is different. Take any selection of industries and you should be able to find differences between them in terms of:
The result of the above differences is that industries vary in terms of how much profit they make. To take two examples:
Why do airlines make so little profit (and such big losses)? There are several factors, including:
By contrast, why are profits so high in the soft drinks market? The answer is mainly that:
What we have illustrated above is some analysis that you would obtain by considering the Five Forces Model.
Porter identified five factors that act together to determine the nature of competition within an industry. These are the:
He identified that high or low industry profits (e.g. soft drinks v airlines) are associated with the following characteristics:
Let's look at each one of the five forces in a little more detail to explain how they work.
Threat of New Entrants
If new entrants move into an industry they will gain market share & rivalry will intensify
The position of existing firms is stronger if there are barriers to entering the market
If barriers to entry are low then the threat of new entrants will be high, and vice versa
Barriers to entry are, therefore, very important in determining the threat of new entrants. An industry can have one or more barriers. The following are common examples of successful barriers:
What makes an industry easy or difficult to enter? The following table helps summarise the issues you should consider:
Bargaining Power of Suppliers
If a firm's suppliers have bargaining power they will:
If the supplier forces up the price paid for inputs, profits will be reduced. It follows that the more powerful the customer (buyer), the lower the price that can be achieved by buying from them.
Suppliers find themselves in a powerful position when:
Just how much power the supplier has is determined by factors such as:
Bargaining Power of Customers
Powerful customers are able to exert pressure to drive down prices, or increase the required quality for the same price, and therefore reduce profits in an industry.
A great example in the UK currently is the dominant grocery supermarkets which exert great power over supplier firms.
Several factors determine the bargaining power of customers, including:
Customers tend to enjoy strong bargaining power when:
Threat of Substitute Products
A substitute product can be regarded as something that meets the same need
Substitute products are produced in a different industry –but crucially satisfy the same customer need. If there are many credible substitutes to a firm's product, they will limit the price that can be charged and will reduce industry profits.
The extent of the threat depends upon
If there is a threat from a rival product the firm will have to improve the performance of their products by reducing costs and therefore prices and by differentiation.
Overall Degree of Competitive Rivalry
If there is intense rivalry in an industry, it will encourage businesses to engage in
All these activities are likely to increase costs and lower profits.
Several factors determine the degree of competitive rivalry; the main ones are: