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Five Forces

Five Forces

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Quick Overview

The five force model is used for analysing the market and the competitive behaviour and also to determine the profit potential of an industry. Obviously the five force model describes five factors, referred to as ‘forces’, influencing an industry’s profit potential. Combining these forces determines the industry’s ultimate profit potential.


Related models: AIDA Model7S ModelKnowledge TriangleINKSWOT AnalysisBalanced ScorecardFive ForcesBCG Matrix6W's of Corporate GrowthCRM;KondratieffCustomer PyramidProduct Life Cycle

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Details

Porter’s Five Forces

 

Background

This model was developed by Michael E. Porter (1947). Porter is an American professor at the Harvard Business School. He is known for his theories relating to competitive strategies. This five force model (Competitive Forces) in particular and the value chain model (Value Chain) are world-famous. Porter studied at Princeton taking a business economics degree from Harvard in 1973.

The five force model is used for analysing the market and the competitive behaviour and also to determine the profit potential of an industry.

Related models: AIDA Model7S ModelKnowledge TriangleINKSWOT AnalysisBalanced ScorecardFive ForcesBCG Matrix6W's of Corporate GrowthCRM;KondratieffCustomer PyramidProduct Life Cycle

 

The model

Obviously the five force model describes five factors, referred to as ‘forces’, influencing an industry’s profit potential. Combining these forces determines the industry’s ultimate profit potential.

 

The five forces are:

-      The power of suppliers
-      The power of buyers
-      The degree to which substitute products and complementary goods are available
-      The threat of new market entrants
-      The internal competition between market players.

 

The power of suppliers

Suppliers may exert pressure for instance by introducing price increases, poorer quality, extending deliveries or shortening payment terms. The pressure which suppliers can exert depends on several aspects:

-      The number of suppliers on the market. Usually: the fewer suppliers, the more influence

-      The number of substitutes

-      Suppliers’ influence on the industry

-      Costs for transferring to a different supplier. In case of high transfer costs you might tack nevertheless in case of increased prices

-      Product standardisation

-      Threat of vertical integration: the possibility to manufacture the product yourself.

 

The power of buyers

Product buyers may exert pressure for instance by demanding lower prices, playing competitors off against each other or extending payment terms. Buyers’ power depends on the following factors:

-      Part of the turnover generated through delivery to the buyer. Large quantities means buyers can exert serious pressure

-      How important is the product. If the product is less important pressure will diminish

-      The extent to which the product has been standardised

-      Transfer costs

-      Buyers’ profits

-      Threat of vertical integration

-      Significance of the product delivered to the buyer for the quality of the buyer’s product

-      The extent to which the buyer is aware of demand, market prices and costs within the industry.

 

Availability of substitutes and complementary goods

Substitute products present a serious threat if good-quality products are delivered at lower prices. Threat will be serious especially if the price-quality is more balanced: the substitute may be a little more expensive but much better, or it can be of lesser quality but much cheaper. Many substitutes present a serious threat. Example: the possibility to buy music online is a serious threat to the CD market. With complementary goods the situation is reversed: more CD players means selling more CDs.

 

The threat of new market entrants

New entrants present a serious threat particularly if newcomers’ ‘boarding’ options and investments are low. Example: the internet sales market. Minor investments are required to offer your products online; the more so if hardly any licenses or permits are required, no physical acquisition of buildings or tools is involved or if sufficient knowledge exists in the market. Entrants threaten to push down turnover or cause higher costs to protect the market share.

 

The following barriers exist:

-      Scale advantages: existing suppliers usually have scale advantages that help them keep costs lower

-      Required capital /product differentiation: the higher the investments, the less the threat of new entrants

-      Transfer costs: costs which customers have to pay to switch over to the new entrant. High costs = less threat

-      Accessing the distribution channels: how much effort and costs are needed for a newcomer to use the existing distribution channels or realise his own distribution channel

-      Internal competition

-      Positioning: strongly positioned companies are able to defend themselves properly against new competitive forces or even put these to their advantage.

 

The internal competition of market players

Surely the existing competitors are not sleeping at it. In fact, they might one way or another pay you a visit; with aggressive advertising campaigns or high discounts they might present a serious threat. Organisations capable of introducing improvements all the time may also intensify competition at the service level.

 

How to use it

Existing companies may use the five force model to analyse and wherever possible anticipate developments and prepare for any threats.

New market entrants should use this model to explore that market/industry. The outcomes may present food for interpreting or changing your business plan.

Suppliers and buyers may use this analysis to receive input for the negotiating strategy.

Good luck, we wish you lots of force and no threats!

 

Related models: 

-   AIDA Model

-   7S Model

-   Knowledge Triangle

-   INK

-   SWOT Analysis

-   Balanced Scorecard

-   Five Forces

-   BCG Matrix

-   6W's of Corporate Growth

-   CRM;Kondratieff

-   Customer Pyramid

-   Product Life Cycle

 

 

Sources:

-       Wikipedia

-       http://123management.nl/0/010_strategie/a120_strategie_09_porter.html

-       Concurrentiestrategie: Analysemethoden voor bedrijfstakken & industriële concurrentie, Michael Porter, EAN 9789025404659

 

The product:

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- Description, full colour, pdf