TEST YOUR KNOWLEDGE
Porter’s Five Forces
According to Michael Porter, noted authority on strategic management,
successful managers do more than simply react to the competitive environment
– they act in ways that actually shape or change the organization’s environment.
Porter developed a method for analyzing the environment in order to adapt to or
influence the nature of competition. He recommends analyzing the five forces
that shape the competitive environment: the threat of new entrants, threat of
substitutes, suppliers, customers, and the intensity of rivalry among competitors.
Threat of new entrants. New entrants change the competitive landscape.
Unless product demand is increasing, a new competitor is likely to take
away part of the market and earnings enjoyed by existing firms. The
threat of new entrants decreases as barriers to entry increase. Barriers to
entry are obstacles that serve as roadblocks to prevent new companies
from entering the industry (e.g. government restriction or patents on
intellectual property). If many factors prevent new companies from
entering the industry, the threat to established firms is less serious. The
threat of new entrants also decreases as the fear of retaliation by current
industry participants increases. Competitors may be reluctant to enter a
market if they believe that existing firms will react strongly.
Threat of substitutes. Technological changes and economic efficiencies
may lead to the discovery and manufacture of new products that supplant
existing products. Higher quality, lower costs, more features, and safety
considerations may induce consumers to shift their preferences from the
old to the new. In addition to current substitutes, companies need to think
about potential substitutes that may be viable in the near future.
Suppliers. Firms purchase inputs from suppliers and transform them to
create products and services. Human resources, raw materials, and capital
are just some of the supplies needed by organizations. Suppliers can raise
their prices or provide poor quality goods and services. Greater
dependence on particular suppliers increases the power of the suppliers to
impose terms on the firm. Thus, powerful suppliers can reduce an
organization’s profits, especially if the organization cannot pass price
increases to its customers.
Customers. Customers are the purchasers of the products or services the
organization offers. They prefer higher quality and better service at lower
cost. They can also play competitors against one another. The greater the
bargaining power of the customers, the greater extent they can impose
their will on the organization.
Intensity of rivalry among competitors. A key issue is to accurately identify
competitors. Organizations may focus on traditional rivalries and miss
emerging ones. Firms use price, product differentiation, advertising, and
product innovation to improve their market position. Typically, one firm’s
action causes a reaction from other firms. The intensity of competitive
rivalry increases with the number of competitors.