Why porters five forces

I shall discuss them in this section. New entrants to an industry bring new capacity, the desire to gain market share, and often substantial resources. Companies diversifying through acquisition into the industry from other markets often leverage their resources to cause a shake-up, as Philip Morris did with Miller beer. The seriousness of the threat of entry depends on the barriers present and on the reaction from existing competitors that entrants can expect.

If barriers to entry are high and newcomers can expect sharp retaliation from the entrenched competitors, obviously the newcomers will not pose a serious threat of entering. These economies deter entry by forcing the aspirant either to come in on a large scale or to accept a cost disadvantage. Scale economies in production, research, marketing, and service are probably the key barriers to entry in the mainframe computer industry, as Xerox and GE sadly discovered.

Economies of scale can also act as hurdles in distribution, utilization of the sales force, financing, and nearly any other part of a business.

Brand identification creates a barrier by forcing entrants to spend heavily to overcome customer loyalty. Advertising, customer service, being first in the industry, and product differences are among the factors fostering brand identification. It is perhaps the most important entry barrier in soft drinks, over-the-counter drugs, cosmetics, investment banking, and public accounting. To create high fences around their businesses, brewers couple brand identification with economies of scale in production, distribution, and marketing.

Capital is necessary not only for fixed facilities but also for customer credit, inventories, and absorbing start-up losses. While major corporations have the financial resources to invade almost any industry, the huge capital requirements in certain fields, such as computer manufacturing and mineral extraction, limit the pool of likely entrants. Entrenched companies may have cost advantages not available to potential rivals, no matter what their size and attainable economies of scale. These advantages can stem from the effects of the learning curve and of its first cousin, the experience curve , proprietary technology, access to the best raw materials sources, assets purchased at preinflation prices, government subsidies, or favorable locations.

Sometimes cost advantages are legally enforceable, as they are through patents. For an analysis of the much-discussed experience curve as a barrier to entry, see the insert. In recent years, the experience curve has become widely discussed as a key element of industry structure. The experience curve, which encompasses many factors, is a broader concept than the better known learning curve, which refers to the efficiency achieved over a period of time by workers through much repetition.

The causes of the decline in unit costs are a combination of elements, including economies of scale, the learning curve for labor, and capital-labor substitution. Adherents of the experience curve concept stress the importance of achieving market leadership to maximize this barrier to entry, and they recommend aggressive action to achieve it, such as price cutting in anticipation of falling costs in order to build volume.

Is the experience curve an entry barrier on which strategies should be built? The answer is: not in every industry.

In fact, in some industries, building a strategy on the experience curve can be potentially disastrous. That costs decline with experience in some industries is not news to corporate executives. The significance of the experience curve for strategy depends on what factors are causing the decline. If costs are falling because a growing company can reap economies of scale through more efficient, automated facilities and vertical integration, then the cumulative volume of production is unimportant to its relative cost position.

Here the lowest-cost producer is the one with the largest, most efficient facilities. A new entrant may well be more efficient than the more experienced competitors; if it has built the newest plant, it will face no disadvantage in having to catch up.

Whether a drop in costs with cumulative not absolute volume erects an entry barrier also depends on the sources of the decline.

If costs go down because of technical advances known generally in the industry or because of the development of improved equipment that can be copied or purchased from equipment suppliers, the experience curve is no entry barrier at all—in fact, new or less experienced competitors may actually enjoy a cost advantage over the leaders. Free of the legacy of heavy past investments, the newcomer or less experienced competitor can purchase or copy the newest and lowest-cost equipment and technology.

If, however, experience can be kept proprietary, the leaders will maintain a cost advantage. But new entrants may require less experience to reduce their costs than the leaders needed. All this suggests that the experience curve can be a shaky entry barrier on which to build a strategy.

While space does not permit a complete treatment here, I want to mention a few other crucial elements in determining the appropriateness of a strategy built on the entry barrier provided by the experience curve:. The newcomer on the block must, of course, secure distribution of its product or service. A new food product, for example, must displace others from the supermarket shelf via price breaks, promotions, intense selling efforts, or some other means.

The more limited the wholesale or retail channels are and the more that existing competitors have these tied up, obviously the tougher that entry into the industry will be. Sometimes this barrier is so high that, to surmount it, a new contestant must create its own distribution channels, as Timex did in the watch industry in the s. The government can limit or even foreclose entry to industries with such controls as license requirements and limits on access to raw materials.

Regulated industries like trucking, liquor retailing, and freight forwarding are noticeable examples; more subtle government restrictions operate in fields like ski-area development and coal mining. Rivalry Among Existing Competitors.

The Five Forces is a framework for understanding the competitive forces at work in an industry, and which drive the way economic value is divided among industry actors.

A Five Forces analysis can help companies assess industry attractiveness, how trends will affect industry competition, which industries a company should compete in—and how companies can position themselves for success. Threat of New Entrants The threat of new entrants into an industry can force current players to keep prices down and spend more to retain customers. Actually, entry brings new capacity and pressure on prices and costs.

The threat of entry, therefore, puts a cap on the profit potential of an industry. This threat depends on the size of a series of barriers to entry, including economies of scale, to the cost of building brand awareness, to accessing distribution channels, to government restrictions.

The threat of entry also depends on the capabilities of the likely potential entrants. If there are well established companies in the industry operating in other geographic regions, for example, the threat of entry rises. Bargaining Power of Suppliers Companies in every industry purchase various inputs from suppliers, which account for differing proportions of cost.

This theory is based on the concept that there are five forces that determine the competitive intensity and attractiveness of a market. By understanding where power lies, the theory can also be used to identify areas of strength, to improve weaknesses and to avoid mistakes.

Supplier power. An assessment of how easy it is for suppliers to drive up prices. This is driven by the: number of suppliers of each essential input; uniqueness of their product or service; relative size and strength of the supplier; and cost of switching from one supplier to another. Buyer power. An assessment of how easy it is for buyers to drive prices down.

This is driven by the: number of buyers in the market; importance of each individual buyer to the organisation; and cost to the buyer of switching from one supplier to another. If a business has just a few powerful buyers, they are often able to dictate terms. Competitive rivalry. The main driver is the number and capability of competitors in the market. This stage of the analysis will require you to consider factors that can make your market easy to penetrate, such as the costs of entering your market and how well it is regulated.

Bargaining power of customers: This refers to whether your customers have the potential to drive the prices of your products or services down, often in regards to whether they can find more competitive prices, higher quality, or increased choice elsewhere. During this stage of the analysis, you need to consider how many buyers there are in your market and what it would cost them to switch to another supplier.

Threat of substitute products of services: Technology is ever-evolving, which means that products and services can easily become outdated — and substitutions can pop-up quickly in the market. With this in mind, ask yourself whether your customers are likely to find a suitable alternative to your product or service and if you are offering a high enough quality service to deter them from jumping ship.

We all know the importance of conducting thorough competitor research. In fact, this is a vital part of any successful marketing strategy.