Porter's five forces Flashcards
What is it?
Porter’s five forces is a model that identifies and analyzes five competitive forces or aspects that shapes every industry, and it also allows businesses to determine the strength and weaknesses of the industry.
The bargaining power of suppliers
This factor addresses how easily suppliers can raise the input of an industry. The more power a supplier has over its customers, the higher the prices it can charge and the more it can move profit from the customer to itself. The fewer suppliers to an industry, the more a company would depend on a supplier. As a result, the supplier has more power and can drive up input costs and push for other advantages in trade. On the other hand, when there are many suppliers or low switching costs between rival suppliers, a company can keep its input costs lower and enhance its profits. Limiting the power of its supplier will improve the competitive position of a business. This can be achieved by growing vertically (backward vertical integration) or it seek for new suppliers to increase competition between suppliers.
The bargaining power of buyers
The ability that customers have to drive prices lower or their level of power is one of the five forces. It is affected by how many buyers or customers a company has, how significant each customer is, and how much it would cost a company to find new customers or markets for its output. A smaller and more powerful client base means that each customer has more power to negotiate for lower prices and better deals. A company that has many, smaller, independent customers will have an easier time charging higher prices to increase profitability.
The threat of new entrants
If businesses can easily enter an industry and leave if profits are lower, it becomes hard for existing businesses in the industry to charge high prices and make high profits. Existing businesses are constantly under threat from new suppliers if the profits in an industry rise too much. This is because the new suppliers can undercut their prices. Businesses can protect themselves by erecting barriers to entry to the industry, such as applying for patents and copyright to protect their intellectual property.
Substitutes
Substitute goods or services that can be used in place of a company’s products or services pose a threat. Companies that produce goods or services for which there are no close substitutes will have more power to increase prices and lock in favorable terms. When close substitutes are available, customers will have the option to forgo buying a company’s product, and a company’s power can be weakened. A business can reduce the number of potential substitutes through research and development, and then patenting the substitutes itself.
Rivalry among existing firms
The level of rivalry among existing firms in an industry will also determine prices and profits for any single firm. Businesses can reduce competition by buying out their rivals (horizontal integration).
