Porter’s five forces model is used for assessing the nature of competition and attractiveness in an industry. The basic porter’s five forces model is demonstrated in the below diagram.
Porter explains that there are five forces that determine industry attractiveness and long-run industry profitability. These five “competitive forces” are
The below diagram shows Porter’s 5 forces model to judge the competitiveness and attractiveness of a particular sector or industry.
Threat of New Entrants
Threat of new entrants increases competition in a particular sector or industry. It depends on the barriers to new entry, initial investments and government policies. Threat of new entrants is low in some sectors like Telecom and high in some sectors like Real Estate.
The Threat of new entrants depends on the following parameters.
Threat of new entrants will be high if entry is difficult for the new companies which depends on restricted distribution channel, high investment, patents/licensing costs etc. At the same time, it is easier for new companies to enter into a sector if the initial investment is low and the distribution network is easily accessible by all the companies.
Threat of Substitutes
Threat of substitutes affects the price elasticity of a product and makes the demand curve more elastic as the customers have more options available in the market for a particular type of product. Also due to more alternative options and higher price elasticity, the industry becomes highly competitive and lowers the profitability of the companies. The threat of substitute depends on the following parameters.
High threat of substitutes is good from customers’ point of view while low threat of substitutes is good for the companies or the services providers’ point of view in a particular industry.
Bargaining Power of Suppliers
Bargaining power of suppliers affects the Price elasticity of the products in one particular industry. Higher bargaining power of the suppliers leads to higher price of one product and make the demand curve less elastic.
Bargaining power of Suppliers becomes very high when there is very less number of substitutes or alternative options available in the market or switching cost is very high. Higher price of the raw materials due to high bargain power of the suppliers can have significant impact on the profitability of the companies operating in a particular industry and affects their business in the long run. As a result, the industry loses its attractiveness.
The bargaining power of suppliers is high for the following scenarios
High bargain power of suppliers exists for high quality products which are achieved through innovations and R&Ds. The price is decided by the manufacturing company and buyers don’t have any other options available rather than buying the same product at the high price. Also it exists for drug industry where a particular patent is available only to a specific number of drug companies and they decide about the end price.
Bargaining Power of Buyers
Bargaining power of buyers affects the Price elasticity of the products in one particular industry. Higher bargaining power of the buyers leads to lower price of one product.
Bargaining power of buyers becomes very high when there is very high number of substitutes or alternative options available in the market or switching cost is very low. High bargain power of the buyers leads to high competition in the market and lower price. As a result, it affects the profitability of the companies operating in a particular industry and the industry also loses its attractiveness
The bargaining power of buyers is high for the following scenarios
An example where bargain power of buyers is high can be defense purchase by big countries. Lots of defense weapon suppliers bid for the same and the bargain power stays with the buyers. At the same time, in telecom industry with many telecom operators, the subscribers or users have the bur gaining power.
Intensity of Rivalry
The intensity of rivalry among the competitors decreases attractiveness of the industry. Here the companies fight for survival and always take strategic decisions to showcase the rivalry. The Intensity of rivalry depends on the following conditions
An the industry is considered to be disciplined if rivalry among the companies is low while high rivalry often leads to legal and business issues among the companies. High rivalry between Apple and Samsung in the smart phone market leads to multiple court cases for patent violations.