Before introducing a new product or a service into the market, it is worthwhile to assess whether or not such a product will be competitive or not. This is possible through Porter’s 5 forces model of competition.
Michael E. Porter came up with this theory to help business people understand the underlying forces of competition in the market and what they mean for success probability in his book “Competitive Strategy.”
Porter’s 5 Forces Model of Competition
1. Industry Rivalry/Competition
The number of competitors in an industry dictates the power of a single competitor to have significant control over different dynamics in such an industry. In an industry characterized by many competitors with relatively equal business sizes, one company in such an industry is unlikely to be the price leader.
In such an industry, customers have many options to consume from, and thus easy to switch from one dealer to another.
On the other hand, in an industry characterized by few competitors, one company could be so strong to dictate the prices of goods or services. Furthermore, such a company could also be strong to manipulate the prices that a supplier(s) charge other players.
2. Threat of substitutes
A substitute is a product that serves a similar purpose to another product in the market or a given industry. Whenever there is a substitute, there is a threat of a company’s product or service being displaced in the market. Such displacement signifies switchovers.
Customers will opt for a substitute if it has more attractive features, is sold at lower costs, and offers almost equal or more value for money.
The threat of substitution is high if competitors have better deals and more attractive prices. Customers in such an industry have more exposure to make price/value tradeoffs decisions. A company needs to have strategies for customer satisfaction and retention and take critical approaches to overcome the threat of substitutes.
3. The threat of new entrants
A new entrant is a new company that starts to operate within a given industry. It offers similar goods or services to existing companies.
When is the threat of new entrants high?
The threat of new entrants is high in an industry where competitors are not as popular and the existing brands are not well known to the consumers. The threat of new entrants is also high if current customers have low loyalty to existing brands.
Furthermore, new entrants have high entrance power if less capital is required to venture into a given industry. This threat remains high if access to distribution channels and raw materials is easy.
When is the threat of new entrants low?
The threat of new entrants is low in an industry where competitors are popular and the existing brands are well-known. The threat of new entrants is also low if current customers have high loyalty to existing brands.
New entrants have low entrance power if high capital is required to venture into a given industry. Furthermore, the threat of new entrants is low if access to distribution channels and access to raw materials is hectic or expensive.
4. Bargaining power of customers
The level of customers’ exposure to information dictates the power at customers’ hands to put a company under pressure for overpricing or poor quality. Before venturing into an industry, a company should assess the future of its sustainability with reference to power of buyers in influencing prices.
When is the bargaining power of customers high?
The bargaining power of customers is high for companies that serve customers who buy in bulk. They strongly influence the price of the bulk purchase compared to a customer buying a single or a few units.
Companies want to retain customers who buy in bulk even if they have high bargaining power. It would cost a company more to win such a new customer after losing an existing one.
Customers who act dependently have high bargaining power because they can mobilize each other to or against consuming from a given company. Customers will also have high bargaining power if close substitutes are readily available. They can easily do simple tradeoffs to ascertain the best dealer to replace their current dealer.
When is the bargaining power of customers low?
The bargaining power of customers is low for companies that serve customers who buy in small amounts. They have a low influence on the price of single units bought rather than bulk purchases.
In such scenarios, customers have low bargaining power because it would cost a company less time and money to win a new customer after losing existing ones.
Independent customers have low bargaining power because they cannot mobilize each other against or against a company. One will buy so long as they are okay with the pricing plans available for them.
Customers will also have low bargaining power if existing market players offer no close substitutes for goods or services. The lack of close substitutes exempts the possibility of tradeoffs.
5. Bargaining power of suppliers
A supplier supplies products or services to a company for further processing for the resale purpose of finished goods. Before venturing into a given industry, a company needs to understand factors that dictate the power of suppliers.
When is the bargaining power of suppliers high?
Suppliers have high bargaining power if there are no close substitutes for resource inputs available from suppliers. Fewer suppliers in a market with many buyer companies also give them high bargaining power. Suppliers in such a market have high bargaining because the switching costs from one supplier to another are high.
When is the bargaining power of suppliers low?
Suppliers have low bargaining power if close substitutes exist for resource inputs they supply. Furthermore, suppliers have low bargaining power if many are in a market with just a few buyer companies. Low switching costs from one supplier to another are relatively low, making suppliers’ bargaining power low.