Porter's five forces is a framework to analyze the attractiveness of an industry in terms of its profitability. The unattractive industry will address genuine competition, in which possible advantages for all businesses would be shared.
Porter's five forces framework was introduced by Michael Porter in 1979. The framework represents the five forces as the microenvironment to compare it with the macroenvironment that consists of those abilities that are close to the company to gain profit. However, the overall industry attractiveness shall not deliver the equivalent profitability. Therefore, businesses should involve their competitive advantage to achieve a higher profit than the industry average.
The framework covers three forces from the horizontal competition - the threat of substitute products or services, the threat of well-established rivals, and the threat of new entrants. The vertical competition includes the bargaining power of suppliers and the bargaining power of customers.
The Threat of New Entrants:
Profitable businesses that generate huge returns will drag new businesses. The more profitable the industry, the more attractive it will be to new competitors. Because of new businesses the competition in the industry will increase.
The industry with high entry barriers and low exit barriers are the most attractive ones. Patents, copyrights, government policies, capital requirements, total cost & switching cost, brand equity, product differentiation, current supply chain, and customer loyalty towards popular brands could affect new businesses.
The Threat of Substitutes:
Different companies use different technologies or techniques to solve customers' problems (solving the same problem employing different industries). For example, cellular phones & landlines, buses & trains. Increased marketing for Uber might reduce the need for buses and trains.
Potential factors:
Buyer's propensity (natural preference) to substitute, the lower price of substitute, product differentiation, brand loyalty, and availability.
Buyer's Bargaining Power:
Buyers' switching costs or availability of substitutes affect the bargaining power. Buyers' ability to bargain affects profitability and product pricing. Buyers' bargaining power will be high if they have alternatives and low if they have few choices.
Supplier's Bargaining Power:
Suppliers' bargaining power can be defined as the market of inputs. Suppliers of raw materials, components, labor, and services to the firm can be a source of power over the firm when there are few substitutes. If the business does not have alternatives than the supplier's bargaining power will be high and if they have alternatives then the bargaining power of suppliers will be low.
Competitive Rivalry:
The strength of competition is the biggest determinant of the competitiveness of the industry. Having an understanding of industry rivals is vital to successfully marketing a product. Positioning depends on how the people notice a product and differentiates it from competitors‘. Businesses must be aware of their competitors' marketing strategies and pricing and also be reactive to any changes made. Rivalry among competitors directs to low profitability.
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