In 1979, Michael E. Porter, a well-known economist, researcher and author theorized that the market competition, in most of the business cases, is determined and driven by five forces. Those five forces are now known as Porter’s Five Forces which are interrelated to each other to determine the market value and market trends that shape the competition, and to develop the strategies for success (Harvard Business School, n.d.). This essay is a summary of the two videos that talk about the Porter’s Five Forces.
Porter’s Five Forces Defined
Every industry has the same set of drivers to profitability and competitive structure. Those drivers for profitability are five in number, namely: 1) rivalry among existing competitors, 2) bargaining power of suppliers, 3) bargaining power of consumers, 4) threats of substitutes or services, and 5) threats of new entrants (Harvard Business School, n.d.). The first video summary describes the five forces in relation to highly profitable industry for instance soft drinks and less profitable industry for instance airlines. Afterward, the next video summary gives more detail insights on the Porter’s Five Forces.
First video summary
In the interview, Dr. Porter explains there are two ways to view the market competition. One is considering only the rivalries, the narrow approach of analyzing competition and another is the broad way of analyzing market attractiveness through his Five Forces analysis tools. He also explains that the Porter’s Five Forces Analysis is the holistic way to understand competition and increase the profitability of a company. (Harvard Business Review, 2008). The Porter’s Five Forces are applicable to any industry regardless the size, sector and service that the industry provides.
In the video, he gives an example of airlines and analyzes the market competition with the five forces where there is intense price competition between the rivalries. The price war benefits the customers to choose the best deals with high customer bargaining power. Suppliers are limited and have high bargaining power that heightens the purchase and maintenance cost of airlines lowering profit. This also lowers the threats of new entrants as the huge budget investment is not the cup of tea for all. Nonetheless, substitutes are less for long travel and people ought to choose only the available option. Overall profitability is lesser as compared to the industries such as soft-drinks Coca-Cola where greater customer loyalty outplays all the forces or the Porter’s Five Forces are less influential. (Harvard Business Review, 2008).
Porter’s Five Forces allow the companies to be aligned with the latest trends and technologies and application of those techniques to develop winning strategies. Moreover, this helps to understand rivalry in terms of zero sum competition where companies compete for similar things versus positive sum competition where companies compete for different things or services. (Harvard Business Review, 2008).
Dr. Porter says, “the Five Forces are sometimes considered as static snapshot, in fact these forces are the tools to understand the dynamics of competition.” (Harvard Business Review, 2008). It is true that the industry structure is dynamic where over time changes occur in every aspect due to technological and managerial innovations, magnitude of competition, buyer and supplier power, new substitutes with recent technology. (Harvard Business School, n.d.). Since the Porter’s Five Forces analyze business and competition based on suppliers, buyers, substitutes, new entrants and existing rivalry, it possesses the dynamic characteristics of the existing competition at one point that helps to build further strategies.
Second video summary
Industries are often differentiated based on the products they manufacture or services they provide. Each industry has unique size, structure, customer needs, growth, and profitability. The low profit industries have strong suppliers, strong consumers, low entry barriers, many opportunities for substitutes, and high competition. And high profit industries have just opposite influence of suppliers, buyers, rivalries, substitutes and new entrants. This is what the Porter’s Five Forces explains. The video further explains that how the Porter’s Five Forces act compositely to determine market competition and profitability of any industry. (Tutor2u, n.d.).
According to Porter’s model, the threats of new entrants depend on the different barriers to market entrance for example economies of scale, vertical integration, brand loyalty, access to the best technologies, and expertise. Suppliers become powerful when there are few large suppliers, there is scarce of supply, supplier switchover is complex, few available substitute resources and the number of customer is small or less influential. Similarly, customers are strong when they have high bargaining power, there are many alternatives available, and there is unhealthy price war between rival companies or products. Also, the profitability is diminished when there are too many substitute products that limit the price. The technological change creates new substitutes that makes the old substitutes/rivals obsolete reducing the profitability. Analyzing business and profitability with Porter’s Five Forces helps to find out the company’s market attraction and market position which is essential to develop further strategy to maximize profitability. (Tutor2u, n.d.).
Furthermore, the second video explains about the determination of intensity of rivalry. The degree of market rivalry depends on number of factors that are explained concisely below:
1. Market size and market growth: slow growth market tends to have intense rivalry,
2. Number of competitors: rivalry is proportional to the number of competitors,
3. Customer loyalty: greater the customer loyalty, less intense the impact of rivalry,
4. Product/ Service differentiation: greater the degree of product or service differentiation, lower the intensity of price competition and rivalry impact,
5. Buyer’s power is high with greater availability of substitutes that will make the competition intense.
6. Cost structure of the industry: profit decreases with increased fixed cost.
7. Miscellaneous forces such as technological changes, changes in bargaining power of buyers and customers, undifferentiated product or service, market innovation etc. tend to lower the profitability and market attractiveness. (Tutor2u, n.d.).
Studying Porter’s Five Forces reminds the Invisible Hand Theory of Adam Smith where the desire to achieve profits drives a free economy (Corporate Finance Institute, n.d.). Within the Porter’s Five Forces, there are numerous factors to play. When the five forces are less influential such as in the case of customer brand loyalty, the Porter’s theory may seem a snapshot, however it is equally applicable to any type of industries to figure out the current market position and scenario that will help to build better future strategy.