Article: - The Five Competitive Forces that shape the strategy

Strategy refers to the set of activities that a company does for attaining long term
sustainable competitive advantage. In order to achieve this it is not enough to keep
tab on the established rivals but also to consider other four additional competitive
forces that can hurt the prospective profit of any company. This article explains the
details of the five competitive forces which was formulated by Michael E Porter.
As a strategist it is important to be aware about the five forces which helps to
understand the structure of the industry where the company belongs to and to
strategically position the company to make itself more profitable and making it less
vulnerable to attacks.
The five Competitive forces that help to shape any strategy are:
 Direct competition
 Threat of new entry
 The power of suppliers
 The power of buyers
 Threat of substitutes
These forces differ by industries and the profitability of an industry depend on
those competitive forces that play stronger for that industry. The strategy
formulation also depend on the stronger industry competitive force/s
1. Threat of new entry : The entry of new players to an industry affect the
profit potential of the industry. This depend on the entry barrier to an
industry .if the barrier to enter is high then the threat of new players coming
to an industry is low.
There are seven major factors that affect the entry barriers:
1. Supply side economies of scale: The companies that produce in large
quantity enjoys a lower cost per unit. This can be because the fixed cost is
spread over larger quantity of products, efficient technology or better terms
with suppliers. This economies of scale may deter the new players from
entering to the industry.
2. Demand-side benefits of scale: This happens when there are many buyers
who patronize the company for their product/services which makes small
players entry difficult
 3. Customer switching cost: These are the fixed cost the customer has to bear
when they change suppliers. The larger the switching cost the more difficult
will be the new entries to gain customers in the market.
4. Capital requirements: Need to invest heavily will defer new small players
from entering the market. But if the return of investments are high and
attractive and are expected to remain the same, investors may provide funds
to the new entrants
5. Incumbency advantage independent of size: Companies who were in the
business for a longer period of time, irrespective of their size or quality will
have advantage over new entrants. For example: Brick and mortar shop. Still
big companies like Target, Walmart were able to enter the market by
attracting customers with huge discounts which the brick and mortar shops
couldn’t match.
6. Unequal access to the distribution channel: This is one of the biggest barrier
that sometimes the new entrants may have to bypass the distribution channel
or create a new distribution channel Ex: low cost airlines had to bypass the
travel agents, who used to promote only prominent airlines, and encourage
passengers to book directly through the internet directly.
7. Government Restriction: This can be supportive or hindering for the new
entrants. Govt subsidiaries, funding research by govt etc. can encourage new
entrant. But at the same time Gove restrictions like patents, licensing
requirements and foreign direct investment restrictions etc. can be a barrier
for entry for new comers.

2. Power of suppliers: The suppliers can quote higher price, limit the quality
or service or shift the cost to other participants. Companies are dependent on
different supplier groups for their inputs.
A supplier group is powerful when:
 Supplier group is more concentrated than the industry
 The supplier group is not heavily dependent on an industry for its revenue
 Industry participants high switching cost to change the supplier
 Supplier offers differentiated product ex: pharmaceuticals
 There is no substitute for the supplier products
 Supplier group threaten to integrate forward into the industry
 3. The power of Buyer: The buyers may force to bring down the prices,
demand for better quality of services. All these may affect the profitability of
the industry. If the buyers are price sensitive then they demand for lower
prices
Buyers or group of customers are more powerful when:
 There are few buyers or the each purchase volume is relatively higher than
the size of a single vendor.
 Industry products are undifferentiated or standard where the customer is free
to choose from any vendor
 Buyer face less switching cost
 Buyer threaten to backward integrate and produce the products themselves.
 Buyers are price sensitive

Buyers are usually sensitive to price when they earn low profits , quality of the
product/service are little affected by the industry products(customer pay less
attention to quality and more on price).Only when the industry product/service
pays many times more by improving performance or reduced labor, material or
other costs, buyers are usually interested in quality more than price.Many times the
bargaining power of the intermediate buyers )ex: jewelry retailers, electronics
retailers etc) are high when then can influence the purchasing decision of the
customers downstream.

4. The Threat of Substitutes:

Substitute is something that perform the similar functions as the industry product
but by different means
Ex: plastic is a substitute of aluminum.
Profitability can be highly affected if the industry does not identify and distant
itself from the substitutes through high performance, differentiation or marketing
activities.
Threat of substitute is high when:
 Substitute provide attractive price- performance trade-off to the existing
industry products
  Example: the long distance telephone service were replaced by its substitute
like internet based services like skype and Vonage.
 Buyers cost of switching is low. Example: the cost of switching from
branded to generic drugs are low
5. Rivalry among existing competitors:
Competition among existing players in an industry can happen for price discounts,
new product introduction, service improvement or advertisement campaigns. The
rivalry between competitors in an industry can affect the profitability. This depend
on the intensity and the basis on which the companies compete.

 The intensity of the rivals are high when:

 Competitions are numerous and similar in size
 Industry growth is slow
 Exit barriers are high
 Competitors are highly committed to business and have high aspiration to
the market leaders
 Firms lack familiarity with each other

Rivalry is destructive when the competition between companies happens solely for
price. Price competition transfer profits directly to customers and can affect the
profitability of the company.
Price competition is highly to occur when:
 Product/service are identical and the switching cost is low
 Fixed cost are high and marginal costs are low
 Capacity must be increased to improve the efficiency which can lead to long
and recurring periods of overcapacity and price cutting ex: polyvinyl
chloride business
 Products are perishable
Rivalry can be made positive by increasing the average profitability of the
industry by serving the needs of the different customer segments with different
mix of price, product, services, feature or brand identity
Thus considering all five forces together is very important for the long term
sustenance of any company. Along with this five forces it is also necessary to
consider the industry growth rate, technology and innovation, Government policies
and complementary product/services
Presence of compliments play an important role in determining the profitability of
an industry and it also affect the threat of substitute
Shift in the industry like any technological changes, chance in the needs of the
customers , or other events can affect the profitability of a company in a positive or
negative way.
Rivalry do happen in any industry as the industry matures and it’s difficult to
eliminate it as new rivals come in the place of old one.
Implication for strategy
Understanding the force that affect and shape an industry competition is the
starting point of developing strategy. every company should know the average
profitability of the industry they belong to. These five forces tells why the industry
profitability of what it is. These forces reveals the strength and weakness of the
company. This helps to strategically position the company in a competitive
environment.