INTERNATIONAL BUSINESS MANAGEMENT

Topic: Porter’s 5 Forces Model and Competitive Advantage of Nations

Group members: Saumyashree, Shivam Jaiswal, Anubhav Thakur, Shruti
Mishra, Sujal Agrawal

INTRODUCTION
Porter's Five Forces is a model that identifies and analyses five competitive forces
that shape every industry and helps determine an industry's weaknesses and
strengths. Five Forces analysis is frequently used to identify an industry's structure to
determine corporate strategy. Porter's model can be applied to any segment of the
economy to understand the level of competition within the industry and enhance a
company's long-term profitability, strength and attractiveness. The Five Forces model
is named after Harvard Business School professor, Michael E. Porter.
Porter's five forces are:

1. Rivalry among existing competitors: It examines how intense the current

competition is in the marketplace, which is determined by the number of existing
competitors and what each competitor is capable of doing. The larger the number of
competitors, along with the number of equivalent products and services they offer, the
lesser the power of a company. When rivalry is high, competitors are likely to actively
engage in advertising and price wars, which can hurt a business’s bottom line. In addition,
rivalry will be more intense when barriers to exit are high, forcing companies to remain in
the industry even though profit margins are declining. These barriers to exit can for example
be long-term loan agreements and high fixed costs. Conversely, when competitive rivalry is
low, a company has greater power to charge higher prices and set the terms of deals to
achieve higher sales and profits.
Let’s take an example to understand this, Starbucks faces strong competition from the likes
of Dunkin Donuts, Costa Coffee, Tim Hortons, as well as thousands of other small
independent stores. These small stores offer great local competition and offer an alternative
for customers.
The competitive rivalry is a strong force for Starbucks as there are a large number of firms
for consumers to choose from. This competitive rivalry puts pressure on Starbucks not only
to offer quality coffee, but also at a competitive price.
It means there are many options for consumers, there are low switching costs, and there are
a variety of product offerings from competitors.

2. Potential of new entrants into the industry: New entrants put pressure on
current organizations within an industry through their desire to gain market share. This in
turn puts pressure on prices, costs, and the rate of investment needed to sustain a business
within the industry. The threat of new entrants is particularly intense if they are diversifying
from another market as they can leverage existing expertise, cash flow, and brand identity
as it puts a strain on existing companies' profitability.
Few companies that have successfully diversified into another industry is ITC.
It was incorporated on August 24, 1910 under the name Imperial Tobacco Company of India
and changed its name to India tobacco company limited in the year 1974.
ITC, is one of those rare examples where the company has successfully diversified much
beyond its core business. The company, which started as a tobacco products manufacturer,
eventually expanded to hotels, paper and packaging, with agri-business and foods being
added recently.
While cigarettes continue to drive the profitability of the company, the other divisions are
witnessing decent growth. Its non-cigarettes FMCG business, which includes packaged
foods, personal care, education and stationery, and apparel, broke even last quarter, and is
currently the fastest growing vertical in ITC. Its other divisions, namely, paper, agri-business
and hotels, are also profitable, despite the current weak economic environment. And it still
continues to invest and grow in diverse business segments.
Barriers to entry restrict the threat of new entrants. If the barriers are high, the threat of
new entrants is reduced and conversely if the barriers are low, the risk of new companies
venturing into a given market is high. Barriers to entry are advantages that existing,
established companies have over new entrants. As A high threat of new entrance can both
make an industry more competitive and decrease profit potential for existing competitors.
On the other hand, a low threat of entry makes an industry less competitive and increases
profit potential for the existing firms.
There are many types of barriers to entry into a market. Some of these include:

a) Economies of Scale:
When manufacturing or selling at a large scale, companies are able to avail cost advantages
because per unit costs of the product fall. So the more the company produces in quantity
the more the benefit. When existing companies have this advantage, it can act as a barrier
to entry because a new entrant will have to try to match the scale to achieve the same cost
advantage as the existing company. This may not be possible at the initial stage.

b) Product differentiation:
If the product being sold by the existing company or companies is highly differentiated or
enjoys strong brand loyalty, then this can act as a strong barrier to entry. The new entrant
will have to invest in creating a product with newer and unique features and benefits that
surpass those offered by the old company. In addition, there will need to be strong efforts to
break existing brand loyalties and shift them to a new untested company.
 c) High Capital Costs:
If an industry requires huge capital investments at the onset, then this will act as a barrier
to entry for many of the potential entrants. Only those will attempt to enter the competitive
fray who have the resources to make this high initial investment.

d) Cost of Switching:
The cost associated with a consumer’s move from one company or product or another is
called the switching cost. If there are significant switching costs, then a new entrant may not
be able to create means of removing these. Or, they may have to offer significant advantage
to counter these switching costs at their own expense.
Airline frequent flyer programs are an example.
Or the most vibrant or the practical example can be of gym membership. When you switch
gym you need to take the membership of their gym and that membership fee is known as
switching cost which is pretty high and that’s why people don’t usually change their gyms
frequently.
e) Legal and Government Created Barriers:
Government and regulatory requirements such as permits and licenses may be a strong
barrier to entry. There may also be laws governing ways to conduct business that may
conflict with a company’s practices in other countries.
f) Barriers to Exit:
Interestingly, barriers to exit may act as a deterrent to entry by new companies. If a
company is unable to easily leave a competitive environment in case business does not work
out, then it will have to stay and compete even if that is a detrimental business practice. In
this case, the company may choose to not enter the market in the first place.

3. Power of Suppliers: The next factor in the five forces model addresses how
easily suppliers can drive up the cost of inputs. It is affected by the number of suppliers of
key inputs of a good or service, how unique these inputs are, and how much it would cost a
company to switch to another supplier. The fewer suppliers to an industry, the more a
company would depend on a supplier. As a result, the supplier has more power and can
drive up input costs and push for other advantages in trade. On the other hand, when there
are many suppliers or low switching costs between rival suppliers, a company can keep its
input costs lower and enhance its profits.
So let’s see what is bargaining power of suppliers
The Bargaining Power of Suppliers, one of the forces in Porter’s Five Forces Industry Analysis
Framework, it refers to the pressure that suppliers can put on companies by raising their
prices, lowering their quality, or reducing the availability of their products. This framework is
a standard part of business strategy.
The bargaining power of the supplier in an industry affects the competitive
environment and profit potential of the buyers. The buyers are the companies and the
suppliers are those who supply the companies.
The bargaining power of suppliers is one of the forces that shape the competitive landscape
of an industry and help determine the attractiveness of an industry.
Types of Suppliers
Depending on the industry, there are various types of suppliers. A list of types includes:

 Manufacturers and Vendors: Sell products to distributors, wholesalers, and retailers

 Distributors and Wholesalers: Purchase goods in medium/high quantity for sale to
retailers or local distributors
 Independent Suppliers / Independent Craftspeople: Sell unique products directly to
retailers or agents
 Importers and Exporters: Purchase products from manufacturers in one country
and export to a distributor in a different country
 Drop shippers: Suppliers of products for different kinds of companies

When is Bargaining Power of Suppliers High/Strong?

Let’s see with the example of diamond industry

The bargaining power of suppliers in the diamond industry can be considered very high.
Diamond industry is a perfect example where the suppliers have power over the buyers as
in the diamond industry the suppliers are very few in comparison to the buyers and hence
they enjoys a dominating power and they are also able to effect profitability and can raise
prices or limit the number of products they will sell.
These inputs however are very much affected by the external environment over which the
diamond dealers themselves have little control. The price of diamond can change wildly
because of geopolitical and other factors.
So here there are.
 Small number of suppliers relative to buyers
 Low dependence of a supplier’s sale on a particular buyer
 Switching costs of suppliers are low
 Substitutes are unavailable
 Buyer relies heavily on sales from suppliers

When is Bargaining Power of Suppliers is Low/Weak?

Let see with the example of Starbucks coffee suppliers
Bargaining Power of Starbucks Coffee’s Suppliers (Weak Force)
Starbucks Coffee faces the weak force or bargaining power of suppliers. The following
external factors contribute to the weak bargaining power of suppliers on Starbucks
Corporation:
1. Moderate size of individual suppliers (moderate force)
2. High variety of suppliers (weak force)
3. Large overall supply (weak force)
The moderate size of individual suppliers is an external factor that imposes a moderate
force on Starbucks. However, the high variety of suppliers weakens their bargaining power.
For example, suppliers have various strategies and competencies that they use to compete
against each other, with the aim of gaining more revenues by supplying more materials,
such as coffee beans, to Starbucks Corporation. The bargaining power of suppliers is further
weakened because of the large overall supply. For instance, there are many suppliers of
coffee and tea around the world. This external factor limits the influence of individual
suppliers.
So here there are.

 Large number of suppliers relative to buyers

 High dependence of a supplier’s sale on a particular buyer
 Switching costs of suppliers are high
 Substitutes are available
 Buyer does not rely heavily on sales from suppliers

4. Power of Buyers: Bargaining Power of Buyer's

The bargaining power of buyers is also described as the market of outputs. This force
analyzes to what extent the customers are able to put the company under pressure, which
also affects the customer's sensitivity to price changes. The customers have a lot of power
when there aren't many of them and when the customers have many alternatives to buy
from. Moreover, it should be easy for them to switch from one company to another.. Buying
power is low however when customers purchase products in small amounts, act
independently and when the seller's product is very different from any of its competitors.
The internet has allowed customers to become more informed and therefore more
empowered. Customers can easily compare prices online, get information about a wide
variety of products and get access to offers from other companies instantly.

The idea is that the bargaining power of buyers in an industry affects the competitive
environment for the seller and influences the seller's ability to achieve profitability. of these
things represent costs to the seller. A strong buyer can make an industry more competitive
and decrease profit potential for the seller. On the other hand, a weak buyer, one who is at
the mercy of the seller in terms of quality and price, makes an industry less competitive and
increases profit potential for the seller.

AN EXAMPLE OF BUYER POWER

A good example of when buyers have influence is insurance for a car, house, travel etc. A
buyer can bargain with an insurer wanting to increase their premiums if there are plenty of
other companies offering the same service cheaper. In fields such as insurance, companies
often promote introductory offers for new customers to encourage them to switch loyalties.

Buyer Power is High/Strong if:

• Buyers are more concentrated than sellers

• Buyer switching costs are low

• Threat of backward integration is high

• Buyer is price sensitive

• Buyer is well-educated regarding the product

• Undifferentiated product

• Buyer purchases product in high volume

• Substitutes are available

• Buyer purchases comprise large portion of seller sales

• Substitutes are available

 Buyer purchases comprise large portion of seller sales

Buyer Power is Low/Weak if:

• Buyers are less concentrated than sellers

• Buyer switching costs are high

• Threat of backward integration is low

 Buyer is not price sensitive

• Buyer is uneducated regarding the product

 Highly differentiated product

• Buyer purchases product in low volume

• Substitutes are unavailable

 Buyer purchases comprise small portion of seller sale

5. Threat of Substitute Products: Let me first clarify what a substitute is (and what it’s
not). It is not the same product from a different company. Buying petrol from a different
brand petrol station is not a substitute. Using a train to commute to work is a substitute for
using a car (on the transport dimension/industry). So substitutes satisfy the same
basic/economic need or utility using a different technology. The threat of substitutes is the
availability of other products that a customer could purchase from outside an industry. The
competitive structure of an industry is threatened when there are substitute products
available that offer a reasonably close benefits match at a competitive price. In this case,
price points are limited by the prices at which substitutes are available, thereby limiting the
amount of profitability that can be generated within an industry.

When there is a strong threat of substitutes, industry players must pay more attention to
operating in the most efficient manner possible; otherwise, their high cost structures will
interfere with profitability and may drive some firms out of business. When there is a
reduced threat of substitutes, industry players tend to be more lax with their cost controls,
resulting in higher prices charged to customers. Because there is little prospect of
competition from outside the industry, there is a higher potential for profits within the
industry. Thus, the firms tend to generate higher profits at the expense of their customers.

Let us take the example of Coca cola Produced by the Coca Cola Company, ‘Coke’ is an
extremely popular carbonated beverage sold all over the world. When it was invented in
the 19th century, the product was intended to be used as a medicine. It was later purchased
by a businessman, who used clever marketing to position it as a soft drink and eventually
led to the brand’s global position today. The number of substitutes of Coca-Cola products is
high. The main substitutes of Coca Cola products are the beverages made by Pepsi, fruit
juices, energy drinks, and other hot and cold beverages. There are several juices and other
kinds of hot and cold beverages as well as energy drinks in the global market. The switching
costs are low for the customers. Apart from it, the quality of the substitute products is also
generally good. Moreover, with increasing consciousness towards health, other beverage
industries are focusing on providing healthy drinks to consumers. So, based on all these
factors the threat from substitutes is strong.

Causes of threat of substitutes

So there are many situations or conditions in which the threat of substitutes is stronger
than usual. Some of these conditions are:

• Switching costs: If there are little of no switching costs for a consumer, then there is
more of a chance that they may explore and move over to a more attractive substitute. In
the absence of other factors such as brand loyalty or differentiation, the choice to move will
not be a difficult one. For example, if a consumer wants to replace cable subscriptions with
online streaming site subscription, they may be able to do so easily.

• Product Price: If substitutes are priced more reasonably, then there may be more risk of
consumers switching products.

• Product Quality: If the quality of substitute products is higher than that of any product,
then it is more likely that consumers will want to make use of this difference and switch
over.

• Product Performance: If a substitute products functions at the same level or at a better

level than a product then there is a chance that consumers will want to switch over. For
example, in travelling short distances, if an airline’s flights are always delayed, while a train
or bus is on time, customers may choose to travel by road.

So now How to Reduce the Threat of Substitutes??? There are a number of ways in which a
company can mitigate the threat of substitutes. For example, it can inspire brand loyalty
through its marketing efforts, product quality, and support services. Or, it can focus intently
on specific market niches, so that the value it offers to customers within those niches
exceeds the value that customers can obtain from substitutes. Another possibility is to
identify those customers who are most likely to shift to substitutes, and target them for
enhanced service and marketing efforts, so that they are aware of the particular value that
the organization brings to them.

Case study
Ok so now let us understand the porters 5 forces model and analyse each forces with a case study of
airline industry to illustrate it’s usage:

Threat of new entrants :

The threat of new entrants in the airline industry can be considered as low to medium. It
takes quite some upfront investments to start an airline company (e.g. purchasing aircrafts).
Moreover, new entrants need licenses, insurances, distribution channels and other
qualifications that are not easy to obtain when you are new to the industry (e.g. access to
flight routes). Furthermore, it can be expected that existing players have built up a large
base of experience over the years to cut costs and increase service levels. A new entrant is
likely to not have this kind of expertise, therefore creating a competitive disadvantage right
from the start. However, due to the liberalization of market access and the availability of
leasing options and external finance from banks, investors, and aircraft manufacturers, new
doors are opening for potential entrants. Even though it doesn’t sound very attractive for
companies to enter the airline industry.

Bargaining power of buyers :

Bargaining power of buyers in the airline industry is high. Customers are able to check prices
of different airline companies fast through the many online price comparisons websites . In
addition, there aren’t any switching costs involved in the process. Customers nowadays are
likely to fly with different carriers to and from their destination if that would lower the costs.
Brand loyalty therefore doesn’t seem to be that high. Some airline companies are trying to
change this with frequent flyer programs aimed at rewarding customers that come back to
them from time to time.

Threat of substitute product :

In terms of the airline industry, it can be said that the general need of its customers is
traveling. There are substitutes in the airline industry. Consumers can choose other form of
transportation such as a car, bus, train, or boat to get to their destination. There is however
a cost to switch. Some means of transportation can be more costly than a plane ticket. The
main cost is time. Planes are by far the fastest form of transportation available. Airlines
surpass all other forms of transportation when it comes to cost, convenience, and
sometimes service. Consumers do sometimes choose other methods for various reasons
such as cost if they are not traveling very far which raises the risk.

The bargaining power of suppliers

The bargaining power of suppliers in the airline industry can be considered very high. When
looking at the major inputs that airline companies need, we see that they are especially
dependent on fuel and aircrafts. These inputs however are very much affected by the
external environment over which the airline companies themselves have little control. The
price of aviation fuel is subject to the fluctuations in the global market for oil, which can
change wildly because of geopolitical and other factors. In terms of aircrafts for example,
only two major suppliers exist: Boeing and Airbus. Boeing and Airbus therefore have
substantial bargaining power on the prices they charge.

Rivalry among existing competitors

When looking at the airline industry in the India , we see that the industry is extremely
competitive because of a number of reasons which include the entry of low cost carriers,
the tight regulation of the industry wherein safety become paramount leading to high fixed
costs and high barriers to exit, and the fact that the industry is very stagnant in terms of
growth at the moment. The switching costs for customers are also very low and many
players in the industry are similar in size leading to extra fierce competition between those
firms. Taken altogether, it can be said that rivalry among existing competitors in the airline
industry is high
Taken this altogether, the threat of substitutes in the airline industry can be considered at
least medium to high.

Michael Porter’s Theory of Competitive Advantage of Nations

In a world of increasingly global competition, nations have become more, not less,
important. As the basis of competition has shifted more and more to the creation and
assimilation of knowledge, the role of the nation has grown. There are striking differences in
the patterns of competitiveness in every country; no nation can or will be competitive in
every or even most industries. Ultimately, nations succeed in particular industries because
their home environment is most forward-looking, dynamic, and challenging.

Michael Porter’s Diamond Model (also known as the Theory of National Competitive
Advantage of Industries) is a diamond-shaped framework that focuses on explaining why
certain industries within a particular nation are competitive internationally, whereas others
might not. And why is it that certain companies in certain countries are capable of
consistent innovation, whereas others might not. Its major components include:

1. Factor Conditions. The nation’s position in factors of production, such as skilled labour or

good infrastructure, scientific knowledge base etc, along with continuous upgradation of
resources are necessary to compete in a given industry.

2. Demand Conditions. The home demand largely affects how favourable industries within a
certain nation are. A larger market means more challenges, but also creates opportunities to
grow and become better as a company. The presence of sophisticated demand conditions
from local customers also pushes companies to grow, innovate and improve quality.

3. Related and Supporting Industries. The presence of related and supporting industries

provides the foundation on which the focal industry can excel. A nation’s companies benefit
most when suppliers themselves are, in fact, global competitors. It can often take years of
hard work and investments to create strong related and supporting industries that assist
domestic companies to become globally competitive.

4. Firm Strategy, Structure, and Rivalry. The national context in which companies operate
largely determines how companies are created, organized and managed: it affects their
strategy and how they structure themselves. Moreover, domestic rivalry is instrumental to
international competitiveness, since it forces companies to develop unique and sustainable
strengths and capabilities.  In the end, this will only help companies when entering the
international arena.

Hence, these 4 determinants create the national environment in which companies are born
and learn how to compete. 

Role of the government

The role of the government in Porter’s Diamond Model is described as both ‘a catalyst and
challenger‘. Porter doesn’t believe in a free market where the government leaves everything in the
economy up to ‘the invisible hand’. However, Porter doesn’t see the government as an essential
helper and supporter of industries either. Governments cannot create competitive industries; only
companies can do that. Rather, governments should encourage and push companies to raise their
aspirations and move to even higher levels of competitiveness. This can be done by stimulating early
demand for advanced products; focusing on specialized factor creations such as infrastructure, the
education system and the health sector; promoting domestic rivalry by enforcing anti-trust laws; and
encouraging change.

Case Study of Germany’s luxury high power car manufacturing industry

An example where Porter’s Diamond can be used to explain a regional advantage is in

Germany’s luxury high power car manufacturing industry, for brands such as Audi.

The car manufacturing industry in German has a regional advantage because it satisfies the
four key factors in Porter’s Diamond. With firm strategy and rivalry, we see that there is
strong rivalry amongst lots of car manufacturers and so they compete intensely and keep
developing more innovative and quality products.

There are also related and supporting industries such as the iron and steel industry which
provide materials for car manufacturers, high level of education and training in the
workforce, banks for capital, component suppliers and IT infrastructure.

There are certain demand conditions amongst the homebuyers. In parts of Germany, there
are no speed limits, so the sophisticated homebuyers want more powerful cars.
Consequently, the industry aims to cater for this particular need by developing innovative
engines.

There are also factor conditions, which include skilled engineers from renowned German
universities and the government’s focus on scientific research, which helps to push the car
manufacturing industry.

The government has played a major role in creating the regional advantage as it supported
and funded scientific research and launched the construction of more roads and canals in
the 19th century. By, satisfying all these factors in Porter’s Diamond it, therefore, helps to
explain why Germany’s luxury high power car manufacturing industry