Competition is an important part of the context in which many firms operate.

It is a
factor equally applicable to the input as well as the output side of business. The
effects of competition, whether from domestic organisations or from overseas firms
is significant at the macro as well as the micro level and its influence can be seen in
the changing structures of many advanced industrial economies (Worthington and
Britton, 2006). Therefore, how firms respond to these competitive challenges is an
important undertaking. This paper describes Michael Porter’s five forces of industrial
competition analysis.

According to Porter (1985), the five forces of industrial competition analysis

attempts to analyze the level of competition within an industry and business strategy
development. The analysis draws upon industrial organization economics to derive
five forces that determine the competitive intensity and therefore attractiveness of
an Industry. He goes on to say that, attractiveness in this context refers to the
overall industry profitability, whilst an “unattractive” industry is one in which the
combination of these five forces acts to drive down overall profitability. A very
unattractive industry would be one approaching “pure competition”, in which
available profits for all firms are driven to normal profit. Porter further notes that, the
collective strength of the five competitive forces determines the ability of firms in an
industry to earn, on average, rates of return on investment in excess of the cost of
capital. This is because these forces influence the prices, costs, and required
investment of firms in an industry, which happen to be the elements of return on
investment.

In 1985, Porter added that, the strength of the five forces varies from industry to
industry, and can change as an industry evolves. The result is that all industries are
not alike from the standpoint of inherent profitability. In industries where the five
forces are favorable, such as pharmaceuticals and soft drinks, many competitors
earn attractive returns. A simple reason could be that pharmaceuticals have certain
requirements that act as a barrier to anyone who may wish to join the industry. In
Zambia for instance, one need to be a part-time or full-time pharmacist duly
registered with Medical Council of Zambia (MCZ) and in possession of a valid
annual practicing license issued by MCZ, in order to qualify to manage the
operations of a pharmaceutical business. This, among other barriers offers
competitors in this industry an opportunity to earn attractive returns. On the other
hand, industries where pressure from one or more of the forces is intense, such as
grocery or food retail, few firms command attractive returns despite the best efforts
of management. One of the contributing factors to perfect competition in grocery
retail could be that new entrants find it easy to penetrate the industry.
Therefore, industry profitability is not a function of what the product looks like or
whether it embodies high or low technology, but of industry structure (Porter, 1985).

In another write up, Porter (2008) referred to these forces as the micro environment
factors. They consist of those forces close to a company that affect its ability to
serve its customers and make a profit. He further posits that a change in any of the
forces normally requires a business unit to re-assess the marketplace given the
overall change in industry information. The overall industry attractiveness does not
imply that every firm in the industry will return the same profitability. Firms are able
to apply their core competencies, business model or network to achieve a profit
above the industry average.

In any industry, whether it is domestic or international or produces a product or a

service, the rules of competition are embodied in five competitive forces: the entry
of new competitors, the threat of substitutes, the bargaining power of buyers,
the bargaining power of suppliers, and the rivalry among the existing
competitors (Porter, 1985). According to Porter, these five forces can be
categorized in 'horizontal' competition and 'vertical' competition. The horizontal
competition include; threat of substitute products or services, the threat of
established rivals, and the threat of new entrants, while the 'vertical' competition
include the two forces of bargaining power of suppliers and the bargaining power
of customers.

Threat of new entrants

Profitable markets that yield high returns will attract new firms. This results in many
new entrants, which eventually will decrease profitability for all firms in the industry.
According to Porter (1985), the threat of entry places a limit on prices, and shapes
the investment required to deter entrants. He further states that, unless the entry of
new firms can be blocked by incumbents (which in business refers to the largest
company in a certain industry), the abnormal profit rate will trend towards zero
(perfect competition). The energy or power utility industry in Zambia is one good
example where the rate of entry of new firms is low. According to a report by the
International Trade Administration (ITA), there are five main electricity generation
companies in Zambia: the state-owned Zambia Electricity Supply Corporation
(ZESCO) Limited; Copperbelt Energy Corporation (CEC); North-Western Energy
Corporation (NWEC); Lunsemfwa Hydro Power Company (LHPC); and Maamba
Collieries Limited. The Zambia Electricity Supply Corporation (ZESCO) which
happens to be the largest company in the energy industry is to a large extent a
barrier to new firms who may wish to join the industry. Thus, competition in this
industry is imperfect thereby, giving an opportunity to large companies like ZESCO
to enjoy huge profits. However, other factors like huge startup capital also deter new
entrants to the industry.
New entrants to an industry bring new capacity and a desire to gain market share
that puts pressure on prices, costs, and rate of investment necessary to compete.
Particularly when new entrants are diversifying from other markets, they can
leverage existing capabilities and cash flows to shake up competition. The threat of
entry, therefore, puts a cap on the profit potential of an industry.
According to Porter (2008), when the threat is high, incumbents must hold down
their prices or boost investment to deter new competitors. In the mobile money
industry, for example, relatively low entry barriers mean that business owners must
invest aggressively in modernizing their booths or outlets and ensure excellent
customer service. The threat of entry depends on the height of entry barriers that
are present and on the reaction entrants can expect from incumbents. If entry
barriers are low and new comers expect little retaliation from the entrenched
competitors, the threat of entry is high and industry profitability is moderated. It is
the threat of entry, not whether entry actually occurs, that holds down profitability.
Porter further posits that, an analysis of barriers to entry and expected retaliation is
obviously crucial for any company contemplating entry into a new industry. The
challenge is to find ways to surmount the entry barriers without nullifying through
heavy investment, the profitability of participating in the industry.

On the other hand, Porter (1985) notes that, some of the factors that can have an
effect on how much of a threat new entrants may pose include; the existence of
barriers to entry (e.g. patents, rights, etc.), government policy, capital requirements,
absolute cost, cost disadvantages independent of size, economies of scale,
economies of product differences, product differentiation and brand equity. Others
include switching costs, expected retaliation, access to distribution, customer loyalty
to established brands and Industry profitability (the more profitable the industry the
more attractive it will be to new competitors)
In Zambia for instance, formal businesses are required by law to have registered
with the Patent and Company Registration Agency (PACRA). They are also among
other requirements, required to obtain a trading license from the government local
authorities in order for them to operate. This is a barrier to some individuals whether
or not they may have attempted to obtain a certificate of incorporation from PACRA.
The most attractive segment is one in which entry barriers are high and exit barriers
are low. Few new firms can enter and non-performing firms can exit easily.
Government policies are indeed a factor that also determines how much of a threat
new entrants may pose. Some businesses such pharmaceuticals for instance are
required by the government through Zambia Medicines Regulatory Authority
(ZAMRA) to ensure that the personnel managing the operations of the business are
qualified pharmacists and in possession of the practicing license.

Threat of substitute products or services

The existence of products outside of the realm of the common product boundaries
increases the propensity of customers to switch to alternatives (Porter, 1985). For
example, ‘Frooty juice’ produced by Californian Beverages Limited and Fruiticana
produced by Big Tree Beverages Limited (a subsidiary of Trade Kings Limited) may
be considered as substitutes. The introduction of ‘Fruiticana’ on the market may
have posed a threat to Californian Beverages who produced a similar product
(Frooty). This may have actually increased the inclination or propensity of some
customers to switch from Frooty to Fruiticana. Therefore, the profitability of Frooty
may not have remained the same after the introduction of Fruiticana. Aggressive
marketing would help Californian Beverages to maintain the market share of its
product. The company might also consider rebranding the product. Another
example is the substitute of traditional phone with a smart phone. Almost everyone
is now switching from buying a traditional phone to replace it with a smart phone.
The market share for traditional phones has in the recent past declined due to the
increased demand for smart phones. Companies producing phones might for
instance consider investing in research and product differentiation in order to
maintain their market share in the industry. Pepsi and Coke are also substitutes that
customers might consider switching from one to the other.

According to Porter (1985), some of the potential factors that might trigger a threat
of substitute products or services include; buyer propensity to substitute, relative
price performance of substitute, buyer switching costs, perceived level of product
differentiation, number of substitute products available in the market, ease of
substitution, substandard product, quality depreciation and availability of close
substitute. It is thus important for every business or company to critically analyse
these factors in the industry where they operate. The results from the analysis may
be used to set up proper strategies that will help a company to remain competitive.
For instance, knowing the fact that customers are most of the times likely to switch
from one product to the other, it is important for any company to maintain the quality
of their products or services. This will not only retain customers, but the company is
likely to win the loyalty of its customers.
In instances where the price of the substitute product is lower than the common
product, customers are more likely to switch from the common product to the
substitute product. Thus, it is imperative for any business to monitor the prices of
substitute products or services and ensure that the quality and benefits of the
common product outlay those of the substitute product or service.

Bargaining power of customers (buyers)

Porter (2008) states that, the bargaining power of customers is also described as
the market of outputs: the ability of customers to put the firm under pressure, which
also affects the customer’s sensitivity to price changes. Firms can take measures to
reduce buyer power, such as implementing a loyalty program. The buyer power is
high if the buyer has many alternatives. The buyer power is low if they act
independently. If for instance, a large number of customers put their efforts together
and ask to make prices low, the company will have no other choice because of the
large number of customers’ pressure. However, in some industries the buyer power
is still high even when customers act independently. The retail clothing industry is
one good example where the buyer power is high despite customers acting
independently.
According to Porter (1985), buyer power influences the prices that firms can charge.
He also notes that, the power of buyers can influence cost and investment, because
powerful buyers demand costly service. Porter further identified the following
potential factors that influence buyer power; buyer concentration to firm
concentration ratio, degree of dependency upon existing channels of distribution,
bargaining leverage, particularly in industries with high fixed costs, buyer switching
costs relative to firm switching costs, buyer information availability, availability of
existing substitute products, buyer price sensitivity, differential advantage
(uniqueness) of industry products, and the total amount of trading.

Bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs.
Suppliers of raw materials, components, labor, and services (such as expertise) to
the firm can be a source of power over the firm when there are few substitutes. If for
example, company A is into the business of manufacturing and selling soft drinks
and company B is the only company selling sweetener, company A has no
alternative but to buy the sweetener from company B. Suppliers may refuse to work
with the firm or charge excessively high prices for unique resources. From the
example above, company A will only act as a price taker because company B has
all the power over the price of sweetener. Therefore, the bargaining power of
suppliers determines the costs of raw materials and other inputs.

On the other hand, Porter (2008) notes that, powerful suppliers, capture more of the
value for themselves by charging higher prices, limiting quality or services, or
shifting costs to industry participants. Powerful suppliers, including suppliers of
labor, can squeeze profitability out of an industry that is unable to pass on cost
increases in its own prices. Companies depend on a wide range of different supplier
groups for inputs. Porter adds that a supplier group is powerful if: i) it is more
concentrated than the industry it sells to. Microsoft’s near monopoly in operating
systems, coupled with the fragmentation of PC assemblers, exemplifies this
situation, ii). The supplier group does not depend heavily on the industry for its
revenues. Suppliers serving many industries will not hesitate to extract maximum
profits from each one. (Porter, 2008).

In 2008, Porter also suggested that some of the factors that can influence the
bargaining power of suppliers include; supplier switching costs relative to firm
switching costs, degree of differentiation of inputs Impact of inputs on cost or
differentiation, presence of substitute inputs, strength of distribution channel,
supplier concentration to firm concentration ratio, employee solidarity (e.g. labor
unions), supplier competition: the ability to forward vertically integrate and cut out
the buyer.

Intensity of competitive rivalry

For most industries the intensity of competitive rivalry is the major determinant of
the competitiveness of the industry. The intensity of rivalry influences prices as well
as the costs of competing in areas such as plant, product development, advertising,
and sales force (Porter, 1985).
Porter further suggests that sustainable competitive advantage through innovation is
one factor that determines the intensity of competition in an industry. Mobile network
providers in Zambia are a good example where competition through innovation has
contributed to the intensity of competitive rivalry in their industry. In the recent years
there has been a lot of innovation among MTN Zambia limited, AIRTEL limited and
ZAMTEL Plc. People are able to save money and enjoy some of the services
provided by banks. This kind of competitive innovation signifies that, the intensity of
competition in the mobile network industry is high.
In 1985 Porter also added that competition between online and offline companies
and the level of advertising expense are among factors that influence competition.
According to Porter, other potential factors include; powerful competitive strategy,
firm concentration ratio and degree of transparency.
In conclusion, the five forces determine industry profitability because they influence
the prices, costs, and required investment of firms in an industry. Buyer power
influences the prices that firms can charge, as does the threat of substitution. The
power of buyers can also influence cost and investment, because powerful buyers
demand costly service. The bargaining power of suppliers determines the costs of
raw materials and other inputs. The intensity of rivalry influences prices as well as
the costs of competing in areas such as plant, product development, advertising,
and sales force. The threat of entry places a limit on prices, and shapes the
investment required to deter entrants. Therefore, porter’s five forces of competition
can help any company to remain productive and competitive if well analysed and
applied.
References:

Guidelines on the establishment of a pharmaceutical business:

https://www.zamra.co.zm/pharmaceutical-license: Retrieved on 3rd

March, 2022.

International Trade Administration (ITA), 6 TH November, 2021. Zambia Country

Commercial Guide:

https://www.trade.gov/country-commercial-guides/zambia-energy :

Retrieved on 3RD March, 2021.

Porter, M. E. (2008). The Five Competitive Forces that Shape Strategy. Harvard
Business School Publishing Corporation: USA. ion

Porter, M. E. (1985). Competitive Advantage: Creating a sustaining superior

performance. The Free Press: New York.

Worthington, I. & Britton, C. (2006). The Business Environment: 5th Edition. Pearson
Education Limited: United Kingdom.