Question

How powerful are the buyers, suppliers, and substitutes? How formidable are the barriers to entry and how intense is the rivalry among existing firms?

Answer 1

Introduction

Power of suppliers and buyers along with the threat of substitute, entry barrier and rivalry are the five factors covered by 'Porter's Five Forces' and are the major determining factors of influencing the industry by competition and its impact on profitability.

Porter's Five Factors

This analysis tool is to understand the competitve position of an industry in the existing business environment.

An industry is attractive if the following situation prevails

1. The entry barrier for a new entrant is comparitively very high.

2. The bargaining power of suppliers is week

3. The bargaining power of buyers is weak.

3. Substitutes for the product/service is not much

4. Product differentiation is high

5. Low competition.

6. General economic condition is good

If all 6 factors mentioned above is just opposite to stated status, then that industry can be considered as unattractive.

Let us look into the factors mentioned by Potter.

1. Entry Barrier.

When the entry barrier of an industry is low, it is easy for a new entrant. If the profit is good the more new firms enter in to that industry then it will increase competition and decrease market share of each one and inturn the profit will drop by intensifying price war. This affects the industry badly. The major factors reducing entry barriers are low capital requirement, no patent protection for existing products, government regulations are week, products are easy to make with economies of scale and the customer loyalty is not present for the products. To keep the entry barrier high, the existing suppliers should have a voice in decisions and regulatory affairs.

2. Bargaining Power of Suppliers

If the demand is high and supply is low, naturally the bargaining power of the existing suppliers will be high. This is an unhealthy situation were the prices of products/services will go very high, supplier behaviour may grow arrogant and quality of the product and supply will deteriorate. This happens when the subtitutes are less, and resources are mainly controlled by existing suppliers. If the cost of switching to new raw material is high then also scope for a new entrant is less. The threat of foreward integration from the exisiting suppliers also is a real power to bargain.

3.Bargaining Power of Buyers

This situation arises when the buyers are of low in numbers, large buying quatities by each buyer, swithching cost to new suppliers are easy and the substitues are in plenty. So the market will be buyer sensitive and payment lead time will be comparitievely high. All these factors afect the profitability of the industry. Buyers will start asking superior product quality and that will again reduce profits. The industry becomes unattractive.

4.Threat of Substitutes

The presence of strong substitues and its availability in plenty make the inustry less attractive. Naturally if the buyers can get better quality substitutes for lower costs then the situation worsens.These situation can be changed only by innovative product development for better product differentiation, reduction of costs through reengineering the processes and adopting new technolgy etc. Creating more demand is also to be done parallely.

5.Rivalry among Competitors

This is one of the major forces affecting the health and profitability of the industry. One of the major factors which increases the rivalry among existing suppliers are big exit barrier from the industry. If there is a decrease in growth in the sector then there will be less demand and price drops below healthy levels. If the size of the firms existing in the industry then quality-price war will sustain for more time and the product differentiation goes down much more. This will agian make the brand loyalty to zero level. It may even make certain firms to play unethical games ant the industry will become completely unattractive.

Conclusion

Poter's five forces are the key elements determining the healthyness of any industry. Govenment regulations are one of the major factors controlling unhealthy competition and financial availabity in a country. Strong innovations has to be encouraged and funded by the Goverment and existing industry associations in order to create new products as well as to increase product differenciation. Strong consumer protection laws will keep a quality check of products and services. The above forcess have to have a balance for making an industry sector attractive and sustainable.