Clearly, there is a direct link between an attractive industry and the threat of new entrants: If an industry is perceived as attractive, new entrants are likely to appear. A larger number of competitors in turn will lead to lower profitability across the industry, which in turn may lower the attractiveness again. If customers can easily substitute your product or service for another, the threat of substitutes is high.
This is not the same as switching to a different company with the same offering, but switching products entirely. For example, Pepsi is not a substitute to Coca Cola, but for somebody seeking primarily a caffeinated drink, coffee or green tea may be a substitute. The more products fulfilling the same need there are, the higher the chances your customers will be drawn to a substitute. How to confront this? Every company has suppliers, whether for raw materials, knowledge support or whatever else.
Often, a lot of research and consultation is necessary to attain the best suppliers at the best price. For some companies, the choice of supplier has a significant impact on the business result, due to specialist knowledge, technology, quality, or simply prices.
For others, just about any of the available suppliers may do the job. But what if there is very little choice of suppliers? Marketers should consider:. Also the customers can have power over the company. This is the case whenever they can exert pressure to companies, in particular pressure to lower their prices.
Like any new entrant, upstarts in the textbook business must prove that they can execute their strategies before they can gain widespread acceptance. Overall, when analyzing the profit potential of their industry, executives must carefully consider whether buyers have the ability to demand lower prices. In the textbook market at the moment, most buyers do not. Every industry is unique to some degree, but some general characteristics help to predict the likelihood that buyers will be powerful relative to the firms from which they purchase goods and services.
Finally, buyers possess power to the extent that they have the ability to become a new entrant to the industry if they wish. This strategy is called backward vertical integration , a strategy that involves a buyer entering the industry that it purchases goods or services from. TiVo was the pioneer of digital video recorders.
This situation changed, however, when media providers grew weary of their relationship with TiVo. The media companies then used a backward vertical integration strategy and started offering their own branded digital video recorders, often bundled with a range of services.
Profits that used to be enjoyed by TiVo were transferred at that point to the media companies. Five forces analysis is useful, but it has some limitations too. The description of five forces analysis provided by its creator, Michael Porter, seems to assume that competition is a zero-sum game, meaning that the amount of profit potential in an industry is fixed.
One implication is that if a firm is to make more profit, it must take that profit from a rival, a supplier, or a buyer. In some settings, however, collaboration can create a larger pool of profit that benefits everyone involved in the collaboration. In general, collaboration is a possibility that five forces analysis tends to downplay.
The relationships among the rivals in an industry, for example, are depicted as adversarial. In reality, these relationships are sometimes adversarial and sometimes collaborative. General Motors and Toyota compete fiercely all around the world, for example, but they also have worked together in joint ventures.
Indeed, concepts such as just-in-time inventory systems depend heavily on a firm working as a partner with its suppliers and buyers. Five forces analysis provides an answer to this question.
Bianco, B. Is Wal-Mart too powerful? Bloomberg Businessweek. Neff, J. Advertising Age. Porter, M. How competitive forces shape strategy. Harvard Business Review , — Understanding the dynamics that shape how much profit potential exists within an industry is key to knowing how likely a particular firm is to succeed within the industry.
There are five key forces that determine the profitability of a particular industry. Industry concentration refers to the extent to which large firms dominate an industry. Buyers and suppliers generally have more bargaining power when they are from concentrated industries. This is because the firms that do business with them have fewer options when seeking buyer and suppliers. One popular way to measure industry concentration is via the percentage of total industry output that is produced by the four biggest competitors.
Below are examples of industries that have high 80 percent to percent , medium 50 percent to 79 percent , and low below 50 percent levels of concentration. The Great Wall of China effectively protected China against potential raiders for centuries. Industries with higher barriers to entry are in a safer defensive position than industries with lower barriers. Below we describe several factors that make it difficult for would-be invaders to enter an industry.
A substitute teacher is a person who fills in for a teacher. In business the competitors in an industry not only must watch each other, they firms in other industries whose products or services can serve as effective substitutes for their offerings. Below we note a number of effective substitutes for particular industries. A number of characteristics that impact the power of suppliers to a given industry are illustrated. Skip to content Chapter 3: Evaluating the External Environment. Explain how five forces analysis is useful to organizations.
Be able to offer an example of each of the five forces. Rivalry among existing competitors tends to be high to the extent that… Competitors are numerous or are roughly equal in size and power. As such, no one firm rules the industry, and cutthroat moves are likely as firms jockey for position. The growth rate of the industry is slow. Competitors are not differentiated from each other.
This forces firms to compete based on price rather than based on the uniqueness of their offerings. Fixed costs in the industry are high. These costs must be covered, even if it means slashing prices in order to do so. Exit barriers are high. Firms must stay and fight rather than leaving the industry gracefully. Excess capacity exists in the industry. When too much of a product is available, firms must work hard to earn sales.
Capacity must be expanded in large increments to be efficient. The high costs of adding these increments needs to be covered. The product is perishable. Firms need to sell their wares before they spoil and become worthless. A large market is attractive because customers already know the value of the products or services the companies in the market provide.
Evaluate the number and strength of competitors. Consider the likelihood of new competitors entering your market. With some businesses, it is difficult to establish barriers to competitive entry, meaning that you could find your company having to compete against an increasing number of businesses in order to retain your customers and build market share. Gauge your excitement about the business. Most business owners have to put in long hours to make the company a success.
Choose a venture in which you will enjoy going to work each day, one where you find the strategic challenge of building the business exciting. Analyze the financial metrics of the business.
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