Porter’s Five Forces

Porter’s Five Forces looks at competition affecting your business from five different angles.

Porter’s Five Forces examine competition in an industry. He argues that 5 basic forces drive competition in an industry as above. These 5 forces need to be examined and understood if the nature of competition in an industry or sector is to be fully appreciated.

Competitive Rivalry

Examines the nature of competitive rivalry within a particular sector or industry. There are numerous factors affecting how fierce competitive rivalry is in an industry or sector and consequently how difficult the market is for organisations operating there. Key questions to examine concern who the present and potential competitors are and how intensive the competition is between them. Some industries have many competitor companies, all of a similar size and capacity, all holding comparable market shares and seeking to dominate their industry. There may be no dominant company(s) within the sector and little to distinguish between the brands and products available to consumers. The market may be established or mature with little prospect of major innovation or design surprises. In such an industry or sector, the intensity of competitive rivalry will be very high, as mature companies have to battle to retain market, sustain differentiation and maintain their customer base.

Economists measure rivalry by indicators of industry competition using the Concentration Ratio (CR) indicating the per cent of market share held by the four largest firms. A high concentration of market share indicates a high concentration of market share is held by the largest firms. With only a few firms holding a large market share, the competitive landscape is less competitive (closer to a monopoly). A low concentration ratio indicates competitive saturated market, with no dominating organisations.

If rivalry among firms is low, the industry is considered as disciplined, either resulting from its history of competition, role of a leading firm or informal compliance with a generally understood code of conduct.

Organisations can choose from several competitive moves to gain advantage over rivals:

 

• Changing prices for temporary change
• Improving product differentiation – improving features, implementing innovations in manufacturing process and in the product itself
• Creatively using channels of distribution – using vertical integration or using a distribution channel that is novel to the industry. selective market
• Exploiting relationships with suppliers e.g. if a firm is dominating a market segment they can set certain standards for product specifications and price.

Intensity is influenced by:

 

• A larger number of firms because more firms must compete for the same customers and resources. This intensifies further if firms have similar market share, leading to a struggle for market leadership.
• Slow market growth causes firms to fight for market share. In a growing market, forms are able to improve revenues simply because of the expanding market.
• High fixed costs result in an economy of scale effect that increases rivalry. When total costs are mostly fixed costs, the firm must produce near capacity to attain the lowest unit costs. Since the firm must sell this large quantity, high levels of production lead to a fight for market share and results.
• High storage costs or highly perishable products cause a producer to sell goods as soon as possible. Competition intensifies if other producers are attempting to unload the same time.
• Low switching costs – when a customer can freely switch from one product to another there is a greater struggle to capture and retain customers.
• Low levels of product differentiation are associated with higher levels of rivalry. Brand identification, on the other hand, tends to constrain rivalry.
• Strategic stakes are high when a form is losing market position or has potential for great gain.
• High exit barriers place a high cost on abandoning the product. High exit barriers cause a firm to remain in industry, even when the venture isn’t profitable. A common exit boundary is asset specificity. When the plant and equipment required for manufacturing a product is highly specialized, these assets cannot easily be sold to other buyers in another industry.
• Diversity of rivals with different cultures, histories and philosophies make an industry unstable. There is greater possibility for mavericks and for misjudging rivals moves.
• Industry shakeout – Occurs in a growing market and the potential for high profit induces new firms to enter a market where incumbent firms (largest company in an industry) to increase production. A point is reached where the industry becomes crowded with competitors and demand cannot support new entrants and resulting in increased supply. The industry may become crowded if its growth rate slows and the market becomes saturated, creating a situation of excess capacity with too many goods chasing too few buyers. A shakeout ensues with intense competition price wars and company failures.

Threat of Substitutes

Porter refers to substitute products in other industries whereas economists refer to how a products demand is affected by substitute products change in price. A products price elasticity is affected by substitute products i.e. as more substitute products become available, the demand becomes more elastic since customers have more alternatives. Close substitute products constrain firms being able to raise prices in industry.

Competition by threat of substitutes comes from products outside the industry. E.g. the price of aluminum cans is constrained by the price of glass, steel and plastic containers which are all substitutes, yet not rivals within the aluminum industry.

While the threat of substitutes typically impacts an industry through price change, there can be other concerns in assessing the threat of substitute’s e.g. different options of TV transmission, such as satellite, cable and telephone lines. The new technologies available and changing structure of entertainment media are contributing to competition among these substitute means of connecting the home to entertainment. Except in remote areas it is unlikely that cable TV could compete with free TV from aerial without the greater diversity of entertainment that it affords the customer.

Bargaining Power of Customers

The impact that consumers have on a producing industry. in general, when buyer power is strong the relationship with producing industry is near to what an economist calls menopsony – many suppliers and one buyer. Under such conditions the buyer sets the price.

Buyers are powerful if:

 

• Buyers are concentrated – there are few buyers with significant market share
• Buyers purchase a significant proportion of output – distribution of purchases or if the product is standardized.
• Buyers possess a credible backward integration threat – can threaten to but producing firms or rival.

Buyers are weak if:

 

• Producers threaten forward integration – producer can take over own distribution/retailing
• Significant switching costs – products not standardized and buyer cannot easily switch products
• Buyers are fragmented (many, different) – no buyer has any particular influence on product or price
• Producers supply critical portions of buyers input – distribution or purchases.

Bargaining Power of Suppliers

A producing industry requires raw materials – labour, components and other supplies. This requirement leads to buyer – supplier relationships between the industry and the firms that provide it the raw materials used to create products. Suppliers, if powerful can exert an influence on the producing industry, such as selling raw materials at a high price to capture some of the industry’s profits.

Suppliers are powerful if:

 

• Credible forward integration threat by suppliers
• Suppliers are concentrated
• Significant costs to switch suppliers
• Customers are powerful

Suppliers are weak if:

 

• Many competitive supplies – product is standardized
• Purchase commodity products
• Credible backward integration, threat by purchases
• Concentrated purchases
• Customers are weak

Threat of New Entrants

It is not only incumbent rivals that pose a threat to firms in an industry; the possibility that new firms may enter the industry also affects competition. In theory, any form should be able to enter and exit a market, and if free entry and exit exists, then profits always should be nominal. In reality, however industries possess characteristics that protect the high profit levels of firms in the market and inhibit additional rivals from entering the market known as barriers to entry.

Barriers to entry are unique industry characteristics that define the industry. Barriers reduce the rate of entry of new firms, thus maintaining a level of profits for those already trading within the industry from a strategic perspective; barriers can be created or exploited to enhance a firm’s competitive advantage.

Barriers to entry arise from several sources:

 

• Government creates barriers – preserve competition through anti-trust actions and restricting through granting of monopolies.
• Patent and propriety knowledge serve to restrict entry into an industry
• Asset specificity inhibits entry to an industry
• Organizational (internal) economies of scale i.e. the most cost effective level of production is formed Minimum Efficient Scale (MES)
• Barriers to exit limit the ability of a firm to leave the industry, a firm must compete.

 

Easy to enter if there is:

 

• Common technology
• Little brand franchise
• Access to distribution channels
• Low scale threshold

Difficult to enter if there is:

 

• Patented or proprietary know how
• Difficulty in brand switching
• Restricted distribution channels
• High scale threshold

Easy to exit if there are:

 

• Specialized assets
• High exit costs
• Interrelated businesses

In terms of utilising this essential business tool in the fashion industry, this is the perfect formula to assess your competitors and how they will impact on your success. Not only will Porter’s Five Forces assist your understanding of other designers you are in direct competition with, this model also helps you to analyse the power struggle between your business against your suppliers and buyers. If you have power over a selection of suppliers, possibly due to the concentration of either party, you will therefore have the power to negotiate costs with them to meet your requirements as they need your business more than you need them due to alternative suppliers availability, and likewise with buyers as above. Power in this instance therefore refers to the power either party has to discuss in terms of costs.