According to business strategy expert Michael Porter, "the essence of formulating competitive strategy is relating a company to its environment." The state of competition in an industry depends on five basic competitive "forces":
the threat of new entrants,
bargaining power of suppliers,
bargaining power of buyers,
threat of substitute products or services, and
rivalry among existing firms. The goal of competitive strategy for a business unit is to find a
position in the industry where the company can best defend itself
against these competitive forces or can influence these forces in its
favor. Porter's "Five Forces" framework is also widely used in evaluating the attractiveness or suitability of an industry for investment or entry, or the competitive standing of a particular player within an industry.
Threat of new entrants
New entrants inject substantial resources and bring new capacity to an industry, thus increasing competition and placing additional pressure on profitability among all players. The threat posed by new entrants primarily depends on the
barriers to entry that are present: the higher the barriers to entry, the lower the threat from new entrants. Major barriers to entry include economies of scale, product differentiation (brand identification and customer loyalties), capital requirements, switching costs, access to distribution channels, and cost disadvantages independent of scale (proprietary product technology, favorable access to raw materials, favorable locations, government subsidies, learning or experience curve, etc.), and government policy. Also, if existing competitors respond forcefully to make the entrant’s stay an unpleasant one, the entry may well be deterred: specifically, the threat of entry into an industry can be eliminated if incumbent firms price products and services low enough
Bargaining power of suppliers
Suppliers can exert bargaining power over participants in an industry by
threatening to raise prices or reduce the quality of purchased goods
and services.
A supplier group is powerful if: it is dominated by a
few companies; it
is not obliged to contend with other substitute products for sale to the
industry; the industry is not an important customer of the supplier
group; the suppliers’ product is an important input to the buyer’s
business; the supplier group’s products are differentiated or it has
built up switching costs; and finally, the supplier group poses a credible threat of
forward integration.
A firm can improve its situation through strategies such as enhancing
its threat of backward integration or eliminating switching costs.
Bargaining power of buyers
Buyers compete with the industry by forcing down prices, bargaining for
higher quality or more services, and playing competitors against each
other--all at the expense of industry profitability.
A buyer group is powerful if: it
is concentrated or purchases large volumes relative to seller sales; the
product it purchases from the industry represents a significant
fraction of the buyer’s costs or purchases; the products it purchases
from the industry are standard or undifferentiated; it faces few
switching costs; it earns low profits, and hence is highly price
sensitive and less loyal to a firm; the buyers pose a credible threat of
backward integration and can therefore demand bargaining concessions; the industry’s product is unimportant to the quality of the buyer’s
products or services; the buyer is well informed; and lastly, the
buyer can influence other buyer’s purchasing decisions.
A company can improve its strategic posture by finding buyers who posses
the least power to influence their profitability adversely.
Threat of substitute products or services
Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitable charge. Substitutes not only limit profits in normal times but these can also reduce the rewards an industry can reap in boom times.
Identifying substitute products is a matter of searching for other products that can perform the same function as the product of the industry. Substitute products that deserve the most attention are those that are subject to trends improving their price-performance tradeoff with the industry’s product, or are produced by industries earning higher profits.
Rivalry among existing competitors
Rivalry among existing competitors takes the familiar form of "jockeying
for position" or performing actions that aim to improve a player's
competitive position in the industry--using tactics like price
competition, advertising battles, product introductions, and increased
customer service and warranties. This occurs because one or more
competitors feel the pressure or see the opportunity to improve its
position in the industry. Intense rivalry may result from numerous or
equally balanced competitors, slow industry growth, high fixed or
storage costs, lack of differentiation or switching costs, over capacity
in the industry, and the diversity of competition. As such, the
intensity of rivalry in industries are often described using industry
classifications that range from "monopoly" (one player = no rivalry) to
"perfect competition" (many players = intense rivalry).
