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5 – FORCES

The tool was created by Harvard Business School professor Michael Porter, to analyze an industry’s attractiveness and likely profitability.

 

Since its publication in 1979, it has become one of the most popular and highly regarded business strategy tools.

 

The Five Forces model can help businesses boost profits, but they must continuously monitor any changes in the five forces and adjust their business strategy.

 

Porter’s five forces are:

  1. Competition in the industry
  2. Potential of new entrants into the industry
  3. Power of suppliers
  4. Power of customers
  5. Threat of substitute products

 

Understanding Porter’s Five Forces and how they apply to an industry, can enable a company to adjust its business strategy to better use its resources to generate higher earnings for its investors.

 

Competition In The Industry

The competition, especially when they are large in number, can hamper and undercut the growth of a company. Aside from the number of competitors, the number of equivalent products and services they offer could also lessen the power of a company. If the prices of the competition are lower compared to a company, buyers and suppliers eventually buy from the competition. Conversely,  when competitive rivalry is low, a company has greater power to charge higher prices and set the terms of deals to achieve higher sales and profits.

 

Potential Of New Entrants Into An Industry

The level of barrier for new entrants to scale into a market could also affect a company’s power. If it cost the competition less time and money to enter a company’s market, that company’s market position could be significantly weakened. That’s why it’s more advantageous to existing companies for an industry to establish strong barriers to entry, because the company will be able to charge higher prices and negotiate better terms.

 

Power Of Suppliers

This factor touches upon the ease of suppliers inflating the cost of inputs. The power of supplies in the forces strategy can be affected by a) the number of suppliers of key inputs of a good or service. b) how unique these inputs are. c) how much it would cost a company to switch to another supplier. An industry with few suppliers makes companies more dependent on these suppliers and as a result, the suppliers have the power to add to costs and push for other advantages in trade. Conversely, when there is a large number of suppliers, companies within that industry can keep its input costs lower and optimize profits.

 

Power Of Customers

Customers also have the ability to drive prices up or down and this can be affected by the number of buyers or customers a company has, the significance of each customer and how much it would cost a company to find new customers or market for its product. A company with a small base of independent customers can easily charge higher prices to increase profitability.

 

Threat Of Substitutes

The last of the five forces focuses on substitutes and is quite similar to the force of competition. Substitute goods or services that can be used in place of a company’s products or services pose a threat. Companies that produce goods or services for which there are no close substitutes will have more power to increase prices and secure more favorable terms. The availability of close subtitutes can weaken a company’s power because customers will have the option to forgo buying a company’s product.

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