Michael Porter developed this model in the early 1980s as a structural tool to assess the attractiveness of any industry. Porter suggests that the attractiveness of and therefore the ability of businesses to compete in, any industry or segment is influenced by the action and interaction of five basic forces that make up any industry. Not every force will have influence on every industry or market, but when a force does have impact it will create its own effect and may also interact with the intensity of competition to generate a combined impact.
THE FIVE FORCES MODEL
Porter identified five factors that act together to determine the nature of competition within an industry. These are the:
1. The intensity of rivalry/ competition between existing competitors.
2. The threat of new entrants to the market, and the ease with which they can enter.
3. The threat of substitutes linked to the ease with which customers will be tempted to switch.
4. The bargaining power of suppliers and their ability to influence costs
5. The bargaining power of buyers (channel or end users) and their ability to influence price.
1. Intensity of rivalry / competition
The intensity of competition in any market or industry will have an impact on the attractiveness of the market or industry. If the greater the competitive rivalry, the harder it is for individual businesses that will achieve sales and profit objectives. However, if the competitive rivalry is lower, and competitors are reasonably content to share the market between them, so that it is easier to achieve sales and profit objectives. Competitive rivalry will be determined by:
a) Number of competitors
b) Relative dominance of competitors
c) Attitude or corporate commitment of competitors
d) The level of differentiation within the industry
e) The cost structures within the industry
f) The existence of high exit barriers
g) The stage of the product life cycle
h) Low buyer switching cost
i) Perishability of the product
• The greater the number of competitors fighting to gain a share of the available customers in any given market or industry, the harder each will need to work in order to convince customers to choose their product. A large number of firms increases rivalry because more firms must compete for the same customers and resources. The rivalry intensifies if the firms have similar market share, leading to a struggle for market leadership.
• In addition, it is suggested that if one or two firms are relatively dominant, competition tend to be less intense. The attitude or corporate commitment of competitors may override the general trend. For instance, in the soft drink market like Coca-Cola and Pepsi are by far the dominant brands, with all other competitors being significantly smaller. This does not stop intense competition between the two major brands, who also behave quite aggressively towards any smaller brand that may seen as a threat.
• The greater the differentiation the less likely competitors are to resort to price competition as they will be targeting different segments or sub-segments. The lower level of product differentiation is associated with higher levels of rivalry. Brand identification, on the other hand tends to constrain rivalry.
• Different cost structures will have different effects on competition. High fixed costs result in an economy of scale effect that increase 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 of product, high levels of production lead to a fight for market share and results in increased rivalry.