Tag Archives | competition

Threat of Substitutes (one of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Threat of New Entrants
Supplier Power
Buyer Bargaining Power
Intensity of Rivalry
Complementors (Sixth Force)

Threat of Substitutes Definition

Porter’s threat of substitutes definition is the availability of a product that the consumer can purchase instead of the industry’s product. A substitute product is a product from another industry that offers similar benefits to the consumer as the product produced by the firms within the industry. According to Porter’s 5 forces, threat of substitutes shapes the competitive structure of an industry.

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The threat of substitution in an industry affects the competitive environment for the firms in that industry and influences those firms’ ability to achieve profitability. The availability of a substitution threat effects the profitability of an industry because consumers can choose to purchase the substitute instead of the industry’s product. The availability of close substitute products can make an industry more competitive and decrease profit potential for the firms in the industry. On the other hand, the lack of close substitute products makes an industry less competitive and increases profit potential for the firms in the industry. A threat of substitutes example is the beverage industry due to a market with many competitors.

Threat of Substitutes – Determining Factors

Several factors determine whether or not there is a threat of substitute products in an industry. First, if the consumer’s switching costs are low, meaning there is little if anything stopping the consumer from purchasing the substitute instead of the industry’s product, then the threat of substitute products is high. Second, if the substitute product is cheaper than the industry’s product – thereby placing a ceiling on the price of the industry’s product – then a threat of substitutes high risk is the case. Third, if the substitute product is of equal or superior quality compared to the industry’s product, the threat of substitutes is high. And fourth, if the functions, attributes, or performance of the substitute product are equal or superior to the industry’s product. Any of these situations is a high threat of substitutes: porter’s 5 forces sees less profit potential.

On the other hand, if the substitute is more expensive, of lower quality, its functionality does not compare with the industry’s product, and the consumer’s switching costs are high, then a low threat of substitutes occurs. And of course, if there is no close substitute for the industry’s product, then the threat of substitutes is low.

Threat of Substitutes – Analysis

When analyzing a given industry, all of the aforementioned factors regarding the threat of substitutes may not apply. But some, if not many, certainly will. And of the factors that do apply, some may indicate high threat of substitutes and some may indicate low threat of substitute products. The results will not always be straightforward. Therefore, it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

The Threat of Substitutes Porter places High risk on:

• Consumer switching costs are low
• Substitute product is cheaper than industry product
• Substitute product quality is equal or superior to industry product quality
• Substitute performance is equal or superior to industry product performance

The Porter Threat of Substitutes Low Risk Situation:

• Consumer switching costs are high
• Substitute product is more expensive than industry product
• Substitute product quality is inferior to industry product quality
• Substitute performance is inferior to industry product performance
• No substitute product is available

Threat of Substitutes Interpretation

When conducting Porter’s 5 forces industry analysis, a low threat of substitute products makes an industry more attractive and increases profit potential for the firms in the industry, while high threat of substitute products makes an industry less attractive and decreases profit potential for the firms in the industry. The threat of substitute products is one of the factors to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework. Start creating a list of potential substitutes that you evaluate as a threat in an external analysis. With this analysis, you’ll be better able to identify and react to any threat of substitutes. Download the free External Analysis whitepaper by clicking here or the image below.

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Threat of New Entrants (one of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Supplier Power
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry
Complementors (Sixth Force)

Threat of New Entrants Definition

In Porters five forces, threat of new entrants refers to the threat new competitors pose to existing competitors in an industry. A profitable industry will attract more competitors looking to achieve profits. If it is easy for these new entrants to enter the market – if entry barriers are low – this poses a threat to the firms already competing in that market. More competition – or increased production capacity without concurrent increase in consumer demand – means less profit to go around. According to Porter’s 5 forces, threat of new entrants is one of the forces that shape the competitive structure of an industry. Porters threat of new entrants definition revolutionized the way people look at competition in an industry.

The threat of new entrants porter created affects the competitive environment for the existing competitors and influences the ability of existing firms to achieve profitability. A high threat of entry means new competitors are likely to be attracted to the profits of the industry and can enter the industry with ease. New competitors entering the marketplace can threaten or decrease the market share and profitability of existing competitors and may result in changes to existing product quality or price levels. An example of the threat of new entrants porter devised exists in the graphic design industry: there are very low barriers to entry.

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A high threat of new entrance can make an industry more competitive and decrease profit potential for existing competitors. On the other hand, a low threat of entry makes an industry less competitive and increases profit potential for the existing firms. New entrants are deterred by barriers to entry.

Barriers to Entry

Several factors determine the degree of the threat of new entrants to an industry. Many of these factors fall into the category of barriers to entry, or entry barriers. Barriers to entry are factors or conditions in the competitive environment of an industry that make it difficult for new businesses to begin operating in that market.

A high production-profitability threshold requirement, or economy of scale, is an entry barrier that can lower the threat of entry. Highly differentiated products or well-known brand names are both barriers to entry that can lower the threat of new entrants. Significant upfront capital investments required to start a business can lower the threat of new entrants. High consumer switching costs are a barrier to entry. When access to distribution channels is an entry barrier – if it is difficult to gain access to these channels, the threat of entry is low. Access to favorable locations, proprietary technology, or proprietary production material inputs also increase entry barriers and decrease the threat of entry.

And of course, if the opposite is true for any of these factors, barriers to entry are low and the threat of new entrants is high. For example, no required economies of scale, standardized or commoditized products, low initial capital investment requirements, low consumer switching costs, easy access to distribution channels, and no relevant advantages due to locale or proprietary assets all indicate that entry barriers are low and the threat of entry is high.

Other factors also influence the threat of new entrants. Expected retaliation of existing competitors and the existence of relevant government subsidies or policies can discourage new entrants. While no expected retaliation and the lack of relevant government subsidies or polices can encourage new entrants.

Threat of Entry Analysis

When analyzing a given industry, all of the aforementioned factors regarding the threat of new entrants may not apply. But some, if not many, certainly will. Of the factors that do apply, some may indicate a high threat of entry and some may indicate a low threat of entry. The results will not always be straightforward. Therefore it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

High Threat of entry of new competitors when:

• Profitability does not require economies of scale
• Products are undifferentiated
• Brand names are not well-known
• Initial capital investment is low
• Consumer switching costs are low
• Accessing distribution channels is easy
• Location is not an issue
• Proprietary technology is not an issue
• Proprietary materials is not an issue
• Government policy is not an issue
• Expected retaliation of existing firms is not an issue

Threat of New Entry is Low if:

• Profitability requires economies of scale
• Products are differentiated
• Brand names are well-known
• Initial capital investment is high
• Consumer switching costs are high
• Accessing distribution channels is difficult
• Location is an issue
• Proprietary technology is an issue
• Proprietary materials is an issue
• Government policy is an issue
• Expected retaliation of existing firms is an issue

Threat of New Entry of competitors Interpretation

When conducting Porter’s 5 forces industry analysis, a low threat of new entrants makes an industry more attractive and increases profit potential for the firms already competing within that industry, while a high threat of new entrants makes an industry less attractive and decreases profit potential for the firms already competing within that industry. The threat of new entrants porter’s 5 forces explained is one of the factors to consider when analyzing the structural environment of an industry. To continue to expand your analysis, download the free External Analysis whitepaper by clicking here .

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Supplier Power (one of Porter’s Five Forces)

See also:
Supplier Power Analysis
Porter’s Five Forces of Competition
Threat of New Entrants
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry

Supplier Power Definition

In Porter’s five forces, supplier power refers to the pressure suppliers can exert on businesses by raising prices, lowering quality, or reducing availability of their products. When analyzing supplier power, the industry analysis is being conducted from the perspective of the industry firms, in this case referred to as the buyers. According to Porter’s 5 forces industry analysis framework, supplier power, or the bargaining power of suppliers, is one of the forces that shape the competitive structure of an industry. The idea is that the bargaining power of the supplier in an industry affects the competitive environment for the buyer and influences the buyer’s ability to achieve profitability. Strong suppliers can pressure buyers by raising prices, lowering product quality, and reducing product availability. All of these things represent costs to the buyer. A strong supplier can make an industry more competitive and decrease profit potential for the buyer. On the other hand, a weak supplier, one who is at the mercy of the buyer in terms of quality and price, makes an industry less competitive and increases profit potential for the buyer.

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Supplier Power – Determining Factors

The supplier power Porter has studied includes several determining factors. If suppliers are concentrated compared to buyers – if there are few suppliers and many buyers – supplier bargaining power is high. If buyer switching costs – the cost of switching from one supplier’s product to another supplier’s product – are high, the bargaining power of suppliers is high. If suppliers can easily forward integrate – or begin to produce the buyer’s product themselves – supplier power is high. If the buyer is not price sensitive and uneducated regarding the product, supplier power is high. If the supplier’s product is highly differentiated, supplier bargaining power is high. If the buyer does not represent a large portion of the supplier’s sales, the bargaining power of suppliers is high. If substitute products are unavailable in the marketplace, supplier power is high.

And of course, if the opposite is true for any of these factors, supplier power is low. For example, low supplier concentration, low switching costs, no threat of forward integration, more buyer price sensitivity, well-educated buyers, buyers that purchase large volumes of standardized products, and the availability of substitute products. Each of the four mentioned factors indicate that the supplier power Porter’s five forces emphasize is low. To help determine the level of supplier power in your industry, start by performing an external analysis. This tool will easily help you determine the level of all of Porter’s Five Forces. Download the free External Analysis whitepaper by clicking here or the image below.

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Porter’s Five Forces of Competition

See also:
SWOT Analysis
Threat of New Entrants
Supplier Power
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry
Complementors (Sixth Force)
Marketing Mix (4 P’s of Marketing)

Porter’s Five Forces Definition

Porter’s 5 forces framework is used for strategic industry analysis. It was developed in 1979 by Michael Porter, Harvard Business School professor. Michael Porter’s five forces of competition can be used to examine and analyze the competitive structure of an industry by looking at 5 forces of competition that influence and shape profit potential. Porter’s five forces of competition have become a central concept to business theory.

Porter’s 5 forces industry analysis does more than look at a company’s direct competitors, it looks at multiple aspects of the industry’s competitive structure and economic environment, including the bargaining power of buyers, the bargaining power of suppliers, the threat of new entrants, and the threat of substitute products. The idea is to look at each of these factors and determine the degree to which they increase competition in the industry. If the forces are strong, they increase competition; if the forces are weak they decrease competition. Porter’s five forces definition can be utilized by any business and can be applied to any industry.

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The competitive environment of an industry has a strong influence on the performance of businesses within that industry. Porter’s five forces defined whether an industry is attractive or unattractive from the perspective of a company competing in that industry. Porter’s 5 forces of competition provide an excellent method to consider an industry before entrance.

An attractive industry is one which offers the potential for profitability. If a company uses Porter’s 5 forces industry analysis and concludes that the competitive structure of the industry is such that there is an opportunity for high profits, the company can elect to enter that industry or market. Or, if the company is already competing in that industry or market, it can use the competitive forces Porter created to determine its optimal position within the marketplace.

An unattractive industry is one which does not offer the potential for profitability. If a company uses the five forces Porter created and concludes that the competitive forces in the industry are too strong or unfavorable, that company may choose not to enter that industry or market. Or, if the company is already competing in that industry or market, it can use Porter’s 5 forces model to find the best possible strategic placement in it.

5 Forces of Competition

Michael Porter’s 5 competitive forces:

1. Threat of new entrants
2. Bargaining power of suppliers
3. Bargaining power of buyers
4. Threat of substitute products
5. Intensity of rivalry among competitors

Sixth Force

Sometimes a sixth force is added to the competitive forces Porter conceptualized. The model is called Porter’s Six Forces. The sixth force of competition is:

6. Complementors

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Porter’s Five Forces Example

Analyzing Porter’s five forces example does not always yield a simple or straightforward evaluation of the attractiveness and profitability of an industry. Some of the forces may be strong, increasing competition and decreasing profit potential, while other forces may be weak, decreasing competition and increasing profit potential. The results may be conflicting and the interpretation depends on the particular business and the particular industry. However, for the sake of simplicity, there is an overall attractive industry structure and an overall unattractive industry structure. Porter’s five forces model is merely a framework.

According to Michael Porter’s five competitive forces industry analysis, an attractive industry has the following characteristics. The threat of new entrants is low. The bargaining power of suppliers is weak. The bargaining power of buyers is weak. The threat of substitute products is low. The intensity of rivalry among industry competitors is low. Complementary products or services are unavailable. If Porter’s forces of competition are as described above, the industry is attractive and there is profit potential.

According to Porter’s 5 forces of competition, an unattractive industry has the following characteristics. The threat of new entrants is high. The bargaining power of suppliers is strong. The bargaining power of buyers is strong. The threat of substitute products is high. The intensity of rivalry among industry competitors is high. Complementary products or services are unavailable. If the forces of competition are as described above, the industry is unattractive and there is limited profit potential.

Porter’s Analysis – Attractive Industry

• Threat of entrants is low
• Threat of substitute products is low
• Bargaining power of buyers is low/weak
• Bargaining power of suppliers is low/weak
• Intensity of rivalry among existing firms is low

Porter’s Analysis – Unattractive Industry

• Threat of entrants is high
• Threat of substitute products is high
• Bargaining power of buyers is high/strong
• Bargaining power of suppliers is high/strong
• Intensity of rivalry among existing firms is high

Porter’s 5 Forces Strengths

Porter’s 5 forces of competition is a strong tool for conducting an in-depth analysis of the competitive structure of an industry. Porter’s 5 forces model can be used to complement a SWOT analysis. The 5 forces framework is useful in strategic planning and can help a company determine whether or not to enter an industry or market by evaluating the potential for profitability.

Porter’s 5 Forces Weaknesses

Porter’s 5 forces of competition have a few weaknesses and limitations. The model underestimates the influence of a company’s core competencies on its ability to achieve profit. It, instead, assumes the industry structure is the sole determining factor. Porter’s 5 forces definition is difficult to apply to large multinational corporations with synergies and interdependencies achieved from a portfolio of businesses. Additionally, the five forces framework assumes there is no collusion in the industry. Finally, Porter’s analysis doesn’t consider the possibility of creating a new market.

As you use Porter’s five forces of competition to shape profit potential, it’s important to expand analysis by evaluating the entire external environment. Download the free External Analysis whitepaper to overcome obstacles and be prepared to react to external forces..

Porter's Five Forces of Competition

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Porter's Five Forces of Competition

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Intensity of Rivalry (one of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Threat of New Entrants
Supplier Power
Buyer Bargaining Power
Threat of Substitutes
Complementors (Sixth Force)

Porter’s Intensity of Rivalry Definition

The intensity of rivalry among competitors in an industry refers to the extent to which firms within an industry put pressure on one another and limit each other’s profit potential. If rivalry is fierce, competitors are trying to steal profit and market share from one another. This reduces profit potential for all firms within the industry. According to Porter’s 5 forces framework, the intensity of rivalry among firms is one of the main forces that shape the competitive structure of an industry.

Porter’s intensity of rivalry in an industry affects the competitive environment and influences the ability of existing firms to achieve profitability. High intensity of rivalry means competitors are aggressively targeting each other’s markets and aggressively pricing products. This represents potential costs to all competitors within the industry.

High intensity of competitive rivalry can make an industry more competitive and decrease profit potential for the existing firms. On the other hand, low intensity of competitive rivalry makes an industry less competitive and increases profit potential for the existing firms.

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Porter’s Intensity of Rivalry Determining Factors

Several factors determine the intensity of competitive rivalry in an industry. If the industry consists of numerous competitors, Porter rivalry will be more intense. If the competitors are of equal size or market share, the intensity of rivalry will increase. If industry growth is slow, the intensity of rivalry will be high. If the industry’s fixed costs are high, competitive rivalry will be intense. If the industry’s products are undifferentiated or are commodities, rivalry will be intense. If brand loyalty is insignificant and consumer switching costs are low, this will intensify industry rivalry. If competitors are strategically diverse – they position themselves differently from other competitors – industry rivalry will be intense. An industry with excess production capacity will have greater rivalry among competitors. And finally, high exit barriers – costs or losses incurred as a result of ceasing operations – will cause intensity of rivalry among industry firms to increase.

And of course, if the opposite is true for any of these factors, the intensity of Porter rivalry among competitors will be low. For example, a small number of firms in the industry, a clear market leader, fast industry growth, low fixed costs, highly differentiated products, prevalent brand loyalties, high consumer switching costs, no excess production capacity, lack of strategic diversity among competitors, and low exit barriers all indicate that the Porter intensity of rivalry among existing firms is low.

Porter’s Intensity of Rivalry Analysis

When analyzing a given industry, all of the aforementioned factors regarding the intensity of competitive rivalry Porter placed among existing competitors may not apply. But some, if not many, certainly will. And of the factors that do apply, some may indicate high intensity of rivalry and some may indicate low intensity of rivalry. The results will not always be straightforward. Therefore it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

Intensity of Rivalry is High if…

• Competitors are numerous

• Competitors have equal size

• Competitors have equal market share

• Industry growth is slow

Fixed costs are high

• Products are undifferentiated

• Brand loyalty is insignificant

• Consumer switching costs are low

• Competitors are strategically diverse

• There is excess production capacity

• Exit barriers are high

Intensity of Rivalry is Low if…

• Competitors are few

• Unequal size among competitors

• Competitors have unequal market share

• Industry growth is fast

• Fixed costs are low

• Products are differentiated

• Brand loyalty is significant

• Consumer switching costs are high

• Competitors are not strategically diverse

• There is no excess production capacity

• Exit barriers are low

Porter’s Intensity of Rivalry Interpretation

When conducting Porter’s 5 forces industry analysis, low intensity of rivalry makes an industry more attractive and increases profit potential for the firms already competing within that industry, while high intensity of rivalry makes an industry less attractive and decreases profit potential for the firms already competing within that industry. The intensity of rivalry among existing firms is one of the factors to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework.

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buyer bargaining power

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buyer bargaining power

Sources on Porter’s Intensity of Rivalry

Harrison, Jeffrey S., Michael A. Hitt, Robert E. Hoskisson, R. Duane Ireland. (2008) “Competing for Advantage”, Thomson South-Western, United States, 2008.

Porter, M.E. (1979) “How competitive forces shape strategy”, Harvard Business Review, March/April 1979.

Porter, M.E. (1980) “Competitive Strategy”, The Free Press, New York, 1980.

Porter, M.E. (1985) “Competitive Advantage”, The Free Press, New York, 1985.

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Complementors (Sixth Force of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Threat of New Entrants
Supplier Power
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry

Porter’s Sixth Force Definition

Complementors, Porter’s sixth force, are companies or entities that sell or offer goods or services that are compatible with, or complementary to, the goods or services produced and sold in a given industry. Complementary goods offer more value to the consumer together than apart. When one product or service complements another there exists a condition called complementarity; a sort of commercial symbiosis. Complementors are often considered the sixth force of Porter’s industry analysis framework. The presence of Porter’s complementors can influence the competitive structure of an industry.

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Porter’s Complementors Analysis

Porter’s six forces provide a method for industry analysis. The presence of the sixth force of Porter, complementors, can benefit or hurt the firms competing in an industry, depending on the circumstances. If business is booming for the complementors, this could positively affect the business of the firms in the given industry. On the other hand, if business is slow for the complementors, this could adversely affect the business of the firms in the given industry. So, complementors and complementary goods do not necessarily increase or decrease the competitiveness of an industry, they merely add another layer to the structural complexity of the competitive environment.

Sixth force of Porter’s- Example

According to Porters six forces, complementary goods offer more value to the consumer together than apart. When one product or service complements another, there exists a condition called complementarity. For illustrative purposes, please consider the following complement examples.

A very simple example of complementary goods, the sixth force of Porter’s framework, is the hotdog and the hotdog bun. A normal consumer prefers to eat a hotdog in a hotdog bun. Rarely would a consumer purchase hotdogs without also purchasing hotdog buns, and rarely would a consumer purchase hotdog buns without also purchasing hotdogs. Under the six forces model Porter coined, these two products are complementary.

In the six forces of competition, an example of complementary industries is the tourism industry and the airline industry. When a consumer heads to a tourist destination, he or she often gets there on an airplane. Similarly, whenever a consumer travels on an airplane, that consumer is most likely going to visit a destination which is a part of the tourism industry, such as a hotel or a rental car agency. These two industries are proved complementary by the six forces analysis.

Porters sixth force has become a central theory to in business management. It is commonly discussed to this day. As you use Porter’s sixth force of competition to shape profit potential, it’s important to expand analysis by evaluating the entire external environment. Download the free External Analysis whitepaper to overcome obstacles and be prepared to react to external forces.

complementors

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