The previous article discussed about the Diamond
Theory introduced by the famous strategist Michael Porter. In this article too
yet another theory put forward by him will be discussed. This strategy is known
as the Five Forces Theory.
Five Forces Theory – Michael Porter
Unlike Generic Strategy and Diamond Theory, this
model focuses on industry competition and developing business strategy on an
industry level. This theory talks about five aspects of the industry which the
business should be aware of and take into account when developing business
strategy.
- Bargaining Power of Customers
- Bargaining Power of Suppliers
- Threat of New Entrants
- Threat of Substitutes
- Rivalry
Bargaining Power of Customers
This focuses on the bargaining power of customers
within the industry as a whole. Bargaining power means the ability to influence
the price of a product. Higher the bargaining power, the higher the influence
of the customers will be and hence the lower the prices will get. A single
customer cannot affect the market price in a general industry. However when
customers get organized, unionized or when customers are backed up by
government institutions, their bargaining power becomes much more intense. Hence
businesses will have to be aware of the nature of the influence of the
customers when setting strategy.
Bargaining Power of Suppliers
This means the bargaining power of suppliers.
Bargaining power is the same concept as mentioned above and the only difference
is that in this aspect, the influence of suppliers is considered. Naturally one
supplier cannot influence the market price but when they are organized their
power is more. They can organize and create artificial shortages of products
and drive the prices up. Hence the business has to strategize to face such
situations.
Threat of New Entrants
This is where the business has to focus on the new
competition that generated through new businesses entering the industry. The
more businesses are in one industry, the more competition will occur. A
considerable level of competition is good for both the businesses and the
customers. Customers will be able to enjoy competitive prices whereas
businesses will be forced to be innovative and implement cost reduction
practices. However very strong competition is not beneficial. Businesses will
lower their prices further and further in order to attract customers and will
come to a level where the business cannot cover its daily expenses. That will
force the business to liquidate.
Threat of Substitutes
This is where the business has to focus on the
substitute products available beyond the industry. All products can be
considered to be substitutes within and industry, and that’s what makes it an
industry. However this aspect focuses on the likely substitutable products
outside of the industry. For an example rice could be identified as a
substitute for bread, although paddy cultivation and bakery industry are
entirely two different industries.
Rivalry
This merely focuses on the competition within the
industry. Higher the competition the more strategic businesses will have to be,
the more innovative and more differentiated.
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