Business strategists’ primary function in companies is their ability to understand competition and create plans to cope with such. The five competitive forces Michael Porter discusses in his article are the threat of new or potential entrants, negotiating power of suppliers, bartering power of customers, threat of substitute products and/ or services and competition among direct rivals.
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An industry’s structure is characterized by the comprehensive competition of the five forces. These forces also outline the temperament of aggressive interaction within an industry. It is important for company strategists to have a thorough understanding of the five forces in order for them to plan out strategies for the company.
In understanding the five competitive forces, the company will be able to “reveal the roots of an industry’s profitability and provide framework for anticipating and influencing competition and profitability” (Porter, 2008). Understanding a given industry’s structure is also essential in the positioning of a company.
The industry structure determines the strength of the five forces. Such is characterized by the economy and technological advancement (Porter, 2008). The five forces which shape strategy differ from industry to industry with regards to their configuration. Evaluating and analyzing the five forces may enable companies to understand the challenges present in the industry. The first force is the threat of new players in the industry.
The presence of new entrants affects the industry’s prices, costs and rate of investments. “New entrants bring new capacity and desire to gain market share. This force puts a cap on the profit potential of an industry” (Porter, 2008). Entry barriers and the reactions of incumbents determine the competition and profitability of an industry.
Industry incumbents have an advantage through the seven entry barriers which are supply-side economies of scale, demand-side benefits of scale, capital requirements, incumbency advantages independent of size, unequal access to distribution channels and restrictive government policy.
In planning out company strategies, managers must take into consideration the relationship of entry barriers and potential players’ capabilities. The second force which affects strategy is the power of suppliers where “they try to gain more value for themselves by charging higher prices, limiting quality or services or shifting costs to industry participants” (Porter, 2008).
Another force is the power of buyers where customers tend to coerce sellers in lowering product prices, demanding superior quality and services. Customers can influence the increase of costs at the expense of the profitability of an industry. The fourth force is the threat of substitutes.
Substitutes can threaten the profitability of an industry for they can act as an alternative when a customers are not satisfied with a given product. Lastly, the rivalry among existing competitors is the fifth force which shapes competition. These rivalries can be manifested in different forms such as price competition, product innovations, marketing and advertising campaigns and improvements of services.
Profitability of industries is limited when rivalry among industry players is high. “The degree to which rivalry drives down an industry’s profit potential depends on the intensity which companies compete and the basis on which they compete” (Porter, 2008). An industry’s profit potential is determined by the industry structure.
Understanding the five forces enables companies to regulate how economic value is created in the industry. Strategists must consider the five forces in keeping the overall industry structure in mind and must focus on structural conditions.
Aside from the five forces, strategists must also take into consideration factors which affect industries namely the growth rate of the industry, technology and innovation, government policies and complementary products and services.
An evaluation of an industry’s forces and factors may provide an understanding that industry structure constantly undergoes adjustments and such can change sporadically. Changes in the industry can originate from within the industry or it can be attributed to factors outside the industry. The outcomes of the changes in the industry can be an advantage or a disadvantage.
The importance of understanding the five factors enables strategists to identify the framework of the industry thus they can expect such developments and anticipate the impacts of such changes in the industry’s profitability. Such changes may include the shifting threat of new entry, changing supplier or buyer power, shifting threat of substitution and new bases of rivalry.
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The thorough understanding of forces, factors and changes in the industry allows strategists to plan out how companies should position themselves, exploit industry change, shape industry structure and define the industry. In developing strategy, it is essential to have a clear understanding of the forces which shape the competition of a given industry.
The five forces expose the profitability of an industry and a thorough understanding of such together with the factors affecting the industry as well as the changes brought about justify such profitability. The five forces expose the most important features of an industry’s competitive environment.
A detailed understanding of the forces enables strategists to determine the standard strengths and weaknesses of a company in a given industry. The knowledge of industry structure helps managers shape strategies for companies to compete in the market.
Porter, Michael. “The Five Competitive Forces that Shape Strategy.” Harvard Business Review January (2008): 78 – 93. Web.