Michael Porters Five Forces Model - Example

Michael Porter’s Five Forces Model Name; Course; Tutor; Date; Michael Porter’s five forces model is a model that was developed by Michael E. Porter (a graduate of Harvard Business School) in 1979 as components of his complete strategic business and industry models. The other elements of Porter’s model are value chain and generic strategies. In this essay, we are going to look at Porter’s Five Forces model, see how it can be applied in the IT industry and criticize its usefulness. This five forces model was developed by Porter as a substitute for carrying out a SWOT analysis which he regarded to be ad hoc and unsuitable. The model was designed to be used for industrial analysis and for the development of strategic business decisions. It applies knowledge in industrial economics to come up with forces that form the basis of competitive intensity of a given market and hence determining the market’s attractiveness. In this case attractiveness refers to the industry’s profitability across the board. An industry is described as an unattractive one if the combination of these forces result in the decline in the overall profitability of the industry while an attractive industry I one where these forces combine to drive up the overall profitability of the industry. An industry will be deemed to be very unattractive if it is close to a situation of “pure competition” whereby all the firm’s profits are made to normal profit. Of the five forces, three are related to external competition while the remaining two forces are related to internal ones. These forces were referred to by Michael Porter as the company’s micro environment as they are forces that are lose to a given company affecting its immediate performance in terms of its ability to satisfactorily serve its customers and its ability to make a profit. Any variation to any of the five forces will usually compel a business unit to perform a reassessment of the whole market given the changes that have occurred in the industry’s information in general. An individual business unit’s profitability will not be equal to the industry’s average as firms are expected to use different methods in application of their business models and major competencies to achieve a profit that might be above the industry’s. For instance in an industry such as the housing industry, profitability across the industry might be low but you will find individual companies making high profits above the industry’s average because they have been able to apply distinctive business models that enable them to derive profits that are above the industry’s average (Porter, 2008). The five forces that were developed by Michael Porter for business or industrial analysis are: threat of substitute products, threat of already established competitors, threat of new entrants into the market, the bargaining power of suppliers and finally the bargaining power of consumers. The first three forces are from ‘vertical competition’ while the last two are from ‘horizontal competition’. This five forces model has been successfully applied in solving various problems ranging from increasing profitability of businesses to assisting governments to stabilize their country’s industries. We are going to take a deeper look at each of these five forces starting with the fist one: threat of substitute products (Porter, 1996). Substitute products and services just like the name suggests are those products and services that can be used in place of one another i.e. they can substitute each other. The threat of substitute product in Porter’s Model analyses the existence of substitute products or services in a business environment and the degree with which these products or services affect an individual business unit or a firm. The level of competition will increase with increase in substitute products or services. Due to their very nature substitute products substitute each other and thus a firm is faced with the threat of its customers switching from their product to the product of another firm hence lowering its profitability or attractiveness. The degree with which consumers might shift from one product to another is affected by a number of factors. The first one being price of the substitute product or service whereby the lower the price, the more likely it will attract more customers hence benefitting the company selling the substitute product in question. The second factor that affects consumer’s capacity to shift from one product to another is the buyers switching costs which is the cost associated with switching from one product to another. When the switching costs are high then more buyers will be discouraged from switching to a substitute product as the cot might outweigh the benefits of switching. Another factor that is associated with the treat of substitute products and services is the number of these substitutes available in the market. The higher the number of substitutes existing in a given market the higher the tendency of the customers to switch from one product to another thus decreasing in the stability of the market. The final factor associated with the threat of substitute products is the availability of information within the market. In markets where there is readily available information about substitute products, there is usually a high propensity of customers shifting from one product to another and vice – versa (Woodward, 1999). The second force that we are going to expound on is the threat of new entrants into the market. In any business environment, high profitability will always result in attraction of new players entering into this market with the hope of cashing in on the high profitability of the market. This entrance by new players will eventually result to a decrease in profitability across all the firms in the market and eventually the profits will tend towards zero a characteristic associated with perfect competition. The incumbent players usually have to take steps to avoid this situation from happening and these steps are referred to as barriers to entry. A market is deemed to be attractive if it has high entry barriers and low exit barriers thus few new players can enter the market and those that are non – performing can easily leave the market. Some of the factors that affect this threat are the overall profitability of the industry whereby the more profitable the industry is, the more firms will be attracted to invest in it. Another factor that has a direct bearing on this force is the capital required to venture into the industry. An industry that has high capital requirements for one to effectively invest in it will always attract fewer new entrants a s opposed to that whose capital requirements are low. Finally there is the aspect of customer loyalty to brands that are already established. A new entrant will always find it difficult to operate in a business environment where the customers are loyal to an already established brand as they will have to use a lot of resources to attract customers and this might end up not paying off. This already demonstrates to us how the threat of already established rivals affects the attractiveness of an industry as it will discourage new entrants and thus increasing the attractiveness of the industry to the incumbents but in the same breath, decreasing its attractiveness to new and potential entrants (Haman, 2007). The bargaining power of the customers is another one of Porter’s forces affect an industry’s attractiveness. The higher the bargaining powers of the customers the higher the customer’s ability to put the firm under pressure and their overall impact on the firm’s activities. Customers with a high bargaining power have the ability to greatly impact on the strategic decisions of the firm such as their pricing decisions and this might result in the reduction of a firm’s overall profitability. The bargaining power is affected by factors such as the availability of market information whereby customers who are better informed about the market will always have leverage over the firm which will increase their bargaining power. The availability of substitute products also affects the bargaining power of customers as they have the option of shifting to another firm’s product if the incumbent firm ignores their demands. The bargaining power of customers also increases with decrease in buyer volume and vice – versa. In a market where the buyers of a certain products are few, then these buyers have a greater bargaining power than in a market where they are many (Edmonds, 2007). Just like the case with the customers, the bargaining powers of suppliers also the impact of increasing its hold over the firm in a situation where the suppliers of the firm are few. Suppliers that supply the firm with input such as labor, raw materials and services like expertise might have a negative impact on the firm’s performance in terms of profitability through actions such as going on strikes in case of labor or suppliers charging unreasonably high prices for the limited resource. The bargaining power of suppliers is influenced by factors such as supplier switching costs whereby the cost of switching fro one supplier to another might be very high thus making the bargaining power of the existing suppliers to be high. Another factor that directly impacts on the bargaining power of suppliers is their concentration ratio in relation to that of the firms. Where the concentration ratio of suppliers is lower than that of the firm’s then this implies that there are only few available suppliers and these will make them more powerful. The degree of solidarity among a firm’s employees is another factor that the bargaining power of suppliers, in this case supply of labor. In firms where the employees have strong labor unions then these employees have more bargaining power over their (employers) firms (Lameck, 2002). As stated earlier, Porter’s Five Forces Model applies to basically each and every industrial sector. In this essay we are going to particularly look at how this model applies to the Information Technology industry. Information Technology is a dynamic industry and anybody intending to venture in this industry must be prepared to deal with this dynamism. Despite of the dynamic nature of the IT industry the world’s major players have remained relatively unchanged over an extended period of time. Some of the big time players such as Microsoft, Apple, IBM and Google have managed to dominate the industry for many years since they first ventured into this market. One obvious reason why some of this major players have managed to dominate the industry for so long is the fact that the start up cost of establishing an Information Technology firm that has the ability to rival them in terms of market share and capital is so high that most of the potential new entrants have to think twice before even considering the option of venturing into this market to the level that these established companies are. Another factor that has contributed to the prolonged domination of the global Information Technology market by these major players is the high quality of the products they produce. These major players have set high standards in the industry through the quality of their software and hardware products which due to economies of scale, they are able to produce at lower costs. A firm intending to enter the market and compete with theses big wigs will have to maintain these set standards and this might mean very high production costs for the firm in question. Due to the high production costs, the firm will be forced to sell the same products or even substandard ones as compared to those of the already established industries a fact that will not make any business sense to any one intending to compete with these major firms on a global scale (Robbins, 1998). Another factor that has contributed to the continued dominance of the already established players in this industry is the fact that most of them application of high switching costs that the major players have imposed on their customers. The two most major types of machines used for most of the IT functions at home or in the office environment are PCs and Apple computers. For clients using PCs, they mostly use the windows operating system as their major software while those using the Apple computers will mostly use an operating system developed for Apple computers. Therefore anyone wishing to change from one operating system to another, they will be forced to purchase another machine which will mean very high cost to the client. Other application software such as word processors might also be machine specific such that if any one wants to change the application software on their computers they will also have to purchase the software and the appropriate machine i.e. either a PC or an Apple one. This is a perfect example in which these companies apply high level of switching costs to tie customers to their products. In a nutshell, these companies that are considered the major or established players in the industry are operating in an attractive business environment according to the five forces described by Porter (Porter, 2008). Just like any other industry, the information technology industry has both its big and small players. From the previous discussion we have seen that this industry has been favorable to the big players. For the case of the small players, things are not so rosy. Most of the smaller firm are not involved with the earth shattering innovations we usually associate with the IT industry’s “big boys”, but they are mostly retailers of already developed hardware software products or they develop IT products but at a way smaller scale. When we come to this level of the market, the completion is very high because the market is constantly being bombarded by new entrants due to the relatively lower set up costs. At these lower levels, the threat of substitute products has greater effect as most of the retailers dealing with specific brands of IT products have to contend with competition from substitute goods. For instance most of the retailers of Microsoft’s Applications such as Microsoft Office software have to compete with open source applications such as Open Office which is actually being offered for free by open source companies. There is also the threat of the ever increasing bargaining power of customers who have been bombarded with very many products in the market hence they have a greater choice due to the access to substitute products and thus they can easily choose to shift from one commodity to another if they feel that their requirements haven’t been met. Due to the high level o competition at theses lower levels, price wars are always experienced as the retailers try to out play each other by reducing prices to levels where they are almost just merely breaking even (Porter, 1996). There are several areas of Porter’s five forces model that provide a basis for criticizing his work especially with regard to the applicability of Porter’s model. First of all, Porter five forces model makes certain assumptions about the business environment in question and these assumptions were clearly not factored by him in developing his model. These are: the assumption that the buyers, competitors and the suppliers are not related and cannot interact and form collisions, structural advantage i.e. the creation of entry barrier is the source of value, and finally that the level of uncertainty is quite low and thus enabling the market players to accurately plan for and make the required responses to competitive behavior. Porter has also been criticized for lack of his justification of his decision carry out his analysis at the industry level. This is because the level at which the analysis is done directly determines the scope that the results of the analysis will cover. The focus of the analysis on only the business environment is also another source of criticism. Porter’s analysis could have been carried on a greater scale and that micro nature of the analysis is not satisfactory. Another area that attracts criticism in Porter’s model is the limitation of the forces i.e. why five. There are clearly other forces that directly impacts on the business environment that Porter’s five forces model has failed to appreciate. Other forces such as the complementary forces have been developed later which the five forces model had overlooked. Complimentary forces are the opposite of competitive forces (one of the forces that have been covered by Porter) and they actually serve the purpose of enhancing the performance of an industry hence increasing its attractiveness. Another force that hasn’t been covered by Porter’s five forces model is the government or the public. The government’s or the public’s effects on the business environment has been dealt with by Porter, but it is usually a major force in any business environment and more often than not it usually affects the attractiveness (profitability ) of an industry through the policies that it adopts. Government policies might either be favorable, in which case the will increase the attractiveness of an industry or they can be unfavorable in which case they decrease the attractiveness of the industry (Isaacs, 2003). After all has been said and done, Porter’s five forces model is a useful tool in carrying out an analysis concerning the attractiveness of a business environment, an industry, a potential business venture or even be applied by governments to access the viability of the industries in their countries. However just like any economic theories that have been developed to explain the various economic phenomena, Porter’s model has its weaknesses and one should consider them while using this model as an assessment tool (Isaacs, 2003). Reference Porter, M.E. (1991). Towards a Dynamic Theory of Strategy. Strategic Management Journal, 13(23), 78-90 Richards, Frank. (2006). Competitiveness and globalization. Global Finance Journal, 56(28), 4-13 McGahan, A.M. & Porter, M.E. Porter. (1997). How Much Does Industry Matter, Really? Strategic Management Journal, 97(21), 7-10 Edmonds, W. (2007). Competing on a global scale. Journal of Business and Entrepreneurship, 78(20), 6-17 Porter, M.E. (2008). The Five Competitive Forces That Shape Strategy. Harvard Business Review, 18(42), 4-18 Isaacs, K. (2003). Competing for advantage. Journal of International Marketing, 48(13), 12-14 Porter, M.E. (1996). What is Strategy? Harvard Business Review, 65(33), 88-90 Lameck, P. (2002). Concepts of strategic management. International Business Review, 23(64), 22-55 Robbins, F. (1998). Creating value based competition. Journal of International Management, 44(43), 11-14 Webber, M. (2003). Strategizing. Journal of emerging markets, 28(12), 78-80 Woodward, L. (1999). Competitiveness and Globalization. Critical Perspectives on International Business journal, 66(18), 12-14 Haman, Richards. (2007). Strategic Positioning. Journal of World Business, 28(17), 16-19 Simons, P. (2002). Corporate Strategies to attain competitive advantage. Journal of World Investment, 68(43), 77-90 Porter, M.E. (1980) Competitive Strategy, Harvard Business Review, 14(22), 55-60 Kiersten, G. (2006).Strategy and society. Harvard Business Review, 48(24), 78-92 Porter, M.E. (1979) How competitive forces shapes strategy, Harvard Business Review, 24(20), 61-60 Read More