WHAT IS PORTER’S FIVE FORCES MODEL?
The model is also known as competitive forces model. Its main aim is to regulate the profit and revenue of a market, the business sector in particular. The term forces refer to the five factors from which every business sector gets influenced.
The five forces of Porter’s model are:
- Power of suppliers
- Power of buyers
- Risk of complementary goods and the substitutes
- Risk of new entries in the market
- Competitive rivalry
POWER OF SUPPLIERS
The first factor of Porter’s Model is suppliers. They can exercise more control by giving a threat of an increase in prices and a decline in the quality of a product.
Power of suppliers is influenced by the following factors:
- The number of suppliers
The organization can purchase the products from another supplier when there are numerous suppliers.
- Substitutes of products available in the market
If the supplier makes threats, you can make use of substitutes. This way, you will not have to depend on the suppliers.
For example, if a catering entrepreneur has some conflicts with his current supplier, he can sell any other brand by contacting another supplier.
- Cost of switching
If the cost of switching is higher, an organization is less likely to shift to another supplier. This is possible when a business is not able to improve the performance of brand and making the audience aware about it. In such a case, the current supplier can exercise more powers and control.
POWER OF BUYERS
The second factor of Porter’s Model is buyers. If the buyers exercise their powers, they can influence the prices of the products.
The powers of buyers are dependent on:
- The turnover of the total market that is bought per buyer
- Product importance for the customer
- The degree of standardization of product
- The costs of switching
- The risk of vertical integration
- How the buyers get information about prices prevailing in the market, demand, and costs in the business sector.
RISK OF COMPLEMENTARY GOODS AND SUBSTITUTES
All the companies which produce substitutes compete with each other in a broad sense. The substitutes available in the market tend to decrease the revenue. For example, the DVD has replaced the VHS videotape. If the first thing has nothing to do with the second one, it can still replace it.
On the other hand, complementary goods tend to exhibit an optimistic connection with the market. For example, if the customers are getting attracted by the DVD players because of fall in prices, it will affect the market in a positive way.
By using the means of cross-selling, markets are able to respond to these effects. For example, a seller can place reading glasses next to the counter of books and magazines.
RISK OF NEW ENTRIES IN THE MARKET
Every organization that enters into a market strive for share. As a result, the prices may fall and the cost of existing competitors may be higher.
It has a negative effect on the profitability of the business because whatever the reward or revenue is, it has to be shared with more individuals. The chance of new entries in the market is subjected to the barriers on the entries and the reaction of existing market players to the new entries.
This is the fifth and the last factor of Porter’s Model. If the competition between the current firms in the market is higher because of various reasons like strategic risks, exit barriers, low cost of switching, increase in fixed costs, etc. it can have a severe effect on the margins.
The organizations in such case, react strongly to the entry of new competition in the market because it leads to a reduction in profitability. As a result, the clash for a share in the market will be aggressive and ferocious.