Michael Porter has also developed a technique for assessing the desirability of competing in a particular industry and how a firm can compete in that industry. 1 Porter’s five-force framework considers the buyers, the sellers, the suppliers, the current competition, and the threat of competition from substitute products. The key idea is that a firm can be more profitable by understanding how the five forces influence the competitive environment, as will be explained next.
Threat of new entrants. This is the degree to which entry into an industry is easy to accomplish. If it is easy to enter an industry and start competing, then there is a threat of new entrants. If an industry has high fixed costs, such as in the case of semiconductor manufacturing, auto manufacturing, or operating systems construction, then there is a low threat of entry. This is in contrast to the situation where entry is easy and relatively inexpensive such as found in online retail stores, home maintenance businesses, and restaurants.
Entry into a market can of course be precluded because of the scarcity of expertise and resources. For example, in the late 1990s, there were very few individuals with expertise in Enterprise Resource Planning systems and in COBOL to handle the Y2K date problem. Numerous firms turned toward India and Singapore to find employees with skills in these areas. 2 Resource scarcity can also limit entry into a market. Examples of industries where resource scarcity is critical include diamond mining, where DeBeers owns a substantial amount of the diamond resources, and oil production where Exxon has access to oil production and installed refining capability.
Threat of substitute products. Substitute products are a constant threat in contemporary commerce. If another product can be substituted for a product in the industry under consideration, then there is a threat of substitute products. It is sometimes impossible to know where your competition will come from. For example, video and audio content can be delivered via satellite, wireless, coax cable, cat 5, and fiber optics. The content can in turn be delivered to a variety of devices including mobile phones, televisions, iPODs/MP3 players, game consoles, DVRs, and computers. A similar situation exists for transportation. You can travel via electric car, bus, and air or in the future, by way of a personal jet craft or some type of Segway device. Indeed content delivery can be a substitute for transportation. As video and audio becomes more robust and easy to use, it may be possible to be there without actually being there. Families will soon get together by linking-up and interacting with their plasma and LCD screens using a high bandwidth carrier to communicate video and audio feeds of a birthday party or anniversary. This has already occurred in businesses with the emergence of virtual meetings. This brings up another issue. People set aside a certain amount of dollars for entertainment. However, although technology is not a perfect substitute for entertainment outside of the home, it can be a substitute for spending on entertainment. Thus, a console or a game might threaten the launching of a new movie during the holidays or vice versa.
Bargaining power of buyers. If individuals, companies, or groups of companies can influence the price and the features required in a product or service, then the buyers have the bargaining power. This often occurs when there are few buyers or when the buyer is large. The auto companies have bargaining power over the component manufactures. The same goes for Dell’s component suppliers and Wal-Mart’s suppliers. When a buyer is large and switching costs are small, then the buyer has the bargaining power. Wal-Mart is in such a position with its suppliers. Dell, however, has less buyer power because it cannot simply switch the component suppliers because desktops systems are built around integrated components and the performance of the system can be adversely impacted when components are not integrated.
Bargaining power of suppliers. If a company supplying a product or service can dictate the terms of the transaction, then the supplier has the bargaining power. The bargaining power of suppliers can be derived from many factors including the scarcity of the resource or technology, the number of suppliers, the characteristics and features of the technology, whether the technology is proprietary, and even the brand image. Intel and Microsoft have some bargaining power over Dell, but the hard drive, dram, motherboard, and monitor manufacturers have less bargaining power. The power supply and case manufacturers have even less bargaining power with Dell. The game console and global positioning system (GPS) manufactures have some power over Wal-Mart when they introduce a new model, but a holiday candle manufacturer has much less power. In many ways, the bargaining power is related to the threat of new entrants and the threat of substitute products or services. The key issue surrounding the bargaining power of suppliers is the availability of other sources of the products and services. If alternative or second sourcing is available, then the bargaining power of the supplier is lessened.
Rivalry among existing competitors. This is the degree to which there is competition among the firms. When there are several competitors and the products they are selling are fairly standard or readily obtainable and the competitors cannot easily leave the industry, then the rivalry will be intense. Examples of intense rivalries include breakfast cereals, flash memory, dram and electronics industries, housing construction, online and offline retailing, and the airline industry. Intense rivalries among competitors are again driven by the threat of new entrants and the threat of substitute products and services. In this context, product differentiation is essential in order to reduce the ruinous effect of perfect competition. This is the reason that the producers of GPS systems are constantly refining and adding features to their product line. Airlines, breakfast cereal producers, and the housing industry are constantly looking for ways to differentiate their offerings and at the same time reduce costs.