Michael Porter developed the five-force model, a widely used model for external analysis, after which he concludes after research that there are five forces that determine the profitability of a company. These five powers are:
1. The power of suppliers,
2. The power of buyers,
3. The availability of substitutes and complementary / complementary goods,
4. The threat of new entrants to the market,
Internal market competition.
The model aims to determine the profit potential of a market. The forces and thus the chance of profits vary widely per market. The analysis aims to provide insight into market relationships and dynamics. For example, the analysis can show that there is too much dependence on one of the suppliers.
1. The power of suppliers
Suppliers can exercise power by threatening to increase costs or decrease quality. Power depends on
(1) the amount of suppliers,
(2) the amount of substitutes,
(3) the importance of the industry to suppliers,
(4) switching costs,
(5) standardization of the product, and
(6) the possibilities of vertical integration (suppliers can start producing the product of the industry themselves, or players in the market can start producing the product of the supplier themselves).
2. The power of buyers
When customers have a lot of power, they can put pressure on the price by playing off competitors against each other. The power of the buyers depends on
(1) the part of the turnover that is purchased by the customer,
(2) the importance of the product to the customer,
(3) the degree of standardization of the product,
(4) switching costs,
(5) the profits of the customers,
(6) the threat of vertical integration,
(7) the importance of the industry ‘s product for the quality of the customer’ s product, and
(8) the extent to which the purchaser has been informed about industry demand, market prices and costs.
3. The extent to which substitutes and complementary goods are available
All companies also compete broadly with other industries where substitutes are produced. These substitutes limit potential revenues for an industry. The complementary goods have a positive correlation with the market. For example, if DVDs become increasingly attractive to consumers (for example, due to falling prices), this will have a positive effect on the market for DVD players.
4. The threat of new entrants to the market
New entrants in an industry strive for market share and provide additional capacity. Prices may drop or the costs of current companies may increase. Both effects have a negative effect on profitability. The likelihood of new entrants entering the market depends on the existing barriers to entry and the reaction of existing competitors to the new entrant.
The six main barriers to entry are: Economies of scale: Economies of scale create a barrier because newcomers are forced to enter between large-scale or small-scale entrances with higher costs. Product Differentiation: When established companies enjoy brand awareness and customer loyalty, newcomers have to invest a lot to compete. The amount of capital needed: in some sectors, a huge amount of capital is needed before production can start. This creates a major barrier for newcomers. Switching costs: Switching costs are the one-off costs that customers have when they switch to another supplier. When these costs are very high, customers are more difficult to persuade to switch to new entrants. Access to distribution channels: When the logical distribution channels are all provided by current companies, it will cost new entrants a lot of money and effort to distribute their products in the mainstream sales channels . Government policy: The government can limit or completely close entry into a business sector through measures such as licensing obligations.
5. Internal competition from market players
When internal competition (competition between current companies in the market) is high due to, for example, high exit barriers, large strategic risks (a lot is at stake), little differentiation and low switching costs, high fixed costs and storage costs, low growth or equivalent competitors , margins can be under severe pressure. As a result, profitability is low and companies in such markets can react strongly to potential newcomers.
The core of formulating a competitive strategy is to position / market the company in the industry. Good positioning is one from which the company can defend itself against this competitive edge.