Impact of external influences - Porter's Five Forces 3.1.4

Porter's Five Force analysis - A tool to analyse five competitive forces that affect a market and the intensity of competition within a industry or market.

Barriers to entry - The obstacles that a business has to face when it is considering competing in an exisiting market

It considers

• the threat of new entrants to a market
• the bargaining power of suppliers
• the bargaining power of customers
• the threat of substitute products
• the degree of competitive rivalry amongst exisiting competitors.

It attempts to provide a simple way to look at all the relevant issues related to the changing competitive environment in which a business operates. Five Forces can be used by a business currently in a market to assess the security of its market position. Or it can be used by a business thinking of entering a market.

THREAT OF NEW ENTRANTS

Refers to the potential effect of a new business entering the market, presuming that it will gain market share and rivalry will increase. The position of the business is stronger the more barriers to entry they are. Whre barriers to entry are said to be high, it is harder for a new business to enter the market. Barriers to entry may include economies of scale, brand loyalty, technology, legal and pricing policies.

BARGAINING POWER OF SUPPLIERS

This is determined by how much power a supplier has, presuming they will sell their products at a higher price if possible. If the supplier is in a dominant position, then the price the business pays for raw materials will be higher and so profits will reduce. Factors that affect the bargaining power of suppliers include the uniqueness of what they are supplying, the number and size of suppliers and the cost of switching to alternative sources of supply. 

BARGAINING POWER OF CUSTOMERS

Refers to the extent to which customers are able to extert pressure and drive down prices. Factors that affect the bargaining power of customers include the volume of their orders, the number of rivals supplying the product and the cost of switching. If customers are few in number, purchase a significant amount of the business's products, can choose from a wide range of suppliers or find it easy and inexpensive to switch to alternative suppliers of the product, then the customer has strong buying power. 

THREAT OF SUBSTITUTE PRODUCTS

This means looking at any product that meets the same needs as the one provided by the business, but outside that industry. The level of the threat depends on issues such as customers' willingness to switch, customer loyalty and the extent to which the alternative matches the business's products on price and performance. 

RIVALRY AMONG EXISITING COMPETITORS

This is the central factor in Five Forces analysis as it shapes the approach a business must adopt. If there is intense rivalry in the market, a business is more likely to look at competitive price reductions, invest in innovation and new products, and increase sales promotion and advertising. This all leads to higher costs and potentially lower profits. The factors that determine the intensity of rivalry include the number of competitors in the market, the potential for market growth, product differentiation and brand loyalty, the availability of substitutes, capacity utilisation, costs of the industru and exit barriers. 

The benefits of Porter's Five Forces analysis include acting as an excellent starting point for evaluating the current situation in a market and showing a business where it may be able to protect and grow its current products. However, the drawbacks of Five Forces is that it assumes market forces stay relatively static, which in many markets may not be the case, it does not consider non-market forces such as the impact of legislation, and it can provide only a snapshot of the market or industry.