Competitive Environment - Five Forces

Porter’s Five Forces

• Devised by Michael Porter
• A framework for analysing the nature of competition within an industry

Summary for industry profits

High industry profits associated with

• Weak suppliers
• Weak customers (buyers)
• High entry barriers
• Few opportunities for substitutes
• Little rivalry

Low industry profits associated with

• Strong suppliers
• Strong customers (buyers)
• Low entry barriers
• Many opportunities for substitutes

The five forces

• Threat of new entrants to a market
• Bargaining power of suppliers
• Threats of Substitute Products
• Bargaining power of buyers (customers)
• Intensity of rivalry within the industry

Threat of new entrants

• If new entrants move into an industry they will gain market share and rivalry will intensify
• The position of existing firms is stronger if there are barriers to entering the market
• If barriers to entry are low then the threat of new entrants will be high, and vice versa.

Barriers to entry

• Investment cost
• Economies of scale available to existing firms
• Regulatory or legal restrictions
• Existing products with a strong brand of USP
• Access to suppliers and distribution channels
• Retaliation by established products (price war)

Bargaining power of suppliers

• If a firm’s suppliers have bargaining power they will:
  • Exercise that power
  • Sell their products at a higher price
  • Squeeze industry profits
• If the supplier forces up the price paid for inputs, profits will be reduced
• The more power the customer (buyer) the lower the price

Determinants of supplier power

• Uniqueness of the input supplied
  • If the resource is essential to the buying firm and no close substitutes are available, suppliers are in a powerful position
• Number and size of firms supplying the resources
  • A few large suppliers can exert more power over market prices than many smaller suppliers each with a small market share
• Competition for the input from other industries
  • If there is great competition, the supplier will be in a stronger position
• Cost of switching to alternative sources

Omission

Worksheet

1. Analyse why overcrowding in the industry might mean smaller firms may be forced out.

   When there are too many businesses operating in the industry, consumers will be offered a lot more choice, both in terms of products and in price. As larger businesses have more financial clout, they will be able to easily outcompete many smaller competitors on price, likely gaining more market share as a result. Smaller businesses won’t have the same level of pricing flexibility, so cannot afford to be involved in a price war. However, as the jewellery market is based on luxuries, people are often willing to pay a premium, allowing some smaller firms to outcompete their larger counterparts in terms of quality.

   Regardless, some small firms will have to go. Overcrowding means that the supply is higher than the demand, and as smaller firms have a smaller piece of the pie, they cannot afford to lose anywhere near as much market share as larger firms, meaning that they will likely collapse first.

2. Evaluate the market conditions for the jewellery and watch industry using Porter’s five forces model.

   As the market is overcrowded, there are many competing businesses, which leads to consumers having much higher bargaining power. If they don’t like a product or a price, they can just go to another jewellery shop and buy something else. If there were fewer jewellery shops, then this would be much less of a problem for businesses, as consumers would be more limited.

   Premium jewellery will be made using expensive, precious materials, which will cost a lot and have fewer suppliers. This will lead to high supplier bargaining power and very elastic costs. Cheaper jewellery producers will use much cheaper materials that can be procured much more easily, from far more suppliers at a much lower cost. While, the lower quality materials will deter some higher end customers, or people looking to buy things like wedding rings, many people will be attracted by the lower prices . This means that the suppliers able to produce products cheaply will be more likely to succeed, especially during economic hardships where individuals have less money to spend. This means that manufacturers using cheaper materials are a potential threat to premium manufacturers.

   Larger companies typically have a stronger brand than smaller independent manufacturers, which means when someone mentions a piece of jewellery—the larger firm comes to mind. This gives them a massive advantage in terms of selling goods as marketing is less of a problem. However, they do also have a much larger budget which allows much greater marketing spending should they want to do a campaign for a new product launch or to rekindle their brand image.

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