Five forces' analysis (Porter 1980) Five Forces Analysis of Competitive Structure

Michael Porters Five Forces Analysis of Competitive Structure is a paradigm for competitive position, which states that overall a company's profitability may be determined as a measure of the industry it is competing in and its strategic position within that industry (Strategy4u, 2004). According to the model some industries by nature will have a higher profit potential than others, primarily because they have a stronger competitive position and are placed within a more profitable industry.

Porter's Model also suggests that profitability is assessed via several factors, including the following: buyers/customers power, supplier's power, and rivalry among competitors, threat of new entrants into the market, and the threat of substitute products (Strategy4u, 2004). The company or industry will have a greater profit potential the less influential each of these items are. For example, if a company sells a product for which there are few or no substitutes, they are likely to have a greater competitive advantage and thus realize a higher profitability. As another example, a company must be able to obtain adequate supplies of their product for reasonable rates via suppliers in order to realize greater profitability. A diagram of some of Porter's five forces model is available in Table 1.1.

Perfect Competition

Perfect competition has been described as the most competitive type of market imaginable, although it is thought to be extraordinarily rare. In a perfect market any one buyer or seller has very little if any impact on the overall market price; additionally all products are considered "homogenous" or the same and firms earn just the exact amount of profit they require to stay in business, no more and no less (Economist, 2004). There is also a distinct absence of lack of barriers into entry meaning that basically any firm or organization can enter the market, thus driving prices down because of added competition. This is why only normal and not maximal profits can be realized. The amount of product that becomes available to consumers is maximized at minimal prices.

MONOPOLY monopoly presents a situation where there is no competition in the market. A single firm controls the price and the amount of output for a given product. In this situation there are also few or no substitutes for the product in the market.

Traditionally a monopoly will produce less of a product thus creating a greater demand. The decreased output often also results in higher prices. This is not always the case, but is fairly standard practice. Traditionally a company will decide what price to sell something at by deciding on a price that will allow a quantity of output to be sold at a rate in which the marginal revenue will equal the marginal costs (Economist, 2004). Few monopolies in today's society actually have "absolute" power; rather their ability to monopolize a product depends on whether or not they are able to obtain the supply they need and to what extent they possible have "near-competitors."

Organizations in today's competitive market will typically attempt to the greatest extent possible to offer some variation of a monopolistic product. Because there are few competitors, the profitability is high.

OLIGOPOLY

An oligopoly is similar to a monopoly; instead of one organization or firm controlling a product in the market however, there are typically several firms dominating a particular market. Firms may unite and join together, thus forming a type of mini-monopoly. They may also collaborate in such a way as to produce a great deal of price competition. They may choose for example to offer competition of price, thus creating a state similar to perfect competition where they produce greater quantities of products in order to compete, yet the price is kept relatively low.

Producers in an oligopoly sometimes assume that their rival competitors will continue producing the same or very similar amounts of a certain product no matter how much or little they produce for themselves (Fellner, 1949). Thus a competitor will attempt to estimate how much he will need to sell to maximize products in this particular situation (Fellner, 1949). In general however, a rival is not likely to keep his output constant, and thus a state of constant fluctuation should be expected.

Consumers traditionally have a habit of searching for substitutes in order to acquire the best "combination of commodity variant and price" (Schulz & Stahl, 1996). Many factors influence price, including a suppliers ability to supply products to a firm, whether a monopoly, oligopoly or any other type of competitive model.

Porter's five forces model is useful in explaining how competition arises and how companies operate, whether in a state of perfect competition, oligopolistic or monopolistic in nature. He describes barriers to entry, supplier roles in a competitive market and economic reasoning practices. Traditionally,...

However, firms might actually sometimes seek out a collaborative relationship with their competitors, as in the case of an oligopathy, in order to reconcile supply problems and demand issues (Schulz & Stahl, 1996).
The Porter model suggests that a new service economy is the model through which economic rebirth and strategic competitive advantages may occur (Goozner, 1998). For example, in inner city may experience economic rebirth by taking advantage of their location, which is optimal for competitive advantage. Inner cities are located near downtown areas, where hubs exist for financial services, medical services, entertainment, media and education (Goozner, 1998). Corporations that benefit from their proximity to downtown services and transportation infrastructures would benefit from setting up shop in these areas. Competitive industries also have an advantage of tapping into underutilized labor pools by setting up shop in these areas.

Porter's five forces model may also be described as a model for perfect competition. It provides the framework that describes industry as being influenced by five forces, and relies on strategic business managers to seek out to develop a unique "edge" against other competitive firms (QuickMBA, 2004). One of the most critical aspects of Porter's five forces model is it's analysis of barriers to entrance and exit of the market. Competition exists in greater quantity when organizations have the ability to easily enter and exit a market. This is not the case in a monopoly, and seldom the case in an oligopoly, where tight controls are in place and barriers to entry exist. Table 2.1 below demonstrates some of the classical barriers to entry and exit. An oligopoly does present fewer barriers, especially when a few firms are working together in a collaborative manner to establish a competitive market.

Supplier analysis is also a critical aspect of Porter's five forces model. Supplier relations are certainly critical in a monopolistic environment, where a supplier has a much greater sense of power. There is few or no competition generally in an environment where products are not interchangeable and easily substituted. The competition among suppliers would be according to Porter's model, somewhat decreased in an oligopolistic situation, but not so in a monopoly. In a state of perfect competition, a much greater balance is established between buyers and sellers, thus the influence of one over the other is much more limited. Consumers do best in this type of environment, because prices are more easily managed and less likely to be excessive. Profits realized by any one company are considered average. A company can be successful; in fact many companies can be successful based on Porter's principles, but no one company is likely to be more dominating than another. Prices level out in a state where all of Porter's five forces are analyzed critically and effectively.

Table 1.1

Michael Porter Five Forces Model of Competition

Source: Business Insight. 2004. Retrieved March 26, 2004. Available: http://www.businessplansoftware.org/porter.asp

Table 2.1 Barriers to Entry and Exit of Market

Easy to Enter Market If there is:

Common technology

Little Brand Franchise

Access to Distribution Channels

Low Scale Threshold

Difficult to Enter if there is:

Patented/Proprietary know-how

Difficulty in brand switching

Restricted Distribution Channels

High Scale threshold

Easy to Exit if there are:

Salable Assets

Low Exit Costs

Independent Businesses

Difficult to Exit if there are:

Specialized assets

High exit costs

Interrelated Business

Source: QuickMBA, 2004. "Porter's Five Forces Model: Barriers to Entry/Exit."

Porter's model suggests several other considerations to create a profitable venue. Among the primary considerations for corporations for example, includes the strength of suppliers. According to Porter's model, suppliers are powerful when they are concentrated, when customers are powerful and have the ability to boycott products, and when the cost to manufacturers to switch suppliers is very high (QuickMBA, 2004). Much like the influence of products in a market, suppliers are much less powerful if there is a great deal of competition available among the supplier market, which often occurs if a product has been standardized. In the case of a monopoly, the supplier will have much power, as the product will not have any standardization. In an oligopoly there will be more of an equilibrium of power between suppliers and buyers. In a state of perfect competition, neither buyers nor suppliers have more power over another.…