Porter’s Five Forces Framework is a method to analyze the competition of a business in the market. It analyses a company’s competitive environment. If there is less competition in the industry, then the profitability will be more and more will be the attractiveness of any business. An industry having pure competition will be less attractive to start a new business. According to Michael E. Porter, there are following five forces which determine the completion in any industry.
- Threat of new entrants
- Industry Rivalry
- Threat of substitutes
- Bargaining power of suppliers
- Bargaining power of Buyers (Consumers)
Threat of New Entrants
A company’s power is affected by the new entrants into the market. If the entry of new entrants is easy or we can say if there is less entry barrier, then the new players will continue to come into the marker and it will weaken the position of already established companies in the market. On the contrary, if any industry has strong entry barrier, then the already existing industries will have more power in terms of prices and negotiation of better terms. Industries like power, petro chemicals, telecom, infrastructure, cement, steel have strong entry barriers and therefore the existing companies enjoy more power and they can derive the prices in and other terms & conditions in their favor. Indian Railways, Reliance Industries, Ultratech Cemant, L&T Ltd., Tata Steel, etc. has a monopoly in their respective sectors due to strong entry barrier.
It is obvious that if an industry has more competition then the company’s power will be less as the consumers will have other options. If there will be less competition, then the company will be in the strong position to charge higher prices and will achieve more profit.
Threat of Substitutes
If there will be more substitutes of a product, a company is offering then the company’s position will not be strong as the consumers may move to other substitutes. If the product of a company is unique such that there is no substitute to that product, then the company will be in strong bargaining position. An example of such company is apple which makes unique products with no substitute and therefore it can charge higher prices. FMCG companies producing daily need consumer goods face such threats as there are many substitutes of such products and the cost of switching the products is less and therefore the companies have to bring down to prices to remain in the competition. You can observe that due to this reason, there is less price variation in FMCG products.
Bargaining power of Suppliers
A company make its products form the input supplies from its suppliers. The more the input cost, the less will be the profit of the company. A company will be in a weak position if there will be few suppliers in the market as the supplies will be in the better position to negotiate prices and better terms and conditions. In this case, the input cost will be more for a company and hence the company will have less profits. On the contrary, if there will be too many suppliers in the market or the cost of switching between the suppliers is less, then the bargaining power of suppliers will be less and the company will be able to keep its input cost low and will make high profits. The suppliers like Motherson Sumi, Rajratan Global Wire Ltd. have made their mark in the industry and therefore they enjoy monopoly in their sector.
Bargaining Power of Buyers (consumers)
The next force among the Porter’s five forces is the bargaining power of buyers (consumers). The bargaining power of consumers is their power to derive the prices of the products in a market. The consumer power is the factor affecting the position of the company. The more the consumer base, the more will the power of the company as individual consumer will have less power to bring down the prices or negotiate the better terms. If the number of consumers will be less, the then they will have more power to affect the prices or better deals in their favor. The companies making premium segment products are in a strong position because their client base is less and hence they can charge high prices for their products. Some examples of such companies are Apple, Mercedes- Benz, Royal Enfield, etc.
A company has to understand these five forces to make their strategy in the market so that they can make better returns for their investors.