Porter’s Five Forces model: In accordance with Porter’s view, there are five basic competitive forces that affect the competition within an industry. The five forces are threat of competitors, entry, substitutes, suppliers and buyers.
The competitors are known as companies which offer the similar products or as the focal company. And the rivals and focal company usually have the same target customers. Take China Telecommunication Industry as example. With the advance of telecommunications reform, there are three companies- China Telecom, China Unicom and China Mobile. Their business is the same, including telephone services Broadband Internet access services cell phone services and professional business services. Each one of them is always trying to enlarging market share by getting the customers from the other two companies. Thus, China Telecom, China Unicom and China Mobile are competitors. And it is said that the following conditions may facilitate the rivalry, large number of competitors, slow and declining growth, high fixed costs and/or high storage costs and low product differentiation. For instance, there are only three telecommunication companies in China, so it is easy for each of them get large amount of customers. To this degree the competition is very low. But many other factors should be taken into consideration. Firstly, the technical skills don’t change a lot in this era, so the rate of growth is slow. Secondly, the fixed costs in this industry are outrageously high. Telecommunication companies have to invest numerous high-tech fundamental facilities in different places in the very beginning and always repair or upgrade these facilities. Eventually, these three companies offer virtually the same services to the customers. Therefore, the threat of competitors is of high in China Telecommunication Industry.
Concept of the threat of entry is easily to understand. And the barriers to entry refer to these factors-economies of scale, product differentiation, cost advantages independent of scale and government polices. Let’s exemplify it by analyzing China Communication Industry. It is very difficult for new companies to enter into this industry. First of all, the three current companies are state-owned and Chinese central government has implemented very strict regulation of entering this industry, though China has join WTO. Second, building networks requires large sums of investments. Third, strong technical support is essential in this high-tech industry. It would be time-consuming and money-consuming for a new company to obtain the out-of-date technology for this industry. Moreover, it is pretty difficult for entrant get enough customers in the early period. If the entrants can’t produce the minimum efficient scale, it will be at a disadvantage.
The threat of buyers roughly decided by the bargaining power of buyers. The power is mainly affected by three factors-the number of products the buyer required, the preferences of buyers and the cost of alternatives. The buyers may try to get high-quality products or services with low price. Furthermore, if the requirement surpasses the demand, the price of products or services would drop and vice versus.
Similarly, the threat of suppliers can be evaluated by analyzing the bargaining power of suppliers. There are various kinds of conditions result in high supplier power, including small number of firms in supplier’s industry, highly differentiated product, lack of close substitutes for suppliers’ products, supplier could integrate forward, and focal firm is an insignificant customer of supplier. If Suppliers have strong power, the focal company might have to spend more money in materials, thus increasing the cost.
Substitutes offer different products or services that have the same kinds of functions to satisfy the customers. Generally speaking, almost all enterprises in an industry are subject to the threat of substitutes. In addition, the price of substitute’s products decides the highest price of the products of focal industry.
In all, Porter’s five forces model is a great “tool” to understand the external environment of the industry.