Michael Porter’s 5 competitive forces model is the basis of modern business strategy. His model is based on the insight that a corporate strategy should take into account the opportunities and threats in the external environment that the organization operates in.
The competitive strategy should be based on a strong understanding of the industry structure and how it may possibly change. In the online world, this principle does apply though in slightly different ways.
Porter identified five competitive forces that shape every industry and every market. According to Porter, these forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The objective of corporate strategy should be to play against these competitive forces in a way that the market share or position of the firm in question is improved.
Bargaining Power of Suppliers
The term ‘suppliers’ comprises all sources for inputs that are needed in order to provide goods or services.
Supplier bargaining power is likely to be high when:
· The market is dominated by a few large suppliers.
· There are no substitutes for the core raw materials required for manufacturing.
· The suppliers’ customers are fragmented so their bargaining power is low. This essentially means that the market is fragmented with many pieces carved out between many players. This also means that the product in question is very generic in nature.
· The switching costs from one supplier to another are high.
The relationship of the firm to powerful suppliers can potentially reduce strategic options for the organization because of their clout in the market.
Bargaining Power of Customers
Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes.
Customers bargaining power is likely to be high when:
- They buy large volumes and there is a concentration of buyers which makes the buyer pool limited.
- The supplying industry comprises a large number of small operators which means that it’s very competitive.
- The supplying industry operates with high fixed costs. This is true when suppliers deliver a high value-added raw product component.
- The product is undifferentiated and can be replaces by substitutes, In this scenario, a generic product competing in the marketplace implies the presence of multiple duplicate products.
- Switching to an alternative product is relatively simple and is a low cost-proposition. Here multiple substitutes are available.
- Customers have low margins and are price-sensitive.
- Customers could produce the product themselves. If a customer has the scaling capability within his existing production facilities to backward integrate some of the manufacturing for their raw material components, they do posses strong bargaining power.
- The product is not of strategic importance for the customer. In this situation, the product may represent a very small portion of annual revenue from a firm’s product portfolio and may not of strategic importance.
- The customer knows about the production costs of the product. If the customer has the capability to produce the material in question, it’s highly possible that he’s aware of the costs involved.
Continued in part II coming next…
