The Competitive Forces Model
Michael Porter (1985) provided a five forces framework to understand the industry in
which a firm operates. An understanding of this model helps the firm to develop a
competitive edge over its rivals. The five forces are rivalry among existing firms,
threat of new entrants, threat of substitutes, bargaining power of suppliers and
bargaining power of buyers.
Rivalry refers to the strong competition between that exists between the firms.
To overcome rivalry, firms can improve their products by adding more features, set
high quality standards, increase or decrease the price to gain temporary advantage,
make the best use of the channels of distribution etc. The intensity of the rivalry
depends on the number of firms in the industry, rate of market growth, fixed costs,
levels of product differentiation, storage costs, exit barriers, diversity of rivals etc.
(Porter, 1985). Threat of new entrants depends on how easy or difficult it is for new
firms to enter the industry and to start competing. For example, an increase in profits
would lead to entry of new firms in that industry whereas a decrease in profits would
expect few firms to exit the industry. However, every industry possesses certain
characteristics that protect the high level of profits of the firm and prevent entry of
additional firms. These barriers to entry may be created by the government in terms of
legal regulations, patents or due to other factors like asset specificity, economies of
scale etc. Threat of substitutes depends on how easy it is for a product or service to be
replaced by another product or service. It essentially occurs when the demand of the
product is affected by the change in price of its substitute. Thus the ability of the firm
to increase prices is hindered by the presence of close substitutes. Supplier power
depends on the size of the suppliers i.e. the number of sellers and their position. If the
suppliers are powerful they...