The 5 force model of market competition


The model constitute five forces. They are:

Competitive Rivalry, Threat of Entry, Threat of substitutes, Power of Buyers, Power of Suppliers.

Rivalry is usually intense when some of the following conditions are existing :

Ø As the number of competitors increase and as they become more equal in size and capability.
Ø When demand for the product is growing slowly.
Ø When competitors are tempted by industry conditions to use price cuts or other competitive weapons to boost unit volume.
Ø When competitor’s products and services are so similar that customers incur low cost in switching from one brand to another.

Threat of Entry

If it is easy to get into an industry then, as soon as profits look attractive, new firms will enter. If demand for the industry’s products does not rise to match the increased capacity that entry has caused, then prices and with them profits, are likely to fall. So, the threat of entry places an upper limit on an industry’s profitability. The most common barriers are:

Ø Economies of scale: These are cost advantages that accrue through having large scale-operations.
Ø The existence of considerable cost benefits to be gained from experience. Here the advantages stem not from large scale facilities but from the experience gained through repeatedly producing the product or service many times.
Ø Brand preferences and customer loyalty make it difficult for a new company to enter into business.
Ø Cost disadvantages independent of sizes. These might be due, for example, to access to cheaper labor or raw materials.
Ø If effective distribution is not done the competitors’ products may be sold better.
Ø Capital requirements also act as a barrier to any industry.

Threat of Substitutes

For our purposes, a substitute is something that meets the needs of the product produced in the industry. If the substitute becomes more attractive in terms of price, performance or both, then some buyers will be tempted to move their custom away from the firms in the industry. If substitutes pose a credible threat, then, firms in the industry will be prevented from raising their prices or from failing to develop and improve their products / services.

The competition from substitutes is affected by the ease with which buyers can switch to a substitute. A key consideration is usually the buyer’s switching costs.

Power of Buyers

Ø When customer are few in number and they purchase in large quantities.
Ø When customer’s purchases represent a sizeable percentage of the selling industry’s total sales.
Ø When the selling industry comprises large numbers of small sellers.
Ø When the item being purchased is sufficiently standardized that customers can both find other suppliers easily and switch to them at virtually zero cost.
Ø When the item being bought is not an important input.
Ø When it is economically feasible for customers to purchase the input from several suppliers rather than one.

Power of Suppliers

In a similar way suppliers of vital resources to the industry can exert high prices, leading to a squeeze on profits through higher input costs. Such suppliers would include suppliers of raw materials, power, skilled labor, components etc.

Ø The input is, in one way or another, important to the buyer.
Ø The supplier industry is dominated by a few large producers who enjoy reasonably secure market positions and who are not influenced by competitive market conditions.
Ø If supplier’s products are unique then it becomes difficult for the buyers to switch from one supplier to the other.

The concept of supplier can be extended to include the supply of management expertise, skilled labor and the supply of capital.

If all the five forces are strong, industry profitability would be expected to be low regardless of the products / services being produced and vice versa . Firms can influence the five forces through the strategies they pursue.