The Five Forces Model
An industry can be defined as a group or companies offering products or services that are close substitutes for each other. Close substitutes are products or services that satisfy the same basic consumer needs. For example, tea and coffee are close substitutes.
Managers have to analyze competitive forces in an industry environment in order to identify opportunities and threats confronting to a company. Michael E. Porter of the Harvard School of Business Administration has developed a framework that helps managers in this analysis. Porter’s framework, known as the five forces model focuses on five forces that shape competition within an industry: (1) the risk of new entry by potential competitors, (2) the degree of rivalry among established companies within an industry, (3) the bargaining power of buyers, (4) the bargaining power of suppliers, and (5) the closeness of substitutes to an industry’s products.
A. Potential Competitors
Established companies try to discourage potential competitors from entering, since the more companies enter an industry, the more difficult it becomes for established companies to hold their share of the marker and to generate profits. Thus a high risk of entry by potential competitors represents a threat to the profitability of established companies. On the other hand, if the risk of new entry is low, established companies can take advantage of this opportunity to rise prices and earn greater returns.
The strength of the competitive force of potential rivals is largely a function of the height of barriers to entry. The concept of barriers to entry implies that there are significant costs to joining an industry. The greater the costs that potential competitors must bear, the greater are the barriers to entry. High entry barriers keep potential competitors out of an industry, even when industry returns are