Five competitive forces

The Five Competitive Forces Theory:

Overview:

In any category of business there are five main forces of competition. The forces can be used to estimate the attractiveness and profitability of entering a business market. These five forces compromise of:

1. Bargaining Power of Suppliers

2. Bargaining Power of Consumers

3. Threat of New Entrants / Barriers to Entry

4. Threat of Substitutes

5. Competitive Rivalry.

Bargaining Power of Suppliers:

The number of suppliers in any given market will determine how much power a supplier has. The perceived power of any given supplier is inversely proportional to how many suppliers there are. There can be a high cost of switching suppliers to a customer. The more power the suppliers have, the less power the consumer will have. An example of this is Microsoft. Having a near-monopoly on the operating system market allows them great freedom in their decisions.

Bargaining Power of Customers:

Customers have the power to directly affect both a supplier’s volume and margin. Volume is the amount of a certain product produced. Margin is the difference between the selling price and the cost of manufacturing. Customers can buy in high volume in order to drive down prices. Wal-Mart is a prime example of this. As more volume is produced the cost of production is also reduced, this is known as economies of scale. Consumers are also afforded the ability to shop around for the best prices.

Threat of New Entrants / Barriers to Entry:

A business that is late to enter an industry can have the cost associated with entering be prohibitive. There is usually a high initial investment to enter. Customers will already have an established brand loyalty to a rival company. Carving a niche market in an established industry is also very difficult. It is almost always better to be first to market rather than being the chaser. A good example of this is Microsoft’s Xbox. It was a late entry in the home game console arena and had to play catch-up against industry leader Sony, while operating at a loss for most of its life cycle.

Threat of Substitutes:

Brand loyalty plays a major factor in many customers' decision. If a consumer as high brand loyalty they are less likely to switch over to a rival. How easily it is for a consumer to switch to a rival can be a major threat to a business. Many cell-phone companies try to combat this by including costly fees on cancellation. Until about a year ago it was impossible to switch your phone number across different cell-phone carriers. This also made people reluctant to switch companies.

Competitive Rivalry:

Many businesses in the same industry employ the same business strategies. It makes it difficult to have a competitive advantage over rivals. If things are not going well, it can also be difficult to exit the business venture. After paying such a high initial investment many businesses are willing to pay more and more on the slight chance that they can turn a profit. A prime example of a company that should exit the market, but hasn’t is Nokia and it’s N-Gage product. The N-Gage is a cell-phone / hand-held console hybrid. It has performed extremely poorly since its introduction and many retailers have stopped carrying their products. Despite this Nokia has released version 2 of the N-Gage and still plans to release more games. After investing so much in the product Nokia is reluctant to exit the market, if only to save face.