Creating Shared Value

¶ … Competitive Forces that Shape Strategy by Michael Porter Michael Porter first published his article about his ideas regarding competitive forces in the Harvard Business Review in 1979. Since that time his ideas have become mainstream and a component of nearly every business curriculum available today. Porter rewrites his article on competitive forces every few years for the Harvard Business Review and provides updated content and new examples of how his model still applies to the modern business environment.

The five forces that he includes in his model are (1) the barriers to entry in the industry; (2) the bargaining power of the suppliers; (3) the threat of any substitute products; (4) the bargaining power of buyers; and (5) the level of rivalry among companies within any given industry. When these forces are intense, it is argued that there is generally less room for profitability and the structure of the industry can drive profitability. This review will analyze the model presented by Porter and offer insights into its value.

The first force in the Porter's model is referred to as barriers to entry. This is basically how easy or difficult it is to enter an industry based on factors such as how much capital is required and how many players have already entered. If the barriers of entry are high, then this often provides a situation in which profits are more obtainable.

However, when the barriers are low then companies must keep their prices down or a new firm can enter the market and accept a slightly lower profit margin. However, companies like Microsoft and Apple are able to charge premiums because it is difficult for small firms to compete with them. Another force is known as the bargaining power of suppliers. In any complex product or service, firms are at dependent in some regard to their supply chain and their raw material suppliers.

When the company's suppliers have a lot of power then they are more likely to retain a greater share of the value chain's profitability. For example, when only one supplier for a material is present then they can charge a premium for whatever good they are selling. However, when there is more competition amongst suppliers, this drives the market prices down. The example Microsoft is given again in regards to its virtual monopoly on operating systems which gives it substantial supplier's power.

Another competitive force is the power of buyers, which is referred to as the flip side of power suppliers. There are many circumstances that can increase the power of buyers such as markets have few potential buyers, the products are standardized or undifferentiated, there are low switching costs, and many others. When the buyer has substantial power they can either dictate their terms or possibly easily switch to a different vendor or make no purchase at all. When buyers have a lot of power this can drive down profitability.

The threat of substitutes is a competitive force in which a substitute is available that comes from outside an industry. This is not exactly a substitute product because it represents a different type of product from a different industry. For example, email is a substitute for express mail and travel websites can be a substitute for travel agents. This threat is always present but can take many different degrees.

When the threat of substitutes is high, then profitability in the industry will be lower because customers can always find different alternatives to fill their demand. For example, the developments of Netflix and YouTube have hurt the cable and video rental suppliers because they offer alternatives. The final competitive force is rivalry among existing competitors and can take many different forms.