Economics professor Michael E. Porter developed the five forces model to help business executives understand and deal with competition. Factors that affect competition are largely similar, despite apparent differences in industry. Porter’s five forces that shape competition include competition among existing competitors, bargaining power of customers, bargaining power of suppliers and threat of substitute products.
Competition among Existing Competitors
Companies that have already established themselves in a market have competitive advantages such as loyal customers, good location, good supply chains and a better understanding of the market. New companies may find it difficult with already established competitors since they need to attract new customers. They may also not get prime locations to set up their businesses. Existing competitors may also have better understanding of the local culture hence may have better public relations. This force is probably the most powerful of the five.
Bargaining Power of Customers
Customers’ bargaining power greatly influences a company’s competitive strategy. Buyers have the power to demand lower prices in a system where their number is relatively small, compared to that of sellers. In such cases, when a customer becomes dissatisfied with the quality of service or pricing in a certain store, they can easily switch to rivals. This compels a business to offer the best service and/or the lowest price to command a larger market share.
Bargaining Power of Suppliers
Suppliers provide the inputs or raw materials for a business. Their bargaining power has a direct impact on a company’s profit margins, as the price at which they sell inputs to a business will determine the selling prices of the finished products. Suppliers have a high bargaining power in cases where they are few, there are no substitutes for supplies or when there is no unity between buying companies.
Threat of Substitute Products
Substitute products give consumers the opportunity to choose alternative products based on price or quality. This increases competition since a consumer can easily forgo buying a particular product in place of another. For instance, a consumer may buy peanut butter in place of margarine because of the former’s apparent health benefits. For a business to maintain superiority over rivals, it needs to invest more in developing brand loyalty based on consumer’s preferences.
Threat of New Entrants
New entrants increase the level of competition in a market since they may take up a portion of consumers and suppliers. New entrants can also introduce tactics like lower pricing and aggressive marketing strategies in an effort to attract customers. New companies can also offer suppliers better prices and terms so that they increase competition with existing players. Nevertheless, new entrants face high entry barriers including customer loyalty, limited distribution channels and shortage of key resources.