IS 112 Blog Activity, Factors Affecting Competitive Advantage The Five-Forces Model:

The five-forces model:

Rivalry among existing competitors - It is the nature of competition that firms will strive for advantage over their rivals. As such, rivalry is typically the strongest of the five competitive forces in any given industry. It can be defined as the competition that goes on between firms as they try to increase their market share. For example, this can be viewed as the competition that the cooperative faces when members look elsewhere to gin their cotton, sell their products or purchase their supplies. Due to the nature of agricultural commodities, this rivalry usually focuses on price competition, with firms attempting to provide the lowest price possible for farm inputs and the highest price possible for farm outputs.

Threat of new entrants - A major force shaping competition within an industry is the threat of new entrants. The threat of new entrants is a function of both barriers to entry and the reaction from existing competitors. There are several types of entry barriers:

Economies of scale. Economies of scale act as barrier to entry by requiring the entrant to come on large scale, risking strong reaction from existing competitors, or alternatively to come in on a small scale accepting a cost disadvantage. Economies of scale refer to the decline in unit costs of a product or service (or an operation, or a function that goes into producing a product or service).

Product differentiation. Product differentiation creates a barrier to entry by forcing entrants to incur expenditure to overcome existing customer loyalties. New entrants must spend a great deal of money and time to overcome this barrier.

Capital requirements. The capital costs of getting established in an industry can be so large as to discourage all but the largest companies.

Cost advantages independent of scale. Existing firms may have cost advantages not available to potential entrants regardless of the entrant's size. These advantages can include access to the best and cheapest raw materials, possession of patents and proprietary technological know-how, the benefits of learning and experience curve effects, having built and equipped plants years earlier at lower costs, favorable locations, and lower borrowing costs.

Switching costs. Switching costs refer to the one-time costs that buyers of the industry's outputs incur if they switch from one company's products to another's. To overcome the switching cost barrier, new entrants may have to offer buyers a bigger price cut or extra quality or service. All this can mean lower profit margins for new entrants.

Access to distribution channels. Access to distribution channels can be a barrier to entry because of the new entrants's need to obtain distribution for its product. A new entrant may have to persuade the distribution channels to accept its product by providing extra incentives which reduce profits.

Governmental and legal barriers. Government agencies can limit or even bar entry by requiring licenses and permits. National governments commonly use tariffs and trade restrictions (anti dumping rules, local content requirements, and quotas) to raise entry barriers for foreign firms.

The effectiveness of all these barriers to entry in excluding potential entrants depends upon the entrants' expectation as to possible retaliation by established firms. Retaliation against a new entrant may take the form of aggressive price-cutting, increased advertising, or a variety of legal man oeuvres.

Threat of substitute products and services - A substitute is a product that performs the same or similar function as another product. Microeconomics teaches that the more substitutes a product has, the demand for the product becomes more elastic. Elastic demand means increased consumer price sensitivity which equates to less certainty of profits. For example, public-transportation is a substitute for driving a car, and e-mail is a substitute for writing letters.  Conditions that increase the threat of substitutes are:


An attractive price of substitutes: The price of substitutes acts as a ceiling to the price of the subject product. An attractive price of a substitute acts inhibits an industry from reaching its profit potential.

Increased quality of substitutes: If the quality of a substitute is high, there is increased pressure to increase the quality of the subject product. For example, products such as Netflix and Hulu have introduced video on demand services offered through the internet. Cable and internet companies have answered back by introducing fiber optic networks to not only compete in the video on demand space, but offer incredible picture quality not yet available to the new technologies.

Low switching costs to consumers: Switching costs to consumers can come in the form of monetary costs (transferring cell phone service: termination and initiation fees) or lifestyle switching costs (switching from driving a car to public transportation). Monetary costs effectively increase the price of the substitute products whereas lifestyle costs are more subjective and difficult to identify. In either case, the easier and less costly it is to switch to a substitute, the higher threat of that substitute.      

Bargaining power of buyers - buyer bargaining power refers to the pressure consumers can exert on businesses to get them to provide higher quality products, better customer service, and lower prices. When analyzing the bargaining power of buyers, the industry analysis is being conducted from the perspective of the seller. According to Porter’s 5 forces industry analysis framework, buyer power is one of the forces that shape the competitive structure of an industry.

The idea is that the bargaining power of buyers in an industry affects the competitive environment for the seller and influences the seller’s ability to achieve profitability. Strong buyers can pressure sellers to lower prices, improve product quality, and offer more and better services. All of these things represent costs to the seller. A strong buyer can make an industry more competitive and decrease profit potential for the seller. On the other hand, a weak buyer, one who is at the mercy of the seller in terms of quality and price, makes an industry less competitive and increases profit potential for the seller. The concept of buyer power Porter created has had a lasting effect in market theory.

Bargaining power of suppliers - The more powerful a seller is relative to the buyer, the more influence the seller has. This influence can be used to reduce the profits of the buyer through more advantageous pricing, limiting quality of the product or service, or shifting some costs onto the buyer (e.g. shipping costs). Suppliers are powerful if:

Suppliers are concentrated or differentiated: If there are only a few suppliers (or one) in the market, the suppliers will have more leverage because of the lack of available alternatives.

Significant costs involved in switching suppliers: Customers are less likely to switch suppliers if there are large costs associated with switching. For example, professional video editors are less likely switch from one system (Final Cut Pro) to another (Adobe Premier Pro) because of the costs associated with purchasing new hardware.

Suppliers can forward integrate: If a supplier has the power to or threatens to forward integrate, the buyer may be forced to accept influence from the supplier.