Maximize profits with the help of Michael Porter’s five forces model


Maximize profits with the help of Michael Porter’s five forces model

Michael Porter’s five forces model helps the organisations to play a key role in building competitive advantage globally and to maximize their profits. The structure of an industry dictates the strength of the competition associated with it and represents the relation existing among the five forces determine the behavior of competing firms within the same industry.

Five fundamental competitive forces operating in a particular industry highly influence the industry’s profit potential. By knowing these forces firms can offer better and greater value products and services. It increases brand loyalty and so that target markets identify and prefer these particular products.

Porter’s five forces model enables the organisations to maximise the profits even in an uncertain business environment also. These forces are called as Porter’s diamond model which is as follows.

1.Threat of entry:

High returns of an industry attract the new arrivals into the market and they would pose the competitive threat to the existing firms that are usually referred to as “incumbents”. New production capability, the bulk of expertise, wide base of resources and strategic approach of the new entrants impose the risk for the incumbent.

Based on two factors new players can conquer the market’s share successfully.

  1. Barriers to entry
  2. Counter-attack of the incumbents

Barriers to entry

a) Economies of scale:

Economies of scale is described as cost advantages that a firm obtain due to the size of the firm, the scale of production, and machinery, etc, here cost per unit greatly reduces with increasing scale. Generally, new entrants will be unable to decide which strategies help them to operate. It will become a great barrier to starting a new venture.

Best methods for overcoming this barrier is possible through the selecting low-priced sites nearer to the target markets, by buying more advanced technology and multi-tasking  machines, buying raw materials during favorable prices, production of customized products and concentrating on the needs of the small group of customers only.

b) Expected retaliation:

If the incumbents adopt retaliation then the new entrants face difficulty with the counter actions of the existed firms. Retaliation is expected when the incumbent’s firm possess a large market share in the industry or it has broad resource base.

Best methods to overcome this barrier

  • Strategic planning
  • Hiring creative and highly skilled manpower
  • By starting a dedicated department to protect the firm from the incumbents counter actions.

c) Product differentiation:

Incorporation of distinctive features into the products which make them different from other firm’s products. Incumbent firms possess good brand recognition and loyalty and this is not easily gained by the new entrants.

Best methods to overcome this barrier:

  • Products with more features
  • Producing superior quality products
  • Providing good customer service
  • Task delivery

d) Capital requirement:

To fulfill the firm’s capital requirements and to face uncertain conditions, established firms have huge capital and credit sources. But in the case of new entrants, these factors discourage them to enter into the industry.

Best methods to overcome this barrier:

  • By using various financial benefits and subsidies granted by the government to the new firms
  • Finding low-interest rate credit sources

e) Distribution channels:

This is a powerful entry barrier due to space restrictions experienced by the distributors. Hence great difficulty occurs to attract the distributors by offering price concessions, but it leads to the reduction in the profit margins of the firm.

Best methods to overcome this barrier:

  • Using distribution channels other than the incumbents’ distribution channels
  • By maintaining good relations with the available distribution channels
  • By giving a chance to the new distribution channels
  • Establishing plants nearer to the suppliers and customers reduces the costs associated with the inbound and outbound logistics

f) Government policies:

The entry of new firms into the market is controlled and regulated by government policies such as, licensing, permit requirements etc, it acts as a major entry barrier.

Best methods to overcome this barrier:

  • By taking the opinions and the support of the experts
  • By approaching legal advisers to fulfill the legal requirements

g) Brand identity:

To create the brand image and identity, firms should put strong efforts and time. Product differentiation, low prices in the market and customer relations of the existed firms act as a barrier to the newcomers.

Best methods to overcome this barrier:

  • Maintaining the target customers’ list
  • Strategic approach

Counter-attack of the incumbents:

If the competitor’s counter attacks are powerful then the new entrants may not be successful in fighting against them. Generally, they enter the new market on a condition that they would share profits equally with the incumbents.

2.Powerful suppliers

The suppliers can use their power over the firms and influence the profit potential.

High supplier concentration:

If suppliers are highly concentrated by the large companies then, they can greatly affect the price, quality and selling terms.

No substitutes:

If the buyer has no alternative choice other than the products of the suppliers then the supplier becomes the “demand for the markets”.

Product important to buyer:

If the products or inputs provided by the supplier are important then the supplier can avail greater bargaining power.

Supplier’s product differentiation:

If the supplier’s products are differentiated and they possess unique features when compared to the competitors then they can acquire the competitive position in the market.

Supplier’s ability to enter the buying industry:

If the suppliers have enough resources and have enough capability to run their own production facilities, distribution channels, retail outlets etc., then they can easily enter the industry for which they are supplying so that, they can have an efficient power of bargaining.

3. Powerful buyers

Customers demand the improved quality or increased service at low cost thereby, decreasing the competition against each other, and all these activities hold influence on the profit generation capability of an industry.

Buyers become powerful in the following situation,

Buyers’ concentration:

If the buyers are concentrated or if they buy in large quantities then they can avail benefits of trade discounts and concessions.

  • If the sales are more, then there is a possibility of getting profits, so giving discounts and concessions always acts as a motivator and it increases sales.

Price sensitivity:

Price is a crucial aspect for the buyers; they always give importance to the product’s price and take decisions. Buyers always ask for the bargains by adopting suitable techniques.

  • Pricing decisions without disturbing the profits and according to the buyer’s point of view is an art, attractive prices maximize the sales in the long run.
  • Qualitative products never make the buyers to bargain. They can afford the skimming prices also if the products are highly qualitative.

 Switching costs:

The switching costs experienced by the buyer would be low; hence they can switch from one buyer to another as per their requirement.

  • Here loyalty plays a major role in retaining the prospective customers.
  • Loyalty comes from the better quality products, customer relations, and better prices.

4.Threat of substitute products:

Substitute products are those products that are produced by the competitor and which perform a similar function as that of products produced by the firm. The existence of substitute goods prevents from charging high prices and if there is a rise in the price of any substitute good then the customer shifts towards the substituted products.

If the product has an improved quality or differentiated due to its unique features only then it can withstand the competition posted by its competitors substitute product.

5.Intensity of rivalry among competitors

Generally, the firms functioning in the same industry are dependent and reliable on each other. The activities of one firm may represent the counter attack for the competitors in terms of price cutting, increased advertising, enhanced customer services, warranties etc.,

All these act as entry barriers and greatly reduce the profits; Michael Porter strategies help the organisations to take right decisions even in the severe competition.