Michael E. Porter of Harvard Business School in 1979 provided five force model for industry analysis and business strategy development, which defines the competitive intensity of the market.
Porter identified five forces that determines the strategic business of an organization and helps in ensuring constant and risk-adjusted growth of an organization by evaluating and analyzing these forces strategically. It is very important for an analyst to understand these five forces comprehensively to understand the complexity of operating business in the industry context.
Porter's five force model basically involves the competition that exists from the external sources rather than the internal sources and referred them as macro environment. Moreover, these five forces are differentiated into two types of competitions namely:
Horizontal Competition: This includes the threat of substitute products or services, the threat of established rivals, and the threat of new entrants.
Vertical Competition: This includes the bargaining power of suppliers and the bargaining power of customers
Threat of substitute products
Substitute products are always a great threat to any existing product as customers are available with many options for the same product due to increasing number of competitors in the market. Customers are easily attracted to the product or services that are available to them in less or same price with similar offerings. Moreover, if the quality of the substitute product is superior, it can also be a threat. Moreover, the profits and prices are affected significantly by the substitute products.
Threat of new entrants
Today, when the market is highly competitive, entry of new competitor is a great threat to the existing product and services. When the degree of new entrants in the market is high, the market power of the existing products or services weakens. Moreover, the customers get more options to switch with more entrants.
Industry rivalry refers to the high intensity of competitiveness among the existing players of the market. Industry rivalry depends upon the number of potential competitors in the same sector. High degree of rivalry leads to advertising wars, price wars, and various modifications in the products and services, which finally results in increased expenditure.
Bargaining power of suppliers
Bargaining power of suppliers refers to the position of seller in the market. It means how much power the sellers have in the market. The power of sellers can be the determining factor for increasing the Price of supplies. Basically, the suppliers are stronger when they are concentrated and well organized with least number of substitutes available to supplies. Moreover, unique products and high switching cost are also the determinants.
Bargaining power of Buyers
Bargaining power of buyers refers to the control of buyers to drive down your products price. Buyers are the masses and can act together to regulate your price. The bargaining power of buyers are high when, purchases in bulk quantities, when there is no product differentiation, low switching cost and most importantly when the buyers are price sensitive and the shopping cost is low.