The Business Book

(Joyce) #1


similar growth is slow; within a
specific star-rating the hotels are all
fairly similar, as are the sizes of the
big hotel chains. Customers can
choose to go to any hotel, and have
good access to prices. Exit from
the industry is difficult because
of the upfront investment. Many
large hotel groups have introduced
loyalty programs as part of their
strategy to differentiate their brand.

The most significant of the five forces
is not always the most obvious one.
For example, even though rivalry is
often fierce in commodity industries,
that may not be the factor that
ultimately limits profitability.
The “threat of substitutes” force
is surprisingly important here—
buyers in these markets can easily
find substitute raw materials or
products that have attractive prices
or are higher quality. What’s more,
buyers can switch from one product
or service to another with little
cost. For example, it costs relatively
little for a consumer to switch from
tea to coffee, unlike switching from
traveling by bicycle to car.
In some industries, companies
try to limit the threat of potential
substitutes by ensuring wider

product accessibility. For example,
soft-drink manufacturers have
achieved this by introducing
branded vending machines, so
competitors are unable to offer their
products at that particular place.

Buyer power
Buyers can demand lower prices
or higher product quality from
producers when their bargaining
power is strong. Both scenarios
result in lower profits for producers,
because lower prices mean lower
revenues, and higher-quality
products usually incur higher
production costs. Buyers exert
strong bargaining power when
there are few of them; they buy
in large quantities; they are price
sensitive; they control distribution
to the final customer; there are
many subsititutes; and switching to
another supplier can be done at low
cost. Buyers may also be able to
produce the product themselves—
so may use this as a threat.
Buyers for big supermarkets have
huge bargaining power in the food
and drink industry. Fresh milk is
often at the heart of supermarket
price wars, because the big chains
have significant buying power over
suppliers. UK farmers have claimed
that they are so pressured to reduce
prices that they often make a loss
on each bottle of milk produced.

Supplier power
When the bargaining power of
suppliers is strong, it allows them
to sell higher priced or lower quality
raw materials. This directly affects
the profits of the company that is
buying, because it has to pay more
for its raw materials. Suppliers have
strong bargaining power when
there are few of them (but many
buyers); they hold scarce resources;
the cost of switching raw materials
is high; and when there are few


Buyer power is high in the food and
beverage industry because consumers
can easily find a substitute that may be
cheaper or differentiated, such as by
offering increased nutritional benefits.

substitute raw materials or
suppliers. Their power is increased
if they are large and can threaten
to step in and produce themselves.
Oil is an example of a scarce
resource that is controlled by a few
countries. OPEC (Organization of
the Petroleum Exporting Countries)
represented the political power of
oil-exporting countries in 1973 when
it placed an oil embargo on the US.
OPEC’s action disrupted supply and
forced up the price of oil four-fold.

New entrants
If an industry is profitable and there
are few barriers to entry, Porter says
that competition will increase and
profits will fall. Typically, existing
organizations try to create ways to
deter new entrants. The threat of
new entrants is high when the cost
of entering the market is low; there
is little government regulation;
customer loyalty is low; existing
businesses can do little to retaliate;
and economies of scale can be
easily achieved. Risk is increased
if existing companies have not
established brand reputation and
do not possess patents, and when

Industry structure,
as manifested in the strength
of the five competitive forces,
determines the industry’s
long-run profit potential.
Michael Porter
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