The Business Book

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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.

Substitutes
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

PORTER’S FIVE FORCES

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