Michael Porter gave the Five Forces Model of competition. It was published in Porter’s book "Competitive Strategy: Techniques for Analyzing Industries and Competitors" in the year 1980. The model focuses on the factors that determine the profitability of firms within various industries. It is of great significance for formulating business strategies. The five forces are described as the micro environment (because these are industry and firm specific). According to this model, an “unattractive” industry is where all these factors lead to a reduction in profitability.

The model is best illustrated through the given diagram:

COMPETITIVE RIVALRY

THREAT OF NEW ENTRANTS

BARGAINING POWER OF BUYERS

The bargaining ability of the buyers or customers also poses a serious threat. The bargaining power of buyers depends on the concentration of the buyers, the order size and the product differentiation in the industry. If the buyers purchase a large portion of the production or, have a significant order quantity, they can overpower the firms and vice versa. If the products of the different firms are well differentiated, it gives the firms an upper hand and the bargaining power of the buyers reduces. In case of a monopsony (a condition where there are many sellers and 1 buyer in the industry), the buyers have excessive bargaining power as they can threaten to shift to some other supplier.

THREAT OF SUBSTITUTE PRODUCTS

Under this model, substitute refers to a product of some other industry which can be substituted for the product of a given industry. This acts as a threat as the consumers may switch to the products of the other industry. The extent of threat posed by this factor depends on the ease of switching for the buyer, availability of a close substitute and relative price of the substitute. If it is easy for the consumers to substitute, it will also restrict the control over prices by the firms as they will constantly fear losing their customers.

BARGAINING POWER OF SUPPLIERS

Limitations of the Porter’s Five Forces model

• It involves clear demarcation of an industry and the 5 forces. This may become difficult in the current scenario with great interdependence and interrelation in the market players.

• The model only considers five forces, in reality, there can be several forces that may exert influence on an industry (such as governmental intervention).