Porter’s Five Competitor Forces Model – Part II

Threat of New Entrants

If there are low barriers to entry in an industry, the easier it is for other firms to enter this industry. In such a situation, new entrants could change major determinants of the market environment (e.g. market share, product pricing, customer loyalty) at any time. There is always a hidden pressure for reaction to any change in the market dynamics and adjustment for existing players in this industry.

The threat of new entries will depend on the extent to which there are barriers to entry – the greater the barriers to entry, the less prone is someone’s inclination to enter the market. The lower the barriers, the easier it is for someone to enter the market. The barriers to entry typically are:

• Economies of scale. This means the minimum size requirements for an operation to be economical.
• High initial investment and fixed costs. This is essentially a cost barrier.
• Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets. With fixed costs depreciated, existing firms will enjoy significant costs advantages.
• Brand loyalty of customers. If the brand has major penetration in the market, then it’s hard to get customers to switch.
• Protected intellectual property like patents, licenses etc.
• Scarcity of important resources and raw materials. Here whatever’s available could be controlled by existing players who have long-term contracts in place.
• Distribution channels are controlled by existing players. This is a problem as a new entrant will then have to either forward integrate or enter into distribution contracts with existing players and take a hit on operating margins.
• Existing players have close customer relations. This is about long-term contracts with a strong customer base and is highly relevant in a B2B scenario.
• High switching costs for customers. Changing to another supplier will involve significant costs from a process and management standpoint for a customer and they may not be inclined to go with a new entrant.
• Legislation and government action prohibits new players in the market.

Threat of Substitutes

A threat from substitutes exists if there are alternative products with lower prices or better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category also relates to complementary products.

Similarly to the threat of new entrants, the threat of substitutes is determined by factors like

• Brand loyalty of customers. The biggest brands will have the highest market share. Changing loyalty means changing habits and that takes too much time.
• Close customer relationships. From a B2B perspective, that’s a hard one to break.
• Switching costs for customers. Customers want to cut costs not increase them. The value proposition of the new entrant’s products need to be extremely high to entice a switch.
• The relative price for performance of substitutes. If the substitute does not perform as well as the original, then there’s a problem.
• Current trends.

Competitive Rivalry between Existing Players

This force describes the intensity of competition between existing players in a market. High competitive pressure results in pressure on prices, margins, and profitability.

Competition between existing players is likely to be high when:

• There are many players of about the same size, Same size implies that the same amount of resources will be available to carry out the marketing tactics in an industry.
• Players have similar strategies. Enough said, with a similar strategy there’s a limited amount of market share that you can grab.
• There is not much differentiation between players and their products, hence, there is a lot of price competition
• Low market growth rates. Here the growth of a firm is possible only at the expense of a competitor, However, in such a scenario, with limited growth the potential of upside is virtually nothing until a disruption derails a competitor.
• Barriers for exit are high. With a lot invested in capital equipment which is expensive and highly specialized, it makes little sense for someone to exit the market – in such a market, it’s also possible to partner with competitors from a manufacturing standpoint and have tolling agreements to utilize capacity.

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