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Explaining Porter’s Five Forces

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Porter’s five forces refer to the framework of qualitative tool that’s used in investment analysis. This framework is useful in the analysis of the company’s status in the industry. 

These five forces analyze industry-specific factors to help investors determine how well a corporation is performing to adapt to the changes in its target market.

Threat of Substitute Product (or Service) 

The threat of substitute product or services comes out when customers can easily switch to alternative products. 

For instance, in an economy where there is a huge population growth, people may opt to change their mode of transportation. From cars and automotive, they may start buying bicycles or using the public transportation services. 

On the other hand, to know whether such a threat is realistic, you have to take into account different factors. These include switching costs and the practicality of the new product. 

Threat of Increased Competition 

Market saturation will usually prevent a single company from gaining too much advantage and experiencing a surge in revenue. 

This is an internal threat that you can find in almost any industry that’s not dominated by monopoly. Also, when analyzing this threat that comes from competition, there are various factors to consider. 

Those factors include brand equity, position in the market, efficiency in advertising, and tech advantage. In most cases, the biggest player in the industry may become obsolete if it doesn’t have the traits that ensure a stable and sustainable competitive advantage. 

Threat of New Entrants 

Porter’s framework has a crucial component in the form of barriers to entry. These barriers can be in the form of patents, capital requirements, government restrictions, access to distribution network, and technological knowhow. 

In other words, the new entrants to the market will have to break multiple barriers if they want to compete with the companies that have already established themselves as key players. 

Most of the time, a firm will be the pioneer in the market if it has an innovative technology or service that may automatically recreate or revolutionize the way the business is done in a certain market. 

The Suppliers’ Bargaining Powers 

The threat of disproportionate supplier bargaining power is usually a problem for smaller companies that exclusively depend on the inputs from one seller. 

For instance, if a restaurant focuses on unique dishes and can only buy ingredients from one seller, that seller-supplier can easily raise the price that the restaurant has to pay to get the ingredients. 

Meanwhile, huge retailers are generally free of this threat because they have access to a wide distribution network.

Customers’ Bargaining Powers 

Now, when these giant retailers are treated as customers in a transaction, they can exercise significant amount of buying power.

Many businesses hope these giant retailers continue buying from them. Therefore, these buyers can easily negotiate favorable price contracts and minimize the revenue potential of their suppliers. 

Following the principle of diversification, companies should not be totally dependent on a single customer. 

For instance, a cancellation of a certain customer’s contract from the seller should not be enough to push the supplier into bankruptcy. 

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