The present work aims to carry out an analysis of the business environment using the Competitiveness Model proposed by Michael Porter, showing how the forces that compose it have a direct impact on the internal functioning of companies, frequently conditioning their strategies and influencing, therefore, in your results. As its main conclusion, it is highly necessary to understand the functioning of the environment, as well as the extent to which its forces are related to organizations and affect their ways of operating.
Introduction
A company is an organism that carries out economic activities to obtain benefits. These activities are framed in various technological specialties and are developed in physical and social areas that may have been the object of a prior arrangement. Companies are not isolated from each other, on the contrary, they are an open system that is in constant interaction with its environment. The globalization of the economy and the appearance of new technologies have transfigured the competitive environment in which they carry out their activity.
The internal dynamics of the company and the speed and way in which the environment moves, have to be treated as a whole when carrying out analyzes from which the strategies to follow will emerge in order to be competitive in an increasingly market convulsed, and with the difficult demands of satisfying the ever-growing expectations of customers and minimizing more and more the resources disbursed, in order to maximize profits. For this, it is essential to take into account that the internal results of the company depend, in a high percentage, on the characteristics of the environment in which it operates and on its capacity to assimilate this environment and to manage it efficiently.
Just a glance at the current business environment is enough to understand that it is not governed only by quantitative variables that can be easily manipulated through economic and mathematical models, with which a forecast of the situation and decisions can be made. On the contrary, the driving forces of the dynamics of the environment are made up of qualitative aspects (relations of economic interests and power, relations of influence, structural differentiation of companies, etc.) that make their operating scheme complex.. According to Porter (1982), " the essence of formulating a competitive strategy consists in relating a company to its environment."
The objective of this work is to make an analysis of the environment of companies through Porter's Expanded Competitiveness Model, showing how the forces that compose it affect, and on many occasions determine, the results expected by them.
Development
Porter's Five Forces compose a holistic model that allows any industry to be analyzed in terms of profitability. Also called " Porter's Expanded Competitiveness Model ", since it better explains what the model is about and what it is for, it constitutes a management tool that allows an external analysis of a company through the analysis of the industry or sector to be carried out. the one that belongs.
Proposed by Michael Porter in 1979, this model outlines a simple and practical scheme to be able to formulate an analysis of each industrial sector.
From this, the company can determine its current position to select the strategies to follow. According to this approach, it would be ideal to compete in an attractive market, with high entry barriers, weak suppliers, atomized clients, few competitors, and no important substitutes.
Porter's model posits that there are five forces that basically make up the structure of the industry. These five forces define prices, costs and investment requirements, which are the basic factors that explain the expectation of long-term profitability, therefore, the attractiveness of the industry. From its analysis it is deduced that the rivalry between the competitors is given by four elements or forces that, combined, create it as a fifth force. The foregoing is summarized in Figure 1.
To undertake an Analysis of Porter's Five Forces Model, it is first necessary to take into account that “there are two dimensions of the business environment: the macro environment, which comprises the forces that at the macro level have and / or may have behavioral implications. of the sector and of the company in particular (economic, political, cultural, social, legal, ecological, demographic and technological forces); and the sector (set of companies that produce the same types of goods or services), whose analysis is related to structural behavior, studying the forces that determine competitiveness in the sector ”(Baena et al., 2003).
The analysis of the sector covers the environment closest to the company, allowing to obtain decisive criteria for the formulation of competitive strategies that propose the positioning of the same.
It is also necessary to know the main elements of the market that serve as the basis for the five forces that intervene in an industrial sector:
- Direct Competitors: Those companies that offer the same good or product. Example: Mercedes Benz and BMW. Clients: Group formed by the buyers of the goods and services. Suppliers: A group of companies that supply the production companies in the sector with everything they need to produce or offer their services. Substitute Products: Those that can appear and cover the same needs that satisfy the products that currently exist on the market. Examples: bread and biscuit; mayonnaise and butter. Potential Competitors: Those companies with the ability to compete with those belonging to a specific sector.
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In the following video, it is Professor Michael Porter himself who explains the conceptual bases of the five forces that shape organizational strategy.
Once the market elements that serve as the basis for the five forces are known, it is possible to proceed to the particular analysis of each of them:
1. Threat of the entry of new competitors
It is considered that in a sector in which it is known that the return on invested capital is higher than its cost, the arrival of companies interested in participating in it will be very large and fast, until they take advantage of the opportunities offered by that market. Obviously, the companies that enter the market increase the productive capacity in the sector.
In the event that there are higher than average profits in the sector, it will attract a greater number of investors, increasing competition and, consequently, lowering the profitability of the sector.
When a new company tries to enter an industry, it could have entry barriers such as lack of experience, customer loyalty, large capital required, lack of distribution channels, lack of access to inputs, market saturation, etc. But they could also easily enter if they have products of a higher quality than the existing ones, or lower prices. This leads to one of the concepts of strategies, the concept of barriers to entry and its relation to the profitability of the industry.
At this time, it is possible to talk about whether or not a sector is contestable, which depends on the existence of entry and exit barriers. For this reason, a sector is contestable when these barriers do not exist, in which prices depend on the competitive level of the sector (law of supply and demand), without influencing the number of companies that exist in the sector. The existence of entry barriers brings with it the so-called sunk costs, which are those that the company must face to enter the sector to invest in certain assets and that it will not be able to recover when it decides to exit the sector.
For this reason it is said that when there are no sunk costs, companies "use" the sector, in the sense of not being interested in its survival and growth, but in the benefits it can bring at a given time, since, once these are achieved, they will leave the sector.
Entry barriers are understood to be “any mechanism by which the expected profitability of a new entrant competitor in the sector is lower than that obtained by competitors already present in it” (Dalmau and Oltra, 1997).
Some of the entry barriers to avoid the vulnerability of the sectors that define this force are:
Necessary Investment or Capital Requirements:
They are high minimum needs to invest capital in infrastructure for production, research and development, inventory, advertising or marketing.
In certain sectors, the investment that is needed just to be part of it is so enormous that companies cannot afford it, no matter how large they are. This is the case, for example, with the passenger aircraft sector, where Boeing and AIRBUS have such an overwhelming dominance of the market that they can hardly compete with them. Other sectors do not have such high entry costs.
Scale economics:
These occur when the unit cost of a given activity is reduced by increasing the volume of production during a specific and defined period of time; therefore small production is not efficient for the company, so you have to produce on a large scale. Therefore, a company that wants to be part of this sector will have to decide whether to enter with a small scale of production, which implies very important unit costs, or to enter with a large production capacity, knowing that it risks that this capacity is underused while the volume of production is not sufficient, with the costs that this entails.
Experience curve:
It covers the know-how accumulated by a company in the development of an activity over a long period of time. It refers to the set of activities of the company, covering all aspects of the organization: management, product technology, processes, etc.
Absolute cost advantage:
The fact of being the first to reach a sector, together with other factors such as the supply of a raw material or learning economies, cause the company that is already within the sector to have cost advantages, which is a major impediment for those companies that want to be part of that sector.
Product differentiation:
Degree to which consumers distinguish one product from another; These can be attributes of design, presentation, customer service, etc. It is very difficult for a company that is new to a sector to compete against others that are already established in it; And it is that these established companies already have a recognized brand and a loyal clientele, which forces the incoming companies to make significant investments in advertising, a cost that they would have saved if they had entered before their competition in the sector.. Another path that these new companies can take to avoid spending so much on advertising is to compete on prices with established companies, or to act in niche markets that they do not consider.
Access to distribution channels:
It is the acceptance of marketing the productof the new competitor through existing channels, with restrictions that reduce the ability of the new company to compete in the market. This barrier is very important, since the end consumer will not have the possibility of acquiring the product if he does not see it at the point of sale. For a new company in the sector, it is not easy to occupy a place in the distribution channels, which are already occupied by well-known companies. In addition, new companies do not have that relationship of trust with the final seller to occupy a privileged position in the place of sale. An example of this is what happens in supermarkets, where the space is limited to that offered by the shelves, and which are already occupied by companies already established in the sector. If access to channels is prevented, the success of the company is impossible.
Brand identification:
Barrier related to the image, credibility, seriousness and reliability that the company has in the market as a consequence of a way of acting and the characteristics of its product, which can lead the buyer to identify the product with the brand. An example of this is the identification by many consumers of cola only with Coca Cola.
Government barriers:
They are those imposed by governments and higher bodies, and are related to obtaining licenses issued by public authorities, patents, copyrights, requirements related to the environment, security, etc. Examples of this are taxis and televisions (licenses), research works (patents). They can also be subsidies to certain groups, creation of state monopolies; For example, in Europe the governments of different countries subsidize and encourage companies that venture into the generation of energy from renewable sources. These barriers, which are increasing especially in relation to quality and the environment, represent significant costs for the entry of new companies.
Retaliation:
Referring to the reprisals that existing companies in the sector could take according to how they interpret the entry of the new company. This retaliation could consist of aggressive advertising campaigns or sharp price drops to the point of suffocating the new company, whose profit margin is lower because it is just starting out. This last measure would lead to the ruin of the new company. Depending on the reaction of established companies, more or fewer new companies will enter.
The threat of entry by new competitors depends mainly on entry barriers and the reaction of companies that are already established within the sector to newcomers. On the other hand, the effectiveness of these barriers to deter incoming companies depends on the resources they have.
2. Threat of possible substitute products
Substitute products are those that perform the same functions as the product under study. They are also a force that determines the attractiveness of the industry, since they can replace the products and services that are offered or represent an alternative to satisfy the demand. They represent a serious threat to the industry if they cover the same needs at a lower price, with superior performance and quality.
Companies in an industrial sector may be in direct competition with those in a different sector if the products can substitute for the other good.
A company must be very aware of those products that can replace those produced by it. For example, if said company sells soft drinks, it is aware of the threat from mineral water sellers, manufacturers of natural juices, smoothies, etc.; but not only that, their competition would also be the juices that families can make at home. In that sense, they would be almost competing with the farmers who produce oranges and with the manufacturers of juicers.
The impact that the threat of substitutes has on the profitability of the industry depends on factors such as (Baena et al., 2003):
Substitute availability:
It refers to the existence of substitute products and ease of access.
Relative price between the substitute product and the one offered:
It refers to the relationship between the price of the substitute product and the one analyzed. A competitively priced substitute good sets a cap on the prices that can be offered in an industry.
Performance and quality compared between the offered product and its substitute:
Customers will favor the replacement product if the quality and performance are superior to the used product.
Exchange costs for the customer:
If exchange costs are low, buyers will have no problem using the substitute good, while if they are high, they are less likely to do so.
In short, the entry of substitute products, depending on their quality, availability, costs and performance, puts a cap on the price that can be charged before consumers opt for a substitute product.
3. Bargaining power of suppliers
This force refers to the negotiating capacity that suppliers have, who partly define the positioning of a company in the market, according to their bargaining power with those who supply them with the inputs for the production of their goods. For example, the fewer suppliers there are, the greater their bargaining power, since there is not so much supply of inputs, they can easily increase their prices.
In addition to the number of suppliers that exist, your bargaining power could also depend on the volume of purchase, the amount of substitute raw materials that exist, the cost of changing raw materials, etc.
An illustrative example of the aforementioned is OPEC, (Navarro, 2009). By having great control over a good part of the oil production, they have a great negotiating capacity with their clients.
Having the ability to negotiate allows suppliers better prices, but also better delivery times, compensation, and payment methods. In a company, the negotiating capacity of suppliers can weigh down its competitiveness, so it is another factor to take into consideration.
The bargaining power of suppliers will depend on market conditions, the rest of the suppliers and the importance of the product they provide; and the most significant variables of this force are the following:
Concentration of suppliers:
It is necessary to identify whether most of the provision of inputs or resources for the companies in the sector is carried out by a few or many companies.
Importance of volume for suppliers:
It is the importance of the volume of purchase that companies in the sector make from suppliers, that is, sales to the sector in relation to the total sales of suppliers.
Differentiation of inputs:
Whether the products offered by the suppliers are differentiated or not.
Exchange costs:
It refers to the costs that the buyer incurs when changing suppliers. The existence of high switching costs can give suppliers relative power.
Availability of substitute inputs:
It is the existence, availability and access to substitute inputs that due to their characteristics can replace the traditional ones.
Impact of inputs:
It is about identifying whether the inputs offered maintain, increase or improve the quality of the good.
As can be understood from the above variables, the supplier will be in an advantageous position if the product it offers is in short supply and buyers need to purchase it for their processes. If, on the other hand, the product you offer is standard and can be easily obtained on the market, that is, there are a large number of suppliers, your influence will be diminished. In this case the buyer will be in a good position to choose the best offer.
4. Bargaining power of customers
Competition in an industrial sector is determined in part by the bargaining power that customers have with the companies that produce the good or service.
In product markets, there are two factors that influence the determination of the strength of a company's bargaining power vis-à-vis its customers: price sensitivity and bargaining power. The main variables that define these factors are:
Customer concentration:
Identify the number of customers that most of the sales in the sector demand. If the number of existing clients is not high, the negotiation lever is affected since they may demand more.
Purchase volume:
The higher the economic value of the purchases made by the customer, the latter will be able to force better conditions on their suppliers.
Differentiation:
The greater the bargaining power of the clients the less differentiated the products or services are. The differentiated products are those that the client identifies by their design, brand and quality superior to the others.
Information about the provider:
If the client has accurate information about the products, quality and prices that allows him to compare them with the competition, he may have more important arguments in the negotiating power with the supplier.
Brand identification:
It is the association that the buyer makes with existing brands in the market, which can lead them to identify a product with a brand, such as the example of Coca Cola.
Substitute products:
The existence of substitute products allows the buyer to put more pressure on prices.
There are people who have considered that an adequate strategy by a business company will have as a key component the attempt to neutralize the bargaining power of suppliers and buyers. This idea has changed today and the idea that there should be a mutually beneficial relationship between supplier and buyer has developed. It is very important that there is a balance and a good relationship between suppliers and buyers, this relationship should be one of collaboration instead of confrontation.
5. Rivalry between existing competitors
The rivalry between competitors is at the center of the forces and is the most determining element of the Porter model. It is the force with which companies usually take actions to strengthen their position in the market and thus protect their competitive position at the expense of their rivals in the sector.
The current market situation in any of the sectors is marked by competition between companies and its influence on generating profits. If companies compete on prices, not only do they generate less profit, but the sector suffers, so that it does not attract the entry of new companies. In sectors where there is no price competition, there is competition in advertising, innovation, product / service quality. Rivalry between competitors defines the profitability of a sector: the less competitive a sector is, the more profitable it will usually be, and vice versa.
To determine the intensity of competition, the influence of the following factors must be considered:
Concentration:
It is a matter of identifying if few companies dominate the market or if, on the contrary, there is a phenomenon of atomization; as well as the size of them. It is suggested that there is a relationship between the number of existing companies and the price of their products. In markets of a company's dominance (such as Microsoft in PC operating systems), the dominant company has freedom to set prices. In the case of oligopolies (a market led by a small group of companies), price competition is limited to “parallel prices” agreements between these companies. In markets where two companies clearly dominate, such as Coca Cola and Pepsi, the competition is not in prices, since they are similar, but in advertising and promotion campaigns.
Diversity of competitors:
Difference in the origins, objectives, costs and strategies of the companies. A few decades ago, the companies that competed within a market had very similar characteristics in terms of their organizational structure, costs and even objectives; that caused less rivalry to have such a similar operation. With globalization and the opening of borders, competition has grown enormously as well as the conditions in which it competes, since companies have changed and tend to relocate. Those that have not yet been relocated have different origins, structures, costs and objectives, but only one market for action.
Cost conditions:
If fixed costs are high relative to the value of products or services, companies will be forced to maintain high business figures.
Excess capacity forces prices to drop. How far a company can go in lowering prices will depend on the structure of its costs. As a general rule, the company must always cover its fixed and variable costs.
Product differentiation:
These are the characteristics of the product that make it different, even to the point of being perceived as unique in the market due to its use or application. It can be due to characteristics of the design, the presentation, the customer service, etc. The tendency for consumers to substitute one product for another will be greater the more similar the products offered by companies, this forces them to reduce their prices in order to increase sales.
Exchange costs:
When the costs of changing from one product to another are low, internal struggle within the sector is encouraged.
Business groups:
The rivalry increases when powerful business groups buy small companies in the sector to relaunch them and enter that market.
Demo effects:
Need to succeed in the most important markets in order to be able to enter the others more easily.
Exit barriers:
The rivalry will be high if the costs to leave the company are higher than the costs to stay in the market and compete, or if there are factors that restrict the exit of companies from an industry, such as:
Durable and specialized resources: existence of specialized assets, which implies a low liquidation value or high conversion costs if one wants to change activities.
Emotional barriers: The resistance to liquidating or leaving the business generated by emotional commitments of the entrepreneur.
Government or contractual restrictions: Limitations imposed by the government to liquidate a business, or the contractual protection of employees in the event of dismissal.
The fact that exit barriers are very high contributes greatly to the deterioration of the industry's attractiveness in mature and declining markets.
From the analysis of this force it can be deduced that the degree of rivalry between competitors will increase as their number increases, they become equal in size and capacity, demand for products decreases, prices fall, etc.
In some articles it is proposed to complete the model with a sixth force, the Government, arguing that companies must also take into account the actions and potential actions of governments, not only because of their regulatory capacity, but because it can become a competition. For example, in capitalist countries private universities have the problem that the government also provides higher education.
With respect to this, the author of this work disagrees with the Government's proposal as a sixth force; Considering that the Government is part of one of the five forces according to the role it plays, whether as a barrier to entry or exit (government barriers), supplier, customer, direct or indirect competition.
Conclusions
The internal functioning of a company is largely determined by its environment, which directly affects its strategies and, therefore, its results. It is for this reason that it is highly necessary to understand the functioning of this environment, as well as the extent to which its forces are related to the company and affect its way of operating.
The application of Porter's Five Forces Model to the industry sector where one works allows comparing strategies and competitive advantages with those of other rival companies by analyzing rivalry between competitors; thus allowing to know if it is necessary to improve or redesign existing strategies.
The analysis of the threat of the entry of new competitors makes it possible to establish entry barriers that prevent the entry of these competitors, such as the search for economies of scale or the obtaining of technologies and specialized knowledge; or, in any case, it allows the design of strategies that face those of said competitors.
By analyzing the threat of the entry of substitute products, it is possible to design strategies to prevent the penetration of companies that sell these products or to implement strategies that allow them to compete with them.
The analysis of the bargaining power of the suppliers allows the design of strategies aimed at achieving better agreements with the suppliers and allowing them to acquire them or have greater control over them.
Finally, the analysis of the bargaining power of customers allows the development of strategies aimed at attracting a greater number of them and obtaining greater loyalty or loyalty from them, such as increasing advertising or offering greater services or guarantees.
Due to the aforementioned reasons, companies must fully exploit the Five Forces in order to increase their competitive advantages.
Bibliography
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