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Porter's Five Forces are a simplified model of the microeconomic environment that surrounds a given business, as well as a graphic representation of business strategy analysis. The forces define the competitive intensity of a given market and the probability of a certain business or product's profitability in the current economic climate.
The Five Forces
The Five Forces affecting the microeconomic climate of a given business are the threat of new entrants to the industry (how easy is it for a new business in the same industry to spring up?), power of suppliers (how many suppliers are there of a given raw material?), power of buyers (how many similar products are there out there?), the threat of substitutes (how easy is it for customers to switch to a similar product?) and finally competitive rivalry (how loyal are customers to a given product?).
Threat of Substitutes
The threat of substitutes is typically greatest when value propositions are based on price and products do not have unique features that set them apart. This may hurt a company when the price of a similar product in the marketplace goes down, for example. As more substitutes become available, both the demand for and the price of the products becomes more elastic. As the price for substitutes goes down, manufacturers may be prevented from raising or forced to lower their own prices. Substitutes may also come from outside the industry of the original product but serve the same or a similar purpose -- for example, glass and plastic bottles are considered a substitute for aluminum cans in this context.
Factors
Several factors may exacerbate the threat of substitutes. For example, the threat is higher if your product has no specific benefit compared to similar products. Email, the postal service and fax machines are all considered substitutes, but each has its own specific benefit that keeps any of them from becoming obsolete. Customers' ease in switching also affects how bad the threat is. For example, it may be easy for a restaurant to switch from one chicken farm to another, but a soda plant would have to reconfigure its operations completely to switch from aluminum cans to plastic bottles. However, the threat of substitutes is greatest if customers see little difference between products apart from price, at which point they may simply buy at lowest cost.
Reducing the Threat
A good way to reduce the threat of substitutes is to increase customer loyalty any way possible. Producing a product with obvious benefits over the substitutes and/or using effective advertising and branding are helpful for an individual company. If there is no difference between two products, consumers need to see a difference between the two companies and what they stand for, or they may simply choose the cheaper option. Innovation may also help -- companies that keep trying to improve their products may reduce the threat of substitutes.
The Five ForcesThe Five Forces affecting the microeconomic climate of a given business are the threat of new entrants to the industry (how easy is it for a new business in the same industry to spring up?), power of suppliers (how many suppliers are there of a given raw material?), power of buyers (how many similar products are there out there?), the threat of substitutes (how easy is it for customers to switch to a similar product?) and finally competitive rivalry (how loyal are customers to a given product?).
Threat of Substitutes
The threat of substitutes is typically greatest when value propositions are based on price and products do not have unique features that set them apart. This may hurt a company when the price of a similar product in the marketplace goes down, for example. As more substitutes become available, both the demand for and the price of the products becomes more elastic. As the price for substitutes goes down, manufacturers may be prevented from raising or forced to lower their own prices. Substitutes may also come from outside the industry of the original product but serve the same or a similar purpose -- for example, glass and plastic bottles are considered a substitute for aluminum cans in this context.
Factors
Several factors may exacerbate the threat of substitutes. For example, the threat is higher if your product has no specific benefit compared to similar products. Email, the postal service and fax machines are all considered substitutes, but each has its own specific benefit that keeps any of them from becoming obsolete. Customers' ease in switching also affects how bad the threat is. For example, it may be easy for a restaurant to switch from one chicken farm to another, but a soda plant would have to reconfigure its operations completely to switch from aluminum cans to plastic bottles. However, the threat of substitutes is greatest if customers see little difference between products apart from price, at which point they may simply buy at lowest cost.
Reducing the Threat
A good way to reduce the threat of substitutes is to increase customer loyalty any way possible. Producing a product with obvious benefits over the substitutes and/or using effective advertising and branding are helpful for an individual company. If there is no difference between two products, consumers need to see a difference between the two companies and what they stand for, or they may simply choose the cheaper option. Innovation may also help -- companies that keep trying to improve their products may reduce the threat of substitutes.
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