Management
students and practitioners are well aware of the Porter’s five forces model.
The model seems to underpin the foundations of both strategy and marketing. The
forces are some agents that an economic agent has to confront when they enter
the competition. In simple terms, Porter’s five forces lists five factor that
determine market entry and strategy. It borrows from the Industrial
Organization (IO) literature and is a pursuit to measure the competitive
intensity of the industry albeit in qualitative terms. While there can be
quantification of the competitive intensity, yet there exists a tendency for
qualitative analysis for the Porterian framework.
In Porterian
framework, the following five forces define the nature of competition in the
industry or the market. The first force is the threat of new entrants. This implies
the barriers of entry into the industry. if the barriers of entry are low, the
new firms are likely to enter given the presence of supernormal profits. As
economists would point out, the presence of cash on the table would attract
other firms and thus wipe out the cash from the table. There would be normal
profits but not supernormal profits. The second force is the threat of
substitutes. The availability of substitutes determine the price elasticity of
demand. If there are a number of substitutes available, the firm will have less
control over the price elasticity of demand. Furthermore there is strong degree
of elasticity in terms of cross price elasticity. The third factor is the bargaining
power of customers. The more elastic the demand is with respect to price, the
more would be the bargaining power of customers. The more inelastic the good is
with respect to demand, the bargaining power of would reduce of the customers.
The fourth force is the bargaining power of the suppliers. This is the inverse
of the customer demand bargaining power. If there are very few suppliers, their
bargaining power would probably be high. In case more number of suppliers
exist, the firm as a customers would able to exert greater bargaining power. The
final force is the competitive rivalry. The more rivalrous the industry forces
are, the lower would likely to be the price.
While Porter has
structured it around literature of management, as it was observed earlier, it
was essentially the industrial organization foundations of economics that
underpinned his models. In fact, it is essentially the economics of market
structures that seem to have underpinned the foundations of the Porter’s model.
Porter seem to have derived from the classification of market structures that
seem to drive his model to understand competitive intensity of rivalry. Therefore it would be interesting to decode
the origins of Porter’s model in the classification of the market structures.
There are
different ways to classify markets but the more common or popular way of
classifying the markets on the basis of the number of firms in the market. The
number of firms in the market would define the nature of rivalry in the market.
The more number of firms exist in the market, the more would be the degree of
rivalry within the firm. Therefore, the perfect competition would be defined by
greater degree of industrial rivalry while the context of industrial rivalry
would be quite low in the case of monopoly. The rivalry could still be strong
in the oligopolistic market if the firms are competitive while colluding firms
might want to reduce the degree of industrial rivalry.
The second way
to understand the market structure classification is the freedom of entry. The
freedom entry was rephrased into barriers to entry and threat of new entrants. For
instance, the perfect competition posits complete freedom of entry and exit. In
fact of threat of new entrants is very high in perfect competition. The entry
of new players is sought to be minimised or barriers erected in monopolistic
competition through differentiation. It is the economies of scale or control
over essential resources that form the natural barrier of entry in the
oligopoly or monopoly form of markets. The artificial barriers of entry are
sought to be erected through legal means either induced or government driven to
prevent the new players from entering into the market.
The nature of
demand curve actually talks about the bargaining power of the customer or the
supplier as the case might be. In fact, the market structures can be classified
not just based on the buyers but also based on the number of sellers. In the
context of market structures classified based on number of buyers, there exists
two forms monopsony and oligopsony. These market structures are inherently
designed for the bargaining power of suppliers. If there are few buyers and
many suppliers, their bargaining power actually wanes with the price being the
casualty. In fact, the China price or the race towards zero is based on these
market structures. The buyers are usually very few and the Chinese structure
creates a large number of sellers. So the supply side market structure results in
the lower prices and this is what Porter termed as the bargaining power of the
suppliers.
The nature of
demand curve indicates the bargaining power of the customer. A horizontal
demand curve, something that is observed in the perfect competition, gives the
control of the price to the market. The firm is a price taker. Given homogenous
goods, the buyer will buy from the firm that offers her the lowest price. On the
other extreme would be the vertical demand curve giving the firm control over
the price. The monopolistic competition offers fair degree of bargaining on
price with the customers. The substitutes does exist though they are not
perfect. In oligopoly, the bargaining power slowly shifts to the firm while in
monopoly the firm exercises great degree of control over the prices especially
if the good is relatively inelastic.
Thus as we
observe the market structures and the classification norms, it becomes evident
that Porterian model of five forces defining competitive intensity is an
adaptation in strategy of the exercises long followed in economics. It was
repositioning or reformulation of these characteristics that define the nature
of the market. Thus as we have observed, jargons in management literature do
trace their roots in economics thus building strong linkages.
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