Industry Analysis: The Porter Five Forces
In this blog post, we will discuss The Porter five forces using IKEA as an example, we will elaborate on how this tool can be used by an organization to have a bird-eye view on the industry.
In 1979, Michael Porter at Harvard business school suggested a business plan divided into five parts for a better “SWOT analysis”. The objective was to aid business enterprises increasing their profit in the market. The Porter five forces have become the main tool for the analysis of an industry. These forces evaluate the rivalry of the market and derive its magnetism. This study identifies and analyzes five (5) competitive forces that shape every industry, and helps determine an industry’s weaknesses and strengths. The Porter Five Forces tool is a simple but dominant tool for understanding where power lies in a business situation.
- Rivalry in the industry
- Power of suppliers
- Power of customers (buyers)
- Potential of new entrants into industry (barriers to entry)
- Threat of substitute products
The framework of Porter five forces industry analysis content three externals and two internals forces. The rivalry from external/outside refers to the micro and microenvironment.
Rivalry within the industry
Industries that held high-profit margin will attract other firms to enter its market. Therefore in the short run, the new entrant that cannot stand the rivalry will leave and the profit margin of the industry remains unchanged. However, in the long-run, the new entrant will take part of the profit margin share; hence reduce the other firms’ profit to break-even (total revenue equal total cost).
The competition in the furniture industry is moderate. However, there are a lot of major players. Furthermore, there are a handful of retailers in the economy, selling furniture at low cost and providing the discount as well like IKEA. Some of those retailers are Wal-Mart Stores Inc, Argos, Galiform plc, and others. Also, many other retailers import and sell furniture it in the market at a low price like IKEA. Nevertheless, IKEA still remains the leader in consumer discount and low-cost
Bargaining power of suppliers
Suppliers’ bargaining power increase when:
- Suppliers are few in number
- Suitable substitute products are not available
- `Suppliers’ goods are critical to buyers’ marketplace success
- Suppliers’ products create high switching costs.
In order for a firm to bright in the business world, it must control its supplier. This is because when the suppliers have high control over your raw materials, the firm they will “rule” your company indirectly, charge a high price to your raw material and sometimes they will not design as you requested. The company, the firm will be left with no other choice but to increase the price of its output in other to increase your revenue. However, when the price of the company’s product increases, its demand will reduce therefore leaving the company in a dilemma.
In the case of IKEA, we can safely say that the power of the supplier is low. The company is having a well-established relationship between each of its suppliers around the world. IKEA had about 1380 suppliers until 2008 in 54 countries with 21% of them in China. In addition, IKEA owns a manufacturing company: “Swedwood Manufacturer”. By having its own manufacturer, it is obvious that the corporation threats the suppliers by entering their industry. Furthermore, with the advantage of having its manufacturing firm, the company can produce at low cost and sell at low prices.
Bargaining power of buyers
When analyzing the buyers’ power, one must ask himself “how easy it is for buyers to drive prices down”. This is determined by a number of buyers, how important is each buyer of the firm, the cost to the customer to switch from your product/services and chose your competitors’ products/services
Many retailers in the industry are involved in the war price against each other. They are mostly importers who get their inventory from China as well with a direct competition in the market. By having all these other retailers in the market, the consumers have a choice between lots of firms/manufacturers. With all so many opportunities open to them, the buyers’ power is moderate to high in this industry. However, most of the consumers will go to IKEA because of the company’s brand, its convenience, and also its main feature low-cost product along with consumer’s discount.
Threats of new entrants
The new entrants affect the power in the industry. If the requirements to enter the industry and compete efficiently is low/short (time and money), and if the firm has not achieved economy of scale, the new entrants will rapidly take down such a firm. However, if the business is strong or the barrier to entry is high, then it can conserve its position and advantages in the market.
The barriers to entries are relatively low. However, the intensity of the rivalry in the industry may fright off new entrants. The beginning capital required is too high. Anyone can start a retail shop with a small capital. But if someone wants his company to have a major strength in the industry, he/she needs to get more capital in the firm, have a reliable warehouse, and establish a nice buyer-supplier relation with its supplier. It will take a lot of time, high investment in order for the new entrant to acquire all the necessity to become a major player in the industry; otherwise, the firm will compete on the side. We can safely say that in the short-run, the new entrants are not a major threat for IKEA.
On the other hand, in the long-run, those small retailers will become high threats as competitors for the company. Therefore this factor has an average impact on IKEA.
Threats of substitutes
The threat of substitute products increases when:
- Buyers face few switching costs
- The substitute product’s price is lower
- Substitute product’s quality and performance are equal to or greater than the existing product
- Differentiated industry products that are valued by customers reduce this threat
This force has a low influence on the company. This is because; there are no substitute products which for furniture, home applicant and other products supplied by the company. Furthermore, The Company is specialized in manufacturing, good quality, and low-cost furniture. Even though customer retention rate remains best with IKEA and Argos; nevertheless, the combination of the firm’s characteristics are yet to be matched by its competitors. IKEA brand perception ‘trendy’ also surpass Argos ‘affordability’ and John Lewis ‘quality’ (Mintel Oxygen,2010), due to unmatched product and service functionality.