Porter’s Five Forces is a framework which was developed in 1979 by Michael
Porter which identifies the nature of competition through 5 competitive forces,
helping businesses to determine the potential for profitability within a given market.
This video explains Porter’s Five Forces and applies the model to the
UK supermarket industry, providing you with examples along the way. Let’s get started.
Porter’s Five Forces model was developed when Michael Porter discovered that profitability
varied immensely between different markets, and he wanted to investigate why.
Therefore, he compared the Airline industry which makes relatively low profits in comparison to the
soft drinks industry and concluded that industries with high profits often have:
high barriers to entry, limited choice for customers, little opportunities for substitutes,
weaker suppliers who have weaker bargaining power, and minimal rivalry within the market.
This eventually led to the formal 5 forces being published, which Porter determined were the 5
factors which influenced profitability within any market. These 5 forces are: Threat of Entry,
Buyer Bargaining Power, Threat of Substitutes, Supplier Bargaining Power, and Rivalry.
If a business applies Porter’s 5 Forces to the existing market they operate within, it can help
them to effectively position themselves in the market. define their value proposition and develop
their future strategy to maximise their overall success and profitability within the market.
Alternatively, if a business is considering entering a new market, the application of
Porter’s 5 Forces can help them to determine the markets potential and whether entering the
market would be a good business decision. Let’s have a look at these five forces in
more detail with supporting examples from the UK supermarket industry.
The threat of entry refers to how easy it is for new businesses to enter the market in focus.
If a market is easy to enter then this would mean the threat of entry is high, which is bad news for
businesses that already exist in the markets. Examples of businesses which operate in markets
with a high threat of entry from new businesses include hairdressers, takeaways, and bakeries,
where competitors can pop up out of nowhere, start a new business and compete with relative ease in
comparison to markets such as the pharmaceutical industry which has a low threat of entry due
to its complex nature and costs involved. If it’s easier for a new business to enter
the market, this presents a threat to the market share of existing businesses in the market.
This is because, new businesses may attract their customers, which in turn can create price wars,
reduce competitive advantage, and decrease overall profitability.
Whereas, if a market is hard to enter, this is good news for the existing businesses
as it is less likely that a new business will enter the market and if they do their instant
impact is likely to be less severe, meaning existing business are more likely to keep their
competitive advantage and core customer base. Markets which are harder to enter often have
multiple barriers to entry which include: economies of scale, bigger businesses often
benefit from economies of scale. meaning they have significant bargaining power over suppliers
and can keep unit costs low. This in turn, creates a barrier to entry for smaller businesses as they
can be priced out of the market. Brand loyalty is also an important factor, if customers are
very loyal to certain brands within a market, it can make it very difficult for new businesses to
enter the market and attract those customers. Also, if a market has several large businesses
which have existed for many years, they are often dominant with expertise and have strong
reputations which can make it very difficult for new businesses who haven’t built their
reputation yet to enter the market. Especially if the market is for high end luxury goods
where trust and confidence in the business is very influential in purchasing decisions.
The UK supermarket industry is a difficult market to enter due to barriers such as the market being
dominated by a few very large businesses with expertise and excellent reputation who benefit
from economies of scale, and businesses wanting to enter require large amounts of capital to compete.
Although new competitors do enter from time to time, the core of the businesses
which exist and thrive in the UK supermarket industry have remained the same for decades.
However, it is possible for new businesses to enter the UK supermarket industry,
and this has happened in recent decades. For example, Aldi started as a small-town
German discount supermarket with just one UK store in 1990, but fast forward a few decades,
they now have over 900 UK based stores in 2021 and are considered a fierce competitor in this market,
influencing many changes in the industry. Aldi’s market share has also grown to nearly 10% and they
have caused price wars with the UK’s biggest players such as Tesco who now offer Aldi price
matches to their customers, effectively lowering their prices so they don’t lose custom to Aldi.
Although Aldi have shown it is possible to enter a market which
has many barriers to entry which include long standing businesses such as Tesco,
Sainsbury’s and Asda benefitting from economies of scale, brand loyalty, and reputation.
It’s important to acknowledge that Aldi already had expertise in the supermarket industry
and an effective business model which already worked in Germany,
therefore they were able to adapt to the UK market and build their UK business slowly overtime.
Buyer bargaining power refers to the customers in the market who are looking to buy goods from
businesses and how powerful they are. This force links to supply and demand as it can
be dependent on the number of businesses in the market selling the same or similar
products in comparison to how many customers there is wanting to buy the said products.
If there is a limited number of buyers i.e. not many customers in the market but
lots of sellers offering the products they are looking to buy, then supply outweighs demand,
customers are likely to have lots of choice and competition is likely to be intense in the market.
This is not good news for the businesses who operate within this market as it is likely
that overall profitability will decrease if buyers have strong bargaining power because:
businesses will have to reduce their selling prices to compete in price wars,
they may have to increase the quality of their products and services to gain a competitive edge
which increases the unit cost or they may have to invest heavily in marketing to attract customers.
In the UK supermarket industry, buyer bargaining power is strong
as customers tend to have a lot of choice as there is fierce competition in this market.
Which means customers can drive a hard bargain and can easily switch to a competitor if they
have a bad experience, causing continuous price wars in the supermarket industry
with the likes of Tesco, Asda, and Sainsbury’s all competing fiercely on price
and investing heavily into marketing which has been further fuelled by the rise of
discount supermarket chains such as Aldi and Lidl. This means that profit margins have been slashed
across the market and strong buyer bargaining power has also led to businesses such as Tesco,
Asda, and Sainsbury’s developing strategies to attract customers away from their competitors and
to give them a competitive edge over the discount supermarket businesses such as Aldi and Lidl.
These strategies include focusing on the quality of their products, introducing a series of own
brand label lines, differentiating the product range to offer customers much more than groceries
to increase convenience and attract a wider audience, and running a membership scheme where
customers can collect points and rewards when they shop with the aim of boosting brand loyalty.
The threat of substitutes focuses on the options customers have and how easy it is
for them to switch between alternatives. The greater the threat of substitutes,
the greater the threat to the business and the less profitable it is likely to be.
Therefore, it’s essential that businesses which operate in markets with a high threat
of substitutes meet the customers wants and needs effectively to ensure
they don’t lose their custom. In the UK supermarket industry,
the threat of substitutes has increased dramatically in the past decade
and the traditional supermarket model is under great threat as customers have so many buying
options mainly due to technological advancements. For example, Amazon has recently entered the
grocery market industry and offer a huge threat to the traditional way of shopping for groceries.
Firstly, they provide their Prime members with a unique shopping experience online with same day
delivery of groceries delivered free of charge. Alternatively, customers who visit their Amazon
Go stores can literally walk into the grocery store pick up their goods
and walk out without queuing to pay as it’s all done automatically through their app.
Another threat of substitution facing the supermarket industry comes in the
form of food subscription services, with the market expected to exceed £1.5billion by 2022
and the lockdown restrictions which were in place due to coronavirus have created a boom in sales
and a change in buying behaviours where customers are seeking the convenience of premade meals
all packaged up and delivered to their homes. Convenience stores also offer a threat of
substitution to the UK supermarket industry as changes in consumer lifestyles and buyer
behaviours means customers may opt to go to their local convenience store
rather than travel to a supermarket. However, many supermarket businesses including
Sainsbury’s and Tesco have adapted their strategy and started investing in convenience stores
to reduce this threat of substitution to their business, building new convenience stores in
locations where there is a gap in the market and buying existing convenience stores from
competitors and adding them to their portfolio such as Tesco Express and Sainsbury’s Local to.
Supplier bargaining power relates to the influence of suppliers on the profitability
of the businesses in the market. If businesses have a wide choice of
suppliers in the market they operate within, supplier bargaining power would be weak,
meaning businesses can dictate negotiations and drive costs down which is good for profitability.
However, the fewer suppliers in the market, the more powerful they are,
especially if the resources they supply are relatively scarce.
If there are only a few suppliers in the market, then they have what Porter referred to
as strong bargaining power meaning they have more influence and can increase their prices
which effectively increases the costs for the businesses in the market, which in turn reduces
their competitive advantage and profit margins. If supplier bargaining power is strong, businesses
can employ several strategies to minimise the impact it has on their overall profitability
such as agreeing to longer contracts which secures better terms or utilising economies of scale and
purchasing larger quantities to drive costs down. In the UK supermarket industry, supplier
bargaining power is generally weak as the market is dominated by a small number of large businesses
who have very strong buyer bargaining power due to the sheer volume of supplies they purchase
to stock in their stores across the UK. This has resulted in UK supermarket businesses
effectively driving down the costs of purchasing raw materials and products from suppliers
to protect their own profit margins. However, this has been met with a wave negative publicity
for some of the UK’s major supermarket chains due to them taking advantage of this power.
For example, in 2016 the supermarket ombudsman found that Tesco
"knowingly delayed paying money to suppliers in order to improve its own financial position”
and in 2018, UK supermarkets were accused by Oxfam of “leaving farmers and food producers
around the world in poverty as they increasingly squeeze the price they pay their suppliers”.
Essentially, suppliers of UK supermarket businesses often have very weak bargaining
power which has been taken advantage of by the business that operate in this market
to what could be viewed as both an unethical and unsustainable level.
This can lead suppliers taking action against the supermarkets,
such as a protest lead by dairy farmers in 2015
where police were called as dairy farmers protested by taking cows into supermarkets because
they believed supermarkets were selling the milk too cheaply for them to be able to make a profit.
Rivalry is the final force that we are going to explore.
Rivalry examines how intense the current competition is within the market
which the business operates or wishes to enter. Porter concluded that rivalry is dependent on
several factors and is most intense when: there are many competitors in the market,
most of the businesses in the market are similar in size and power, there’s slow industry growth or
the market is in decline. there’s not much differentiation between the competitors in
the market, which leads to most businesses offering similar products and services, and
when barriers to exit the market are high, which leads to businesses staying in the market longer.
Put simply, as a business faces more competition, it’s likely that their selling prices will
decrease and their investment in marketing will increase to support the business to compete,
which will typically lead to a decrease in overall profitability.
As we’ve already discussed, there is intense competitive rivalry in the UK supermarket industry
which has increased buyer bargaining power and placed additional pressure on suppliers
as supermarket businesses look to compete on low prices
but retain as much of their profit margins as possible.
Also, customers can easily find alternative options and shop with a competitor as lots of
competition exists in the market, with many businesses being of similar size and power,
offering little differentiation between the core products and services they offer.
Although, some supermarkets businesses have extended the range of products
and services they offer to try and gain a competitive advantage over the years, such as
having dedicated departments for clothing and electronical products, whilst providing
services such as an onsite cafe or even offering their own insurance and mobile phone services.
An additional strategy that some UK supermarkets have employed to gain a competitive advantage
is developing partnerships with other businesses such as Greggs and Timpson
by offering space in store for them to sell their goods and services to the supermarket’s
customers with the aim of providing them with convenience and an improved shopping experience.
It could be argued that competitive rivalry has intensified over the years in the UK
supermarket industry as customers have even more choice, not only do they typically have
multiple supermarket stores within travelling distance but the option to shop online means
they have more alternatives and even more businesses are competing for their custom.
So that’s it, Porter’s 5 Forces, a very useful framework developed by Michael Porter which aids
businesses to analyse the market they operate within or wish to enter and can be used to guide
business strategy by considering a variety of factors including the threat of new entrants into
the market, the bargaining power of its customers and suppliers, the threat of substitutes, and the
intensity of competitive rivalries in the market. I hope that’s helped and if you want to learn
more about business, don’t forget to subscribe to Two Teachers on YouTube to see our weekly
video uploads on key business topics. Thanks for listening and all the best.