Porter’s Five Forces



Porter’s Five Forces

A competitive strategy must meet the opportunities and threats inherent in the external environment; it should be based on an understanding of industry and economic change.

Porter identifies five forces that shape every industry and which determine the intensity and direction of competition and therefore the profitability of an industry. The objective of strategic planning is to modify these competitive forces such that the organization’s position is improved. Management can then decide, based on the information given by the Five Forces model, how to influence or to exploit industry characteristics.

Bargaining Power of Suppliers

The term “suppliers” comprises all sources for inputs necessary to provide products. And “supplier power” refers to their relative bargaining power, which, when high, allows significant influence on the industry and expropriation of profits.

Home Depot’s expense controls and cost initiatives – its core competencies – derive in part from efficient supply chain management. The company also plans to centralize purchasing operations and to decrease merchandise inventories, both of which will further reduce the power of its suppliers. That the primary source of both planned and actual efficiencies in this area, however, derive largely from cost initiatives and financial policy, points to the firm’s emphasis on cost leadership.

But Lowe’s has already established centralized logistics systems based not so much on economies of scale or rigid accounting an on logistical flexibility. To determine the most efficient way to purchase inventory, Lowe’s looks at every product of every vendor individually.

This method should decrease cost per product via four methods of distribution: flowing goods through regional centers, shipping by commodity focused consolidation, reloading distribution centers, and direct shipment to stores. “Our goal,” says Bob Tillman, chairman and CEO, is to be sending more trucks from our distribution centers more often with any one sku per shipment.” (Home Textiles Today. 8/26/02. p. 10.) Hence, Lowe’s has the advantage.

Bargaining Power of Customers

The bargaining power of customers – their influence over price -- is reduced via efficient supply chain management. Other factors -- brand loyalty, threat of backward integration, and marketing based on factors other than price – influence buyer power. Naturally, reduction in the number of competing firms is the preferred method of addressing this influence.

Women, who represent a concentrated group of buyers and a significant market share, prefer Lowe’s and therefore threaten Home Depot. Lowe’s provides incentives to this group and adds value to the products women want. But Home Depot, in their effort to retain a strong market base of professional contractors, continues to dissuade women and maintains its traditional, masculine image.

Threat of New Entrants

The magnitude of this threat is inversely related to MES, which determines the amount of market share necessary to enter the industry. The greater the difference between industry MES and entry unit costs, the greater the barrier. Based on relative economies of scale, it can be inferred that Home Depot and Lowe’s have created an advantage extending to all incumbent firms.

Barriers also result from brand loyalty, and this implies proprietary brands. For example, Home Depot is the exclusive seller of John Deer lawn tractors; Lowe’s carries Jenn-Air grills. But it is not the barriers to entry represented by these proprietary contracts that confers the greatest value; the brands are a necessary component of differentiation strategy -- a primary source of competitive advantage. A strong influence over suppliers and distributors, moreover, as well as price-cutting, for which both Lowe’s and Home Depot are well positioned for, can also create barriers to entry.

Threat of Substitutes

This threat, in so much as it exists, points to marketing failures. Outside of technological revolutions, innovative offerings and product development, identification of and response to consumer needs, reduces this threat. In so much as substitute products consist of those in other industries, however, a threat exists when a product’s demand is affected by the price change of a substitute product. But there are no true substitutes for home improvement supplies; and therefore we may discount this factor.

Rivalry

Rivalry is identified and measured according to industry concentration. A low concentration indicates a competitive or “fragmented” market composed of many rivals, none having significant market share. (A large number of firms increase rivalry.) Conversely, a high concentration indicates less competition; a small number of large firms hold most of the market share. Product differentiation, avoiding excess productive capacity, segmentation, and industry-wide communication are effective means of combating rivalry. Ultimately, mergers or acquisitions with or of competing firms can be invoked.

That Home Depot has saturated the market gives Lowe’s an advantage: any new Lowe’s (or OSH or ACE) outlet immediately appropriates significant market share. While Lowe’s grows, HD struggles to increase sales at existing outlets or to maintain current levels. This, according to industry analyst Colin McGranahan of Bernstein, accounts for a disparity between Lowe’s and HD in terms of growth. “What we are seeing,” says McGranahan, “ are two companies in different life cycles.” Hence, while Lowe’s grows, HD is faced with shake-out phase problems: excess capacity with too many goods chasing too few buyers.

The definition of what constitutes the “market” is important here. The industry, despite the dominance of Lowe’s and Home Depot, is fragmented. Competition for the same customers and resources is spread among a relatively large number of firms. The industry in general, then, is fragmented, a partial result of the varied merchandise that each store sells. Appliances, for example, are carried by both Home Depot and Lowe’s and represent a significant component of their revenue, but appliances are not part of the home improvement industry.

Conclusions

Strategy is formulated on three levels: corporate, business, and functional. The primary context of industry rivalry is the business level, and Porter defined three generic strategies that can be implemented at this level to create competitive advantage: cost leadership, differentiation, and focus. The correct generic strategy will position a firm to leverage its strengths and counter the adverse affects of the five forces.

Home Depot’s response to loss of market share, for example, is not one of changing overall market position; for Home Depot recognizes that Lowe’s benefits from current economic factors that are temporary. When the real estate bubble bursts, so will Lowe’s advantage. Therefore, Home Depot maintains its cost leadership approach and implements increased emphasis on customer responsiveness – a factor of competitive advantage which transcends and is not dependent on temporary economic anomalies.

Works Cited

Tillman, Bob. “Lowe’s looks to logistics for growth.” Home Textiles Today 23.49 (2002): 10+

McGranahan, Colin. “Lowe’s grows, HD slows.” Usenet Posting. 10 Nov. 2002.

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