Five Major Factors that Threaten Business Profits

“Concentration is the secret of strengths in politics, in war, in trade, in short in all management of human affairs.”

- Ralph Waldo Emerson

In the business world, there are a multitude of forces that exert pressure on an organization. The role of founders and managers is to find a way to concentrate, analyze and lead an organization through all of the forces and create a successful organization. A well-known model that will help an owner or manager isolate particular forces and analyze which of these in the external environment are potential threats is the Five Forces Model developed by Michael Porter. Porter identified five major threats due to their ability to affect how much profit organizations competing within the same industry can expect to make.

  1. Industry Rivalry - For many industries, the major determinant of the competitiveness of an industry is the intensity of competitive rivalry. The more the companies within an industry compete against one another for customers, the lower the level of industry profits there will be. This is seen when companies lower prices or when they embark on expensive advertising campaigns. Lower prices and higher costs mean less profits.
     
  2. Threat of New Entrants - When companies find great success in an industry, it becomes more attractive for newcomers to throw their hats into the ring. Limited barriers to entry such as weak brand loyalty or low startup costs make it easier for companies to enter the industry. This ease of entry will make it more likely that industry prices will have to remain low and therefore negatively impact industry profits.
     
  3. Power of Suppliers - Also known as the market of inputs, the fewer the amount of suppliers or the more specialized the good supplied creates a situation where suppliers can wield a lot of power and influence. Suppliers can then control the price of their goods. If the price is increased, then the costs of the company will also increase therefore driving down profits.
     
  4. Power of Customers/Buyers - Also known as the market of outputs, the greater the pressure buyers can exert on a business, the more control over the price they have. This will therefore lead to lower profits or a business as consumers will always push to have prices as low as possible. Where there are only a few large buyers purchasing an industry’s output, then they have greater power to bargain and drive down the price of the output. Loyalty programs are a way for businesses to retain some of their power by offering incentives for customers to come to them.
     
  5. Threat of Substitutes - Often, the output of one industry is a substitute for the output of another industry. A clear example is water being a substitute for Coke. As more people prefer to drink water, less people will drink Coke. This should be differentiated from similar products though. Pepsi and Coke are both soft drinks. An increase of water drinkers hurts the soft drink industry overall by shrinking the soft drink “pie.” However, if Coke began marketing their product, there may be a larger section of the pie for soda drinkers, thereby raising all ships, albeit raising Coke’s the most. Businesses producing a product with known substitutes cannot demand higher prices for their products. This restriction keeps their prices, and therefore profits, low.

Porter argues that organizations, especially managers, must pay particularly close attention to these forces as they are major threats that an organization will encounter. The job of the managers at the various levels of an organization is to analyze and formulate strategies to counter these threats so the organization can respond to its environment, perform at a high level, and generate higher profits.

 

Andrew Bethel
DKB Strategies
We plan, you perform, you prosper.


Sources

Jones, G. R., & George, J. M. (2006). Contemporary Management: Fourth edition. New York: McGraw-Hill/Irwin

Porter's five forces analysis. (2016, November 25). In Wikipedia, The Free Encyclopedia. Retrieved 08:21, November 25, 2016, from https://en.wikipedia.org/w/index.php?title=Porter%27s_five_forces_analysis&oldid=751380575