5 Forces Framework

Hector Rodriguez

Irvine, CA 92651

September 5, 2016

Dr. Sean D. Jasso

California State University, Fullerton

800 N State College Blvd

Fullerton, California

Dear Dr. Jasso,

The five competitive forces that shape competition, which can help a company understand the structure of its industry is the following: threat of entry, the power of suppliers, the power of buyers, the threat of substitutes, and rivalry among existing competitors. The structure of the five forces varies by industry. The greatest competitive forces determine the profitability and become the clearest blueprints to follow. It can be fairly difficult establishing the forces since a conscious force may not always be apparent.

Upon dissecting the forces that shape competition we find out that industry structure grows out of a set of economical and technical features that determine the power of each competitive force. The first force is threat of entry, which bring stress on prices, cost, and the rate of investment necessary to compete. Newcomers entering an industry bring new volume and a aspiration to gain market share.  When existing companies are diversifying from other markets, they can cause a ruckus in the industry. The threat of entry can put a cap on the potential profit an industry is capable. There are several advantages that companies already present in the industry have going against new entrants. The first is supply-side economics of sale, which a firm can produce large volumes with lower costs per unit because they can spread fixed costs over different units. Supply-side economics force newcomers to either go big or take cost disadvantages.  Secondly, we have demand-side benefits of sale, which the more users there are, the more valuable the product or service becomes. For example Microsoft excel, companies will have a hard time competing with such program since a vast majority of businesses already utilize Microsoft excel. Third, there is consumer-switching cost that any additional cost the consumer supports to switch over to a new product increases the effective price of the new product. Forth is capital requirements which is the need to invest in large financial resources to order to compete. Many new entrants may not have the extra capital to extend customer credit, create inventories, and supply start up loses. For example a pharmaceutical firm must spend millions in research and development costs to create a product. We can compare an accounting firm requires little capital to compete within the industry. Fifth are Incumbency advantages independent of size, where advantages can come from different categories such as technology, raw material sources, favorable geographic locations, established brand identities, or a cumulative experience (an experience people get by simply living: accumulation of all experiences, and helps people decide how to approach things you do in the future). Unequal access to distribution channels is a competition for a space in the shelf of a grocery shelf.  Large companies will have a strong relationship with stores while a new firm will have a difficult time finding a place to sell their product. Restrictive government policy can help or delay new entry directly. The government limits or ban entrance through licensing requirements and restrictions on foreign investment (example: Pharmaceutical companies). In certain industries that are more efficient for a monopoly (electricity, water), the government will not allow competition.