Question

How the firm creates and develops competitive advantages in the international marketplace? Explain The Porter Diamond and Porter’s Five Forces models.

Answer 1

The five-forces of Michael E. Porter of Harvard University is a method of analysis used by businesses. It is studied in industrial economics. The main purpose or use case of this model is to determine the competitiveness and attractiveness of an industry reflected through its profitability or profit prognosis. The model broadly divides an industry in two domains.

1. Unattractive Industry

2. Attractive Industry

On application of these five forces, when the five forces of this model result into reduced profit margins, it is termed as unattractive. Similarly, when the five forces of this model result into enhanced profit margins, it is termed as attractive. A perfectly competitive industry is considered as the most unattractive industry because the profits are reduced to normal profits in the long run.

The five forces of porter have been borrowed from two concepts in business theory, “Horizontal Competition” and Vertical Competition”. Horizontal competition comes as a threat from existing rivals and new comers in terms of substitute products or services. Vertical competition comes from the bargaining power of suppliers and the bargaining power of customers.

The five forces of Porter are defined as below:

1. New Entrant risk: this threat arises whenever the industry is yielding high returns on investment. But the high yields remain sustainable if and only if the barriers to entry are present. Otherwise all the profits will be drained by new entrants. A legalized monopoly or oligopoly is desirable under such circumstances.

2. Substitutes risk: if substitutes of a product arrive in the market at lower prices, it will reduce the profit margins. Here it is important to understand the concept of substitutes, if two companies are producing a similar product like ‘Lays’ and ‘Diamond chips’ it will not be problematic for the either of the company because any one’s increased advertisement can grow the market and help the other to grow at it s expense. But if suppose ‘wafers’ comes in the market, it can result in reduced profitability.   

3. Customer Bargaining Power: the profitability of a firm depends on its product price and the product price in turn depends on the availability of substitutes. If the customer has more substitutes, it has more power or control over the firms price strategy and therefore their profits.

4. Supplier Bargaining Power: the above idea of bargaining power also works on the input side. If the suppliers of inputs to firm have greater power over the firms input prices because of less availability of input suppliers. It can result in reduced profits/profitability.

5. Competitive Rivalry: to differentiate its product, a firm needs to know its competitors. Understanding its rivals in terms of marketing strategies helps to place its product better in the market and results in increased profitability.