Trending – Five Forces

One of the surprising omissions in the new BM programme is Porter’s Five Forces at the time that a non-motivational theorist, Dan Pink, is included under motivation theory. However, Five Forces remains in the BM programme until 2015 examinations and could still be used legitimately in internal assessments and extended essays after that.

Porter’s Five Forces model is a useful tool that is not really understood by many students, which is possibly why it has been dropped! Five Forces is used to examine the degree and nature of competition within a market place, as part of the process of developing and/or amending a firm’s corporate strategy. Students tend to perceive Five Forces as some kind of static model and fail mostly to analyse its implications. Like ratio analysis, a student will learn far more by looking at how the environment changes over time, and the effect this has on the firm’s competitiveness and market strength.

For example, I recently posted on the student blog about Tesco and its failure to adjust to a rapidly changing external environment. You could use the retail market as a case study using two Five Forces models – a sort of before Aldi and Lidl and an after Aldi and Lidl! Tesco’s decline as the market leader in the UK retail sector can be categorised using the Five Forces model. The effect of the retail discounters has been felt across Europe and the US and it would not be difficult to find retailers in most countries, which have been similarly affected.

Post Aldi and Lidl:

New market entry

Although significant capital expenditure is required to enter the physical retail market place, the development of the World Wide Web has significantly reduced barriers to entry to the retail sector, particularly in niche sectors, which the large retailers are unwilling to serve as returns are too low. Niche sectors may include fashion lines for the ‘larger customer’ or relatively small technology markets; markets which do offer significant returns for smaller organisations. The development of efficient distribution networks is still a barrier to entry, even online – after all products have to be delivered. However, the growth of innovative logistics organisations is providing access to global markets, even for smaller operators.

For this ‘force’, students can be asked to select specific retail categories and look at the nature of competition and barriers to entry within these categories, using an historical approach. They might be pointed to Chris Anderson and his Long Tail theory as a starting point.

Competitive rivalry

Traditionally, retail sectors are essentially oligopolistic in that they are dominated by five to fifteen major players.  However, the major players are growing in number in physical markets, particularly grocery, as a new breed of discounters, such as Aldi and Lidl grab market share. At the same time, demand for the products of the traditional powerhouses like Tesco, are being further eroded by online competition, such as that from Amazon and eBay; retailers which do not respect national boundaries. Mass retailers, like Tesco, are becoming marooned ‘ in the middle’ unsure whether to compete with the discounters at the bottom end of the market or to react to the high end retailers offering a higher quality range. This uncertainty is affecting their customer base, who are finding it more difficult to know what firms stand for.

Suppliers

As ‘high street’ retailers grew in size, their purchasing power also increased, to the extent that they could pressurise their suppliers to cut their profit margins to the bone. Losing a major buyer like Tesco, could lead to commercial disaster for a supplier, so few were able to resist the pressure to reduce prices. However, the entry of the retail discounters has actually increased the power of the suppliers in the sense that traditional retailers are increasingly reliant on their suppliers offering better value products for them to remain competitive. However, larger chains are also looking to cut the numbers of product lines they offer to increase economies of scale and reduce unit cost. For some suppliers this may mean that they lose contracts. The remaining suppliers are likely to receive larger orders and higher profits.

Buyers

It is becoming a buyers’ market as choice rapidly increases. The recession has resulted in customers becoming increasingly disloyal to their existing retail suppliers; willing to alter shopping habits to find better value merchandise. One noticeable group changing shopping habits of a lifetime is the ‘middle class’ market, which has become less concerned with status and more concerned with value.  Middle income customers are leaving mainstream retailers in droves and transferring, at least some of, their custom to the discounters and online retailers. In the UK, Aldi has just announced a 60% increase in operating profits at the same time that Tesco is issuing profit warnings (ironically in Germany, Aldi and Lidl are losing customers to higher end retailers as the economy recovers and disposable income increases). Large retailers are not reacting quickly enough to demographic and social changes. Research is showing that customers are shopping more frequently and increasingly seeking convenience and personal service. Large retailers, such as Walmart, Carrefour and Tesco appear to have been caught out by these changes and have continued to build larger hypermarkets outside of town centres, reducing staff and increasing self-scanning.

Substitutes

This aspect of the Five Forces model is more specific to the industry, or market, under review. Technology, however, is impacting most markets and new substitutes are capable of decimating existing models of supply. 3D printing, for example, has the potential to revolutionise the way products are sold and distributed, as well as opening up the opportunity for increasing customisation.