Understanding of Porter’s Five Forces Theory with real life example

We all love ice-creams, and some of us prefer gelatos. Some of us prefer going to the stalls and choose a flavor while some of us prefer to stock up at home. A common reluctance in over consumption of ice-cream is that of catching a cold or falling sick. In the pandemic times that we now live in, there is a hesitancy in indulging this delicacy for your runny nose might be feared and mistaken for a Covid-19 symptom. Ice-cream industry was also one of the industries that was impacted by the pandemic and I begin to wonder how would this industry bounce back.

Now think about this from the perspective of the business. If someone would be in the ice cream business or is intending to enter one, how would he decide whether it’s the right time to do so or no?

Here comes the brilliant Porter’s Five Forces Model of analyzing competition in an industry.

Understanding Porter’s Five Forces model

First published in the Harvard Business Review in 1979 by Michael Porter, the doyen of marketing, this model elucidates that competition does not necessarily mean competitors but is based on five sets of parameters that govern a new entrant’s decision making. The model met with a mixed response though several management professionals and consultants were happy to have a model which they can use as a starting point when analyzing competition for a new business or an entrant in a new sector. Most opined that further analysis would be needed before reaching to any conclusion.

Let us take the above example of a new entrant in the ice-cream business. The model looks at competition analysis through a set of five parameters:

  1. Threat of new entrants: Ice-cream per se is sub divided into several categories and micro markets with individual niche segments when it comes to flavours and offering sizes. While global players like Nestle, Lotte, Unilever and general Mills dominate most segments, several countries are dominated by local players who know local tastes better initially and are soon caught up by the global players till the former skims the market. For an established player, a new entrant is a major threat because it brings some amount of disruption in flavors, size, texture, price or availability to gain market share quickly. Since the ice-cream market is governed by spending power, proclivity towards eating sweets, health consciousness, increasing number of lactose intolerant people and availability at the right place at the right price point, it is highly volatile to say the least. Impulse ice creams, Take-home packs and artisanal ice-cream further make matters complicated because a new player must cater to these competitors. If the new entrant brings disruption in any of these, the existing players must match up better or prepare to be left aside.
  2. Bargaining power of suppliers: The ice-cream industry is solely dependent upon the supply of milk from individual farmers or farmer cooperatives/ collectives. Being a perishable item, milk needs extensive use of technology in collection, storage, transportation, and usage in the lowest possible time. Geography makes a huge difference when it comes to choosing substitute suppliers since the farther you move away from the factory, the more complex the logistics become. This puts the industry heavily dependent on local milk suppliers who can govern the price. Though most countries have strict control over the price of milk as an essential commodity, it is still vulnerable to supplier’s demands since substitutes are not easy to come by. This has, however, been addressed successfully by certain industries where backward integration of a company has breached the dominance of suppliers.
  3. Bargaining power of buyers: Being a crowded market, ice-cream buyers have a whole platter of options available at different price points. Starting from a popsicle (though not theoretically an ice-cream, it still makes the cut) to cups, cones and family packs, there’s one brand at every corner and many at the mall. Customers are spoilt for choice when it comes to flavors and price and these two remain the most important criteria for purchase. Artisanal ice-creams need to appeal to the customer’s eclectic tastes with use of exotic fruits and nuts, texture, fresh ingredients, or rarity. Factory-made ice creams can rarely achieve that feat and hence steer clear of this segment most of the time. Artisanal ice-creams are also an acquired taste which the key customer base- the kids, may not always appreciate. So customers generally stick to what is available at the nearest point at the most reasonable price and in a flavor that appeals to the family’s taste. If your brand does not have it, they will move to the next competitor who smilingly offers it. Most ice-cream customers stick to their favorite flavors and generally don’t not try new exotic flavors easily. Health consciousness has also resulted in many customers being careful about reading the calories of the portion and healthy options like frozen yogurt are preferred over whole cream rich ice-creams.
  1. Threat of substitute products: When a kid wants ice-cream, can you substitute his demand with some other product, say, a pastry? Not quite. The craving for an ice cream can be satisfied with only an ice-cream. However, this is only when it comes to impulse buying. In most cases, ice creams can be substituted with other sweets, especially if a person is carrying it home back from work without an ice box in his car. When someone does not find a favorite flavor or the right portion size, he/she could switch to alternatives like dark chocolate that offer the same heady dose of happy hormones that is so much a part of the entire ice-cream eating experience. Perhaps more. Frozen yoghurt, fruit juices, smoothies, milk shakes, custards can any time substitute an ice-cream when it comes to sweet cravings.
  1. Rivalry among existing competitors: Forget the global behemoths, most intense competition comes from local brands who know customer tastes better and can keep bringing new flavors quickly and easily owing to their small size of operations. They can reach out to local customers better with simple communication channels that cost less too. Competition often comes in the form of flavors and price points and the latter is a competitive advantage for the biggies owing to their financial muscle. However, it does not necessarily mean that just because there are existing global and local players already dominating a market, a new entrant must refrain from gaining entry. A new company can gain advantage by innovation and disruption, provided the other market conditions are satisfactory or assuming that they will relatively remain constant for the near future at least.

This theory by Michael Porter is also criticized for not considering the micro business environment like price volatility, changing customer preferences and that it presumes that the three forces: customers, buyers and suppliers are unrelated and do not impact each other or collude whereas in reality it is very much possible. Using the model, new entrants can decide whether that business can survive and make profits or yield into competitors’ dominance.

Benefit of the Porter’s Five Forces theory

The benefit of putting this model to use is that you tend to apply several factors that could impact your new business. Combined with additional caveats in the form of Value Chain Analysis (the source of the cost advantage coming through the most valued activities in a company) or the VRIO Framework (that analyses whether a resource is Valuable, Rare, Inimitable and Organized and the PESTEL Analysis (Political, Economical, Social, Technological, Environmental and Legal aspects of a business). Together, this groundwork can yield good results that can help a company make an informed and a Data Driven Decision.

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