How do the five competitive forces in Porters model affect t

How do the five competitive forces in Porter’s model affect the average profitability of the industry? For example, in what way might weak forces increase industry profits, and in what way do strong forces reduce industry profits?

Solution

Answer:

One important model that is used to explain and analyze the industry where there are various types of firm operates. This model is very important in explaining the strengths and weaknesses of any business. There are five forces in Porter\'s model helps to analyze the competitiveness of industry determine the attractiveness of the industry.

1) Threats to new entrants in the industry that reduces the profitability of all existing firms. So in the long run many firms could not enter into the industry and profits will not fall in the long run.

2) Threats of substitute goods that explains the market power of existing firms. If the product is homogeneous that means have good substitutes in the market then, firms have low market power as if they want to increase the price consumers will shift to the new product.

3) Bargaining power of consumers: If the bargaining power of consumers is more effective than producers then, it will be easy for consumers to extract more producer surplus for any exchange. Price will be set near to the marginal cost of the product.

4) Bargaining power of the producers: If producers have bargaining power over an exchange then they will enjoy the market power and can set the price of the product near to the reservation prices so as to extract the consumer surplus.

5) Competitive relationship between firms: If the intensity of rivalry between the firms is very high then, there will be a price war between them and this war may lead to the competitive outcomes.

In many ways the industry can increase the profits like when the bargaining power of consumers is very low this can increase the firm\'s profits because now consumers get more power to bargain the price of the product and can set it near the marginal cost.

When intensity of competition is very low between firms, firms can enjoy more profits by making peaceful agreement in between them.

When there are lower substitutes of the good, the consumers have less option to switch in so they have to consume the same good if price increases.

On the other hand if there is strong entry restriction in the markets for the new firms then, existing firms can enjoy the higher profits in the long run. When there is an entry into the new firms in the markets, supply will increase and that results in a reduction in the price that negatively affects the firms.

When producers have more bargaining power in the market, they can set the price near to the reservation price so as to increase the producer surplus. So these effects can increase the profits of the producers in the market.