Page 63 - DCOM506_DMGT502_STRATEGIC_MANAGEMENT

Unit 4: External Assessment

profits from each one. If a particular industry accounts for a large portion of a Notes
supplier group’s volume or profit, however, suppliers will want to protect the
industry through reasonable pricing.
(d) Importance of the product of the firm: When the product is an important input to the
firm’s business or when such inputs are important to the success of a firm’s
manufacturing process or product quality, the bargaining power of suppliers is
high.

(e) Threat of forward integration: When the supplier poses a credible threat of integrating
forward, this provides a check against the firm’s ability to improve the terms by
which it purchases.
(f) Lack of substitutes: The power of even large, powerful suppliers can be checked if
they compete with substitutes. But, if they are not obliged to compete with substitutes
as they are not readily available, the suppliers can exert power.
7. Threat of substitute products: The fifth of Porter’s Five Forces model is the threat of
substitute products. A substitute performs the same or a similar function as an industry’s
product. Video conferences are a substitute for travel. Plastic is a substitute for aluminum.
E-mail is a substitute for a mail. All firms within an industry compete with industries
producing substitute products. For example, companies in the coffee industry compete
indirectly with those in the tea and soft drink industries because all these serve the same
need of the customer for refreshment.
The existence of close substitutes is a strong competitive threat because this limits the
price that companies in one industry can charge for their product. If the price of coffee rises
too much relative to that of tea or soft drink, coffee drinkers may switch to those substitutes.
Thus, according to Porter, “substitutes limit the potential returns of an industry by placing
a ceiling on the prices firms in the industry can profitably charge”. For example, the price
of tea puts a ceiling on the price of coffee. To the extent that switching costs are low,
substitutes may have a strong effect on the profitability of an industry.

The more attractive is the price/performance ratio of substitute products, the more likely
they affect an industry’s profits. In other words, when the threat of substitutes is high,
industry profitability suffers. If an industry does not ward off the substitutes through
product performance, marketing, price or other means, it will suffer in terms of profitability
and growth potential in the following circumstances:
(a) It offers an attractive price and performance: The better the relative value of the substitute,
the worse is the profit potential of the industry. For example, long distance telephone
service providers suffered with the advent of Internet-based phone services.
(b) The buyer’s switching costs to the substitutes is low: For example, switching from a
proprietary, branded drug to a generic drug usually involves minimum switching
costs.
Strategists should be particularly alert to changes in other industries that may make attractive
substitutes. For example, improvements in plastic materials prompted the automobile
manufactures to substitute plastic for steel in many automobile components.

Task Compare FMCG and Automobile sectors based on Porter's five forces model.

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