7 Reasons Why Customer Power is Crucial in Porter’s Five Forces Analysis

Customer power is one of the five forces that shape the competitive environment of any industry, according to Michael Porter’s framework. It refers to the ability of customers to influence the price, quality, and availability of products or services in the market. The higher the customer power, the more pressure they can put on the suppliers to lower their prices, improve their quality, or offer more variety and innovation.

KEY TAKEAWAYS

Customer power affects the bargaining power of suppliers, the threat of new entrants, the threat of substitutes, the rivalry among existing competitors, the value chain, the innovation and differentiation, and the sustainability and social responsibility of an industry.

Customer power is influenced by factors such as the number and size of customers, the concentration and diversity of suppliers, the availability and attractiveness of substitutes, the degree of differentiation and standardization of products or services, and the level of information and awareness of customers.

Customer power can be reduced by segmenting, branding, relationship-building, innovating, co-creating, educating, or increasing switching costs for customers.

Customer power can be leveraged by listening to, engaging with, empowering, or rewarding customers for their feedback, suggestions, or referrals.

In this article, we will explore why customer power is crucial in Porter’s five forces analysis and how it can affect the profitability and attractiveness of an industry. We will also provide some tips on how to reduce customer power and increase customer loyalty.

Here are some of the main reasons why customer power is important in Porter’s five forces analysis:

1. Customer power affects the bargaining power of suppliers.

If customers have high power, they can demand lower prices, better quality, or more features from the suppliers, which can reduce their profit margins and bargaining power. On the other hand, if customers have low power, they have fewer options and alternatives, and they have to accept the terms and conditions of the suppliers, which can increase their profit margins and bargaining power.

2. Customer power affects the threat of new entrants.

If customers have high power, they can easily switch to new entrants who offer lower prices, better quality, or more innovation, which can increase the threat of new entrants and reduce the entry barriers. On the other hand, if customers have low power, they are loyal to the existing suppliers and have high switching costs, which can decrease the threat of new entrants and increase the entry barriers.

3. Customer power affects the threat of substitutes.

If customers have high power, they can easily switch to substitute products or services that offer similar or better value, which can increase the threat of substitutes and reduce the differentiation of the industry. On the other hand, if customers have low power, they are satisfied with the current products or services and have high switching costs, which can decrease the threat of substitutes and increase the differentiation of the industry.

4. Customer power affects the rivalry among existing competitors.

If customers have high power, they can play off one competitor against another and force them to compete on price, quality, or innovation, which can increase the rivalry among existing competitors and reduce the profitability of the industry. On the other hand, if customers have low power, they are loyal to one or a few competitors and are less sensitive to price, quality, or innovation, which can decrease the rivalry among existing competitors and increase the profitability of the industry.

5. Customer power affects the value chain of the industry.

If customers have high power, they can influence not only the suppliers but also the distributors, retailers, and intermediaries who are involved in delivering the products or services to them. They can demand lower prices, better service, or more convenience from these actors, which can reduce their value added and bargaining power. On the other hand, if customers have low power, they have less influence on these actors and have to accept their prices, service, or convenience levels, which can increase their value added and bargaining power.

6. Customer power affects the innovation and differentiation of the industry.

If customers have high power, they can demand more variety, customization, or novelty from the suppliers, which can increase the innovation and differentiation of the industry. On the other hand, if customers have low power, they are content with standardization or commoditization of products or services, which can decrease the innovation and differentiation of the industry.

7. Customer power affects the sustainability and social responsibility of the industry.

If customers have high power, they can demand more ethical, environmental, or social standards from the suppliers, which can increase the sustainability and social responsibility of the industry. On the other hand, if customers have low power, they are indifferent to these standards and have to accept the practices of the suppliers, which can decrease the sustainability and social responsibility of the industry.

As you can see, customer power is a crucial factor in Porter’s five forces analysis that can affect various aspects of an industry’s competitive environment. Therefore, it is important for managers to understand how customer power works and how it can be influenced.

Here are some tips on how to reduce customer power and increase customer loyalty:

Segment your customers based on their needs, preferences, or behaviors and offer them tailored products or services that meet their specific requirements.
Create a strong brand identity that differentiates your products or services from those of your competitors and conveys a unique value proposition to your customers.
Build long-term relationships with your customers by providing them with excellent customer service, after-sales support, or loyalty programs that reward them for their repeat purchases or referrals.
Invest in research and development to innovate your products or services and offer your customers new or improved features, functions, or benefits that they cannot find elsewhere.
Collaborate with your customers to co-create value by involving them in the design, development, or testing of your products or services or by soliciting their feedback, suggestions, or ideas.
Educate your customers about the value and quality of your products or services and how they compare to those of your competitors or substitutes.
Increase the switching costs for your customers by making them dependent on your products or services or by creating network effects that increase the value of your products or services as more customers use them.

TIP

Customer power is a key force that shapes the competitive environment of any industry. To succeed in a market with high customer power, you need to offer superior value to your customers and build strong loyalty with them.

The Power of Customers in Porter’s Five Forces

One of the key factors that determine the attractiveness and profitability of an industry is the power of customers. According to Porter’s Five Forces framework, the power of customers is one of the forces that shape the competitive structure of an industry. The power of customers refers to the ability of customers to influence the price, quality, service, and other aspects of the products or services offered by the sellers in the industry.

How to Assess the Power of Customers

There are several factors that can increase or decrease the power of customers in an industry. Some of these factors are:

The concentration of customers: If there are few customers who buy large volumes of products or services from many sellers, they have more bargaining power than if there are many customers who buy small quantities from many sellers.

The switching costs for customers: If it is easy and cheap for customers to switch from one seller to another, they have more bargaining power than if it is difficult and expensive for them to switch.

The information available to customers: If customers are well informed about the products or services, their features, prices, quality, and alternatives, they have more bargaining power than if they are poorly informed or misled by sellers.

The price sensitivity of customers: If customers are very sensitive to changes in prices and demand lower prices or discounts, they have more bargaining power than if they are less sensitive or loyal to sellers.

The importance of the product or service to customers: If the product or service is essential or highly valued by customers, they have less bargaining power than if the product or service is non-essential or low-valued by them.

How to Reduce the Power of Customers

Sellers can adopt various strategies to reduce the power of customers and increase their own competitive advantage in the industry. Some of these strategies are:

Differentiating the products or services: By offering unique features, benefits, quality, design, or branding that create value for customers and make them loyal or willing to pay a premium price.

Increasing the switching costs for customers: By creating loyalty programs, contracts, exclusive deals, or bundling products or services that make it harder or costlier for customers to switch to competitors.

Providing better customer service: By offering superior after-sales service, support, warranties, guarantees, or feedback mechanisms that enhance customer satisfaction and retention.

Segmenting the market: By identifying and targeting different groups of customers with different needs, preferences, and willingness to pay, and offering customized products or services that meet their specific demands.

Building long-term relationships: By establishing trust, communication, cooperation, and mutual benefits with customers that create loyalty and reduce their bargaining power.

How Customer Power Affects Industry Demand

The power of customers can have a significant impact on the global demand for products or services in an industry. Depending on the level of customer power and the strategies adopted by sellers, the demand can increase or decrease in different ways. Some examples are:

If customers have high bargaining power and demand lower prices or higher quality from sellers, this can reduce the profit margins and revenues of sellers, and lower the overall demand in the industry.
If customers have low bargaining power and accept higher prices or lower quality from sellers, this can increase the profit margins and revenues of sellers, and raise the overall demand in the industry.
If sellers differentiate their products or services and create loyal or premium segments of customers, this can increase the demand for their products or services and reduce the demand for competitors’ products or services.
If sellers increase the switching costs for customers and create lock-in effects, this can increase the demand for their products or services and reduce the demand for competitors’ products or services.
If sellers provide better customer service and enhance customer satisfaction and retention, this can increase the demand for their products or services and reduce the demand for competitors’ products or services.

The power of customers is one of the key forces that shape the competitive structure and profitability of an industry. Sellers need to assess the level of customer power in their industry and adopt appropriate strategies to reduce it and increase their own competitive advantage. By doing so, they can also influence the global demand for their products or services in positive ways.

FREQUENTLY QUESTIONS

Q: What is customer power?
A: Customer power is the ability of customers to influence the price, quality, and availability of products or services in the market.

Q: What are the sources of customer power?
A: The sources of customer power are the number and size of customers, the concentration and diversity of suppliers, the availability and attractiveness of substitutes, the degree of differentiation and standardization of products or services, and the level of information and awareness of customers.

Q: How can customer power be measured?
A: Customer power can be measured by indicators such as the price sensitivity, switching costs, loyalty, satisfaction, retention, or advocacy of customers.

Q: How can customer power be reduced?
A: Customer power can be reduced by segmenting, branding, relationship-building, innovating, co-creating, educating, or increasing switching costs for customers.

Q: How can customer power be leveraged?
A: Customer power can be leveraged by listening to, engaging with, empowering, or rewarding customers for their feedback, suggestions, or referrals.

References:

https://spinup-000d1a-wp-offload-media.s3.amazonaws.com/faculty/wp-content/uploads/sites/8/2019/06/RightGame_HBR1995.pdf

http://web.mit.edu/bwerner/www/papers/AResource-BasedViewoftheFirm.pdf

https://courses.lumenlearning.com/boundless-management/chapter/external-inputs-to-strategy/