PORTERS FIVE FORCES ANALYSIS

Introduction Porters five forces model of industry competition is used to inspect a competitive environment and establish a firms possible profits. The model uses five competitive forces that determine a particular firms capability to compete. The chocolate and cocoa industry can use the five forces model as an analytical tool to determine the competitive market. The five competitive forces used in the model are threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitute products, and intensity of rivalry among competitors.

Threat of New Entrants

The threat of new entrants is a competitive force that determines how easily a firms profits can be lowered because of new competitors in the industry. There are six barriers that determine the risk of new entrants. These include economies of scale, product differentiation, capital requirements, switching costs, access to distribution channels and cost disadvantages independent of scale

Economies of scale reduce the per-unit cost of a product as the number of units being produced increases. The chocolate and cocoa industry does have a significant economy of scale entry barrier because large companies exist in the industry that has high production output, which reduces the cost to produce chocolate and cocoa. If a new competitor wanted to enter the market, the company would have to enter the market producing a large quantity at the same low price as

competitors or the company would have to compete with a cost disadvantage. Because economies of scale exist in the industry, it deters smaller competitors from entering into the market and reduces the threat of entrants.

In addition to economy of scale, product differentiation is another entry barrier in the chocolate and cocoa industry. There are many competitors in the industry that have remarkably identifiable

brand names and customer loyalty. Some of the strongest competitors in the industry are Hershey Foods Corporation, Farley Candy Company, Worlds

Finest Chocolate, Inc., Merckens Chocolate Company, and Ghirardelli Chocolate Company (www.answers.com). All of the companies have established brand names and customer loyalty, which creates a considerable entry barrier for new companies. Thus, the new company must increase spending to overcome the reputation and large customer base of the existing companies.

Another entry barrier is the presence of large capital requirements that are required in the chocolate and cocoa industry. Large capital requirements create an entry barrier for new entrants because it requires the company to have a significant source of capital to get started. The large capital investment entails costs for items such as production equipment, labor, raw materials, and research and development. In addition to these costs, a new company would need to spend a large amount of money on advertising and marketing to overcome product differentiation. An example of the large capital requirement needed for production is Grace Cocoas new production plant that cost $95 million dollars (www.answers.com). It would be difficult for a new company to enter the market because of this significant need for capital.

Furthermore, switching cost create a barrier to entry for new companies entering the chocolate and cocoa industry. Switching the supplier of chocolates raw materials such as cocoa beans, sugar, and milk create additional testing and research that must be completed by the company to ensure correct quality, safety and taste.

Additionally, the expense and network that must be present to obtain access to distribution channels is an entry barrier for new companies. A new company must acquire distribution channels for their chocolate and cocoa products. This requires the company to create a network of buyers, which is time and money intensive. Further, the new companies have to compete for shelf space in stores with the larger players in the industry that have existing distribution channels already established.

Cost disadvantages independent of scale such as patents, favorable access to raw materials, government subsidies and polices create barriers of entry for new companies. Because the industry produces food for the end consumer, companies in the industry must meet several government standards. For these companies, the Food and Drug Administration is the government agency that sets the guidelines and regulations. These regulations increase barrier to entry for new companies in the chocolate and cocoa industry.

There is a low threat of new entrants in the chocolate and cocoa product industry because the existence of economy of scale, the differences in products, the need for large capital requirements, the existence of switching costs, the lack of access to distribution channels, and the regulations that are in place for food manufacturers.

Bargaining Power of Buyers

The bargaining power of buyers is a competitive force that can result in lower prices for a product and increase the quality of service, which decreases profits and increases costs for the industry. Buyers power increases if large volumes of the product are purchased, the product is undifferentiated, few switching costs exist, low profits are earned, backward integration is possible, and the quality of the buyers product is not affected by the suppliers product If a buyer represents a large percentage of the suppliers sales, the buyer has more bargaining power over the supplier. The chocolate and cocoa industry has several large volume retailers, like Wal-Mart, that have significant bargaining power. These large volume retailers can bargain for lower prices and reduce the industrys profits.

Another condition that affects the power of buyers is product differentiation. If the product is undifferentiated, the buyer has the power to play competitors against each other and reduce the cost. The chocolate and cocoa industry has a differentiated product, which reduces the power of buyers. The industry has several large players that have brand identification and customer loyalty, which makes it hard for buyers not to use a particular supplier.

The lack of switching costs also increases the power of buyers in a particular industry because the buyer can threaten to change suppliers if they are not getting an adequate price or service from the supplier. The buyers switching costs in the chocolate and cocoa industry is moderate to high. Specifically, the industrys

industrial-use buyers have significant switching costs because the suppliers product can change the flavor or texture of the buyers product. If the buyer wanted to play competitors against each other, the buyer would have to extensively taste test different recipes for different products. In addition, the buyers customers may react poorly to new flavors, forcing the buyer to switch back to the original supplier. The high switching costs decrease the power of buyers in the chocolate and cocoa industry.

Furthermore, if the buyer earns low profits on products they sell, they are more price-sensitive. This causes buyers to shop around the industry and create more bargaining power. The chocolate and cocoa industrys buyers usually make low profits on the products they sell, forcing the buyer to lower purchasing costs. This gives the buyer more power in the industry. However, the buyer must be willing to accept taste changes in the product, which restricts their bargaining power. The buyer can gain power if they pose a threat of backward integration. If a buyer can successfully become his or her own supplier, the bargaining power of the buyer increases. Both retail buyers and industrial-use buyers are limited when posing a threat of backward integration because the ability to produce chocolate and cocoa products requires significant capital investment and other barriers to entry. This lack of threat reduces the buyers bargaining power. Buyers are able to increase bargaining power if the quality of their product is not affected by the industrys product. When it is unimportant to the buyers product, the buyer is able to be more price-conscious. The industrial-use buyer of the chocolate and cocoa industry relies heavily on the industrys input product. The input product directly affects the quality and taste of the buyers end product. This dependency decreases the buyers bargaining power.