Porter’s Five Forces Analysis and Sephora’s Bargaining Power
In class, we learned about how Nash bargaining balances the outcome of an network exchange. In a two-person bargaining problem, Nash bargaining solution provides a way to divide the surplus, or outside options of both players. In addition, we also learned about how bargaining power increases when one person has more options relative to the others in a network exchange. I’m interested in real world applications of bargaining power in networks, so I ended up searching Porter’s five forces analysis, which is a practical framework that measures the competitiveness of a business. Porter’s five forces for a business consists of following component:
- Threat of new entrants. Because a profitable industry that yields high returns attracts new firms to join, and new entrants lower the profitability of the business.
- Threat of substitutes. A company’s bargaining power is weakened if customers can switch to another company that sells similar product with a fairly easy cost. For example, people who buy Pepsi can easily switch to buying coke.
- Rivalry among existing competitors. Rivalry competition is intense when there are just a few businesses equally selling a product or service. Competing with industry rivalries lead to more money invested in advertising and potentially a price war.
- Bargaining power of suppliers. This forces analyzes how much power and control the suppliers have to raise prices that lower a company’s profits. An increasing number of suppliers weakens the bargaining power of suppliers.
- Bargaining power of customers. This forces analyzes how customers affect the price and quality of the products. The bargaining power of customers is weakened when there are fewer competing firms available.
Porter’s five forces practically measures a company’s competitiveness or bargaining power. It can be applied to the cosmetic retail industry. For example, Sephora is one of the most popular cosmetic chain. It is a French brand that features more than 300 cosmetics brands including makeup, skincare and fragrance. Applying Porter’s five forces to Sephora, we can see that Sephora has a lower threat of new entrants because the entry barrier of starting a cosmetics chain that features different brands is high. Since there are department store and drugstore that sells the similar products as Sephora, the threat of substitutes is moderate. The rivalry among existing competitors is high because companies such like Ulta Beauty and Feelunique are popular cosmetic chains that also feature different brands of similar products. The bargaining power of popular cosmetic brands is moderate because selling their products in Sephora increases the revenue, but they have more bargaining power since Sephora wants to feature a popular brand. The bargaining power of niche brand is low because if they don’t introduce their products in Sephora, they don’t have access to a large base of customers. Since Sephora offers many discounts and a variety of options, the customer’s bargaining power is low because the demand for Sephora products is high.
After decomposing the bargaining power of Sephora, we can model a network exchange between a cosmetic brand and Sephora. For example, if Sephora wants to feature a popular makeup brand called Beauty Networks, which targets college students. The exchange network is follows:
If Sephora does not sell Beauty Networks products, they can feature another popular makeup brand that targets a young audience with a revenue of 50. If Beauty Networks sells their products on Ulta Beauty, they get a revenue of 30. The surplus in this case is 100-(30+50) = 20. So in a Nash Bargaining solution, Sephora shares 50+20/2 = 60 and Beauty Networks shares 30+20/10 = 40. Similarly, we can also model different components of Porter’s five forces analysis, for example, the network exchange between customers and Sephora, using the Nash Bargaining solution.
Links:
http://www.economist.com/node/325132
https://prezi.com/if459ielwnjl/sephora/
http://www.businessnewsdaily.com/5446-porters-five-forces.html