Evaluation of Banks Using Porter’s 5 Forces

1 January 2017

This report will investigate how Porter’s five forces might be used to evaluate the future potential of modern banks, such as Tesco Bank and Virgin Money. This question has occurred through recent research into market structure and has highlighted its significance in the current market place by introducing more competition to traditional banks, supermarkets and other businesses. However, this also gives customers more choice in today’s climate, where in some cases banks have lost customers’ trust.

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Porter makes clear that when there is competition in the market place, every business should have a strategic plan so they are able to manage the competition. The plan should include the additional four factors; customers, suppliers, potential entrants and substitute products. These factors will form the “competitive interaction within an industry” (Porter, 2008:3-8) and will ultimately give an insight into how successful these new banks could be.

Barriers to entering the banking industry include regulators such as the Financial Services Authority. Banks have a number of regulations they have to meet in order to get a banking licence. This takes a lengthy period of time to comply to prove “that they have the integrity, financial and managerial resources necessary to run a bank, that they are worthy of the trust that people expect to be able to place in the bank that holds their deposits and in many cases, their life savings” (Buckle & Thomson, year:page no). The UK financial system: theory and practice By Mike Buckle, John L. Thompson)

Thus it is very costly. Likewise this is not the only cost, when banks start-up they need a wide range of specialist contractors, buildings, and I. T. For example Tesco Bank recently built a new building in Glasgow creating 200 new jobs, thus it is pricey. However unlike some “barriers such as asset specificity” (Wengler, 2006:176) banks tend not to have this problem because although the buildings are costly and they have a lot of highly specialised I.

T, it can be turned into another asset, so if you are an established firm like Tesco that could put these assets to other use, this is an attractive opportunity. To conclude, the set up costs of setting up a bank are enormous, therefore the chance of new banks entering the market is low, unless they are an already accomplished business with the finance to support them. There three factors that make suppliers powerful are “demand for suppliers products-more demands drives the price of supplies up in a market based system”.

Secondly “whether quality and performance of nputs are differentiated-greater uniqueness of an input allows a higher price to be charged and decreases the ability of clients in firms in the industry to switch easily between suppliers” and finally “the ability of the industry to vertically integrate” because this would mean owning your own supply method, cutting the costs (Ahlstrom & Bruton, 2009: page no). Every industry requires suppliers and in banks they would supply I. T-computers, printers, telephony equipment and software. They would also need supplies of stationary-paper, pens etc.

For example the Glasgow and Newcastle insurance and banking customer services in Tesco Bank signed a deal with Cable and Wireless for their managed data centres and hosted telephony (King, 2010). Kurtz, MacKenzie & Snow (2009:57) use Porters idea that “the number of available suppliers to a manufacturer or retailer affects their bargaining power. ” Cousins (1999:112) states that “and due to the decision of the OFTEL regulator in July 1999 to remove this monopoly will benefit the consumer by allowing the access of new broadband technologies to his home”.

Although the service is for businesses instead of homes, there are now many competitors in the cable industry, so the suppliers do not have as much power. However, in products like software, because of the specialist, patented, technology that has developed, they can charge high prices. Nevertheless in Tesco Finance they have managed to take control over some software suppliers because they are a reputable company and suppliers want to be associated with them. This leads on to the factor buyer power. Tesco are a great example of having high buyer power through a whole range of strengths.

Their brand identity gives them bargaining leverage when they need supplies. Suppliers would find Tesco or Virgin Money attractive to supply for because they own a large per cent of the market share in their industries, Tesco dominating with 30. 4%. By supplying to a market leader, it could open doors to other contacts who want to use their product, and because Tesco supermarket has already proven their successfulness, it would be true to say that the bank will expand too. This gives the chance to supplier to supply more to Tesco as the company grows, increasing their profits.

Moreover they have the power of economies of scale. The Tesco business model states that “to continually increase the size of its operations, realise greater economies of scale and reflect them back into lower prices and or higher quality to generate greater sales and more economies of scale” (Reading, 2004:page no). The banks ‘father’-( Tesco supermarket) already has economies of scale and this had been passed onto the bank by arranging cheaper deals with existing suppliers, ultimately having more machinery and software will allow more sales to be made and increasing their revenue further.

Thus, it becomes a want to supply for Tesco Bank, leaving the bank with all the power to bargain for lower prices. In nearly all industries there are substitutes for each product, giving consumers the option to swap to the substitute if their original choice becomes more expensive. “The threat of substitutes is there for an important market force setting limits upon the prices that firms are able to charge” (Davies & Lam, 2001:228). There are three factors that determine how well a business could do.

Firstly, is the relative price performance of substitutes. This is where there are two products which are nearly identical however, one is cheaper than the other and that is the product which consumers would usually swap also. However, in the case of banks the cheaper option is not always the best option and can be illegal. People who struggle to get loans from banks are more likely to go to a loan shark because they know they can get money easily without the lengthy credit history checks.

Additionally, another substitute for a bank could be a credit union which is a “cooperative depository financial institution whose members can obtain loans from their combined savings”. This is more expected in the current climate where there has been trust lost in banks, when they lost customers money and also because it is a non-profit organisation, it works out cheaper for the consumer. Secondly, are the switching costs for customers. Today, investors who would have usually used banks to invest their money might now switch to other substitute methods of getting return.

For example they might invest in stock or buy gold. Finally, is the ‘buyer’s propensity to substitute’. If consumers are less inclined to find other substitutes then it shows they are happy enough with the product they consume. In conclusion regarding to the threat of substitutes, because there are so many people unemployed and desperate, they will result to borrowing from loan sharks instead of using banks which will have a negative impact on the banks.

The final point of Porter’s five forces is ‘the degree of rivalry. The basic economics 101 class states that “more competitors and rivals competing against each other will put a downward pressure on the price increases and their profit” (Desmond, 2004:32). Rivalry can be influenced my many factors, one being the industry concentration. Currently there is a high concentration in the banking industry, but low competition. This is due to the fact that there is little room for growth, so it is difficult for banks to grow profits. This has resulted in them merging with other banks to increase their market share.

It also has other benefits “when banks merge they can spread fixed costs associated with technology, operating infrastructure, online services and so on” (Maharaj, 2005:20). An example of this would be the Lloyds TSB and HBOS merger in 2008 and ‘combined they had over a quarter of the UK mortgage market and a large chunk of the personal banking and business baking markets’. The government however, are now making banks sell parts of their business to increase the competition and new banks like Virgin and Tesco will be welcomed not only to the government but also to customers because prices will become more competitive.

Another element is ‘product differences’. Banking products are very similar however, there is opportunity for new banks to introduce slightly differentiated products. For example, Tesco Bank is offering the incentive of gaining club card points to any customer who uses their bank ‘Credit card holders are currently getting a great deal from exclusive special offers such as: Earn Clubcard points’. And Virgin Money offer discounts on nearly all their other services like 10% off virgin holidays.

Moreover, the factor of corporate stakes in this case gives new bank entrants a lot of financial power. Tesco now completely own the entire of Tesco bank after buying the other half of it off the Royal Bank of Scotland and because Tesco are already so successful they have a lot of financial power backing them. In conclusion, this report has investigated how might Porter’s five forces can be used to evaluate the future potential of modern banks, such as Tesco Bank and Virgin Money.

This question had occurred through recent research into ‘market structure’ and has highlighted how successful these new, upcoming should be. Although, it is a hard market to enter due to high barriers to entry because of regulations and high set up costs, they have already broke into the market and the threat of more new banks entering are slim, even though the government want more. They also have control of suppliers because of the already existing supermarket, brand name and economies of scale, which cuts their costs and gives them an advantage over other banks.

Additionally, there is a degree of rivalry between banks at the moment but it seems newer banks have an advantage because they can offer incentives like ‘club card points’ that other banks cannot offer and with banks like RBS losing customers trust, they might want to try the new banks. However, because of the conditions of the current economic climate and the millions of unemployed, substitutes like loan sharks or credit unions could steal potential customers from them. Ultimately, they should do well.

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