The document analyzes the financial industry using Porter's five forces model. It finds that the threat of new entrants is low due to the lengthy regulatory approval process required. Rivalry is strong as institutions compete for customers and deposits. The threat of substitutes is high as customers frequently use multiple institutions. Suppliers like the Federal Reserve and credit card companies have significant bargaining power. The bargaining power of buyers is low for commercial banks but higher for credit unions which are member-owned.

1. 5 Factors Analysis: The Financial Industry 1
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5 Forces Analysis: The Financial Industry
Kristina Kivi
University of Maryland University College
IMAN 601 9040
According to Michael Porter, an industry’s innate structure will drive competition and
determine its overall profitability (Porter, 2008). He postulates that there are five major
categories by which an industry’s structure is analyzed: threat of new entrants, rivalry among
existing competitors, threat of substitute products or services, bargaining power of suppliers, and
bargaining power of buyers (Porter, 2008). As the topic in question is whether credit unions
should keep their tax-exempt status, it is important to analyze not only credit unions, but the
entire financial industry.
A long and arduous road lies ahead for those persons who wish to start a bank or credit
union. Each entity takes from a year or more to gain approval from the necessary governing
bodies. For national banks, the overseeing bodies are the Office of the Comptroller of the
Currency and the Federal Deposit Insurance Corporation (Federal Reserve, 2013). Credit unions
must undergo steps determined by the National Credit Union Administration. Each potential
financial institution must submit application packages that detail its current assets, business and
marketing plans, and board of directors or leaders (National Credit Union Administration, 2014).
Because of the time and effort it takes to form a new financial institutions, the threat of
new entrants is very low. Assuming that one makes if through the application process, most new

2. 5 Factors Analysis: The Financial Industry 2
entrants in finance start as small regional firms and are quickly bought up by large commercial
banks. In a report issued in 2004 by the Board of Governors of the Federal Reserve System, over
3,500 mergers between various commercial banks occurred between 1994 and 2003 (Pilloff,
2004). Credit Unions are a more viable option due to their charter requirement. As commercial
banks can serve any consumer, credit unions are limited to those consumers who fit within their
field of membership. Therefore, a credit union that serves military members cannot merge with
another credit union that serves the employees of an insurance company. While mergers do
happen between credit unions, they are much more rare when compared to national banks.
Considering the restrictions placed on membership, credit unions will always maintain a smaller
share of those consumers using financial institutions.
Despite the fact that commercial banks and credit unions are considered two different
types of financial institutions, the rivalry amongst them is very strong. This also applies to those
individual entities that make up the entire financial industry. Success in finances is dictated not
only in the amount of customers or members an organization has, but on the total number of
assets. Without a high deposit base, financial institutions cannot be strong competitors,
especially considering how deposits affect the ability to lend.
In order for financial institutions to remain solvent, their total number of assets must
exceed their total number of liabilities (Federal Reserve, 2014). After the market crash in 2008,
the Federal Reserve began implementing measures to ensure that consumers never again faced
such financial hardships in the wake of poor comptroller decisions. As a result, it enacted the
Basel III Liquidity Coverage Ratio in 2013, setting a new precedent for asset requirements
(Federal Reserve, 2014). This applies to all financial institutions that provide lending products. If

3. 5 Factors Analysis: The Financial Industry 3
an organization does not have a large customer base, their deposits are likely to be small as well.
Most institutions pay dividends for deposits. If the lending portfolio is small, the organization
cannot offset dividend payouts with lending fees, such as late payment fees and mortgage
origination fees. Therefore, it is of utmost importance for financial institutions to compete for the
largest amount of customers and the largest amount of deposits.
Most customers have their funds in multiple financial institutions. This makes threat of
substitutes generally high. The majority of their deposits may be at a commercial bank whereas
their lending products may be at a credit union due to more favorable interest rates. Financial
institutions may also have programs created in conjunction with certain large employers to offer
more favorable products, such as early deposit access. Customers and members are free to shop
between financial institutions to find the best rates. However, the switching costs focus more on
a customer’s time and convenience as opposed to monetary costs. It takes time for direct deposits
to change to another institution and certain firms may not have as many local branches to
conduct business. Consumers must weigh their options before considering whether the time and
energy associated with changing their direct deposit institution is worth the additional .05% in
interest.
While the latter information focused on customers keeping their funds in financial
institutions, there are other important substitutes to consider. Depending how risk-adverse a
customer may be, he or she may also place her funds into the stock market. Other investments
include helping to fund a new business or donating money to charity in hopes of offsetting
federal taxes. For the true miser, he or she may choose to keep large cash holdings out of the
financial industry altogether and place them underneath the couch.

4. 5 Factors Analysis: The Financial Industry 4
The suppliers of the financial industry can be seen as three major groups: the Federal
Reserve, major credit card companies, and employees. Considering these three suppliers, the
bargaining power shared amongst them is very high. Beginning with the Federal Reserve, this
supplier determines the rate by which financial institutions may purchase money. Once again, we
turn to the events of 2008 to highlight their authority. In the wake of economic collapse, the
Federal Reserve waived the normal charges paid by banks and credit unions to place monetary
orders. This continues to this day. Deposit dividends also took a sharp dive, as financial
institutions no longer needed to rely on their customers funds for liquidity. If financial
institutions begin to pay fees again, one will expect the dividend rate of deposits to increase as
well. The effects of the Federal Reserve’s policies on monetary orders trickles down from the
comptroller’s offices of financial institutions to the consumers and is reflected in their earned
interest.
Major credit card companies also play a large role in the industry. Those organizations,
such as Visa and Mastercard, set industry standards on fraud procedures and account security. In
order for financial institutions to produce cards with their logos, bank and credit unions must
comply with a number of terms. For instance, in order to have an instant card issue machine that
produces VISA cards at branches, organizations must place those machines in secure areas with
a camera directly facing it. If there are no cameras installed that meet those requirements, one
must be retrofitted to face the machine. Additional requirements may include the number of
cards issued to consumers in a specific period of time, point of sale amount limitations, and
reserve card stock limitations. If financial institutions do not comply with their requirements,
they cannot issue those company’s cards.

5. 5 Factors Analysis: The Financial Industry 5
Employees of financial institutions are not to be discounted when considering the
bargaining power of suppliers. Those that supply their labor to banks and credit unions do not
necessarily have the most bargaining power in the industry when compared to the Federal
Reserve and major credit card companies. When observing the labor market, employers still have
the majority of the power. While unemployment is declining slowly and steadily, the locus of
power has not yet shifted to the employees. Employers may supplement their workforce with
applicants with cash handling skills, not necessarily banking skills. There are still too many
people looking for employment as opposed to employers looking to fill vacancies.
Depending upon the type of financial institution the bargaining power of buyers may be
high or low. With regard to commercial banks, the bargaining power is very low. The most
influential stakeholder for publicly traded entities is the stockholders, not the customers. Profit is
the overriding principle and the ultimate concern when planning marketing strategies and
product development. For credit unions, which are not-for-profit, the power of the buyer is
higher. Because they are not-for-profits, the majority of the income of credit unions is returned
back to the member in the form of higher dividend rates and other services. The rest of the
income is used to cover operating costs. Credit unions have a member-owner structure in which
each individual member gets a vote and owns a portion of the organization. While changes may
be slow to take effect, members have a much greater say in the actions of credit unions as
opposed to customers of commercial banks.
With the proper ration of assets to lending, financial institutions can reap generous
rewards. However, there are a few caveats. If a financial institutions has a number of assets but a
very small amount of lending, income will be limited as you are paying out more dividends than

6. 5 Factors Analysis: The Financial Industry 6
receiving in interest. As most small institutions are bought by larger commercial banks, the
individual identity of the institution does not last long. This also plays a huge role in the
restructuring of the newer institution. Branches may close and individuals, especially mid-level
managers, may lose their jobs as there are too many employees for that leadership level. For
those sitting in the board room of financial institutions, the profitability is high.

7. 5 Factors Analysis: The Financial Industry 7
Bibliography
Board of Governors of the Federal Reserve (2013, August). How can I start a bank? Retrieved
from http://www.federalreserve.gov/faqs/banking_12779.htm
National Credit Union Administration (2014, September). Federal Credit Union Charter
Application Guide. Retrieved from http://www.ncua.gov/Resources/Documents/CUDev/
Federal-Credit-Union-Charter-Application-Guide.pdf
Pilloff, S. (2004, May). Bank merger activity in the United States. Federal Reserve Bulletin.
Retrieved from http://www.federalreserve.gov/pubs/staffstudies/2000-present/ss176.pdf
Porter, M. (2008). The five competitive forces that shape strategy. Harvard Business Review,
86(1), 78-93. Retrieved from http://eds.a.ebscohost.com.ezproxy.umuc.edu