Porter’s Five Forces analysis is a business framework for industry analysis and business strategy development. It draws upon industrial organization economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. An unattractive industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching pure competition, in which available profits for all firms are driven to normal profit.
Three of Porter’s five forces refer to competition from external sources. The remainder are internal threats.
These are the 5 fundamental competitive forces:
- Entry of competitors. How easy or difficult is it for new entrants to start competing, which barriers do exist.
- Threat of substitutes. How easy can a product or service be substituted, especially made cheaper.
- Bargaining power of buyers. How strong is the position of buyers. Can they work together in ordering large volumes.
- Bargaining power of suppliers. How strong is the position of sellers. Do many potential suppliers exist or only few potential suppliers, monopoly?
- Rivalry among the existing players. Does a strong competition between the existing players exist? Is one player very dominant or are all equal in strength and size.
Sometimes a sixth competitive force is added:
Porter’s Competitive Forces model is probably one of the most often used business strategy tools. It has proven its usefulness on numerous occasions. Porter’s model is particularly strong in thinking Outside-in.
Threat of New Entrants depends on:
- Economies of scale.
- Capital / investment requirements.
- Customer switching costs.
- Access to industry distribution channels.
- Access to technology.
- Brand loyalty. Are customers loyal?
- The likelihood of retaliation from existing industry players.
- Government regulations. Can new entrants get subsidies?
Threat of Substitutes depends on:
- Quality. Is a substitute better?
- Buyers’ willingness to substitute.
- The relative price and performance of substitutes.
- The costs of switching to substitutes. Is it easy to change to another product?
Bargaining Power of Suppliers depends on:
- Concentration of suppliers. Are there many buyers and few dominant suppliers? Compare: Kraljic Model.
- Branding. Is the brand of the supplier strong?
- Profitability of suppliers. Are suppliers forced to raise prices?
- Suppliers threaten to integrate forward into the industry (for example: brand manufacturers threatening to set up their own retail outlets).
- Buyers do not threaten to integrate backwards into supply.
- Role of quality and service.
- The industry is not a key customer group to the suppliers.
- Switching costs. Is it easy for suppliers to find new customers?
Bargaining Power of Buyers depends on:
- Concentration of buyers. Are there a few dominant buyers and many sellers in the industry?
- Differentiation. Are products standardized?
- Profitability of buyers. Are buyers forced to be tough?
- Role of quality and service.
- Threat of backward and forward integration into the industry.
- Switching costs. Is it easy for buyers to switch their supplier?
Intensity of Rivalry depends on:
- The structure of competition. Rivalry will be more intense if there are lots of small or equally sized competitors; rivalry will be less if an industry has a clear market leader.
- The structure of industry costs. Industries with high fixed costs encourage competitors to manufacture at full capacity by cutting prices if needed.
- Degree of product differentiation. Industries where products are commodities (e.g. steel, coal) typically have greater rivalry.
- Switching costs. Rivalry is reduced when buyers have high switching costs.
- Strategic objectives. If competitors pursue aggressive growth strategies, rivalry will be more intense. If competitors are merely “milking” profits in a mature industry, the degree of rivalry is typically low.
- Exit barriers. When barriers to leaving an industry are high, competitors tend to exhibit greater rivalry.
Strengths of the Five Competitive Forces Model
- The model is a strong tool for competitive analysis at industry level. Compare this with the PEST Analysis framework.
- It provides useful input for performing a SWOT Analysis.
Limitation of Porter’s Five Forces model
- Care should be taken when using this model for the following: do not underestimate or underemphasize the importance of the (existing) strengths of the organization (Inside-out strategy). See: Core Competence
- The model was designed for analyzing individual business strategies. It does not cope with synergies and interdependencies within the portfolio of large corporations. See: Parenting Advantage
- From a more theoretical perspective, the model does not address the possibility that an industry could be attractive because certain companies are in it.
- Some people claim that environments which are characterized by rapid, systemic and radical change require more flexible, dynamic or emergent approaches to strategy formulation. See: Disruptive Innovation
- Sometimes it may be possible to create completely new markets instead of selecting from existing ones. This is the focus of the growth strategy framework, Blue Ocean Strategy.
Overview of the Book “Competitive Strategy”
- In Part I, Porter discusses the structural analysis of industries (with the five forces), the three generic competitive strategies (overall Cost Leadership, Focus, and Differentiation), offering an excellent framework for competitor analysis, competitive moves, strategy toward buyers and suppliers, structural analysis within industries (strategic groups, strategic mapping, mobility barriers), and industry evolution (life cycle, evolutionary processes).
- In Part II, Porter discusses competitive strategy within various generic industry environments. Such as: fragmented industries (with no real market leader), emerging industries, mature industries, declining industries, and global industries.
- In Part III, Porter discusses strategic decisions which businesses/firms can take. Such as: vertical integration (forward, backward, partnerships), capacity expansion, and entry into new industries/businesses.
Source: Michael E. Porter – Competitive Strategy
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Porter’s Five Forces
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