Porters 5 Forces

1 2 Introduction The Five Competitive Forces 2.1 Bargaining Power of Suppliers 2.2 Bargaining Power of Customers 2.3 Threat of ew !ntrants 2." Threat of Su#stitutes 2.$ Competitive %ivalr& #etween !'isting Pla&ers 3 (se of the Information form Five Forces )nal&sis " Influencing the Power of Five Forces ".1 %educing the Bargaining Power of Suppliers ".2 %educing the Bargaining Power of Customers ".3 %educing the Treat of ew !ntrants "." %educing the Threat of Su#stitutes ".$ %educing the Competitive %ivalr& #etween !'isting Pla&ers $ Criti*ue

Introduction

The model of the Five Competitive Forces was developed by Michael E. Porter in his book Competitive Strategy Techni!"es for #naly$ing %nd"stries and Competitors& in '()*. Since that time it has become an important tool for analy$ing an organi$ations ind"stry str"ct"re in strategic processes. Porters model is based on the insight that a corporate strategy sho"ld meet the opport"nities and threats in the organi$ations e+ternal environment. Especially, competitive strategy sho"ld base on and "nderstanding of ind"stry str"ct"res and the way they change. Porter has identified five competitive forces that shape every ind"stry and every market. These forces determine the intensity of competition and hence the profitability and attractiveness of an ind"stry. The ob-ective of corporate strategy sho"ld be to modify these competitive forces in a way that improves the position of the organi$ation. Porters model s"pports analysis of the driving forces in an ind"stry. .ased on the information derived from the Five Forces #nalysis, management can decide how to infl"ence or to e+ploit partic"lar characteristics of their ind"stry.

The Five Competitive Forces

The Five Competitive Forces are typically described as follows

2.1

Bargaining Power of Suppliers

The term /s"ppliers/ comprises all so"rces for inp"ts that are needed in order to provide goods or services. S"pplier bargaining power is likely to be high when The mar+et is dominated #& a few large suppliers rather than a fragmented source of suppl&, There are no su#stitutes for the particular input, The suppliers customers are fragmented, so their #argaining power is low, The switching costs from one supplier to another are high, There is the possi#ilit& of the supplier integrating forwards in order to o#tain higher prices and margins. This threat is especiall& high when The #u&ing industr& has a higher profita#ilit& than the suppl&ing industr&,

Forward integration provides economies of scale for the supplier, The #u&ing industr& hinders the suppl&ing industr& in their development -e.g. reluctance to accept new releases of products., The #u&ing industr& has low #arriers to entr&.

%n s"ch sit"ations, the b"ying ind"stry often faces a high press"re on margins from their s"ppliers. The relationship to powerf"l s"ppliers can potentially red"ce strategic options for the organi$ation.

2.2

Bargaining Power of Customers

Similarly, the bargaining power of c"stomers determines how m"ch c"stomers can impose press"re on margins and vol"mes. C"stomers bargaining power is likely to be high when The& #u& large volumes, there is a concentration of #u&ers, The suppl&ing industr& comprises a large num#er of small operators The suppl&ing industr& operates with high fi'ed costs, The product is undifferentiated and can #e replaces #& su#stitutes, Switching to an alternative product is relativel& simple and is not related to high costs, Customers have low margins and are price/sensitive, Customers could produce the product themselves, The product is not of strategical importance for the customer, The customer +nows a#out the production costs of the product There is the possi#ilit& for the customer integrating #ac+wards.

2.

Threat of !ew "ntrants

The competition in an ind"stry will be the higher, the easier it is for other companies to enter this ind"stry. %n s"ch a sit"ation, new entrants co"ld change ma-or determinants of the market environment 0e.g. market shares, prices, c"stomer loyalty1 at any time. There is always a latent press"re for reaction and ad-"stment for e+isting players in this ind"stry. The threat of new entries will depend on the e+tent to which there are barriers to entry. These are typically !conomies of scale -minimum si0e re*uirements for profita#le operations., 1igh initial investments and fi'ed costs, Cost advantages of e'isting pla&ers due to e'perience curve effects of operation with full& depreciated assets, Brand lo&alt& of customers Protected intellectual propert& li+e patents, licenses etc, Scarcit& of important resources, e.g. *ualified e'pert staff )ccess to raw materials is controlled #& e'isting pla&ers, 2istri#ution channels are controlled #& e'isting pla&ers, !'isting pla&ers have close customer relations, e.g. from long/term service contracts, 1igh switching costs for customers 3egislation and government action

2.#

Threat of Su$stitutes

# threat from s"bstit"tes e+ists if there are alternative prod"cts with lower prices of better performance parameters for the same p"rpose. They co"ld potentially attract a significant proportion of market vol"me and hence red"ce the potential sales vol"me for e+isting players. This category also relates to complementary prod"cts. Similarly to the threat of new entrants, the treat of s"bstit"tes is determined by factors like Brand lo&alt& of customers, Close customer relationships, Switching costs for customers, The relative price for performance of su#stitutes, Current trends.

2.5

Competitive %ivalr& $etween "'isting Pla&ers

This force describes the intensity of competition between e+isting players 0companies1 in an ind"stry. 2igh competitive press"re res"lts in press"re on prices, margins, and hence, on profitability for every single company in the ind"stry. Competition between e+isting players is likely to be high when There are man& pla&ers of a#out the same si0e, Pla&ers have similar strategies There is not much differentiation #etween pla&ers and their products, hence, there is much price competition 3ow mar+et growth rates -growth of a particular compan& is possi#le onl& at the e'pense of a competitor., Barriers for e'it are high -e.g. e'pensive and highl& speciali0ed e*uipment..

(se of the Information form Five Forces )nal&sis Five Forces #nalysis can provide val"able information for three aspects of corporate planning Statical )nal&sis* The Five Forces #nalysis allows determining the attractiveness of an ind"stry. %t provides insights on profitability. Th"s, it s"pports decisions abo"t entry to or e+it from and ind"stry or a market segment. Moreover, the model can be "sed to compare the impact of competitive forces on the own organi$ation with their impact on competitors. Competitors may have different options to react to changes in competitive forces from their different reso"rces and competences. This may infl"ence the str"ct"re of the whole ind"stry.

+&namical )nal&sis* %n combination with a PEST3#nalysis, which reveals drivers for change in an ind"stry, Five Forces #nalysis can reveal insights abo"t the potential f"t"re attractiveness of the ind"stry. E+pected political, economical, socio3 demographical and technological changes can infl"ence the five competitive forces and th"s have impact on ind"stry str"ct"res. 4sef"l tools to determine potential changes of competitive forces are scenarios.

)nal&sis of ,ptions* 5ith the knowledge abo"t intensity and power of competitive forces, organi$ations can develop options to infl"ence them in a way that improves their own competitive position. The res"lt co"ld be a new strategic direction, e.g. a new positioning, differentiation for competitive prod"cts of strategic partnerships 0see section 61.

Th"s, Porters model of Five Competitive Forces allows a systematic and str"ct"red analysis of market str"ct"re and competitive sit"ation. The model can be applied to partic"lar companies, market segments, ind"stries or regions. Therefore, it is necessary to determine the scope of the market to be analy$ed in a first step. Following, all relevant forces for this market are identified and analy$ed. 2ence, it is not necessary to analy$e all elements of all competitive forces with the same depth. The Five Forces Model is based on microeconomics. %t takes into acco"nt s"pply and demand, complementary prod"cts and s"bstit"tes, the relationship between vol"me of prod"ction and cost of prod"ction, and market str"ct"res like monopoly, oligopoly or perfect competition.

Influencing the Power of Five Forces

#fter the analysis of c"rrent and potential f"t"re state of the five competitive forces, managers can search for options to infl"ence these forces in their organi$ation7s interest. #ltho"gh ind"stry3specific b"siness models will limit options, the own strategy can change the impact of competitive forces on the organi$ation. The ob-ective is to red"ce the power of competitive forces. The following fig"re provides some e+amples. They are of general nat"re. 2ence, they have to be ad-"sted to each organi$ation7s specific sit"ation. The options of an organi$ation are determined not only by the e+ternal market environment, b"t also by its own internal reso"rces, competences and ob-ectives.

6.'

8ed"cing the .argaining Power of S"ppliers Partnering Suppl& chain management Suppl& chain training Increase dependenc& Build +nowledge of supplier costs and methods Ta+e over a supplier 8ed"cing the Treat of ;ew Entrants Increase minimum efficient scales of operations Create a mar+eting 5 #rand image -lo&alt& as a #arrier. Patents, protection of intellectual propert& )lliances with lin+ed products 5 services Tie up with suppliers Tie up with distri#utors %etaliation tactics 8ed"cing the Competitive 8ivalry between E+isting Players )void price competition 2ifferentiate &our product Bu& out competition %educe industr& over/capacit& Focus on different segments Communicate with competitors

6.9

8ed"cing the .argaining Power of C"stomers Partnering Suppl& chain management Increase lo&alt& Increase incentives and value added 4ove purchase decision awa& from price Cut put powerful intermediaries -go directl& to customer. 8ed"cing the Threat of S"bstit"tes 3egal actions Increase switching costs )lliances Customer surve&s to learn a#out their preferences !nter su#stitute mar+et and influence from within )ccentuate differences -real or perceived.

6.:

6.6

6.<

Criti-ue

Porter7s model of Five Competitive Forces has been s"b-ect of m"ch criti!"e. %ts main weakness res"lts from the historical conte+t in which it was developed. %n the early eighties, cyclical growth characteri$ed the global economy. Th"s, primary corporate ob-ectives consisted of profitability and s"rvival. # ma-or prere!"isite for achieving these ob-ectives has been optimi$ation of strategy in relation to the e+ternal environment. #t that time, development in most ind"stries has been fairly stable and predictable, compared with today7s dynamics. %n general, the meaningf"lness of this model is red"ced by the following factors In the economic sense, the model assumes a classic perfect mar+et. The more an industr& is regulated, the less meaningful insights the model can deliver. The model is #est applica#le for anal&sis of simple mar+et structures. ) comprehensive description and anal&sis of all five forces gets ver& difficult in comple' industries with multiple interrelations, product groups, #&/products and segments. ) too narrow focus on particular segments of such industries, however, #ears the ris+ of missing important elements. The model assumes relativel& static mar+et structures. This is hardl& the case in toda&6s d&namic mar+ets. Technological #rea+throughs and d&namic mar+et entrants from start/ups or other industries ma& completel& change #usiness models, entr& #arriers and relationships along the suppl& chain within short times. The Five Forces model ma& have some use for later anal&sis of the new situation7 #ut it will hardl& provide much meaningful advice for preventive actions. The model is #ased on the idea of competition. It assumes that companies tr& to achieve competitive advantages over other pla&ers in the mar+ets as well as over suppliers or customers. 8ith this focus, it dos not reall& ta+e into consideration strategies li+e strategic alliances, electronic lin+ing of information s&stems of all companies along a value chain, virtual enterprise/networ+s or others. =verall, Porters Five Forces Model has some ma-or limitations in today7s market environment. %t is not able to take into acco"nt new b"siness models and the dynamics of markets. The val"e of Porters model is more that it enables managers to think abo"t the c"rrent sit"ation of their ind"stry in a str"ct"red, easy3to3"nderstand way > as a starting point for f"rther analysis.

Porter9s Five Forces

A MODEL FOR INDUSTRY ANALYSIS The model of pure competition implies that ris+/ad:usted rates of return should #e constant across firms and industries. 1owever, numerous economic studies have affirmed that different industries can sustain different levels of profita#ilit&7 part of this difference is e'plained #& industr& structure. 4ichael Porter provided a framewor+ that models an industr& as #eing influenced #& five forces. The strategic #usiness manager see+ing to develop an edge over rival firms can use this model to #etter understand the industr& conte't in which the firm operates.

Diagram of Porter's 5 Forces

SUPPLIER POWER
Supplier concentration Importance of volume to supplier 2ifferentiation of inputs Impact of inputs on cost or differentiation Switching costs of firms in the industr& Presence of su#stitute inputs Threat of forward integration Cost relative to total purchases in industr&

BARRIERS TO ENTRY
)#solute cost advantages Proprietar& learning curve )ccess to inputs ;overnment polic& !conomies of scale Capital re*uirements Brand identit& Switching costs )ccess to distri#ution !'pected retaliation Proprietar& products

T REAT OF SUBSTITUTES
/Switching costs /Bu&er inclination to su#stitute /Price/performance trade/off of su#stitutes

BUYER POWER
Bargaining leverage Bu&er volume Bu&er information Brand identit& Price sensitivit& Threat of #ac+ward integration Product differentiation Bu&er concentration vs. industr& Su#stitutes availa#le Bu&ers9 incentives

DE!REE OF RI"ALRY /!'it #arriers /Industr& concentration /Fi'ed costs5<alue added /Industr& growth /Intermittent overcapacit& /Product differences /Switching costs /Brand identit& /2iversit& of rivals /Corporate sta+es

I# Ri$a%r& In the traditional economic model, competition among rival firms drives profits to 0ero. But competition is not perfect and firms are not unsophisticated passive price ta+ers. %ather, firms strive for a competitive advantage over their rivals. The intensit& of rivalr& among firms varies across industries, and strategic anal&sts are interested in these differences. !conomists measure rivalr& #& indicators of industr& concentration. The Concentration %atio -C%. is one such measure. The Bureau of Census periodicall& reports the C% for ma:or Standard Industrial Classifications -SIC9s.. The C% indicates the percent of mar+et share held #& the four largest firms -C%9s for the largest =, 2$, and $> firms in an industr& also are availa#le.. ) high concentration ratio indicates that a high concentration of mar+et share is held #& the largest firms / the industr& is concentrated. 8ith onl& a few firms holding a large mar+et share, the competitive landscape is less competitive -closer to a monopol&.. ) low concentration ratio indicates that the industr& is characteri0ed #& man& rivals, none of which has a significant mar+et share. These fragmented mar+ets are said to #e competitive. The concentration ratio is not the onl& availa#le measure7 the trend is to define industries in terms that conve& more information than distri#ution of mar+et share. If rivalr& among firms in an industr& is low, the industr& is considered to #e disciplined. This discipline ma& result from the industr&9s histor& of competition, the role of a leading firm, or informal compliance with a generall& understood code of conduct. !'plicit collusion generall& is illegal and not an option7 in low/rivalr& industries competitive moves must #e constrained informall&. 1owever, a maveric+ firm see+ing a competitive advantage can displace the otherwise disciplined mar+et. 8hen a rival acts in a wa& that elicits a counter/response #& other firms, rivalr& intensifies. The intensit& of rivalr& commonl& is referred to as #eing cutthroat, intense, moderate, or wea+, #ased on the firms9 aggressiveness in attempting to gain an advantage. In pursuing an advantage over its rivals, a firm can choose from several competitive moves?

Changing prices / raising or lowering prices to gain a temporar& advantage. Improving product differentiation / improving features, implementing innovations in the manufacturing process and in the product itself. Creativel& using channels of distri#ution / using vertical integration or using a distri#ution channel that is novel to the industr&. For e'ample, with high/end :ewelr& stores reluctant to carr& its watches, Time' moved into drugstores and other non/traditional outlets and cornered the low to mid/price watch mar+et. !'ploiting relationships with suppliers / for e'ample, from the 1@$>9s to the 1@A>9s Sears, %oe#uc+ and Co. dominated the retail household appliance mar+et. Sears set high *ualit& standards and re*uired suppliers to meet its demands for product specifications and price.

The intensit& of rivalr& is influenced #& the following industr& characteristics? 1. A %arger '(m)er of firms increases rivalr& #ecause more firms must compete for the same customers and resources. The rivalr& intensifies if the firms have similar mar+et share, leading to a struggle for mar+et leadership. 2. S%o* mar+et gro*t, causes firms to fight for mar+et share. In a growing mar+et, firms are a#le to improve revenues simpl& #ecause of the e'panding mar+et. 3. ig, fi-e. costs result in an econom& of scale effect that increases rivalr&. 8hen total costs are mostl& fi'ed costs, the firm must produce near capacit& to attain the lowest unit costs. Since the firm must sell this large *uantit& of product, high levels of production lead to a fight for mar+et share and results in increased rivalr&. ig, storage costs or ,ig,%& /eris,a)%e /ro.(cts cause a producer to sell goods as soon as possi#le. If other producers are attempting to unload at the same time, competition for customers intensifies.

".

$. Lo* s*itc,i'g costs increases rivalr&. 8hen a customer can freel& switch from one product to another there is a greater struggle to capture customers. B. Lo* %e$e%s of /ro.(ct .iffere'tiatio' is associated with higher levels of rivalr&. Brand identification, on the other hand, tends to constrain rivalr&. A. Strategic sta+es are ,ig, when a firm is losing mar+et position or has potential for great gains. This intensifies rivalr&. =. ig, e-it )arriers place a high cost on a#andoning the product. The firm must compete. 1igh e'it #arriers cause a firm to remain in an industr&, even when the venture is not profita#le. ) common e'it #arrier is asset specificit&. 8hen the plant and e*uipment re*uired for manufacturing a product is highl& speciali0ed, these assets cannot easil& #e sold to other #u&ers in another industr&. 3itton Industries9 ac*uisition of Ingalls Ship#uilding facilities illustrates this concept. 3itton was successful in the 1@B>9s with its contracts to #uild av& ships. But when the <ietnam war ended, defense spending declined and 3itton saw a sudden decline in its earnings. )s the firm restructured, divesting from the ship#uilding plant was not feasi#le since such a large and highl& speciali0ed investment could not #e sold easil&, and 3itton was forced to sta& in a declining ship#uilding mar+et.

@. A .i$ersit& of ri$a%s with different cultures, histories, and philosophies ma+e an industr& unsta#le. There is greater possi#ilit& for maveric+s and for mis:udging rival9s moves. %ivalr& is volatile and can #e intense. The hospital industr&, for e'ample, is populated #& hospitals that historicall& are communit& or charita#le institutions, #& hospitals that are associated with religious organi0ations or universities, and #& hospitals that are for/profit enterprises. This mi' of philosophies a#out mission has lead occasionall& to fierce local struggles #& hospitals over who will get e'pensive diagnostic and therapeutic

services. )t other times, local hospitals are highl& cooperative with one another on issues such as communit& disaster planning. 1>. I'.(str& S,a+eo(t# ) growing mar+et and the potential for high profits induces new firms to enter a mar+et and incum#ent firms to increase production. ) point is reached where the industr& #ecomes crowded with competitors, and demand cannot support the new entrants and the resulting increased suppl&. The industr& ma& #ecome crowded if its growth rate slows and the mar+et #ecomes saturated, creating a situation of e'cess capacit& with too man& goods chasing too few #u&ers. ) sha+eout ensues, with intense competition, price wars, and compan& failures. BC; founder Bruce 1enderson generali0ed this o#servation as the %ule of Three and Four? a sta#le mar+et will not have more than three significant competitors, and the largest competitor will have no more than four times the mar+et share of the smallest. If this rule is true, it implies that?
o o o o o

If there is a larger num#er of competitors, a sha+eout is inevita#le Surviving rivals will have to grow faster than the mar+et !ventual losers will have a negative cash flow if the& attempt to grow )ll e'cept the two largest rivals will #e losers The definition of what constitutes the Cmar+etC is strategicall& important.

8hatever the merits of this rule for sta#le mar+ets, it is clear that mar+et sta#ilit& and changes in suppl& and demand affect rivalr&. C&clical demand tends to create cutthroat competition. This is true in the disposa#le diaper industr& in which demand fluctuates with #irth rates, and in the greeting card industr& in which there are more predicta#le #usiness c&cles.

II# T,reat Of S()stit(tes In Porter9s model, su#stitute products refer to products in other industries. To the economist, a threat of su#stitutes e'ists when a product9s demand is affected #& the price change of a su#stitute product. ) product9s price elasticit& is affected #& su#stitute products / as more su#stitutes #ecome availa#le, the demand #ecomes more elastic since customers have more alternatives. ) close su#stitute product constrains the a#ilit& of firms in an industr& to raise prices. The competition engendered #& a Threat of Su#stitute comes from products outside the industr&. The price of aluminum #everage cans is constrained #& the price of glass #ottles, steel cans, and plastic containers. These containers are su#stitutes, &et the& are not rivals in the aluminum can industr&. To the manufacturer of automo#ile tires, tire retreads are a su#stitute. Toda&, new tires are not so e'pensive that car owners give much consideration to retreading old tires. But in the truc+ing industr& new tires are e'pensive and tires must #e replaced often. In the truc+ tire mar+et, retreading remains a via#le su#stitute industr&. In the disposa#le diaper industr&, cloth diapers are a su#stitute and their prices constrain the price of disposa#les. 8hile the treat of su#stitutes t&picall& impacts an industr& through price competition, there can #e other concerns in assessing the threat of su#stitutes. Consider the su#stituta#ilit& of different t&pes of T< transmission? local station transmission to home T< antennas via the airwa&s versus transmission via ca#le, satellite, and telephone lines. The new technologies availa#le and the changing structure of the entertainment media are contri#uting to competition among these su#stitute means of connecting the home to entertainment. !'cept in remote areas it is unli+el& that ca#le T< could compete with free T< from an aerial without the greater diversit& of entertainment that it affords the customer.

III# B(&er Po*er The power of #u&ers is the impact that customers have on a producing industr&. In general, when #u&er power is strong, the relationship to the producing industr& is near to what an economist terms a mo'o/so'& / a mar+et in which there are man& suppliers and one #u&er. (nder such mar+et conditions, the #u&er sets the price. In realit& few pure monopsonies e'ist, #ut fre*uentl& there is some as&mmetr& #etween a producing industr& and #u&ers. The following ta#les outline some factors that determine #u&er power. Bu&ers are Powerful if*
."yers are concentrated 3 there are a few b"yers with significant market share ."yers p"rchase a significant proportion of o"tp"t 3 distrib"tion of p"rchases or if the prod"ct is standardi$ed ."yers possess a credible backward integration threat 3 can threaten to b"y prod"cing firm or rival

"'ample
?=? p"rchases from defense contractors Circ"it City and Sears/ large retail market provides power over appliance man"fact"rers @arge a"to man"fact"rers/ p"rchases of tires

Bu&ers are .ea/ if*

Prod"cers threaten forward integration 3 prod"cer can take over own distrib"tionAretailing Significant b"yer switching costs 3 prod"cts not standardi$ed and b"yer cannot easily switch to another prod"ct ."yers are fragmented 0many, different1 3 no b"yer has any partic"lar infl"ence on prod"ct or price Prod"cers s"pply critical portions of b"yers/ inp"t 3 distrib"tion of p"rchases

"'ample
Movie3prod"cing companies have integrated forward to ac!"ire theaters %.M/s :B* system strategy in the '(B*/s

Most cons"mer prod"cts %ntel/s relationship with PC man"fact"rers

I"# S(//%ier Po*er ) producing industr& re*uires raw materials / la#or, components, and other supplies. This re*uirement leads to #u&er/supplier relationships #etween the industr& and the firms that provide it the raw materials used to create products. Suppliers, if powerful, can e'ert an influence on the producing industr&, such as selling raw materials at a high price to capture some of the industr&9s profits. The following ta#les outline some factors that determine supplier power.

Suppliers are Powerful if*

Credible forward integration threat by s"ppliers S"ppliers concentrated Significant cost to switch s"ppliers C"stomers Powerf"l

"'ample
.a+ter %nternational, man"fact"rer of hospital s"pplies, ac!"ired #merican 2ospital S"pply, a distrib"tor ?r"g ind"stry/s relationship to hospitals Microsoft/s relationship with PC man"fact"rers .oycott of grocery stores selling non3"nion picked grapes

Suppliers are .ea/ if*

Many competitive s"ppliers 3 prod"ct is standardi$ed P"rchase commodity prod"cts Credible backward integration threat by p"rchasers Concentrated p"rchasers C"stomers 5eak

"'ample
Tire ind"stry relationship to a"tomobile man"fact"rers Crocery store brand label prod"cts Timber prod"cers relationship to paper companies Carment ind"stry relationship to ma-or department stores Travel agents/ relationship to airlines

"# Barriers to E'tr& 0 T,reat of E'tr& It is not onl& incum#ent rivals that pose a threat to firms in an industr&7 the possi#ilit& that new firms ma& enter the industr& also affects competition. In theor&, an& firm should #e a#le to enter and e'it a mar+et, and if free entr& and e'it e'ists, then profits alwa&s should #e nominal. In realit&, however, industries possess characteristics that protect the high profit levels of firms in the mar+et and inhi#it additional rivals from entering the mar+et. These are barriers to entry. Barriers to entr& are more than the normal e*uili#rium ad:ustments that mar+ets t&picall& ma+e. For e'ample, when industr& profits increase, we would e'pect additional firms to enter the mar+et to ta+e advantage of the high profit levels, over time driving down profits for all firms in the industr&. 8hen profits decrease, we would e'pect some firms to e'it the mar+et thus restoring a mar+et e*uili#rium. Falling prices, or the e'pectation that future prices will fall, deters rivals from entering a mar+et. Firms also ma& #e reluctant to enter mar+ets that are e'tremel& uncertain, especiall& if entering involves e'pensive start/up costs. These are normal accommodations to mar+et conditions. But if firms individuall& -collective action would #e illegal collusion. +eep prices artificiall& low as a strateg& to prevent potential entrants from entering the mar+et, such e'tr&1.eterri'g /rici'g esta#lishes a #arrier. Barriers to entr& are uni*ue industr& characteristics that define the industr&. Barriers reduce the rate of entr& of new firms, thus maintaining a level of profits for those alread& in the industr&. From a strategic perspective, #arriers can #e created or e'ploited to enhance a firm9s competitive advantage. Barriers to entr& arise from several sources? 1. !o$er'me't creates )arriers# )lthough the principal role of the government in a mar+et is to preserve competition through anti/trust actions, government also restricts competition through the granting of monopolies and through regulation. Industries such as utilities are considered natural monopolies #ecause it has #een more efficient to have one electric compan& provide power to a localit& than to permit man& electric companies to compete in a local mar+et. To restrain utilities from e'ploiting this advantage, government permits a monopol&, #ut regulates the industr&. Illustrative of this +ind of #arrier to entr& is the local ca#le compan&. The franchise to a ca#le provider ma& #e granted #& competitive #idding, #ut once the franchise is awarded #& a communit& a monopol& is created. 3ocal governments were not effective in monitoring price gouging #& ca#le operators, so the federal government has enacted legislation to review and restrict prices. The regulator& authorit& of the government in restricting competition is historicall& evident in the #an+ing industr&. (ntil the 1@A>9s, the mar+ets that #an+s could enter were limited #& state governments. )s a result, most #an+s were local commercial and retail #an+ing facilities. Ban+s competed through strategies that emphasi0ed simple mar+eting devices such as awarding toasters to new customers for opening a chec+ing account. 8hen #an+s were deregulated, #an+s were permitted to cross state #oundaries and e'pand their

mar+ets. 2eregulation of #an+s intensified rivalr& and created uncertaint& for #an+s as the& attempted to maintain mar+et share. In the late 1@A>9s, the strateg& of #an+s shifted from simple mar+eting tactics to mergers and geographic e'pansion as rivals attempted to e'pand mar+ets. 2. Pate'ts a'. /ro/rietar& +'o*%e.ge ser$e to restrict e'tr& i'to a' i'.(str&# Ideas and +nowledge that provide competitive advantages are treated as private propert& when patented, preventing others from using the +nowledge and thus creating a #arrier to entr&. !dwin 3and introduced the Polaroid camera in 1@"A and held a monopol& in the instant photograph& industr&. In 1@A$, Doda+ attempted to enter the instant camera mar+et and sold a compara#le camera. Polaroid sued for patent infringement and won, +eeping Doda+ out of the instant camera industr&. 3. Asset s/ecificit& i',i)its e'tr& i'to a' i'.(str&# )sset specificit& is the e'tent to which the firm9s assets can #e utili0ed to produce a different product. 8hen an industr& re*uires highl& speciali0ed technolog& or plants and e*uipment, potential entrants are reluctant to commit to ac*uiring speciali0ed assets that cannot #e sold or converted into other uses if the venture fails. )sset specificit& provides a #arrier to entr& for two reasons? First, when firms alread& hold speciali0ed assets the& fiercel& resist efforts #& others from ta+ing their mar+et share. ew entrants can anticipate aggressive rivalr&. For e'ample, Doda+ had much capital invested in its photographic e*uipment #usiness and aggressivel& resisted efforts #& Fu:i to intrude in its mar+et. These assets are #oth large and industr& specific. The second reason is that potential entrants are reluctant to ma+e investments in highl& speciali0ed assets. ". Orga'i2atio'a% 3I'ter'a%4 Eco'omies of Sca%e# The most cost efficient level of production is termed Mi'im(m Efficie't Sca%e -4!S.. This is the point at which unit costs for production are at minimum / i.e., the most cost efficient level of production. If 4!S for firms in an industr& is +nown, then we can determine the amount of mar+et share necessar& for low cost entr& or cost parit& with rivals. For e'ample, in long distance communications roughl& 1>E of the mar+et is necessar& for 4!S. If sales for a long distance operator fail to reach 1>E of the mar+et, the firm is not competitive. The e'istence of such an econom& of scale creates a #arrier to entr&. The greater the difference #etween industr& 4!S and entr& unit costs, the greater the #arrier to entr&. So industries with high 4!S deter entr& of small, start/up #usinesses. To operate at less than 4!S there must #e a consideration that permits the firm to sell at a premium price / such as product differentiation or local monopol&. Barriers to e'it wor+ similarl& to #arriers to entr&. !'it #arriers limit the a#ilit& of a firm to leave the mar+et and can e'acer#ate rivalr& / una#le to leave the industr&, a firm must compete. Some of an industr&9s entr& and e'it #arriers can #e summari0ed as follows?

"as& to "nter if there is*

+ifficult to "nter if there is*

Common technology @ittle brand franchise #ccess to distrib"tion channels @ow scale threshold

Patented or proprietary know3how ?iffic"lty in brand switching 8estricted distrib"tion channels 2igh scale threshold

"as& to "'it if there are*

+ifficult to "'it if there are*

Salable assets @ow e+it costs %ndependent b"sinesses

Speciali$ed assets 2igh e+it costs %nterrelated b"sinesses

DYNAMI5 NATURE OF INDUSTRY RI"ALRY Fur descriptive and anal&tic models of industr& tend to e'amine the industr& at a given state. The nature and fascination of #usiness is that it is not static. 8hile we are prone to generali0e, for e'ample, list ;4, Ford, and Chr&sler as the CBig 3C and assume their dominance, we also have seen the automo#ile industr& change. Currentl&, the entertainment and communications industries are in flu'. Phone companies, computer firms, and entertainment are merging and forming strategic alliances that re/map the information terrain. Schumpeter and, more recentl&, Porter have attempted to move the understanding of industr& competition from a static economic or industr& organi0ation model to an emphasis on the interdependence of forces as d&namic, or punctuated equilibrium, as Porter terms it. In Schumpeter9s and Porter9s view the d&namism of mar+ets is driven #& innovation. 8e can envision these forces at wor+ as we e'amine the following changes? To/ 67 US I'.(stria% Firms )& Sa%es 6869 1 68:: 1011 ' 4S Steel 9 Swift : #rmo"r < Standard =il 3;D B .ethlehem Steel E Ford ) ?"Pont ( #merican S"gar 10#5
4S Steel Ford

1022
E++on

103
Ceneral Motors Ford

1033
Ceneral Motors

Ceneral Motors Ceneral Motors

Standard =il 3;D Standard =il 3;D 0E++on1 Mobil Ceneral Electric Te+aco Ford %.M Socal 0=il1 ?"Pont C"lf =il

E++on %.M Ceneral Electric Mobil Chrysler Te+aco ?"Pont

6 #merican Smelting 4S Steel

Swift #rmo"r C"rtiss35right Chrysler

.ethlehem Steel Chrysler Mobil Te+aco 4S Steel %.M

'* Ceneral Electric

Ford

C"lf =il

Standard =il of %ndiana Philip Morris

67 Largest US Firms )& Assets; 6878 a'. 68:9 1040 ' 4S STEE@ 9 ST#;?#8? =%@, ;D 0;ow, EFF=; G:1 : #ME8%C#; T=.#CC= 0;ow, #merican .rands G<91 6 Jidde, %nc., '(B(I sold to Mc@ean %nd"stries, '(E)I bankr"ptcy, '()B < e!"ipment
#ME8%C#; ME8C#;T%@E M#8%;E 08enamed 4S @inesI ac!"ired by %;TE8;#T%=;#@ 2#8KESTE8 08enamed ;avistar G')91I divested farm

1031
CM 0;ot listed in '(*(1 SE#8S 0'(*( H 6<1 EFF=; 0Standard =il tr"st broken "p in '(''1 %.M 08anked B), '(6)1 F=8? 0@isted in '('(1 M=.%@ =%@ CE;E8#@ E@ECT8%C 0'(*(H 'B1

B #;#C=;?# C=PPE8 0ac!"ired by #8C= in '(EE1 E 4S @E#T2E8 0@i!"idated in '(:<1 ) sold to Con#gra1

#8M=48 0Merged in '(B) with Ceneral 2ostI in '(B( by Creyho"ndI '(): C2EK8=; 0;ot listed in '(*(1 #ME8%C#; S4C#8 8EF%;%;C 08enamed #MST#8. %n '(BE H:9*1 P4@@M#;, %;C 0#c!"ired by 5heelabrator Frye, '()*I sp"n3off as TEF#C= 0'(*(H ('1 ?4 P=;T 0'(*(H 9(1

( @everaged b"yo"t and sold in pieces1

'* P"llman3Peabody, '()'I '()6 sold to Trinity %nd"stries1

!ENERI5 STRATE!IES TO 5OUNTER T E FI"E FOR5ES Strateg& can #e formulated on three levels?

corporate level #usiness unit level functional or departmental level.

The #usiness unit level is the primar& conte't of industr& rivalr&. 4ichael Porter identified three generic strategies -cost leadership, differentiation, and focus. that can #e implemented at the #usiness unit level to create a competitive advantage. The proper generic strateg& will position the firm to leverage its strengths and defend against the adverse effects of the five forces. Recomme'.e. Rea.i'g
Porter, 4ichael !., Competitive Strategy: Techniques for Analyzing Industries and Competitors Competitive Strategy is the #asis for much of modern #usiness strateg&. In this classic wor+, 4ichael Porter presents his five forces and generic strategies, then discusses how to recogni0e and act on mar+et signals and how to forecast the evolution of industr& structure. 1e then discusses competitive strateg& for emerging, mature, declining, and fragmented industries. The last part of the #oo+ covers

strategic decisions related to vertical integration, capacit& e'pansion, and entr& into an industr&. The #oo+ concludes with an appendi' on how to conduct an industr& anal&sis.

<DRO=

http?55www.#usiness#alls.com5portersfiveforcesofcompetition.htm
The use this material is free provided cop&right -)lan Chapman 2>>1/$ #ased on 4ichael Porter9s Five Forces of Competition theor&. is ac+nowledged and reference or lin+ is made to the www.#usiness#alls.com we#site. This material ma& not #e sold, or pu#lished in an& form. 2isclaimer? %eliance on information, material, advice, or other lin+ed or recommended resources, received from )lan Chapman, shall #e at &our sole ris+, and )lan Chapman assumes no responsi#ilit& for an& errors, omissions, or damages arising. (sers of this we#site are encouraged to confirm information received with other sources, and to see+ local *ualified advice if em#ar+ing on an& actions that could carr& personal or organi0ational lia#ilities. 4anaging people and relationships are sensitive activities7 the free material and advice availa#le via this we#site do not provide all necessar& safeguards and chec+s. Please retain this notice on all copies.

L alan chapman 9**'3<

/orter's fi$e forces mo.e%

Mic,ae% E Porter's fi$e forces of com/etiti$e /ositio' mo.e% a'. .iagrams 4ichael Porter9s famous Five Forces of Competitive Position model provides a simple perspective for assessing and anal&sing the competitive strength and position of a corporation or #usiness organi0ation. ) free Five Forces diagram in 4S8ord is availa#le here. -Porter9s Five Forces diagram pdf here.. )merican 4ichael Porter was #orn in 1@"A. )fter initiall& graduating in aeronautical engineering, Porter achieved an economics doctorate at 1arvard, where he was su#se*uentl& awarded universit& professorship, a position he continues to fulfil at 1arvard Business School. 1is research group is #ased at the 1arvard Business School, and separatel& he co/founded with 4ar+ Dramer the Foundation Strateg& ;roup, 9a mission/driven social enterprise, dedicated to advancing the practice of philanthrop& and corporate social investment, through consulting to foundations and corporations9. ) prime e'ample of someone operating at a self/actuali0ation level if ever there was one.

)fter his earlier wor+ on corporate strateg& Porter e'tended the application of his ideas and theories to international economies and the competitive positioning of

nations, as featured in his later #oo+s. In fact in 1@=$ Porter was appointed to President %onald %eagan9s Commission on Industrial Competitiveness, which mar+ed the widening of his perspective to national economies. B& the 1@@>9s Porter had esta#lished a reputation as a strateg& guru on the international spea+ing circuit second onl& to Tom Peters, and was among the world9s highest earning academics. Porter9s first #oo+ Competitive Strateg& -1@=>., which he wrote in his thirties, #ecame an international #est seller, and is considered #& man& to #e a seminal and definitive wor+ on corporate strateg&. The #oo+, which has #een pu#lished in nineteen languages and re/printed approaching si't& times, changed the wa& #usiness leaders thought and remains a guide of choice for strategic managers the world over. )side from his innovative thin+ing, Porter has a special a#ilit& to represent comple' concepts in relativel& easil& accessi#le formats, nota#l& his Five Forces model, in which mar+et factors can #e anal&sed so as to ma+e a strategic assessment of the competitive position of a given supplier in a given mar+et. The five forces that Porter suggests drive competition are?

/orter's fi$e forces

'. 9. :. 6. <. E-isti'g com/etiti$e ri$a%r& )et*ee' s(//%iers T,reat of 'e* mar+et e'tra'ts Bargai'i'g /o*er of )(&ers Po*er of s(//%iers T,reat of s()stit(te /ro.(cts 3i'c%(.i'g tec,'o%og& c,a'ge4

T&picall& this five forces model is shown as a series of five #o'es in a cross formation, item 1 #eing central. -Pdf diagram here, 4S8ord diagram here.. Porter9s Five Forces model can #e used to good anal&tical effect alongside other models such as the S8FT and P!ST anal&sis tools. Porter9s Five Forces model provides suggested points under each main heading, #& which &ou can develop a #road and sophisticated anal&sis of competitive position, as might #e used when creating strateg&, plans, or ma+ing investment decisions a#out a #usiness or organi0ation. Porter is also +nown for his simple identification of five generic descriptions of industries? '. 9. :. 6. <. Fragme'te. -eg, shoe repairs, gift shops. Emergi'g -eg, space travel. Mat(re -eg, automotive. Dec%i'i'g -eg, solid fuels. !%o)a% -eg, micro/processors.

)nd Porter is also particularl& recognised for his competitive 9diamond9 model, used for assessing relative competitive strength of nations, and #& implication their industries?

'. Factor 5o'.itio's> production factors re*uired for a given industr&, eg., s+illed la#our, logistics and infrastructure. 9. Dema'. 5o'.itio's> e'tent and nature of demand within the nation concerned for the product or service. :. Re%ate. I'.(stries> the e'istence, e'tent and international competitive strength of other industries in the nation concerned that support or assist the industr& in *uestion. 6. 5or/orate Strateg&; Str(ct(re a'. Ri$a%r&> the conditions in the home mar+et that affect how corporations are created, managed and grown7 the idea #eing that firms that have to fight hard in their home mar+et are more li+el& to #e a#le to succeed in international mar+ets. 4ichael Porter9s +e& #oo+s? Competitive Strateg&? Techni*ues for )nal&0ing Industries and Competitors, 1@=> Competitive )dvantage? Creating and Sustaining Superior Performance, 1@=$ Competition in ;lo#al Industries, 1@=B The Competitive )dvantage of ations, 1@@> See also? S8FT anal&sis template P!ST anal&sis template #usiness and mar+eting planning process and templates