Porters Five Forces Model

Porters Five Forces

The Five Forces model of Harvard professor Michael E. Porter is an effective tool used to analyze the attractiveness and value of an industry structure. He advocates that a structural analysis of industries be made so that a firm is in a better position to identify its strengths and weaknesses. In comparison with the PESTLE analysis - which deals with factors outside the industry (the macro environment) - the Five Forces model focuses on factors inside the industry (the microenvironment).
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The Role of the Macro and Micro environment

The purpose of Five-Forces Analysis

The five forces are environmental forces that impact on a companys ability to compete in a given market. The purpose of five-forces analysis is to diagnose the principal competitive pressures in a market and assess how strong and important each one is.

Porters Five Forces Model

Threat of New Entrants

Bargaining Power of Suppliers

Rivalry Among Competing Firms in Industry

Bargaining Power of Buyers

Threat of Substitute Products 5

1. The Threat of the entry of new Entrants

Profitable markets that yield high returns will draw firms. This results in many new entrants, which will effectively decrease profitability. Unless the entry of new firms can be blocked by incumbents, the profit rate will fall towards a competitive level New entrants into an industry threaten incumbent companies They have to share the growing market pie with the competitors or part with some of their own market share. The threat of new entrants will depend on 2 factors the entry barriers to the industry and the expected retaliation from the existing firms 6

Threat of New Entrants - Entry barriers reduce the threat of new competition.
Economies of Scale (example FMCG companies)

Barriers to Entry

Product Differentiation (example Mobile phones) Capital Requirements (automobile sector) Switching Costs (CNG) Access to Distribution Channels (Soft
drinks)

Cost Disadvantages Independent of Scale

(favorable location, proprietary products, access to raw material etc)

Government Policy (licensing) Expected Retaliation from incumbent firms the existing firm may lower its price or alter the base of competition 7

The Threat of new entrants

Despite the formidable hurdles posed by existing firms, new firms do enter industries if they find them to be promising. The popular strategy for doing this to find market niches not served by existing firms and to gradually build up their presence in the industry

Threat of Substitute Products

Products with similar function limit the prices firms can charge

The existence of close substitute products increases the propensity of customers to switch to alternatives in response to price increases. Example Tea and coffee can be considered as close substitutes for the market of stimulant drinks. Firms with products which have no close substitutes can charge a higher price and earn more profits

Bargaining power of Suppliers

Any industry requires raw materials components, labor and other supplies. Suppliers too have a level of bargaining power. Suppliers if powerful can exert an influence of the manufacturing industry, such as selling the raw materials at a higher price which eats into the profits of the firms Powerful suppliers are a entry barrier to new firms.

Bargaining Power of Suppliers

Suppliers exert power in the industry by: * Threatening to raise prices or to reduce quality

Supplier industry is dominated by a few firms (drugs suppliers and Hospitals as in case of Tamiflu by Roche) Suppliers products have few substitutes (Microprocessors) Buyer is not an important customer to supplier (Kirana shops to FMCG companies) Suppliers product is an important input to buyers product (Steel to cars) Suppliers products are differentiated (Apple products to retailer)

Powerful suppliers can squeeze industry profitability if firms are unable to recover cost increases

Suppliers products have high switching costs (Microsoft to computers)

Suppliers can vertically integrate forward to compete with buyers and buyers cant integrate backward to supply their own needs (Movie producing companies have integrated forward to acquire theatres)

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Bargaining power of Buyers

The bargaining power of Buyers constitute the ability of the buyers, individually or collectively to force reduction of prices of products, demand a higher quality or seek more value for their purchases. A higher buyer bargaining power constitutes a negative feature for the existing firms and the new entrants

The Bargaining Power of Buyers

Buyers are most powerful when:

Buyers are few in number. Buyers purchase in large quantities. A single buyer is a large customer to a firm. Buyers can switch suppliers at low cost. Buyers purchase from multiple sellers at once. When the purchased product constitutes a high percentage of the buyers cost. Buyers can easily vertically integrate to compete with suppliers (private labels in retail industry) 13

Rivalry Among Established Companies

The intensity of competitive rivalry in an industry arises from:

1. 2.

1.

2.

Industrys competitive structure. Fragmented low entry barriers Consolidated structure Oligopolistic or monopolistic. The intensity of competition may vary from guarded tolerance to fierce rivalry. Demand (growth or decline) conditions in industry. High demand moderate competition Stagnant demand competitive strategies to snatch others business Height of industry exit barriers (Economic, Strategic or emotional).

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Competitive Structure
Continuum of Industry Structures
Fragmented Many small firms, no dominant firm Consolidated One firm or one dominant firm (monopoly)

Few firms, shared dominance (oligopoly)

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Changing industry structures

Amazon, who spotted an opportunity to surpass brick & mortar stores, by becoming a distributor with a web-based store-front. Traditionally, the book-industry was organised as follows. A book gets printed, it then gets distributed, it then lands in a store, and then the customer buys it. Amazon integrated three of these functions: distribution, store, and customers (four, if you include ebooks into the formula). The endresult was that the customer became empowered: he could review books, even sell books second-hand. Which disempowered other stores where this was not possible, and publishers, who were before able to simply push out best-sellers downstream. Publishers are still powerful of course, essentially acting as a gatekeeper to writers, but this will change as soon as online publishing can be consumed comfortably.