Porter's Five

Forces Analysis
 Components of Business
Environment/ Factors affecting
Business Environment
COMPONENTS OF BUSINESS ENVIRONMENT

Internal Environment External Environment

Financial resources Micro Environment Macro Environment

Physical & human resources
Objectives of business
Economic
Managerial policies Political
Human resources Suppliers
Socio-cultural
Work environment Customers Technological
Brand & Corporate image Market intermediaries Natural
Labor management relations Competitors Demographic
Public International
Porter's five forces analysis:
Meaning
 A framework for industry analysis and business
strategy development developed by Michael E. Porter
of Harvard Business School in 1979
 Five forces which 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 where the
combination of forces acts to drive down overall
profitability
 A very unattractive industry would be one approaching
"pure competition.
Porter's five forces
analysis….
 Porter referred to these forces as the micro
environment, to contrast it with macro environment
 Forces close to a company that affect its ability to
serve its customers and make a profit
 A change in any of the forces requires a company to
re-assess the market
 The overall industry attractiveness does not imply
that every firm in the industry will have same
profitability
 Example :airline industry. As an industry, profitability
is low and yet individual companies, get return in
excess of the industry average
Porter's five forces
analysis….
Porter's five forces include three forces from
'horizontal' competition:
 threat of substitute products

 the threat of established rivals

 threat of new entrants

Two forces from 'vertical' competition:

 bargaining power of suppliers

 bargaining power of customers

Porter's five forces
analysis….
 Five forces model should be used at the
industry level
 Industry is defined as one in which similar or
closely related products and/or services are
sold to buyers
 Firms that compete in a single industry
should develop, at a minimum, one five
forces analysis for its industry
The Five Forces: The threat of
substitute products
The existence of close substitute products increases the propensity of
customers to switch to alternatives in response to price increases (high
elasticity of demand)
 buyer propensity to substitute
 relative price performance of substitutes
 buyer switching costs
 perceived level of product differentiation
 The ability of customers to find a different way of getting what you offer
 If substitution is easy and substitution is viable, then this weakens your
power
The Five Forces: The threat of the
entry of new competitors

 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, profit rate will fall towards a
competitive level (perfect competition)
The Five Forces: The threat
of the entry of new
competitors….


Existence of barriers to entry (patents rights, etc.)
Economies of scale
 Brand equity ( the marketing effects or outcomes that accrue to a
product with its brand name compared with those that would
accrue if the same product did not have the brand name)
 Switching costs or sunk costs ( that cannot be recovered once
they have been incurred )
 Capital requirements
 Access to distribution
 Learning curve advantages
 Expected retaliation by incumbents
 Government policies
Threat of New Entry….
 New competitors can quickly enter your market
and weaken your position
 If:
 it costs little in time or money to enter your
market and compete effectively,
 there are few economies of scale in place,
 you have little protection for your key
technologies,
 If you have strong and durable barriers to entry,
then you can preserve a favorable position
The Five Forces: The intensity of
competitive rivalry/ the threat of
established rivals

 The major determinant of the competitiveness of

the industry.
 Rivals compete:
 by price and
 in non-price dimensions such as innovation,
marketing, etc.
 The Five Forces: The intensity of
competitive rivalry/ the threat of
established rivals….
 Number of competitors
 Rate of industry growth
 Industry overcapacity
 Diversity of competitors
 Fixed cost allocation per value added
 Advertising expense
 Economies of scale
 Sustainable competitive advantage through
improvisation
Competitive Rivalry / the threat of
established rivals…..

 Number and capability of your competitors – if you

have many competitors, and they offer equally
attractive products and services
 If suppliers and buyers don’t get a good deal from
you,
 But if no-one can do what you do, then you can
have strength
The Five Forces: The
bargaining power of
customers
Also described as the market of outputs
The ability of customers to put the firm under pressure
 buyer volume
 buyer switching costs
 buyer information availability
 availability of existing substitute products: elasticity of
demand
 buyer price sensitivity
 differential advantage (uniqueness) of industry products
Buyer Power….

 How easy it is for buyers to drive prices down

 Driven by number of buyers, importance of
each buyer to your business, cost to them of
switching from your products and services to
those of someone else,
 If you deal with few, powerful buyers, they
are often able to dictate terms to you
The Five Forces: The
bargaining power of
suppliers
 Also described as market of inputs
 Suppliers of raw materials, components, labor,
and services (such as expertise) to the firm can
be a source of power over the firm.
 Suppliers may refuse to work with the firm, or
e.g. charge excessively high prices
The Five Forces: The
bargaining power of
suppliers….
 Supplier switching costs relative to firm switching
costs
 Degree of differentiation of inputs
 Presence of substitute inputs
 Cost of inputs relative to selling price of the
product
Supplier Power….

 Here you assess how easy it is for suppliers to

drive up prices
 This is driven by the number of suppliers of each
key input, the uniqueness of their product or
service, their strength and control over you, the
cost of switching from one to another, and so on.
 The fewer the supplier choices you have, and the
more you need suppliers' help, the more powerful
your suppliers are
 Porter's Five Forces Model

Industry competitors

Source: Michael E. Porter Competitive Strategy: Techniques for Analyzing Industries and Competitors, (The Free Press, 1980)
 Porter's Five Forces Model

Industry competitors

Rivalry among
existing firms

Source: Michael E. Porter Competitive Strategy: Techniques for Analyzing Industries and Competitors, (The Free Press, 1980)
 Porter's Five Forces Model

Potential
entrants

Threat of
new entrants

Industry competitors

Rivalry among
existing firms

Source: Michael E. Porter Competitive Strategy: Techniques for Analyzing Industries and Competitors, (The Free Press, 1980)
 Porter's Five Forces Model

Potential
entrants

Threat of
new entrants

Industry competitors

Rivalry among
existing firms

Threat of
substitutes

Substitute
products
Source: Michael E. Porter Competitive Strategy: Techniques for Analyzing Industries and Competitors, (The Free Press, 1980)
 Porter's Five Forces Model

Potential
entrants

Threat of
new entrants

Bargaining power Industry competitors

of suppliers
Suppliers
Rivalry among
existing firms

Threat of
substitutes

Substitute
products
Source: Michael E. Porter Competitive Strategy: Techniques for Analyzing Industries and Competitors, (The Free Press, 1980)
 Porter's Five Forces Model

Potential
entrants

Threat of
new entrants

Bargaining power Industry competitors Bargaining power

of suppliers of buyers
Suppliers Buyers
Rivalry among
existing firms

Threat of
substitutes

Substitute
products
Source: Michael E. Porter Competitive Strategy: Techniques for Analyzing Industries and Competitors, (The Free Press, 1980)
Usefulness
 Simple but powerful tool for understanding where power
lies in a business situation
 It helps you understand both the strength of your current
competitive position, and the strength of a position you're
looking to move into
 An important part of your planning toolkit
 Conventionally, the tool is used to identify whether new
products, services or businesses have potential to be
profitable
 Can be used to understand the balance of power