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Porter's Five Forces

Porter's Five Forces

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05/13/2014

1 Name: Course: Instructor: Date: Analysis of Porter’s Five Forces of Competition Porter’s five forces analysis model, attributed

to Michael Porter, is one of the most comprehensive industry analysis models. The model was designed in 1979 and offers an ideal alternative to the narrow and ad hoc SWOT analysis models. The new model, Porter’s, incorporate five forces that firms in the same industry take into consideration when formulating and implementing strategies. Three of the five forces are considered to be external or horizontal forces while the other two are said to be internal or vertical threats. The three external forces include threat of new entrants, threat of substitutes, and the extent or degree of rivalry among and between existing firms. The two internal or vertical threats that firms in the same industry face include bargaining power of buyers and bargaining power of suppliers (Hill 3). Although the five forces determine the attractiveness or profitability of an industry, firms in the same industry do not make average profits. Some firms do better than others because they effectively implement other unique models and take advantage of their core competencies (Roy 66). One of the vertical forces that firms consider in their decision making processes is the threat of new entrants. Ordinarily, new entrants increase competition in markets thus making an industry less attractive. Whether new entrants enter an industry is determined by barriers of entry. Industries like ship and airplanes manufacture are known to have high barriers of entry due to the costs and risks associated with setting up these firms (Roy 78). Restaurants and retailing, on the other hand, are classic examples of industries with low entry barriers. Key entry barriers

2 universally shared by industries include capital investments required to set up a firm, resource ownership or patent rights, customer switching costs, and access to distribution channels. The second force identified by Porter, and which firms have no direct control over, is the threat of substitutes. Typically, presences of a wide variety of products in an industry reduce its profitability. Whether the presence of substitutes becomes a real threat to competing firms depends on consumers’ willingness and ability to switch to substitutes; relative prices of substitutes; and switching costs that consumer are likely to incur once they choose to shift loyalty to other substitutes (Hill 45). Intensity of rivalry among competitors has been identified by Porter as the third external forces that play a critical role in shaping strategies. The intensity of competition or rivalry among firms in the same industry largely depends on three factors. Structure of competition is one of these factors. If there are equally sized firms in the same industry, then there is the likelihood of these firms competing fiercely (Hill 144). If one firm in an industry is a clear market leader, then the fierceness of competitors is likely to be reduced. The other two factors that shape intensity of rivalry include industry cost structures and strategic objectives of major competitors (Hill 158). Besides the three horizontal or external forces that shape strategy, there are two internal forces or threats that have also been incorporated into Porter’s five forces model. The two forces include bargaining power of consumers or buyers and the bargaining power of suppliers. Bargaining power of consumers, or buyers who are responsible for creating demand of a product or service, is determined by several factors. One of these factors is the ratio of buyers to sellers in a specific industry. If there are a few prevailing buyers, then these buyers are likely to have a great bargaining power. Other factors that like presence of standardized products in an industry, threats of buyers to integrate backwards or suppliers threat to integrate forwards increases

3 buyers’ bargaining power. If an industry is not the key supplier to a section of leading buyers, then these buyers are also likely to have an increased bargaining power (Hill 123). Bargaining power of suppliers is the last, but certainly, not the least, force incorporated in Porter’s five forces model. Suppliers refer to individuals and business organizations whose role is to deliver raw materials, or other materials used in the production process, to a firm. Generally, raw materials or any form of materials delivered by suppliers have a significant effect on the total value of costs incurred by a firm (Roy 129). This means that where suppliers have greater bargaining power over that of firms, that industry has reduced profitability. This fact is applicable both in theory and practice. Bargaining power of suppliers in any given industry is determined by several factors, including the ratio of buyers to suppliers, presence or absence of buyers’ threat to integrate backwards into supply, and the presence or absence of undifferentiated products and services (Hill 189). In wrapping up, we note that Porter’s five forces play a critical role in shaping strategies made by firms in all industries. The new analytical model seeks to replace the narrow and ad hoc SWOT analysis model. Three of the five forces identified by Porter, including threat of new entrants, threat of substitutes and intensity of rivalry among competitors, are external forces. Porter, on the other hand, identifies power of buyers and power of suppliers as internally generated threats.

4 References Hill, Charles. Strategic Management Theory: An Integrated Approach. Stamford: Cengage Learning, 2009. Roy, Daniel, Strategic Foresight and Porter’s Five Forces: towards a Synthesis. GRIN Verlag: Munich, 2010.

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