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What is Porter's 5 Forces analysis? What are the main aspects of Porter's 5 Forces analysis? How to write Good Porter's 5 Forces analysis of a company? Where to find information for Porter's 5 Forces analysis?
Porter's Five Forces Examples; Reports on Different Companies Introduction There is continuing interest in the study of the forces that impact on an organisation, particularly those that can be harnessed to provide competitive advantage. The ideas and models which emerged during the period from 1979 to the mid-1980s (Porter, 1998) were based on the idea that competitive advantage came from the ability to earn a return on investment that was better than the average for the industry sector (Thurlby, 1998). As Porter's 5 Forces analysis deals with factors outside an industry that influence the nature of competition within it, the forces inside the industry (microenvironment) that influence the way in which firms compete, and so the industry’s likely profitability is conducted in Porter’s five forces model. A business has to understand the dynamics of its industries and markets in order to compete effectively in the marketplace. Porter (1980a) defined the forces which drive competition, contending that the competitive environment is created by the interaction of five different forces acting on a business. In addition to rivalry among existing firms and the threat of new entrants into the market, there are also the forces of supplier power, the power of the buyers, and the threat of substitute products or services. Porter suggested that the intensity of competition is determined by the relative strengths of these forces. Main Aspects of Porter’s Five Forces Analysis The original competitive forces model, as proposed by Porter, identified five forces which would impact on an organization’s behaviour in a competitive market. These include the following:
• • • • •
The rivalry between existing sellers in the market. The power exerted by the customers in the market. The impact of the suppliers on the sellers. The potential threat of new sellers entering the market. The threat of substitute products becoming available in the market.
Understanding the nature of each of these forces gives organizations the necessary insights to enable them to formulate the appropriate strategies to be successful in their market (Thurlby, 1998). Force 1: The Degree of Rivalry The intensity of rivalry, which is the most obvious of the five forces in an industry, helps determine the extent to which the value created by an industry will be dissipated through
and existing power of suppliers and buyers in the market. Generic substitution (Video suppliers compete with travel companies). They can take diverse forms and are used to prevent an influx of firms into an industry whenever profits. • • This force is located at the centre of the diagram. Other factors are the extent to which the buyers are informed and the concentration or differentiation of the . are as follows: • • • • • • Economies of scale: for example. benefits associated with bulk purchasing. It also involves: • • • Product-for-product substitution (email for mail. Substitution that relates to something that people can do without (cigarettes. The most important determinants of buyer power are the size and the concentration of customers. the costs in areas such as retraining. rise above zero. In contrast. retooling and redesigning that are incurred when a customer switches to a different type of product or service. Government legislations: for example. investment into technology. Force 2: The Threat of Entry Both potential and existing competitors influence average industry profitability. contacts and expertise. adjusted for the cost of capital. The threat of new entrants is usually based on the market entry barriers. The most valuable contribution of Porter's “five forces” framework in this issue may be its suggestion that rivalry. Cost of entry: for example. Distribution channels: for example. introduction of new laws might weaken company’s competitive position. is only one of several forces that determine industry attractiveness. Sanderson. while important. a certain brand that cannot be copied (The Champagne) Force 3: The Threat of Substitutes The threat that substitute products pose to an industry's profitability depends on the relative price-to-performance ratios of the different types of products or services to which customers can turn to satisfy the same basic need. 1980b. Force 4: Buyer Power Buyer power is one of the two horizontal forces that influence the appropriation of the value created by an industry (refer to the diagram). The threat of substitution is also affected by switching costs – that is. fax). except intrinsic physical or legal obstacles. Is most likely to be high in those industries where there is a threat of substitute products.head-to-head competition. entry barriers exist whenever it is difficult or not economically feasible for an outsider to replicate the incumbents’ position (Porter. Differentiation: for example. is based on the substitution of need. ease of access for competitors. 1998) The most common forms of entry barriers. Cost advantages not related to the size of the company: for example. alcohol).
and the stronger the threats of entry and substitution. according to this model. The nature of competition in an industry is strongly affected by the suggested five forces. as it is the case with retailers an grocery stores. than in fragmented ones. organizations would be expected to compete less fiercely. Fragmentation of customers (not in clusters) with a limited bargaining power (Gas/Petrol stations in remote places). Despite the fact that the Five Force framework focuses on business concerns . The ability to charge customers different prices in line with differences in the value created for each of those buyers usually indicates that the market is characterized by high supplier power and at the same time by low buyer power (Porter. In concentrated industries. British Airways. large players in the market. and the strength of a position a company is looking to move into. Indeed. Kippenberger (1998) states that it is often useful to distinguish potential buyer power from the buyer's willingness or incentive to use that power. Force 5: Supplier Power Supplier power is a mirror image of the buyer power. However. The stronger the power of buyers and suppliers. High power of brands (McDonalds. and make higher profits. As a result. which in turn determines their profitability (performance). the whole five-forces framework is based on an economic theory know as the “StructureConduct-Performance” (SCP) model: the structure of an industry determines organizations’ competitive behaviour (conduct). Possibility of forward integration of suppliers (Brewers buying bars). the analysis of supplier power typically focuses first on the relative size and concentration of suppliers relative to industry participants and second on the degree of differentiation in the inputs supplied. • • • This force is relatively high where there a few. Low cost of switching between suppliers. How to write a Good Porter's 5 Forces analysis The Porter’s Five Forces model is a simple tool that supports strategic understanding where power lies in a business situation. as Haberberg and Rieple (2001) state. 1998). Present where there is a large number of undifferentiated. willingness that derives mainly from the “risk of failure” associated with a product's use.competitors. such as small farming businesses supplying large grocery companies. Tesco). It also helps to understand both the strength of a firm’s current competitive position. Bargaining power of suppliers exists in the following situations: • • • • Where the switching costs are high (switching from one Internet provider to another). the histories and cultures of the firms in the industry also play a very important role in shaping competitive behaviour. the more intense competition is likely to be within the industry. small suppliers. and the predictions of the SCP model need to be modified accordingly. these five factors are not the only ones that determine how firms in an industry will compete – the structure of the industry itself may play an important role. However. such as from one fleet supplier of trucks to another.
and then check against the factors presented for each force in the diagram above. There may also be the potential threat of new entrants. but. it provides an opportunity to identify the strength of the position and the ability to make a sustained profit in the industry (Mind Tools. for instance. it is required to brainstorm all relevant factors for the company’s market situation. there might be competition from substitute products or services. Are the five forces able to foresee industry expansion? Is it the corporate strategist's goal to find a position in the industry where his or her company can best defend itself against these forces or can influence them in its favour. An example would be plastic bottles. “+” and “-" to represent the forces moderately in company’s favour.rather than public policy. improve weaknesses. it is important to understand the situation and to look at each of the forces individually. and avoid taking wrong steps. or is the goal to become part of the ongoing commerce with the intention to produce innovative ideas that will expand the size of the industry? Is it true that the environment poses a threat to the organisation. and by identifying the strength and direction of each force. it is important to look beyond one’s immediate competitors as there are other determinates of profitability. he contends. One of the critical comments made of the Five Forces framework is its static nature. and cans for packaging soft drinks. The next step is to highlight the key factors on a diagram. it also emphasizes extended competition for value rather than just competition among existing rivals. or does it offer the ground for a constitutive industry player co-operation? By thinking through how each force affects a company. services or businesses have the potential to be profitable. 1998). pricing or advertising. After identifying favourable and unfavourable forces for the company’s performance and industry’s attractiveness. although some competitors will see this as an opportunity to . Porter argues that five forces determine the profitability of an industry. and the simplicity of its application inspired numerous companies as well as business schools to adopt its use (Wheelen and Hunger. it is important to analyse the situation and examine the impacts of the forces. it will enable a company to take fair advantage of its strengths. It is suggested to use relevant signs. Specifically. leading to the consideration of suppliers and buyers as threats that need to be tackled. glass bottles. These alternatives may be perceived as substitutes by buyers even though they are part of a different industry. to apply this planning tool effectively. Therefore. At the heart of industry are rivals and their competitive strategies linked to. Limitations of Porter’s Five Force Model Porter’s model is a strategic tool used to identify whether new products. or for a force strongly against. for example. and summarize the size and the scale of the force on the diagram. whereas the competitive environment is changing turbulently. However it can also be very illuminating when used to understand the balance of power in other situations. In conducting an analysis of Porter’s Five Forces. 2006). With a clear understanding of where power lies.
the computer and software industry is often considered as being highly competitive. a supplier or customer and thereby gains greater control over the chain of activities which leads from basic materials through to final consumption (Luffman and et al. The Six Forces model though is very similar to the Five Forces model with the only difference being the addition of the sixth force in the framework. and is included in the framework if it has potential to impact on all the other five forces (Gordon. 2001).. • The government – The sixth force in the framework can also be considered to be the government. it is not able to take into account new business models and the dynamism of the industries. It is important to be aware that this model has further limitations in today's market environment. depending on the factor which has the greatest influence including: • Complementors – One school of thought looks at the sixth force to be complementors. This relates to the strategic option of vertical integration. Porter's Six Forces model and its relationship to the standard Five Forces model Porter’s Five Forces model actually has an extension referred to as Porter’s Six Forces model. as it assumes relatively static market structures. What needs to be done is to adopt the model with the knowledge of its limitations and to use it as part of a larger framework of management tools. Based originally on the economic situation in the eighties with its strong competition and relatively stable market structures. it is not advisable to develop a strategy solely on the basis of Porter’s models (Kippenberger. is advisable for the application of every business model (Recklies. by forcing either cost increases or price decreases. Haberberg and Rieple. This sixth force in the model is termed as the relative power of other stakeholders. Nevertheless. The author states that these complementary businesses. affect the industry as changes in these businesses (such as new techniques. approaches or technologies) can impact on the dynamics between the industry and the complementors. such as technological innovations and dynamic market entrants from startups that will completely change business models within short times. This approach. which are businesses offering complementary products to the sector in focus and being analysed (Grove 1996). the government can have direct impact on the industry . when the company acquires. as a sixth factor. If they are powerful they are in a position to bargain profits away through reduced margins. 2001). but to examine it in addition to other strategic frameworks of SWOT and PEST analysis. that does not mean that Porters theories became invalid. 1998. customer loyalty. Therefore. Wheelen and Hunger. it is important to appreciate that companies purchase from suppliers and sell to buyers. For instance. The industry structure is constantly being revolutionized by innovation that indicates Five Forces model being of limited value since it represents no more than snapshots of a moving picture. however. Finally. or merges with. as far as they can. It is considerably less popular than the Five Forces model as its acceptance has been less positive than the Five Forces model. Thus.strengthen their position in the market by ensuring. 1997). 1996. and can refer to a number of other groups or entities. 1998). techniques and theories.
business articles on the industry performance. It is important to make sure that the sources are reliable and relevant to the current condition of the industry. Anything that will give the exposure to the market situation. Further limitations could be present in the nature of market forces that reduce the applicability of the information sources to present situations. The status of employees seems to follow similar rules in certain sectors. a large part of the work force are unionised. This is more important in recent years where shareholder activity has increased significantly in the boardroom.as the sixth force. is that there is no definite and specific sixth force in all sectors. • The public – Yet other viewpoints look at the public as the sixth force in the model. and thus could be considered a strong influence in these sectors. in the automobile sector in the US. This can be prohibitive to its practical use. whether favourably or unfavourably. It has to be viable. the level of competitor information required is very detailed and may not always be available. while a sixth force could be defined for all sectors. . particularly if the public has a strong influence in the dynamics of the sector resulting in changes to the other forces or in the sector as a whole. For example. Second. For example. For this purpose. and management of firms has been scrutinised much more and even given ‘threats’ if certain actions favoured by the shareholders were not pursued. Analyst reports and trade organisations. • Employees – Employees could also be considered as the sixth force if they wielded extraordinarily strong influence on the firm in a particular sector. reliable and valid. the gathered data and information has to be checked and be applied to the current business conditions. Where to find information for Porter's 5 Forces analysis In conducting the analysis it is crucial to examine the existing literature: • • • • Periodicals. new emerging companies in the industry. and the amount of detailed information required. the acceptance of this framework has been somewhat limited. While a sixth force has been added to Porter’s original Five Forces model. etc. in order to conduct a good analysis of the model. • Shareholders – This group can also be considered potentially as the sixth force. but can also have indirect impact or influence by affecting the other five forces. Company annual reports and its publications on the main suppliers and distribution network. competitors present in the market. the influence of this factor can also be captured in the other five forces and thus the necessity of having it in the framework is less compelling. as it is different for each sector. and thus could be considered the sixth force instead of the government or complementors. This could be for two reasons. First.
B.9-13. (1998) New approaches to strategy: new ways of thinking for the millennium. M. it will be in a stronger position to defend itself against any threats and to influence the forces with its strategy. and the nature and relative power of the forces will change. Scenario Planning. Sanderson. Some issues during the implementation of these Five Forces are crucially important for organizations to build long-term business strategy and sustaining competitive advantages rather than simply list the forces. Porter. Successful use of the Porter Model Analysis includes identifying the sources of competition. Competitor Analysis. Critical Success Factors. Vol. T. pp. A. If a company fully understands the nature of the Porter’s five forces. (1998) Competitive Strategy: Techniques for Analyzing Industries and Competitors. Marketing Mix and Product Life Cycle. Luffman. 36 issue 1. 24-25. Porter. Kippenberger. Oxford: Blackwell Publishers Inc. and strategic recommendations for the action a company should take in order to develop barriers to competition. Balanced Scorecard. 3 Issue 6. (1998) Strategy according to Michael Porter. Management Decision London . Lea. BCG Growth-Share Matrix. New York: Free Press. (2001) The Strategic Management of Organizations. The Antidote. the strength and likelihood of that competition existing. September-October. and Rieple.Conclusion Any company must seek to understand the nature of its competitive environment if it is to be successful in achieving its objectives and in establishing appropriate strategies. S. (1980a) How Competition Forces Shape Strategy. SWOT analysis. the need to monitor and stay aware is continuous. (1996) Strategic Management. Value chain analysis. Harvard Business Review. and Kenny. Industry Lifecycle. Pest Analysis. Porter's Generic Strategies. Essex: Pearson Education Limited.. New York: Free Press. E. A. Thurlby B (1998) “Competitive forces are also subject to change”. G. M. Sanderson. Vol. Porter. References Haberberg. (1980b) Competitive Strategy. McKinsey 7S Framework. S. M. pp. Management Decision.137-145. Consequently. The situation is fluid. and particularly appreciates which one is the most important.. If you found this article useful please have a look at the other articles we have written: Ansoff analysis. pp.
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