Five Forces Analysis

Five Forces Analysis Introduction (1)
• • • Devised by Michael Porter It is a framework for the analysis of the structural factors that shape competition within an industry The five forces:
– Determine the profitability of an industry – Assess how attractive and potentially profitable is an industry

Five Forces Analysis_v1

Dr. Harald Fien

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Five Forces Analysis Introduction (2) • This is a framework for understanding an industry or an organisation’s position with respect to the forces operating in the microenvironment It can be used to explain the performance of competitors in a market From the analysis a number of generic competitive strategies can be derived – Cost leadership – Differentiation – Focus • • Five Forces Analysis_v1 Dr. Harald Fien 3 .

the ability of new competitors to enter the industry – Bargaining power of suppliers – Bargaining power of customers – Threat of substitute products – Degree of competitive rivalry Five Forces Analysis_v1 Dr.Five Forces Analysis The five forces • The ability of firms to earn an good return depends on five forces: namely the… – Threat of new entrants. Harald Fien 4 .

Five Forces Analysis The five forces framework Threat of Substitute Products Bargaining Power of Suppliers Intensity of rivalry within the industry Bargaining Power of Buyers (Customers) Threat of New Entrants Five Forces Analysis_v1 Dr. Harald Fien 5 .

The threat of new entrants .

and vice versa Five Forces Analysis_v1 Dr. rivalry will accelerate and profits will decline If it is difficult to enter an industry the position of existing firms will be strengthened Impediments to the entry of new firms are known as barriers to entry If barriers to entry are low then the threat of new entrants will be high. Harald Fien 7 .Five Forces Analysis Threat of new entrants • • • • If new entrants move into an industry they will gain market share.

at least in the short run Five Forces Analysis_v1 Dr.Five Forces Analysis Barriers to entry • Capital cost of entry – High cost will deter entry – High capital requirements might mean that only large firms can compete • Economies of scale available to existing firms – If they enjoy absolute cost advantages based on large scale then it will be difficult for smaller newcomers to break into the market and compete effectively • Regulatory and legal restrictions – Each restriction can act as a barrier to entry – Eg patents provide the patent holder with a monopoly position. Harald Fien 8 .

Harald Fien 9 .Five Forces Analysis Ease and difficulty of entry Easy to enter if there is • Common technology • Access to distribution channels • Low capital requirements • Low scale threshold • Absence of strong brands and customer loyalty Difficult to enter if there is • Patented or proprietary know-how • Difficult in brand switching • Restricted distribution channels • High capital requirements • High scale threshold Five Forces Analysis_v1 Dr.

Supplier power .

Harald Fien 11 .Five Forces Analysis Bargaining power of suppliers • If a firm’s suppliers have bargaining power they will: – Exercise that power – Sell their products at a higher price – Squeeze industry profits • • • If the supplier forces up the price paid for inputs profits will be reduced The more powerful the buyer the lower the price So are the determinants of supplier power? Five Forces Analysis_v1 Dr.

Harald Fien 12 .Five Forces Analysis Bargaining power of suppliers • • The determinants of supplier power are: The uniqueness of the resource that supplier provide – If the resource is essential to the buying firm and if no close substitutes are available then suppliers are in a powerful position • • • The number and size of firms supplying the resources – A single large suppliers is able to exert monopoly power over the market The competition for the resource from other industries – If there is great competition the supplier will be in a strong position The cost of switching to alternative sources Five Forces Analysis_v1 Dr.

Harald Fien 13 .Five Forces Analysis Suppliers are powerful when • • • • • • • There are only a few large suppliers The resource they supply is scarce The cost of switching to an alternative supplier is high The product is easy to distinguish and loyal customers are reluctant to switch The supplier can threaten to integrate vertically The customer firm is small and unimportant There are no substitute resources available Five Forces Analysis_v1 Dr.

Buyer power .

Harald Fien 15 .Five Forces Analysis The power of customers • • Powerful customers are able to exert pressure to drive down prices For instance the supermarket business is increasingly dominated by a small number of large retail chains able exert great power over supply firms Five Forces Analysis_v1 Dr.

the bargaining power of buyers The number of firms supplying the product – The smaller the number of suppliers. the less opportunity customers have for shopping around • • The threat of integrating backwards. Harald Fien 16 .if buyers pose a threat of integrating backwards they will enjoy increase power The cost of switching Five Forces Analysis_v1 Dr. the greater their power The volume of their order sizes – The larger the volume the greater.Five Forces Analysis Determinants of buyer power • • • The number of customers – The smaller the number of buyers.

Threat of substitute products .

Five Forces Analysis Threat of substitute products • • • A substitute product can be regarded as something that meets the same need Substitute products are produced in a different industry –but crucially satisfy the same customer need If there are substitutes to a firm’s product. Harald Fien 18 . they will limit the price that can be charged and will reduce profits Five Forces Analysis_v1 Dr.

Harald Fien 19 .Five Forces Analysis The threat of substitutes • The extent of the threat depends upon – The extent to which the price and performance of the substitute can match the industry’s product – The willingness of buyers to switch – Customer loyalty and switching costs • If there is a threat from a rival product the firm will have to improve the performance of their products by reducing costs and therefore prices and by differentiation Five Forces Analysis_v1 Dr.

Degree of rivalry .

it will force organisations to engage in – Price wars (competitive price reductions). Harald Fien 21 .Five Forces Analysis Degree of competitive rivalry • If there is intense rivalry in an industry. – Intense competition over R and D and new product development – Intensely competitive advertising and promotion wars (intensive use of sales promotion and high spending on advertising) • All these measure are likely to raise costs and reduce profits Five Forces Analysis_v1 Dr.

Five Forces Analysis Intensity of rivalry • • The intensity of rivalry is determined by: The number of competitors in the market – Competitive rivalry will be higher in an industry with many current and potential competitors • • Market size and growth prospects – Competition is always most intense in stagnating markets Product differentiation and brand loyalty – The greater the customer loyalty the less intense the competition – The lower the degree of product differentiation the greater the intensity of price competition Five Forces Analysis_v1 Dr. Harald Fien 22 .

Five Forces Analysis Intensity of rivalry • The power of buyers and the availability of substitutes – If buyers are strong and/or if close substitutes are available. there will be more intense competitive rivalry • • Capacity utilisation – The existence of spare capacity will increase the intensity of competition The cost structure of the industry – Where fixed costs are a high percentage of costs then profits will be very dependent on volume – As a result there will be intense competition over market shares • Exit barriers – If it is difficult or expensive to exit an industry. Harald Fien 23 . firms will remain thus adding to the intensity of competition Five Forces Analysis_v1 Dr.

Five Forces Analysis A summary of the five forces High profits are associated with: • Weak supplier • Weak buyers • High entry barriers • Few possibilities for substitution • Little rivalry Low profits are associated with: • Strong suppliers • Strong buyers • Low entry barriers • Many possibilities for substitute products • Intense rivalry Five Forces Analysis_v1 Dr. Harald Fien 24 .

costs and the investment required Knowing the forces and how they impact upon the industry enables managers to decide on future policy Five Forces Analysis_v1 Dr.Five Forces Analysis Conclusion • • • • The collective strength of the five forces determine the industry’s profitability The stronger the forces the less likely an industry is to be profitable in the long run These forces impact upon profitability through they impact on prices. Harald Fien 25 .

Five Forces Analysis Lessons Learned • • • • • • • • What are the five forces? Explain the threat of new entrants Explain bargaining power of suppliers Explain bargaining power of customers Explain threat of substitute products Explain degree of competitive rivalry When is t easy / when ist difficult to entry a market? To what points are high/low profits associated? Five Forces Analysis_v1 Dr. Harald Fien 26 .