Five Forces Model by Michael Porter

Five Forces model of Michael Porter is a very elaborate concept for evaluating company's competitive position. Michael Porter provided a framework that models an industry and therefore implicitly also businesses as being influenced by five forces. Michael Porter's Five Forces model is often used in strategic planning. Porter's competitive five forces model is probably one of the most commonly used business strategy tools and has proven its usefulness in numerous situations. When exploring strategic management models, you also might want to check out the BCG matrix, SWOT analysis, IFE matrix, and SPACE matrix models. Why would I need to use Porter's Five Forces model? In general, any CEO or a strategic business manager is trying to steer his or her business in a direction where the business will develop an edge over rival firms. Michael Porter's model of Five Forces can be used to better understand the industry context in which the firm operates. Porter's Five Forces model is a strategy tool that is used to analyze attractiveness of an industry structure. What is good about Porter's Five Forces model? Porter has the ability to represent complex concepts in relatively easily accessible formats. His book about the Five Forces model is written in a very easy and understandable language. Even though his model is backed up by some complex model, the model itself is simple and easily comprehensible at all levels. Porter's Five Forces model provides suggested points under each main heading, by which you can develop a broad and sophisticated analysis of competitive position. This can be then used when creating strategy, plans, or making investment decisions about your business or organization.

While some agree that Porter's Five Forces model is the ultimate explanation of how world works. Numerous economic studies have shown that different industries can sustain different levels of profitability. This can be attributed to differences in industry structures.Does Porter's Five Forces model really work? Theoreticians have different view on this. When putting all these points together in a graphical representation. It depends in what time frame we judge the state of the facts. Even Michael Porter himself acknowledges that time is of essence when it comes to how his forces interact with each other. we get Porter's Five Forces model which looks like this: . others disagree. What is the basic idea behind Porter's Five Forces model? Porter's Five Forces model is made up by identification of 5 fundamental competitive forces: o o o o o Barriers to entry Threat of substitutes Bargaining power of buyers Bargaining power of suppliers Rivalry among the existing players Some later economists also consider government as the sixth force in this model.

branding. Government policies and taxation Production cycle and learning curve Capital requirements Access to distribution channels Patents. . economies of scope) Access to production inputs and financing. and image also fall into this category. This can involve for example: o o o o o o Cost advantages (economies of scale.Force 1: Barriers to entry Barriers to entry measure how easy or difficult it is for new entrants to enter into the industry.

can your customers work together to order large volumes to squeeze your profit margins? The following is a list of other examples: o o o o o o o o Buyer volume and concentration What information buyers have Can buyers corner you in negotiations about price How loyal are customers to your brand Price sensitivity Threat of backward integration How well differentiated your product is Availability of substitutes Having a customer that has the leverage to dictate your prices is not a good position. Force 4: Bargaining power of suppliers This relates to what your suppliers can do in relationship with you. then it is a threat to the company because it can compete with price only. o o How strong is the position of sellers? Are there many or only few potential suppliers? . Force 3: Bargaining power of buyers Now the question is how strong the position of buyers is. For example.Force 2: Threat of substitutes Every top decision makes has to ask: How easy can our product or service be substituted? The following needs to be analyzed: o o o How much does it cost the customer to switch to competing products or services? How likely are customers to switch? What is the price-performance trade-off of substitutes? If a product can be easily substituted.

. o o o o o o o o Is one player very dominant or all equal in strength/size? Are there exit barriers? How fast does the industry grow? Does the industry operate at surplus or shortage? How is the industry concentrated? How do customers identify themselves with your brand? Is the product differentiated? How well are rivals diversified? Rivalry is the fifth factor in the Five Forces model but probably the one with the most attention. Force 5: Rivalry among the existing players Finally.o o o o o Is there a monopoly? Do you take inputs from a single supplier or from a group? (concentration) How much do you take from each of your suppliers? Can you easily switch from one supplier to another one? (switching costs) If you switch to another supplier. Five Forces model indirectly implies that risk-adjusted rates of return should be constant across firms and industries. What are the assumptions behind the Five Forces model? From the risk-return perspective. will it affect the cost and differentiation of your Are there other suppliers with the same inputs available? (substitute inputs) product? o The threat of forward integration is also an important factor here. we have to analyze the level of competition between existing players in the industry.

Michigan . you might want to consider the SWOT model. Who is Michael Porter? Michael Porter is a professor at Harvard Business School and is a leading authority on competitive strategy and international competitiveness. If you wanted to analyze your firm from within. It focuses on assessing competitive position within industry.How can I analyze my business from inside? Porter's Five Forces model views the business from outside. Michael Porter was born in Ann Arbor. Another model that you might want to consider is the Balanced Scorecard and IFE/EFE matrix. The SWOT model has some aspects of external view as well but complements Porter's Five Forces model in the internal view.

7 tonnes of limestone and coal need to be assembled. January 3rd. In the manufacture of cement. for every tonne of cement produced. but to minimise unit delivered cost as well. For OPC. about 1. Rewa.4-1. freight cost becomes a significant factor in deter mining the landed cost of . outward freight is minimised and marketing flexibility enhanced at the cost of higher raw material assembly costs. In this scenario. In addition. locating the plant along the limestone deposits is the logical corollary. The plant also has to address issues of logistics (evacuation of cement by rail.6-1. power availability in the region. there can be two broad locational strategies. up to another 250 kg of pozzolonic material such as fly ash requires to be assembled. A split-location cement plant can be a good compromise between the two options. For PPC. etc). In this case.Cement Industry Barriers to entry. close to 1. the coal pitheads are also quite close by. While deciding on the plant location. The second strategy is to locate the plant close to the mineral deposits. slag. and The first strategy is to locate manufacturing facilities near the consuming centres. outward freight accounts for close to one fifth of the total manufacturing cost. road or waterways). high bulk commodity. stemming from the principal objective. Given that 1. the location of the cement plant becomes crucial. another 50 kg of gypsum is required while grinding the clinker down. availability of materials (limestone.5 tonnes of limestone are required per tonne of clinker. there is a trade-off between proximity to raw material sources and proximity to markets. for every 1 tonne of clinker. and Raipur. coal. The bulk of the cement manufactured is consumed near urban centres. Occasionally. 2009 Cement being a high bulk and low value commodity. As cement is a low value.7 tonnes of raw material (including coal) is transported. as in areas like Satna. Thus. which is not merely to minimise unit-manufacturing cost. so as to minimise raw material assembly costs.

Countries. by opting for bulk transportation. Also in these countries. For example. freight costs are considerably high for cement plants. there are countries. Bulk transportation leads to significant advantages such as savings in freight costs and packing costs. international competitiveness is not really a serious issue Outward freight on cement is an important element in the operating cost of a cement plant. which export a large share of their domestic production. These clusters are distant from the collieries and the markets for cement. Countries. which impor t a significant share of their consumption. appear to be having one thing in common. However. pilferage. Greece is in a position to export over 50% of its cement production. cement companies have to rely on extensive transportation for moving coal from the coal pitheads to the cement plants and for despatching cement from the plant to the markets. avoidance of transit loss. As both coal and cement are of low value and bulky in nature. As cement is primarily a regional commodity. adulteration. It accounts for around one third of the total variable costs. This has resulted in a very low volume of inter national trade in cement. Thus. Although. World cement trade has averaged just around 6-7% of the total production. Indian cement is quite competitive with many global cement producing regions. appear to be falling in the developing world category. The Middle East countries (although not falling in the developing world category) have huge requirements of cement because of construction work in projects in the oil sector. At the ex-factor y level. where the public expenditure on infrastructure projects is very high. which either import a significant share of their total consumption or export a major share of their total production. Countries with high export thrust opt for bulk transportation for exporting cement. a plethora of duties along with infrastructure bottleneck reduces this competitiveness.cement. world trade in cement is limited because of high freight costs. inadequate cement limestone reserves) have discouraged cement capacity creation. unfavourable conditions (for example. bursting of bags and damage to cement. Cement has an average lead of around 535 km. Cement companies use both road and rail . Most of the cement plants in India are located in and around the limestone clusters.

The railways had launched the "Own Your Wagon" scheme-a scheme where companies could buy wagons and lease it to the Railways and the Railways would in turn operate these wagons and ensure their availability to the owner. underlines the tremendous scope for growth in the Indian cement industry in the long term. This. registering a growth of nearly 9% to 10%. But the unfavourable ter ms and conditions of this scheme prevented its successful commercialisation. Despite the fact that the Indian cement industry has clocked production of more than 100 MT for the last five years. cement companies have started preferring road transportation even for longer distances because of several reasons. . the dependence on rail network is still very high and accounts for around 70% of coal movement Although rail transportation is more economical for distances beyond 250-300 km. Rail dispatches amount for about 33% while roads carry the balance 66%. The balance 1% is accounted by Sea transporation. Bargaining power of buyers The Indian cement industry with a total capacity of about 200 m tonnes (MT) in FY09 is the second largest market after China. the per capita consumption of around 134 kgs compares poorly with the world average of over 263 kgs. the balance capacity still remains pretty fragmented. Rising railway traffic coupled with insufficient investments by the railways for increased wagon supplies and the fact that the cement industry is not an important customer of the Railways (cement cargo accounts for just 78% of the total railway freight) have resulted in a shortage of wagon supply to the cement industry. more than anything. Although consolidation has taken place in the Indian cement industry with the top five players controlling almost 60% of the capacity.transport to transport cement and to receive coal. For coal transportation. The share of road over rail has only gone up over the years. and more than 950 kgs in China. The The Railways have also increased their tariff on a regular basis (often higher than the increases in the road sector). making them uneconomical vis-à-vis road tariffs even for longer distances.

However. south. west. Holcim has acquired stake in domestic companies Ambuja Cements and ACC and has increased its stake gradually to gain full control. with capacity addition taking place at a slower rate as compared to growth in demand. The global players put together account of quarter share of the domestic market. it must be noted that the transnationals will find the going tough since cement is a game of volumes and with the median capacity of fragmented players. the players have lined up expansion plans accordingly. Considering the pace at which infrastructural activity is taking place in different regions.Cement. . However. recently the demand supply parity had also been restored to some extent in the Southern region. Italcementi acquired 100% stake in Zuari Cement and 95% stake in Shree Vishnu. the Portugese cement manufacturer. Further. transnationals eyed median capacity producers. the transnationals will have to acquire capacities piecemeal and this route is fraught with a lot of uncertainties. Already. acquired Grasim’s stake (53. Given the high potential for growth.63%) in Shree Dig Vijay. while companies like Lafarge. fragmented structure of the industry and low gearing. being a bulk commodity. turning around few of the companies at a time when the cycle is at its peak would be a difficult task. While the southern region always had excess capacity in the past owing to abundant availability of limestone. This has resulted in cement being largely a regional play with the industry divided into five main regions viz. quite a few foreign transnationals have been eyeing the Indian markets and are planning to acquire domestic companies. is a freight intensive industry and transporting cement over long distances can prove to be uneconomical. Considering the long term growth story. Cimpor. the western and northern regions are the most lucrative markets on account of higher income levels. fair valuations. north. east and the central region. Heidelberg and Italicementi have made a couple of acquisitions. an another wave of consolidation would not come as a surprise. After acquiring stake in big companies.

supply of power from the state grid and availability of railways for transport are all controlled by a single entity.High capital costs and long gestation periods.The demand-supply situation is tightly balanced with the latter being marginally higher than the former.Key Points --------------------------------------Supply -. industrial and infrastructure sector have also emerged as demand drivers for cement. Demand -.Housing sector acts as the principal growth driver for cement. the competition is intense with players resorting to expanding reach and achieving pan India presence. but the shortage of coal and volatile fuel prices remain a concern. nowadays producers are relying more on captive power. Competition -. However. Bargaining power of suppliers -.Due to large number of players in the industry and very little brand differentiation to speak of. things are changing and few brands have started commanding a premium on account of better quality perception.Cement is a commodity business and sales volumes mostly depend upon the distribution reach of the company. . However.Licensing of coal and limestone reserves. Access to limestone reserves (principal raw material for the manufacture of cement) also acts as a significant entry barrier. in recent times. Bargaining power of customers -. However. which is the government. Barriers to entry -.

the benefit of which should start flowing in starting quarter ended March 2009 onwards. The industry volumes and realisations were higher during FY09 that boosted topline growth.Financial Year '09 --------------------------------------------------During FY09. the exports were curtailed in FY09 in order to satisfy the domestic demand and contain inflation. cost of operation did also witnessed northward movement that exerted pressure on margins. However. India owing to its locational advantage has been catering to the cement requirements of the Middle East and the South East Asian nations. the demand for cement has moderated. To ensure smooth functioning of plants and lower costs. Recently the ratio has dropped below 50%. However. The cement industry on an average maintains two months inventory of fuel and such costs. The industry added nearly 30 MT in FY09 over the previous year taking the total capacity to nearly 212 MTPA. On account of general economic slowdown and these issues. Smooth supply of state grid power is another problem. financial institutions have tightened their credit norms. But coal linkages for the industry are poor. This has increased cost of operation. the industry maintained volume growth of around 10% YoY. This cautious stance has led to a credit crunch and the same has impacted upcoming projects. The growth in realisations slowed down as additional capacities coming on stream eased the supply pressures. . Considering the financial turmoil witnessed globally. This has resulted in increase in demand for coal. While demand growth stood at 10% YoY. So the players either have to purchase it from open market or import it. The industry had lined up huge capex plans with that depreciation costs have moved up. stimulus packages announced by the government and agricultural income gave a fillip to the demand for the commodity. industry has opted to set up captive power plants based on coal. All of this dented profitability. average industry cement realisations (average of price per bag of cement) were higher by about 5% YoY. However. The overheated real estate sector has cooled off now. The crude prices have only started cooling off November 2008 onwards.

with more incentives being spelled out for the .5% on RMC cement. However. Also. Government initiatives in the infrastructure sector and the housing sector are likely to be the main drivers of growth for the industry. leading to demand supply mismatch.Prospects ---------------------------------------------------The industry is likely to maintain its growth momentum and continue growing at around 8% to 9% in the medium to long term. it would impact the growth in consumption of cement. In the recent past. Having said that. Imposition of 7. The fresh capacities announced till date will add up 60 MT to the existing capacity (200 MT). and are expected to go on stream by FY10. If this support wanes. cement producers have lined up capacity expansion plans either by brownfield or greenfiled expansion route. While infrastructure spending has been a boon. resulting in healthy cement prices across the country. As the capacities become operational. Further. this scenario is likely to reverse as the industry has lined up huge capacity expansion plans. recently the demand has slowed down as real estate and construction activities in the urban areas have taken a back seat with economic slowdown. The importance of the housing sector in cement demand can be gauged from the fact that it consumes almost 60%-70% of the country’s cement. the hike in prices of coal and petroleum products could impact cement companies’ margins. temporary relief may be provided if there are delays in any of the proposed expansion plans. The government has increased budgetary allocation for roads under NHDP. it won’t have a severe impact as RMC constitutes not more than 5% of total cement consumption. demand has surpassed supply. In the budget. However. which has started taking place. while the government refrained from cutting lowering the burden of taxes and duties on cement.5% customs duty on concrete batching plants is likely to negatively impact the ready mix concrete manufacturers. supply may once again outstrip demand putting downward pressure on margins. However. With the growth in the sector and waning demand supply gap. it imposed customs duty of 7. there was also a strong cushion from the steady growth of the construction sector (read housing).

The budget measures such as increasing excise duties have proved to be futile and in the future too. Going forward. we believe that it is the market dynamics that will determine these variables. cement manufacturers will continue to benefit. . Good agricultural income has supported demand for the commodity despite slowdown in real estate sector. we believe the government’s initiatives in the infrastructure and housing sectors are likely to be the main drivers of growth for the industry in the long run.infrastructure and housing sector.

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