Five Forces Analysis

Clare Devlin
 Exhibit 2.2 The Five Forces
Framework
Potential
entrants

Competitive
Suppliers Buyers
rivalry

Substitutes
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 Five Forces Analysis 1
• An industry analysis usually begins with a
general examination of the forces
influencing the organisation
• The objective is to develop the competitive
advantage of the organisation to enable it to
defeat its rival companies

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 Five Forces Analysis 2
• The basic assumption of the model is that all
organisations wish to benefit and protect their
own interests first
• This is not true in some cases such as some
charitable and not-for-profit organisations
• The general principle applies to the public
service and not-for-profit organisation when they
compete for resources
• Lynch

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Five Forces Analysis: Trainers 1
• Athletic Shoe industry
• Rivalry is high (Nike, Reebok, Adidas)
• Threat of potential entrants is low (industry
has reached maturity, sales growth has
slowed)
• Bargaining power of suppliers is medium
but rising (suppliers in Asian countries are
increasing in size and ability)
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Five Forces Analysis: Trainers
2
• Bargaining power of buyers is medium, but
increasing (athletic shoes are dropping in
popularity as brown shoes gain)
• Threat of other stakeholders is medium to
high (government and human rights
concerns are growing)

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Five Forces Analysis: Trainers 3
• Based on current trends in each of these
competitive forces, the industry appears to
increasing in its level of competitive
intensity, meaning profit margins will be
falling for the industry as a whole

• From Wheelen and Hunger, Strategic

Management and Business Policy
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 Five Forces Analysis
Five basic forces that can act on the
organisation:
• Threat of entry
• Power of buyers
• Power of suppliers
• Threat of substitutes
• Competitive rivalry
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 Threat of entry
• Economies of scale
• Capital requirements of entry
• Access to distribution channels
• Cost disadvantage independent of size
• Legislation
• Differentiation
• Switching Costs
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 Economies of Scale
To compete with Avon a new company
would have to:
• recruit and train an efficient sales force skilled in
party selling
• establish warehouses to maintain buffer stocks
• hire a design team to develop a competitive product
range
• manufacture and distribute the volume and quality
required
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 Capital requirements of
entry
• Entry into some markets may involve major
investment in technology, plant distribution
service outlets and other areas. The cost of
such outlays of capital will deter some
companies from entering these markets

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 Access to distribution
channels
• A company entering the market must find
distribution channels which may be
controlled by companies already there.
• Petrol companies own retail sites
• HB refused to let Mars use their fridges
• The concept of “hello” money

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 Cost disadvantage
independent of size
• This can be the experience gained by early
entry into the market. It can include good
relationships with key buyers and suppliers,
favourable locations, government subsidies
• When Korean cars were attempting to enter
the European car market they faced such
barriers from Ford,VW and Renault
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 Legislation
• Patents and copyright can offer companies
some protection against new entrants
• Governments can license the right to
produce some products
– Electricity and telecommunications.
– Offshore drilling for oil

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 Differentiation
• Branding ,customer knowledge ,special
levels of services may create barriers to
entry.
– Ikea has strong brand
– Proctor and Gamble and Kellogg's create high
entry barriers through their levels of
advertising

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 Switching Costs
• If a company is satisfied with the existing
product it is harder for a company to
persuade them to change.
– Persuading users to switch from Microsoft
is difficult.
– Furthermore Microsoft may act to protect its
interests by upgrading products etc.

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Threats from potential entrants
New competitors to an industry make it
more competitive by
• Expanding capacity without increasing
overall market size to penetrate the market
and to achieve critical mass
• Increasing costs as they bid for factors of
production

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 Power of buyers 1
The power of buyers is high:
• If there are few buyers and they are concentrated
• If the product is undifferentiated
• If backward integration is possible
• If changing suppliers costs very little
• If the product to be bought is unimportant to the
price or quality of the final product

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 Power of buyers 2
Buyers are the customers of the organisation

They have power:

• If there are few buyers and they are
concentrated
– National governments can drive a hard bargain
in health and education contracts

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 Power of buyers 3
• If the product is undifferentiated and is
much the same as other producers the buyer
can switch without problems
– Coffee and sugar producers have little power
– Farmers have little power against the
supermarkets

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 Power of buyers 4
• If backward integration is possible. The
buyer may backward integrate and take
over the supplier role.
– Tesco and Dunne's produce own brand labels

• If changing suppliers costs very little

– Office supplies are very easy to find

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 Power of buyers 5
• If the product to be bought is unimportant
to the price or quality of the final product
then it can be easily found elsewhere
– electric wire bought for use in lamps

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Threats from bargaining power
of Buyers
• Forcing down prices
• Bargaining for higher quality
• Playing competitors against each other
• In grocery retail trade, buyers have
strong power
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 Threat of substitutes
• Substitutes can render a product in an industry
redundant
– Electric typewriter replaced by PC

• Substitutes can affect the price a product can

command because it enables buyers to switch
– Sucrose and sugar

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 Threat of substitutes

Substitutes can perform the same

function as existing products:
• e.g., quartz watches replaced wind-up
clockwork watches
• In telecommunications, fax replaced
telex, which in turn is being replaced by
e-mail
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 Substitutes
• Wikipedia replaced Encyclopaedia
Britannica

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 Threat of substitutes
• E-mail in turn is being replaced by instant
messaging

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 Power of Suppliers 1
Porter suggests that suppliers are powerful when:
• There are few suppliers
• There are few substitutes
• The industry supplied is not an important
customer
• The supplier's product is differentiated or there are
switching costs
• Suppliers can integrate forward
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 Power of suppliers 2

Suppliers are powerful when:

• The supplier industry is dominated by a few
companies but sells to many
– Petrol companies
• When substitutes are not readily available
– Electricity

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 Power of suppliers 3
• If the industry buys only a small portion of
the supplier product it is not as important
to the supplier
– sales of lawn mower tyres are less important to
tyre manufacturers than sales of car tyres

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 Power of Suppliers 4

• When the product is differentiated or there

is a large cost in switching from one
product or service to another
– Shops need to stock Coca Cola
– Word processing software

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 Power of Suppliers 5
• Suppliers are able to integrate forward and
compete with their present customers
– Breweries can sell beer
–

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 Threats from the power of
suppliers
Suppliers can exert bargaining power over
companies in an industry in 2 main ways:
• Threatening to raise their price
• Threatening to reduce the quality of their
goods and services

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 Competitive rivalry 1

• Balance
• Market growth rates (in mature
markets, taking customers from rivals)
• High exit barriers
• Excess capacity
• Acquisition
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 Competitive rivalry 2
• High exit barriers
– Steel companies find it is hard to leave
the industry because the plant cannot be
used for anything else

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 Competitive rivalry 3
• Excess capacity
– Companies may run on full capacity to
reduce unit costs and cause over-
capacity and price reductions throughout
the industry
– the paper industry

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 Competitive rivalry 4
• Balance: when competitors are few and
more or less the same size they watch each
other carefully and make counter moves
• Retail Grocery business
• Automobile industry

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 Competitive rivalry 5
• Market growth rates
in mature markets sales can only be
achieved by taking customers from
rivals

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 Competitive rivalry 6
• High fixed Costs: can result in competitors
cutting prices to obtain turnover
• If there is extra capacity in large increments
the new competitor can create short term
over-capacity e.g Japanese cars in America
• Differentiation: in a commodity market
where there is little differentiation buyers
can switch easily and create competition
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 Structurally Attractive
Industry
• High average R.O.I.
• Difficult to enter
• Suppliers & buyers have only modest
bargaining power
• Few substitute products or services
• Rivalry between competitors stable
Example: Major branded soft drinks
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 Structurally Unattractive
Industry
• largely undifferentiated product
• big, powerful buyers
• lots of substitutes (& growing)
• excessive rivalry
• high fixed costs
• over-capacity
• many competitors (often subsidised)
Example: Steel Industry
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 Structurally Unattractive
Industry
An industry can be unattractive if one of more
forces is very strong:
Manufacture of Disc Drives
• High rivalry
• Buyer power
• Threat of substitutes high e.g., memory
• Entry threat low (high expertise and rate of
change)
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 Structurally Unattractive
Industry
Tyre Manufacturing
• High rivalry
• High power of buyers
• Over-capacity
• High exit costs
• Big investment
Traditionally low profits
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 Structurally Unattractive
Industry
Clothes Manufacturing
• High rivalry
• High power of buyers
• Over capacity
• Obsolescence caused by fashion
• Temporary tariffs/quotas holding back
some new entrants
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 Supplier Power: examples
• Manufacturers who have products that are well
known as prestigious brand names have suppler
power over small scale retailers because
consumers expect to see these products on their
shelves
• Franchise operators must agree not only to source
some of their supplies from the franchisor at
prices and terms favorable to that franchisor but
must operate their facilities in a manner dictated
by the franchisor
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 Substitutes: examples
• Producers of glasses and contact lenses are
facing mounting competitive pressure from
laser surgery.
• Newspapers are feeling the competitive
force of the general public tuning into cable
news channels for late breaking news and
using the internet

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 Buyer Power: motor vehicle
manufacturers

Most motor vehicle manufacturers have

strong bargaining power negotiating to buy
tyres from Goodyear, Michelin ,
Bridgestone/ Firestone

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 Buyer Power
• By and large individual consumers have
little bargaining power, they have to take
the price stated or go elsewhere.
• For some big purchase items there may be
some bargaining power e.g., houses, new
and second-hand cars

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 Threat of entrants
• Competition increased in on-line music
selling, when Barnesandnoble.com and
Amazon.com, who were traditionally book
sellers, joined the market
• In the pharmaceutical industry, when a drug
patent expires many companies will come
into the market with a generic drug of their
own
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 Competitive Rivalry
Some industries more competitive
than others:
• Microsoft was virtually unchallenged in PC
operating systems till Linux came along
• Fast food industry has many competitors

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