PORTER MODEL

N Sawaikar
INTRODUCTION
 Porter model first detailed in Competitive Strategy by
Michael Porter in 1980
 To a large extent it applied basic economic concepts like
the structure-conduct-performance paradigm to general
business analysis
 The aim of the model is to analyse the basic forces that
affect industry profitability and provide a guide to
successful strategy
FIVE FORCE MODEL
THREATS TO ENTRY
Above-average returns will always attract potential entrants into an industry.
Defending high profitability means there have to be barriers to entry.
Barriers to Entry:
 Economies of Scale
 Capital Requirements
 Product Differentiation, Strong Brands
 Distribution Channels
 Switching Costs
 Patents, location, government subsidies etc.

 Barriers to entry will depend on the technological features of the industry.

However firms can raise barriers to entry through their strategy by building
brand loyalty and raising switching costs.
INTENSITY OF RIVALRY
 What is the nature of competition: price or non-price? Price competition
tends to erode profits. Non-price competition is often consistent with
sustained profitability.
 Numerous, equally balanced competitors are more likely to compete
intensely
 Slow Industry growth intensifies rivalry
 Excess capacity: pressure to raise sales, firms can easily steal business from
rivals
 Lack of differentiation means that price is the main competitive variable
which intensifies rivalry
 Diversity of competitors may mean that firms are unable to analyse other
firms’ intentions and therefore make a price war more likely
 High exit barriers like highly specialized assets and long-term labour
agreements will help prolong rivalry
BARGAINING POWER OF BUYERS
 Bargaining power of buyers is high:
 If buyer purchases a large proportion of seller’s sales.
 Product it purchases are a significant proportion of buyer’s costs.
 Product is standardized and has few switching costs.
 Buyer is well-informed about demand, supplier costs etc.

 Backward integration can increase bargaining power of buyer.

e.g. retail sector backward integrating into FMCG or electronics
 Government is often an important buyer which can use bargaining
power to reduce prices. E.g. Pharmaceuticals
BARGAINING POWER OF SUPPLIERS
The following factors affect bargaining power of suppliers:
 If supplying industry is concentrated it will have more power. E.g.
aircraft manufacturing.
 Few substitutes for product that is being supplied
 If the industry isn’t important customer for supplier group
 Supplier group has a credible threat of forward integration

Labour must also be considered an important supplier.

Eg. Power of unions
THREATS OF SUBSTITUTES
 Competition comes not just from within the industry but from
products which perform the same function outside the industry.
 Sometimes the substitute may be quite different from the original
industry. E.g.... equity brokers face indirect competition from real
estate markets as an avenue for investment
Eg. Video-conferencing may be a substitute for business travel.
 Substitute products are especially important if:
a) They face favourable trends in terms of cost/performance
b) They are produced by an industry producing high profits
THREE STRATEGIES
 Porter identifies three strategies for coping with the five
forces:
 Cost Leadership
 Differentiation
 Focus

The first two are the most important and a fundamental

point of the Porter model is that there is a trade-off
between the two
COST LEADERSHIP
1. Economies of Scale
2. Cost minimization should be pursued systematically across different divisions:
R&D, sales, advertising etc
3. Intense supervision of labour
4. Ease of manufacture
5. Incentives based on quantitative targets

 Cost leadership provides protection from rivals because low-cost firm will earn
profits at lower prices giving it greater staying power in a price war
 Factors that provide low-cost leadership typically result in high barriers to entry
because of scale advantages

Risks from cost leadership strategy:

 Technological progress that nullifies learning
 Economic growth that creates demand for superior products
 Inability to adjust to innovation because of low R&D budgets
E.g. Ford and General Motor in 1920’s
DIFFERENTIATION
 Differentiation means creating a product or service
which is viewed industry-wide as being unique
 Differentiation can come through brand-image,
technology, customer service etc.
 This strategy requires strong marketing skills, R&D and
engineering skills and a reputation for quality
 Risks:

Price differentials become too large

Brand differentiation declines as industry matures and
buyers become more educated
POSSIBLE TO COMBINE THE TWO?
 A fundamental claim of the Porter model is that it is not
possible to combine cost leadership and differentiation (a
focus strategy is a possible exception)
 He argues that firms that do this will fall between two
stools and lose both the high-volume customers who
want low prices and customers who want high quality
 He also claims that firms that pursue both strategies will
suffer from conflicting and confused corporate culture
 E.g. Kmart which lies between cost-leader Walmart and
differentiator Target.
STRATEGY AND INDUSTRIAL
EVOLUTION
 Emerging industry:
Rules of the game are unwritten ; firms have significant leeway in strategic behaviour
Customers may be relatively unfamiliar with product
Product quality likely to be erratic

 Maturing industry
Buyers become more knowledgeable and perhaps more cost-conscious
Firm is growing at a much slower rate
International competition may increase
Profits fall and rivalry may increase

 Declining Industry
Of particular importance is the role of exit barriers which may keep a firm from exiting a
sub-performing industry. E.g. specialized assets, legal restrictions, prestige and
reputation etc.
STRATEGIC DECISIONS
 Big strategic decisions include whether to vertically integrate, which
new businesses to enter, how much to expand capacity.
 These decisions have a direct impact on the bottom line but also an
important indirect impact through the five forces and the generic
strategies
 E.g... vertical integration may lead to cost savings and provide cost
leadership and may also serve as a means of differentiation
 The threat to vertically integrate may affect bargaining power of
buyers and suppliers
 Entry in one market may affect rivalry in other markets
CRITIQUE OF THE PORTER MODEL
 Is there really a trade-off between low-cost and quality. Why can’t a firm provide both
through hybrid strategies?
E.g.... Blue Ocean strategy
 Porter model doesn’t have much to say about internal organization of the firm.

In contrast the resource-based view provides detailed analysis of the how the firm can
combine resources to create value
 Porter model focuses in rivalries between firms, suppliers,buyers rather than potential
co-operation.
 Porter model is industry-centric. How do you define an industry? In some industries
especially in the IT sector, competition comes from outside industry lines.
 Finally from the point of view of public policy, the Porter model may violate the
principles of a competitive economy. A successful strategy may involve pursuing high
returns by reducing the amount of competition