Porter's Five Competitive Forces Analysis

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					This document discusses Michael Porter's Five Competitive Forces Analysis which is
used for assessing and analyzing the competitive strength and position of a corporation
or business organization. It draws upon industrial organization economics to derive five
forces that determine the competitive intensity and profitability of a market. This is a
simple yet powerful tool for understanding where power lies in a business situation. It
can be used to identify whether new products or services have potential to be profitable.
This document should be used by individuals in management positions of a company or
anyone interested in understanding competitive strategy for businesses.
Porter’s Five Competitive Force s Analysis

Porter’s Five
Competitive Forces
    Porter’s Five Competitive Force s Analysis

Table of Contents
Introduction ......................................................................................... 1
  About Michael Porter .......................................................................... 1

Porter's Five Forces............................................................................... 5
  Other Things Michael Porter is known for .............................................. 5

The Main Characteristics of Porter’s Five Forces Analysis ........................... 6
  Force 1: The Degree of Rivalry ............................................................ 6

  Force 2: The Threat of Entry ............................................................... 7

  Force 3: The Threat of Substitutes ....................................................... 8

  Force 4: Buyer Power ......................................................................... 8

  Force 5: Supplier Power ...................................................................... 9

  The Limitations of Porter’s Five Force Model ........................................ 10
      Porter’s Five Competitive Force s Analysis


      here is continuing interest in the study of the forces that impact on
      companies, particularly the forces that can be harnessed to provide a
      competitive advantage. The ideas and models that 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).1

About Michael Porter
      Michael Porter is an American who was born in 1947. After first
graduating in aeronautical engineering, Mr. Porter received an economics
doctorate at Harvard, where he was later honored with a university
professorship. Porter's famous Five Forces of Competitive Position model
presents a simple point of view for assessing and analyzing the competitive
strength and position of a corporation or business organization.
      Mr. Porter’s research group is based at the Harvard Business School.
He also co-founded the Foundation Strategy Group with Mark Kramer. This
foundation is 'a mission-driven social enterprise, dedicated to advancing the
practice of philanthropy and corporate social investments, through
consulting to foundations and corporations'. 2
       Porter's first book, Competitive Strategy (1980), which he wrote in his
thirties, became an international best seller. It is considered by many to be
an influential and definitive effort on corporate strategy. The book has been
published in nineteen languages and re-printed almost sixty times. It has
changed the way business leaders think, and internationally, it still is a guide
of choice for strategic managers.

      When he finished working on corporate strategy, Porter extended the
application of his ideas and theories to international economies and the
competitive positioning of entire nations. In 1985 Porter was appointed to
President Ronald Reagan's Commission on Industrial Competitiveness, which

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   Porter’s Five Competitive Force s Analysis

marked the widening of his perspective to national economies. By the 1990's
Porter had created a reputation as a strategy expert on the international
speaking circuit. He was among the world's highest earning academic
scholars, second only to Tom Peters.

       Aside from his innovative thinking, Porter has a special talent for
presenting complex concepts in formats that are fairly easy to access, as in
his Five Forces model. This model allows market factors to be analyzed and
strategic assessments of the competitive position of a given supplier in a
given market to be assessed.

      The model uses theories that were developed in Industrial
Organization (IO) economics to take from five forces that establish the
competitive intensity and the appeal of a market. In this context, appeal
refers to the overall industry profitability. An “unappealing” industry is one
where the combination of forces serves to drive down overall profitability. A
very unappealing industry would be one approaching “pure competition”.
      Michael Porter labeled the forces the micro environment, to contrast it
with the more general term of macro environment. They include the forces
that are close to a company, and that affect its capability to serve its
customers and make a profit as well. An alteration in any of the forces
generally mandates that a company re-assess the marketplace. The overall
industry appeal does not imply that every corporation in the industry will
have the same return on profits. Agencies are able to administer their core
competencies, business model or network so as to realize a profit that is
above the industry average.
      Occasionally strategists will use Porter’s five forces model to make
qualitative evaluations of an agency’s strategic posture.            For most
strategists, the model is simply a starting point, or check-list that they can
refer to. Like all general models, utilizing it to exclude the particulars or
specifics is viewed as naive.
   Porter’s Five Competitive Force s Analysis

      The five forces that Porter suggests drive competition include five
forces. Three forces result from ‘horizontal’ competition.

     1. Competitive Rivalry
        a. number and size of firms
        b. industry size and trends
        c. fixed v variable cost bases
        d. product/service ranges
        e. differentiation, strategy

     2. New Market Entrants
         a.   entry ease/barriers
         b.   geographical factors
         c.   incumbents resistance
         d.   new entrant strategy
         e.   routes to market             A graphical depiction of Porter's Five Forces

     3. Product & Technology Development
        a) alternatives price/quality      b) market distribution changes
        c) fashion and trends              d) legislative effects

        e) bidding
   Porter’s Five Competitive Force s Analysis

      And two forces are the result of ‘vertical’ competition:
      1. Supplier Power
         a) brand reputation                   b) geographical coverage
         c) product/service level quality      d) relationships            with
         e) bidding
      2. Buyer Power
         a) buyer choice                      b) buyers size/number
         c) change cost/frequency             d) product/service importance
         e) volumes, JIT scheduling

      According to Porter, the five forces model is not suited at the industry
group or industry sector level. It should be implemented at the industry
level. An industry is defined at a lower, more basic level. It is a market
comprised of similar or closely related products and/or services that are sold
to consumers.
      Agencies that compete in a single industry should devise at least one
five forces analysis for its industry. Porter clarifies that for diversified
agencies, the first basic issue in corporate strategy is the assortment of lines
of business in which the company should compete; and each line of business
should develop its own industry specific five forces analysis. The average
Global 1,000 Company will compete in roughly 52 different lines of business.
      This five forces analysis is only one component of all of the Porter
strategic models. The other parts are the value chain and the generic
strategies. Porter's Five Forces model can be used to good analytical effect
along with other models like the SWOT and PEST analysis tools.
   Porter’s Five Competitive Force s Analysis

Porter's Five Forces
      1. Existing competitive rivalry between suppliers

      2. Threat of new market entrants

      3. Bargaining power of buyers

      4. Power of suppliers

      5. Threat of substitute products (including technology change)

                                                A graphical depiction of Porter's Five Forces
      This five forces model usually is shown as a series of five boxes in a
cross formation, with item 1 being the central point. This particular diagram
depicts circles instead of boxes.
      Porter's Five Forces model provides suggested points under each main
heading, which you can use to develop a broad and complicated analysis of
competitive position, such as what might be used for creating strategy,
plans, or for making venture decisions regarding a business or organization.

Other Things Michael Porter is known for
      Porter is also known for his simple identification of five generic
descriptions of industries:
      1. Declining (solid fuels)
      2. Emerging (space travel)
      3. Fragmented (shoe repairs,
         gift shops)
      4. Global (micro-processors)
      5. Mature (automotive)

       Porter is also particularly
recognized    for  his    competitive
'diamond' model, used for assessing
relative competitive strength of
nations, and by implication their industries:
      1. Factor Conditions: production factors required for a given
         industry, e.g., skilled labor, logistics and infrastructure.
      2. Demand Conditions: extent and nature of demand within the
         nation concerned for the product or service.
   Porter’s Five Competitive Force s Analysis

       3. Related Industries: the existence, extent and international
          competitive strength of other industries in the nation concerned
          that support or assist the industry in question.
       4. Corporate Strategy, Structure and Rivalry: the conditions in the
          home market that affect how corporations are created, managed
          and grown; the idea being that firms that have to fight hard in their
          home market are more likely to be able to succeed in international

The Main Characteristics of Porter’s Five
Forces Analysis
      The original competitive forces model, that Porter proposed identified
five forces that would impact an organization’s behavior in a competitive
market. They are as follows:
          The rivalry between current or existing sellers in the market.
          The power exercised by the consumers in the market.
          The impact that the suppliers have on the sellers.
          The threat possibilities of new sellers entering the market.
          The danger of substitute products entering the market and
           becoming available.

      Understanding the nature of each of these forces gives companies the
insight they need that enables them to develop appropriate and relevant
strategies in order for them to be successful in their market (Thurlby, 1998).

Force 1: The Degree of Rivalry
       The intensity of the rivalry in an industry is the most obvious of the
five forces. It helps to determine the extent to which the value created by
an industry will be dissipated by head-to-head competition. The most
valuable contribution of Porter's “five forces” framework in this issue may be
its suggestion that rivalry, while important, is only one of several forces that
establishes industry appeal:
      This force is located at the centre of the diagram;
   Porter’s Five Competitive Force s Analysis

     Is most likely to be high in those industries where there is a threat of
      substitute products; and existing power of suppliers and buyers in the

Force 2: The Threat of Entry
      Prospective and existing competitors will both influence average
industry profitability. The threat of new entrants is usually based on the
market entry barriers. They can take assorted forms; and are used to thwart
an influx of companies into an industry whenever profits that have been
adjusted for the cost of capital rise above zero.
      In contrast, entry barriers are present whenever it is difficult or not
economically feasible for an outsider to replicate the incumbents’ position
(Porter, 1980b; Sanderson, 1998) The most common forms of entry
barriers, except intrinsic physical or legal obstacles, are:
     Economies of scale: for example, benefits associated with bulk
     Cost of entry: for example, speculations into technology;
     Distribution channels: for example, ease of access for competitors;
     Cost advantages that are not related to the size of the company: for
      example, contacts and expertise;
     Government legislations: for example, the introduction of new laws
      that might weaken a company’s competitive position;
     Differentiation:   for   example,   a   specific   brand   that   cannot   be
   Porter’s Five Competitive Force s Analysis

Force 3: The Threat of Substitutes
      The threat that substitute products pose to an industry's profitability
depends on the comparative price-to-performance ratios of the different
types of products or services that consumers can access in order to satisfy a
basic need that is the same. The threat of substitution is also affected by
changing costs, specifically the costs that are incurred when a customer
switches to a different type of product or service, and generally will affect
costs in areas like retraining, retooling and redesigning. It also involves:
     Product-for-product substitution (email for mail, fax); is based on the
      substitution of need;
     Generic substitution (Video suppliers compete with travel companies);
     Substitution that relates to products that people can do without like
      cigarettes or alcohol.

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
most important determinants of buyer power are the size and the
concentration of customers. Other factors are the extent to which the buyers
are informed and the concentration or differentiation of the competitors.
      Kippenberger (1998) states that it is often useful to distinguish
potential buyer power from the buyer's willingness or incentive to use that
power, willingness that derives mainly from the “risk of failure” associated
with a product's use.
     This force is relatively high where there a few, large players in the
      market, as is the circumstance with retailers and grocery stores;
     Present where there is a large number of small suppliers, that are all
      similar like small farming businesses that supply large grocery
     Low cost of changing between suppliers, like from one fleet supplier of
      trucks to another.

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   Porter’s Five Competitive Force s Analysis

Force 5: Supplier Power
       Supplier power is the mirror image of the buyer’s power. As such, the
analysis of supplier power generally will focus first on the comparative size
and concentration of suppliers relative to industry participants; and second
on the level of differentiation in the inputs that are supplied. The ability to
charge customers different prices that are in line with differences in the
value created for each of those buyers usually points out that the market is
characterized by high supplier power and at the same time, by low buyer
power (Porter, 1998). Bargaining power of suppliers exists in the following

      Where the changing costs are high (changing from one Internet
       provider to another);
      High power of brands (McDonalds, British Airways, Tesco);
      Possibility of forward integration of suppliers (Brewers buying bars);
      Fragmentation of customers (not in clusters) with a limited bargaining
       power (Gas/Petrol stations in remote places).
      The nature of competition in an industry is strongly affected by
suggested five forces. The stronger the power of buyers and suppliers, and
the stronger the threats of entry and substitution, the more intense
competition is likely to be within the industry. However, these five factors
are not the only ones that determine how firms in an industry will compete.
The composition of the industry itself can play an important role. Indeed, the
whole five-forces framework is based on an economic theory know as the
“Structure-Conduct-Performance” (SCP) model: the structure of an industry
determines organizations’ competitive behavior or conduct, which in turn
decides their profitability or performance.
       In concentrated industries, according to this model, companies would
be expected to compete less fiercely, and make higher profits, than in
fragmented ones. However, as Haberberg and Rieple (2001) state, the
histories and cultures of the firms in the industry also play a very important
role in shaping competitive behavior. The predictions of the SCP model will
have to be modified accordingly.
   Porter’s Five Competitive Force s Analysis

The Limitations of Porter’s Five Force Model
      Porter’s model is a strategic tool used to recognize whether new
products, services or businesses have the potential to be profitable. It can
also be very illuminating when used to understand the balance of power in
other situations. Porter argues that five forces determine the profitability of
an industry. At the heart of industry are rivals and their competitive
strategies linked to, for example, pricing or advertising. Porter contends,
however that it is important to look past one’s immediate competitors
because there are other determinations of profitability. Specifically, there
might be competition from substitute products or services.
      These alternatives can be viewed as substitutes by buyers even
though they are part of a different industry. An example would be plastic
bottles, cans and glass bottles for packaging soft drinks. There may also be
potential threat of new entrants, although some competitors will see this as
an opportunity to strengthen their position in the market by ensuring,
customer loyalty as best they can. Finally, it is important to appreciate that
company’s buy from suppliers and sell to buyers. If they are powerful, they
are in a position to bargain profits away through reduced margins, by forcing
either cost increases or price decreases. This relates to the strategic option
of vertical integration, when the company acquires, or merges with, a
supplier or customer for the purpose of gaining a greater control over the
chain of activities which leads from basic materials through to final
consumption (Luffman and et al., 1996; Wheelen and Hunger, 1998).
        It is important to note that this model has additional limitations in
today's market environment because it assumes relatively static market
structures. It is originally based on the economic situation of the nineteen-
eighties. With its strong competition and relatively stable market structures,
it is not able to take into account new business models and the dynamism of
these industries, like technological innovations and dynamic market entrants
from start-ups that will completely change business models within short
times. As an example, the computer and the software industry is often
viewed as being highly competitive. The industry structure is constantly
being revolutionized by innovation that indicates that the Five Forces model
is of limited value because it represents no more than snapshots of a moving
picture. Therefore, it is not advisable to develop a strategy solely on the
basis of Porter’s models (Kippenberger, 1998; Haberberg and Rieple, 2001),
      Porter’s Five Competitive Force s Analysis

but rather to examine it in addition to other strategic frameworks of SWOT
and PEST analysis.
      This does not mean that Porters theories have become invalid. What
needs to happen is that the model needs to be adopted with the
understanding of their limitations; and to use them as a part of a larger
framework of management tools, techniques and theories. This approach is
advisable when practically applying all business models (Recklies, 2001).3

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      Porter’s Five Competitive Force s Analysis

Description: This document discusses Michael Porter's Five Competitive Forces Analysis which is used for assessing and analyzing the competitive strength and position of a corporation or business organization. It draws upon industrial organization economics to derive five forces that determine the competitive intensity and profitability of a market. This is a simple yet powerful tool for understanding where power lies in a business situation. It can be used to identify whether new products or services have potential to be profitable. This document should be used by individuals in management positions of a company or anyone interested in understanding competitive strategy for businesses.
This document is also part of a package Effective Leadership Starter Kit 9 Documents Included