Porter 5 forces analysis

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Porter's 5 forces analysis is a framework for the industry analysis and business strategy development developed by Michael E. Porter of Harvard Business School in 1979 . It uses concepts developed in Industrial Organization (IO) economics to derive 5 forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. An "unattractive" industry is one where the combination of forces acts to drive down overall profitability. A very unattractive industry would be one approaching "pure competition". Porter referred to these forces as the micro environment, to contrast it with the more general term macro environment. They consist of those forces close to a company that affect its ability to serve its customers and make a profit. A change in any of the forces normally requires a company to re-assess the marketplace. The overall industry attractiveness does not imply that every firm operating in the industry will return the same profitability. Firms are able to apply their uniqueness in resource, business model or network to achieve a profit above the industry average. A clear example of this being the airline industry. As an industry profitability is low (and since the dawn of flight the entire industry has failed to make a profit!) and yet individual companies by applying unique business models (Ryanair for instance) have been able to make a return in excess of the industry average.

Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a firm's strategic position. However, for most consultants, the framework is only a starting point or 'check-list' they might use. Like all general frameworks, an analysis that uses it to the exclusion of specificities about a particular situation is considered naive.

Porter's Five Forces include three forces from 'horizontal' competition: threat of substitute products, the threat of established rivals, and the threat of new entrants; and two forces from 'vertical' competition: the bargaining power of suppliers, bargaining power of customers.

Each of these forces has several determinants:

A graphical representation of Porter's Five Forces
A graphical representation of Porter's Five Forces


Contents

[edit] Model/framework

The threat of substitute products
The existence of close substitute products increases the propensity of customers to switch to alternatives in response to price increases (high elasticity of demand).

  • buyer propensity to substitute
  • relative price performance of substitutes
  • buyer switching costs
  • perceived level of product differentiation

The threat of the entry of new competitors
Profitable markets that yield high returns will draw firms. The results is many new entrants, which will effectively decrease profitability. Unless the entry of new firms can be blocked by incumbents, the profit rate will fall towards a competitive level (perfect competition).

The intensity of competitive rivalry
For most industries, this is the major determinant of the competitiveness of the industry. Sometimes rivals compete aggressively and sometimes rivals compete in non-price dimensions such as innovation, marketing, etc.

  • number of competitors
  • rate of industry growth
  • intermittent industry overcapacity
  • exit barriers
  • diversity of competitors
  • informational complexity and asymmetry
  • fixed cost allocation per value added
  • level of advertising expense
  • Economies of scale
  • Sustainable competitive advantage through improvisation


The bargaining power of customers
Also described as the market of outputs. The ability of customers to put the firm under pressure and it also affects the customer's sensitivity to price changes.

  • buyer concentration to firm concentration ratio
  • bargaining leverage, particularly in industries with high fixed costs
  • buyer volume
  • buyer switching costs relative to firm switching costs
  • buyer information availability
  • ability to backward integrate
  • availability of existing substitute products
  • buyer price sensitivity
  • differential advantage (uniqueness) of industry products
  • RFM Analysis

The bargaining power of suppliers
Also described as market of inputs. Suppliers of raw materials, components, and services (such as expertise) to the firm can be a source of power over the firm. Suppliers may refuse to work with the firm, or e.g. charge excessively high prices for unique resources.

  • supplier switching costs relative to firm switching costs
  • degree of differentiation of inputs
  • presence of substitute inputs
  • supplier concentration to firm concentration ratio
  • threat of forward integration by suppliers relative to the threat of backward integration by firms
  • cost of inputs relative to selling price of the product

This 5 forces analysis is just one part of the complete Porter strategic models. The other elements are the value chain and the generic strategies.

[edit] References

  • Brandenburger, A.M. and Nalebuff, B.J. (1995), "The Right Game: Use Game Theory to Shape Strategy", Harvard Business Review, Jul-Aug, pp.57-71
  • Coyne, K.P. and Sujit Balakrishnan (1996), "Bringing discipline to strategy", The McKinsey Quarterly, No.4
  • Grant, R.M. (2005), "Contemporary Strategy Analysis", Blackwell Publishing Ltd., Oxford (U.K.), 2005
  • Porter, M.E. (1979) "How competitive forces shape strategy", Harvard Business Review, March/April 1979.
  • Porter, M.E. (1980) "Competitive Strategy", The Free Press, New York, 1980.
  • Porter, M.E. (1985) "Competitive Advantage", The Free Press, New York, 1985.
  • Hunger, J. David & Wheelen, Thomas L. (2003) "Essentials of Strategic Management". New Jersey: Pearson Education Inc.
  • McGahan, A. (2004) "How Industries Evolve - Principles for Achieving and Sustaining Superior Performance". Harvard Business School Press, Boston, 2004

[edit] See also

[edit] External links