Porter's Five Forces Overview
Structural Determinants of the Intensity of Competition
“The five competitive forces–entry, threat of substitution, bargaining power of buyers, bargaining power of suppliers, and rivalry among current competitors–reflect the fact that competition in an industry goes well beyond the established players.” … “Competition in this broader sense might be termed extended rivalry. All five competitive forces jointly determine the intensity of competition and profitability, and the strongest force or forces are governing and become crucial from the point of view of strategy formulation (Porter, 1980, p. 6)”.
1 - Threat of Entry
“New entrants to an industry bring new capacity, the desire to gain market share, and often substantial resources. Prices can be bid down or incumbents’ costs inflated as a result, reducing profitability. Companies diversifying through acquisition into the industry from other markets often use their resources to cause a shakeup … . Thus acquisition into an industry with intent to build market position should probably be viewed as entry even though no entirely new entity is created. The threat of entry into an industry depends on the barriers to entry that are present, coupled with the reaction from existing competitors that the entrant can expect. If barriers are high and/or the newcomer can expect sharp retaliation from entrenched competitors the threat of entry is low (Porter, 1980, p. 7).”
Barriers to entry (Porter, 1980):
· Economies of scale
· Product differentiation
· Capital requirements
· Switching costs
· Access to distribution channels
· Cost disadvantages independent of scale
o Proprietary product technology
o Favorable access to raw materials
o Favorable locations
o Government subsidies (and policies)
o Experience curve
2 - Intensity of Rivalry Among Existing Competitors
“Rivalry among existing competitors takes the familiar form of jockeying for position–using tactics like price competition, advertising battles, product introductions, and increased customer service or warranties. Rivalry occurs because one or more competitors either feels the pressure or sees the opportunity to improve position. In most industries, competitive moves by one firm have noticeable effects on its competitors and thus may incite retaliation or efforts to counter the move; that is, firms are mutually dependent (Porter, 1980, p. 17).”
Structural factors increasing rivalry:
· Numerous or equally balanced competitors
· Slow industry growth
· High fixed or storage costs
· Lack of differentiation or switching costs
· Capacity augmented in large increments
· Diverse competitors
· High strategic stakes
· High exit barriers
3 - Pressure from Substitute Products
“All firms in an industry are competing, in a broad sense, with industries producing substitute products. Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge. … Identifying substitute products is a matter of searching for other products that can perform the same function as the product of the industry. … Substitute products that deserve the most attention are those that (1) are subject to trends improving their price-performance tradeoff with the industry’s product, or (2) are produced by industries earning high profits (Porter, 1980, p. 23-24).”
4 - Bargaining Power of Buyers
“Buyers compete with the industry by forcing down prices, bargaining for higher quality or more services, and playing competitors against each other–all at the expense of industry profitability. The power of each of the industry’s important buyer groups depends on a number of characteristics of its market situation and on the relative importance of its purchases from the industry compared with its overall business (Porter, 1980, p. 24).”
Factors adding power to a buyer group:
· It is concentrated or purchases large volumes relative to seller sales
· The products it purchases from the industry represent a significant fraction of the buyer’s costs or purchases
· The products it purchases from the industry are standard or undifferentiated
· It faces few switching costs
· It earns low profits
· Buyers pose a credible threat of backward integration
· The industry’s product is unimportant to the quality of the buyers’ products or services
· The buyer has full information
5 - Bargaining Power of Suppliers
“Suppliers can exert bargaining power over participants in an industry by threatening to raise prices or reduce the quality of purchased goods or services. Powerful suppliers can thereby squeeze profitability out of an industry unable to recover cost increases in its own prices. … The conditions making suppliers powerful tend to mirror those making buyers powerful (Porter, 1980, p. 27).”
Factors adding power to a supplier group:
· It is dominated by a few companies and is more concentrated than the industry it sells to
· It is not obliged to contend with other substitute products for sale to the industry
· The industry is not an important customer of the supplier group
· The suppliers product is an important input to the buyer’s business
· The supplier group’s products are differentiated or it has built up switching costs
· The supplier group poses a credible threat of forward integration
Structural Analysis and Competitive Strategy
“An effective competitive strategy takes offensive or defensive action in order to create a defendable position against the five competitive forces. Broadly, this involves a number of possible approaches:
· positioning the firm so that its capabilities provide the best defense against the array of competitive forces;
· influencing the balance of forces through strategic moves, thereby improving the firm’s relative position; or
· anticipating shifts in the factors underlying the forces and responding to them, thereby exploiting change by choosing a strategy appropriate to the new competitive balance before rivals recognize it (Porter, 1980, pp. 29-30).”
Reference:
Porter, Michael E. (1980). Competitive strategy: Techniques for analyzing industries and competitors. New York: Free Press.
- R. S. Kulzick - 10/12/2003 -