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Porter's Five Forces Model

The document discusses Porter's Five Forces model, which is a framework for analyzing competition within an industry. It identifies five competitive forces that determine the profitability of an industry: the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitute products, and the intensity of rivalry among existing competitors. The document uses examples from the airline industry to illustrate how each of these forces affects competition.

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70 views

Porter's Five Forces Model

The document discusses Porter's Five Forces model, which is a framework for analyzing competition within an industry. It identifies five competitive forces that determine the profitability of an industry: the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitute products, and the intensity of rivalry among existing competitors. The document uses examples from the airline industry to illustrate how each of these forces affects competition.

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Saba
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Porter’s Five Forces Model:

Porter’s Five Forces analysis is a framework that helps analyzing the level of competition within
a certain industry. It is especially useful when starting a new business or when entering a new
industry sector. According to this framework, competitiveness does not only come from
competitors. Rather, the state of competition in an industry depends on five basic forces: threat
of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitute
products or services, and existing industry rivalry. The collective strength of these forces
determines the profit potential of an industry and thus its attractiveness. If the five forces are
intense (e.g. airline industry), almost no company in the industry earns attractive returns on
investments. If the forces are mild however (e.g. soft drink industry), there is room for higher
returns. Each force will be elaborated on below with the aid of examples from the airline
industry to illustrate the usage.

The Five Forces are:

1. Bargaining power of buyers


2. Bargaining power of suppliers
3. Threat of new entrants
4. Threat of substitutes
5. Rivalry among existing competitors

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1. Threat of new entrants:
New entrants in an industry bring new capacity and the desire to gain market share. The seriousness
of the threat depends on the barriers to enter a certain industry. The higher these barriers to entry,
the smaller the threat for existing players. Examples of barriers to entry are the need for economies
of scale, high customer loyalty for existing brands, large capital requirements (e.g. large
investments in marketing or R&D), the need for cumulative experience, government policies, and
limited access to distribution channels. More barriers can be found in the table below.
Example
The threat of new entrants in the airline industry can be considered as low to medium. It takes
quite some upfront investments to start an airline company (e.g. purchasing aircrafts). Moreover,
new entrants need licenses, insurances, distribution channels and other qualifications that are not
easy to obtain when you are new to the industry (e.g. access to flight routes). Furthermore, it can
be expected that existing players have built up a large base of experience over the years to cut costs
and increase service levels. A new entrant is likely to not have this kind of expertise, therefore
creating a competitive disadvantage right from the start.

2. Bargaining power of suppliers:


This force analyzes how much power and control a company’s supplier (also known as the market
of inputs) has over the potential to raise its prices or to reduce the quality of purchased goods or
services, which in turn would lower an industry’s profitability potential. The concentration of
suppliers and the availability of substitute suppliers are important factors in determining supplier
power. The fewer there are, the more power they have.

Example
The bargaining power of suppliers in the airline industry can be considered very high. When
looking at the major inputs that airline companies need, we see that they are especially dependent
on fuel and aircrafts. These inputs however are very much affected by the external environment
over which the airline companies themselves have little control. The price of aviation fuel is subject
to the fluctuations in the global market for oil, which can change wildly because of geopolitical
and other factors. In terms of aircrafts for example, only two major suppliers exist: Boeing and
Airbus. Boeing and Airbus therefore have substantial bargaining power on the prices they charge.

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3. Bargaining power of buyers:
The bargaining power of buyers is also described as the market of outputs. This force analyzes to
what extent the customers are able to put the company under pressure, which also affects the
customer’s sensitivity to price changes. The customers have a lot of power when there aren’t many
of them and when the customers have many alternatives to buy from.

Example
Bargaining power of buyers in the airline industry is high. Customers are able to check prices of
different airline companies fast through the many online price comparisons websites such as Sky
scanner and Expedia.

4. Threat of substitute products:


The existence of products outside of the realm of the common product boundaries increases the
propensity of customers to switch to alternatives. In order to discover these alternatives one should
look beyond similar products that are branded differently by competitors. Instead, every product
that serves a similar need for customers should be taken into account.

Example

Energy drink like Redbull for instance is usually not considered a competitor of coffee brands such
as Nespresso or Starbucks.

5. Rivalry among existing competitors:


This last force of the Porter’s Five Forces examines how intense the current competition is in the
market place, which is determined by the number of existing competitors and what each competitor
is capable of doing. Rivalry is high when there are a lot of competitors that are roughly equal in
size and power, when the industry is growing slowly and when consumers can easily switch to a
competitors offering for little cost. A good indicator of competitive rivalry is the concentration
ratio of an industry. The lower this ration, the more intense rivalry will probably be.
Example
When looking at the airline industry in the United States, we see that the industry is extremely
competitive because of a number of reasons which include the entry of low cost carriers, the tight

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regulation of the industry wherein safety become paramount leading to high fixed costs and high
barriers to exit, and the fact that the industry is very stagnant in terms of growth at the moment.

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