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Strategic management - Porter model - handout

Porter's five forces model is a framework for analyzing the competitive forces within an industry to assess its profitability and structure. The five forces include the threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitutes, and rivalry among existing competitors, each influencing the competitive landscape. This model aids strategists in evaluating their competitive position and formulating effective strategies based on the analysis of these forces.

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28 views5 pages

Strategic management - Porter model - handout

Porter's five forces model is a framework for analyzing the competitive forces within an industry to assess its profitability and structure. The five forces include the threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitutes, and rivalry among existing competitors, each influencing the competitive landscape. This model aids strategists in evaluating their competitive position and formulating effective strategies based on the analysis of these forces.

Uploaded by

zakaria ah
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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 model is an analysis tool that uses five industry forces to determine the intensity
of competition in an industry and its profitability level

Five forces model was created by M. Porter in 1979 to understand how five key competitive forces
are affecting an industry. The five forces identified are:

These forces determine an industry structure and the level of competition in that industry. The
stronger competitive forces in the industry are the less profitable it is. An industry with low barriers
to enter, having few buyers and suppliers but many substitute products and competitors will be seen
as very competitive and thus, not so attractive due to its low profitability.
It is every strategist’s job to evaluate company’s competitive position in the industry and to identify
what strengths or weakness can be exploited to strengthen that position. The tool is very useful in
formulating firm’s strategy as it reveals how powerful each of the five key forces is in a particular
industry.

Threat of new entrants. This force determines how easy (or not) it is to enter a particular industry. If
an industry is profitable and there are few barriers to enter, rivalry soon intensifies. When more
organizations compete for the same market share, profits start to fall. It is essential for existing
organizations to create high barriers to enter to deter new entrants. Threat of new entrants is high
when:

 Low amount of capital is required to enter a market;


 Existing companies can do little to retaliate;
 Existing firms do not possess patents, trademarks or do not have established brand
reputation;
 There is no government regulation;
 Customer switching costs are low (it doesn’t cost a lot of money for a firm to switch to other
industries);
 There is low customer loyalty;
 Products are nearly identical;
 Economies of scale can be easily achieved.

Bargaining power of suppliers. Strong bargaining power allows suppliers to sell higher priced or low
quality raw materials to their buyers. This directly affects the buying firms’ profits because it has to
pay more for materials. Suppliers have strong bargaining power when:
 There are few suppliers but many buyers;
 Suppliers are large and threaten to forward integrate;
 Few substitute raw materials exist;
 Suppliers hold scarce resources;
 Cost of switching raw materials is especially high.

Bargaining power of buyers. Buyers have the power to demand lower price or higher product quality
from industry producers when their bargaining power is strong. Lower price means lower revenues
for the producer, while higher quality products usually raise production costs. Both scenarios result
in lower profits for producers. Buyers exert strong bargaining power when:

 Buying in large quantities or control many access points to the final customer;
 Only few buyers exist;
 Switching costs to other supplier are low;
 They threaten to backward integrate;
 There are many substitutes;
 Buyers are price sensitive.

Threat of substitutes. This force is especially threatening when buyers can easily find substitute
products with attractive prices or better quality and when buyers can switch from one product or
service to another with little cost. For example, to switch from coffee to tea doesn’t cost anything,
unlike switching from car to bicycle.

Rivalry among existing competitors. This force is the major determinant on how competitive and
profitable an industry is. In competitive industry, firms have to compete aggressively for a market
share, which results in low profits. Rivalry among competitors is intense when:

 There are many competitors;


 Exit barriers are high;
 Industry of growth is slow or negative;
 Products are not differentiated and can be easily substituted;
 Competitors are of equal size;
 Low customer loyalty.

Although, Porter originally introduced five forces affecting an industry, scholars have suggested
including the sixth force: complements. Complements increase the demand of the primary product
with which they are used, thus, increasing firm’s and industry’s profit potential. For example, iTunes
was created to complement iPod and added value for both products. As a result, both iTunes and
iPod sales increased, increasing Apple’s profits.

Using the tool

We now understand that Porter’s five forces framework is used to analyze industry’s competitive
forces and to shape organization’s strategy according to the results of the analysis. But how to use
this tool? You can follow these steps:

 Step 1. Gather the information on each of the five forces


 Step 2. Analyze the results and display them on a diagram
 Step 3. Formulate strategies based on the conclusions

Step 1. Gather the information on each of the five forces. What managers should do during this step
is to gather information about their industry and to check it against each of the factors (such as
“number of competitors in the industry”) influencing the force. The most important factors are listed
in the table below.

Porter's Five Forces Factors:

Threat of new entry

 Amount of capital required


 Retaliation by existing companies
 Legal barriers (patents, copyrights, etc.)
 Brand reputation
 Product differentiation
 Access to suppliers and distributors
 Economies of scale
 Sunk costs
 Government regulation

Supplier power

 Number of suppliers
 Suppliers’ size
 Ability to find substitute materials
 Materials scarcity
 Cost of switching to alternative materials
 Threat of integrating forward

Buyer power

 Number of buyers
 Size of buyers
 Size of each order
 Buyers’ cost of switching suppliers
 There are many substitutes
 Price sensitivity
 Threat of integrating backward

Threat of substitutes

 Number of substitutes
 Performance of substitutes
 Cost of changing

Rivalry among existing competitors


 Number of competitors
 Cost of leaving an industry
 Industry growth rate and size
 Product differentiation
 Competitors’ size
 Customer loyalty
 Threat of horizontal integration
 Level of advertising expense

Step 2. Analyze the results and display them on a diagram. After gathering all the information, you
should analyze it and determine how each force is affecting an industry. For example, if there are
many companies of equal size operating in the slow growth industry, it means that rivalry between
existing companies is strong. Remember that five forces affect different industries differently so
don’t use the same results of analysis for even similar industries!

Step 3. Formulate strategies based on the conclusions. At this stage, managers should formulate
firm’s strategies using the results of the analysis For example, if it is hard to achieve economies of
scale in the market, the company should pursue cost leadership strategy. Product development
strategy should be used if the current market growth is slow and the market is saturated.

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