5 - PORTER’S 5 FORCE MODEL

PORTER’S 5 FORCE MODEL FOR COMPETITIVE ENVIRONMENT

COMPETITION ANALYSIS

The purpose of Five-Forces Analysis

Five competitive forces collectively determine an industry’s long-term attractiveness.

The five forces are environmental forces that impact on a company’s ability to compete in a given market.

The purpose of five-forces analysis is to diagnose the principal competitive pressures in a market and assess how strong and important each one is.

Threat of

Substitute

Products

Threat of

Substitute

Products

Threat of New

EntrantsThreat of

New Entrants

Threat of New

Entrants

Rivalry Among

Competing Firms in Industry

Rivalry Among


Bargaining

Power of Buyers

Bargaining

Power of Buyers

Bargaining

Power of Supplier

s

Bargaining

Power of Supplier

s

Porter’s Five Forces Model of CompetitionPorter’s Five Forces Model of Competition

Threat of New

Entrants

Threat of New

EntrantsThreat of

New Entrants

Threat of New

Entrants


The greater is the threat of new entrants, lesser will be industry attractiveness.

Threat of New EntrantsThreat of New Entrants

Barriers to EntryBarriers to Entry

Expected Retaliation

Government Policy

Economies of Scale

Product Differentiation

Capital Requirements

Switching Costs

Access to Distribution Channels

Cost Disadvantages Independent of Scale

New Entrants: Barriers to Entry Economies of Scale

To the extent that there are economies of scale, it will be difficult for a new firm to come in and compete with established firms.

Product Differentiation To the extent that the firm’s products are

distinct and non-copiable, new firms won’t be able to come in and take away customers.

Brand Identification To the extent that there is brand

identification, customers will remember the firm’s product and will resist switching.

Switching Cost If it is costly for the customer to switch, new

entrants won’t be able to convince them to do so.

Access to Distribution Channels If the firm has preferential or monopolistic

access to distribution channels, it is more resistant to competition.

Capital Requirements If capital requirements are high, new under-

capitalized firms won’t be able to enter the industry.

Access to Latest Technology If technology is important in the industry,

new firms are less likely to have access to them, which is good for established firms.

Experience and Learning Effects If experience is necessary for a firm to

figure out how to operate efficiently, established firms have a distinct advantage.

New Entrants: Barriers to Entry

Barriers to Entry: Examples

Regulatory restrictions (e.g. banking license)

Brand names (e.g. Xerox, McDonalds – can develop customer loyalty; hard to develop and/or imitate)

Patents (illegal to exploit without ownership; e.g. new drugs ) A small co., NTP, had a patent on crucial

technology that was used for Blackberry Unique know-how (e.g. WalMart’s

technique of logistics management) Accumulated experience (of. learning

curve)

Bargaining

Power of Supplier

s

Bargaining

Power of Supplier

s

Threat of New

EntrantsThreat of

New Entrants

Threat of New

Entrants


Bargaining Power of SuppliersBargaining Power of Suppliers

Suppliers exert power in the industry by:

Suppliers exert power in the industry by:* Threatening to raise* Threatening to raiseprices or to reduce

qualityprices or to reduce quality

Powerful suppliers can squeeze industry profitability if firms are unable to recover cost increases

Powerful suppliers can squeeze industry profitability if firms are unable to recover cost increases

Suppliers are likely to be powerful if:

Supplier industry is dominated by a few firmsSuppliers’ products have few substitutesBuyer is not an important customer to supplier

Suppliers’ product is an important input to buyers’ productSuppliers’ products are differentiatedSuppliers’ products have high switching costs

Supplier poses credible threat of forward integration

Bargaining Power of Suppliers Number of Important Suppliers

The fewer the number of important suppliers, the more power they have over the firm, and the greater their ability to extract producer surplus.

Availability of Substitutes for the Suppliers’ Products This would reduce supplier power

Differentiation or Switching Costs of Suppliers’ Products If it’s difficult for the firm to switch to other

suppliers, the current suppliers can charge more Suppliers’ Threat of Forward Integration

To the extent that suppliers might potentially themselves become competitors, they are less reliable and need to be looked at strategically

Bargaining Power of Suppliers Industry Threat of Forward Integration

To what extent is it possible that the entire supplier industry might integrate forward?

Suppliers’ Contribution to Quality or Service of the Industry Products How crucial are suppliers in the maintenance

of the quality of industry products? Clearly, this will determine supplier power. Also, if this is an important factor, then the supplier industry might be more important, and might integrate forward.

Total Industry Cost Contributed by Suppliers This goes to the same issue as above, but

from a more quantitative perspective. Importance of the Industry to Suppliers’

Profits

Bargaining

Power of Buyers

Bargaining

Power of Buyers

Threat of New

EntrantsThreat of

New Entrants

Threat of New

Entrants

Bargaining

Power of Supplier

s

Bargaining

Power of Supplier

s


Bargaining Power of BuyersBargaining Power of Buyers

Buyers compete with the

supplying industry by:

Buyers compete with the

supplying industry by:

* Bargaining down prices* Bargaining down prices

* Forcing higher quality

* Forcing higher quality

* Playing firms off of

* Playing firms off ofeach othereach

other

Buyer groups are likely to be powerful if:

Buyers are concentrated or purchases are large relative to seller’s salesPurchase accounts for a significant fraction of supplier’s sales

Products are undifferentiated

Buyers face few switching costs

Buyers’ industry earns low profits

Buyer presents a credible threat of backward integration

Product unimportant to quality

Buyer has full information

Bargaining Power of Buyers Number of Important Buyers

The greater the number of important buyers, the less power does the firm have to manipulate prices

Availability of Substitutes for the Industry Products The impact of this on price elasticity of demand for

the industry’s products is obvious. Buyer’s Switching Costs

This is relevant both in terms of switching to competitors’ products and switching to products manufactured by other industries.

Buyer’s Threat of Backward Integration The buyer might choose to integrate backward and

manufacture his input goods, himself. This means that buyers have to be looked at strategically; they also have more power over the prices they are charged.

Bargaining Power of Buyers

Industry Threat of Backward Integration The entire buyer industry might integrate backward.

Contribution to Quality or Service of Buyer’s Products The greater the contribution of the firm’s product to

the quality of the product, the greater the power of the firm. On the other hand, this might also impel the buyer to integrate backward.

Total Buyer’s Cost Contributed by the Industry This is similar to the previous point, but in a more

quantitative fashion. Buyer’s Profitability

The more profitable buyers are, the more amenable they are to paying more for their input products.

Threat of

Substitute

Products

Threat of

Substitute

Products

Threat of New

EntrantsThreat of

New Entrants

Threat of New

Entrants

Bargaining

Power of Buyers

Bargaining

Power of Buyers

Bargaining

Power of Supplier

s

Bargaining

Power of Supplier

s


Threat of Substitute ProductsThreat of Substitute Products

Products with similar function limit the prices firms can charge

Products with similar function limit the prices firms can charge

Keys to evaluate substitute products:

Products with improving price/performance tradeoffs relative to present industry productsExample:

Electronic security systems in place of security guardsFax machines in place of overnight mail delivery

Threat of

Substitute

Products

Threat of

Substitute

Products

Threat of New

EntrantsThreat of

New Entrants

Threat of New

Entrants

Rivalry Among


Rivalry Among


Bargaining

Power of Buyers

Bargaining

Power of Buyers

Bargaining

Power of Supplier

s

Bargaining

Power of Supplier

s


Rivalry Among Existing Competitors


Intense rivalry often plays out in the following ways:Jockeying for strategic position

Using price competition

Staging advertising battles

Making new product introductions

Increasing consumer warranties or service

Occurs when a firm is pressured or sees an opportunityPrice competition often leaves the entire industry worse off

Advertising battles may increase total industry demand, but may be costly to smaller competitors

Cutthroat competition is more likely to occur when:



Numerous or equally balanced competitorsSlow growth industry

High fixed costs

Lack of differentiation

High switching costs

Capacity added in large increments

High strategic stakes

High exit barriers

Diverse competitors

Industry Competition:Rivalry Among Competitors

Concentration and Balance among Competitors To the extent that there is no single large competitor,

the firm is better off Industry Growth

If the industry is growing, there’s more room for everybody; less pressure on the firm

Fixed Cost The higher the operating leverage, the more

competitors are going to be hungry for revenue – downside risks are greater

Product Differentiation If products are differentiated, markets are in a sense,

segmented, and there are no competitors

Industry Competition:Rivalry Among Competitors

Intermittent Overcapacity The extent to which firms have overcapacity from

time to time, leading them to find additional sources of orders to keep resources fully employed.

Switching Costs The extent to which it’s easy for customers to switch

from this firm to other firms’ products will also determine how much other firms will exert themselves to get them to switch

Corporate Strategic Stakes If the strategic stakes are high – for example, if there

is only room for a few players, then firms will fight harder

The Five Forces are Unique to Your Industry

Five-Forces Analysis is a framework for analyzing a particular industry. Yet, the five forces affect all the other

businesses in that industry.

Competitor AnalysisCompetitor Analysis

The follow-up to Industry Analysis is effective analysis of

a firm’s Competitors

CompetitiveEnvironment

Industry Environment

Industry Environment

Competitor AnalysisCompetitor AnalysisAssumptions

What assumptions do our competitors hold about the future of industry and themselves?

Current StrategyDoes our current strategy support changes in the competitive environment?

Future ObjectivesHow do our goals compare to our competitors’ goals?

CapabilitiesHow do our capabilities compare to our competitors?

Response

ResponseWhat will our

competitors do in the future?

What will our competitors do in the future?

Where do we have a competitive advantage?

Where do we have a competitive advantage?

How will this change our relationship with our competition?


Future Objectives

Future ObjectivesHow do our goals

compare to our competitors’ goals?

How do our goals compare to our competitors’ goals?Where will emphasis be placed in the future?

Where will emphasis be placed in the future?What is the attitude toward risk?What is the attitude toward risk?

What Drives the competitor?


What is the competitor doing?

What can the competitor do?

Future Objectives





Current StrategyCurrent StrategyHow are we

currently competing?

How are we currently competing?Does this strategy support changes in the competitive structure?

Does this strategy support changes in the competitive structure?


What does the competitor believe about itself and the industry?

Future Objectives







How are we currently competing?Does this strategy support changes in the competition structure?

Does this strategy support changes in the competition structure?

Do we assume the future will be volatile?


Are we assuming stable competitive conditions?

Are we assuming stable competitive conditions?

What assumptions do our competitors hold about the industry and themselves?


Assumptions

Assumptions


What are the competitor’s capabilities?

Future Objectives











Are we operating under a status quo?




Assumptions

Assumptions

What are my competitors’ strengths and weaknesses?

What are my competitors’ strengths and weaknesses?How do our capabilities compare to our competitors?

How do our capabilities compare to our competitors?

Capabilities


Future Objectives















Assumptions

Assumptions

ResponseResponseWhat will our competitors do in the future?

What will our competitors do in the future?Where do we have a competitive advantage?

Where do we have a competitive advantage?How will this change our relationship with our competition?


Capabilities

CapabilitiesWhat are my

competitors’ strengths and weaknesses?

What are my competitors’ strengths and weaknesses?How do our capabilities compare to our competitors?

How do our capabilities compare to our competitors?


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5 - PORTER’S 5 FORCE MODEL