Porter five forces analysis is a framework to analyse level of competition within an
industry and business strategy development.
It draws upon industrial organization economics to derive five 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 in which the combination of these five forces acts
to drive down overall profitability.
A very unattractive industry would be one approaching "pure competition", in which available
profits for all firms are driven to normal profit.
This analysis is associated with its principal innovator Michael E. Porter of Harvard University.
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 business unit to re-assess the marketplace
given the overall change in industry information.
The overall industry attractiveness does not imply that every firm in the industry will
return the same profitability.
Firms are able to apply their core competencies, business model or network to achieve a profit
above the industry average.
A clear example of this is the airline industry.
As an industry, profitability is low and yet individual companies, by applying unique business
models, have been able to make a return in excess of the industry average.
Porter's five forces include - three forces from 'horizontal' competition: the threat
of substitute products or services, the threat of established rivals, and the threat of new
entrants; and two forces from 'vertical' competition: the bargaining power of suppliers and the
bargaining power of customers.
Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis,
which he found unrigorous and ad hoc.
Porter's five forces is based on the Structure-Conduct-Performance paradigm in industrial organizational economics.
It has been applied to a diverse range of problems, from helping businesses become more
profitable to helping governments stabilize industries.
Other Porter strategic frameworks include the value chain and the generic strategies.
History Porter five forces analysis is a framework
for industry analysis and business strategy development formed by Michael E. Porter of
Harvard Business School in 1979.
Five forces Threat of new entrants
Profitable markets that yield high returns will attract new firms.
This results in many new entrants, which eventually will decrease profitability for all firms
in the industry.
Unless the entry of new firms can be blocked by incumbents, the abnormal profit rate will
trend towards zero.
The following factors can have an effect on how much of a threat new entrants may pose:
The existence of barriers to entry.
The most attractive segment is one in which entry barriers are high and exit barriers
are low.
Few new firms can enter and non-performing firms can exit easily.
Government policy Capital requirements
Absolute cost Cost disadvantages independent of size
Economies of scale Economies of product differences
Product differentiation Brand equity
Switching costs or sunk costs Expected retaliation
Access to distribution Customer loyalty to established brands
Industry profitability Threat of substitute products or services
The existence of products outside of the realm of the common product boundaries increases
the propensity of customers to switch to alternatives.
For example, tap water might be considered a substitute for Coke, whereas Pepsi is a
competitor's similar product.
Increased marketing for drinking tap water might "shrink the pie" for both Coke and Pepsi,
whereas increased Pepsi advertising would likely "grow the pie", albeit while giving
Pepsi a larger slice at Coke's expense.
Another example is the substitute of traditional phone with VoIP phone.
Potential factors: Buyer propensity to substitute
Relative price performance of substitute Buyer switching costs
Perceived level of product differentiation Number of substitute products available in
the market Ease of substitution
Substandard product Quality depreciation
Bargaining power of customers The bargaining power of customers is also
described as the market of outputs: the ability of customers to put the firm under pressure,
which also affects the customer's sensitivity to price changes.
Firms can take measures to reduce buyer power, such as implementing a loyalty program.
The buyer power is high if the buyer has many alternatives.
Potential factors: Buyer concentration to firm concentration
ratio Degree of dependency upon existing channels
of distribution Bargaining leverage, particularly in industries
with high fixed costs Buyer switching costs relative to firm switching
costs Buyer information availability
Force down prices Availability of existing substitute products
Buyer price sensitivity Differential advantage of industry products
RFM Analysis The total amount of trading
Bargaining power of suppliers The bargaining power of suppliers is also
described as the market of inputs.
Suppliers of raw materials, components, labor, and services to the firm can be a source of
power over the firm when there are few substitutes.
If you are making biscuits and there is only one person who sells flour, you have no alternative
but to buy it from them.
Suppliers may refuse to work with the firm or charge excessively high prices for unique
resources.
Potential factors: Supplier switching costs relative to firm
switching costs Degree of differentiation of inputs
Impact of inputs on cost or differentiation Presence of substitute inputs
Strength of distribution channel Supplier concentration to firm concentration
ratio Employee solidarity
Supplier competition: the ability to forward vertically integrate and cut out the buyer.
Intensity of competitive rivalry For most industries the intensity of competitive
rivalry is the major determinant of the competitiveness of the industry.
Potential factors: Sustainable competitive advantage through
innovation Competition between online and offline companies
Level of advertising expense Powerful competitive strategy
Firm concentration ratio Degree of transparency
Usage 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 "checklist."
They might use "Value Chain" afterward.
Like all general frameworks, an analysis that uses it to the exclusion of specifics about
a particular situation is considered naїve.
According to Porter, the five forces model should be used at the line-of-business industry
level; it is not designed to be used at the industry group or industry sector level.
An industry is defined at a lower, more basic level: a market in which similar or closely
related products and/or services are sold to buyers.
A firm that competes in a single industry should develop, at a minimum, one five forces
analysis for its industry.
Porter makes clear that for diversified companies, the first fundamental issue in corporate strategy
is the selection of industries in which the company should compete; and each line of business
should develop its own, industry-specific, five forces analysis.
The average Global 1,000 company competes in approximately 52 industries.
Criticisms Porter's framework has been challenged by
other academics and strategists such as Stewart Neill.
Similarly, the likes of ABC, Kevin P. Coyne [1] and Somu Subramaniam have stated that
three dubious assumptions underlie the five forces:
That buyers, competitors, and suppliers are unrelated and do not interact and collude.
That the source of value is structural advantage.
That uncertainty is low, allowing participants in a market to plan for and respond to competitive
behavior.
An important extension to Porter was found in the work of Adam Brandenburger and Barry
Nalebuff of Yale School of Management in the mid-1990s.
Using game theory, they added the concept of complementors, helping to explain the reasoning
behind strategic alliances.
The idea that complementors are the sixth force has often been credited to Andrew Grove,
former CEO of Intel Corporation.
According to most references, the sixth force is government or the public.
Martyn Richard Jones, whilst consulting at Groupe Bull, developed an augmented 5 forces
model in Scotland in 1993.
It is based on Porter's model and includes Government as well as Pressure Groups as the
notional 6th force.
This model was the result of work carried out as part of Groupe Bull's Knowledge Asset
Management Organisation initiative.
Porter indirectly rebutted the assertions of other forces, by referring to innovation,
government, and complementary products and services as "factors" that affect the five
forces.
It is also perhaps not feasible to evaluate the attractiveness of an industry independent
of the resources a firm brings to that industry.
It is thus argued that this theory be coupled with the Resource-Based View in order for
the firm to develop a much more sound strategy.
It provides a simple perspective for accessing and analyzing the competitive strength and
position of a corporation, business or organization.
See also National Diamond
Value chain Porter's four corners model
Industry classification Nonmarket forces
References
Further reading Coyne, K.P. and Sujit Balakrishnan,Bringing
discipline to strategy, The McKinsey Quarterly, No.4.
Porter, M.E..
"How Competitive Forces Shape Strategy".
Harvard Business Review.
Porter, M.E.
Competitive Strategy, Free Press, New York, 1980.
Porter, M.E.
The Five Competitive Forces That Shape Strategy, Harvard business Review, January 2008.
Ireland, Hoskisson, Understanding Business Strategy.
SOUTH WESTERN.
Rainer and Turban, Introduction to Information Systems, Wiley, 2009, pp 36–41.
Kotler Philip, Marketing Management, Prentice-Hall, Inc. 1997
Mintzberg, Ahlstrand and Lampel,Strategy Safari 1998.
External links