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