Porter’s 5 forces analysis (Strategic Management)

Porter’s Five Forces Framework helps identify the attractiveness of an industry in terms of five competitive forces:

• The threat of entry.
• The threat of substitutes.
• The bargaining power of buyers.
• The bargaining power of suppliers and.
• The extent of rivalry between competitors.

The five forces constitute an industry’s ‘structure’.

Rivalry between existing competitors

Competitive rivals are organisations with similar products and services aimed at the same customer group and are direct competitors in the same industry/market (distinct from substitutes).

The degree of rivalry depends on:

• Competitor concentration and balance.
• Industry growth rate.
• High fixed costs.
• High exit barriers.
• Low differentiation.

The threat of entry

Barriers to entry are the factors that need to be overcome by new entrants if they are to compete. The threat of entry is low when the barriers to entry are high and vice versa.

The main barriers to entry are:

• Economies of scale/Experience/Network effects.
• Access to supply and distribution channels.
• Differentiation and market penetration costs.
• Legislation or government restrictions (e.g. licensing).
• Expected retaliation.
• Incumbency advantages.

The threat of substitutes

Substitutes are products or services that offer a similar benefit to an industry’s products or services, but have a different nature i.e. they are from outside the industry.

Customers will switch to alternatives (and thus the threat increases) if:

• The price/performance ratio of the substitute is superior (e.g. aluminium is more expensive than steel but it is more cost efficient for car parts)
• The substitute benefits from an innovation that improves customer satisfaction (e.g. high speed trains can be quicker than airlines from city centre to city centre on short haul routes).
• Extra-industry effects. Substitutes come from outside the incumbents’ industry which forces managers to look outside their own industry to consider more distant threats and constraints.

The bargaining power of buyers

Buyers are the organisation’s immediate customers, not necessarily the ultimate consumers. If buyers are powerful, then they can demand cheap prices or product/service improvements to reduce profits. Buyer power is likely to be high when:

• Buyers are concentrated.
• Buyers have low switching costs.
• Buyers can supply their own inputs (backward vertical integration).
• Low buyer profits (under pressure to improve profits) and the purchased inputs have a low impact on quality (can cut costs without loss of quality).

The bargaining power of suppliers

Suppliers are those who supply what organisations need to produce the product or service. Powerful suppliers can reduce an organisation’s profits. Supplier power is likely to be high when:

• The suppliers are concentrated (few of them).
• Suppliers provide a specialist or rare input.
• Switching costs are high (it is disruptive or expensive to change suppliers).
• Suppliers can integrate forwards (e.g. low-cost airlines have cut out the use of travel agents).

Complementors

Demand complementors: An organisation is your complementor if it enhances your business attractiveness to customers. (E.g. app suppliers are complementors to smartphone producers).

Supply complementors: An organisation is a complementor with respect to suppliers if it is more attractive for a supplier to deliver when it also supplies the other organisation. (E.g. a competing airline can be a complementor with respect to a supplier like Boeing – as Boeing may invest more in improvements if they are supplying both airlines).

Implications of five forces analysis

Which industries/markets to enter or leave? – it helps identify the attractiveness of industries.

What influence can be exerted? Identifies strategies that can influence the impact of the five forces. E.g. building barriers to entry by becoming more vertically integrated.

The forces may have a different impact on different organisations. E.g. large firms can deal with barriers to entry more easily than small firms.

Issues in five forces analysis

Defining the ‘right’ industry. Applying the model at the most appropriate level – not necessarily the whole industry. E.g. the European low-cost airline industry rather than airlines globally.

Converging industries – particularly in the high tech arenas – where industries overlap (e.g. digital industries – mobile phones/cameras/mp3 players).

Complementary organisations – which enhance the attractiveness of a business to customers or suppliers. Microsoft Windows and McAfee computer security systems are complementors. This can almost be considered as a sixth force.

Academic Questions: Porter’s 5 forces analysis (Strategic Management)

Q) Geely, a Chinese automotive major wishes to enter into India to offer its automotive brands in the Indian market.
A) Perform Porter’s 5 forces analysis. (5 Marks)
B) Based on Porter’s 5 forces analysis, suggest whether the company should enter into India or not. Suggest the reasons behind entry or non-entry into the Indian market. (5 Marks)

Answer:
Porter’s Five Forces Framework is a tool for analyzing competition of a business. It draws from industrial organization (IO) economics to derive five forces that determine the competitive intensity and, therefore, the attractiveness (or lack of it) of an industry in terms of its profitability.

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