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Porter's Five Forces of Analysis

Porter five forces analysisFrom Wikipedia, the free encyclopedia[Question book-new.svg]
This article relies on references to primary sources. Please add references to secondary or tertiary sources. (October 2009)A graphical representation of Porter's Five ForcesPorter five forces analysis is a framework for industry analysis and business strategy development. It draws upon industrial organization (IO) 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.

Three of Porter's five forces refer to competition from external sources. The remainder are internal threats.

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 theircore competencies, business model or network to achieve a profit above the industry average. A clear example of this is the airlineindustry. 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.

This five forces analysis, is just one part of the complete Porter strategic models. The other elements are the value chain and the generic strategies.[citation needed]

Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis, which he found unrigorous and ad hoc.[1] 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.[2]

Contents  [hide] 1 History
2 Five forces

2.1 Threat of new entrants
2.2 Threat of substitute products or services
2.3 Bargaining power of customers (buyers)
2.4 Bargaining power of suppliers
2.5 Intensity of competitive rivalry

3 Usage
4 Criticisms
5 See also
6 References
7 Further reading
8 External links

History[edit]

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[edit]
Threat of new entrants[edit]

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 (perfect competition).

The existence of barriers to entry (patents, rights, etc.) 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.
Economies of product differences
Brand equity
Switching costs or sunk costs
Capital requirements
Expected retaliation
Access to distribution
Customer loyalty to established brands
Absolute cost
Industry profitability; the more profitable the industry the more attractive it will be to new competitors.

Threat of new entrants, sources. 1)Economies of scale, 2)Product differentiation, 3)Cost disadvantages independent of size, 4)Access to distribution channels, 5)Government Policy.

Threat of substitute products or services[edit]

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" (increase consumption of all soft drinks), albeit while giving Pepsi a larger slice at Coke's expense. Another example is the substitute of traditional phone with VoIP phone.

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. Information-based products are more prone to substitution, as online product can easily replace material product.
Substandard product
Quality depreciation

Bargaining power of customers (buyers)[edit]

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. e.g. firm can implement loyalty program to reduce the buyer power.

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 (uniqueness) of industry products
RFM (customer value) Analysis

Bargaining power of suppliers[edit]

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm, when there are few substitutes. Suppliers may refuse to work with the firm, or, e.g., charge excessively high prices for unique resources.

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 (e.g. labor unions)
Supplier competition - ability to forward vertically integrate and cut out the BUYER

E.g. if you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them.

Intensity of competitive rivalry[edit]

For most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the industry.

Sustainable competitive advantage through innovation
Competition between online and offline companies
Level of advertising expense
Powerful competitive strategy
Firm concentration ratio
Degree of transparency