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Porters 5 Forces

1 Introduction
2 The Five Competitive Forces
2.1 Bargaining Power of Suppliers
2.2 Bargaining Power of Customers
2.3 Threat of New Entrants
2.4 Threat of Substitutes
2.5 Competitive Rivalry between Existing Players
3 Use of the Information form Five Forces Analysis
4 Influencing the Power of Five Forces
4.1 Reducing the Bargaining Power of Suppliers
4.2 Reducing the Bargaining Power of Customers
4.3 Reducing the Treat of New Entrants
4.4 Reducing the Threat of Substitutes
4.5 Reducing the Competitive Rivalry between Existing Players
5 Critique

competitive forces in a way that improves the


1 Introduction
position of the organization. Porters model
The model of the Five Competitive Forces was
supports analysis of the driving forces in an
developed by Michael E. Porter in his book
industry. Based on the information derived
„Competitive Strategy: Techniques for
from the Five Forces Analysis, management
Analyzing Industries and Competitors“ in 1980.
can decide how to influence or to exploit
Since that time it has become an important tool
particular characteristics of their industry.
for analyzing an organizations industry
structure in strategic processes.
2 The Five Competitive Forces
Porters model is based on the insight that a The Five Competitive Forces are typically
corporate strategy should meet the described as follows:
opportunities and threats in the organizations
external environment. Especially, competitive
strategy should base on and understanding of
industry structures and the way they change.
Porter has identified five competitive forces
that shape every industry and every market.
These forces determine the intensity of
competition and hence the profitability and
attractiveness of an industry. The objective of
corporate strategy should be to modify these

© Dagmar Recklies, 2001


Recklies Management Project GmbH § www.themanager.org
Tel. 0049/391/5975930 § Fax 0049/721/151235542 § mail: drecklies@themanagement.de
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Threat of
new
entrants

Competiti ve
rivalery wit hin Bargaining power
Bargaining power the industry of customers
of suppliers

Threat of
substitutes

• The buying industry hinders the


2.1 Bargaining Power of Suppliers
supplying industry in their development
The term 'suppliers' comprises all sources for (e.g. reluctance to accept new releases
inputs that are needed in order to provide of products),
goods or services. • The buying industry has low barriers to
Supplier bargaining power is likely to be high entry.
when:
In such situations, the buying industry often
• The market is dominated by a few large faces a high pressure on margins from their
suppliers rather than a fragmented source suppliers. The relationship to powerful
of supply, suppliers can potentially reduce strategic
• There are no substitutes for the particular options for the organization.
input,
• The suppliers customers are fragmented,
so their bargaining power is low, 2.2 Bargaining Power of Customers
• The switching costs from one supplier to Similarly, the bargaining power of customers
another are high, determines how much customers can impose
• There is the possibility of the supplier pressure on margins and volumes.
integrating forwards in order to obtain Customers bargaining power is likely to be
higher prices and margins. This threat is high when
especially high when • They buy large volumes, there is a
• The buying industry has a higher concentration of buyers,
profitability than the supplying industry, • The supplying industry comprises a large
• Forward integration provides economies number of small operators
of scale for the supplier, • The supplying industry operates with high
fixed costs,
© Dagmar Recklies, 2001
Recklies Management Project GmbH § www.themanager.org
Tel. 0049/391/5975930 § Fax 0049/721/151235542 § mail: drecklies@themanagement.de
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• The product is undifferentiated and can be • High switching costs for customers
replaces by substitutes, • Legislation and government action
• Switching to an alternative product is
relatively simple and is not related to high
costs, 2.4 Threat of Substitutes
• Customers have low margins and are price- A threat from substitutes exists if there are
sensitive, alternative products with lower prices of better
• Customers could produce the product performance parameters for the same
themselves, purpose. They could potentially attract a
• The product is not of strategical importance significant proportion of market volume and
for the customer, hence reduce the potential sales volume for
• The customer knows about the production existing players. This category also relates to
costs of the product complementary products.
• There is the possibility for the customer Similarly to the threat of new entrants, the treat
integrating backwards. of substitutes is determined by factors like
• Brand loyalty of customers,
• Close customer relationships,
• Switching costs for customers,
2.3 Threat of New Entrants • The relative price for performance of
The competition in an industry will be the substitutes,
higher, the easier it is for other companies to • Current trends.
enter this industry. In such a situation, new
entrants could change major determinants of
the market environment (e.g. market shares, 2.5 Competitive Rivalry between Existing
prices, customer loyalty) at any time. There is Players
always a latent pressure for reaction and This force describes the intensity of
adjustment for existing players in this industry. competition between existing players
The threat of new entries will depend on the (companies) in an industry. High competitive
extent to which there are barriers to entry. pressure results in pressure on prices,
These are typically margins, and hence, on profitability for every
• Economies of scale (minimum size single company in the industry.
requirements for profitable operations), Competition between existing players is likely
• High initial investments and fixed costs, to be high when
• Cost advantages of existing players due to • There are many players of about the same
experience curve effects of operation with size,
fully depreciated assets, • Players have similar strategies
• Brand loyalty of customers • There is not much differentiation between
• Protected intellectual property like patents, players and their products, hence, there is
licenses etc, much price competition
• Scarcity of important resources, e.g. • Low market growth rates (growth of a
qualified expert staff particular company is possible only at the
• Access to raw materials is controlled by expense of a competitor),
existing players, • Barriers for exit are high (e.g. expensive
• Distribution channels are controlled by and highly specialized equipment).
existing players,
• Existing players have close customer
relations, e.g. from long-term service
contracts,
© Dagmar Recklies, 2001
Recklies Management Project GmbH § www.themanager.org
Tel. 0049/391/5975930 § Fax 0049/721/151235542 § mail: drecklies@themanagement.de
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3 Use of the Information form Five


Forces Analysis
Five Forces Analysis can provide valuable Thus, Porters model of Five Competitive
information for three aspects of corporate Forces allows a systematic and structured
planning: analysis of market structure and competitive
situation. The model can be applied to
Statical Analysis: particular companies, market segments,
The Five Forces Analysis allows determining industries or regions. Therefore, it is necessary
the attractiveness of an industry. It provides to determine the scope of the market to be
insights on profitability. Thus, it supports analyzed in a first step. Following, all relevant
decisions about entry to or exit from and forces for this market are identified and
industry or a market segment. Moreover, the analyzed. Hence, it is not necessary to analyze
model can be used to compare the impact of all elements of all competitive forces with the
competitive forces on the own organization same depth.
with their impact on competitors. Competitors
may have different options to react to changes The Five Forces Model is based on
in competitive forces from their different microeconomics. It takes into account supply
resources and competences. This may and demand, complementary products and
influence the structure of the whole industry. substitutes, the relationship between volume of
production and cost of production, and market
structures like monopoly, oligopoly or perfect
Dynamical Analysis: competition.
In combination with a PEST-Analysis, which
reveals drivers for change in an industry, Five
Forces Analysis can reveal insights about the
potential future attractiveness of the industry. 4 Influencing the Power of Five Forces
Expected political, economical, socio- After the analysis of current and potential
demographical and technological changes can future state of the five competitive forces,
influence the five competitive forces and thus managers can search for options to influence
have impact on industry structures. these forces in their organization’s interest.
Useful tools to determine potential changes of Although industry-specific business models will
competitive forces are scenarios. limit options, the own strategy can change the
impact of competitive forces on the
organization. The objective is to reduce the
Analysis of Options: power of competitive forces.
With the knowledge about intensity and power
of competitive forces, organizations can The following figure provides some examples.
develop options to influence them in a way that They are of general nature. Hence, they have
improves their own competitive position. The to be adjusted to each organization’s specific
result could be a new strategic direction, e.g. a situation. The options of an organization are
new positioning, differentiation for competitive determined not only by the external market
products of strategic partnerships (see section environment, but also by its own internal
4). resources, competences and objectives.

© Dagmar Recklies, 2001


Recklies Management Project GmbH § www.themanager.org
Tel. 0049/391/5975930 § Fax 0049/721/151235542 § mail: drecklies@themanagement.de
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4.1 Reducing the Bargaining Power of 4.2 Reducing the Bargaining Power of
Suppliers Customers
• Partnering • Partnering
• Supply chain management • Supply chain management
• Supply chain training • Increase loyalty
• Increase dependency • Increase incentives and value added
• Build knowledge of supplier costs and • Move purchase decision away from price
methods • Cut put powerful intermediaries (go directly to
• Take over a supplier customer)

4.3 Reducing the Treat of New Entrants 4.4 Reducing the Threat of Substitutes
• Increase minimum efficient scales of • Legal actions
operations • Increase switching costs
• Create a marketing / brand image (loyalty as a • Alliances
barrier) • Customer surveys to learn about their
• Patents, protection of intellectual property preferences
• Alliances with linked products / services • Enter substitute market and influence from
• Tie up with suppliers within
• Tie up with distributors • Accentuate differences (real or perceived)
• Retaliation tactics

4.5 Reducing the Competitive Rivalry between


Existing Players
• Avoid price competition
• Differentiate your product
• Buy out competition
• Reduce industry over-capacity
• Focus on different segments
• Communicate with competitors

• In the economic sense, the model assumes


5 Critique a classic perfect market. The more an
Porter’s model of Five Competitive Forces has industry is regulated, the less meaningful
been subject of much critique. Its main insights the model can deliver.
weakness results from the historical context in • The model is best applicable for analysis of
which it was developed. In the early eighties, simple market structures. A comprehensive
cyclical growth characterized the global description and analysis of all five forces
economy. Thus, primary corporate objectives gets very difficult in complex industries with
consisted of profitability and survival. A major multiple interrelations, product groups, by-
prerequisite for achieving these objectives has products and segments. A too narrow focus
been optimization of strategy in relation to the on particular segments of such industries,
external environment. At that time, however, bears the risk of missing
development in most industries has been fairly important elements.
stable and predictable, compared with today’s • The model assumes relatively static market
dynamics. structures. This is hardly the case in today’s
In general, the meaningfulness of this model is dynamic markets. Technological
reduced by the following factors: breakthroughs and dynamic market
© Dagmar Recklies, 2001
Recklies Management Project GmbH § www.themanager.org
Tel. 0049/391/5975930 § Fax 0049/721/151235542 § mail: drecklies@themanagement.de
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entrants from start-ups or other industries


may completely change business models, Overall, Porters Five Forces Model has some
entry barriers and relationships along the major limitations in today’s market
supply chain within short times. The Five environment. It is not able to take into account
Forces model may have some use for later new business models and the dynamics of
analysis of the new situation; but it will markets. The value of Porters model is more
hardly provide much meaningful advice for that it enables managers to think about the
preventive actions. current situation of their industry in a
• The model is based on the idea of structured, easy-to-understand way – as a
competition. It assumes that companies try starting point for further analysis.
to achieve competitive advantages over
other players in the markets as well as over
suppliers or customers. With this focus, it
dos not really take into consideration
strategies like strategic alliances, electronic
linking of information systems of all
companies along a value chain, virtual
enterprise-networks or others.

© Dagmar Recklies, 2001


Recklies Management Project GmbH § www.themanager.org
Tel. 0049/391/5975930 § Fax 0049/721/151235542 § mail: drecklies@themanagement.de