Porter Five Forces Model

Originally developed by Harvard Business School's Michael E.

Porter in 1979, the five forces model looks at five specific
factors that help determine whether or not a business can be
profitable, based on other businesses in the industry.
Porter wrote in a Harvard Business Review article. "A healthy
industry structure should be as much a competitive concern
to strategists as their companys own position."
 What are 'Porter's 5 Forces'
Porter's Five Forces model, named after Michael E. Porter,
identifies and analyzes five competitive forces that shape
every industry, and helps determine an industry's
weaknesses and strengths. These forces are:
1. Competition/Rivalry in the industry;
2. Potential of new entrants into the industry;
3. Power of suppliers;
4. Power of customers;
5. Threat of substitute products.
 BREAKING DOWN 'Porter's 5 Forces'

Competition/Rivalry in the Industry

The importance of this force is the number of competitors and
their ability to threaten a company. The larger the number of
competitors, along with the number of equivalent products and
services they offer, dictates the power of a company. Suppliers and
buyers seek out a company's competition if they are unable to
receive a suitable deal.
Potential of New Entrants Into an Industry
A company's power is also affected by the force of new entrants
into its market. The less money and time it costs for a competitor
to enter a company's market and be an effective competitor, the
more a company's position may be significantly weakened.

Power of Suppliers
This force addresses how easily suppliers can drive up the price of goods and
services. It is affected by the number of suppliers of key aspects of a good or
service, how unique these aspects are and how much it would cost a company to
switch from one supplier to another. The fewer number of suppliers, and the
more a company depends upon a supplier, the more power a supplier holds.
Power of Customers
This specifically deals with the ability customers have to drive prices down. It is
affected by how many buyers, or customers, a company has, how significant each
customer is and how much it would cost a customer to switch from one company
to another. The smaller and more powerful a client base, the more power it
holds.
Threat of Substitutes
Competitor substitutions that can be used in place of a company's products or
services pose a threat. For example, if customers rely on a company to provide a
tool or service that can be substituted with another tool or service or by
performing the task manually, and this substitution is fairly easy and of low cost,
a company's power can be weakened.

 What is rivalry?
Rivalry more..Profit????
Rivalry less.Profit?????
 In pursuing an advantage over its rivals, a firm can
choose from several competitive moves:
Changing prices - raising or lowering prices to gain a temporary advantage.
Improving product differentiation - improving features, implementing
innovations in the manufacturing process and in the product itself.
Creatively using channels of distribution - using vertical integration or
using a distribution channel that is novel to the industry. For example, with
high-end jewelry stores reluctant to carry its watches, Timex moved into
drugstores and other non-traditional outlets and cornered the low to mid-
price watch market.
Exploiting relationships with suppliers
 The intensity of rivalry is influenced by the following industry
characteristics
A larger number of firms. if the firms have similar market share, leading to
a struggle for market leadership.
Slow market growth causes firms to fight for market share. In a growing
market, firms are able to improve revenues simply because of the
expanding market.
High fixed costs. When total costs are mostly fixed costs, the firm must
produce near capacity to attain the lowest unit costs. Since the firm must
sell this large quantity of product, high levels of production lead to a fight
for market share and results in increased rivalry.
High storage costs or highly perishable products cause a producer to sell
goods as soon as possible. If other producers are attempting to unload at
the same time, competition for customers intensifies.
Low switching costs
Strategic stakes are high when a firm is losing market position or has
potential for great gains
 High exit barriers. High exit barriers cause a firm to remain in an industry,
even when the venture is not profitable
A diversity of rivals with different cultures, histories, and philosophies
make an industry unstable
Industry Shakeout. growing market/high profits .. introduces new firms
 Buyers are Powerful,if:

Buyers are concentrated - there are a few buyers with

significant market share
Buyers purchase a significant proportion of output
if the product is standardized
Buyers are Weak if:
producer can take over own distribution/retailing
Significant buyer switching costs
products not standardized
buyer cannot easily switch to another product
Buyers are fragmented/not united (many, different) - no buyer
has any particular influence on product or price
 Suppliers are Powerful if:
Suppliers concentrated/united
Less number of suppliers in the market
Proprietary item
Involves high-tech in production,which is not available in the
market by anyone.
Limited market
Highly valued item for the customer
Suppliers are Weak if:
Many competitive suppliers
product is standardized
Open market
Involves less tech in production that anyone can participate.
 Easy to Enter a market if there is:
Common technology
Little brand franchise
Access to distribution channels
Low scale threshold
Difficult to Enter a market if there is:
Patented or proprietary know-how
Difficulty in brand switching
Restricted distribution channels
High scale threshold
 Easy to Exit if there are:
Salable assets
Low exit costs
Independent businesses
Difficult to Exit if there are:
Specialized assets
High exit costs
Interrelated businesses
MARKETTINGEASY/DIFFICULT TO LEAVE?
MARKETTINGEASY/DIFFICULT TO LEAVE?
 Threat of new entrants. This force determines how easy (or not) it is to
enter a particular industry. If an industry is profitable and there are few
barriers to enter, rivalry soon intensifies. When more organizations
compete for the same market share, profits start to fall. It is essential for
existing organizations to create high barriers to enter to deter new
entrants. Threat of new entrants is high when:
Low amount of capital is required to enter a market;
Existing companies can do little to retaliate;
Existing firms do not possess patents, trademarks or do not have
established brand reputation;
There is no government regulation;
Customer switching costs are low (it doesnt cost a lot of money for a firm
to switch to other industries);
There is low customer loyalty;
Products are nearly identical;
 Bargaining power of suppliers. Strong bargaining
power allows suppliers to sell higher priced or
low quality raw materials to their buyers. This
directly affects the buying firms profits because
it has to pay more for materials. Suppliers have
strong bargaining power when:
There are few suppliers but many buyers;
Few substitute raw materials exist;
Suppliers hold scarce resources;
Cost of switching raw materials is especially high.
 Bargaining power of buyers. Buyers have the power to
demand lower price or higher product quality from industry
producers when their bargaining power is strong. Lower
price means lower revenues for the producer, while higher
quality products usually raise production costs. Both
scenarios result in lower profits for producers. Buyers exert
strong bargaining power when:
Buying in large quantities or control many access points to
the final customer;
Only few buyers exist;
Switching costs to other supplier are low;
There are many substitutes;
Buyers are price sensitive.
 Threat of substitutes. This force is especially
threatening when buyers can easily find
substitute products with attractive prices or
better quality and when buyers can switch
from one product or service to another with
little cost. For example, to switch from coffee
to tea doesnt cost anything, unlike switching
from car to bicycle.
 Rivalry among existing competitors. This force is the major
determinant on how competitive and profitable an industry
is. In competitive industry, firms have to compete
aggressively for a market share, which results in low profits.
Rivalry among competitors is intense when:
There are many competitors;
Exit barriers are high;
Industry of growth is slow or negative;
Products are not differentiated and can be easily
substituted;
Competitors are of equal size;
Low customer loyalty.
 Although, Porter originally introduced five forces
affecting an industry, scholars have suggested
including the sixth force: complements.
Complements increase the demand of the
primary product with which they are used, thus,
increasing firms and industrys profit potential.
For example, iTunes was created to complement
iPod and added value for both products. As a
result, both iTunes and iPod sales increased,
increasing Apples profits.
 Using the tool

Step 1. Gather the information on each of the

five forces
Step 2. Analyze the results and display them
on a diagram
Step 3. Formulate strategies based on the
conclusions
 STEP 1:INFO COLLECTION,Threat of new entry

Amount of capital required

Legal barriers (patents, copyrights, etc.)
Brand reputation
Product differentiation
Access to suppliers and distributors
Government regulation
 Supplier power

Number of suppliers
Suppliers size
Ability to find substitute materials
Materials scarcity
Cost of switching to alternative materials
 Buyer power

Number of buyers
Size of buyers
Size of each order
Buyers cost of switching suppliers
There are many substitutes
Price sensitivity
 Threat of substitutes

Number of substitutes
Performance of substitutes
Cost of changing
 Rivalry among existing competitors

Number of competitors
Cost of leaving an industry
Industry growth rate and size
Product differentiation
Competitors size
Customer loyalty
Level of advertising expense
Example
 Porter's Five Forces Evaluation
Threat of new entry
Large amount of capital required
High retaliation possible from existing companies, if new entrants would
bring innovative products and ideas to the industry
Few legal barriers protect existing companies from new entrants
All automotive companies have established brand image and reputation
Products are mainly differentiated by design and engineering quality
A firm has to produce at least 5 million (by some estimations) vehicles to
be cost competitive, therefore it is very hard to achieve economies of
scale
Governments often protect their home markets by introducing high
import taxes
EASY/DIFFICULT ENTRY??????
 Supplier power
Large number of suppliers
Some suppliers are large but the most of them
are pretty small
Companies use another type of material (use
one metal instead of another) but only to
some extent (plastic instead of metal)
Materials widely accessible
WEAK/STRONG SUPPLIER??????
 Buyer power
There are many buyers
Most of the buyers are individuals that buy one car, but
corporates or governments usually buy large fleets and can
bargain for lower prices
It doesnt cost much for buyers to switch to another brand of
vehicle or to start using other type of transportation
Buyers can easily choose alternative car brand
Buyers are price sensitive and their decision is often based on
how much does a vehicle cost
BUYER IS STRONG/WEAK??????
 Threat of substitutes
There are many alternative types of
transportation, such as bicycles, motorcycles,
trains, buses or planes
Alternative types of transportation almost
always cost less and sometimes are more
environment friendly
EASY/DIFFICULT SUSTITUTE??????
 Competitive rivalry
Moderate number of competitors
If a firm would decide to leave an industry it would
incur huge losses, so most of the time it either
bankrupts or stays in automotive industry for the
lifetime
Industry is very large but matured
Customers are loyal to their brands
There is moderate threat of being acquired by a
competitor
VERY STRONG/WEAK RIVALARY?????
 CRITICAL ANALYSIS
Benefits: Helps to evaluate strength and
weaknesses. Assess Profitability at root level.
Simple focus.
Limitations: Gives snap shots only,Only 5
forces are evaluated.Mostly static in
nature.Market trends are not considered.Time
factor is not considered.
 Thank you
See you in next class