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  1. 1. Porter five forces analysisFrom Wikipedia, the free encyclopediaJump to: navigation, search This article relies on references to primary sources or sources affiliated with the subject, rather than references from independent authors and third-party publications. Please add citations from reliable sources. (October 2009)A graphical representation of Porters Five ForcesPorters five forces analysis is a framework for industry analysis and business strategydevelopment formed by Michael E. Porter of Harvard Business School in 1979. It draws uponindustrial organization (IO) economics to derive five forces that determine the competitiveintensity and therefore attractiveness of a market. Attractiveness in this context refers to theoverall industry profitability. An "unattractive" industry is one in which the combination of thesefive forces acts to drive down overall profitability. A very unattractive industry would be oneapproaching "pure competition", in which available profits for all firms are driven to normalprofit.Three of Porters five forces refer to competition from external sources. The remainder areinternal threats.Porter referred to these forces as the micro environment, to contrast it with the more general termmacro environment. They consist of those forces close to a company that affect its ability toserve its customers and make a profit. A change in any of the forces normally requires a businessunit to re-assess the marketplace given the overall change in industry information. The overallindustry attractiveness does not imply that every firm in the industry will return the sameprofitability. Firms are able to apply their core competencies, business model or network toachieve a profit above the industry average. A clear example of this is the airline industry. As anindustry, 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.Porters five forces include - three forces from horizontal competition: threat of substituteproducts, the threat of established rivals, and the threat of new entrants; and two forces fromvertical competition: the bargaining power of suppliers and the bargaining power of customers.
  2. 2. This five forces analysis, is just one part of the complete Porter strategic models. The otherelements are the value chain and the generic strategies.[citation needed]Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis, whichhe found unrigorous and ad hoc.[1] Porters five forces is based on the Structure-Conduct-Performance paradigm in industrial organizational economics. It has been applied to a diverserange of problems, from helping businesses become more profitable to helping governmentsstabilize industries.[2]Contents[hide] 1 Five forces o 1.1 Threat of new competition o 1.2 Threat of substitute products or services o 1.3 Bargaining power of customers (buyers) o 1.4 Bargaining power of suppliers o 1.5 Intensity of competitive rivalry 2 Usage 3 Criticisms 4 See also 5 References 6 Further reading 7 External links[edit] Five forces[edit] Threat of new competitionProfitable markets that yield high returns will attract new firms. This results in many newentrants, which eventually will decrease profitability for all firms in the industry. Unless theentry of new firms can be blocked by incumbents, the abnormal profit rate will tend 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 Access to distribution Customer loyalty to established brands
  3. 3. Absolute cost Industry profitability; the more profitable the industry the more attractive it will be to new competitors.[edit] Threat of substitute products or servicesThe existence of products outside of the realm of the common product boundaries increases thepropensity of customers to switch to alternatives. Note that this should not be confused withcompetitors similar products but entirely different ones instead. For example, Pepsi is notconsidered a substitute for Coke but water, tea, coffee, and milk are. 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[edit] Bargaining power of customers (buyers)The bargaining power of customers is also described as the market of outputs: the ability ofcustomers to put the firm under pressure, which also affects the customers sensitivity to pricechanges. Buyer concentration to firm concentration ratio Degree of dependency upon existing channels of distribution Bargaining leverage, particularly in industries with high fixed costs Buyer volume Buyer switching costs relative to firm switching costs Buyer information availability Availability of existing substitute products Buyer price sensitivity Differential advantage (uniqueness) of industry products RFM Analysis[edit] Bargaining power of suppliersThe bargaining power of suppliers is also described as the market of inputs. Suppliers of rawmaterials, components, labor, and services (such as expertise) to the firm can be a source ofpower 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.
  4. 4. 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 BUYEREx.: If you are making biscuits and there is only one person who sells flour, you have noalternative but to buy it from him.[edit] Intensity of competitive rivalryFor most industries, the intensity of competitive rivalry is the major determinant of thecompetitiveness of the industry. Sustainable competitive advantage through innovation Competition between online and offline companies Level of advertising expense Powerful competitive strategy[edit] UsageStrategy consultants occasionally use Porters five forces framework when making a qualitativeevaluation of a firms strategic position. However, for most consultants, the framework is only astarting point or "checklist." They might use " Value Chain" afterward. Like all generalframeworks, an analysis that uses it to the exclusion of specifics about a particular situation isconsidered naїve.According to Porter, the five forces model should be used at the line-of-business industry level; itis not designed to be used at the industry group or industry sector level. An industry is defined ata lower, more basic level: a market in which similar or closely related products and/or servicesare sold to buyers. (See industry information.) A firm that competes in a single industry shoulddevelop, at a minimum, one five forces analysis for its industry. Porter makes clear that fordiversified companies, the first fundamental issue in corporate strategy is the selection ofindustries (lines of business) in which the company should compete; and each line of businessshould develop its own, industry-specific, five forces analysis. The average Global 1,000company competes in approximately 52 industries (lines of business).[edit] CriticismsPorters framework has been challenged by other academics and strategists such as Stewart Neill.Similarly, the likes of Kevin P. Coyne [1] and Somu Subramaniam have stated that three dubiousassumptions underlie the five forces:
  5. 5. That buyers, competitors, and suppliers are unrelated and do not interact and collude. That the source of value is structural advantage (creating barriers to entry). That uncertainty is low, allowing participants in a market to plan for and respond to competitive behavior. [3]An important extension to Porter was found in the work of Adam Brandenburger and BarryNalebuff in the mid-1990s. Using game theory, they added the concept of complementors (alsocalled "the 6th force"), helping to explain the reasoning behind strategic alliances. The idea thatcomplementors are the sixth force has often been credited to Andrew Grove, former CEO of IntelCorporation. According to most references, the sixth force is government or the public. MartynRichard Jones, whilst consulting at Groupe Bull, developed an augmented 5 forces model inScotland in 1993. It is based on Porters model and includes Government (national and regional)as well as Pressure Groups as the notional 6th force. This model was the result of work carriedout as part of Groupe Bulls 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.[4]It is also perhaps not feasible to evaluate the attractiveness of an industry independent of theresources a firm brings to that industry. It is thus argued[citation needed] that this theory be coupledwith the Resource-Based View (RBV) in order for the firm to develop a much more soundstrategy.[edit] See also Delta model Six Forces Model National Diamond Value chain Porters four corners model Industry classification Nonmarket forcesStrategy: Porters Five Forces Model:analysing industry structureDefining an industryAn industry is a group of firms that market products which are close substitutes for each other(e.g. the car industry, the travel industry).
  6. 6. Some industries are more profitable than others. Why? The answer lies in understanding thedynamics of competitive structure in an industry.The most influential analytical model for assessing the nature of competition in an industry isMichael Porters Five Forces Model, which is described below:Porter explains that there are five forces that determine industry attractiveness and long-runindustry profitability. These five "competitive forces" are- The threat of entry of new competitors (new entrants)- The threat of substitutes- The bargaining power of buyers- The bargaining power of suppliers- The degree of rivalry between existing competitorsThreat of New EntrantsNew entrants to an industry can raise the level of competition, thereby reducing its attractiveness.The threat of new entrants largely depends on the barriers to entry. High entry barriers exist insome industries (e.g. shipbuilding) whereas other industries are very easy to enter (e.g. estateagency, restaurants). Key barriers to entry include- Economies of scale- Capital / investment requirements- Customer switching costs- Access to industry distribution channels- The likelihood of retaliation from existing industry players.Threat of Substitutes
  7. 7. The presence of substitute products can lower industry attractiveness and profitability becausethey limit price levels. The threat of substitute products depends on:- Buyers willingness to substitute- The relative price and performance of substitutes- The costs of switching to substitutesBargaining Power of SuppliersSuppliers are the businesses that supply materials & other products into the industry.The cost of items bought from suppliers (e.g. raw materials, components) can have a significantimpact on a companys profitability. If suppliers have high bargaining power over a company,then in theory the companys industry is less attractive. The bargaining power of suppliers will behigh when:- There are many buyers and few dominant suppliers- There are undifferentiated, highly valued products- Suppliers threaten to integrate forward into the industry (e.g. brand manufacturers threateningto set up their own retail outlets)- Buyers do not threaten to integrate backwards into supply- The industry is not a key customer group to the suppliersBargaining Power of BuyersBuyers are the people / organisations who create demand in an industryThe bargaining power of buyers is greater when- There are few dominant buyers and many sellers in the industry- Products are standardised- Buyers threaten to integrate backward into the industry- Suppliers do not threaten to integrate forward into the buyers industry- The industry is not a key supplying group for buyersIntensity of RivalryThe intensity of rivalry between competitors in an industry will depend on:- The structure of competition - for example, rivalry is more intense where there are manysmall or equally sized competitors; rivalry is less when an industry has a clear market leader- The structure of industry costs - for example, industries with high fixed costs encouragecompetitors to fill unused capacity by price cutting
  8. 8. - Degree of differentiation - industries where products are commodities (e.g. steel, coal) havegreater rivalry; industries where competitors can differentiate their products have less rivalry- Switching costs - rivalry is reduced where buyers have high switching costs - i.e. there is asignificant cost associated with the decision to buy a product from an alternative supplier- Strategic objectives - when competitors are pursuing aggressive growth strategies, rivalry ismore intense. Where competitors are "milking" profits in a mature industry, the degree of rivalryis less- Exit barriers - when barriers to leaving an industry are high (e.g. the cost of closing downfactories) - then competitors tend to exhibit greater rivalry. Michael Porter Five Forces ModelWanting to incorporate Michael Porters Five Forces Model into your marketing strategy?Business Insight® will do this for you automatically.Michael Porter described a concept that has become known as the "five forces model". Thisconcept involves a relationship between competitors within an industry, potential competitors,suppliers, buyers and alternative solutions to the problem being addressed. We used the five-forces model as a basic structure and built on it with concepts from the works of many otherauthors. The result was a model with over 5,000 relational links.
  9. 9. While each industry involves all of these factors, the relational strengths vary. Business Insight®uses input from the user to create a unique model of their industry. Then thousands of "rules" areapplied to evaluate hundreds of marketing and business concepts as they relate to the usersunique circumstances. This results in a set of analyses, including: a success potential rating in eleven key areas a list of strategic strengths and weaknesses observations on strategic inconsistencies a written critique of your strategy a graphic analysis of key marketing concepts a written draft of a marketing planBusiness Insight® will also show you where you can improve your strategy for any givenbusiness concept. It will even compare your strategy to your competition!To learn more about software that implements Michael Porters five forces model, click here fora detailed product description of Business Insight®.