Porter's 5 Forces

1. McGraw-Hill/Irwin
Strategic Management, 10/e Copyright © 2007 The McGraw-Hill Companies, Inc. All rights reserved.
Session 6
Chapter 4
External Environmental Analysis
Remote/General
Industry/Competitive
Direct /Operating/Task

2. 4-2
Session Objectives
• To stress the importance of the sectors of the firm’s
external environment to strategy formulation.
• To develop a broader sense of competition and
competitive pressures.
• To understand the purpose of competitive strategy

3. 4-3
The Firm’s External Environment
Remote Environment (Global and Domestic)
Industry Environment (Global and Domestic)
Operating Environment (Global and Domestic)
• Economic
• Social
• Political
• Technological
• Ecological
• Entry barriers
• Supplier power
• Buyer power
• Substitute availability
• Competitive rivalry
• Competitors
• Creditors
• Customers
• Labor
• Suppliers
THE FIRM

4. 4-4
4
Economic Factors
• Concern nature and direction of economy in
which a firm operates
• Types of factors
– General availability of credit
– Level of disposable income
– Propensity of people to spend
– Prime interest rates
– Inflation rates
– Trends in growth of gross national product

5. 4-5
5
Social Factors
• Include beliefs, values, opinions, and lifestyles
of people
• Recent social trends
– Entry of large numbers of women into labor market
– Accelerating interest of consumers and employees
in quality-of-life issues
– Shift in age distribution of population

6. 4-6
6
Political Factors
• Define legal and regulatory parameters within
which firms must operate
• Types of factors
– Fair-trade decisions
– Antitrust laws
– Tax programs
– Minimum wage legislation
– Pollution and pricing policies
– Administrative jawboning

7. 4-7
7
Technological Factors
• Focus on technological changes affecting industry
• Types of changes
– New products
– Improvements in existing products
– Manufacturing and marketing techniques
• Role of technological forecasting
– Foresees advancements and estimating their impact
– Alerts managers to impending challenges and
promising opportunities

8. 4-8
8
Ecological Factors
• Involve relationships among human beings
and other living things and air, soil, and water
• Current concerns
– Global warming
– Loss of habitat and biodiversity
– Air, water, and land pollution
• Responsibilities of firms
– Eliminating toxic by-products of current
manufacturing processes
– Cleaning up prior environmental damage

9. 4-9
Firm’s External Environment

10. 4-10
Industry/Competitive Environment
• Michael E. Porter’s Five Forces Model the
concept of industry environment as integral to
strategic thought and business planning.
• The five forces shape competition in an industry.
• The framework helps strategic managers link
remote factors to their effects on a firm’s operating
environment.

11. 4-11
Competitive Forces Shape Strategy
• The essence of strategy formulation is to better
cope with competition.
• Competition in an industry is rooted in its
underlying economics, and competitive forces
exist that go well beyond the established
combatants in a particular industry.
• The corporate strategists’ goal is to find a position
in the industry where his or her company can best
defend itself against these forces or can influence
them in its favor.

12. 4-12
The Goal of Competitive Strategy
To Achieve a Defensible Position Against the
Competitive (Five) Forces that Are Constantly
Working to Erode Industrywide Profitability

13. 4-13
Competitive Forces
Any Entity (Group or Class of
Firms) that has the Potential to
Erode Profitability Among Firms
within an Industry

14. 4-14
Government Influence on the Model
We Consider the Influence of
Government as Felt through its
Role(s) as one of the Five Forces:
Government can be a Potential
Entrant, Supplier, Buyer, Substitute,
or Rival Firm

15. 4-15
Industry Analysis
& Competitive Analysis
• An industry is a collection of firms that offer
similar products or services.
• Structural attributes are the enduring
characteristics that give an industry its distinctive
character.
• Concentration refers to the extent to which
industry sales are dominated by only a few firms.
• Barriers to entry are the obstacles that a firm
must overcome to enter an industry.

16. 4-16
Five Forces Driving Industry Competition

17. 4-17
Let’s Hear from Dr. Porter
• http://www.youtube.com/watch?v=mYF2_FBCvXw
&feature=results_video&playnext=1&list=PL72A65
662D7647704

18. 4-18
Breakout Groups by Case
• 1. Define your Industry
• 2. Most Significant General Environmental Factor
• 3. Top Two More Significant of the Five Forces
You have 15 minutes!

19. 4-19
The Five Forces
• Threat of Entry
• Bargaining Power of Suppliers
• Bargaining Power of Buyers
• Pressure from Substitute Products
• Rivalry Among Existing Firms

20. 4-20
Forces Affecting Entry Decision
• Economies of Scale
• Product Differentiation
• Capital Requirements
• Cost Disadvantages
Independent of Size
• Access to Distribution
Channels
• Government Policy

21. 4-21
Powerful Suppliers
A supplier group is powerful if:
• It is dominated by a few companies and
is more concentrated than the industry
it sells to
• Its product is unique or at least
differentiated, or if it has built-up
switching costs
• It is not obliged to contend with other
products for sale to the industry
• It poses a credible threat of integrating forward into the
industry’s business
• The industry is not an important customer of the supplier
group

22. 4-22
Powerful Buyers
A buyer group is powerful if:
• It is concentrated or purchases in
large volumes
• The products it purchases from the industry are standard
• The products it purchases from the industry form a
component of its product and represent a significant
fraction of its cost
• It earns low profits
• The industry’s product is unimportant to the quality of the
buyers’ products or services
• The industry’s product does not save the buyer money
• The buyers pose a credible threat of integrating backward

23. 4-23
Substitute Products
• By placing a ceiling on the prices it can charge,
substitute products or services limit the potential of
an industry
• Substitutes not only limit profits in normal times
but also reduce the bonanza an industry can reap in
boom times
• Substitute products that deserve the most attention
strategically are those that are
– subject to trends improving their price-performance
trade-off with the industry’s product or
– produced by industries earning high profits

24. 4-24
Jockeying for Position
Intense rivalry occurs when:
• Competitors are numerous or are roughly equal
• Industry growth is slow, precipitating fights for market
share that involve expansion
• The product or service lacks differentiation or switching
costs
• Fixed costs are high or the product is perishable, creating
strong temptation to cut prices
• Capacity normally is augmented in large increments
• Exit barriers are high
• Rivals are diverse in strategy, origin, and personality

25. 4-25
Direct/Operating/Task
Environment
• Also called task environment
• Includes competitor positions relative to the five
forces and profiling based on the following factors:
– Geographic
– Demographic
– Psychographic
– Buyer Behavior
• Also includes suppliers & creditors and HRM

26. 4-26
HR: Nature of the Labor Market
Access to personnel is affected by 4 factors:
• Firm’s reputation as an employer
• Local employment rates
• Availability of people with the needed skills
• Its relationship with labor unions.

27. 4-27
Emphasis on Environmental Factors
• Differing external elements affect different strategies at
different times and with varying strengths
• Only certainty is that the effect of the remote and
operating environments will be uncertain until a strategy
is implemented
• Many managers, particularly in less powerful firms,
minimize long-term planning
• Instead, they allow managers to adapt to new pressures
from the environment
• Absence of strong resources and psychological
commitment to a proactive strategy effectively bars a firm
from assuming a leadership role in its environment