PORTER FIVE FORCES ANALYSIS

Porter 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 their core
competencies, business model or network to achieve a profit above the industry average. A
clear example of this is the airline industry. 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.

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 (which in business refers to the largest
company in a certain industry, for instance, in telecommunications, the traditional phone
company, typically called the "incumbent operator"), the abnormal profit rate will trend
towards zero (perfect competition).

The following factors can have an effect on how much of a threat new entrants may pose:

 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.

 Government policy

 Capital requirements

 Absolute cost

 Cost disadvantages independent of size

 Economies of scale
  Economies of product differences

 Product differentiation

 Brand equity

 Switching costs or sunk costs

 Expected retaliation

 Access to distribution

 Customer loyalty to established brands

 Industry profitability (the more profitable the industry the more attractive it will be
to new competitors)

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.

Potential factors:

 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. Firms can take measures to reduce buyer power, such as implementing a
loyalty program.

Potential factors:

 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

 The total amount of trading

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. If you are making biscuits and there is
only one person who sells flour, you have no alternative but to buy it from them. Suppliers
may refuse to work with the firm or charge excessively high prices for unique resources.

Potential factors:

 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: the ability to forward vertically integrate and cut out the
buyer.

Intensity of competitive rivalry[edit]

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

Potential factors:

 Sustainable competitive advantage through innovation

 Competition between online and offline companies

 Level of advertising expense

 Powerful competitive strategy

 Firm concentration ratio

 Degree of transparency

Usage[edit]

Strategy consultants occasionally use Porter's five forces framework when making a

qualitative evaluation of a firm's strategic position. However, for most consultants, the
framework is only a starting point or "checklist." They might use "Value Chain" afterward.
Like all general frameworks, an analysis that uses it to the exclusion of specifics about a
particular situation is considered naїve.

According to Porter, the five forces model should be used at the line-of-business industry
level; it is not designed to be used at the industry group or industry sector level. An industry
is defined at a lower, more basic level: a market in which similar or closely related products
and/or services are sold to buyers. (See industry information.) A firm that competes in a
single industry should develop, at a minimum, one five forces analysis for its industry. Porter
makes clear that for diversified companies, the first fundamental issue in corporate
strategy is the selection of industries (lines of business) in which the company should
compete; and each line of business should develop its own, industry-specific, five forces
analysis. The average Global 1,000 company competes in approximately 52 industries (lines
of business).

Criticisms[edit]
Porter's framework has been challenged by other academics and strategists such as Stewart
Neill. Similarly, the likes of ABC, Kevin P. Coyne [1] and Somu Subramaniam have stated that
three dubious assumptions underlie the five forces:

 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 Barry
Nalebuff of Yale School of Management in the mid-1990s. Using game theory, they added the
concept of complementors (also called "the 6th force"), helping to explain the reasoning behind
strategic alliances. The idea that complementors are the sixth force has often been credited
to Andrew Grove, former CEO of Intel Corporation. According to most references, the sixth force
is government or the public. Martyn Richard Jones, whilst consulting at Groupe Bull, developed an
augmented 5 forces model in Scotland in 1993. It is based on Porter's model and includes
Government (national and regional) as well as Pressure Groups as the notional 6th force. This model
was the result of work carried out as part of Groupe Bull's 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

the resources a firm brings to that industry. It is thus argued (Werner 1984)[5] that this
theory be coupled with the Resource-Based View (RBV) in order for the firm to develop a
much more sound strategy. It provides a simple perspective for accessing and analyzing the
competitive strength and position of a corporation, business or organization.