Porter's Five Forces EXPLAINED with EXAMPLES | B2U

Full list of Porter's Five Forces factors: · Threat of new entrants · Bargaining power of suppliers · Bargaining power of buyers · Threat of ... Skiptocontent IndustryAnalysis TopRated  August3,2016December5,2020 LarsdeBruin 22Comments BargainingPowerofBuyers,BargainingPowerofSuppliers,BarrierstoEntry,Competition,Competitiveness,ConcentrationRate,IndustryAnalysis,Porter'sFiveForces,Rivalry,ThreatofNewEntry,ThreatofSubstituteProductsorServicesPorter’sFiveForcesanalysisisaframeworkthathelps analyzingthelevelofcompetitionwithinacertainindustry.Itisespeciallyusefulwhenstartinganewbusinessorwhenenteringanewindustrysector.Accordingtothisframework,competitivenessdoesnotonlycomefromcompetitors.Rather,thestateofcompetitioninanindustrydependsonfivebasicforces:threatofnewentrants,bargainingpowerofsuppliers,bargainingpowerofbuyers,threatofsubstituteproductsorservices,andexistingindustryrivalry.Thecollectivestrengthoftheseforcesdeterminestheprofitpotentialofanindustryandthusitsattractiveness.Ifthefiveforcesareintense(e.g.airlineindustry),almostnocompanyintheindustryearnsattractivereturnsoninvestments.Iftheforcesaremildhowever(e.g.softdrinkindustry),thereisroomforhigherreturns.Eachforcewillbeelaboratedonbelowwiththeaidofexamplesfromtheairlineindustrytoillustratetheusage.Figure1:FiveForcesModelThreatofnewentrantsNewentrantsinanindustrybringnewcapacityandthedesiretogainmarketshare.Theseriousnessofthethreatdependsonthebarrierstoenteracertainindustry.Thehigherthesebarrierstoentry,thesmallerthethreatforexistingplayers.Examplesofbarrierstoentryaretheneedforeconomiesofscale,highcustomerloyaltyforexistingbrands,largecapitalrequirements(e.g.largeinvestmentsinmarketingorR&D),theneedforcumulativeexperience,governmentpolicies,andlimitedaccesstodistributionchannels.Morebarrierscanbefoundinthetablebelow.ExampleThethreatofnewentrantsintheairlineindustrycanbeconsideredaslowto medium.Ittakesquitesomeupfrontinvestmentstostartanairlinecompany(e.g.purchasingaircrafts).Moreover,newentrantsneedlicenses,insurances,distributionchannelsandotherqualificationsthatarenoteasytoobtainwhenyouarenewtotheindustry(e.g.accesstoflightroutes).Furthermore,itcanbeexpectedthatexistingplayershavebuiltupalargebaseofexperienceovertheyearstocutcostsandincreaseservicelevels. Anewentrantislikelytonothavethiskindofexpertise,thereforecreatingacompetitivedisadvantagerightfromthestart.However,duetotheliberalizationofmarketaccessandtheavailabilityofleasingoptionsandexternalfinancefrombanks,investors,andaircraftmanufacturers,newdoorsareopeningforpotentialentrants.Eventhoughitdoesn’tsoundveryattractiveforcompaniestoentertheairlineindustry,itisNOTimpossible.Manylow-costcarrierslikeSouthwestAirlines,RyanAirandEasyJethavesuccessfullyenteredtheindustryovertheyears byintroducinginnovativecost-cuttingbusinessmodels,therebyshakinguporiginal playerslikeAmericanAirlines,DeltaAirLinesandKLM.Porter’sFiveForcesVideoTutorialBargainingpowerofsuppliersThisforceanalyzeshowmuchpowerandcontrolacompany’ssupplier(alsoknownasthemarketofinputs)hasoverthepotentialtoraiseitspricesortoreducethequalityofpurchasedgoodsorservices,whichinturnwouldloweranindustry’sprofitabilitypotential.Theconcentrationofsuppliersandtheavailabilityofsubstitutesuppliersareimportantfactorsindeterminingsupplierpower.Thefewerthereare,themorepowertheyhave.Businessesareinabetterpositionwhenthereareamultitudeofsuppliers.Sourcesofsupplierpoweralsoincludetheswitchingcostsofcompaniesintheindustry,thepresenceofavailablesubstitutes,thestrengthoftheirdistributionchannelsandthe uniquenessorlevelofdifferentiationintheproductorservicethesupplierisdelivering.ExampleThebargainingpowerofsuppliersintheairlineindustrycanbeconsideredveryhigh. Whenlookingatthemajorinputsthatairlinecompaniesneed,weseethattheyareespeciallydependentonfuelandaircrafts.Theseinputshoweverareverymuchaffectedbytheexternalenvironmentoverwhichtheairlinecompaniesthemselveshavelittlecontrol.Thepriceofaviationfuelissubjecttothefluctuationsintheglobalmarketforoil,whichcanchangewildlybecauseofgeopoliticalandotherfactors.Intermsofaircraftsforexample,onlytwomajorsuppliersexist:BoeingandAirbus.BoeingandAirbusthereforehavesubstantialbargainingpoweronthepricestheycharge.BargainingpowerofbuyersThebargainingpowerofbuyers isalsodescribedasthemarketofoutputs. Thisforceanalyzestowhatextentthecustomersareabletoputthecompany underpressure,whichalsoaffectsthecustomer’ssensitivitytopricechanges.Thecustomers havealotofpowerwhentherearen’tmanyofthemandwhenthecustomers havemanyalternativestobuyfrom.Moreover,itshouldbeeasyforthemtoswitchfromonecompanytoanother. Buyingpowerislowhoweverwhencustomerspurchaseproductsinsmallamounts,actindependentlyandwhentheseller’sproductisverydifferentfromanyofitscompetitors.Theinternethasallowedcustomerstobecomemoreinformedandthereforemoreempowered.Customerscaneasilycomparepricesonline,getinformationaboutawidevarietyofproductsandgetaccesstooffersfromothercompaniesinstantly. Companiescantakemeasurestoreducebuyerpowerbyforexampleimplementingloyaltyprogramsorbydifferentiatingtheirproductsandservices.ExampleBargainingpowerofbuyersintheairlineindustryishigh.CustomersareabletocheckpricesofdifferentairlinecompaniesfastthroughthemanyonlinepricecomparisonswebsitessuchasSkyscannerandExpedia.Inaddition,therearen’tanyswitchingcostsinvolvedintheprocess.Customersnowadaysarelikelytoflywithdifferentcarrierstoandfromtheirdestinationifthatwouldlowerthecosts.Brandloyaltythereforedoesn’tseemtobethathigh.Someairlinecompaniesaretryingtochangethiswithfrequentflyerprogramsaimedatrewardingcustomersthatcomebacktothemfromtimetotime.ThreatofsubstituteproductsTheexistenceofproductsoutsideoftherealmofthecommonproductboundariesincreasesthepropensityofcustomerstoswitchtoalternatives.Inordertodiscoverthesealternativesoneshouldlookbeyondsimilarproductsthatarebrandeddifferentlybycompetitors.Instead,everyproductthatservesasimilarneedforcustomersshouldbetakenintoaccount.EnergydrinklikeRedbullforinstanceisusuallynotconsideredacompetitorofcoffeebrandssuchasNespressoorStarbucks.However,sincebothcoffeeandenergydrinkfulfillasimilarneed(i.e.stayingawake/gettingenergy),customersmightbewillingtoswitchfromonetoanotheriftheyfeelthatpricesincreasetoomuchineithercoffeeorenergydrinks.Thiswillultimatelyaffectanindustry’sprofitabilityandshouldthereforealsobetakenintoaccountwhenevaluatingtheindustry’sattractiveness.ExampleIntermsoftheairlineindustry,itcanbesaidthatthegeneralneedofitscustomersistraveling.Itmaybeclearthattherearemanyalternativesfortravelingbesidesgoingbyairplane.Dependingontheurgencyanddistance,customerscouldtakethetrainorgobycar.EspeciallyinAsia,moreandmorepeoplemakeuseofhighspeedtrainssuchasBulletTrainsandMaglevTrains.Furthermore,theairlineindustrymightgetsomeseriousfuturecompetitionfromElonMusk’sHyperloopconceptinwhichpassengerswillbetravelingincapsulesthroughavacuumtubereachingspeedlimitsof1200km/h.Takenthisaltogether,thethreatofsubstitutesintheairlineindustrycanbeconsideredatleastmediumtohigh.RivalryamongexistingcompetitorsThislastforceofthePorter’sFiveForcesexamineshowintensethecurrentcompetitionisinthemarketplace,whichisdeterminedbythenumberofexistingcompetitorsandwhateachcompetitoriscapableofdoing.Rivalryishighwhentherearealotof competitors thatareroughlyequalinsizeandpower,whentheindustryisgrowingslowlyandwhenconsumerscaneasilyswitchtoacompetitorsofferingforlittlecost.Agoodindicatorofcompetitiverivalryistheconcentrationratioofanindustry. Thelowerthisration,themoreintenserivalrywillprobablybe.Whenrivalryishigh,competitorsarelikelytoactivelyengageinadvertisingandpricewars,whichcanhurtabusiness’sbottomline.Inaddition,rivalrywillbemoreintensewhenbarrierstoexitarehigh,forcingcompaniestoremainintheindustryeventhoughprofitmarginsaredeclining.Thesebarrierstoexitcanforexamplebelong-termloanagreementsandhighfixedcosts.ExampleWhenlookingattheairlineindustryintheUnitedStates,weseethattheindustryisextremelycompetitivebecauseofanumberofreasonswhichincludetheentryoflowcostcarriers,thetightregulationoftheindustrywhereinsafetybecomeparamountleadingtohighfixedcostsandhighbarrierstoexit,andthefactthatthe industryisverystagnantintermsofgrowthatthemoment.Theswitchingcostsforcustomersarealsoverylowandmanyplayersintheindustryaresimilarinsize(seegraphbelow)leadingtoextrafiercecompetitionbetweenthosefirms.Takenaltogether,itcanbesaidthatrivalryamongexistingcompetitorsintheairlineindustryishigh. (Source:UnitedStatesDepartmentofTransportation,2016)Bylookingateachcompetitiveforceindividually,youareabletoroughlymapoutthefocalindustryanditsattractiveness.Notethatindustriesmightdifferintermsofattractivenessdependingonthecountryyouarelookingat.Governmentpoliciesareforexamplelikelytobedifferentineachcountryandalsotheamountofsuppliersandbuyersmightvaryfrom nationtonation.Porter’sFiveForcesisagoodstartingpointtoevaluateanindustrybutshouldnotbeusedinisolation.YoucouldforexamplecombineitwithaValueChainAnalysisorthroughtheVRIOFrameworkinordertogetabettersenseofwhereyourcompany’scompetitiveadvantageiscomingfromandtobetterpositionyourcompanybetweentherivals.Moreover,Porter’sFiveForcesisoftencombinedwiththePESTELanalysistogiveagoodoverviewoftheorganization’senvironment.Lastly,itshouldbesaidthattheframeworkalsoreceivedsomecriticismfromseveralauthors.Someauthorshaveforinstancearguedthatthemodelneedsa6thforcecalledthe‘complementors’,inordertoexplainthereasoningbehindstrategicalliancesandjointventures.ThisextendedmodelisalsoknownastheValueNetModel.However,eventhoughthecriticismitgot,Porter’sFiveForcesisstilloneofthemostusedframeworksforstrategydevelopmentandislikelytoremainthatwayinthenearfuture.Figure2:Porter’sFiveForcesFactorsFulllistofPorter’sFiveForcesfactors:ThreatofnewentrantsEconomiesofscaleProductdifferentiationBrandidentity/loyaltyAccesstodistributionchannelsCapitalrequirementsAccesstolatesttechnologyAccesstonecessaryinputsAbsolutecostadvantagesExperienceandlearningeffectsGovernmentpoliciesSwitchingcostsExpectedretaliationfromexistingplayersBargainingpowerofsuppliersNumberofsuppliersSizeofsuppliersSupplierconcentrationAvailabilityofsubstitutesforthesupplier’sproductsUniquenessofsupplier’sproductsorservices(differentiation)Switchingcostforsupplier’sproductsSupplier’sthreatofforwardintegrationIndustrythreatofbackwardintegrationSupplier’scontributiontoqualityorserviceoftheindustryproductsImportanceofvolumetosupplierTotalindustrycostcontributedbysuppliersImportanceoftheindustrytosupplier’sprofitBargainingpowerofbuyersBuyervolume(numberofcustomers)Sizeofeachbuyer’sorderBuyerconcentrationBuyer’sabilitytosubstituteBuyer’sswitchingcostsBuyer’sinformationavailabilityBuyer’sthreatofbackwardintegrationIndustrythreatofforwardintegrationPricesensitivityThreatofsubstituteproductsorservicesNumberofsubstituteproductsavailableBuyer’spropensitytosubstituteRelativepriceperformanceofsubstitutesPerceivedlevelofproductdifferentiationSwitchingcostsSubstituteproducer’sprofitability&aggressivenessRivalryamongexistingcompetitorsNumberofcompetitorsDiversityofcompetitorsIndustryconcentrationandbalanceIndustrygrowthIndustrylifecycleQualitydifferencesProductdifferentiationBrandidentity/loyaltySwitchingcostsIntermittentovercapacityInformationalcomplexityBarrierstoexitFurtherReading:Porter,M.E.(1979).HowCompetitiveForcesShapeStrategy.HarvardBusinessReviewPorter,M.E.(2008).TheFiveCompetitiveForcesThatShapeStrategy.HarvardBusinessReview

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