Porter’s Five Forces

Porter’s Five Forces is a strategic analytical tool that is used to assess the level of intensity of competition in the industry. The tool can also be applied to evaluate the balance of power in the industry. Developed by a famous strategy guru Michael Porter[1], the framework assumes that the level of intensity of competition in the industry.

 

Porter’s Five Forces Analysis

 

Threat of new entrants

High level of profit in a market or industry attracts new companies to join the industry affecting the level and pattern of competition in the marketplace. Theoretically, firms should be able to enter and exit to maintain the nominal level of profits. In practice, however, there is a range of factors that may emerge as a barrier for firms aiming to enter an industry. Specifically, the threat of new entrants depends on the following set of factors:

  1. Economies of scale.
  2. Product differentiation
  3. Capital requirements.
  4. Customer switching costs
  5. Access to distribution channels
  6. Legal and regulatory barriers
  7. Expected retaliation from existing businesses
  8. Time of entry

 

Bargaining power of buyers

Buyer bargaining power is associated with the extent of impact customers can have on the industry. The stronger the buyer, the greater his ability to reduce prices and/or increase the quality of products and services. The following set of factors determine bargaining power of buyers:

  1. Size and concentration of buyers compared to suppliers
  2. Buyers’ price sensitivity
  3. Product differentiation
  4. Switching costs
  5. Information about products and services
  6. Buyer’s ability to go for substitute products and services

 

Bargaining power of suppliers

Supplier bargaining power forms the nature of supplier-manufacturer relationships. Suppliers with strong bargaining power are able to sell raw materials for higher prices with direct implications on the levels of profit to be generated by manufacturers. Supplier bargaining power depends on the following:

  1. Number of suppliers
  2. Size of suppliers
  3. Differentiation of products provided by suppliers
  4. Uniqueness of products and services provided by suppliers
  5. Switching costs
  6. Forward integration
  7. Importance of volume to supplier
  8. Cost of supplies relative to selling price of products
  9. Ability of the firm to substitute suppliers

 

Threat of substitute products and services

Firms have less bargaining power if substitutes exit to their products and services. Substitutes can be direct or indirect and the threat of substitute products and services depends on the following set of factors:

  1. Existence of close substitutes
  2. Existence of indirect substitutes
  3. Switching costs
  4. Perceived level of product differentiation
  5. Buyers’ propensity to substitute
  6. Performance and quality of substitute products and services

 

Rivalry among existing firms

The level of intensity of competition in the industry determines the level of its profitability. The more competitive is the industry, the more difficult for firms to maintain and increase their market share. The following set of factors determine the extent of rivalry among existing firms:

  1. Rate of growth of the industry
  2. Number of competitors and the balance between them
  3. Diversity of competitors
  4. Differentiation of rival products and services
  5. Differences in quality among competing firms
  6. Switching costs
  7. Excess capacity and exit barriers
  8. Brand equity
  9. Level of advertising expenditure
  10. Degree of transparency

This portal contains samples of Porter’s Five Forces analyses of many multinational enterprises as part of Company Reports.

 

 

[1] Porter, M.E. (1979) “How Competitive Forces Shape Strategy” Harvard Business Review, March 1979