Porter’s Five Forces as External Analysis Tool:

Michael Porter provided a framework that shows an industry as being influenced by five forces.
The strategic business manager who wants to develop an edge over rival firms can use this model
to better understand the industry in which the firm operates.

1. Rivalry among Firms:

What is important here is the number and capability of your competitors. If you have many
competitors, and they offer equally attractive products and services, then you will most likely
have little power in the situation. If suppliers and buyers don’t get a good deal from you, they’ll
go elsewhere. On the other hand, if no-one else can do what you do, then you can often have a
monopoly like situation.

In pursuing an advantage over its rivals, a firm can choose from several competitive moves:

• Changing prices - raising or lowering prices to gain a temporary advantage.

• Improving product differentiation - improving features, implementing innovations in the
manufacturing process and in the product itself.
• Creatively using channels of distribution - using vertical integration or using a
distribution channel that is unique to the industry. For example, with high-end jewelry
stores reluctant to carry its watches, Timex moved into drugstores and other non-
traditional outlets and entered the low to mid-price watch market.
• Exploiting relationships with suppliers - for example, from the 1950's to the 1970's Sears,
Roebuck and Co. dominated the retail household appliance market. Sears set high quality
standards and required suppliers to meet its demands for product specifications and price.

2. Threat of Substitutes:

This is affected by the ability of your customers to find a different way of doing what you do for
example, if you supply a unique software product that automates an important process, people
may substitute by doing the process manually or by outsourcing it. If substitution is easy and
substitution is viable, then this weakens your power.
The competition by a Threat of Substitute comes from products outside the industry as well. The
price of aluminum beverage cans is constrained by the price of glass bottles, steel cans, and
plastic containers. These containers are substitutes, yet they are not rivals in the aluminum can
industry. To the manufacturer of automobile tires, tire retreads are a substitute. Today, new tires
are not so expensive that car owners give much consideration to retreading old tires. But in the
trucking industry new tires are expensive and tires must be replaced often. In the truck tire
market, retreading remains a substitute industry. In the disposable diaper industry, cloth diapers
are a substitute and their prices constrain the price of disposables.

While the threat of substitutes typically impacts an industry through price competition, there can
be other concerns in assessing the threat of substitutes. Consider the substitutability of different
types of TV transmission: local station transmission to home TV antennas via the airways versus
transmission via cable, satellite, and telephone lines. The new technologies available and the
changing structure of the entertainment media are contributing to competition among these
substitute means of connecting the home to entertainment. Except in remote areas it is unlikely
that cable TV could compete with free TV from an aerial.

3. Bargaining Power of Buyer:

Here you ask yourself how easy it is for buyers to get prices down. Again, this is impacted by the
number of buyers, the importance of each individual buyer to your business, the cost to them of
switching from your products and services to those of someone else, and so on. If you deal with
few, powerful buyers, they are often able to dictate terms to you.

The power of buyers is the impact that customers have on a producing industry. When buyer
power is strong, the relationship to the producing industry is near to what an economist terms a
monopsony, a market in which there are many suppliers and one buyer. Under such market
conditions, the buyer sets the price. In reality few pure monopsonies exist.

• This is high where there a few, large players in a market e.g. the large grocery chains.
• If there are a large number of undifferentiated, small suppliers e.g. small farming
businesses supplying the large grocery chains.
 • The cost of switching between suppliers is low e.g. from one fleet supplier of trucks to
another.

4. Bargaining Power of Supplier:

Here you assess how easy it is for suppliers to drive up prices. This is driven by the number of
suppliers of each key input, the uniqueness of their product or service, their strength and control
over you, the cost of switching from one to another, and so on. The fewer the supplier choices
you have, and the more you need suppliers' help, the more powerful your suppliers are.

A producing industry requires raw materials labor, raw materials, and other supplies. This
requirement leads to buyer-supplier relationships between the industry and the firms that provide
it the raw materials used to create products. Suppliers, if powerful, can have an influence on the
producing industry, such as selling raw materials at a high price to capture some of the industry's
profits.

The power of suppliers tends to be a reverse of the power of buyers.

• Where the switching costs are high e.g. switching from one software supplier to another.
• Power is high where the brand is powerful e.g. Cadillac, Pizza Hut, Microsoft.
• There is a possibility of the supplier integrating forward e.g. Brewers buying bars.
• Customers are fragmented (not in clusters) so that they have little bargaining power e.g.
Gas/Petrol stations in remote places.

5. Threat of New Entrants:

Power is also affected by the ability of people to enter your market. If it costs little in time or
money to enter your market and compete effectively, if there are few economies of scale in
place, or if you have little protection for your key technologies, then new competitors can
quickly enter your market and weaken your position. If you have strong and durable barriers to
entry, then you can have a favorable position and take fair advantage of it.
Easy to Enter if there is:

• Common technology
• Little brand patent protection
• Access to distribution channels
• Low government trade barriers

Difficult to Enter if there is:

• Patented or Intellectual property know-how

• Difficulty in brand switching
• Restricted distribution channels
• High government trade barriers

Value Chain Analysis as tool of Internal Environment Assessment:

To understand the activities through which a firm develops a competitive advantage and creates
shareholder value, it is useful to separate the business system into a series of value-generating activities
referred to as the value chain. In his 1985 book Competitive Advantage, Michael Porter introduced a
basic value chain model that comprises a sequence of activities found to be common to a wide range of
firms.

1. Inbound Logistics

Here goods are received from a company's suppliers. They are stored until they are needed on the
production/assembly line. Goods are moved around the organization.

Inbound Logistics Technologies include

• Transportation
• Material handling
• Material storage
• Communications
 • Testing
• Information systems

Operations

This is where goods are manufactured or assembled. Individual operations could include room service in
a hotel, packing of books/videos/games by an online retailer, or the final tune for a new car's engine.

Operations Technologies include

• Process
• Materials
• Machine tools
• Material handling
• Packaging
• Maintenance
• Testing
• Building design & operation
• Information systems

Outbound Logistics

The goods are now finished, and they need to be sent along the supply chain to wholesalers, retailers or
the final consumer.

Outbound Logistics Technologies include

• Transportation
• Material handling
• Packaging
• Communications
• Information systems
Marketing and Sales

In true customer orientated fashion, at this stage the organization prepares the offering to meet
the needs of targeted customers. This area focuses strongly upon marketing communications and
the promotions mix.

Marketing & Sales Technologies

• Media
• Audio/video
• Communications
• Information systems

Service

This includes all areas of service such as installation, after-sales service, complaints handling,
training and so on.

Service Technologies include

• Testing
• Communications
• Information systems

References:

• http://www.mindtools.com/pages/article/newTMC_08.htm
• http://www.marketingteacher.com/Lessons/lesson_fivefoces.htm
• http://www.quickmba.com/strategy/porter.shtml
• http://www.netmba.com/strategy/value-chain/
• http://www.marketingteacher.com/Lessons/lesson_value_chain.htm