IIM Calcutta

Strategic Management

The 5 Competitive
Forces that Shape
Strategy
Michael E. Porter

December 19th, 2009

Submitted By:

Group A5 – Section A

Ajay Bansal 023/46

Alpesh Chaddha 026/46
Aman Deep 027/46
Amit Gupta 032/46
Amol Deherkar 040/46
Ankit Jain 048/46
Amit Nagdewani 036/46
Avinash Pandit 085/46
Gautam Adukia 022/46
Ankit Kumar Singh 404/16
INTRODUCTION

Competition in today’s industries spreads far beyond today’s direct

competitors. As per Porter, an organization’s competitive standing is
determined by 4 important factors apart from industry rivals: customers,
suppliers, potential entrants, and substitute products. The extended
rivalry that results from all five forces defines an industry’s structure and
shapes the nature of competitive interaction within an industry. Thus in
the long run the combination of these factors drives competition and
profitability rather than where the product is in its life cycle. Whether the
company earns attractive returns on investment or incurs losses hinges
on whether these forces are intense or benign.

THREAT OF NEW ENTRY

The threat of entry in an industry depends on the entry barriers in the

industry and the reaction entrants can expect from incumbents. If entry
barriers are low and incumbents are unlikely to react much the threat of
entry is high. Such a threat of entry is adequate to moderate profitability
in the industry. It does not matter whether entry actually occurs or not.

The 7 major barriers to entry are:

1. Supply-side economies of scale- As the volumes produced by a firm

grow it enjoys scale economies which reduces per unit costs. They also
benefit by spreading technology and marketing costs over larger volumes.

2. Demand-side benefits of scale- This benefit is usually seen in industries

where the ‘network effect’ exists.

3. Customer switching costs- Switching costs can be a major factor that

can deter new players. If the users of the product face high switching
costs they are unlikely to shift to a new vendor especially a new entrant to
the market.

4. Capital requirements- If the capital required to be invested is high to

begin a new venture the industry is likely to face a minimal threat of new
entry. However this barrier stands weakened if the returns are high and
expected to remain so.

5. Incumbency advantages independent of size- some incumbents may

enjoy advantages such as proprietary technology, preferential access to
the best raw material sources and established brand identities. Such
advantages may prove to be significant entry barriers.
6. Unequal access to distribution channels- a new player has to setup
distribution channels for it’s or service which can prove to be a major
entry barrier at times.

7. Restrictive government policy- government policies such as licensing or

subsidies can directly deter or aid the entry of new players.

THE POWER OF SUPPLIERS

Suppliers can majorly affect the profitability of the user industry. Supplier
power is high if there exist:
1. Large number of suppliers
2. Low percentage share of the industry in the supplier’s revenue
3. High supplier switching costs
4. Easy availability of substitutes of the input
5. High possibility of forward integration

THE POWER OF BUYERS

Powerful buyers demand better quality or more service which raises costs.
The bargaining power of buyers is high when:
1. Number of buyers is low
2. Volume of purchase is high
3. Standardisation of products is high
4. Switching costs are high
5. Possibility of backward integration is high

THE THREAT OF SUBSTITUTES

Substitutes are products that perform the same functions as the original
product. Substitutes limit the price an industry can charge. The threat
from substitutes depends on the following factors:

1. Price-performance trade-off offered by the substitute

2. Buyers switching cost
3. Similarity to functions performed by original product

RIVALRY AMONG EXISTING COMPETITORS

Rivalry among competitors, if high, can severely affect industry

profitability. It may lead to price wars, inflation of advertising budgets,
new product introductions etc. The intensity of competition is high if:

1. Number of competitors is high and their market shares are low

2. No clear market leader exists
3. Industry growth is slow
 4. Exit barriers are high
5. Products are similar in nature
6. Marginal costs are low
7. Excess capacity exists

IMPLICATIONS OF PORTERS FIVE FORCES ON STRATEGY

The Porter’s 5-force model can enable a company to clearly determine its
industry structure and develop its strategy accordingly. The 5-force
analysis provides a complete picture of where the company stands versus
buyers, suppliers, entrants, rivals, and substitutes. This environment
analysis can help the company decided its strategy with respect to the
following:

Positioning the company

A company can determine which parts of the market witness the highest
competitive rivalry and which ones are relatively less competitive. The
company can accordingly select its positioning and target those areas of
the market where it expects the highest returns. The company will also
have to alter its product and other processes accordingly.

For ex. Netflix realized it would be difficult to compete with Blockbuster

adopting the same model. They therefore adopted the net-based model.

Exploiting industry change

Industry changes often result in new opportunities which can be grabbed

by companies gaining a competitive advantage. If a manager has a clear
understanding of the industry structure he can quickly adapt his strategy
to suit the new environment. When such changes occur they lead to the
development of new needs. In some case these needs are overlooked by
industry leaders and can be profitable exploited.

For ex. With the increased internet usage, airline companies soon realized
that customers preferred purchasing tickets over the net. The airlines
which initially adopted e-ticketing gained majorly and also reduce their
costs. Moreover travel agents who solely relied on air ticket commission
were slow to change and now are a dying breed. This change also opened
up new opportunities and online sites like makemytrip.com came into
existence.

Shaping industry structure

A company which clearly recognizes the major forces that are affecting
the industry structure can work towards altering these forces to transform
the industry, which ultimately benefits all players. There are 2 ways
through which the industry can be reshaped. The company may work
towards redividing profitability or towards expanding the profit pool.

In case of Redividing profitability the company has to determine which

forces are currently restraining the profitability of the industry. The
company can then take measures to contain the leakage of profits to
buyers, supplier, and substitutes. The company can reduce the bargaining
power of buyers or suppliers thereby retaining a greater percentage of the
value chain for the industry.

For ex. In the west, Walmart, the world’s largest retailer, took advantage
of its sophisticated distribution to garner a greater share of the value
chain from the suppliers. It forced them to streamline their processes and
distribution. Soon other retailers also gained he same benefits. Similarly in
India, organized retailers are capturing a greater percentage of the price
of a product despite selling at prices lower than mom and pop stores due
to their increased bargaining power with suppliers.

Expanding the overall profit pool creates win-win opportunities for

multiple industry participants. The profit pool can be expanded by serving
markets with latent needs that were not served earlier. The company can
also join hands with other players to improve co-ordination to reduce
overall costs and eliminate wastage.

For ex. When the stock exchanges in India moved over to electronic
trading they significantly expand the profit pool for all players. Companies
found it easier to manage registration of transfers. This significantly
reduced the settlement time and attracted new buyers. The exchanges
made it cheaper for their members to trade which increased their volume
significantly. Similarly when the brokers started offering online trading to
their clients at lower costs volumes jumped. They could offer lower rates
since all players i.e. banks, depositories and brokers themselves
coordinated and reduced their costs.

COMPETITION AND VALUE

The competitive forces explain the main drivers of industry competition.

The company strategy has to take into consideration that competition
stretches well beyond existing competitors. A study of the industries
competitive forces can help a manger gain crucial insight. He can
determine the value gaining and value draining part of the operations and
make suitable changes. He can spot new opportunities and exploit them
accordingly. Moreover he forecast future danger spots like new entrants,
price wars and prepare accordingly. In a world of more open competition
and relentless change, it is more important than ever to think structurally
about competition.