PORTER FIVE FORCES MODEL

10/26/2012

Prof P K Agarwal

Introduction

In 1979, the Harvard Business Review published the article How Competitive Forces Shape Strategy by the Harvard Professor Michael Porter. It started a revolution in the strategy field.

In subsequent decades, Porters five forces have shaped a generation of academic, research and business practice. This session explores how competitive analysis can be done using Porters five forces model.
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The Five Forces - Michael Porter

Analytical tool for examining competitive environment. According to this model, the intensity of competition in an industry depends on five basic forces. 1. Threat of new entrants

2. Intensity of rivalry among industry competitors 3. Bargaining power of buyers 4. Bargaining power of suppliers

5. Threat of substitute products and services.

Cont.

10/26/2012

Prof P K Agarwal

PORTERS FIVE FORCES MODEL

10/26/2012

Prof P K Agarwal

Forces that Shape Competition

1. The Threat of New Entrants
The first of Porters Five Forces model is the threat of new entrants. New entrants bring new capacity & substantial resources to an industry with a desire to gain market share.

10/26/2012

Prof P K Agarwal

Forces that Shape Competition

2. Barriers to entry
Entry barriers depend on the advantages that existing companies have relative to new entrants. There are seven major sources: i. Economies of scale ii. Product differentiation iii. Capital requirements iv. Switching costs v. Access to distribution channels vi. Cost disadvantages independent of size vii. Government policy
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Expected Retaliation
New entrants -- likely to fear expected retaliation if:

Existing companies - earlier responded vigorously

Existing companies possess substantial resources to fight

back
Existing companies likely to cut prices to protect market share Industry growth is slow, so newcomers can gain volume only by taking the market share from existing companies.
10/26/2012 Prof P K Agarwal
Cont.

Intensity of Rivalry among Competitors

The second of Porters Five-Forces model . Rivalry means the competitive struggle between companies in an industry to gain market share from each other.
Intensity of rivalry is greatest under following conditions:
i.

Numerous competitors or equally powerful competitors

ii. Slow industry growth iii. High fixed but low marginal costs iv. Lack of differentiation or switching costs v. Capacity augmentation in large increments vi. High exit barriers
Cont.

Common exit barriers are:

1. Investment in specialized assets like plant and machinery - no value, cannot be put to alternative use. Hence discontinue. 2. High costs of exit viz. retrenchment benefits, etc. to be paid to redundant workers when a company ceases to operate. 3. Emotional attachment to industry keep owners/ employees unwilling to exit from an industry for sentimental reasons.
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Common exit barriers are:

4. Economic dependence on the industry when the firm depends on a single industry for revenue and profit. 5. Government & social pressures discourage exit concern --job loss. 6. Strategic interrelationships between business units and others prevent exit because of shared facilities, image and so on.
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Bargaining power of buyers

The third of Porters five competitive forces. Bargaining power of buyers refers to the ability of buyers to bargain down prices

charged by firms in the industry or driving up the costs of the firm

by demanding better product quality and service. Buyers are most powerful under the following conditions:
i.

There are few buyers

ii. The products are standard or undifferentiated iii. The buyer faces low switching costs iv. The buyer earns low profits v. The quality of buyers products
10/26/2012 Prof P K Agarwal
Cont.

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Bargaining power of suppliers

The fourth of Porters Five Forces model. Suppliers are companies that supply RM, components, etc
A suppliers bargaining power high under following conditions:
i.

Few suppliers

ii. Product is differentiated

iii. Dependence of supplier group on the firm iv. Importance of the product of the firm v. Threat of forward integration vi. Lack of substitutes
Cont.

Threat of Substitute Products

Fifth of Porters Five Forces model . A substitute performs the same or a similar function as an industrys product. Video conferences are a substitute for travel. Plastic is a substitute for aluminum. E-mail is a substitute for a mail. All firms within an industry compete with industries producing substitute products.
Existence of close substitutes a strong competitive

threat because this limits the price that companies in one industry can charge for their product. price of coffee rises too much relative to tea/ soft drink, coffee drinkers may switch to those substitutes.
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 According to Porter, substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge.

The more attractive is the price/performance ratio of substitute products, the more likely they affect an industrys profits.

10/26/2012

Prof P K Agarwal

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Critical Assessment - Five Forces Model

Propelled the concept of industry environment into the foreground of strategic thought and business planning. Helps Managers to link competitive forces to their effect on a firms operating environment.

Merits
1. powerful tool helps managers to think strategically. 2. helps a firm not only to evaluate the profit potential of an industry, but also to consider various ways to strengthen its position vis--vis the five forces.
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3. The model helps managers to assess how to improve the firms competitive position with regard to each of the five forces. 4. It provides the rationale for increasing or decreasing resources commitment. 5. It helps managers to decide whether the firm should remain in or exit from the industry

10/26/2012

Prof P K Agarwal

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Limitations
Despite being the most popular and widely used framework for competitive analysis, Porters Five Forces model suffers from the following limitations: 1. Assumes the existence of a clear, recognizable industry. As complexity associated with industry definition increases, the ability to draw coherent conclusions from the model diminishes. 2. It presents a static view of competition among the firms in the industry rather than a dynamic interaction of competitive forces.

10/26/2012

Prof P K Agarwal

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 It is short-sighted and implicitly assumes a zero-sum game. It overlooks the many potential benefits of developing constructive win-win partnerships with suppliers and customers. Establishing long-term mutually beneficial relationships with suppliers improves a firms ability to implement just-in-time (JIT) inventory systems. Further, by working together as partners, suppliers and manufactures can provide the greatest value at the lowest possible cost.

10/26/2012

Prof P K Agarwal

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The model does not take into account the fact that some firms, most notably the large ones, can often take steps to modify the industry structure, thereby increasing their
4.

prospects for profits. For example, large airlines have been known to lobby for hefty safety restrictions to create an entry barrier to potential upstarts. 5. A firm that competes in many countries typically must be concerned with multiple industry structures. The nature of industry competition in the international area differs among nations, and may present challenges that are not present in a firms host country.
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 A firm that competes in many countries typically must be concerned with multiple industry structures. The nature of industry competition in the international area differs among nations, and may present challenges that are not present in a firms host country.

10/26/2012

Prof P K Agarwal

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Examples of a Companys Strengths, Weaknesses, Opportunities, and Threats

10/26/2012

Prof P K Agarwal

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