Environmental

Analysis

M. Porter’s 5
Forces
 Michael Porter’s five forces
describe the characteristics of
an industry that influence how
profitable firms
in the industry will be.
 The five forces are……
(1) Rivalry among existing firms in the
industry
(2) Potential entrants and barriers to entry
(3) Substitute and complementary
products
(4) The bargaining power of
clients/customers
(5) The bargaining power of suppliers
 In general,
a firm is likely to be more profitable
(1) the less intense is the rivalry in its industry;
(2) the less danger of potential entrants & the higher the
barriers to entry;
(3) the less numerous and less aggressive the firms that
sell substitute products, and the more numerous and
more aggressive the firms that sell complementary
products;
(4) the weaker the bargaining power of clients/customers;
and
(5) the weaker the bargaining power of suppliers.

In industry and competitive analysis, firms examine their

positions along these lines and seek ways to change
conditions to be more favorable to the firm.
 (1) Rivalry
Good rivals, in terms of industry profits, are
rivals who are restrained in their
competition.
They are willing to follow/maintain their
firm’s lead.
In markets that are segmented into different
groups of buyers, good rivals are satisfied
with taking care of their groups and letting
others to take care of their own..
 (2) Potential Entrants &
Barriers to Entry
Since industry profits encourage new firms
to enter, firms in a profitable industry
remain profitable to the extent that barriers
to entry keep out potential entrants.
 Types of Entry Barriers
1. Tangible barriers – anything that would
put a potential entrant at a competitive
disadvantage after entry.
2. Psychological barriers – beliefs on the
part of potential entrants that, if they enter,
firms already in the business will react
aggressively, and are even willing to incur
short-term losses, to force out the new
entrant.
 Tangible barriers - examples
1. scale-based cost advantages: when fixed
costs are high & the efficient scale is large
2. scope-based cost advantages: when
fixed costs can be shared among different
products (Operation may be cheaper for
firms that are already producing other
products with connected fixed costs.)
3. knowledge-based cost advantages:
when experience is an important factor in
knowing how to do things efficiently
 Tangible barriers – examples….
4. financial resources: when firms are able to
fight off new entrants by cutting prices as a
result of having significant financial resources
available
5. favored access to particular resources:
when existing firms control resources that are
useful or essential to efficient operation (For
example, airlines may control landing slots at
favorable times.)
6. favored access to distribution channels:
when existing firms can more easily reach the
customers
 Tangible barriers – examples….
7. customer goodwill and reputation: when a firm
has built up a loyal customer base, but new
entrants have to win those loyal customers away
or convince new customers who were not buying
the product to do so
8. customer lock-in: when customers tend to
continue with the original firm because of issues
such as compatibility with existing equipment,
economies in maintenance & repair, etc.
9. legal & political restrictions: when firms are
protected against entry by legal restrictions such
as government certification or licenses (Existing
firms may also encourage the government to ban
foreign competitors from entering the industry.)
 Creating Psychological Barriers
1. Fighting off an entrant or two is one way
for a firm to gain a reputation for being
willing & able to fight off new entrants.
2. Maintaining excess capacity for production
or distribution can also deter entry.
3. Keeping patents & products on the shelf
ready for use if needed can also send a
strong signal.
(3) Substitutes & Complements
If there are many good substitutes for a product,
the elasticity of demand for that product will be
high.
This will limit the ability of the firm to raise prices
and will consequently lower potential profits.
Suppose in addition, that a firm raises its prices.
If firms producing substitute goods would take
advantage of the opportunity to actively entice
away customers, the profitability of the original
firm would be limited.
Strong complements can increase the
profitability of a good.

For example, disposable diapers (as

opposed to cloth diapers) are strongly
complementary with travel. So when the
travel industry is booming, the disposable
diaper industry is better off.
(4) Bargaining power of clients/customers
Factors that tend to make a client/customer more
powerful:
1. The client industry is highly concentrated. (The
firms buying the product are in an industry in
which there are just a few companies and they
are large.)
2. One particular client industry buys a very large
share of the products of the selling industry.
3. The item is not essential to the clients; there are
lots of good substitute inputs in the clients’
production process.
4. The cost of the item is a large fraction of the
clients’ costs/budget. The client is then likely to
resist attempts to push up prices.
 (5) Bargaining power of
suppliers
Factors that tend to make a supplier more
powerful:
1. The supplier has a franchise or patent on
a particular item that is required by firms
in the industry.
2. The supplier is not restrained by any
close substitutes for its product.
3. The supplier industry is concentrated
(there are very few firms) and the firms
are not aggressive rivals with each other.
 Competitive Advantage
A firm's relative position within its
industry determines whether a firm's
profitability is above or below the
industry average.
The fundamental basis of above
average profitability in the long run
is sustainable competitive
advantage.
Strategies are based on a combination of
Competitive Advantage and Competitive
Scope.

Competitive Advantage

Competitiv
e Scope
There are two types of competitive
advantage a firm can possess: lower cost or
differentiation.

Competitive Advantage
Lower Differentiatio
Cost n

Competitiv
e Scope
The firm can seek to achieve these
advantages for a broadly or narrowly
focused scope of activities or customers.

Competitive Advantage
Lower Differentiatio
Cost n
Broad
Competitiv Target
e Scope Narrow
Target
Combining the two types of competitive advantage
with the scope of activities or customers leads to
four strategies.
The two narrowly focused strategies are often
considered a single focus strategy with two
variants.

Competitive Advantage

Lower Cost Differentiation

Broad Overall Cost Broadly Targeted

Competitiv Target Leadership Differentiation
e Scope Narrow Differentiation
Cost Focus
Target Focus