Porter's Five Forces Model - Analysing Industry Structure PDF

22/03/2015
Porter'sFiveForcesModel:analysingindustrystructure
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Author: Jim Riley Last updated: Sunday 23 September, 2012
Overview of the Five Forces Model

Porter identified five factors that act together to determine the nature of competition within an industry.
These are the:
Threat of new entrants to a market
Bargaining power of suppliers
Bargaining power of customers (buyers)

Threat of substitute products
Degree of competitive rivalry
Related study notes

Strategic Models & Analysis
Boston Matrix
Benchmarking
Competitor Analysis
Core Competencies
Five Forces Model
GE Industry Matrix
McKinsey Growth Pyramid
PEST Analysis
Strategic Audit
SWOT Analysis
Value Chain Analysis

Strategic Planning
What is Strategy?
Competitive Advantage
Mission
Objectives
Strategy and Marketing

Strategic Resources
Vision
Balanced Scorecard Introduction

Balanced Scorecard -
Perspectives
He identified that high or low industry profits (e.g. soft drinks v airlines) are associated with the following
characteristics:
Managing Change
Introduction
Force Field Analysis (Lewin)
Resistance & Barriers
Implementation
Corporate Social
Responsibility
Corporate Social Responsibilty

- Introduction
Corporate Social Responsibilty
- Issues
Risk Management
Introduction
Risk Management
Planning & Action
Global Business
Introduction
Lets look at each one of the five forces in a little more detail to explain how they work.
Threat of new entrants to an industry

If new entrants move into an industry they will gain market share & rivalry will intensify
The position of existing firms is stronger if there are barriers to entering the market
If barriers to entry are low then the threat of new entrants will be high, and vice versa
Barriers to entry are, therefore, very important in determining the threat of new entrants. An industry can
have one or more barriers. The following are common examples of successful barriers:
Barrier
Notes
Competitiveness
Global Strategy
Globalisation
Stakeholders
Introduction
Interests and Power
Economic Environment
Economic Growth
Business Cycle
Business & Growth

Interest Rates
Technological Change
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Technological Change
Investment cost
High cost will deter entry
High capital requirements might mean that only large businesses

can compete
Economies of scale available

to existing firms
Leadership
Role of leadership
Leadership models & styles
Lower unit costs make it difficult for smaller newcomers to break

into the market and compete effectively
Growth Strategy
Business Culture & Ethics
Regulatory and legal

restrictions
Product differentiation
(including branding)
Each restriction can act as a barrier to entry

E.g. patents provide the patent holder with protection, at least in
the short run
Existing products with strong USPs and/or brand increase
customer loyalty and make it difficult for newcomers to gain
market share
A lack of access will make it difficult for newcomers to enter the
Retaliation by established
E.g. the threat of price war will act to discourage new entrants
products
Culture - Types
Culture - Role in Change
Access to suppliers and

distribution channels
Introduction to Ethics
Culture - Introduction
market
But note that competition law outlaws actions like predatory

pricing
What makes an industry easy or difficult to enter? The following table helps summarise the issues you
should consider:
Easy to Enter
Difficult to Enter
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Common technology
Patented or proprietary know-how
Access to distribution channels

Low capital requirements
No need to have high capacity and output
Absence of strong brands and customer loyalty
Well-established brands
Restricted distribution channels
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High capital requirements
Need to achieve economies of scale for

acceptable unit costs
Bargaining power of suppliers

If a firms suppliers have bargaining power they will:
Exercise that power
Sell their products at a higher price

Squeeze industry profits
If the supplier forces up the price paid for inputs, profits will be reduced. It follows that the more powerful
the customer (buyer), the lower the price that can be achieved by buying from them.
Suppliers find themselves in a powerful position when:
There are only a few large suppliers
The resource they supply is scarce
The cost of switching to an alternative supplier is high

The product is easy to distinguish and loyal customers are reluctant to switch
The supplier can threaten to integrate vertically
The customer is small and unimportant
There are no or few substitute resources available
Just how much power the supplier has is determined by factors such as:
Factor
Uniqueness of the input

supplied
Note
If the resource is essential to the buying firm and no close

substitutes are available, suppliers are in a powerful position
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supplied
substitutes are available, suppliers are in a powerful position
Number and size of firms
A few large suppliers can exert more power over market prices
Competition for the input from

other industries
If there is great competition, the supplier will be in a stronger

position
Cost of switching to alternative

sources
A business may be locked in to using inputs from particular

suppliers e.g. if certain components or raw materials are
supplying the resources
that many smaller suppliers each with a small market share
designed into their production processes. To change the

supplier may mean changing a significant part of production
Bargaining power of customers

Powerful customers are able to exert pressure to drive down prices, or increase the required quality for
the same price, and therefore reduce profits in an industry.
A great example in the UK currently is the dominant grocery supermarkets which are able exert great
power over supply firms. You can see a great video about this issue here.
Several factors determine the bargaining power of customers, including:
Factor
Note
Number of customers
The smaller the number of customers, the greater their power
Their size of their orders
The larger the volume, the greater the bargaining power of

customers
Number of firms supplying the

product
The smaller the number of alternative suppliers, the less

opportunity customers have for shopping around
The threat of integrating
If customers pose a threat of integrating backwards they will
The cost of switching
Customers that are tied into using a suppliers products (e.g. key
components) are less likely to switch because there would be
backwards
enjoy increased power
costs involved
Customers tend to enjoy strong bargaining power when:

There are only a few of them
The customer purchases a significant proportion of output of an industry
They possess a credible backward integration threat that is they threaten to buy the producing firm
or its rivals
They can choose from a wide range of supply firms
They find it easy and inexpensive to switch to alternative suppliers
Threat of substitute products

A substitute product can be regarded as something that meets the same need
Substitute products are produced in a different industry but crucially satisfy the same customer need. If
there are many credible substitutes to a firms product, they will limit the price that can be charged and
will reduce industry profits.
As an example, consider the many substitutes that consumers now have to buying a newspaper for their
news:
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The extent of the threat depends upon

The extent to which the price and performance of the substitute can match the industrys product
The willingness of customers to switch
Customer loyalty and switching costs
If there is a threat from a rival product the firm will have to improve the performance of their products by
reducing costs and therefore prices and by differentiation.
Degree of competitive rivalry

If there is intense rivalry in an industry, it will encourage businesses to engage in
Price wars (competitive price reductions),
Investment in innovation & new products

Intensive promotion (sales promotion and higher spending on advertising)
All these activities are likely to increase costs and lower profits.
Several factors determine the degree of competitive rivalry; the main ones are:
Factor
Note
Number of competitors in the

market
Competitive rivalry will be higher in an industry with

many current and potential competitors
Market size and growth prospects
Competition is always most intense in stagnating
Product differentiation and brand

loyalty
The greater the customer loyalty the less intense the

competition
The power of buyers and the

availability of substitutes
If buyers are strong and/or if close substitutes are

available, there will be more intense competitive rivalry
Capacity utilisation
The existence of spare capacity will increase the
The cost structure of the industry
Where fixed costs are a high percentage of costs then

profits will be very dependent on volume
markets
The lower the degree of product differentiation the

greater the intensity of price competition
intensity of competition
As a result there will be intense competition over market

shares
Exit barriers
If it is difficult or expensive to exit an industry, firms will

remain thus adding to the intensity of competition
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22/03/2015

Visit the new tutor2u website here

Porter's Five Forces Model: analysing industry

Author: Jim Riley Last updated: Sunday 23 September, 2012

Overview of the Five Forces Model

Bargaining power of customers (buyers)

Related study notes

Value Chain Analysis

Strategy and Marketing

Balanced Scorecard Introduction

Corporate Social Responsibilty

Threat of new entrants to an industry

Business & Growth

High cost will deter entry

High capital requirements might mean that only large businesses

Economies of scale available

Leadership models & styles

Lower unit costs make it difficult for smaller newcomers to break

Business Culture & Ethics

Regulatory and legal

Each restriction can act as a barrier to entry

Existing products with strong USPs and/or brand increase

customer loyalty and make it difficult for newcomers to gain

A lack of access will make it difficult for newcomers to enter the

Culture - Role in Change

Access to suppliers and

But note that competition law outlaws actions like predatory

Patented or proprietary know-how

Access to distribution channels

No need to have high capacity and output

Absence of strong brands and customer loyalty

Download for IOS

High capital requirements

Need to achieve economies of scale for

Bargaining power of suppliers

Sell their products at a higher price

The cost of switching to an alternative supplier is high

Uniqueness of the input

If the resource is essential to the buying firm and no close

substitutes are available, suppliers are in a powerful position

Number and size of firms

Competition for the input from

If there is great competition, the supplier will be in a stronger

Cost of switching to alternative

A business may be locked in to using inputs from particular

supplying the resources

that many smaller suppliers each with a small market share

designed into their production processes. To change the

Bargaining power of customers

The smaller the number of customers, the greater their power

Their size of their orders

The larger the volume, the greater the bargaining power of

Number of firms supplying the

The smaller the number of alternative suppliers, the less

The threat of integrating

If customers pose a threat of integrating backwards they will

The cost of switching

enjoy increased power

Customers tend to enjoy strong bargaining power when:

Threat of substitute products

The extent of the threat depends upon

Degree of competitive rivalry