What is Porter’s 5 forces useful for?
- Framework for assessing the average profit potential (attractiveness) of an industry (or positioning within the industry)
- Basic notion that there are good and bad industries and that strategy is (partly) about ending up in a good industry.
- Use industry characteristics the assess the strength (or benignness) of each force
What is the basic notion of Porter’s 5 forces?
Basic notion that there are good and bad industries and that strategy is (partly) about ending up in a good industry.
What does Porter’s 5 forces framework assess?
The average profit potential (attractiveness) of an industry (or positioning within the industry)
Which are Porter’s 5 forces?
- Threat of entry
- Threat of substitutes
- Relative power of suppliers
- Relative power of buyers
- Rivalry
How have Coke/Pepsi (as concentrate producers) created and captured value?
CREATED VALUE 1. Advertising (strong brands) 2. Product proliferation (Segmentation, exploit CV) 3. Wide availability (high volume, lower unit supplier costs)
CAPTURED VALUE
1. Defined bottler structure (hence reduced their power)
2. Exercised power over suppliers and buyers
(national level negotiations)
3. Avoided price-based rivalry
What should we think about when assessing profitability by distribution channel?
- CV (context, substitutes)
- Price (rivalry, bargaining power)
- Unit cost (cost to serve/distribute)
What are the pros and cons of vertically integrating bottlers?
- Pros
- Eliminate power of consolidated bottlers - Cons
- Reduces flexibility
- why own such low margin business
Average industry profitability determined by…
… strength of 5 Forces
Key insight in porter’s 5 forces
Competition doesn’t just come from direct competitors, it also comes from potential competitors, suppliers and buyers and from substitutes
Compare porter and value capture framework
A. Potential to create and sustain competitive advantage
1) Threat of imitation
B. Ability to capture value
1) Bargaining power of customers
2) Intensity of rivalry
3) Bargaining power od suppliers
C. Ability to create value
1) Threat of substitute
What characteristics determine the Threat of Entry?
BARRIERS TO ENTRY
- Supply side economies of scale
- Demand side benefits of scale
- Superior ‘experience’ (cumulative learning)
- Customer switching costs
- (Capital requirements)
- Incumbency advantages independent of scale
- proprietary tech
- preferential access to better or cheaper inputs
- pre-emption of best locations
- superior brand - Unequal access to distribution channels
- Restrictive gov policy (licencing, patents)
EXPECTED RETALIATION TO ENTRY?
If strong reaction from incumbent(s) is likely, industry profitability may fall so that it is not worth entering
Likely retaliation driven by:
– Economic incentive (e.g. to retain volume)
– Incumbent resources
– Incumbent’s track record of behavior
Likely retaliation to entry driven by:
– Economic incentive (e.g. to retain volume)
– Incumbent resources
– Incumbent’s track record of behavior
What characteristics determine the Relative Power of Suppliers?
SUPPLIERS MORE POWERFUL IF:
- Supplier industry is more concentrated than buying industry
- Supplier doesn’t depend heavily on the buying industry (e.g. small part of output)
- Buyers have significant switching costs
- Supplier’s product is differentiated
- Lack of acceptable substitutes (for the supplied product)
- Suppliers have a credible threat of forward integration
What characteristics determine the Relative Power of Buyers?
Buyers more powerful if:
1. Few buying firms, many selling firms
2. Product is undifferentiated
3. Buyers face few switching costs
4. Buyers have credible threat of backward integration
5. Buyers are price sensitive
– Product is large part of buyer’s cost
– Buyers have low profitability
– Quality of buyers output, or efficiency of buyers processes are unaffected by quality of the product being bought
6. Buyer exerts significant influence over what end customer buys (e.g. distributor)
What characteristics determine the Threat of Substitutes?
THREAT TENDS TO HIGHER IF: 1. Many substitutes 2. Substitutes offer attractive price- performance propositions 3. Substitutes involve low switching costs
What determines the Intensity of Rivalry from Direct Competitors?
INTENSITY TENDS TO BE HIGH IF: 1. Many competitors 2. Little difference between competitors in terms of ‘competitive advantage’ – No ‘industry leader’ 3. Slow growth 4. High exit barriers 5. Strong reasons to fight (managerial aspirations, social goals) 6. Inability to read or respond to ‘market signaling’ 7. Price is major basis of competition – Low product differentiation – High fixed costs – Large increments of capacity – Product is perishable
What are the pitfalls of Porter’s 5F?
- Be careful to have all five assessments working in the same direction
- Don’t just add up the strengths to get your overall assessment!
- The forces are NOT additive
- You only need one strong force to make the profitability potential of the industry poor
- You only need one hole in the boat!! - Beware ‘universal rules’!
– Do high barriers to entry imply low rivalry? Not necessarily!
What’s the best way to enter a market?
Much better to get into a (new) business early – before barriers and bargaining power are fully developed
Three main uses of the Five Forces framework
- Understanding the current profitability of an industry
‒ Where best to be positioned? - Assessing future profitability of an industry (or positioning)
- Sometimes a way of coming up with ideas for better strategy
What should managers do according to porter?
- Managers should seek to compete in industries which support high average profitability
- Managers should assess the strength of the five forces (for an industry) by looking at the relevant industry ‘characteristics’ (products, buyers, suppliers, economics, etc.)
Is growth necessary or sufficient for strong profitability?
growth is neither necessary nor sufficient to ensure strong
profitability
