What are Porter’s Five Forces?
- THREAT OF NEW ENTRANTS
- POWER OF SUPPLIERS
- POWER OF BUYERS
- THREAT OF SUBSTITUTES
- EXISTING COMPETITION
What is the fundamental equation of Porter’s Five Forces?
Profit = Price - Cost
What is the Porter’s Five Forces Framework?
Porter created what he calls “frameworks” to help firms maximize value.
“if you’re going to have higher profitability, you’ve got to have a higher price or a lower cost.”
What are Threat of New Entrants?
- New entrants bring new capacity and
desire to gain market share that puts
pressure on prices, costs and rate of
investment needed to compete.
What are Barriers to Entry?
Entry barriers protect an industry from newcomers who would add new
capacity and seek to gain market share.
*Low entry barrier = high threat of entry = low profitability
*High entry barrier = low threat of entry = high profitability
BARRIERS TO ENTRY:
Supply-side economies of scale…
- Firms derive lower costs because of larger volumes
More volume = lower cost = harder to compete with
BARRIERS TO ENTRY:
Demand-side benefits of scale…
- the value of a product or service increases in accordance with the
number of users of that product or service
More users = more value = harder to compete with
BARRIERS TO ENTRY:
High customer switching costs…
– Fixed costs when changing suppliers
BARRIERS TO ENTRY:
High Capital requirements…
- Need to invest large resources to enter and to compete
BARRIERS TO ENTRY:
Incumbency advantages…
– Incumbents will always have cost or quality advantages over new entrants
– Unequal access to distribution channels and prime locations
– Proprietary technology or patents
– Well-established brands
BARRIERS TO ENTRY:
Restrictive government policy…
– May hinder or aid new entrants
– Permits, tariffs, high taxes, patents
What are the power of suppliers?
Powerful Suppliers capture more of
the value for themselves by
charging higher prices or insist on
more favorable terms, shifting
costs to industry participants
What is the bargaining power of suppliers?
- More concentrated than industry it sells to
- Does not depend heavily on one industry/product for revenues
- Industry faces switching costs in changing suppliers
- Supplier offers products that are differentiated
- No substitute for what supplier provides
- Supplier can integrate forward into the industry
What is the power of buyers?
Powerful buyers capture
more value by forcing down prices,
demanding better quality or more
service, play industry participants off one another at expense of profitability.
BUYERS’ NEGOTIATING LEVERAGE:
Buyers are powerful if…
*Buyers are concentrated - there are a few buyers with significant market share
*Buyers purchase a significant proportion of output - distribution of purchases or if the product is standardized
*Buyers possess a credible backward
integration threat - can threaten to buy
producing firm or rival
BUYERS’ NEGOTIATING LEVERAGE:
Buyers are weak if…
- Producers threaten forward integration - producer can take over own distribution/retailing
- Significant buyer switching costs - products not standardized and buyer cannot easily switch to another product
- Buyers are fragmented (many, different) - no buyer has any particular influence on product or price
- Producers supply critical portions of buyers’ input - distribution of purchases
What are threat of substitutes?
Substitutes:
* Products or services that
meet same or similar
function as industry’s
product by different means
- always present but easy to
overlook
HIGH THREAT OF SUBSTITUTE IF….
- It offers attractive price-performance trade-off
- Cost of switching is low
What is rivalry among existing competition?
If rivalry is intense, companies
compete away the value they
create, passing it on to buyers in
lower prices or dissipating it in
higher costs of competing.
May take many forms: price
discounting, new product
introductions, advertising
campaigns and service
improvements
Intensity of rivalry is
greatest if…
- Competitors are numerous or are
roughly equal in size and power - Industry growth is low
- Exit barriers are high
- Rivals have aspirations for
leadership beyond economic
performance
Price competition is deadly and most liable to occur if…
- Products or services or rivals are
nearly identical and there are few
switching costs - Fixed costs are high and marginal
costs are low - Capacity must be expanded in large
increments to be efficient and to
lower costs - Product is perishable
Rivalry should lead to:
Positive Sum
Competition:
When each competitor aims to serve needs of different customer segments with different mixes of price, products, services, features of brand identities.
How do we apply the Five Forces in our
strategies?
- Positioning the company to
cope with current competitive landscape:
- As defense against competitive forces
- Finding a position where forces are weakest
- Exploiting Industry Change
- Industry changes bring the opportunity to spot promising new strategic positions.
3.Shaping Industry Structure
- A firm can lead its industry toward new ways of competing that alter five forces for the better.
- Defining the industry
- Five forces will help define the relevant industry where a firm competes
What is an internal assessment?
Identifying and evaluating a firm’s strengths and weaknesses in all the functional areas of business
