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PORTER FIVE FORCES MODEL

10/26/2012 1Prof P K Agarwal


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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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Cont.

The Five Forces - Michael Porter

Analytical tool for examining competitive environment. According

to this model, the intensity of competition in an industry dependson 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.



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PORTERS FIVE FORCES MODEL

10/26/2012 Prof P K Agarwal


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Forces that Shape Competition

1. The Threat of New Entrants

The first ofPorters Five Forces model is

the threat of new entrants. Newentrants bring new capacity &

substantial resources to an industry

with a desire to gain market share.

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Forces that Shape Competition

2. Barriers to entry

Entry barriers depend on the advantages that existingcompanies have relative to new entrants. There areseven major sources:

i. Economies of scale

ii. Product differentiation

iii. Capital requirements

iv. Switching costs

v. Access to distribution channelsvi. Cost disadvantages independent of size

vii. Government policy



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Cont.

Expected Retaliation

New entrants -- likely to fear expected retaliation if:

Existing companies - earlier responded vigorously

Existing companies possess substantial resources to fightback

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.



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Cont.

Intensity of Rivalry among Competitors

The second of Porters Five-Forces model . Rivalry means thecompetitive 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


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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 businessunits and others prevent exit because of shared

facilities, image and so on.



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Cont.

Bargaining power of buyers

The third ofPorters 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 ofbuyers products



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Cont.

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


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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 firmswithin an industry compete with industries

producing substitute products.

Existence of close substitutes a strong competitive

threat because this limits the price that companiesin 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.10/26/2012 Prof P K Agarwal 13


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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.



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Critical Assessment - Five Forces Model

Propelled the concept of industry environment into theforeground 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 ofan 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 ordecreasing resources commitment.

5. It helps managers to decide whether the firm

should remain in or exit from the industry



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Limitations

Despite being the most popular and widely used

framework for competitive analysis, Porters FiveForces 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.



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It is short-sighted and implicitly assumes a zero-sum

game. It overlooks the many potential benefits ofdeveloping 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.



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4. 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

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 amongnations, 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 areadiffers among nations, and may present

challenges that are not present in a firms

host country.



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Examples of a Companys Strengths,

Weaknesses, Opportunities, and Threats


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