Porter’s Five Forces Model of Industry Structure and Competition

The model was developed by Michael E. Porter in his book “Competitive Strategy": Techniques for Analyzing Industries and Competitors“ in 1980. Since that time this model gained popularity as framework for analyzing the business environment and the development of the strategic action plans.
Porters model is based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Especially, competitive strategy should base on and understanding of industry structures and the way they change. Porter has identified that every industry and every market are mainly governed by these five external forces..
Intensity of competition is the resultant of these forces and hence these has impact on the profitability and attractiveness of an industry. The objective of corporate strategy should be to take strategic action plan ready when these forces are changing.
Five Forces Analysis yeilds the necessary informations so that the management can decide how to react with respect to a situation.
The Five Competitive Forces

The Five Competitive Forces are described as follows:

1 Bargaining Power of Suppliers:

'Suppliers' comprises all sources for inputs required to deliver values in terms of product or services or a suitable mix of both.
Supplier bargaining power is likely to be high when:
• There is a monopolistic or oligopolistic situation for the suppliers.
• Unavailability of substitute of a particular input.
• The supplier's customers are fragmented, so their bargaining power is low,
• The switching costs from one supplier to another are high,
• There is the possibility of the supplier integrating forwards in order to obtain higher prices and margins.

This threat is
Especially high when
• The buying industry has a higher profitability than the supplying industry,
• Forward integration provides economies of scale for the supplier,
• The buying industry hinders the supplying industry in their development (e.g. reluctance to accept new releases of products),
• The buying industry has low barriers to entry.
In such situations, the buying industry often faces a high pressure on margins from their suppliers. The relationship to powerful suppliers can potentially reduce strategic options for the organization.

2 Bargaining Power of Customers:
Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes.
Customers bargaining power is likely to be high when
• They buy large volumes, there is a concentration of buyers,
• The supplying industry comprises a large number of small operators
• The supplying industry operates with high fixed costs, The product is undifferentiated and can be
replaces by substitutes,
• Switching to an alternative product is relatively simple and is not related to high costs,
• Customers have low margins and are pricesensitive,
• Customers could produce the product themselves,
• The product is not of strategical importance for the customer,
• The customer knows about the production costs of the product
• There is the possibility for the customer integrating backwards.

3 Threat of New Entrants
The competition in an industry will be the higher, the easier it is for other companies to enter this industry. In such a situation, new entrants could change major determinants of the market environment (e.g. market shares, prices, customer loyalty) at any time. There is always a latent pressure for reaction and
adjustment for existing players in this industry. The threat of new entries will depend on the extent to which there are barriers to entry.
These are typically
• Economies of scale (minimum size requirements for profitable operations),
• High initial investments and fixed costs,
• Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets,
• Brand loyalty of customers
• Protected intellectual property like patents, licenses etc,
• Scarcity of important resources, e.g. qualified expert staff
• Access to raw materials is controlled by existing players,
• Distribution channels are controlled by existing players,
• Existing players have close customer relations, e.g. from long-term service contracts,
• High switching costs for customers
• Legislation and government action

4 Threat of Substitutes
A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category also relates to complementary products. Similarly to the threat of new entrants, the treat
of substitutes is determined by factors like
• Brand loyalty of customers,
• Close customer relationships,
• Switching costs for customers,
• The relative price for performance of substitutes,
• Current trends.
5 Competitive Rivalry between Existing Players
This force describes the intensity of competition between existing players (companies) in an industry. High competitive pressure results in pressure on prices, margins, and hence, on profitability for every single company in the industry. Competition between existing players is likely
to be high when
• There are many players of about the same size,
• Players have similar strategies
• There is not much differentiation between players and their products, hence, there is much price competition
• Low market growth rates (growth of a particular company is possible only at the expense of a competitor),
• Barriers for exit are high (e.g. expensive and highly specialized equipment).

Use of the Information form Five Forces Analysis
Five Forces Analysis can provide valuable information for three aspects of corporate planning:

Statical Analysis:
The Five Forces Analysis allows determining the attractiveness of an industry. It provides insights on profitability. Thus, it supports decisions about entry to or exit from and industry or a market segment. Moreover, the model can be used to compare the impact of competitive forces on the own organization
with their impact on competitors. Competitors may have different options to react to changes
in competitive forces from their different resources and competences. This may influence the structure of the whole industry.

Dynamical Analysis:
In combination with a PEST-Analysis, which reveals drivers for change in an industry, Five Forces Analysis can reveal insights about the potential future attractiveness of the industry. Expected political, economical, sociodemographical and technological changes can influence the five competitive forces and thus have impact on industry structures. Useful tools to determine potential changes of competitive forces are scenarios.

Analysis of Options:
With the knowledge about intensity and power of competitive forces, organizations can develop options to influence them in a way that improves their own competitive position. The result could be a new strategic direction, e.g. a new positioning, differentiation for competitive products of strategic partnerships (see section 4). Thus, Porters model of Five Competitive Forces allows a systematic and structured analysis of market structure and competitive situation. The model can be applied to particular companies, market segments, industries or regions. Therefore, it is necessary to determine the scope of the market to be analyzed in a first step. Following, all relevant forces for this market are identified and analyzed. Hence, it is not necessary to analyze all elements of all competitive forces with the same depth.
The Five Forces Model is based on microeconomics. It takes into account supply and demand, complementary products and substitutes, the relationship between volume of production and cost of production, and market structures like monopoly, oligopoly or perfect competition.

Influencing the Power of Five Forces

After the analysis of current and potential future state of the five competitive forces, managers can search for options to influence these forces in their organization's interest. Although industry-specific business models will limit options, the own strategy can change the impact of competitive forces on the
organization. The objective is to reduce the power of competitive forces. The following figure provides some examples. They are of general nature. Hence, they have to be adjusted to each organization's specific situation. The options of an organization are determined not only by the external market environment, but also by its own internal resources, competences and objectives.


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