Introduction to Michael Porters Five Forces

Michael E. Porter’s five forces framework is used to evaluate the competitiveness, and hence the attractiveness and profitability of different markets and market segments. It is important for business managers to realize that a 5 forces analysis should be conducted at the level of strategic business units (SBUs), and not at the level of the whole organization. Many larger companies have several SBUs conducting business in different markets that serve many different customer segments. Likewise, these SBUs may have completely different suppliers, competitors and substituting products.
Every SBU should therefore conduct its own analysis, and try to evaluate the attractiveness and profitability of its own markets and market segments. The five forces are shortly described below: Competitive Rivalry The evaluation of the rivalry between competitors helps to examine the degree of head-to-head competition in an industry. In Porter’s “five forces” framework this issue is of course included, but is only seen as one of several forces that determine industry attractiveness. Commen reasons for high rivalry are depicted below: § Low industry growth rates § High exit barriers Undifferentiated supply of products § Price wars to cover high fixed costs Threat of new entrants The threat of new entrants is usually based on the market entry barriers, which can be said to provide obstacles for newcomers to gain a foothold in any given industry. These barriers can take many different forms. Briefly, it can be said that entry barriers exist whenever it is difficult or not economically feasible for an outsider to copy or imitate the existing players’ competitive capabilities. Common forms of entry barriers are depicted below: § Economies of scale § Capital requirement of entry Access to supplies and distribution channels § Customer or supplier loyalty § Lack of experience in industry § Legal restrains such as trade barriers Threat of Substitute Products The threat of substitute products, depends on the relative price difference between different products that can equally satisfy the same basic customer needs. Switching costs also affect the threat of substitution – which can be defined as the costs found by buyers in switching to a rivals product or service. § Product for products substitution (e. g. e-mail instead of postal service) New products make older products obsolete (e. g. better cars require fewer automobile services) Bargaining Power of Buyers Important determinants of buyer power are the size and the concentration of customers. Other factors are the extent to which the buyers are informed about other vendors and suppliers, and to the extent to which buyers can quickly identify other sources of supply. Common reasons for great bargaining power of buyers are depicted below. § Great concentration of buyers – few buyers § The cost of switching supplier is low § Many equally competent suppliers § Backward integration
Bargaining Power of Suppliers If there are few suppliers of e. g. raw materials, these suppliers may eventually be very strong, and able to put pressure on the buying company. Likewise, if the switching costs related to switching supplier are high, the respective supplier may be very strong, and thus be able to put pressure on the buying partner concerning e. g. prices, quantities and quality. Common reasons for great bargaining power of suppliers are depicted below. § Great concentration of suppliers – few suppliers § Great switching costs related to changing supplier § Forward integration

The competition and attractiveness in an industry is strongly affected by these suggested forces. The stronger the power of buyers and suppliers, and the stronger the threats of entry and substitution, the more intense competition is likely to be within the industry, where less competitive industries are seen as more attractive and profitable. Using the 5 forces framework, business managers may conduct an analysis of the attractiveness and profitability of different markets, so that business managers can evaluate different courses of strategic action, and evaluate which forces may be most important for current and future business success.