LEARNING OBJECTIVE
KEY POINTS
- Porter's Five Forces include threat of new entrants (also known
as barriers to entry), threat of substitutes, rivalry, bargaining power
of suppliers, and bargaining power of buyers.
- Managers use the Five Forces model to help identify
opportunities and threats or to evaluate decisions in the context of
their organization's environment.
- Attractiveness refers to the overall industry profitability. An
"unattractive" industry is one in which the combination of the Five
Forces drives down overall profitability.
- In analyzing these five factors, it is useful to rate each
category as an external risk factor (i.e., low, medium, or high). Ideal
industries have low threats from each of these forces (i.e., low buy
power, low rivalry, low risk of new entrants, etc.).
- This model is a useful for the strategic derivation of managers;
it allows them to narrow down their focus on specific key issues within
a given industry.
TERMS
Michael Porter, a leading business analyst and professor at Harvard
Business School, has identified five key forces that affect the strategy
of any industry. His list, Porter's Five Forces, draws upon industrial
organization (IO) economics to derive forces
that determine the competitive intensity – and therefore
attractiveness – of a market.
Industry Attractiveness
Attractiveness refers to the overall industry profitability. An
"unattractive" industry is one in which the combination of the Five
Forces drives down overall profitability. A very unattractive industry
would be one approaching "pure competition". In
this state, available profits for all firms are driven to normal
profit rates. In analyzing the following five factors, it is useful to
rate each category as an external risk factor (i.e., low, medium, or
high). Ideal industries will have low threats
from each of these forces (i.e., low buy power, low rivalry, low
risk of new entrants, etc.).
The Five Forces
Porter's Five Forces include:
- Threat of new entrants (or barriers to entry): From the
view of current incumbents, profitable markets that yield high returns
will attract new firms. This results in many new competitors and
eventually decreases profitability for all firms
in the industry. Unless the entry of new firms can be blocked by
incumbents, the abnormal profit rate will tend toward zero (also known
as "perfect competition"). From the perspective of new entrants, high
barriers to entry mean that the capital
costs of getting into the industry make it difficult to compete
with current incumbents.
- Threat of substitute products or services: The
existence of products outside of the realm of the common product
boundaries, which fulfill the same need, increases the propensity of
customers to switch to alternatives. This should not be confused
with competitors' similar products; it is instead a different
product that fills the same need. Take transportation as an example:
General Motors (GM) would view city subways as a substitute for someone
buying a new car.
- Rivalry: For most industries, the intensity of
competitive rivalry is the major determinant of the competitiveness of
the industry. This involves how many firms are in the industry and how
their competitive dynamics reduce profitability.
Airlines have an extremely high rivalry, for example.
- Bargaining power of buyers: The bargaining power of
customers is also described as the market of outputs. It is the ability
of customers to put the firm under pressure, which also affects the
customer's sensitivity to price changes. Picture
a supply and demand curve: if the supply greatly outstrips the
demand, the buyers have more power than the suppliers.
- Bargaining power of suppliers: The bargaining power of
suppliers is also described as the market of inputs. When there are few
substitutes, suppliers of raw materials, components, labor, and services
(such as expertise) to the firm can be
a source of power over the firm. Suppliers can refuse to work
with the firm or charge excessively high prices for unique resources.
Similar to the power of buyers, this bargaining power relies on scarcity
and basic economics of supply and demand.
Strategic Implications
Managers use the Five Forces Model to help identify opportunities or
evaluate decisions in the context of the environment. Often, the Five
Forces are mapped against a SWOT analysis to develop a corporate
strategy. To complete a Five Forces analysis, it
is often best to build a grid on a piece of paper and label each
section. Filling in each section to develop a view of the industry can
help managers determine if the industry is truly competitive, a
monopoly, or an oligopoly. An important question
to ask is: "What will make a company able to compete in this environment?"
Porter's Five Forces
This image illustrates the important factors within Porter's Five Forces model.
Source: Boundless, https://courses.lumenlearning.com/boundless-management/chapter/external-inputs-to-strategy/
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