Michael Porter's
Industry Structural Analysis
5 Forces of Competition
Competition drives the return down to that which would
be earned by the economist’s “perfectly competitive”
industry.
All five competitive forces jointly determine the intensity
of industry competition and profitability.
Different from short-run factors that can affect
competition and profitability in a transient way.
5 Forces and Strategy
The goal is to find a position in the industry where the
company can best defend itself against these
competitive forces or can influence them in its favor.
Since the collective strength of the forces may well be
apparent to all competitors, the key for developing
strategy is to analyze the sources of each.
Force 1. THREAT OF ENTRY
Depends on extant barriers to entry, coupled with the
expected reaction from existing competitors.
Barriers of Entry
Economies of Scale.
Product Differentiation.
Capital Requirements.
Switching Costs.
Access to Distribution Channels.
Cost Disadvantages Independent of Scale.
Government Policy
Force 2. INTENSITY OF RIVALRY
AMONG EXISTING COMPETITORS
Firms are mutually dependent.
Some forms of competition, notably price competition, are
highly unstable and quite likely to leave the entire industry
worse off from the standpoint of profitability.
Intense rivalry is the result of interacting structural factors.
Numerous or Equally Balanced Competitors.
Slow Industry Growth.
High Fixed or Storage Costs.
Lack of Differentiation or Switching Costs.
Capacity Augmented in Large Increments.
Diverse Competitors.
High Strategic Stakes.
High Exit Barriers.
Notes on Exit Barriers
Economic, strategic, and emotional factors that keep
companies competing in businesses despite low or
even negative returns on investment.
Major sources of exit barriers
Specialized assets
Fixed costs of exit
Strategic interrelationships
Emotional barriers
Government and social restrictions
Force 3. PRESSURE FROM
SUBSTITUTE PRODUCTS
Industry’s overall elasticity of demand.
Limits profits in normal times and also reduce the
bonanza an industry can reap in boom times.
Position vis-à-vis substitute products may well be a
matter of collective industry actions.
Substitute products that deserve the most attention are
those that (1) are subject to trends improving their priceperformance tradeoff with the industry’s product, or (2)
are produced by industries earning high profits.
Force 4. BARGAINING POWER OF
BUYERS... is high if...
The industry is concentrated or purchases large volumes
relative to seller sales.
The products it purchases from the industry represent a
significant fraction of the buyer’s costs or purchases.
The products it purchases from the industry are standard
or undifferentiated.
It faces few switching costs.
It earns low profits.
Buyers pose a credible threat of backward integration.
The industry’s product is unimportant to the quality of the
buyers’ products or services.
Force 5. BARGAINING POWER OF
SUPPLIERS ... is high if ...
Industry is is dominated by a few companies and is more
concentrated than the industry it sells to.
Suppliers are not obliged to contend with other substitute
products for sale to the industry.
The industry is not an important customer of the supplier group.
Suppliers’ product is an important input to the buyer’s business.
Supplier group’s products are differentiated or it has built up
switching costs.
Supplier group poses a credible threat of forward integration.
BTW... labor must be recognized as a supplier as well,
The principles re the potential power of labor are similar to
those of suppliers. The key additions are labor's degree of
organization, and whether the supply of scarce varieties of
labor can expand.
Summary of 5 Forces
1.
2.
3.
4.
5.
If the Threat of New Entrants is High, prices can be bid down and/or
incumbents' costs inflated, reducing profitability.
If the Intensity of Rivalry Among Existing Competitors is High, tactics
like price competition, advertising battles, product introductions, and
increased customer service or warranties are common, having
noticeable effects on all competitors.
If the Pressure from Substitute Products is High, it limits the potential
returns by placing a ceiling on the prices firms in the industry can
profitably charge. The more attractive the alternative, the firmer the lid
on industry profits.
If the Bargaining Power of Buyers is High, Buyers compete by forcing
down prices, bargaining for higher quality or more services, playing
competitors against each other, reducing profitability.
If the Bargaining Power of Suppliers is High, Suppliers can exert
bargaining power over participants in an industry by threatening to raise
prices or reduce the quality of purchased goods/services.