Porter's Five Forces

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Porter’s Five Forces

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Developed by Michael Porter, Porter’s Five Forces is a classic business framework for evaluating the attractiveness of a particular industry by analyzing 5 forces. It is useful to utilize Porter’s Five Forces in conjunction with a SWOT analysis of the industry.

4. Suppliers

Suppliers negotiation power

2. Competitors in the industry

Rivalry among existing

companies

1. Potential new competitors

Threat by new competitors

3. Substitution products

Threat by substitution

products

5. Customers

Buyers’ negotiation power

2Questions & feedback? Email me – [email protected] diagrams in this pack are to be used by the original buyer only.

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Porter’s five forces constitutes a framework for analysing a company’s environment (or industry structure):– Porter first structured the framework in his 1980

book Competitive Strategy. Porter assumes that competition in an industry

depends on five basic forces:

The collective strength of these forces determines the ultimate profit potential and allocation in the industry.

Porter’s Five Forces – Introduction

What It Is Why We Use It

Strengths & Limitations

Industry Competitors

Substitutes

Potential Entrants

BuyersSuppliers

Rivalry Among Existing Firms

Bargaining power of buyers

Bargaining power of suppliers

Threat of substitute products or services

Threat of new entrants

Source: M.E. Porter, Competitive Strategy, 1980, p. 4 Free Press.

Strengths:

– Quite comprehensive framework.

– Good starting point to understand key drivers and trends.

Limitations:

– Very often used strictly qualitatively.

Assess attractiveness on the basis of competition in an industry.

Highlight areas in which industry trends may pose opportunities or threats.

Analyze where the company stands vis-a-vis the underlying causes of each competitive force.

To understand/diagnose levels of return.

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Porter’s Five Forces – Framework Diagram

4. Suppliers

Suppliers negotiation power

2. Competitors in the industry

Rivalry among existing companies

1. Potential new competitors

Threat by new competitors

3. Substitution products

Threat by substitution

products

5. Customers

Buyers’ negotiation power




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Porter’s Five Forces – Potential Insight & Output

Pressure from Substitute Products

Bargaining Power of BuyersBargaining Power of Suppliers

Threat of New Entrants

Intensity of Rivalry

Low, stable returns

Low, risky returns

High, stable returns

High, risky returns

Exit Barriers

Entry Barriers

L

H

L H

CostLeadership Differentiation

CostFocus

DifferentiationFocus

Competitive Advantage

CompetitiveScope

Broad

Narrow

Lower Cost Differentiation

• Several important economic and technical characteristics of an industry are critical to the strengths of each competitive force:

A supplier group is powerful when: It is dominated by a few companies and is more

concentrated than the industry it sells to. There are no substitute products. The industry is not an important customer. Its products are important to the industry. Products are differentiated or suppliers have built

up switching costs. It poses a credible threat of forward integration.

Barriers to entry: Economies of scale (including shared resources) Product differentiation (proprietary) Capital requirements Switching costs Access to distribution channels Cost disadvantages independent of scale Government policy Expected reaction of incumbent

Intense rivalry results from: 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

A buyer group is powerful when: It is concentrated or purchases large volumes relative

to seller sales. The products represent a significant fraction of the

buyers’ costs or purchases. The products are standard or undifferentiated. It faces few switching costs. It earns low profits. It poses a credible threat of backward integration. The bought product is unimportant. It has full information.

Search for products that can perform the same function.

Assess buyers’ propensity to substitute.

Focus on those that: Are improving their price performance trade-off

compared with the industries products. Require low switching costs. Are produced by industries earning high profits.

Take offensive or defensive actions to create a defensible position against the forces:

Positioning the firm so its capabilities provide the best defense

Influencing the balance of forces through strategic moves

Anticipating shifts in the factors underlying the forces and responding to them




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Total U.S. printed media revenues, 1989-1999Includes both consumer and advertising spending

The publishing industry has seen only modest increases in sales in recent years

Source:Veronis, Suhler & Associates; S&P Industry SurveyNote:Magazine and newspaper spending includes both advertising and consumer spending

The internet provides an innovative new distribution medium that magazines and newspapers can use to recover readers and lure advertisers.The internet provides an innovative new distribution medium that magazines and newspapers can use to recover readers and lure advertisers.

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– $ Billions

95E949392919089

EXAMPLE

Total revenues CAGR

Newspapers

Books

Magazines

• Newspaper and magazine revenue growth has been driven by price increases, as circulation has been flat to falling

• Newspapers and magazines share of total advertisers’ spending has also fallen from 32% to 28% over the last five years

• Book publishers have seen growth in book unit volumes, with stable prices:

– Books remain a popular source for access to fiction and non-fiction despite a growing number of substitutes

– Recent growth of discount stores has helped increase sales

1989-19944.6%

1994-1999E5.7%




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The stock market, unsure of publishing’s future role, is not rewarding print-focused players

Value of $100 invested in March 1985

Source:CompustatNote:All dividends reinvested. Indices track independent, “pure play” print media companies in each print segment

Publishing companies must to transition to full media companies, expanding beyond print to distribute their products to be seen as long-term competitors.Publishing companies must to transition to full media companies, expanding beyond print to distribute their products to be seen as long-term competitors.

The Wall Street appeal of online involvement could help publishers who proactively use the new distribution medium

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50

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250

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450S&P 500NewspapersBooksMagazines

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a-8

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EXAMPLE




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Leaders in the PC business have changed as quickly as the need for computing power

New entrants and industry consolidation are forcing competitors to continually redefine their business strategies.New entrants and industry consolidation are forcing competitors to continually redefine their business strategies.

U.S. Unit Market Share of top 10 competitors(quarterly changes in market share)

40%

30%

20%

10%

0%

U.S. UnitMarket Share

70%

60%

50%

2Q 1994 4Q 19944Q 1993

CompanyX

1Q 19943Q 19932Q 19931Q 1993 3Q 1994

EXAMPLE

CompanyX

CompanyX

CompanyX

CompanyX

CompanyX

CompanyX

CompanyX

CompanyX

CompanyX




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Average PC makers’ revenue spending Top PC makers’ gross margin, 1989-1994

Gross margins have declined as the PC becomes a commodity product

Taiwanese hardware manufacturers, such as Acer, have experienced 25% compound annual revenue growth since 1986 by being the lowest cost suppliers to the top PC makers worldwide.Taiwanese hardware manufacturers, such as Acer, have experienced 25% compound annual revenue growth since 1986 by being the lowest cost suppliers to the top PC makers worldwide.

$1.00

Revenue

$0.76

Cost of goods

$0.04

R&D

$0.13

Mktg. & distribution

$0.02

SG&A

$0.05

Operating profit

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1989 1990 1991 1992 1993 1994

% Gross margin

EXAMPLE




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Several factors determine the bargaining power of buyers

A buyer group is powerful when:

• It is concentrated or purchases large volumes relative to seller sales

• Its purchases from the industry represent a significant fraction of the buyers’ costs or purchases

• It purchases standard or undifferentiated products

• Brand identification is low

• Its switching costs are low

• Its profits are low

• It poses a credible threat of backward integration

• Its purchases from the industry is unimportant for the quality of its products or services

• It possesses full information

These factors may change over time and alter buyer power.These factors may change over time and alter buyer power.




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Bookstores are the only channel with the ability to exert pressure on publishers

Limited bandwidth will slow book publishers’ ability to distribute products on-line, but could bypass bookstores through Internet-based mail-order services and other creative services.Limited bandwidth will slow book publishers’ ability to distribute products on-line, but could bypass bookstores through Internet-based mail-order services and other creative services.

Publishers

• These large national stores played a central role in boosting book sales to record levels in 1994, but put pricing pressure on publishers

• For newspapers and magazines the customer-base is more fragmented

Convenience Stores &

Newsstands

Direct Distribution

(subscription)

Other retail outlets

Schools & Universities

BookstoresU.S. Retail Market Share, 1994

1. Barnes & Nobles

17.3%2. Borders-Walden

16.1%3. Crown Books

3.2%4. Books-a-Million

1.8%Total retail market of $9.4 billion

38.4%

Primarily newspapers and magazines Primarily books

EXAMPLE




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Business

Distinct distribution channels serve the two major different end-user segments

Massive increase of home PC usage has increased the strength of the mainstream channel, especially retailers.Massive increase of home PC usage has increased the strength of the mainstream channel, especially retailers.

Source:IDC and Merrin Information Services, Inc.

Channels

Direct Sales

System Integrators (SI)

Value-Added Resellers (VAR)

Dealers

Computer Superstores

Mass Merchants

Consumer Electronic Stores

Office Stores

Mail Order

Direct Response

Value-added channels

Mainstream channels

Definitions

Those sales made by a manufacturers’ sales force, agent, or representative

Provide customized value-added solutions for clients

Offer unique, tangible solutions “off-the-shelf” to targeted customers

The “traditional” computer dealer channel. Do not add unique value to the system but do offer some value in the form of support, training, or other services

Large, well-merchandized store fronts , with most revenue generated by computer-related sales

Typically offer a wide range of products, including computer-related equipment

Offer a wide range of electronic merchandise, including computer-related items

Retailers and resellers focusing on office supplies

Third-party computer sales that use telephone to perform all levels of sale

Direct telephone sales from manufacturers not using third parties

Typical buyer

Home users

EXAMPLE




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Porter’s Five Forces – Framework Diagram TemplatePorter’s Five Forces – Template

Suppliers Internal Rivalry

New Entrants

Substitutes

Buyers

• Bullet point 1• Bullet point 2• Bullet point 3• Bullet point 4





Competitive Advantage

Lower Cost Differentiation

CostLeadership Differentiation

CostFocus

DifferentiationFocus

Co

mp

etit

ive

Sco

pe

Broad

Narrow

INDUSTRY COMPETITIVE ASSESSMENT COMPETITIVE STRATEGY




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Porter's Five Forces