Porters 5 forces
Porters 5 Forces is model that can be used to evaluate the attractiveness of an industry and what strategy companies can us. The Attractiveness is evaluated by both measuring internal competition in the industry as well as the main external factors (Power of Buyers, Power of Suppliers, Threat of New Entrants, Threat of Substitutes). The higher the internal competitiveness, the power of suppliers and/or buyers, and the threat of new entrants and/or substitutes the less attractive an industry is (i.e. the return on invested capital is less likely to be significantly above long-term government securities adjusted upwards by the risk of capital loss).
Intensity of Rivalry among Existing Competitors
Rivalry among existing competitors in an industry takes the form of tactical activities to improve a firm’s position relative to competitors. This can take the form of price wars, Advertising battles, product introductions, customer service or warranties. A competitive move is in most cases countered by competition. If this pattern of action and reaction escalate then all firms in the industry may suffer and be worse off then before.
Some factors has a tendency to stimulate a higher rivalry within an industry: Numerous or Equally Balanced Competitors, Slow Industry Growth, High Fixed or Storage Costs, Lack of Differentiation of Switching Costs, Capacity Augmented in Large Increments, Diverse Competitors, High Strategic Stake, High Exit Barriers.
Bargaining Power of Buyers
Buyers constantly tries to force down the prices, bargaining for higher quality or more services, and playing competitors against each others – all at the expense of industry profitability. A buyer group is powerful if the following apply:
Bargaining Power of Suppliers
Suppliers can effect an industry by threatening to raise prices of reduce quality of purchased goods and services. Powerful suppliers can thereby reduce profitability in an industry if unable to recover cost increases in its own prices. A supplier group is powerful if the following circumstances hold true:
Threat of Substitute Products or Services
Substitute products limits the potential return of an industry by placing a ceiling in the prices firms in the industry can profitably charge. Substitute products that deserves the most attention are those that (1) are subject to trends improving their price-performance tradeoff with the industry’s products, (2) are produced by industries earning higher profits. In the latter case, substitutes often come rapidly into play if some development increases competition in their industry and causes price reductions or performance improvements.
Threat of New Entrants
New Entrants to an industry brings new capacity to the industry and a desire to gain market share. Prices can be reduced in order to gain market share resulting in lower profitability. The threat of entry into an industry depends on the barriers to entry that are present, coupled with the reaction from existing competitors. If barriers are high and/or the entrant can expect sharp retaliation from entrenched competitors, the threat of entry is low. There are 6 major sources of barriers to entry: Economics of Scale, Product Differentiation, Switching Costs, Access to distribution Channels, Cost Disadvantage Independent of Scale, Government Policy.
Rivalry among existing competitors in an industry takes the form of tactical activities to improve a firm’s position relative to competitors. This can take the form of price wars, Advertising battles, product introductions, customer service or warranties. A competitive move is in most cases countered by competition. If this pattern of action and reaction escalate then all firms in the industry may suffer and be worse off then before.
Some factors has a tendency to stimulate a higher rivalry within an industry: Numerous or Equally Balanced Competitors, Slow Industry Growth, High Fixed or Storage Costs, Lack of Differentiation of Switching Costs, Capacity Augmented in Large Increments, Diverse Competitors, High Strategic Stake, High Exit Barriers.
Bargaining Power of Buyers
Buyers constantly tries to force down the prices, bargaining for higher quality or more services, and playing competitors against each others – all at the expense of industry profitability. A buyer group is powerful if the following apply:
- It is concentrated or purchasing large volumes relative to seller sales
- The products it purchases from the industry represent a significant fraction of the buyer’s costs of purchases
- The products it purchases from the industry are standard or undifferentiated
- If faces few switching costs
- It earns low profits
- Buyers pose a credible threat of backward integration
- The industry’s products is unimportant to the quality of the buyers’ products or services
- The buyer has full information
Bargaining Power of Suppliers
Suppliers can effect an industry by threatening to raise prices of reduce quality of purchased goods and services. Powerful suppliers can thereby reduce profitability in an industry if unable to recover cost increases in its own prices. A supplier group is powerful if the following circumstances hold true:
- It is dominated by a few companies and is more concentrated then the industry is sells to
- It is not obliged to contend with other substitute products for sale to the industry
- The industry is not an important customer of the supplier group
- The suppliers’ product is an important input to the buyer’s business
- The supplier group’s products are differentiated or it has built up switching costs
- The supplier group poses a credible threat of forward integration
Threat of Substitute Products or Services
Substitute products limits the potential return of an industry by placing a ceiling in the prices firms in the industry can profitably charge. Substitute products that deserves the most attention are those that (1) are subject to trends improving their price-performance tradeoff with the industry’s products, (2) are produced by industries earning higher profits. In the latter case, substitutes often come rapidly into play if some development increases competition in their industry and causes price reductions or performance improvements.
Threat of New Entrants
New Entrants to an industry brings new capacity to the industry and a desire to gain market share. Prices can be reduced in order to gain market share resulting in lower profitability. The threat of entry into an industry depends on the barriers to entry that are present, coupled with the reaction from existing competitors. If barriers are high and/or the entrant can expect sharp retaliation from entrenched competitors, the threat of entry is low. There are 6 major sources of barriers to entry: Economics of Scale, Product Differentiation, Switching Costs, Access to distribution Channels, Cost Disadvantage Independent of Scale, Government Policy.
Source: Michael E. Porter, Competetive Strategy, 1998, New York (link to latest edition)
