Porter’s Five Forces Model 3.1 Business objectives and strategy

Impact of external influences: Porter’s Five Forces What you need to know Impact of external influences: Porter’s Five Forces

Porter’s Five Forces Model Disruptive innovation Concept links Porter’s Five Forces Model Economies of scale Disruptive innovation Efficiency Market share Competition

What is Porter’s Five Forces Model? Devised by Michael Porter A framework for analysing the nature of competition within an industry Helps understand & assess industry profitability & attractiveness

Reasons Why Competitive Rivalry (and Profits) Vary Between Industries Size (revenues, quantity) Structure Distribution channels Customer needs and wants Profitability Growth Product life cycle Alternatives for the consumer Which means that industry profits are different too

Examples of High Profit and Low Profit Industries Airlines Low Profits Soft Drinks High Profits Cafes Pharmaceuticals

Example: Why Profits are High in Soft Drinks A “licence to print money” Customers and suppliers have little power High brand awareness & loyalty = less desire for substitutes High barriers to entry (economies of scale)

How Porter’s Model Links with Industry Profitability Low industry profits associated with: Strong suppliers Strong customers (buyers) Low entry barriers Many opportunities for substitutes Intense rivalry High industry profits associated with: Weak suppliers Weak customers (buyers) High entry barriers Few opportunities for substitutes Little rivalry

Porter’s 5 Forces Model Threat of Substitute Products Intensity New Entrants Bargaining Power of Suppliers Buyers (Customers) Intensity of rivalry within the industry

Threat of New Entrants If new entrants move into an industry they will gain market share & rivalry will intensify The position of existing firms is stronger if there are barriers to entering the market If barriers to entry are low then the threat of new entrants will be high, and vice versa

Examples of Barriers to Entry Economies of scale Vertical integration Brand loyalty Access to the best technologies Expertise & reputation

Easy to enter Industries… (low barriers)

Much harder to enter markets (high barriers)

Bargaining Power of Suppliers If a firm’s suppliers have bargaining power they will: Exercise that power Sell their products at a higher price Squeeze industry profits If the supplier forces up the price paid for inputs, profits will be reduced

Suppliers are powerful when There are only a few large suppliers The resource they supply is scarce The cost of switching to an alternative supplier is high The customer is small and unimportant There are no or few substitute resources available

Bargaining Power of Customers Powerful customers are able to exert pressure to drive down prices E.g. supermarket business is increasingly dominated by a small number of large retail chains able exert great power over suppliers

Customer Power in Action?

Threat of Substitute Products A substitute product - something that meets the same customer need If there are substitutes to a firm’s product, they will limit the price that can be charged and will reduce profits Customer loyalty and availability will limit the extent of this threat Note the role of technological change in rapidly creating new substitutes

Substitutes for Newspapers

Substitute: Not Going Out…

Determinants of Intensity of Rivalry (1) Number of competitors in the market Competitive rivalry will be higher in an industry with many current and potential competitors Market size and growth prospects Competition is tends to be most intense in slow-growth or declining markets Product differentiation and brand loyalty The greater the customer loyalty the less intense the competition The lower the degree of product differentiation the greater the intensity of price competition

Determinants of intensity of rivalry (2) The power of buyers and the availability of substitutes If buyers are strong and/or if close substitutes are available, there will be more intense competitive rivalry Capacity utilisation The existence of spare capacity will increase the intensity of competition Cost structure of the industry Where fixed costs are a high percentage of costs then profits will be very dependent on volume As a result there will be intense competition over market shares Exit barriers If it is difficult or expensive to exit an industry, firms will remain thus adding to the intensity of competition