Porter’s Five Forces A framework for analysing the nature of competition within an industry and potential for profit

MICHAEL PORTER “MANAGEMENT GURU”

High Profit Industries Low Profit Industries

INDUSTRY PROFITS Low Profits associated with High Profits associated with Strong suppliers Strong buyers (customers) Low entry barriers Many substitutes Intense rivalry Weak suppliers Weak buyers (customers) High entry barriers Few substitutes Little rivalry

THREAT OF NEW ENTRANTS Depends on Barriers to Entry including: Capital Requirements Economies of Scale available to existing firms Regulatory & Legal restrictions Product Differentiation (including Brands) Access to Suppliers & Distribution Channels Expertise and know-how Retaliation by established companies

THREAT OF NEW ENTRANTS Depends on Barriers to Entry including: Capital Requirements e.g. Airlines (need planes & landing rights) Economies of Scale available to existing firms e.g. Coca-cola can produce 2,000 cans per minute Regulatory & Legal restrictions e.g. Pharmaceutical industry heavily regulated Product Differentiation (including Brands) e.g. new search engine competing against Google Access to Suppliers & Distribution Channels e.g. Amazon’s distribution systems & next day delivery Retaliation by established companies - e.g. Hoover bagless vacuum cleaner

Easy to enter….. (low barriers to entry)

Hard to enter ….. (high barriers to entry)

BARGAINING POWER OF CUSTOMERS Depends on: Number of Customers Volume of their order sizes Number of firms supplying the product Threat of Backward Integration Cost of Switching

BARGAINING POWER OF CUSTOMERS Depends on: Number of Customers Foxconn relies heavily on orders from a few large buyers such as Apple, Nintendo & Sony pushing selling price down Volume of their order sizes Number of firms supplying the product the greater the number of sellers, the more choice available to buyers Threat of Backward Integration Some firms face being bought by their customers to secure supply e.g. Starbucks buying coffee bean farms in China Cost of Switching The more homogenous the product, the easier it is to switch giving more power to buyers

Bargaining Power of Customer Higher in the B2B Markets

THREAT OF SUBSTITUTES (FROM A DIFFERENT INDUSTRY) Depends on: Extent to which Price & Performance of substitute matches industry product Customer Loyalty Switching Costs

THREAT OF SUBSTITUTES (FROM A DIFFERENT INDUSTRY) The more choice there is for consumers, the lower profit margins tend to be Firms have less pricing power Depends on: Extent to which Price & Performance of substitute matches industry product In general, the greater the quality of a firm’s products, the lower the threat from substitutes Customer Loyalty Are customers willing to switch brands or do they stick with favourites? Switching Costs Are customers tied into contracts? Will their peripheral products be compatible – e.g. Macbook, iPhone – makes it difficult to swap to Android

Substitutes for Meal in Indian Restaurant

BARGAINING POWER OF SUPPLIERS Depends on: Uniqueness of Input supplied Number and Size of firms supplying resource Competition for Input from other industries Cost of Switching to alternative sources

BARGAINING POWER OF SUPPLIERS Directly affects the cost of the items a business buys Depends on: Uniqueness of Input supplied Can firm easily get product from another supplier? Only Cadbury’s produce Cadbury Dairy Milk Number and Size of firms supplying resource If supplier has a monopoly they will have strong bargaining power reducing profit for firm Competition for Input from other industries e.g. Corn used for food and as a bio-fuel Cost of Switching to alternative sources

DEGREE OF COMPETITIVE RIVALRY Depends on: Number of Competitors in the market Market Size and Growth prospects Product Differentiation and Brand Loyalty Capacity Utilisation Barriers to Exit

DEGREE OF COMPETITIVE RIVALRY Depends on: Number of Competitors in the market Microsoft faces little competition Rivalry in the supermarkets is intense leading to price wars Market Size and Growth prospects Growing markets generally mean less competitive pressure Shrinking markets make competition more intense Product Differentiation and Brand Loyalty The more customers see products as unique, the more price inelastic they are Capacity Utilisation Increasing capacity utilisation reduces unit cost enabling lower prices / larger profit margins Barriers to Exit How easy is it to get out of a market? Can a firm afford to lose its sunk costs?

Evaluation of Five Forces Model Should be used at the broader level of whole industry, not smaller market levels Issue of defining industry Many companies operate in more than one industry Static (at a point in time) Not so good for long term planning Best combined with other more dynamic models – e.g. PEST Brainstorming tool Should be taken in context of broader discussion, not as a stand alone source of recommendation