Porter’s five forces Corporate strategy Philip Allan Publishers © 2016

Background Michael Porter developed a method by which a business can analyse the competitive environment in which it operates in order to best devise its strategy. Basically: know your competitors and how to beat them. Philip Allan Publishers © 2016

Concept Porter suggests that firms need to analyse five factors within an industry in order to understand the market. This will help the management understand the level of competition. ‘The five forces will provide information that can be used to help devise an appropriate business strategy’ (Michael Porter, competitive advantage) Philip Allan Publishers © 2016

Porter’s five forces Porter believes that the overall strength or weakness of a firm’s position depends on five forces: ① degree of rivalry ② threat of new entrants ③ threat of substitutes ④ bargaining power of buyers ⑤ bargaining power of suppliers Philip Allan Publishers © 2016

Degree of rivalry The more intense the rivalry between existing firms within the industry, the more likely that prices are forced down by competitive pressure. A number of potential strategies are available to firms in order to reduce the rivalry, for example:  Develop a differentiated product, e.g. Dyson.  Acquire competitors via mergers and takeovers.  Push to be a market leader via internal growth, e.g. Tesco. This is very difficult to maintain in the long run. Philip Allan Publishers © 2016

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. Barriers to entry are, therefore, very important in determining the threat of new entrants. An industry can have one or more barriers. Philip Allan Publishers © 2016

Threat of substitutes A substitute product can be regarded as a similar product with similar specifications that meets the same purpose. For example, cars, trains and bikes are all substitutes for travel. Substitute products are produced in a different industry –but crucially satisfy the same customer need. The extent of the threat depends upon the extent to which the price and performance of the substitute can match the industry's product, as well as the willingness of customers to switch and customer loyalty and switching costs. Philip Allan Publishers © 2016

Bargaining power of buyers Buyers will want prices in the industry to be as low as possible. The more powerful this group, the lower the profits in the industry. For example, British dairy farmers struggle to make a profit due to the huge bargaining power of their main buyers in the UK supermarket industry. A number of strategies are available to reduce the power of buyers: £Open up your own outlets, e.g. farm shops based on the example above. £Acquire retail outlets. £Make it expensive for the buyer to switch to another competitor, e.g. software companies do this when making certain elements of their products compatible with certain equipment. If you switch you have to change everything. Philip Allan Publishers © 2016

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. It follows that the more powerful the customer (buyer), the lower the price that can be achieved by buying from them. Suppliers find themselves in a powerful position 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 product is easy to distinguish and loyal customers are reluctant to switch £the customer is small and unimportant £there are no or few substitute resources available Philip Allan Publishers © 2016