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Five Forces Industry Analysis

Nicole Fiamingo

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Five Forces Industry Analysis Description & Purpose

Developed by Michael Porter

Provides an understanding of an industry and its participants

Used as a means to decrease the gap between a firm’s external environment and its internal resources

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Five Forces Industry Analysis Objective of the Five Forces

Identify the profit potential of an industry

Identify the forces that would harm your company’s profitability in that industry

Protect and extend your competitive advantage

Anticipate changes in industry structure

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Five Forces Industry Analysis Porter’s Five Forces

1. Threat of new entrants2. Bargaining power of suppliers3. Bargaining power of buyers4. Threat of substitute products or services5. Degree of rivalry among existing competitors

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Five Forces Industry Analysis 1. Threat of New Entrants

1. Entry-deterring price 2. Incumbent retaliation 3. High entry costs 4. Experience effects 5. Other cost advantages6. Product differentiation 7. Distribution access 8. Government restrictions9. Switching costs

New entrants usually face several barriers to entry, including:

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Easy to Enter if there is:

•Common technology

•Little brand franchise

•Access to distribution channels

•Low scale threshold

Difficult to Enter if there is:

•Patented or proprietary know-how

•Difficulty in brand switching

•Restricted distribution channels

•High scale threshold

Easy to Exit if there are:

•Salable assets

•Low exit costs

•Independent businesses

Difficult to Exit if there are:

•Specialized assets

•High exit costs

•Interrelated businesses

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Five Forces Industry Analysis 2. Bargaining Power of Suppliers

Suppliers bargaining power may be influenced by:

1. Concentration2. Diversification 3. Switching costs 4. Organization 5. Government

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Suppliers are Powerful if: ExampleCredible forward integration threat by suppliers

Baxter International, manufacturer of hospital supplies, acquired American Hospital Supply, a distributor

Suppliers concentrated Drug industry's relationship to hospitals

Significant cost to switch suppliers Microsoft's relationship with PC manufacturers

Customers Powerful  Boycott of grocery stores selling non-union picked grapes

Suppliers are Weak if: ExamplePurchase commodity products Grocery store brand label productsConcentrated purchasers Garment industry relationship to

major department storesCustomers Weak Travel agents' relationship to

airlineshttp://www.quickmba.com/strategy/porter.shtml

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Five Forces Industry Analysis 3. Bargaining Power of Buyers

Buyer’s Bargaining power my be influenced by:

1. Differentiation2. Concentration3. Profitability4. Quality

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Buyers are Powerful if: Example

Buyers are concentrated - there are a few buyers with significant market share

DOD purchases from defense contractors

Buyers purchase a significant proportion of output - distribution of purchases or if the product is standardized

Best Buy and Sears' large retail market provides power over appliance manufacturers

Buyers possess a credible backward integration threat - can threaten to buy producing firm or rival

Large auto manufacturers' purchases of tires

Buyers are Weak if: ExampleProducers threaten forward integration - producer can take over own distribution/retailing

Movie-producing companies have integrated forward to acquire theaters

Buyers are fragmented (many, different) - no buyer has any particular influence on product or price

Most consumer products

Producers supply critical portions of buyers' input - distribution of purchases

Intel's relationship with PC manufacturers

http://www.quickmba.com/strategy/porter.shtml

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Five Forces Industry Analysis 4. Threat of Substitute Products or Services

Market displacement by existing/potential substitutes can be influenced by:

1. Relative price/performance trade off2. Switching costs3. Profitability

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The Threat of Substitutes is High Risk:

The Threat of Substitutes Low Risk:

Consumer switching costs are low Consumer switching costs are high

Substitute product is cheaper than industry product

Substitute product is more expensive than industry product

Substitute product quality is equal or superior to industry product quality

Substitute product quality is inferior to industry product quality

Substitute performance is equal or superior to industry product performance

Substitute performance is inferior to industry product performance

http://www.wikicfo.com/Wiki/default.aspx?Page=Threat+of+Substitutes+-+one+of+Porters+Five+Forces&AspxAutoDetectCookieSupport=1

No substitute product is available

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Five Forces Industry Analysis 5. The Degree of Rivalry Among Existing Players

The intensity of competition within an industry is determined by:

1. Market Growth2. Cost Structure3. Barriers to exit4. Product switching5. Diversity

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Rivalry will be high:There are a large number of similar sized firms (rather than a few dominant firms) all competing with each other for customers

The costs of leaving the industry are high e.g. because of high levels of investment. This means that existing firms will fight hard to survive because they cannot easily transfer their resources elsewhere

The level of capacity utilization. If there are high levels of capacity being under-utilized the existing firms will be very competitive to try and win sales to boost their own demand

The market is shrinking so firms are fighting for their share of falling salesThere is little brand loyalty so customer are likely to switch easily between products

http://www.oup.com/uk/orc/bin/9780199296378/01student/additional/page_11.htm

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Five Forces Industry Analysis Strengths

Forecast future changes in each of the five forces

Discover how these changes will affect the other forces

Discover how the interrelated changes will affect the future profitability of the industry

Discover how you might change the strategy to exploit the changing industry structure

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Five Forces Industry Analysis Weaknesses

Underestimates the capabilities that may serve as the company’s competitive advantage in the long-term

Does not take into account the synergies and interdependence within a corporation’s overall portfolio

Strict interpretations ignore social & political factors

Does not address why or how companies are able to get advantageous positions

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Five Forces Industry Analysis How to Do It

Step 1: Collect Information Identify your industry Look at existing demand & supply patterns Identify the characteristics of each of the five

forces Examine & assess their impact on the industry

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Five Forces Industry Analysis How to Do It

Main Sources of Competitive Pressures1. Rivalry among competitors2. Threat of substitute products3. Threat of potential entry4. Bargaining power of suppliers5. Bargaining power of buyers

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Five Forces Industry Analysis How to Do It

Step 2: Assess & Evaluate Determine the direction of the force

Give each force a value indicating if it is strong,

moderate, or weak. Scale of 1 – 5, with 1 being the weakest

The ultimate goal: To identify the ability of your company to successfully compete within its industry, given the collective strength of the five forces

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Five Forces Industry Analysis How to Do It

Step 3: Develop Strategy Repeat the first two steps in light of industry

change and evolution

Long-term industry trends should be analyzed to determine whether the profitability of the industry is sustainable and how this will affect your company’s competitive position.

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Five Forces Industry Analysis Conclusion

Understanding how an industry will evolve provides important direction for selecting and managing strategy around these five criteria

Not all industries are alike-for companies with product portfolios across numerous industries, this technique should be repeated for each industry