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Porter's Five Forces
Since its publication back in 1980 (M E Porter, Competitive Strategy, Free Press, 1980) Porter’s Five Forces model has become one of the most popular and valued frameworks in the strategists toolkit. The purpose of the model is to help analyse and understand in depth the range and relative importance of the competitive forces that impact on an organisation. The principle is that in ideal markets, with free entry and exit, profits should be “normal”. That is, the market will offer an economic rate of return.
In reality, however, different industry structures sustain different levels of profitability and some companies in a given industry sector are much better equipped to gain competitive advantage than are others.
Where Porter’s model can help is first of all in assessing market attractiveness in terns of deciding which market sectors to enter, remain in or exit. For larger companies this analysis is best done at a Strategic Business Unit (SBU) level, as the analysis otherwise starts to become too general and meaningless. Secondly, the model can be used in a more proactive sense by identifying factors that can be used to enable a business to position itself to gain competitive advantage.
One of the main criticisms of the model is that it presents a very passive and reactive view of strategy in that it focuses on how the organisation can react to external forces, many of which are outside its control. For a more balanced approach, it is worth combining the undoubted value of a Five Forces analysis with an approach that looks at what the organisation can do relative to its internal resources and capabilities to bolster its competitive advantage. For example, the CORE COMPETENCY model as first put forward by C.K Prahalad and G. Hamel in a 1990 Harvard Business Review article.
The model advocates analysing competitive forces and market attractiveness under five headings:
o Competitor rivalry
o Threat of new entrants
o Potential for substitutes
o Bargaining power of buyers
o Bargaining power of suppliers
Under each of these headings, the following factors should be considered:
Competitive Rivalry
o Number of firms in the market
o Rate of market growth
o Level of fixed costs
o Product differentiation – whether products are perceived as a commodity
o Whether extra capacity can only be gained in large increments
o Level of diversity among competitors
o Switching costs
o Cost and barriers to exiting markets
Threat of new entrants
o Governmental and legislative control
o Differentiation
o Cost of entry
o Economies of scale and minimum efficient scale
o Expectation of retaliation by existing players
o Access to distribution channels
o Patents and proprietary knowledge
o Brand equity
o Learning curve advantages
Potential for substitutes
o Threat of substitution from products outside the market
o Relative price performance of substitutes
o Buyers switching costs
o Existing of a new product undermining the need for existing products
o Other products competing for the same generic need
o Customers doing without (eg. Tobacco)
Bargaining power of buyers
o Concentration of buyers
o Availability of alternative sources of supply
o Threat of backward integration
o Switching costs
o Relative contribution to cost of finished product
o Product differentiation
o Impact on product performance and perceived value
o Buyer information availability
o Buyer price sensitivity
Bargaining power of suppliers
o Concentration of suppliers
o Volume
o Presence of substitutes
o Threat of forward integration
o Switching costs
o Relative contribution to cost of finished product
o Product differentiation
o Impact of product performance
o Perceived value
For a diagramatic representation of the model click on the download below
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