Porters 5 forces analysis

There is continuing interest in the study of the forces that impact on an organisation, particularly those
that can be harnessed to provide competitive advantage. The ideas and models which emerged
during the period from 1979 to the mid-1980s (Porter, 1998) were based on the idea that competitive
advantage came from the ability to earn a return on investment that was better than the average for
the industry sector (Thurlby, 1998).

As Porter's 5 Forces analysis deals with factors outside an industry that influence the nature of
competition within it, the forces inside the industry (microenvironment) that influence the way in which
firms compete, and so the industry’s likely profitability is conducted in Porter’s five forces model. A
business has to understand the dynamics of its industries and markets in order to compete effectively
in the marketplace. Porter (1980a) defined the forces which drive competition, contending that the
competitive environment is created by the interaction of five different forces acting on a business. In
addition to rivalry among existing firms and the threat of new entrants into the market, there are also
the forces of supplier power, the power of the buyers, and the threat of substitute products or
services. Porter suggested that the intensity of competition is determined by the relative strengths of
these forces.

Main Aspects of Porter’s Five Forces Analysis

The original competitive forces model, as proposed by Porter, identified five forces which would
impact on an organization’s behaviour in a competitive market. These include the following:

• The rivalry between existing sellers in the market.

• The power exerted by the customers in the market.
• The impact of the suppliers on the sellers.
• The potential threat of new sellers entering the market.
• The threat of substitute products becoming available in the market.

Understanding the nature of each of these forces gives organizations the necessary insights to enable
them to formulate the appropriate strategies to be successful in their market (Thurlby, 1998).

Force 1: The Degree of Rivalry

The intensity of rivalry, which is the most obvious of the five forces in an industry, helps determine the
extent to which the value created by an industry will be dissipated through head-to-head competition.
The most valuable contribution of Porter's “five forces” framework in this issue may be its suggestion
that rivalry, while important, is only one of several forces that determine industry attractiveness.

• This force is located at the centre of the diagram;

• Is most likely to be high in those industries where there is a threat of substitute products; and
existing power of suppliers and buyers in the market.

Force 2: The Threat of Entry

Both potential and existing competitors influence average industry profitability. The threat of new
entrants is usually based on the market entry barriers. They can take diverse forms and are used to
prevent an influx of firms into an industry whenever profits, adjusted for the cost of capital, rise above
zero. In contrast, entry barriers exist whenever it is difficult or not economically feasible for an outsider
to replicate the incumbents’ position (Porter, 1980b; Sanderson, 1998) The most common forms of
entry barriers, except intrinsic physical or legal obstacles, are as follows:

• Economies of scale: for example, benefits associated with bulk purchasing;

• Cost of entry: for example, investment into technology;
• Distribution channels: for example, ease of access for competitors;
• Cost advantages not related to the size of the company: for example, contacts and expertise;
• Government legislations: for example, introduction of new laws might weaken company’s
competitive position;
• Differentiation: for example, certain brand that cannot be copied (The Champagne)

Force 3: The Threat of Substitutes

The threat that substitute products pose to an industry's profitability depends on the relative price-to-
performance ratios of the different types of products or services to which customers can turn to satisfy
the same basic need. The threat of substitution is also affected by switching costs – that is, the costs
in areas such as retraining, retooling and redesigning that are incurred when a customer switches to a
different type of product or service. It also involves:

• Product-for-product substitution (email for mail, fax); is based on the substitution of need;
• Generic substitution (Video suppliers compete with travel companies);
• Substitution that relates to something that people can do without (cigarettes, alcohol).

Force 4: Buyer Power

Buyer power is one of the two horizontal forces that influence the appropriation of the value created
by an industry (refer to the diagram). The most important determinants of buyer power are the size
and the concentration of customers. Other factors are the extent to which the buyers are informed and
the concentration or differentiation of the competitors. Kippenberger (1998) states that it is often
useful to distinguish potential buyer power from the buyer's willingness or incentive to use that power,
willingness that derives mainly from the “risk of failure” associated with a product's use.

• This force is relatively high where there a few, large players in the market, as it is the case with
retailers an grocery stores;
• Present where there is a large number of undifferentiated, small suppliers, such as small farming
businesses supplying large grocery companies;
• Low cost of switching between suppliers, such as from one fleet supplier of trucks to another.

Force 5: Supplier Power

Supplier power is a mirror image of the buyer power. As a result, the analysis of supplier power
typically focuses first on the relative size and concentration of suppliers relative to industry
participants and second on the degree of differentiation in the inputs supplied. The ability to charge
customers different prices in line with differences in the value created for each of those buyers usually
indicates that the market is characterized by high supplier power and at the same time by low buyer
power (Porter, 1998). Bargaining power of suppliers exists in the following situations:

• Where the switching costs are high (switching from one Internet provider to another);
• High power of brands (McDonalds, British Airways, Tesco);
• Possibility of forward integration of suppliers (Brewers buying bars);
• Fragmentation of customers (not in clusters) with a limited bargaining power (Gas/Petrol stations in
remote places).
The nature of competition in an industry is strongly affected by suggested five forces. The stronger the
power of buyers and suppliers, and the stronger the threats of entry and substitution, the more intense
competition is likely to be within the industry. However, these five factors are not the only ones that
determine how firms in an industry will compete – the structure of the industry itself may play an
important role. Indeed, the whole five-forces framework is based on an economic theory know as the
“Structure-Conduct-Performance” (SCP) model: the structure of an industry determines organizations’
competitive behaviour (conduct), which in turn determines their profitability (performance). In
concentrated industries, according to this model, organizations would be expected to compete less
fiercely, and make higher profits, than in fragmented ones. However, as Haberberg and Rieple (2001)
state, the histories and cultures of the firms in the industry also play a very important role in shaping
competitive behaviour, and the predictions of the SCP model need to be modified accordingly.

How to write a Good Porter's 5 Forces analysis

The Porter’s Five Forces model is a simple tool that supports strategic understanding where
power lies in a business situation. It also helps to understand both the strength of a firm’s
current competitive position, and the strength of a position a company is looking to move
into. Despite the fact that the Five Force framework focuses on business concerns rather than
public policy, it also emphasizes extended competition for value rather than just competition
among existing rivals, and the simpleness of its application inspired numerous companies as
well as business schools to adopt its use (Wheelen and Hunger, 1998).

With a clear understanding of where power lies, it will enable a company to take fair
advantage of its strengths, improve weaknesses, and avoid taking wrong steps. Therefore, to
apply this planning tool effectively, it is important to understand the situation and to look at
each of the forces individually.

In conducting an analysis of Porter’s Five Forces, it is required to brainstorm all relevant

factors for the company’s market situation, and then check against the factors presented for
each force in the diagram above. The next step is to highlight the key factors on a diagram,
and summarize the size and the scale of the force on the diagram. It is suggested to use signs,
as for instance, “+” and “--" signs for the forces moderately in company’s favor, or for a force
strongly against.

After identifying favourable and unfavourable forces for the company’s performance and
industry’s attractiveness, it is important to analyse the situation and examine the impacts of
the forces. One of the critical comments made of the Five Forces framework is its static
nature, whereas the competitive environment is changing turbulently. Are the five forces able
to foresee industry expansion? Is it the corporate strategist's goal to find a position in the
industry where his or her company can best defend itself against these forces or can influence
them in its favour, or is the goal to become part of the ongoing commerce with the intention
to produce innovative ideas that will expand the size of the industry? Is it true that the
environment poses a threat to the organisation, leading to the consideration of suppliers and
buyers as threats that need to be tackled, or does it offer the ground for a constitutive industry
player co-operation?

By thinking through how each force affects a company, and by identifying the strength and
direction of each force, it provides with an opportunity to identify the strength of the position
and the ability to make a sustained profit in the industry (Mind Tools, 2006).

Limitations of Porter’s Five Force Model

Porter’s model is a strategic tool used to identify whether new products, services or
businesses have the potential to be profitable. However it can also be very illuminating when
used to understand the balance of power in other situations.

Porter argues that five forces determine the profitability of an industry. At the heart of
industry are rivals and their competitive strategies linked to, for example, pricing
or advertising; but, he contends, it is important to look beyond one’s immediate competitors
as there are other determines of profitability. Specifically, there might be competition from
substitutes products or services. These alternatives may be perceived as substitutes by buyers
even though they are part of a different industry. An example would be plastic bottles, cans
and glass bottle for packaging soft drinks. There may also be potential threat of new entrants,
although some competitors will see this as an opportunity to strengthen their position in the
market by ensuring, as far as they can, customer loyalty. Finally, it is important to appreciate
that companies purchase from suppliers and sell to buyers. If they are powerful they are in a
position to bargain profits away through reduced margins, by forcing either cost increases or
price decreases. This relates to the strategic option of vertical integration, when the company
acquires, or mergers with, a supplier or customer and thereby gains greater control over the
chain of activities which leads from basic materials through to final consumption (Luffman
and et al., 1996; Wheelen and Hunger, 1998).

It is important to be aware that this model has further limitations in today's market
environment; as it assumes relatively static market structures. Based originally on the
economic situation in the eighties with its strong competition and relatively stable market
structures, it is not able to take into account new business models and the dynamism of the
industries, such as technological innovations and dynamic market entrants from start-ups that
will completely change business models within short times. For instance, the computer
and software industry is often considered as being highly competitive. The industry structure
is constantly being revolutionized by innovation that indicates Five Forces model being of
limited value since it represents no more than snapshots of a moving picture. Therefore, it is
not advisable to develop a strategy solely on the basis of Porter’s models (Kippenberger,
1998; Haberberg and Rieple, 2001), but to examine it in addition to other strategic
frameworks of SWOT and PEST analysis.

Nevertheless, that does not mean that Porters theories became invalid. What needs to be done
is to adopt the model with the knowledge of their limitations and to use them as a part of a
larger framework of management tools, techniques and theories. This approach, however, is
advisable for the application of every business model (Recklies, 2001).

Porter's Six Forces model and its relationship to the standard Five Forces
model

Porter’s Five Forces model actually has an extension referred to as Porter’s Six Forces model.
It is considerably less popular than the Five Forces model as its acceptance has been less
positive than the Five Forces model. The Six Forces model though is very similar to the Five
Forces model with the only difference being the addition of the sixth force in the framework.
This sixth force in the model is termed as the relative power of other stakeholders, and
can refer to a number of other groups or entities, depending on the factor which has the
greatest influence including:
• Complementors – One school of thought looks at the sixth force to be complementors,
which are businesses offering complementary products to the sector in focus and being
analysed (Grove 1996). The author states that these complementary businesses, as a sixth
factor, affect the industry as changes in these businesses (such as new techniques, approaches
or technologies) can impact on the dynamics between the industry and the complementors.
• The government – The sixth force in the framework can also be considered to be the
government, and is included in the framework if it has potential to impact on all the other five
forces (Gordon, 1997). Thus, the government can have direct impact in the industry as the
sixth force, but can also have indirect impact or influence by affecting the other five forces,
whether favourably or unfavourably.
• The public – Yet other viewpoints look at the public as the sixth force in the model,
particularly if the public has a strong influence in the dynamics of the sector resulting in
changes to the other forces or in the sector as a whole.
• Shareholders – This group can also be considered potentially as the sixth force. This is
more important in recent years where shareholder activity has increased significantly in the
boardroom, and management of firms has been scrutinised much more and even given
‘threats’ if certain actions favoured by the shareholders were not pursued.
• Employees – Employees could also be considered as the sixth force if they wielded
extraordinarily strong influence on the firm in a particular sector. The status of employees
seems to follow similar rules in certain sectors, and thus could be considered a strong
influence in these sectors. For example, in the automobile sector in the US, a large part of the
work force are unionised, and thus could be considered the sixth force instead of the
government or complementors.

While a sixth force has been added to Porter’s original Five Forces model, the acceptance of
this framework has been somewhat limited. This could be for two reasons. First, is that there
is no definite and specific sixth force in all sectors, as it is different for each sector. Second,
while a sixth force could be defined for all sectors, the influence of this factor can also be
captured in the other five forces and thus the necessity of having it in the framework is less
compelling.

Where to find information for Porter's 5 Forces analysis

In conducting the analysis it is crucial to examine the existing literature:

• Periodicals, business articles on the industry performance, etc;

• Analyst reports and trade organisations;
• Company annual reports and its publications on the main suppliers an distribution network;
• Anything that will give the exposure to the market situation, competitors present in the
market, new emerging companies in the industry.

It is important to make sure that the sources are reliable and relevant to the current condition
of the industry. It has to be viable, reliable and valid, in order to make conduct a good
analysis of the model. For this purpose, the gathered data and information has to be checked
and be applied to the current business conditions. Further limitations could be present in the
nature of market forces that reduce the applicability of the information sources to present
situations; and the amount of detailed information required. This can be prohibitive to its
practical use. For example, the level of competitor information required is very detailed and
may not always be available.
Conclusion

Any company must seek to understand the nature of its competitive environment if it is to be
successful in achieving its objectives and in establishing appropriate strategies. If a company
fully understands the nature of the Porter’s five forces, and particularly appreciates which one
is the most important, it will be in a stronger position to defend itself against any threats and
to influence the forces with its strategy. The situation is fluid, and the nature and relative
power of the forces will change. Consequently, the need to monitor and stay aware is
continuous.

Some issues during the implementation of these Five Forces are crucially important for
organizations to build long-term business strategy and sustaining competitive advantages
rather than simply list the forces. Successful use of the Porter Model Analysis includes
identifying the sources of competition, the strength and likelihood of that competition
existing, and strategic recommendations for the action a company should take to in order to
develop barriers to competition.