7L. Porter Five Forces Model

“The secret of success in competition lies often not so much in the use of one's own strength but in the exploitation of the other side's weaknesses.”

3

LEARNING OBJECTIVES

Understand the importance of the external context for strategy and firm performance

1

2 Identify the major features of an industry and the forces that affect industry profitability

3 Understand the dynamic characteristics of the external context

Political/Legal

Economic

Technological

Global

DemographicSociocultural

CompetitiveEnvironment

Industry Environment

COMPONENTS OF THE GENERAL ENVIRONMENT

5

THE EXTERNAL ENVIRONMENT OF THE ORGANIZATION

Macro Environment Political, Economic, Sociocultural,

Technological, Environmental, Legal

Industry Environment

Strategic Group

The Organization

FORMS OF COMETITION

6

Generic Competition

Form Competition

Industry Competition

Brand Competition

7

INDUSTRY FRAGMENTATION AND CONCENTRATION

Monopoly Duopoly Fragmented

8

KEY QUESTION TO ASK

What macro environmental conditions will have a material effect on our ability to implement our strategy successfully?

How stable are these characteristics?

What is our firm’s industry?

What are the characteristics of the industry?

9

EXTERNAL CONTEXT OF STRATEGY

• An internal analysis is just half of what is needed to build strategy

• The SWOT and more complicated frameworks help us understand the full picture

Internal

• Strengths

• Weaknesses

• Capabilities

• Relationships

• Etc.

10

THE COLA WARS (TIMELINE)

Coca-Cola

Coca-Cola invented

“Kick Pepsi's can” Diet CokeNew Coke

Repair Coke and restore Stock price Diversify product line

1886

1950

1960

1970

1980

1990

2000

Pepsi

“Beat Coke”

“Pepsi Generation”

“Pepsi Challenge”

Foster entrepreneurial spirit of Pepsi’s people

Diversify beyond soft-drinks

FIVE-FORCES ANALYSIS

1.The five forces are environmental forces that impact on a company’s ability to compete in a given market.

2.The purpose of five-forces analysis is to diagnose the principal competitive pressures in a market and assess how strong and important each one is.

Threat of New

EntrantsThreat of New

Entrants

PORTER’S FIVE FORCES MODEL OF COMPETITION

THREAT OF NEW ENTRANTS

Barriers to Entry

Expected Retaliation

Government Policy

Economies of Scale

Product Differentiation

Capital Requirements

Switching Costs

Access to Distribution Channels

Bargaining Power of Suppliers

Threat of New

Entrants

Threat of New Entrants

PORTER’S FIVE FORCES MODEL OF COMPETITION

BARGAINING POWER OF SUPPLIERS

Suppliers exert power in the industry by:* Threatening to raise

prices or to reduce quality

Powerful suppliers can squeeze industry profitability if firms are unable to recover cost increases

Suppliers are likely to be powerful if:

Supplier industry is dominated by a few firms

Suppliers’ products have few substitutes

Buyer is not an important customer to supplier

Suppliers’ product is an important input to buyers’ product

Suppliers’ products are differentiated

Suppliers’ products have high switching costs

Supplier poses credible threat of forward integration

18

SUPPLIER POWER

When firms in the supply industry can dictate terms, they can extract greater profits

Diamond supplyPercent

DeBeers

Others

50

Diamond Retailers

50

Bargaining Power of Buyers

Threat of New

EntrantsThreat of New

Entrants

Bargaining Power of Suppliers

PORTER’S FIVE FORCES MODEL OF COMPETITION

BARGAINING POWER OF BUYERS

Buyers compete with the supplying industry by:

* Bargaining down prices

* Forcing higher quality

* Playing firms off ofeach other

Buyer groups are likely to be powerful if:

Buyers are concentrated or purchases are large relative to seller’s sales

Purchase accounts for a significant fraction of supplier’s sales

Products are undifferentiated

Buyers face few switching costs

Buyers’ industry earns low profits

Buyer presents a credible threat of backward integration

Product unimportant to quality

Buyer has full information

23

BUYER POWER

Suppliers Buyers

Profits

ILLUSTRATIVE

In industries characterized with many suppliers and few buyers, buyers often capture a greater share of profits

Industry A

Suppliers Buyers

Industry B

Profits

Threat of Substitute Products

Threat of New

EntrantsThreat of New

Entrants

Bargaining Power of Buyers

Bargaining Power of Suppliers

PORTER’S FIVE FORCES MODEL OF COMPETITION

THREAT OF SUBSTITUTE PRODUCTS

Products with similar function limit the prices

firms can charge

Keys to evaluate substitute products:Keys to evaluate substitute products:

Products with improving price/performance tradeoffs relative to present industry products

Example:

Electronic security systems in place of security guards

Fax machines in place of overnight mail delivery

26

THREAT OF SUBSTITUTES

Soft drinks

Coke Pepsi

Movie rentals

Block buster

Hollywood videoB

ottle

d w

ater

Cab

le T

V

27

CAUSES OF RIVARLY

Barriers to Entry

• Strong brands • Proprietary technology• Start-up costs • Etc.,

Barriers to Exit

• Few other opportunities • Sunk investments• Etc.,

In addition to entry and exit barriers,many factors drive rivalry • History of price wars

• Level of fixed costs

• Industry concentration

• Market growth

• Etc.

Threat of Substitute Products

Threat of New

EntrantsThreat of New

Entrants

Rivalry Among Competing Firms in

Industry

Bargaining Power of Buyers

Bargaining Power of Suppliers

PORTER’S FIVE FORCES MODEL OF COMPETITION

RIVALRY AMONG EXISTING COMPETITORS

Intense rivalry often plays out in the following ways:

Jockeying for strategic position

Using price competition

Staging advertising battles

Making new product introductions

Increasing consumer warranties or service

Occurs when a firm is pressured or sees an opportunityPrice competition often leaves the entire industry worse off

Advertising battles may increase total industry demand, but may be costly to smaller competitors

Cutthroat competition is more likely to occur when:

RIVALRY AMONG EXISTING COMPETITORS

Numerous or equally balanced competitorsSlow growth industryHigh fixed costsLack of differentiation or switching costs

High strategic stakes

High exit barriers

Diverse competitors

33

IMPACT OF COMPLEMENTOR

Any factor that makes it more attractive for suppliers to supply an industry on favorable terms or that makes it more attractive for buyers to purchase products or services from an industry at prices higher than it would pay on absence the complementor

Complementor:

Hot dogs

+

Buns

More sales

Three Examples

Music

+

MP3 player

More attractive offering

Delta plane

orders+

American Airlinesplane orders

Lower costs from Boeing