Strategic Management

This paper presents overview of NEXT and Porter's 5 forces analysis of NEXT which is analysing bargaining power of customers, bargaining power of suppliers, threat of new entrants, threat of substitute products and intensity of competitive rivalry affecting NEXT. op the Directory 

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Michael Giffels

Analysis of NEXT plc and its environment

Contents

1 INTRODUCTION 2 2 OVERVIEW 2

2.1 The Market 2 2.2 The Company 3

3 ANALYTIC TOOLS 4

3.1 PEST - Analysis 4 3.2 SWOT - Analysis 7 3.3 Competitive Analysis 9

4 CONCLUSION 12 5 MISSION STATEMENT 13 6 OBJECTIVES AND STRATEGIES 14

6.1 Good quality and price 14 6.2 Relationship between Next and its environment 14 6.3 Shopping as en event 15

7 BIBLIOGRAPHY 16

1 Introduction This Report should give the reader an overview of the clothing retail market in general and an in-depth analyse of NEXT Plc in detail. The main emphasis in this essay are the Retail and Directive division of NEXT Plc because they are the cash generators. Furthermore it shows the current situation of NEXT, its environment and the recent development of the company. The report also provides a mission statement and strategies how to be more successful in the near future.

2 Overview 2.1 The Market The UK clothing market is a declining market. The clothing industry is beset by competition from companies which have invested in hi-tech machinery leading to greater efficiency or have moved their production to factories in cheap labour cost countries to produce their products. However, most companies in this sector make only moderate profits. To expand the market share in this arena is not easy, and therefore it needs a great deal of endeavour, knowledge, as well as energy and money.

Clothes retailers fall into two broad categories: firstly, those selling own-brand clothing and, secondly, those selling third-party wear. Major retailers such as Marks & Spencer and the Arcadia Group are good examples of the first group, as are chain operations such as NEXT and Gap. The second group includes the major department stores and the majority of independent retailers in the UK. Clothing retailing is a highly diverse industry. The retail sector ranges from low-cost and discounts retailers through to independents, sportswear, formal wear and highly exclusive designer boutiques. However, as in most consumer goods markets, it is at the middle level where the major players are to be found and money can be earned.

2.2 The Company The history of NEXT goes back to 1864 when it was founded by J. Hepworth & Son under the name of Gentleman′s Tailors. In 1981 Hepworth bought the chain of Kendalls shops to establish a new Womenswear group of shops. This was the birth of NEXT. NEXT Plc is a trendy high street retailer which sells moderately priced clothing for stylish women and men in the age range 20 to 40. The company also provides home shopping and financial services. NEXT operates through five divisions: NEXT Retail operates the high street shops through more than 330 stores covering the UK and Ireland; NEXT Directory is the mail order division which also contain the e-commerce platform; NEXT Overseas operates retail outlets in the United States, Asia, Continental Europe, and the Middle East through franchise agreements; Ventura runs the financial services division. Other activities include telecommunications software services and property management. NEXT Retail accounted for 69% of the fiscal revenue for the year 2000 ; NEXT Directory, 19%; Ventura, 9%; NEXT Overseas, 1% and other activities, 2%. More than 96% of sales were achieved in the UK market.

Taking an up to date snapshot of the current situation of the Company, it is quite a success story. NEXT nearly

tripled their sales during the last six years, Source: see Chapter 7

from GBP 544 m (1994) to GBP 1430 m (2000) and dividends have increased steadily.

3 Analytic Tools 3.1 PEST - Analysis This analysis is a helpful tool to take a closer look at the general environment. Although the PEST analysis rely on past events and experience, it can be used as a forecast of the future (Wilson and Gilligan, 1998).

Political factors The political environment is good. The government is stable and reliable, even if Britain fails to achieve total agreement with some EU policies from time to time. At the present no EU directives are known which will have a direct effect on the UK clothing retail industry in the near future. Due to the EU membership a trend can be seen towards stricter environmental protection legislation. This may have a direct or indirect effect on NEXT or his suppliers.

Economic factors Looking at the economic environment, it is somewhat tricky since on the one hand there is the strong sterling compared to the Euro. Euroland encourages imports and endeavours to hold domestic prices at an attractive level. But on the other hand it is difficult for the UK to be competitive outside its boundaries because of the high pound sterling exchange rate against the Euro. As NEXT sells about 96% in the UK marketplace, this may currently only have a limited effect, but could be more important in the future when thinking globally. Fig. 2

This can also be seen on the "Big Mac - Cross Rates" table, where hamburgers sold in the UK are more expensive than in most other countries. So an investment outside the UK might be very attractive - also speaking of "re-imports" to transfer the goods back into the domestic market.

Source: see Chapter 7

Another issue is the falling unemployment rate. For the UK population this is good news but for companies like NEXT, this has different implications. For NEXT it means higher expenditure on wages, as well as greater difficulties in recruiting good employees.

Social factors Speaking of the socio-cultural future it should be mentioned that people retire earlier these days, as well as working shorter hours. Average working hours per week have decreased over the last 20 years. As a result many people have more spare time. This means they have time to compare prices in the High Street and the quality of goods and services from retailers. But as a result, they spend more time in the shops. Another issue these days are the "Green environmental issues". Because people have more time and have ample access to the media via the TV, radio, as well as newspapers and the Internet, the consumer is better informed and therefore this awareness of environmental issues challenges him to care. He wants more than just a product. He is interested in the production process. He wants to know if the factories are environmentally friendly or not, where his product was build and under which circumstances etc. etc. So one problem in the clothing retail sector could be child labour. There are companies who rely on it in order to be competitive in their domestic market, for example Marks and Spencer. Marks & Spencer had been accused of using child

labour in Indonesia in 1999. But once the customers becomes aware of such practices, companies get into real trouble if they do not respond immediately. Consumers who are looking for a best price purchase, may however not be prepared to consider the economic price which their social conscience inflicts on those companies whose products offends their ethics and which they consequently shun.

Technological factors Another issue is the speed of technological transfers which also has an impact on the industry - it is not comparable with the fast growing internet business - but nevertheless it is important. New technology allows new products to be developed, e.g. Lycra®, Supplex® or other synthetic material. Existing materials can be produced quicker and cheaper. Adopting these technologies can be a decisive factor as to whether a company is ahead of his competitors or whether it lags behind.

3.2 SWOT - Analysis The SWOT analysis examines the organisation′s external environment and also explores the internal environment (Lynch, R 1997). This requires listing and analysing the main strengths of business, its weakness and the likely threats and opportunities it will be facing in the future (Doyle, P 1998).

Organisational Strength The strength of NEXT Plc is their adult fashion wear for people between 20 to 40 which are sold under their own label. This is their main target group. While some of its competitors have problems to satisfy this segment, NEXT managed it very well in the past, selling their stylish products at reasonable prices. NEXT customers associate with the NEXT label - good quality of the cloths used and good workmanship. As they are using their own brand they can react on consumer wishes very quickly and have total control over the quality management.

Organisational Weakness Further gains can be made by the e-commerce division. NEXT, who spent GBP 125,000 sees the internet as an extension of the telephone to order their products online. It is nothing more than a vehicle to get the orders to the retailer. Their competitors interpret the internet phenomenon differently. Debenhams for example invest more than GBP 5m on internet technology and Mark and Spencer even spend GBP 50m in e-commerce and digital TV. Right now, nobody can tell if e-commerce will be the future of shopping and customers are satisfied sitting on the computer to chose their clothes. But if the trend of internet shopping goes further NEXT is in a bad situation compared to its competitors because its platform is not sufficient enough. Another weakness is the concentration of similar type of clothing retail companies on the UK market. This can damage NEXT if competitors gain market share or if consumers change their habits and NEXT cannot adapt to these changing trends quickly. To diversify into foreign markets could balance any possible risk of decreasing sales. Furthermore such a policy would strengthen NEXT′s position if the pound become weaker or if the government decides to join the Monetary Union.

Environmental opportunities Nevertheless mail order is an important plank in the retail trading stakes. Employees aged 20-40 have little time to do their shopping. So it is good that NEXT has gained a foothold in this market. They are ranked number one among the High Street names which are offering mail order clothing. This could be a great opportunity for NEXT to increase market share -speaking of the domestic market as of the foreign markets - to use their knowledge and experience over the years they can make it even harder for its competitors to step in. More opportunities are mentioned at chapter 6.

Environmental threats A threat is the low market growth and the strong competition. Some companies are very aggressive in their attempts to gain market share or to maintain it. To reach their aim they are offering high street products manufactured in third world low labour cost areas at dumping prices. Tesco for example offered Lewis 501 denims twenty pound cheaper than the high street shops.

3.3 Competitive Analysis The objective of such an analysis is to investigate how the organisation needs too form its strategy in order to develop opportunities in its environment and protect itself against competition and other threats (Lynch, R 1997).

The report will use the Porter Model to give an idea what kind of influences exists and how a company can deal with it. Fig. 3

Porter′s Five Forces Model

Bargaining power of suppliers

Source: see Chapter 7

To what extend have the suppliers of NEXT power over the company? In the case of NEXT the influence is limited because there are a lot of providers in this sector. If a supplier were to ask for an increase in his price, or for other better conditions, his

customer could easily replace him in a short period of time. Therefore mutual dependence is rated low.

Bargaining power of customers So far as the customer is concerned he has probably the most power because it is he who buys the product and spends his money. The impact of an individual buyer who goes shopping at a branch and seeks price cuts is likely to be negligible. However speaking more generally, if the phenomenon was multiplied by many thousands of price conscious customers who are not willing to pay the ticket price, management will need to cut prices to avoid losing sales. Because clothing is not very item specific - a pullover is a pullover - whether you buy it from NEXT or Marks and Spencer. The only way to attract consumers to buy a company′s products instead of the competition′s, is to add value, such as label, style, price or quality. But still there is no guarantee that NEXT will perform better than other clothing companies. The customer decides which product he likes - not the company.

Threat of new entrants to the industry A threat to NEXT are the new competitors entering the market. Maybe not the small ones because there is a lot of capital needed to go head to head with NEXT - the threat comes more from the big labels, department stores or chain companies outside the UK. Companies such as Calvin Klein and Donna Karan, for example, have money, knowledge and the power to enter the clothing market in a short period of time. Both which opened their 8,000 to 10,000 square feet stores on New Bond Street or Ralph Lauren which opened his 45,000 square feet store in central London demonstrate how to infiltrate a rather conservative domestic market. Additionally, US catalogue retailers are venturing into the UK market. Lands′ End, the ninth biggest mail order company in the US, had opened a subsidiary in the UK but also struggle from the strong rivalry, sales are down by 1.9% to USD 143m (2000).

Threat of substitute products or services Another threat in the eyes of Michael Porter is the issue of substitution. Speaking of the clothing retail market this problem is not a big issue. A pullover can be a substitute for a jacket, or trousers for skirts, but since NEXT is provider of all these items anyway so the impact of a substitute is limited. However the threat in this market is that NEXT fails to note these trends. The Customers would substitute NEXT with a trendier company if their products are not stylish, interesting or mainstream enough to attract customers or the timing is wrong.

Rivalry among current competitors There exist a huge number of clothes retailer in the UK approximately over 25,000 combined with other outlets make them more than 45,000. This indicates a high rivalry between competitors. In this phase of the market cycle where there is more or less no growth, competition is often price-based and therefore very aggressive. To build customer loyalty with price cutting strategies is very difficult if not impossible. That means consumers are looking for the best offer with regard to price, service and quality. If NEXT wants to increase market share it must take sales from its competitors and that

increases rivalry. So it is a kind of price spiral where companies have to cut prices to sell their products. This leads to decreasing margins and probably to less competitors. This can be seen in the grocery shopping sector where competition was such though that only a few big companies survived. Another issue are the high export exit tariffs. If a company like NEXT, Marks & Spencer or C&A want to leave the UK market it means they have to sell all their branches and get rid of most of their employees. This causes a lot of problems in terms of the relevant trade unions, bad publicity or cost for developing a social viability plan. These are some reasons why companies mostly stay in their known marketplace instead of leaving them for new opportunities.

4 Conclusion NEXT is an example how a boat can be steered through storms and waves. While most of its competitors struggle from the declining market, NEXT managed to increase its market share over the last six years. Due to high sales they could increase their dividends which had a positive effect on shareholders and investors.

The company is well positioned in the UK market and very flexible to react to consumer wishes. They established with a minimum of time and money a quick and easy solution for those customers who want to order via the internet. By now they are the only big UK clothes retail company who earns money with e-commerce. Marks and Spencer for example expects to be profitable by 2003.

In our time it is very important to link a company with an image, to give it its individual identity. That is one way or probably the only way to differentiate from its competitors. Many big British corporations like British Airways, Rover or Marks and Spencer missed to build a strong brand value and that is one additional reason why those companies suffer today. NEXT on the other hand linked their label with trendy clothes and professional fashion with good quality and price.

NEXT also expands its network by opening more, bigger and more customer friendlier stores. To translate their aim into action, a contract was signed to buy at least 13 former C&A stores which will bring them face to face with Marks and Spencer.

5 Mission Statement A mission statement should provide focus for goals, clarify issues and outline visions and objectives. It needs to communicate the essence of the company to the employees, shareholders and to the public (Hassan, M 1988). Similar to this, Doyle (1998) points out, that a mission statement describes the purpose of the business and its essential characters.

Without a statement it is like the Cheshire Cat in Alice in Wonderland who said, "If you don′t know where you′re going, it doesn′t matter which way you go."

One example of a mission statement for NEXT Plc could be:

We want to be the best clothing retailer in the United Kingdom. We strive to exceed our

customers expectations, for our customer is our king. Our stores are well situated and easy to reach. The environment is to be treated with care. We sell fashionable clothes of excellent quality and price. Our employees are our treasure. Our goals are double-digit sales growth and satisfaction of our shareholders in the long run.

This statement indicates that NEXT relies on its core business as a basis for further enlargement. Furthermore the management is marketing orientated - customers are top priority and should be satisfied as often as possible speaking of clothes as of services. The stores should be easy to reach to attract new customers whose intention was to shop elsewhere rather than at NEXT. Because the "green issue" is getting more important everyday it should be one of NEXT main concerns. The product itself must satisfy the customer speaking of quality and price to generate customer loyalty in the long run. The employees are the soul of a company. If employees are well motivated and committed to their jobs, they can surmount every obstacle. In increasing market share NEXT is improving its negotiating position with its suppliers which in turn is likely to lead to an increase in profit margins. As a result NEXT will become an attractive investment proposition which will lead to strengthening of its capital base. These are the pillars of success and will lead NEXT to increased sales and shareholder value.

6 Objectives and Strategies 6.1 Good quality and price This is the key factor for success. But how can this objective be achieved? One possibility is to look for a supplier who is located in an emerging market to participate at the low labour costs. However this country should have a clothing manufacturing background, for example India, Turkey or Hong Kong so that it is easy to recruit well trained employees. Furthermore should the supplier be a part of the production process so lean management could be implemented and stock capacity reduced. A quality officer from NEXT should be at the suppliers at all the time to guarantee the high quality of clothes. To lower the costs and to gain a better trade position - suppliers should be reduced to a minimum and therefore new price conditions negotiated. This can lead NEXT to low costs and high quality in the long run.

6.2 Relationship between NEXT and its environment As it was mentioned at the PEST analysis - the green issue is gaining greater importance and NEXT should strive to make further progress in this direction. There are two tracks which should be followed. First of all the production process. NEXT should guarantee that the plants are environment friendly. In other words that the factories are equipped with up-to-date filters which reduces erosion and the used chemicals are biological decompositioned at all times. Another issue is labour force - NEXT and its suppliers should aim their production to be achieved without using child labour and should communicate this to its customers. To be credible in the public eye a joining up with a non-profit-organisation such as Save the Children to monitor NEXT activities in this sector could prove worthwhile. The outcome of this could be a badge which says "we fight against child labour" and this is useful for

marketing purposes. The second track is the customer itself. He should be aware that resources are limited and therefore the use should not be wasteful. Because of this, NEXT should use paper bags and only when it is really needed, contrary to this, Tesco uses plastic bags and even the smallest items are wrapped. So money can be saved and the environmentally awareness be sharpened.

6.3 Shopping as en event In this segment where market shares are mostly gained by price competition it is vivid to be special. One way to make shopping as an event and therefore add value for customers is to have superstores. Everything should be generous. Starting with shelves to corridors to customer care and service in general. Nothing should be omitted to satisfy the customer - he is king.

So NEXT should close their smaller branches and replace them by superstores. They should offer special services like make-up studio, clothing consulting stations or child care. Also small events like fashion shows, autographing sessions or book reviews could be helpful to attract new customers and make them enjoy their shopping. NEXT should also provide a resting place where husbands or other not actively engaged in the shopping process can sit, relax and drink a cup of cafe.

A strong brand, good service and all the other strategies which are mentioned above should lead automatically to the main aim "double digit growth" and an even better market positioning for NEXT Plc in the near future. 7 Bibliography

Books Lynch, R (1997), Corporate Strategy, Financial Times Management, London Wilson and Gilligan (1998), Strategic Marketing Management, 2nd edition, Butterwoth Heinemann, Oxford Doyle, P (1998), Marketing Management and Strategy, 2nd edition, Financial Times Prentice Hall, Harlow

Hausarbeiten.de - Analysis of NEXT plc and its environment ...

Another weakness is the concentration of similar type of clothing retail companies on the UK market. This can damage NEXT if competitors gain market share ...www.hausarbeiten.de/faecher/vorschau/99429.html

We analyze the UK Wine Industry in Michael Porter’s Five Forces Analysis. It uses concepts developed in Industrial Organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Porter referred to these forces as the microenvironment, to contrast it with the more general term macro-environment. They consist of those forces close to a company that affect its ability to serve its customers and make a profit. A change in any of the forces normally requires a company to re-assess the marketplace. five forces that determine the competitive intensity and therefore attractiveness of a market.

Sainsbury's And Waitrose Uk Supermarkets Porter's 5 Forces Competitive Advantage

INTRODUCTION

The UK supermarket industry is a very competitive and profitable industry. It is made up of four main players with significant share of the market, and then various smaller companies who focus on smaller niches in the market such as the bottom of the market discounters and the top of the line speciality stores. It is an interesting market and this report evaluates the attractiveness of the industry using Porter’s five forces model with an insight into how market nicher Waitrose sustains a competitive advantage. Next this report looks at how major player Sainsbury’s successfully competes against its rivals using differentiation strategies, and analyses current consumer trends and problems can effect this industry.

UK GROCERY INDUSTRY

The UK grocery retail industry is estimated to be worth £134.8bn with 95,585 stores. Supermarkets and superstores consist of 6,336 stores with an estimated worth of 97.9 billion pounds, according to the UK Retail Food Sector Market Brief, (2008). The grocery market is concentrated with seventy-five percent market share in the hands of just four supermarket chains. The ‘Big Four’ consist of Tesco, ASDA, Sainbury’s and Morrisons. The market shares of the UK’s supermarket chains are as follows:

UK Supermarket Market Shares[pic]UK Food Sector Market Brief, 2008.

Competitive AnalysisMarket leader Tesco, occupies the largest market share and targets the middle market offering value to consumers, providing both economy and up-scale products at very competitive prices. (Bradmore, 2005). Market challenger ASDA is slightly down-market of Tesco competing closely in price and focuses on delivering low prices to customers, and Morrisons competes at much the same level as ASDA. (UK Food Sector Market Brief 2008). Sainsbury’s, also a market challenger, is pitched slightly up-market of Tesco, targeting the premium end of the middle market, the consumers who appreciate good quality products for a slightly higher price....

2 Market-based approach to strategy

The ‘near environment’

All organisations operate in a near or micro-environment, with which they frequently interact. These organisations will include customers, suppliers and competitors. Examples of the impact of the near environment on an organisation include:

competition for customers competition for (or collaboration with) suppliers competition for resources competition (or collaboration) to influence external factors.

A market-based approach to strategy starts by analysing the near environment and the organisation's resources, and seeks through a process of further analysis and planning to fit the organisation to its environment.

The near environment is usually contrasted to the far environment (the macro influences on the organisation such as general economic and political trends).

2 Market-based approach to strategy

2.1 Porter's five forces framework

Much strategy (particularly in the private sector) is concerned with establishing and maintaining competitive advantage. One of the tools available to assist managers in analysing the near environment for this purpose is Porter's ‘five forces of competition’ (Porter, 1980). This model is widely used as a means of understanding the structure of an industry or sector, and as a framework within which to identify possible structural changes.

The model identifies five types of competitive pressure within a sector: established competitors, new entrants to the market, substitute products, and the bargaining power of suppliers and of customers. These are summarised in Figure 2.

Suppliers are important because their relative power can determine what proportion of the price of the final product they capture. In the automotive component business, for example, many makers of components vie with each other to supply a small number of car manufacturers, allowing the car manufacturers to put pressure on suppliers’ margins.

In contrast, a large number of computer manufacturers are supplied by a small number of makers of computer chips for central processors. Customers may vary similarly in their relative power.

Figure 2: The five forces of competition (Source: Porter, 1980)

Organisations need to consider not only the behaviour of current competitors, but also the potential for other organisations to enter the market. The important issue here is assessing the level of barriers to entry. For example, in sectors where brand recognition is important, new entrants need to spend heavily to build a brand. In other sectors, the minimum economic scale of operations may be high, thereby requiring heavy capital investment by new entrants.

An organisation needs to consider not only those competitors offering similar products or services, but also those offering products or services that may act as substitutes. For example, cheaper restaurants now suffer considerable competition from supermarkets selling high-quality, easily prepared ‘ready meals’ to eat at home as a substitute for dining out.

Porter argues that the degree of competitiveness or rivalry within an industry depends on the availability of substitutes, the strength of suppliers and buyers (customers), and the threat of new entrants (which in turn depends on the ease of entry). Thus pharmaceutical research, with its high entry costs, sophisticated technology and patent protection, has low levels of rivalry and high margins and profitability. Only the growing power of customers (health services) threatens this profitability. In the restaurant business, in contrast, the entry barriers and start-up costs are low, customers have a wide choice and therefore considerable bargaining power, and there is a range of substitutes. The restaurant trade is highly competitive and margins and profitability are generally low.

Business analysisThe assignment is to research a specific industry and to analyse the external drivers that affect that particular industry. This is group assignment. So my part is to analyse the micro-external environment of the existing organisation. The chosen organisation is NEXT. The elements of micro-external environment to look at: Porters 5 Forces Threat of entry Substitutes Buyer/Supplier Power Competitive rivalry

As this is a group assignment this part needs to be only 600 words. This part is about the market, in which NEXT is. Harvard method referencing

This assignment is in the strategic management. The conclusion for my part should be regarding the attractiveness of industry NEXT is.

Porters Five Forces

1. The threat of substitute products

The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives:

Buyer propensity to substitute Relative price performance of substitutes Buyer switching costs Perceived level of product differentiation Number of substitute product available in the market

2. The threat of the entry of new competitors

Profitable markets that yield high returns will draw firms. This results in many new entrants, which will effectively decrease profitability. Unless the entry of new firms can be blocked by incumbents, the profit rate will fall towards a competitive level (perfect competition).

The existence of barriers to entry (patents, rights, etc.) Economies of product differences Brand equity Switching costs or sunk costs Capital requirements Access to distribution Customer loyalty to established brands Absolute cost advantages Learning curve advantages Expected retaliation by incumbents Government policies

3. The intensity of competitive rivalry

For most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the industry.

Sustainable competitive advantage through improvisation

4. The bargaining power of customers

The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes.

Buyer concentration to firm concentration ratio Degree of dependency upon existing channels of distribution Bargaining leverage, particularly in industries with high fixed costs Buyer volume Buyer switching costs relative to firm switching costs Buyer information availability Ability to backward integrate Availability of existing substitute products Buyer price sensitivity Differential advantage (uniqueness) of industry products RFM Analysis

5. The bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm. Suppliers may refuse to work with the firm, or, e.g., charge excessively high prices for unique resources.

Supplier switching costs relative to firm switching costs Degree of differentiation of inputs Presence of substitute inputs Supplier concentration to firm concentration ratio Employee solidarity (e.g., labor unions)

Criticisms of the 5 Forces model

Porter's framework has been challenged by other academics and strategists such as Stewart Neill. Similarly, the likes of Kevin P. Coyne and Somu Subramaniam have stated that three dubious assumptions underlie the five forces:

That buyers, competitors, and suppliers are unrelated and do not interact and collude.

That the source of value is structural advantage (creating barriers to entry).

That uncertainty is low, allowing participants in a market to plan for and respond to competitive behavior.

An important extension to Porter was found in the work of Brandenburger and Nalebuff in the mid-1990s. Using game theory, they added the concept of complementors (also called "the 6th force"), helping to explain the reasoning behind strategic alliances. The idea that complementors are the sixth force has often been credited to Andrew Grove, former CEO of Intel Corporation. According to most references, the sixth force is government or the public. Martyn Richard Jones, whilst consulting at Groupe Bull, developed an augmented 5 forces model in Scotland in 1993. It is based on Porter's model and includes Government (national and regional) as well as Pressure Groups as the notional 6th force. This model was the result of work carried out as part of Group Bull's Knowledge Asset Management Organisation initiative.

It is also perhaps not feasible to evaluate the attractiveness of an industry independent of the resources a firm brings to that industry. It is thus argued that this theory be coupled with the Resource-Based View (RBV) in order for the firm to develop a much more sound strategy.

[edit] See also

Delta Model Six Forces Model

[edit] References

Porter, M.E. (1979) "How competitive forces shape strategy", Harvard business Review, March/April 1979.

Porter, M.E. (1980) Competitive Strategy, Free Press, New York, 1980.

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.

If you found this article useful please have a look at the other articles we have written: PEST

analysis, SWOT analysis, Ansoff analysis, BCG Growth-Share Matrix, Porter's Generic

Strategies, Scenario Planning, Value chain analysis.

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