Porter’s five forces analysis is a framework for industry analysis and business strategy development. It draws upon industrial organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability.
Threat of new competition
Profitable markets that yield high returns will attract new firms. This results in many new entrants, which eventually will decrease profitability for all firms in the industry. Unless the entry of new firms can be blocked by incumbents, the abnormal profit rate will tend towards zero (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 brand
- Absolute cost
- Industry profitability; the more profitable the industry the more attractive it will be to new competitors.
Threat of substitute products or services
The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives. Note that this should not be confused with competitors’ similar products but entirely different ones instead.
- Buyer propensity to substitute
- Relative price performance of substitute
- Buyer switching costs
- Perceived level of product differentiation
- Number of substitute products available in the market
- Ease of substitution. Information-based products are more prone to substitution, as online product can easily replace material product.
- Substandard product
- Quality depreciation
Bargaining power of customers (buyers)
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 switching costs relative to firm switching costs
- Buyer information availability
- Availability of existing substitute products
- Buyer price sensitivity
- Differential advantage (uniqueness) of industry products
- RFM Analysis
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, when there are few substitutes. 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
- Impact of inputs on cost or differentiation
- Presence of substitute inputs
- Strength of distribution channel
- Supplier concentration to firm concentration ratio
- Employee solidarity (e.g. labor unions)
- Supplier competition – ability to forward vertically integrate and cut out the BUYER
Ex.: If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from him.
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 innovation
- Competition between online and offline companies
- Level of advertising expense
- Powerful competitive strategy
