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PORTER FIVE FORCES MODEL
10/26/2012 1Prof P K Agarwal
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Introduction
In 1979, the Harvard Business Review published the
article How Competitive Forces Shape Strategy by the
Harvard Professor Michael Porter. It started a revolution
in the strategy field.
In subsequent decades, Porters five forces have
shaped a generation of academic, research and business
practice.
This session explores how competitive analysis can
be done using Porters five forces model.
10/26/2012 2Prof P K Agarwal
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Cont.
The Five Forces - Michael Porter
Analytical tool for examining competitive environment. According
to this model, the intensity of competition in an industry dependson five basic forces.
1. Threat of new entrants
2. Intensity of rivalry among industry competitors
3. Bargaining power of buyers
4. Bargaining power of suppliers
5. Threat of substitute products and services.
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PORTERS FIVE FORCES MODEL
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Forces that Shape Competition
1. The Threat of New Entrants
The first ofPorters Five Forces model is
the threat of new entrants. Newentrants bring new capacity &
substantial resources to an industry
with a desire to gain market share.
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Forces that Shape Competition
2. Barriers to entry
Entry barriers depend on the advantages that existingcompanies have relative to new entrants. There areseven major sources:
i. Economies of scale
ii. Product differentiation
iii. Capital requirements
iv. Switching costs
v. Access to distribution channelsvi. Cost disadvantages independent of size
vii. Government policy
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Cont.
Expected Retaliation
New entrants -- likely to fear expected retaliation if:
Existing companies - earlier responded vigorously
Existing companies possess substantial resources to fightback
Existing companies likely to cut prices to protect market
share
Industry growth is slow, so newcomers can gain volume only
by taking the market share from existing companies.
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Cont.
Intensity of Rivalry among Competitors
The second of Porters Five-Forces model . Rivalry means thecompetitive struggle between companies in an industry to gain
market share from each other.
Intensity of rivalry is greatest under following conditions:
i. Numerous competitors or equally powerful competitors
ii. Slow industry growth
iii. High fixed but low marginal costs
iv. Lack of differentiation or switching costs
v. Capacity augmentation in large increments
vi. High exit barriers
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Common exit barriers are:
1. Investment in specialized assets like plant and
machinery - no value, cannot be put to alternative
use. Hence discontinue.
2. High costs of exit viz. retrenchment benefits, etc. to be
paid to redundant workers when a company ceases to
operate.
3. Emotional attachment to industry keep owners/employees unwilling to exit from an industry for
sentimental reasons.
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Common exit barriers are:
4. Economic dependence on the industry when the
firm depends on a single industry for revenue and
profit.
5. Government & social pressures discourage exit
concern --job loss.
6. Strategic interrelationships between businessunits and others prevent exit because of shared
facilities, image and so on.
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Cont.
Bargaining power of buyers
The third ofPorters five competitive forces. Bargaining power of
buyers refers to the ability of buyers to bargain down prices
charged by firms in the industry or driving up the costs of the firm
by demanding better product quality and service.
Buyers are most powerful under the following conditions:
i. There are few buyers
ii. The products are standard or undifferentiated
iii. The buyer faces low switching costs
iv. The buyer earns low profits
v. The quality ofbuyers products
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Cont.
Bargaining power of suppliers
The fourth of Porters Five Forces model. Suppliers are
companies that supply RM, components, etc
A suppliers bargaining power high under following conditions:
i. Few suppliers
ii. Product is differentiated
iii. Dependence of supplier group on the firm
iv. Importance of the product of the firm
v. Threat of forward integration
vi. Lack of substitutes
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Threat of Substitute Products
Fifth of Porters Five Forces model . A substitute
performs the same or a similar function as an
industrys product. Video conferences are a
substitute for travel. Plastic is a substitute for
aluminum. E-mail is a substitute for a mail. All firmswithin an industry compete with industries
producing substitute products.
Existence of close substitutes a strong competitive
threat because this limits the price that companiesin one industry can charge for their product. price of
coffee rises too much relative to tea/ soft drink,
coffee drinkers may switch to those substitutes.10/26/2012 Prof P K Agarwal 13
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According to Porter, substitutes limit the
potential returns of an industry by placing a
ceiling on the prices firms in the industry can
profitably charge.
The more attractive is the price/performance
ratio of substitute products, the more likely
they affect an industrys profits.
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Critical Assessment - Five Forces Model
Propelled the concept of industry environment into theforeground of strategic thought and business planning.
Helps Managers to link competitive forces to their effect
on a firms operating environment.
Merits
1. powerful tool helps managers to think strategically.
2. helps a firm not only to evaluate the profit potential ofan industry, but also to consider various ways to
strengthen its position vis--vis the five forces.
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3. The model helps managers to assess how to
improve the firms competitive position with
regard to each of the five forces.
4. It provides the rationale for increasing ordecreasing resources commitment.
5. It helps managers to decide whether the firm
should remain in or exit from the industry
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Limitations
Despite being the most popular and widely used
framework for competitive analysis, Porters FiveForces model suffers from the following limitations:
1. Assumes the existence of a clear, recognizable
industry. As complexity associated with industry
definition increases, the ability to draw coherent
conclusions from the model diminishes.
2. It presents a static view of competition among the
firms in the industry rather than a dynamic interaction
of competitive forces.
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It is short-sighted and implicitly assumes a zero-sum
game. It overlooks the many potential benefits ofdeveloping constructive win-win partnerships with
suppliers and customers. Establishing long-term
mutually beneficial relationships with suppliers
improves a firms ability to implement just-in-time
(JIT) inventory systems. Further, by working
together as partners, suppliers and manufactures
can provide the greatest value at the lowest possible
cost.
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4. The model does not take into account the fact that some
firms, most notably the large ones, can often take steps to
modify the industry structure, thereby increasing their
prospects for profits. For example, large airlines have been
known to lobby for hefty safety restrictions to create an entry
barrier to potential upstarts.
5. A firm that competes in many countries typically must be
concerned with multiple industry structures. The nature of
industry competition in the international area differs amongnations, and may present challenges that are not present in a
firms host country.
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A firm that competes in many countries
typically must be concerned with multiple
industry structures. The nature of industry
competition in the international areadiffers among nations, and may present
challenges that are not present in a firms
host country.
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Examples of a Companys Strengths,
Weaknesses, Opportunities, and Threats
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