Porter’s Five Forces as External Analysis Tool:

Michael Porter provided a framework that shows an industry as being influenced by five forces.

The strategic business manager who wants to develop an edge over rival firms can use this model

to better understand the industry in which the firm operates.

1. Rivalry among Firms:

What is important here is the number and capability of your competitors. If you have many

competitors, and they offer equally attractive products and services, then you will most likely

have little power in the situation. If suppliers and buyers don’t get a good deal from you, they’ll

go elsewhere. On the other hand, if no-one else can do what you do, then you can often have a

monopoly like situation.

In pursuing an advantage over its rivals, a firm can choose from several competitive moves:

Changing prices - raising or lowering prices to gain a temporary advantage.

Improving product differentiation - improving features, implementing innovations in the

manufacturing process and in the product itself.

Creatively using channels of distribution - using vertical integration or using a

distribution channel that is unique to the industry. For example, with high-end jewelry

stores reluctant to carry its watches, Timex moved into drugstores and other non-

traditional outlets and entered the low to mid-price watch market.

Exploiting relationships with suppliers - for example, from the 1950's to the 1970's Sears,

Roebuck and Co. dominated the retail household appliance market. Sears set high quality

standards and required suppliers to meet its demands for product specifications and price.

2. Threat of Substitutes:

This is affected by the ability of your customers to find a different way of doing what you do for

example, if you supply a unique software product that automates an important process, people

may substitute by doing the process manually or by outsourcing it. If substitution is easy and

substitution is viable, then this weakens your power.

The competition by a Threat of Substitute comes from products outside the industry as well. The

price of aluminum beverage cans is constrained by the price of glass bottles, steel cans, and

plastic containers. These containers are substitutes, yet they are not rivals in the aluminum can

industry. To the manufacturer of automobile tires, tire retreads are a substitute. Today, new tires

are not so expensive that car owners give much consideration to retreading old tires. But in the

trucking industry new tires are expensive and tires must be replaced often. In the truck tire

market, retreading remains a substitute industry. In the disposable diaper industry, cloth diapers

are a substitute and their prices constrain the price of disposables.

While the threat of substitutes typically impacts an industry through price competition, there can

be other concerns in assessing the threat of substitutes. Consider the substitutability of different

types of TV transmission: local station transmission to home TV antennas via the airways versus

transmission via cable, satellite, and telephone lines. The new technologies available and the

changing structure of the entertainment media are contributing to competition among these

substitute means of connecting the home to entertainment. Except in remote areas it is unlikely

that cable TV could compete with free TV from an aerial.

3. Bargaining Power of Buyer:

Here you ask yourself how easy it is for buyers to get prices down. Again, this is impacted by the

number of buyers, the importance of each individual buyer to your business, the cost to them of

switching from your products and services to those of someone else, and so on. If you deal with

few, powerful buyers, they are often able to dictate terms to you.

The power of buyers is the impact that customers have on a producing industry. When buyer

power is strong, the relationship to the producing industry is near to what an economist terms a

monopsony, a market in which there are many suppliers and one buyer. Under such market

conditions, the buyer sets the price. In reality few pure monopsonies exist.

This is high where there a few, large players in a market e.g. the large grocery chains.

If there are a large number of undifferentiated, small suppliers e.g. small farming

businesses supplying the large grocery chains.

The cost of switching between suppliers is low e.g. from one fleet supplier of trucks to

another.

4. Bargaining Power of Supplier:

Here you assess how easy it is for suppliers to drive up prices. This is driven by the number of

suppliers of each key input, the uniqueness of their product or service, their strength and control

over you, the cost of switching from one to another, and so on. The fewer the supplier choices

you have, and the more you need suppliers' help, the more powerful your suppliers are.

A producing industry requires raw materials labor, raw materials, and other supplies. This

requirement leads to buyer-supplier relationships between the industry and the firms that provide

it the raw materials used to create products. Suppliers, if powerful, can have an influence on the

producing industry, such as selling raw materials at a high price to capture some of the industry's

profits.

The power of suppliers tends to be a reverse of the power of buyers.

Where the switching costs are high e.g. switching from one software supplier to another.

Power is high where the brand is powerful e.g. Cadillac, Pizza Hut, Microsoft.

There is a possibility of the supplier integrating forward e.g. Brewers buying bars.

Customers are fragmented (not in clusters) so that they have little bargaining power e.g.

Gas/Petrol stations in remote places.

5. Threat of New Entrants:

Power is also affected by the ability of people to enter your market. If it costs little in time or

money to enter your market and compete effectively, if there are few economies of scale in

place, or if you have little protection for your key technologies, then new competitors can

quickly enter your market and weaken your position. If you have strong and durable barriers to

entry, then you can have a favorable position and take fair advantage of it.

Easy to Enter if there is:

Common technology

Little brand patent protection

Access to distribution channels

Low government trade barriers

Difficult to Enter if there is:

Patented or Intellectual property know-how

Difficulty in brand switching

Restricted distribution channels

High government trade barriers

Value Chain Analysis as tool of Internal Environment Assessment:

To understand the activities through which a firm develops a competitive advantage and creates

shareholder value, it is useful to separate the business system into a series of value-generating activities

referred to as the value chain. In his 1985 book Competitive Advantage, Michael Porter introduced a

basic value chain model that comprises a sequence of activities found to be common to a wide range of

firms.

1. Inbound Logistics

Here goods are received from a company's suppliers. They are stored until they are needed on the

production/assembly line. Goods are moved around the organization.

Inbound Logistics Technologies include

Transportation

Material handling

Material storage

Communications

Testing

Information systems

2. Operations

This is where goods are manufactured or assembled. Individual operations could include room service in

a hotel, packing of books/videos/games by an online retailer, or the final tune for a new car's engine.

Operations Technologies include

Process

Materials

Machine tools

Material handling

Packaging

Maintenance

Testing

Building design & operation

Information systems

3. Outbound Logistics

The goods are now finished, and they need to be sent along the supply chain to wholesalers, retailers or

the final consumer.

Outbound Logistics Technologies include

Transportation

Material handling

Packaging

Communications

Information systems

4. Marketing and Sales

In true customer orientated fashion, at this stage the organization prepares the offering to meet

the needs of targeted customers. This area focuses strongly upon marketing communications and

the promotions mix.

Marketing & Sales Technologies

Media

Audio/video

Communications

Information systems

5. Service

This includes all areas of service such as installation, after-sales service, complaints handling,

training and so on.

Service Technologies include

Testing

Communications

Information systems

References:

http://www.mindtools.com/pages/article/newTMC_08.htm

http://www.marketingteacher.com/Lessons/lesson_fivefoces.htm

http://www.quickmba.com/strategy/porter.shtml

http://www.netmba.com/strategy/value-chain/

http://www.marketingteacher.com/Lessons/lesson_value_chain.htm