industry and business strategy development. It draws upon industrial organization 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. An

"unattractive" industry is one in which the combination of these five forces acts to drive

down overall profitability. A very unattractive industry would be one approaching "pure competition",

in which available profits for all firms are driven to normal profit. This analysis is

associated with its principal innovator Michael E. Porter of Harvard University.

Porter referred to these forces as the micro environment, 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 business unit to re-assess the marketplace given the overall change in industry

information. The overall industry attractiveness does not imply that every firm in the industry

will return the same profitability. Firms are able to apply their core competencies,

business model or network to achieve a profit above the industry average. A clear example

of this is the airline industry. As an industry, profitability is low and yet individual companies,

by applying unique business models, have been able to make a return in excess of the industry

average. Porter's five forces include - three forces

from 'horizontal' competition: the threat of substitute products or services, the threat

of established rivals, and the threat of new entrants; and two forces from 'vertical' competition:

the bargaining power of suppliers and the bargaining power of customers.

Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis,

which he found unrigorous and ad hoc. Porter's five forces is based on the Structure-Conduct-Performance

paradigm in industrial organizational economics. It has been applied to a diverse range of

problems, from helping businesses become more profitable to helping governments stabilize

industries. Other Porter strategic frameworks include the value chain and the generic strategies.

History Porter five forces analysis is a framework

for industry analysis and business strategy development formed by Michael E. Porter of

Harvard Business School in 1979. Five forces

Threat of new entrants 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 trend towards zero.

The following factors can have an effect on how much of a threat new entrants may pose:

The existence of barriers to entry. The most attractive segment is one in which entry barriers

are high and exit barriers are low. Few new firms can enter and non-performing firms can

exit easily. Government policy

Capital requirements Absolute cost

Cost disadvantages independent of size Economies of scale

Economies of product differences Product differentiation

Brand equity Switching costs or sunk costs

Expected retaliation Access to distribution

Customer loyalty to established brands Industry profitability

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.

For example, tap water might be considered a substitute for Coke, whereas Pepsi is a

competitor's similar product. Increased marketing for drinking tap water might "shrink the pie"

for both Coke and Pepsi, whereas increased Pepsi advertising would likely "grow the pie",

albeit while giving Pepsi a larger slice at Coke's expense. Another example is the substitute

of traditional phone with VoIP phone. Potential factors:

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 Substandard product

Quality depreciation 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. Firms can take measures to reduce buyer power, such as implementing

a loyalty program. The buyer power is high if the buyer has many alternatives.

Potential factors: 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

Force down prices Availability of existing substitute products

Buyer price sensitivity Differential advantage of industry products

RFM Analysis The total amount of trading

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

to the firm can be a source of power over the firm when there are few substitutes. If

you are making biscuits and there is only one person who sells flour, you have no alternative

but to buy it from them. Suppliers may refuse to work with the firm or charge excessively

high prices for unique resources. Potential factors:

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 Supplier competition: the ability to forward

vertically integrate and cut out the buyer. Intensity of competitive rivalry

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

of the industry. Potential factors:

Sustainable competitive advantage through innovation

Competition between online and offline companies Level of advertising expense

Powerful competitive strategy Firm concentration ratio

Degree of transparency Usage

Strategy consultants occasionally use Porter's five forces framework when making a qualitative

evaluation of a firm's strategic position. However, for most consultants, the framework

is only a starting point or "checklist." They might use "Value Chain" afterward. Like all

general frameworks, an analysis that uses it to the exclusion of specifics about a particular

situation is considered naїve. According to Porter, the five forces model

should be used at the line-of-business industry level; it is not designed to be used at the

industry group or industry sector level. An industry is defined at a lower, more basic

level: a market in which similar or closely related products and/or services are sold

to buyers. A firm that competes in a single industry should develop, at a minimum, one

five forces analysis for its industry. Porter makes clear that for diversified companies,

the first fundamental issue in corporate strategy is the selection of industries in which the

company should compete; and each line of business should develop its own, industry-specific,

five forces analysis. The average Global 1,000 company competes in approximately 52 industries.

Criticisms Porter's framework has been challenged by

other academics and strategists such as Stewart Neill. Similarly, the likes of ABC, Kevin

P. Coyne [1] 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.

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 Adam Brandenburger and Barry Nalebuff of Yale School of Management in the

mid-1990s. Using game theory, they added the concept of complementors, 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 as well as Pressure Groups as the notional

6th force. This model was the result of work carried out as part of Groupe Bull's Knowledge

Asset Management Organisation initiative. Porter indirectly rebutted the assertions

of other forces, by referring to innovation, government, and complementary products and

services as "factors" that affect the five forces.

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 in order for the firm to develop a much more sound strategy.

It provides a simple perspective for accessing and analyzing the competitive strength and

position of a corporation, business or organization. See also

National Diamond Value chain

Porter's four corners model Industry classification

Nonmarket forces References

Further reading Coyne, K.P. and Sujit Balakrishnan,Bringing

discipline to strategy, The McKinsey Quarterly, No.4.

Porter, M.E.. "How Competitive Forces Shape Strategy". Harvard Business Review. 

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

Porter, M.E. The Five Competitive Forces That Shape Strategy, Harvard business Review, January

2008. Ireland, Hoskisson, Understanding Business

Strategy. SOUTH WESTERN. Rainer and Turban, Introduction to Information

Systems, Wiley, 2009, pp 36–41. Kotler Philip, Marketing Management, Prentice-Hall,

Inc. 1997 Mintzberg, Ahlstrand and Lampel,Strategy Safari

1998. External links