Porters Five Forces – content, application, and critique
- Based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment => understanding of industry structures and the way they change
1. Bargaining Power of Suppliers
- All input sources that are needed in order to provide goods/services
- High when:
- Market is dominated by few large suppliers
- No substituted for that particular input
- Suppliers’ customers are fragmented, so their bargaining power is low
- Switching costs from one supplier to another are high
- Possibility that supplier integrate forward in order to obtain higher prices and margins
- Buying industry has a higher profitability than the supplying industry
- Forward integration provides economies of scale for the supplier
- Buying industry hinders the supplying industry in their development (e.g. reluctance to accept new releases of products)
- Buying industry has low barriers to entry
- Buying industries face high pressure on margin from their suppliers in the situations
- Dependence on powerful suppliers can reduce strategic options for the organization
2. Bargaining Power of Customers
- Determines how much pressure customers can impose on margins and volumes
- High when:
- They buy large volumes/ There’s a concentration of buyers
- Supplying industry comprises of a large number of small operators
- Supply industry operates with high fixed costs
- Product is undifferentiated and can be replaced by substitutes
- Switching to an alternative product is relatively simple and is not related to high costs
- Customers have low margins and are price-sensitive
- Customers could produce the product themselves
- Product is not of strategical importance for the customer
- Customer knows about the production costs of the product
- There is the possibility for customer to integrate backwards
3. Threat of New Entrants
- Always a latent pressure for reaction and adjustment for existing players in the industry
- Level of threat from new entrants depends on the extent to which there are barriers to entry:
- Economies of scale (min. size requirements for profitable operations)
- High initial investment and fixed costs
- Cost advantages for existing players due to experience curve effects of operation with fully depreciated assets
- Brand loyalty
- Protected intellectual property like patents, licenses, etc.
- Scarcity of important resources
- Access to raw materials is controlled by existing players
- Distribution channels are controlled by existing players
- Existing players have close customer relations
- High switching costs for customers
- Legislation and government action
4. Threat of Substitutes
- Potentially attract a significant portion of market volume => reduce potential sales volume for existing players
- Also relates to complementary products
- Treat of substitutes is determined by factors like:
- Brand loyalty
- Close customer relationships
- Switching costs for customers
- Relative price for performance of substitutes
- Current trends in technology, customer preferences, etc.
5. Competitive Rivalry Between Existing Players
- High competitive pressure leads to pressure on prices, margins, and profitability for every single company in the industry
- Competition likely to be high when:
- There are many players of the same size
- Players have similar strategies
- There is not much differentiation between players and their products, hence, there is much price competition
- Low market growth rates (growth of a particular company is possibly only at the expense of a competitor)
- Barriers for exit are high (e.g. expensive and highly specialized equipment)
- Customers are price sensitive and/or have low switching costs