Porter's 5 Forces Analysis

There is continuing interest in the study of the forces that impact on an organisation, particularly those that can be harnessed to provide competitive advantage. The ideas and models which emerged during the period from 1979 to the mid-1980s (Porter, 1998) were based on the idea that competitive advantage came from the ability to earn a return on investment that was better than the average for the industry sector (Thurlby, 1998).

As Porter's 5 Forces analysis deals with factors outside an industry that influence the nature of competition within it, the forces inside the industry (microenvironment) that influence the way in which firms compete, and so the industry’s likely profitability is conducted in Porter’s five forces model. A business has to understand the dynamics of its industries and markets in order to compete effectively in the marketplace. Porter (1980a) defined the forces which drive competition, contending that the competitive environment is created by the interaction of five different forces acting on a business. In addition to rivalry among existing firms and the threat of new entrants into the market, there are also the forces of supplier power, the power of the buyers, and the threat of substitute products or services. Porter suggested that the intensity of competition is determined by the relative strengths of these forces.

Main Aspects of Porter’s Five Forces Analysis

The original competitive forces model, as proposed by Porter, identified five forces which would impact on an organization’s behaviour in a competitive market. These include the following:

• The rivalry between existing sellers in the market.

• The power exerted by the customers in the market.

• The impact of the suppliers on the sellers.

• The potential threat of new sellers entering the market.

• The threat of substitute products becoming available in the market.

Understanding the nature of each of these forces gives organizations the necessary insights to enable them to formulate the appropriate strategies to be successful in their market (Thurlby, 1998).

Force 1: The Degree of Rivalry

The intensity of rivalry, which is the most obvious of the five forces in an industry, helps determine the extent to which the value created by an industry will be dissipated through head-to-head competition. The most valuable contribution of Porter's “five forces” framework in this issue may be its suggestion that rivalry, while important, is only one of several forces that determine industry attractiveness.

• This force is located at the centre of the diagram;

• Is most likely to be high in those industries where there is a threat of substitute products; and existing power of suppliers and buyers in the market.

Force 2: The Threat of Entry

Both potential and existing competitors influence average industry profitability. The threat of new entrants is usually based on the market entry barriers. They can take diverse forms and are used to prevent an influx of firms into an industry whenever profits, adjusted for the cost of capital, rise above zero. In contrast, entry barriers exist whenever it is difficult or not economically feasible for an outsider to replicate the incumbents’ position (Porter, 1980b; Sanderson, 1998) The most common forms of entry barriers, except intrinsic physical or legal obstacles, are as follows:

• Economies of scale: for example, benefits associated with bulk purchasing;

• Cost of entry: for example, investment into technology;

• Distribution channels: for example, ease of access for competitors;

• Cost advantages not related to the size of the company: for example, contacts and expertise;

• Government legislations: for example, introduction of new laws might weaken company’s competitive position;

• Differentiation: for example, certain brand that cannot be copied (The Champagne)

Force 3: The Threat of Substitutes

The threat that substitute products pose to an industry's profitability depends on the relative price-to-performance ratios of the different types of products or services to which customers can turn to satisfy the same basic need. The threat of substitution is also affected by switching costs вЂ" that is, the costs in areas such as retraining, retooling and redesigning that are incurred when a customer switches to a different type of product or service. It also involves:

• Product-for-product substitution (email for mail, fax); is based on the substitution of need;

• Generic substitution (Video suppliers compete with travel companies);

• Substitution that relates to something that people can do without (cigarettes, alcohol).

Force 4: Buyer Power

Buyer power is one of the two horizontal forces that influence the appropriation of the value created by an industry (refer to the diagram). The most important determinants of buyer power are the size and