Porter 5 forces analysis

Michael Porter's 1979 framework uses concepts developed in Industrial Organization (IO) economics to derive 5 forces that determine the attractiveness of a market. Porter referred to these forces as the microenvironment, to contrast it with the more general term macroenvironment. 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 company to re-assess the marketplace.

Five Forces

Five forces -- the bargaining power of customers, the bargaining power of suppliers, the threat of new entrants, and the threat of substitute products -- combine with other variables to influence a fifth force, the level of competition in an industry. Each of these forces has several determinants:

The bargaining power of customers
- buyer concentration to firm concentration ratio
- bargaining leverage
- buyer volume
- buyer switching costs relative to firm switching costs
- buyer information availability
- ability to backward integrate
- availability of existing substitute products
- buyer price sensitivity
- price of total purchase
The bargaining power of suppliers
- supplier switching costs relative to firm switching costs
- degree of differentiation of inputs
- presence of substitute inputs
- supplier concentration to firm concentration ratio
- threat of forward integration by suppliers relative to the threat of backward integration by firms
- cost of inputs relative to selling price of the product
- importance of volume to supplier
The threat of new entrants
- the existence of barriers to entry
- economies of product differences
- brand equity
- switching costs
- capital requirements
- access to distribution
- absolute cost advantages
- learning curve advantages
- expected retaliation
- government policies
The threat of substitute products
- buyer propensity to substitute
- relative price performance of substitutes
- buyer switching costs
- perceived level of product differentiation
The intensity of competitive rivalry
- power of buyers
- power of suppliers
- threat of new entrants
- threat of substitute products
- number of competitors
- rate of industry growth
- intermittent industry overcapacity
- exit barriers
- diversity of competitors
- informational complexity and asymmetry
- brand equity
- fixed cost allocation per value added
- level of advertising expense

Some argue that a 6th force should be added to Porter's list to include a variety of stakeholder groups from the task environment. This force is referred to as "Relative Power of Other Stakeholders". Some examples of these stakeholders are governments, local communities, creditors, and shareholders.

This 5 forces analysis is just one part of the complete Porter strategic models. The other elements are the value chain and the generic strategies.

Criticism and Extensions

Porter's framework has repeatedly been challenged by other academics and strategists. Kevin Coyne 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 (creating barriers to entry)
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 Brandenburger and Nalebuff in the mid-1990s. Using game theory, they added the concept of complementors (also called "the 6th force"), helping to explain the reasoning behind strategic alliances. According to most references, the sixth force is government or the public.

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

References

Brandenburger, A.M. and Nalebuff, B.J. (1995), "The Right Game: Use Game Theory to Shape Strategy", Harvard Business Review, Jul-Aug, pp.57-71
Coyne, K.P. and Subramaniam, S. (1996), "Bringing discipline to strategy", The McKinsey Quarterly, No.4
Porter, M. (1979) "How competitive forces shape strategy", Harvard Business Review, March/April 1979.
Porter, M. (1980) "Competitive Strategy", The Free Press, New York, 1980.
Hunger, J. David & Wheelen, Thomas L. (2003) "Essentials of Strategic Management". New Jersey: Pearson Education Inc.
McGahan, A. (2004) "How Industries Evolve - Principles for Achieving and Sustaining Superior Performance". Harvard Business School Press, Boston, 2004

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Five Forces

Criticism and Extensions

References

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