Michael Porter's Industry Structural Analysis

Michael Porter's
Industry Structural
Analysis
5 Forces of Competition
Competition drives the return down to that which
would be earned by the economists perfectly
competitive industry.
All five competitive forces jointly determine the

intensity of industry competition and profitability.
Different from short-run factors that can affect

competition and profitability in a transient way.
5 Forces and Strategy
The goal is to find a position in the industry where
the company can best defend itself against these
competitive forces or can influence them in its favor.
Since the collective strength of the forces may well

be apparent to all competitors, the key for
developing strategy is to analyze the sources of each.
Force 1. THREAT OF ENTRY
Depends on extant barriers to entry, coupled with
the expected reaction from existing competitors.
Barriers of Entry
Economies of Scale.
Product Differentiation.
Capital Requirements.
Switching Costs.
Access to Distribution Channels.
Cost Disadvantages Independent of Scale.
Government Policy
Force 1. THREAT OF ENTRY
THE ENTRY DETERRING PRICE: the prevailing
structure of prices (and related terms such as
product quality and service) which just balances the
potential rewards from entry (forecast by the
potential entrant) with the expected costs of
overcoming structural entry barriers and risking
retaliation.
EXIT BARRIERS AND ENTRY BARRIERS
low entry barriers = low returns.
high entry barriers = high returns.
low exit barriers = stable returns.
high exit barriers = risky returns.
Force 2. INTENSITY OF RIVALRY
AMONG EXISTING COMPETITORS
Firms are mutually dependent.
Some forms of competition, notably price competition, are
highly unstable and quite likely to leave the entire industry
worse off from the standpoint of profitability.
Intense rivalry is the result of interacting structural
factors.
Numerous or Equally Balanced Competitors.
Slow Industry Growth.
High Fixed or Storage Costs.
Lack of Differentiation or Switching Costs.
Capacity Augmented in Large Increments.
Diverse Competitors.
High Strategic Stakes.
High Exit Barriers.
Notes on Exit Barriers
Economic, strategic, and emotional factors that keep
companies competing in businesses despite low or
even negative returns on investment.
Major sources of exit barriers
Specialized assets
Fixed costs of exit
Strategic interrelationships
Emotional barriers
Government and social restrictions
Force 3. PRESSURE FROM
SUBSTITUTE PRODUCTS
Industrys overall elasticity of demand.
Limits profits in normal times and also reduce the

bonanza an industry can reap in boom times.
Position vis--vis substitute products may well be a

matter of collective industry actions.
Substitute products that deserve the most attention

are those that (1) are subject to trends improving
their price-performance tradeoff with the industrys
product, or (2) are produced by industries earning
high profits.
Force 4. BARGAINING POWER OF
BUYERS... is high if...
The industry is concentrated or purchases large
volumes relative to seller sales.
The products it purchases from the industry
represent a significant fraction of the buyers costs
or purchases.
The products it purchases from the industry are
standard or undifferentiated.
It faces few switching costs.
It earns low profits.
Buyers pose a credible threat of backward
integration.
The industrys product is unimportant to the quality
Force 5. BARGAINING POWER OF
SUPPLIERS ... is high if ...
Industry is is dominated by a few companies and is more
concentrated than the industry it sells to.
Suppliers are not obliged to contend with other substitute
products for sale to the industry.
The industry is not an important customer of the supplier
group.
Suppliers product is an important input to the buyers
business.
Supplier groups products are differentiated or it has built
up switching costs.
Supplier group poses a credible threat of forward
integration.
BTW... labor must be recognized as a supplier as well,
The principles re the potential power of labor are similar
Summary of 5 Forces
1. If the Threat of New Entrants is High, prices can be bid down
and/or incumbents' costs inflated, reducing profitability.
2. If the Intensity of Rivalry Among Existing Competitors is High,
tactics like price competition, advertising battles, product
introductions, and increased customer service or warranties are
common, having noticeable effects on all competitors.
3. If the Pressure from Substitute Products is High, it limits the
potential returns by placing a ceiling on the prices firms in the
industry can profitably charge. The more attractive the alternative,
the firmer the lid on industry profits.
4. If the Bargaining Power of Buyers is High, Buyers compete by
forcing down prices, bargaining for higher quality or more services,
playing competitors against each other, reducing profitability.
5. If the Bargaining Power of Suppliers is High, Suppliers can exert
bargaining power over participants in an industry by threatening to
raise prices or reduce the quality of purchased goods/services.

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Michael Porter's

All five competitive forces jointly determine the

Different from short-run factors that can affect

Since the collective strength of the forces may well

Limits profits in normal times and also reduce the

Position vis--vis substitute products may well be a

Substitute products that deserve the most attention

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