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Michael Porters 5 force model is based on the insight that a corporate strategy should
meet the opportunities and threats in the organizations external environment.
Especially, competitive strategy should base on and understanding of industry structures
and the way they change.

Porter has identified five competitive forces that shape every industry and every market.
These forces determine the intensity of competition and hence the profitability and
attractiveness of an industry.
Customers, suppliers, potential entrants and substitute products are all competition
that may be more or less active depends on the industry.
The state of competition in an industry depends on 5 basic forces. These collective
strength of 5 forces can determines the ultimate profit potential in an industry. They
highlight the critical strength and weaknesses of a company, animate the position of the
company in its industry, clarify the areas where strategic changes may yield the greatest
payoff and highlight industry trends.

New potential Entrants

New entrants to an industry bring new capacity that desire to gain market share
and substantial resources.

The threat of new entries will depend on the barriers to entry. There are 6 major sources
of it :

1. Economies of Scale- these economies deter entry by forcing the aspirant either to
come in on large scale or to accept a cost disadvantages. Scale economies in
production, research, marketing and service are probably the key barriers to entry
in the bank industry. Economies of Scale can also act as hurdles in distribution ,
utilization of the sales force, financing and other parts of a business.
2. Product Differentiation – brand identification that creates a barrier by forcing
entrants to spend heavily to overcome customer loyalty. Advertisement and
customer services are the 1st in the industry. Product differentiation are among the
factors fostering brand identification. It is the most important entry barriers in
investment banking. To create high fences around their businesses, brewers
couple brand identification with economics of scale in production, distribution
and marketing.
3. Capital Requirements- the needs to invest large financial resources in order to
compete the creates a barrier to entry if the capital is require for unrecoverable
expenditure in up front advertising or R & D. capital is necessary not only for
fixed facilities but also for customers credit , inventories and absorb start up
losses.
4. Cost disadvantages independent of size – entrenched companies may have cost
advantages but not available to potential rivals. No matters what their size and
attainable economies of scale. These advantages can stem from the effect of the
 learning curve. Proprietary technology and access to the best raw materials
sources, assets purchased at pre-inflation prices and government subsidies.
5. Access to distribution Channel – the newcomer on the block must secure
distribution of its products or service. The more limited the wholesale or retail
channels are , the more that existing competitors have these tied up, obviously the
tougher that the entry into industry will be.
6. Government policy- the government can limit entry to industries with controls
as license requirements and limits on access to raw material. They also can play a
major indirect role by affecting entry barriers through controls such as safety
regulation.

Bargaining Power of Suppliers

Suppliers can exert bargaining power on participants in an industry by increase
prices or decrease the quality of purchased goods and services. A powerful suppliers can
squeeze the profitability out of the industry that are unable to recover the cost increase in
its own prices.
Supplier bargaining power is powerful when :

 The market is dominated by a few large suppliers rather than the industry it
sell to.

 There are no substitutes for the particular input,

 Its product is unique and least differentiated

 The switching costs from one supplier to another are high,

 There is the possibility of the supplier integrating forwards in order to obtain

higher prices and margins.

 The buying industry has a higher profitability than the supplying industry,

 Forward integration provides economies of scale for the supplier,

In such situations, the buying industry often faces a high pressure on margins from their
suppliers. The relationship to powerful suppliers can potentially reduce strategic options
for the organization.

2.2 buyers

Similarly, the bargaining power of customers determines how much customers can
impose pressure on margins and volumes. Customers bargaining power is powerful when

 · They buy large volumes; there is a concentration of buyers.

  · The products it purchase from the industry is standard or undifferentiated

 · It earns low profit which creates great incentives to lower its purchase costs.

 · Customers have low margins and are price-sensitive and could produce the
product themselves,

 · The product it purchase from the industry , form a component of its product
and represent a significant fraction of its cost.

 · There is the possibility for the customer integrating backwards.

Substitutes

By placing the ceiling on prices it can change, substitutes product limit the potential of
an industry. Substitutes not only limit profits in normal times. It deserve the most
attention strategically are those subject to trends improving their price performance
tradeoff with industry product or produced by industries earning high profits.l

the treat of substitutes is determined by factors like

 Fixed costs are high or product is perishable , creating strong temptation to cut
prices.
 Industry growth is slow, as fight for market share
 Competitors are roughly equal in size and power.
 Exit barriers are high
The product lacks differentiation .

Competitive Rivalry between Existing Players

This force describes the intensity of competition between existing players in an industry.
High competitive pressure results in pressure on prices, margins, and hence, on
profitability for every single company in the industry.

Competition between existing players is powerful when There are many players of about
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 . Barriers for exit are high

Reducing the Competitive Rivalry between Existing Players

Avoid price competition
Differentiate your product
Buy out competition
Reduce industry over-capacity
Focus on different segments
Communicate with competitors
 Use of the Information form Five Forces Analysis

Five Forces Analysis can provide valuable information for three aspects of corporate
planning:
Statical Analysis:
The Five Forces Analysis allows determining the attractiveness of an industry. It
provides insights on profitability. Thus, it supports decisions about entry to or exit from
the industry or a market segment. Moreover, the model can be used to compare the
impact of competitive forces on the own organization with their impact on
competitors. Competitors may have different options to react to changes in competitive
forces from their different resources and competences. This may influence the structure
of the whole industry.

Dynamical Analysis:
In combination with a PEST-Analysis, which reveals drivers for change in an industry,
Five Forces Analysis can reveal insights about the potential future attractiveness of the
industry. Expected political, economical, socio-demographical and technological changes
can influence the five competitive forces and thus have impact on industry structures.

Analysis of Options:

With the knowledge about intensity and power of competitive forces, organizations
can develop options to influence them in a way that improves their own competitive
position. The result could be a new strategic direction, e.g. a new positioning,
differentiation for competitive products of strategic partnerships

Porters model of Five Competitive Forces allows a systematic and structured analysis
of market structure and competitive situation. The model can be applied to particular
companies, market segments, industries or regions. Therefore, it is necessary to
determine the scope of the market to be analyzed in a first step. Following, all relevant
forces for this market are identified and analyzed. Hence, it is not necessary to analyze all
elements of all competitive forces with the same depth.

The Five Forces Model is based on microeconomics. It takes into account supply and
demand, complementary products and substitutes, the relationship between volume of
production and cost of production, and market structures like monopoly, oligopoly or
perfect competition.
Influencing the Power of Five Forces

After the analysis of current and potential future state of the five competitive forces,
managers can search for options to influence these forces in their organization’s interest.
Although industry-specific business models will limit options, the own strategy can
change the impact of competitive forces on the organization. The objective is to reduce
the power of competitive forces.
Porter’s model of Five Competitive Forces has been subject of much critique. Its main
weakness results from the historical context in which it was developed. In the early
eighties, cyclical growth characterized the global economy. Thus, primary corporate
objectives consisted of profitability and survival. A major prerequisite for achieving these
objectives has been optimization of strategy in relation to the external environment. At
that time, development in most industries has been fairly stable and predictable,
compared with today’s dynamics.

In general, the meaningfulness of this model is reduced by the following factors:

In the economic sense, the model assumes a classic perfect market. The more an
industry is regulated, the less meaningful insights the model can deliver.

· The model is best applicable for analysis of simple market structures. A

comprehensive description and analysis of all five forces gets very difficult in complex
industries with multiple interrelations, product groups, by-products and segments. A too
narrow focus on particular segments of such industries, however, bears the risk of
missing important elements.

· The model assumes relatively static market structures. This is hardly the case in
today’s dynamic markets. Technological breakthroughs and dynamic market entrants
from start-ups or other industries may completely change business models, entry barriers
and relationships along the supply chain within short times. The Five Forces model may
have some use for later analysis of the new situation; but it will hardly provide much
meaningful advice for preventive actions.

· The model is based on the idea of competition. It assumes that companies try to
achieve competitive advantages over other players in the markets as well as over
suppliers or customers. With this focus, it dos not really take into consideration strategies
like strategic alliances, electronic linking of information systems of all companies along a
value chain, virtual enterprise-networks or others.

Overall, Porters Five Forces Model has some major limitations in today’s market
environment. It is not able to take into account new business models and the dynamics of
markets. The value of Porters model is more that it enables managers to think about the
current situation of their industry in a structured, easy-to-understand way – as a starting
point for further analysis.