Porter five forces Essay

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Porter five forces Essay
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  • University/College:
    University of California

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  • Words: 2248

  • Pages: 9

Porter five forces

Content
1. Introduction
2. Explanation of the Porter Model
3. Porters five forces Automobile industry
4. Conclusion and weaknesses

1. Introduction
Audi History

It all began with August Horch, one of Germany’s pioneering personalities automobile engineers. He set up business on his own in 1899, establishing Horch & Cie. Motorwagen Werke in Cologne on November 14 of that year. August Horch left the company in 1909 and immediately established a second car company in Zwickau. Because his surname was already in use and was protected by trademark, he chose its Latin translation for the new company. So “horch!” – or “hark” – became “audi!”. The Audi brand established a tradition of sporting achievement from the very outset.

Thanks to his victorious involvement in the Austrian Alpine Runs between 1911 and 1914, August Horch succeeded in making Audi internationally known within just a few years. The Audi four-ring emblem symbolises the merger in 1932 of four previously independent motor-vehicle manufacturers: Audi, DKW, Horch and Wanderer. In 1969 Auto Union GmbH amalgamated with NSU Motorenwerke AG. [1]

Audi Financial situation

The revenue in 2013 is 49,880 ERU million, which is higher than that in 2012(48,711 ERU million). Operating income in 2013 is 1,952 ERU million, which is also higher than 2012. With 1,575,480 Audi vehicles sold over the course of the past fiscal year (2013), the volume target of 1.5 million deliveries originally envisaged for 2015waseasilly Exceeded, two years ahead of schedule. [2]

The reason

I choose to analyze porter five forces of Audi, because I like the appearance of Audi SUV Q5 and Q7. And I deserve to own my car in the few years when I have enough money. Thus, for me, it has some help that I have the knowledge of the background.

2. Explanation of the Porter Model

Porter five forces analysis is a framework for industry analysis and business strategy development. It draws upon industrial organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. An “unattractive” industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching “pure competition”, in which available profits for all firms are driven to normal profit. This analysis is associated with its principal innovator Michael E. Porter of Harvard University (as of 2014).

3. Porters five forces Automobile industry

Barriers to Entry
Capital requirements

The amount of capital required to start a car company is enormous. For the average person, they can’t come along and start manufacturing automobiles. As to build an auto firm, they need many factors like the site, labor and the support of technology, which be obtain by capital. Thus, the capital is the biggest factor for the creation of auto firm.

Technology

Technology also is an import factor to build the auto firm. It is complicated not only for the auto firm itself, also for the parts suppliers. As we know, production of the cars can’t complete by the auto firm, which has significant influence by the automotive suppliers. Meanwhile, ideas and technology that provides competitive advantage over others when patented, preventing others from using it and thus creates barrier to entry.

Competition

There are already significant well established competitors. Globalization the tendency of world investment and businesses to move from national and domestic markets to a worldwide environment, is a huge factor affecting the auto market. Thus, many auto firms are able to compete with the others from domestic markets to the world. Competition will become more violent than the past.

Government regulations and policies

Although government’s job is to preserve free competitive market, it restricts competition through regulations and restrictions. Thus, government regulations are a big part of barriers for the auto industry. Automobile firms need to observe safety design, emission standards and fuel efficiency by government. And different countries have various policies and restriction on automobile industry for instance Economic Commission of Europe.

Marketing a new brand

Marketing a new brand can be difficult. Not only distribution costs and marking costs are very expensive, but people cannot easy to accept a new brand especially auto brand. People will be worried on the performance and safety of cars. For this reason, marking a new brand is a barrier to entry automobile industry.

Bargaining Power of Suppliers

For automotive suppliers, there are two different situations which due to different bargaining power. Firstly, some strong suppliers (e.g. BOSCH, DENSO) have big discourse power to auto companies and the market, as they supply many products for a number of auto companies (not only Audi). The suppliers have more market share than the others and much revenue. And the products of the suppliers have patents and are not able to replace through changing the suppliers. If there are few suppliers providing material essential to make a product then they can set the price high to capture more profit. Powerful suppliers can squeeze industry profitability to great extend. Thus, auto companies are vulnerable to the suppliers. Secondly, some suppliers are often small and medium size, whereas car companies are large and globalized. Many suppliers are dependent on a single car manufacturer, as they just have the capacity of supplying a litter product.

Moreover, as we know, globalization has greatly increased the possibility to lower-cost but suitable suppliers. If an automaker decided to switch suppliers, it could be devastating to the previous supplier’s business. As a result, suppliers are extremely susceptible to the demands and requirements of the automobile manufacturer. For many years, the relationship between assemblers and suppliers has been straightforward. Because each car was designed from scratch and seen by the automaker as a unique product, all investments in solutions and technologies for new models were undertaken by the automaker. Given this market setting, it is easy to conclude from the above discussion that no role existed for the supplier at the development level. At the manufacturing stage, particularly for simpler parts where there was a well-developed market, subcontracting would naturally occur. [3] For this reason, Audi AG has significant power to these suppliers.

Bargaining Power of customers

For Audi cars, customers may be distinguished by the power of economic function. While consumers are very price sensitive, they don’t have much buying power as they never purchase huge volumes of cars. However, the price is not a main factor for the people who have capacity of buying luxury cars. The customer can freely choose the product that best fits its preferences, status and lifestyle among many. Customers can find many different brands and car models in the market, paying attention to widely differing performance, quality, appearance, pricing, additional features.

Customers have substantial power, mainly because of the large variety of luxury brands and product to choose from, and because of the presence of substitutes. The presence of many substitutes to luxury cars enhances significantly the bargaining power of potential customers. Buyers have the power to demand lower price or higher product quality from industry producers when their bargaining power is strong. [4] On the other hand, it is positive to help the auto firms develop and promote themselves.

Threat of substitute products

Substitute products have two different types. Other types of transport can fulfil the commuting of demand, such as motorbikes, bicycles, public transportation systems, planes. To personal considerations, people will find substitute products. Jogging and bicycle can give people a healthy lifestyle, while protects environment by choosing transport. While we analyze porter five forces of Audi, we should consider not only other types of transport for substitute products, also concern cars themselves. As customers choose cars of other brands in the marker, which replaces the cars of Audi. If we consider the problems which use other brands to substitute the Audi, we will find the relativity between bargaining power of customers, threat of substitute products and competitive rivalry.

With increasing number of substitute products, bargaining power of customers and competitive rivalry will become increase at the same time. For Audi, BMW and Mercedes-Benz are the most obvious substitutes in the market of mid-luxury cars. Or either higher-end cars which ultra-luxury brands (such as Ferrari, Lamborghini, Rolls Royce, Bentley)and the other end of the spectrum, less expensive cars from non-luxury brands (such as Toyota, Ford, Fiat, GM) are able to participate in the competition. Actually, the distinction between luxury cars and non-luxury cars itself is rather blurred sometimes. Pressure of the bad economic climate induces customers to choose less expensive cars, as their income decreases and expectations on the future worsen. Thus, threat of substitute products change with demand of our lives and the situation of economy.

Competitive rivalry

The rivalry between companies is rather intense, especially between the three global leaders: Audi, BMW and Mercedes-Benz. It is not simple that three companies have competitive rivalry. Because trends that are not radical that you lose touch with the market, but that go far enough that the market is prepared to follow. [2] It means a little mistake will make the auto firms lose its market. The three companies explicitly recognize each other as competitors, and their public statements and advertising campaigns make provocative comparison between the cars as to performance and innovativeness. Technological innovation is one of the fields of fiercer competition, as each of them claims to be technological leader in the industry. As previously said, substitute products will intensify competitive rivalry. With the development of Asian market, there are new luxury brands taking part in competition, such as Lexus, Infiniti and Acura. As we can see, competitive rivalry will be more intense that the past.

Audi weaknesses

Audi is clearly aiming to be a leader in automotive sustainability and is therefore stronger for it. Investment into production and vehicle technology can only increase the carmaker’s potential to become carbon-neutral. Investment into new technology could also be the cause for Audi’s biggest weakness: its cars’ reliability issues. Fitting complex electronic systems to every single one of its new cars, Audi has received a poor rating in many aspects of reliability. [5] The other weakness is about design language of cars of Audi. For the normal people who are not really into cars, they can’t really point out the differences between the A4 and the A6. Therefore, Audi need to make their productions diversified. In Audi annual report 2013, trends that are not radical that you lose touch with the market, but that go far enough that the market is prepared to follow.[2] Thus, Audi need to find a balance between trends, technology and design.

Conclusion

For the average person, they can’t come along and start manufacturing automobiles. The barriers are so high to the average person. Of course, Audi is not worried about barriers to entry. For Audi, bargaining power of suppliers are mutative depend on different suppliers, but overall bargaining power of suppliers at low position. As the suppliers and automotive firms they support each other. Then when we focus on bargaining power of customers, threat of substitute products and competitive rivalry, there is an interesting phenomenon. As previously said, if we consider the problems which use other brands to substitute the Audi, we will find the relativity between bargaining power of customers, threat of substitute products and competitive rivalry.

Thus, when people find they have many substitute products to Audi cars, bargaining power of customers, threat of substitute products and competitive rivalry are high. Auto industry has many barriers and violent competition rivalry which not be limited in mid-luxury cars market. Meanwhile, there are many difficulties and challenges, as the situation of global economy is not well that the past. However, with appearing the burgeoning Asian market, such as China and India, auto industry has many chances to develop themselves or walking away from difficulties.

Reference
[1] Audi History (n.d.) [online], available: http://www.audi.com/corporate/en/company/history/videos.html [accessed 18 May 2014]. [2] Audi Annual Report 2013 (n.d.) [online], available: http://www.audi-reports.com/ar2013/ [accessed 18 May 2014]. [3] Fixson, S. (2010) ‘Make–Buy Decisions in the Auto Industry: New Perspectives on the Role of the Supplier as an Innovator ’, Technological Forecasting and Social Change, pp. 239–257. [4] Porter’s five forces model (2013) Porter’s Five Forces [online], available: http://www.strategicmanagementinsight.com/tools/porters-five-forces.html [accessed 21 May 2014]. [5] Sam Sheehan (2014) The Strengths And Weaknesses Of Audi [online], available: http://auto2014.wordpress.com/2014/01/11/the-strengths-and-weaknesses-of-audi/ [accessed 19 May 2014].

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Porter Five Forces Essay

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Porter Five Forces Essay
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  • University/College:
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  • Words: 2055

  • Pages: 8

Porter Five Forces

Understanding the dynamics of competitors within an industry is critical for several reasons. First, it can help to assess the potential opportunities for your venture, particularly important if you are entering this industry as a new player. It can also be a critical step to better differentiate yourself from others that offer similar products and services.

One of the most respected models to assist with this analysis is Porter’s Five Forces Model. This model, created by Michael E. Porter and described in the book “Competitive Strategy: Techniques for Analyzing Industries and Competitors,” has proven to be a useful tool for both business and marketing-based planning.

Background
The pure competition model does not present a viable tool to assess an industry. Porter’s Five Forces attempts to realistically assess potential levels of profitability, opportunity and risk based on five key factors within an industry. This model may be used as a tool to better develop a strategic advantage over competing firms within an industry in a competitive and healthy environment. It identifies five forces that determine the long-run profitability of a market or market segment.

Suppliers
Buyers
Entry/Exit Barriers
Substitutes
Rivalry
Porter’s 5 Forces

Supplier power

Supplier concentration
Importance of volume to supplier
Differentiation of inputs
Impact of inputs on cost or differentiation
Switching costs of firms in the industry
Presence of substitute inputs
Threat of forward integration
Cost relative to total purchases in industry
Buyer power

Bargaining leverage
Buyer volume
Buyer information
Brand identity
Price sensitivity
Threat of backward integration
Product differentiation
Buyer concentration vs. industry
Substitutes available
Buyers’ incentives
Entry/exit barriers

Absolute cost advantages
Proprietary learning curve
Access to inputs
Government or other binding policy
Economies of scale
Capital requirements
Brand identity
Switching costs
Access to distribution
Expected retaliation
Proprietary products
Substitutes

Switching costs
Buyer inclination to find alternatives
Price-performance
Trade-off of the available substitute products or services
Rivalry

Exit barriers
Industry concentration
Fixed costs
Perceived value add
Industry growth
Overcapacity status
Product differences
Switching costs
Brand identity
Diversity of rivals
Corporate stakes
Service

Level of service compared to others
Added value perceptions
Dynamics with other attributes
Power of suppliers
An industry that produces goods requires raw materials. This leads to buyer-supplier relationships between the industry and the firms that provide the raw materials. Depending on where the power lies, suppliers may be able to exert an influence on the producing industry. They may be able to dictate price and influence availability. A segment is unattractive when an organization’s suppliers have the ability to:

Increase prices without suffering from a decrease in volume
Reduce the quantity supplied
Organize in a formal or informal manner
Compete in an environment with relatively few substitutes
Provide a product/material that is a critical part of the end product or service Impose switching costs on their customers when they depart
Integrate downstream by purchasing or controlling the distribution channels. One example of this is DeBeers’ ability to wield influence within the diamond industry. DeBeers’ high level of control over some of the most productive diamond mines in the world gives them extreme power within the industry.

The best defense in mitigating the power of suppliers is to build win–win relationships with suppliers or arrange to use multiple suppliers.

Power of buyers
The power of buyers describes the impact customers have on an industry. When buyer power is strong, the relationship to the producing industry becomes closer to what economists term a monopsony. A Monopsony is a market where there are many suppliers and one buyer. Under these market conditions, the buyer has the most influence in determining the price. Few pure monopsonies actually exist, but there is often a connection between an industry and buyers that determines where power lies.

The bargaining power of buyers increases when they have the ability to:

Be “organized” in some form with others providing similar products and services Purchase a product that represents a significant fraction of the buyer’s costs Buy a product that is undifferentiated

Incur low switching costs when they change vendors
Be price sensitive, with other options available
Integrate upstream, to purchase the providers of the goods.
To mitigate the power of buyers, sellers can seek to select buyers with less power to negotiate, switch suppliers, or develop superior offers that strong buyers cannot refuse.

Barriers to entry/exit
The possibility of new firms entering the industry impacts competition. A key is to assess how easy it is for a new player to enter an industry. The most attractive segment has high entry barriers and low exit barriers. Although any firm should be able to enter and exit a market, each industry often presents varying levels of difficulty, commonly driven by economics. Manufacturing-based industries are more difficult to enter than many service-based industries. The definable characteristics of each industry protect profitable areas for firms and inhibit additional rivals from entering the market. These inhibitive characteristics are referred to as barriers to entry.

Barriers to entry are more than the expected ebb and flow that markets typically experience. For example, when industry profits increase, one would expect firms to enter the market to take advantage of the high profit levels, which will eventually result in reducing profits.

Conversely, when profits decrease, we would expect some firms to exit. Other factors that will deter new entrants are falling prices, actions that keep prices artificially low, expectations that future prices will fall, large or unpredictable start-up expenditures, and other extreme uncertainties.

Barriers to entry are unique characteristics to each industry. They reduce the rate of entry of new firms and, therefore, maintain a level of profits for current industry competitors. Barriers to entry can be created or exploited to enhance a firm’s competitive advantage.

Barriers to entry arise from several sources:

Patents and proprietary knowledge
Asset specificity – (Specialized technology or infrastructure) Economies of scale
Government.
Barriers to exit work similarly to barriers to entry. Exit barriers limit the ability of a firm to leave the market and can exacerbate rivalry – unable to leave the industry, a firm must compete. Some of an industry’s entry and exit barriers can be summarized as follows: Profitability potential is high when both entry and exit barriers are high. In this situation, firms do face more risk because poorer-performing ones tend to continue to produce regardless of profitability and, therefore, continue to add to the supply.

Substitute products
Porter’s Five Forces model refers to “substitute products” as those products that are available in other industries that meet an identical or similar need for the end user. As more substitutes become available and affordable, the demand becomes more elastic since customers have more alternatives. Substitute products may limit the ability of firms within an industry to raise prices and improve margins.

For example, the price of aluminum cans is constrained by the price of glass bottles, steel cans, and plastic containers. These containers are substitutes, yet they are not rivals in the same industries. A substitute product to the services offered by a CPA firm is accounting or tax-based software – two very different industries that offer some of the same consumer benefits.

The treat of substitutes often impacts price-based competition. There are other concerns in assessing the threat of substitutes relating to technology. New technologies contribute to competition though substitute products and services. Think of the impact wireless technologies have had on traditional telephone service. Except in remote areas it is unlikely that cable TV could compete with free broadcast TV from an antenna without the greater diversity of entertainment that it affords the customer.

Again, a segment is unattractive when there are actual or potential substitutes for a product.

Rivalry
Firms strive to secure a competitive advantage over their rivals. The intensity of rivalry varies within each industry and these differences can be important in the development of strategy.

Industries that are “concentrated,” versus “fragmented,” often display the highest level of rivalry. Many, including The US Bureau of Census, recognize industry concentration and measure it by the “concentration ratio” (CR). The Census Bureau reports the CR by Standard Industrial Classification (SIC) Code and it indicates the percent of market share held by the four largest firms. A high concentration ratio indicates that a majority of market share is controlled by the largest firms. If a few firms hold a large market share, the competitive landscape is less competitive as it nears that of a monopoly. A low CR indicates that the industry has many rivals, none with significant market share. These fragmented markets are said to be competitive.

In pursuing an advantage over its rivals, a firm can choose from several competitive moves:

Changing prices
Improving product differentiation
Creatively using channels of distribution
Exploiting relationships with suppliers.
For example, the intensity of rivalry is increased by the following industry characteristics:

Numerous competitors that are particularly strong or aggressive that are competing for the same customers and resources Declining sales revenues and volumes resulting in slow market growth, creating the need to actively fight for market share High fixed costs result in an economy of scale effect

High storage costs or highly perishable products
Plant capacity is being added, over and above what is needed to meet demand Low switching costs for buyers
Low levels of product differentiation
Strategic stakes are high when a firm is losing market position or has potential for great gains High exit barriers place a significant cost on abandoning the product A diversity of rivals with different cultures, histories, and philosophies An industry shakeout

When a rival acts in a way that elicits a counter-response by other firms Competitors have high stakes – economic and other – and will battle to remain as a player within the segment. These conditions will make competing within the industry more challenging, commonly leading to frequent price wars, advertising battles, and the addition of new products.

Service
Service can also play a part in the industry’s dynamics. Those competitors that provide superior service may bring an advantage to their competitive position if the industry/customer places value on this attribute. This is another point of differentiation and can be a key strategic element to consider. If a competitor has a service component that is difficult to replicate, it will prove to offer a strategic advantage.

The result
We can look at several industries and see how Porter’s Five Forces would depict them; the entertainment industry is in flux, telecommunications companies are volatile, computer firms are merging, utility industries are down, the housing market is up. Porter’s Five Forces can assist us to better understand these dynamics in a more objective manner and hopefully make better strategic decisions as a result.

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  • University/College:
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  • Words: 3190

  • Pages: 13

Porter Five Forces

What is Porter’s 5 Forces analysis? What are the main aspects of Porter’s 5 Forces analysis? How to write Good Porter’s 5 Forces analysis of a company? Where to find information for Porter’s 5 Forces analysis? Porter’s Five Forces Examples; Reports on Different Companies Introduction

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, a 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 – 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 the concentration of customers. Other factors are the extent to which the buyers are informed and the concentration or differentiation of the competitors. Kippenberger (1998) states that it is often useful to distinguish potential buyer power from the buyer’s willingness or incentive to use that power, willingness that derives mainly from the “risk of failure” associated with a product’s use.

This force is relatively high where there a few, large players in the market, as it is the case with retailers an grocery stores; Present where there is a large number of undifferentiated, small suppliers, such as small farming businesses supplying large grocery companies; Low cost of switching between suppliers, such as from one fleet supplier of trucks to another.

Force 5: Supplier Power

Supplier power is a mirror image of the buyer power. As a result, the analysis of supplier power typically focuses first on the relative size and concentration of suppliers relative to industry participants and second on the degree of differentiation in the inputs supplied. The ability to charge customers different prices in line with differences in the value created for each of those buyers usually indicates that the market is characterized by high supplier power and at the same time by low buyer power (Porter, 1998).

Bargaining power of suppliers exists in the following situations:

Where the switching costs are high (switching from one Internet provider to another); High power of brands (McDonalds, British Airways, Tesco); Possibility of forward integration of suppliers (Brewers buying bars); Fragmentation of customers (not in clusters) with a limited bargaining power (Gas/Petrol stations in remote places). The nature of competition in an industry is strongly affected by the suggested five forces. The stronger the power of buyers and suppliers, and the stronger the threats of entry and substitution, the more intense competition is likely to be within the industry. However, these five factors are not the only ones that determine how firms in an industry will compete – the structure of the industry itself may play an important role.

Indeed, the whole five-forces framework is based on an economic theory know as the “Structure-Conduct-Performance” (SCP) model: the structure of an industry determines organizations’ competitive behaviour (conduct), which in turn determines their profitability (performance). In concentrated industries, according to this model, organizations would be expected to compete less fiercely, and make higher profits, than in fragmented ones. However, as Haberberg and Rieple (2001) state, the histories and cultures of the firms in the industry also play a very important role in shaping competitive behaviour, and the predictions of the SCP model need to be modified accordingly.

How to write a Good Porter’s 5 Forces analysis

The Porter’s Five Forces model is a simple tool that supports strategic understanding where power lies in a business situation. It also helps to understand both the strength of a firm’s current competitive position, and the strength of a position a company is looking to move into. Despite the fact that the Five Force framework focuses on business concerns rather than public policy, it also emphasizes extended competition for value rather than just competition among existing rivals, and the simplicity of its application inspired numerous companies as well as business schools to adopt its use (Wheelen and Hunger, 1998).

With a clear understanding of where power lies, it will enable a company to take fair advantage of its strengths, improve weaknesses, and avoid taking wrong steps. Therefore, to apply this planning tool effectively, it is important to understand the situation and to look at each of the forces individually.

In conducting an analysis of Porter’s Five Forces, it is required to brainstorm all relevant factors for the company’s market situation, and then check against the factors presented for each force in the diagram above. The next step is to highlight the key factors on a diagram, and summarize the size and the scale of the force on the diagram. It is suggested to use relevant signs, for instance, “+” and “-” to represent the forces moderately in company’s favour, or for a force strongly against.

After identifying favourable and unfavourable forces for the company’s performance and industry’s attractiveness, it is important to analyse the situation and examine the impacts of the forces. One of the critical comments made of the Five Forces framework is its static nature, whereas the competitive environment is changing turbulently. Are the five forces able to foresee industry expansion? Is it the corporate strategist’s goal to find a position in the industry where his or her company can best defend itself against these forces or can influence them in its favour, or is the goal to become part of the ongoing commerce with the intention to produce innovative ideas that will expand the size of the industry? Is it true that the environment poses a threat to the organisation, leading to the consideration of suppliers and buyers as threats that need to be tackled, or does it offer the ground for a constitutive industry player co-operation?

By thinking through how each force affects a company, and by identifying the strength and direction of each force, it provides an opportunity to identify the strength of the position and the ability to make a sustained profit in the industry (Mind Tools, 2006).

Limitations of Porter’s Five Force Model

Porter’s model is a strategic tool used to identify whether new products, services or businesses have the potential to be profitable. However it can also be very illuminating when used to understand the balance of power in other situations.

Porter argues that five forces determine the profitability of an industry. At the heart of industry are rivals and their competitive strategies linked to, for example, pricing or advertising; but, he contends, it is important to look beyond one’s immediate competitors as there are other determinates of profitability. Specifically, there might be competition from substitute products or services. These alternatives may be perceived as substitutes by buyers even though they are part of a different industry. An example would be plastic bottles, glass bottles, and cans for packaging soft drinks. There may also be the potential threat of new entrants, although some competitors will see this as an opportunity to strengthen their position in the market by ensuring, as far as they can, customer loyalty.

Finally, it is important to appreciate that companies purchase from suppliers and sell to buyers. If they are powerful they are in a position to bargain profits away through reduced margins, by forcing either cost increases or price decreases. This relates to the strategic option of vertical integration, when the company acquires, or merges with, a supplier or customer and thereby gains greater control over the chain of activities which leads from basic materials through to final consumption (Luffman and et al., 1996; Wheelen and Hunger, 1998).

It is important to be aware that this model has further limitations in today’s market environment; as it assumes relatively static market structures. Based originally on the economic situation in the eighties with its strong competition and relatively stable market structures, it is not able to take into account new business models and the dynamism of the industries, such as technological innovations and dynamic market entrants from start-ups that will completely change business models within short times.

For instance, the computer and software industry is often considered as being highly competitive. The industry structure is constantly being revolutionized by innovation that indicates Five Forces model being of limited value since it represents no more than snapshots of a moving picture. Therefore, it is not advisable to develop a strategy solely on the basis of Porter’s models (Kippenberger, 1998; Haberberg and Rieple, 2001), but to examine it in addition to other strategic frameworks of SWOT and PEST analysis.

Nevertheless, that does not mean that Porters theories became invalid. What needs to be done is to adopt the model with the knowledge of its limitations and to use it as part of a larger framework of management tools, techniques and theories. This approach, however, is advisable for the application of every business model (Recklies, 2001).

Porter’s Six Forces model and its relationship to the standard Five Forces model Porter’s Five Forces model actually has an extension referred to as Porter’s Six Forces model. It is considerably less popular than the Five Forces model as its acceptance has been less positive than the Five Forces model. The Six Forces model though is very similar to the Five Forces model with the only difference being the addition of the sixth force in the framework. This sixth force in the model is termed as the relative power of other stakeholders, and can refer to a number of other groups or entities, depending on the factor which has the greatest influence including:

• Complementors – One school of thought looks at the sixth force to be complementors, which are businesses offering complementary products to the sector in focus and being analysed (Grove 1996). The author states that these complementary businesses, as a sixth factor, affect the industry as changes in these businesses (such as new techniques, approaches or technologies) can impact on the dynamics between the industry and the complementors.

• The government – The sixth force in the framework can also be considered to be the government, and is included in the framework if it has potential to impact on all the other five forces (Gordon, 1997). Thus, the government can have direct impact on the industry as the sixth force, but can also have indirect impact or influence by affecting the other five forces, whether favourably or unfavourably.

• The public – Yet other viewpoints look at the public as the sixth force in the model, particularly if the public has a strong influence in the dynamics of the sector resulting in changes to the other forces or in the sector as a whole.

• Shareholders – This group can also be considered potentially as the sixth force. This is more important in recent years where shareholder activity has increased significantly in the boardroom, and management of firms has been scrutinised much more and even given ‘threats’ if certain actions favoured by the shareholders were not pursued.

• Employees – Employees could also be considered as the sixth force if they wielded extraordinarily strong influence on the firm in a particular sector. The status of employees seems to follow similar rules in certain sectors, and thus could be considered a strong influence in these sectors. For example, in the automobile sector in the US, a large part of the work force are unionised, and thus could be considered the sixth force instead of the government or complementors.

While a sixth force has been added to Porter’s original Five Forces model, the acceptance of this framework has been somewhat limited. This could be for two reasons. First, is that there is no definite and specific sixth force in all sectors, as it is different for each sector. Second, while a sixth force could be defined for all sectors, the influence of this factor can also be captured in the other five forces and thus the necessity of having it in the framework is less compelling.

Where to find information for Porter’s 5 Forces analysis
In conducting the analysis it is crucial to examine the existing literature:

Periodicals, business articles on the industry performance, etc; Analyst reports and trade organisations;
Company annual reports and its publications on the main suppliers and distribution network; Anything that will give the exposure to the market situation, competitors present in the market, new emerging companies in the industry. It is important to make sure that the sources are reliable and relevant to the current condition of the industry. It has to be viable, reliable and valid, in order to conduct a good analysis of the model. For this purpose, the gathered data and information has to be checked and be applied to the current business conditions.

Further limitations could be present in the nature of market forces that reduce the applicability of the information sources to present situations; and the amount of detailed information required. This can be prohibitive to its practical use. For example, the level of competitor information required is very detailed and may not always be available.

Conclusion

Any company must seek to understand the nature of its competitive environment if it is to be successful in achieving its objectives and in establishing appropriate strategies. If a company fully understands the nature of the Porter’s five forces, and particularly appreciates which one is the most important, it will be in a stronger position to defend itself against any threats and to influence the forces with its strategy. The situation is fluid, and the nature and relative power of the forces will change. Consequently, the need to monitor and stay aware is continuous.

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