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You are here: Home / Created Articles / Porter’s Five Forces for competitor analysis & advantage

Porter’s Five Forces for competitor analysis & advantageSeptember 7, 2012 by support 20 Comments

Porter’s Five Forces – Competitor Analysis

Michael Porter’s Five Forces

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Michael Porter’s five forces is a model used to explore the environment in which a product or company operates to generate competitive advantage.

Porter’s Five forces analysis looks at five key areas mainly the threat of entry, the power of buyers, the power of suppliers, the threat of substitutes, and competitive rivalry (advantage).

 

Michael Porter’s Five Forces:

New Entrants

Suppliers

Industry competitors and extent of rivalry

& advantage

Buyers

Substitutes

Introduction to Porter’s five forcesThe model of the Five Competitive Forces was developed by Michael E. Porter in his book “Competitive Strategy: Techniques for Analysing Industries and Competitors” in 1980. Since that time the ‘five forces tool’ has become an important method for analysing an organizations industry structure in strategic processes.

Michael Porter’s five forces 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 based on an 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. The objective of corporate strategy should be to modify

these competitive forces in a way that improves the position of the organization. Porters model supports analysis of the driving forces in an industry. Based on the information derived from the Porter’s Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry.

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Overview of Porter’s Five Forces

The Porter’s Five Forces model is an “outside looking in” business unit strategy tool that is used to make an analysis of the attractiveness or value of an industry structure.

The Competitive Forces analysis is made by the identification of 5 fundamental competitive forces:

The entry of competitors (how easy or difficult is it for new entrants to start to compete, which barriers do exist)

The threat of substitutes (how easy can our product or service be substituted, especially cheaper)

The bargaining power of buyers (how strong is the position of buyers, can they work together to order large volumes)

The bargaining power of suppliers (how strong is the position of sellers, are there many or only few potential suppliers, is there a monopoly)

The rivalry among the existing players (is there a strong competition between the existing players, is one player very dominant or all all equal in strength/size)

Some academics believe that a sixth force could be included – government.

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The Original Porter’s Five Forces (Factors) for competitor advantage and competitive advantage:Michael Porter’s Factor 1) Threat of New Entrants -

The easier it is for new companies to enter the industry, the more cut-throat competition there will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include:

Existing loyalty to major brands

Incentives for using a particular buyer (such as frequent shopper programs)

High fixed costs

Scarcity of resources

Government restrictions or legislation

Entry protection (patents, rights, etc.)

Economies of product differences

Brand equity

Switching costs or sunk costs

Capital requirements

Access to distribution

Absolute cost advantages

Learning curve advantages

Expected retaliation by incumbentsMichael Porter’s Factor 2) Power of Suppliers

This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a company’s margins and volumes, then they hold substantial power. Here are a few reasons that suppliers might have power:

There are very few suppliers of a particular product

There are no substitutes

The product is extremely important to the buyer, they cannot do without it

The supplying industry has a higher profitability than the buying industry

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 productMichael Porter’s Factor 3) Power of Buyers/ Customers

This is how much pressure customers can place on a business. If one customer has a large enough impact to affect a company’s margins and volumes, then they hold substantial power. Here are a few reasons that customers might have power

Small number of buyers

Purchases of large volumes

Switching to another (competitive) product is simple

The product is not extremely important to the buyer, they can do without it for a

period of time.

Customers are price sensitive

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 purchaseMichael Porter’s Factor 4) Availability of Substitutes

What is the likelihood that someone will switch to a competitive product or service? If the cost of switching is low, then this poses to be a serious threat. Here are a few factors that can affect the threat of substitutes:

Buyer propensity to substitute

Relative price performance of substitutes

Buyer switching costs

Perceived level of product differentiation

Fad and fashion

Technology change and product innovationThe main issue is the similarity of substitutes. For example, if the price of coffee rises substantially, a coffee drinker is likely to switch over to a beverage like tea because the products are so similar.

If substitutes are similar, then it can be viewed in the same light as a new entrant.

Consider technology substitutes (who would have thought that MP3 technology

would replace tape & CD’s?)Michael Porter’s Factor 5) Competitive Rivalry

And last but not least, this describes the intensity of competition between existing firms in an industry. Highly competitive industries generally earn low returns because the cost of competition is high. A highly competitive market might result from:

Many players of about the same size, no dominant firm.

Little differentiation between competitors products and services.

A mature industry with very little growth.

Companies can only grow by stealing customers away from competitors.For many industries, this is the major determinant of the competitiveness of the industry. Sometimes rivals compete aggressively and sometimes rivals compete in non-price dimensions such as innovation, marketing, etc.

Number of competitors

Rate of industry growth

Intermittent industry overcapacity

Exit barriers

Diversity of competitors

Informational complexity and asymmetry

Fixed cost allocation per value added

Level of advertising expense

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Use of the Information from Michael Porter’s Five Forces Analysis:Five Forces Analysis can provide valuable information for three aspects of corporate planning:

Statistical Analysis:

The Porter’s 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 and 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 competence’s. This may

influence the structure of the whole industry.

Dynamical Analysis:

In combination with a PESTLE Analysis, which reveals drivers for change in an

industry, Porter’s Five Forces Analysis can reveal insights about the potential future

attractiveness of the industry. Expected Political, Economical, Socio-

demographical, Technological, Legal and Environmental changes can influence the

five competitive forces and thus have impact on industry structures.

Useful tools to determine potential changes of competitive forces are scenarios.

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 (see section 4).Porter’s model of Five Competitive Forces (Porter’s five forces) allows a structured and systematic 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 analysed in a first step. Following, all relevant forces for this market are identified and analysed Hence, it is not necessary to analyzer all elements of all competitive forces with the same depth.

The Porter’s 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.

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Influencing the Power of Porter’s Five ForcesAfter 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 organisation. The objective is to reduce the power of competitive forces.

The following figure provides some examples. They are of general nature. Hence, they have to be adjusted to each organization’s specific situation. The options of an organization are determined not only by the external market environment, but also by its own internal resources, competence’s and objectives.

Michael Porter’s Five Forces

Reducing the Bargaining Power of Suppliers

PartneringSupply chain managementSupply chain trainingIncrease dependencyBuild knowledge of supplier costs and methodsTake over a supplier

Reducing the Treat of New Entrants

Increase minimum efficient scales of operationsCreate a marketing / brand image (loyalty as a barrier)Patents, protection of intellectual propertyAlliances with linked products / servicesTie up with suppliersTie up with distributorsRetaliation tactics

Reducing the Competitive Rivalry between Existing Players

Avoid price competitionDifferentiate your productBuy out competitionReduce industry over-capacityFocus on different segmentsCommunicate with competitors

Reducing the Bargaining Power of Customers

PartneringSupply chain managementIncrease loyaltyIncrease incentives and value addedMove purchase decision away from priceCut put powerful intermediaries (go directly to customer)

Reducing the Threat of Substitutes

Legal actionsIncrease switching costsAlliancesCustomer surveys to learn about their preferencesEnter substitute market and influence from withinAccentuate differences (real or perceived)

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Generic Strategies to help counter the Porter’s Five ForcesTo counter the Porter’s five forces, Strategy can be formulated on three levels:

Corporate level

Business unit level

Functional or departmental level.The business unit level is the primary context of industry rivalry. Michael Porter identified three generic strategies (cost leadership, differentiation, and focus) that can be implemented at the business unit level to create a competitive advantage. The proper generic strategy will position the firm to leverage its strengths and defend against the adverse effects of Porter’s five forces.

Assumptions made about the Porter’s Five Forces model: 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 behaviour.

Use of the Porter’s Five Forces modelThe Porter’s Five Forces tool is a simple but powerful tool for understanding where power lies in a given business situation. This is important, as it helps you understand both the strength of your current competitive position, and the strength of a position you’re looking to move into.

With a clear understanding of where power lies, (using Porter’s five forces)you can take fair advantage of a situation of strength, improve a situation of weakness, and avoid taking wrong steps. This makes it an important part of your business planning toolkit.

Supplier PowerSupplier concentration

Importance of volume to supplier

Differentiation of inputsImpact of inputs on cost

or differentiationSwitching costs of firms

in the industryPresence of substitute

inputsThreat of forward

integrationCost relative to total purchases in industry

Barriers to EntryAbsolute cost advantages

Proprietary learning curve

Access to inputsGovernment policyEconomies of scale

Capital requirements

Degree of RivalryExit barriersIndustry concentrationFixed costs/Value addedIndustry growthIntermittent overcapacityProduct differencesSwitching costs

Threat of SubstitutesSwitching costsBuyer inclination tosubstitutePrice-performancetrade-off of substitutes

Brand identitySwitching costs

Access to distributionExpected retaliationProprietary products

Brand identityDiversity of rivalsCorporate stakes

Buyer Power Bargaining leverageBuyer volumeBuyer informationBrand identityPrice sensitivityThreat of backward integrationProduct differentiationBuyer concentration vs. industrySubstitutes availableBuyers’ incentives

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Application with other tools

Porter’s five forces model works well in association with  a SWOT analysis and a PESTLE analysis

About Michael Porter

American Michael Porter was born in 1947. After initially graduating in engineering, Porter achieved an economics doctorate at Harvard, where he was subsequently awarded university professorship, a position he continues to fulfil at Harvard Business School. Porter’s research group is based at the Harvard Business School, and separately he co-founded with Mark Kramer the Foundation Strategy Group, ‘a mission-driven social enterprise, dedicated to advancing the practice of philanthropy and corporate social investment, through consulting to foundations and corporations’.

After his earlier work on corporate strategy Porter extended the application of his ideas and theories to international economies and the competitive positioning of nations, as featured in his later books. In fact in 1985 Porter was appointed to President Ronald Reagan’s Commission on Industrial Competitiveness, which marked the widening of his perspective to national economies. By the 1990′s Porter had established a reputation as a strategy guru on the international speaking circuit second only to Tom Peters, and was among the world’s highest earning academics.

Porter’s first book Competitive Strategy (1980), which he wrote in his thirties, became an international best seller, and is considered by many to be a seminal and definitive work on corporate strategy. The book, which has been published in nineteen languages and re-printed approaching sixty times, changed the way business leaders thought and remains a guide of choice for strategic managers the world over.

References:

This tool (Porter’s five forces) was created by Harvard Business School professor, Michael Porter, to analyze the attractiveness and likely-profitability of an industry. Since publication, it has become one of the most important business strategy tools. The classic article which introduces it is “How Competitive Forces Shape Strategy” in Harvard Business Review 57, March – April 1979, pages 86-93

Michael Porter’s key books:

Competitive Strategy: Techniques for Analyzing Industries and Competitors, 1980Competitive Advantage: Creating and Sustaining Superior Performance, 1985Competition in Global Industries, 1986The Competitive Advantage of Nations, 1990

Porter’ s Five Forces article – Key words:5 forces, analysis, review, Porter, Harvard,  competitors, substitutes, buyers, suppliers, change, strategic, strategy, competitive, tool, framework, Michael Porter’s five forces

WHAT IS THE BCG GROWTH-SHARE MATRIX? 

To begin with, BCG is the acronym for Boston Consulting Group—a general management consulting firm highly

respected in business strategy consulting. BCG Growth-Share Matrix (see figure 1) happens to be one of many of

BCG's strategic concepts the organisationdeveloped in the late 1970s, and is being taught at leading business

schools and executive education programmes around the world.

It is a management tool that serves four distinct purposes (McDonald 2003; Kotler 2003; Cipher 2006): it can be

used to classify product portfolio in four business types based on four graphic labels including Stars, Cash Cows,

Question Marks and Dogs; it can be used to determine what priorities should be given in the product portfolio of a

company; to classify an organisation’s product portfolio according to their cash usage and generation; and offers

management available strategies to tackle various product lines. Consider companies like Apple

Computer, General Electric, Unilever, Siemens, Centrica and many more, engaging in diversified product lines. The

BCG model therefore becomes an invaluable analytical tool to evaluate an organisation’s diversified product lines

as later seen in the ensuing sections.

WHAT ARE THE MAIN ASPECTS OF THE BCG GROWTH-SHARE MATRIX? 

The BCG Growth-Share Matrix is based on two dimensional variables: relative market share and market growth.

They often are pointers to healthiness of a business (Kotler 2003; McDonald 2003). In other words, products with

greater market share or within a fast growing market are expected to wield relatively greater profit margins. The

reverse is also true. Let’s look at the following components of the model:

Figure 1

Relative Market Share

According to the proponents of the BCG (Herndemson 1972), It captures the relative market share of a business

unit or product. But that is not all! It allows the analysed business unit be pitted against its competitors. As earlier

emphasized above, this is due to the sometime correlation between relative market share and the product’s cash

generation. This phenomenon is often likened to the experience curve paradigm that when an organisation enjoys

lower costs, improved efficiency from conducting business operations overtime. The basic tenet of this postulation

is that the more an organisation performs a task often; it tends to develop new ways in performing those tasks

better which results in lower operating cost (Cipher 2006). What that suggests is that the experience curve effect

requires that market share is increased to be able to drive down costs in the long run and at the same time a

company with a dominant market share will inevitably have a cost advantage over competitor companies because

they have the greater share of the market. Hence, market share is correlated with experience.

A case in point is Apple Computer’s flagship product called the iPod, which occupies a dominant 73% share the

portable music player market (Cantrell 2006). Analysts believe it is the impetus for Apple's financial rebirth 40% of

Apple's sales is attributed to the iPod product line (Cantrell 2006). Similarly, Dell’s PC line shares the same market

dominance theory as the iPod. The PC manufacture giant occupies a worldwide market share of 18.1%, which is

commensurate to its large market revenue above its competitors (see figure 2).

Figure 2

Market Growth

Market growth axis, correlates with the product life cycle paradigm, and predicates the cash requirement a product

needs relative to the growth of that market. A fast growing market is generally considered attractive, and pulls a lot

of organisation’s resources in an effort to increase gains. A case in point is the technological market widely consider

by experts as a fast growing market, and tends to attract a lot of competition. Therefore, a product life cycle and its

associated market play a key role in decision-making.

Cash Cows

These products are said to have high profitability, and require low investment for the fact that they are market

leaders in a low-growth market. This viewpoint is captured by the founders themselves thus:

The cash cows fund their own growth. They pay the corporate dividend. They pay the corporate overhead. They

pay the corporate interest charges. They supply the funds for R&D. They supply the investment resource for other

products. They justify the debt capacity for the whole company. Protect them (Henderson 1976).

According to experts (Drummond & Ensor 2004; Kotler 2003; McDonald 2003), surplus cash from cash cow

products should be channelled into Stars and Questions in order to create the future Cash Cows.

Stars

Stars are leaders in high growth markets. They tend to/should generate large amounts of cash but also use a lot of

cash because of growth market conditions. For example, Apple Computer has a large share in the rapidly growing

market for portable digital music players (Cantrell 2006).

Question Marks 

Question Marks have not achieved a dominant market position, and hence do not generate much cash. They tend

to use a lot of cash because of growth market conditions. ConsiderHewlett-Packard’s small share of the digital

camera market, behind industry leader Canon’s 21% (Canon 2006). However, this is a rapidly growing market.

Dogs

Dogs often have little future and are big cash drainers on the company as they generate very little cash by virtue of

their low market share in a highly low growth market. 

Consider Pfizer’s Inspra (Gibson 2006):

“Pfizer launched this drug in Q4 2003 and continues to pump money into this problem child, despite anaemic sales

of roughly $40 million in the $2.7 billion heart-failure market dominated by Toprol-XL (metoprolol). It was thought to

gain market share and become a star, and eventually a cash cow when the market growth slowed. But, according

to industry’s experts, Inspra is likely to remain a dog, despite any amount of promotion, given its perceived safety

issues and a cheaper, more effective spironolactone in the samePfizer portfolio. Because Pfizer invested heavily in

promotion early on with Inspra, the drug's earnings potential and positive cash flow is elusive at best. A portfolio

analysis ofPfizer's cardiovascular franchise would suggest redeploying promotional spend on Inspra to up-and-

coming stars like Caduet (amlodipine/atorvastatin) or torcetrapib to ensure those drugs reach their sales potential.”

HOW TO DEVELOP GOOD BCG GROWTH-SHARE MATRIX OF A COMPANY? 

SBUs or products are represented on the model by circles and fall into one of the four cells of the matrix already

described above. Mathematically, the mid-point of the axis on the scale of Low-High is represented by 1.0

(Drummond & Ensor 2004; Kotler 2003). At this point, the SBU’s or product’s market share equals that of its largest

competitor’s market share (Drummond & Ensor 2004; Kotler 2003). Next, calculate the relative market share and

market growth for each SBU and product. Figure 3 depicts the formulas to calculate the relative market share and

market growth.

Figure 3

Oftentimes, if you are versed with a particular industry and companies operating in it, you could draw up a BCG

matrix for any company without necessarily computing figures for the relative market share and market growth.

Figure 4 depicts a fairly accurate BCG growth-share matrix for Apple Computer developed in the spring of 2005

without the author calculating the relative market share and market growth.

Figure 4

Once the products or SBUs have been plotted, the planner then has to decide on the objective, strategy and budget

for the business lines. Basically, at this juncture the organisations should strive to maintain a balanced portfolio.

Cash generated from Cash Cows should flow into Stars and Question Marks in an effort to create future Cash

Cows. Moreover, there are 4 major strategies that can be pursued at this stage as described in the ensuing section.

AVAILABLE STRATEGIES TO PURSUE

Build

The product or SBU’s market share needs to be increased to strengthen its position. Short-term earnings and

profits are deliberately forfeited because it is hoped that the long-term gains will be higher than this. This strategy is

suited to Question Marks if they are to become stars.

Hold

The objective is to maintain the current share position and this strategy is often used for Cash Cows so that they

continue to generate large amounts of cash.

Harvest

Here management tries to increase short-term cash flows as far as possible (e.g. price increase, cutting costs) even

at the expense of the products or SBU’s longer-term future. It is a strategy suited to weak Cash Cows or Cash

Cows that are in a market with a limited future. Harvesting is also used for Question Marks where there is no

possibility of turning them into Stars, and for Dogs.

Divest

The objective of this strategy is to rid the organisation of the products or SBUs that are a drain on profits and to

utilize these resources elsewhere in the business where they will be of greater benefit. This strategy is typically

used for Question Marks that will not become Stars and for Dogs.

WHERE TO FIND INFORMATION FOR THE BCG GROWTH-SHARE MATRIX? 

Information for the BCG Growth-Share matrix is generated from multiple sources including company’s annual

reports, sec fillings and a host of specialised research organisations such as IDC, Hoover, Edgar, Forrester and

many more. Armed with this information, developing a BCG growth-share matrix should pose less of a problem.

Limitations

The BCG model is criticised for having a number of limitations (Kotler 2003; McDonald 2003):

There are other reasons other than relative market share and market growth that could influence the

allocation of resources to a product or SBU: reasons such as the need for strong brand name and

product positioning could compel resource allocation to an SBU or product (Drummond & Ensor 2004).

What is more, the model rests on net cash consumption or generation as the fundamental portfolio

balancing criterion. That is appropriate only in a capital constrained environment. In modern economies,

with relatively frictionless capital flows, this is not the appropriate metric to apply – rather, risk-adjusted

discounted cash flows should be used (ManyWorlds 2005).

Also, the matrix assumes products/business units are independent of each other, and independent of

assets outside of the business. In other words, there is no provision for synergy among products/business

units. This is rarely realistic.

The relationship between cash flow and market share may be weak due to a number of factors including

(Cipher 2006): competitors may have access to lower cost materials unrelated to their relative share

position; low market share producers may be on steeper experience curves due to superior production

technology; and strategic factors other than relative market share may affect profit margins.

In addition, the growth-share matrix is based on the assumption that high rates of growth use large cash

resources and that maturity of the life cycle brings about the expected profit returns. This may be

incorrect due to various reasons (Cipher 2006): capital intensity may be low and the business/product

could be grown without major cash outlay; high entry barriers may exist so margins may be sustainable

and big enough to produce a positive cash flow and a growth at the same time; and industry overcapacity

and price competition may depress prices in maturity.

Furthermore, market growth is not the only factor or necessarily the most important factor when

assessing the attractiveness of a market. A fast growing market is not necessarily an attractive one.

Growth markets attract new entrants and if capacity exceeds demand then the market may become a low

margin one and therefore unattractive. A high growth market may lack size and stability.

Given the aforementioned weaknesses, the BCG Growth-Share matrix must be used with care; nonetheless, it is a

best-known business portfolio evaluation model (Kotler 2003).

If you found this article useful please have a look at the other articles we have written:Ansoff analysis, McKinsey 7S

Framework, SWOT analysis, Scenario Planning, Porter's 5 Forces analysis, Product Life Cycle, Value chain

analysis, Pest Analysis, Balanced Scorecard, Competitor Analysis, Critical Success Factors, Industry

Lifecycle, Marketing Mixand Porter's Generic Strategies.