porter's 5 forces model macr
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TERM PAPER
ON
Porter’s five forces model
Submitted to
DR ANITHA
Submitted by
DARSHANKUMAR GARAG
USN 1PI11MBA46
Acknowledgements
I am thankful to Dr Anitha for providing me the task of
preparing the Term Paper. We at Pesit believe in taking
challenges and the term paper provided me the
opportunity to tackle a practical challenge in the subject
of management. This term paper tested my patience at
every step of preparation but the courage provided by my
teachers helped me to swim against the tide and move
against the wind.
1.1 Abstract
Strategic Analysis and Planning is a field in which expertise and
experience are key factors. In order to decide on strategic matters such as the
competitive position of a company experts heavily lean on their ability to
reason with uncertain or incomplete knowledge, or in other words on their
experience and expertise. An important aspect is to assess a company's profit
potential in the industry for which Porter's competitive Forces Model is by
far the most widely used framework.
Porter's five forces analysis is a framework for industry analysis and
business strategy development formed by Michael E. Porter of Harvard
Business School in 1979. 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.
Introduction
The model of the Five Competitive Forces was developed by
Michael E. Porter in his book “Competitive Strategy: Techniques for
Analyzing Industries and Competitors” in 1980. Since that time it has
become an important tool for analyzing an organizations industry
structure in strategic processes.
Porter’s 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.
The objective of corporate strategy should be to modify these
competitive forces in a way that guides the organization for making
decisions regarding the mergers and acquisitions. Porter’s model
supports analysis of the driving forces in an industry. Based on the
information derived from the Five Forces Analysis, management can
decide how to influence or to exploit particular characteristics of their
industry or make decisions regarding M&A.
An important part of the Strategic Analysis and Planning concerns
Porter's Competitive Forces Model and it is interesting to see how this
well-defined part can be modeled so that the knowledge that it contains
can be used in an expert system for various technicalities in the field of
mergers and acquisitions for the companies to make reliable decisions.
Knowledge in the field of strategic analysis is either uncertain or
incomplete. An expert in the field generally will not have all data at his
disposal. In particular, many data concerning the environment (external
& internal) of the enterprise, such as data of competitors and suppliers,
will sometimes be missing or is difficult to uncover and thus cannot be
taken into account. But also data from within the own enterprise is not
always readily available. Whatever the reason for this lack of data may
be, the expert is expected to generate an analysis the best he can based
on data that is available. Naturally, the more relevant data he can use,
the better the quality of the analysis will be. In other words, if the input
data is not sufficiently available, conclusions drawn will be
correspondingly less certain. This is one of the most striking
characteristics of an expert. He is able to come to conclusions based on a
limited number of data that - in addition - may also be uncertain. For this
purpose he will use his experience.
Literature review
Three of Porter's five forces refer to competition from external
sources. The remaining are internal threats.
Porter referred to these forces as the micro environment, to contrast it
with the more general term macro environment. 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
business unit to re-assess the marketplace given the overall change
in industry information. The overall industry attractiveness does not
imply that every firm in the industry will return the same profitability.
Firms are able to apply their core competencies, business model or
network to achieve a profit above the industry average as well as to
make ideal decisions regarding M&A. A clear example of this is the
airline industry. As an industry, profitability is low and yet individual
companies, by applying unique business models, have been able to make
a return in excess of the industry average by ways of merger among
various companies.
Components of Porter’s competitive forces
Porter's five forces include - three forces from 'horizontal' competition:
threat of substitute products, the threat of established rivals, and the threat of
new entrants; and two forces from 'vertical' competition: the bargaining
power of suppliers and the bargaining power of customers.
This five forces analysis is just one part of the complete Porter strategic
models. The other elements are the value chain and the generic strategies
Porter developed his Five Forces analysis in reaction to the then-
popular SWOT analysis, which he found un-rigorous and ad hoc. Porter's five
forces is based on the Structure-Conduct-Performance paradigm in industrial
organizational economics. It has been applied to a diverse range of problems,
from helping businesses become more profitable to helping governments
stabilize industries.
The Porter model is also useful in examining the future configuration of
strategic strength and attractiveness of markets which the firm wishes to
enter. It is this configuration which will determine the strategic choice that
the firm makes.
Each of these five forces is based on structural features
(dimensions) which collectively impact the profit potential. All
five forces jointly determine the intensity of the industry
competition and profitability. The strongest forces become crucial
from the point of view of decisions regarding M&A strategy
formulation.
Unsystematic Risk
Unsystematic Risk
Systematic RiskSystematic Risk
Bargainig power of customer
Bargaining power of suppliers
Threat from Substiture Products
Threat of new Entrants
Main aspects of porter’s five forces model
The original competitive forces model, as proposed by Porter,
identified five forces which would impact on an organization’s behavior 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.
1.1.1 Primary Dimensions of Porter's Five Forces Model
The primary dimensions of the competitive forces model consists of five
forces that significantly impacts on an organization's behavior in a competitive
market and should be consistent for a particular industry.
These include the rivalry between current vendors in the market, the muscle
wielded by the customers in the market, the impact of suppliers on the trader, the
impending threat of additional merchants entering the market and the threat of
substitute products developing into a viable alternative in the market. According to
Porter the intensity of competition is determined by the comparative strengths of
these forces.
Barriers to entry
These are the important structural components with an industry to limit or
prohibit the entrance of new competitors. The major components are scale
economies (advantage of experience, learning and volume), differentiation (brand
image and loyalty), capital requirements (new entrants will face a risk premium),
switching cost involved by the customer, access to distribution channels and cost
disadvantages (patents, location, subsidies).
Rivalry among existing competitors
In most industries, especially when there are only a few major competitors,
competition will very closely match the offering of others. Aggressiveness will
depend mainly on factors like number of competitors, industry growth, high fixed
costs, lack of differentiation, capacity augmented in large increments, diversity in
type of competitors and strategic importance of the business unit.
Substitutes
These are products or solutions that basically perform the same function but
are often based on a different technology. Depending on the level of abstraction
nearly everything can be a substitution. In general the only factor that really
matters is a shift in technology.
Power of Buyers
Through their bargaining power buyers can force the competitors to lower
their prices or force higher quality or better service. The major factors which
determine the bargaining power are volume (relative to seller sales), does the
product represent a major fraction of the buyer’s costs or purchases, differentiation
or standard product, switching costs, buyer profitability (hence their price
sensitivity), threat of backward integration, importance to the quality of the final
product, and level of knowledge and information of the buyer of industry demand,
actual market prices and supplier cost.
Power of Suppliers
Suppliers can exert their bargaining power over participants by threatening
to raise prices or reduce the quality. A supplier group is powerful if they are more
concentrated than the industry they sell to, or if the customer group is not
important for the suppliers, if the product is an important input to the buyer’s
business, or they have built up switching costs, or the supplier group poses a threat
of forward integration. Through addressing these dimensions which make up the
Five Forces we have outlined factors which will be taken into account in our expert
system. It will still be the expert’s insight who will assert the value of impact of
each individual variable.
Advantages of Utilizing the Porter Five Forces Model
Porter's five forces model (1980) is based on the premise that a competitive
advantage can only be achieved once a capacity to generate a better than industry
average return on investment can be maintained.
When the model is correctly implemented it can provide companies with a
simple picture that can be used to assess and analyze the business or organization's
competitive position and practical strengths that can be capitalized on to achieve
the allusive sustainable competitive advantage.
In order to use the model, according to its designer, involves establishing the
relationship between the five competitive forces that shape the industry and the
market segment selected for the product. Analyzing the relationship between all
potential competitors, suppliers and buyers provides a platform for generating
alternative solutions to problems that need resolving for success.
Limitations of porter’s five forces 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. It is important to appreciate that company’s
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. 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.
Some issues during the implementation of these Five Forces are crucially
important for organizations to build long-term business strategy and
sustaining competitive advantages rather than simply list the forces. Successful use
of the Porter Model Analysis includes identifying the sources of competition, the
strength and likelihood of that competition existing, and strategic
recommendations for the action a company should take in order to develop barriers
to competition.
Conclusion
In order to understand the five forces model that Porter's
recommends one need to establish and understand the relationship
between the five forces first.
The primary objective of a successful corporate strategy that is based on
the porter five forces model should be to identify and take advantage of
the existing competitive forces in a manner that will enhance the
competitive position of the company by deciding on the merger or
acquisition.
One of the main advantages of using the Porter five forces model
as a basis of industry analysis is that the model provides an objective
framework for conducting an analysis of the primary constrains and
driving forces that may be present in the industry within which the
company operates. The information that can be obtained by using the
Five Forces Analysis model is normally utilized by the management
team to determine how to manipulate or take advantage of identifiable
characteristics of the industry being analyzed.
References
Valuation for mergers buyouts & restructuring- Azak Wiley
India (P) Ltd
http://en.wikipedia.org/wiki/Porter_five_forces_analysis
http://www.quickmba.com/strategy/porter.shtml
http://www.tutor2u.net/business/strategy/porter_five_forces.htm
http://www.businessballs.com/portersfiveforcesofcompetition.htm
http://www.managementstudyguide.com/porters-model-of-
competetion.htm
http://wiki.telfer.uottawa.ca/ci-wiki/index.php/
Mergers_And_Acquisitions
http://mis.postech.ac.kr/class/MEIE780_AdvMIS/2012%20paper/
Part4%20(Pack8)/Strategic%20Management%20of%20Technological
%20Innovation/8-7)%20Rethinking%20and%20reinventing%20Michael
%20Porter's%20five%20forces%20model.pdf
http://theinternationalcouncil.blogspot.in/2005/08/michael-porter-five-
forces-model.html