Porter Five Forces PDF

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Porter Five Forces - Prof Mathew Hughes...

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Porter's Five Forces Framework -

Helps to analyse an industry and identify the attractiveness of it in terms of five competitive forces: 1. Extent of rivalry between competitors, 2. Threat of entry, 3. Threat of substitutes, 4. Power of buyers, 5. Power of suppliers.

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Porter's main message is that where five forces are high and strong, industries are not attractive.

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Excessive competitive rivalry, powerful buyers and suppliers and the threat of substitutes or new entrants will all combine to squeeze profitability.

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The Competitive Five Forces Framework provides several useful insights into the forces and actors at work in the industry or market environment of an organisation. The objective is simply more than simply listing the strengths of the forces and their underlying driving factors.

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The ultimate aim is rather to determine whether the industry is a good one to compete in or not and to what extent there are strategic positions where an individual organisation can defend itself against strong competitive forces, can exploit weak ones or can influence the forces in its favour.

FORCE 1: The Threat of Entry: Entry barriers include: - Scale and experience. o Economies of scale are extremely important. Once large-scale production has been reached, it will be expensive for new entrants to match them and until they reach a similar volume they will have high unit costs. o Barriers to entry also come from experience curve effects that give incumbents a costs advantage because they have learnt how to do things. -

Access to supply or distribution channels. o This can be through direct ownership (vertical integration) e.g. through customer loyalty. Or can be overcome by new entrants who have bypassed retail distributors and sold directly to consumers through e-commerce (e.g. Amazon).

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Expected retaliation. o If an organisation considering entering an industry believes that the retaliation of an existing firm will be so great as to prevent entry, or mean that entry would be too costly, this is also a barrier.

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Legislation or government action. o Legal restraints on new entry vary from patent protection, to regulation of markets, through to direct government action.

FORCE 2: The Threat of Substitutes: -

Substitutes are products or services that offer the same or similar benefit to an industry's products or services, but have a different nature.

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Managers often focus on their competitors in their own industry, and neglect the thread posed by substitutes.

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Substitutes can reduce demand for a particular type of product as customers switch to alternatives – even to extent that this type of product or service becomes obsolete.

 The price/performance ratio is critical to substitution threats. A substitute is still an effective threat even if more expensive, so long as it offers performance advantages that customers value.  Extra-industry effects are the core of the substitution concept. The value of the substitution concept is to force managers to look outside their own industry to consider more distant threats and constraints.

FORCE 3: The Power of Buyers: Buyer power is likely to be high when some of the following conditions prevail: -

Concentrated Buyers: Where a few large customers account for the majority of sales, buyer power is increased.

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Low Switching Costs: Where buyers can easily switch between one supplier and another, they have a strong negotiating position and can squeeze suppliers who are desperate for their business.

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Buyer Competition Threat: If the buyer has the capability to supply itself, or if it has the possibility of acquiring such a capability, it tends to be powerful. In negotiation with tits suppliers, it can raise the threat of doing the suppliers' job themselves.

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Low buyer profits and impact on quality.

FORCE 4: The Power of Suppliers:

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Suppliers are those who supply the organisation with what it needs to produce the product or service.

Supplier power is likely to be high where: -

Concentrated suppliers: Where just a few producers dominate supply, suppliers have more power over buyers.

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High Switching Powers: If it is expensive or disruptive to move from one supplier to another, then the buyer becomes relatively dependent and correspondingly weak.

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Supplier concentration threat: Suppliers have increased power where they are able to enter the industry themselves or cut out buyers who are acting as intermediaries.

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Differentiated products: When the products or services are highly differentiated, suppliers will be more powerful. E.g. Discount Retailers are extremely powerful, suppliers with strong suppliers, like P&G and Gilette, still have high negotiating power.

FORCE 5: Competitive Rivalry: -

Competitive rivals are organisations aiming at the same customer groups and with similar products and services.

Factors that define the extent of rivalry in an industry or market: - Competitive concentration and balance: Where competitors are numerous or of roughly equal size or power there is the danger of intensely rivalrous behaviour as competitors attempt to gain dominance over others. Industry growth rate: -

In situations of strong growth, an organisation can grow with the market. Low-growth markets are therefore often associated with price competition and low profitability.

High fixed costs: -

Industries with high fixed costs can require high investments in capital equipment or initial research, tend to be highly rivalrous.

High exit barriers: -

The existence of high barriers to exit – in other words, closure or disinvestment – tends to increase rivalry, especially in declining industries. Excess capacity persists and consequently incumbents fight to maintain market share.

Low differentiation: -

In a commodity market, where products or services are poorly differentiated, rivalry is increased because there is little to stop customers switching between competitors and the only way to compete is on price. (e.g. Price).

Implications of the Competitive Five Forces:

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Which industries to enter (or leave)? – Entrepreneurs and Managers should invest in industries where the five forces work in their favour and avoid, or disinvest from, markets where they are strongly unfavourable. Entrepreneurs sometimes choose markets because entry barriers are low: unless barriers are likely to rise quickly, this is the wrong reason to enter. It is important to note that just one significantly adverse force can be enough to undermine the attractiveness of the industry as a whole.

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How can the five forces be managed? - Managers should try to influence and exploit any weak forces to its advantage and neutralise any strong ones. E.g. if barriers to entry are low, an organisation can raise them by increasing advertising spending to improve customer loyalty. Managers can buy competitors to reduce rivalry and to increase power over suppliers or buyers.

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How are competitors affected differently? – If barriers are rising because of increased R&D or advertising spending, smaller players in the industry may not be able to keep up with larger competitors and be pushed out. Growing buyer power is also likely to hurt small competitors most. Strategic group analysis is therefore helpful here.

Strategic Analysis 2: The Internal Organisation

Value Chain: The value chain describes the categories of activities within an organisation which, together, create a product or service. -

If organisations are to achieve competitive advantage by delivering value to customers, managers need to understand which activities their organisation undertakes that are especially important in creating that value and which are not.

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Inbound Logistics – concerned with receiving, storing and distributing inputs to the product or service including materials handling, stock control, transport etc.

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Operations – transform these inputs into the final product or service.

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Outbound logistics – Collect, Store and Distribute the product or service to customers.

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Marketing and Sales – provide the means whereby customers or users are made aware of the product or service and are able to purchase it.

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Service – includes those activities that enhance or maintain the value of a product or a service, such as installation, repair, training and spares.

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Procurement – Processes that occur in many parts of the organisation for acquiring the various resource inputs to the primary activities.

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Technology Development – Technologies may be directly concerned with a product (e.g. R&D, product design) or with processes.

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Human Resource Management - Concerned with recruiting, managing, training, developing and rewarding.

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Infrastructure – Formal systems of planning, finance, quality control, information management and the structure of an organisation.

The Value Chain can be used to understand the strategic position of an organisation and analyse resources and capabilities in three ways: -

Generic description of activities – it can help managers understand if there is a cluster of activities providing benefit to customers located within particular areas of the value chain.

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Analyse the competition position of the organisation by using the VRIO analysis for individual value chain activities and functions.

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Analyse the cost and value of activities of an organisation through identifying sets of value activities, assessing the relative importance of activity costs internally, assess the relative importance of activities externally and identifying where and how costs can be reduced.

Corporate Level Strategy:

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A central corporate strategy choice is about in which areas a company should grow.

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Ansoff's product/market growth matrix is a corporate strategy framework for generating four basic directions for organisational growth.

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Diversification involves increasing the range of products or markets served by an organisation.

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Related Diversification involves expanding into products or services with relationships to the existing business.

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Conglomerate (unrelated) diversification involves diversifying into products or services with no relationships to existing businesses.

Market Penetration: -

Market penetration implies increasing share of current markets with the current product range.

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Greater market share implies increased power vis-à-vis buyers and suppliers, greater economies of scale and experience curve benefits. Constraints:

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Retaliation from competitors. o Increased rivalry might involve price wards or expensive marketing battles, which may cost more than any market-share gains are worth. o In low growth or declining markets, it can be more effective simply to acquire competitors. o Acquisitions may reduce rivalry, by taking out independent players and controlling them under one umbrella.

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Legal constraints. o Can raise concerns from official competitions regulators concerning excessive market power. o Most countries have regulators with the powers to restrain powerful companies or prevent mergers and acquisitions that would create such excessive power. 

Market penetration may also not be an option where economic constraints are severe, for instance during a market downturn or public-sector funding crisis.

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Here organisations will need to consider retrenchment: withdrawal from marginal activities in order to concentrate on the most valuable segments and products within their existing business.

Product Development: -

Is where organisations deliver modified or new products (or services) to existing markets.

o This can involve varying degrees of diversification along the horizontal axis. For Apple, developing its products from the original iPod, through iPhone to iPad involved little diversification: although technologies differed, Apple was targeting the same customers and using very similar production processes and distribution channels. Product Development can be expensive and high risk:  New resources and capabilities – Product development strategies typically involve mastering new processes or technologies that are unfamiliar to the organisation. This product development typically involves heavy investments and can have high risk of project failures.  Project management risk – Product development projects are typically subject to the risk of delays and increased costs due to project complexity and changing project specifications over time. Market Development:

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Involves offering existing products to new markets.

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It is essential that market development strategies be based on products or services that meet the critical success factors of the new market.

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Market developers often lack the right marketing skills and brands to make progress in a market with unfamiliar customers.

Conglomerate Diversification:

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Conglomerate diversification is growth strategy that involves adding new products or services that are significantly different from the organization's present products or services.

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Conglomerate diversification occurs when the firm diversifies into an area(s) totally unrelated to the organization current business.

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However, there are two biggest drawbacks to unrelated diversification: the difficulties of managing broad diversification and the absence of strategic opportunities to turn diversification into competitive advantage. Appeals include:

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Business risk is scattered over a variety of industries, making the company less dependent on one business.

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Capital resources can be invested in whatever industries offer the best profit prospects; cash from businesses with lower profit prospects can be diverted to acquiring and expanding businesses.

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Company profitability is somewhat more stable because hard times in one industry may be partially offset by good time in another.

Diversification Drivers: Value creating drivers for diversification are as follows:

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Exploiting economies of scope – refers to efficiency gains made through applying the organisation’s existing resources or competences to new markets or services. o If an organisation has under-utilised resources or competences that it cannot effectively close or sell to other potential users, it is efficient to use these resources or competences by diversification into a new activity. o E.g. University hall of residence which are underutilised during the summer. Efficiently used if the universities expand the scope of their activities into conferencing and tourism during holiday periods.

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Stretching corporate management competences – refers to applying the skills of talented corporate-level managers to new businesses. o Dominant logic – set of corporate-level managerial competences applied across the portfolio of businesses.

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Exploiting superior internal processes – Internal processes within a diversified corporation can often be more efficient than external processes in the open market.

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Increasing market power – Being diversified in many businesses can increase power vis-à-vis competitors in at least two ways. o Having the same wide portfolio of products as a competitor increases the potential for mutual forbearance (ability to retaliate across the whole range of the portfolio acts to discourage the competitor from making any aggressive moves at all). o Increases the power to cross-subsidise one business form the profits of the others. (The ability to cross-subsidise can support aggressive bids to drive competitors out of a particular market.

Synergies – are benefits gained where activities or assets complement each other so that their combined effect is greater than the sum of the parts Value-destroying diversification drivers are:

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Responding to market decline - is a common but doubtful driver for diversification. Conventional finance theory suggests it is usually best to let shareholders find new growth investment opportunities for themselves.

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Spreading risk across a range of markets.

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Managerial ambition.

Vertical Integration:

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Describes entering activities where the organisation is its own supplier or customer. Forward and Backward Integration:

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Backward integration - is movement into input activities concerned with the company’s current business (i.e. further back in the value network). E.g. acquiring a component supplier for a car manufacturer.

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Forward integration – is movement into output activities concerned with the company’s current business (i.e. further forward in the value network). For a car manufacturer this would be into car retail, repairs and servicing.

Outsourcing - the process by which activities previously carried out internally are subcontracted to external suppliers Value-adding activities:

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Envisioning – The corporate parent can provide a clear overall vision or strategic intent for it business units. This should guide and motivate business unit managers to maximise corporation-wide performance through commitment to a common purpose.

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Facilitating Synergies – The corporate parent can facilitate cooperation and sharing across business units, so improving synergies from being within the same corporate organisation through incentives, rewards and remuneration schemes.

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Coaching - The corporate parent can help business unit managers develop strategic capabilities, by coaching them to improve their skills and confidence.

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Providing central services and resources.

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Intervening – The corporate parent should be able to closely monitor business unit performance and improve performance either by replacing weak managers or by assisting them in turning around their businesses.

Value-destroying activities:

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Adding management costs.

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Adding bureaucratic complexity - ‘Bureaucratic fog’ created by an additional layer of management and the need to coordinate with sister businesses. These typically slow down managers’ responses to issues and lead to compromises between the interests of individual businesses.

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Obscuring financial performance – weak businesses might be cross-subsidised by stronger ones.

The portfolio manager:

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Operates as an active investor in a way that shareholders in the stock market are either too dispersed or too inexpert to be able to do.

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Acting as an agent on behalf of financial markets and shareholders with a view to extracting more value from the various businesses than they...