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Porter’s Five Forces

 

Porter’s Five Forces is a method for analysing competition of a business. It derives five forces that determine the competitive intensity and, therefore, the attractiveness (or lack of it) of an industry in terms of its profitability.

Porter’s Five Forces is a model that identifies and analyzes five competitive forces that shape every industry and helps determine an industry’s weaknesses and strengths. Five Forces analysis is frequently used to identify an industry’s structure to determine corporate strategy.

You can use these to guide your business strategy both for a new business entering an industry or to grow an existing business.

An “unattractive” industry is one in which the effect of these five forces reduces overall profitability. The most unattractive industry would be one approaching “pure competition”, in which available profits for all firms are driven to normal profit levels.

Five Forces
1. Threat of new entrants
Profitable industries that yield high returns will attract new entities. New entrants eventually will decrease profitability for other firms in the industry. Unless the entry of new firms can be made more difficult by incumbents, abnormal profitability will fall towards zero (perfect competition), which is the minimum level of profitability required to keep an industry in business.

2. Threat of substitutes
A substitute product uses a different technology to try to solve the same economic need. Examples of substitutes are meat, poultry, and fish; landlines and cellular telephones; airlines, automobiles, trains, and ships; beer and wine; and so on. For example, tap water is a substitute for Coke, but Pepsi is a product that uses the same technology (albeit different ingredients) to compete head-to-head with Coke, so it is not a substitute. Increased marketing for drinking tap water might “shrink the pie” for both Coke and Pepsi, whereas increased Pepsi advertising would likely “grow the pie” (increase consumption of all soft drinks), while giving Pepsi a larger market share at Coke’s expense.

3. Bargaining power of customers
The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer’s sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers’ power is high if buyers have many alternatives. It is low if they have few choices.

4. Bargaining power of suppliers
The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources.

5. Competitive rivalry
For most industries the intensity of competitive rivalry is the major determinant of the competitiveness of the industry. Having an understanding of industry rivals is vital to successfully marketing a product. Positioning pertains to how the public perceives a product and distinguishes it from competitors‘. An organization must be aware of its competitors’ marketing strategies and pricing and also be reactive to any changes made. Rivalry among competitors tends to be cutthroat and industry profitability low.

You can read more an in-depth analysis on the Wikipedia page.

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Porter’s Five Forces Analysis & Strategy

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