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Porter’s Five Forces

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Published: 09 Dec 2015 Update History

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Explore the competitive landscape of your industry sector.

Introduction

Porter developed his Five Forces framework as a way of exploring the competitiveness of a particular industry setting or market place. The strength of the approach lies in the questions it asks about your industry, market or niche.

The five Forces are:

  • The rivalry between competitors.
  • The bargaining powers of suppliers.
  • The bargaining powers of customers.
  • The threat of new entrants.
  • The threat of product or service substitution.

Rivalry between competitors often depends on the structure of the industry. A monopoly situation, or a situation with a few dominant competitors, can mean that rivalry is not intense. Similarly, if the market is fast growing and companies are struggling to keep up with the demand, again competition can be reduced. However, it just takes one company to be aggressively increasing market share for this situation to change and create intense competition between existing incumbents.

The bargaining power of your suppliers will depend on a number of factors; the volume you require, the number of alternative suppliers in the market place, your growth potential as a customer or even your brand. Customer bargaining power can be seen as the mirror image of these factors.

What moderates the bargaining power of either party is moderated by the substitutability of the product or service and the threat of new entrants. The former leaves either the buyer the option of going elsewhere and the latter may deter suppliers from being over greedy as a new entrant will change the dynamics of the market. For existing players, managing the dynamics is important as the entry of new suppliers will often drive down prices for all.

Practical examples

UK supermarkets

For many years the UK has been served by four big supermarket chains, Asda, Morrisons, Sainsbury and Tesco. For many years they took market share from the traditional high street shops. They built their out of town super stores and grew rapidly. Because of their size and volume they had substantial buying power. As shoppers will only drive so far to a store, they did compete, but really only in the local market. Competition was often moderated by the distance to the nearest competitor and so they made good margins.

So in five forces terms, I would argue the supermarkets had some monopoly power - customers have a choice but the time and cost of travelling to a competitor is a factor. The time and cost of shopping at local shops and farmers’ markets is prohibitive for many, so the sheer convenience of super marketing shopping is a competitive advantage. Further, there are no substitutes for groceries. Super markets have significant buying power and cost advantages from economies of scale. I would also argue that because the market was growing rapidly, the completion between store chains was relatively benign. In fact, most of the completion was for sites for new stores rather than direct completion itself.

However, (at the time of writing in early 2015) that now appears to have changed. Firstly, it appears that customer buying habits have change; customers are buying less each shop, but shopping more often. This reduces the advantage of out of town stores. New entrants have arrived. At the top end, Marks & Spencer Food is being sold in the high street, Waitrose have expanded and then we have new entrants, Aldi and Lidl, who have very keen pricing. The market has also matured, so the new stores and formats are much closer to each other and competition is increasing. The result is price discounting. It is not easy to predict what will happen next, but it appears that this market is less attractive than it was two or three years ago.

Building Materials

Aerated concrete blocks are a material used widely in house building. It is difficult to produce as the aeration is created during the manufacturing process. These tiny pockets make the blocks light and insulating, so the blocks are both structural and energy efficient.

Originally, the product became popular as it reduced builders’ building costs. The blocks were easy to lay, but more expensive than alternative masonry products, but the insulation properties meant that small (and so cheaper) boilers could be installed, giving the product an advantage. Two suppliers emerged, Celcon and Thermalite. There was competition, but transport is expensive, so it is not economic to move blocks more than 50 or 60 miles. This makes competition local and where there wasn’t a local competitor block plant, completion was only with substitute products. The market grew extremely quickly as building regulations changed requiring even greater levels of insulation, making the product even more competitive compared to alternatives. This reduced rivalry between the competitors as they had enough to do just opening new plants. They became profitable. This profitability was noticed, making the market attractive to new entrants. However, there were barriers for new entrants as it is hard to make the product and the new entrants found that it was not as easy as they first thought.

But over time, markets change and move on. Products that have competitive advantage today can lose that advantage as regulation and other factors change.

Michael Porter

But over time, markets change and move on. Products that have competitive advantage today can lose that advantage as regulation and other factors change. The block makers strove to create lighter blocks and were successful in doing this. But the latest building regulations mean that very high levels of insulation are required making substitute products much more competitive than aerated concrete. So the market has changed again and now some consolidation has occurred, reducing the number of aerated concrete block producers in this market.

Questions you may ask

  • How many competitors are there in this market?
  • Is there real competition?
  • Is the market protected by import duties?
  • Is the competition limited because of distance between rivals?
  • Is the market homogeneous or are there niches, and what does that mean?
  • Are there economies of scale?
  • How much buying power do you have?
  • What is the source of this power, volume, supplier over capacity?
  • How much buying power do your customers have?
  • What is the source of this power, volume, alternative suppliers, substitute products and services?
  • What are the dynamics in substitution? Do changes in the market give you an advantage or the substitutes?
  • How attractive is your market to new entrants?
  • What are the barriers to entry; are they real and significant?

Benefits

  • Porters five forces gives a good framework to structure your analysis of a market
  • It will help you understand the dynamics of what has happened and is happening in the market
  • It is more useful in more mature markets

Pitfalls to be avoided

  • It has limited use in very dynamic markets where technology change is rapid and competitive positions never settle for long.
  • Don’t simply look at the existing position; try to think how the market will change. Tools such as PESTEL (Political, Economic, Social, Technological, Environmental and Legal analysis) will help you think about the possibilities for the future.
  • Be careful if you are relying on regulation to protect your market. Regulation can change quickly removing barriers to entry or making competitor products and services much more competitive before you have time to react.
  • Be sure you understand how the companies in the market actually compete. Competition isn’t just about price, and markets that look homogeneous to an outsider may have more niches than you realise.

Bibliography

Michael Porter, (2004), Competitive Strategy: techniques for analysing industries and competitors, Free Press, London.

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