Porters 5 Forces Analysis

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Competitive Rivalry. What is it?
Competitive Rivalry
Competitive rivalry is a measure of the extent of competition among existing firms.
Intense rivalry can limit profits and lead to competitive moves including price cutting,
increased advertising expenditures, or spending on service/product improvements and
innovation.
Questions to Ask
How intense is competition in the industry?
What is the market share of the top companies? Is the industry fragmented? Or
dominated by a few firms?
What is the rate of industry sales growth? Is the industry mature or in a slow growth
phase?
Are products differentiated? Can customers switch with ease?
Are there high fixed costs or high exit barriers that keep companies competing?
What does the M&A landscape look like? Are competitors getting stronger through
mergers?
Are there global opportunities or threats?

Research Strategy for a Five Forces Analysis

Start with the Big Picture
Gather Industry profiles. Industry overviews from S&P NetAdvantage, IBISWorld,
and BMI Research examine current market forces, analyze performance, identify recent
trends, list leading companies, and provide aggregate financial data and forecasts.
Immerse Yourself in the Industry.
Supplement your industry profiles with news on the industry from trade journals and
business magazines. Trade journals, magazines written for practitioners in an industry,
cover trends and offer analysis from industry insiders. Use business news
databases, Business Source, ABI/INFORM, and Factiva to update your industry profiles
with the latest analysis.
Look for reports from industry associations. Associations monitor industry trends, collect
industry data and promote the interests of their members. Their publications are
excellent sources of industry data. Use the database Statista to find data and reports
from trade associations, government agencies, and market research companies.
Your goal here is to learn as much as you can about how the industry operates. Do not
rely on one source. Gather alternative viewpoints with multiple sources.
Research Your Company and Its Competitors
Start at the company website but don't stop there. Read the company's 10-K report to
the SEC. Companies often describe the competitive environment and list their top
competitors in their 10-K report. They describe their business, products and brands and
discuss strategy in Item 1 of the 10-K.  They evaluate the environment and identify risk
factors in Items 1-A and 7-A.
Use the company website to find transcripts, PPTs or webcasts of management
presentations at various investor events.  These can be bank-
sponsored Conferences that focus on various industry sectors or a company
sponsored Analyst Meeting. Many companies  schedule conference calls to discuss
their quarterly earnings and to report on important transactions like a merger or
acquisition or change of management.  Large institutional investors and financial
analysts listen in to the webcast and can ask questions.  If transcripts are not posted on
the website, find free transcripts of the earnings calls at the website Seeking Alpha.
Many databases offer profiles of public companies. Thomson ONE and Mergent
Online profile companies with an emphasis on financial data. ValueLine and CFRA
Equity Research reports (found in the database S&P NetAdvantage) offer investment
analysis.
Use the Wall Street Journal to get a timeline of company events over the last year.
The Wall Street Journal is online in Factiva and ABI/INFORM.
Look for Expert Analysis
Bank analysts' reports can be found in Bloomberg (in the Wasserman Trading Floor).
These reports identify strategic issues as well as provide financial analysis and
forecasts.
Also look for market research reports in Passport, Mintel Academic or Gartner. Market
research firms gather competitive intelligence for their clients. Their research reports
can include: analysis of market trends, market share and market size data, distribution
channels, brand and product information, demographics of consumers (and sometimes
life style information), forecasts, and alternative industry scenarios.
Supplement with a Google Search
Be strategic when using Google. Google is not a good first place to search. Use it when
you need to fill in gaps, find a report referenced in a news article, or find reports from
government agencies, think tanks or consulting firms like McKinsey or PwC. Focus your
Google searches by looking for websites in the .org or .gov domains (combine your
search terms with site:.org or site:.gov).  Always evaluate information found on the web.
Ask: Is the source credible? Who is the author and what audience is he speaking to?
Read and Evaluate
Now you are ready to bring your team together and use the information you have
gathered.  Look at each of the five forces and determine how each is affecting the
industry. Use the "Questions to Ask" listed in this guide  to structure your analysis. Make
a list of the evidence that supports your analysis. Be careful to question your
assumptions and validate your results.

Five external industry forces affecting an organization.

Definition

Porter’s five forces model

 
is an analysis tool that uses five industry forces to determine the intensity of
competition in an industry and its profitability level.
[1]

Understanding the tool

Five forces model was created by M. Porter in 1979 to understand how five key competitive
forces are affecting an industry. The five forces identified are:
These forces determine an industry structure and the level of competition in that industry. The
stronger competitive forces in the industry are the less profitable it is. An industry with low
barriers to enter, having few buyers and suppliers but many substitute products and competitors
will be seen as very competitive and thus, not so attractive due to its low profitability.
It is every strategist’s job to evaluate company’s competitive position in the industry and to
identify what strengths or weakness can be exploited to strengthen that position. The tool is very
useful in formulating firm’s strategy as it reveals how powerful each of the five key forces is in a
particular industry.

Threat of new entrants. This force determines how easy (or not) it is to enter a particular
industry. If an industry is profitable and there are few barriers to enter, rivalry soon intensifies.
When more organizations compete for the same market share, profits start to fall. It is essential
for existing organizations to create high barriers to enter to deter new entrants. Threat of new
entrants is high when:

 Low amount of capital is required to enter a market;

 Existing companies can do little to retaliate;
 Existing firms do not possess patents, trademarks or do not have established brand
reputation;
 There is no government regulation;
 Customer switching costs are low (it doesn’t cost a lot of money for a firm to switch to
other industries);
 There is low customer loyalty;
 Products are nearly identical;
 Economies of scale can be easily achieved.

Bargaining power of suppliers. Strong bargaining power allows suppliers to sell higher priced
or low quality raw materials to their buyers. This directly affects the buying firms’ profits
because it has to pay more for materials. Suppliers have strong bargaining power when:

 There are few suppliers but many buyers;

 Suppliers are large and threaten to forward integrate;
 Few substitute raw materials exist;
 Suppliers hold scarce resources;
 Cost of switching raw materials is especially high.

Bargaining power of buyers. Buyers have the power to demand lower price or higher product
quality from industry producers when their bargaining power is strong. Lower price means lower
revenues for the producer, while higher quality products usually raise production costs. Both
scenarios result in lower profits for producers. Buyers exert strong bargaining power when:

 Buying in large quantities or control many access points to the final customer;
 Only few buyers exist;
 Switching costs to other supplier are low;
 They threaten to backward integrate;
 There are many substitutes;
 Buyers are price sensitive.
Threat of substitutes. This force is especially threatening when buyers can easily find substitute
products with attractive prices or better quality and when buyers can switch from one product or
service to another with little cost. For example, to switch from coffee to tea doesn’t cost
anything, unlike switching from car to bicycle.

Rivalry among existing competitors. This force is the major determinant on how competitive
and profitable an industry is. In competitive industry, firms have to compete aggressively for a
market share, which results in low profits. Rivalry among competitors is intense when:

 There are many competitors;

 Exit barriers are high;
 Industry of growth is slow or negative;
 Products are not differentiated and can be easily substituted;
 Competitors are of equal size;
 Low customer loyalty.

Although, Porter originally introduced five forces affecting an industry, scholars have suggested
including the sixth force: complements. Complements increase the demand of the primary
product with which they are used, thus, increasing firm’s and industry’s profit potential. For
example, iTunes was created to complement iPod and added value for both products. As a result,
both iTunes and iPod sales increased, increasing Apple’s profits.

Using the tool

We now understand that Porter’s five forces framework is used to analyze industry’s competitive
forces and to shape organization’s strategy according to the results of the analysis. But how to
use this tool? We have identified the following steps:

 Step 1. Gather the information on each of the five forces

 Step 2. Analyze the results and display them on a diagram
 Step 3. Formulate strategies based on the conclusions

Step 1. Gather the information on each of the five forces. What managers should do during
this step is to gather information about their industry and to check it against each of the factors
(such as “number of competitors in the industry”) influencing the force. We have already
identified the most important factors in the table below.

Porter's Five Forces Factors

 Threat of new entry

 Amount of capital required

 Retaliation by existing companies
 Legal barriers (patents, copyrights, etc.)
 Brand reputation
 Product differentiation
 Access to suppliers and distributors
 Economies of scale
 Sunk costs
 Government regulation

Supplier power

 Number of suppliers
 Suppliers’ size
 Ability to find substitute materials
 Materials scarcity
 Cost of switching to alternative materials
 Threat of integrating forward

Buyer power

 Number of buyers
 Size of buyers
 Size of each order
 Buyers’ cost of switching suppliers
 There are many substitutes
 Price sensitivity
 Threat of integrating backward

Threat of substitutes

 Number of substitutes
 Performance of substitutes
 Cost of changing

Rivalry among existing competitors

 Number of competitors
 Cost of leaving an industry
 Industry growth rate and size
 Product differentiation
 Competitors’ size
 Customer loyalty
 Threat of horizontal integration
 Level of advertising expense

Step 2. Analyze the results and display them on a diagram. After gathering all the
information, you should analyze it and determine how each force is affecting an industry. For
example, if there are many companies of equal size operating in the slow growth industry, it
means that rivalry between existing companies is strong. Remember that five forces affect
different industries differently so don’t use the same results of analysis for even similar
industries!

Step 3. Formulate strategies based on the conclusions. At this stage, managers should
formulate firm’s strategies using the results of the analysis For example, if it is hard to achieve
economies of scale in the market, the company should pursue cost leadership strategy. Product
development strategy should be used if the current market growth is slow and the market is
saturated.

Although, Porter’s five forces is a great tool to analyze industry’s structure and use the results to
formulate firm’s strategy, it has its limitations and requires further analysis to be done, such
as SWOT, PEST or Value Chain analysis.

Example

This is Porter’s five forces analysis example for an automotive industry.

 Porter's Five Forces Evaluation

Threat of new entry (very weak)

 Large amount of capital required

 High retaliation possible from existing companies, if new entrants would bring innovative
products and ideas to the industry
 Few legal barriers protect existing companies from new entrants
 All automotive companies have established brand image and reputation
 Products are mainly differentiated by design and engineering quality
 New entrant could easily access suppliers and distributors
 A firm has to produce at least 5 million (by some estimations) vehicles to be cost
competitive, therefore it is very hard to achieve economies of scale
 Governments often protect their home markets by introducing high import taxes

Supplier power (weak)

 Large number of suppliers

 Some suppliers are large but the most of them are pretty small
 Companies use another type of material (use one metal instead of another) but only to
some extent (plastic instead of metal)
 Materials widely accessible
 Suppliers do not pose any threat of forward integration

Buyer power (strong)

 There are many buyers

 Most of the buyers are individuals that buy one car, but corporates or governments
usually buy large fleets and can bargain for lower prices
 It doesn’t cost much for buyers to switch to another brand of vehicle or to start using
other type of transportation
 Buyers can easily choose alternative car brand
 Buyers are price sensitive and their decision is often based on how much does a vehicle
cost
 Buyers do not threaten backward integration

Threat of substitutes (weak)

 There are many alternative types of transportation, such as bicycles, motorcycles, trains,
buses or planes
 Substitutes can rarely offer the same convenience
 Alternative types of transportation almost always cost less and sometimes are more
environment friendly

Competitive rivalry (very strong)

 Moderate number of competitors

 If a firm would decide to leave an industry it would incur huge losses, so most of the time
it either bankrupts or stays in automotive industry for the lifetime
 Industry is very large but matured
 Size of competing firm’s vary but they usually compete for different consumer segments
 Customers are loyal to their brands
 There is moderate threat of being acquired by a competitor