Five forces that shape industry competition

Threat of New
entrants

Rivalry
Bargaining Power among Bargaining power
of suppliers of buyers
existing
competitors

Threat of substitute
products or
services
 Threat of Entry
 New entrants to an industry bring new capacity and a desire to gain market share
 This puts pressure on prices, costs and rate of investment necessary to compete
 Especially when new entrants are diversifying they can leverage existing capabilities and
cash flows to shake up competition
 Pepsi when it entered bottled water industry
 Reliance when it is entering telecom
 When “threat of entry” is high, incumbents must hold down their prices or boost
investments
Threat of Entry
Barriers to Entry
 Supply-side economies of scale: These economies arise when firms produce at larger volumes enjoy
lower costs per unit
 Eg: Intel is protected by scale economics in research, chip design and consumer marketing
 Demand-side benefits of scale: Also known as Network Effect.
 Buyers willingness to pay for a company’s product increases with the number of other buyers
 Eg: IBM when it was a dominant computer maker, Maruti in India
 Customer switching costs: Fixed cost the buyers face when they switch customers.
 Eg: Enterprise Resource Planning (ERP) Software. Shifting from SAP is not that easy
 Capital requirements: The need to invest large financial resources in order to compete can deter new
entrants
 Incumbency advantages independent of size: Incumbents have cost or quality advantages.
 Eg: Access to best technology, raw material source, Eg: Amul
 Unequal access to distribution channels: New entrant must secure distribution of its product or service
 A new food item must displace other from the supermarket shelf via price breaks, promotions etc
 Eg: Maggi.
 Restrictive Government Policy: Policy can hinder new entry
 Eg: Regulated industries like liquor retailing, taxi services and airlines
Power of Suppliers
 Powerful suppliers capture more of the value for themselves by charging higher prices, limiting
quality or services
 Eg: Microsoft has contributed to the erosion of profitability among personal computer makers
by raising prices on OS.
 PC makers competing fiercely for customers who can easily switch them, have limited freedom
to raise their prices accordingly
 Also, presence of PC assemblers amplify the situation.
 Shifting suppliers is difficult if companies have invested heavily in ancillary equipment or in
learning how to operate a suppliers equipment (eg: Bloomberg terminals used by finance
professionals)
 Pilot unions exercise considerable supplier power over airlines
Power of Buyers
 Powerful customers can capture more value by forcing down prices, demanding
better quality or more service (drives up cost)
 Large-volume buyers are particularly powerful in industries with high fixed costs
such as telecommunication equipment, offshore drilling and bulk chemicals.
 If Industry’s products are standardized or undifferentiated, buyers believe they can
always find an equivalent product.
Threat of substitutes
 A substitute performs the same or similar function as an industry’s product by a
different means.
 Videoconferencing is a substitute for travel
 Plastic is a substitute for aluminium
 Software sold to travel agents is threatened when airline and travel websites substitute for travel agents.
 When the threat of substitutes is high, industry profitability suffers.
 Substitute products limit an industry’s profit potential by placing a ceiling on prices.
 Switching from branded drugs to generic drugs– cost of shifting is low.
 Plastic substitute steel in many automobile components.
Rivalry among existing competitors
 Rivalry among existing competitors take many forms
 Price discounting, new product introductions, advertising campaigns and service improvements
 High rivalry limits the profitability of an industry
 Eg; Airline industry, e-commerce industry
 The intensity of rivalry is greatest if
 Competitors are numerous or are roughly equal in size and power
 Industry growth is slow. Slow growth precipitates fights for market share
 Exit barriers are high. Specialised assets are managements devotion to a particular business. These barriers keep
companies in market even though their earnings are low
 Rivals are highly committed to the business and have aspirations for leadership
 Rivalry is destructive to profitability if it gravitates solely to price.
 Price competition transfers profits directly from an industry to customer
 Eg: E-commerce industry- discounts
 Price competition is most likely to occur if
 Products or services of rivals are nearly identical and few switching costs for buyers
 Fixed costs are high and marginal costs are low
 The product is perishable
Implications for Strategy
 Understanding the forces that shape industry competition is the starting point for
developing strategy
 Baseline for sizing up company’s strengths and weaknesses
 Where does the company stand versus buyers, suppliers, entrants, rivals and substitutes.

 Positioning the company: Strategy can be viewed as building defences against the
competitive forces or finding a position in the industry where forces are weakest
 Exploiting Industry Change: Opportunity to spot and claim new strategic positions if
the strategist has an understanding of these five forces.
Steps in Industry Analysis
Define the relevant industry

• What products are in it?

• Which ones are part of?
• What is the geographic scope of competition?

Identify the participants and segment them into group

• Who are the buyer and buyer groups?

• Who are the supplier and supplier groups?
• Who are the competitors?
• Who are the substitutes?
• Who are the potential entrants?

Asses the drives of each competitive force to determine which forces are strong and
which are weak and why?

Determine overall industry structure

• Why is the level of profitability what it is?

• Which are the controlling forces for profitability?
• Is the industry analysis consistent with long term profitability?

Analyse recent and likely future changes in each force, both positive and negative

Analyse aspects of industry structure that might be influenced by competitors by new

entrants, or by your company
Options for an organization
 Low Cost
 Differentiation
 Low Cost and Differentiation
Options for an organization
• Industry is attractive and the organization has the
resources and capabilities to build a distinctive
position
• Industry is less than attractive but the organization has
the resources and capabilities to outperform
competitors
• The organization has a bias towards defending current
strategic positions and a reluctance to venture into
unfamiliar territory
Options for the organizations
• Industry is attractive but players are well-entrenched
and the organization lacks the resources or capabilities
to outperform them
• Industry conditions are unattractive and they work
against an organization irrespective of its resources
and capabilities
• The organization has an orientation towards
innovation and a willingness to pursue new
opportunities
Limitations of Porter’s Framework
Thank You