THE FIVE FORCES

APPROACH
TO COMPETITIVE
STRUCTURE
Developed by
Professor Michael
Porter at the
Harvard Business Fig. 10.1 The Five Forces Model
School (1980).
POTENTIAL
ENTRANTS
Treat of entry
Power of Power
suppliers of buyers
INDUSTRY
SUPPLIERS COMPETITORS BUYERS
Rivalry among existing
fiirms

Treat of substitutes

SUBSTITUTES
 The five forces model is much more
complete than the set of textbook models, but it
also mush less rigorous. It allows for dozens of
different types of market structure but does not
provide absolutely clearpredictions with regard
to the outcome of those structures. Indeed, its
value lies not in providing predictions for every
conceivable type of industry, but rather in
giving executives through checklist which they
can use to identify the most important features
of competition in their industry. These salient
features provide a starting point from which
firms can begin to develop a competitive
strategy.
 FIVE FORCES APPROACH

1 the intensity rivalry amongst

existing firms

2 the threat of entry

the threat of substitutes

3

the power of buyers

4

5 the power of suppliers

01 FIVE FORCES APPROACH

THE INTENSITY OF RIVALRY AMONGST EXISTING

FIRMS

The intensity of rivalry amongst firms is not a variable which can easily
be measured in a quantitative way. Neverthless, in some industries rivalry
is said to be intense, even ‘cut-throat’, while in others relations between
firms are said to be ‘gentleman’, or ‘polite’ or orderly.
FACTORS WHICH DETERMINE THE DEGREE OF RIVALRY

Industry Growth
• It is a key factor. If growth of the industry as a whole is rapid,
each firm will be able to grow without needing to take market
share away from its rivals and managerial time will be devoted
to keeping up with industry growth, rather than attacking
rivals. On the other hand, if an industry is growing slowly or
declining, growth for one firm can only be at the expense of
others and rivalry will be intense.

High Fixed Costs or Storage Costs

• If these costs are high, failure to maintain the volume of sales
may cause a dramatic increase in costs and loss of proofits.

Intermittent Over-Capacity
• If an industry experiences periods of over-capacity, either
because demand fluctuates or beacuse economies of scale
require that additions to capacity are very large, rivalry will
tend to become more intense.
 FACTORS WHICH DETERMINE THE DEGREE OF RIVALRY
Product differences, brand identity and switching costs for customers
• If an industry’s products are identical and there is no brand identity
and customers can change from one supplier to another without
incurring costs then customers will be very sensitive to price and the
demand for each firm’s product will be very highly elastic, as in
perfect competition.

The number of firms and their relative size

• If the number of firms producing close substitutes is relatively large,
it will be difficult for them to monitor each others’ activities and
there will be the danger that some firms believe that they can make
competitive moves without being noticed.

Diversity of Competitors
• If rivals within an industry share objectives and goals and have
similar ‘corporate cultures’ and relationships with their parent
companies, then they will tend to think in similar ways, be able to
predict how each other will respond and agree on a impliciit set of
‘rules of game’.
FACTORS WHICH DETERMINE THE DEGREE OF RIVALRY

Corporate Stakes
• Rivalry will tend to be more intense if success in the industry
is of particular importance for the firms involved, either
because of its potential contribution to their profits, or
because it has some ategic value to them.

High Exit Barriers

• If leaving the industry entails incurring high costs then firms
will be anxious to remain in the industry and rivalry will tend
to be intense. The cost of leaving may include financial cs like
redundancy payments or the loss in value of highly
specialized assets, but may also include psychic costs like
executives’ unwillingness to abandon a business, or loss of
goodwill from government if unemployment is caused.
02 FIVE FORCES APPROACH

THE THREAT OF NEW ENTRANTS

The second of the five forces, whose importance is determined by the

height of ‘barriers to entry’. If entry barriers are very high, the existing
firms in the industry do not need to concern themselves unduly with
the possibility that high prices and profits may attract competition from
new entrants. On the other hand, if entry barriers are low, entry may
take place with case whenever the incumbent firms in an industry
make substantial profits.
FACTORS OF THE THREAT OF NEW ENTRANTS
Economic Scale
• If there are substantial economies of scale, a firm which is
considering entering the industry must either build a large
market share immediately, in order to achieve the scale
required to keep costs down,, or suffer higher costs than the
incumbent firms.

Product Differentiation and Brand Loyalty

• If exixting firms have successfully developed buyer loyalty to
their products a new entrant may have to amke expensive
and risky investments iadvertising and promotion in order to
overcome that loyalty. If entry should fail, those investments
become worthless.

Capital Requirements
• In some industries, very large amounts of capital have to be
acquired if entry is to take place. Entry will often be
regarded as risky venture and investors will require high
returns in order to pursuade them to take that risk.
FACTORS OF THE THREAT OF NEW ENTRANTS

Switching Costs for Buyers

• If customers have to face additional costs in switching from
one supplier to another, they will be unwilling to change
suppliers and it will be difficult for a new entrant to be
successful, without a heavy invesment to help customers
overcome those switching costs.
• Switching sosts are not significant for either caravan or
feedstock buyers.

Access to Distribution Channels

• A newentrant6 must establish its own distribution channels,
persuading wholesalers and retailers to stock and display its
product alongside, or in preference to, the products of
exixting firms.
• This factor is of some significance in the caravan industry,
but is not relevant for feedstock.
FACTORS OF THE THREAT OF NEW ENTRANTS
Absolute Cost Advantages
• One of the most general sources of entry barriers is the existence of
absolute cost advantages, whereby incumbent firms have lower costs
than entrants. Ifthere are such advantages, existing firms will always
have the ability to cut their prices to a level at which new entrants
cannot survive.

Possible sources of Absolute Cost Advantages

• PROPRIETATECHNOLOGY.
• ACCESS TO INPUTS.
• PROPRIETARY LEARNING EFFECTS.
• FAVOURABLE LOCATIONS.

In feedstock production absolute cost advantage are crucial aspect of the

industry’s competitive structure. The market leader has proprietary
technology which it controls, learving effects are continuous and
important and are consciously pursueed through research and
development. Locations next to sources of raw materials, which are
relatively few, are important in securing low costs.
FACTORS OF THE THREAT OF NEW ENTRANTS

Expected Retaliation
• In many industries the reaction of the established firms to
new entry is a key factor determining the entrant’s success.
If they are accommodating, an entrant has a greater
chanceof success. On thye ther hand, if they retaliate
aggressively through price-cutting ofr promotional
campaigns, the entrant will only be able to survive if it some
very strong advantages to compensate for its inexperinece
in the industry.

Government Policy
• In some industries, in some countries, government policy
stes up barriers to entry. At the extreme these involve
industrial licensing, wehere a firm has to have government
permission before setting up in an industry.
03 FIVE FORCES APPROACH

THE THREAT OF SUBSTITUTES

If substitutes are available for the industry’s products customers will

be able to switch to those substitutes if the existing firms attempt to
charge high prices. The threat os substitutes is therefore an important
market foorce setting limits upon the prices which firms are able to
charge.
 3 FACTORS OF THE THREAT OF SUBSTITUTES

The Relative Price and Performance of Substitutes

• If substitutes are available which offer similar performance
at the same level of price, then the threat of substitution is
very strong. On the other hand, if substitutes are more
expensive and offer inferior performance, the threat is
much weaker.

Switching Costs for Customers

• This factor has been referred to above as source of entry
barriers, and it also determines the threat of substitutes.
In the case of feedstock, customers would incur little cost
in switching from one supplier of feedstock to another.

Buyres’ Propensity to Substitute

• If customers put relatively liitle effort into searching for
sustitutes and are disinclined to change suppliers, the
threat of substitution is correspondingly reduced.
04 FIVE FORCES APPROACH

THE POWER OF BUYERS

The power of buyerrs depends upon two general

factors. The first is the extent of their price sensitivity
and the second is their bargaining leverage, each of
whioch can be considered in turn.
2 GENERAL FACTORS OF THE POWER OF BUYERS

Price Sensitivity
• It is essentially the same concept as elasticity of demand,
although in the Poorter analysis no attempt is made to
quantify it.

Function of Price Sensitivity

• PURCHASES FROM THE INDUSTRY AS A

PROPORTION OF TOTAL PURCHASES.
• PRODUCT DIFFERENCEES ANND BRAND IDENTITY.
• THE IMPACTT OF THE INDUSTRY’S PRODUCT ON
THE QUALITY OF THE CUSTOMER’S PRODUCT OR
SERVICES.
• CUSTOMERS’ OWN PROFITABILITY
• DECISION-MAKERS’ INCENTIVES
2 GENERAL FACTORS OF THE POWER OF BUYERS

Bargaining Leverage
• The extent to which buyers can exert bargaining leverage
also depends upon a fairly extensive list of factors.

Factors of Bargaining Leverage

• BUYER CONCENTRATION AND BUYER VOLUME

• BUYER SWITCHING COSTS
• BUYER INFORMATION
• THREAT OF BACKWARD VERTICAL INTEGRATION BY
BUYERS
• THE EXISTENCE OF SUBSTITUTES
05 FIVE FORCES APPROACH

THE POWER OF SUPPLIERS

The last of the five forces to be considered is the

power of suppliers, determined by the following
factors.
 FACTORS OF THE POWER OF SUPPLIERS

Differentiation of Inputs
• If firms in an industry are dependent upon the
partilar variants of an input produced by indiviadual
suppliers, those suppliers will be relatively powerful.
• Neither of these factors is significant in caravans or
feedstock

Switching Costs of Transferring to Alternative Suppliers

• If these are high, suppliers will be relatively powerful
as firms face costs in transferring to competing
suppliers.

Availability of Substitute Inputs

• If substitute inputs are available, supplier power will
be reduced.
 FACTORS OF THE POWER OF SUPPLIERS

Supplier Concentration
• Higher levels of concentration amongst suppliers will
tend to enhance their power, especially if suppliers
are more concentrated than buyers.

The Importance of Volume to Suppliers

• If suppliers are dependent for their survival or profits
on maintaining large vols of sales, they will tend to
have more limited bargaining power.

Cost Relative to the Purchasing Industry’s total Costs

• If the cost of inputs purchased from a particular
supplier industry is an important part of the
industry’s total cost, suppliers will find it harder to
exert leverage. On the other hand, if a supplier
industry supplies inputs which are only a small
proportion of the users’ total costs it will find it much
easier to secure higher prices.
 FACTORS OF THE POWER OF SUPPLIERS

The Impact of Inputs on Costs or Differentiation

• Supplier power will also depend upon the
importance of inputs in the user’s ability to maintain
low costor to differentiate the product. If the quality
of inputs, or their cost, is an important determinant
of the industry’s ability to compete, then suppliers
will have substantial bargaining power.

The Threat of Forward Integration by Suppliers

• If forward integration i the industry by suppliers is
easy to achieve then suppliers will have considerate
bargaining power. Any attempt on the part of firms
in the industtry to secure lower input prices could
be met by suppliers establishing production facilities
for themselves
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