Michael Porter's Industry Structural Analysis

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Michael Porter's Industry Structural Analysis
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5 Forces of Competition

• Competition drives the return down to that which
  would be earned by the economists perfectly
  competitive industry.
• All five competitive forces jointly determine the
  intensity of industry competition and
  profitability.
• Different from short-run factors that can affect
  competition and profitability in a transient way.

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5 Forces and Strategy

• The goal is to find a position in the industry
  where the company can best defend itself against
  these competitive forces or can influence them in
  its favor.
• Since the collective strength of the forces may
  well be apparent to all competitors, the key for
  developing strategy is to analyze the sources of
  each.

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Force 1. THREAT OF ENTRY

• Depends on extant barriers to entry, coupled with
  the expected reaction from existing competitors.
• Barriers of Entry
• Economies of Scale.
• Product Differentiation.
• Capital Requirements.
• Switching Costs.
• Access to Distribution Channels.
• Cost Disadvantages Independent of Scale.
• Government Policy

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Force 1. THREAT OF ENTRY

• THE ENTRY DETERRING PRICE the prevailing
  structure of prices (and related terms such as
  product quality and service) which just balances
  the potential rewards from entry (forecast by the
  potential entrant) with the expected costs of
  overcoming structural entry barriers and risking
  retaliation.
• EXIT BARRIERS AND ENTRY BARRIERS
• low entry barriers low returns. 
• high entry barriers high returns. 
• low exit barriers stable returns. 
• high exit barriers risky returns.

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Force 2. INTENSITY OF RIVALRY AMONG EXISTING
COMPETITORS

• Firms are mutually dependent.
• Some forms of competition, notably price
  competition, are highly unstable and quite likely
  to leave the entire industry worse off from the
  standpoint of profitability.
• Intense rivalry is the result of interacting
  structural factors.
• Numerous or Equally Balanced Competitors.
• Slow Industry Growth.
• High Fixed or Storage Costs.
• Lack of Differentiation or Switching Costs.
• Capacity Augmented in Large Increments.
• Diverse Competitors.
• High Strategic Stakes.
• High Exit Barriers.

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Notes on Exit Barriers

• Economic, strategic, and emotional factors that
  keep companies competing in businesses despite
  low or even negative returns on investment.
• Major sources of exit barriers
• Specialized assets
• Fixed costs of exit
• Strategic interrelationships
• Emotional barriers
• Government and social restrictions

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Force 3. PRESSURE FROM SUBSTITUTE PRODUCTS

• Industrys overall elasticity of demand.
• Limits profits in normal times and also reduce
  the bonanza an industry can reap in boom times.
• Position vis-à-vis substitute products may well
  be a matter of collective industry actions.
• Substitute products that deserve the most
  attention are those that (1) are subject to
  trends improving their price-performance tradeoff
  with the industrys product, or (2) are produced
  by industries earning high profits.

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Force 4. BARGAINING POWER OF BUYERS... is high
if...

• The industry is concentrated or purchases large
  volumes relative to seller sales.
• The products it purchases from the industry
  represent a significant fraction of the buyers
  costs or purchases.
• The products it purchases from the industry are
  standard or undifferentiated.
• It faces few switching costs.
• It earns low profits.
• Buyers pose a credible threat of backward
  integration.
• The industrys product is unimportant to the
  quality of the buyers products or services.
• The buyer has full information. Retailers can
  gain significant bargaining power over
  manufacturers when they can influence consumers
  purchasing decisions,

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Force 5. BARGAINING POWER OF SUPPLIERS ... is
high if ...

• Industry is is dominated by a few companies and
  is more concentrated than the industry it sells
  to.
• Suppliers are not obliged to contend with other
  substitute products for sale to the industry.
• The industry is not an important customer of the
  supplier group.
• Suppliers product is an important input to the
  buyers business.
• Supplier groups products are differentiated or
  it has built up switching costs.
• Supplier group poses a credible threat of forward
  integration.
• BTW... labor must be recognized as a supplier as
  well,
• The principles re the potential power of labor
  are similar to those of suppliers. The key
  additions are labor's degree of organization, and
  whether the supply of scarce varieties of labor
  can expand.

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Summary of 5 Forces

1. If the Threat of New Entrants is High, prices can
   be bid down and/or incumbents' costs inflated,
   reducing profitability.
2. If the Intensity of Rivalry Among Existing
   Competitors is High, tactics like price
   competition, advertising battles, product
   introductions, and increased customer service or
   warranties are common, having noticeable effects
   on all competitors.
3. If the Pressure from Substitute Products is High,
   it limits the potential returns by placing a
   ceiling on the prices firms in the industry can
   profitably charge. The more attractive the
   alternative, the firmer the lid on industry
   profits.
4. If the Bargaining Power of Buyers is High, Buyers
   compete by forcing down prices, bargaining for
   higher quality or more services, playing
   competitors against each other, reducing
   profitability.
5. If the Bargaining Power of Suppliers is High,
   Suppliers can exert bargaining power over
   participants in an industry by threatening to
   raise prices or reduce the quality of purchased
   goods/services.