Industry Analysis: Porter's Five Forces Model | Strategic Management | From A Business Professor
Summary
TLDRIn this video, we explore Michael Porter's Five Forces model, a fundamental framework for understanding industry competition and profitability. The model analyzes the threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitute products, and rivalry among existing competitors. By examining these forces, businesses can strategize to leverage opportunities and mitigate threats, ultimately aiming to gain and sustain a competitive advantage in their respective industries.
Takeaways
- 😀 Michael Porter's Five Forces Model is a framework for analyzing the competitive landscape of an industry.
- 🔒 The Threat of Entry refers to the potential for new competitors to enter the market, which can decrease industry profitability.
- 🏭 Economies of Scale can act as a barrier to entry, benefiting incumbent firms by allowing them to spread costs over more units and negotiate better terms with suppliers.
- 🌐 Network Effects can deter new entrants by increasing the value of a product or service as more people use it, as seen in social networks like LinkedIn.
- 💼 High Customer Switching Costs can serve as a barrier to entry, as significant effort and resources are required to change suppliers, benefiting firms like Intuit Inc.
- 💰 Capital Requirements can deter new entrants by necessitating substantial investments to compete in an industry, often linked to economies of scale.
- 🛠 Advantages Independent of Size can be a barrier for new entrants, as incumbent firms may possess proprietary technology, brand loyalty, or other unique advantages.
- 🛍️ The Power of Buyers influences industry profitability, with powerful buyers able to demand lower prices or higher quality, affecting firm revenue and costs.
- 🛒 The Threat of Substitutes impacts industry competitiveness and profitability, as the availability of substitute products can increase competition.
- 🏁 Rivalry Among Existing Competitors is influenced by factors like industry structure, growth, strategic commitments, and exit barriers, shaping the intensity of competition.
Q & A
What is the Five Forces Model developed by Michael Porter?
-The Five Forces Model is a framework created by Harvard Business School professor Michael Porter to analyze the competitive landscape of an industry and understand the profit potential. It consists of five forces: threat of entry, power of suppliers, power of buyers, threat of substitutes, and rivalry among existing competitors.
How does the threat of entry affect industry profit potential?
-The threat of entry can depress industry profit potential by two major ways: first, by the potential of additional capacity coming into the industry, which may lead incumbent firms to lower prices to deter new entrants, and second, by forcing incumbent firms to spend more to retain their customers, which reduces profit potential if they can't raise prices.
What are some barriers to entry that can reduce the threat of new competitors?
-Barriers to entry that can reduce the threat of new competitors include economies of scale, network effects, customer switching costs, capital requirements, and advantages independent of size.
How do network effects influence the threat of potential entry in an industry?
-Network effects describe the positive impact that one user of a product or service has on the value of that product or service for other users. When network effects are present, the value of the product or service increases with the number of users, which can reduce the threat of potential entry.
What is the significance of customer switching costs as a barrier to entry?
-Customer switching costs are one-time sunk costs incurred when moving from one supplier to another. High switching costs can be a significant barrier to entry because they make it difficult for new entrants to attract customers away from established firms.
How does the power of suppliers impact an industry's profit potential?
-The power of suppliers can reduce an industry's profit potential by exerting pressures on firms to accept higher input costs or lower quality inputs. Suppliers are more powerful when their industry is more concentrated, they don't rely heavily on the industry for revenues, or when switching costs for buyers are high.
What factors contribute to the power of buyers in an industry?
-The power of buyers is high when there are few buyers who purchase large quantities, the industry's products are standardized, buyers face low switching costs, and they can credibly threaten to backwardly integrate into the industry.
How does the threat of substitutes affect the competitive environment within an industry?
-The threat of substitutes affects the competitive environment by making the industry more competitive and decreasing profit potential when close substitutes are available. Conversely, the lack of close substitutes can make an industry less competitive and increase profit potential.
What are the four competitive industry structures as described by Porter's Five Forces Model?
-The four competitive industry structures are perfect competition, monopolistic competition, oligopoly, and monopoly. Each structure is characterized by the number and size of competitors, the degree of product differentiation, the ease of entry, and the pricing power of firms.
How do exit barriers influence the intensity of rivalry among existing competitors?
-Exit barriers are obstacles that prevent a company from leaving a market. High exit barriers can lead to excess capacity remaining in the industry, which reduces profit potential as firms struggle to compete. Low exit barriers allow underperforming firms to exit more easily, reducing competitive pressure.
What strategic position should managers craft for their companies based on the Five Forces Model?
-Managers should craft a strategic position that leverages weak forces into opportunities and mitigates strong forces, which are potential threats to the firm's ability to gain and sustain a competitive advantage.
Outlines
🏭 Understanding Industry Dynamics Through Porter's Five Forces
This paragraph introduces the concept of an industry and the Five Forces model developed by Michael Porter. The Five Forces model is a framework for analyzing the competitive landscape of an industry and the profitability of firms within it. The forces include the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitute products or services, and the intensity of competitive rivalry. The paragraph explains how these forces interact and influence industry attractiveness and profitability, and how incumbent firms can use the model to gain a competitive advantage.
🛠️ Analyzing Barriers to Entry and Their Impact on Industry Competition
This section delves into the first of Porter's Five Forces: the threat of entry. It discusses how potential new competitors can affect industry profit potential by increasing capacity and forcing incumbent firms to lower prices or increase spending to retain customers. The paragraph then outlines various barriers to entry that can protect incumbent firms from new competition, such as economies of scale, network effects, customer switching costs, capital requirements, and advantages independent of size. Each type of barrier is explained with examples, illustrating how they can be leveraged by existing firms to maintain their market position.
✈️ The Influence of Supplier Power on Industry Profitability
The second force, the power of suppliers, is explored in this paragraph. It explains how suppliers can impact an industry's profitability by raising input costs or reducing input quality. The bargaining power of suppliers is influenced by factors such as industry concentration, dependency on the industry, switching costs, product differentiation, availability of substitutes, and the threat of forward integration. The example of Boeing and Airbus as powerful suppliers to the airline industry is used to illustrate the concept, highlighting how their market position allows them to exert significant influence over the profitability of airlines.
💼 Buyer Power and Its Effects on Industry Competition
This paragraph focuses on the third force: the power of buyers. It discusses how buyers can pressure producers to lower prices or increase product quality, affecting the industry's profit margins. The power of buyers is high when there are few buyers, the industry's products are standardized, buyers face low switching costs, and when buyers can credibly threaten to integrate backward. The example of Costco is provided to demonstrate the impact of buyer power, showing how its large-scale purchases and market influence can lead to significant pressure on suppliers to lower prices and improve quality.
🌐 The Threat of Substitutes and Its Role in Shaping Industry Competition
The fourth force, the threat of substitutes, is the subject of this paragraph. It describes how the availability of substitute products can increase competition within an industry and decrease its profit potential. Substitutes are products from other industries that offer similar benefits to consumers, making the industry more competitive. Examples of substitutes for various industries are given, such as smartphones for digital cameras, online shopping for brick-and-mortar stores, and the potential for self-driving vehicles to substitute human delivery drivers. The paragraph emphasizes the importance of understanding and addressing the threat of substitutes to maintain industry competitiveness.
🚀 Rivalry Among Competitors and Its Impact on Industry Profitability
This paragraph examines the fifth and final force: rivalry among existing competitors. It outlines how the intensity of this rivalry is influenced by factors such as industry structure, growth, strategic commitments, and exit barriers. The paragraph discusses the four main competitive industry structures: perfect competition, monopolistic competition, oligopoly, and monopoly, providing examples for each. It also explains how industry growth can affect competition, with high growth leading to less rivalry and low growth intensifying it. The impact of strategic commitments and exit barriers on the intensity of rivalry is also discussed, with examples illustrating how these factors can lead to more or less intense competition.
🔍 Crafting Strategy Based on Porter's Five Forces
The concluding paragraph summarizes the Five Forces model and its importance for managers in understanding industry profit potential and positioning their firms for competitive advantage. It emphasizes the need for managers to leverage weak forces as opportunities and mitigate strong forces as threats. The paragraph invites viewers to consider how the model can be applied to industries of their interest and encourages discussion and engagement through comments and subscriptions.
Mindmap
Keywords
💡Five Forces Model
💡Threat of Entry
💡Power of Suppliers
💡Power of Buyers
💡Threat of Substitutes
💡Rivalry Among Existing Competitors
💡Economies of Scale
💡Network Effects
💡Customer Switching Costs
💡Capital Requirements
💡Advantages Independent of Size
Highlights
An industry comprises companies offering similar products or services to meet specific customer needs.
Michael Porter's Five Forces Model is a tool for understanding industry profit potential and competitive advantage.
The Threat of Entry refers to the risk of new competitors entering the industry, which can reduce profit potential.
Barriers to entry, such as economies of scale, can protect incumbent firms from new competition.
Network effects can deter new entrants by increasing the value of a product with more users.
Customer switching costs can act as a barrier to entry, benefiting firms with unique products.
Capital requirements can deter new entrants, especially when related to economies of scale.
Advantages independent of size can create entry barriers based on brand loyalty and proprietary technology.
The power of suppliers can influence an industry's profitability through their bargaining power.
Suppliers with differentiated products and low availability of substitutes can exert significant power.
The power of buyers is high when they can demand lower prices or higher quality, affecting producers' margins.
Buyers with significant purchase power, such as Costco, can pressure suppliers to lower prices.
The threat of substitutes can decrease an industry's profit potential if consumers have alternative options.
Rivalry among existing competitors is influenced by industry structure, growth, strategic commitments, and exit barriers.
Competitive industry structures range from perfect competition to monopoly, affecting pricing power and profitability.
Industry growth can either reduce or intensify rivalry among competitors, depending on the market expansion.
Strategic commitments can lead to intense rivalry as firms are less likely to exit the industry.
High exit barriers can keep excess capacity in the market, reducing industry profit potential.
Managers should leverage weak forces and mitigate strong forces to gain and sustain competitive advantage.
Transcripts
hello everyone welcome to business
school 101.
an industry is a group of incumbent
companies facing more or less the same
set of suppliers and buyers
firms competing in the same industry
tend to offer similar products or
services to meet specific customer needs
harvard business school professor
michael porter developed a highly
influential five forces model to help
managers understand the profit potential
of different industries and how they can
position their respective firms to gain
and sustain competitive advantage
those forces are threat of entry
power of suppliers
power of buyers
threats of substitutes
and rivalry among existing competitors
so let us analyze those five forces
individually
force number one the threat of entry
the threat of entry describes the risk
that potential competitors will enter
the industry
potential new entry depresses industry
profit potential in two major ways
first with the threat of additional
capacity coming into an industry
incumbent firms may lower prices to make
entry appear less attractive to the
potential new competitors which would in
turn reduce the overall industry's
profit potential especially in
industries with slow or no overall
growth in demand
second the threat of entry by additional
competitors may force incumbent firms to
spend more to satisfy their existing
customers this spending reduces an
industry's profit potential especially
if firms can't raise prices
as we know the more profitable in
industry the more attractive it is for
new competitors to enter
however there are a number of important
barriers to entry that raise the cost
for potential competitors and reduce the
threat of entry
entry barriers which are advantageous
for incumbent firms are obstacles that
determine how easily a firm can enter an
industry
incumbent firms can benefit from several
important sources of entry barriers
those barriers are economies of scale
network effects customer switching costs
capital requirements and advantages
independent of size
one economies of scale
economies of scale are cost advantages
that accrue to firms with larger output
because they can spread fixed costs over
more units employee technology more
efficiently benefit from a more
specialized division of labor and demand
better terms from their suppliers
these factors in turn drive down the
cost per unit allowing large incumbent
firms to enjoy a cost advantage over new
entrants who cannot muster such scale
two
network effects
network effects describe the positive
effect that one user of a product or
service has on the value of that product
or service for other users
when network effects are present the
value of the product or service
increases with the number of users
the threat of potential entry is reduced
when network effects are present
social networks are the clearest example
of this take linkedin
which grew through memberships as
linkedin started to get broader adoption
the numbers grew exponentially as the
utility of the product became stronger
three
customer switching costs
switching costs are incurred by moving
from one supplier to another
changing vendors may require the buyer
to alter product specifications retrain
employees and modify existing processes
switching costs are one-time sunk costs
which can be quite significant and a
formidable barrier to entry
for example companies that create unique
products that have few substitutes and
require significant effort to perfect
their use enjoy significant switching
costs
consider intuit inc which offers its
customers various bookkeeping software
solutions such as turbotax quickbooks
and mint
because learning to use intuits
applications take significant time
effort and training costs
fewer users are willing to switch away
from intuit
4. capital requirements
capital requirements describe the price
of the entry ticket into a new industry
how much capital is required to compete
in this industry and which companies are
willing and able to make such
investments
frequently related to economies of scale
capital requirements may encompass
investments to set up plans with
dedicated machinery run a production
process and cover startup losses
however please keep in mind that capital
unlike proprietary technology and
industry-specific know-how is a fungible
resource that can be relatively easily
acquired in the face of attractive
returns
five advantages independent of size
incumbent firms often possess cost and
quality advantages that are independent
of size
these advantages can be based on brand
loyalty proprietary technology
preferential access to raw materials and
distribution channels favorable
geographic locations and cumulative
learning and experience effects
in addition incumbent firms often
benefit from cumulative learning and
experience effects accrued over long
periods of time
attempting to obtain such deep knowledge
within a shorter time frame is often
costly if not impossible which in turn
constitutes a formidable barrier to
entry
the second force in porter's model is
the power of suppliers the bargaining
power of suppliers captures pressures
that industry suppliers can exert on an
industry's profit potential
this force reduces a firm's ability to
obtain superior performance because
powerful suppliers can raise the cost of
production by demanding higher prices
for their inputs or by reducing their
quality of the input factor or service
level delivered
to compete effectively companies
generally need a wide variety of inputs
into the production process including
raw materials and components
labor and services
the relative bargaining power of
suppliers is high under following
scenarios
one the suppliers industry is more
concentrated than the industry it sells
to
two suppliers do not depend heavily on
the industry for a large portion of
their revenues three incumbent firms
face significant switching costs when
changing suppliers
four suppliers offer products that are
differentiated
five there are no readily available
substitutes for the products or services
that the suppliers offer
and six suppliers can credibly threaten
to forward integrate into the industry
let's take a closer look at one
important supply group to the airline
industry
boeing and airbus the makers of large
commercial jets
the reason airframe manufacturers are
powerful suppliers to airlines is
because their industry is much more
concentrated than the industry it sells
to
compared to two airframe suppliers there
are hundreds of commercial airlines
around the world
in addition the airlines face
non-trivial switching costs when
changing suppliers because pilots and
crew would need to be retrained to fly a
new type of aircraft maintenance
capabilities would need to be expanded
and some routes may need to even be
reconfigured due to differences in
aircraft range and passenger capacity
moreover while some of the aircraft can
be used as substitutes boeing and airbus
offer differentiated products
thus the supplier power of commercial
aircraft manufacturers is quite
significant
this puts boeing and airbus in a strong
position to extract profits from the
airline industry thus reducing the
profit potential of the airline
themselves
force 3 the power of buyers
the bargaining power of buyers is the
flip side of the bargaining power of
suppliers
buyers are the customers of an industry
the power of buyers concerns the
pressure in industries customers can put
on the producers margins and the
industry by demanding a lower price or
higher product quality
when buyers successfully obtain price
discounts it reduces a firm's revenue
when buyers demand higher quality and
more service it generally raises
production costs
the power of buyers is high when there
are few buyers and each buyer purchases
large quantities relative to the size of
a single seller
the industry's products are standardized
or undifferentiated commodities
buyers face low or no switching costs
and buyers can credibly threaten to
backwardly integrate into the industry
in addition
companies need to be aware of situations
when buyers are especially price
sensitive
this is the case when
one the buyer's purchase represents a
significant fraction of its cost
structure or procurement budget
two buyers earn low profits or are
strapped for cash
three the quality or cost of the buyer's
products and services is not affected
much by the quality or cost of their
inputs
the retail giant costco provides a
potent example of tremendous buyer power
costco is not only one of the largest
retailers worldwide but it is also one
of the world's fortune 500 companies
costco is one of the few large big box
global retail chains and frequently
purchases large quantities from its
suppliers
costco leverages its buyer power by
exerting tremendous pressure on its
supplier to lower prices and to increase
quality or risk losing access to shelf
space at their worldwide stores
force 4 the threat of substitutes
porter's threat of substitutes
definition is the availability of a
product that the consumer can purchase
instead of the industry's product
a substitute product is a product from
another industry that offers similar
benefits to the consumer as the product
produced by the firms within the
industry
the threat of substitution in an
industry affects the competitive
environment for the firms in that
industry and influences those firms
ability to achieve profitability
the availability of close substitute
products can make an industry more
competitive
and decrease profit potential for the
firms in the industry
on the other hand the lack of close
substitute products makes an industry
less competitive and increases profit
potential for the firms in the industry
here are some examples of substitutes
for digital cameras substitutes are
smartphones
for traditional brick and mortar stores
substitutes are online shopping websites
for human delivery drivers
substitutes could be advanced
self-driving vehicles in the future
force 5
rivalry among existing competitors
rivalry among existing competitors
describes the intensity with which
companies within the same industry
jockey for market share and
profitability
the intensity of rivalry among existing
competitors is determined largely by the
following four factors
competitive industry structure
industry growth
strategic commitments and exit barriers
factor one competitive industry
structure
the competitive industry structure
refers to elements and features common
to all industries
the structure of an industry is largely
captured by the number and size of its
competitors
the firm's degree of pricing power
the type of product or service and the
height of entry
barriers the four main competitive
industry structures are
perfect competition
monopolistic competition
oligopoly
monopoly
let us discuss these separately
first perfect competition
a perfect competitive industry is
fragmented and has many small firms a
commodity product ease of entry and
little or no ability for each individual
firm to raise its prices
the firms competing in this type of
industry are approximately similar in
size and resources
consumers make purchasing decisions
solely on price because the commodity
product offerings are more or less
identical
the resulting performance of the
industry shows low profitability
although perfect competition is a rare
industry structure in its pure form
markets for commodities such as natural
gas copper and iron tend to approach
this structure
second monopolistic competition
a monopolistically competitive industry
has many firms a differentiated product
some obstacles to entry and the ability
to raise prices for a relatively unique
product while retaining customers
the key to understanding this industry
structure is that the firms now offer
products or services with unique
features
the global smartphone industry provides
one example of monopolistic competition
many firms compete in this industry and
even the largest of them such as samsung
apple xiaomi huawei or vivo have less
than 20 percent market share
moreover
while products between competitors tend
to be similar they are by no means
identical
as a consequence firms selling a product
with unique features tend to have some
ability to raise prices
when a firm is able to differentiate its
product or service offerings it carves
out a niche in the market in which it
has some degree of monopolistic power
over pricing
thus the name monopolistic competition
firms frequently communicate the degree
of product differentiation through
advertising
third oligopoly
an oligopolistic industry is
consolidated with a few large firms
differentiated products high barriers to
entry and some degree of pricing power
the degree of pricing power depends just
as in monopolistic competition on the
degree of product differentiation
a key feature of an oligopoly is that
the competing firms are interdependent
with only a few competitors in the mix
the actions of one firm influence the
behaviors of the other
therefore each competitor in an
oligopoly must consider the strategic
actions of the other competitors this
type of industry structure is often
analyzed using game theory which
attempts to predict strategic behaviors
by assuming that the moves and reactions
of competitors can be anticipated
due to their strategic interdependence
companies and oligopolies have an
incentive to coordinate their strategic
actions to maximize joint performance
examples of oligopolies include the soft
drink industry coca-cola versus pepsi
airframe manufacturing business
boeing versus airbus
home improvement retailing the home
depot versus lowe's
operating systems for smartphones
apple ios and google android and
detergents
png versus unilever
fourth monopoly
an industry is a monopoly when there is
only one firm supplying the market
the firm may offer a unique product and
the challenges to moving into the
industry tend to be high
the monopolist has considerable pricing
power as a consequence
firm and thus industry profit tends to
be high
a classic example of a monopoly based on
resource control is d beers
d beers consolidated mines were founded
in 1888 in south africa as an
amalgamation of a number of individual
diamond mining operations
d beers had a monopoly over the
production of diamonds for most of the
20th century
and it used its dominant position to
manipulate the international diamond
market it convinced independent
producers to join its single-channel
monopoly
d-beers also purchased and stockpiled
diamonds produced by other manufacturers
in order to control prices through
supply
the de beers model changed at the turn
of the 21st century when diamond
producers from russia canada and
australia started to distribute diamonds
outside of the beer's channel
the sale of diamonds also suffered from
rising awareness about blood diamonds de
beers market share fell from as high as
90 percent in the 1980s to less than 40
percent in 2012.
the second factor affecting the
intensity of rivalry among existing
competitors is industry growth industry
growth directly affects the intensity of
rivalry among competitors
in periods of high growth
consumer demand rises and price
competition among firms frequently
decreases
because the pie is expanding rivals are
focused on capturing part of that larger
pie rather than taking market share and
profitability away from one another
in contrast
rivalry among competitors becomes fierce
during slow or even negative industry
growth
price discounts frequent new product
releases with minor modifications
intense promotional campaigns and fast
retaliation by rivals are all tactics
indicative of an industry with slow or
negative growth
competition is fierce because rivals can
gain only at the expense of others
therefore companies are focused on
taking business away from one another
the third factor affecting the intensity
of rivalry among existing competitors is
strategic commitments
if firms make strategic commitments to
compete in an industry rivalry among
competitors is likely to be more intense
we define strategic commitments as firm
actions that are costly long-term
oriented and difficult to reverse
strategic commitments to a specific
industry can stem from large fixed cost
requirements but also from non-economic
considerations
for example airbus was created by a
number of european governments through
direct subsidies to provide
countervailing power to boeing
the european union in turn claims that
boeing is subsidized by the us
government indirectly via defense
contracts
given these political considerations and
large-scale strategic commitments
neither airbus or boeing is likely to
exit the aircraft manufacturing industry
even if industry profit potential falls
to zero
the last factor affecting the intensity
of rivalry among existing competitors is
exit barriers barriers to exit are
obstacles or impediments that prevent a
company from exiting a market in which
it is considering cessation of
operations or from which it wishes to
separate
typical barriers to exit include highly
specialized assets which may be
difficult to sell or relocate and high
exit costs such as asset write-offs and
closure costs
a common barrier to exit can also be the
loss of customer goodwill an industry
with low exit barriers is more
attractive because it allows
underperforming firms to exit more
easily
such exits reduce competitive pressure
on the remaining firms because excess
capacity is removed in contrast an
industry with high exit barriers reduces
its profit potential because excess
capacity still remains
okay let's wrap up today's topic
harvard business school professor
michael porter developed the highly
influential five forces model to help
managers understand the profit potential
of different industries and how they can
position their respective firms to gain
and sustain competitive advantage
these five forces are threat of entry
power of suppliers power of buyers
threat of substitutes and rivalry among
existing firms
generally the stronger those forces the
lower the firm's ability to gain and
sustain a competitive advantage
conversely the weaker those forces the
greater the firm's ability to gain and
sustain competitive advantage
therefore managers need to craft a
strategic position for the company that
leverages weak forces into opportunities
and mitigates strong forces because they
are potential threats to the firm's
ability to gain and sustain a
competitive advantage
so what do you think about porter's five
forces model
can you apply this model to an industry
you are interested in
please leave your thoughts in a comment
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