Porter's 5 Forces EXPLAINED | B2U | Business To You
Summary
TLDRIn this episode, Lars explores Michael Porter's Five Forces, a strategic framework for analyzing industry competition and profitability. He explains the five key forcesβrivalry among competitors, threat of new entrants, substitutes, supplier power, and buyer powerβand illustrates their impact using the airline industry. Lars also discusses how understanding these forces can inform strategic business decisions, emphasizing the model's utility in shaping competitive advantage.
Takeaways
- π Porter's Five Forces is a strategic framework developed by Michael Porter in 1979 to analyze the competitive landscape of an industry.
- π The framework identifies five key forces that shape industry structure and competitive intensity: rivalry among existing competitors, threat of new entrants, threat of substitute products or services, bargaining power of suppliers, and bargaining power of buyers.
- π‘ The model is used to evaluate the root causes of profitability in an industry, understanding that intense competitive forces can decrease a firm's profit potential.
- βοΈ The airline industry is used as a case study to illustrate how each of the five forces can be analyzed in a real-world context.
- π₯ Rivalry among existing competitors is high in industries with many competitors of similar size, slow industry growth, and high exit barriers.
- π The threat of new entrants is influenced by barriers to entry, such as capital requirements, access to distribution channels, and government policies.
- ποΈ Substitute products or services can significantly impact an industry if they fulfill the same underlying customer needs, potentially leading to customer defection.
- βοΈ The bargaining power of suppliers is high when there are few suppliers, high switching costs, and low availability of substitutes.
- π The bargaining power of buyers is strong when they have many alternatives, low switching costs, and when the product is a commodity with little differentiation.
- π οΈ Companies can influence the Five Forces by strategic actions such as product differentiation, building brand loyalty, and raising barriers to entry to protect profitability.
- π Understanding and shaping the Five Forces is crucial for developing effective business strategies that enhance long-term profitability.
Q & A
What is Porter's Five Forces framework?
-Porter's Five Forces is a strategic framework developed by Michael Porter in 1979 that analyzes the competitive forces within an industry that shape its structure and determine its profitability and attractiveness.
What are the five forces that make up Porter's model?
-The five forces include rivalry among existing competitors, threat of new entrants, threat of substitute products or services, bargaining power of suppliers, and bargaining power of buyers.
Why is it important to understand the distinction between macro environment and task environment when analyzing Porter's Five Forces?
-Understanding the distinction is important because the macro environment contains factors that affect all organizations, while the task environment, which includes Porter's Five Forces, contains factors that are in direct contact with the focal company and interact with each other.
How does the intensity of rivalry among existing competitors affect an industry's profitability?
-High rivalry can lead to aggressive advertising and price wars, which can decrease profit margins as companies try to maintain market share.
What are some examples of barriers to entry that can affect the threat of new entrants in an industry?
-Examples include economies of scale, high customer loyalty for existing brands, large capital requirements, cumulative experience, government policies, and limited access to distribution channels.
How can the threat of substitutes impact an industry's profitability?
-The threat of substitutes can cause customers to switch to alternatives if they offer similar functionality at a lower price or better performance, which can decrease the demand for the industry's products and lower profit margins.
What factors determine the bargaining power of suppliers in an industry?
-Factors include the number and concentration of suppliers, switching costs for the industry, presence of substitutes, strength of distribution channels, and the uniqueness or differentiation of the supplier's product or service.
How can the bargaining power of buyers influence an industry's profitability?
-Buyers with high bargaining power can demand better quality or lower prices, which can increase costs or decrease revenue for the industry, thus affecting profitability.
What is the significance of the airline industry example in explaining Porter's Five Forces?
-The airline industry serves as a practical example to illustrate how each of the five forces can impact profitability, showing how intense competition, high supplier power, and the threat of substitutes can shape the industry's structure.
How can a company use Porter's Five Forces to develop strategic actions?
-A company can use the framework to understand the forces affecting its industry and then take strategic actions to mitigate negative impacts, such as differentiating products, investing in brand awareness, or standardizing components to reduce supplier dependency.
What is the ultimate goal of using Porter's Five Forces in strategic planning?
-The ultimate goal is to protect and enhance the company's profitability by understanding and shaping the competitive forces within the industry.
Outlines
π Introduction to Porter's Five Forces
This paragraph introduces the concept of Porter's Five Forces, a strategic framework developed by Michael Porter in 1979. It explains that the model is used to analyze the competitive forces within an industry that affects its profitability and attractiveness. The paragraph outlines the five forces: rivalry among existing competitors, threat of new entrants, threat of substitute products or services, bargaining power of suppliers, and bargaining power of buyers. It emphasizes the model's purpose in evaluating the root causes of profitability and distinguishes between macro and task environments, with Porter's Five Forces falling into the latter as it involves direct interaction with the company.
π« Rivalry Among Existing Competitors and Threat of New Entrants
This section delves into the first two forces of Porter's model: rivalry among existing competitors and the threat of new entrants. It discusses how the intensity of competition is influenced by factors such as the number and size of competitors, industry growth rate, product differentiation, and exit barriers. The paragraph uses the airline industry as an example, highlighting its high competition due to a large number of players, stagnant growth, and high fixed costs. It also examines the barriers to entry, such as upfront investments, access to routes, and regulatory requirements, which are particularly high in the airline industry, making it difficult for new entrants to compete with established players.
π Threat of Substitutes and Bargaining Power of Suppliers and Buyers
The third force, the threat of substitutes, is explored in this paragraph, which can fulfill the same need as the industry's product but through different means. The discussion includes the importance of considering all products that serve a similar need, not just direct competitors. The paragraph then moves on to the bargaining power of suppliers and buyers, explaining how these can affect an industry's profitability. For suppliers, factors such as the number of suppliers, switching costs, and uniqueness of the product or service play a role. Buyers' power is influenced by their number, alternatives, and ease of switching. The airline industry's reliance on fuel and aircraft suppliers, like Boeing and Airbus, is highlighted, indicating high supplier power. Buyers' power is also significant, with customers having many alternatives and the ability to easily compare prices online.
π Strategic Implications and Actions Based on Porter's Five Forces
The final paragraph discusses the strategic implications of Porter's Five Forces and how understanding these forces can help shape a company's strategy. It suggests that by recognizing dependencies on suppliers or the potential for price wars, a company can take proactive steps to mitigate risks and protect profitability. Examples include standardizing components to reduce reliance on a single supplier or investing in product development to differentiate from competitors. The paragraph concludes by encouraging viewers to subscribe for more business insights and to share suggestions for future video topics.
Mindmap
Keywords
π‘Porter's Five Forces
π‘Competitive Forces
π‘Industry Structure
π‘Rivalry Among Existing Competitors
π‘Threat of New Entrants
π‘Threat of Substitutes
π‘Bargaining Power of Suppliers
π‘Bargaining Power of Buyers
π‘Profit Potential
π‘Strategic Actions
π‘External Analysis Framework
Highlights
Porter's Five Forces is a strategic framework developed by Michael Porter in 1979 to analyze industry competition and profitability.
The framework includes five forces: rivalry among competitors, threat of new entrants, threat of substitutes, bargaining power of suppliers, and bargaining power of buyers.
Rivalry among existing competitors can be high when there are many competitors of similar size, slow industry growth, and high exit barriers.
High rivalry can lead to price wars and increased advertising costs, negatively affecting profit margins.
The airline industry exemplifies high rivalry due to numerous competitors, stagnant growth, and high fixed costs.
The threat of new entrants depends on barriers to entry, such as capital requirements and access to resources.
In the airline industry, the threat of new entrants is considered minimal due to significant upfront investments and strict regulations.
Substitutes can fulfill the same need as the industry's product, posing a threat if customers are willing to switch due to price or performance.
The airline industry faces a medium to high threat from substitutes like trains and the potential Hyperloop concept.
Bargaining power of suppliers is high when there are few suppliers and they control key inputs, as seen with fuel and aircraft suppliers in the airline industry.
Buyers have significant power when they can easily compare prices and switch between providers, as is common in the airline industry.
Understanding the Five Forces can help companies develop strategic actions to mitigate competitive pressures.
Strategic actions can include standardizing components to reduce dependency on suppliers or investing in product development to differentiate from competitors.
Raising barriers to entry through marketing investments can deter new competitors and protect a company's profitability.
Porter's Five Forces is not just for evaluating industry attractiveness but also for shaping industry competition to a company's advantage.
The framework encourages a proactive approach to strategy development by understanding and influencing competitive forces.
Transcripts
Porter's five forces a strategy
framework that probably every business
students and practitioner has heard
about but do you also know how to use it
properly
today you will be finding it out because
I'm going to tell you everything you
need to know about Porter's five forces
my name is Lars and welcome to a new
episode of business to you in 1979
Michael Porter one of the founding
fathers of business strategy published
an article called how competitive forces
shape strategy in this article he argued
that we often view competition way too
narrowly and as a solution came up with
five basic forces that together shape
the industry structure and determine the
competitive intensity of an industry in
the end these forces affect the long
term profit potential in an industry and
therefore its attractiveness we will
come back to that in a second because
we're talking about competitive forces
the Five Forces model can be considered
an external analysis framework similar
to pestle however as explained in my
previous video on PESTEL analysis it is
important to make a distinction between
the macro environment and the task
environments or meso environments do you
remember how the macro environment
contains factors that have a one-way
effect on organizations and a task
environment on the other hand contains
factors that are in a direct contact
with the focal company they interact
with each other Porter's five forces
falls within this latter category and
includes the following five forces
rivalry among existing competitors
threat of new entrants the threat of
substitute products or services the
bargaining power of suppliers and the
bargaining power of buyers before we go
into each force separately it is
important to understand that the main
purpose of this model is to evaluate the
root causes of profitability in an
industry true to competitive forces
porter dev force draws a connection
between competition on the one hand and
profitability on the other hand if
competitive forces in an industry are
high or intense the profit potential of
a firm in that specific industry will
decrease as you will be seeing in this
video each of the five forces are able
to affect the profit potential in the
industry both positively and negatively
we will be illustrating this dynamic
relationship between competition and
profitability throughout this video with
some examples from the airline industry
let's start off with the middle section
of the framework this force of the Five
Forces model examines how intense the
current competition is in the
marketplace this is for example
determined by the number and size of
existing competitors the industry growth
rate product differentiation between
rivals and exit barriers rivalry is for
example high when there are a lot of
competitors that are roughly equal in
size and power when the industry is
growing slowly which increases the fight
for market share and when competitors
are not much differentiated from each
other resulting in products and services
that are nearly identical
in addition rivalry will be more intense
when barriers to exit are high forcing
companies to remain in the industry even
though profit margins are declining
these barriers to exit can for example
exist due to long term loan agreements
and high fixed costs when rivalry is
high competitors are likely to actively
engage in advertising and price wars
which can seriously hurt a business
bottom line let's look at this more
closely
if direct competitors fight for market
share and decide to battle each other by
dropping the prices profit margin will
decrease
moreover they might decide to spend more
money on advertising raising the costs
and again decreasing the profit margin
when looking at the airline industry we
see that the industry is extremely
competitive
because of several reasons which include
the vast amount of players that are
active in the industry the fact that the
industry itself is very stagnant in
terms of growth at the moment and the
high fixed costs that result in too high
barriers to exit in addition many
players in industry are similar in size
leading to extra fierce competition
between those firms taken altogether it
can be said that rivalry among existing
competitors in the airline industry is
high threat of new entrants new entrants
in an industry bring new capacity and
the desire to gain market share that put
pressure on prices costs and the rate of
investments necessary to compete simply
said you will have to share the pie with
more players the seriousness of the
threat depends on the barriers to entry
in a certain industry the higher these
barriers the smaller the chance that
more players will enter the playing
field and the smaller the treads for
existing rivals examples of barriers to
entry are the needs of economies of
skill high customer loyalty for existing
brands large capital requirements the
need for cumulative experience
government policies and limited access
to distribution channels if new
competitors enter the industry existing
players might need to increase their
investments in product development or
marketing in order to stay ahead of the
game
this will increase costs and lower the
profit margin or in order to prevent new
competitors from entering existing
players might decide to lower prices in
order to scare off new competitors again
this will decrease the profit margin the
threat of new entrants in the airline
industry can be considered mininum it
takes quite some upfront investments to
start an airline company moreover new
entrants need access to flight routes
licenses insurances distribution
channels and other qualifications that
are not easy to obtain when you're new
to the industry furthermore it can be
expected
existing players have built up a large
base of experience over the years to cut
costs and to increase service levels a
new entrant is likely to not have this
kind of expertise therefore creating a
competitive disadvantage right from the
start however due to the liberalisation
of mark Texas and the availability of
leasing options and external finance
from banks investors and aircraft
manufacturers new doors are opening for
potential entrants over the years many
low-cost carriers like Southwest
Airlines Ryanair and easyJet have
successfully entered the industry by
introducing innovative cost-cutting
business models thereby shaking up
existing players like American Airlines
Lufthansa Delta Airlines and air
france-klm the threat of substitutes a
substitute product performs the same or
a similar function as an industry
product by a different means they
essentially fulfill the same underlying
need even though they may not look
identical on the surface they are
therefore easy to overlook the existence
of these products alone increases the
possibility that customers switched to
alternatives in order to discover these
alternatives you should look beyond
similar products that are branded
differently by competitors instead every
product that serves a similar need for
customers should be taken into account
energy drinks like Red Bull for instance
are usually not considered competitors
of coffee brands such as Nespresso or
Starbucks
however since both coffee and energy
drinks fulfill a similar need that is
staying awake or getting energy
customers might be willing to switch
from one to another if they feel that
the prices increase too much in either
coffee or energy drink the number of
substitutes the willingness of customers
to substitute and the relative price
performance of substitute products are
therefore factors that determine the
total threat of substitute products
since substitute products can lure
customers away companies need to take
actions to stay more attract
and prevent their product from becoming
replaced or obsolete they can for
example lower the prices which will also
lower the profit margin they can spend
more money on advertising which
increases the costs or they can invest
heavily in product upgrades or
additional services that will give
customers an incentive to stay again
this will increase the costs and lower
the profit margin in terms of the
airline industry it is safe to say that
the general need of customers is to
travel of course there are many
alternatives for travelling besides
going by airplane depending on the
urgency and the distance customers could
take the train or go by car especially
in Asia it is very common to make use of
high-speed trains such as bullet trains
for medium to long distance travelling
we see a similar tendency developing
within Europe furthermore the airline
industry might get some serious future
competition from the Hyperloop concept
in which passengers will be travelling
in capsules through a vacuum tube
reaching speed limits of 1,200
kilometers an hour taking this all
together the threat of substitutes in
the airline industry can be considered
at least medium to high now we enter the
horizontal section of the framework the
suppliers and the buyers this section is
basically illustrating a company's
supply chain let's start off with the
bargaining power of suppliers this force
analyzes how much power and control a
company's supplier has over the
potential to raise its prices or to
reduce the quality of purchased goods or
services which in turn would lower an
industry's profitability potential the
number and concentration of suppliers to
choose from are important factors in
determining supplier power the fewer
there are the more power they have
businesses are in a better position when
there are a multitude of suppliers
sources of supplier power also includes
the switching cost of companies in the
industry
the presence of available substitutes
the strengh
of their distribution channels and the
uniqueness or level of differentiation
in the product or service the supplier
is delivering the bargaining power of
suppliers in the airline industry can be
considered very high when looking at the
major inputs that airline companies need
we see that they are especially
dependent on fuel and aircrafts these
inputs however are very much affected by
the external environment over which the
airline companies themselves have little
control the price for aviation fuel is
for example subject to the fluctuations
in the global markets for oil which can
change wildly because of the
geopolitical and other factors in terms
of aircrafts only two major suppliers
exists Boeing and Airbus Boeing and
Airbus therefore have a substantial
bargaining power of the prices they
charge the bargaining power of buyers
this force analyzes to what extent
customers are able to put the company
under pressure by demanding better
quality they're right driving up costs
or exertion trol over price keep in mind
that buyers do not always have to be the
end consumer in case your business is a
manufacturing company buyers can be
other companies like retailers for
example customers have a lot of power
when they aren't many of them and when
the customers have many alternatives to
buy from moreover it should be easy for
them to switch from one company to
another buying power is low however when
customers purchase products in small
amounts act independently and when the
sellers product is very different from
any of its competitors the Internet has
allowed customers to become more
informed and therefore more empowered
customers can easily compare prices
online get information about a wide
variety of products and get access to
offers from other companies instantly
companies can take measures to reduce
buyer power by for example implementing
loyalty programs or by differentiating
their products and services bargaining
power of buyers in the airline industry
is
customers are able to check prices of
different airline companies fast through
the many online price comparison
websites such as Skyscanner and Expedia
in addition there aren't any switching
costs involved in that process customers
nowadays are willing to fly with
different carriers to and from their
destination as long as it lowers their
ticket price brand loyalty therefore
doesn't seem to be that high some
airline companies are trying to change
this with frequent flyer programs aimed
at rewarding customers that come back to
them from time to time now we have
looked at every force individually you
will notice that we start to get a
better picture of how competition in an
industry looks like and which of the
forces have the biggest impact on your
profit margin however Porter's five
forces is not just a tool to evaluate an
industry and determine whether an
industry is attractive or not do you
remember how the Five Forces are part of
the task environment causing them to be
in a direct contact with the focal
company this means that a company is
able to affect these forces similarly to
how these forces are able to affect your
company in other words you can do
something about it you can fight them
you can shape them understanding the
forces that shape industry competition
is the starting point for developing
strategy the model is therefore a great
tool to come up with strategic actions
on what to do in the future
imagine that you start to notice that
your dependency on one particular
supplier is increasing what you could do
is try to standardize the components
needed to create your products so that
you could choose from multiple suppliers
and switch more easily among them or if
you fear that your competitors will
start to enter price wars you could
invest more money in product development
in order to significantly differentiate
your products from those of your rivals
make sure that you offer features and
benefits that your competitors cannot
offer and you will have less chance that
you will be forced to cut prices as well
if you feel that new competitors might
enter the playing field you could raise
the barriers to entry by investing more
into marketing this will enhance your
brand awareness and scare off entrance
because of the high costs needed to
overcome that brand awareness even
though these actions involve costs in
the short term it will help you to
protect your company's profitability in
a long term because that in the end is
the purpose of strategy if you like
business-related stuff and want to learn
more business frameworks feel free to
subscribe to not miss out on any of our
future videos and if you have any
suggestion on what to cover in the
future please let me know in the comment
section down below thanks for watching
and as always don't forget alone we are
smart
together we are brilliant see you next
time
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