Porter's 5 Forces EXPLAINED | B2U | Business To You

Summary

In this episode, Lars explores Michael Porter's Five Forces, a strategic framework for analyzing industry competition and profitability. He explains the five key forces—rivalry among competitors, threat of new entrants, substitutes, supplier power, and buyer power—and 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

• 📚 Porter's Five Forces is a strategic framework developed by Michael Porter in 1979 to analyze the competitive landscape of an industry.
• 🔍 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.
• 💡 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.
• ✈️ 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.
• 💥 Rivalry among existing competitors is high in industries with many competitors of similar size, slow industry growth, and high exit barriers.
• 🚀 The threat of new entrants is influenced by barriers to entry, such as capital requirements, access to distribution channels, and government policies.
• 🛍️ Substitute products or services can significantly impact an industry if they fulfill the same underlying customer needs, potentially leading to customer defection.
• ⚖️ The bargaining power of suppliers is high when there are few suppliers, high switching costs, and low availability of substitutes.
• 🛒 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.
• 🛠️ Companies can influence the Five Forces by strategic actions such as product differentiation, building brand loyalty, and raising barriers to entry to protect profitability.
• 🌟 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

00:00

📚 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.

05:03

🛫 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.

10:04

🔄 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.

15:06

🛠 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.

Keywords

💡Porter's Five Forces

Porter's Five Forces is a strategic framework developed by Michael Porter in 1979 to analyze the competitive forces within an industry. It is fundamental to the video's theme as it helps determine the industry's attractiveness and long-term profit potential. The script uses the framework to dissect various aspects of the airline industry, illustrating how each force affects profitability.

💡Competitive Forces

Competitive forces refer to the elements that shape the competitive landscape of an industry. In the context of the video, these forces are the five components of Porter's model, which include rivalry among competitors, threat of new entrants, threat of substitutes, bargaining power of suppliers, and bargaining power of buyers. The script explains how these forces impact the profitability of firms within an industry.

💡Industry Structure

Industry structure refers to the organization and characteristics of an industry, which includes the number of competitors, the similarity of products, and the barriers to entry or exit. The video script discusses how the five forces shape the industry structure, affecting the competitive intensity and ultimately the profitability of the industry.

💡Rivalry Among Existing Competitors

Rivalry among existing competitors is one of the five forces that measures the intensity of competition within an industry. The script uses the example of the airline industry to explain how factors like the number of competitors, industry growth rate, and product differentiation contribute to rivalry and affect profit margins.

💡Threat of New Entrants

The threat of new entrants is a force that considers the likelihood of new companies entering an industry and how that affects existing competitors. The video script explains that high barriers to entry, such as significant upfront investments and regulatory requirements, can limit new entrants, as seen in the airline industry.

💡Threat of Substitutes

The threat of substitutes is the risk that customers may switch to alternative products or services that fulfill the same need. The script discusses how the existence of substitutes, such as high-speed trains and the potential Hyperloop concept, can impact the airline industry by providing customers with alternative travel options.

💡Bargaining Power of Suppliers

Bargaining power of suppliers measures the influence suppliers have over an industry, often through their ability to raise prices or reduce product quality. The video script highlights the airline industry's dependence on fuel and aircraft suppliers, where the suppliers' power can significantly affect the industry's profitability.

💡Bargaining Power of Buyers

Bargaining power of buyers examines the ability of customers to influence a company's pricing and product offerings. The script explains how the internet has empowered buyers in the airline industry to easily compare prices and switch carriers, leading to lower brand loyalty and increased pressure on ticket prices.

💡Profit Potential

Profit potential refers to the long-term profitability of an industry or a firm within that industry. The video script connects the five forces to profit potential, explaining that intense competitive forces can decrease profit potential, while a balanced competitive environment can sustain or increase it.

💡Strategic Actions

Strategic actions are steps a company can take to influence or respond to the competitive forces within its industry. The script suggests that understanding these forces allows companies to develop strategies, such as differentiating products or raising barriers to entry, to protect and enhance their profitability.

💡External Analysis Framework

An external analysis framework is a tool used to assess the external factors affecting an organization. The video script positions Porter's Five Forces as an external analysis tool, distinct from the macro environment, and emphasizes its importance in evaluating the competitive environment directly impacting the company.

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

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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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