Sunday, September 20, 2009

Porter’s Five Forces analysis

Within the Market Summary of your Marketing Plan it might be useful for you to include Porter’s five forces analysis. This is a framework for industry analysis that determines the attractiveness of an industry by helping you understand both the strength or your current competitive position and the strength of a position you are looking to move into. Developed by Harvard Business School professor, Michael E. Porter in 1979, the Five Forces analysis has some similarities with other environmental tools such as the PEST analysis, although the first one is more closely related to the company (microenvironment) by measuring how it can be directly affected in its ability to serve its customers and make a profit.
These 5 forces that affect your competitive strength can then be defined as follows:
  • The threat of entry of new competitors - your strength is affected by the facility of other companies to enter your market as based on:

- economies of scale

- initial investment and fixed costs

- brand loyalty

- close customer relations

- switching costs for customers

- ease of customers to change provider

- the relative price for performance of substitutes

- ease of access to distribution channels

- learning curve advantages

- expected retaliation by competitors

- government action to new entries

  • The threat of substitute products - your strength is affected by how easily available are there any other substitutes or complementary products that have either lower prices or better performance. This is determined by factors such as:

- price performance of substitutes

- buyer switching costs

- perceived level of product differentiation

- close customer relationships

- current trends

  • The competitive rivalry - this force is many times determinant to define the industry competitiveness as high competitive pressure can result in changes in prices, margins and innovation for each individual company and for the overall industry. To determine the competitive rivalry the following should be analysed:

- number of competitors

- industry growth rate

- players strategies

- product differentiation

- barriers for exit

  • The Bargaining power of suppliers - company suppliers may have a source of power over the company depending on how dependent the companies are from their suppliers. To analyse this force should be considered:

- number of available suppliers

- switching costs from one supplier to another

- threat of forward integration by suppliers

- presence of substitute inputs

- cost of inputs relative to the selling price of the product

  • The bargaining power of customers - this force will define how much customers can impose pressure on margins and volumes. To analyse this, the following factors should be considered:

- cost of switching between product providers to the buyer

- the product's ability/ease to be replaced

- how strategically important is the product to the buyer

- possibility for the customer integrating backwards

- buyer concentration to firm concentration ratio

- bargaining leverage

- buyer information availability

Th Porter’s Five Forces model can be illustrated as below:

Each force should be analysed individually as only by identifying the strength and direction of each one, you can assess the strength of your company’s position and its ability to make a sustained profit within the industry.
To clarify how this can be done let’s look at an example:
“John Smith is tired of the high demands of his job at a financial firm in the City of London and is looking to start up a more relaxed business as an Internet cafe owner. To understand the potential benefits of entering this market he decides to make a Porter five forces analysis and classifies each force with one or more “+” (if the force is in his favour), “-“ (if the force is against him) or “0” (if the force doesn’t affect him) signs depending on how strongly the forces influence his business competitive position in the market. The result follows:

Porter’s Five Forces Analysis – Internet Cafe

Click image to enlarge

After conducting the Porter’s Five Forces for his potential new Internet cafe business, John decided to stick to banking while he thinks about a new business to get involved.”