Porter's 5 Forces

- The tool was created by Harvard Business School professor Michael Porter, to analyze an industry's attractiveness and
likely profitability. Since its publication in 1979, it has become one of the most popular and highly regarded business
strategy tools.
- Porter's Five Forces is a simple but powerful tool for understanding the competitiveness of your business environment,
and for identifying your strategy's potential profitability
- Porter recognized that organizations likely keep a close watch on their rivals, but he encouraged them to look beyond the
actions of their competitors and examine what other factors could impact the business environment.

Importance:
- It identifies and analyzes five competitive forces that shape every industry, and helps determine an industry's weaknesses
and strengths
- Helps to explain why different industries are able to sustain different levels of profitability
- Used to analyze the industry structure of a company as well as its corporate strategy
- Understanding Porter's Five Forces and how they apply to an industry, can enable a company adjust its business strategy
to better use its resources to generate higher earnings for its investors.
- You could take fair advantage of a strong position or improve a weak one, and avoid taking wrong steps in future

5 Forces are the following:

1. Competition in the industry;
2. Potential of new entrants into the industry;
3. Power of suppliers;
4. Power of customers;
5. Threat of substitute products.

1. Competition in the industry

- The importance of this force is the number of competitors and their ability to threaten a company
- How many rivals do you have? Who are they, and how does the quality of their products and services compare with
yours?
- The larger the number of competitors, along with the number of equivalent products and services they offer, the lesser
the power of a company
- When competitive rivalry is low, a company has greater power to do what it wants to do to achieve higher sales and
profits

2. Potential of new entrants into the industry

- The less time and money it costs for a competitor to enter a company's market and be an effective competitor, the more a
company's position may be significantly weakened.
- An industry with strong barriers to entry is an attractive feature for companies that would prefer to operate in a space
with fewer competitors
- How easy is it to get a foothold in your industry or market? How much would it cost, and how tightly is your sector
regulated?

3. Power of suppliers
- This force addresses how easily suppliers can drive up the price of goods and services.
- This is determined by how easy it is for your suppliers to increase their prices.
- It is affected by the number of suppliers of key aspects of a good or service, how unique these aspects are, and how much
it would cost a company to switch from one supplier to another.
- The fewer the number of suppliers, and the more a company depends upon a supplier, the more power a supplier holds

4. Power of customers
- This specifically deals with the ability customers have to drive prices down.
- Here, you ask yourself how easy it is for buyers to drive your prices down.
- It is affected by how many buyers or customers a company has, how significant each customer is, and how much it would
cost a customer to switch from one company to another.
- The smaller and more powerful a client base, the more power it holds.

5. Threat of substitute products

- Competitor substitutes that can be used in place of a company's products or services pose a threat
- This refers to the likelihood of your customers finding a different way of doing what you do.
- For example, if customers rely on a company to provide a tool or service that can be substituted with another tool or
service or by performing the task manually, and if this substitution is fairly easy and of low cost, a company's power can be
weakened.
- A substitution that is easy and cheap to make can weaken your position and threaten your profitability.

Notes:
- By thinking about how each force affects you, and by identifying its strength and direction, you can quickly assess your
position. You can then look at what strategic changes you need to make to deliver long-term profit.
Strategies for success

Once your analysis is complete, it's time to implement a strategy to expand your competitive advantage. To that end,
Porter identified three generic strategies that can be implemented in any industry (and in companies of any size).

Cost leadership
- Your goal is to increase profits by reducing costs while charging industry-standard prices, or to increase market share by
reducing the sales price while retaining profits.

Differentiation
- To implement this strategy, make the company's products significantly different from the competition, improving their
competitiveness and value to the public. It requires both good research and development plus effective sales and
marketing teams.

Focus
- A successful implementation means the company selects niche markets in which to sell their goods. It requires an intense
understanding of the marketplace, its sellers, buyers and competitors.

Forward Integration
- Forward integration is a type of vertical integration that extends to the next levels of the supply chain, aiming to lower
production costs and increase the efficiency of the firm.
- a business strategy that involves expanding your business to control more of your supply chain in the direction of the
customer.
- Operational strategy implemented by a company that wants to increase control over its suppliers, manufacturers or
distributors, so it can increase its market power.
- For a forward integration to be successful, a company needs to gain ownership over other companies that were once
customers.
- The goal of forward integration is for a company to move forward in the supply chain, increasing its overall ownership of
the industry.
- In other words, it’s a business strategy where a firm replaces third party distribution or supply channels with its own in an
effect to consolidate operations, reduce costs, and become a step closer to the end consumer.
- The positive outcome of this integration is higher operating margins due to increased sales as a result of the firm’s access
to more distribution channels

For example:
Manufacturing
a manufacturer of parts begins manufacturing finished goods. For example, a bicycle tire manufacturer who begins
manufacturing bicycles.

Logistics
An ecommerce firm that begins a delivery service to reach the customer without the services of delivery companies. This
may be done to reduce costs, improve turnaround time and offer value-added services to customers.

Customer Service
An ecommerce company insources customer service functions that were previously outsourced. This may be done to
improve the customer experience.

Notes:
Forward integration makes the most sense when you're clearly leaving money on the table if you don't do it. If shipping
costs are killing you, for example, you're likelier to benefit from buying your own delivery truck. If your distributors and
retailers make significantly more profit from your product than you do, it makes sense to at least investigate taking over
your own distribution and retail channels. Like any other major business decision, you'll have to weigh the potential risks
and benefits before you take that jump.

Backward Integration
- The strategy of taking over more of your supply chain in the opposite direction of your customers.
For Example: a jam company that begins growing its own fruit.

For example:
Manufacturing
- A manufacturer of coffee begins to run its own coffee plantations. This may be done to cut costs, secure a reliable supply
and/or improve quality.

Retail
A fashion retailer begins designing and manufacturing its own line of clothing.

Services
A software consulting firm begins to develop its own software products.

A general example of backward integration is when a bakery business moves up the supply chain to purchase a wheat
processor or a wheat farm. In this scenario, a retail supplier is purchasing one of its manufacturers, therefore cutting out
the middleman, and hindering competition.

Importance:
- Costs can be controlled significantly from the production through to the distribution process
- Businesses can also gain more control over their value chain, increasing efficiency and gaining direct access to the
materials that they need.

Business Example:
Amazon.com Inc., for example, became vertically integrated backward when it expanded its business to become both a
book retailer and a book publisher. Amazon began as an online book retailer in 1995, procuring books from publishers. In
2009, it opened its own dedicated publishing division, acquiring the rights to both older and new titles. It now has several
imprints. Although it still sells books produced by others, its own publishing efforts have boosted profits by attracting
consumers to its own products, helped control distribution on its Kindle platform, and given it leverage over other
publishing houses.
Horizontal Integration
- The acquisition of a business operating at the same level of the value chain in a similar or different industry.
- When a company wishes to grow through horizontal integration, its aim is to acquire a similar company in the same
industry.
- Companies may choose to undergo horizontal integration in order to increase their size, diversify product or services
offerings, achieve economies of scale, or reduce competition. By merging two businesses, they may be able to produce
more revenue than they would have been able to do independently.
- However, when horizontal mergers succeed, it is often at the expense of consumers, especially if they reduce competition.
If horizontal mergers within the same industry concentrate market share among a small number of companies, it creates an
oligopoly.
- If one company ends up with a dominant market share, it has a monopoly. This is why horizontal mergers are heavily
scrutinized under antitrust laws.

Business Example:

Proctor & Gamble’s 2005 acquisition of Gillette is a good example of a horizontal merger which realized economies of
scope. Because both companies produced hundreds of hygiene-related products from razors to toothpaste, the merger
reduced the marketing and product development costs per product.

A retail business that sells clothes may decide to also offer accessories, or might merge with a similar business in another
country to gain a foothold there and avoid having to build a distribution network from scratch.

Marriott's 2016 acquisition of Sheraton (hotels)

Volkswagen’s 2012 acquisition of Porsche (automobiles),
Facebook's 2012 acquisition of Instagram (social media),
Disney's 2006 acquisition of Pixar (entertainment media)

Reducing Competition
The real motive behind a lot of horizontal mergers is that companies want to reduce “horizontal” competition in the form
of competition from substitutes, competition from potential new entrants and the competition from established rivals.
These are three of the five competitive forces that shape every industry and which are identified in Porter’s Five Forces
model. The other two forces, the power of suppliers and customers, drive vertical integration.

Notes:
What Is a Value Chain?

A value chain is a business model that describes the full range of activities needed to create a product or service. For
companies that produce goods, a value chain comprises the steps that involve bringing a product from conception to
distribution, and everything in between—such as procuring raw materials, manufacturing functions, and marketing
activities.

Horizontal vs. Vertical Integration:

- In a horizontal acquisition, a company takes over another that operates at the same level of the value chain in an industry.
A vertical integration, on the other hand, involves the acquisition of business operations within the same production vertical.
- Horizontal integrations help companies expand in size, diversify product offerings, reduce competition, and expand into
new markets.
-Vertical integrations can help boost profit, allow companies more immediate access to consumers, and cut down on time
and money.

This strategy is important for many companies for several reasons. Not only does it increase profits from the newly acquired
operations by selling its products directly to consumers, it also guarantees efficiencies in the production process, and cuts
down on delays in delivery and transportation.

DIVERSIFICATION
A business owner needs to consider efficient diversification strategies to build a competitive advantage, to achieve
economies of scale or scope, and/or to take advantage of a financial opportunity that aligns with the business' strategic
plan.

Related Diversification
- A process that takes place when a business expands its activities into product lines that are similar to those it currently
offers.
For Example: a manufacturer of computers might begin making calculators as a form of related diversification of its
existing business
- It is when a business adds or expands its existing product lines or markets.
For Example: a phone company that adds or expands its wireless products and services by purchasing another wireless
company is engaging in related diversification.
- With a related diversification strategy you have the advantage of understanding the business and of knowing what the
industry opportunities and threats are; yet a number of related acquisitions fail to provide the benefits or returns originally
predicted.