Porter’s framework of analyzing the level of competition within a certain

industry. 

Overview of 5 Forces framework:

Five Forces Analysis assumes that there are five important forces that determine
competitive power in a business situation. These are:

1. Supplier Power: Here you assess how easy it is for suppliers to drive up
prices. This is driven by the number of suppliers of each key input, the
uniqueness of their product or service, their strength and control over you, the
cost of switching from one to another, and so on. The fewer the supplier
choices you have, and the more you need suppliers' help, the more powerful
your suppliers are.
2. Buyer Power: Here you ask yourself how easy it is for buyers to drive
prices down. Again, this is driven by the number of buyers, the importance of
each individual buyer to your business, the cost to them of switching from your
products and services to those of someone else, and so on. If you deal with
few, powerful buyers, then they are often able to dictate terms to you.
3. Competitive Rivalry: What is important here is the number and capability
of your competitors. If you have many competitors, and they offer equally
attractive products and services, then you'll most likely have little power in the
situation, because suppliers and buyers will go elsewhere if they don't get a
good deal from you. On the other hand, if no-one else can do what you do,
then you can often have tremendous strength.
4. Threat of Substitution: This is affected by the ability of your customers to
find a different way of doing what you do – for example, if you supply a unique
software product that automates an important process, people may substitute
by doing the process manually or by outsourcing it. If substitution is easy and
substitution is viable, then this weakens your power.
5. Threat of New Entry: Power is also affected by the ability of people to
enter your market. If it costs little in time or money to enter your market and
compete effectively, if there are few economies of scale in place, or if you have
little protection for your key technologies, then new competitors can quickly
enter your market and weaken your position. If you have strong and durable
barriers to entry, then you can preserve a favorable position and take fair
advantage of it.

Porter's Five Forces

 Porter's Five Forces Model: analysing industry structure

Author: Jim Riley   Last updated: Sunday 23 September 2012

Porter identified five factors that act together to determine the nature of
competition within an industry.  He identified that high or low industry
profits (e.g. soft drinks v airlines) are associated with the following
characteristics:

Let’s look at each one of the five forces in a little more detail to explain how
they work.

Threat of new entrants to an industry

 If new entrants move into an industry they will gain market share &
rivalry will intensify
 The position of existing firms is stronger if there are barriers to
entering the market
 If barriers to entry are low then the threat of new entrants will be high,
and vice versa
Barriers to entry are, therefore, very important in determining the threat of
new entrants.  An industry can have one or more barriers.  The following are
common examples of successful barriers:

Barrier Notes

Investment cost High cost will deter entry

High capital requirements might mean that only
large businesses can compete

Economies of scale Lower unit costs make it difficult for smaller

available to existing newcomers to break into the market and
firms compete effectively

Regulatory and legal Each restriction can act as a barrier to entry

restrictions E.g. patents provide the patent holder with
protection, at least in the short run

Product Existing products with strong USPs and/or brand

differentiation increase customer loyalty and make it difficult
(including branding) for newcomers to gain market share

Access to suppliers A lack of access will make it difficult for

and distribution newcomers to enter the market
channels

Retaliation by E.g. the threat of price war will act to discourage

established products new entrants
But note that competition law outlaws actions
like predatory pricing

What makes an industry easy or difficult to enter?  The following table helps
summarise the issues you should consider:

Easy to Enter Difficult to Enter

Common technology Patented or proprietary know-how

Access to distribution channels Well-established brands
Low capital requirements Restricted distribution channels
No need to have high capacity and High capital requirements
output Need to achieve economies of scale
Absence of strong brands and for acceptable unit costs
customer loyalty

Bargaining power of suppliers

If a firm’s suppliers have bargaining power they can exercise that power by:

 Selling their products at a higher price

 Squeezing industry profits

If the supplier forces up the price paid for inputs, profits will be reduced.
Suppliers find themselves in a powerful position when:

 There are only a few large suppliers

 The resource they supply is scarce
 The cost of switching to an alternative supplier is high 
 The product is easy to distinguish, and loyal customers are reluctant
to switch
 The supplier can threaten to integrate vertically
 The customer is small and unimportant
 There are no or few substitute resources available

Just how much power the supplier has is determined by factors such as:

Factor Note

Uniqueness of the If the resource is essential to the buying firm

input supplied and no close substitutes are available,
suppliers are in a powerful position

Number and size of A few large suppliers can exert more power
firms supplying the over market prices that many smaller suppliers
resources each with a small market share

Competition for the If there is great competition, the supplier will

input from other be in a stronger position
industries

Cost of switching to A business may be “locked in” to using inputs

alternative sources from particular suppliers – e.g. if certain
components or raw materials are designed into
their production processes.  To change the
supplier may mean changing a significant part
of production
Remember: It is the threat of entry, not whether entry actually occurs, that holds
down profitability

Bargaining power of customers

Powerful customers are able to exert pressure to drive down prices, or
increase the required quality for the same price, and therefore reduce profits
in an industry.

Several factors determine the bargaining power of customers, including:

Factor Note

Number of customers The smaller the number of customers, the

greater their power

Their size of their The larger the volume, the greater the
orders bargaining power of customers

Number of firms The smaller the number of alternative

supplying the product suppliers, the less opportunity customers have
for shopping around

The threat of If customers pose a threat of integrating

integrating backwards backwards they will enjoy increased power

The cost of switching Customers that are tied into using a supplier’s
products (e.g. key components) are less likely
to switch because there would be costs
involved

Customers tend to enjoy strong bargaining power when:

 There are only a few of them

 The customer purchases a significant proportion of output of an
industry
 They possess a credible backward integration threat – that is they
threaten to buy the producing firm or its rivals
 They can choose from a wide range of supply firms
 They find it easy and inexpensive to switch to alternative suppliers

Threat of substitute products

A substitute product can be regarded as something that meets the same

need
Substitute products are produced in a different industry –but crucially satisfy
the same customer need.  If there are many credible substitutes to a firm’s
product, they will limit the price that can be charged and will reduce industry
profits.

As an example, consider the many substitutes that consumers now have to

buying a newspaper for their news:

The extent of the threat depends upon

 The extent to which the price and performance of the substitute can
match the industry’s product
 The willingness of customers to switch
 Customer loyalty and switching costs

If there is a threat from a rival product the firm will have to improve the
performance of their products by reducing costs and therefore prices and by
differentiation.

Degree of competitive rivalry

If there is intense rivalry in an industry, it will encourage businesses to

engage in
  Price wars (competitive price reductions),
 Investment in innovation & new products
 Intensive promotion (sales promotion and higher spending on
advertising)

All these activities are likely to increase costs and lower profits.

Several factors determine the degree of competitive rivalry; the main ones
are:

Factor Note

Number of competitors in the Competitive rivalry will be higher in an industry with

market many current and potential competitors

Market size and growth prospects Competition is always most intense in stagnating
markets

Product differentiation and brand The greater the customer loyalty the less intense the
loyalty competition
The lower the degree of product differentiation the
greater the intensity of price competition

The power of buyers and the If buyers are strong and/or if close substitutes are
availability of substitutes available, there will be more intense competitive
rivalry

Capacity utilisation The existence of spare capacity will increase the

intensity of competition

The cost structure of the industry Where fixed costs are a high percentage of costs then
profits will be very dependent on volume
As a result there will be intense competition over
market shares

Exit barriers If it is difficult or expensive to exit an industry, firms

will remain thus adding to the intensity of
competition 

The Story of IKEA.

When Ingvar Kamprad founded the first IKEA business back in 1943 he could never imagine
how his business would develop. In the beginning of the 1980s - with IKEA stores in almost
20 countries and with a plan to keep expanding - Ingvar Kamprad realized that in order to
stay true to the IKEA vision of creating a better everyday life for the many people, he
needed to protect the unique IKEA Concept. To protect the IKEA Concept, Ingvar looked for
a system that would always act in the best interests of the IKEA Concept and of the many
people. Since he wanted total independence and an ownership structure suited for a long-
term perspective, the stock market wasn’t an alternative. Besides – he believed that all the
different companies operating under the IKEA Brand first had to build resources before they
could expand. This old fashion common-sense proved pretty successful.

Today IKEA faces an intense in the global market of discount furniture and the major players
in the industry include Euromarket Designs Inc, Galiform plc, Wal-Mart Stores Inc, Argos and
others. However, currently IKEA is the undisputed market leader in the industry of
discounted furniture in the global scale. Moreover, chances of emergence of new
competition for IKEA is insubstantial as the current market is saturated and significant
amount of financial investments and expertise are required to become a discounted
furniture retailer in a global scale.

However, chances of emergence of new competition for IKEA is insubstantial as the current
market is saturated and significant amount of financial investments and expertise are
required to become a discounted furniture retailer in a global scale. Yet there are no too
many products and services available that can substitute the demand for furniture, home
appliances and a range of other products offered by IKEA. There are numerous factories
around the globe with the capabilities and resources to form partnership with IKEA. At the
same time, IKEA pursues the strategy of forming strategic long-term relationships with its
suppliers.

(source: Research Methodology. At: http://research-methodology.net/ikea-porters-five-forces-analysis/.

Q: List the 5 of Porters’ competitive forces and identify examples from the above story of
IKEA that illustrates each force.
 Starbucks.

The industry Starbucks operates in has major competitors like Costa, McDonald’s, Caribou
Coffee, and Dunkin Donuts and thousands of small local coffee shops and cafes. One of the
challengers Starbucks faces is that there is no and minimal switching cost for customers, and
there is an abundance of offers available for them.

There are a couple of substitutes for Starbucks Coffee like tea, juices, soft drinks, water and
energy drinks, whereas pubs and bars can be highlighted as substitute places for customers
to meet someone and spend their times outside of home and work environments. The
demand for coffee is high in global level and coffee beans can be produced only in certain
geographical areas. Moreover, the issues associated with African coffee producers being
treated unfairly by multinational companies are being resolved with the efforts of various
non-government organisations, and this is contributing to the increasing bargaining power
of suppliers. The market is highly saturated and substantial amount of financial resources
associated with buildings and properties are required in order to enter into the industry.

(source: Research Methodology. At http://research-methodology.net/starbucks-

porters-five-forces-analysis/. Accessed on 21/Oct/2013)

Q: List the 5 of Porters’ competitive forces and identify examples from the above case of
Starbucks that illustrates each force.