INDUSTRY ANALYSIS

RESOURCES

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 PORTER’S FIVE FORCES

Porter’s Five Forces Michael Porter​ designed a framework to analyse

the strengths and the weaknesses of a sector and
determine its profitability in the long term. The
framework is named​ PORTER'S FIVE FORCES​, and
it's one of the most well known and widely used
strategic models of analysis and that is why it’s
essential for you to understand it.

Porter, M.E. (1979). How Competitive Forces Shape Strategy. Harvard Business Review

What is it for? It was created with the objective to help us e

​ valuate
the profitability of an industry​.

Furthermore, it helps to create an i​ mage​ of the five

different forces that affect a sector​:

● The t​ hreat​ of existing s​ ubstitute products​.

● The t​ hreat​ of n​ ew competitors ​entering, which
is closely related to the barriers to entry.
● The p ​ ower​ that s​ uppliers​ have over you.
● The p ​ ower​ that c ​ ustomers​ have over you.
● These four previous forces greatly influence
the degree of c ​ ompetitive rivalry​ that exists
within a sector.

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1. Threat of These are the products that s​ atisfy the same needs​,
for example, beer and wine. These products don’t need
substitution
to necessarily compete head-on in the marketplace. If
there are products in your sector or outside of it that
can substitute the value that you’re offering, your
position in the marketplace and profitability could be
threatened.

2. Threat of New This is one of the most important factors and it has a
lot to do with the b​ arriers to entry​: if the barriers are
Entrants
high, the threat of new competitors entering will be
lower. For example, if there is a need for a large
investment or if there are a lot of regulations, the
barriers to entry are high. A sector that is better
protected​ from the new competitors entering will
allow you to have a far more favourable position and
to be more p ​ rofitable​.

3. The Power This force determines whether the suppliers have a lot
of power over you, which would compromise your
of Suppliers profits.

For example, the mobile phone shop, Orange; imagine

your service provider is Orange, who has a great deal
of power over you and they can easily replace you,
and this affects negatively your profitability.

The opposite example would be a large scale food

distributor, such as Mercadona; in this case, the
providers are generally smaller, therefore this favours
the company as they can enhance their profitability.

4. The Power If they have a lot of power, they are bigger, etc. we will
have problems with profitability. For example, in the
of Buyers
case of the farmer who supplies Walmart, the buyer
(Walmart) is much bigger than them, so the farmer will
be less profitable.

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 Switching Cost
A very important concept is the S​ witching Cost​, i.e.
how easy it is for your buyer to switch the provider.

As we saw in the case of the SAAS models, the clients

that had higher switching costs benefited the business.
On the contrary, if the switching costs are low, like in
the car insurance industry, it results in a greater
competitive rivalry.

Commodities
Another important element to keep in mind are
commodities​, i.e. that your value proposition is the
same as everyone else’s. In the case of a highly
commoditized sector, where everyone offers the same
and it boils down to a simple question of price, the
power of the buyer is huge because the switching
costs are so low​.

5. Competitive All of these forces influence the degree of competitive

rivalry within a sector. Usually, it is said that almost all
Rivalry
sectors are like r​ ed oceans​, i.e. there is a lot of
competitive rivalry (​ pricing, investments to
differentiate themselves, etc.) which causes l​ ower
profits​.

For example, in commercial banking, there are lots of

different competitors and all of them offer the same,
which results in lower profits.

You also need to understand the b ​ arriers to exit​. If the

competitors within a sector have heavily invested to
enter the sector, leaving it would imply huge
carry-over costs or they may not even be able to
leave the sector at all. These are what we call barriers
to exit, if you’re forced to compete within a sector,
you’re doomed to make the competitive rivalry much
worse, which lowers the profits even further.

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 BARRIERS TO ENTRY

What are barriers to Remember, that barriers to entry increase the

profitability and the value of a company. They also
entry?
influence the running of many sectors and the
competitive rivalry.

Warren Buffett says that he only invests in businesses

with barriers to entry (which he actually calls moats),
and he defines them like this:

“A good business is like a strong castle with a deep

moat around it. I want sharks in the moat. I want it
untouchable”.

Depending on which perspective you look at it from,

the barriers to entry could be p ​ ositive​ (if you are
already within the market or the sector) or they could
be n
​ egative​ (if you’re outside of the market).

Main Factors Economies of Scale: ​to compete in a sector, you have

to be very big. Many times, these are sectors with high
which Promote
price sensibility: e.g. Walmart or Amazon.
Barriers to Entry
•N
​ etwork Effects: ​you reach a huge critical mass by
connecting the supply and demand and you generate
more value. For example, Waze.

•B​ rands: ​a powerful brand that customers feel

identified with, like Nike or Coca-Cola.

•N​ ecessary Investment: s​ ectors where you have to

invest a lot to enter. For example, cruise ships or real
estate.

•S
​ witching Costs: ​there are sectors that manage to
maintain their customers. These customers are
discouraged from changing to a different provider. For
example the case of Microsoft.

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 •A
​ ccess to Resources: ​for example, oil stations with
access to natural resources or a gym in a specific
area.

•P
​ atent: y
​ our business is protected for​ a
​ certain
period of time, like Tetrapack.

•L
​ egal Protection: ​you always need to think about the
possible barriers to entry, how to protect your business
with regards to potential competitors in the sector. The
barriers to entry generate an enormous advantage for
those that are already in the market.

PRODUCT LIFE CYCLE

What is a product Understanding well what is a p ​ roduct life cycle w ​ ill

help us better analyze a sector and understand the
life cycle?
factors like the competitive rivalry, profitability, growth
strategies, etc.

We want you to understand how the life cycle affects

the business in each of the stages. In other words, how
is business’ profitability evolving, what is its growth
strategy, its costs and the competitive rivalry.

All products, product categories, brands and

businesses go through the following phases or stages:

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Introduction Sales grow slowly as demand hasn’t quite yet
validated the product. There are still very few
customers, the majority are what we call e ​ arly
adopters​.

• The product is manufactured on a smaller scale, it’s

still not efficient nor they have access to economies of
scale.

• Very high unit costs and low profits.

• A lot of investment is required to grow.

• There are few competitors. It’s necessary to invest

heavily in marketing to make the product known.

Growth • The demand grows and as a consequence, the sales

are skyrocketing.

• Businesses begin to be profitable.

• Other companies attracted by the profits, begin to

enter the market space.

• There’s still a lot of growth potential.

• One of the biggest challenges is investing a lot in

marketing to achieve more growth.

• It’s better to invest before the maturity phase as

there is still potential for growth.

Maturity • Almost all the demand already accessed the product

and from here on, sales grow in a vegetative way,
through pure renewal.

• Competitors that achieve a good market share

become big companies, with economies of scale, and
very profitable.

• We already know the size of the market so in order

to grow, you have to take the market share from the

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 competition which is quite complicated. This is where
the ​red ocean c
​ omes in.

Decline • It is the moment when various factors, such as a

change in taste or substitute products, cause sales to
drop.

• The demand decelerates.

• There is almost no demand for the product, the

companies need to reinvent themselves or simply die.

CONCENTRATION

Levels of The concentration depends on the number of

competitors and how they divide the total market
concentration
share. It’s important to consider this perspective
because it determines how the competition works
within a sector, what profits each player receives, the
barriers to entry, etc.

The market share is the percentage of sales

generated by a company out of the whole market.
The concentration depends on:

• The number of competitors.

• The size of the competitors.
• The distribution of the market share.

In consequence, we have a scale that starts with​ low

concentration​ or f​ ragmented sectors​ to h
​ ighly
concentrated sectors​.

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Monopoly There is just one company, no competition, giving
great advantages such as fixing prices and not
worrying about others. It’s an ideal situation for a
business. For example, Microsoft.

Oligopoly Without becoming a monopoly, there are sectors in

which few players share almost the entire market.
These are very concentrated sectors. For example, in
the search engine industry: Google, Bing, Yahoo. They
have almost no competition and they lead the change
in the industry as well as fixing the prices.

Low concentration There are a lot of competitors and not one of them
has a high market share. For example, the restaurant
or fragmented industry or business schools. There’s no leader but
sectors there are businesses bigger than others, all of them
competing with differentiation.

DIFFERENTIATION

Levels of Another approach or perspective to analyze a sector is

to evaluate the differentiation between the value
differentiation
propositions between the different competitors in a
sector. This needs to be analyzed from the client’s
point of view.

Differentiation also follows a scale.

Commoditized On the extreme left are all the sectors with a similar
value proposition and the client perceives them to all
be alike or the same. We can use the term,
commoditized​, ​to describe this. For example, raw

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 materials industries or industrial sectors.

Differentiated On the other extreme, we can find the sectors which

are easily differentiated, like the luxury watch sector,
for example.

In between In this center ground, we can find industries such as

the wine sector or the banking sector where the
customer doesn’t feel strongly linked or identified to
the brands. Their proposals are generally quite
commoditized.

There are times when, within the same industry there

are different levels of differentiation, like in the case of
the car manufacturing industry. In this instance we find
that the differentiation is average at a more economic
price point, however there is a far higher level of
differentiation within the luxury car sector.

MACRO ENVIRONMENT (PEST)

PEST Analysis Aside from the sector analysis or analysing the

industry where a company competes, the strategy
should take other ​external factors into account, this is
known as the ​macro environment​. This comprises of
various political, economic, social, technological
factors, these are elements a company can’t control
however they can generate opportunities or pose a
potential threat.

In order to identify them and analyze them, we’re

going to use a simple tool, known as the ​PEST
analysis​.

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What 's it for? This ​tool will help us to ​analyze the environment
where a company is operating. This can be useful to
determine what are the ​political​, ​economic​, ​social ​and
technological factors which could potentially affect a
company.
It’s necessary to do this analysis from a more holistic
point of view.

Perhaps you’ve heard of P

​ ESTEL​, which also includes
legal​ and ​environmental f​ actors in the analysis.

Political There are political factors that can influence your

business or even the whole industry. You need to be
aware of policy and/or changes in legislation that
affect the economy, the specific industry, and the
organization in question.

Government policy, political stability or instability,

bureaucracy, corruption, competition regulation,
foreign trade policy, tax policy, trade restrictions,
labor/environmental/copyright/consumer protection
laws, funding grants & initiatives, etc.

Economic You have to analyze the macro environmental data

such as: the evolution of the GDP, inflation rates, the
rates of unemployment, income levels, exchange rates,
access to resources, levels of development and
economic cycles. It’s also important to investigate the
current and future economic scenarios and economic
policies.

Social Have in mind the following factors: demographic

changes, social mobility, changes in lifestyles. Also
elements such as the levels of education and other
cultural norms such as religion or beliefs, gender roles.
Social habits such as tastes in fashions and spending
habits should be looked at. In short, these are social
trends that could affect a business project.

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Technological The biggest game changer, without a doubt, in the last
few decades with regards to technology was the
internet. You need to understand the technology
penetration, the obsolescence of certain technologies
over time, the coverage, the digital gap, investment in
R&D, new trends in the use of information, as well as
the smart phones.

These are just a few examples of some of the factors

that could affect a sector but it is much better and far
more efficient to identify the ones that will only affect
your business and classify them in terms of their
impact: some will have a greater impact than others,
some won’t affect it at all, this will depend on the
company, the sector and the countries in which you
operate. For example, the impact of political factors on
Uber nowadays are very high. What’s more, this could
have a positive or negative impact.

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