Porter's Five Forces analysis of market structure
The competitive structure of an industry can be analysed using Porter's five forces.
This model attempts to analyse the attractiveness of an industry by considering five forces within a market.
According to Porter (1980) the likelihood of firms making profits in a given industry depends on five factors:
1. The likelihood of new entry i.e. the extent to which barriers to entry exist. The more difficult it is for other firms to enter a market the more likely it is that existing firms can make relatively high profits.
The likelihood of entering a market would be lower if:
2. The power of buyers.
The stronger the power of buyers in an industry the more likely it is that they will be able to force down prices and reduce the profits of firms that provide the product.
Buyer power will be higher if:
3. The power of suppliers.
The stronger the power of suppliers in an industry the more difficult it is for firms within that sector to make a profit because suppliers can determine the terms and conditions on which business is conducted.
Suppliers will be more powerful if:
4. The degree of rivalry
This measures the degree of competition between existing firms. The higher the degree of rivalry the more difficult it is for existing firms to generate high profits.
Rivalry will be higher if:
5. The substitute threat.
This measures the ease with which buyers can switch to another product that does the same thing e.g. aluminium cans rather than glass or plastic bottles. The ease of switching depends on what costs would be involved (e.g. transferring all your data to a new database system and retraining staff could be expensive) and how similar customers perceive the alternatives to be.
Using Porter's analysis firms are likely to generate higher returns if the industry:
On the other hands returns are likely to be low if:
The implication of Porter's analysis for managers is that they should examine these five factors before choosing an industry to move into. They should also consider ways of changing the five factors to make them more favourable.
The five forces will change over time as market conditions alter. For example, more information is available nowadays to enable customers to compare offerings and prices; this gives buyers more power. The opening up of world markets (for example through the efforts of the World Trade Organisation to reduce protectionist measures that limit trade and the expansion of the European Union enabling free trade between more countries) has led to much more rivalry in markets in recent years. In North America, for example, the sales of Japanese firms such as Toyota have gradually been reducing the market share of American producers such as General Motors as consumers have more choice. Meanwhile, the success of the internet has made it easier for producers to enter many markets such as finance, book retailing and clothes retailing; the ability to start selling online has reduced a major barrier to entry which was the investment required to set up a network of shops. As ever the business world is not static and the conditions in any industry will always be changing. As this happens the various elements of the five forces are always shifting requiring established firms and potential entrants to review their strategies.
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