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Michael Porter’s 5 Forces Model Cheat Sheet by

business     model     strategies     porter     forces

Introd­uction

Porter’s 5 forces model is one of the most recognized framework for the analysis of business strategy. Porter, the guru of modern day business strategy, used theore­tical frameworks derived from Industrial Organi­zation (IO) economics to derive five forces which determine the compet­itive intensity and therefore attrac­tiv­eness of a market. This theore­tical framework, based on 5 forces, describes the attributes of an attractive industry and thus suggests when opport­unities will be greater, and threats less, in these of indust­ries.

Attrac­tiv­eness in this context refers to the overall industry profit­ability and also reflects upon the profit­ability of the firm under analysis. An “unatt­rac­tive” industry is one where the combin­ation of forces acts to drive down overall profit­abi­lity. A very unattr­active industry would be one approa­ching “pure compet­ition”, from the perspe­ctive of pure industrial economics theory. It is important to note that this framework is not for the analysis of individual firms but for the analysis of the industry.

Despite its limita­tions in the technology enabled business era, Porter’s 5 forces model is still the leading framework for the analysis of industry attrac­tiv­eness. The limita­tions of the Porter’s 5 forces model induced the introd­uction of the 6th Force, namely the Comple­men­tors.

This model comprises of an analysis dependent on 4 entities external to the firm and the fifth force: the Industry structure. These forces are defined as follows:

1. The threat of the entry of new compet­itors

The following factors can have an effect on how much of a threat new entrants may pose:
The existence of barriers to entry (patents, rights, etc.). The most attractive segment is one in which entry barriers are high and exit barriers are low. Few new firms can enter and non-pe­rfo­rming firms can exit easily.
Government policy
Capital requir­ements
Absolute cost
Cost disadv­antages indepe­ndent of size
Economies of scale
Economies of product differ­ences
Product differ­ent­iation
Brand equity
Switching costs or sunk costs
Expected retali­ation
Access to distri­bution
Customer loyalty to establ­ished brands
Industry profit­ability (the more profitable the industry the more attractive it will be to new compet­itors)
 

Porter 5 Factors

2.The intensity of compet­itive rivalry

This is captured by a number of metrics like the growth rate of the industry, the ratio of cost structure to the value added, cost of over-c­apa­city, degree of output differ­ences among compet­itors, impact of brand and its conversion to sales, switching costs, concen­tration among the leading players (Herfindal Index), Inform­ation flow and comple­xity, diversity of competing businesses and exit barriers. Higher is the intensity, lower is the industry attrac­tiv­eness.

3. The threat of substitute products or services

The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to altern­atives. Potential factors:
Buyer propensity to substitute
Relative price perfor­mance of substitute
Buyer switching costs
Perceived level of product differ­ent­iation
Number of substitute products available in the market
Ease of substi­tution
Substandard product
Quality deprec­iation
Availability of close substitute

4.The bargaining power of custom­ers­/buyers

This force tries to estimate the degree of bargaining of post-facto relati­onships that may be empowered due to the dynamics of the relati­onship. This could be captured through some metrics like the buyer’s concen­tration as compared to the Industry’s concen­tra­tion, customer’s volume vs industry output, customer’s switching cost, price sensit­ivity, degree of product differ­ences, buyer’s profits and decision maker’s incent­ives. Higher is the bargaining power of the customer, lower is the industry attrac­tiv­eness.

5. The bargaining power of suppliers

This force tries to explore the impact of the bargaining power of the industry’s suppliers and how much they can force the industry to share the benefits of value creation through this bargaining power. Factors are covered in terms of differ­ent­iation of inputs, switching cost of the suppliers, relati­onship specific invest­ments required, presence of substitute inputs, supplier’s industry concen­tra­tion, importance of volume to the suppliers, cost relative to the total purchases in the industry, impact of supplier’s inputs to overall cost structure or differ­ent­iation, threats of forward integr­ation, and potential for backward integr­ation. Higher is the bargaining power of the suppliers, lower is the industry attrac­tiv­eness.

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