What Is Porter’s 5 Forces?

What is Porter’s 5 Forces? Porter’s fives forces model is a strategic analysis model that can help analyse a particular environment of a market/sector. It considers the impact and influence of 5 main forces: 1) Competitive Rivalry 2) Power of suppliers 3) Power of buyers 4) Threats of substitutes 5) Threat of new entrants. The above five main factors are key factors that influence industry/market performance; hence it is common sense and practical to find out about these factors when working within the industry. Where does it fit in with Category Management? Gather Internal and External Data Analyse Data and Generate Options

Plan and Implement Strategy What is included in this guide? Porter’s 5 Forces Use of the information from Porter’s 5 Forces Example Tactics – Reducing Competitive Forces Which processes does the tool apply to? SRM and Strategic Sourcing Which other tools link to this guide? SWOT Analysis PEST Analysis Supply Market Analysis Supply Market Research 3 Porter’s 5 Forces Analysis Porter’s 5 Forces The most commonly used technique in Supply Market Analysis is Porter’s “Five Forces” tool, which looks at the pressures the supplier is facing in their marketplace and how these can be used to the buyer’s advantage.

For example, if the supplier is under cost pressure from its other buyers, its patent is about to expire (letting substitutes in), and a new competitor can provide the goods at lower cost, the supplier will not want to lose the contract with us, and we are in a strong negotiating position. Bargaining Power of Suppliers Supplier bargaining power is likely to be high when: The market is dominated by a few large suppliers rather than a fragmented source of supply There are no substitutes for the particular input The suppliers customers are fragmented, so their bargaining power is low The switching costs from one supplier to another are high

There is the possibility of the supplier integrating forwards in order to obtain higher prices and margins. This threat is especially high when Insights to Develop • What forces are at work? • What drivers most influence supplier competitiveness in this segment? • What is the profile of a successful competitor in this market? • How can you use supply market dynamics to its advantage? 4 The buying industry has a higher profitability than the supplying industry Forward integration provides economies of scale for the supplier The buying industry hinders the supplying industry in their development (e. . reluctance to accept new releases of products) The buying industry has low barriers to entry. In such situations, the buying industry often faces a high pressure on margins from their suppliers. The relationship to powerful suppliers can potentially reduce strategic options for the organisation. Bargaining Power of Customers Similarly, the bargaining power of customers determines how much customers can impose pressure on margins and volumes Customers bargaining power is likely to be high when: They buy large volumes, there is a concentration of buyers

The supplying industry comprises a large number of small operators The supplying industry operates with high fixed costs The product is undifferentiated and can be replaces by substitutes Switching to an alternative product is relatively simple and is not related to high costs The product is not of strategic importance for the customer The customer knows about the production costs of the product. Threat of New Entrants There will be more competition in an industry where other companies can easily enter the market. In such a situation, new entrants could change major determinants of the market environment (e. . market shares, prices, customer loyalty) at any time. The threat of new entries will depend on the extent to which there are barriers to entry. These are typically: Economies of scale (minimum size requirements for profitable operations) High initial investments and fixed costs Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets Brand loyalty of customers Protected intellectual property like patents, licenses etc 5 Scarcity of important resources, e. g. qualified expert staff Access to raw materials is controlled by existing players

Distribution channels are controlled by existing players Existing players have close customer relations, e. g. from long-term service contracts High switching costs for customers Legislation and government action. Threat of Substitutes A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category also relates to complementary products.

Similarly to the threat of new entrants, the threat of substitutes is determined by factors such as: Brand loyalty of customers Close customer relationships Switching costs for customers The relative price for performance of substitutes Current trends. Competitive Rivalry between Existing Players This force describes the intensity of competition between existing players (companies) in an industry. High competitive pressures result in pressure on prices, margins, and hence, on profitability for every single company in the industry.

Competition between existing players is likely to be high when: There are many players of about the same size Players have similar strategies There is not much differentiation between players and their products, hence, there is much price competition Low market growth rates (growth of a particular company is possible only at the expense of a competitor), Barriers for exit are high (e. g. expensive and highly specialized equipment). 6 How to use the Five Forces Model The approach to applying Porter’s 5 Forces Analysis follows a number of key steps, which can be summarised as: 1.

Determine the scope of the market to be analysed, but not too narrow so as to miss important factors 2. Identify and analyse all relevant forces for this market 3. Examine current and potential future states of the five competitive forces 4. Identify options to influence the forces in your organisation’s interest 5. The objective is to reduce the power of competitive forces Use of the information from Five Forces Analysis Five Forces analysis can provide a valuable contribution to the data analysis and generation of strategic options. Statistical Analysis

The Five Forces analysis allows determining the attractiveness of a specific industry or supply market. It provides insights on profitability and thus the potential strengths of key players and future strategies they may be looking to adopt. Dynamical Analysis In combination with a PEST-Analysis, which reveals drivers for change in an industry, Five Forces can reveal insights about future attractiveness. Expected political, economical, socio-demographical and technological changes can influence the five competitive forces and thus have an impact on industry structures. Analysis of Options

With the knowledge about intensity and power of competitive forces, organisations can develop options to influence them in a way that improves their own competitive position. The result could be a new strategic direction or approach to the management of the supply market or management of specific key suppliers therein. Some example tactics are provided below. 7 Example Tactics – Reducing Competitive Forces Buyers Perspective The buyers use of Porter’s Five Forces will be driven creating a view of the suppliers perspective and creating a strategy to negate the supplier desired state. Reduce the suppliers bargaining power

Encourage new entrants to maintain market competitiveness Encourage substitute product development to reduce cost / increase competition Encourage competitive rivalry. • Partnering • Supply chain management • Increase loyalty • Increase incentives and value added • Move purchase decision away from price • Cut put powerful intermediaries (go directly to customer) • Partnering • Supply chain management • Supply chain training • Increase dependency • Build knowledge of supplier costs and methods • Take over a supplier • Increase minimum efficient scales of operations • Create a marketing / brand image (loyalty as a barrier) Patents, protection of intellectual property • Alliances with linked products / services • Tie up with suppliers • Tie up with distributors • Retaliation tactics Reducing the Treat of New Entrants Reducing the Threat of Substitutes Reducing the Bargaining Power of Customers Reducing the Bargaining Power of Suppliers • Legal actions • Increase switching costs • Alliances • Customer surveys to learn about their preferences • Enter substitute market and influence from within • Accentuate differences (real or perceived) Reducing the Competitive Rivalry between Existing Players • Existing Players • Avoid price competition Differentiate your product • Buy out competition • Reduce industry over – capacity • Focus on different segments • Communicate with competitors• Partnering• management• loyalty• added• price• out Threat of New Entrants Substitutes• actions• costs• property• Alliances• services• preferences• within• Players• overcapacity• segments• About OGC OGC – the UK Office of Government Commerce – is an Office of HM Treasury. The OGC logo is a registered trademark of the Office of Government Commerce. OGC Service Desk OGC customers can contact the central OGC Service Desk about all aspects of OGC business.

The Service Desk will also channel queries to the appropriate second-line support. We look forward to hearing from you. You can contact the Service Desk 8am – 6pm Monday to Friday T: 0845 000 4999 E: [email protected] gsi. gov. uk W: www. ogc. gov. uk Press enquiries T: 020 7271 1318 F: 020 7271 1345 This document is printed on material comprising 80 per cent post consumer waste and 20 per cent ECF pulp. Office of Government Commerce, 1 Horse Guards Road, London SW1A 2HQ Service Desk: 0845 000 4999 E: [email protected] gsi. gov. uk W: www. ogc. gov. uk © Crown Copyright 2006

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