The Five Forces Framework

12 Key excerpts on "The Five Forces Framework"

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  Strategy in Practice

  A Practitioner's Guide to Strategic Thinking

  • George Tovstiga(Author)
  • 2015(Publication Date)
  • Wiley

    (Publisher)

  Firms' conduct – that is, their strategy – is determined by the nature of competition in their respective competitive contexts. The “five forces” represent structural forces that determine the attractiveness (e.g. profitability potential) of a market place. The corresponding analysis places the emphasis on identifying the “right industry” and within that the attractive positions. It provides an external perspective that is most suitable for a market-level analysis. It is less suitable for an industry group or sector level analysis, unless that industry features similar or comparable value offerings. The “five forces” analysis can provide valuable insights into the nature of competition in a market and, by extension, the attractiveness of that market from the firm's perspective. In essence, the “five forces” analysis framework is comprised of an industry value chain that features the possibility of additional inputs that account for the threat of new entrants and/or the threat of substitution of the value offering in question altogether. The framework has limitations. First, it is based on assumptions that for the most part are no longer considered tenable. Our understanding of the determinants of industry rivalry, market dynamics, and competitive behavior of firms has progressed significantly since the framework made its appearance. Industry boundaries – a fundamental element of the Porter framework – are increasingly defying precise definition. Value chains are becoming ever more complex, with organizations simultaneously engaging in competition and selective collaboration; situations referred to as “co-opetition.” There is also an increase in the number of complementary relationships, such as that between Microsoft and Intel, that the limited framework is incapable of taking into consideration. Many industries can be viewed as complex networks of mutually dependent players in which niche players assume important roles in complementing the market leaders

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  Business Strategy

  • George Stonehouse, Bill Houston, David Campbell(Authors)
  • 2003(Publication Date)
  • Routledge

    (Publisher)

  Figure 7.1 ) it is important to identify which of the five forces are the key forces at work in an industry at any given point in time. In many cases, it transpires that one or more of the five forces prove to be ‘key forces’ and the strategic analysis must focus on these if it is to use the framework fruitfully. The dynamic nature of the competitive environment (meaning that it is constantly changing) means that the relative strength of the forces in a particular industry will change over time. It is therefore important that the five forces analysis is repeated on a regular basis so as to detect such changes before competitors and allow an early adjustment of strategy. Before any conclusions can be drawn about the nature of competition within an industry each of the five forces must be analysed in detail.

  Figure 7.1 Porter's five forces framework (adapted from Porter, 1980).

  We will now discuss each of the five forces in turn.

  Force 1: The threat of new entrants to the industry

  The threat of entry to an industry by new competitors depends upon the ‘height’ of a number of entry barriers. As a rule of thumb, the lower the entry barriers to an industry are, the more competitors will be players in the industry. Barriers to entry can take a number of forms.

  The capital costs of entry

  The size of the investment required by a business wishing to enter the industry will be an important determinant of the extent of the threat of new entrants. The higher the investment required, the less the threat from new entrants. The lower the required investment, the greater the threat.

  Regulatory and legal constraints

  Industry regulation varies. Some industries, such as energy, pharmaceuticals and defence equipment, are subject to a complex regulatory framework whereas others are less so. In some industries, regulation concerns health and safety, product handling and licences to operate, export, set up new facilities, etc. Each regulatory or legal permission or restriction is capable of acting as a barrier to entry.

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  Public Sector Strategy Design

  Theory and Practice for Government and Nonprofit Organizations

  • David E. McNabb, Chung-Shing Lee(Authors)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  PART II

  Frameworks for Designing Strategy

  Passage contains an image

  4 THE COMPETITIVE FORCES FRAMEWORK

   

  The competitive forces framework (also known as the strategic positioning approach or as Porter’s five forces approach) to strategic management developed. Credit for introducing the framework is given to Michael Porter, who in 1979 and 1980 emphasized the importance of managing an organization’s value chain and adoption of a competitive positioning in the marketplace. The five forces that Porter said make up an organization’s competitive environment are: (1) the firm’s competitive rivalry, (2) the power of its suppliers, (3) the power of buyers of the organization’s goods or services, (4) the threat of substitute products, and (5) the threat of new suppliers entering the market. The five forces are all external environment factors. Porter then named four types of generic strategies that organizations adopt to deal with these forces: differentiation, cost leadership, cost focus, and differentiation focus. Many alternative strategies have been added since the 1980s, including a combination strategy, innovation strategy, technology strategy, learning strategy, and others.

  Writing on game theory as studied in economics, Samuelson and Nordhaus (1985) saw the variety in the paths followed by researchers in the social sciences as different not so much by what the researchers studied, but by how they studied their subject. The same idea can help explain the differences in the organizing frameworks preferred by researchers in public sector management. The framework followed for several decades beginning in the 1970s was patterned after the private sector’s competitive advantage concept and how to adjust operating in a competitive environment to public sector operations.

  The competitive forces framework was developed as a means of analyzing the competitive environment faced by a firm in a given industry. The approach has also been modified for use for in-depth analysis of a public sector organization’s operation environment. In both applications, designing strategy using the Porter five forces framework is generally conducted after a SWOT environmental analysis. The applications process includes the following seven steps.

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  Economics of Strategy

  • David Besanko, David Dranove, Mark Shanley, Scott Schaefer(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  We selected these markets both because they present a diversity of competitive forces and because we have a strong institutional understanding of each. Indeed, solid industry analysis is not possible without such understanding. Before presenting the five-forces framework, it is important to note its limita-tions. First, it pays limited attention to factors that might affect demand. It accounts for the availability and prices of substitute and complementary products but ignores changes in consumer income, tastes, and firm strategies for boosting demand, such as advertising. Second, it focuses on a whole industry rather than on individual firms that may occupy unique positions that insulate them from some competitive forces. Third, the framework does not explicitly account for the role of the government, except when the government is a supplier or buyer. The government as a regulator can profoundly affect industry profitability and could be considered a sixth force. Fourth, five-forces analysis is qualitative. For example, an analysis of industry structure may suggest that the threat of entry is high, but the framework does not show how to estimate the cost of entry or the likelihood that entry will occur. P ERFORMING A F IVE -F ORCES A NALYSIS The five forces, as represented in Figure 8.1, are: • Internal rivalry • Entry • Substitute and complementary products • Supplier power • Buyer power Internal rivalry is in the center because it may be affected by each of the other forces. One assesses each force by asking “Is it sufficiently strong to reduce or eliminate industry profits?” The answer to this question can be found by applying the eco-nomic principles that we have presented in this text.

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  Business Development

  A Market-Oriented Perspective

  • Hans Eibe Sørensen(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  So trainers may be substitutes for jeans to some segments. Remember that and ponder on how this influences your next competitor analysis. Who are my true competitors? PAUSE FOR THOUGHT! Consider a recent purchase and identify the producer’s real competitors from your perspective. No hint. 4.2 The P5F framework: industry attractiveness and future investments Professor Porter’s five competitive forces framework (Figure 7.6), or P5F, gives us the managerial version of robust research based on industrial organization, as mentioned earlier in Chapter 6. In essence, the P5F framework focuses on how five different forces – competitive rivalry, buyers’ bargaining power, suppliers’ bargaining power, potential entrants and extra- industry substitutes – at industry level influence the business venture’s ability to generate profits (Porter, 1980, 2001, 2008). For the business developer, the P5F framework serves two main purposes, as Porter (2008) kindly reminded the lecturers, scholars and practitioners alike who had forgotten his great work from the 1980s. First, the combined five forces provide an assessment of the industry’s overall attractiveness for new investments. Second, they provide an immediate overview of the industry’s opportunities and threats, which indicates the direction for future investments. The former is of special interest to potential investors interested in business start-ups. The 250 B U S I N E S S D E V E L O P M E N T business developer’s ability to identify the critical competitive forces and assess their actual magnitude is also very important to establish credibility about his or her capability as a business developer and the viability of the business opportunity for decision-makers, be they senior management or the board, investors or industry experts that the investors draw on to make a due diligence or assess an investment opportunity.

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  Strategic Thinking

  Today’s Business Imperative

  • Irene M. Duhaime, Larry Stimpert, Julie Chesley(Authors)
  • 2012(Publication Date)
  • Routledge

    (Publisher)

  The implicit aim of industrial organization economics has been to understand the structural characteristics that allow industries to deviate from the perfectly competitive “ideal.” Porter’s model adopted the structure-conduct-performance framework, but Porter’s work departed from the traditional industrial organization economics perspective in two significant ways. First, he recognized that if firms could either make their industries less competitive or shield themselves from the competitive forces in their industries, then they could enjoy higher performance. Second, Porter’s approach identified and described five specific “forces” that could be used to evaluate the structural characteristics of an industry. For each of the five forces, Porter identified sets of factors that would determine the presence and power of the force in a particular industry environment.

  The Five Forces Model is almost always depicted as shown in Exhibit 4.4. Exhibit 4.4 also provides a comprehensive list of factors for evaluating the power or intensity of each of the five forces. The logic behind the model is straightforward: As the intensity of the forces increases, the industry environment becomes more hostile and overall industry profitability will decline. In the following sections, the five forces and the sets of factors associated with each of the five forces are examined in more detail.

  Exhibit 4.4 The Five Forces Model

  The Threat of Entry

  If new rivals can enter an industry relatively easily, then the industry will probably be more competitive and it is less likely that the industry will enjoy a high level of average profitability. For example, the lack of entry barriers allowed retailers like Wal-Mart and Target to become major sellers of toys. As a result of their entry and aggressive pricing strategies into this retail segment, longtime toy retailers FAO Schwarz and KB Toys have been forced into bankruptcy. Thus, it is desirable for incumbent firms—those already in an industry or market segment—to erect barriers to prevent other firms from entering. What factors can serve as entry barriers, minimizing the threat of new firms entering an industry? In general, four types of factors can make entry less likely.

  The first set of factors can be thought of as cost barriers. For example, if incumbent firms enjoy scale economies, the benefits of experience and learning effects, or privileged access to key raw materials or technologies, then potential entrants will necessarily enter the industry at a serious cost disadvantage. Economies of scale exist when unit costs decline with increases in production as fixed costs are spread over a larger volume of output. Larger firms that can realize economies of scale can enjoy significant cost advantages over smaller rivals. The concept of minimum efficient scale (MES) is closely related to the concept of economies of scale and refers to the level of production that is required in order to produce at the lowest level of average unit cost. Firms operating at MES are operating at a level of output that allows them to enjoy the lowest possible unit costs, as illustrated in Exhibit 4.5.

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  Tools for Project Management, Workshops and Consulting

  A Must-Have Compendium of Essential Tools and Techniques

  • Nicolai Andler(Author)
  • 2016(Publication Date)
  • Publicis

    (Publisher)

  price structure, investment recovery starts despite slowly declining profits Low prices and margins, falling prices, prices might rise in late decline Business priorities Getting through start-up, ensure enough cash is available Choose between profit and profit- ability, manage rapid growth Consolidation and con- trol of financial gains, size and volumes Reinvest or divest Table 40 Typical insight provided by the life cycle analysis for each development stage (continued) Category Development stages (→) Introduction Growth Maturity Decline 5.1 Strategic analysis 289 Cross-reference to related tools in this book Organisational structure (chapter 5.3.1) for the maturity perspective of the organ- isation. Source: Porter, Rowe, Fleischer, Hax, Glass, Hofmann 5.1.6 5 Forces Intention (Why and when do I use it?) Porter’s Five Forces represents a tool for analysing a company’s environment or industry structure and was first published in 1980 in the book ‘Competitive Strat- egy’ by Michael E. Porter. This tool is one of the classic and standard strategy tools. Despite its age and though it is often critized, it can provide a great deal of insight and learning, hence it is still valuable if used correctly. The Five Forces (5F) tool is best used: • to assess the attractiveness on the basis of competition in an industry, • to identify areas in which industry trends may pose opportunities or threats, • to analyse where the company stands in comparison to the external competi- tive forces, • to understand/diagnose levels of return, • to provide a starting point to understand key drivers and trends. The model can be applied to particular companies, market segments, industries or regions and is best applied to mass production companies or industries that focus on products rather than services.

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  International Encyclopedia of Organization Studies

  • Stewart Clegg, James R. Bailey, Stewart R Clegg, James Bailey(Authors)
  • 2007(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  Competition in an industry continually works to drive the rate of return on invested capital down toward the competitive floor rate of return. The strength of competition forces in an industry deter-mines the ability of firms to sustain above-average returns. The five forces reflect the fact that competi-tion in an industry goes well beyond the established players. Customers, suppliers, substitutes, and poten-tial entrants are considered “extended rivalry.” All five competitive forces jointly determine the intensity of an industry’s competition and profitabil-ity, and the strongest force(s) is/are crucial to strategy formulation. The underlying structure of an industry, reflected in the strength of the forces, should be distinguished from the many short-term factors that can affect com-petition and profitability in a transitory period. The focus of the structural analysis is on identifying indus-try rooted in its economics and technology, which shape the arena in which competitive strategy takes place. Firms will each have unique core competencies in dealing with industry structure, and these will change over time. Although the industry structure is historically built, an understanding of its basic forces is the starting point for analyzing the dynamics of firms’ competitive strategies. Critical Commentary and Future Directions Methodologically, there is some controversy over the appropriate definition of an industry, which is cen-tered on how close substitutes need to be in terms of products and processes. Also, the geographical bound-aries of the industry are not clearly limited to a spe-cific area, region, or nation, nor are they open to the world. Therefore, Porter’s concept of a “national dia-mond” is an extension of the five forces model where “related industries” and national competitive advan-tage are treated in a dynamic context.

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  Contemporary Strategy Analysis

  • Robert M. Grant(Author)
  • 2021(Publication Date)
  • Wiley

    (Publisher)

  ◆ ◆ Apply segmentation analysis and strategic group analysis in order to analyze industries at a more disaggregated level. 78 PART II THE TOOLS OF STRATEGY ANALYSIS is important that we acknowledge the limitations of the Porter framework and, where possible, augment our industry analysis. Hypercompetition The Porter’s five forces framework is based upon the assumption that industry structure determines competitive behavior, which in turn determines industry profitability. But competition also unleashes the forces of innovation and entrepreneurship that trans- form industry structures. Joseph Schumpeter viewed competition as a “perennial gale of creative destruction” in which market-dominating incumbents are challenged, and often unseated, by rivals’ innovations. 3 Schumpeter’s view of competition as a dynamic process in which industry structure is in constant change raises the issue of whether competitive behavior should be seen as an outcome of industry structure or a determinant of industry structure. 4 The issue here is the speed of structural change in the industry: if structural transformation is rapid, then The Five Forces Framework does not offer a stable basis for predicting com- petition and profitability. In most industries, Schumpeter’s process of “creative destruction” tends to be more of a breeze than a gale. In established industries, new entry tends to be infrequent and changes in industrial concentration are slow. 5 One survey observed: “the picture of the competitive process . . . is, to say the least, sluggish in the extreme.” 6 As a result, both at firm and industry levels, profits tend to be highly persistent in the long run. 7 However, this stability of industry structures is being eroded by the disruptive impact of digital technologies.

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  Strategic Management

  Concepts and Cases

  • Jeffrey H. Dyer, Paul C. Godfrey, Robert J. Jensen, David J. Bryce(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  Figures 2.4 through 2.9 are general analytical tools used by a number of Fortune 500 firms to evaluate the intensity of the five forces in an industry, either their own or one they are thinking about entering. 48 These tools essentially help to quantify the ideas that we have already discussed in this chapter. In practice, top management often implicitly understands the dynamics of the five forces and might not personally use the tools presented here to map out the strength of each force and its overall effect on industry profitability. However, a number of For- tune 500 firms use these tools in their strategic planning departments to provide rigor to the strategic analyses and recommendations they present to top management. Although the tools might appear compli- cated, they distill the concepts from this chapter, allowing a relatively simple, yet comprehensive and detailed analysis of the five forces. You can look for the data to complete these analysis tools in the sources listed in the appendix at the end of the book. Many of the indicators in these analysis tools are objective numbers that you can obtain from various data sources. Others are more subjective; they require a logical argument for the level—low, medium, or high—that you choose. Even for more subjective indicators, however, data from various sources, for instance, articles in the business press, can take the guesswork out of doing a five-forces analysis. To use the tools, for each separate item, put an X in the box that most accurately reflects the data you have gathered on your industry. For some boxes this is a range of data, for instance, 60 to 70 percent combined market share in the rivalry tool. If the correct number is anywhere within the range, put an X in the appropriate box. Cite your data source and/or explain the logic of your placement underneath each item. Your answer for some rows of boxes will be an average of more than one item.

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  Essentials of Strategic Management

  • Charles Hill, Gareth Jones(Authors)
  • 2011(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  For example, there is no close substitute for microprocessors, which gives companies like Intel and AMD the ability to charge higher. Porter’s Model Summarized The systematic analysis of forces in the industry environment using the Porter frame-work is a powerful tool that helps managers to think strategically. It is important to recognize that one competitive force often affects the others, so that all forces need to be considered and thought about when performing industry analysis. Indeed, in-dustry analysis leads managers to think systematically about the way their strategic choices will both be affected by the forces of industry competition and how their choices will affect the five forces and change conditions in the industry. For an ex-ample of industry analysis using Porter’s framework, see the Running Case. Strategic Groups within Industries Companies in an industry often differ significantly from each other with respect to the way they strategically position their products in the market in terms of such fac-tors as the distribution channels they use, the market segments they serve, the quality of their products, technological leadership, customer service, pricing policy, advertis-ing policy, and promotions. As a result of these differences, within most industries, it is possible to observe groups of companies in which each company follows a strategy that is similar to that pursued by other companies in the group, but different from the strategies followed by companies in other groups. These different groups of com-panies are known as strategic groups . 12 Normally, the basic differences between the strategies that companies in different strategic groups use can be captured by a relatively small number of strategic fac-tors. For example, in the pharmaceutical industry, two main strategic groups stand out (see Figure 3.2).

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  Strategic Management

  From Theory to Practice

  • Allen C. Amason, Andrew Ward, Allen Amason(Authors)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Other firms may, through regulatory means, try to limit customer options. Cable TV companies, local phone service providers, and power generation firms have all benefited from their status as protected monopolies. While they are subject to considerable regulation and oversight, they are also protected from direct competition. As a result, customers are often left with limited options for cable or power service. In the absence of options, these customers have little or no bargaining power. Indeed, it is to prevent these sorts of suppliers from abusing this bargaining power advantage that these firms and their prices are so carefully regulated. Other firms benefit from legal limitations on competition as well. Companies in the pharmaceutical and biotech businesses often get patents for their products and processes. These patents protect the firms by limiting the ability of competitors to make and sell comparable products. With few if any comparable products available, customers must deal with the patent holder. As a result, the holder of the patent has great bargaining power and great ability to sell more and to sell at a premium price.

  Bargaining power relates directly to competitive advantage and is a large part of understanding profitability. Firms with much bargaining power are often able to sell more and to sell at a higher price. Firms with little bargaining power must often work harder to make sales and will often sell less or sell at a lower price. Thus, understanding bargaining power and the various forces that govern it is a key part of environmental analysis.

  THE 5-FORCES MODEL

  Fortunately, a considerable amount of time and effort has been devoted to understanding bargaining power. From this work has emerged a simple, yet powerful tool, the 5-Forces model (Figure 4.3 ). Developed by Michael Porter (1980), the 5-Forces model depicts competitiveness or profit potential as resulting from the interaction of 5 forces: the bargaining power of sellers, the bargaining power of buyers, the availability of substitute products, the threat of new entrants, and the rivalry among existing competitors.

  FIGURE 4.3

  The Five-Forces Model

  Bargaining Power of the Seller

  Bargaining power of the seller relates to the attractiveness and availability of particular products and services in relation to available options. Returning to the earlier example, Nike is considered a maker of reliable, high-quality athletic shoes and apparel. That perception translates into bargaining power for Nike. Customers can pay Nike’s price or they can settle for something else, but buying from Nike likely means paying a premium price. Quality then, or perceived quality, produces bargaining power for the seller. Bargaining power for the seller can also relate to the absence of competition. Airline ticket prices are generally higher on routes that are served by only one carrier, for instance (Chen et al., 1992). The importance of the product or service also relates to bargaining power. For example, buyers rarely choose a surgeon based on cost. Because of the importance of the service, customers will generally want the best available provider. To get that provider, they may end up having to wait longer for their procedure, having to pay more for the procedure, or both. Quality, exclusivity, prestige, or importance of the product or service can all shift bargaining power away from the buyer and to the seller by limiting the ability of the customer to walk away and go elsewhere.

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