Porter’s 5 Forces Framework – Competitive Analysis of an Industry

Porter’s framework is extremely established as a premium model to establish the competitiveness of any industry.  One of the challenges in using the framework is understanding what each of the nuances of the forces are. In this article we provide the details which are captured within each force conceptualized by Michael Porter in the framework diagram provided below.

So what do these five forces comprise of? Let us try to understand them one by one.

Porters_Five_Forces

  1. The bargaining power of buyers / customers : This paradigm of challenge 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, degree of product differences, customer’s switching cost, customer’s volume vs industry output, price sensitivity, buyer’s profits and last but not the least decision maker’s incentives. Higher is the bargaining power of the customer, as can be comprehended easily, automatically, lower is the industry attractiveness.
  2. The intensity of competitive rivalry: This threat 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, concentration among the leading players, switching costs, Information flow, Information sharing complexity, diversity of competing businesses and last but not the least exit barriers. Higher is the intensity, as easily understood, automatically, lower is the industry attractiveness.
  3. The threat of substitutes: This threat attempts to understand to what extent there is a possibility of the industry’s output, namely the manufactured product or the delivered services being substituted by some other category of products or services. Factors which predominantly matter in this force are the relative relative functional performance advantage, price advantage, delivery regularity advantage, switching costs of the customer for moving to the substitute (like investments in new technology) and the customer’s propensity to substitute. Higher is the treat of substitutes, lesser is the attractiveness of the industry.
  4. The threat of the entry of new competitors: This encompasses the challenges surrounding if new competitors were to enter the same industry for which the analysis is being conducted. The subsequent issue is that if such a condition were to come true, how would the profitability be affected? This is measured by the indicators which are detailed subsequently and is a proxy measure for the degree of attractiveness of the industry. Factors could be issues surrounding brand identity, economies of scale,switching costs for the customers, proprietory product differences,capital intensive nature of the industry, absolute cost advantages, access to distribution channels, access to skilled work-force, government policy surrounding new entrants and potential retaliation or fallouts. It needs to be noted that higher is the threats of entry of new competitors, as easily comprehended, automatically, lower is the industry attractiveness.
  5. The bargaining power of vendors / suppliers: This force of Porter’s framework 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, potential for backward integration and threats of forward integration. Higher is the bargaining power of the suppliers, as easily understood, automatically, lower is the industry attractiveness.

This has evolved to become one of the most preferred frameworks of strategic management. However, it should be noted that Porter’s framework (or Barney’s approach) is that of a static view of the industry. However the industry is very dynamic in meeting its business as usual. That is where this framework has some serious limitations. This becomes extremely critical especially in the digital era, where businesses, processes, commodities, products and services are digitised, and thereby making the ecosystem all the more dynamic for the analysis of attractiveness. The networked digital economy with the introduction of inter-organization information systems, is a case, which the framework fails to explain.

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