Industry analysis is an essential task for any organisation that seeks to maximise profits. The most prolific management tool for analysing market forces is Porter’s Five Forces.1 This model has shaped thinking about strategic management for the past thirty years. Just like the fundamental forces of nature, Porter’ Five Forces are the building blocks in our thinking on how the structure of competitive markets influences the profitability of firms.
Industry analysis assesses the profitability of an industry by reviewing its structure. From Porter’s point of view five fundamental forces influence industry. The basic premise of the model is that, the stronger each of the forces in an industry, the weaker the potential for profitability.
- The threat of New Entrants: How likely is it that a new competitor will enter this industry?
- Bargaining Power of Buyers: To what extent are prices set by consumers?
- The threat of Substitute Products or Services: What are the substitutes for the benefits provided by this industry?
- Bargaining Power of Suppliers: To what extent are suppliers able to influence cost?
- Rivalry Among Existing Competitors: To what extent do existing competitors compete on price?
The first four forces influence the rivalry among existing competitors. Industry analysis considers the combination of all five forces to ascertain the profitability of an industry.
The Ethics of Porter’s Five Forces
This model exposes an inconvenient truth about free market economies. A normative perspective on the Five Forces model illustrates why the free market as espoused by economists does not exist. Porter’s Five Forces is not just a model that tells helps managers to understand an industry; It also helps them to identify actions that increase profitability. Some examples:
- Controlling distribution networks increases the barriers to entry in an industry (supermarket slotting fees)
- A firm can increase the switching cost for consumers to lower their bargaining power (Vendor lock-in).
- Protecting intellectual property to prevent cheap alternatives (Generic pharmaceuticals)
- Lastly, companies can form a cartel to reduce their rivalry
These types of actions can in certain circumstances lead to unethical behaviour and abuse of market power.
A Porter’s Five Forces Example
The presentation below discusses Porter’s Five forces and uses tap water and bottled water as an example. This example shows why bottled water is more profitable than tap water. This video also discusses the normative perspective of the five forces model.