five forces - sample model

Michael Porter's innovative research in the 1980's changed managers' perceptions of their own industry's importance as a factor for their company's strategy. Business unit managers would now have to study their industry's characteristics since an industry's structure determines its relative economic attractiveness and hence, the profit potential of all companies within that particular industry.

Prior to Porter's publication, economists studying Industrial Organisation explained varying levels of profitability between industries on their structural differences. Porter focused on private policy rather than on public policy, that is, how to maximize profits instead of how to locate excess profits. Industry as a factor changed almost overnight from a given to an important variable in a firm's strategic decision-making process. Porter made it clear that choosing a firm's relative competitive position within a selected industry is a decision of secondary importance.

Porter's framework consists of five fundamental competitive forces:

1. Entry of competitors
assessing the ability of new entrants to start operations and the structural barriers they must overcome;

2. Threat of substitutes
assessing the ability of new products with superior characteristics to replace existing product(s) or service(s);

3. Bargaining power of buyers
assessing the relative strength and number of buyers;*

4. Bargaining power of suppliers
assessing the relative strength and number of sellers;*

5. Rivalry among the existing players
assessing the relative competitive strength of rival firms.*

* Concentration ratio (CR): the percent of market share held by the four largest firms within an industry is frequently used as a leading measure. A high CR means that few firms hold a large market share, are less competitive, and create a less competitive, more monopolistic landscape. Less competition leads to higher profit margins. A low concentration ratio indicates that an industry is characterized by many rivals, none of which has a significant market share. These fragmented markets are said to be competitive.