Understanding Industry Structure: A Deep Dive into Porter's Five Forces

Examples:

• Socio-cultural factors: A clothing retailer may be primarily concerned with social changes driving customer tastes and behavior. For example, forces encouraging out-of-town shopping.
• Technological factors: A computer manufacturer is likely to be concerned with technological change. For example, increases in microprocessor speeds.

An industry is a group of firms producing the same principal product or service.

A market consists of a group of customers with a specific set of needs and wants, which may be satisfied by one or more products.

Porter's Five Forces is a framework for analyzing the competitive forces within an industry and identifying the attractiveness of that industry. The five forces are:

1. The threat of entry into an industry
2. The threat of substitutes to the industry's products or services
3. The power of buyers of the industry's products or services
4. The power of suppliers into the industry
5. The extent of rivalry between competitors in the industry

How it works: The framework analyzes the strength of these five forces to determine the overall competitive intensity and potential profitability of an industry.

Supplier power refers to the power of suppliers to drive up the prices of your inputs. Factors influencing supplier power include:

• Concentrated suppliers: Number and size of suppliers
• High switching costs: Difficulty and expense of changing suppliers
• Supplier competition threat: Suppliers' ability to cut out buyers who are middlemen

Buyer power refers to the power of your customers to drive down your prices. Factors influencing buyer power include:

• Concentrated buyers: Number and size of customers
• Low switching costs: Ease and affordability of switching to competitors
• Buyer competition threat: Buyers having the facilities to supply themselves

Competitive rivalry refers to the strength of competition in the industry. Factors influencing competitive rivalry include:

• Competitor balance: Number and quality of competitors
• Industry growth rate: Slow growth can lead to intense competition
• High fixed costs: Pressure to maintain volume
• High exit barriers: Difficulty in leaving the industry
• Low differentiation: Products or services are similar

The threat of substitution refers to the extent to which different products and services can be used in place of your own. Substitutes offer a similar benefit but through a different process.

The threat of new entry refers to the ease with which new competitors can enter the market and potentially drive prices down. Barriers to entry are factors that new entrants need to overcome, such as:

• Scale and experience: Existing firms may have cost advantages
• Access to supply or distribution channels: New entrants may face challenges
• Legislation or government action: Regulations can create barriers

Key takeaway: Industries with high forces are less attractive to compete in due to intense competition, pressure on profitability, and limited potential for reasonable profits.

Applications:

• Deciding which industries to enter or leave
• Identifying areas where a company can exert influence

• Defining the 'right' industry: Clearly defining the industry boundaries is crucial
• Converging industries: Industries may overlap or merge, requiring broader analysis
• Complementary products: Consider the impact of products or services that complement the industry