Porters 5 Forces

2.1 Porter’s Five Forces

2. Industry Analysis

Porter’s Five Forces provides a convenient framework for exploring the economic factors that affect the profits and prices of an industry. Porter’s analysis systematically and comprehensively applies economic tools to analyse an industry in depth:

• How can the firm make profits? • Opportunities for success and threats to

Entry

success?

• A basis for generating strategic choices. • Applies to service sectors as well as industrial.

Supplier Power

Internal Industry Rivalry

Buyer Power

Limitations of the framework:

• it does not address the size of demand or its

growth

• it focusses on the entire industry, not on a

Substitute Products

particular firm

• it does not explicitly account for the role of

government

• it is qualitative

2.2 The Economics of the Five Forces

2.2.2 Entry

Firms attracted by (economic) profits. Remember that Total Cost includes a normal return to capital, so positive accounting profits may not be sufficient incentive to entry. Entry of new firms erodes profits by:

• reductions in sales and shares, and • reductions in market concentration, which →

2.2.1 Internal Industry Rivalry

This may occur via price competition, or via nonprice competition. (See Lectures 3–5.) Six factors favour price competition:

• market structure: many sellers • no product differentiation: homogeneous • the nature of the sales process: secretive, large,

and lumpy

• capacity utilisation: excess • consumers (buyers) — motivated, and capable:

greater internal (industry) rivalry, and often reducing cost-price margins. (Remember the mark-up formula on page 1-20.) Barriers to entry (see Lecture 6) may be structural or regulatory:

• economies of scale and scope (see §2.5 below) • limited access to essential resources or

low switching costs Even without apparent competitors, an incumbent firm may set competitive prices. See contestable markets in Lecture 6. A history of coexistence with...