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hello everyone welcome to business
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school 101.
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an industry is a group of incumbent
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companies facing more or less the same
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set of suppliers and buyers
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firms competing in the same industry
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tend to offer similar products or
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services to meet specific customer needs
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harvard business school professor
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michael porter developed a highly
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influential five forces model to help
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managers understand the profit potential
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of different industries and how they can
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position their respective firms to gain
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and sustain competitive advantage
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those forces are threat of entry
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power of suppliers
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power of buyers
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threats of substitutes
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and rivalry among existing competitors
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so let us analyze those five forces
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individually
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force number one the threat of entry
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the threat of entry describes the risk
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that potential competitors will enter
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the industry
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potential new entry depresses industry
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profit potential in two major ways
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first with the threat of additional
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capacity coming into an industry
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incumbent firms may lower prices to make
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entry appear less attractive to the
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potential new competitors which would in
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turn reduce the overall industry's
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profit potential especially in
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industries with slow or no overall
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growth in demand
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second the threat of entry by additional
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competitors may force incumbent firms to
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spend more to satisfy their existing
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customers this spending reduces an
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industry's profit potential especially
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if firms can't raise prices
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as we know the more profitable in
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industry the more attractive it is for
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new competitors to enter
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however there are a number of important
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barriers to entry that raise the cost
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for potential competitors and reduce the
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threat of entry
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entry barriers which are advantageous
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for incumbent firms are obstacles that
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determine how easily a firm can enter an
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industry
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incumbent firms can benefit from several
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important sources of entry barriers
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those barriers are economies of scale
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network effects customer switching costs
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capital requirements and advantages
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independent of size
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one economies of scale
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economies of scale are cost advantages
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that accrue to firms with larger output
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because they can spread fixed costs over
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more units employee technology more
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efficiently benefit from a more
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specialized division of labor and demand
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better terms from their suppliers
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these factors in turn drive down the
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cost per unit allowing large incumbent
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firms to enjoy a cost advantage over new
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entrants who cannot muster such scale
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two
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network effects
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network effects describe the positive
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effect that one user of a product or
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service has on the value of that product
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or service for other users
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when network effects are present the
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value of the product or service
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increases with the number of users
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the threat of potential entry is reduced
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when network effects are present
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social networks are the clearest example
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of this take linkedin
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which grew through memberships as
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linkedin started to get broader adoption
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the numbers grew exponentially as the
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utility of the product became stronger
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three
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customer switching costs
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switching costs are incurred by moving
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from one supplier to another
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changing vendors may require the buyer
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to alter product specifications retrain
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employees and modify existing processes
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switching costs are one-time sunk costs
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which can be quite significant and a
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formidable barrier to entry
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for example companies that create unique
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products that have few substitutes and
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require significant effort to perfect
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their use enjoy significant switching
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costs
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consider intuit inc which offers its
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customers various bookkeeping software
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solutions such as turbotax quickbooks
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and mint
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because learning to use intuits
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applications take significant time
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effort and training costs
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fewer users are willing to switch away
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from intuit
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4. capital requirements
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capital requirements describe the price
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of the entry ticket into a new industry
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how much capital is required to compete
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in this industry and which companies are
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willing and able to make such
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investments
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frequently related to economies of scale
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capital requirements may encompass
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investments to set up plans with
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dedicated machinery run a production
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process and cover startup losses
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however please keep in mind that capital
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unlike proprietary technology and
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industry-specific know-how is a fungible
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resource that can be relatively easily
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acquired in the face of attractive
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returns
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five advantages independent of size
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incumbent firms often possess cost and
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quality advantages that are independent
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of size
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these advantages can be based on brand
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loyalty proprietary technology
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preferential access to raw materials and
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distribution channels favorable
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geographic locations and cumulative
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learning and experience effects
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in addition incumbent firms often
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benefit from cumulative learning and
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experience effects accrued over long
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periods of time
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attempting to obtain such deep knowledge
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within a shorter time frame is often
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costly if not impossible which in turn
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constitutes a formidable barrier to
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entry
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the second force in porter's model is
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the power of suppliers the bargaining
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power of suppliers captures pressures
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that industry suppliers can exert on an
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industry's profit potential
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this force reduces a firm's ability to
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obtain superior performance because
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powerful suppliers can raise the cost of
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production by demanding higher prices
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for their inputs or by reducing their
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quality of the input factor or service
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level delivered
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to compete effectively companies
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generally need a wide variety of inputs
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into the production process including
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raw materials and components
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labor and services
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the relative bargaining power of
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suppliers is high under following
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scenarios
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one the suppliers industry is more
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concentrated than the industry it sells
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to
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two suppliers do not depend heavily on
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the industry for a large portion of
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their revenues three incumbent firms
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face significant switching costs when
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changing suppliers
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four suppliers offer products that are
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differentiated
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five there are no readily available
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substitutes for the products or services
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that the suppliers offer
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and six suppliers can credibly threaten
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to forward integrate into the industry
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let's take a closer look at one
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important supply group to the airline
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industry
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boeing and airbus the makers of large
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commercial jets
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the reason airframe manufacturers are
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powerful suppliers to airlines is
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because their industry is much more
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concentrated than the industry it sells
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to
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compared to two airframe suppliers there
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are hundreds of commercial airlines
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around the world
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in addition the airlines face
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non-trivial switching costs when
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changing suppliers because pilots and
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crew would need to be retrained to fly a
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new type of aircraft maintenance
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capabilities would need to be expanded
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and some routes may need to even be
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reconfigured due to differences in
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aircraft range and passenger capacity
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moreover while some of the aircraft can
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be used as substitutes boeing and airbus
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offer differentiated products
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thus the supplier power of commercial
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aircraft manufacturers is quite
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significant
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this puts boeing and airbus in a strong
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position to extract profits from the
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airline industry thus reducing the
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profit potential of the airline
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themselves
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force 3 the power of buyers
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the bargaining power of buyers is the
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flip side of the bargaining power of
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suppliers
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buyers are the customers of an industry
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the power of buyers concerns the
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pressure in industries customers can put
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on the producers margins and the
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industry by demanding a lower price or
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higher product quality
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when buyers successfully obtain price
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discounts it reduces a firm's revenue
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when buyers demand higher quality and
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more service it generally raises
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production costs
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the power of buyers is high when there
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are few buyers and each buyer purchases
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large quantities relative to the size of
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a single seller
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the industry's products are standardized
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or undifferentiated commodities
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buyers face low or no switching costs
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and buyers can credibly threaten to
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backwardly integrate into the industry
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in addition
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companies need to be aware of situations
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when buyers are especially price
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sensitive
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this is the case when
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one the buyer's purchase represents a
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significant fraction of its cost
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structure or procurement budget
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two buyers earn low profits or are
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strapped for cash
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three the quality or cost of the buyer's
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products and services is not affected
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much by the quality or cost of their
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inputs
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the retail giant costco provides a
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potent example of tremendous buyer power
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costco is not only one of the largest
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retailers worldwide but it is also one
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of the world's fortune 500 companies
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costco is one of the few large big box
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global retail chains and frequently
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purchases large quantities from its
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suppliers
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costco leverages its buyer power by
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exerting tremendous pressure on its
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supplier to lower prices and to increase
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quality or risk losing access to shelf
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space at their worldwide stores
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force 4 the threat of substitutes
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porter's threat of substitutes
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definition is the availability of a
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product that the consumer can purchase
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instead of the industry's product
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a substitute product is a product from
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another industry that offers similar
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benefits to the consumer as the product
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produced by the firms within the
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industry
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the threat of substitution in an
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industry affects the competitive
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environment for the firms in that
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industry and influences those firms
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ability to achieve profitability
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the availability of close substitute
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products can make an industry more
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competitive
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and decrease profit potential for the
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firms in the industry
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on the other hand the lack of close
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substitute products makes an industry
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less competitive and increases profit
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potential for the firms in the industry
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here are some examples of substitutes
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for digital cameras substitutes are
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smartphones
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for traditional brick and mortar stores
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substitutes are online shopping websites
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for human delivery drivers
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substitutes could be advanced
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self-driving vehicles in the future
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force 5
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rivalry among existing competitors
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rivalry among existing competitors
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describes the intensity with which
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companies within the same industry
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jockey for market share and
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profitability
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the intensity of rivalry among existing
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competitors is determined largely by the
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following four factors
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competitive industry structure
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industry growth
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strategic commitments and exit barriers
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factor one competitive industry
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structure
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the competitive industry structure
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refers to elements and features common
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to all industries
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the structure of an industry is largely
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captured by the number and size of its
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competitors
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the firm's degree of pricing power
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the type of product or service and the
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height of entry
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barriers the four main competitive
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industry structures are
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perfect competition
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monopolistic competition
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oligopoly
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monopoly
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let us discuss these separately
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first perfect competition
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a perfect competitive industry is
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fragmented and has many small firms a
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commodity product ease of entry and
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little or no ability for each individual
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firm to raise its prices
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the firms competing in this type of
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industry are approximately similar in
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size and resources
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consumers make purchasing decisions
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solely on price because the commodity
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product offerings are more or less
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identical
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the resulting performance of the
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industry shows low profitability
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although perfect competition is a rare
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industry structure in its pure form
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markets for commodities such as natural
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gas copper and iron tend to approach
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this structure
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second monopolistic competition
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a monopolistically competitive industry
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has many firms a differentiated product
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some obstacles to entry and the ability
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to raise prices for a relatively unique
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product while retaining customers
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the key to understanding this industry
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structure is that the firms now offer
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products or services with unique
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features
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the global smartphone industry provides
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one example of monopolistic competition
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many firms compete in this industry and
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even the largest of them such as samsung
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apple xiaomi huawei or vivo have less
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than 20 percent market share
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moreover
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while products between competitors tend
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to be similar they are by no means
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identical
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as a consequence firms selling a product
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with unique features tend to have some
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ability to raise prices
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when a firm is able to differentiate its
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product or service offerings it carves
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out a niche in the market in which it
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has some degree of monopolistic power
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over pricing
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thus the name monopolistic competition
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firms frequently communicate the degree
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of product differentiation through
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advertising
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third oligopoly
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an oligopolistic industry is
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consolidated with a few large firms
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differentiated products high barriers to
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entry and some degree of pricing power
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the degree of pricing power depends just
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as in monopolistic competition on the
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degree of product differentiation
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a key feature of an oligopoly is that
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the competing firms are interdependent
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with only a few competitors in the mix
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the actions of one firm influence the
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behaviors of the other
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therefore each competitor in an
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oligopoly must consider the strategic
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actions of the other competitors this
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type of industry structure is often
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analyzed using game theory which
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attempts to predict strategic behaviors
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by assuming that the moves and reactions
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of competitors can be anticipated
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due to their strategic interdependence
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companies and oligopolies have an
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incentive to coordinate their strategic
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actions to maximize joint performance
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examples of oligopolies include the soft
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drink industry coca-cola versus pepsi
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airframe manufacturing business
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boeing versus airbus
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home improvement retailing the home
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depot versus lowe's
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operating systems for smartphones
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apple ios and google android and
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detergents
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png versus unilever
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fourth monopoly
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an industry is a monopoly when there is
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only one firm supplying the market
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the firm may offer a unique product and
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the challenges to moving into the
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industry tend to be high
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the monopolist has considerable pricing
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power as a consequence
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firm and thus industry profit tends to
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be high
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a classic example of a monopoly based on
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resource control is d beers
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d beers consolidated mines were founded
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in 1888 in south africa as an
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amalgamation of a number of individual
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diamond mining operations
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d beers had a monopoly over the
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production of diamonds for most of the
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20th century
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and it used its dominant position to
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manipulate the international diamond
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market it convinced independent
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producers to join its single-channel
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monopoly
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d-beers also purchased and stockpiled
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diamonds produced by other manufacturers
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in order to control prices through
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supply
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the de beers model changed at the turn
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of the 21st century when diamond
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producers from russia canada and
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australia started to distribute diamonds
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outside of the beer's channel
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the sale of diamonds also suffered from
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rising awareness about blood diamonds de
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beers market share fell from as high as
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90 percent in the 1980s to less than 40
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percent in 2012.
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the second factor affecting the
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intensity of rivalry among existing
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competitors is industry growth industry
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growth directly affects the intensity of
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rivalry among competitors
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in periods of high growth
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consumer demand rises and price
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competition among firms frequently
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decreases
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because the pie is expanding rivals are
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focused on capturing part of that larger
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pie rather than taking market share and
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profitability away from one another
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in contrast
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rivalry among competitors becomes fierce
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during slow or even negative industry
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growth
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price discounts frequent new product
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releases with minor modifications
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intense promotional campaigns and fast
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retaliation by rivals are all tactics
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indicative of an industry with slow or
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negative growth
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competition is fierce because rivals can
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gain only at the expense of others
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therefore companies are focused on
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taking business away from one another
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the third factor affecting the intensity
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of rivalry among existing competitors is
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strategic commitments
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if firms make strategic commitments to
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compete in an industry rivalry among
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competitors is likely to be more intense
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we define strategic commitments as firm
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actions that are costly long-term
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oriented and difficult to reverse
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strategic commitments to a specific
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industry can stem from large fixed cost
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requirements but also from non-economic
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considerations
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for example airbus was created by a
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number of european governments through
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direct subsidies to provide
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countervailing power to boeing
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the european union in turn claims that
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boeing is subsidized by the us
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government indirectly via defense
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contracts
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given these political considerations and
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large-scale strategic commitments
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neither airbus or boeing is likely to
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exit the aircraft manufacturing industry
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even if industry profit potential falls
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to zero
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the last factor affecting the intensity
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of rivalry among existing competitors is
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exit barriers barriers to exit are
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obstacles or impediments that prevent a
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company from exiting a market in which
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it is considering cessation of
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operations or from which it wishes to
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separate
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typical barriers to exit include highly
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specialized assets which may be
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difficult to sell or relocate and high
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exit costs such as asset write-offs and
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closure costs
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a common barrier to exit can also be the
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loss of customer goodwill an industry
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with low exit barriers is more
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attractive because it allows
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underperforming firms to exit more
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easily
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such exits reduce competitive pressure
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on the remaining firms because excess
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capacity is removed in contrast an
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industry with high exit barriers reduces
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its profit potential because excess
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capacity still remains
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okay let's wrap up today's topic
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harvard business school professor
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michael porter developed the highly
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influential five forces model to help
00:19:42
managers understand the profit potential
00:19:44
of different industries and how they can
00:19:46
position their respective firms to gain
00:19:48
and sustain competitive advantage
00:19:51
these five forces are threat of entry
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power of suppliers power of buyers
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threat of substitutes and rivalry among
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existing firms
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generally the stronger those forces the
00:20:03
lower the firm's ability to gain and
00:20:05
sustain a competitive advantage
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conversely the weaker those forces the
00:20:10
greater the firm's ability to gain and
00:20:12
sustain competitive advantage
00:20:14
therefore managers need to craft a
00:20:16
strategic position for the company that
00:20:18
leverages weak forces into opportunities
00:20:20
and mitigates strong forces because they
00:20:23
are potential threats to the firm's
00:20:24
ability to gain and sustain a
00:20:26
competitive advantage
00:20:28
so what do you think about porter's five
00:20:30
forces model
00:20:31
can you apply this model to an industry
00:20:33
you are interested in
00:20:35
please leave your thoughts in a comment
00:20:36
below if you liked this video please
00:20:39
make sure to give it a thumbs up and
00:20:40
subscribe to the channel
00:20:42
thanks for watching and i will see you
00:20:43
next time
