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Porter's five forces a strategy
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framework that probably every business
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students and practitioner has heard
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about but do you also know how to use it
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properly
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today you will be finding it out because
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I'm going to tell you everything you
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need to know about Porter's five forces
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my name is Lars and welcome to a new
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episode of business to you in 1979
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Michael Porter one of the founding
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fathers of business strategy published
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an article called how competitive forces
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shape strategy in this article he argued
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that we often view competition way too
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narrowly and as a solution came up with
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five basic forces that together shape
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the industry structure and determine the
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competitive intensity of an industry in
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the end these forces affect the long
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term profit potential in an industry and
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therefore its attractiveness we will
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come back to that in a second because
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we're talking about competitive forces
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the Five Forces model can be considered
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an external analysis framework similar
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to pestle however as explained in my
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previous video on PESTEL analysis it is
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important to make a distinction between
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the macro environment and the task
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environments or meso environments do you
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remember how the macro environment
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contains factors that have a one-way
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effect on organizations and a task
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environment on the other hand contains
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factors that are in a direct contact
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with the focal company they interact
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with each other Porter's five forces
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falls within this latter category and
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includes the following five forces
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rivalry among existing competitors
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threat of new entrants the threat of
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substitute products or services the
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bargaining power of suppliers and the
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bargaining power of buyers before we go
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into each force separately it is
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important to understand that the main
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purpose of this model is to evaluate the
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root causes of profitability in an
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industry true to competitive forces
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porter dev force draws a connection
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between competition on the one hand and
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profitability on the other hand if
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competitive forces in an industry are
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high or intense the profit potential of
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a firm in that specific industry will
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decrease as you will be seeing in this
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video each of the five forces are able
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to affect the profit potential in the
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industry both positively and negatively
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we will be illustrating this dynamic
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relationship between competition and
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profitability throughout this video with
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some examples from the airline industry
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let's start off with the middle section
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of the framework this force of the Five
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Forces model examines how intense the
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current competition is in the
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marketplace this is for example
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determined by the number and size of
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existing competitors the industry growth
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rate product differentiation between
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rivals and exit barriers rivalry is for
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example high when there are a lot of
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competitors that are roughly equal in
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size and power when the industry is
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growing slowly which increases the fight
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for market share and when competitors
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are not much differentiated from each
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other resulting in products and services
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that are nearly identical
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in addition rivalry will be more intense
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when barriers to exit are high forcing
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companies to remain in the industry even
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though profit margins are declining
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these barriers to exit can for example
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exist due to long term loan agreements
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and high fixed costs when rivalry is
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high competitors are likely to actively
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engage in advertising and price wars
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which can seriously hurt a business
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bottom line let's look at this more
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closely
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if direct competitors fight for market
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share and decide to battle each other by
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dropping the prices profit margin will
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decrease
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moreover they might decide to spend more
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money on advertising raising the costs
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and again decreasing the profit margin
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when looking at the airline industry we
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see that the industry is extremely
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competitive
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because of several reasons which include
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the vast amount of players that are
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active in the industry the fact that the
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industry itself is very stagnant in
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terms of growth at the moment and the
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high fixed costs that result in too high
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barriers to exit in addition many
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players in industry are similar in size
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leading to extra fierce competition
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between those firms taken altogether it
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can be said that rivalry among existing
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competitors in the airline industry is
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high threat of new entrants new entrants
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in an industry bring new capacity and
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the desire to gain market share that put
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pressure on prices costs and the rate of
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investments necessary to compete simply
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said you will have to share the pie with
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more players the seriousness of the
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threat depends on the barriers to entry
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in a certain industry the higher these
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barriers the smaller the chance that
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more players will enter the playing
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field and the smaller the treads for
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existing rivals examples of barriers to
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entry are the needs of economies of
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skill high customer loyalty for existing
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brands large capital requirements the
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need for cumulative experience
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government policies and limited access
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to distribution channels if new
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competitors enter the industry existing
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players might need to increase their
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investments in product development or
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marketing in order to stay ahead of the
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game
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this will increase costs and lower the
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profit margin or in order to prevent new
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competitors from entering existing
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players might decide to lower prices in
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order to scare off new competitors again
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this will decrease the profit margin the
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threat of new entrants in the airline
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industry can be considered mininum it
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takes quite some upfront investments to
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start an airline company moreover new
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entrants need access to flight routes
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licenses insurances distribution
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channels and other qualifications that
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are not easy to obtain when you're new
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to the industry furthermore it can be
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expected
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existing players have built up a large
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base of experience over the years to cut
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costs and to increase service levels a
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new entrant is likely to not have this
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kind of expertise therefore creating a
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competitive disadvantage right from the
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start however due to the liberalisation
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of mark Texas and the availability of
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leasing options and external finance
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from banks investors and aircraft
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manufacturers new doors are opening for
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potential entrants over the years many
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low-cost carriers like Southwest
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Airlines Ryanair and easyJet have
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successfully entered the industry by
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introducing innovative cost-cutting
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business models thereby shaking up
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existing players like American Airlines
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Lufthansa Delta Airlines and air
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france-klm the threat of substitutes a
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substitute product performs the same or
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a similar function as an industry
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product by a different means they
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essentially fulfill the same underlying
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need even though they may not look
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identical on the surface they are
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therefore easy to overlook the existence
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of these products alone increases the
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possibility that customers switched to
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alternatives in order to discover these
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alternatives you should look beyond
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similar products that are branded
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differently by competitors instead every
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product that serves a similar need for
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customers should be taken into account
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energy drinks like Red Bull for instance
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are usually not considered competitors
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of coffee brands such as Nespresso or
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Starbucks
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however since both coffee and energy
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drinks fulfill a similar need that is
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staying awake or getting energy
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customers might be willing to switch
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from one to another if they feel that
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the prices increase too much in either
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coffee or energy drink the number of
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substitutes the willingness of customers
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to substitute and the relative price
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performance of substitute products are
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therefore factors that determine the
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total threat of substitute products
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since substitute products can lure
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customers away companies need to take
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actions to stay more attract
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and prevent their product from becoming
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replaced or obsolete they can for
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example lower the prices which will also
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lower the profit margin they can spend
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more money on advertising which
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increases the costs or they can invest
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heavily in product upgrades or
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additional services that will give
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customers an incentive to stay again
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this will increase the costs and lower
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the profit margin in terms of the
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airline industry it is safe to say that
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the general need of customers is to
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travel of course there are many
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alternatives for travelling besides
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going by airplane depending on the
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urgency and the distance customers could
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take the train or go by car especially
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in Asia it is very common to make use of
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high-speed trains such as bullet trains
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for medium to long distance travelling
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we see a similar tendency developing
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within Europe furthermore the airline
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industry might get some serious future
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competition from the Hyperloop concept
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in which passengers will be travelling
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in capsules through a vacuum tube
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reaching speed limits of 1,200
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kilometers an hour taking this all
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together the threat of substitutes in
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the airline industry can be considered
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at least medium to high now we enter the
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horizontal section of the framework the
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suppliers and the buyers this section is
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basically illustrating a company's
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supply chain let's start off with the
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bargaining power of suppliers this force
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analyzes how much power and control a
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company's supplier has over the
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potential to raise its prices or to
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reduce the quality of purchased goods or
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services which in turn would lower an
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industry's profitability potential the
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number and concentration of suppliers to
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choose from are important factors in
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determining supplier power the fewer
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there are the more power they have
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businesses are in a better position when
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there are a multitude of suppliers
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sources of supplier power also includes
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the switching cost of companies in the
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industry
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the presence of available substitutes
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the strengh
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of their distribution channels and the
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uniqueness or level of differentiation
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in the product or service the supplier
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is delivering the bargaining power of
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suppliers in the airline industry can be
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considered very high when looking at the
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major inputs that airline companies need
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we see that they are especially
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dependent on fuel and aircrafts these
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inputs however are very much affected by
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the external environment over which the
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airline companies themselves have little
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control the price for aviation fuel is
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for example subject to the fluctuations
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in the global markets for oil which can
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change wildly because of the
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geopolitical and other factors in terms
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of aircrafts only two major suppliers
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exists Boeing and Airbus Boeing and
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Airbus therefore have a substantial
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bargaining power of the prices they
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charge the bargaining power of buyers
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this force analyzes to what extent
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customers are able to put the company
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under pressure by demanding better
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quality they're right driving up costs
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or exertion trol over price keep in mind
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that buyers do not always have to be the
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end consumer in case your business is a
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manufacturing company buyers can be
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other companies like retailers for
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example customers have a lot of power
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when they aren't many of them and when
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the customers have many alternatives to
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buy from moreover it should be easy for
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them to switch from one company to
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another buying power is low however when
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customers purchase products in small
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amounts act independently and when the
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sellers product is very different from
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any of its competitors the Internet has
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allowed customers to become more
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informed and therefore more empowered
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customers can easily compare prices
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online get information about a wide
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variety of products and get access to
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offers from other companies instantly
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companies can take measures to reduce
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buyer power by for example implementing
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loyalty programs or by differentiating
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their products and services bargaining
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power of buyers in the airline industry
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is
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customers are able to check prices of
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different airline companies fast through
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the many online price comparison
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websites such as Skyscanner and Expedia
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in addition there aren't any switching
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costs involved in that process customers
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nowadays are willing to fly with
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different carriers to and from their
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destination as long as it lowers their
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ticket price brand loyalty therefore
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doesn't seem to be that high some
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airline companies are trying to change
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this with frequent flyer programs aimed
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at rewarding customers that come back to
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them from time to time now we have
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looked at every force individually you
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will notice that we start to get a
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better picture of how competition in an
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industry looks like and which of the
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forces have the biggest impact on your
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profit margin however Porter's five
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forces is not just a tool to evaluate an
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industry and determine whether an
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industry is attractive or not do you
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remember how the Five Forces are part of
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the task environment causing them to be
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in a direct contact with the focal
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company this means that a company is
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able to affect these forces similarly to
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how these forces are able to affect your
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company in other words you can do
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something about it you can fight them
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you can shape them understanding the
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forces that shape industry competition
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is the starting point for developing
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strategy the model is therefore a great
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tool to come up with strategic actions
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on what to do in the future
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imagine that you start to notice that
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your dependency on one particular
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supplier is increasing what you could do
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is try to standardize the components
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needed to create your products so that
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you could choose from multiple suppliers
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and switch more easily among them or if
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you fear that your competitors will
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start to enter price wars you could
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invest more money in product development
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in order to significantly differentiate
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your products from those of your rivals
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make sure that you offer features and
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benefits that your competitors cannot
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offer and you will have less chance that
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you will be forced to cut prices as well
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if you feel that new competitors might
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enter the playing field you could raise
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the barriers to entry by investing more
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into marketing this will enhance your
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brand awareness and scare off entrance
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because of the high costs needed to
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overcome that brand awareness even
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though these actions involve costs in
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the short term it will help you to
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protect your company's profitability in
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a long term because that in the end is
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the purpose of strategy if you like
00:16:05
business-related stuff and want to learn
00:16:07
more business frameworks feel free to
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subscribe to not miss out on any of our
00:16:13
future videos and if you have any
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suggestion on what to cover in the
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future please let me know in the comment
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section down below thanks for watching
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and as always don't forget alone we are
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smart
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together we are brilliant see you next
00:16:29
time
00:16:35
[Music]
