Analyzing the industry
This is the second in a compilation of stories drawn from my learnings on the Fundamentals of Business Strategy from the University of Virginia’s course.
An important aspect of business strategy is the ability to understand the dynamics and the structure of an industry or market segment, and specifically, how that make up of an industry can impact the future profitability potential of firms who operate in that industry.
Porter’s Five Forces analysis is a framework that helps analyzing the level of competition within a certain industry. It is especially useful when starting a new business or when entering a new industry sector. According to this framework, competitiveness does not only come from competitors. Rather, the state of competition in an industry depends on five basic forces:
- Threat of new entrants
- Bargaining power of suppliers
- Bargaining power of buyers
- Threat of substitute products or services
- Existing industry rivalry.
The collective strength of these forces determines the profit potential of an industry and thus its attractiveness. If the five forces are intense — e.g. airline industry — , almost no company in the industry earns attractive returns on investments. If the forces are mild however — e.g. softdrink industry — , there is room for higher returns. Each force will be elaborated on below with the aid of examples from the airline industry to illustrate the usage.
The Threat of New Entry: the ease with which new competitors can enter the market if they see that you are making good profits
- Time and cost of entry
- Specialist knowledge
- Economies of scale
- Cost advantage
- Technology IP
- Barriers to entry
Buyer Power: the strength of your customers to drive down your prices
- Number of customers
- Size of each order
- Differences between competitors
- Price sensitivity
- Ability to substitute
- Cost of changing
The Threat of Substitution: the extent to which different products and services can be used in place of your own
- Substitute performance
- Cost of change
Supplier Power: the ability of suppliers to drive up the prices of your inputs
- Number of suppliers
- Size of suppliers
- Uniqueness of service
- Cost of changing
Competitive Rivalry: the strength of competition in the industry
- Number of competitors
- Quality differences
- Switching costs
- Customer loyalty
