Michael E Porter developed the Porter’s five forces analysis in 1979 which serves as a framework for industry analysis and business strategy development. Its five forces determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. Three of Porter’s five forces refer to competition from external sources. The remainder are internal threats. It is useful to use Porter’s five forces in conjunction with SWOT analysis (Strengths, Weaknesses, Opportunities, and Threats). Porter referred to these forces as the micro environment. They consist of those forces close to a company that affect its ability to serve its customers and make a profit.
The stronger the forces, the less profit they will make and vice-versa. A change in any of the forces normally, requires a business unit to re-assess the marketplace given the overall change in industry information. The overall industry attractiveness does not imply that every firm in the industry will return the same profitability. Porter’s five forces include – three forces from ‘horizontal’ competition: threat of substitute products, the threat of established rivals, and the threat of new entrants; and two forces from ‘vertical’ competition: the bargaining power of suppliers and the bargaining power of customers.
The threat of the entry of new competitors
The treat of new entrants depend on the ease with which they can enter the market.
Markets with high profits will attracts new firms. The major barriers are:
* Need for economies of scale
* High entry costs
* Lack of distribution channels
* Government policies such as selective subsidies
* Cost advantages of existing firms such as access to raw materials, know how
* Strong product- loyal customers
The intensity of competitive rivalry
Strong rivalry will reduce profits. This occurs when:
* Many firms, none dominant
* Slow market growth
* Fixed costs are high
* High exit costs
* Similar products
In high competitive markets, threat of new entrants is high.