Porters Five Forces Industry AnalysisIndustry analysis The profitability of any industry depends upon five environmental factors The five forces The threat of entry The threat of substitution The power of the buyers The power of the suppliers Competitive rivalry within the industryPorters Five Forces of Competition FrameworkSUPPLIERSPOTENTIAL ENTRANTSSUBSTITUTESBUYERSINDUSTRY COMPETITORSRivalry among existing firmsBargaining power of suppliersBargaining power of buyersThreat ofnew entrantsThreat ofsubstitutesThe threat of entry Threat that new entrants will start up, increase capacity and competition and erode profits Depends on the size of the entry barriers Eg scale economies, patentsThe threat of substitution Threat other industries will take business away: eg aluminium industry faces threat from glass, plastics, steel These substitute products place a cap upon industry prices above which buyers will desertPower of buyers Power of industrys buyers to secure discounts or negotiate added value to products Depends on buyer concentration, information, switching costs Eg fragmented horticulture industry faces concentrated, expert buyers with low switching costsPower of suppliers Ability of suppliers to dictate the terms and conditions of supply Supply concentration and differentiation is key Eg operating system component of PC Eg the transmission system in bicyclesCompetitive Rivalry The degree of competition within the industry for market share Especially the degree of price competition Some industries are very price competitive Eg airlines Others are non price competitive and highly differentiated in products Eg pharmaceuticalsTHREAT OF ENTRY Capital requirements Economies of scale Absolute cost advantage Product differentiation Access to distributionchannels Legal/ regulatory barriers RetaliationSUBSTITUTE COMPETITION Buyers propensityto substitute Relative prices & performance ofsubstitutesBUYER POWER Buyers price sensitivity Relative bargainingpowerINDUSTRY RIVALRY Concentration Diversity ofcompetitors Product differentiation Excess capacity &exit barriers Cost conditionsSUPPLIER POWER Buyers price sensitivity Relative bargainingpower The Structural Determinants of CompetitionExamples of industry analysis Airlines Pharmaceuticals Professional football Road Recovery ServicesAirlines The threat of entry Very high because Deregulated Low start up costs Modest economies of scale The threat of substitution High in some short haul routes lower in long haul The power of the buyers Considerable Little customer loyalty despite air miles Easy to switch between carriersAirlines Power of the suppliers Considerable Aircraft manufacturers large and very differentiated, high switching costs Unionised staff Capacity shortages in many airports Competitive Rivalry Intense price competition Very high fixed operational costs and low variable costs encourages discounting to maximise utilisation Airlines: conclusion All five forces are operating to the industrys disadvantage Would expect the industry to experience poor profit performancePharmaceuticals The threat of entry Very low Products protected by patents and copyright Formidable research, development and approval costs of new drugs Very large medical sales force required The threat of substitution Very low Often no alternative to a drug in dealing with an illnessPharmaceuticals Power of buyers Limited Purchase decisions made by powerful medical profession able to influence what the state or insurance co. must pay for Power of suppliers Negligible Drug ingredients are largely commodities, widely available Competitive rivalry Limited Little or no price competitionConclusion on Pharmaceuticals All five forces working to industrys advantage Would expect the industry to be highly profitableProfitability of US IndustriesPharmaceuticals 26.8Gas & Electric Utilities 10.5 Tobacco22.0 Food and Drug Stores 10.3 Household & Personal Products 20.5 Motor Vehicles & Parts 9.8 Food Consumer Products20.3Home Equipment 9.5 Medical Products & Equipment 18.8Railroads 9.0 Beverages18.8 Hotels, Casinos, Resorts 8.0 Scientific & Photographic Equipt.16.5Insurance: Life and Health 7.6 Commercial Banks16.0 Building Materials, Glass 7.0 Publishing, Printing 14.3 Metals 6.0 Petroleum Refining14.3 Semiconductors & Apparel 14. 3 Electronic Components 5.8 Computer Software 13.5 Insurance: Property & Casualty 5.3 Electronics, Electrical Equipment 13.3 Food Production 5.3 Furniture13.3Telecommunications 3.5 Chemicals12.8Forest and Paper Products 3.5 Computers, Office Equipment11.8 Communications Equipment (4.0) Health Care11.5 Airlines (34.8)(Grant, 2005)Median return on equity (%), 1999-2002 Some comments on the method