Strategic view of performance
Strategic view of performance

This free course is available to start right now. Review the full course description and key learning outcomes and create an account and enrol if you want a free statement of participation.

Free course

Strategic view of performance

2.2 Porter's five forces framework

Much strategy (particularly in the private sector) is concerned with establishing and maintaining competitive advantage. One of the tools available to assist managers in analysing the near environment for this purpose is Porter's ‘five forces of competition’ (Porter, 1980). This model is widely used as a means of understanding the structure of an industry or sector, and as a framework within which to identify possible structural changes.

The model identifies five types of competitive pressure within a sector: established competitors, new entrants to the market, substitute products, and the bargaining power of suppliers and of customers. These are summarised in Figure 2.

Suppliers are important because their relative power can determine what proportion of the price of the final product they capture. In the automotive component business, for example, many makers of components vie with each other to supply a small number of car manufacturers, allowing the car manufacturers to put pressure on suppliers’ margins. In contrast, a large number of computer manufacturers are supplied by a small number of makers of computer chips for central processors. Customers may vary similarly in their relative power.

Figure 2
Figure 2 The five forces of competition (Source: Porter, 1980)

Organisations need to consider not only the behaviour of current competitors, but also the potential for other organisations to enter the market. The important issue here is assessing the level of barriers to entry. For example, in sectors where brand recognition is important, new entrants need to spend heavily to build a brand. In other sectors, the minimum economic scale of operations may be high, thereby requiring heavy capital investment by new entrants.

An organisation needs to consider not only those competitors offering similar products or services, but also those offering products or services that may act as substitutes. For example, cheaper restaurants now suffer considerable competition from supermarkets selling high-quality, easily prepared ‘ready meals’ to eat at home as a substitute for dining out.

Porter argues that the degree of competitiveness or rivalry within an industry depends on the availability of substitutes, the strength of suppliers and buyers (customers), and the threat of new entrants (which in turn depends on the ease of entry). Thus pharmaceutical research, with its high entry costs, sophisticated technology and patent protection, has low levels of rivalry and high margins and profitability. Only the growing power of customers (health services) threatens this profitability. In the restaurant business, in contrast, the entry barriers and start-up costs are low, customers have a wide choice and therefore considerable bargaining power, and there is a range of substitutes. The restaurant trade is highly competitive and margins and profitability are generally low.

B700_3

Take your learning further

Making the decision to study can be a big step, which is why you'll want a trusted University. The Open University has 50 years’ experience delivering flexible learning and 170,000 students are studying with us right now. Take a look at all Open University courses.

If you are new to university level study, find out more about the types of qualifications we offer, including our entry level Access courses and Certificates.

Not ready for University study then browse over 900 free courses on OpenLearn and sign up to our newsletter to hear about new free courses as they are released.

Every year, thousands of students decide to study with The Open University. With over 120 qualifications, we’ve got the right course for you.

Request an Open University prospectus