Teaching guide: Porter's five forces
Use this teaching guide in the classroom to engage your students, contextualise the model/theory in real-world business and prepare them for the exam.
Section 3.7.7 Analysing the external environment to assess opportunities and threats: the competitive environment
Overview
In the 1980s Michael Porter analysed the competitive environment of an industry and identified five forces that he thought determined the likely profits of businesses operating within it. He originally observed that the profitability of industries varied considerably and developed the five forces model to explain why.
Model/theory
Watch the five forces that shape competitive strategy
The degree of rivalry in the industry
If rivalry is intense, ie existing businesses compete fiercely with each other this is likely to push prices down and reduce the profits of the businesses.
Buyer power
If the customers of the businesses are very powerful (perhaps because there are only a few of them so they know the businesses need them as customers) they will be able to push down prices and reduce the profits of the businesses in the industry.
Supplier power
If the businesses supplying the established firms are powerful (perhaps because there relatively few of them and so they know their customers need them) they may be able to push up prices increasing their profits and reducing the profits of the established businesses that now have higher costs.
Entry threat
If it is relatively easy for new firms to enter the industry this will tend to drive down profits within the industry – if established businesses earn high profits others will enter and this will bring prices down reducing profits.
Substitute threat
A substitute in Porter’s model is a product that performs the same function as the one in the industry, eg if we are examining the aluminium can industry then a glass bottle would be a substitute. If there are a large amount of substitutes, this would lead to a more competitive environment and they’re likely to reduce profitability.
Common issues
Students often get muddled on supplier power and buyer power. They get confused over who is supplying whom. The key is to define the industry, eg if you are examining the passenger airline industry this means the aircraft manufacturers are the suppliers and passengers are the buyers. By comparison, if we were examining the aircraft manufacturing industry the companies making aircraft engines companies are the suppliers and the airlines are the buyers.
When you can use this
- Consider why the profits of some industries may be much higher than others (in Porter’s study soft drinks earned much higher profits than hotels and airlines).
- Consider the effect of changing some of the forces in relation to the impact on industry profits.
- Consider how businesses might change their strategy to change the forces, eg how can they may reduce the entry threat.
Where it’s been used
- Q9, A-level paper 1, 2018
- Q4, A-level paper 3, 2017
- Q8, A-level paper 1, SAM set 2
- Q20, A-level paper 1, SAM set 1