Saturday, July 01, 2006

The 5 Forces Theory

Harvard Professor Michael Porter's Five Forces is a great way to systematically consider the attractiveness of entering a given industry, in case you were not sure whether you should start that basement brewery you've been planning. Previously economists focused on consumer surplus, but Porter flipped this around to determine the attractiveness of an industry based on producer surplus. The result was a easy step by step way to estimate the profitability of an industry.

Force 1
Supplier Power
Do suppliers have power because you have few alternatives?

Force 2
Buyer Power
Do buyers have power because they have lots of alternatives?

Force 3
Threat of Substitutes
Can consumer's easily substitute your product? i.e. Email instead of snail mail

Force 4
Extent of Rivalry
Are the existing firms highly competitive? i.e. Beer Companies

Force 5
Access to Entry
Are there high barriers to entry because of high initial investment or retaliation from existing firms?

If you answered yes to all these questions then this is not a very attractive industry to enter. Some of the forces may have varying importance depending on the industry you are looking at, which opens this up to subjectivity. However it is still better then going on your gut feeling, which has historically been less accurate.

1 comment:

Jorge Enrique said...

This was very interesting. Can you tell me where can I get more information about this analysis?