Porter’s Five Forces and PESTLE Frameworks

Understanding Porter’s Five Forces Analysis

Porter’s Five Forces is a vital analytical tool used to scrutinize the structure of an industry, which subsequently aids in predicting the potential long-term profitability of the industry, gauged through the returns on invested capital. The magnitude of the five pivotal forces in an industry greatly influences its profitability prospects.

Intense forces imply subdued profitability for companies within the industry, while milder forces suggest a potentially lucrative industry.

While historical data from industry surveys may have offered insights into the industry’s past profitability, analyzing the structural forces transcends mere profitability measurement. It encompasses a qualitative evaluation of the profitability drivers and enhances awareness of critical factors that could influence industry profitability in the future. This method proves particularly beneficial in nascent industries where data might be scarce or in industries that are yet to reach a profitable stage, helping to anticipate potential profitability trajectories.

The critical forces to be evaluated are as follows:

Analyzing Porter’s Five Forces

Examining the five forces is akin to analyzing a company’s business model, characterized by qualitative research that resists generalization. More specifically, we will employ a checklist approach, which involves a set of questions in each respective force.

1. Threat of New Entrants

Analysis in this segment involves evaluating the probable threats that new industry entrants might pose. It involves answering the following questions:

• Has there been a notable influx of new entrants in the industry in recent times?
• Are there network effects in the industry, where the value of the product or service increases as more people use it, potentially causing a new entrant to have a less valuable offering until it achieves a larger user base?
• Do established players gain advantages from economies of scale due to substantial fixed costs, implying that a newcomer might need considerable time and face unprofitable conditions before achieving competitiveness?
• Do existing companies gain advantages from economies of scope spanning various business segments–resulting from heightened customer convenience and market dominance and/or from shared costs that can be optimized across their operations?
• Do consumers exhibit brand loyalty?
• Do customers face considerable switching costs in terms of time, education, or substitution?
• Do established players possess unique or favored access to scarce resources or direct customer touchpoints?
• Do government regulations impose limitations or delays on entering the industry?

2. Threat of Substitutes

This analysis entails examining the threats presented by alternative products or services:

• Is there an alternative product or service that meets the same or similar customer requirements? Is its cost lower?
• Can consumers manage without the product offered by the industry?
• Is the alternative product’s performance getting better compared to the product of the industry?
• Is the transition to an alternative challenging for consumers?

3. Bargaining Power of Customers

Here, the focus is on evaluating the negotiating strength of customers or buyers in the industry:

• Does a small number of dominant customers characterize the industry?
• Is the industry’s products standardized or undifferentiated?
• Do the customers deem the industry’s products as essential?
• Do the industry’s products constitute a significant portion of the customers’ budget?
• Can customers opt for backward integration, meaning they choose to “produce” instead of “purchase” what the industry offers?

4. Bargaining Power of Suppliers

This segment involves evaluating the negotiating power of suppliers:

• Does a small number of dominant suppliers characterize the industry?
•  Are there considerable costs associated with changing suppliers?
• What are the switching costs for companies to change suppliers?
• Are the suppliers distinct or specialized in their offerings?
• Are there alternative products available that can replace those provided by the suppliers?

5. Rivalry among Existing Competitors

This analysis examines the extent of competition or rivalry among the existing players in the industry. For instance, the fast-food industry is marked by intense competition with numerous established players:

• Has there been a history of price rivalry among competitors?
•  Do multiple competitors of similar size exist in the market?
•  Are the products differentiated?
• Are there significant obstacles to leaving the industry?
• Is the growth rate of the industry sluggish?

External Influences on Industry Growth

The external influence on industry growth is done using the PESTLE analysis framework. It involves the assessment of political, economic, social, technological, legal, and environmental impacts on an industry.

Political Influences on Various Sectors

Political influence influences involve changes in fiscal and monetary policies, the government’s direct interventions in markets, regulatory shifts, and geopolitical developments. Political impacts are significant in the following sectors: energy, healthcare, and defense:

Energy Sector

The energy sector is affected by three main political influences: short-term political desire for stable and low energy prices, climate accords and laws advocating for reduced emissions, and the activities of OPEC (Organization of the Petroleum Exporting Countries).

Short-term political interest in maintaining low energy prices to appeal to consumers and businesses with inelastic price demand. On the other hand,  long-term strategies may focus on higher prices to curb demand and meet emission targets. Investors and producers might be concerned about the long-term perspective, given that governments plan to reduce the proportion of fossil fuels in the energy mix. However, cutting down on fossil fuel production conflicts with the desire for low energy prices in the short run.

The actions of OPEC, which controlled 35% of global crude oil production in 2021, significantly influence global energy prices, possibly maintaining low prices to slow the transition to renewables. For instance, OPEC members might opt to maintain prices at a level that hinders the shift to renewables, capitalizing on governments’ short-term requirements for low energy prices.

Healthcare Sector

Governments are the primary purchasers of healthcare products and services, sometimes implementing reforms to gain political favor or address fiscal issues. For instance, governments have undertaken reforms, including extending healthcare coverage and subsidies, implementing price controls or reductions, and limiting specific healthcare services or products.

Defense Sector

Defense spending is dictated by geopolitical objectives, perceived threats, and alliance commitments. From the late 1990s to 2010, a notable increase in global military spending as a share of global GDP benefited defense companies. Moreover, geopolitical events and competing budgetary priorities will determine future defense expenditures.

Nations are selective regarding the countries they allow their domestic defense companies to engage with. The contracting procedure is complex, encompassing third-party expenses and performance evaluations.

Economic Influences on an Industry

Various economic indicators, including fluctuations in GDP, personal income, inflation, interest rates, and exchange rates, play a pivotal role in shaping industries. Some of these influences are cyclical, moving in tandem with the business cycle. Others are structural, arising from enduring demographic shifts or productivity growth rates in various nations.

Specific sectors like financial services and consumer discretionary goods are particularly sensitive to these cyclical economic shifts. For example, during economic recessions, discretionary spending has a noticeable contraction, which can significantly impact the luxury goods sector.

Managing exchange rate fluctuations becomes paramount to safeguard profitability for industries operating in multiple currency zones. This is especially crucial when there’s a significant mismatch between the currency composition of revenues and costs or when operating in countries known for currency instability. To navigate such challenges, companies often turn to strategies like hedging.

With faster growth, multinational corporations frequently set their sights on emerging markets. A case in point: Nestlé SA, which in 2022, derived over 40% of its sales from emerging markets, registered faster volume growth there compared to its performance in developed markets.

The automotive industry, selling high-priced durable goods, experiences significant influences from economic factors. In economic downtimes, consumers may delay buying new vehicles, opting for used cars, or retaining their current vehicles.

Social Influences on Industries

Social influences on an industry cover cultural and consumer trends, demographic changes such as relative population growth rates, and lifestyle changes.

Social influences are pivotal in shaping industries, particularly those directly interacting with consumers. These influences foster a dynamic relationship between companies and society, characterized by mutual influence and changing trends.

While these influences appear external, they’re intricately linked with industry actions. Companies shape cultural narratives through avenues like political lobbying, advertising, and strategies like product media placements. Additionally, the rising prominence of social media and journalism has magnified reputational risks for businesses. There’s mounting pressure to ensure sustainable sourcing and a heightened examination of supply chains for potential human rights infringements.

Social influences are particularly amplified in industries that target direct consumers. For instance, together with technological and economic influences, the global beauty industry, especially the premium segment, has seen robust growth since 2010. Moreover, the advent of superior camera quality in mobile devices, coupled with social media, has amplified the significance of personal aesthetics. Furthermore, these platforms have enabled beauty brands to market through third-party influencers and video demonstrations effectively.

Creation of a dynamic ecosystem where companies and society mutually influence each other.

Technological Influences on Industries

Technological advancements significantly influence industries by either fostering new developments or rendering existing products obsolete. These advancements can be categorized into sustaining and disruptive innovations, which have varying impacts on the market dynamics and industry leaders.

Sustaining Innovations

Sustaining innovations refers to incremental improvements in products or services without altering core functionalities or operations. They are typically led by established industry players (incumbents) aiming to better cater to existing or adjacent customers.

An example of sustaining innovation is progressive enhancements in cable television technology, including digital transmission, improved video quality, and increased channel offerings.

Disruptive Innovations

Disruptive innovations introduce new markets or reshape existing ones with radically different value propositions that, initially, might not appeal to existing customers but gradually gain traction. For instance, the rise of internet-based video streaming services disrupted the traditional cable television industry.

With the rise of disruptive innovations, the incumbent companies face a dilemma in adopting disruptive innovations (innovator’s dilemma). They will choose to Adopt disruptive innovations, which might accelerate the decline of existing businesses but can prevent market share loss. Alternatively, the incumbents may choose to Ignore the disruptive innovations, which can maintain short to medium-term profits but risk market share loss in the long run.

Legal Influences on an Industry

Legal influences pertain to the modifications in laws and regulations that could modify the operational practices or economic outcomes of industries. These changes often represent adjustments to existing regulations that oversee the industry’s functioning. Companies usually try to mold these legal influences through policy advocacy and legal actions.

Two industries where legal influences have a pronounced impact are the tobacco and cannabis sectors:

Tobacco Industry

Jurisdictions globally have implemented diverse laws and regulations governing the entire spectrum of tobacco-related activities. These rules aim to deter consumption and mitigate the detrimental health effects linked to tobacco, including the risks of secondhand smoke. Regulatory aspects cover a vast area, from advertising restrictions, mandatory graphic warnings on packaging, and age-specific sales limits to more comprehensive bans on public smoking and restrictions on nicotine content and flavor additives. Besides these specific regulations, the sector is also subjected to considerable taxation.

Cannabis Industry

The cannabis industry’s legal framework is in a state of flux. Various jurisdictions stand at different points on the legalization spectrum. For instance, Canada has legalized cannabis production, sales, and consumption. In contrast, nations like the USA exhibit a more fragmented approach, with individual states dictating their distinct cannabis policies. Yet, in most Asian and African countries, cannabis remains completely illegal.

Environmental Influences on Industries

Environmental influences are primarily aligned with legal influences, encompassing the challenges and prospects that arise with the shift towards a greener economy. These influences include aspects such as carbon emission reductions, waste and land management, and environmental conservation.

Due to environmental influences, companies may need to adapt business operations due to regulatory shifts, taxation, and consumer preferences. Failure to adapt might lead to losing market share to greener alternatives.

Question

Which of the following is most likely the difference/similarity between sustaining and disruptive innovations in the context of technological changes?

1. Both sustaining and disruptive innovations refer to improvements in product or service performance.
2. Sustaining innovations create a new market or enter an existing one with a different value proposition, while disruptive innovations refer to improvements in product or service performance.
3. Sustaining innovations refer to improvements in product or service performance, while disruptive innovations create a new market or enter an existing one with a different value proposition.

The correct answer is C.

Sustaining innovations refer to improvements in product or service performance, while disruptive innovations create a new market or enter an existing one with a different value proposition. Sustaining innovations are typically incremental improvements or advancements in technology that help a company maintain or strengthen its position in the market.

They are often targeted at a company’s existing customers and are designed to meet their expected needs. On the other hand, disruptive innovations are not just improvements or advancements. They create a new market and value network, or they disrupt an existing market and value network by introducing simplicity, convenience, accessibility, and affordability.

Disruptive innovations are typically produced by outsiders and entrepreneurs rather than existing market-leading companies. The term ‘disruptive innovation’ was defined and analyzed by the American scholar Clayton M. Christensen and his collaborators beginning in 1995.

A is incorrect. This choice incorrectly states that both sustaining and disruptive innovations refer to improvements in product or service performance. While it is true that sustaining innovations refer to such improvements, disruptive innovations are characterized by creating a new market or disrupting an existing one with a different value proposition, not merely by improving product or service performance.

B is incorrect. This choice incorrectly swaps the definitions of sustaining and disruptive innovations. As explained above, sustaining innovations refer to improvements in product or service performance, while disruptive innovations create a new market or enter an existing one with a different value proposition.