To maintain competitive advantage, firms must constantly adapt their existing strategies to emerging threats and opportunities in the environment. A useful tool for determining those emerging threats and opportunities is the Five Forces Model of industry competition and firm performance (Porter, 1980). In this note, we give some tips on how to undertake a five-forces analysis and apply the framework to an analysis of the discount retailing industry as described in Wal-Mart Stores Inc.

Porter's Five Forces Model seeks to explain the level of rivalry in an industry (and hence the average level of performance in the industry) as a function of four external factors: buyer power and preferences, supplier power, the threat of entry, and the threat of substitutes. Each of these forces have both direct and indirect effects on the level of rivalry within an industry. In analyzing an industry, you should attempt to understand not only how the forces affect the level of rivalry but also how they may affect each other. To understand how an industry will evolve over time, it is important that we understand how the forces are related to one another.

Rivalry

In determining who are the rivals, ask yourself the question, "Whose profitability am I trying to explain?" Changes in technology will simultaneously affect both the height of the entry barriers into an industry as well as the projected industry concentration (i.e., a shift in the minimum efficient scale will occur and the concentration will decrease). Changes in the ability to differentiate products will affect the ability of firms to deter entry via differentiation as well as their ability to avoid price rivalry with one another.

Customer Power & Preferences

It is important that you not only look at issues of customer power but also customer tastes, especially in consumer branded goods and services. How are customer tastes shifting? Can existing competitors easily change their strategies to meet these new consumer tastes? What is the relative bargaining power of different customers? Often changes in technology and the availability of substitutes can affect such power. Be sure that you identify all customer groups relevant to the competitors in the rivalry group, including distributors and merchandisers of the product.

Entry Barriers

Be sure to identify all of the types of investments necessary for competing in an industry, both the tangible (e.g., physical assets) and intangible investments (e.g., brand image, reputation, and knowledge). Changes in technology will affect the height of entry barriers, sometimes causing them to go up and sometimes down. As demand increases, economies of scale may become a less effective barrier to entry.

Substitutes

What are all of the relevant substitutes for the product or service produced by the "rivals?"

Changes in consumer tastes can often lead to an increased threat of substitutes.

To measure the threat of substitutes, one must gauge the "cross of elasticity of demand" between the products, in at least a qualitative manner.

Supplier Power

As the relationship between companies and their suppliers becomes more specific, the bargaining power of suppliers becomes more important in determining competitive advantage.

Vertical integration into supplier channels can increase the height of entry barriers into the industry, help to decrease risks associated with fluctuations in demand, and reduce production and transaction costs.