21512 Chap.8 Porter's Five Forces and the I/O Paradigm
Porter's Five Forces and the I/O Paradigm
The lecture answers the question of how to apply systems theory in practice with the industrial organisation (I/O) paradigm from applied economics and its best-known tool, Michael Porter's five-force model.
The model treats an industry as a system in which rivalry among current players is shaped by four further forces: the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers and the threat of substitutes.
The strongest force or forces determine the industry's profitability and become the key variable in strategy.
The chapter rates each force for an electric-scooter hire industry, sets out the drivers that make each force strong, and draws the lessons a strategist takes from the analysis.
It then covers the criticisms, from the static snapshot and blurred industry boundaries to subjective judgement, and the suggestion that complementors form a sixth force.
What this chapter covers
- 01
The I/O paradigm as applied systems theory
- 02
Rivalry among current players
- 03
Threat of new entrants and barriers to entry
- 04
Bargaining power of suppliers and buyers
- 05
Threat of substitutes
- 06
Lessons for strategy from the strongest force
- 07
Criticisms and complementors
Worked example · free
Rate entry barriers for a new gym chain
- 1Capital: high fit-out costs mean large capital is required to set up, one barrier to entry.
- 1Switching costs: twelve-month contracts make it costly for members to switch, a second barrier.
- 1Retaliation: incumbents cut prices whenever a rival opens, showing high retaliatory power; together the barriers make the threat of new entrants weak for this start-up.
Key terms
- Industrial organisation paradigm
- An applied economics view that an industry's structure shapes how its firms compete and profit.
- Barriers to entry
- Obstacles such as capital needs, switching costs or regulation that keep new firms out of an industry.
- Substitute
- A product that meets the same need as an industry's product in a different way.
- Switching costs
- The costs a buyer or firm bears when moving from one product or supplier to another.
- Complementors
- Firms whose products add value to an industry's products, suggested as a sixth force.
Porter's Five Forces and the I/O Paradigm FAQ
What are Porter's five forces?
The five forces are rivalry among current players, the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers and the threat of substitutes. Porter's argument is that the four outer forces drive the intensity of rivalry, so a firm must look beyond its direct competitors to understand an industry's profitability and attractiveness.
How is the five-force model connected to open systems theory?
The lecture presents the industrial organisation paradigm as an application of systems theory. A firm imports from suppliers, sells to buyers and faces rivals, entrants and substitutes, so the industry behaves like a system. Ideas such as feedback loops, negative entropy and equifinality, the many possible responses, carry straight across.
What are the limitations of the five-force model?
The lecture says it gives a good snapshot but a static view, and ignores complementary products made by other firms. Industry boundaries are hard to define, the relative power of the forces is hard to gauge, and because the model is qualitative its assessments are subjective and open to cognitive bias.
What lessons does the lecture draw from a five-force analysis?
It turns the analysis into strategic questions: which industries are profitable and attractive and which to exit; how to organise the firm to compete, and which structure responds best to the key forces; which forces need attention; how to exploit the weak forces; and how to respond to the strong ones.
Assessment move
Learn the drivers for each force as a short list and practise rating each force for two industries, one you know as a customer and one you could research. Always finish with the strongest force and one strategic response to it. Then add a sentence on a criticism that applies to your rating, so the analysis shows judgement as well as method.
Keep your ratings for each force in a small table with the driver beside every rating, so the evidence is easy to check and easy to revise.
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