AP® Business with Personal Finance review sheet from Aim for Five (aimforfive.com/business-finance/units/4/4-4)
Unit 4 · Topic 4.4
4.4 Strategic Frameworks: Porter’s Five Forces and SWOT Analysis
Two strategic frameworks help businesses size up their situation. Porter's Five Forces judges how attractive and profitable a market is by looking at five sources of competitive pressure. SWOT analysis lists a business's internal strengths and weaknesses and its external opportunities and threats.
Key terms
- Porter's Five Forces
- competitive rivalry
- threat of substitutes
- switching costs
- supplier power
- SWOT analysis
Porter's Five Forces
Harvard Business School professor Michael Porter's Five Forces framework measures how intense the competition in a market is, and so how attractive and profitable it's likely to be. Businesses use it for decisions like which market to enter or which pricing strategy to use. When the forces are strong, profit potential is low; when they're weak, the market is more attractive.
| Force | What it asks | Strong (bad for the business) when |
|---|---|---|
| Competitive rivalry | How fiercely do current rivals compete? Usually the most important force. | Many rivals sell nearly identical products and no one has pricing power |
| Threat of new entrants | How easily can new businesses join? | Barriers to entry are low |
| Threat of substitutes | Can customers meet the same need another way? | Alternatives are cheaper, easier to get or better |
| Customer power | Can buyers push prices down? | There are few customers, each buys a lot, acquisition costs are high and switching costs are low |
| Supplier power | Can suppliers push input costs up? | There are few suppliers and switching to another is costly |
Key terms inside the forces
- Substitutes are different products that meet the same need, not direct competitors. For a movie theater, rival theaters are rivalry; streaming services are substitutes.
- Switching costs are the money and hassle (including the psychological cost) of changing brands. High switching costs, like moving all your photos to a new phone system, keep customers from leaving and weaken customer power.
- Supplier power depends on how competitive the supplier's own market is. If only two companies make a key chip, they can raise prices.
SWOT analysis
SWOT looks at the factors that affect whether a business can reach its goals and stay competitive. Strengths and weaknesses are internal, things the business controls. Opportunities and threats are external, things it can't control.
| Factor | Inside or outside? | Examples |
|---|---|---|
| Strengths | Internal | Core competencies, brand recognition, patents, product quality, plenty of cash, skilled staff, efficient supply chain |
| Weaknesses | Internal | Missing skills, weak brand, product flaws, limited funds, trouble hiring, poor service, outdated technology, supply chain risks |
| Opportunities | External | A growing market, rivals leaving, new technology, helpful new regulations |
| Threats | External | Rising input costs, natural disasters, harmful new regulations, disruptive innovations that change how customers meet their needs |
Using SWOT
To decide whether something is a strength or weakness, compare it with rivals, industry benchmarks, past performance and outside conditions. To find opportunities and threats, look at market size, customer preferences, PESTEL factors and the Five Forces. Then act: build on strengths, fix weaknesses, take advantage of opportunities and prepare for threats.
Worked examples
Try each one yourself first, then open the solution.
- Example 1
Sorting facts into SWOT
A local bike shop notes: (a) its mechanics are the most experienced in town; (b) its website can't take online orders; (c) the city is building 20 miles of new bike lanes; (d) a big online retailer now offers free next-day delivery on bikes. Classify each fact and suggest a response to (d).
Show the solutionHide the solution
- Step 1: Ask two questions: is it inside or outside the business, and does it help or hurt?
- Step 2: (a) Inside and helpful: a strength.
- Step 3: (b) Inside and harmful: a weakness. The trap is calling it a threat because it involves technology; it's the shop's own website, so it's internal.
- Step 4: (c) Outside and helpful: an opportunity, since more riders means more customers.
- Step 5: (d) Outside and harmful: a threat. A response: lean on strength (a) by offering expert repairs, fittings and service that an online retailer can't.
Answer: (a) strength, (b) weakness, (c) opportunity, (d) threat. Respond to (d) by competing on expert service rather than price.
- Example 2
Applying the Five Forces
Jo wants to open a bubble tea shop in a mall food court. There are already four drink stands; setting up a stand is cheap; customers can easily buy coffee, smoothies or soda instead; the mall food court has thousands of separate customers, each buying one drink; and many suppliers sell tea, milk and tapioca. Judge each force and the overall attractiveness.
Show the solutionHide the solution
- Step 1: Rivalry: four drink stands nearby, so strong.
- Step 2: New entrants: setup is cheap, so barriers are low and the threat is strong.
- Step 3: Substitutes: coffee, smoothies and soda are easy to get, so strong.
- Step 4: Customer power: thousands of separate buyers, each a tiny share of sales, so customer power is weak overall, even though low switching costs let any one customer walk to another stand.
- Step 5: Supplier power: many suppliers, easy to switch, so weak.
- Step 6: Three of five forces are strong, including rivalry, the most important one.
Answer: Rivalry, new entrants and substitutes are strong; customer and supplier power are weak. Overall the market is fairly unattractive, so Jo would need a clear way to stand out.
Common mistakes
- Calling an internal problem a threat. Threats come from outside; internal problems are weaknesses.
- Treating rival products as substitutes. Substitutes meet the same need in a different way.
- Thinking a strong force is good for the business. Strong forces mean more pressure and lower profit potential.
On the exam
- Expect a scenario where you must identify which force or which SWOT category a fact belongs to, or explain how a force affects profitability.
- In Question 4, describing a factor as internal, market or external (part A) uses the same thinking as SWOT and the Five Forces.
Connected topics
Videos
Check yourself: 4.4 Strategic Frameworks: Porter’s Five Forces and SWOT Analysis
4 questions on 4.4 Strategic Frameworks: Porter’s Five Forces and SWOT Analysis. Pick an answer to see if you got it, and why.
Pixel Print is considering entering the market for custom phone cases sold online. Its research found the following.
Dozens of online sellers offer nearly identical custom cases, and prices have been falling.
Anyone can start selling custom cases with a few hundred dollars of printing equipment.
Many phone owners decorate their phones with stickers or use no case at all.
Customers can switch to another online seller with one click.
Blank cases are made by hundreds of factories, and switching factories is easy.
Hypothetical market research
The finding that anyone can start selling cases with a few hundred dollars of equipment shows that which force is strong?
How strong is supplier power in this market, and why?
Which finding shows that customer power is strong?
Based on Porter's Five Forces, what is the best overall conclusion about this market?
0 of 4 answered