Strategic Analysis - Five Forces

Michael Porter’s Five Forces analysis helps us to understand why some industries are profitable and others aren’t. That’s industries, not companies. The two industries that Porter cites most often are airlines and soft drinks ("a licence to mint money".

Airlines are "among the least profitable businesses known to man". Freddie Laker, one of the pioneers of low cost flying once said that the way to become a millionaire was first to become a billionaire, and then buy an airline.

And yet over the the last thirty years or so there have been a steady stream of new airlines, many of which have gone bust. They are just ’sexy’ - but unprofitable.

Porter’s Five Forces model helps us to see why. Here is the a slide from one of my strategy training workshops.

Let’s look. at the forces that shape the industry. Firstly, suppliers. It is the airports that own the slots; you can’t fly if you can’t land and take-off. If you want to fly to New York, there are a restricted number of places you can land - all the power is with the airport. Similarly, there are few major aircraft manufacturers and limited competition means less pressure to lower prices.

On the buyer side, there is lots of information via the internet. There is little differentiation - the airlines cannot convince us to pay more, we simply want the cheapest ticket.

It is very easy for new entrants to come into the market - the technology is all generic (and run by the airports) and the cost of entry can be low by starting with flights between two cities and building slowly. There are no switching costs for buyers.

And all of these factors contribute to incredible competitive rivalry between the airlines themselves, some of whom face exit barriers and so remain fighting whilst sustaining losses.

Not a pretty picture and one that Porter argues is perfectly predictable from a five forces analysis.

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