Porter’s Five Forces

Threat of New Entrants

The Porter’s Five Forces Framework is a strategic tool for analyzing the competitive dynamics in a market. Each force affect a company’s ability to make a profit.

Michael Porter first published his “Five Forces”  in a Harvard Business Review (HBR) article in 1979. In 2008 he published an updated article in HBR entitled The Five Competitive Forces That Shape Strategy. It is from this 2008 article that many of these case study examples come from.

According to Wikipedia:

Profitable industries that yield high returns will attract new entities. New entrants eventually will decrease profitability for other firms in the industry. Unless the entry of new firms can be made more difficult by incumbents, abnormal profitability will fall towards zero (perfect competition), which is the minimum level of profitability required to keep an industry in business.

The Barriers to Entry that effect the degree of threat posed by new entrants include:

  • Patents and Copyrights
  • Capital Requirements
  • Economies of Scale
  • Brand Equity
  • Distribution Channel Access
  • Customer Switching Costs
  • Network Effects

This Case Study provides a high-level overview of the workflow without detailed explanation. It assumes you are already somewhat familiar with KNIME and Market Simulation. If not, start by reviewing the Building Blocks and Community Nodes.

Case Study

Barriers to entry can come from patents, regulations, product differentiation, brand equity, and network effects. But the strategic decisions of the incumbents can also raise barriers to entry.

In the 1970s, Kmart and other “big box” retailers adopted new automated distribution and procurement controls with large fixed costs. These strategies reduced costs and prices, but had a modest impact on profitability. However, these high fixed costs raised barriers which prevented easy entry by new competitors.

Customer Value

Customer shopping baskets vary not only in size and price, but also in the cost to the retailer and the Consumer Surplus value provided to the customer. In this Market Simulation, it is assumed that customers could buy the same basket of goods at either Kmart or at the New Entrant’s store (once the New Entrant were to enter the market).

But the shopping experience of customers will vary by store. The experience offered by Kmart will be different than the experience offered by the New Entrant. And the experience will also vary by customer. Some customers will have a positive experience, but most customers will have a negative experience (after accounting for wasted time, distance traveled, parking, manual hauling, etc).

These individual values can be replicated by the consumer-agents in the Market Simulation.

Basket Value

The Market Price of each Basket of Products will vary by Customer, as will their Consumer Surplus as a percentage of Price (Surplus %). Also, the Profit Margin (Margin %) for the Seller will vary by Basket.

Kmart Experience

The Customer Experience enjoyed by shoppers differentiate Kmart from the New Entrant. Here, the average Kmart Experience is set to an average of -10 with a Standard Deviation of +10.


Each of the 10,000 customer-agents (C00001 to C10000) have individual values for Basket Price, Profit Margin, Consumer Surplus, and Store Experience.

Stage 1: Kmart 1970

Kmart pre-1970’s had no high fixed-cost automated distribution and procurement controls.

In this branch of the Market Simulation, customers select different baskets of goods to buy from Kmart. The simulation calculates the Cost, Profit Margin, Willingness To Pay (WTP), and Consumer Surplus of each basket (taking into account the positive or negative experience a customer would enjoy shopping at Kmart). The simulation then predicts the number of customers who actual purchase from Kmart, along with Kmart’s Revenue, COGS, and Profit.

Calculations include:

  • Kmart Cost of Basket = Market Price / (1 + Margin %)
  • Kmart Profit Margin = Market Price – Kmart Cost
  • Kmart WTP = Market Price * (1 + Surplus %) + Kmart Experience
  • Kmart Consumer Surplus = Kmart WTP – Market Price

Value Calculations

Kmart’s Cost of Basket, Profit Margin, Customer Willingness To Pay (WTP), and Consumer Surplus are all calculated using the ‘Math Formula’ nodes.

Purchase Decisions

Before the New Entrant arrives, customers with a postive Consumer Surplus will purchase their basket from Kmart.

Sum Sales

The GroupBy node counts the number of Customers, then calculates Kmart’s Revenue (sum of price paid), Cost of Goods Sold (sum of basket cost), and Profit (sum of margin).

Stage 2: New Entrant

Stage 2 of the Market Simulation considers the early arrival of a New Entrant. This predicts what would have happened in the 1970’s if a competitor had entered the market before Kmart had a chance to raise the barriers to entry by making large fixed cost investments.


Simulate Market

As before, the simulation calculates the per-Customer Cost, Profit Margin, Willingness To Pay (WTP), and Consumer Surplus for the new Entrant. It also takes into account the different Customer Experience offered by the New Entrant.

The simulation then compares the basket from Kmart against the exact same basket from the New Entrant (from the perspective of each Customer). The highlighted ‘Simulate Market’ node ensures that customers will select the vendor that yields them the greatest Consumer Surplus.

Note that now Customers base their purchase decisions not only upon whether the basket yields them a positive Consumer Surplus, but also upon which vendor maximizes their Consumer Surplus.


Customers now select between Kmart and the New Entrant. Customers marked ‘No Sale’ have negative Consumer Surplus for both vendors, so do not purchase from either.


In Stage 2, only Customer Experience differentiates Kmart from the New Entrant. Hence both vendors are expected to split the market evenly.

Stage 3: Kmart Investment

In Stage 3, Kmart makes the high-fixed-cost investment but no New Entrant arrives.

The simulation assumes that Kmart make a large, Fixed Cost investment that reduces both their Marginal Costs and Prices by 10%. That Fixed Cost is amortized so that end-of-period Profit must be reduced by 20,000. But this shift in business model doesn’t make a huge impact to the overall Profitability – even if a new competitor doesn’t enter the market.

Investment %

The high-fixed-cost investment by Kmart into a new procurement system can be manually adjusted as a percentage of 1 year of revenue. It is assumed that Kmart decreases Price by the same amount.

Purchase Decisions

Again, Customers with a positive Consumer Surplus will purchase their basket from Kmart. This is achieved with the ‘Row Filter’ node in the same way as Stage 1 when there was no New Entrant.

Stage 4: New Entrant

In Stage 4, Kmart must compete against the New Entrant. But now we see that Kmart’s high-fixed-cost investment creates a Barrier to Entry for new Competitors.

This branch predicts what would happen if a new Competitor were to enter the Market using the old business model and without making the same level of investment as Kmart has made.

Here, customers compare the same Basket of Products – with Kmart Prices being 10% cheaper. Some Customers will still prefer the new Entrant Experience. But Kmart’s Market Share is not significantly weakened after the arrival of the New Entrant. On the other hand, the new Market Entrant has a much harder time generating sales. In this simulation, the Barrier to Entry created by Kmart ensure they’re twice as profitable as the Late New Entrant ($21,742 vs $10,059).


Kmart’s high-fixed-cost investment initially made little difference to it’s profitability. But its change in business model created a Barrier to Entry that makes it harder for new competitors to enter the market. Hence this Market Simulation has demonstrated Michael Porter’s proposition that the strategic decisions of the incumbents can also raise barriers to entry.

Before Investment

An Early Market Entrant would have had no problem entering the market and taking a considerable portion of Kmart’s profitability.

After Investment

Kmart’s investment created a Barrier to Entry. Now if a Late Market Entrant were to enter the market, Kmart could protect its profits.