AP Business with Personal Finance · Lesson 3

SWOT and Porter's Five Forces

Know Know it

A SWOT analysis sorts what a business knows into four boxes. Strengths and weaknesses are internal: things the business has or does, such as a skilled staff, a loyal following, old equipment or high debt. Opportunities and threats are external: things in the market or the wider world that the business does not control, such as a growing customer group, a new law, a rival or rising supplier prices.

A SWOT is useful only when it leads to action. Strong strategies use a strength to seize an opportunity, or use a strength to defend against a threat. Other moves fix a weakness so the business can seize an opportunity, or cut back where a weakness meets a threat.

Porter's Five Forces judges how attractive an industry is, meaning how easy it is for firms in it to earn good profits. The five pressures: rivalry among existing competitors; the threat of new entrants; the threat of substitutes, different products that meet the same need; the bargaining power of buyers; and the bargaining power of suppliers.

Each strong force pushes profits down. Rivalry is stronger with many similar rivals. New entrants are a bigger threat when barriers to entry (start-up costs, licenses, patents, brand loyalty) are low. Buyers have more power when they are few, buy in large amounts or can switch easily. Suppliers have more power when they are few or switching away from them is costly. An industry where most forces are weak is more attractive to enter.

Trap Inside or outside the business

The test for SWOT is where the fact comes from, not whether it is good or bad. A rival opening nearby is a threat, not a weakness, because it is outside the business. A slow website is a weakness, not a threat, because the business controls it.

Worked example Easy

A fictional bike shop learns that the city will build 20 miles of new bike lanes next year. In the shop's SWOT analysis, this is

  1. a strength
  2. a weakness
  3. an opportunityAnswer
  4. a threat

How to solve it

  1. Ask whether the fact is inside or outside the shop: the city's bike lanes are outside.
  2. Ask whether it is likely to help or hurt: more riders helps a bike shop.
  3. External and helpful means opportunity.

Why each choice is right or wrong

  • A. Incorrect. A strength is internal to the shop, but the bike lanes are a change in the city outside the shop.
  • B. Incorrect. A weakness is an internal problem, and new bike lanes are neither internal nor a problem for a bike shop.
  • C. Correct. The bike lanes are external and could bring the shop more riders and sales, so they are an opportunity.
  • D. Incorrect. A threat is an outside change that could hurt the business, but more bike lanes are likely to help a bike shop.

Explain Explain it

Task verbs: analyze, explain

To analyze an industry with the Five Forces, name the force, say whether it is strong or weak, and point to the fact in the case that shows it. Then explain what that does to the profits a firm could earn there.

To explain a SWOT strategy, name the strength and the opportunity it uses, then say how the action connects them.

Worked example Hard

Only two companies in a fictional country make the special chips used in electric scooters, and a scooter maker that switches chip suppliers must redesign its scooters, which takes about a year.

Which of Porter's Five Forces does this describe, and how strong is it for the scooter makers?

  1. Threat of substitutes, which is high
  2. Bargaining power of buyers, which is low
  3. Threat of new entrants into the industry, which is high
  4. Bargaining power of suppliers, which is highAnswer

How to solve it

  1. The chip makers sell inputs to the scooter makers, so they are suppliers.
  2. Few suppliers and a high cost of switching both raise supplier power.
  3. So the bargaining power of suppliers is high, which can squeeze the scooter makers' profits.

Why each choice is right or wrong

  • A. Incorrect. Substitutes are other products that meet the scooter buyer's need; this passage is about who sells chips to the scooter makers.
  • B. Incorrect. Buyers are the scooter makers' customers, and the passage says nothing about them.
  • C. Incorrect. New entrants are new scooter makers; the passage is about the chip makers that supply the industry.
  • D. Correct. With only two chip makers and a year-long redesign to switch, suppliers can push up prices, so their power is high.

Analyze Your turn

A fictional company already sells canned cold-brew coffee in its region. Fact 1: its customers can easily switch to brewing coffee at home or to buying energy drinks. Fact 2: setting up a new canning line for cold brew costs several million dollars, and new brands need years to win shelf space in stores. For each fact, name the force from Porter's Five Forces it shows, say whether that force is strong or weak, and explain how it affects the company's profits.

Write it, then compare. Nothing you type here is saved or graded.

Compare with a model answer

A full answer does this

  • For Fact 1, names the threat of substitutes and says it is strong
  • Explains that strong substitutes limit the price the company can charge, which holds down its profits
  • For Fact 2, names the threat of new entrants (or barriers to entry) and says the threat is weak
  • Explains that a weak threat of new entrants protects the company's profits

Model answer

Fact 1 shows the threat of substitutes, and it is strong: customers can easily brew coffee at home or switch to energy drinks. So the company cannot raise its price much without losing buyers to those substitutes, which holds down its profits. Fact 2 shows the threat of new entrants, and it is weak, because a canning line costs millions and new brands need years to get shelf space, so barriers to entry are high. With few new brands able to enter, the company faces fewer new rivals, which helps it keep its customers and protects its profits.

Apply Apply it

Practice these topics. AP Practice questions on exactly what this lesson covers, with an explanation for every answer.

Practice these topics