Porter’s five forces was devised and put to use by Michael Porter in 1979 and this model was first published in the Harvard Business Review. Unsatisfied with the SWOT analysis conclusion and the absence on ad-hoc framework lead his to come up with this particular framework. These five forces lets one carry out a meso analysis to better understand their company’s stance in the market,
These five forces defined by Porter, i.e., the model as a whole, can be said to be a framework for analysing the nature of the competition within an industry. It also helps in understanding and assessing the industry profitability or in simple words, how attractive an industry is.
It is necessary for an business- big or small- to constantly keep in mind the factor which affect their viability in the market. To be able to make a mark, you need to be sure that you have marked out what exactly needs to be done in order to bolster your company’s stand in the industry it is competing in.
Establishes market attractiveness of a business, how we determine attractiveness. Rivalry among existing competitors are influenced by the four forces surrounding it-
- Threat of new entrants: businesses trying to enter the market you compete in. products may be similar to what you sell.
For example, Lay’s in an established chips brand, however people are looking for healthier alternatives such as baked chips, so new and upcoming entrants who are coming up with these alternatives pose a threat to such established brands.
- Threat of substitute products or services: businesses that sell products that are perfect substitutes to the products you sell. Substitutes use a different technology to meet the same economic need.
For example, Water is a perfect substitute for Pepsi, since it is meeting the same need of quenching people’s thirst, and uses a different technology. However, Coke can’t be a substitute for Pepsi since it uses the same technology albeit with different ingredients.
- Bargaining power of suppliers: if there is an abundance of suppliers, you can pick and choose, however if there a restricted number of suppliers, the power goes to the supplier.
For example, Apple uses a particular glass for their phone screens, which is supplied by exactly two suppliers. Hence, if the suppliers decide to increase their cost of material, Apple has no option but to comply.
- Bargaining power of buyers: if you are transparent and your buyers know exactly how much your product should cost, they have the power to move on to another vendor which may be selling the same the same thing at a lower price. However if your product is exclusive then your buyers have less options and therefore the power is transferred to you.
For example, Tesla makes electric cars and because of the technology used, they are expensive to produce and hence automatically exclusive. So a person looking to buy a quality electric car, will go to Tesla as a first option.
If these four forces are really strong, then the rivalry automatically becomes really strong as well. Then the market becomes unattractive.
It is also important to consider that every industry differs on the basis of the following points-
- Size (revenues, quantity)
- Distribution channels- direct or middlemen/intermediaries
- Customer needs and wants
- Product life cycle
- Alternatives for the consumer
Industry profits vary. For example, Airlines have low profits whereas soft drink industries are a high profit industry. This mostly depends on the demand and the revenue. Again, cafes are low profit industries, even though some rake in a high revenues whereas, pharmaceuticals are always high profit industries.
Low profits may be because of-
- Strong suppliers
- Strong customers/buyers
- Low entry barriers
- Many opportunities for substitutes
- Intense rivalry
High profits may be due to-
- Weak suppliers
- Weak customers
- High entry barriers
- Few opportunities for substitutes
- Little rivalry
Looking into the soft drinks industries’ case study, profits here are really high because-
- Customers and suppliers have little power
- High brand awareness and loyalty leads to less desire for substitutes to companies like Pepsi or Coca-Cola
- High barriers to entry
All the forces act together to determine the overall nature of competition in the industry and in some industries, some of the forces will be much more significant than the other.
If new entrants move into an industry they will gain market share and rivalry will intensify. The position of existing firms is stronger if there are barriers to entering the market. If barriers to entry are low, then the threat of new entrants will be high and vice versa.
Barriers to entry are those which restrict/discourage the entry of competitors. They can be:
- Economies of scale- in some industries you need to be big in order to have low unit costs. Significant bargaining power of suppliers, you need to operate at quite a high level of outputs given the fixed costs and the capacity needed to operate efficiently. Very high economies of scale in an industry show that you have to be big in order to be able to compete in this industry effectively
- Vertical integration- the combination in one firm of two or more stages of production normally operated by separate firms.
- Brand loyalty- we feel comfortable with a certain brand and hence it may be difficult for a new entrant to build the customer’s trust in them
- Access to the best technologies
- Expertise (industry know-how and reputation)
Eg: pharma (high economy of scale), dog walking (low economy of scale)
Bargaining power of suppliers:
- If a firm’s suppliers have bargaining power they will: exercise that power by selling their products at a higher price, squeeze industry profits
- If the supplier forces up the price paid for inputs, profits will be reduced
Supplier tend to be powerful when:
- there are only a few large suppliers
- the resource they supply is scarce
- the cost of switching to an alternative supplier is high
- the customer is small and unimportant
- there are no or few substitute resources available
The power of customers
- powerful customers are able to exert pressure to drive down prices
Threat of substitute products:
- something that meets the same customer need
- if there are substitutes to a firm’s product, they will limit the price that can be charged and will reduce profits
- customer loyalty and availability will limit the extent of this threat
- note the role of technological change in rapidly creating new substitutes
How to use the model:
Write down your current situation – the model is dynamic in the sense that threats may keep changing in the coming years. And hence lets you predict the situation for the near future. Figure out your current situation, and how it will develop in the near future. Consider barriers to entry and barriers to exit- these can be said to be the two extra forces.
The question that needs to be considered: How attractive is the market?
The conclusion that needs to be made: The market is attractive/ not attractive because of the following reason…
Software packages like VComply allow you keep constant track of business- by assessing how your employees are performing on a regular basis and therefore you know the track on which your business is progressing.
The five forces mentioned here are extremely important for every business in every industry and give a complete and radical outlook of the market situation. Keep in mind these five forces and success is guaranteed!Add to favorites