The Porter's Five Forces analysis was created by Michael Porter, a professor at Harvard Business School in 1979. Since its publication, it has become one of the most popular and highly regarded business strategy tools. Let's take a look at what it is exactly and how businesses can use this tool to guide their strategy.
Porter's Five Forces Framework
Porter's Five Forces is a method for analysing a company's competitive environment. It identifies and analyses five competitive forces that shape the industry.
The purpose of Porter's Five Forces is to determine the profit potential of a market. It helps business people understand the relative attractiveness of an industry and the industry's competitive pressure. Each business sector is influenced by the five factors and therefore understanding them and how they apply to an industry can enable a company to implement a suitable business strategy. It can help to make decisions relating to whether to enter a specific industry, increase capacity in a specific industry and develop competitive strategies.
Porter's Five Forces Model
The five main forces that make up this model are:
Competitive rivalry |
New entrants |
Power of Buyers |
Power of Suppliers |
Threat of Substitutes |
Competitive Rivalry
The type of competition can vary depending on the balance of the competitive relationship. The competitive rivalry is high when there are numerous competitors because then consumers can easily switch to competitors offering similar products or services. Similar size companies are likely to be more fierce than when there are large and small companies. It is also worth keeping an eye on the market growth as a growing market allows both companies to grow in sales and a stagnant market means that a market steal is required.
Therefore, it is important to know your competitors:
New Entrants
New entrants to the market can threaten your own sales volume and market share. Therefore, think about how easily this could be done.
Entry barriers:
Economies of scale,
Capital cost of entry,
Expected retaliation,
Brand loyalty,
Government policies,
Specialist knowledge.
Power of Buyers
Power of buyers is an ability that customers have to drive prices lower or higher.
Buyers' power is high when there are few large players and proportionally many suppliers. If many sources are available, buyers may shop around for other materials or supplies which may include a risk of losing a key client.
Factors determining the power of buyers:
Number of customers,
Order size,
Differences between competitors,
Buyers' ability to substitute,
Price sensitivity,
Information availability.
Power of Suppliers
Power of suppliers is an ability that suppliers have to drive up the cost of inputs.
Opposite to the power of buyers, power of suppliers is high when there are few suppliers. When there are few suppliers, a product is new or specific, it might be difficult and expensive for a company to switch suppliers.
Factors determining the power of suppliers:
Number of suppliers,
Size of suppliers,
Uniqueness of the product or service,
Suppliers' ability to substitute,
Switching costs.
Threat of Substitutes
Most products can be substituted for other offerings, not necessarily in the same category. This is known as the threat of substitutes.
There are several types of substitution:
Product-for-product.
A camera can be replaced with a smartphone.
Need-based. The same product, but better, improved.
A computer with better software.
Generic substitution. There is no competitive product. It is just a decision on what to buy.
A new car, new kitchen or holiday.
Go without.
Give up smoking, alcohol, or meat.
Porter's Five Forces in Practice with Example
Let's take a look at Porter's Five Forces in action with a detailed example of the airline industry.
Competitive Rivalry
Characteristics:
Numerous airlines,
Two categories regarding quality: low fare airlines and regular airlines,
Concentrated mostly in North America, Europe and Asia,
No matter how big they are, some of them have built trust among customers,
The industry is very stagnant in terms of growth.
The airline industry is very competitive. No matter where a company is based, how big it is and what types of services it offers, the competitive rivalry among existing competitors is high.
New Entrants
Entry barriers:
Inability to procure cheap equipment since there are many established companies with significant customer base,
High cost of entry (cost of planes and airport spots),
High risk of retaliation,
Difficulties in building brand loyalty,
Many Government policies,
Need for specialist knowledge.
New entrants would face many difficulties when entering the market. Therefore, you should not worry about new competitors.
Power of Buyers
Characteristics:
High number of customers all over the world,
Different order sizes (individual and corporate flights),
Large differences between competitors (low fare, regular and more exclusive flight offers),
Small ability to substitute (many destinations are reachable by plane only),
Relatively big price differences (prices change continually),
Large information availability.
Power of buyers seems to be very high. There are many customers who are able to choose from many different services at different prices.
Power of Suppliers
Characteristics:
Low number of suppliers,
Big-sized suppliers,
Low uniqueness of products or services (there are that many types of planes),
Moderate ability to substitute,
High switching costs.
Power of suppliers appears as moderate. They are able to raise prices since there are few suppliers and it is tough to change a supplier. However, there are not many competitive suppliers and it might be difficult for them to offer a new, unique product.
Threat of Substitutes
It is hard to substitute a plane with any other type of transport since many destinations are reachable this way only. In the future there might be some inventions which will substitute planes, but for now you should not worry about them.
Limitations of the Porter's Five Forces
It is just a starting point for a deeper investigation. The framework is very general and does not assess whether the factors are advantageous or not.
There is no quantitative analysis involved.
It tends to be very subjective.
Porter's Five Forces - Key Takeaways
Porter's Five Forces is a tool for understanding the competitiveness of your business environment.
The five forces are: competitive rivalry, new entrants, power of buyers, power of suppliers and threat of substitutes.
Its purpose is to identify a company's potential profitability and adjust its strategy.
The forces should be continuously monitored as they may change frequently.
Subjects Free & expert-verified explanations.
Exams Exam preparation made easy.
Textbooks Free and expert-verified textbook solutions.
Magazine Best study tips and tricks for your exams.
