Porter's Five Forces Explained — Here's a Comprehensive Guide to the Managment Model. If you're familiar with strategic management, you may have heard about Porter's Five Forces. Keep reading to learn everything you need to know.
By Dan Bova
Porter's Five Forces model serves as a framework for strategic management. It has served as the North Star of the business industry since Michael E. Porter introduced it in a 1979 issue of the Harvard Business Review.
For such an important topic, you'll need a comprehensive guide, so keep reading for everything you need to know about Porter's Five Forces.
Who is Michael Porter?
With various management frameworks, you might wonder who Michael Porter is and why his framework is so respected. Porter is a scholar, economist and researcher with many impressive accolades on his resume, including experience as an author, advisor, speaker and teacher.
He spent much of his career at Harvard Business School teaching economic theory and strategy, focusing on market competition, environmental affairs and health care. His work is world-renowned and is used by businesses, governments, NGOs and academics.
While Porter has written many pieces of economic literature, perhaps his most impactful publication is Competitive Strategy: Techniques for Analyzing Industries and Competitors, which is the book that introduced the Five Forces.
What are Porter's Five Forces?
Porter's Five Forces is a strategic management framework that provides a systematic way of analyzing the competitiveness of an industry.
It is widely used and revered by companies, investors and management consultants to evaluate an industry's strength and identify potential opportunities and threats.
1. Bargaining power of customers
When it comes down to it, customers control demand. They can force prices down or require more service at the same price.
Customers have the most buying power when:
- They are large compared to the serving suppliers.
- The products aren't differentiated and pose a high cost.
- There aren't many switching costs from one business to another.
The bargaining power of buyers is more likely to be high in industries where fewer buyers have significant purchasing power. One good example is the pharmaceutical industry, where a few large health insurance companies have substantial bargaining power over the price and quality of drugs.
2. Bargaining power of suppliers
Suppliers can use negotiations to leverage price and demand based on industry competition, which has the potential to lower overall industry profitability.
This means that if there are few suppliers of an essential product or service or if switching is too costly or time-consuming, more power is in the supplier's hands.
For example, the bargaining power of suppliers is more likely to be high in industries with a few dominant suppliers, like the oil and gas industry, where a few large oil companies have significant bargaining power over the price and quality of inputs.
3. Threats of new competition
When new competition enters an industry structure, it can decrease current players' prices to maintain customer retention. New market entries bring about new capacities and more pressures on costs and prices.
While more options can be good for the consumer, if the number of competitors is too high, it caps the industry's profit potential because it drives prices down instead of up.
Keep in mind that the actual threat depends on the following:
- Size of the competition.
- Barriers to entry.
- Ability to build brand awareness.
- Access to distribution channels.
- Government policy restrictions.
For example, the threat of new entrants is more likely to be high in industries with low entry barriers, such as the retail industry, where new entrants can enter the market relatively easily and begin competing with established businesses.
Related: Do You Know Who Your Real Competitors Are?
4. Threats of substitute products or services
When another product or service can serve the same need of the industry differently, it is considered a threat.
For example, video chat platforms like Zoom and Skype have forever changed business travel, and the invention of email drastically affected postal service. If the substitute offers a better price and product or service, it is considered a substantial threat.
5. Strength of existing competition
Healthy competition in business is one thing, but too much competitive intensity within the competition drives down prices and can damage profits due to the cost of competing. When companies go head to head with each other, they risk competing away their value.
Fierce industry competitive rivalry happens when:
- There are too many competitors in the industry.
- The competitors are too close in size and market position.
- Industry growth is too slow.
- High fixed costs result in price-cutting incentives.
- The exit barrier is too high.
- Industry competitors are genuinely invested and committed to their business and will not give up.
- Industry competitors have competition goals that are too different.
- Industry competitors are not familiar with each other's business.
For example, the rivalry among existing competitors is likely to be high in industries with a large number of companies, such as the fast-food industry, where intense competition among firms can lead to price wars and reductions in profitability.
Related: How To Create A High-Performing Strategic Plan
How can you use Porter's Five Forces analysis in conjunction with SWOT?
It is essential to reflect on the current state of your business to conduct a Five Forces analysis. Many believe it is best to use a SWOT analysis template in conjunction with Porter's Five Forces to complete the most thorough process possible.
SWOT analysis
SWOT stands for:
- Strengths.
- Weaknesses.
- Opportunities.
- Threats.
SWOT is an acronym and system built to help revamp weak areas of a business and monitor strong areas to ensure they remain strong.
These eight essential questions will guide a SWOT analysis:
- Is the business starting from scratch?
- Does the established business or a department of the business need a revamp?
- What type of buyer does the business want to attract?
- What are the company's strengths?
- How do those strengths provide a competitive advantage?
- What are the company's weaknesses?
- What are the company's opportunities for growth?
- How can the business distinguish its products or services from its competitors' offerings?
Related: How to Use SWOT Analysis to Strengthen Your Marketing Strategy
Porter's strategies for success
For a business to remain effective, consider completing a SWOT analysis with a Five Forces analysis. The process will assist in strategic decisions and forward progress.
Porter's strategies for Five Forces analysis are as follows:
- Cost leadership: A company's core goal should always be to increase profits while reducing costs and charging standard industry prices or increase its market share while reducing sales and retaining profits.
- Differentiation: A company's product must outperform the competition's to improve competitiveness and overall public value. Achieving this requires effective sales and marketing techniques based on thorough research and development.
- Focus: The company must know itself, define its niche and identify a space to sell its goods. In order to do this, a company must thoroughly understand the market, its audience, its sellers and its competition.
Related: 3 Steps to Becoming an Independent Professional Services Provider
What are the possible drawbacks of Porter's Five Forces?
Porter's model is a staple in business. However, there is rarely such a thing as perfection. Before committing to one framework, it is important to understand possible holes in the theory and the challenges you may encounter.
1. Limited scope
Porter's Five Forces framework focuses only on the internal factors within an industry. It does not consider external factors such as macroeconomic conditions, the rapid rate of globalization, technological advances and many government regulations, which all significantly impact industry competition.
For example, the framework's analysis of the airline industry would focus on the industry's competitive forces, such as the threat of new entrants and suppliers' bargaining power.
However, it would not consider external factors such as the impact of increased fuel prices or changes in government regulations on the industry.
Related: One Low-Cost U.S. Airline Is Buying Another for Nearly $3 Billion, Raising Monopoly Red Flags
2. Static nature
The framework assumes that the competitive forces remain constant over time, which may not always be the case in rapidly changing business environments with unpredictable factors.
In reality, competitive forces often change quickly and on a large scale, so companies must be able to adapt to these changes in order to remain competitive.
For example, the rise of e-commerce has dramatically changed the retail industry, altering the bargaining power of suppliers, the threat of new entrants and the bargaining power of buyers.
Related: Understanding the Need and Relationship of Strategies With Innovation and Change
3. Industry-specific
The framework is designed for use in analyzing specific industries. While it is a relatively flexible model, it does have its limitations when it comes to industries that are not built quite the same as big corporate businesses.
For example, the framework may be less helpful in analyzing the competitiveness of non-profit organizations, as the factors that drive competitiveness in this sector may differ from those in for-profit industries.
Related: Building a Value Chain For Sustaining Your Startup
4. Reliance on subjective assessments
The Five Forces industry analysis is partially based on subjective assessments, which can lead to different interpretations and conclusions by different analysts. This can become problematic if there is bias included in the analysis. This is another reason many businesses use Porter's work as a framework but use other tools like SWOT to complete an accurate analysis.
For example, two analysts may come to different conclusions about the suppliers' bargaining power based on their different assessments of the factors that contribute to this power, such as the availability of substitute products, the size, concentration and the number of suppliers, as well as the degree of differentiation of their products.
5. Limited predictive value
While the framework can provide insights into the current state of competition within an industry, it may not accurately predict future trends or changes in the competitive environment. For example, it may not consider disruptive technologies, new competitors or industry disruption that could fundamentally alter the competitive landscape.
For example, the rise of ride-sharing companies like Uber and Lyft has disrupted the taxi and transportation industry, altering the bargaining power of buyers and the threat of new entrants.
Related: Having a 10-Year Plan Is a Bad Idea. Here's Why — and What You Should Do Instead.
6. Oversimplification
The framework can oversimplify the complexities of a competitive environment and may not capture all the critical factors that influence an industry's competitiveness. For example, it may not fully capture the impact of a brand's reputation, distribution channels or consumer behavior.
For example, Porter's framework may not fully capture the complex relationships between buyers and sellers, such as the impact of brand identity recognition or distribution channels on the bargaining power of buyers.
7. Incomplete understanding of buyer power
The framework may not fully capture the power of buyers in a market and the impact they can have on the profitability of companies in an industry. For example, it may not consider the bargaining power of large buyers, the influence of consumers on product design and pricing or the impact of e-commerce on the distribution of products.
For example, the framework may not fully capture the bargaining power of large buyers, such as corporations or government agencies, who can negotiate favorable terms and conditions with suppliers.
What can Porter's Five Forces do for you?
Porter's Five Forces framework is a valuable tool for analyzing an industry's competitiveness by examining the internal factors that influence the intensity of competition.
As you use the framework, remember that it can be paired with other tools to provide a comprehensive picture of the intended industry.
Make sure to remain on top of market trends and adapt your analysis techniques as industries and norms of the world continue to grow and change.
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