Porter’s Five Forces
Porter’s Five Forces is a business analysis model that helps to explain why different industries are able to sustain different levels of profitability. The model was published in Michael E. Porter‘s book, Competitive Strategy: Techniques for Analyzing Industries and Competitors in 1980. The model is widely used to analyze the industry structure of a company as well as its corporate strategy. Porter identified five definite forces that play a part in shaping every market and industry in the world. The forces are often used to measure competition intensity, attractiveness, and profitability of an industry or market. These forces are:
- Competition in the industry;
- Potential of new entrants into the industry;
- Power of suppliers;
- Power of customers;
- Threat of substitute products.
Competition in the industry
The importance of this force is the number of competitors and their ability to threaten a company. The larger the number of competitors, along with the number of equivalent products and services they offer, the lesser the power of a company. Suppliers and buyers seek out a company’s competition if they are unable to receive a suitable deal. When competitive rivalry is low, a company has greater power to do what it wants to do to achieve higher sales and profits.
Potential of new entrants into an industry
New entrants into its market affect a company’s position. The less time and money it costs for a competitor to enter a company’s market and be an effective competitor, the more a company’s condition may be significantly diluted. An industry with strong restrictions to entry is an attractive feature for companies that would prefer to work in a space with fewer opponents.
Power of suppliers
This force addresses how easily suppliers can drive up the price of goods and services. It is affected by the number of suppliers of key aspects of a good or service, how unique these aspects are, and how much it would cost a company to switch from one supplier to another. Thus the fewer the number of suppliers, and the more a company depends upon a supplier, the more power a supplier holds.
Power of Customers
This specifically deals with the ability customers have to drive prices down. It is affected by how many buyers or customers a company has, how significant each customer is, and how much it would cost a customer to switch from one company to another. The smaller and more powerful a client base, the more power it holds.
Threat of substitutes
Competitor substitutes used in place of a company’s products or services pose a threat. For example, if customers rely on a company to provide a tool or service that substitute with another tool or service or by performing the task manually, and if this substitution is fairly easy and of low cost, a company’s power can be weakened.
Porter’s Five Forces examples
Competition in the industry
Competition plays a huge part in your industry’s profitability. The potential to produce a high ROI and, in turn, its ability to attract new players. If there’s a lot of competition in your industry, it is harder to turn a profit. Customers have a rich pool of options to choose from, so if your prices are too high, they can just strike a deal with a supplier who will sell to them at their favored price.
In other words, customers typically utilize more power than suppliers in competitive industries. This usually leads suppliers to undermine each other’s prices until their revenue barely exceeds their costs.
If there’s less competition in your industry, it’s easier to turn a profit. Hence customers can only choose from so many suppliers, so if they want to buy your market’s product or service, they must accept the higher prices or else they won’t be able to buy it. Thus this potential for high profitability encourages new players to enter your business.
Examples
Here’s an analysis of the competition in the hospitality industry.
Different categories of travelers have different preferences for their budget. To cater to every category of need, all the well-known hotel booking applications have different classification of hotels with different budgets. Thus travelers can find a 5-star hotel or a 3-star hotel or even homestays to rent for a period of time.
Potential of new entrants into the industry
If new players can enter your market quickly and cheaply, they can sell their minimum viable product. This is a product with just enough features to satisfy early customers. As a result, they can snatch established player’s market share and threaten incumbents’ position in the industry more easily.
The frequency of new players entering your market hinges on your industry’s barriers to entry. If it costs a lot of money and time to build a minimum viable product and cover essential overhead expenses. Hence startups can only afford to build an unsophisticated product that’s a sole differentiating factor is a slightly cheaper price. With these high barriers to entry, they wouldn’t be able to compete, discouraging them from entering your market.
However, if building a minimum viable product and covering essential overhead expenses don’t cost that much money or time, your market’s low barriers to entry will encourage most start-ups to enter.
To help you examine the potential of new entrants in your own industry, here’s an analysis:
For example, in the case of the mobility industry, the car-sharing platforms need a heavy investment before they embark upon the market. Getting the entire fleet ready before starting the business is both a risk and a challenge. The barriers they face usually are initial investments and acceptance of a new means of mobility among commuters.
The social media platforms face the challenge of acquiring a large user base. With strong players existing in the market already, the barrier for new entrants becomes very high to become a potential competitor. It means procuring users who are already used to a stable platform that has existed over time and also new ones.
Power of suppliers
Thus the number of suppliers or competitors in your market directly affects your company’s ability to control prices. When there are only a few suppliers in your industry, each supplier holds a ton of pricing power. This is because if a consumer doesn’t accept your prices, you and your fellow suppliers can easily find someone else who will.
For example, Amazon holds a monopoly in e-commerce. They have many suppliers each competing to provide the best product or service at the best possible price.
I hope you enjoyed going through some marketing basics. Porter’s 5 forces will always be applicable in any business at any phase. You are welcome to share your thoughts and opinions on it.