Porter’s Five Forces is a very simple yet effective strategic management tool for understanding the competitiveness of your business environment, and also for identifying your strategy’s potential success and overall profitability
Ever wondered how competitive is your company in the current market or situation? Porter’s Five Forces of competition model provides a deeper understanding of a firm’s current competitiveness and also highlights options to improve competitiveness. It also helps in decision making, whether to enter a specific industry or increase capacity in a specific industry, and develop competitive strategies.
Understanding these forces in your market environment or industry has wide applications and it directly impacts your organizational success. Once implemented correctly you will have the ability to align your strategy that would ensure profitability and success in the current competitive environment.
You’ll also be able to take advantage of a strong position or work on improving the weaker ones. This will also ensure that you avoid making the wrong decisions in the future.
Understanding Porter’s Five Forces of Competition
Porter’s five forces model is an analysis tool that uses five industry forces to determine the intensity of competition in an industry and its profitability level.
These forces determine an industry structure and the level of competition in that industry. The stronger competitive forces in the industry are the less profitable it is.
For example, an industry with low entry barriers, few buyers and suppliers but many substitute products and competitors will be seen as very competitive and thus, not so attractive due to its low profitability. On the other hand, an industry with high entry barrier, lots of buyers and suppliers but no substitute product will be seen as less competitive and very attractive due to high profitability
This, however, is an extreme example. In any market environment, there will always be some forces that favor you, while others that don’t. This is where this tool is so useful. The tool was created by Harvard Business School professor Michael Porter, to analyze an industry’s attractiveness and likely profitability. After its publication in 1979, it has become one of the most popular and widely accepted business strategy tools.
In this article, we will cover the Porter’s Five Forces Model in detail with its application and use as strategic management and decision-making tool with examples.
Porter’s Five Forces Diagram
The five competitive forces in Porter’s Five Forces model are:
1 New entrants
2 Substitute products
5 Existing competitors
Let us understand the details about each of the 5 competitive forces
1. New Entrants
The threat of New Entrants
The first of the five forces in Porter’s Model is ‘New Entrants’. Your competitive position can be threatened by new entrants in the market. You need to analyze how easily someone can enter your market. Start by looking at the entry barriers in your industry.
The factors to consider, include barriers to entry such as patents and high set-up costs, the attractiveness of profit margins and also the strength and reputation of your brand.
For example, if you are in the online training industry the threat of new entry is very high. It doesn’t require a lot of investment to launch a website and an app.
However, if you are in an industry like manufacturing aircraft, the investment and resource requirements are so high that you can count all the major players in the world on your fingers.
Look at the following variables to ascertain the force of ‘New Entrants
- Investment required and timing of entry
- Capability to respond to new competition
- Do existing companies hold patents, trademarks or do not have established brand reputation
- Specialize Knowledge and Manpower
- Cost Advantage
- Technology protection
- Economies of scale
Assess how easy it is for your products to be substituted by other products. This includes all alternatives – not just similar products. For example, airlines compete with train and coach companies, not just other airlines.
Look at following variables to ascertain the force of ‘Threat of Substitutes
- Switching costs
- Low cost-alternative
- Alternatives from other industries
- New technologies that can make your product or service less valuable
- Future government regulation that will force substitution
Look at following variables to ascertain the force of ‘Buyer Power
- Number of buyers
- Buying in large quantities or control many access points to the final customer
- They threaten to backward integrate
- Price sensitivity
- There are many substitutes
- Cost of switching
- There are few suppliers but many buyers
- Suppliers are large and threaten to forward integrate
- Few substitute raw materials exist
- Suppliers hold scarce resources
- Cost of switching raw materials is especially high
5. Existing competitors
Look at following variables to ascertain the force of ‘Existing Competitors
- Understand your competitors and how you compare to them.
- What threat do they pose?
- What are their strengths and weaknesses?
- Could there be a price war or other aggressive strategies – and would you be able to survive such tactics?
- Are they innovative?
- Are customers able to move to other companies easily?
- How many competitors are there?
- Which companies are the strongest?
- Are there any newcomers ready to take the market by storm or render your products redundant?
Identifying and then assessing your current position vis-a-vis your rivals by using the five forces will help you to determine how your organization is placed for profitability and success. It will help recognize its strengths and weaknesses and the direction it is heading in.
|Porter stressed that Forces are the key sources of competitive pressure within an industry. It must not be confused with temporary factors like government regulations and technological changes which are often temporary in nature.
Porter’s five forces are persistent competitive forces acting withing an industry environment and are often long-term in nature.
Using the tool
When the concept of Porter’s Five Forces is clear and you understand the variables to evaluate each force, the application of tools involves three steps
- Collect Information about all five forces
- List the variables and assign a weight
- Analyze results and realign your strategy
Step 1. Collect Information about all five forces
The first step is to collect information about your industry through brainstorming, consultation and gathering primary and secondary data. All the variables like the number of competitors, information about customers, suppliers, and competition should be gathered in this stage.
Step 2. List the variables and assign a weight
Once you have gathered all the information, you should analyze it and determine how each force is affecting an industry. For example, if there are many equal-sized competitors are operating within the industry the competitive rivalry is considered to be very high.
Once you have listed down all the forces write them down with assigning a weight to all of them. You can use a positive score on the scale of 5 for competitive forces that work in your favor and similarly negative score on the scale of 5 for competitive forces working against you.
You will see the application of Porter’s five forces in the example in the next section.
Step 3. Analyze results and realign your strategy
At this stage, managers should formulate firm’s strategies using the results of the analysis For example, if it is hard to achieve economies of scale in the market, the company should pursue cost leadership strategy. Product development strategy should be used if the current market growth is slow and the market is saturated.
Although Porter’s Five forces is a great tool to analyze the industry’s structure and use the results to formulate a firm’s strategy, it has its limitations and requires further analysis to be done, such as SWOT, PEST or Value Chain analysis.
Application of Porter’s Five Forces Example
For example, to show Porter’s five forces in the real business environment within an industry we pick a scenario where Rahul, is planning to launch app-based cab service in India. He is applying the Porters Five Forces model and framework to make a strategic move.
|Porter’s Five Forces Evaluation – Example for app based cab service in India|
|The threat of new entry (High)|
|-A moderate amount of capital required (+2)
-High retaliation possible from existing companies (-5)
-Government regulation for safety of passengers due to past incidents is high (-2)
-Existing competitors like Ola and Uber have a high brand image (-4)
-Level of differentiation is very low, same cab operators operate multiple services (+5)
-A new entrant can easily source the services of existing cab owners (+5)
-A new entrant has to infuse capital in the short term without adequate returns (-4)
– New innovations in the app or services can very easily be copied (-1)
|Supplier power (Weak)|
|-A large number of suppliers (+5)
-Human capital and IT infrastructure easily available (+4)
-Suppliers, in this case, the cab owners can easily switch and refuse to work (-2)
-Registering new cab owners and drivers is easy (+3)
-Suppliers do not pose any threat of forward integration (+2)
|Buyer power (Weak)|
|-A large number of buyers (+4)
-Most of the buyers are individuals who will switch to whoever offers lesser cost and quality of service (+4)
-It doesn’t cost anything for buyers to switch to another brand of cab service (+4)
-Buyers can easily choose the alternative app-based service (+4)
-Buyers are price sensitive and their decision is often based on how much does the trip cost (-4)
-Buyers do not threaten backward integration (+1)
|Threat of substitutes (High)|
|-There are many alternative types of transportation, such as bicycles, motorcycles, trains, buses (-1)
– Substitutes can rarely offer the same convenience (+2)
– App-based auto and bike services are a viable and quick alternatives for users (-4)
– Alternative types of transportation almost always cost less and sometimes are more environment-friendly (-3)
|Competitive rivalry (High)|
|– A small number of competitors (+5)
– The cost of switching industry is low, many app-based cab services are also expanding into food delivery and other services (+3)
-The industry is medium-sized but expanding and replacing traditional cab services (+2)
-Size of competing firms is large with big global and domestic brands (-5)
-Customers are moderately loyal to their brands (-3)
-There is a high threat of being acquired by a competitor (-5)
The table of analysis is for better readability and explantation, however, you should do it on the template with a diagram to give you a more holistic picture. You can download the Poter’s Five Forces worksheet template in pdf.
As you can see in the table above Rahul has the complete picture of competitive forces with scores in front of him. He can now choose his best strategy based on the given results. He has to work on the negative weights and try to analyze if he can overcome them.
One important point to note here is that Rahul is trying to enter the industry and thus his weight to different competitive forces will be different from an existing player who is operating within the industry and many times can be just opposite of Rahul’s weightage.
For example -Level of differentiation is very low, same cab operators operate multiple services (+5) can be (-5) for the existing player as their key operators can easily switch. The existing competitor will work to ensure that it addresses this problem by various engagement initiatives for their cab operators to make them loyal and stick with their brand.
|Porter’s Five Forces Analysis is a simple yet powerful strategic business and change management tool to understand the forces that shape competition within an industry. It helps organizations adapt their strategy to suit their competitive environment and to improve their potential profit.
The analysis involves looking at the strength of five important forces that affect competition:
–Supplier Power: the strength of the supplier to impact the business. It could be through price increase or other bargaining powers
–Buyer Power: the possibility that the customers can impact the business by bringing down prices or other bargaining powers
–Competitive Rivalry: the overall strength of the competitors operating in the industry
–The Threat of Substitution: the extent to which different products and services can be replicated or replaced
–The Threat of New Entry: the ease with which new competitors can enter the market if they see that one is making good profits and could the business
By assessing the impact of all the five forces, and by identifying its strength and direction, one can quickly evaluate their current standing in the industry then look for the strategic changes that one can make to deliver long term profit.