My last blog post discusses the importance of a clear strategy and its elements for a company.
Most businesses use Porter’s Five Forces model as their primary model to understand the dynamics of their market and, as a result, to drive their company strategy.
What is Porter’s Five Forces?
Porter’s Five Forces is a competitive analysis framework based on Michael Porter’s article for the Harvard Business Review. It helps you in examining the competitive market forces in an industry or segment.
The Five Competitive Forces
The five forces outlined by Porter in its industry analysis method are:
- The Threat of Entry
- The Power of Suppliers
- The Power of Buyers
- The Threat of Substitutes
- Rivalry Among Existing Competitors
“the collective strength of these forces determines the ultimate profit potential of an industry.”Porter
Let’s break down each economic force:
The Threat of Entry
New entrants into a company’s market have an effect on its power. New entrants put pressure on pricing, costs, and the rate of investment necessary to compete.
The less time and money it takes a competitor to enter and compete in a company’s market, the weaker an established company’s position.
The Power of Suppliers
The number of suppliers in your market has a direct impact on your company’s ability to control prices. Powerful suppliers gain a larger share of the value for themselves by demanding higher prices, limiting the quality of services offered, or shifting costs to industry players.
Profitability can be squeezed out of an industry that is unable to pass on cost increases in its own prices by powerful suppliers.
A supplier group is powerful if:
• It is more concentrated than the industry it sells to.
• The supplier group does not depend heavily on the industry for its revenues.
• Suppliers serving many industries will not hesitate to extract maximum profits from each one.
• Industry participants face switching costs in changing suppliers.Porter
The Power of Buyers
Your industry’s ability to control pricing is strongly related to the number of consumers.
Powerful customers can capture more value by pushing down prices, demanding higher quality or greater service, and overall putting industry members against one another.
If your industry has only a few customers, they will hold powerful positions.
The Threat of Substitutes
A substitute offers the same or comparable function as an industry’s product but in a different way, and they have the potential to drastically influence your business.
Videoconferencing is a substitute for travel. Plastic is a substitute for aluminum. E-mail is a substitute for express mail.
When there is a strong threat of substitutes, industry profitability decreases. Substitute products or services limit the profit potential of any industry by putting a price limit in place. If an industry does not differentiate itself from competitors through product performance, marketing, or other ways, it will struggle in terms of profitability.
Rivalry Among Existing Competitors
High rivalry lowers an industry’s profitability. Because customers have more alternatives in industries with a higher number of competing rivals, it is more difficult for a company to secure loyal customers.
The extent to which rivalry reduces an industry’s profit potential is determined by two factors: first, the intensity with which companies compete, and second, the foundation on which they compete.
A strategist keeps the overall structure in mind by examining all five forces rather than leaning to just one element.
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