What is Porter’s Five Forces Model?

Porter’s Five Forces model is a framework developed by Michael Porter that helps analyze the competitiveness forces within an industry.

While there have been countless business analysis tools that have risen and fallen, Michael Porter’s Five Forces Model, developed more than four decades ago, is still impressively relevant and potent. The model has aided innumerable organizations, ranging from startups to Fortune 500 firms, to understand their competitive landscape and develop successful strategies.

First published in Harvard Business Review in 1979, Porter’s model goes beyond the straightforward analysis of direct rivals. It probes deeper, analyzing the underlying pressures that influence industry dynamics—from the negotiating power of suppliers to the threat of new entrants.

Let’s explore the Porter’s five forces model and its each component and how companies can utilise this tool to gain competitive advantages.

Industry Rivalry

This factor determines how profitable and competitive an industry is. The degree of competition depends on variables such as costs, industry concentration, industry growth rate, differentiation, and transition costs.

An analyst will use Porter’s model to figure out if each force has a strong or weak effect on firms in an industry. In the context of rivalry, the question of strength focuses on how fiercely firms must compete with industry competitors (rivals) for customers and market share. Strong competition in an industry reduces the profit potential of all firms because consumers can base at least a portion of their purchasing decisions on price when they have numerous firms from which to choose.

An industry with weak rivalry will have few firms, indicating that there are enough customers for everyone or firms that have each staked out a unique position within the industry, meaning that customers will be more loyal to the firm that meets their specific needs the best.

The Threat of New Entrants

Profitable markets that yield high returns will entice new firms, according to incumbents. This creates a large number of new competitors and ultimately reduces the profitability of all firms in the industry. Unless incumbent firms can prevent the entry of new firms, the abnormal profit rate tends toward zero (also known as “perfect competition”). From the perspective of new entrants, high barriers to entry imply that the capital costs of entering the industry make it challenging to contend with the current market leaders.

In an industry, new entrants can join the fray in a number of methods. Entrepreneurial start-ups, foreign firms that decide to enter a new geographic area, supplier firms that choose to enter their customers’ businesses, and client firms that choose to enter their suppliers’ businesses are all examples of new entrants. Depending on the industry, the likelihood of these four paths being pursued varies.

Different industries may be easier or more challenging to enter based on entry barriers, which prevent new firms from competing successfully in the industry. Common entry barriers include cost, brand loyalty, and industry expansion. For instance, firms in the airline industry rarely face competition from new entrants due to the high cost of acquiring equipment, airport landing rights, and specialised knowledge.

Brand loyalty can also prevent new firms from entering an industry, as customers accustomed to a well-known brand may be reluctant to try a new, unfamiliar brand. Industry expansion can increase or decrease the likelihood of success for a new entrant. New customers are scarce in an industry with low growth, and a company can only increase its market share by acquiring the customers of competing companies. Consider all the advertisements you see and hear for competing cell phone service providers. The cell phone industry is experiencing slower growth, and companies must offer consumers incentives to switch to another provider.

Also Explore: What is Lewin’s Change Management Model?

Threat of Substitutes

In the context of Porter’s 5 forces model, a substitute is any other product or service that meets the same customer need as the industry’s offerings. Avoid conflating substitutes with competitors. They offer similar goods or services and compete directly with one another. Substitutes are products or services consumers would be willing to use instead of their current favourites.

For instance, the fast food industry offers inexpensive, quickly prepared, and convenient meals. Customers can choose McDonald’s, Wendy’s, Burger King, and Taco Bell, all of which compete for business. However, their customers are merely hungry individuals. What else could one do if they were starving? You could go to the supermarket and purchase food to cook at home.

McDonald’s and Kroger are in different industries, so they do not directly compete with customers. However, McDonald’s faces a threat from grocery stores because they both sell food. How does McDonald’s defend itself against Kroger as a potential substitute? By ensuring that their food is prepared and easy to purchase, you can buy a burger or salad without having to exit your vehicle.

Also Read: Top 5 Biggest Tech Brands in the World

Supplier Bargaining Power

Supplier bargaining power is the degree of influence suppliers exert over your business by their capacity to increase price, decrease quality, or restrict supply of products or services. The more powerful they are, the greater the effect on your profitability and operations.

For instance, when Sony develops a new PlayStation model, it frequently collaborates with a single supplier to create the most advanced processor chip possible for the game console. This indicates that the processors’ supplier will be able to command a relatively high price, indicating the supplier’s power. In contrast, a company whose operations require commodity resources such as oil, wheat, or aluminium will have numerous suppliers to choose from and can easily switch to a new partner if the price or quality is superior. Typically, commodity suppliers have little influence.

Buyer’s Bargaining Power

Buyer’s bargaining power refers to the pressure that customers can exert on businesses to lower prices, improve product quality, or provide better service.

If a company offers a one-of-a-kind product or service, it will have the ability to charge premium prices, as its customers will have no other option but to purchase from it. In contrast, when customers have multiple potential sources for a product, firms will need to offer lower prices or greater value for the money to attract customers if they wish to sell their products.

Is Porter’s Five Forces Model still relevant today?

Porter’s Five Forces aren’t going away anytime soon. The fundamental concept of each firm working in a network of buyers, suppliers, substitutes, new entrants, and competitors remains true. Each of the five forces is influenced by the three new forces. Because of the Internet, buyers were able to get a lot more information, which gave them more bargaining power.

Also, firms’ investments in high-tech have made it harder for new companies to get into the market, which discourages them from doing so. The ‘New Economy’ differs from the ‘Old Economy,’ which is the foundation of the Five Forces concept.

Also Explore: What is Kingdon’s Multiple Streams Framework?