Michael Porters devised Porter’s Five Forces Analysis Framework in 1979. The model enables industries to classify and analyze the five forces that shape an industry, as well as evaluate a company’s competitive strength and position.
Porter’s Five Forces Model, also known as Porter’s Competitive Forces Model, is likely one of the most frequently employed business strategy instruments. It has demonstrated its utility on numerous occasions. Porter’s model excels at fostering a competitive perspective, from external forces within the organisation.
Given the total shift in industry knowledge, a change in any of the factors usually necessitates a re-evaluation of the marketplace by a business unit. The sector’s attractiveness as a whole does not indicate that every company in it will be profitable.
With certain limitations, Porter identified five irrefutable factors that shape every global market and sector. The five forces are commonly used to assess an industry’s or market’s competitiveness, attractiveness, and profitability.
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.
On the other hand, high-growth industries have a growing customer base, and new firms can successfully attract new customers by offering them something existing firms cannot. It is important to note that entry barriers are not always external; firms frequently lobby politicians for regulations that can act as entry barriers. These types of obstacles will be covered in greater depth in courses at a higher level.
Threat of Substitutes
In the context of Porter’s five 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.
Supplier Bargaining Power
Strong bargaining power enables suppliers to sell buyers raw materials with a higher price tag or of inferior quality. This has a direct impact on the profits of the purchasing company because it must pay more for materials.
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
The final of Porter’s five forces model is buyer power, which refers to the balance of power between a company and its clients. 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.
Switching costs, the penalty incurred by consumers when they decide to use a product manufactured by a different company, are a form of defence for businesses against buyer power. Switching costs can be monetary (the additional price paid to select an alternative product) or practical (the time or hassle required to switch to a different product). Consider, for instance, your smartphone. What would be the cost of switching to a non-Apple smartphone if you own an iPhone? Would the new phone be the only expense? Even when cell phone service providers offer free smartphones to new customers, many people still do not switch. The loss of compatibility with other Apple products, the need to transfer apps and phone settings to a different system, and the absence of beloved iPhone features such as iMessage are sufficient to keep many people loyal to their iPhones.
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.