Porter’s Five Forces

Understanding Porter’s Five Forces

Porter’s Five Forces is a strategic analysis tool, developed by Michael Porter, which identifies and analyses five competitive forces that shape every industry, and helps determine an industry’s strengths and weaknesses.
These forces include the threat of new entrants, the bargaining power of buyers, the bargaining power of suppliers, the threat of substitute products or services, and the intensity of competitive rivalry.
The model provides useful insight into how a company can maximise its competitive advantage within its industry.

Threat of New Entrants

The threat of new entrants refers to how easy or difficult it is for potential competitors to enter an industry.
High entry barriers include high capital requirements, strong brand identities, networks effects, patents or trademarks, customer loyalty and the absolute cost advantages associated with economies of scale.
Low barriers to entry invite increased competition, which can dilute profitability and market share, thus it’s important for businesses to create and maintain barriers.

Bargaining Power of Buyers

The bargaining power of buyers determines how much customers can dictate the price and terms.
If there are many alternatives available or few buyers purchasing in large volumes, buyer power is high.
When buyer power is strong, the industry becomes more competitive, potentially affecting the profitability of existing firms.

Bargaining Power of Suppliers

The bargaining power of suppliers determines the input costs for a firm.
When supplier power is high, the seller can demand more favourable terms, prices, and conditions.
This could be due to the supplier’s brand, the size of the supplier, the uniqueness of the service, or if it controls an essential resource.

Threat of Substitute Products or Services

The threat of substitute products or services refers to the likelihood of customers finding a different way of doing what your product/service does.
If it’s easy and cheap for your buyers to switch to your competitors, then this competitive force is high.
The presence of substitutes can reduce profitability by limiting the price firms can charge and by making them more sensitive to price.

Rivalry Among Existing Competitors

The intensity of competitive rivalry includes all factors that influence how companies compete within an industry like marketing, pricing and innovation.
High competition can lead to reduced profit margins as companies compete for market share.
The level of rivalry often depends on the number of competitors, the diversity of competitors, and the importance of fixed costs to the business.

Benefits of Porter’s Five Forces Analysis

Performing a Porter’s Five Forces Analysis allows companies to understand where their power lies in a business situation.
This analysis helps businesses understand the competition, improve their business strategy, and identify market trends and the dynamics of competition.
Companies can use the results to inform their strategic planning and decision-making processes.
However, just like PEST analysis, Porter’s Five Forces should not replace other forms of analysis but should be used to complement them.