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Michael Porters Five Forces Model For Competitive and Strategic Analysis of any Industry

Updated on September 27, 2013
Harvard Business School's Michael Porter
Harvard Business School's Michael Porter

Michael Porters Five Forces Model

In the late1970’s Michael Porter of the Harvard Business School developed a comprehensive framework to consider the internal and external threats and the vertical and horizontal competition to any organisation. Porters Five Forces model was the result.

The Five Forces Model allows individuals or companies to better understand the dynamics of the industry in which they operate or wish to operate in. It is less quantitative than some other methods and tends to rely on qualitative assessment rather than spreadsheet models and this approach can often leave people thinking they have not completed it fully.

The Five Forces Model allows you to analyse what your competitive advantage is compared to others and assess how attractive an industry is before investing the time and money required to enter it, whether you are an individual or an organisation. Porter’s Five Forces Model is a key technique for making strategic decisions as it allows a business to determine how attractive a specific area is and therefore maximise their allocation and utilisation of resource and investment against the opportunities with the greatest potential.

The Five Forces model is so named as it comprises five elements:

  • Threat of new entrants to the market
  • Power of suppliers
  • Power of Customers / Buyers / End Users
  • Threat of substitutes
  • Competition in the market

How Should the Five Forces Model be Used?

An analysis of each of the above areas should be looked at in terms of why, who, what and how they could affect you or your organisation. Porter’s Five Forces Model is often used with other strategic tools such as PESTLE Analysis and SWOT Analysis to develop a more informed strategic plan. A guide to each of the areas is included below.

The Five Forces
The Five Forces

Threat of New Entrants to the Market.

New entrants entering the market has the effect of increasing the competition in that market, leading to potential reductions in profitability. New entrants enter the market as it is attractive to them, when too many units enter the market it becomes sated and market wide profitability diminishes to a point where it is no longer attractive to enter. If you are thinking of entering a new market you should look at potential barriers to entry into that market that protect the incumbents.

Things to consider:

  • Economies of scale – how big are the incumbents and what is their ability to leverage your their size to benefit from bulk buying.
  • How much will it cost to enter the market
  • How effective are the incumbents distribution channels
  • How will competition react
  • What is the reputation of the incumbents, if they are well respected it will be more difficult to compete
  • What are the barriers to entry
  • How much will it cost customers to switch to your services / products.

Power of Suppliers.

Suppliers in the market wish to maximise their profits. If they can they will raise prices to as high a point as the market will tolerate. The stronger they are the higher the prices they can set and the lower your profits will be in turn.

Things to consider:

  • How much does it cost to switch suppliers
  • How powerful is the suppliers brand
  • How fragmented are the customers, the more fragmented the greater the supplier power.
  • How many substitute suppliers are there
  • Do you compete with your suppliers, is there a risk of forward integration?
  • Who will your potential suppliers be
  • How can you reduce the power of your suppliers

Bargaining Power of Customers

Just as suppliers wish to maximise profits, customers wish to minimise the price they pay. The relative bargaining power of these parties will have a great effect on the determination of the actual price and determine how much profit.

Things to consider:

  • How powerful are your largest customers, if a few customers account for much of your sales you will have reduced power to increase prices and will face pressure reduce price for bulk purchases.
  • What are your fixed or sunk costs, the higher these are the more power the customers will have as they provide a barrier to exit.
  • How much does it cost for customers to switch, the higher their switching costs the less power they have to move.
  • Are substitutes available?
  • How sensitive are customers to price changes
  • Who are your potential customers
  • How many and how large are the potential customers

The Threat of Substitutes

Competition comes not only from within your own market, but from similar markets. For instance trains companies compete with other train companies, but also against air transport sand cars / coaches. It is the power that the customer has to switch between alternatives that can affect how high a price can be charged. The easier it is for similar products or services to enter your market the lower the price will have to be to act as a barrier to entry. The higher the threat of alternatives or substitutes, the lower the price will have to be to compete or the more will have to be done to differentiate.

Things to consider:

  • How important is your product / service to the customer i.e. a holiday is less important than bread, so bread might offer a substitute to your holiday service.
  • Could the customer do without your product altogether?
  • How do customers differentiate your products or services from those of your competitors
  • How comparable are your products or services to your competitors
  • What are your competitors switching costs? If high they are less likely to leave the market.

Intensity of Competition in the Market

All the other points contribute to overall competitive behaviour, however this is also a point in it’s own right. Where threat of entry is high, there are numerous substitutes, and buyers and supplier are struggling to exert control the competitive rivalry will be higher. Conversely where there are few substitutes, low bargaining power amongst buyers and suppliers and high barriers to entry there will potentially be less rivalry in the market and all players should be able to earn reasonable profits.

Things to consider:

  • Who is the current competition?
  • What is the possibility of new competitors in your sector field?
  • What are the abilities that they possess?
  • How could this affect you, your project and/or your organization?
  • Are there any barriers that you and/or they must over come?
  • How quickly is the industry / market growing
  • What are the barriers to exit, the more difficult to leave the market, the more desperate and competitive the behaviour

Michael Porter talking about his Five Forces Model

Tips for Performing Five Forces Analysis

What to think about when applying Porter’s five forces Analysis

Preparation:

  • What are your expectations
  • What is the scope and who will benefit;
  • Consider both positive and negative aspects.

Analysis:

  • Think about how markets will be in future, the past has already happened so has less impact;
  • Be open and honest with your analysis no matter how hard the answers are.

Post analysis:

  • Consider lessons learned and how they can be applied in the future
  • Ensure everything is document for future use
  • How many of the recommendations have you implemented?
  • Have you missed anything?

Comments

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    • dommcg profile imageAUTHOR

      dommcg 

      7 years ago

      Hi Mel, Michael Porter really wrote the book on this subject and changed the way we think about business strategy and competition. glad you enjoyed it.

    • Mel Carriere profile image

      Mel Carriere 

      7 years ago from San Diego California

      Very good summary of the five forces model. I believe I read about that in an Economics textbook somewhere many years ago and this was a good refresher course. Thank you.

    • profile image

      erikson saragih 

      7 years ago

      THANK YOU

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