Porter’s Five Forces

Porter’s Five Forces is a model that can be used as part of strategic planning to help you understand the strength of your competitive position, along with the comparative strength of a position you are considering moving too.

When you understand the relative strengths and weaknesses of a given situation, it enables you to take decisive action, either to take full advantage of your position of strength or to address your weaknesses, making your competitive position stronger and more resilient. The most common use of Porter’s Five Forces is to understand whether a product or service has the potential to be successful in a market, but it can also be used simply to understand where the power lies in any given situation.

Porter’s Five Forces: How to

The Five Forces model works by analyzing the competitive landscape from all perspectives, based on five fundamental forces. By determining both the strength and direction of each force, it is possible to assess the strength of a position.

Let’s examine the key questions to ask for each of the five forces:

Force 1: New Entrants

Here the key question is:

• What are new competitors barriers to entry?

A number of factors need to be considered in answering this question. Are economies of scale important? Would a new entrant be competing with established brands? Is a large amount of up-front capital required to enter the market? How big are margins in this market currently – the bigger the margin or expected margin, the greater the number of new competitors. How high are switching costs for customers? Are their other barriers to entry: patents, regulatory requirements, experienced workers etc? The bigger the barrier to entry the greater your power.

Force 2: Substitutes

Here the key questions are:

• How easy is it to replace one product with another similar product?

The more difficult it is to substitute your product or service with another the greater your power. A substitute will be particularly threatening if it offers a new price/performance curve. From a customers perspective, a train might be a substitute for a plane. Contact lenses might be a substitute for glasses.

Force 3: Buyer’s Bargaining Power

Here the key question is:

• By how much can buyers bargain?

The more buyers are able to bargain the weaker your position. Again, there are a number of factors to consider in answering this question. Low switching costs increase their power. In a business to business environment, buyers in low margin businesses will be hard negotiators. Does the product or service drive the buyer’s performance? The more it drives performance the less price sensitive the buyer is likely to be. Buyers of huge quantities of a particular product will have a greater bargaining power.

Force 4: Supplier’s Command of Industry

Here the key question is:

• How much influence do suppliers have?

Suppliers can have a large impact on the overall profitability of an industry. The forces applied by suppliers reflect those of buyers. How indispensable is the supplier’s product to you? How important are you as a customer to the supplier? How difficult might it be for you to switch supplier (speed of switch / cost of switch / practicality)? The greater the suppliers power the less strong your position.

Force 5: Existing Competitors

Here the key question is:

• What advantages do competitors have?

An industry with many similar competitors engaging in price wars may obviously be unattractive to enter. There are a number of indicators to examine in order to determine the strength of this force. How many competitors are there? Are they equally strong? Are costs high? Are the products being sold commodities, making it difficult to add value and have a high-margin? Are exit barriers high – will our new assets be easy to sell if the new venture doesn’t work, and will we get a fair market price quickly?

Disadvantages

Despite being one of the most popular methods for performing strategic positioning analysis, the Five Forces model has the disadvantage that it focuses on external factors only. The model is therefore said to be reactive in nature (rather than proactive) and doesn’t develop an organization’s core competencies.

Summary

The Five Forces model provides a way to understand the relative strengths and weaknesses of a market or position, and for this reason, it is commonly used in strategic planning. Because there are so many questions to consider as part of the Five Forces exercise it is best to perform it by involving many key people within the organization. It allows us to understand the different dynamics and relationships at play within an industry. Porter’s Five Forces model can thus be used to find the most attractive position to move to – the strongest and most defendable one.