What is Porter’s Five Forces Model?
Porter’s Five Forces Model or competitive forces model was developed by Michael Porter with the motive to analyze the external business environment of the industry. It explains whether or not we should enter an industry, and if we enter it, what are the challenges we need to face.
‘Competition’ is something which determines the success or failure of a company in the corporate world. Everyone knows that there will be other players who might be ready to give a competition to the other businesses. This is where; this model is used to understand the picture of the industry when there is huge competition.
According to Michael Porter, each industry is influenced by five factors that he mentioned as forces. The power of Porter’s five forces determines the ultimate profit potential of the business in the marketplace.
Porter’s Five Forces of competitive position analysis:
How can we use Porter’s Five Forces?
1. Competitive Rivalry
This force examines the number and capability of existing competitors in the marketplace. Rivalry competition is high when an industry is growing and there are a few businesses equally selling a product and services. This is when a consumer can easily substitute to opponent’s product for a little cost. Let’s take an example of beverages: Coca-Cola and PepsiCo have a wide range of products under their respective brands and have a huge fan following. Many brands have entered the market but could not survive. Following potential factors come handy while analyzing this force:
- The level of competition in this sector
- The competitor’s marketing strategy
- Advertisement expenses
2. Bargaining Power of Suppliers
This force analyzes the power of a supplier, how he will alter the price of a product or how he will bargain with the business firms. In addition, suppliers have an advantage when they are fewer in the market. Further, businesses are in better position when there is a multitude of suppliers. For example, the main ingredients for a soft drink are carbonated water, sweetener, caffeine, and phosphoric acid, and if there is only one supplier of these, then companies like Coca-Cola have no alternative but to buy these from them. Following potential factors come handy while analyzing this force:
- The number of suppliers in the market
- Supplier switching costs
- Supplier concentration to Business firm concentration ratio
- Presence of Supplier Unions
- Supplier’s distribution strength
3. Bargaining Power of Customers
This force analyzes the potential of the customer to alter business’s pricing and strategy. Consumers have the power to drive the prices down to make businesses incompletion with other businesses. It works, when consumers are fewer, but a multitude of sellers, and when it is easy to substitute from one business product to another business product. Let’s take an example of McDonald’s. Due to market saturation, consumers can choose from various substitute of outlets such as Burger King, Subway, KFC, etc. This is where McDonald must develop strategies to attract consumers. Following potential factors come handy while analyzing this force:
- The potential buyers
- Buyer concentration to Seller concentration ratio
- Availability of Buyer’s information
4. Threat of New Entrants
Is it easy for someone to start a new business in any specific industry? If yes, it can cause the trouble for the existing businesses in the same industry. This force examines the easy and difficulty level for a competitor to enter the industry. If it is easy for a competitor to enter the industry, it is a risk for existing businesses to survive. In the end, industries with strong barriers result in less competition. For example, due to low switching cost, the customer can easily substitute to another outlet from McDonald’s. Furthermore, if the capital cost of establishing a new firm is moderate, the existing firms like McDonald’ need to worry. Following potential factors come handy while analyzing this force:
- The existence of entry barriers (patents, rights, etc.)
- Availability of capitals to start a new business
- Rules and regulations for new entrants
- The loyalty of customers to established brands
5. Threat of Substitutes
This force studies if it is easy for a consumer to substitute from a business product to that of a competitor. This examines on the basis of few factors – how many competitors are there, comparison of quality and price of a product of competitors, and how much profit competitors are earning. In McDonald’s case, there are many substitutes in the marketplace such as Burger King, KFC, Subway, etc. Therefore, it is easy for a consumer to switch from McDonald’s to another outlet due to low switching cost. Following potential factors come handy while analyzing this force:
- The propensity of Buyers to substitute
- The relative price of substitutes
- Availability of substitutes
Five Forces model helps industries to determine the various factors affecting profitability and strategies. Further, it helps in making decisions relating to whether to enter a specific industry; whether to increase size in a specific industry; should develop competitive strategies; and what are the questions need to consider before entering the industry. In addition, this model should be used where there are at least three competitors in the market and avoid using it for an individual firm.