Porter’s Five Forces: Analyzing Industry Competition
Porter’s Five Forces: A Competitive Analysis Model
Porter’s Five Forces is a model that identifies and analyzes five competitive forces that shape every industry. It helps determine an industry’s weaknesses and strengths. Five Forces analysis is frequently used to identify an industry’s structure to determine corporate strategy. Porter’s 5 Forces are:
1. Competition in the Industry
For most industries, the intensity of competitive rivalry is the major determinant of the industry’s competitiveness. Understanding industry rivals is vital to successfully marketing a product. Positioning pertains to how the public perceives a product and distinguishes it from competitors. An organization must be aware of its competitors’ marketing strategies and pricing and also be reactive to any changes made.
Potential Factors:
- Concentration
- Diversity of competitors
- Product differentiation
- Excess capacity and exit barriers
- Cost conditions: ratio of fixed to variable costs
2. Potential of New Entrants into the Industry
Profitable industries that yield high returns will attract new entities. New entrants eventually will decrease profitability for other firms in the industry. Unless the entry of new firms can be made more difficult by incumbents, abnormal profitability will fall towards zero perfect competition, which is the minimum level of profitability required to keep an industry in business.
Factors That Can Have an Effect:
- Capital requirement
- Economies of scale
- Absolute cost advantage
- Access to channels of distribution
- Governmental regulations and obligations
- Product differentiation
3. Power of Suppliers
The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes.
Suppliers may refuse to work with the firm or charge excessively high prices for unique resources. Pressure is put on companies by raising prices, decreasing quality, and reducing the availability of the product.
4. Power of Customers
It’s the ability of customers to put the firm under pressure, which also affects the customer’s sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers’ power is high if buyers have many alternatives.
- Buyer’s price sensitivity: price elasticity
- Strong buyers can pressure sellers to lower prices
- Concentration of buyers
5. Threat of Substitute Products
A substitute product uses a different technology to try to solve the same economic need.
- Availability of a product that the consumer can purchase instead of another.
- Products with the same benefits.
The model is best applicable for the analysis of simple market structures. A comprehensive description and analysis of all five forces gets very difficult in complex industries with multiple interrelations, product groups, by-products, segments, and intermediaries. A too narrow focus on particular segments of such industries, however, bears the risk of missing important forces.
The model is based on the idea of competition. It assumes that companies try to achieve competitive advantages over other players in the markets as well as over suppliers or customers. With this focus, it is less suitable to analyze highly collaborative markets.