Porter’s Five Forces: Strategic Analysis Model
Porter’s Five Forces: A Strategic Analysis Model
Porter’s Five Forces is a strategic model developed by economist and Harvard Business School professor Michael Porter in 1979. Porter’s Five Forces is a holistic model that allows analysis of any industry in terms of profitability. According to this model, rivalry with competitors is determined by four elements or forces that combine to create a fifth force: rivalry among competitors.
(F1) Bargaining Power of Buyers or Customers
- Solvency of buyers regarding the concentration of companies.
- Degree of reliance on distribution channels.
- Possibility of negotiation, especially in industries with many fixed costs.
- Buyer volume.
- Customer costs or facilities to change companies.
- Availability of information for the buyer.
- Ability to integrate backward.
- Existence of substitutes.
- Sensitivity of the buyer to the price.
- Differential advantages (exclusivity) of the product.
- Customer RFM Analysis (Recency, Frequency, Monetary Value).
(F2) Bargaining Power of Suppliers or Vendors
The “bargaining power” refers to a threat imposed on an industry by suppliers, because of the power that they have, either by their degree of concentration, the specific inputs they provide, or the impact of these inputs on the cost of the industry. For example, oil-extracting companies operate in a very cost-effective manner because they have high bargaining power with customers. Similarly, a pharmaceutical company with sole ownership of a drug has high bargaining power. The ability to negotiate with suppliers is generally considered high; for example, in supermarkets, they can opt for a large number of suppliers, mostly undifferentiated. Some factors associated with the second force are:
- Facilities or cost for changing suppliers.
- Degree of differentiation of the supplier’s products.
- Presence of substitute products.
- Solvency of suppliers.
- Solidarity of employees (e.g., trade unions).
- Threat of forward vertical integration by suppliers.
- Threat of backward vertical integration by competitors.
- Cost of the supplier’s products in connection with the final product cost.
(F3) Threat of New Entrants
While it is very easy to set up a small business, the amount of resources needed to organize an aerospace industry is very high. In that market, for example, very few competitors operate, and the entry of new players is unlikely. Some factors that define this force are:
- Existence of barriers to entry.
- Economies of scale.
- Differences in proprietary products.
- Value of the brand.
- Cost of change.
- Capital requirements.
- Access to distribution.
- Absolute cost advantages.
- Advantages in the learning curve.
- Expected retaliation.
- Access to distribution channels.
- Improvements in technology.
(F4) Threat of Substitute Products
As in the case referred to in the first force, drug or technology patents that are very difficult to copy allow for fixing prices and usually involve very high profitability. On the other hand, markets in which there are many products of the same or similar form are generally low in profitability. We can cite, among others, the following factors:
- Buyer propensity to substitute.
- Prices for substitute products.
- Cost or ease of changing for the buyer.
- Level of perceived product differentiation.
- Availability of close substitutes.
(F5) Rivalry Among Competitors
More than a force, rivalry among competitors is the result of the previous four. The rivalry among competitors defines the profitability of an industry: the less competitive a sector is, the more profitable it usually is, and vice versa.
Porter’s Five Forces model proposes a systematic strategic thinking model to determine the profitability of a sector, usually with a view to assessing the value and future projection of businesses or business units operating in that sector.