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Porter's five forces model is a strategy tool used to analyze the immediate competitive environment of individual industries. In this blog, we will discuss the model with a detailed overview of the framework and evaluate whether it applies to the modern business environment. Based on the analysis of the model, the essay contends that it is especially useful when starting a new business or when entering a new industry sector.
The ‘five forces’ perspective is associated with its originator, Michael E. Porter of Harvard University. Porter's five forces framework is based on the structure–conduct–performance paradigm in industrial organizational economics. Porter recognized this need and proposed a framework for analyzing the basic system suitable for every industry. This foundation constitutes of five essential factors that summarize the vital criteria to explore a particular sector's critical drivers of success. Based on the results, a strategy is proposed on growth factors and certainty rather than scenarios and forecasts.
Porter's Five Forces Framework has a varied use. It helps to identify top competitors and structuring marketing strategies for a company's growth in the existing market or attracting a new market. The five forces that Porter recognized are:
This force of Porter's Five Forces examines the intensity of the current competition by determining the number of existing competitors and their capabilities. The rivalry is intense when the number of competitors is high as the customers can get multiple choices to switch easily for a better product at a low price. The rivalry also gets intense when the barriers to exit are high, forcing businesses to remain in the industry despite the low-profit margin.
This force helps to determine the power and control of a company's supplier to raise the prices of the supplies. Expensive supplies and sudden shifts in supplier pricing can impact a company’s profitability. Hence, businesses should have a multitude of suppliers to work with to maintain the company's profit factor. Supplier power also includes – the switching costs of companies, availability of substitutes, the strength of their distribution channels and the uniqueness of the product and service.
This force analyzes the customer base and their ability to influence the quality and pricing of the product and service. Customers are in power when they are less in number and have sufficient alternatives to choose from – meaning they switch from one company to another easily. Buying power becomes less when the buyers act independently or buy products in small quantities. Companies should take necessary measures to reduce buyer power by differentiating their products from competitors or implementing various loyalty schemes.
Existing products increases the propensity of customers to make an alternate choice. When the number of substitute products or services is high on the market, a business must maintain the quality of their products or services. That way, even if there is a substitute, customers will continue to purchase the product or service. However, a business must understand that a buyer would any day opt for an alternative product with the same features but at a lower price. That's why it's highly crucial to engage with the customers and understand them on a deeper level.
If the barriers to get into your industry are low, the chances of new competitive rivals are high. This often leads to a crowded industry where competitors appear frequently and cause more significant threats to the existing companies. Hence, the higher the barriers, the smaller will be the threat of new entrants. Examples of barriers to entry are high brand loyalty among the customers, large capital requirements, cumulative experience, government policies, limited access to distribution channels and the economies of scale,
Porter's Five Forces analysis is a framework for analyzing the level of competition within a specific industry. Here's an example from the airline industry to illustrate the usage.
The threat of new entrants in the airline industry is low to medium. It takes quite some upfront investments to start an airline company (e.g. purchasing aircraft). Moreover, new entrants need licenses, insurances, distribution channels and other qualifications that are not easy to obtain when you are new to the industry (e.g. access to flight routes). Furthermore, the existing players have built up a broad base of experience over the years to cut costs and increase service levels. A new entrant is likely not to have this kind of expertise, therefore creating a competitive disadvantage right from the start. The bargaining power of suppliers in the airline industry is very high. When looking at the primary inputs that airline companies need, we see that they are mainly dependent on fuel and aircraft. These inputs, however, are very much affected by the external environment over which the airline companies themselves have little control. The price of aviation fuel is subject to the fluctuations in the global market for oil, which can change wildly because of geopolitical and other factors. Bargaining power of buyers in the airline industry is high. Customers can check prices of different airline companies fast through the online price comparisons websites such as Skyscanner and Expedia. Besides, there aren't any switching costs involved in the process. Customers nowadays tend to fly with different carriers to and from their destination due to the price factor, which highlights low brand loyalty. For the airline industry, the general need of its customers is traveling. There are many alternatives for traveling like - customers could take the train or go by car. Especially in Asia, more and more people make use of highspeed trains such as Bullet Trains and Maglev Trains. The American airline industry is extremely competitive because of several reasons. Such as - the entry of low cost carriers, the tight regulation of the industry wherein safety become paramount leading to high fixed costs and high barriers to exit, and the fact that the industry is very stagnant in terms of growth. The switching costs for customers are also meager, and many players in the industry are similar in size leading to extra fierce competition between those firms. Thus, it is safe to say that rivalry among existing competitors in the airline industry is intense.
In analyzing Porter's Five Forces, an individual needs to brainstorm all relevant factors for the company's market situation, and then check against the elements presented for each force in the diagram above. Highlight the critical factors; summarize the size and the scale of the force on the diagram using signs like "+" and "--" signs for the forces moderately in company's favor, or a power strongly against. After identifying favorable and unfavorable forces for the company's performance and industry's attractiveness, it is crucial to analyze the situation and examine the impacts of the forces. One of the critical comments made of the Five Forces framework is its static nature, whereas the competitive environment is changing turbulently.
Understanding how each force affects a company and identifying the strength and direction of each force, it is possible to locate the power of the position and the ability to make a sustained profit in the industry.
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16 Oct, 2020
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