What is Porter’s five forces model and how to use it?

Are you thinking of starting your own business or already have one and would like to improve its performance? Regardless of the industry, learning about competitive forces and the attractiveness of your sector will help you build a stable, profitable company. You can use Porter’s five forces model to help you do this. Read on to find out more.

Porter’s five forces – table of contents:

1. Understanding Porter’s five forces
2. Porter’s five forces – examples
3. Pros and cons of Porter’s five forces model

Understanding Porter’s five forces

This is a method to determine the profitability and potential of the selected sector. What’s more, it will help you gather information about your competition and the threats and opportunities associated with it.

Porter’s five forces include:

• Potential of new entrants into the industry
• Threat of substitute products
• Competition in the industry
• Power of customers
• Power of suppliers

Potential of new entrants into the industry

It determines the barrier to market entry and maintaining a good position in it. Starting a business involves investing financial capital, having patents or specialized skills. An additional difficulty may be the already existing, diverse range of products and services – it will be much harder for you to stand out from the competition.

Threat of substitute products

It refers to how easy it is to find a substitute offer to yours. The more such products or services you can find, the less chance you have of gaining a strong position in the sector. The following factors can influence the degree of this threat:

• Uniqueness, innovativeness of the product/service as they are more difficult to replace,
• A great number of substitutes already on the market,
• A high cost of improving or changing the product/service.

Competition in the industry

Competitiveness is an important element that significantly affects the overall market environment. This force is influenced by the following factors:

• Market entry barriers – the need to invest a lot of money or have an innovative offer or a patent,
• A great number of competitors with a similar strategic profile to yours,
• Consumer loyalty – satisfied, long-standing customers may be reluctant to change their habits in favor of a new, fledgling company.

If you would like to learn about the strengths and weaknesses of your competitors, and how to use this knowledge in your management strategy – read this article.

Power of customers

It depends on their ability to exert pressure and change prices. The incentives that can shape the relationship between buyers and sellers are:

• Product/service differentiation – if your offer does not significantly differ from the offer of your competitors, consumers are more likely to choose products that will be cheaper,
• Switching costs – the lower these costs, the bigger the bargaining power of buyers,
• Their quantity or tendency to group together – strong groups gain an advantage as they can decide about prices (an unsatisfactory offer may lead to abandoning the purchase and, as a result, worsening the company’s situation).

Power of suppliers

It depends on their ability to manipulate prices, quality and delivery dates. In this case, the suppliers’ situation will be influenced by the following factors:

• A diverse offer – if there are many products/services similar to ours on the market, the competition is stronger,
• Expenses associated with changing suppliers – the higher the costs, the greater the bargaining power of suppliers,
• A great number of different suppliers – the need to compete with other suppliers and accept unfavorable terms of cooperation with buyers.

Porter’s five forces – examples

Example 1. IT industry (e.g. Apple)

• Potential of new entrants into the industry – new market participants would need to have a lot of money for research, marketing and the development of new technology that would set them apart from rivals.
• Threat of substitute products – there are many substitutes on the market, although consumers who are attached to the brand are unlikely to change it.
• Competition in the industry – there are many competitors in the sector (including Samsung, Xiaomi, Huawei, LG), which are growing rapidly.
• Power of customers – consumer needs have been shaped by technological progress (the demand for Apple’s products is great and tends to grow), the product range is being expanded with new products that are compatible with each other (e.g., iPhone, iPod, iWatch) to make them easier to use.
• Power of suppliers – in this case, Apple has such a strong position in the market that it can decide on the relations and terms of contracts between suppliers (terminating the cooperation would be more harmful to the latter).

Example 2. A language school in a big city

• Potential of new entrants into the industry – good language skills are now a desirable skill, therefore a lot of new players in the industry constantly appear (other schools, as well as individual tutors), a lack of specific legal regulations also makes it easier to enter the market).
• Threat of substitute products – a substitute for a traditional language school may be remote learning or online courses, which are more flexible when it comes to adjusting class schedules.
• Competition in the industry – there is high competition, and in order to stand out, educational institutions or teachers may, for example, offer to teach niche languages and prepare for language certificates.
• Power of customers – consumers have a dominant position as they can compare prices, offers, school locations and choose the most attractive option – the company in order to survive should adapt to the buyers’ needs.
• Power of suppliers – tutors are the providers of services offered by the school – their number, experience or chosen specialization will determine its reputation and quality of teaching. It is certainly worth noting that it may be more difficult for English teachers to find an attractive position where they will dictate the terms of their contract (due to the popularity of the language). This is a positive aspect from the perspective of the educational institution.

Example 3. Pharmaceutical industry (e.g. Pfizer)

• Potential of new entrants into the industry – there is low competition, the pharmaceutical sector is dominated by large players who can’t be threatened by new entrants. This is because of the need to invest huge sums of money, hold patents, and meet legal requirements.
• Threat of substitute products – cheaper alternative drugs may appear on the market, which can negatively affect the reputation of the company producing the original product in the long run.
• Competition in the industry – there is a struggle for qualified researchers and a high risk of information leaks between research teams.
• Power of customers – here patients have little clout because they buy drugs that are prescribed to them by their doctors (by choosing alternatives, they risk less effective treatment).
• Power of suppliers – raw materials or machines needed to produce pharmaceuticals are widely available from many industrial manufacturers, so pharmaceutical companies can choose more attractive offers.

Pros and cons of Porter’s five forces model

Porter’s five forces model has its advantages and disadvantages. Now, let’s take a quick look at them.

Pros

It helps you conduct a competitor analysis

Porter’s five forces help you identify risks related to the bargaining power of buyers and suppliers, emerging substitutes for products or services and new competitors. Being aware of the challenges you will have to face, will help you create an effective management strategy.

It is useful in creating a corporate strategy

By examining your business environment, you will gain an objective view of your business and make the right decisions.

It lets you understand business risks

Getting information about the influence of competitors, suppliers and buyers will let you understand the causes of your failures and draw conclusions for the future.

It identifies your strengths and weaknesses

By understanding the impact of external factors, you will be able to isolate the strengths and weaknesses of your business and bolster your strategic position, as well as consider solutions to existing problems.

It indicates strong players

You will learn who of your competitors, suppliers or buyers has the most clout in a given sector. As a result, you will know how to deal with the market participants in question.

It draws attention to your growth opportunities

The analysis can help you answer the question of how to expand your company. For example, is it profitable to enter into a partnership with another similar entity or perhaps a completely different one?

Cons

It only focuses on five factors

This analysis ignores technological or legal aspects, which can actually have a huge impact on how your business operates. Sometimes, these very factors play a dominant role in achieving success or failing. Therefore, you should not use only this method to assess the attractiveness of a sector – the best way is to combine it with others (e.g., SWOT, CSF analysis).

It is not universal for all industries

The presented model focuses on only one sector of the economy, so it is not suitable for large companies operating in several industries at once.

It is only a component of a deeper analysis

In practice, Porter’s five forces model is a simple tool that can’t provide all the information needed to develop an effective management strategy. Rather, it is a good start to a thorough exploration of the company and its environment.

Read also: SWOT analysis of online stores.

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