porter-five-forces

What Is Porter’s Five Forces And Why It Matters

Porter’s Five Forces is a model that helps organizations to gain a better understanding of their industries and competition. Published for the first time by Professor Michael Porter in his book “Competitive Strategy” in the 1980s. The model breaks down industries and markets by analyzing them through five forces:

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

Porter’s five forces is a business framework which can provide a qualitative assessment and come up with a corporate strategy“>strategy            

Breaking down Porters’ five forces

Porter’s five forces help, according to the author, to identify the attractiveness of an industry, and whether this might be retained in the long-run.-

According to Porter, the attractiveness of the industry, coupled with its competitive positioning (either through cost leadership or differentiation) can help a firm build a competitive advantage. 

Competitive rivalry

This force examines the intensity of the competition in the marketplace. The competition is given by several factors such as barriers to entry, the bargaining power of buyers and suppliers, and the threat of substitute products or services.

All those factors combined determine the competitive rivalry within an industry, and how attractive that is. 

Some of the key elements that Porter takes into account in his book, “Competitive Strategy” are: 

  • Industry growth.
  • Fixed (or storage} costs value-added.
  • Intermittent overcapacity.
  • Product differences.
  • Brand identity.
  • Switching costs.
  • Concentration and balance.
  • Informational complexity.
  • Diversity of competitors.
  • Corporate stakes.
  • Exit barriers.

Barriers to entry

Imagine operating in a business where anyone can become your competitor. This is a market where there is no high capital requirement to start a business, and there are no particular regulations in place to limit the entrance from new competitors.

For example, in today’s world where anyone with internet access can create its blog or website with very few overhead costs, barriers to entry are very low, therefore the competition is fierce, and it is tough to keep the market share for too long.

What does determine barriers to entry? According to Porter, there are some key factors: 

  • Economics of Scale.
  • Proprietary product differences.
  • Brand identity.
  • Switching cow.
  • Capital requirements.
  • Access to distribution.
  • Absolute cost advantages (Proprietary learning curve, Access to necessary inputs).
  • Proprietary low-cost.
  • Government policy.
  • Expected retaliation.

Bargaining power of suppliers

This force studies the numbers of suppliers in the marketplace. Indeed, a smaller number indicates the power of those suppliers to dictate prices. A more significant number shows no power of those suppliers over price control.

For example, Coca-Cola operates in a market where the suppliers are neither concentrated nor differentiated. Indeed, Coke ingredients such as caffeine and sweetener can be easily found in the marketplace.

Therefore suppliers, in general, cannot control prices. Other factors that according to Porter determine the power of suppliers are: 

  • Differentiation of inputs.
  • Switching costs of suppliers and firms in the industry.
  • Presence of substitute inputs.
  • Supplier concentration.
  • Importance of volume to a supplier.
  • Cost relative to total purchases in the industry.
  • Impact of inputs on cost or differentiation.
  • The threat of forward integration relative to the threat of backward integration by firms in the industry.

Bargaining power of customers

This is the flip side of the power of the supplier. Imagine a business where there are very few customers and switching between one supplier and the other is extremely easy.

Undeniably, this gives total control to customers to set the prices they want. Going back to our previous example, Coke is very powerful to its bottler suppliers.

According to Porter, there are two major factors affecting the bargaining power of customers: 

  • Bargaining leverage: perhaps how many buyers (concentration vs firm concentration there is in that industry). The switching costs for the buyer compared to those for the firm, and how much information buyers have. 
  • Price sensitivity: include price/total purchases; Product differences, Brand identity, Impact on quality performance, Buyer profits, Decision-makers’ incentives. 

Threats of substitute products or services

This force examines how easy it is for customers to switch from a product or service to the other. For example, Coke is extremely powerful in relation to its can manufacturer.

Indeed, competition among can suppliers is fierce. Also, the threat of substitution is very high. In effect, Coke can easily switch to plastic bottles.

That includes

  • The relative price performance of substitutes.
  • Switching costs.
  • Buyer propensity to substitute.

Competitive advantage and competitive positioning according to Porter

competitive-advantage
According to Michael Porter, a competitive advantage, in a given industry could be pursued in two key ways: low cost (cost leadership), or differentiation. A third generic strategy is focus. According to Porter a failure to do so would end up stuck in the middle scenario, where the company will not retain a long-term competitive advantage.

differentiation-strategy

cost-leadership

focus-strategies-porter

stuck-in-the-middle

Are Porter’s five forces still relevant today?

Having analyzed the factors that influence an organization through Porter’s five forces,  a company can draw conclusions on its corporate strategy“>strategy and integrate it with its business strategy“>strategy, to maintain a competitive advantage.

However, it’s important to highlight that the world has changed substantially, since the 1980s. And there is one force that, in my opinion, broke down the walls of the Porter’s five forces: buyers’ information. 

Where in the previous era, factors that spanned from economies of scale, integration, and distribution played a primary role. 

In today’s business world, a core factor flipped it upside down: data and information. The Internet enabled many innovations. And yet, at business level, it helped companies get to know customers in ways that it was not possible before (or at least it was not possible to mass customize marketing activities). 

And it gave much more information to customers. Indeed, today the matter isn’t much about how much information customers have. But rather what information to ignore. 

In an era of information overload, easy access to the web and its applications has given to customers many options to pick from.

With much more information on the side of customers, lower switching costs (you can access offers from several competitors in a few clicks), and platform business models, competitive advantages have turned much more inward.

The customer-centered approach (what you see in design thinking, business model innovation, and lean methodologies) has taken over. And those companies that obsessed over customers also managed to build valuable businesses: 

customer-obsession
Customer obsession goes beyond quantitative and qualitative data about customers, and it moves around customers’ feedback to gather valuable insights. Those insights start by the entrepreneur’s wandering process, driven by hunch, gut, intuition, curiosity, and a builder mindset. The product discovery moves around a building, reworking, experimenting, and iterating loop.

Porter’s forces might still be useful, as an exercise to analyze industries. Yet, the faster you move in gathering customers’ feedback, the more you will know whether you’re moving in the right direction.

Shorter product cycles, customer-centered frameworks, and lean methodologies have become the rule, in this era. 

Other frameworks from Michael Porter

Porter’s Generic Strategies

porters-generic-strategies
In his book, “Competitive Advantage,” in 1985, Porter conceptualized the concept of competitive advantage, by looking at two key aspects. Industry attractiveness, and the company’s strategic positioning. The latter, according to Porter, can be achieved either via cost leadership, differentiation, or focus.

Porter’s Value Chain Model

porters-value-chain-model
In his 1985 book Competitive Advantage, Porter explains that a value chain is a collection of processes that a company performs to create value for its consumers. As a result, he asserts that value chain analysis is directly linked to competitive advantage. Porter’s Value Chain Model is a strategic management tool developed by Harvard Business School professor Michael Porter. The tool analyses a company’s value chain – defined as the combination of processes that the company uses to make money.

Porter’s Diamond Model

porters-diamond-model
Porter’s Diamond Model is a diamond-shaped framework that explains why specific industries in a nation become internationally competitive while those in other nations do not. The model was first published in Michael Porter’s 1990 book The Competitive Advantage of Nations. This framework looks at the firm strategy, structure/rivalry, factor conditions, demand conditions, related and supporting industries.

Porter’s Four Corners Analysis 

four-corners-analysis
Developed by American academic Michael Porter, the Four Corners Analysis helps a business understand its particular competitive landscape. The analysis is a form of competitive intelligence where a business determines its future strategy by assessing its competitors’ strategy, looking at four elements: drivers, current strategy, management assumptions, and capabilities.

Other companion frameworks to Porter’s five forces 

Other frameworks that you can use in conjunction with Porter’s five forces are:

Ansoff Matrix

ansoff-matrix
You can use the Ansoff Matrix as a strategic framework to understand what growth strategy is more suited based on the market context. Developed by mathematician and business manager Igor Ansoff, it assumes a growth strategy can be derived by whether the market is new or existing, and the product is new or existing.

Read: Ansoff Matrix In A Nutshell

BCG Matrix

bcg-matrix
In the 1970s, Bruce D. Henderson, founder of the Boston Consulting Group, came up with The Product Portfolio (aka BCG Matrix, or Growth-share Matrix), which would look at a successful business product portfolio based on potential growth and market shares. It divided products into four main categories: cash cows, pets (dogs), question marks, and stars.

Read: BCG Matrix

Balanced Scorecard

balanced-scorecard
First proposed by accounting academic Robert Kaplan, the balanced scorecard is a management system that allows an organization to focus on big-picture strategic goals. The four perspectives of the balanced scorecard include financial, customer, business process, and organizational capacity. From there, according to the balanced scorecard, it’s possible to have a holistic view of the business.

Read: Balanced Scorecard

Blue Ocean Strategy

blue-ocean-strategy
A blue ocean is a strategy where the boundaries of existing markets are redefined, and new uncontested markets are created. At its core, there is value innovation, for which uncontested markets are created, where competition is made irrelevant. And the cost-value trade-off is broken. Thus, companies following a blue ocean strategy offer much more value at a lower cost for the end customers.

Read: Blue Ocean Strategy

PEST Analysis

pestel-analysis
The PESTEL analysis is a framework that can help marketers assess whether macro-economic factors are affecting an organization. This is a critical step that helps organizations identify potential threats and weaknesses that can be used in other frameworks such as SWOT or to gain a broader and better understanding of the overall marketing environment.

Read: Pestel Analysis

Scenario Planning

scenario-planning
Businesses use scenario planning to make assumptions on future events and how their respective business environments may change in response to those future events. Therefore, scenario planning identifies specific uncertainties – or different realities and how they might affect future business operations. Scenario planning attempts at better strategic decision making by avoiding two pitfalls: underprediction, and overprediction.

Read: Scenario Planning

SWOT Analysis

A SWOT Analysis is a framework used for evaluating the business’s Strengths, Weaknesses, Opportunities, and Threats. It can aid in identifying the problematic areas of your business so that you can maximize your opportunities. It will also alert you to the challenges your organization might face in the future.

Read: SWOT Analysis In A Nutshell

Growth Matrix

growth-strategies
In the FourWeekMBA growth matrix, you can apply growth for existing customers by tackling the same problems (gain mode). Or by tackling existing problems, for new customers (expand mode). Or by tackling new problems for existing customers (extend mode). Or perhaps by tackling whole new problems for new customers (reinvent mode).

Read: Growth Matrix In A Nutshell

Comparable Analysis Framework

comparable-company-analysis
A comparable company analysis is a process that enables the identification of similar organizations to be used as a comparison to understand the business and financial performance of the target company. To find comparables you can look at two key profiles: the business and financial profile. From the comparable company analysis it is possible to understand the competitive landscape of the target organization.

Read: Comparable Analysis Framework In A Nutshell

Business Model Canvas

business-model-canvas
The business model canvas is a framework proposed by Alexander Osterwalder and Yves Pigneur in Busines Model Generation enabling the design of business models through nine building blocks comprising: key partners, key activities, value propositions, customer relationships, customer segments, critical resources, channels, cost structure, and revenue streams.

Read: Business Model Canvas In A Nutshell

Business Experimentation 

business-experimentation
Business experiments help entrepreneurs test their hypotheses. Rather than define the problem by making too many hypotheses, a digital entrepreneur can formulate a few assumptions, design experiments, and check them against the actions of potential customers. Once measured, the impact, the entrepreneur, will be closer to define the problem.

Read: Business Experimentation

Speed Reversibility

decision-making-matrix

The speed-reversibility Matrix, by FourWeekMBA will help you understand how to allocate the resources based on the worst-case-scenario-test.

Read: Speed-Reversibility Matrix

Blue Ocean

blue-ocean-strategy
A blue ocean is a strategy where the boundaries of existing markets are redefined, and new uncontested markets are created. At its core, there is value innovation, for which uncontested markets are created, where competition is made irrelevant. And the cost-value trade-off is broken. Thus, companies following a blue ocean strategy offer much more value at a lower cost for the end customers.

Read: Blue Ocean Strategy

BCG Matrix

bcg-matrix
In the 1970s, Bruce D. Henderson, founder of the Boston Consulting Group, came up with The Product Portfolio (aka BCG Matrix, or Growth-share Matrix), which would look at a successful business product portfolio based on potential growth and market shares. It divided products into four main categories: cash cows, pets (dogs), question marks, and stars.

Read more: BCG Matrix

AIDA Model

aida-model
AIDA stands for attention, interest, desire, and action. That is a model that is used in marketing to describe the potential journey a customer might go through before purchasing a product or service. The AIDA model helps organizations focus their efforts when optimizing their marketing activities based on the customers’ journeys.

Read more: AIDA Model

Pirate Funnel

pirate-metrics
Venture capitalist, Dave McClure, coined the acronym AARRR which is a simplified model that enables to understand what metrics and channels to look at, at each stage for the users’ path toward becoming customers and referrers of a brand.

Read more: Pirate Funnel

Other resources: 

Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here

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