Porter’s Five Forces was originally created by Michael Porter, a Harvard Business School professor in 1979. Today it has become a powerful tool to use for markets and business owners.
The theory is based on the idea that there are five forces that control the competitive intensity and attractiveness of a market. Porter’s five forces help to recognise where power lies in a business situation.
This is valuable both in understanding the strength of an organisation’s current competitive position, and the strength of a position that an organisation may look to move into at a later stage.
The five forces are:
- Supplier Power
- Buyer Power
- Competitive Rivalry
- Threat of Substitution
- Threat of New Entry
Let’s look at each one in further detail…..
Supplier Power – This is an assessment and evaluation of how suppliers can increase prices. The general idea is the more suppliers you have to choose from, the easier it will be to switch to a cheaper alternative. But the fewer suppliers there are, and the more you need their help, the stronger their position and their ability to charge you more. You’ll need to think about how unique the product you’re purchasing is, how expensive it would be from another supplier and if you’re able to move if required.
Buyer Power – This is an assessment of how easy it is for buyers to drive prices down. You need to consider how many buyers are purchasing and in what volume they’re purchasing in, could they switch to a competitor? If they could, would be it cheap to do. You should also think about whether your buyers are able to dictate terms to you, meaning they have more power in negotiations.
Competitive Rivalry – This is the primary number of competitors in the market, you should also consider what’s their capability over you. You need to also look at the products and services in which they offer and understand if you differentiate at any point.
Threat of Substitution – In your market you need to see if substitute products exist, if they do, this means the chance of customers switching to an alternative is higher, should your prices increase.
Threat of New Entry – Markets which are performing well, often means new businesses entering, this tends to decrease your profitability as more competition enters. You need to consider how easy it is to start selling in your industry, how much would it cost for a new company and if your industry is regulated.
As you can see, the Five forces analysis helps business owners and marketers to understand the factors affecting profitability in a precise industry, and can help to inform decisions, it can also be valuable when developing competitive strategies.