Porter’s Five Forces: Explanation with Industry Examples
Porter’s Five Forces is a competitive position analysis tool. This is a simple framework to analyze the competitive strength and competitive position of a company. Company strengths and weaknesses are measured compared to the competitive forces.
Simply, porter’s five forces analysis business concept demonstrates how industry-related forces affect your company’s performance. If the competitive forces are strong then it is unlikely for an industry to be profitable.
Porter’s Five Forces Analysis will help to answer the below questions.
- Why companies in various industries able to sustain a different level of profitability?
- How can a company increase its competitive advantage?
- What are external powers affect the business?
- Understanding the strength of the company in the current competitive position?
Michael E. Porter identified five forces of the competitive environment. Those are,
- Threat of New Entrants
- Buyer Bargain Power
- Threat of Substitution
- Supplier Bargain Power
- Competitive Rivalries
1. Threat of New Entrants
This force determines the relative easiness to enter a particular industry. The company’s risk of market share dilution depends on this force. The power of this force depends on the difficulty of a new company to offer the same product and enter the industry. This is also called as barriers of entering into the industry,
There are six types of barriers to entry,
- Economies of Scale – When the company grows bigger it will experience cost decreases along with the increase in its level of output.
- Required Capital – Initial investment required to start a company in the industry.
- Regulation Policy – Complexity and level of regulation of the industry.
- Specialized Skill/Patents Required – Some industries required specialized skills and patents to enter into the market.
- Product Differentiation – the level of variants available on the products in the market.
- Access to Distribution Channels – the level of easiness to a partnership with the distribution channels of the industry.
- Oil and Gas Industry: It is difficult for a new company to enter into the oil and gas industry because it is hard to achieve economies of scale, require a high level of capital, and complex regulations policy.
- Pharmaceutical Industry: It is difficult for a new company to enter into the Pharmaceutical Industry because of initial capital, patent/specialized skill requirements, and product differentiation.
2. Buyer Bargain Power
Buyer bargain power depends on easiness for the buyer (customer) to drive the prices down. There are four drives of this power,
- Cost of Switching Suppliers – Customer’s power of bargain will be more if switching cost is less.
- Number of Sellers versus Number of Customers – Customer’s power of bargain will be more if the relative number of customers is less than the suppliers.
- Product Differentiation – Customer’s power of bargain will be more if products are less differentiated.
- The Threat of Forward Integration – Customer’s power of bargain will be more there is less threat of forwarding value chain integration.
- FMG (Fast Moving Goods) Industry: Customer’s bargain power is high because of the high number of customers, less product differentiation, and less switching cost.
- Aircraft Manufacturing Industry: Customer’s bargain power is low because of less number of suppliers, high product differentiation, less threat of forwarding integration, and high switching cost.
3. Threat of Substitution
This force determines the likelihood of the product being replaced. Simply, this depends on how much is it easy for the customer to find a similar product in the market. When this thread is high then it will reduce the supplier power and attractiveness of the industry. There are three drivers of this power,
- Cost of switching between products/service – higher the switching cost is better for existing veteran suppliers.
- The uniqueness of the product/service compare to the other similar products – it is harder to replace when the product/service is much unique.
- The number of identical substitutes in the market – supplier power will reduce drastically when this is there are many similar substitutes.
- Mobile Device Manufacturing Industry: the threat of substitution is high because the cost of switching is low, the uniqueness of each model becoming low and the number of identical substitutes is high.
- Cruise Ship Manufacturing Industry: the threat of substitution is low because each ship has it’s own uniqueness, identical suppliers being low and the cost of switching is higher.
4. Supplier Bargain Power
Bargain power of suppliers related to how much influence the supplier has to demand the price, quality, and delivery timelines. This directly hit the profit of the buyer because of the high prices on supplies.
As an example if you own a bakery and if there is only one supplier sells flour. In this case, you don’t have any alternative but purchase with the supplier high price. There are four drivers of this power,
- Cost of Switching Suppliers – The demand for the suppliers will become high when the switching cost is high.
- Number of Suppliers versus Number of Customers – Price and the demand will become low when there are more suppliers.
- The threat of Forward Integration – Supplier power will be increase when it is easy to integrate on forwarding value chain integration.
- Size of the main suppliers in the industry – If there are big suppliers in the market then the supplier power will increase.
- Defense Products Manufacturing Industry: Supplier bargain power is high because there is less number of suppliers who are qualified in this industry. Those suppliers are big companies, comparatively lesser than customers, and have high switching costs.
- FMG (Fast Moving Goods) Industry: Supplier bargain power is very low because there are many customers compared with suppliers. The cost of switching suppliers is very low and very easy.
5. Competitive Rivalries
The competitive rivalry of Porter’s Five Forces Analysis is related to how intense the competition of the industry as a whole. This force depends on all four previous forces. Market attractiveness reduces when competitors offer undifferentiated products/services. The company should be aware of its competitors to ensure its market share.
High competition results in higher operational and administrative expenses, which results in the profitability of all companies in the industry low. All industries are not similar. Some industries have competition compared with others.
There are four drivers of this power,
- The number of Direct Competitors – Competitive rivalry increases when there is more direct competition.
- Entry Barriers – Competitive rivalry decreases when there is a higher level of entry barriers.
- Industry Growth Rate – Competitive rivalry increases when the industry growth rate is lower. In this case, all companies will try to get the market share from someone else.
- Customer Loyalty – Competitive rivalry decreases when customer loyalty is high.
- Telecommunications Industry (Mobile Carriers): Rivalry among companies is comparatively low because of high entry barriers, high industry growth rate, and customer loyalty.
- Hotel Industry: Rivalry among companies is comparatively high because of low entry barriers, a high number of direct competitors, and fewer return customers.
Advantages and Disadvantages of Porter’s Five Forces:
Michael E. Porter’s Published Article on Harvard Business Review – The Five Competitive Forces That Shape Strategy. Available at: https://hbr.org/2008/01/the-five-competitive-forces-that-shape-strategy