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Porter's Five Forces Model

What is the Porter's Five Forces model?

A framework to assess the strength of competition and the profitability of market."

Porter’s Five Forces is a framework that businesses can use to assess the strength of their competition and the profitability of their market.

When you understand the Five Forces model, you are more informed about your industry, competitors, and business. It is important to know what each force means, and what metrics you can use to determine their impact on your company and market.

Porter's Five Forces

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Supplier Power

Porters Five Forces: 1.Supplier Power

Depending on certain factors, a supplier can have various levels of control and influence on your success. They can influence your product cost, profit margin, and inventory.

There are different types of suppliers, which vary based on your industry and product. Most fall into one of these four categories: manufacturing, independent craftspeople, importers or distributors.

The factors used to gauge the supplier power can include:

Number of suppliers in the market. If there are only a few suppliers, then their power is high.
Number of customers they serve. A higher number makes them more powerful. (They could also be a supplier to your competitors. If they have a large volume of customers, they could have more bargaining power.)
How unique is their product? If it can’t be replicated, then they hold some control.

Buyer Power

Buyers can influence your business by demanding lower prices, better customer experiences, higher-quality products or more services and features. There are several factors that would make buyer bargaining power higher than that of a business. Here are the most important to know:

1. Buyer demand is lower than supply.

2. The cost of switching to your competitor is very low. If it doesn’t cost buyers significantly to switch to another competitor, then their power is higher.

3. It’s easy and possibly less expensive for the buyer to DIY.

Competitive Rivalry

I How fierce are your competitors? Extremely high degrees of competitiveness can negatively impact your business and the industry. It makes it harder to gain customers and increase profitability. It can also stunt innovation and growth.

When you consider entering a market or launching a new product, it is critical to assess the competitive landscape. You should consider these questions:

How many competitors are there?

Generally the higher number of players, the more competition, and difficulty to enter and grow. There is an exception though. If there are a few players, each fiercely competing to be the market leader, then competition can be high. (Telecommunications is an example of this.)

Is the market expected to grow?

Many startups are popping up in markets like artificial intelligence, autonomous software, virtual reality and mobile technology because they are experiencing growth. Industries that are growing have fewer barriers and more opportunities to enter.

What’s the cost to switch to a competitor?

(Again, low cost = high threat.)

Are fixed costs high?

If they are, you’ll have to sell a large number to make a profit.

Detecting the level of rivalry can sometimes be difficult to do. But, competitive rivalry is usually displayed when companies try to differentiate themselves from their competitors. They do this through:

Pricing
Efficiency and productivity
New features and products
Customer perks and experience
Attack Advertising

Telecommunications is one of the most notoriously competitive markets.

Most recently, Verizon and Sprint had a very public advertising battle. You may remember Verizon’s commercials with Paul, the guy that said: Can you hear me now? Well, Sprint hired him as their spokesperson. In their ads, he throws a direct jab at Verizon and wields their own slogan against them.

Of course, Verizon had to retaliate with their own attack ads featuring Jamie Foxx. T-Mobile has also jumped into the battle, and the feuding continues in a cycle. For years, telecommunications companies have been and will likely continue to fight it out like contenders in a battle royale wrestling match.

Competition isn’t always bad. When the level of competition is healthy, it can be good for the market, regulators, and consumers though. Businesses are more driven to innovate and offer competitive prices, which can improve economic growth.

To grow as a business, you have to find out what separates you from your competitors and how to demonstrate it. For example, if you claim to be faster or more productive, prove it. Use a time-tracking app like Toggl Track that monitors how long it takes to complete certain tasks.

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Threat of Substitution

Threat of substitution

When you have a great idea or innovative product, there will always be copycats. Some may disappear and pose little threat to your business. Others could rise to become serious contenders.

Porter’s Threat of Substitution evaluates the likelihood that your product or company can be replaced. The substitute solves the same problem, is of similar or better quality and may be cheaper.

Substitution is common in the pharmaceutical industry. Brand name medications usually come with a huge price tag, when they are still under patent.

But, when their drug patent expires, manufacturers can produce generic versions at prices that are up to 85 percent lower. According to the FDA, there isn’t a significant difference between the quality of most brand and generic drugs either. They contain the same active ingredients.

If people can get a substitute that offers the same value as your product but at a much lower cost, why wouldn’t they? Many business owners mistakenly believe that their product is unique.

Unless you offer something that your copycats can’t replicate, people will choose the better or cheaper option. It’s why 80% of the prescriptions filled in the US are generic.

If people can replicate what you do and charge less for it, it’s a threat to your business. However, the threat is higher if the substitution:

Is easily or more available than yours.
Has a higher quality.
Performs at the same or at a higher level than your product.
Costs less than yours.
Is more convenient or easier to use.

It’s not just the ones in your own industry that you have to look out for though. What problem does your company solve? Anyone else in or outside of your company that could solve that problem more efficiently or at a lower-cost should be considered. For example, airlines also have to consider other methods of transportation like buses and trains.

Threat of New Entry

Threat of new entry

Analyzing threats to entry can help you decide if the launch of a new product or business is worth the investment. It may not even be practical or possible. For existing companies, the threat of new entry can help gauge the chance that newcomers will emerge and hurt your profitability.

It is assessed by looking at the barriers to entry. These are conditions that would make it difficult or impossible for new businesses to enter the market. The most common are:

High startup costs
Extensive legal requirements
Strict and/or lengthy regulations

A high barrier doesn’t necessarily mean that you should drop your plans altogether. If the long-term payout is worth the initial struggle, increase your chances of you overcoming it by putting the right pieces in place. Structure and plan with those barriers in mind.

The pharmaceutical industry has high barriers because of the strict regulations and lengthy process. For example, drug patents act as a barrier. The term for a drug patent lasts 20 years, but it can also take as much as 7 years or more of research and testing to reach that point. The high cost of medications usually accounts for it though.

If there are few barriers to new entry, existing companies may have more threats to their profit. But, you can decrease the risks of losing business to new entrants by strengthening your brand image and loyalty, registering patents and strategically lowering your price to discourage newcomers from competing.

When you are equipped with the right insights and intelligence, you can create more effective business strategies. You can feel more confident about the decisions you make and how they will play out in the future.

Porter’s Five Forces can help you assess your market and make more accurate predictions. With it, you can tip the balance of power to your advantage.

However, it is important to revisit and reevaluate your research. Market conditions can change. Buyer interest can shift, so don’t become stagnant.