Porter's 5 Forces Model

Before you start to implement Porter’s 5 Forces Model, it is important to understand the context in which it is used. It is most valuable when applied to an entire market (either national or global) rather than to a sub-section of a market (e.g. you and a handful of direct competitors). It is very much a high-level strategic tool to understand your market position rather than a tool which should be applied within a narrow range of focus. Using the tool in a narrow manner presents a high-risk of missing something important and either over-estimating your strengths in the market or under-estimating them.

The model itself was proposed by Michael Porter in 1980 in his famous work; “Competitive Strategy” it theorizes that there are 5 forces exerted on any given market and the strength of those forces determines your competitive position within that market. It is considered to be a universal model which can be equally applied to a local greengrocer’s as it can be to corporate giants such as Microsoft.

Author/Copyright holder: Grahams Child. Copyright terms and licence: CC BY-SA 3.0

Porter’s 5 Forces as traditionally displayed in marketing terms. It’s a simple but powerful model for use by anyone in an organization not just marketing.

Using Porter’s 5 Forces Model

The application of Porter’s model is quite straightforward it requires you to answer 5 simple questions to determine the strength of your position within the market you are analyzing. These questions relate to the five forces that are applied in the model.

• Force 1 – What is the threat of new entry to this market?

• Force 2 – How much power do buyers have within the market?

• Force 3 – What is the threat of a substitute product in the market?

• Force 4 – What power do suppliers have within the market?

• Force 5 – What competitive rivalries and alliances exist within the market?

Determining the Threat of New Entry

The easier it is for a business to enter the market without any substantial investment in that business – the higher the level of threat that is established of new entry. For example, there is a high barrier to entry to producing DSLR cameras – both the cameras and lenses are expensive to produce and it would require huge investment to move to production; something that the established players such as Canon and Nikon can rely on. In contrast, there is little barrier to entering Internet Publishing where all that is required is some hosting space and a domain name.

To determine threat of entry you need to be able to answer questions like these:

• How easy would it be to start a new business in this space? What would it cost?

• What are the rules and regulations governing this space? (For example, drug research companies face high-regulatory burdens but online marketers do not).

• What barriers exist to entry that empower your business currently?

Author/Copyright holder: SilverStar. Copyright terms and licence: CC BY-SA 3.0

This kind of analysis can become very complicated if you take it to its longest conclusion. This graph articulates the advantages of monopoly positions in markets that are impossible to enter.

Determining Buyer Power

Buyer power relates to the scarcity of buyers in any given market. For example if your product is only useful to multi-national cola makers – there are very few buyers (such as Coca-Cola or Pepsi) and thus the power they hold over your business is disproportionately high. Conversely the affiliate marketer may have a near unlimited customer base and the power that their customers exert over them is thus minimal (on a per customer basis).

You should be able to determine buyer power from answer questions like these:

• How many potential and actual buyers exist in this market?

• Are buyers able to influence the costs of products within the market?

• Are buyers able to dictate terms to their suppliers?

Determining the Threat of Substitution

The threat of substitution is about the availability of alternative products or methods of achieving an objective that exist within the market or may exist within the market. For example an outsourced payroll service which manually processes payments may be substituted with an automated payroll service which automatically credits payments to recipients’ bank accounts.

You should examine the threat of substitution in context with these questions?

• How easy is it to ascertain an alternative to our product or service?

• Could this product/service be outsourced internationally to lower cost?

• Could this product/service be automated or could current levels of automation be enhanced?

Author/Copyright holder: Raysonho. Copyright terms and licence: CC0 1.0

The threat of substitution exists in almost every market. For example, Sweet N Low is a low calorie substitute for sugar. It may not have ended demand for sugar worldwide but it has helped curtail it.

Determining the Supplier Power

Markets with large numbers of customers and few suppliers may be unbalanced in favor of the existing suppliers. A good example of this was the early period of smartphone availability with few suppliers and a huge demand for products – smartphone manufacturers were able to dictate terms to network providers about how their products would be sold. These advantages can, as they did with smartphones, become vulnerable very quickly as more suppliers enter the market.

You want to ask:

• How many other suppliers are there in our market?

• Are they able to dictate pricing? Or is pricing determined on a market value basis?

• How simple is it for a customer to move from one supplier to another? (High barriers to switching can force customer retention even when other offerings are competitive. For example, for a long time the banking sector made it challenging for a client to switch banks quickly and effectively.)

Determining Competitive Rivalry

When you have many competitors in a market chasing a limited supply of business there is a high-level of threat to your market position. These markets are incredibly innovative and are likely to lead to large volumes of supplier attrition. Conversely, it may be tempting to enter a market with a low number of competitors with a large potential client base but there is a risk that this market will appear attractive to many other companies and thus quickly become over-competitive.

You should be asking:

• How many competitors exist in the market?

• How easy is to compete on a geographical basis? (Internet businesses may hold an advantage over bricks and mortar businesses or vice-versa depending on the business type).

• Is the market a “commodity market” (e.g. one where price is pretty much fixed and profits are based on extra value services)?

Competitive rivalry often depends on strategic positioning (as shown here) - oddly, this too was a model designed by Michael Porter.

The Take Away

Porter’s 5 forces model is a simple but effective way to examine a business or product’s position within a market. It helps the designer or marketer to better understand how to provide competitive advantage and how best to promote products in that market.

It’s worth noting that the output of this model is not fixed. Markets change over time and this analysis needs to be done on a regular basis to provide maximum value.

References

You can find Michael Porter’s original book “Competitive Strategy” via Google here.

Quick MBA takes a generic business look at the 5 forces model here.

Hero Image: Author/Copyright holder: Denis Fadeev. Copyright terms and licence: CC BY-SA 3.0