Michael Porter Five Forces Analysis
Ozie Melzer
Porter's Five Forces Framework is a method of analysing the operating environment of a competition of a business. It draws from industrial organization (IO) economics to derive five forces that determine the competitive intensity and, therefore, the attractiveness (or lack thereof) of an industry in terms of its profitability. An "unattractive" industry is one in which the effect of these five forces reduces overall profitability. The most unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven to normal profit levels. The five-forces perspective is associated with its originator, Michael E. Porter of Harvard University. This framework was first published in Harvard Business Review in 1979.[1]
New entrants put pressure on current organizations within an industry through their desire to gain market share. This in turn puts pressure on prices, costs, and the rate of investment needed to sustain a business within the industry. The threat of new entrants is particularly intense if they are diversifying from another market as they can leverage existing expertise, cash flow, and brand identity which puts a strain on existing companies profitability.
Barriers to entry restrict the threat of new entrants. If the barriers are high, the threat of new entrants is reduced, and conversely, if the barriers are low, the risk of new companies venturing into a given market is high. Barriers to entry are advantages that existing, established companies have over new entrants.[4][5]
A substitute product uses a different technology to try to solve the same economic need. Examples of substitutes are meat, poultry, and fish; landlines and cellular telephones; airlines, automobiles, trains, and ships; beer and wine; and so on. For example, tap water is a substitute for Coke, but Pepsi is a product that uses the same technology (albeit different ingredients) to compete head-to-head with Coke, so it is not a substitute. Increased marketing for drinking tap water might "shrink the pie" for both Coke and Pepsi, whereas increased Pepsi advertising would likely "grow the pie" (increase consumption of all soft drinks), while giving Pepsi a larger market share at Coke's expense.
The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers' power is high if buyers have many alternatives. It is low if they have few choices.
The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources.
Competitive rivalry is a measure of the extent of competition among existing firms. Price cuts, increased advertising expenditures, or investing in service/product enhancements and innovation are all examples of competitive moves that might limit profitability and lead to competitive moves(Dhliwayo, Witness 2022). For most industries, the intensity of competitive rivalry is the biggest determinant of the competitiveness of the industry. Understanding industry rivals is vital to successfully marketing a product. Positioning depends on how the public perceives a product and distinguishes it from that of competitors. An organization must be aware of its competitors' marketing strategies and pricing and also be reactive to any changes made. Rivalry among competitors tends to be cutthroat and industry profitability is low while having the potential factors below:
Other factors below should also be considered as they can contribute in evaluating a firm's strategic position. These factors can commonly be mistaken for being the underlying structure of the firm; however, the underlying structure consists of the five factors above.[7]
Sometimes bad strategy decisions can be made when a narrow focus is kept on the growth rate of an industry.[8] While rapid growth in an industry can seem attractive, it can also attract new entrants especially if entry barriers are low and suppliers are powerful.[7] Furthermore, profitability is not guaranteed if powerful substitutes become available to the customers.
For example, Blockbuster dominated the rental market throughout 1990s. In 1998, Reed Hastings founded Netflix and entered the market. Netflix's CEO was famously laughed out of the room.[9] While Blockbuster was thriving and expanding rapidly, its key pitfall was ignoring its competitors and focusing on its growth in the industry.
Technology in itself is a rapidly growing industry. Regardless of the advanced growth, it presents its limitations; such as customers not being able to physically touch/test products. Technology stand alone cannot always provide a desirable experience for a customer. "Boring" companies that are in high entry barrier industries with high switching costs and price-sensitive buyers can be more profitable than "tech savvy" companies.[10]
For example, quite commonly websites with menus and online booking options attract customers to a restaurant. But the restaurant experience cannot be delivered online with the use of technology. Food delivery companies like Uber Eats can deliver food to customers but cannot replace the restaurant's atmospheric experience.
Similar to the government above, complementary products/services cannot be a standalone factor because it's not necessarily bad or good for the industry's profitability.[7] Complements occur when a customer benefits from multiple products combined. Individually those standalone products can be redundant. For example, a car would be unusable without petrol/gas and a driver. Or for example, a computer is best used with computer software.[10] This factor is controversial (as discussed below in Criticisms) as many believe it to be 6th Force. However, complements influence the forces more than they form the underlying structure of the market.
Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a firm's strategic position. However, for most consultants, the framework is only a starting point and value chain analysis or another type of analysis may be used in conjunction with this model.[11] Like all general frameworks, an analysis that uses it to the exclusion of specifics about a particular situation is considered nave [by whom?].
According to Porter, the five forces framework should be used at the line-of-business industry level; it is not designed to be used at the industry group or industry sector level. An industry is defined at a lower, more basic level: a market in which similar or closely related products and/or services are sold to buyers (see industry information). A firm that competes in a single industry should develop, at a minimum, one five forces analysis for its industry. Porter makes clear that for diversified companies, the primary issue in corporate strategy is the selection of industries (lines of business) in which the company will compete. The average Fortune Global 1,000 company competes in 52 industries.[12]
An important extension to Porter's work came from Adam Brandenburger and Barry Nalebuff of Yale School of Management in the mid-1990s. Using game theory, they added the concept of complementors (also called "the 6th force") to try to explain the reasoning behind strategic alliances. Complementors are known as the impact of related products and services already in the market.[14] The idea that complementors are the sixth force has often been credited to Andrew Grove, former CEO of Intel Corporation. Martyn Richard Jones, while consulting at Groupe Bull, developed an augmented five forces model in Scotland in 1993. It is based on Porter's Framework and includes Government (national and regional) as well as pressure groups as the notional 6th force. This model was the result of work carried out as part of Groupe Bull's Knowledge Asset Management Organisation initiative.
It is also perhaps not feasible to evaluate the attractiveness of an industry independently of the resources that a firm brings to that industry. It is thus argued (Wernerfelt 1984)[15] that this theory be combined with the resource-based view (RBV) in order for the firm to develop a sounder framework.
An analysis of all five competitive forces gives you a comprehensive view of the factors affecting industry profitability. When you understand each force, you can formulate a strategy that will allow the company to better cope with competitive forces and increase profit potential. Let's take a closer look at each force:
Volkswagen Group's suppliers have limited bargaining power due to VW's global presence with suppliers scattered around the globe. Volkswagen also has at least 1 or 2 backup suppliers for each part and can shift demand between them.
On the contrary, many automotive suppliers manufacture only a specific part and are heavily dependent on the industry. These automotive industry dynamics put Volkswagen in a superior position while its suppliers have relatively low bargaining power.
In Porter's Five Forces model, buyers are your customers. At the expense of industry profitability, strong buyer power can lower prices, pit rivals against each other, and demand higher quality or service.
In the fashion world, brands like Zara or H&M deal with a lot of bargaining power from shoppers who have tons of choices, from fast-fashion giants to boutique stores. With so many options, consumers can push for better prices, higher quality, and even more sustainable practices. This puts a lot of pressure on brands to keep up and constantly improve their products.
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