Porters 5 Forces
Porter’s Five Forces, identified by Michael E. Porter in his book “Strategic Planning,” are factors that determine the power and vulnerability of a business within an industry or market. The five forces are competition within the industry; the threat of new entrants; the threat of product or service substitution; customer bargaining power; and supplier bargaining power. When mapping the five forces, strategic analysts generally place competition in the center, with the four additional forces placed at the four cardinal points, all pointing inward.
Competition within the industry
The competitive landscape within your industry or market is of critical importance in determining the power of your business to succeed, or even survive. Two key factors that drive the force of competition are the number of competitors, and the similarity of their competing products and services to your own. If you have a large number of established competitors with products or services that are similar to your own, this will deplete your company’s power to succeed. To compensate, your business will need to differentiate itself, either by price or by other means.
The two threats
In visual representations of the five forces, the two threats form an axis with one on either end to show that they are mirror-images of one another.
As a rule, the greater the barriers to entry in your industry, the more power your business will have, and the more protected it will be from new entrants. Although a number of factors, such as patents and branding, can serve as strong barriers to entry, the primary barrier is generally the cost of establishing a competing product or service. For example, if you are a silicon chip maker, such as Intel, the cost of entry into your market is likely billions of dollars, and the threat of a large number of new entrants is relatively low.
Product or service substitution
If your customers can easily substitute your product or service with a counterpart from a competitor, then your business is vulnerable. Additionally, if your business provides a service of convenience that the customer can easily perform themselves, then your business may find itself even more vulnerable. This is the threat of substitution at work.
The two types of bargaining power
In visual representations of the five forces, the two types of bargaining power, like the two threats, form an axis to show that these two forces are mirror-images of one another.
A company’s customers are in a unique position to drive prices down if they have sufficient power. Whether they succeed depends on a number of factors, such as the cost and inconvenience of switching to a competitor. However, the primary driver of customer power is generally the quantity of customers. The fewer customers you have, the more bargaining power each of them has over you. For example, if you are a government contractor, and thus the government is your sole customer, then they have a great deal of bargaining power to negotiate the cost of your product or service.
Businesses can often find themselves vulnerable to their own suppliers, especially with regard to price. Yet the degree of vulnerability depends on a number of key factors, such as the terms of any long-term contracts the business has in place with the supplier. However, foremost among these factors is generally the company’s capacity to substitute the supplier’s product with a similar one from another supplier. For example, if your supplier makes paint for your product that is nearly identical in price and quality to the paint offered by your supplier’s competitors, then you supplier will generally have diminished leverage on the price of their paint. On the other hand, if your supplier’s paint is far less expensive, or of higher quality than any other supplier, then their leverage will increase accordingly.
Applying Porter’s Five Forces to your business
In order to get a clearer picture of your company’s power or vulnerability in your industry, try assessing its position in terms of Porter’s Five Forces. Take a good look at your competition; assess the barriers of entry in place to prevent new entrants from eroding your market share; determine your customers’ difficulty in substituting your product or service with another; gauge your customers’ power to drive your prices down; and finally, gauge your suppliers’ power to drive their prices up.
Overall, by carefully mapping out how these five forces impinge upon your business, you can more clearly see where your business holds the greatest advantage, and where its most vulnerable.