Porters Five Forces

Porter's Five Forces Model

Porter's Five Forces model is a business tool used to analyze the competitive environment of an industry. The model looks at five key elements that impact a company's competitive position within its industry.

The five main forces that makeup Porter's five forces model are:

1. Threat of new entrants
2. Bargaining power of suppliers
3. Bargaining power of buyers
4. Threat of substitutes
5. Competitive rivalry

Threat of new entrants

New entrants to the market can threaten your own sales volume and market share. The harder it is to enter the market the easier it is to maintain a market position.

Examples of entry barriers include:

• Cost of entry,

• Brand loyalty,

• Government policies,

• Specialist knowledge.

Bargaining power of Suppliers

Bargaining power of suppliers is the ability of suppliers to influence the prices and quality of the goods and services they provide. When there are few suppliers, and a product is new or specific, it might be difficult and expensive for a company to switch suppliers.

Factors determining the power of suppliers:

• Number of suppliers,

• Size of suppliers,

• Uniqueness of the product or service,

• Suppliers' ability to substitute,

• Switching costs.

Bargaining power of buyers

Bargaining power of buyers is the ability that customers have to drive prices lower or higher.

Buyers' power is high when there are few large players and proportionally many suppliers. If many sources are available, buyers may shop around for other materials or supplies which may include a risk of losing a key client.

Factors determining the power of buyers:

• Number of customers,

• Order size,

• Differences between competitors,

• Buyers' ability to substitute,

• Price sensitivity,

• Information availability.

Threat of Substitutes

Most products can be substituted by their alternatives, not necessarily in the same category. This is known as the threat of substitutes.

Threat of substitutes depends on the following factors:

• availability of substitutes
• price of substitutes
• type of good (for example, necessities, luxury goods, comfort product)

Competitive Rivalry

The type of competition can vary depending on the balance of the competitive relationship. The competitive rivalry is high when there are numerous competitors because then consumers can easily switch to competitors offering similar products or services. Similar size companies are likely to be more fierce than when there are large and small companies. It is also worth keeping an eye on the market growth as a growing market allows both companies to grow in sales and a stagnant market means that a market steal is required.

Therefore, it is important to know your competitors:

• Number of competitors,

• Quality differences,

• Concentration of industry,

• Brand loyalty,

• Market growth.

Porter's Five Forces Example

Porter used the airline industry example to explain his concepts. We will use fast food industry as an example of Porter's five forces analysis.

1. Threat of new entrants: The fast food industry has relatively low barriers to entry, as it doesn't require significant capital investment or technical expertise to start a fast food restaurant. However, established players like McDonald's, Burger King, and Wendy's have significant economies of scale and brand recognition, which can make it difficult for new entrants to gain a foothold in the market.

2. Bargaining power of suppliers: The fast food industry is highly dependent on a few key suppliers, such as food distributors, meat producers, and soft drink companies. This gives these suppliers significant bargaining power over fast food companies. For example, if a meat producer were to raise prices, it could significantly impact the profitability of fast food restaurants that rely on that supplier.

3. Bargaining power of buyers: Fast food customers have a high degree of bargaining power, as they can easily switch to a competitor or substitute product if they are dissatisfied with the prices or quality of the food. Additionally, consumers are increasingly demanding healthier and more sustainable food options, which can put pressure on fast food companies to change their menus.

4. Threat of substitute products or services: The fast food industry faces significant competition from other types of restaurants, such as casual dining and fast casual restaurants. Additionally, many consumers are choosing to cook at home or order food delivery, which can also impact the sales of fast food companies.

5. Intensity of competitive rivalry: The fast food industry is highly competitive, with many players vying for market share. Companies like McDonald's, Burger King, and Wendy's engage in intense advertising and promotional campaigns to attract customers and gain market share. Additionally, the rise of fast casual restaurants like Chipotle and Panera Bread has increased competition in the industry.

Strength and weakness of Porter's five forces

Porter's five forces model helps businesses see the competitive landscape of their industry and identify potential opportunities and threats. However, like any tool, it has its strengths and weaknesses.

Strengths of Porter's five forces:

• Comprehensive analysis: Porter's Five Forces analysis covers a wide range of factors that impact the competitive environment of an industry.
• Easy to use: The model is relatively easy to use and can be applied to a wide range of industries and businesses.
• Helps identify who holds the power in the industry: By analyzing the bargaining power of suppliers and buyers, as well as the threat of new entrants and substitutes, businesses can gain insights into who holds the power in the industry and make more informed strategic decisions.
• Helps identify opportunities and threats: By analyzing the competitive dynamics of an industry, businesses can gain insights into potential opportunities and threats, allowing them to make more informed strategic decisions.

Weaknesses of Porter's five:

• Limited scope: The model focuses primarily on the external factors that impact industry and doesn't consider internal factors like company culture, management, or resources.
• Static analysis: Porter's Five Forces analysis is a snapshot in time and doesn't take into account changes in the industry or wider business environment.
• Can be subjective: The analysis can be influenced by the biases and perspectives of the person conducting the analysis, leading to potentially inaccurate results
• Challenging for diversified businesses: The model is less effective for businesses with a wide portfolio of products and services, as the competitive dynamics can vary significantly across different segments of the business.