Porter’s Five Forces is a quite simple, but robust tool for strategic management which can be used by businesses towards understanding the competitive nature of the prevailing business environment and help the company to formulate a potential strategy to achieve growth in revenues, profitability and market share.
The 5-Forces Model helps in understanding difference forces within the competitive environment or the industry which can affect the profitability of the business. The 5-Forces Model was developed by marketing guru Michael Porter, and this model was first published in 1980 in a book authored by Mr Porter titled “Competitive Strategy: Techniques for Analysing Industries and Competitors.” This model has become popular and is frequently used by businesses to analyse their firm’s industry structure and its overall business strategy.
What is Porter’s Five Forces Model
The Five Forces Model was first developed in 1979 by Michael Porter, who was a professor in the Harvard Business School and the Porter’s Five Forces Model has become a potent business strategy tool for businesses and corporations all over the world.
Michael Porter pointed out that business organisation are required to keep a lookout on its competitors, businesses need to act beyond the actions its competition and design, plan and implement strategies to attain a position of competitive advantage within its business environment. Michael Porter identified 5-forces which together form the competitive environment, which can erode the revenues, profitability and market share of a business.
- Competitive Rivalry
Competitive rivalry implies the existing competitors of business within the market place, their strengths and weaknesses, the position within the market etc. It is vital for any company to analyse what their competitors are doing, analyse their product strategy, their pricing strategy, examine how the competition is marketing and promoting its brands, products and services etc. This analysis aids the business to analyse its strengths and weakness while compared to its competitors and accordingly formulate a strategy to overcome and sustain competitors. For instance, in a highly competitive market, companies often compete on pricing or market aggressively. Also, in a highly competitive environment, consumers have the option to select a product or service from multiple companies. Whereas, in a market scenario where the competitive rivalry is minimal, the business can charge a premium for their products and services and earn healthy profits.
- Power of Supplier
The factor analyses the availability of suppliers and their ability to dictate the prices of their goods and services. Business, especially in a competitive environment need to maintain their prices low and as a result of this, need to ensure keeping its costs low to remain profitable.
Businesses need to analyse the number of suppliers available in the market place, the degree of uniqueness of their goods and services, cost involved in switching to another supplier. When the number of suppliers in the market is high, it is easier for a business to obtain competitive quotes and rates for goods and services, switch to another supplier who can offer economical and better service. Whereas in a scenario where there are limited suppliers in the market place, and your business has a high degree of reliance on your supplier, they shall be in a position for asking a higher price, and this can impact your profitability.
For instance, in case of the steel market in India, manufacturers have the option of buying mild steel from thousands of dealers, stockist and wholesalers, hence can the company has a stronger position than its suppliers. But, in an event the company wishes to procure specialised steel alloy, the number of suppliers supplying specialised steel alloy is low, and as a result of this the supplier can charge the business a premium and has a stronger position than the business.
- Power of the Buyer
The business needs to analyse the ability of the buyer to drive your prices down, switch to your competitor or another substitute product, the cost a consumer needs to incur to switch-over to another product. Companies such as Microsoft have a dominant position within the Operating System industry and can charge a premium from its customers due to non-availability of alternative products and high switching cost involved in switching over to the Operating System of Apple Inc. On the other hand, FMCG brands have a non-dominant position within the marketplace as the customer can choose among a wide array of brands and products and also can easily switch from one brand to another.
- Availability of Substitute Products
This refers to the threat a business can experience due to a substitute product. For instance, the companies manufacturing cameras can experience a threat of losing its customers to smartphones with good quality cameras. Consumers can switch to an alternate or substitute product either due to cost factor or convenience. Hence, a business whose products can be replaced by another substitute product has a weak position within the market, and this can adversely impact the revenues and profits of the company.
- Threats of a New Entrant
While analysing existing competition is vital, businesses should also examine the ability of new competition in the form of new entrants within the marketplace place. A company needs to analyse how easy or difficult it is for a new entrant to enter and gain a foothold within a market or an industry? The costs involved in entering the industry? When an industry as low barriers to entry, it makes it easier for new entrants to enter the market and as a result of this weakens the position of the business. Whereas, if an industry has high barriers to entry, it restricts the entry of new entrants in the market or the industry, and as a result of this, the business remains in a favourable position and allows the firm to take good advantage of its position in the market.
Conclusion
While Porter’s 5 Forces Model is a relatively simple strategic tool for business, it allows businesses to analyse their competitive advantage by examining the competitive rivalry within the marketplace, the power of the suppliers, the power of the consumers, the threat of substitute products and the threat of new entrants. This analysis of competitive environment helps the business to formulate a potential strategy to achieve growth in revenues, profitability and market share.
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