Porter’s Five Forces: Analyzing Industry Competition

Any business owner who desires to gain an edge over others must be observant to appreciate the competitive forces that drive any particular industry. One commonly used tool for this is Porter’s Five Forces framework by Michael E. Porter. The model enables a business to analyze an industry’s competitiveness level and develop ways to better their position. In this article, each of the five forces will be considered in detail, and examples on how they are applied in analyzing the competition of any given industry.

Overview of Porter’s Five Forces

The Porter’s Five Forces framework consists of five forces that help in determining competitive intensity and, hence, the attractiveness of a market. They are:

1. Threat of New Entrants
2. Bargaining Power of Suppliers
3. Bargaining Power of Buyers
4. Threat of Substitute Products or Services
5. Rivalry Among Existing Competitors

By analyzing these forces separately, businesses can trace out the strengths and weaknesses of their competitive environment and make informed strategic decisions.

1. Threat of New Entrants

The threat of new entrants refers to the possibility that new organizations will enter the industry and bring added competition. High entry barrier forces seem to protect established companies from new competitors, while low entry barrier forces provide an opportunity for greater rivalry and a corresponding reduction in profitability.

Factors Influencing the Threat of New Entrants

• Economies of Scale: The already established companies usually get economies of scale, which makes it hard for new entrants to compete on cost.
• Capital Requirements: High capital requirements for initial investment can act as an entry deterrent to new entrants within the market.
• Access to distribution channels: The existing firms may have developed close relations with the distributors and hence, can make entry difficult for new entrants.
• Brand identification is high: In case of high brand identification by the buyers and customer loyalty, entry becomes difficult.
• Government barriers: Government regulations and licensing requirements can also serve to limit the entry of new firms.

Strategies to reduce the threat

• Innovate: That is, continuously innovate to stand ahead of any new entrants.
• Strengthen Ties: Cultivate relationships with suppliers and distributors to further strengthen your position.
• Brand Loyalty: Increase brand loyalty/ customer retention through marketing and customer service.

2. Bargaining Power of Suppliers

Supplier Power is the ability of suppliers to affect the prices and terms of supply. Suppliers with more power charge higher prices or otherwise impose terms favorable to themselves at the expense of industry participants.

Factors Influencing Supplier Power

• Number of Suppliers: Fewer suppliers increase supplier power.
• Uniqueness of Products: Suppliers offering unique or specialized products have more power.
• Switching Costs: High switching costs of businesses increase supplier power.
• Forward Integration: If the suppliers can somehow bypass the intermediaries and sell directly to the consumers, the power again shifts into their hands.

Strategies to Reduce Supplier Power

• Diversify Suppliers: Buy from more than one supplier to avoid dependence on any single supplier.
• Develop Alternatives: The company should invest in research and development that will create alternatives to present sources of supply or substitute products.
• Build Long-Term Relationship: Negotiate long-term contracts to secure favorable terms.

3. Bargaining Power of Buyers

Buyer power is the ability of customers to influence the price and the quality of delivered products and services within the market. In case of high power on the buyer’s side, through demanding lower prices or higher quality of products and services, they may lower businesses’ profitability.

Factors Influencing Buyer Power

• Number of Buyers: Fewer buyers result in higher buyer power.
• Product Differentiation: Low product differentiation raises buyer power as it eases switching between the offered products.
• Price Sensitivity: The buyer’s power is higher in cases where customers are price-sensitive.
• Backward Integration: The Buyer’s Power gets involved if the buyers can produce the products.

Strategies to Reduce Buyer Power

• Differentiate More: Higher differentiation reduces price sensitivity and creates stickiness among the customers.
• Improve Customer Experience: Great customer service and value-enhancing services generate loyalty.
• Focus on All Niche Markets: Target those markets where buyers have low power and are ready to offer a premium price.

4. Threat of Substitute Products or Services

The threat of substitutes is the likelihood of customers moving to other products or services that meet the same need. A high availability of substitutes puts an upper limit on the price that can be charged and significantly limits profitability.

Factors Affecting the Threat of Substitutes

• Availability of Substitutes: More available substitutes increase the threat.
• Relative Price and Performance: If substitutes have better price-performance ratios, the threat is raised.
• Switching Costs: Low switching costs make it increasingly convenient to switch over to substitutes.

Minimize the power of the threat

• Increase the Quality of Products: Continuously enhance the quality and performance of your products in order to make substitutes less attractive or unappealing.
• Develop Customer Loyalty: Build relationships with customers, thereby decreasing their chances of going to substitutes.
• Product or Service Diversification: Spread across various product or service offerings to offer a diversified product selection so that more customer needs would be served, thereby avoiding substitution.

5. Rivalry Among Existing Competitors

Competitive rivalry of existing competitors Rate at which the firms in the industry compete with each other. If the competitive force is very high, it might result in a price war, increased marketing promotional expenses, and a decrease in profitability.

Factors Influencing Competitive Rivalry

• Number of competitors: More number of firms enhances competitive rivalry.
• Industry Growth: Slow growth of the industry may enhance competitive rivalry as every firm starts struggling to get the available market share.
• Product Differentiation: Low product differentiation would move the force towards high competitive rivalry as customers can easily switch to another competitor.
• Exit Barriers: High exit barriers compel firms to persist in the market, increasing competitive rivalry.

Manage Competitive Rivalry

• Differentiate Your Products: Avail in your products some unique features or services that set it apart from competitors.
• Build Relationships with Customers: Establish solid relationships with customers. The developed bonding will help minimize the effect of the competitive moves of other players.
• Improve Operational Efficiency: Improve operational efficiency so that costs can be minimized and profits maintained even in a very competitive market.

Conclusion

Porter’s analytical framework of Five Forces is one framework that serve to better understand the competition of an industry and to improve one’s position within it. In simple, after businesses understand the forces establishing the degree of competition, they could develop corresponding approaches that would help their companies gain more market share and increase profitability. The application of Porter’s Five Forces involves permanent observation and adaptation of changing market conditions. Businesses that would navigate these forces successfully would make them stand in good stead to succeed in their respective industries.

Related Terms

SLEPT Analysis – Definition With Examples and Tips

SWOT Analysis – Definition with Real World Examples

Template for Porter’s Five Forces

Some of the following very basic templates to run an industry analysis by Porter’s Five Forces:

Industry: [Your Industry]

1. Threat of New Entrants

• Economies of Scale: [High/Medium/Low]
• Capital Requirements: [High/Medium/Low]
• Access to Distribution Channels: [High/Medium/Low]
• Brand Loyalty: [High/Medium/Low]
• Regulatory Barriers: [High/Medium

 

2. Bargaining Power of Suppliers:

• Number of Suppliers: [High/Medium/Low]
• Uniqueness of Products: [High/Medium/Low]
• Switching Costs: [High/Medium/Low]
• Forward Integration: [High/Medium/Low]

 

3. Bargaining Power of Buyers:

• Number of Buyers: [High/Medium/Low]
• Product Differentiation: [High/Medium/Low]
• Price Sensitivity: [High/Medium/Low]
• Backward Integration: [High/Medium/Low]

 

4. Threat of Substitutes:

• Availability of Substitutes: [High/Medium/Low]
• Relative Price and Performance: [High/Medium/Low]
• Switching Costs: [High/Medium/Low]

 

5. Rivalry Among Existing Competitors:

• Number of Competitors: [High/Medium/Low]
• Industry Growth: [High/Medium/Low]
• Product Differentiation: [High/Medium/Low]
• Exit Barriers: [High/Medium/Low]

Frequently Asked Questions (FAQ’s)

1. What is Porter’s Five Forces framework?

• Porter’s Five Forces model aids businesses in analyzing competitive forces within their industry. It includes new entrant threats, bargaining power of suppliers, buyers, substitutes, and rivalry among existing competitors.

2. How does the threat of new entrants affect an industry?

• The threat of new entrants raises the level of competition and is unprofitable to existing businesses. High barriers to entry safeguard the position of the incumbents; low barriers to entry make it easier for new competitors to enter the market.

3. Why is the bargaining power of suppliers important?

• High bargaining power of the suppliers means that they would have a still better offer of price and terms, which may result in lower profitability in the industry in the long run.

4. How can companies reduce the bargaining power of buyers?

• Companies will be in a position to reduce buyer power due to product differentiation, enhance customer experience, and target niche markets where the buyers command less power.

5. What strategies can businesses use to mitigate the threat of substitutes?

• Companies can lessen the threat of substitutes by increasing quality, fomenting loyalty, and broadening their product line.

6. What factors increase competitive rivalry within an industry?

• High rivalry is primarily attributed to the large number of competitors, slow industry growth, low differentiation of products, and high exit barriers.

7. Why Porter’s five forces are important?

• Porter’s five forces are important because it helps to identify the main sources of competition in your industry.

8. what is the aim of Porter’s 5 forces?

• The main aim of Porter’s five forces is to help strategists understand what makes an industry profitable and provide insights needed to make strategic choices.