Porter’s Five Forces Model For Competitive Analysis (Part 1)

Michael Porter, a renowned strategy expert, introduced the world in the 1980s to a powerful framework for analyzing the competitive forces in an industry. This model has become a cornerstone of strategic thinking and is widely used by businesses to understand the competitive landscape in which they operate.

Porter’s Five Forces model outlines the key forces that shape the competition within an industry, and understanding and analyzing these forces is crucial for businesses to develop an effective strategy that helps them be competitive and able to sustain their position in the market, whether it is a Fortune 500 company or a small local business, competition has a direct influence to their success.

In this blog post, we’ll dive into each of the five forces that make up Porter’s model and explore real-life examples of how these forces continue to shape industries and influence business strategies across different industries.

THE FIVE FORCES EXPLAINED

The Five Forces model is a widely used strategic framework that provides a structured approach to analyzing the competitive forces that affect an industry, with the ultimate goal of helping organizations choose their business strategy and positioning in the market, The model is based on the idea that competition within an industry is driven by five forces:

1. The threat of new entrants,
2. the bargaining power of suppliers,
3. the bargaining power of buyers,
4. the threat of substitute products or services,
5. and the intensity of rivalry among existing competitors.

Now, let’s delve into the five forces that Michael Porter identified as important determinants of industry competition:

1. THREAT OF NEW ENTRANTS

When we talk about the threat of new entrants, we are referring to the possibility of new companies entering an industry and disrupting the existing market. In simple terms, it’s about how easy or difficult it is for new players to enter the game and compete with the existing companies.

An example of the threat of new entrants can be seen in the ride-sharing industry. The taxi industry was the dominant player in providing transportation services to people before companies like Uber and Lyft entered the market, they offered a more convenient and affordable service using technology that allowed customers to book rides easily through their smartphones. As a result, the taxi industry faced increased competition, lost market share, and had to adapt to compete with the new entrants.

2. BARGAINING POWER OF SUPPLIERS

Suppliers can exert significant influence over an industry if they have a dominant market position or if the industry is heavily reliant on a particular set of inputs. In such cases, suppliers can demand higher prices, better terms, or other concessions that can impact the profitability of firms in the industry. Other factors that can affect the bargaining power of suppliers include the availability of substitute inputs and the degree of differentiation among suppliers.

In 2018, the automobile industry — an industry that requires a wide range of essential raw materials such as steel, aluminum, plastic, and rubber to name a few to manufacture cars — suffered a shortage of semiconductors that are used in many car components, including infotainment systems and engine management systems.

This shortage occurred due to an unexpected increase in demand from the consumer electronics industry, and as a result, the semiconductor suppliers were able to increase their prices, causing automakers to experience supply chain disruptions and production delays, which led to lost revenue and increased costs.

The suppliers’ bargaining power was significant in this case, as the automakers were reliant on the suppliers for an essential component, and there were limited alternative suppliers available.

3. BARGAINING POWER OF BUYERS

Buyers can also impact an industry’s competitiveness if they have significant bargaining power. This is more likely to occur in industries with high levels of competition, where buyers have a wide range of choices and can easily switch suppliers. Factors that can affect the bargaining power of buyers include the size and concentration of buyers, the degree of differentiation among products, and the level of switching costs for buyers.

During the 2008 financial crisis, the mortgage lending industry had it rough when many borrowers had difficulty repaying their mortgages, leading to a significant increase in the number of foreclosures. This, in turn, led to decreased demand for mortgages, causing banks to compete aggressively for the remaining borrowers. The buyers back then were able to negotiate more favorable terms, such as lower interest rates and reduced closing costs, and the banks were willing to offer more attractive deals to attract borrowers.

Furthermore, with the rise of online lending platforms and other fintech companies, borrowers have even more bargaining power as they can easily compare and access different loan options from multiple lenders, increasing competition among banks.

Overall, the bargaining power of buyers in the banking sector has increased due to increased transparency, access to information, and the availability of alternative options.

4. THREAT OF SUBSTITUTE PRODUCTS OR SERVICES

The presence of substitute products or services can also impact an industry’s competitiveness. This force refers to the likelihood that customers will switch to alternative products or services if prices increase, quality declines or other factors make the existing products or services less attractive. The availability and price of substitute products or services, as well as their level of differentiation, are important factors that can affect the threat of substitutes.

The threat of substitute products and services in agriculture for example is significant as changing consumer preferences and the development of new technologies continue to drive innovation in the industry. This can be seen in the shift towards plant-based diets, as more consumers become health-conscious and concerned about the environmental impact of meat production, the demand for plant-based proteins has increased.

This shift in consumer preferences poses a threat to traditional animal agriculture, as plant-based proteins such as soy, lentils, and chickpeas can be used as a substitute for meat. In reaction to this trend, some farmers are diversifying their operations to include the production of plant-based proteins, while others are exploring new ways to market and promote their meat products as healthy and sustainable.

With the rise of alternative protein sources such as lab-grown meat and even insect-based proteins, there is the potential for further disruption in the agriculture industry. These substitutes offer a more sustainable and potentially healthier alternative to traditional meat production, which could impact the demand for traditional animal agriculture products.

5. RIVALRY AMONG EXISTING COMPETITORS

The final force identified by Porter is the intensity of rivalry among existing competitors. This refers to the level of competition within the industry and the degree to which firms are competing on price, quality, innovation, or other factors. Factors that can impact the intensity of rivalry include the number and size of competitors, the rate of industry growth, the level of product differentiation, and the level of exit barriers in the industry.

There are many examples where a company has failed to successfully assess this force and eventually led to its demise, let’s take for example the former retail giant: Sears.

Sears was once one of the largest and most successful retailers in the United States, with a massive chain of department stores across the country. However, with the rise of online retailers like Amazon, Sears struggled to adapt to the shift in consumer preferences toward online shopping.

Sears also faced intense competition from other brick-and-mortar retailers like Walmart and Target, which were able to offer lower prices and a wider variety of products than Sears. Additionally, Sears faced challenges in managing its supply chain and inventory, which resulted in a decline in the quality of its products and the overall shopping experience for its customers.

As a result of these challenges, Sears experienced declining sales and mounting debt and was forced to file for bankruptcy in 2018. Sears’ failure to adapt to the changing market conditions and respond effectively to the new competition from online retailers and other brick-and-mortar players is a prime example of how rivalry among existing competitors can have significant consequences for established players in the industry.

CONCLUSION

Porter’s Five Forces model is an effective and time-tested tool for analyzing the competitive forces in an industry and plays a key role in formulating business strategies. While it provides a structured approach to identifying the key factors that influence a firm’s competitiveness, it has some limitations that may hinder its applicability in certain contexts.

On the one hand, the model helps businesses understand the dynamics of their industry and can make informed decisions about pricing, marketing, product development, and other strategic areas. However, the model is criticized for its static nature and its failure to account for dynamic factors that affect industry dynamics, such as technological disruption, government policies, strategic alliances, and changes in consumer preferences. Moreover, some scholars argue that the model oversimplifies the complexity of real-world markets and may lead to a focus on short-term gains at the expense of long-term sustainability.

Nonetheless, it remains a valuable framework for strategic analysis, especially in industries where competition is intense and the balance of power between stakeholders is constantly shifting, and businesses should use it as a starting point for analyzing their industry but also complement it with other tools and frameworks to gain a more comprehensive understanding of their competitive environment.

In part 2 of this series, I will be discussing how to use Porter’s Five Forces Framework, providing a more in-depth analysis of how to apply this model to your business. I will cover topics such as how to identify the factors that can affect your industry, how to analyze the competitive environment, how to use the framework to develop a strategy and create a competitive advantage, and how to use the framework to identify opportunities and threats in a changing industry landscape.