Porter's Five Forces - From MindTools.com

Porter's Five Forces is a simple but powerful tool that you can use to identify the main sources of competition in your industry or sector. 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Whenyouunderstandtheforcesaffectingyourindustry,youcanadjustyourstrategy,boostyourprofitability,andstayaheadofthecompetition.Youcantakefairadvantageofastrongpositionorimproveaweakone,andavoidtakingwrongstepsinthefuture. Inthisarticleandvideo,weexploreeachofPorter'sFiveForcesandshowyouhowtousethem.Thiswillhelpyoutoanalyzeyourorganization'sstrengthsandweaknesses,andtoidentifycriticalfactorsthatmayaffectyourprofitability. Contents IntroductiontoPorter'sModel Porter'sFiveForcesFAQs WhoCreatedtheFiveForcesModel? WhatArePorter'sFiveForces? CompetitiveRivalry SupplierPower BuyerPower ThreatofSubstitution ThreatofNewEntry HowtoUsePorter'sFiveForcesModel Porter'sFiveForcesExample CriticismofPorter'sFiveForcesModel Porter'sFiveForcesFAQs WhatisthepurposeofPorter'sFiveForces? Porter'sFiveForcesmodelcanhelpyoutoanalyzetheattractivenessofaparticularindustry,evaluateinvestmentoptions,andassessthecompetitiveenvironmentinyourmarket. HowdoyouusePorter'sFiveForces? Thinkabouteachforceinturn,andhowitappliestoyourindustry.Gatherdataoneachforce,anduseittohelpinformyourfuturestrategicdecisionmaking.ReadmoreinthesectionHowtoUsePorter'sFiveForcesModel. WhatarethebenefitsofusingPorter'sFiveForces? Porter'sFiveForcesallowsyoutogainvaluableinsightsintoyourcurrentmarket,oronethatyou'reconsideringmovinginto.Thiscanhelpyoutodevelopastrategytosucceed. WhoCreatedtheFiveForcesModel? ThetoolwascreatedbyHarvardBusinessSchoolprofessorMichaelPorter.Sinceitspublicationin1979,ithasbecomeoneofthemostpopularandhighlyregardedbusinessstrategytools. Porterrecognizedthatorganizationsliketokeepaclosewatchontheirrivals,but,inhisHarvardBusinessReviewarticle,'HowCompetitiveForcesShapeStrategy,'heencouragedbusinessleaderstolookbeyondtheactionsoftheircompetitorsandexaminetheforcesatworkintheirwiderbusinessenvironment.[1] WhatArePorter'sFiveForces? AccordingtoPorter,therearefiveforcesthatrepresentthekeysourcesofcompetitivepressurewithinanindustryTheyare: CompetitiveRivalry. SupplierPower. BuyerPower. ThreatofSubstitution. ThreatofNewEntry. Hedescribedthemfurtherinhislaterarticle,"TheFiveCompetitiveForcesThatShapeStrategy."[2] Porterstressedthatit'simportantnottoconfusethesefiveforceswithmorefleetingfactors,suchasindustrygrowthratesandgovernmentinterventions.AccordingtoPorter,thoseareexamplesoftemporaryfactors,whiletheFiveForcesarepermanentpartsofanindustry'sstructure. Let'stakealookatPorter'sFiveForcesinmoredetail. 1.CompetitiveRivalry ThefirstofPorter'sFiveForceslooksatthenumberandstrengthofyourcompetitors.Considerhowmanyrivalsyouhave,whotheyare,andhowthequalityoftheirproductcompareswithyours. Inanindustrywhererivalryisintense,companiesattractcustomersbycuttingpricesaggressivelyandlaunchinghigh-impactmarketingcampaigns.Thiscanmakeiteasyforsuppliersandbuyerstogoelsewhereiftheyfeelthatthey'renotgettingagooddealfromyou. Ontheotherhand,wherecompetitiverivalryisminimal,andnooneelseisdoingwhatyoudo,thenyou'lllikelyhavetremendouscompetitorpower,aswellashealthyprofits. Example Ifyouweresettingupahaulagebusiness,you'dlikelybeenteringacrowdedmarket.You'dhavetoconsidermanypotentialrivals,howmuchtheycharged,andwhethertheywereabletodiscountdeeply.You'dalsoneedtothinkabouttheirresources:youmightbesettinguptocompetewithinternationallogisticscompanies,aswellaslocalcompetitors Rememberthatatthispointtheanalysisshouldfocusonyourpotentialrivals.Onlystartthinkingaboutyourownofferwhenyou'vegotyourdatatogetheronthecompetition. NotethatMichaelPorterdevelopedhisFourCornersModel   allaboutcompetitorbehavior.Youcanfindoutmoreaboutthatinourarticle. 2.SupplierPower Suppliers   gainpoweriftheycanincreasetheirpriceseasily,orreducethequalityoftheirproduct.Ifyoursuppliersaretheonlyoneswhocansupplyaparticularservice,thentheyhaveconsiderablesupplierpower.Evenifyoucanswitchsuppliers,youneedtoconsiderhowexpensiveitwouldbetodoso. Themoresuppliersyouhavetochoosefrom,theeasieritwillbetoswitchtoacheaperalternative.Butiftherearefewersuppliers,andyourelyheavilyonthem,thestrongertheirposition–andtheirabilitytochargeyoumore.Thiscanimpactyourprofitability,forexample,ifyou'reforcedintoexpensivecontracts. Example Let'ssayyourbusinessideawastomanufactureelectronicdevices.You'dhavetoassessyoursupplyoptionsforarangeofspecialistcomponents.Ifonesupplierdominatedthecomponentsmarket,thentheycouldraisetheirpriceswithoutworryingabouttheirowncompetitors.Thismightaffecttheviabilityofyourproduct. 3.BuyerPower Ifthenumberofbuyersislowcomparedtothenumberofsuppliersinanindustry,thentheyhavewhat'sknownas"buyerpower."Thismeanstheymayfinditeasytoswitchtonew,cheapercompetitors,whichcanultimatelydrivedownprices. Thinkabouthowmanybuyersyouhave(thatis,peoplewhobuyproductsorservicesfromyou).Considerthesizeoftheirorders,andhowmuchitwouldcostthemtoswitchtoarival. Whenyoudealwithonlyafewsavvycustomers,theyhavemorepower.Butifyouhavemanycustomersandlittlecompetition,buyerpowerdecreases. Example Buyerpowerisasignificantfactorinfoodretail.Thinkoflargesupermarketsthatoperateinacrowded,highlycompetitivemarket.Thismarkethaschangeddramaticallywiththearrivalofcheap,no-frillsfooddiscounters.Shoppershavestrongbuyerpowerhere.That'swhysupermarketshavecouponschemes,loyaltycards,andaggressivediscounting–tocapturethelargestshareofbuyers. Theseorganizationsinturnhavestrongbuyerpowerwiththeirownsuppliers,usingtheirinfluencetodrivedownthecostoffoodatthemanufacturinglevel. Tip Judginghowtopriceyourproducttoattractthecustomersyouwant,andtoprotectyourbrand,requiresgreatskill.FindoutmoreinourarticleaboutKotler'sPricingStrategies   . 4.ThreatofSubstitution Thisreferstothelikelihoodofyourcustomersfindingadifferentwayofdoingwhatyoudo.Itcouldbecheaper,orbetter,orboth.Thethreatofsubstitutionriseswhencustomersfinditeasytoswitchtoanotherproduct,orwhenanewanddesirableproductentersthemarketunexpectedly. Example Ifyourorganizationmakesmedicalinstruments,youmayfindyourpositionbeingthreatenedbytheriseof3Dprinting.Thisenablesinstrumentstobemadefromawiderangeofmaterials,sometimesatafractionofthecostoftraditionalmethods.Ifacompetitorgetsitright,itcanweakenyourpositionandthreatenyourprofitability. 5.ThreatofNewEntry Yourpositioncanbeaffectedbypotentialrivals'abilitytoenteryourmarket.Ifittakeslittlemoneyandefforttoenteryourmarketandcompeteeffectively,orifyouhavelittleprotectionforyourkeytechnologies,thenrivalscanquicklyenteryourmarketandweakenyourposition. However,ifyouhavestronganddurablebarrierstoentry,thenyoucanpreserveafavorablepositionandtakefairadvantageofit.Thesebarrierscanincludecomplexdistributionnetworks,highstartingcapitalcosts,anddifficultiesinfindingsupplierswhoarenotalreadycommittedtocompetitors. Existinglargeorganizationsmaybeabletouseeconomiesofscaletodrivetheircostsdown,andmaintaincompetitiveadvantageovernewcomers. Ifitcostscustomerstoomuchtoswitchbetweenonesupplierandanother,thiscanalsobeasignificantbarriertoentry.Socanextensivegovernmentregulationofanindustry. Example Evenindustriesthatseemtobewellprotectedagainstnewentrycanprovetobevulnerable.Formanyyears,high-volumeairtravelwasinthehandsofarelativelysmallnumberofestablishedairlines.Thebarrierstoentrywereformidable.Start-upcostswerehigh,routesandtake-offslotsweremostlygrabbedbythebigoperators,andtheindustrywasstrictlyregulated. Evenso,somesmalloperatorsdidmanagetobreakintothemarket,mostlybyofferingno-frills,low-costtraveltopopulardestinations,andtakingadvantageofreducedregulation.Thesesmaller,moreagileoperatorsnowholdstrongpositionsintheindustry,particularlyinshort-tomedium-haultravel. HowtoUsePorter'sFiveForcesModel Tousethemodel,startbylookingateachofthefiveforcesinturn,andthinkabouthowtheyapplyinyourindustry.(MindToolssubscriberscanseefigure1,above,andcopythesubheadings.Theycanalsodownloadahandytemplate.) Next,writedowntheforcesthatareatplayinyourindustry,andsummarizethesizeandscaleofeachonyourdiagram.Aneasywaytodothisistouseasingle"+"signforaforcethat'smoderatelyinyourfavor,ora"-"signforaforcethat'smoderatelyagainstyou. Use"++"foraforcethat'sstronglyinyourfavor,or"--"foronethat'sstronglyagainst.Foraneutralforce,youcanuse"o."(Anexampleofthismethodcanbefoundinfigure2,below.) Finally,thinkabouthowyouranalysiswilllikelyimpactyou.Fewsituationsareperfect.Nonetheless,analyzingyourindustryusingPorter'sFiveForcescanhelpyoutothinkthroughwhatyoucouldchangetoimproveyourcompetitivepositionandincreaseyourprofitability. What'smore,ifyoufindyourselfinastructurallyweakposition,themodelcanhelpyoutothinkaboutwhatyoucandotomoveintoastrongerone. VideoofHowtoUsePorter'sFiveForces.Clickhere   toviewatranscript. Porter'sFiveForcesExample Inthissection,we'lllookatafullworkedexampleofPorter'sFiveForcesmodeltohelpyoumakeeffectivebusinessdecisions.You'llalsofindshortexamplesofapplyingeachoftheForcesseparatelyinthesectionsabove. OurworkedexampleisbasedonafictitiousbusinessownercalledMartin.He'sdecidingwhethertoswitchhisfocustosomethinginagriculture,ashelikestheideaofhands-onwork,inaruralenvironment,supplyingpeoplewithsomethingtheyreallyneed.HecarriesoutaFiveForcesanalysistohelphimdecidewhethertobuyafarmandstartanewenterprise–andmeetssomesurprises! MembersoftheMindToolsClubcanseetheanalysisinfigure2(clickontheimagetoviewitfullscreen). Martin'sanalysishasraisedanumberof"redflags"thatpreviouslyhedidn'tknowexisted.Forexample: Thethreatofnewentryisquitehigh.Ifanyonelooksasifthey'remakingasustainedprofit,newcompetitorscancomeintotheindustryeasily,reducingprofits. Competitiverivalryisextremelyhigh.Ifsomeoneraisesprices,they'llquicklybeundercut.Intensecompetitionputsstrongdownwardpressureonprices. Buyerpowerisstrong.Againthiscanputastrongdownwardpressureonprices. Thereissomethreatofsubstitution.There'ssomecross-productsubstitutionandabilitytoimportfood. UnlessMartinisabletofindsomewayofchangingthissituation,itlookslikethefarmingindustryisaverytoughmarkettocompeteandsurvivein.Maybehe'llneedtospecializeinasectorofthemarketthat'sprotectedfromsomeoftheseforces,orfindarelatedbusinessthat'sinastrongerposition. CriticismofPorter'sFiveForcesModel Despiteitsenduringpopularity,Porter'sFiveForcesmodelhascomeinforconsiderablecriticisminrecentyears.Inparticular,criticshavepointedtoitsage,lackofflexibility,andthefactthatitdoesn'ttakeaccountofnewtechnology. YoucanreadmoreaboutthisinourarticlePitfallsofPorter'sFiveForces   . KeyPoints Porter'sFiveForcesModelisanimportanttoolforunderstandingthemaincompetitiveforcesatworkinanindustry.Thiscanhelpyoutoassesstheattractivenessofanindustry,andpinpointareaswhereyoucanadjustyourstrategytoimproveprofitability. AccordingtoPorter,thefivemainforcesthatcanimpactthecompetitivenessofanindustryare: CompetitiveRivalry:thestrengthofcompetitionintheindustry. SupplierPower:theabilityofsupplierstodriveupthepricesofyourinputsandrawmaterials. BuyerPower:thestrengthofyourcustomerstodrivedownyourprices. ThreatofSubstitution:theextenttowhichdifferentproductsandservicescanbeusedinplaceofyourown. ThreatofNewEntry:theeasewithwhichnewcompetitorscanenterthemarket(andpotentiallydrivedownyourprices). Bythinkingabouthoweachforceaffectsyourorganization,andbyidentifyingitsstrengthanddirection,youcanquicklyassessyourcompetitiveposition. Youcanthenlookatwhatstrategicchangesyouneedtomaketodeliverlong-termprofit. IfyouwanttousethePorter'sFiveForcesmodeltoanalyzethecompetitiveforcesatworkinyourindustry,andyou'reaMindToolssubscriber,downloadourtemplateworksheethere. Thissiteteachesyoutheskillsyouneedforahappyandsuccessfulcareer;andthisisjustoneofmany toolsandresourcesthatyou'llfindhereatMindTools.Subscribetoour freenewsletter,or jointheMindToolsClubandreallysuperchargeyourcareer! AddthisarticletoMyLearningPlan MarkarticleasComplete ShowRatings HideRatings Ratings Ratethisresource Freeloginneeded. Login / CreateLogin. 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RelatedResources FromMindTools Porter'sGenericStrategies Porter\'sValueChain References [1]Porter,M.E.(1979).'HowCompetitiveForcesShapeStrategy,'HarvardBusinessReview[online].Availablehere. [2]Porter,M.E.(2008.)'TheFiveCompetitiveForcesThatShapeStrategy,'HarvardBusinessReview[online].Availablehere. Signup Toprovidefeedback UserResearch We'realwaysstrivingtoimproveyourexperienceontheplatformandwe'dlovetohearyourfeedbackonsomenewandexistingdesigns. Signuphereandgetinvitedtoparticipateinouruserresearch! 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